regional legal and regulatory issues march 2014. clifford chance agenda and status...

Regional Legal and Regulatory Issues

March 2014

Clifford Chance

Agenda and status Extra-territoriality impact CRD IV

Status / upcoming Extra-territoriality of EMIR Documentation Projects

Status of HK OTC Derivatives Reforms

EU Resolution Directive

Status Bail in

Agenda

Regional Legal and Regulatory Issues 2

EU's too big to fail initiatives

OTC Reforms in Europe

Hong Kong – Securities and Futures Amendment Bill

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Margin for uncleared swaps

Hong Kong Resolution Proposals Consultation Process

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Hong Kong Australia China Japan Korea Singapore

Agenda (continued)

Regional Legal and Regulatory Issues 33Clifford Chance

EU MiFID2/MiFIR

EU shadow bank reforms update

EU securities depository directive

AsiaPac OTC reform

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Ending Too Big to Fail – the Global Plan

4Regional Legal and Regulatory Issues

1

Reducing probabilityof distress

Basel III capital rules and stress tests

Capital surcharge for globally systemically important banks

Controlling size of banks Improved supervision

2

Reducing adverseconsequences of

distress

Recovery and resolution planning

Structural changes to banks

New resolution powers as alternative to conventional insolvency process

Deposit guarantee reforms

3

Reducing transmissionof distress

Basel III charges on intra-system exposures

Derivatives reforms (central clearing and collateral)

Robust financial market infrastructure

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Overview of CRD IV

CRD


Basel III

Passporting

Remuneration Governance

CRR

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CRD IV Timeline

NB: Any frontrunners?


CRD IV package (Regulation (CRR) and Directive (CRD)) published in the Official Journal on 27 June 2013

CRR entered into force on 28 June 2013 and will apply from 1 January 2014

CRD entered into force on 17 July 2013 and needs to be implemented by EU member states (with the exception of new rules regarding capital buffers which come into effect on 1 January 2016) by 31 December 2013

Liquidity coverage ratio to be phased in between 2015-2018

Leverage ratio to be introduced from 2018

Net Stable Funding Ratio to be introduced from 2018

Firms to report from 1 January 2014 on Leverage Ratio, Liquidity Coverage Ratio and Net Stable Funding Ratio

27 June 2013

28 June 2013

17 July 2013

2015 – 20181 January

20142018

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Status of EMIR

7

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EMIR (August 2012)

Short Selling Regulation

(November 2012)

AIFMD (July 2013)

CRD IV / CRR (1 Jan 2014)

FTT (2014?)

MAD 2 (expected to be applied at the same time as MiFID2)

MiFID2 / MiFIR

Timeline for European OTC Derivatives Reform


Proposed regulation on CSDs (2015)

Margin requirements for uncleared swaps (from

2015)

2013 2014 2015 2016

Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4Q3 Q1Q4

2012

Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4Q3 Q1Q4

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NFC+ notification, timely confirmation, daily valuation

Portfolio reconciliation, compression, dispute resolution

Mandatory Reporting Obligation

Mandatory Clearing Obligation

Margin requirements for uncleared OTC derivatives

EMIR regulates OTC derivatives, CCPs and trade repositories and came into force on 16 August 2012. However, many obligations require secondary legislation in order to become effective. The first of these obligations became effective in March 2013 and September 2013.

EMIR Timeline


15 March 2013

15 September 2013

12 February 2014

Summer 2014?

Expected December 2015

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EMIR FAQs for APAC

Clearing

Why is my counterparty asking me what my status is

under EMIR?

What is Article 25 and how does it impact on clearing of

all derivatives overseas?

Reporting

Do I, and if so, where do I have to report?

What are my global confidentiality, data privacy

and other regulatory issues?

Risk Mitigation

My bank / client wants me to sign up to the ISDA EMIR Protocols. What do these

documents do?Branches

Is there any difference if I face a non-EU branch or an APAC subsidiary or an EU

bank?

Non-EU trades

Neither my counterparty nor I are EU entities. Can EMIR

still apply?

EMIR FAQs for Asia Based Market Participants


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Obligation FCs NFC+s NFC-s TCEs

Clearing *

Reporting *

Risk Mitigation:

Confirmations *

Portfolio Reconciliation, Portfolio Compression and Dispute Resolution *

Daily Valuation *

Margining *

Capital *

EMIR Obligations for Different Entities

* On 17 July 2013, ESMA published a consultation paper on the draft RTS on contracts having a direct, substantial and foreseeable effect within the Union and non-evasion of provisions of EMIR (i.e. application of EMIR to non-EU trades). The draft TRS is due to be delivered by ESMA on 15 November 2013.


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Timely confirmation†

Appropriate procedures and arrangements for confirmation

Via electronic means where available

As soon as possible, by T+1 (or T+2 for trades with non-financial counterparties)

Deadlines phased in by counterparty and asset class in stages from 15 March 2013 to 31 August 2014

Financial counterparties to have procedures to report to regulator monthly number of trades unconfirmed for > 5 business days

Portfolio compression

Financial counterparties and non-financial counterparties with portfolio ≥ 500 trades

Must address portfolio reconciliation opportunities on six monthly basis

**Dispute resolution†

Counterparties must agree detailed procedures and processes for:

Identification, recording, monitoring of disputes

Timely resolution of disputes

Financial counterparties to report to regulator disputes > €15m outstanding for ≥ 15 business days

Portfolio reconciliation†

Counterparties must agree portfolio reconciliation arrangements

Covering key trade terms and mandatory valuations

Frequency varies by counterparty type and portfolio size: daily, weekly, quarterly, annually

Daily valuation

Financial counterparties and non-financial counterparties over clearing threshold must carry out daily mark to market/model valuations of transactions

EMIR – Risk Mitigation


† Applicable even if only have one swap with counterparty. No de minimis exemption

* * On 12 August 2013 the U.K. regulation (the Financial Conduct Authority “FCA”) published a webpage about notifications and exemptions under EMIR. The webpage explains that the FCA are developing a web portal for notifications and exemptions required to ensure EMIR compliance.

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On 13 February 2014, the European Commission adopted the RTS on contracts having a “direct, substantial and foreseeable effect within the EU and on non-evasion of provisions of EMIR and non-evasion”.

These RTS address EMIR Article 4(4) (in relation to the clearing obligation) and Article 11(14)(e) (in relation to the risk mitigation obligations). The draft RTS covers:

OTC derivative contracts entered into between two counterparties established in third countries

What would be considered to be “direct, substantial and foreseeable effect” within the EU

When it is necessary to apply the provisions of EMIR in order to prevent evasion

The provisions in these RTS will become effective six months after the RTS comes into force.

Regulatory Technical Standards on Extraterritoriality

13Regional Legal and Regulatory Issues Clifford Chance

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“Direct, Substantial and Foreseeable Effect within the EU”

Under the RTS:

Equivalent third countries Article 13 relief will apply to transactions between two third country entities where at least one counterparty is

established in the equivalent third country

“the provisions of EMIR can be disapplied” vs “counterparties shall be deemed to have fulfilled the obligations”

Which contracts would have a “direct, substantial and foreseeable effect”? Guaranteed OTC derivative contracts

– Guaranteed by an EU financial counterparty – direct effect

– Amount of guarantee exceeds two cumulative thresholds – substantial effect

– ESMA considers that the proposed tests above are sufficiently clear that counterparties can predict which contracts will be within scope – foreseeable

EU branches of non-EU entities

– Contracts concluded with another EU branch of a non-EU entity (but not with an EU entity or non-EU entity) – direct effect

– Contracts concluded with another EU branch of a non-EU entity from a non-equivalent jurisdiction – substantial effect

– Counterparties can predict which contracts will be within scope – foreseeable


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ESMA’s 2013 Equivalence Assessments

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On 3 September 2013, ESMA delivered its first technical advice to the Commission on the equivalence of six jurisdictions (US, Japan, Australia, Hong Kong, Singapore, Switzerland) for the purposes of EMIR. Further reports were published by ESMA on 2 October 2013.

EMIR – Status of Equivalence Assessments

16Regional Legal and Regulatory Issues 16

CCPs Trade repositories Article 13 EMIR

US Conditional equivalence Conditional equivalence Partial/conditional equivalence

Japan Conditional equivalence PostponedNot yet equivalent for risk mitigation. Conditional equivalence for clearing.

AustraliaEquivalence except ASX equities clearing

EquivalenceNot yet equivalent for risk mitigation. Conditional equivalence for clearing.

Hong Kong Conditional equivalencePremature to give advice due to absence of rules

Premature to give advice due to absence of rules

Singapore Conditional equivalence Conditional equivalence Not planned

Switzerland Equivalence Not plannedPremature to give advice due to absence of rules

Canada Not planned Not planned Not yet equivalent

India Conditional equivalence Not planned Not planned

South Korea Conditional equivalence Not planned Not planned

Rest of world Not planned Not planned Not planned

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ISDA EMIR Protocols / Documents

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Pros Cons

Public

Restrictions on withdrawal

Inflexible

Efficient

Market standard solution

No requirement to negotiate

EMIR – ISDA Protocols / Documents

Multilateral contractual amendment mechanism

Market participants can adhere to an ISDA Protocol (even if they are not an ISDA member)

Ongoing discussions with counterparties in APAC


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ISDA EMIR Documents

Standard Amendment Agreement for Timely Confirmations (March

2013)

2013 EMIR NFC Representation

Protocol (March 2013)

2013 EMIR Portfolio Rec, Dispute Res and Disclosure Protocol

(July 2013)

EMIR – ISDA Protocols / Documents (continued)


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EMIR – ISDA Standard Amendment Agreement for Timely Confirmations


■ Article 11(1)(a) – “the timely confirmation…of the terms of the relevant OTC derivative contract”

What aspect of EMIR does it

address?

■ It adds additional provisions to the Schedule of your ISDA Master Agreement with your counterparty

What does this document amend?

■ Each “Relevant Confirmation Transaction” needs to be confirmed by the “Timely Confirmation Deadline”

What obligation(s) does this document

create?

■ “Documenting Party” vs “Receiving Party”

■ Negative affirmation

What elections do I need to make?

■ Changing from Event of Default to Additional Termination Event

What should I be aware of?

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EMIR – ISDA 2013 EMIR NFC Representation Protocol

NB: AS AT 7 JANUARY 2014, THERE ARE 1,316 ADHERING PARTIES


■ Your classification as a NFC+ or NFC- under EMIR

What aspect of EMIR does it

address?

■ Clearing■ Timing of

confirmations■ Frequency of

portfolio reconciliation

■ Daily valuation

Why is it important to distinguish

between NFC+ and NFC-?

■ A representation of your status

■ Delivery of “change of status” notices

What obligation(s) does this document

create?

■ NFC+ vs NFC- vs No representation

■ Notice delivery method


■ Consequence of breach of NFC representation

■ Balancing Payments


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EMIR – ISDA 2013 EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Protocol

NB: as at 7 January 2014, there are 8,416 adhering parties

NB: ISDA Standard Amendment Agreement – 2013 EMIR Portfolio Reconciliation, Dispute Resolution and Disclosure Form


■ Article 11(1)(b) – “formalised processes…to reconcile portfolios” and “to identify disputes between parties…and resolve them”

■ Article 9 – “details of any derivative contract…reported to a trade repository”

What aspect of EMIR does it address?

■ “Portfolio Data Sending Entity” – provide portfolio data

■ “Portfolio Data Receiving Entity” – perform data reconciliation

■ Resolution of disputes■ Confidentiality waiver

What obligation(s) does this document create?

■ “Portfolio Data Sending Entity” vs “Portfolio Data Receiving Entity”

■ Business Day election


■ No Event of Default or Termination Event

■ Two Portfolio Data Receiving Entities

■ Dispute Notice■ Limitations of

confidentiality waiver


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Status of HK OTC Derivatives Reforms

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* Joint consultation conclusions on the proposed regulatory regime for OTC derivatives market in Hong Kong.** Supplemental consultation on the OTC derivatives regime for Hong Kong – proposed scope of new/expanded regulatory activities and regulatory oversight of systemically

important players.

Possible Implementation Timeline for HK Reforms


2013 2014

Q2 Q3 Q4 Q1 Q2 Q3 Q4Q3 Q1Q4 Q1

2012

OTC Clear has RCH status

HKMA/SFC publish joint consultation conclusions*

HKMA/SFC publish supplemental consultation** on scope of new regulated activities (Types 11 + 12) + SIP

Phase 1: Interim reporting

requirement announced

Backloading for interim reporting to

begin August

Drafting subsidiary legislation and public

consultation expected

Mandatory interim reporting began on

9 December

Earliest start date for mandatory reporting and clearing in Hong Kong?

Securities and Futures

(Amendment) Bill published.

First reading at Legco on 10 July

2013

2015

Q2 Q1 Q2 Q3 Q4Q3 Q1Q4 Q1Q3 Q4

Mandatory clearing

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BCBS-IOSCO Final Policy Framework for Margin Requirements for Uncleared Derivatives

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Introduction

BCBS-IOSCO have published a final policy framework setting minimum standards for margin requirements for uncleared derivatives “Margin requirements for non-centrally cleared derivatives” (September 2013) published by the Basel Committee on Banking

Supervision (BCBS) and the International Organisation of Securities Commissions (IOSCO)

Follows first and second consultation documents published by BSBS-IOSCO in July 2012 and September 2013 (the second consultation document included the results of a quantitative impact.study)

Response to G20 Cannes November 2011 declaration calling for BCBS-IOSCO to develop standards on margin for uncleared derivatives

BCBS-IOSCO to create monitoring group to work during 2014 Monitoring group will evaluate the standards, focusing on relation and consistency of standards with other initiatives including:

changes to trading book and counterparty credit risk. potential minimum haircuts for repos/reverse repos, implementation of the liquidity coverage ratio and capital requirements for central cleared derivatives

Further analysis of costs and benefits and overall efficiency and appropriateness of regime, including macroeconomic impact

Possible areas for review include:

– Possible alignment of the model and standardised schedule approaches for calculating initial margin;

– Guidance on validation and backtesting of models for margining;

– Risks of not subjecting the fixed physically settled FX transactions associated with the exchange of principal of cross-currency swaps to the initial margin requirements (and possible adjustments to this exception)

Likely next steps EU: ESAs to consult on regulatory technical standards setting margin requirements for financial counterparties and non-financial

counterparties over the clearing threshold under EMIR for endorsement by the Commission

US: CFTC, SEC and prudential regulators continue to consider margin requirements under the Dodd-Frank Act for swap dealers and major swap participants


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BCBS-IOSCO Final Margin Framework: Universal Two-way Margin System

*Margin transfers can be subject to a minimum transfer amount not exceeding €500,000


Zero threshold for variation margin*

■ All covered entities engaging in uncleared derivatives must exchange on a bilateral basis full amount of variation margin (i.e. zero threshold) on a regular basis (e.g.daily)

■ Start date 1 December 2015

Maximum €50 million threshold for initial

margin*

■ All covered entities engaging in uncleared derivatives must exchange on a bilateral basis initial margin with a threshold not to exceed €50 million

■ Threshold applies at level of consolidated group to which the threshold is being extended and is based on all uncleared derivatives between the two groups (groups choose how to allocate among group entities)

■ Start date 1 December 2015, but phased in over period to 1 December 2019 starting with largest users■ At the end of phase-in, a consolidated group will have to have a minimum level of OTC derivatives business (at least

€8 billion total gross notional value) in order to be subject to initial margin requirements

Covered entities

■ All financial entities and systemically important non-financial entities (defined by national rules)■ Excluding sovereigns, central banks, multilateral development banks and BIS■ National discretion to exclude inter-affiliate transactions■ Foreign branches of banks subject to home or host state rules. Group home state supervisor may choose to

recognise .margin regime applicable to foreign subsidiaries if equivalent

Covered transactions

■ All non-centrally cleared derivatives entered into between covered entities■ Exclude physically settled FX forwards and swaps but these are included in calculating trigger levels for phase in of

initial margin requirements and national discretion for supervisory guidance/rules on variation margin■ Initial margin for cross-currency swaps do not apply to the fixed physically settled exchange of FX principal

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The revised framework makes a number of significant changes to the proposals in the second consultation document including:


Main Changes from Second Consultation

1 The framework sets a revised start date for the new regime (1 December 2015, instead of 1 January 2015)

2 Exemption for physically settled FX forwards and swaps (but national regulators may implement variation margin standards by supervisory guidance or national regulation) but these transactions count towards thresholds determining application of initial margin requirements

3 Initial margin requirements for cross-currency swaps do not apply to the fixed physically settled FX transactions associated with exchange of principal of cross currency swaps (but other cash flows must be subject to initial margin requirements)

4 The requirements will cover transactions indirectly cleared through a CCP and intermediated through a broker unless the non-member customer is subject to the CCP’s margin requirements or provides margin consistent with the CCP’s margin requirements

5 De minimise minimum transfer amounts for margin transfers must not exceed €500,000 (previously €100,000)

6 Managed funds to be considered separate entities outside consolidated group for the purposes of the €50 million initial margin threshold which applies to groups on a consolidated basis. National discretion to exclude public sector entities from margin regime

7 Firms may only rehypothecate or reuse buy-side customer (and not sell-side) initial margin for the purposes of hedging the firm’s exposures to customers and subject to conditions that protect the customer’s rights to the collateral (and ensure only one-time reuse of collateral)

8 Branches of legal entities may be subject to the margin rules of the entity’s home state or the requirements of the host country

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Objectives of Margin

1 Objectives of margin requirements for non-centrally cleared derivatives:

Reduction of systemic risk: reduce contagion and spillover effects from counterparty default plus broader macro-prudential benefits of reducing pro-cyclality and limiting build-up of uncollateralised exposures

Promotion of central clearing: margin requirements should reflect higher risk of uncleared trades

International consistency: needed to avoid undermining effectiveness of national regimes and competitive disparities

2 Proposals favour margining over capital:

Margin is “defaulter-pay” on a counterparty default, where capital is “survivor-pay”.

Margin is more targeted and dynamic taking into account risks of losses from a particular portfolio and is adjusted over time, where capital is shared collectively and is more likely to be depleted and is less easy to adjust (also capital requirements are not designed to be sufficient for the default of a particular counterparty, rather reflect a probability of default).

Therefore, margin offers enhanced protection against counterparty default if accessible at time of need and capable of being liquidated quickly.

But potential benefits must be weighed against the liquidity impact resulting from counterparties’ need to provide liquid, high quality collateral, including the impact on market functioning from aggregate demands for that collateral.

3 Revised proposals aim to take account of potential impact on liquidity by:

Allowing use of margin thresholds;

Eligibility of a broad range of eligible collateral;

Phasing–in the requirements over the period to 2019.

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Results of Quantitative Impact Study

QIS based on data from 39 institutions including 19 large internationally active dealers QIS firms have €216 trillion of non-centrally cleared derivatives, representing 75% of global total

Central clearing mandate will reduce gross notionals of uncleared derivatives by 46% Interest rate/equity derivatives expected to have biggest decline (53%, 56%) compared to FX/other asset classes (13%, 21%)

Currently, QIS firms only hold €100bn initial margin against uncleared derivatives Represents 0.03% of gross notional exposure. Initial margin requirements are currently negotiated individually and market practice

varies

Proposals would result in QIS firms holding €558bn initial margin against uncleared derivatives (if extrapolated to whole global market would require €0.7 trillion initial margin) Estimates assume the reduction in portfolios resulting from mandatory clearing and reflect impact of €50m proposed threshold With zero threshold, required margin would increase to €1.3 trillion (or €1.7 trillion for whole global market) Figures assume use of models to calculate margin: under standardised margin schedule figures could be between 6 and 11 times

higher

Bilateral initial margin requirements significantly higher than those required for central clearing Bilateral requirements average about 0.5% of gross notional, compared to 0.1% for centrally cleared transactions (i.e. 5 times) Main reason for higher requirements is lack of multilateral netting that is achieved by central clearing

Requirements represent 8% of QIS firms’ available unencumbered margin eligible assets But this figure increases to 86% of available liquid assets if standardised margin schedule usedNote: All figures are estimates and approximate.


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BCBS-IOSCO Key Principles

1. Appropriate margining practices should be in place with respect to all derivatives transactions that are not cleared by CCPs.

2. All financial firms and systemically important non-financial entities (“covered entities”) that engage in noncentrally cleared derivatives must exchange initial and variation margin as appropriate to the counterparty risks posed by such transactions.

3. The methodologies for calculating initial and variation margin that serve as the baseline for margin collected from a counterparty should (i) be consistent across entities covered by the requirements and reflect the potential future exposure (initial margin) and current exposure (variation margin) associated with the portfolio of non-centrally cleared derivatives in question and (ii) ensure that all counterparty risk exposures are fully covered with a high degree of confidence.

4. To ensure that assets collected as collateral for initial and variation margin purposes can be liquidated in a reasonable amount of time to generate proceeds that could sufficiently protect collecting entities covered by the requirements from losses on non-centrally cleared derivatives in the event of a counterparty default, these assets should be highly liquid and should, after accounting for an appropriate haircut, be able to hold their value in a time of financial stress.

5. Initial margin should be exchanged by both parties, without netting of amounts collected by each party (ie on a gross basis), and held in such a way as to ensure that (i) the margin collected is immediately available to the collecting party in the event of the counterparty’s default; and (ii) the collected margin must be subject to arrangements that fully protect the posting party to the extent possible under applicable law in the event that the collecting party enters bankruptcy.

6. Transactions between a firm and its affiliates should be subject to appropriate regulation in a manner consistent with each jurisdiction’s legal and regulatory framework.

7. Regulatory regimes should interact so as to result in sufficiently consistent and non-duplicative regulatory margin requirements for non-centrally cleared derivatives across jurisdictions.

8. Margin requirements should be phased in over an appropriate period of time to ensure that the transition costs associated with the new framework can be appropriately managed. Regulators should undertake a coordinated review of the margin standards once the requirements are in place and functioning to assess the overall efficacy of the standards and to ensure harmonisation across national jurisdictions as well as across related regulatory initiatives.

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Universal Two-way Margin System

*Margin transfers can be subject to a minimum transfer amount not exceeding €500,000


Zero threshold for variation margin

■ All covered entities engaging in uncleared derivatives must exchange on a bilateral basis full amount of variation margin (i.e. zero threshold) on a regular basis (e.g.daily)

Maximum €50 million threshold for initial margin

■ All covered entities engaging in uncleared derivatives must exchange on a bilateral basis initial margin with a threshold not to exceed €50 million

■ Threshold applies at level of consolidated group to which the threshold is being extended and is based on all uncleared derivatives between the two groups

■ Up to each group how to allocate the threshold between different entities in the group■ At the end of phase-in, a consolidated group will have to have a minimum level of OTC derivatives business (at least

€8 billion total gross notional value) in order to be subject to initial margin requirements

Minimum transferamount

■ Margin transfers can be subject to a minimum transfer amount not exceeding €100,000

Dispute resolution ■ Parties should have rigorous and robust dispute resolution procedures

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Margin Amounts and Methodologies


Initial Margin

Designed to reflect potential future exposure of a transaction Required amount of initial margin may be calculated by reference to either (i) a quantitative portfolio margin model or (ii) a standardised margin

schedule Quantitative portfolio margin model

– Models must be approved by the appropriate supervisory authority and be subject to an appropriate governance process– For purposes of informing the initial margin baseline, the potential future exposure of a non-centrally-cleared derivative should reflect an

extreme but plausible estimate of an increase in the value of the instrument that is consistent with a one-tailed 99 percent confidence interval over a 10-day horizon, based on historical data that incorporates a period of significant financial stress

– Subject to approval by the relevant supervisory authority, netting may be performed within well-defined asset classes (such as currency/rates, equity, credit and commodities), subject to being covered by an enforceable netting agreement, but not across such asset classes

Standardised margin schedule Initial margin calculated as a percentage (2% – 15% depending on asset class) of notional exposure Allowed to reduce the gross notional initial margin for derivatives subject to enforceable netting using the net-to-gross ratio used for regulatory

capital purposes Can exclude transactions which do not give rise to any counterparty risk (e.g. sold options)

Variation Margin

For the purpose of informing the variation margin baseline, the full net current exposure of the non-centrally-cleared derivative must be used Netting may be performed across all non-centrally-cleared derivatives under the same netting agreement

National Supervisory Discretion

BCBS-IOSCO recognise that national supervisors may wish to alter margin requirements to achieve macroprudential outcomes, such as preventing build up of leverage and balance sheet expansion

Considering possible macroprudential add-on or buffer on top of baseline or minimum requirements

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Phase-in of Requirements


From 1 December:

Trigger level for consolidated groups

2015 €3 trillion

2016 €2.25 trillion



2019 onwards €8 billion

Note: based on total gross notional value of uncleared derivatives of the consolidated group (including FX forwards and swaps).

Variation Margin

Requirement to exchange variation margin between covered entities applies from 1 December 2015

Initial Margin

Aim is to ensure that larger and most systemically risky firms are subject to initial margin requirement at an earlier stage

Requirement to exchange two-way initial margin with a threshold of up to €50 million staged phased in from 1 December 2015 to 1 December 2019

In each year, covered entities will be subject to requirement if total gross notional value of uncleared derivatives of their consolidated group is over the specified trigger level

From 1 December 2019 a permanent exclusion from requirement applies for covered entities if gross notional value of uncleared derivatives of their consolidated group is below trigger level of €8 billion

Trigger levels calculated by averaging month-end positions of the consolidated group for June, July, August preceding relevant 1 December

A covered entity subject to the initial margin requirement is only required to exchange initial margin with other covered entities also subject to that requirement

Regulators to work to ensure sufficient transparency as to which entities are and are not subject to the requirement

Comments sought on whether phase-in is appropriate

Rules Apply Prospectively

Margin requirements apply to new transactions entered into after specified dates (and may also apply if existing transactions amended to extend the contract for the purpose of avoiding margin requirements)

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EU Resolution Planning

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Bank Recovery and Resolution Directive (RRD)

– Crisis Management Directive (CMD)

Parameters agreed 27 June 2013 by ECOFIN

Final compromise text published 19 December 2013

National legislation by year end

Member state compliance by 1 January 2015

Bail in provisions by 2018

The EU Status of Implementation of RRD/CMD

Regional Legal and Regulatory Issues 36Clifford Chance

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Objectives and Principles


Objectives (avoid destruction of value, minimise cost of resolution)

Ensure continuity of critical functions

Avoid significant adverse effects on financial stability

Protect public funds

Protect depositors and investors

Protect client funds and assets

Principles

Shareholders bear first losses

Creditors bear losses after shareholders in order of priority of claims

Senior management is generally replaced

Former members of management shall provide necessary assistance

Senior management are made liable for their individual responsibility

Except where otherwise provided, creditors of same class treated equitably

No creditor incurs greater loss than in insolvency proceedings

Principles

Objectives

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Key Elements of Directive


Res

olut

ion P

reparation

Early intervention

Recovery and resolution planning

Resolvability assessments

Regulators’ powers to address or remove impediments to resolvability

Intra-group financial support agreements

Harmonised objectives and triggers

Common set of resolution tools (sale, bridge bank, asset separation, bail-in)

European system of financing arrangements

Triggered by failure/likely failure to meet authorisation conditions

Regulators’ powers to direct remedial action

Power to appoint special manager

1

23

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Resolution Tools


Bridge institution Bail-inAsset separationSale of business

Transfer of shares or all/ part of assets/ liabilities to purchaser on commercial terms

Transfer of all/ part of assets/ liabilities to asset management vehicles(s) controlled by public authorities

Aim to maximise value by sale or ensure orderly wind down

Can only be used with other tools

Power to write-down eligible liabilities (or convert to shares) to (re)capitalise an institution or bridge institution

Mandatory write down of capital instruments

Transfer of all/ part of assets/ liabilities to a bridge institution

Bridge controlled by public authorities, aim to sell within two years

Additional tools and powers at Member State discretion:If do not obstruct effective group resolution and consistent with resolution objectives/principles

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Bail-in of Loss Absorbing Capital

40Regional Legal and Regulatory IssuesUpdate on Bank Capital

Aim of Bail in proposal

Contrast with contingent capital: Co

Co’s

No absolute requirement

to issue “bail-in bonds”

Lessen likelihood of tax payer intervention

Exercise of statutory power, not a contractual trigger

Co Co’s have clear objective triggers

Bail in relies on Regulator’s discretion

Co Cos based on going concern trigger

Bail in based on resolution authorities determination of non-viability

LAC requirement may be fully met with Tier 1 and Tier 2

National resolution authorities to set requirements

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Triggers for Tier 1 Capital

Article 51 states that a trigger event occurs when the Common Equity Tier 1 capital ratio of the institution falls below a minimum of 5.125%

Terms of instrument may specify a higher level or one or more additional triggers

Recent example of BBVA banks set out the following 4 trigger events

– The CET ratio is less than 5.125%

– The Capital Principal Ratio is less than 7%

– The EBA CT 1 Ratio is less than 7%

– The Tier 1 ratio is less than 6% and the Bank/Group has reported losses for last 4 quarters with result that capital and reserves have been reduced by 1/3rd more.

Also BBVA had a non-viability trigger

Now seeing non-viability in Asia deals

– Who is determining?

– How is it being determined?


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Hong Kong Consultation on Resolution

Joint consultation by Financial Services and the Treasury Bureau, the Hong Kong Monetary Authority, the Securities and Futures Commission and the Insurance Authority

Two-stage consultation process

Responses by 6 April 2014 for first stage

Broad issues to determined

– Resolution authority?

– Home/host/branches

– Scope and balance of requirements for Hong Kong

– FMIs

– Bail-in provision

– Pre-emption, stays and early termination


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EU Central Securities Depositories (CSD) Reform

Common status:

EU presidency annoucement in December 2013

Preliminary political agreement with EU parliament

Full text for agreement in 2014

Implementation 2015

Timed with Target 2-securities initiatives

Scope and impact

Improve settlement of securities

Trading under MiFID2 (OTFs etc)

Avoid settlement fails

Regulation of CSDs

Common EU approach for authorisation and supervision


Clifford Chance

EU Central Securities Depositories (CSD) Reform (continued)

Regulation of CSDs

competent authority and regulation

Supervision and organisational requirements

Conduct

Management of legal, operational and other risks

Capital requirements

Conflict of laws

Will it improve legal certainty issues?

Will they be included?


Clifford Chance

EU Central Securities Depositories (CSD) Reform (continued)

On-going Access

With securities issuers

Between depositories

With other FMIs

Restrictions from carrying out other businesses?

Cross-border impact

Passporting

Recognition of 3rd countries

Registration

Transition timeline


Clifford Chance

A key focus of G20 and policy makers globally post financial crisis

Securities financing integral to shadow banking debate

EU – Regulation of Shadow Banking

46

SFTs – perceived risks – ‘run risk’ due to procyclical

nature of SFTs– high levels of (sometimes

hidden) leverage– rehypothecation concerns –

who owns collateral when a counterparty defaults?

– Contagion risk - high degree of connectedness between banking and shadow banking sectors


Clifford Chance

Financial Stability BoardShadow Banking Policy for SFTs


Two ‘workstreams’ focusing on SFTs: WS3 and WS5 WS5 proposals – to make the securities financing markets more

robust e.g. enhanced transparency, improvements to market structure etc.

WS5 consulting on minimum standards for haircut methodologies and numerical haircut floors

WS3 (‘other shadow banking entities’) focus on risky activities,

– primarily short term funding e.g. SFTs

– policy tools – imposing bank like regulatory capital requirements (liquidity buffers, leverage limits, large exposures limits, restrictions on types of liabilities held)

Implementation date unknown – will depend on national implementation

47

Clifford Chance

EU Regulation on Reporting and Transparency of SFTs


29 January 2014 – Commission proposed regulation on reporting transparency of securities financing transactions

Scope

– Parties to securities financing transactions or financing structures with equivalent economic effect

– UCITS managers and investment companies

– AIFMs

– Parties to rehypothecation arrangements Implementation – unknown at present

48

Clifford Chance

EU Regulation on Reporting and Transparency of SFTs – Key Features

All SFTs to be reported to a central repository Detailed reporting on SFT activity by investment funds (including

UCITS and AIFs) Prior risk disclosure and express written consent required before any

rehypothecation of assets


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MiFID2 / MiFIR


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Why the New Legislation?


Response

Scheduled review of 2003 MiFID1

Implementation of G20 agenda

Enhancing the single rulebook

Response to market developments

MiFID2 / MiFIR

EnhanceImplement

Review

Clifford Chance

Wide Ranging Changes to Existing Rules

Markets rules

Market structure

Platform trading obligation

Pre- and post-trade

transparency

Transaction reporting

Data service providers

Algorithmic trading


Other changes

Third country

Extended business conduct

Product intervention

GovernanceCommodity derivatives

Clifford Chance

Structure of the Legislation


Recast Markets in Financial Instruments Directive (MiFID2) Scope: instruments, services, exemptions Authorisation, controllers, governance,

passporting, branches of third country firms Organisational and conduct of business rules Obligations of MTFs, OTFs, regulated markets Commodity derivatives position limits,

management, reporting Data reporting services providers Regulatory powers Reviews, reports

Markets in Financial Instruments Regulation (MiFIR) Definitions Pre- and post-trade transparency and waivers Platform trading obligations for shares and OTC

derivatives Transaction reporting Clearing of derivatives on regulated markets Access issues Cross-border business by third country firms Product/practices intervention powers ESMA position management powers

Delegated/implementing acts (regulations or directives): Drafted and adopted by Commission following advice from ESMARegulatory/implementing technical standards (regulations): Drafted by ESMA and endorsed by the Commission

Lev

el 1

Lev

el 2

National implementation: Primary or secondary legislation, regulatory rules Penalty regimes

ESMA guidelines and ESMA/Commission FAQs

Lev

el 3

Clifford Chance

MiFID2/MiFIR: Expected Timeline


Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2Q1

2014 2015

Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2Q1

2016 2017 2018

Publication in Official Journal and

in force

National transposition

deadline

New rules begin to apply

24 months 6 months

ESMA delivers draft RTS/ITS to

Commission

12 months 6 months

Notes: Legislation in force 20 days after publication in Official Journal Commission may request ESMA to provide advice on delegated

acts in advance of draft RTS/ITS Very limited transitional provisions Market Abuse Regulation (MAR) expected to be published at

same time and to apply from 24 months after it comes into force

Consultation on national

implementation

ESMA consults on advice/RTS/ITS

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Clients

Systems

Documentation and compliance

Non-EU impact

Strategy

Implementation Challenges


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MiFID2 – Market Structure

Clifford Chance

Market Structure

* “trading venues”


Regulated Markets (RMs)

Multilateral Trading Facilities (MTFs)

Multilateral*

Systematic internalisers (SIs)

OTC

Bilateral

MiFID1

Regulated Markets (RMs)

Multilateral Trading Facilities (MTFs)

Multilateral*

Organised Trading Facilities (OTFs)

Systematic internalisers (SIs)

OTC

Bilateral

MiFID2Key changes:

New trading venue – OTFs

SIs wider in scope

Trading pushed on venue or SI

Align RM and MTFs

Clifford Chance

Key Definitions


Multilateral

RMs and MTFs

a multilateral system... which brings together … multiple third-party buying and selling interests in financial instruments – in the system and in accordance with non-discretionary rules – in a way that results in a contract

OTFs (new)

any system or facility, which is not a regulated market or MTF, ... in which multiple third-party buying and selling interests in financial instruments are able to interact in the system in a way that results in a contract

Multilateral system

any system or facility in which multiple third parties buying and selling trading interests in financial instruments are able to interact

Bilateral

SIs

an investment firm which, on an organised, frequent and systematic basis, deals on own account by executing client orders outside a regulated market or an MTF or an OTF(note likely change to implementing acts)

OTC transactions

no definition in compromise text

Clifford Chance

Market Structure Under MiFID2

1. Non-equities only; 2. Publicly available information


RMs MTFs OTFs1 SIs OTC

Operator Exchange Exchange or Firm Exchange or Firm Firm Firm

Non-discretion’y execution Yes Yes No Where quotes

binding No

Conduct of business rules No No Yes Yes Yes

Operator can use own capital No No No Yes Yes

Access to facilities

Transparent, non-discriminatory rules, objective

criteria

Transparent , non-discriminatory rules, objective

criteria

Transparent, non-discriminatory rules, objective

criteria

Commercial policy (in objective, non-

discriminatory way)Commercial policy

Admission to trading

Clear, transparent rules (+ other

criteria)

Transparent rules (+ adequate PAI2)

Transparent rules (+ adequate PAI2) N/A N/A

Resilience, circuit breakers, tick size Yes Yes Yes No No

Surveillance required (MAR) Yes Yes Yes No No

Clifford Chance

Market Structure Under MiFID2 (continued)

1. Non-equities only


RMs MTFs OTFs1 SIs OTC

Pre-trade transparency

Yes (incl. non-equities)

Yes (incl. non-equities) Yes Yes (incl. non-

equities) No

Pre-trade waiver available


Yes (incl. non-equities) Yes No N/a

Post trade transparency


Yes (incl. non-equities) Yes Yes (incl. non-

equities)Yes (incl. non-

equities)

Publish execut’n quality data Yes Yes Yes Yes No

Eligible OTC derivs platform Yes Yes Yes No No

Authorities can suspend trading Yes Yes Yes Yes Yes

Record orders Yes Yes Yes No No

Clifford Chance

Fixed Income and Derivatives Markets Transparency

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Liquidity definition (Art 2 (7a) MiFIR)

ESMA RTS to calibrate waiver and deferral regimes

Keyvariables

Bonds and structured products

Emission allowances

Derivatives traded on a trading venue

Firms, SIs, OTFs, MTFs, RMs.

Scope

Transparency Rules for Non-equities


Pre-trade waivers

Post-trade deferral Exemptions

Clifford Chance

Transparency Rules for Non-equities (continued)

(Trading Venues pre-trade) Articles 7 and 8 of MiFIR


Obligations (Art. 7)

All RMs, MTFs, OTFs to publish bid/offer and depth of trading interest

Applies to actionable indications of interest

Continuous basis during normal trading hours

Give access to publication arrangements on reasonable commercial terms and non-discriminatory basis to firms subject to Art. 17

Waivers (Art. 8)

Granted by NCAs following ESMA opinion

1. Orders large in scale relative to normal market size

2. Indications of interest in RFQ and voice trading systems above a specific size that would expose liquidity providers to undue risk

3. Derivatives not subject to trading obligation / other instruments without liquid market.

NCA can temporarily suspend the Art. 7 obligation if liquidity drops (3 month rolling period)

ESMA RTS to cover variables (size and liquidity thresholds)

Clifford Chance


(Trading Venues post-trade) Articles 9 and 10 of MiFIR


Obligation (Art. 9)

Publish price, volume and time of trade

As close to real-time as reasonably possible

Give access to publication arrangements on reasonable commercial terms and non-discriminatory basis to firms subject to Art. 20

Deferral (Art. 10)

Granted by NCAs following ESMA opinion

1. Orders large in scale relative to normal market size

2. No liquid market

3. Size of trade would expose liquidity providers to undue risk

Limited publication during deferral period / volume omission during extended deferral period possible

NCA can temporarily suspend the Art. 9 obligation if liquidity drops (3 month rolling period)

ESMA RTS to specify what data to be published and conditions/criteria for deferral

Clifford Chance


(OTC and SIs pre-trade and post-trade) Articles 17 and 20 of MiFIR


Pre-trade

SIs must publish firm quotes for liquid instruments and make those quotes available to other clients.

Undertaking to transact with other clients to whom quote made available where trade below a specified size.

SIs can set non-discriminatory limits on number of transactions per quote.

No Art. 17 obligation if trade above specified size threshold (Art. 8 threshold)

Post-trade

SIs must publish volume and price of trades at time concluded via APA

Scope and time limits for deferral (and temporary suspension of obligation) analogous to Art. 9 and 10 (deferred publication, limited publication, volume omission, etc.)

ESMA RTS will specify disclosable data and application of the obligation in securities financing context

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Derivatives Execution and High Frequency Trading

Clifford Chance

Derivatives – Mandatory Trading Obligation


In order to become subject to mandatory trading, derivatives must be: Admitted to trading on at least one

relevant trading venue;

Sufficiently liquid

ESMA to take into account anticipated impact on liquidity of relevant derivatives and commercial activities of end users

ESMA also to consider whether derivatives only sufficiently liquid in transactions below a certain sizeMust be traded only on:

Declared subject to mandatory venue trading obligation

Regulated market MTF OTF

Equivalent third country

market

OTC derivative subject to the clearing obligation under EMIR

Not an intragroup transaction under

Article 3 EMIR

Not subject to transitional provisions under Article 89 EMIR

Clifford Chance

Mandatory Trading Process


“Bottom up” process

Class of OTC derivatives is declared subject to mandatory clearing under EMIR

ESMA consults on whether to impose mandatory trading on that class or a subset of that class

ESMA proposes draft regulatory technical standards (RTS) to Commission within fixed period after adoption of RTS on clearing under EMIR

Mandatory trading may be phased-in for some counterparty types

“Top down” process

Where a class of OTC derivatives has not been declared subject to mandatory trading

ESMA shall regularly monitor activity in those derivatives to identify cases where this may pose systemic risk and to prevent regulatory arbitrage

ESMA shall, on its own initiative, identify and notify to the Commission derivatives that should be subject to the trading obligation but which no CCP is authorised to clear under EMIR or which are not admitted to trading.

Clifford Chance

Derivatives – Mandatory Trading Obligation (2)


Must be traded only on:

Declared subject to mandatory venue trading obligation

Regulated market MTF OTF

Equivalent third country

market

OTC derivative subject to the clearing obligation under EMIR

Not an intragroup transaction under

Article 3 EMIR

Not subject to transitional provisions under Article 89 EMIR

Effective equivalent recognition for EU trading venues in relation to derivatives;

Commission decision that there are equivalent legally binding requirements:

– Authorisation and supervision; – Venue has clear and transparent

rules on admission to trading; – Issuers are subject to periodic

information requirements; – Market abuse rules

Commission decision only for purposes of determining eligibility as a trading venue for these purposes, and may be limited to a category or categories of trading venues.

Clifford Chance

Who is Subject to Mandatory Trading?

Note: Exemption for duplicative or conflicting obligations.

Treatment of entities exempt under Article 1(4) or 1(5) EMIR?


EU Non-EU

FC or NFC+

FC or NFC+

FC or NFC+

Third country financial

institutionor

TCE

TCE TCE

OTC derivative

OTC derivative

OTC derivative

Only if transaction has a direct, substantial and foreseeable effect in the EU or if necessary or appropriate to prevent evasion

Where possible and appropriate, ESMA’s technical standards shall be identical to those under EMIR

FC = financial counterpartyNFC+ = non-financial counterparty over the EMIR clearing thresholdTCE = non-EU entity which would have been subject to the trading obligation if established in the EUThird country financial institution = non-EU entity authorised to carry on any of the activities listed in BCD, MiFID 2, Solvency II, UCITS, IORPs, AIFMD

Clifford Chance

Definition of “algorithmic trading” cross refers to MiFID

Market manipulation definition now expressly refers to algorithmic or high frequency trading strategies

Interaction with MAR /

MAD2

Algorithmic trading

High frequency algorithmic trading techniques

Direct electronic access (DMA / sponsored access)

What is algorithmic

trading?

Algorithmic Trading


Systems and controls, business continuity

Notify competent authorities (competent authorities may request further details)

Record keeping obligations

Liquidity provision obligation where market making

Effective systems and controls regarding DMA / sponsored access

Obligations on investment

firms

Clifford Chance

Conduct of Business – Third Country Firms

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Branch Regime(Articles 41-46 MiFID2)


■ If a branch is required, member states must impose:

– criteria for authorisation

– Compliance with MiFID conduct of business rules

Criteria for authorisation

■ Member states may require TCFs to establish branches when providing services to retail or elective professionals

■ Alternatively, member states can allow such services to continue to be provided on the basis of existing member state rules

Scope

■ Some member states may require branches for retail and elective professional services

■ Current UK position – preserving the status quo?

PracticalImpact

Clifford Chance

Cross-border Regime(Articles 36-45 MiFIR)


■ Registration by ESMA is contingent on equivalence decision

■ Reciprocity by third country also required

Equivalence

■ TCF must register with ESMA to provide services on a cross-border basis

■ OR if TCF has established a MiFID2 branch, it can provide services to eligible counterparties and per se professionals across member states on the basis of the rules applicable to that branch (subject to equivalence decision – see below)

■ Limited to services to eligible counterparties and per se professionals

Registration with ESMA

■ Member state rules will continue to apply for three years after an equivalence decision has been reached

■ After three years, ESMA-registered TCFs can provide services to eligible counterparties and per se professionals throughout member states on the basis of their home state rules

Effect ofequivalence

decision

Clifford Chance

APAC OTC Reform status slides [to be included in March set]


Clifford Chance

Contact


PartnerPaget Dare Bryan

T: +852 2826 2459

[email protected]

E:

Worldwide contact information 36* offices in 26 countries

* Clifford Chance’s offices include a second office in London at 4 Coleman Street, London EC2R 5JJ. ** Linda Widyati & Partners in association with Clifford Chance.

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