exchange – international newsletter issue 39 – june …/media/files/insights/... · newsletter...
TRANSCRIPT
EU
UK
BELGIUM
SPAIN
US
INTERNATIONAL
IN FOCUS
CONTACTS
EXCHANGE – INTERNATIONAL NEWSLETTERISSUE 39 – JUNE 2019
Financial Services Regulation
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IntroductionWelcomeDLA Piper’s Financial Services International Regulatory team welcomes you to the 39th edition of Exchange – International, our international, newsletter designed to keep you informed of regulatory developments in the financial services sector.
This issue includes updates from the EU, as well as contributions from the UK, Belgium, Spain the US and other International developments.
In this edition, In Focus looks at the amended European Market Infrastructure Regulation (also known as EMIR 2.1 or EMIR Refit) and discusses how market participants should prepare for the upcoming changes.
In the EU, we provide insights on the approach of the European Securities and Markets Authority regarding the trading obligation for shares and how this will affect shares listed both in the EU and the UK post-Brexit. We also discuss the proposals set forth by the European Supervisory Authorities concerning the regulation of third-party cloud service providers.
In the UK, the Financial Conduct Authority recently confirmed the “biggest shake-up to the overdraft market for a generation” and we provide insights on these reforms. Moreover, we discuss the new rules concerning peer-to-peer lending platforms and
how these will affect the provision of crowdfunding services to retail clients. We also look at the new rules implementing the revised Shareholder Rights Directive in the UK that aim to promote shareholder engagement from life insurers and asset managers.
In addition, we provide insights on the long-awaited rules introduced in the US which set out standard of conduct and disclosure requirements for broker-dealers and investment advisors dealing with retail customers. We also examine how new rules relating to insurance intermediaries aim to make Belgium an attractive insurance marketplace post-Brexit and how the expanded scope of the Spanish regulatory regime regarding advertising and transparency in banking services will affect marketing of certain financial services in Spain.
On an international level, we look at IOSCO’s report on cryptoasset trading venues as well as the recent report of the Financial Stability Board on the decline of correspondent banking services.
Your feedback is important to us. If you have any comments or suggestions for future issues, we welcome your feedback.
The DLA Piper Financial Services Regulatory Team
June 2019
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Brexit impact on shared trading of equities: Another grab for UK trading business?On March 19, 2019 the European Securities and Markets Authority (ESMA) published a public statement on the impact of a no-deal Brexit on the trading obligation for shares under the Markets in Financial Instruments Regulation (MiFIR). The statement clarifies how the relevant requirements will apply to UK-listed shares if the UK leaves the EU without a deal. However, as discussed in our relevant commentary, this statement could be problematic, particularly for dual-listed stocks which are listed in the UK and on a trading venue in another EU member state as it could potentially force trading on these shares into the EU and out of the UK. In light of concerns expressed by some stakeholders, ESMA published a revised statement on May 29, 2019. Nevertheless, as highlighted in the response of the UK Financial Conduct Authority (FCA), ESMA’s approach could
“still cause disruption to investors, some issuers and other market participants, leading to fragmentation of markets and liquidity in both the EU and UK.”
MiFIR trading obligation for sharesShares that are listed on an EU regulated market or are traded on an EU trading venue are subject to certain trading obligations under MiFIR. In particular, Article 23 of MiFIR requires investment firms to ensure the trades they undertake in shares admitted on an EU Regulated Market (RM) or traded on a trading venue take place on an EU RM, Multilateral Trading Facility or systematic internalizer or an equivalent third country trading venue, unless they are “non-systematic, ad hoc, irregular and infrequent” or are carried out between eligible and/or professional counterparties and do not contribute to the price discovery process.
Trading obligation for shares post-BrexitThe Article 23 trading obligation does not apply to shares that are traded in the EU on a non-systematic, ad hoc, irregular and infrequent basis. Therefore, in principle, post-Brexit shares admitted to trading on a UK regulated market could benefit from this exemption.
EU
In the event of a no-deal Brexit, UK trading venues will be considered as third-country trading venues for the purposes of the MiFIR regime. However, to date, the EU Commission has not issued an equivalence decision on UK trading venues. This means that after exit day investment firms may not be able to use UK trading venues to meet their trading obligations for shares under MiFIR.
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The original statement clarified the concept of “non-systematic, ad hoc, irregular and infrequent” by distinguishing shares on the basis of their International Securities Identification Number (ISIN). EU shares are shares with an ISIN from an EU Member State or Norway, Iceland and Liechtenstein, while UK shares are shares with an ISIN starting with GB. EU shares are deemed to have their main pool of liquidity in the EU, which means that they are traded in a systematic, deliberate, regular and frequent way in the EU. As a result, they are in scope of the MiFIR trading obligation. On the contrary, UK shares, which are considered to have their main pool of liquidity in the UK market, are as a rule traded on a “non-systematic, ad hoc, irregular and infrequent” basis in the EU. Therefore, the original statement provided that the MiFIR trading obligation would not apply to UK shares, unless they qualified as liquid in the EU.
The revised statement replaces the above with a simpler approach, which is only based on the ISIN of the share. As a result:
• EU shares are within the scope of the MiFIR trading obligation; and
• GB shares are outside the scope of the MiFIR trading obligation.
The aim is to minimize disruption by a potential overlap between EU and UK rules around trading obligations for shares. In particular, ESMA has identified 14 GB shares that would otherwise have been caught by the MiFIR trading obligation based on the original statement.
Remaining issuesHowever, the revised statement does not solve the fundamental issues for dual-listed shares post-Brexit. In its response the FCA highlights that ESMA’s approach could still be problematic for shares with an EU ISIN, which are, however, dual-listed in the EU and the UK and their main – or even
only – pool of liquidity is in the UK. In the FCA’s view, the ISIN of a share, which is determined by the place of incorporation of the issuer, does not and should not determine the scope of the trading obligation. According to the FCA, this approach would restrict access to capital for issuers as well as the freedom to choose the trading venue for listing.
The FCA is expected to clarify its approach regarding the trading obligation for shares soon.
According to the FCA, the only realistic solution and the “best way” to address the issue of overlapping share trading obligations remains “reciprocal equivalence.” It also noted that, given that the UK has onshored the MiFIR regime, its regulatory framework is one of the most equivalent in the world. Alternatively, agreeing on a transitional period for the relevant obligations with ESMA would also be a temporary viable option.
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European supervisory authorities propose regulation of third-party cloud service providersOn April 10, 2019 the European Supervisory Authorities (ESAs) published joint advice on the need for legislative improvements relating to Information and Communication Technology (ICT) risk management in the EU financial sector. The three ESAs are the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority (EIOPA). The joint advice includes, among other things, a recommendation addressed to the EU Commission to establish a framework for the oversight and monitoring of critical cloud services providers.
The joint adviceThe joint advice makes several proposals to the Commission for legislative improvements, focusing on incident reporting and third-party cloud services providers. The joint advice also includes a useful mapping of the current framework relating to operational resilience across different sectors in the financial system.
According to the joint advice, all firms should establish and maintain effective risk-management procedures to address ICT and cybersecurity risks. To this end, they must put in place the appropriate governance, operational and control measures. At the same time the ESAs recognize that the current legislative framework could benefit from clarification and standardization.
More specifically, in the area of banking and payments the joint advice recommends the amendment of the Capital Requirements Directive and the second Payment Services Directive to include specific provisions on operational resilience. These will be part of firms’ wider obligations relating to governance and internal controls. Similar changes should be made to Solvency II Directive for the insurance and re-insurance sector. It is also proposed that the Commission should consider closing gaps in the securities markets legislation, by making explicit references to cybersecurity and introducing incident reporting requirements, where there are currently none.
More interesting are the following the cross-sectoral proposals:
• Streamlining requirements on incident reporting: Presently, there are multiple frameworks for incident reporting. This adds significant complexity, especially when a single breach triggers several incident reporting obligations. The joint advice does not propose removing the existing requirements, but rather to clarify overlapping provisions and to standardize reporting templates and timeframes, with a view to making incident reporting a more streamlined process across sectors.
• Establishing framework for the oversight of cloud service providers: There is increasing reliance on third parties for the provision of critical services in
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the financial sector. The relevant interconnections and concentration risks raise system risk concerns. This is particularly the case with cloud services, where a handful of large providers service the majority of the EU financial sector. The joint advice concludes that
there is a need to establish an effective oversight framework for monitoring critical service providers when their activities may affect financial firms. In particular, the relevant framework should clarify the conditions for qualifying as a critical service
provider and specify which activities would fall into scope. The joint advice further notes that international coordination will be key in this regard, considering that cloud services providers operate on a cross-border basis both within but also outside the EU.
New draft disclosure rules aim to promote sustainable investments in the EUOn April 18, 2019 the European Parliament adopted at first reading its position on the Commission’s proposal for a regulation on disclosures relating to sustainable investments and sustainability risks (Draft Disclosure Regulation). The Draft Disclosure Regulation forms part of a wider effort to promote sustainable development in the EU by incorporating Environmental, Social and Governance (ESG) considerations into the investment and advisory process. It also aims to enhance transparency and comparability of financial products that target sustainable investments.
Scope of proposed rulesThe Draft Disclosure Regulation imposes a number of disclosure and transparency requirements on the following entities:
• financial market participants, which include Undertakings for Collective Investment in Transferable Securities (UCITS) management companies, Alternative Investment Fund Managers (AIFMs), European Venture Capital fund (EuVECA) managers, European Social Entrepreneurship funds (EuSEF) managers, investment firms which provide portfolio
management, Institutions for Occupational Retirement Provision (IORP), providers of pension products and insurance undertakings which make available Insurance-Based Investment Products (IBIPs);
• insurance intermediaries which provide insurance advice with regard to IBIPs; and
• investment firms which provide investment advice.
New disclosure and transparency obligationsThe main transparency requirements relating to sustainable investments contained in the rules are:
• Website content: The relevant entities will be required to publish written policies on the integration of sustainability risks in the decision-making or advisory process on their websites. They will also need to publish certain information relating to products that have as their target sustainable investments, such as the methodologies used to assess, measure and monitor the impact of the relevant sustainable investments selected.
• Pre-contractual disclosures: Firms will be required to make additional pre-contractual
disclosures to cover sustainability considerations. Among other things, these should explain the extent to which sustainability risks may affect the returns of the relevant financial products as well as how remuneration policies of the relevant entities are aligned with the integration of sustainability risks and the sustainable investment target of the financial product. Firms should also demonstrate how the target of sustainable investments is reached.
• Periodical reports: Firms will also need to make periodical reports, which should include the overall sustainability-related impact of the financial product using relevant sustainability indicators.
• Marketing communications: All marketing communications should be consistent with the information disclosed under the Draft Disclosure Regulation.
Next stepsThe Council is due to formally adopt the Draft Disclosure Regulation in the course of 2019. The regulation will enter into force 12 months following its publication in the Official Journal of the EU.
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ESMA provides clarification on the delegation of depositaries’ functions under the AIFMD and the UCITS DirectiveOn June 4, 2019 the European Securities and Markets Authority (ESMA) published its updated Questions and Answers (Q&As) on the application of the Alternative Investment Fund Managers Directive (AIFMD) and the Undertakings for the Collective Investment in Transferable Securities (UCITS) Directive. The updated Q&As clarify ESMA’s approach to certain aspects concerning the delegation of
depositaries’ functions to third parties under the AIFMD and the UCITS Directive.
More specifically, the updated Q&As cover the following issues:
• Delegation of supporting tasks: The EU rules allow depositaries to delegate freely supporting tasks, such as administrative or technical functions, to third parties. The updated Q&As
specify that a task qualifies as a supporting task provided that (i) the execution of that task does not require discretionary judgement or interpretation on behalf of the third party; (ii) the third party does not need specific expertise on the depositary function to execute that task; and (iii) the task is standardized and pre-defined.
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• Delegation of safekeeping functions: It is clarified that where depositaries delegate to third parties tasks that would allow them to transfer assets of the relevant funds, without intervention of the depositary, then the rules on delegation of safekeeping functions under AIFMD and UCITS Directive should apply.
• Delegation of depositary functions to branches located in other member states: According to ESMA, it is possible to allocate internally depositary functions between the head office and a branch, which is located in a different member state, as long as the branch
has adequate operational infrastructure and internal governance systems to be able to carry out the depositary function independently from the head office and provided that national implementing legislation is complied with.
• Supervision of depositary functions where branches are located in other member states: It is noted that the AIFMD and the UCITS Directive do not grant any passporting rights in relation to depositary activities. This means that a branch may need to obtain local authorization for the performance of depositary functions, where the branch is located in the home member
state of the relevant fund and this is different from the member state of the depositary’s head office. Therefore, the branch will be supervised by the competent authority of the member state where it is established, which would also cover the supervision of delegation of depositary functions from branch to head office and vice versa.
• Intra-group delegation of depositary functions: The updated Q&As clarify that legal entities of the same group qualify as third parties for the purposes of the rules concerning depositary delegation.
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Prudential Regulation Authority publishes its 2019/2020 business planOn April 15, 2019 the Prudential Regulation Authority (PRA) published its 2019/2020 business plan setting out its strategy and workplan for the coming year.
The business plans covers the following main strategic goals and explains the ways of achieving them:
• Robust prudential standards and supervision: The PRA will continue its work on the post-crisis regulatory regime, specifically through monitoring the implementation of ring-fencing and reviewing proprietary trading by banks. The PRA will also assess the effectiveness of the Senior Managers and Certification Regime (SMCR) and remuneration policies for banks and insurers.
• Adapting to market changes and horizon scanning: In this respect, the PRA will focus on issues such as Brexit and financial risks arising from climate change. It will also look at risks and opportunities associated with technological developments, including crypto-assets and fintech.
• Financial resilience: The PRA will be assessing the adequacy of credit and liquidity resources of firms and reviewing asset quality. The PRA’s work in relation to insurers will focus on risks stemming from complex products and asset exposures.
• Operational resilience: The PRA will seek to embed operational resilience in its prudential framework and will publish a consultation paper in the second
half of 2019 setting out its proposed approach in this regard. The PRA will focus particularly on the way that firms respond to cyber incidents.
• Recovery and resolution: Ensuring that banks and insurers have credible plans in place to recover from financial stress remains a top priority. In this regard, the PRA will be looking at the ability of firms to wind down their trading and derivatives businesses in an orderly way and will work with firms to develop its final approach.
• Competition: In relation to its secondary competition objective, the PRA aims to ensure that firms, especially small ones, are treated proportionally. To this end, it will examine the use of the internal-rating based approach for smaller banks, complete new bank authorizations and promote its new bank startup unit and the new insurers startup unit.
• Brexit: The PRA will continue its work to ensure a smooth transition when the UK leaves the EU. This includes monitoring risks, clarifying its approach to Brexit, dealing with authorizations of new firms and firms entering the temporary permissions regime as well as promoting supervisory cooperation.
• Efficiency and effectiveness: The PRA aims to allocate resources efficiently and effectively to attain its strategic objectives. It recognizes, however, that factors such as its reliance on the systems of the Financial Conduct Authority may undermine efficiency.
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Financial Conduct Authority publishes its 2019/20 Business PlanOn April 17, 2019 the Financial Conduct Authority (FCA) published its business plan for 2019/20, outlining its key priorities for the coming year. The FCA’s focus remains largely consistent with previous years, with a number of cross-sector priorities following on from the 2018 report. In addition, the business plan sets out three strategic challenges which the regulator intends to focus on in the coming years.
The five cross-sector priorities which follow on from the 2018 report include:
• Brexit: The FCA’s immediate priority is to ensure a smooth transition when the UK leaves the EU and to strengthen engagement with regulators across the world. Post-Brexit, the FCA will focus on ensuring that the regulatory landscape remains “fit for the challenges it faces.” while “remaining open to international markets and realising new trading opportunities.” Specifically the FCA has acknowledged that its role in providing technical advice to the UK government and engagement in standards setting bodies will increase in importance following Brexit.
• Culture and governance: Building on its previous work, the FCA continues to seek to embed a healthy culture at the firms it regulates, focusing on four key drivers of behaviour: purpose, leadership, reward/management of people and governance. The expansion
of the Senior Managers and Certification Regime (SM&CR) is a key priority in facilitating this. The FCA also intends to keep remuneration practices under review and establish a directory, containing information on individuals performing key roles who are not captured as senior managers under the SMCR.
• Fair treatment of existing customers: The FCA is concerned that existing customers in some sectors are being “penalised for their loyalty.” This issue has become particularly relevant in the context of the Citizens Advice super complaint to the Competition and Markets Authority (CMA), which covers pricing practices in home insurance, cash savings and mortgages. The FCA is currently carrying out a market study on how customers are charged for home and motor insurance and has published a discussion paper on fair pricing in financial services.
• Operational resilience: The business plan highlights the challenges stemming from incidents such as cyber-attacks and technology outages that may lead to considerable disruption for firms. The FCA notes that the relevant risks are amplified by complex and ageing IT systems as well as increasing reliance on third-party service providers. According to the FCA, 17% of incidents firms reported were caused by IT failure of a third-party service provider, making it the second highest root cause of disruption to services.
Evidence also shows that cyber-criminals are targeting smaller firms as a gateway into the UK financial system. The FCA will be monitoring and assessing the relevant risks in the coming year.
• Financial Crime: The FCA has re-iterated its intention to stop the UK financial sector being used to facilitate financial crime. In particular, it intends to improve its anti-money laundering capabilities using enhanced analytical software and intelligence gathering. It will also seek to become a catalyst for industry-led initiatives to “design out” fraud using improved datasets and technology.
• In addition to the cross-sector priorities outlined above, the FCA has highlighted the following “strategic challenges” that it expects to face in the coming years:
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• Innovation, use of data and data ethics: The FCA seeks to ensure that innovation and data use continues to work in consumers’ interests. Noting its “longstanding strategic commitment” to supporting innovation and competition, the FCA wants to use initiatives like the regulatory sandbox, regtech and open banking to improve outcomes for consumers. In the area of cryptoassets, the FCA will provide technical advice to HM Treasury on extending the regulatory perimeter to capture utility and exchange tokens.
• Demographic change: The FCA has cited a number of challenges which will arise as a consequence of demographic changes in the UK. In particular, the FCA notes that Baby Boomers, Generation X and Millennials “all lead different financial lives, have different financial needs
and different financial resources,” which are often exacerbated by recent developments in housing, employment and interest rates. Accordingly, it intends to publish a discussion paper this year on intergenerational differences. In addition, the FCA has stated it will be providing greater clarity to firms about its expectations around vulnerable customers and the good practices it has seen in this area.
• The future of regulation: The FCA notes that technology and innovation, changing consumer needs and new models and services are transforming financial services. Post-Brexit the regulator intends to look at its regulatory model to ensure that the landscape is fit for the challenges it faces. Specifically the FCA has stated that this will include looking at issues of equivalence, future-proofing its
principles and rules, how data and technology can support better regulation and where the regulatory perimeter should sit. The report also notes that the FCA will need to be ready to respond flexibly in the aftermath of Brexit. Interestingly in this context, Charles Randall, the FCA Chair, has noted that, “changes in the global context may also provide opportunities to make UK regulation smarter, focusing more on the outcomes we want to achieve.”
In addition to these cross-sector priorities and strategic challenges, the business plan also outlines the FCA’s key areas of focus with regard to specific sectors. These include investment management, retail lending, pensions, retail investments, retail banking, insurance and wholesale financial markets.
FCA delays publication of policy statement and final
rules for CFDs and CFD-like options
On April 26, 2019 the Financial Conduct Authority (FCA) announced that it will delay the publication of a Policy Statement and any final FCA Handbook rules for contracts for difference (CFDs) and CFD-like options sold to retail clients. The FCA had previously indicated that publication of a Policy Statement and final rules would take place in April 2019, but its recent statement has announced that it now plans to publish these rules in summer 2019.
In June 2018, the European Securities and Markets Authority (ESMA) introduced a temporary EU-wide ban on the sale of binary options to retail investors and restrictions that limited how
particular CFDs could be sold to retail investors due to the significant investor protection risks they pose. This represented ESMA’s first use of its temporary product intervention powers under Article 40 of the Markets in Financial Instruments Regulation 648/2012 (MiFIR). ESMA has extended its application of its temporary product intervention powers on a rolling three month basis to date.
Following ESMA’s temporary restrictions, the FCA published Consultation Paper 18/38 (CP 18/38), on December 7, 2018 which proposes measures to address poor conduct in the UK market by UK and EEA firms who offer CFDs to retail consumers, and to limit the
sale of CFDs and CFD-like options with excessive risk features that result in harm to retail consumers.
CP 18/38 proposed to make ESMA’s measures permanent in the UK (ESMA may not make permanent product interventions) and sets out that FCA-authorized firms must continue to comply with ESMA’s temporary decision that restricts the marketing, distribution or sale of particular CFDs to retail clients. Any final FCA Handbook rules for CFDs would apply from the date that ESMA’s restrictions expire, if not before. The FCA announced that firms would be given at least two months to comply with any new FCA rules. If EU law ceases to apply in the UK before ESMA’s temporary
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decision expires, the consultation paper proposes that ESMA’s temporary measures will continue to apply as part of UK domestic law.
Investments caught within the scope of the proposal include CFDs, spread bets, rolling spot forex contracts and restricted options (the last of which is a new glossary definition set out in the paper to catch CFD-like options), but only where such investments qualify as financial instruments under MiFID. The FCA’s proposed intervention is wider in scope than ESMA’s temporary restriction (which includes only CFDs) by including both
CFDs and CFD-like options. The most commonly traded CFD-like options are sold under labels such as ‘turbo certificates’, ‘knock out options’ and ‘delta one options’, all of which are products that have many of the same characteristics as CFDs. Additionally, the FCA’s intervention proposes to set leverage limits for CFDs referencing certain government bonds to 30:1 (in comparison to 5:1 under ESMA’s measure).
The proposal will directly impact: retail clients who invest in CFDs and CFD-like options; UK and EEA MiFID investment firms marketing,
distributing or selling CFDs and CFD-like options in or from the UK to retail clients; and UK branches of third country investment firms marketing, distributing or selling CFDs and CFD-like options.
Whether the proposals in CP 18/38 will apply in the UK will depend on the FCA’s views following consultation. Given the large interest in the proposals, it is possible that the revised timeframe for final rules in summer 2019. may further be delayed.
UK’s payment systems regulator delays the implementation of confirmation of payee
On May 9, 2019 the UK’s Payment Systems Regulator (PSR) published a consultation paper announcing a delay of the implementation
deadline of Confirmation of Payee (CoP). CoP, was due to come into force by April 1, 2019 but will now be pushed back until December 31, 2019.
Gareth Shaw, Head of Money Content at consumer group Which? claims that consumers will lose GBP108.75 million during the nine-month delay “Delays to the introduction of vital name-check security leaves millions of customers vulnerable to losing life-changing sums of money as a direct result of this missed deadline…This system, which would cut losses to bank transfer fraud in half overnight, should have been introduced years ago. Banks and the regulator must urgently work towards its implementation.”
Difficulties in meeting the implementation deadlines, the impact on different types of
Payment Service Providers (PSPs) and the need to clarify standards and guidance on CoP were identified by the PSR as the main reasons for delaying the proposed measure. The PSR has now proposed specific directions to the UK’s six largest banking groups (Lloyds Group, Barclays Group, HSBC Group, Royal Bank of Scotland Group, Santander Group and Nationwide Building Society). The specified PSPs must be able to respond to CoP requests from December 31, 2019 and must be able to send CoP requests and present responses to their customers from March 31, 2020.
The PSR has set out a voluntary code which outlines the protections and standards that will be implemented by PSPs with respect to APP scams. This voluntary code became applicable from May 28, 2019.
Confirmation of Payee (CoP) is a name-checking system that the PSR and payments industry has identified as an important tool to help prevent Authorised Push Payment (APP) scams. According to UK Finance, GBP354 million was stolen by fraudsters from UK banking customers in 2018 through APP fraud. The CoP system will check whether the name of the account that a payer is sending money to matches the name they have entered. The objective of implementing CoP is to reduce losses from APP scams and accidentally misdirected payments in electronic bank transfers.
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FCA publishes new rules to promote shareholder engagementOn May 31, 2019 the Financial Conduct Authority (FCA) published policy statement (PS19/13) setting out new rules which aim to improve shareholder engagement from life insurers and asset managers. The policy statement provides feedback to the relevant Consultation Paper (CP19/7) and implements the requirements which were introduced by the revised Shareholder Rights Directive (SRDII).
Background and objectivesThe objective of the SRDII is to enhance shareholder engagement, promote long-term investment decision making and improve transparency around companies’ ownership structure. To this end, it requires transparency of engagement policies and investment strategies and imposes disclosure and approval obligations with regard to certain transactions with related parties.
The new rules will affect regulated life insurers, asset managers and companies with shares admitted to trading on a regulated market.
Rules for asset managers and life insurersAsset managers and asset owners will be required to disclose certain information relating to their engagement policies and investment strategies. More specifically:
• Life insurers and asset managers will need to publish their engagement policy as well as information on how this has been implemented, unless they can publicly explain the reasons for not doing so.
• Life insurers must disclose information on their arrangements with asset managers, on an annual basis. They must also explain how the main elements of their equity investment strategy are consistent with the profile and duration of their liabilities and demonstrate how the relevant elements promote the medium to long term performance of their assets.
• Asset managers must share information with asset owners, including on how their investment strategies contribute to the medium to long term performance of the assets.
Related party transactionsCertain transactions with related parties may in practice affect the valuation of the company by its shareholders. Therefore, the SRD II also requires companies with shares admitted to trading on regulated markets to provide information on material Related Party Transactions (RPTs) and to establish arrangements for the approval of RPTs. It is noted that issuers with a premium listing are already subject
to extensive RPT requirements in the UK and the FCA has generally retained them.
The FCA has made the following changes to its original proposals:
• Materiality threshold: Originally the FCA proposed the materiality threshold for RPTs covered by the SRD II framework to be 25%. However, in order to increase investor protection, the FCA subsequently lowered the relevant threshold to 5%.
• Non-EEA issuers: With a view to lowering the cost of compliance, the FCA has made the rules relating to non-EEA issuers more proportionate. In particular, to avoid conflict with overseas corporate governance obligations, non-EEA issuers can comply with the relevant requirements by obtaining board approval prior to transacting with a related party. Moreover, for the purpose of disclosing information about their RPTs, non-EEA issuers will be allowed to use the definition of a related party under the International Financial Reporting Standards (IFRS) or under the equivalent accounting standards that they use for the preparation of their consolidated annual financial reports.
In general the policy statement has replicated the relevant requirements under the SRD II. However, in order to reflect the international nature of the UK’s asset management industry, the FCA has gone beyond the relevant SRD II rules. Consequently, in the UK the new rules will apply to investments in shares not only traded on markets of the European Economic Area (EEA), which is the minimum SRD II requirement, but also on non-EEA comparable markets.
The relevant SRDII rules apply to issuers with a registered office in an EU member state and holding voting shares, which are admitted to trading on a regulated market. In CP19/7, the FCA also proposed to extend these requirements to non-EEA issuers.
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What should firms do now?The new rules came into force on June 10, 2019 which was the deadline for implementation of the SRDII. This means that asset managers and life insurers should have already published their engagement policy or explained the
reasons for not doing so. However, given the very short period from their publication, the FCA has clarified that for the purposes of complying with these obligations it will be sufficient for a firm to demonstrate that it has taken steps to develop an engagement policy. In addition, it is specified that
disclosures, where required, must be made from the first full period after the rules come into effect.
Firms must ensure compliance with the rules concerning related party transactions from the beginning of their first financial year following the entry into force of the new rules.
FCA publishes final rules for peer-to-peer crowdfunding platformsOn June 4, 2019 the Financial Conduct Authority (FCA) published Policy Statement (PS19/14) setting out final rules on loan-based (or Peer-to-Peer) and investment-based crowdfunding platforms and providing feedback to Consultation Paper (CP18/20) (policy statement). The policy statement primarily focuses on Peer-to-Peer (P2P) platforms, which are platforms that match potential investors with borrowers.
The new rulesThe new rules aim to improve standards in the sector and protect investors, without stifling innovation. The FCA adopted most of its original proposals in CP18/20, while providing clarifications where necessary to enhance regulatory certainty. In brief, the new rules relate to the following:
• Risk management framework: P2P platforms must put in place an appropriate risk management system to assess and price the credit risk of the loans that are listed on their platform. The policy statement clarifies the rules relating to risk management for the basic pricing of a loan as well as additional requirements for more complex models.
• Governance: There are new requirements relating to the establishment of independent risk management, internal audit and
compliance functions. The policy statement also clarifies that the development and oversight of the risk management framework should be the responsibility of a person approved for a senior manager function under the Senior Managers and Certification Regime (SMCR), such as a director.
• Marketing restrictions: In general, P2P platforms may provide information on specific risk characteristics and investments offered. However, the new rules impose restrictions on direct offer financial promotions to retail clients, which cover, for example, the provision of details on how to make an offer or application. For instance, these communications can only be made to certain types of retail investors (certified or self-certified sophisticated investors or certified high-net-worth investors) or otherwise they should be subject to a 10% of net investible assets cap.
• Appropriateness assessment: P2P platforms must make an appropriateness assessment before an investor can submit an instruction to invest. The FCA has provided specific guidance on the risk factors to be covered in this assessment.
• Wind-down arrangements and the resolution manual: P2P platforms must have in place wind-down arrangements to ensure continuity of the contracts they facilitate should they cease their operations. They must also produce and keep up-to-date a P2P resolution manual that would assist resolution in the event of insolvency.
• Minimum disclosure requirements: P2P platforms should provide investors with information about the role of the platform, the provision of any contingency fund, the practical impact of providing direct loans to borrowers under a P2P agreement and information about the investment.
• Mortgages and home finance: Where P2P platforms facilitate home finance products and at least one of the investors is not required to be authorized as a home finance provider, they will be subject to a number of rules under the FCA’s Mortgage and Home Finance: Conduct of Business sourcebook (MCOB).
The new rules will apply to P2P platforms from December 9, 2019 with the exception of the rules relating to home finance products. Those came into effect on June 4, 2019.
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The change which is expected to have the biggest impact is the restriction on retail investors – capping their investments to 10% of their investible assets. This could have a significant impact on businesses whose platform focuses on retail investors, both in terms of added compliance burden and potentially discouraging investment from retail investors.
FCA announces significant reforms in the overdraft marketJune 7, 2019 the Financial Conduct Authority (FCA) announced a major reform package, which aims to ‘fix’ the “dysfunctional.” overdraft market. In particular, Policy Statement (PS19/16) sets out final rules and guidance regarding arranged and unarranged overdrafts. In general, the FCA adopted its initial proposals, which were introduced in December 2018 in Consultation Paper (CP18/42), with only minor changes. On the same day, the FCA also published Consultation Paper (CP19/18), proposing additional competition remedies.
BackgroundFollowing its 18-month review of the high-cost credit market, the FCA found evidence of consumer harm and poor competition in the market for consumer credit. The FCA’s main concerns and focus related to arranged and unarranged overdrafts, the rent-to-own market, home-collected credit, catalogue credit and store card products. According to the FCA, overdrafts in particular are poorly understood by consumers, even though they are a widely used credit product.
The new rules will affect banks and building societies providing personal current accounts. Also, Payment Service Providers (PSPs) offering payment accounts must consider the revised guidance relating to situations when a payment instruction from a customer is refused by the PSP and charges have been incurred.
Overview of the new rulesThe policy statement aims to make the overdraft market simpler and fairer by introducing the following reforms:
• Aligning arranged and unarranged overdraft prices: Firms must charge the same, or lower, prices for unarranged overdrafts as for arranged overdrafts. The FCA expects the new rules to enhance competition and consequently constrain excessive prices in unarranged overdrafts.
• Simplifying pricing: The price for each overdraft should be expressed as a single annual interest rate, which will be charged on the total amount borrowed. Daily or monthly charges will no longer be possible. Firms will also be prohibited from charging fees for arranging overdrafts of up to GBP10,000. According to the FCA, these changes will effectively put an end to all fixed fees for borrowing under an arranged overdraft as well as monthly usage fees and allowed payment fees for unarranged overdrafts. Refused payment fees, which are fees for refusing payment due to lack of funds, will still be permitted.
• Standardising advertising: With a view to enhancing comparability of products, firms will be required to display a representative Annual Percentage Rate (APR) for their arranged overdraft products.
• Addressing repeat use of overdrafts: Firms must put in place policies and procedures to identify repeat overdraft users and develop a strategy, which will be shared with the FCA, to address repeat use.
• Revised guidance on payment fees where a payment instruction has been refused: The FCA provided guidance to clarify that charges relating to refused payment fees must reasonably correspond to the actual cost incurred by the provider. This guidance will be relevant to all payment service providers, not just banks and building societies.
In CP19/18 the FCA proposes some additional remedies. These would require firms to disclose certain pricing details, including overdraft prices and fees, together with their quarterly metrics. Moreover, the FCA proposes some changes in the definition of private bank to better align the competition remedy rules, the current account service metrics rules and the pricing rules. It also proposes to exempt foreign currency accounts from the competition remedy rules. The FCA also discusses ways of improving customer experience.
The revised guidance relating to refused payment fees took effect immediately and is applicable from June 7, 2019. The rules on repeat use will come into force on December 18, 2019 Those relating to pricing will take effect on April 6, 2020.
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Our commentsThe FCA expects the newly introduced reforms to have a significant impact on the overdraft
market. “Following our changes we expect the typical cost of borrowing GBP100 through an unarranged overdraft to drop from GBP5 a day
to less than 20 pence a day.” said Andrew Bailey, Chief Executive of the FCA.
The Directory: A new public register for financial servicesIn March 2019, the Financial Conduct Authority (FCA) published Policy Statement PS19/7 introducing the Director’, a new public register for financial services which will include information specifically on individuals. Following this, firms will be required to submit certain information about their firm and their relevant staff starting from September 2019.
The DirectoryThe Financial Services Register (FS Register) provides information on firms regulated by the FCA and the Prudential Regulation Authority, including information on a firm’s senior management. Following the extension of the Senior Managers and Certification Regime (SMCR) to insurers and solo-regulated firms, the FS Register will only include individuals that are approved by the FCA for specified Senior Manager roles. The Directory will contain a wider range of individuals, including advisors, traders, portfolio managers as well as providers of mortgage advice. Consumers will be able to use the Directory to verify whether an individual works for an authorized firm.
More specifically, the Directory will provide information on three categories of individuals:
• certified staff, i.e. individuals with a certification function under the SMCR;
• executive and non-executive directors not performing Senior Management Functions; and
• sole traders or appointed representatives with a customer-facing role.
What should firms do?Firms will be required to provide the FCA with certain information about their firm and their relevant staff. This includes any restrictions applying to a firm’s regulated activities as well as details about the specific individual and the type of business the individual is qualified to undertake. Banks, insurers and their appointed representatives need to make their submissions by March 9, 2020. All other firms that are authorized to provide financial services and are currently subject to the approved persons regime, including sole traders, need to submit the relevant information
by December 9, 2020. These deadlines are aligned with the SMCR transitional arrangements for insurers and solo-regulated firms that require these firms to certify their staff as fit and proper within 12 months from the commencement of the regime. The Directory will go live in two phases shortly after the expiry of the respective submission deadlines.
Firms need to start taking steps to gather the necessary information and verify its accuracy before submission. Firms will make their submissions through the FCA’s Connect system starting from September 2019 for banks and insurers and December 2019 for all FCA regulated firms. Firms will also need to update the information provided within seven business days when a change occurs.
However, while the policy rationale for this change is based upon economic and competition philosophies, and pressure from consumers to limit the penalties of unplanned overdrafts, it could also disincentivize sensible money management by bank customers. Therefore, we could see more customers entering into more short-term debt – which is not what the FCA intends.
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Belgium
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Belgium regulates the mandated underwriter: Attractive insurance marketplace post-BrexitThe Brexit Act of 3 April 2019 on the withdrawal of the UK from the EU introduced a new category of insurance intermediaries in the Belgian market by amending the Act of April 4, 2014 on insurances (the Insurance Act).
Although several insurance intermediaries were already conducting the activity of mandated underwriter in the Belgian market, their status and role was often unclear and cause of confusion. Many policyholders and even professional parties wrongly believed that the mandated underwriter itself would cover the insurance risk, acting as insurer.
Also, many of these underwriters often offer specialised services and insurances and were performing their activities in Belgium on a cross-border basis from the UK. Following Brexit, many of these underwriters might not be able to continue their activities in Belgium.
The mandated underwriter: DefinitionA mandated underwriter is defined as “insurance intermediary who, acting on behalf of one or more insurance undertakings, has the authority to accept the coverage of risks in the name and on behalf of such insurance undertaking(s) and to underwrite and manage insurance agreements.”
Registration and organizational requirementsExercising the activity of mandated underwriter requires a prior registration as insurance intermediary with the FSMA. The organizational requirements for mandated underwriters are almost identical to those for insurance brokers (which are set out in section 2, chapter 3, part 6 of the Insurance Act). However, contrary to insurance brokers, a mandated underwriter is not required to act independently; it can act (almost) exclusively on behalf of one specific insurance undertaking.
Additionally, a mandated underwriter must have an appropriate internal organization in place, allowing it to manage the risks associated with its activities and taking into account the size, nature and complexity of its activities. It is customary that the insurance undertaking itself also imposes certain organizational requirements on the mandated underwriter, in order to ensure effective management of the risks underwritten and timely communication.
Therefore and in order to position Belgium as an attractive insurance marketplace post-Brexit, the Belgian legislator decided to take away these uncertainties and to formally regulate this type of insurance intermediary.
The mandated underwriter itself does not underwrite the risks, but does so on behalf of the insurance undertaking, who is the actual risk carrier. The difference with other types of insurance intermediaries is that the mandated underwriter is authorized to accept the risk on behalf of the insurance undertaking and that it is also often mandated to determine the insurance premium on behalf of the insurance undertaking, within the limits of its mandate. It may also actually underwrite the insurance agreement with the policyholder, acting as the insurance undertaking’s attorney.
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Apart from the general information requirements, a mandated underwriter must specifically mention:
• the name of all insurance undertakings who have mandated the mandated underwriter, including for which classes of insurance, on its website or on a durable medium at the client’s request if it doesn’t have a website; and
• the name of the insurance undertaking(s) in whose name and on whose behalf the insurance agreement was underwritten in each insurance agreement.
The Insurance Act provides that the King can impose further organizational requirements by Royal Decree, which has not been done to this date.
Finally, it is not possible for a mandated underwriter to also act as an insurance (sub-)agent or broker, since this would lead to confusion and inevitably to conflicts of interest.
TimingThe new provisions relating to mandated underwriters in the Insurance Act entered into force on April 10, 2019.
Short term to do’sInsurance intermediaries already acting as mandated underwriter in the Belgian market and registered as insurance intermediary with the FSMA on April 10, 2019, may continue to exercise their activities until April 10, 2020 provided they notify the FSMA thereof by July 10, 2019 at the latest. They will then have to file an application for registration as mandated underwriter with the FSMA
before April 10, 2020. Insurance intermediaries failing to do so, or whose registration is denied by the FSMA, may no longer carry out the activity of mandated underwriter.
Persons not registered as insurance intermediary with the FSMA on April 10, 2019 and wishing to exercise the activity of mandated underwriter will have to immediately register as mandated underwriter and may not carry out the activity of mandated underwriter without such registration.
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Spain
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Spanish Advertising and Transparency Regulation on Banking Services expands its scopeOn April 29, 2019 Order ECE/482/2019, dated April 26, was published in the Spanish Official State Gazette (Boletín Oficial del Estado). Order ECE/482/2019 amends Order EHA/1718/2010, dated June 11, on the regulation and control of advertising of banking products and services (Orden EHA/1718/2010, de 11 de junio, de regulación y control de la publicidad de los servicios y productos bancarios) (the Advertising Order) as well as Order EHA/2899/2011, dated October 28, on transparency and client protection in banking services (Orden EHA/2899/2011, de 28 de octubre, de transparencia y protección del cliente de servicios bancarios) (the Transparency Order).
Since its entry into force in 2010, the purpose of the Advertising Order is to establish the rules, principles and criteria, which are applicable to advertising activity of banking products and services in Spain. Meanwhile, the Transparency Order, which was adopted a year later, introduces rules of conduct and transparency measures regarding the provision of financial banking services to individuals with the purpose to ensure the appropriate
level of client protection in the provision of banking products and services by credit institutions.
Until recently, these regimes were only applicable to Spanish credit institutions and Spanish branches of foreign credit institutions (either of credit institutions established in other member states or in third-country member states). However, the legislator extends the geographical scope of application of both set of rules. Consequently, these regimes will now apply to such entities providing banking services (including payment services) in Spain through agents or under the freedom to provide services.
In addition, the Advertising Order is no longer applicable only to credit institutions. The Spanish legislator expressly adds into its scope mortgage loan lenders, mortgage loan intermediaries and payment and electronic money institutions as entities subject to the advertising control obligations laid down in that rule.
As regards the Transparency Order, its content is now mandatory not only for credit institutions, but also
for the so-called financial credit establishments (establecimientos financieros de crédito). These are Spanish regulated entities which cannot take deposits but which can engage in lending and related activities.
Apart from the above mentioned changes, the main purpose of the amendments introduced in both the Advertising Order and the Transparency Order is to adapt them to the Spanish legislation implementing Directive 2014/17/EU of the European Parliament and of the Council of February 4, 2014 on credit agreements for consumers relating to residential immovable property. By way of example, the Advertising Order sets out, among other things, the conditions to be met in relation to the representative example of a mortgage loan (ejemplo representativo de préstamo hipotecario) that appears in the advertisements made by lenders or credit intermediaries.
The regulatory amendments contained in Order ECE/482/2019 entered into force on June 16, 2019.
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US
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Fed proposes revised framework for determining bank controlThe Federal Reserve Board of Governors (Fed) on April 23, 2019 unanimously approved a proposal to revise its criteria for determining control of a banking organization. In its notice of proposed rulemaking, intended to “simplify and increase the transparency” of its rules on control, the Fed is seeking to “significantly expand the number of presumptions” in its “determinations of whether a company has the ability to exercise a controlling influence over another company for purposes of the Bank Holding Company Act or the Home Owners’ Loan Act.” The proposal would revise the Fed’s Regulations Y and LL by implementing a tiered framework to incorporate the major factors and thresholds that the Fed has historically viewed as presenting controlling influence concerns, along with some “targeted adjustments.” The tiered presumptions, summarized in a chart provided by the Fed, would be based on share ownership of any class of voting securities (below 5%, 5-9.99%,
10-14.99%, and 15-24.99%), and the presumption would be triggered if any relationship exceeds the amount on the table. Presumption of control would be based on factors such as voting and non-voting equity investments, director representation, proxy solicitations, management interlocks, contractual rights that influence or restrict management policies or operations, and business relationships. The proposal also would include a new presumption of non-control. “The proposal is structured so that, as an investor’s ownership percentage in the target company increases, the additional relationships and other factors through which the investor could exercise control generally must decrease in order to avoid triggering the application of a presumption of control,” the proposed rule states.
Comments will be accepted for 60 days after publication of the proposal in the Federal Register.
FinCEN issues interpretive guidance and new advisory on virtual currenciesThe Financial Crimes Enforcement Network (FinCEN) has issued an interpretive guidance affirming its longstanding regulatory framework for virtual currencies, as well as a new advisory warning of threats posed by virtual currency misuse. The May 9, 2019 Application of FinCEN’s Regulations to Certain Business
Models Involving Convertible Virtual Currencies (Guidance) is intended to remind persons subject to the Bank Secrecy Act (BSA) how FinCEN regulations relating to money services businesses apply to certain business models involving money transmission denominated in value that substitutes for currency, specifically, Convertible Virtual
Currencies (CVC). This Guidance, issued in response to questions from the industry, law enforcement and regulators, does not establish any new regulatory expectations or requirements, but is intended to help financial institutions comply with their existing obligations under the BSA as they relate to current and emerging business models
An April 16 a memo prepared by Fed staff acknowledges “frustration with the Board’s control framework” on the part of investors and financial institutions, adding, “this is a particular issue for community banking organizations, which may need to rely on substantial investments from a few significant investors to raise capital.” Randal Quarles, the Fed’s vice chair for supervision, also noted in his opening statement that the “control regime has developed over many decades through a common law process and has become one of the more ad hoc and complicated areas of the Board’s regulatory administration,” and stressed that the goal of the new proposal is to establish “a broadly applicable and uniform set of rules to address the large majority of control fact patterns.”
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involving CVC. It consolidates current FinCEN regulations, and related administrative rulings and guidance issued since 2011, and applies these rules and interpretations to other common business models involving CVC engaging in the same underlying patterns of activity.
On the same day, FinCEN also issued an Advisory on Illicit Activity Involving Convertible Virtual Currency to assist financial institutions in identifying and reporting suspicious activity related to criminal exploitation of CVCs for money laundering, sanctions
evasion, and other illicit financing purposes, highlighting red flags and identifying information that would be most valuable to law enforcement if contained in suspicious activity reports.
SEC adopts conduct rules and interpretations affecting broker-dealers and investment advisorsOn June 5, 2019 the Securities and Exchange Commission (SEC) adopted Regulation Best Interest (Reg BI) and Form CRS. Reg BI contains long-awaited rules governing the standard of conduct applicable to broker-dealers dealing with retail customers. Form CRS requires additional disclosures by broker-dealers and investments advisors designed to enhance the transparency of their relationships with retail investors.
The SEC also issued two interpretations under the Investment Advisers Act of 1940 (Advisers Act) relating to the fiduciary standard of conduct for investment advisors and the “solely incidental” prong of the broker-dealer exclusion.
The package of rules and interpretations is intended to enhance the quality and transparency of retail investor relationships with broker-dealers and investment advisors. The adopted rulemaking and interpretations package includes four components.
Regulation Best InterestReg BI imposes an enhanced standard of conduct for broker-dealers and associated persons of broker-dealers when making any
recommendation of a securities transaction or investment strategy involving securities to a retail customer. The definition of retail customer focuses on natural persons and their legal representatives; institutions and certain professional fiduciaries are not covered by the regulation. Under the Regulation, when making a recommendation of a securities transaction or an investment strategy involving securities, a broker-dealer will have to act in the customer’s best interest without placing its own interests ahead of those of the customer.
The term “best interest” remains undefined; compliance will turn on an objective assessment of the facts and circumstances related to how the components of the rule (Disclosure, Duty of Care, Conflicts of Interest, and Compliance Obligations) are satisfied at the time a particular recommendation is made to a particular retail customer.
The duty under Reg BI applies to transactions and investment recommendation strategies, including recommendations to roll over or transfer assets from one type of account to another.
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information about a firm’s services, fees and costs, conflicts of interest, legal standard of conduct, and the disciplinary history of the firm and its financial professionals.
Investment advisor fiduciary duty interpretationThe SEC’s interpretation reaffirmed and, in some cases, clarified certain aspects of the fiduciary duty owed by an investment advisor to its clients. The SEC stated that the duty of loyalty owed by an advisor to its clients is one that does not permit the advisor to “place its own interest ahead of its client’s interests.” The SEC took pains to make clear that an advisor’s duty is to “eliminate OR at least expose through full and fair disclosure all conflicts of interest,” (emphasis added), and it omitted reference to any requirement that the advisor seek to avoid conflicts of interest separately from obtaining informed consent from them via disclosure. The SEC also confirmed that while the advisor’s fiduciary duty applies to the entire relationship between the advisor and its client, the parties can tailor the scope of the relationship to which the fiduciary duty applies through contract.
“Solely incidental” interpretationThe Advisers Act contains an exclusion from the definition of “investment advisor” for a broker-dealer whose conduct of investment advisory services is “solely incidental” to the conduct of its business as a broker and who receives no special compensation for those services. The SEC’s interpretation illustrates the practical application of the exclusion in the context where a
broker is exercising investment discretion over customer accounts or performing account monitoring services. The interpretation is intended to provide more guidance as to when a broker-dealer’s advisory activities causes it to become an investment advisor for purposes of the Advisers Act.
What happens nextThe final forms of the rules and interpretations have been published on the SEC’s website and will shortly be published in the Federal Register. See SEC Adopts Rules and Interpretations to Enhance Protections and Preserve Choice for Retail Investors in Their Relationships With Financial Professionals, SEC Press Release (June 5, 2019). Reg BI and Form CRS (and the related rules) will become effective 60 days from publication in the Federal Register. The interpretations issued under the Advisers Act will become effective upon publication in the Federal Register.
Form CRSUnder newly adopted rules and amendments to existing rules, investment advisors and broker-dealers will be required to provide a brief relationship summary disclosure – known as Form CRS – to retail investors (defined differently than the Reg BI definition of retail customer to encompass potential customers) at the beginning of the relationship. Form CRS uses a standardized Q&A format intended to promote comparisons among firms by retail investors. The form requires the inclusion of summary
More importantly, the compliance date for Reg BI and Form CRS is June 30, 2020. By that date, broker-dealers registered with the SEC that provide the covered recommendations must be in compliance with Reg BI. Already registered investment advisors, broker-dealers, and investment advisors with SEC registration pending prior to June 30, 2020 will have to file their initial Form CRS with the SEC by June 30, 2020. After that date, newly registered broker-dealers will have to file Form CRS prior to the date on which their registration becomes effective.
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International
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IOSCO consults on regulation of cryptoasset trading platformsOn May 28, 2019, the Board of the International Organisation of Securities Commissions (IOSCO) published a consultation report on Crypto-Asset Trading Platforms. Even though in many cases Crypto-Asset Trading Platforms operate similarly to traditional trading venues, they also raise novel issues due to their specific characteristics. IOSCO has therefore highlighted certain areas in its Consultation Report that may warrant additional regulatory consideration.
Background on regulation of cryptoassets A number of cryptoassets essentially function like securities such as shares or bonds. These cryptoassets are often referred to as security tokens. In these cases, a common approach of regulators, including IOSCO, the European Securities and Markets Authority (ESMA) and the UK Financial Conduct Authority (FCA), is to require the application of existing securities regulation rules.
Issues for regulatory consideration specific to CTPsAccording to IOSCO, the areas that may warrant additional regulatory attention include:
• access to CTPs and onboarding process for investors;
• safeguarding participant assets;
• conflicts of interest resulting from the performance of various roles;
• availability of information on the operations of CTPs;
• market integrity and applicability of existing rules on market abuse;
• efficiency of price discovery;
• technology, cybersecurity and resilience; and
• clearing and settlement.
More specifically, the consultation report raises the following points for consideration:
• Typically, intermediaries access trading venues on behalf of their clients, especially retail ones. However, it is common for CTPs to provide non-intermediated (i.e. direct), access to their services, including to retail investors. In absence of an intermediary, the question arises around who should be responsible for the
client/investor onboarding process, which usually involves checks for anti-money laundering and counter-terrorist financing purposes as well as suitability assessments.
• CTPs often act as custodians for participant assets, which may be cryptoassets, but also fiat currency and other funds. However, typically it is intermediaries or other third parties who provide custody services, rather than trading venues themselves. According to IOSCO, risks could arise from custody including operational failure, loss of private keys, co-mingling of assets or insufficient assets to meet liabilities. Therefore, it is suggested that CTPs should need to have appropriate financial resources, which may also take the form of capital requirements, such as those typically imposed on intermediaries.
• CTPs often provide a range of services, which are usually performed by different parties, covering admittance and trading of the crypto-asset as well as settlement, custody, market making and advisory services. In those cases, additional conflicts of interest may arise.
• Traditional transaction settlement systems may not be necessary or appropriate for CTPs. It is important to clarify issues around settlement finality and transfer of legal ownership when transactions are recorded on a distributed ledger. When CTPs also provide clearing services, it is important to ensure that they maintain accurate internal accounting systems.
Stakeholders may submit their comments on the Consultation Report before July 29, 2019.
IOSCO defines a Crypto-Asset Trading Platform (CTP) as “a facility or system that brings together multiple buyers and sellers of crypto-assets for the purpose of completing transactions or trades.” In that respect, CTPs are very similar to traditional trading venues and therefore should be subject to the same rules, for example around market abuse. However, there are certain elements that differentiate CTPs from traditional trading venues. Firstly, the underlying technology and operational model raise new issues, for instance in relation to the protection of private keys. Secondly, while CTPs’ functions are similar to those of trading venues, they will also often perform a number of additional roles usually undertaken by other financial markets participants, such as intermediaries, custodians, transfer agents and clearing houses.
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FSB seeks to slow decline in correspondent bankingWith ever fewer banks providing cross-border services, the Financial Stability Board (FSB) on May 29, 2019 issued the latest in a series of progress reports on its efforts to check the decline in worldwide correspondent banking relationships. The FSB Action Plan to Assess and Address the Decline in Correspondent Banking (report) reports that the number of active correspondent banks declined by 3.4% last year, although the figure represents a slight slowing of the rate of decline compared to the previous year. Still, the report notes a steady pattern of decline since 2015 when FSB launched its action plan to address this trend, with regions of the developing world among the most severely impacted.
The report found increased concentration in the correspondent banking market, which could affect competition, raise costs and lead to more potentially fragile networks susceptible to the failure of a single participant – although it also noted that consolidation could also serve to strengthen remaining correspondent banking relationships. More clarity in terms of regulatory expectations would go a long way to help address some of the problems, FSB stated, along with coordination of domestic capacity-building to improve and build trust in the supervisory and compliance frameworks of affected jurisdictions, and more technical assistance from international organizations.
Financial Stability Board publishes report on market fragmentationOn June 4, 2019 the Financial Stability Board (FSB) published a report discussing market fragmentation in the financial sector and exploring ways to address it. This followed a request from the G20 that the FSB explore issues around market fragmentation and consider tools to address them, where appropriate. In particular, the report looks at areas, where financial activities are fragmented along geographical lines and examines ways of promoting cross-border operations, while enhancing financial stability.
Areas of market fragmentationThe FSB acknowledges that authorities often need to strike a difficult balance between promoting cross-border activity and adjusting domestic regulatory regimes to the specific characteristics of their respective markets. The report specifically looks at the following areas which show signs of market fragmentation:
• Cross-border trading and clearing of OTC derivatives: The FSB has identified divergent approaches in the substance and
timing of the implementation of post-financial crisis international standards relating to Over-The-Counter (OTC) derivatives. It also notes that certain national policies with extraterritorial effects (e.g. requirements in some jurisdictions that certain types of transaction be centrally cleared at local central counterparties) may be a cause of fragmentation.
• Banks’ cross-border management of capital and liquidity: Post-crisis reforms, such as bank resolution regimes, aim to increase resilience of institutions and reduce moral
On the same day, FSB also published a monitoring report on implementation of its March 2018 recommendations to address problems with remittance services providers’ access to banking services, which was significantly impacted by the reduction in correspondent banking relationships. The report calls for ongoing efforts by national authorities, international organizations, remittance service providers and banks to improve supervisory frameworks, enhance communication and cooperation, and provide technical assistance to affected jurisdictions, while accommodating innovative technologies.
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hazard, while promoting global financial integration. However, several domestic regulations impose additional restrictions over and above international standards, which may increase fragmentation. These include national regimes on structural reforms and ring-fencing.
• Cross-border information sharing: The FSB has identified differences in the way that jurisdictions have implemented trade reporting requirements for OTC derivatives. In addition, some jurisdictions have imposed legal barriers to full data reporting and sharing in pursuit of other policy objectives, such as data privacy. However, these may make it difficult for financial authorities to access data or may impose restrictions on cross-border data sharing. The FSB has also identified differences in jurisdictions’ reporting requirements relating to cyber-risk and stress testing.
Mechanisms to address fragmentationThe report also examines possible ways of dealing with market fragmentation. Among other things, the FSB recommends increasing clarity on the way that authorities currently assess and grant deference to other regulatory and enforcement regimes that achieve similar outcomes and make equivalence decisions. According to the report, the following areas may require further work in the future:
• deference processes in derivatives and securities markets;
• jurisdictional ring-fencing and pre-positioning of financial resources by international banks;
• regulatory and supervisory communication and information sharing, for instance through international forums; and
• addressing the issue of market fragmentation as part of the evaluation process of the post-crisis reforms.
The FSB will review progress on the above in November 2019.
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In Focus
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EMIR Refit: How market participants should prepare for the upcoming changesThe amending regulation to the European Market Infrastructure Regulation (also known as EMIR 2.1 or EMIR Refit) will introduce several key changes to the regulation of EU derivatives from next month. On May 14, 2019 the Council of the EU adopted the amended regulation and confirmed that the final text is expected to be signed in the coming weeks, with the amending regulation entering into force 20 days after its publication in the Official Journal of the EU. The EMIR Refit is designed to streamline existing requirements under EMIR and regulators have already advised market participants to take prompt action and review their positions in Over-The-Counter (OTC) derivative contracts in light of the expected changes.
This note specifically focuses on some of the key changes relevant to non-EU counterparties, including:
• the expansion of the definition of financial counterparty (FC);
• the new small FC designation and the practical consequences of this;
• the new exemption from reporting for inter-group trades involving a non-financial counterparty (NFC);
• changes to reporting obligations for smaller non-financial counterparties (NFC-);
• the transfer of reporting responsibilities from alternative investment funds (AIFs) and Undertakings for Collective Investment in Transferable Securities (UCITS) funds to fund managers; and
• the removal of the reporting requirement for historic trades before February 12, 2014 (i.e. backloading).
BackgroundEMIR, which came into force in 2012, lays down the requirements for the regulation of OTC derivative transactions, central counterparties (CCPs) and trade repositories. Its various requirements have been phased in since this date. Importantly, EMIR introduced the obligation to clear certain OTC derivative contracts through a CCP. Market participants caught by the relevant rules include FCs and NFCs whose gross notional value of OTC derivative positions over a rolling 30-day period exceeds certain clearing thresholds. Other important provisions introduced margin requirements for OTC derivative contracts not subject to a clearing obligation, risk mitigation requirements and mandatory reporting of trades to trade repositories.
New FC definition: Impact on the classification of AIFsThe EMIR Refit broadens the definition of financial counterparty to include any AIF either established in the EU or managed by an Alternative Investment Fund Manager (AIFM) authorized or registered in accordance with the Alternative Investment Fund Managers Directive (AIFMD). The International Swaps and Derivatives Association has highlighted that these changes will also affect the classification of non-EU AIFs that are caught indirectly by the regime. This is because, under EMIR, the relevant obligations are determined as if a non-EU AIF were established in the EU. Once EMIR Refit comes into force, a non-EU AIF trading with EU entities will therefore always be considered as a (third country entity) FC for the purposes of the regime, because were it to be established in the EU, it would be an AIF established in the EU and therefore a FC.
The reforms in the EMIR REFIT aim to simplify these requirements, with a view to making regulation of OTC derivatives more proportionate and improving the functioning of the market, particularly for smaller participants. That said, the rule changes also broaden the definition of financial counterparty and will require some entities to re-evaluate their categorization.
It is noted that certain AIFs will be automatically exempt from the regime. These include AIFs that are set up exclusively for the purpose of serving one or more employee share purchase plans as well as AIFs that are securitization special purpose entities. Moreover, AIFs with limited activity in the OTC derivatives markets may benefit from the newly-introduced exemptions for small financial counterparties (see below).
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New FC category: Small Financial CounterpartiesEMIR REFIT introduces a new category of financial counterparty, so called small financial counterparties (FC-) that may be exempt from the clearing obligation where they fall under the relevant clearing threshold for a particular asset class. In effect, EMIR Refit applies the equivalent clearing thresholds which currently apply to NFCs to determine whether FCs will be subject to the mandatory clearing obligation in that particular asset class. However, the calculation methodology for these thresholds does differ between FCs and NFCs as explained below.
The clearing obligation will not apply to a FC if the gross notional value of its OTC derivative positions over a rolling 30-day period does not exceed the relevant clearing threshold, being:
• Credit derivatives: Gross notional value of EUR1 billion.
• Equity derivatives: Gross notional value of EUR1 billion.
• Interest rate derivatives: Gross notional value of EUR3 billion.
• Foreign exchange: Gross notional value of EUR3 billion.
• Commodity derivatives and other OTC derivatives not defined above: Gross notional value of EUR3 billion.
Calculation of clearing thresholds for FC and NFCsIn its Statement of March 28, 2019, the European Securities and Markets Authority (ESMA) clarified that in order to benefit from this exemption counterparties are required to have calculated their aggregate month-end average position for the previous 12 months as at the date the EMIR REFIT enters into force.
FCs and NFCs must calculate their positions in OTC derivative contracts taking into account all OTC derivative contracts, at a group level. However, positions in relation to UCITS and AIFs shall be calculated at the fund level (or in case of umbrella funds, at the level of the sub-fund), and not at the level of the fund manager.
However, there are certain key differences between FCs and NFCs when it comes to this calculation:
• NFCs shall take into account only non-risk reducing OTC derivatives transactions. On the contrary, FCs make their calculations by reference to all OTC derivatives transactions, whether risk-reducing or not.
• A NFC that exceeds the clearing threshold in one asset class will be subject to clearing requirements in respect of that asset class only. It is noted that in that case, the relevant NFC+ will still need to post margin by
The changes were introduced to address concerns that some smaller market participants had been unable to access viable central clearing solutions in the EU. That said, we expect the new FC- designation to have limited impact on asset managers given that: (i) FCs falling under the threshold will still be subject to other obligations under EMIR, including margin requirements; and (ii) some EU dealers registered in the US as swap dealers will in any event continue to be subject to CFTC clearing obligations.
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reference to transactions in all asset classes. FCs, however, that exceed the clearing threshold in one asset class will be subject to the clearing obligation with regards to all asset classes.
Reporting of intra-group transactionsEMIR Refit exempts certain intra-group transactions from the trade reporting obligation under EMIR, where at least one of the counterparties is a NFC. The justification behind these changes is that intragroup transactions involving NFCs represent a relatively small fraction of all OTC derivative transactions and are used primarily for internal hedging within groups. To benefit from this exemption both parties must be included in the same consolidation, be subject to centralized risk evaluation and the parent undertaking must not be a FC.
Changes to reporting obligations for smaller non-financial counterpartiesFinancial counterparties will now be responsible for reporting on behalf of both parties where they enter into a trade with a smaller non-financial counterparty (i.e. NFC-). The NFC- will be expected to provide accurate data to the FC to facilitate such reporting. This specific change will apply 12 months after the EMIR Refit comes into force and could impact on any delegated reporting arrangements FCs have in place with NFC- counterparties.
Transfer of reporting responsibilities from AIFs and UCITS funds to fund managersThe EMIR Refit transfers the reporting obligation under EMIR from UCITS and AIFs (i.e. the legal counterparty) to the UCITS management company and AIFM respectively. We would therefore advise fund managers to ensure this transfer of responsibility is reflected in their reporting delegation agreements.
Removal of backloading requirementThis backloading requirement refers to the obligation on entities to report historic trades which were outstanding on or after August 16, 2012 (the date EMIR came into force) and terminated before February 12, 2014 (the EMIR reporting start date). Given the substantial and costly adjustments that reporting entities would need to comply with the backloading requirement and limited volume and value of such data, the changes under the EMIR Refit have now removed this requirement.
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