2014 was an active year for financial regulation in the EU with a push to finalize much of the outstanding primary legislation on the regulatory reform agenda in advance of the European Parliamentary elections in May 2014. This resulted in the adoption of many EU Regulations and Directives in the first half of the year. There is still, however, some outstanding legislation still going through the EU legislative process, and much of the legislation that has been adopted envisages further legislation and regulation in the form of delegated regulations to be adopted by the EU Commission comprising technical standards to be drafted by the European Supervisory Authorities (the “ESAs”)1. We have set out below the likely key areas of activity during 2015.
Derivatives Reporting. The European Market Infrastructure Regulation (“EMIR”), providing for the regulation of derivatives in the EU, has been in force since 2012 but many of the key provisions are only now beginning to come into effect. Rules requiring reporting of derivative transactions to trade repositories started to be phased in from February 2014 and are now largely implemented. There were, however, some difficulties in implementation of the rules which represented a logistical and administrative challenge for many market participants. Many of these issues have now been resolved, but in November 2014 ESMA proposed various changes to the relevant technical standards to seek to resolve certain issues. It is therefore likely that there will be some technical amendments to the derivatives reporting regime in early 2015.
Derivatives Clearing. Provisions in EMIR requiring the central clearing of many OTC derivatives are not yet in operation, but the implementation process is well underway. In 2014 ESMA published a number of draft technical standards setting out the initial classes of derivatives it proposes be subject to the clearing obligation, including many vanilla interest rate derivatives, credit derivatives referencing certain untranched credit indices and some non-deliverable fx forwards. ESMA proposes a phase-in for the clearing obligation based on four categorizations of counterparties with the largest and most active market participants being required to clear first. Category 1 entities will be required to clear transactions six months after the date the applicable technical standards come into force, which means such entities are likely to be subject to the clearing obligation for relevant derivatives from around August 2015.
Derivatives – Collateralization of Uncleared Transactions. In April 2014, the ESAs published technical standards on risk mitigation techniques for the collateralization of uncleared derivatives transactions. The proposals included the collection of both variation margin during the life of the transaction and initial margin upon inception of the trade. Assets provided as collateral are subject to eligibility criteria. Once received, margin must be segregated from proprietary assets of the relevant custodian, and initial margin cannot be rehypothecated. The collateralization of uncleared trades will be phased in from December 1, 2015, although only the largest market participants (those trading non-centrally cleared derivatives in excess of €3 trillion in monthly aggregate notional amount) will initially be subject to the rules. All counterparties trading such derivatives in excess of €8 billion will be subject to the requirements by December 2019.
MiFID II. MiFID II is the overhaul of the Markets in Financial Instruments Directive and comprises a Regulation (“MiFIR”) and recast Directive. It came into force in August 2014 but does not become effective until January 2017. ESMA is due to publish many draft technical standards during 2015, including in relation to provisions relating to investor protection, market infrastructure, exchange trading of derivatives and pre and post-trade transparency requirements for bonds, structured finance instruments and derivatives traded on a trading venue. ESMA published a Consultation Paper and a Discussion Paper in July 2014 outlining its initial views, and a second consultation paper is expected in December 2014.
PRIIPs. The Regulation on key information documents (“KIDs”) for packaged retail and insurance-based investment products (“PRIIPs”) comes into force on December 29, 2014, although it does not become effective until December 2016. When a person is advising on or selling a PRIIP to retail investors, a pre-contract KID must be provided to the investor. The Regulation contains detailed requirements as to the form and content of the KID. In November 2014, the ESAs released a joint discussion paper setting out their thoughts as to the presentation and content of each element of the KID content and other matters including the methodology underpinning the presentation of risk and reward. The ESAs are expected to publish a consultation on draft technical standards and a further technical discussion paper during 2015.
Benchmark Regulation. The use of benchmarks in financial transactions has been in focus in recent years following alleged misconduct in relation to the setting of LIBOR and other financial benchmarks. In July 2013, the International Organization of Securities Commissions (“IOSCO”) published principles for financial benchmarks, and in September 2013 the EU Commission published a draft regulation in relation to indices used as benchmarks in financial instruments and contracts, which seeks to impose various obligations on benchmark administrators, contributors and users.
Administrators located in the EU will be subject to authorization and supervision by their competent authorities and be subject to detailed governance and reporting requirements. The legislative process will continue into 2015, and there are likely to be considerable efforts to finalize the Regulation during the year.
BRRD / Bail-in. Under the Bank Recovery and Resolution Directive (the “BRRD”), unsecured structured notes and other structured products issued by a bank will be liable to be written off or converted into equity instruments by a national resolution authority if the bank enters into resolution. Such authority will also be able to terminate and close out derivatives contracts of an EU bank as part of the resolution process and bail-in the resulting net liability. These concepts are consistent with the “Key Attributes of Effective Resolution Regimes for Financial Institutions” updated by the Financial Stability Board (“FSB”) in October 2014. Surprisingly, the FSB has proposed that structured notes will not be counted towards the required minimum levels of bail-inable liabilities that it recommends a global systemically important bank must maintain. There is likely to be further discussion on this issue into 2015.
Structural Banking Reform. Based on the current proposed form of the EU Bank Structural Reform Regulation, the structured products and related activities of in-scope entities should not constitute prohibited proprietary trading, due to their connection to actual or anticipated client activity. However, in-scope entities that accept insured deposits will remain subject to the possibility of being forced to separate off structured products or other activities, if their national competent authority decides that the activities pose a threat to the financial stability of the institution or the EU financial system as a whole. The draft Regulation is still in the early stages of the EU legislative process and is subject to further debate and negotiation during 2015.
Banking Reform Act in the UK. In the UK, it looks likely that a ring-fenced bank (broadly, a bank engaging in significant non-institutional deposit-taking) will not be permitted to sell structured products or derivatives unless they fall within a specified range of hedging transactions for customers. In addition, it seems that neither their subsidiaries, nor their parent companies will be able to engage in such activities, and banking groups that contain a ring-fenced bank will need to engage in these activities through “sibling” entities. These proposals are controversial and likely to be subject to further debate into 2015. The ring-fence will not come into force until 2019, but banks are already planning the transition to the new regime.
AIFMD. The Alternative Investment Fund Managers Directive (“AIFMD”) came into effect in July 2013 and governs the management and marketing of alternative investment funds (“AIFs”) by Alternative Investment Fund Managers (“AIFMs”) in the EU. Non-EU AIFMs marketing one or more AIFs to professional investors in an EU country are currently required to comply with that country’s AIFMD implementing legislation irrespective of the domicile of such AIFs. However, such non-EU AIFMs cannot benefit from the AIFMD marketing passport across the EU until the European Commission implements delegated legislation extending the passporting regime to non-EU AIFMs (following a positive opinion from ESMA). This is expected to be in place by the end of 2015 but until then non-EU AIFMs can only actively market AIFs to professional investors in the EU in accordance with the relevant national private placement regime.
Financial Transactions Tax. Despite lack of support for an EU-wide financial transactions tax (“FTT”), 11 Member States2 are proceeding with proposals to harmonize legislation on the indirect taxation of financial transactions with a tax of 0.1% on all transactions relating to financial instruments other than derivatives which will attract a tax rate of 0.01% on the notional amount of the transaction. The UK challenged the proposals based upon, among other things, their potential extraterritorial effect but this was rejected by the European Court of Justice, at least for the time being. The legislative process somewhat stalled during 2014 but the EU Council indicated in November 2014 that work will be intensified amongst the relevant member states during 2015. Further legislative proposals are likely sometime in the New Year.
UCITS V. The UCITS V Directive came into force in September 2014, and EU member states have until 18 March 2016 to transpose it into their national laws. It makes various changes to the existing UCITS Directive, principally seeking to make provisions relating to depositaries and remuneration rules for management companies more consistent with those applicable to AIFs under the AIFMD. A number of delegated acts and technical standards must be adopted by the EU Commission, and ESMA has published technical advice, including in relation to insolvency protection of the assets of a UCITS when the depositary has delegated safekeeping duties to a third party and the requirements on the management company and depositary to act independently. The EU Commission is likely to finalize the delegated acts during 2015.