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Italian Securities Exchange Commission Announces Market Practice on Liquidity Contracts

Latham & Watkins LLP

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European Union, Italy May 6 2019

Latham & Watkins operates worldwide as a limited liability partnership organized under the laws of the State of Delaware (USA) with affiliated limited liability partnerships conducting the practice in the United Kingdom, France, Italy and Singapore and as affiliated partnerships conducting the practice in Hong Kong and Japan. Latham & Watkins operates in Seoul as a Foreign Legal Consultant Office. The Law Office of Salman M. Al-Sudairi is Latham & Watkins associated office in the Kingdom of Saudi Arabia. Under New York’s Code of Professional Responsibility, portions of this communication contain attorney advertising. Prior results do not guarantee a similar outcome. Results depend upon a variety of factors unique to each representation. Please direct all inquiries regarding our conduct under New York’s Disciplinary Rules to Latham & Watkins LLP, 885 Third Avenue, New York, NY 10022-4834, Phone: +1.212.906.1200. © Copyright Friday, May 3, 2019 6:22:29 PM Latham & Watkins. All Rights Reserved.

Latham & Watkins Capital Markets Practice May 3, 2019 | Number 2496

The measure is intended to align market practice with the principles laid down under the

European market abuse regulation.

Per visualizzare questo Client Alert in italiano, fare clic qui.

The Italian Securities and Exchange Commission (Commissione Nazionale per le Società e la Borsa, or

Consob):

ï‚· Approved the new accepted market practice on liquidity contracts

ï‚· Ordered the termination of market practices on the purchase of own shares to set up a share

warehouse position and for the buyback of bonds at predetermined conditions, as of June 30, 2019

ï‚· Announced the issuance of guidelines to regulate the set-up of share warehouse positions and bond

buybacks, which will no longer benefit from market practice safe harbor provisions

This Client Alert outlines the main steps Consob has taken to reform market practices, focusing on the

key features of the new accepted market practice on liquidity contracts (New Practice No. 1) as well as on

the main differences vis-Ã -vis Practice No. 1 previously in force.

Introduction

The market abuse provisions introduced by Regulation (EU) No 596/2014 (MAR) and Directive

2014/57/EU (MAD2) provide for an exemption from sanctions in case a transaction breaches the general

prohibition of market manipulation for transactions carried out for legitimate reasons and in line with

accepted market practices (AMPs) established by national competent authorities (NCAs). NCAs are

required to update the respective national AMPs adopted under formerly-in-force Directive 2003/6/EC

(MAD1), in accordance with the newer European framework.

On April 8, 2019, Consob, in its capacity as Italian NCA, notified the European Securities and Markets

Authority (ESMA) of New Practice No. 1 to enable ESMA to issue its assessment of the compatibility of

the new Italian AMP with the MAR1 provisions.

New Practice No 1 was notified following the conclusion of a public consultation procedure launched in

September 2018 regarding the proposal to amend the formerly-in-force market practices (the

Consultation), and in light of the comments some Italian market participants shared with Consob

(including Latham & Watkins, by letter dated October 22, 2018) in response to the Consultation.

Under MAD1, Consob established three market practices:

ï‚· Practice No. 1: relating to liquidity contracts

ï‚· Practice No. 2: relating to the purchase of own shares to set up a share warehouse position

ï‚· Practice No. 3: relating to the buyback of bonds at predetermined conditions

Practice No. 1 and Practice No. 2 were adopted in 2009,2 followed by Practice No. 3 in 20123 (together,

the Practices).

Following the Consultation, Consob updated and replaced Practice No. 1 with New Practice No. 1,

notified this new practice to ESMA, and ordered that both Practice No. 2 and Practice No. 3 be terminated

as of June 30, 20194. Therefore, starting from June 30, 2019, the purchase of own shares to set up a

share warehouse position and the buyback of bonds at predetermined conditions will no longer benefit

from the MAR safe harbor provisions applicable to transactions carried out in accordance with AMPs.

The Temporary Application of the Practices

On September 9, 2016, and November 4, 2016, Consob notified ESMA of its intention to temporarily

retain in force5 the Practices6, pending the completion of its ongoing revision process aimed at aligning

such Practices with the principles laid down under MAR. In light of the foregoing, ESMA suspended its

review of the Practices notified by Consob for the purpose of issuing the compatibility opinion that the

European Authority should have issued within two months from receiving the notification.

Therefore, the Practices were retained in force, pending amendments, for more than two and a half years,

until completion of the Consob revision process (which occurred in April 2019).

The Consultation

In December 2016, ESMA published a document providing common criteria addressed to NCAs (Points

for Convergence or Opinion)7 to facilitate the convergence of the national AMPs on liquidity contracts —

governed, in Italy, by Practice No. 1 — with the aim of promoting a uniform application of the principles

laid down under MAR8.

On September 21, 2018, Consob launched the Consultation regarding, among other things, the

amendments required to align Practice No. 1 with the Points for Convergence and, more in general, with

the principles laid down under MAR.

Consob also proposed to terminate Practice No. 2 and Practice No. 3, following the concerns raised by

ESMA’s Market Integrity Standing Committee regarding the integrity of the market as well as the

compatibility of those practices with the new legal framework on market abuse. Consob additionally

pointed out that, over the years, issuers had rarely used Practice No. 3.

Termination of the shares warehouse position and bond buyback market practices (Practice No. 2 and Practice No. 3)

In the course of the Consultation, market participants (including Latham & Watkins) pointed out to Consob

the opportunity to retain in force Practice No. 2 in light of the fact that the practice is widely used by listed

companies; indeed, Practice No. 2 represents a useful tool to achieve purposes not otherwise covered by

the safe harbor provision provided by Article 5 of MAR, but which are justified by the need to ensure

market integrity, such as in the case of purchase of own shares in the context of certain M&A

Latham & Watkins May 6, 2019 | Client Alert Number 2496 | Page 3

transactions. This specific aspect was highlighted by Consob in its explanatory report on the results of the

Consultation issued on April 8, 2019 (the Explanatory Report).

In light of the criticisms expressed by ESMA on the retention of Practice No. 2 and also due to the fact

that none of the other NCAs have established similar practices, Consob ordered its termination, together

with Practice No. 3, as of June 30, 2019. In particular, the Italian Authority did not accepted the requests

received during the course of the Consultation to extend such term (June 30, 2019) for the benefit of

listed companies whose ordinary shareholders’ meetings have already been called to approve the

authorization to purchase own shares in accordance with Article 2357 of the Italian civil code and

pursuant to Practice No. 2 for a period subsequent to the termination of Practice No. 2 or to listed

companies that have already passed any such resolution.

In its Explanatory Report, Consob clarified that companies will still be able to operate substantially in line

with the operating procedures and purposes provided by the terminated market practices (even if they

can no longer benefit from the market practices’ safe harbor provisions following termination of Practice

No. 2 and Practice No. 3), by complying with the obligations set out in the Italian domestic regulations

(i.e., the obligation to disclose the purchase of own shares in line with the provisions set forth in

Schedule 3F of Regulation No 11971/1999).

Consob announced the release of guidelines to regulate the set-up of share warehouse positions and

bond buybacks at predetermined conditions in order to provide companies and investment firms with an

operative tool to help them continue to operate while reducing the risk of market manipulation.

Liquidity support activities according to New Practice No. 1

In line with Practice No. 1, New Practice No. 1 provides that issuers interested in supporting the liquidity

of their own shares may appoint an intermediary, on the basis of a contract, to independently carry out

liquidity support activities to facilitate trading activities and with the purpose to avoid misalignments

between price movements and market trends.

In performing the liquidity support activities, the intermediary shall:

ï‚· Act independently

 Have no access to issuers’ inside information

ï‚· Ensure that such activity is not affected by other interests, including those relating to the performance

of investment services

The remuneration of the appointed intermediary shall be structured so that it does not incentivize the

intermediary to influence prices or trading of the financial instruments.

The appointed intermediary shall close the open positions as soon as practicable, thus avoiding the

extension over time of the market liquidity conditions and of the comparison between current market

prices and the book value of the trading positions9.

Key features of New Practice No. 1

Distinction between “liquid†and “Illiquid†financial instruments

As recommended by the Points for Convergence, the New Practice No. 1 introduces different limits in

terms of resources that may be allocated to the performance of liquidity contracts and the number of

shares that may be purchased and sold by the intermediary, depending on whether the liquidity contract

refers to issuers of liquid or illiquid financial instruments.10

Latham & Watkins May 6, 2019 | Client Alert Number 2496 | Page 4

In particular, instead of the 2% limit on the value of the issued financial instruments set out in Practice

No. 1, New Practice No. 1 provides that the overall resources that may be allocated in terms of liquidity

and/or financial instruments must not exceed:

ï‚· For liquid financial instruments, 200% of the average trading volume associated to a resources cap of

maximum €20 million

ï‚· For illiquid financial instruments, 500% of the average trading volume, or 1%11 of the outstanding

issued financial instruments calculated as of the opening of the start of the liquidity support activities

associated to a resources cap of maximum €1 million

According to the Points for Convergence, NCAs shall on a voluntary basis be entitled to introduce in their

AMPs on liquidity contracts the distinction between issuers of liquid, illiquid, and “highly liquid†shares,

corresponding — in Italy — to the issuers listed on the FTSE MIB index. However, it is worth noting that

Practice No. 1 has been rarely applied by Italian issuers included in such group.

In light of this and of the inputs that most participants (including Latham & Watkins) provided to Consob

during the course of the Consultation , the Italian Authority introduced in New Practice No. 1 the only

distinction between issuers of liquid and illiquid financial instruments, without providing for any additional

special provision for issuers of “highly liquid†financial instruments.

Reference period for the calculation of the average trading volume

The reference period for the calculation of the average trading volume for the purpose of defining the

resources that can be allocated for liquidity support activities is 30 days.12

According to the Italian Authority’s intentions, such a timeframe — which is in line with the timeframe set

forth for stabilization transactions pursuant to Article 5 of Commission Delegated Regulation (EU)

No 1052/2016 — should foster the recourse to liquidity contracts by issuers who have been admitted to

trading for only one month.

In response to the Consultation, on one side our firm recognized the adequacy of the 30-day timeframe

introduced while at the same time expressing concern about the fact that a fixed time limit might

discourage the recourse to that measure if not backed up by a residual (and exceptional) provision

allowing for the application of different terms whenever market conditions do not permit to usefully apply a

general 30-day term.

In its Explanatory Report, Consob expressly acknowledged our request for flexibility and, therefore, set

out that, wherever the 30-day period does not apply,13 the issuer may refer to any different period,

provided that such term is prior to the launch of the liquidity support activities.

Remuneration of the intermediary appointed by way of the liquidity contract

New Practice No. 114 specifies that the fixed component of the remuneration of the intermediary must

prevail over the variable component, if any, which in any event must not exceed 15% of the total

remuneration.

Such a remuneration mechanism is aimed at ensuring the independence of the intermediary with respect

to the issuer’s interests and at discouraging any trading activities not strictly required.

Operational limits

New Practice No. 1 sets forth the following limits in term of volumes exchangeable by intermediaries on a

daily basis:

Latham & Watkins May 6, 2019 | Client Alert Number 2496 | Page 5

ï‚· For liquid financial instruments, 15% of the daily average trading volumes in the preceding 20 trading

days

ï‚· For illiquid financial instruments, 25% of the daily average trading volumes in the preceding 20 trading

days

Such percentage values shall be calculated as the sum of all sale and purchase transactions carried out

against the total number of trades, and not independently15 as provided for by Practice No. 1. No

derogations are allowed.

Performance of liquidity contracts during auction phases

New Practice No. 1 introduces restrictions with respect to transactions carried out during auction phases16

with the aim of avoiding that the placed orders impact the final price of the auction itself and of granting to

the other participants enough time to react. In particular:

ï‚· For purchase transactions, the price of the trade proposals must be lower than the theoretical auction

price

ï‚· For sale transactions, the price of the trade proposals must be higher than the theoretical auction

price

Block trades

In line with Practice No. 1, New Practice No. 1 does not cover block trades.

ESMA’s Points for Convergence allow NCAs to introduce the possibility to carry out block trades in certain

exceptional circumstances. During the course of the Consultation, Consob considered this option, but the

Italian Authority thought it preferable to retain, as a conservative measure, the prohibition set forth under

the previous regime, considering that block trades may allow the extension of long positions on financial

instruments, thus enhancing market prices and potentially entailing the manipulation thereof.

Transparency

In addition to the information required under Practice No. 1, both issuers and intermediaries are required

to provide the following:

ï‚· Prior to the start of the liquidity support activities, the issuer must disclose to the public, among

others, whether the financial instruments fall within the category of liquid or illiquid instruments, the

markets where the liquidity support activities will be performed, the duration of the liquidity contract,

and the conditions that may determine the suspension or termination of the activity

ï‚· During the performance of the liquidity support activities, the intermediary must disclose, within the

first 15 days of the month following the end of each quarter, among other things, details of the daily

activities carried out during the relevant quarterly period by means of the form provided by Consob on

its website.

The issuer must produce the relevant publication on a quarterly basis and send the communication to

Consob by certified email (PEC).

Conclusion

Consob’s interpretation of the guidance provided by ESMA in its Opinion is substantially in line with the

purpose of ensuring the uniform application of the principles laid down in Article 13 of the MAR with

Latham & Watkins May 6, 2019 | Client Alert Number 2496 | Page 6

respect to the choices made by other Member States that already comply with the new regulatory

framework. Moreover, Consob gave great importance to the specific features of the Italian domestic

market to facilitate (compared with Practice No. 1) the recourse to liquidity contracts by issuers listed on

the FITSE MIB index and by newly listed SMEs.

The indications arising from the use of New Practice No. 1 over the coming months will help demonstrate

whether market participants recognize the full worth of the measures introduced by Consob or whether

the level of detail, including with respect to the EU measures, will discourage the recourse to liquidity

contracts for the benefit of other instruments fulfilling similar purposes that had greater success (i.e.,

specialist contracts). Consob’s efforts to provide clarification in outlining the operational limits for

intermediaries are, however, remarkable.

Particularly useful are the guidelines the Authority provided in response to the market participants’

concerns about termination of Practice No. 2, which has been broadly used over the years by Italian-

listed companies to set up share warehouse positions, including for purposes not covered by MAR’s safe

harbors but equally deserving protection. At the same time, Consob showed remarkable commitment to

provide the market participants with guidelines to continue to operate while reducing the risk of abuse in

the absence of an accepted market practice.

Latham & Watkins May 6, 2019 | Client Alert Number 2496 | Page 7

If you have questions about this Client Alert, please contact one of the authors listed below or the Latham

lawyer with whom you normally consult:

Antonio Coletti [email protected] +39.02.3046.2061 Milan

Maria Cristina Storchi [email protected] +39.02.3046.2044 Milan

Isabella Porchia [email protected] +39.02.3046.2078 Milan

Marco Bonasso [email protected] +39.02.3046.2055 Milan

You Might Also Be Interested In:

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Italy Approves Regulatory Provisions Implementing Market Abuse Regulation

Client Alert is published by Latham & Watkins as a news reporting service to clients and other friends. The information contained in this publication should not be construed as legal advice. Should further analysis or explanation of the subject matter be required, please contact the lawyer with whom you normally consult. A complete list of Latham’s Client Alerts can be found at www.lw.com. If you wish to update your contact details or customize the information you receive from Latham & Watkins, visit http://events.lw.com/reaction/subscriptionpage.html to subscribe to the firm’s global client mailings program.

Endnotes

1 Pursuant to Article 13(3), (4) and (5) of the MAR, NCAs are required to notify their intention to establish a new AMP to ESMA at

least three months before such AMP is intended to take effect. Such notification shall provide the details of the assessments

made by the NCA on the possibility of establishing the new market practice. Within two months following the receipt of the

notification, ESMA shall issue an opinion assessing the compatibility of the practice with the market abuse provisions. ESMA

shall also assess whether the establishment of the AMP would not threaten the market confidence in the Union’s financial

market. Where a NCA establishes an AMP contrary to the opinion of ESMA, it shall publish on its website within 24 hours of

establishing the AMP a notice setting out in full its reasons for doing so.

2 See Resolution No 16839 of March 19, 2009.

3 See Resolution No 18406 of December 13, 2012.

4 See Resolution No 20876 of April 3, 2019.

5 Pursuant to Article 13(11)(2) of the MAR.

6 Besides Consob, NCAs in France, Spain and Portugal notified ESMA of their intention to retain in force a number of AMPs on

liquidity contracts established prior to the entry into force of MAR.

7 ESMA’s Opinion sets out, among other things, that: (i) AMPs should provide for the liquidity contract to be entered into in a written

form, (ii) the person performing the liquidity contract should be a supervised firm providing investment services and executing

the contract as member of the relevant trading venue, (iii) AMPs should gradate between liquid and illiquid instruments (and, if

relevant, highly liquid instruments), (iv) AMPs should set forth trading conditions for the performance of liquidity contracts in

terms of price limits, volume limits, requirements to operate during tender phases without impacting the final price of the tender.

Latham & Watkins May 6, 2019 | Client Alert Number 2496 | Page 8

8 Following the disclosure of ESMA’s Opinion, the NCAs in France, Spain and Portugal aligned their respective market practices and

notified such practices to ESMA. Upon obtaining the favorable opinion of the European Authority, those AMPs entered into force

in the relevant Member States.

9 The scope of this provision is to avoid that liquidity contracts will turn into instruments to enhance financial instruments’ price

(instead of their liquidity). Moreover, trading of predetermined volumes of financial instruments at predetermined prices with

selected counterparties shall not be permitted.

10 See Paragraph 7 of New Practice No 1.

11 The 1% limit shall be calculated at the beginning of the day in which the activity is initiated and shall be updated upon each

significant variation of the issued financial instruments.

12 France adopted the same reference timeframe.

13 For example, to suspend the financial instrument from trading or admitting it to trade on a different market segment characterized

by a lower liquidity.

14 See Paragraph 14.

15 In order to clarity how such mechanism operates, Consob provided the following example in its consultation document dated

September 21, 2018: “if, therefore, the intermediary carries out purchase transactions on illiquid instruments amounting to 20%

of the average trades, such intermediary may not carry out sale transactions in excess of 5% of that same average value;

whereas, in accordance with current practice (editor’s note: i.e., Practice No 1), it may reach 25%â€.

16 See Paragraphs 17-bis and 18-bis.

This article is made available by Latham & Watkins for educational purposes only as well as to give you general information and a general understanding of the law, not to provide specific legal advice. Your receipt of this communication alone creates no attorney client relationship between you and Latham & Watkins. Any content of this article should not be used as a substitute for competent legal advice from a licensed professional attorney in your jurisdiction.

Latham & Watkins LLP - Antonio Coletti, Maria Cristina Storchi, Isabella Porchia and Marco Bonasso
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