EUROPEAN FINANCIAL & REGULATORY DEVELOPMENTS INTO 2017
"There are greater storms in politics than you will ever find at sea. Piracy, broadsides, blood on the decks. You will find them all in politics."
David Lloyd George, British Prime Minister, 1916-1922
"The greater the difficulty the more glory in surmounting it. Skillful pilots gain their reputation from storms and tempests"
Charting New and Dangerous Waters
Lloyd George and Epictetus may be long gone but their words have much resonance with the events of 2016. The political fallout from the UK's vote to leave the European Union ("EU") was immediate and brutal and Lloyd George's words above could have been written for the events in the UK in the aftermath of the vote. Prime Minister David Cameron resigned immediately. Theresa May became the new UK Prime Minister after a short and dramatic Conservative Party leadership election contest, following which she swiftly sacked Chancellor of the Exchequer George Osborne and appointed Boris Johnson, not known for his diplomatic turn of phrase, as UK foreign secretary (days after he had withdrawn from the leadership race after a spectacular falling out with his fellow Brexit supporter Michael Gove). In the subsequent months, the new UK government has had to plot a course for the UK to negotiate its exit from the EU, regarded by many commentators as likely to be one of the most complex political and trade negotiations ever attempted. And this in a continuing febrile political environment with many Brexit supporters suspicious that the UK government will strike a deal with the EU that will neuter the effect of Brexit, many businesses and financial institutions concerned that a "hard" Brexit could result in a swift loss of access to the EU single market and many EU politicians keen that a hard line should be taken against the UK in negotiations to deter other member states from leaving. Financial markets, initially stunned by the result, reacted with the pound losing 15% of its value against the dollar (falling to a 30-year low), but they have subsequently stabilised although the potential for future volatility remains acute.
As if that wasn't enough, the election in November of Donald Trump to the Presidency of the United States shocked not only the political establishment in the US but almost the entire world. Again, despite some initial jitters, financial markets have remained relatively stable in the aftermath of his election but considerable uncertainty surrounds the direction of the new administration with President-elect Trump having made inconsistent statements on the stump, at times espousing protectionist views on trade whilst calling for less financial regulation and greater fiscal stimulus. We should have more clarity on some of these issues in the coming months.
Despite the uncertainty caused by the events of 2016, we can surely add the ongoing development of global financial regulation to Benjamin Franklin's two certainties of death and taxes. However, the direction of travel is perhaps now more uncertain than it has been for a while. We highlight below some of the uncertainties within the EU caused by the Brexit vote in the UK. Whilst the impact of the forthcoming Trump presidency in the US on the Dodd-Frank Act and other relevant financial regulation in the US is outside the scope of this memorandum, European regulators and legislators will keep a very close eye on the new administration's approach on financial regulation as the position becomes clearer. As we set out in more detail below, the EU has also undertaken a review on the impact of new regulation since the onset of the financial crisis and this may result in some changes to certain aspects of EU regulation. Also, looking at the political landscape, there are major presidential and governmental elections in a number of important jurisdictions in 2017 including France, Germany and the Netherlands. With populist parties growing in importance in all these elections, the outcomes will be keenly awaited.
That said, few in the EU are expecting a dramatic change in the global approach to financial regulation in the foreseeable future, and it would be a major surprise if there were a significant deviation from the coordinated approach of recent years, spearheaded primarily by the G20 group of nations ("G20"), the Basel Committee for Banking Supervision ("BCBS") and the Financial Stability Board ("FSB"). Therefore, for the most part, our expected developments for 2017 as set out below are a continuation of the development of rules and regulations that have already been many years in the making. However, if there has been one lesson of the last 12 months, it is that nothing is certain and the potential for further surprises remains.
In this guide we set out our summary of the principal areas of financial regulation and other important events impacting on financial regulation that have impacted markets over the recent past, as well as how we see these areas developing in 2017 and beyond.
TABLE OF CONTENTS
1. Brexit......................................................................................................................... 4 2. EMIR Implementation................................................................................................ 5 3. MiFID II Implementation............................................................................................ 8 4. PRIIPS Implementation ............................................................................................ 10 5. EU Benchmark Regulation....................................................................................... 11 6. Capital Markets Union............................................................................................. 12 7. PD III (Prospectus Regulation)................................................................................. 13 8. EU Securitisation Regulation ................................................................................... 15 9. BRRD Implementation ............................................................................................. 16 10. TLAC/MREL............................................................................................................. 17 11. SRM Regulation ....................................................................................................... 20 12. CRD IV/Basel III ...................................................................................................... 21 13. UK Ring-fencing ...................................................................................................... 24 14. Possible EU Banking Reform ................................................................................... 26 15. AIFMD ..................................................................................................................... 27 16. Shadow Banking ...................................................................................................... 29 17. MAR/MAD II Implementation .................................................................................. 32 18. Possible New Covered Bond Framework................................................................ 33 19. UCITS ...................................................................................................................... 34 20. EU Deposit Insurance Regulation ............................................................................ 35 21. PSD II....................................................................................................................... 36 22. EU Consultation in Relation to Combined Impact of Financial Regulation .............. 38 23. Final Thoughts ......................................................................................................... 40
On 23 June 2016, the UK voted in referendum to leave the EU. This outcome was generally a surprise to the financial markets and gave rise to immediate market volatility, particularly in relation to the pound, which fell heavily in value against the euro and dollar. The vote, however, has no immediate effect. The UK currently remains a member of the EU, and existing EU-derived laws and regulations continue to apply to the UK. To commence its exit from the EU, the UK government has to serve notice of its intention to leave under Article 50 of the EU Treaty. The UK then has two years to negotiate the terms of its exit with the EU. If no agreement is reached, then at the end of this period (assuming no extension is agreed), the UK will automatically leave the UK and its trading relationship with the EU will default to World Trade Organisation ("WTO") rules. The UK Prime Minister, Theresa May, has indicated her intention that the Article 50 notice be served by the end of March 2017. The UK Supreme Court is currently considering whether such notice can be served by the UK government under its Royal Prerogative or whether the approval of the UK Parliament is necessary. The Supreme Court's decision is expected in early 2017 but, whatever the outcome, it is not expected to have a major impact on the timing of service of the Article 50 notice.
There is considerable uncertainty as to the nature of the UK's relationship with the EU following its exit. In particular, it is currently unclear the extent to which the UK will seek, and the terms on which it will be able to agree, access to the EU single market for goods and services once it leaves the EU. Having regard to the importance of the financial services industry to the UK and the importance of London as an international financial centre, banks and other financial institutions are already considering carefully the potential implications of Brexit and, in many cases, seeking to consult with the UK government on the impact of the various options for the UK to leave the EU.
We will not consider in detail here the potential options for the future relationship between the UK and the EU. However, it currently seems unlikely that the UK will seek to remain in the European Economic Area ("EEA") (made up of the current 28 EU members plus Norway, Liechtenstein and Iceland). Although this option would enable the UK to retain access to the EU single market, it would continue to be bound by much existing EU law (including being bound to the free movement of people across the EEA) and continue to contribute to the EU budget, both of which were major issues for Brexit supporters. Although Theresa May has, as yet, given very little in the way of detail as to what the UK will seek from the Brexit negotiations, she has indicated the UK is likely to seek a bespoke arrangement, different from any current arrangement between the EU and any non-member state.
One of the key areas for banks and financial services firms currently located in the UK is the extent to which, following Brexit, the UK will be able to continue to benefit from the "single passport" for financial services that operates within EU member states, whereby a firm that obtains authorisation to carry out a particular financial activity or service in one EU member state can carry out that activity or service in other member states without further authorisation. In reality, there is no single EU passport for financial services, but the matter is dealt with separately in relation to each piece of relevant legislation.
Assuming the UK will not remain in the EEA, it seems unlikely that it will be able to maintain its current position in relation to passporting. There are, however, other options that could be sought in the Brexit negotiations. Many pieces of relevant EU financial services legislation enable firms located in non-EU jurisdictions to perform relevant services and activities, often on a pan-European basis, where the EU Commission has determined regulation in the entity's home jurisdiction to be equivalent to relevant rules in the EU. Although such determinations have so far taken considerable time, the UK is in a unique position since, as at the immediate point of exit, EU law will form part of UK law and therefore be, as a matter of fact, equivalent. It should not be controversial for the UK to maintain the bulk of EU financial regulation then in force as much of it derives from international accords and G20 agreements, and the UK has had an important role in the development of much existing EU law in this regard. However, not every piece of EU financial regulation includes
equivalence arrangements, including legislation relating to the provision of financial services to retail investors and new proposed rules relating to securitisation.
Having regard to their importance to the UK economy, the regulation of financial services is expected to form a central element of the negotiations with the EU. Other free trade agreements entered into by the EU, including with Canada and South Korea, took many years to negotiate and did not cover financial services in any detail, so it seems unlikely that a comprehensive arrangement can be reached between the EU and the UK in two years. An interim arrangement where the EU Commission provides an immediate equivalence determination where it can, and transitional arrangements are agreed in other fundamental areas, is more realistic. Many banks and financial institutions have already sought to persuade the UK government of the benefit of interim arrangements of this nature and in December 2016, the Chancellor of the Exchequer, Phillip Hammond, indicated that such an arrangement made sense. The issue is, however, politically sensitive, and many Brexit supporters are pushing for a "clean break" from the EU at an early stage.
It remains unclear how much transparency the UK government will be prepared to give in advance of serving the Article 50 notice as to what relationship it will seek with the EU after Brexit. It is equally unclear to what extent and on what terms the rest of EU will be prepared to negotiate continued access for the UK to the EU single market. The position is not helped by the fact that the French presidential election and German parliamentary election (amongst other elections in EU member states) will take place during 2017 and the outcome of these elections will undoubtedly have an impact on the dynamics of the Brexit negotiations.
2. EMIR Implementation
The European Market Infrastructure Regulation ("EMIR")1 regulating derivatives transactions in the EU entered into force on 16 August 2012. However, much of the relevant rule-making under EMIR needs to be introduced by technical standards through delegated legislation. Although this process is well under way, some aspects of EMIR are still in the process of being introduced and this will continue into 2017 and beyond. Two areas in particular that are still not or are only just in the process of being implemented are the provisions for mandatory clearing of derivatives and the margining requirements for OTC derivative transactions that are not subject to central clearing.
One of the central limbs of EMIR is the requirement for mandatory central clearing for derivatives entered into by financial counterparties and certain significant non-financial counterparties ("NFCs+"), subject to the European Securities and Markets Authority ("ESMA") mandating that a particular class of derivative should be subject to such requirement. The first regulatory technical standards ("RTS") on clearing interest rate swaps2 provide for mandatory clearing of the following:
fixed-to-floating (plain vanilla) swaps denominated in Euro, GBP, JPY and USD;
float-to-float (basis) swaps denominated in Euro, GBP, JPY and USD;
forward rate agreements denominated in Euro, GBP and USD; and
overnight index swaps denominated in Euro, GBP and USD.
1 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32012R0648&from=EN 2 Commission Delegated Regulation (EU) 2015/2205, http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:32015R2205.
The RTS divide market participants into categories in order to ensure the most active market participants are required to clear first, and Category 1 and 2 counterparties became subject to the obligation during 2016. The phase-in schedule is as follows:
21 June 2016 - Category 1: counterparties that are clearing members of an authorised CCP.
21 December 2016 - Category 2: financial counterparties and alternative investment funds ("AIFs") that belong to a group that exceeds a threshold of EUR 8 billion aggregate monthend average outstanding gross notional amount of non-centrally cleared derivatives.
21 June 2017 - Category 3: financial counterparties and other AIFs with a level of activity in uncleared derivatives below the threshold of EUR 8 billion aggregate month-end average outstanding gross notional amount of non-centrally cleared derivatives.
21 December 2018 - Category 4: non-financial counterparties above the clearing threshold.
Pursuant to further RTS3 relating to the clearing of interest rate swaps, mandatory clearing will apply from 9 February 2017 for Category 1 counterparties in respect of fixed-to-floating rate interest rate swaps and forward rate agreements denominated in Norwegian krone, Swedish krona and Polish zloty. Category 2 counterparties will be subject to mandatory clearing in respect of such transactions from 9 August 2017, category 3 counterparties from 9 February 2018 and category 4 counterparties from 9 August 2019.
Mandatory clearing of certain credit default swap ("CDS") transactions will also commence in 2017, pursuant to further RTS4. The obligation will apply to untranched index CDS referencing the iTraxx Main and ITraxx Crossover indices with a tenor of five years from 9 February 2017 in respect of Category 1 counterparties. Category 2 counterparties will be subject to mandatory clearing in respect of such transactions from 9 August 2017, category 3 counterparties from 9 February 2018 and category 4 counterparties from 9 August 2019.
An ESMA Consultation Paper5 published in July 2016 considers whether the implementation date for the clearing obligation in respect of financial counterparties in category 3 should be delayed by up to two years for all classes of derivatives above in view of difficulties such counterparties are having in establishing the necessary clearing arrangements. ESMA is likely to revert on this issue during 2017. ESMA confirmed back in 2015 that, for the time being, the clearing obligation will not apply to foreign exchange derivatives. There are also no current proposals to extend the obligation to any classes of equity or commodity derivatives. It is however possible that these areas will be reviewed further in the future.
Risk Mitigation Collateral
Article 11(3) of EMIR requires financial counterparties to adopt procedures with respect to the timely, accurate and appropriately segregated exchange of collateral with respect to non-cleared derivatives. The European Supervisory Authorities ("ESAs") (being ESMA, the European Banking Authority ("EBA") and the European Insurance and Occupational Pensions Authority ("EIOPA")) are required to develop RTS as to the necessary procedures, levels and type of collateral and segregation arrangements. In April 2014, the ESAs published their first joint consultation on draft RTS6 and their second Consultation Paper on draft RTS7 was published in June 2015, which, among
3 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R1178&from=EN 4 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R0592&from=EN 5 https://www.esma.europa.eu/sites/default/files/library/20161125_cp_on_clearing_obligation_for_financial_counterparties.pdf 6http://www.eba.europa.eu/documents/10180/655149/JC+CP+2014+03+%28CP+on+risk+mitigation+for+OTC+derivatives% 29.pdf 7 http://www.eba.europa.eu/documents/10180/1106136/JC-CP-2015002+JC+CP+on+Risk+Management+Techniques+for+OTC+derivatives+.pdf
other provisions, prescribed the regulatory amount of initial and variation margin to be posted and collected, and the methodologies by which that minimum amount would be calculated.
Following a somewhat protracted process, the EU Commission adopted a final draft text of relevant RTS8 (the "Risk Mitigation RTS") on 4 October 2016. The Risk Mitigation RTS only directly affect financial counterparties and NFCs+ that are established in the EU. However, non-EU entities that trade with EU entities that are subject to the margin requirements are likely to be obliged to put collateralisation procedures in place in order to allow their EU-established counterparties to comply with EMIR. The Risk Mitigation RTS require the posting of Initial Margin ("IM") and Variation Margin ("VM"). They also set out the eligibility criteria for assets that may be used as collateral, designed to ensure that the collateral is sufficiently liquid, not exposed to excessive credit, market or FX risk, and it holds its value during times of financial stress.
Collateral collected as IM must be segregated from the other assets of the third party or custodian that is holding it. Counterparties that collect IM are forbidden from re-hypothecating, re-pledging or otherwise re-using the collateral. There are some exemptions from the collateral requirements for transactions below certain financial thresholds and intragroup transactions complying with specified criteria. The Risk Mitigation RTS came into force on 4 January 2017. However, only the largest market participants (those trading non-centrally cleared derivatives in excess of 3trn in aggregate notional amount) will initially be subject to the rules. By September 2020, all in-scope entities trading such derivatives in excess of 8bn will be subject to the requirements.
Other aspects of EMIR and the EC Commission Report
Other provisions of EMIR that had been largely implemented prior to 2016 included trade reporting requirements for all counterparties (including non-financial counterparties ("NFCs") to derivative transactions and risk mitigation measures (other than margining) in respect of uncleared derivatives. On 23 November 2016, the EU Commission published a Report9 to the European Parliament and the EU Council of Ministers that recommended a number of changes in relation to EMIR.
In particular, the Report notes that NFCs are, due to limited resources and experience, facing significant challenges in complying with relevant provisions of EMIR, and it is considered that it may be appropriate to remove such entities from the scope of the operational risk mitigation requirements and to simplify their transaction reporting obligations. The Report also recommends that consideration be given as to whether the clearing and margining requirements should apply to any NFCs based on the volume and type of their activity in derivatives markets. The EU Commission also recognises that small financial counterparties are facing significant challenges in establishing access to clearing facilitates in meeting their obligations to clear relevant derivatives. As mentioned above, ESMA has already proposed postponing the date on which the clearing obligation applies to such entities. ESMA also notes in the Report that certain pension funds currently benefit from an exemption from the EMIR clearing requirements the EU Commission has indicated that it is likely to extend this exemption until August 2018 due to the difficulty such funds would have in meeting variation margin requirements. ESMA suggests further extending this exemption or making it permanent. Following on from this Report, the EU Commission will undertake a legislative review of EMIR in 2017 that will consider the issues raised in more depth and possibly propose relevant amendments to EMIR.
8 https://ec.europa.eu/transparency/regdoc/rep/3/2016/EN/3-2016-6329-EN-F1-1.PDF 9 http://ec.europa.eu/finance/financial-markets/docs/derivatives/161123-report_en.pdf
3. MiFID II Implementation
MiFID II is the commonly-used term for the overhaul of the Markets in Financial Instruments Directive, which originally came into force in 2007. The primary MiFID II legislation comprises a Regulation ("MiFIR")10 and recast Directive11 (together with MiFIR referred to as "MiFID II"). MiFID II was published in the Official Journal (the "OJ") of the EU on 12 July 2014 and entered into force 20 days after that date.
MiFID II was originally due to become effective on 1 January 2017. However, due principally to delays in drafting and finalising a number of the many RTS required to be prepared under MiFID II, legislation was adopted in July 2016,12 delaying the implementation date of MiFID II for a year until 3 January 2018. The deadline for member states to transpose the MIFID II Directive into national legislation was extended to 3 July 2017.
MiFID II will make some fundamental changes to MiFID, including significantly widening the regulatory capture for both financial products and entities within the EU. Structured deposits are now subject to a number of the provisions of MiFID II, and MiFID II extends the scope of many existing provisions to "organised trading facilities" or "OTFs" that will cover many forms of organised trading venues (not being regulated markets or multilateral trading facilities ("MTFs")) on which bonds, structured finance products and derivatives are traded. All derivatives that are subject to the clearing obligation under EMIR, and that ESMA determines to be sufficiently liquid, will be required to be traded on a regulated market, MTF or OTF, and MiFID II extends the pre- and post- trade transparency regime (which currently only applies to shares) to bonds, structured finance instruments and derivatives traded on a trading venue.
In addition, new product governance rules will require manufacturers of financial instruments to undertake a product approval process for each financial product and ensure that each product is designed to meet the needs of an identified target market. Distributors must have arrangements in place to obtain relevant information for products they have not manufactured and to understand the characteristics and identified target market of products they distribute. New rules in relation to inducements will severely limit the circumstances in which firms can pay or be paid fees or commissions by any party other than their client.
Many of the relevant technical standards under MiFID II have now been finalised and adopted. The Commission has published (and maintains) a table13 providing an overview of the RTS and Implementing Technical Standards ("ITS") required under MiFID II and their current status. This includes, where relevant, the date the relevant technical standards were adopted by the EU Commission and the date they were published in the OJ.
Much of the focus during 2017 will be on competent authorities in member states ensuring that they are in a position to ensure compliance with MiFID II from 2018. In the UK, the Financial Conduct Authority ("FCA") is currently consulting on the UK implementation of MiFID II, with a deadline for comments of 4 January 2017. The FCA is expected to publish policy statements on all aspects of MiFID II implementation in the first half of 2017. Member states are required to have transposed MiFID II into national laws by 3 July 2017.
In the UK, the FCA published has published four Consultation Papers in relation to MiFID II implementation. The first published in December 201514 focused on secondary trading of financial
10 Regulation (EU) No 600/2014, http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014R0600&from=EN 11 Directive 2014/65/EU, http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014L0065&from=EN 12 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016L1034&from=EN and http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32016R1033&from=EN 13 http://ec.europa.eu/finance/securities/docs/isd/mifid/its-rts-overview-table_en.pdf 14 https://www.fca.org.uk/publications/consultation-papers/cp15-43-markets-financial-instruments-directive-iiimplementation
instruments including the rules relating to pre- and post-trade transparency. A further paper in July 201615 covered a number of issues, including commodity derivatives, supervision, senior management arrangements, remuneration and the impact of MiFID II on the Client Assets Sourcebook ("CASS"). In September 2016, the FCA published a third Consultation Paper16 that principally covered conduct of business issues. These Consultation Papers propose changes to the UK Financial Services and Markets Act 2000 (the "FSMA")(and relevant secondary legislation) and the FCA Handbook. In relation to amendments to the FSMA, HM Treasury has also consulted on draft statutory instruments to give effect to the necessary amendments and draft statutory instruments have been published in this regard.
In its third Consultation Paper, the FCA deals with requirements in relation to MiFID II "Article 3" firms. Article 3 of MiFID II permits member states to disapply the MiFID II Directive to firms that do not have permission to hold client assets and whose activities are limited to investment advice and reception and transmission of orders (and many UK firms currently benefit from the equivalent opt out under MiFID). MiFID II requires member state rules relating to such entities to be at least analogous to the MiFID II rules relating to authorisation, conduct of business and organisational requirements. In its consultation, the FCA states that it intends to apply certain MiFID II rules directly on such firms to comply with the "at least analogous" requirement. This includes rules relating to best execution and inducements. In relation to inducements, the FCA indicates that it will apply the required restriction on inducements to both restricted and independent advice (only the latter is required to be covered under MiFID II) and will ban the rebating of inducements to retail clients. The FCA also proposes specific rules to deal with the MiFID II exemption from the restriction on inducements relating to research payments that are paid out of an investment firm's own resources or from a separate research payment account complying with certain requirements. The third Consultation Paper sets out some guidance from the FCA as how the research payments exemption should work in practice. In relation to MiFID II's rules relating to product governance, many of these are already similar to FCA guidance. The FCA proposes to replace its existing guidance with binding rules on product governance in a new sourcebook to the FCA Handbook, PROD.
The FCA published its final Consultation Paper in relation to MiFID II governance on 16 December 201617. This relates to provisions in respect of tied agents, market data, SME growth markets and fees. The deadline for responses to the consultation is 17 February 2017 (16 January in respect of the provisions relating to fees). The FCA has indicated that it will publish two Policy Statements in the first half of 2017 (one in March and the second in June) dealing with the matters covered in all four Consultation Papers.
In addition to the FCA consultations, the UK Prudential Regulation Authority ("PRA") has also published two Consultation Papers on MIFID II implementation. The first Consultation Paper18 published in March 2016 focused on passporting and algorithmic trading. It followed this with a Policy Statement19 published in October 2016. The second Consultation Paper20 published in November 2016 considers how the PRA will amend its governance requirements and how it will apply MIFID II rules on management and organisational requirements (including in relation to Article 3 firms). This second consultation is open until 27 February 2017.
15 http://www.bankofengland.co.uk/pra/Documents/publications/cp/2016/cp4316.pdf 16 https://www.fca.org.uk/sites/default/files/cp16-29.pdf 17 https://www.fca.org.uk/publication/consultation/cp16-43.pdf 18 http://www.bankofengland.co.uk/pra/Documents/publications/cp/2016/cp916.pdf 19 http://www.bankofengland.co.uk/pra/Documents/publications/ps/2016/ps2916.pdf 20 http://www.bankofengland.co.uk/pra/Documents/publications/cp/2016/cp4316.pdf
4. PRIIPS Implementation
The Regulation on key information documents ("KIDs") for packaged retail and insurance-based investment products ("PRIIPs")21 ("the PRIIPs Regulation") was due to become effective on 29 December 2016, having come into force in December 2014. This two-year delay was deemed necessary in order to give PRIIPs manufacturers, advisors and sellers sufficient time to prepare for the practical application of the Regulation. However, due to a delay in finalising the RTS setting out the detailed requirements for preparation of the KID, the implementation date has now been delayed until 1 January 2018.
Under the PRIIPs Regulation, when a person is advising on or selling a PRIIP to retail investors, a precontract KID must be provided to the investor prior to any contract being concluded, as the aim is for all KIDs to be comparable side-by-side; for example, the KID must be a `stand-alone' document separate from marketing materials and must be a maximum of three sides of A4. The Regulation contains detailed requirements as to the form and content of the KID, and the order of items and headings should be consistent throughout all of the documentation. The KID must contain all the information which could be material to an investor, such as the nature, risks, costs, potential gains and losses of the product, but must also be short, concise and avoid financial jargon.
The draft RTS were first published by the ESAs in November 2015. They focused, in particular, on the presentation and content of the KID (including methodologies for calculating and presenting risks, rewards and costs), the review, revision and republication of KIDs, and the conditions for fulfilling the requirement to provide the KID in good time. The draft RTS also require each KID to contain a risk indicator scale from 1 to 7 on which PRIIPs must be ranked. The draft RTS also provide that the KID be reviewed by the PRIIP manufacturer at least every 12 months to ensure that it is accurate, fair, clear and not misleading, and that the KID is provided in `good time' so that the investor has time to fully consider it. Following the consultation process, revised draft RTS22 were published by the ESAs on 31 March 2016. The EU Commission adopted the RTS in June 2016 and proposed a draft delegated regulation to give effect to them. A workshop was also held for market participants in July 2016. However, echoing the concerns raised by a number of market participants and trade associations, the EU Parliament subsequently raised a number of issues on the draft RTS including the methodology for the calculation of future performance scenarios and the lack of detailed guidance on how the required "comprehension alert" should be structured. It formally rejected the proposed delegated regulation in September 2016, and the EU Commission subsequently agreed to the delay in the implementation date.
In its revised timetable, the EU Commission has indicated that the ESAs should submit revised RTS to it by the end of 2016, with a view to them being finalised within the first half of 2017. The EU Commission is also expected to issue further guidance on aspects of the PRIIPs Regulation and the RTS during the first half of 2017 in the form of Q&A. Although many market participants were well advanced in preparing their KID templates, the delay is generally welcome in the market. In particular, manufacturers of complex products were concerned with the prospect of the PRIIPs Regulation becoming effective without detailed guidance as to contents of the KID. The delay will give product manufacturers more time to consider fully whether and how the requirements in respect of the KID can be applied in respect of certain products.
21 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014R1286&from=EN 22 https://www.esma.europa.eu/sites/default/files/library/jc_2016_21_final_draft_rts_priips_kid_report.pdf
5. EU 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 indebtedness. In July 2013, the International Organisation of Securities Commissions ("IOSCO") published a Final Report23 on principles for financial benchmarks, and later that year the European Commission published a draft regulation in relation to indices used as benchmarks in financial contracts with the aim of reducing the risk of manipulation by ensuring that benchmark providers in the EU have prior authorisation and are subject to supervision. The subsequent legislative process was lengthy and involved significant amendments to the initial draft. The final regulation (the "Benchmark Regulation")24 came into force on 30 June 2016, although most of its provisions do not become effective until January 2018.
The Benchmark Regulation takes a different approach from existing benchmark regulation in a number of jurisdictions (including the UK) that have focused principally on widely-used benchmarks. Instead, the Benchmark Regulation will apply to a very wide range of indices, including proprietary indices, which are used as benchmarks in a wider range of financial instruments or investment funds. The Regulation requires administrators of benchmarks that are located in the EU to be authorised or registered by their relevant competent authority. Such benchmark administrators are subject to a number of obligations, including governance requirements, oversight function obligations and record-keeping. Additional requirements apply to administrators of commodity and interest rate benchmarks. Benchmarks that are regarded as "critical" (determined by specified criteria, including that the benchmark is used as a reference for financial instruments having a total value of at least 500 billion) are subject to additional requirements, particularly where the administrator of such benchmark intends to cease to provide such benchmark.
The Benchmark Regulation is particularly significant for financial securities sold in the EU, as a supervised entity will only be permitted to "use" a benchmark in the EU (which includes the issuance of a financial instrument referencing a benchmark or determining the amount payable under a financial instrument or contract by reference to a benchmark) if it is provided by an administrator authorised or registered under the Benchmark Regulation. For administrators located outside the EU, the Regulation provides various routes under which they can come within the scope of the Regulation. This will generally require the administrator to be authorised in a jurisdiction with equivalent regulation or to comply with the vast majority of the provisions of the Benchmark Regulation.
In May 2016 (following on from an earlier Discussion Paper), ESMA published a Consultation Paper25 on draft technical advice on the Benchmark Regulation that covered various aspects of the Regulation, including the circumstances in which an index will be regarded as having been made available to the public, measurements for the use of critical and significant benchmarks, and the criteria for the identification of critical benchmarks. ESMA published copies of the responses received to the Consultation Paper in July 2016. It was due to have published its final technical advice to the Commission in relation to the areas covered by the consultation in October 2016. This has not yet been published and is therefore likely to come out some time in early 2017.
ESMA published a further Consultation Paper26 in September 2016 setting out draft RTS in relation to certain aspects of the Benchmark Regulation for which technical standards are required. These include:
procedures, characteristics and positioning of the oversight function;
appropriateness and verifiability of input data;
23 http://www.iosco.org/library/pubdocs/pdf/IOSCOPD415.pdf 24 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R1011&from=EN 25 https://www.esma.europa.eu/sites/default/files/library/2016-723_cp_benchmarks_regulation.pdf 26 https://www.esma.europa.eu/sites/default/files/library/2016-1406.pdf
the code of conduct for benchmark contributors;
information to be provided in applications for authorisation and registration as benchmark administrator; and
procedures for the application for recognition by non-EU administrators.
Responses were due by 2 December 2016. It is expected that ESMA will submit final draft RTS to the EU Commission by April 2017, with a view to these being finalised well in advance of the 1 January 2018 implementation date.
On 11 August 2016, the EU Commission adopted an implementing Regulation that specified EURIBOR as a critical benchmark for the purpose of the Benchmark Regulation.
6. Capital Markets Union
In September 2015, the EU Commission launched its Capital Markets Union ("CMU") Action Plan27, intended to cover the 28 EU member states. The CMU initiative was first suggested in response to concerns that, compared with the United States and other jurisdictions, capital markets-based financing in Europe is fragmented and underdeveloped, with significant reliance on banks to provide sources of funding. For example, compared with the United States, European small and mediumsized enterprises ("SMEs") receive five times less funding from capital markets.
Based on consultations that began in February 2015, the EU Commission has confirmed that, rather than establishing the CMU through a single measure, it will be achieved through a range of initiatives. These will be targeted towards specific sectors, as well as more generally towards the EU supervisory structure, in each case with the aim of removing the barriers that stand between investors' money and investment opportunities. The EU Commission has stated that this is a long term plan, but that it intends to have a fully functioning CMU by 2019.
The following measures have been designated as priorities: providing greater funding choice for Europe's businesses and SMEs; ensuring an appropriate regulatory environment for long-term and sustainable investment and financing of Europe's infrastructure; increasing investment and choice for retail and institutional investors; enhancing the capacity of banks to lend; and bringing down crossborder barriers and developing markets for all 28 member states.
In April 2016, the EU Commission published a Staff Working Document28 giving its first status report on CMU. It notes that work undertaken since the adoption of the Action Plan includes:
work on creating a framework for simple, transparent and standardised securitisations (see further below) to support bank financing of the wider economy and to open up investment opportunities for a wider set of non-bank investors;
to seek to reduce the costs for companies accessing capital markets it has sought to overhaul the legislation relating to prospectuses for offerings of securities (see further below);
it has already sought to boost infrastructure investments by reducing the calibration of capital charges under the Solvency II Regulation for insurance sector exposures to infrastructure projects
27 http://ec.europa.eu/finance/capital-markets-union/docs/building-cmu-action-plan_en.pdf 28 http://ec.europa.eu/finance/capital-markets-union/docs/cmu-first-status-report_en.pdf
and European long-term investment funds. These changes entered into force under a delegated regulation in April 2016;29
the Commission published a Green Paper30 on retail financial services in December 2015, with a view to overcoming barriers to the creation of a deeper single market for financial services;
it launched a consultation on business, restructuring and insolvency in the EU31 (and subsequently, in November 2016, published a Proposal32 for a Directive on preventative restructuring frameworks, second chance and measures to increase the efficiency of restructuring, insolvency and discharge procedures);
it has sought to strengthen supervisory convergence including through the establishment of an ESMA standing committee on supervisory convergence; and
it has consulted in relation to the cumulative impact of financial reform in the EU (see further below).
The Working Document also set out further planned initiatives including work in relation to crowdfunding (and it subsequently published a Report33 on this issue in May 2016), work to strengthen venture capital markets and support for small high-growth firms. Longer term projects include supporting market-led initiatives on the development of private placements of corporate debt, possible changes to the Solvency II Regulation, a further review of the covered bonds markets in the EU (see further below) and work on encouraging finance for sustainable and green investments.
The EU Commission subsequently published a Consultation Document34 in relation to "CMU Action on Cross-border Distribution of Funds (UCITS, SIF, ELTIF, EUVECA and EUSEF) across the EU". This set out a number of questions to seek further evidence from fund managers, investors and customer representatives to assess where and how the cross-border distribution of funds could be improved.
In September 2016, the EU Commission published a further Communication35 in respect of the CMU headed "Accelerating Reform". This stated the view that in the current political and economic context, developing stronger capital markets in the EU is even more important, it is essential to step up implementation of the CMU and to accelerate reform. It indicated a mid-term review of the CMU would be carried out by the EU Commission in 2017.
7. PD III (Prospectus Regulation)
As part of its implementation of the CMU Action Plan, on 30 November 2015, the EU Commission published a legislative proposal36 for a new Prospectus Regulation ("PD III"), which will repeal and replace the current Prospectus Directive 2003/71/EC and its implementing measures. As set out in the EU Commission's Consultation Document37 published in February 2015, the EU Commission concludes that the barriers to accessing capital in the EU need lowering and that the mandatory disclosure requirements under the Prospectus Directive are particularly burdensome. Therefore, the
29 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R0467&from=en 30 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52015DC0630&from=EN 31 http://ec.europa.eu/newsroom/just/item-detail.cfm?item_id=30544 32 http://ec.europa.eu/information_society/newsroom/image/document/2016-48/proposal_40046.pdf 33 http://ec.europa.eu/finance/general-policy/docs/crowdfunding/160428-crowdfunding-study_en.pdf 34 http://ec.europa.eu/finance/consultations/2016/cross-borders-investment-funds/docs/consultation-document_en.pdf 35 http://ec.europa.eu/finance/capital-markets-union/docs/20160913-cmu-accelerating-reform_en.pdf 36 http://eur-lex.europa.eu/resource.html?uri=cellar:036c16c7-9763-11e5-983e-01aa75ed71a1.0006.02/DOC_1&format=PDF 37 http://ec.europa.eu/finance/consultations/2015/prospectus-directive/docs/consultation-document_en.pdf
hope is that implementation of PD III will make it easier and cheaper for SMEs to access capital markets, whilst also simplifying the process for all companies wishing to issue debt or shares.
The key proposals involve the following:
a higher threshold for determining when a prospectus is required for smaller capital raisings (proposed to be increased from 100,000 to 500,000, with the ability for member states to increase the threshold further in their domestic markets);
the doubling of the firm size threshold under which SMEs are allowed to submit a `lighter' prospectus (to include SMEs with a market capitalisation of up to 200 million);
a simpler prospectus for secondary issuances by listed companies to reflect the reduced risk posed by such issuances;
a shorter, clearer prospectus summary emphasising only material risk factors;
a fast-track approvals process for frequent issuers via a `Universal Registration Document' (the "URD") (similar to a shelf registration concept); and
the creation of a free, searchable online portal, which will act as a single access point for all prospectuses approved in the EEA.
Most other exemptions from the requirement to produce a prospectus, such as for offerings to qualified investors only and to fewer than 150 persons per member state, are proposed to remain unchanged.
In September 2016, the EU Parliament adopted PD III with some amendments, including:
a proposed amendment to the current exemption where offers are to fewer than 150 persons per member state so that the exemption will apply where an offer is to less than 350 persons per member state and no more than 4,000 persons in the EU in aggregate;
an exemption where the offer raises less than 1 million over a 12-month period. Member states will also be able to exempt offers where the total consideration of the offer in the EU does not exceed 5 million over a 12-month period;
in exceptional circumstances, a competent authority may permit summaries of up to 10 pages (rather than 6) where the complexity of the issuer's activities so requires.
It is understood that the EU Parliament, EU Council of Ministers and the EU Commission have now reached political agreement as to the terms of the Regulation. The final version should therefore be published sometime early in 2017, and it is expected that the Regulation will come into force sometime during 2017. It is believed that agreed amendments to the previous draft include:
the wholesale disclosure regime, including exemption from the summary requirement, will be available for prospectuses relating to the admission to trading of securities on a regulated market that can only be traded on a regulated market or that have a minimum denomination of 100,000;
some amendments to the provisions on risk factors. Risk factors will still be required to be presented in a limited number of categories with the most material risk factors being listed first in each category; and
removal of the EU Commission's requirement for a representative to be appointed by non-EU issuers.
The draft Regulation provides that it will come into effect 12 months after it is published in the OJ. It is, however, believed that this period may be extended to two years in the final version of the Regulation. In this case, the provisions would not become effective until sometime in 2019 at the earliest.
8. EU Securitisation Regulation
Securitisation has continued to be criticised in some quarters for the product's perceived role in causing and/or exacerbating the effects of the recent financial crisis. However, during the last couple of years, there have been increasing signs that the securitisation market is viewed by EU regulators as having an important part to play in creating well-functioning capital markets. This is principally due to the role such structures can play in diversifying funding sources and allocating risk more efficiently within the financial system.
In connection with the CMU, on 30 September 2015, the EU Commission published a legislative proposal for a "Securitisation Regulation"38 with a view to setting out common rules on securitisation and creating an EU framework for simple, transparent and standardised ("STS") securitisations. In effect, these are securitisations that satisfy certain criteria and are, therefore, able to benefit from the resulting STS label (for example, through reduced capital charges). This concept is not dissimilar to the idea that a fund might qualify for the UCITS label. According to the EU Commission, the development of an STS market is a key building block of the CMU and contributes to the priority objectives of supporting job creation and sustainable growth. At the same time, the EU Commission also published a draft Regulation to amend the CRR (referred to and defined below) to provide more favourable regulatory capital treatment for STS securitisations.
The draft Securitisation Regulation has two principal goals, the first being to harmonise EU securitisation rules applicable to all securitisation transactions, while the second is to establish a more risk-sensitive prudential framework for STS securitisations in particular. The first goal is to be achieved through repealing the separate, and often inconsistent, disclosure, due diligence and risk retention provisions found in relation to securitisation across EU legislation, such as the CRR, the Alternative Investment Fund Managers Directive and the Solvency II Directive, and replacing them with a single, shorter set of provisions, consisting of uniform definitions and rules, which will apply across financial sectors.
To achieve the second goal, the Securitisation Regulation seeks to create a framework for STS securitisations and aims to provide clear criteria for transactions to qualify as STS securitisations. These include residential mortgage-backed securities ("RMBS"), auto loans/leases and credit card transactions, whereas actively managed portfolios (for example, CLOs), resecuritisations (for example, CDOs and SIVs) and structures, which include derivatives as investments, have been specifically prohibited. Those transactions which qualify as STS securitisations will result in preferential regulatory capital treatment for institutional investors. The EU Commission's hope is that in recognising the different risk profile of STS and non-STS securitisations, investing in safer and simpler securitisation products will become more attractive for credit institutions established in the EU and will thus release additional capital for lending to businesses and individuals.
The proposed Securitisation Regulation has made slow progress during 2016, and the timing of the Regulation being adopted and finalised is not yet clear. Although the ECB and the EBA support the Securitisation Regulation, some members of the European Parliament have expressed concern at efforts to reinvigorate the securitisation markets. The European Parliament's Committee on Economic
and Monetary Affairs ("ECON") has prepared reports seeking various amendments to the proposals. In particular, Paul Tang, the EU parliament's rapporteur in relation to the draft Regulation has sought to make amendments to the "risk retention" requirements currently set at 5% in CRD IV (as defined below). He has proposed increasing the requirement to 20%. Many in the securitisation industry believe this would have a detrimental effect on securitisations and run counter to the stated aims of the CMU in this regard. Other proposed amendments include requirements for further disclosures by originators, sponsors and original lenders of loan-level data through the European Securitisation Data Repository and a requirement for a third-party certification of a transaction's compliance with the STS requirements. Some MEPs are also seeking to change the minimum capital requirements for STS securitisations in the CRR from the 10% proposed in the draft Regulation to 13%.
It is expected that the European Parliament will vote on the proposed Securitisation Regulation and amendments in plenary session early in 2017. It is not yet clear when it will be possible to have political agreement between the EU Parliament, the EU Commission and the EU Council of Ministers. However, the Securitisation Regulation remains an important element of the CMU initiative, and the EU Commission is likely to seek to get the legislation finalised during 2017 if possible.
9. BRRD Implementation
Having come into force in July 2014, the Bank Recovery and Resolution Directive39 ("BRRD") was required to be implemented into EU member states' national laws by 1 January 2015, except for the provisions relating to the bail-in tool, which should have been implemented by each EU member state by 1 January 2016.
The main aim of the BRRD is to create a framework in which a bank can be allowed to fail, with the minimum of public-sector support and the minimum of disruption to the broader financial system. Therefore, in addition to provisions relating to formulating recovery plans, resolution plans and provisions relating to the transfer of businesses and liabilities, the BRRD for the first time in EU law created an additional `resolution tool' for EU national resolution authorities, in the shape of the `bail-in tool'. This tool allows national resolution authorities to convert liabilities of the failing bank into equity or to write down the principal amount of those liabilities so that, in this way those liabilities can be forced to absorb some of the losses of the bank entering into resolution. The bail-in tool is most likely to be used to resolve banks that are systemically important whether on a global basis or a domestic basis.
In addition to the resolution tools, the BRRD also introduced an additional prudential measure, in the form of an obligation to maintain Minimum Required Eligible Liabilities ("MREL"). MREL can be viewed as the European version of the total loss-absorbing capacity ("TLAC") rules referred to below (in that they provide for each EU national resolution authority to prescribe, for each bank under its jurisdiction, a minimum level of loss-absorbing capital and liabilities to be held by the bank, that can credibly be bailed-in in a bank resolution situation). These MREL provisions will apply to EU banks on top of the minimum regulatory capital requirements and capital buffer requirements that have been prescribed by the CRR.
Article 55 of BRRD requires that for most liabilities that can be bailed-in, where the contract for the liability is governed by a non-EU law, the party subject to BRRD must ensure that, in that contract, the beneficiary of the liability acknowledges that the liability can be bailed-in and agrees to be bound by any such bail-in action. This contractual bail-in recognition requirement applies unless it can be shown that the EU bail-in action can be put into effect by the laws of the non-EU jurisdiction or by binding agreement with that jurisdiction.
This Article also became effective from 1 January 2016, and it has given rise to a flurry of activity for EU banks in explaining this obligation to their non-EU counterparties and obtaining their agreement
to the inclusion of appropriate wording in the contract. Given that the scope of bail - inable liabilities is so broad, including not only purely `financial liabilities', the intensive efforts needed for banks to comply fully with Article 55 will continue well into 2017, until counterparties become familiar with the requirement and its implications.
On 23 November 2016, the European Commission released a package of proposed legislative reforms to the BRRD, primarily focused on the setting of MREL for global systemically important institutions ("GSIIs") and for non-GSIIs, but also proposing changes to Article 55 of BRRD and a new pre-resolution power of suspension. These proposals consist of a draft Regulation40 to amend the CRR, a draft directive amending the BRRD in relation to MREL41, a draft second directive amending BRRD in respect of the insolvency ranking of certain liabilities42and a draft regulation43 amending the SRM Regulation (see below).
In relation to Article 55, and in response to the difficulties facing banks in complying with this Article, the European Commission proposes that a bank need not comply with Article 55 so long as (i) the EU bail-in action will be recognised by the non-EU law that governs the relevant liability or by a binding agreement of that non-EU country, (ii) it is legally, contractually or economically impracticable to include such a contractual agreement in the relevant liability and (iii) a waiver of Article 55 in respect of such liability would not impede the resolvability of the bank. This proposed waiver would not apply to liabilities counting towards MREL only those ranking senior to MREL liabilities.
In addition to Article 55 and the MREL provisions discussed below, the European Commission also proposed an additional power for resolution authorities to intervene early in a bank's decline, in the form of the ability to suspend any payment or delivery obligation of a bank for up to five working days. However, excluded from this power are obligations owed to central clearing counterparties, payment and securities settlement systems and deposits covered by a deposit guarantee scheme, as well as eligible claims under investment compensation schemes.
The European Commission's proposals will now be considered by the European Parliament and the EU Council during 2017.
On 9 November 2015, the FSB published its final principles on the amount of loss absorption capacity to be held by global systemically important banks ("GSIBs")44. The principles were endorsed at the November 2015 meeting of the G20 nations in Antalya, Turkey. As such, they are now expected to be implemented into the national laws of the G20 nations, although the principles will have no binding effect on any GSIB until its home nation has in fact implemented the principles.
The FSB maintains a list of global banks that it considers to be GSIBs and updates this list periodically. Currently, the list consists of 30 banks from around the globe.45 For each bank that is contained on the list, the TLAC principles will establish minimum levels of capital and liabilities that are able to absorb losses in the event of the GSIB's failure. Those banks that were designated as GSIBs before the end of 2015, and continue to be so designated thereafter, and that are not established in an emerging market economy, must meet a minimum TLAC requirement, as from 1 January 2019, of at least 16% of their risk-weighted assets, and at least 6% of the denominator for the Basel III leverage ratio. For such firms, these minimum requirements will increase, as from 1 January 2022, to at least 18% of risk-weighted assets and at least 6.75% of the Basel III leverage ratio denominator. For those
40 http://ec.europa.eu/transparency/regdoc/rep/1/2016/EN/COM-2016-850-F1-EN-MAIN.PDF 41 http://ec.europa.eu/finance/bank/docs/crisis-management/161123-proposal-directive-recapitalisation-capacity_en.pdf 42 http://ec.europa.eu/finance/bank/docs/crisis-management/161123-proposal-directive-unsecured-debt-instruments_en.pdf 43 http://ec.europa.eu/finance/general-policy/docs/banking-union/single-resolution-mechanism/161123-proposalregulation_en.pdf 44 http://www.fsb.org/wp-content/uploads/TLAC-Principles-and-Term-Sheet-for-publication-final.pdf 45 http://www.fsb.org/wp-content/uploads/2016-list-of-global-systemically-important-banks-G-SIBs.pdf
GSIBs that are currently headquartered in an emerging market economy (which currently encompasses only banks in the People's Republic of China), these two pairs of minimum figures must be complied with by 1 January 2025 and 1 January 2028, respectively.
Any Tier 1 capital, other than Common Equity Tier 1 capital, or Tier 2 capital held towards a GSIB's minimum capital requirements also can be counted by it towards its TLAC requirements. However, the figures above are exclusive of capital maintained to meet the various buffer requirements under the Basel III framework, which buffers must be maintained on top of the minimum TLAC requirement.
In terms of eligibility for TLAC, a liability that does not count as Tier 1 or Tier 2 capital must be unsecured and must be perpetual in nature or not be redeemable at the instigation of the holder within one year. It must also be subordinated to liabilities that are expressly excluded from counting towards TLAC and must absorb losses prior to such excluded liabilities in insolvency, without giving rise to legal challenge or compensation claims. In addition, such liability cannot be hedged or netted in a way that would reduce its ability to absorb losses in a resolution.
The TLAC principles include a list of liabilities that are excluded from TLAC, on the basis that they may be difficult in practice to bail-in in a resolution, or where there are policy reasons why they should not be bailed-in. These include:
deposits with an original maturity of less than 1 year;
liabilities arising from derivatives or instruments with derivative-linked features (such as structured notes);
liabilities that arise other than through a contract (such as tax liabilities);
liabilities which are preferred to normal senior unsecured creditors; and
any other liabilities that are excluded from bail-in under the resolution entity's national laws or that cannot be bailed-in without risk of a successful legal challenge or compensation claim from the relevant creditor.
2016 has seen the beginning of efforts to implement the TLAC principles into national legislation. In Europe, the Bank of England issued its Statement of Policy46 on setting MREL for UK banks on 8 November 2016. In addition, the European Commission set out its legislative proposals (as mentioned in "BRRD Implementation" above) for the setting of MREL on 23 November 2016, by way of proposed amendments to BRRD and to the Capital Requirements Regulation. The MREL provisions, although they address the same risk as the TLAC principles, differ in certain respects from the TLAC principles. For instance, they apply to all EU banks and not just GSIBs and are to be set on an entityby-entity basis. Currently, they are to be set by national resolution authorities as a percentage of the bank's own funds and eligible liabilities, on a non-risk-weighted basis. However, the European Commission now proposes that MREL should be set as a ratio both of risk-weighted assets and of the bank's leverage ratio denominator. For GSIBs, the minimum MREL will mirror the FSB's minimum TLAC requirements mentioned above, although there is to be no minimum level of MREL established for non-GSIBs.
The levels of MREL set by Europe's national resolution authorities ("NRAs") will be of significant impact to the European banking industry because, unlike the TLAC principles, a level of MREL must be set for every single European bank, not just GSIBs. Since this is set on an entity-by-entity basis, NRAs will have to apply a certain amount of discretion and judgment in setting the relevant levels. However, each NRA will be required to comply with the final form of the BRRD when this is amended
pursuant to the above legislative proposals, as supplemented by the final RTS on setting MREL, as adopted by the European Commission and published in the OJ on 3 September 201647. These standards provide that a bank's MREL must consist of both an amount necessary for loss absorption prior to and during resolution, as well as an amount necessary for the subsequent recapitalisation of the bank. The loss absorption amount will have to at least equal the minimum capital requirement prescribed by the EU's Capital Requirements Regulation (defined below), together with any applicable leverage ratio requirement that is set by the relevant national competent authority.
In the UK, the Bank of England has stated in its Statement of Policy that it intends to use its MRELsetting powers to reflect the FSB's TLAC principles in relation to UK-based GSIBs.
The Bank of England has stated that for the biggest/most complex UK banks, it intends to set MREL at a level equivalent to twice the bank's current minimum capital requirements once for the loss absorption portion and once for the recapitalisation portion. The Bank of England also proposes that MREL liabilities for UK GSIBs should be subordinated to senior operating liabilities of the relevant bank. This is not required by the current form of BRRD, but it will be required for GSIBs if the European Commission's new legislative proposals are implemented as drafted. For non-GSIBs, the legislative proposals intend that NRAs will have the final decision on whether subordination of MRELeligible liabilities should be required.
The issue of subordination of certain liabilities, in the context of MREL and TLAC, is and will remain throughout 2017, a controversial subject. Under the FSB principles, TLAC-eligible liabilities are required to be subordinated to other unsecured liabilities that cannot be bailed-in or are unlikely to be bailed-in during a resolution situation. This subordination is required in order to prevent a myriad of claims that might arise from bailed-in creditors in circumstances where other equal-ranking unsecured liabilities, deposits in particular, have not been bailed-in, and the bailed-in creditors have suffered detriment as a result.
However, different EU member states are using different methodologies to achieve a level of subordination for MREL-eligible liabilities. For instance, the UK envisages that structural subordination will be employed. This entails MREL liabilities being issued from a holding company that has no MREL-excluded liabilities that rank junior or pari passu to its MREL liabilities. In contrast, Germany is in the process of enacting legislation which will provide that certain existing and future bank bonds are automatically subordinated to depositors and other unsubordinated liabilities. In turn, France is in the process of enacting a law that provides for a new class of "non-preferred senior debt," which would rank junior to other senior debt, but senior to regulatory capital.
The European Commission has proposed that all member states should provide for a new class of non-preferred senior debt, along the lines being enacted in France. However, these European Commission proposals represent only one of the possible methods of achieving subordination, and the precise methodology and wording used to achieve subordination of certain bail-inable liabilities could have a huge impact on the market for senior unsecured bank bonds and other liabilities. We expect further developments in this regard during 2017.
Intermediate Holding Companies
One of the most controversial proposals in the draft November 2016 legislative proposals of the European Commission was to amend the CRD IV Directive, by way of a draft directive,48 to require the establishment of EU intermediate holding companies ("IHCs"). An IHC would be required where a non-EU banking group has at least two subsidiaries in the EU that are banks or investment firms, in circumstances where the total value of all EU assets of the non-EU banking group (including for this
47 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R1450&from=EN 48 http://ec.europa.eu/transparency/regdoc/rep/1/2016/EN/COM-2016-854-F1-EN-MAIN.PDF
purpose assets of all EU branches and subsidiaries) is at least EUR30 billion, or where the non-EU banking group is a GSIB.
It seems that such IHC would need to comply with the capital, liquidity and other CRR requirements, as well as the eventual MREL requirements, on a consolidated basis.
This proposal has been explained by the Commission as a natural continuation of bank resolution plans, though some commentators have explained this proposal in different terms a "tit-for-tat" measure aimed at creating in Europe a similar regime for foreign banks as exists in the United States or, alternatively, a measure designed to make life difficult, post-Brexit, for UK banks with substantial EU business.
11. SRM Regulation
Closely linked to the BRRD is the Single Resolution Mechanism ("SRM"), which forms part of the European Banking Union. The aim of the SRM is to apply a uniform resolution process to all banks established in EU member states that are participating in the Single Supervisory Mechanism ("SSM"), in other words: all banks in the Eurozone and other member states that are participating in the SSM. Under the SSM, the European Central Bank acts as the ultimate supervisor for all the banks subject to the SSM.
The SRM (which is constituted by the SRM Regulation49) is extremely closely related to the BRRD and mirrors the resolution tools and options available under the BRRD. The important difference is that a Single Resolution Board ("SRB") is appointed to perform most of the functions that are performed by national resolution authorities according to the BRRD. The SRM Regulation came into full effect on 1 January 2016. As mentioned in "BRRD Implementation" above, the European Commission, in November 2016, proposed various changes to the BRRD, and, at the same time, it also proposed various changes to the SRM Regulation, which were designed to keep its provisions consistent with the BRRD.
The SRB consists of a full-time chair, four full-time members and one member appointed by each member state participating in the SSM, to represent that member state's national resolution authority. In December 2015, an agreement between the SRB and the European Parliament came into force in relation to procedures relating to the accountability of the SRB to the European Parliament. In addition, the SRB and the European Central Bank have concluded a memorandum of understanding relating to cooperation and exchange of information in their respective roles of Single Resolution Authority and Single Supervisor for the SSM.
The SRM Regulation also established a Single Resolution Fund ("SRF"), with a target size of 1% of the amount of the deposits of all SSM banks that are guaranteed under the Deposit Guarantee Schemes Directive. The initial target date for such a figure to be reached is 1 January 2024. The purpose of the SRF is the same as that of a national resolution fund under the BRRD, namely to support a resolution under the SRM, if necessary by making loans or providing guarantees, purchasing assets and making contributions to a bridge institution or asset management vehicle or paying compensation to shareholders or creditors who end up worse off in the resolution than they would have in an insolvency procedure.
The SRF is funded by contributions from the banking industry, including by ex ante contributions. The implementing Regulation in relation to the SRF, which harmonises the methodologies for raising ex ante contributions with those in the BRRD, became effective from 1 January 2016. A separate delegated Regulation, dealing with the criteria for calculating ex ante contributions and the deferral of ex post contributions to the SRF, was adopted by the European Commission in December 2015.
The EU Council of Ministers confirmed that they had no objections, and assuming the European Parliament raises no objections, it will enter into force 20 days after its publication in the OJ of the EU.
While the SRF is building up its resources, it will require bridge financing, and the EU Council of Ministers in November 2015 published details of the work in progress for an agreement on such bridge financing. It envisaged that it would consist of national credit lines from the participating member states, and these national credit lines are presumably in place, given that the SRF became operational on 1 January 2016.
Looking further into the future, the European Commission is required to publish a report by 31 December 2018, and once every five years thereafter, on the application of the SRM Regulation, dealing with how it is functioning and its cost efficiency, including particularly how effective the co-operation and information sharing arrangements have been between the SRB and the European Central Bank and between the SRB and national resolution authorities and national competent authorities.
12. CRD IV/Basel III
The Basel III reforms, in the form of the Capital Requirements Regulation ("CRR")50 and the CRD IV Directive51 (together with the CRR referred to as "CRD IV"), largely came into effect on 1 January 2014 in Europe. This included the revised requirements in relation to minimum capital requirements for firms and the introduction of new capital buffers. These requirements are now being phased in in accordance with the terms of CRD IV.
Although the principal minimum regulatory capital requirements started to apply from 1 January 2014, a number of the other provisions take effect at a later date, in particular those relating to the liquidity coverage and net stable funding ratios, leverage ratio and systemic buffers referred to below.
Liquidity Coverage Ratio ("LCR")
In October 2014, the EU Commission adopted a delegated Regulation52 in relation to the LCR mandated by the Basel III framework, containing detailed provisions for the ratio that requires firms to hold an adequate level of high-quality liquid assets to meet net cash outflows over a 30 day stress scenario period. The delegated Regulation generally followed the Basel III LCR standard, with certain amendments, including in relation to giving certain covered bonds extensive recognition and also including, as part of the permitted liquid assets, certain types of securitised assets, such as securities backed by auto loans. The LCR started to be phased in from 1 October 2015, commencing at 60% of the full requirement and rising to 100% of the full requirement by 1 January 2018, unless the EU Commission exercises its power to delay full implementation until 1 January 2019.
Net Stable Funding Ratio ("NSFR")
The NSFR is also prescribed by the Basel III framework and provides for a longer term amount of stable funding to be available. A bank must have "available stable funding" to meet 100% of its "required stable funding" over a one-year period. There are, as yet, no binding requirements as to the NSFR in CRD IV. However, as required by the CRR, in December 2015, following the EBA Report53 in relation to the introduction of the NSFR in the EU, the European Commission's November 2016 legislative proposals to amend CRR (see "BRRD Implementation" above) now include a proposal for a binding NSFR. These proposals closely match the Basel III NSFR provisions, but they differ in some
50 Regulation (EU) No. 575/2013, http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013R0575&from=EN. 51 Directive 2013/26/EU, http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013L0036&from=EN. 52 http://ec.europa.eu/finance/bank/docs/regcapital/acts/delegated/141010_delegated-act-liquidity-coverage_en.pdf. 53 https://www.eba.europa.eu/documents/10180/983359/EBA-Op-2015-22+NSFR+Report.pdf
respects, such as the RSF factors assigned to certain assets. These differences will be reviewed by the Commission within the first three years of operation of the NSFR.
The above legislative proposals will be considered by the European Parliament and the EU Council during the first half of 2017 and, if approved, are currently intended to become applicable two years after the entry into force of the legislative changes.
The Basel III framework envisages the introduction of the NSFR by 1 January 2018. This timetable is also envisaged by the recitals to the CRR, but the draft legislation published by the EU Commission tentatively envisages the NSFR requirement becoming applicable two years after the amends to the CRR enter into force.
The leverage ratio also forms part of the Basel III framework and is a measure of a firm's Tier I capital divided by the non-risk weighted values of its assets. Basel III provides for such ratio to be a minimum of 3%. Following the current period of bank-level reporting of the leverage ratio and its components to national supervisory authorities, the BCBS intends to make any final calibrations and amendments to the requirements by 2017 with the intention that a minimum leverage ratio requirement will become effective from 1 January 2018.
Following on from the Report54 of the EBA on the impact and effectiveness of the leverage ratio, the European Commission's November 2016 legislative proposals to amend CRR (see "BRRD Implementation" above) now include a proposal for a binding leverage ratio. These proposals closely match the Basel III leverage ratio provision, including the minimum 3% calibration.
The above legislative proposals will be considered by the European Parliament and the EU Council during the first half of 2017 and, if approved, are currently intended to become applicable two years after the entry into force of the legislative changes.
In addition to the minimum capital requirements, Basel III also introduced capital buffers which apply to credit institutions and certain investment firms. These consist of (i) a capital conservation buffer of 2.5% of risk weighted assets ("RWAs") comprised of common equity tier 1 capital ("CET1") (which, if not met, will result in a limitation of the maximum amount of profits that may be distributed by the firm), (ii) a countercyclical buffer that can be set by national supervisory authorities of up to 2.5% of RWAs and must again comprise only CET1 and (iii) systemic risk buffers referred to below. The capital conservation buffer and the countercyclical buffer started to be phased in on 1 January 2016, and the buffer requirements will be fully implemented by 1 January 2019. In December 2015, the EBA published an Opinion55 on the interaction of Pillar 1 and Pillar II requirements under Basel III / CRD IV and the combined buffer requirements and restrictions on distributions. In the Opinion, the EBA recommended, among other things, that competent authorities ensure that the CET1 capital taken into account for calculating the maximum distributable amount where the capital conservation buffer is not met should be limited to the amount not used to meet the Pillar 1 and own funds requirements of the firm. Under the European Commission's proposed changes to CRDIV, a differentiation is made between Pillar 2 requirements on own funds and Pillar 2 guidance on own funds. It is proposed that a failure to comply with the latter will not reduce the maximum distributable amount.
Under CRD IV, national competent authorities must assess GSIIs and other systemically important institutions ("OSIIs"). Each GSII will be placed into one of five sub-categories. CRD IV imposes an additional buffer for each GSII of between 1% and 3.5% of RWAs. Competent authorities will also
54 http://www.eba.europa.eu/documents/10180/1360107/EBA-Op-2016-13+%28Leverage+ratio+report%29.pdf 55 https://www.eba.europa.eu/documents/10180/983359/EBA-Op-2015-24+Opinion+on+MDA.pdf
have the discretion to impose a buffer on OSIIs of up to 2% of RWAs. In each case, these buffer requirements must be met by CET1 capital and are in addition to a firm's minimum capital requirements and capital conservation and countercyclical buffers. Member states will also have the power to introduce a systemic risk buffer, comprised of CET1 capital, which can be applied to the financial sector (or subsets of such sector). These buffers can be up to 3% of RWAs for all exposures and up to 5% of RWAs for domestic and third-country exposures. These buffers are not intended to be cumulative with the GSII buffer and the OSII buffer. Only the highest will apply to a firm.
CRD IV also contains provisions relating to firms' remuneration policies. These require firms to ensure that their remuneration policies make a clear distinction between criteria for setting basic fixed remuneration and variable remuneration. CRD IV also sets out a number of principles on variable remuneration, most controversially that a person's variable remuneration should not exceed the amount of fixed remuneration (with the possibility of it being 200% of fixed remuneration only with shareholder approval (66% majority required with a minimum quorum of 50%)). This has been referred to as the "bonus cap". Variable remuneration must also be subject to clawback arrangements. Concerns were raised by the EBA and the EU Commission during 2014 as to the practice by some firms of redesignating some variable pay into allowances. Their view was that, in many cases, the allowances would still be regarded as variable pay. In October 2014, the EBA published an Opinion56 outlining what sort of pay structures it would consider to be variable pay. However, the paper has no binding force in the EU, and it is therefore possible that some firms could press ahead with allowance-type arrangements, leaving open the possibility of competent authorities seeking to impose sanctions and possible future legal action in this area.
In May 2015, the EBA published correspondence between it and the EU Commission as to the interpretation of the proportionality principle set out in Article 92(2) of the CRD IV Directive that states that the remuneration principles should be applied to firms in a manner and to the extent that is appropriate to their size, internal organisation and the nature, scope and complexity of their activities. The EU Commission's view is that the remuneration principles under CRD IV have to be applied to each firm, and any discretion those provisions may leave to member states and competent authorities must be exercised in accordance with the proportionality principle. Therefore, the EU Commission is of the view that the proportionality principle does not disapply any of the remuneration principles and that requirements on deferral and payment in instruments must be applied to all institutions.
In December 2015, the EBA published an Opinion57 on the application of the proportionality principle. It also published a Final Report on its Guidelines in relation to the CRD IV remuneration requirements.58 The revised Guidelines will come into force on 1 January 2017 and will apply on a "comply or explain" basis, i.e. national competent authorities will have to state whether they intend to comply with the Guidelines and, if not, the reason for not doing so. However, in February 2016, the UK's PRA and FCA issued a joint statement that they had notified the EBA that they would not automatically impose the bonus cap on all UK firms and that they consider the imposition of a bonus cap is subject to the proportionality principle.
In the Opinion, the EBA repeated its view in relation to the proportionality principle stated above. It also proposed amendments to CRD IV that would permit smaller and less complex firms to disapply the requirements in relation to deferral and payment in instruments, as well as for these requirements
56 http://www.eba.europa.eu/documents/10180/657547/EBA-Op-2014-10+Opinion+on+remuneration+and+allowances.pdf 57 https://www.eba.europa.eu/documents/10180/983359/EBA-Op-201525+Opinion+on+the+Application+of+Proportionality.pdf 58 https://www.eba.europa.eu/documents/10180/1314839/EBA-GL-201522+Guidelines+on+Sound+Remuneration+Policies.pdf/1b0f3f99-f913-461a-b3e9-fa0064b1946b
to be waived for staff who receive low levels of variable remuneration. These proposals have been adopted by the European Commission in its November 2016 legislative proposals to amend the CRD IV Directive (see "BRRD Implementation" above).
However, neither the Opinion nor the European Commission's legislative proposals have suggested any amendment to the bonus cap. This would mean that all CRD IV firms would have to apply the bonus cap from 1 January 2017 (including all asset managers and investment firms coming under CRD IV). However, no change has been made by the FCA or the PRA to their position on the bonus cap since February 2016, and in September 2016, the FCA consulted on proposals to amend the FCA Handbook to be consistent (in most cases) with the Guidelines, and this consultation closed in November 2016. The FCA consultation restated the position that smaller UK firms would have discretion to disapply the bonus cap, where relevant.
13. UK Ring-fencing
The UK's Financial Services (Banking Reform) Act 2013 requires retail banking services to be ringfenced from other bank activities. The base legislation has now been in force for some time in the UK, but the precise details of exactly what will be required to comply with the new ring-fencing regime, by its proposed implementation date of 1 January 2019, are to be provided by secondary legislation to be passed by the UK Treasury. Over the course of 2016, there have been various developments in such secondary legislation, some of which are intended to assist UK banks in making more definitive plans as to how to reorganise their businesses. Furthermore, the PRA and Bank of England were particularly active in 2016 in publishing consultation papers and statements relating to ring-fencing.
What is known is that the ring-fenced retail entity can remain as part of the broader banking group, so long as it is functionally and legally separated. The legislation will catch firms that, on a three-year average period, hold more than 25 billion worth of core deposits, meaning all deposits other than from financial institutions, large to medium sized companies and high net worth individuals. In order to be able to survive the failure of another member of the banking group, the ring-fenced banks ("RFBs," each an "RFB") will be subject to stand-alone prudential rules, including minimum capital requirements, leverage ratios, liquidity ratios and risk buffers.
Such banks will be prevented from undertaking certain excluded activities, such as dealing in investments as principal and commodities trading, although it is possible that further activities may in the future be specified as excluded for this purpose. Generally, they will not be able to engage in investment banking activities, but they will be able to offer limited types of derivatives to their customers, such as derivatives commonly used to hedge currency and interest rate risk.
The Financial Services and Markets Act 2000 (Ring-fenced Bodies, Core Activities, Excluded Activities and Prohibitions) (Amendment) Order 2016 (SI 2016/1032)59 ("Amendment Order") came into force on 1 December 2016. The Amendment Order made various technical amendments to the Financial Services and Markets Act (Ring-fenced Bodies and Core Activities) Order 2014 (the "Core Activities Order") and the Financial Services and Markets Act 2000 (Excluded Activities and Prohibitions) Order 2014 (the "Excluded Activities Order"). According to an undated memorandum by the UK Treasury, published in October 2016,60 among other considerations, the purpose of these legislative developments is to ensure legislative consistency, provide greater clarification, mitigate unintended consequences, remove unnecessary and administrative logistical burdens and strengthen the "resolution toolkit."
The Amendment Order, inter alia, allows an RFB to hedge the risks of another entity in its ring-fenced sub-group, amends the definition of liquidity risk in the Excluded Activities Order to allow an RFB to hedge the liquidity risks of its subsidiaries or financing vehicles and removes the
59 http://www.legislation.gov.uk/uksi/2016/1032/pdfs/uksi_20161032_en.pdf 60 https://www.parliament.uk/documents/commons-committees/treasury/Correspondence/Amendments-Explanation.pdf
requirement for larger corporate depositors to complete a "qualifying declaration" (before a bank can move their account to a non-ring fenced bank ("NRFB")) and instead requires banks to reach a determination as to whether a customer is eligible to be moved to the NRFB.
In March 2016, the PRA published a policy statement on ring-fencing transfer schemes61 ("RFTSs") and a final statement of policy in respect of its approach to RFTSs.62 In the same month, the FCA also published its final guidance on how it will approach RFTSs.63 Without requiring affected parties' consents, an RFTS allows a bank to transfer all or part of its business to another body, in order to comply with the ring-fencing regime. It is the PRA's responsibility, after consultation with the FCA, to (i) approve the skilled person who is appointed to make a related scheme report, and (ii) approve the scheme report itself.
In July 2016, the PRA published a policy statement relating to prudential requirements, intra-group arrangements and the use of financial market infrastructures.64 Furthermore, the PRA published a new webpage relating to ring-fencing, providing information on applications that firms should submit to the PRA (including on applications for the approval of a skilled person relating to preparing a scheme report for a ring-fencing transfer scheme65 and applications for permission to indirectly participate in inter-bank payment systems).66
At the end of January 2016, the Financial Policy Committee of the Bank of England (the "FPC") published a Consultation Paper (the "FPC Consultation Paper")67 on its proposals for a framework for the systemic risk buffer that it is required to develop pursuant to the Capital Requirements (Capital Buffers and Macro prudential Measures) Regulations 2014. This systemic risk buffer ("SRiB") is intended to apply, inter alia, to RFBs and is part of the UK's framework for identifying and setting higher capital requirements for domestic systemically important banks.
The FPC Consultation Paper sets out the FPC's proposals that each RFB will be required to hold a certain amount of Tier 1 capital in addition to its minimum capital requirements, its capital conservation buffer and any countercyclical capital buffer. After the FPC's consultation (in respect of the FPC Consultation Paper) closed in April 2016, the FPC then published its framework for the systemic risk buffer in May 201668 ("FPC Framework"), with broadly the same proposals that were set out in its FPC Consultation Paper. The amount of required additional Tier 1 capital will range from a SRiB rate of 1% for banks with total assets of 175 billion or greater to a SRiB rate of 3% for banks with total assets of 755 billion or greater (although the FPC expects that the largest ring-fenced banks will have an initial SRiB rate of 2.5%). A 3% minimum leverage ratio requirement and an additional leverage ratio buffer of 35% of the relevant SRiB rate ("ALRB") will be applicable to firms subject to the SRiB. According to the FPC, the SRiB (including through its impact on the ALRB) is expected to add around 0.5% of RWAs to equity requirements of UK systemic banks overall.
The FPC Framework recommended that the PRA should ensure that, where systemic buffers apply at different levels of consolidation, there is sufficient capital within the consolidated group, and distributed appropriately across it, in order to address both global systemic risks and domestic systemic risks. The PRA published a consultation paper in July 2016 ("PRA CP25/16,")69 stating its intention to comply with such recommendations and that it would increase the PRA buffer at the group consolidated level where the applicable SRiB rate at the RPB sub-group level exceeds the GSIB buffer rate applied at the group consolidated level.
61 http://www.bankofengland.co.uk/pra/Documents/publications/ps/2016/ps1016.pdf 62 http://www.bankofengland.co.uk/pra/Documents/publications/sop/2016/rftssop.pdf 63 https://www.fca.org.uk/publication/finalised-guidance/fg16-1.pdf 64 http://www.bankofengland.co.uk/pra/Documents/publications/ps/2016/ps2016.pdf 65 http://www.bankofengland.co.uk/pra/Pages/authorisations/rfts/default.aspx 66 http://www.bankofengland.co.uk/pra/Pages/authorisations/structuralreform/indirect.aspx 67 http://www.bankofengland.co.uk/financialstability/Documents/fpc/srbf_cp.pdf 68 http://www.bankofengland.co.uk/financialstability/Documents/fpc/srbf_cp260516.pdf 69 http://www.bankofengland.co.uk/pra/Documents/publications/cp/2016/cp2516.pdf
In PRA CP25/16, the PRA also set out reporting requirements applicable to RFBs. Proposals included: (i) extension of non-CRR reporting requirements to an RFB sub-group (as these currently only apply on a consolidated basis to banking groups affected by ring-fencing); (ii) a RFB sub-group must report transactions with group entities outside of its RFB sub-group; and (iii) reporting requirements to monitor an RFB's use of exceptions to excluded and prohibited activities under the Excluded Activities Order and extent of adherence to certain PRA supervisory statements. PRA CP25/16 also recommends making amendments to ring-fencing notifications, which would require RFBs to provide specification notifications in respect of the core deposit level condition.
The PRA published a statement of policy ("SoP") on 5 December 201670 based on an earlier draft as published in July 2016. The SoP sets out how the PRA will approach the implementation of the SRiB and the FPC Framework. The SRiB rates to be set by the PRA are expected to be announced in early 2019 and the PRA will apply these rates three months following the announcement. Once these initial SRiB rates are applied, the PRA will then apply the FPC Framework on an annual basis. The PRA also affirms that SRiB institutions cannot use capital maintained to meet the SRiB to meet any other capital requirements or buffers. The PRA plans to review the SoP in 2018 (after the review of the FPC Framework). It is expected that the PRA will publish another policy statement in the first half of 2017 relating to ring-fencing rules that it consulted on in the PRA CP25/16.
The SRiB is proposed to apply in tandem with the implementation date for the ring-fencing regime.
In its Occasional Consultation Paper as published in October 2016 ("OCP")71, the PRA also set out proposed changes to certain parts of the PRA Rulebook. In relation to the chapter on Ring-fenced Bodies and Notifications Parts, and the Rulebook Glossary, the consultation closed on 12 December 2016. The OCP sets out proposals for consequential amendments to the ring-fencing rules and amendments to the reporting templates and instructions for monitoring the use of exceptions in the Excluded Activities Order.
Following the publication of its July 2015 consultation paper on disclosures that non-RFBs should make to customers that are individuals, the FCA published near-final rules in a policy statement in March 2016 and then published its final rules in November 2016. These came into force on 1 December 2016.72
14. Possible EU Banking Reform
As we noted in our client alert "From EMIR To Eternity?" that was published in 201573, the draft Regulation74 on EU-level bank structural reform published by the EU Commission had been expected to be considered by the European Parliament during its April 2015 session, and adopted by June 2015. That has not happened.
Currently, the EU Council of Ministers and the European Parliament are considering the EU Commission's legislative proposal. It is now expected that the European Parliament will decide on its negotiating position on the legislative proposal during the first half of 2017 and will attempt to reach political agreement with the Council in the latter part of 2017. However, even those estimates are very tentative, bearing in mind the history of this draft Regulation so far and the fact that this topic remains highly politically sensitive.
70 http://www.bankofengland.co.uk/pra/Documents/publications/sop/2016/srbapproach.pdf 71 http://www.bankofengland.co.uk/pra/Documents/publications/cp/2016/cp3616.pdf 72 https://www.fca.org.uk/publication/handbook/handbook-notice-38.pdf 73 http://www.mofo.com/~/media/Files/ClientAlert/2015/01/150105FromEMIRtoEternity.pdf 74 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52014PC0043&from=EN.
It was originally proposed that the provision in the Regulation as to prohibition of proprietary trading would become effective on 1 January 2017 (six months after the publication of a list of covered and derogated banks), and the provisions regarding potential separation of trading activities would become effective on 1 July 2018. Given the delay in the progress of this Regulation, these timings will certainly need to change.
The Alternative Investment Fund Managers Directive75 (the "AIFMD") and its supplementary Regulation came into effect in the EU in July 2013 and introduced a centralised rulebook for the management and marketing of alternative investment funds ("AIFs") within the EU by alternative investment fund managers ("AIFMs").
The concept of an AIF is fairly broad and is defined as a collective investment undertaking (including investment compartments thereof) that is not a UCITS fund, but which raises capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors. However, certain entities and arrangements are expressly excluded, such as segregated managed accounts, family offices, joint ventures, insurance contracts and certain special purpose vehicles. Furthermore, AIFs that are categorised as `small AIFs' are exempted from many of the provisions of the AIFMD, and where the aggregate assets of all AIFs under an AIFM's management do not exceed the relevant thresholds, that AIFM will only have basic obligations in relation to registration and notification of certain information.
An AIFM is a legal person whose regular business is the managing of one or more AIF by, for example, performing portfolio or risk management activities. Each AIF within the scope of the AIFMD must have a single authorised AIFM for AIFMD purposes, although it can continue to utilise the services of multiple entities for management and administration activities. Aside from having to be authorised, AIFMs are subject to supervision by their home competent authority, must meet capital requirements of at least 125,000 and meet various additional requirements, such as having appropriate governance and conduct of business standards and systems in place to manage risks, liquidity and conflicts of interest. The AIFMD also aims to enhance the transparency of AIFMs and the funds they manage by imposing on them various transparency requirements, including reporting obligations (to the relevant competent authorities) and detailed disclosures in annual reports.
The AIFMD does not apply only to funds and managers based in the EU. Any non-EU AIFMs that market one or more AIFs managed by them to professional investors in the EU are currently subject to the national private placement regime of each of the member states where the AIFs are marketed or managed.
The AIFMD provides for the possibility in the future of an `AIFMD passport' by which a non-EU AIFM that has complied with the full rigour of the AIFMD's requirements can market its funds throughout the EU following a simplified regulatory notification process. A similar passport regime is already in place for EU AIFMs marketing EU AIFs. It was hoped that the passporting regime for non-EU AIFMs would come into play as early as 2015, but even now this has not yet happened. The extension of the AIFMD passport depends on the recommendations of ESMA, and ESMA has provided its advice and opinion to the European Commission in this regard on a country-by-country basis, even though it is unclear whether (under the AIFMD itself) it is possible to extend the passport on a country-bycountry basis.
Despite a positive recommendation from ESMA in July 2016 (which was updated in September 2016) for the extension of the passport to Canada, Guernsey, Japan, Jersey and Switzerland ("ESMA 2016
Advice,")76 the EU Commission has not yet adopted the delegated act specifying when the passporting regime will become effective for these, or any, jurisdictions.
Although ESMA concluded in the ESMA 2016 Advice that there are no significant obstacles to extending the passport regime to Hong Kong and Singapore, ESMA did express concerns about limited access of UCITS to retail investors in these jurisdictions. Furthermore, ESMA concluded that there are no significant obstacles relating to market disruption and obstacles to competition if the passport were to be extended to Australia, provided that the Australian Securities and Investment Committee extends to all EU member states the "class order relief" from some requirements of the Australian regulatory framework.
In terms of investor protection and monitoring systemic risk, ESMA found no significant obstacles in extending the passport to the United States of America, and ESMA noted that it did not find any significant obstacles for funds marketed by managers to professional investors so long as they do not involve any public offering. However, to the extent that funds are marketed by managers to professional investors, which do involve a public offering, it concluded that there is a risk of an "unlevel playing field" between EU and non-EU AIFMs if the passport were to be extended to the United States of America.
In the ESMA 2016 Advice, ESMA was unable to provide any advice relating to Bermuda or the Cayman Islands. This is because both jurisdictions are currently in the process of adopting new regimes. Additionally, ESMA found it difficult to assess investor protection in the Isle of Man (as there is an absence of any AIFMD-like regime).
In preparing the ESMA 2016 Advice, ESMA also gathered intelligence on Malaysia, Egypt, Chile, Peru, India, China and Taiwan in relation to investor protection, competition, potential market disruption and monitoring of systemic risk. ESMA set out its intention to agree a memorandum of understanding with the authorities of these jurisdictions in future. At the time of delivering the ESMA 2016 Advice, ESMA found that the current level of activity by entities from these countries within the EU did not justify a detailed assessment. Nonetheless, ESMA intends to both monitor the evolution of the level of activity between these jurisdictions and consider whether a particular jurisdiction should be assessed in detail.
On 11 October 2016, ESMA's Chair, Steven Maijoor made an opening statement to the Economic and Monetary Affairs Committee ("SM Statement,")77 which detailed ESMA's next steps. Firstly, ESMA aims to continue its assessment of Bermuda and Cayman Islands in order to determine whether there is scope to extend the passport to those countries. Secondly, ESMA plans to assess another group of non-EU countries after receiving further clarity from the co-legislators as regards next steps. Thirdly, ESMA is looking to focus on setting up the framework foreseen by co-legislators should the passport be extended to one or more non-EU countries (and ESMA would therefore be required to prepare itself for the role as an overseer of such system).
As set out in our client alert "Extension of the AIFMD Passport to Non-EU Managers",78 the intention of the AIFMD is that a non-EU AIFM in a jurisdiction to which the passport is extended will, for a period of three years, have the option of either becoming authorised in its EU member state of reference and using the passport to market or manage funds throughout the rest of the EU or, alternatively, continuing to use the individual national private placement regimes ("NPPRs") of those EU member states in which it wishes to market its AIFs. However, after that three-year period, the expectation is that, at least for AIFMs in those non-EU jurisdictions that have the benefit of the passport, NPPR regimes shall cease to be available. It is also possible that certain individual member states will
76 https://www.esma.europa.eu/press-news/esma-news/esma-advises-extension-funds-passport-12-non-eu-countries 77 https://www.esma.europa.eu/sites/default/files/library/20161459_econ_hearing_aifmd_passport_steven_maijoor_opening_statement.docx 78 https://media2.mofo.com/documents/160728extensionoftheaifmd.pdf
withdraw their NPPR, and Germany, for instance, has already indicated that it will do so once the passport has been extended.
Furthermore, the consequences of the United Kingdom's Brexit vote on 23 June 2016 could potentially require (depending on the United Kingdom's future post-Brexit relationship with the EU) United Kingdom-based AIFMs to be treated as those of a non-EU country. Therefore, UK AIFMs may, postBrexit, be required to (a) use individual NPPRs of EU member states (if NPPRs for such member state(s) is/are still available by then); (b) become authorised in a (non-UK) member state of reference to be eligible for the passport, if the passport is extended to the UK as a third country; or (c) if the passport is not extended to the UK as a third country, have a registered office in a (non-UK) member state to be authorised as an EU AIFM. Given the level of implementation of EU law throughout the United Kingdom as part of its EU membership (both historic and current), it would be unsurprising if UK AIFMs were to become eligible for the passport.
In March 2016, ESMA published its final report on guidelines on sound remuneration policies under the UCITS Directive and the AIFMD.79 The amended AIFMD guidelines came into force on 1 January 2017, and the amendments relate to the application of remuneration rules in a group context (and are intended to acknowledge the potential outreach of CRD IV rules in a banking group).
ESMA published a call for evidence on asset segregation and custody services under the AIFMD and UCITS V in July 201680 and the responses to the call for evidence in October 2016.81 ESMA will consider such feedback with a view to finalising its work on asset segregation and had intended to finalise such work by the end of 2016. However, this has not yet happened.
ESMA has also made various amendments to its Q&A on the application of the AIFMD82 (of which the latest draft was published on 16 December 2016). These updates relate to, inter alia, notification requirements relating to AIFs; reporting to national competent authorities under Articles 3, 24 and 42 delegation; and the impact of EMIR on the AIFMD.
By July 2017, the EU Commission is expected to start a review on the application and scope of the AIFMD as a whole.
The United Kingdom's FCA also published some final guidance for depositaries of AIFs,83 which they consulted on in their March 2015 quarterly consultation paper CP15/8.84
16. Shadow Banking
The FSB has been spearheading a review of "shadow banking" since the financial crisis in light of concerns that shadow banking entities and activities contributed to the crisis and subsequent concerns that increased regulation in the banking sector since the crisis could push certain banking activities into the less regulated sectors. The FSB refers to "shadow banking" as a system of credit intermediation that involves entities and activities that are outside the regular banking system, although it has stressed that this is not a rigid definition and should be adapted according to the financial markets.85 The FSB has been coordinating various international workstreams and has, together with ISOCO, developed a package of policy recommendations which have been endorsed by the G20 leaders.
79 https://www.esma.europa.eu/sites/default/files/library/2016411_final_report_on_guidelines_on_sound_remuneration_policies_under_the_ucits_directive_and_aifmd.pdf 80 https://www.esma.europa.eu/sites/default/files/library/2016-1137_call_for_evidence_asset_segregation.pdf 81 https://www.esma.europa.eu/press-news/consultations/call-evidence-asset-segregation 82 https://www.esma.europa.eu/sites/default/files/library/2016-1669_qa_on_aifmd.pdf 83 https://www.fca.org.uk/publication/policy/ps16-02.pdf 84 https://www.fca.org.uk/publication/consultation/cp15-08.pdf 85 See "Shadow Banking: Scoping the Issues", http://www.financialstabilityboard.org/wp-content/uploads/r_110412a.pdf.
In November 2016 the FSB published its workplan for 2017.86 This stated that the FSB has agreed that it will undertake by July 2017 an assessment of progress in transforming shadow banking into resilient market-based finance. This will include an assessment of the evolution of shadow banking activities since the global financial crisis and related financial stability risks and whether the policies and monitoring put in place by FSB members since then are adequate to address these risks.
The EU Commission has also identified resolving the issues surrounding shadow banking as a priority and published its "Communication"87 on shadow banking in September 2013 as a roadmap for the EU Commission's future work in the area. The EU Commission has endorsed the FSB's general definition of shadow banking and given an indication of the activities (primarily securitisation, securities lending and repos) and entities (including SPVs performing liquidity and/or market transformation and money market funds), which it believes fall within the definition.
Two shadow banking areas, in respect of which there has been considerable work in the EU legislative context during the last two years or so, have been securities financing transactions and money market funds. The current status of each is as follows:
Securities Financing Transactions
One of the FSB's main priorities has been assessing financial stability risks and developing policy recommendations to strengthen regulation of securities lending and repos, as it believes that the majority of such transactions are entered into by non-banks, thus giving rise to maturity and liquidity transformation risks outside the banking sector. These are of particular concern, as the securities lending and repo markets are vital for facilitating market-making, supporting secondary market liquidity and meeting many financial institutions' financing needs.
On 12 November 2015, the FSB published a Report88 finalising its policy recommendations on a regulatory framework for haircuts on non-centrally cleared securities financing transactions (to apply numerical haircut floors to non-bank-to-non-bank transactions). The framework is intended to limit the build-up of excessive leverage outside the banking system and to help reduce procyclicality of that leverage.
In November 2015, the EU Council of Ministers adopted the EU Commission's proposed Regulation on transparency of securities financing transactions (the "SFT Regulation"),89 and the SFT Regulation came into force on 12 January 2016. The SFT Regulation provides for details of all SFTs to be reported to trade repositories, similar to the reporting requirements for OTC derivatives under EMIR, and imposes additional disclosure requirements on managers of UCITS and AIFs. Furthermore, in relation to rehypothecation, the SFT Regulation's "reuse" arrangements require that counterparties must consent in writing to an asset being rehypothecated in the case of a security financial collateral arrangement, the risks of rehypothecation must be explained in writing to the collateral provider and assets received as collateral must be transferred to an account opened in the name of the receiving counterparty.
The SFT reporting obligations will be phased in, the timing dependent upon the nature of the relevant counterparty. Investment firms and credit institutions will be subject to the obligation 12 months after the relevant RTS enter into force. The obligation comes into force 15 months after such date for Central Securities Depositaries and CCPs, 18 months after such date for all other financial counterparties and 21 months after such date for all other counterparties. On 30 September 2016, ESMA published a Consultation Paper90 in relation to draft RTS and ITS under the SFT Regulation.
86 http://www.fsb.org/wp-content/uploads/Financial-Stability-Board-agrees-2017-workplan.pdf 87 http://ec.europa.eu/internal_market/finances/docs/shadow-banking/130904_communication_en.pdf. 88 http://www.fsb.org/wp-content/uploads/SFT_haircuts_framework.pdf 89 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32015R2365&from=EN 90 https://www.esma.europa.eu/sites/default/files/library/2016-1409_sftr_consultation_paper__draft_rts_and_its_under_sftr_and_amendments_to_related_emir_rts.pdf
ESMA indicates that following the completion of the consultation by the end of 2016, it will submit final draft RTS to the EU Commission during the first half of 2017. It therefore seems unlikely that the RTS will come into force until towards the end of 2017 at the earliest, and, in that case, the reporting obligations would not come into force until late 2018.
On 4 October 2016 ESMA published a Report91 on securities financing transactions and leverage in the EU. The Report makes a number of recommendations including that:
the FSB qualitative standards92 on the methodology used to calculate haircuts in non-centrally cleared SFTs should be introduced to improve the transparency and stability of haircuts and the resilience of financial institutions;
the procyclicality of collateral haircuts used by CCPs should be addressed in the context of the upcoming EMIR review;
the numerical haircut floors for non-centrally cleared transactions should only be introduced and calibrated following a thorough analysis and careful assessment of the scope, considering in particular the size and relevance of EU government bond markets;
other macroprudential instruments, including counter-cyclical ones, should be agreed at international level first, and they should only be introduced after a careful assessment that existing measures do not limit the leverage in the system.
Money Market Funds ("MMFs")
Historically MMFs have been regarded as a safe investment with a stable net asset value ("NAV"). The FSB considers MMFs to be an important element of the shadow banking system, both as a source of short-term funding for banks and for provision of maturity and liquidity transformation. It notes, however, that during the financial crisis, some MMFs suffered large losses due to holdings of ABS and other financial instruments, leading to significant investor redemptions and instability. IOSCO published two reports in April93 and October94 2012, setting out policy recommendations for a common approach to MMF regulation, including the need for compliance with general principles of fair value when valuing securities in a portfolio, the requirement to hold a minimum amount of liquid assets to meet redemptions and prevent fire sales and the requirement that MMFs offering a stable NAV should be subject to measures designed to reduce the specific risks associated with this feature. In accordance with these recommendations, the US Securities and Exchange Commission ("SEC") adopted new rules on MMFs (which were established after October 2014), resulting in the imposition of a floating NAV requirement for non-retail and non-governmental MMFs.
The EU Commission has supported the FSB's analysis of the importance of MMFs and agreed that they need to become more resilient to crises. As a result, the EU Commission has proposed a Regulation95 ("MMF Regulation") which will introduce a framework of requirements to enhance the liquidity and stability of MMF funds. Progress on the draft Regulation has been slow with concerns raised about fundamental aspects of the draft including the proposed imposition of a capital buffer of 3% for constant NAV funds. Many in the industry believed this would make such funds uneconomic.
On 7 December 2016, the EU Council of Ministers announced that it reached an agreement with the EU Parliament on the terms of a revised MMF Regulation and published the agreed compromise text.96 Key elements in the MMF Regulation as amended in principle following such negotiations are:
91 https://www.esma.europa.eu/sites/default/files/library/2016-1415_-_report_on_sfts_procyclicality_and_leverage.pdf 92 http://www.fsb.org/wp-content/uploads/SFT_haircuts_framework.pdf 93 http://www.iosco.org/library/pubdocs/pdf/IOSCOPD379.pdf 94 http://www.iosco.org/library/pubdocs/pdf/IOSCOPD392.pdf?v=1 95 http://ec.europa.eu/internal_market/investment/docs/money-market-funds/130904_mmfs-regulation_en.pdf. 96 http://data.consilium.europa.eu/doc/document/ST-14939-2016-INIT/en/pdf
MMFs will be permitted to be established in the EU as either (i) a Variable Net Asset Value MMF ("VNAV"),(ii) a Constant Net Asset Value MMF ("CNAV") or (iii) a Low Volatility Net Asset Value MMF ("LVNAV");
LVNAV is a new category of fund introduced following the EU negotiations;
CNAVs will be required to seek to maintain an unchanging NAV per unit or share and must invest at least 99.5% of its assets in specified assets and cash;
LVNAVs must comply with specific requirements and may be valued using the amortised cost method only if the fund has a residual maturity up to 75 days and provided such valuation does not deviate from a mark to market or model valuation by more than 10 basis points. Units or shares in the LVNAV may be issued or redeemed at a price equal to the constant NAV provided such valuation does not deviate from the NAV per share or unit calculated on a mark to market or model valuation by more than 20 basis points;
CNAVs and LVNAV MMFs will be subject to liquidity requirements, including a minimum 10%. portfolio investment in daily maturing assets and a minimum 30% portfolio investment in weekly maturing assets. VNAVs must have a minimum 7.5% portfolio investment in daily maturing assets and a minimum 15% portfolio investment in weekly maturing assets;
MMFs will be subject to diversification requirements including a 17.5% limit on investments in other MMFs and a 15% limit on reverse repos; and
the proposed constant NAV fund buffer has been deleted.
The agreed draft must be approved by the European Parliament. This is expected to happen early in 2017. It will then be submitted to the EU Council for adoption and is likely to come into force sometime within the first half of 2017. Existing MMFs will have 18 months to comply with the MMF Regulation after it comes into force.
17. MAR/MAD II Implementation
On 3 July 2016, the Market Abuse Regulation (Regulation 596/2014) ("MAR")97 came into effect and repealed and replaced the Market Abuse Directive (2003/6/EC) ("MAD") and its implementing legislation. MAR forms part of a revised legislative package governing market abuse adopted by the EU Council of Ministers in April 2014 along with the Criminal Sanctions for Market Abuse Directive ("CSMAD") (together known as "MAD II"). The aim of the new legislation is to strengthen the market abuse regulatory framework and bring the instruments and markets within its scope into line with the MiFID II regime.
MAR greatly expands the scope of the market abuse regime in the EU. In addition to applying to financial instruments admitted for trading (or subject to a request for admission to trading) on an EU regulated market or traded or admitted for trading (or subject to a request for admission to trading) on an MTF, it will also apply to instruments traded on an OTF (within the meaning of MiFID II). The definition of "financial instruments" has also been widened and includes emission allowances and related auctioned products, commodity derivatives and related spot commodity contracts and benchmarks.
MAR also introduces a new offence of `attempted' insider dealing and market manipulation and includes a prohibition on certain automated trading methods using algorithmic trading or high-frequency trading strategies which can be used to manipulate markets. Further, market
participants subject to MAR will need to adjust their internal compliance procedures to ensure that they comply with the new requirements on insider lists, notification obligations and directors' dealings, amongst other changes. The bulk of MAR provisions became effective on 3 July 2016, but certain provisions relating to OTFs, SME growth markets, emission allowances and related auctioned products will not apply until January 2018 when MiFID II becomes applicable.
MAR makes significant changes to the "market soundings" regime which applies to the communication of information, usually by a dealer or manager on behalf of an issuer, about a potential new issuance, in order to gauge the likely interest of potential investors. New and more detailed requirements now have to be satisfied by the disclosing party. These include a statement that the communication is for the purposes of a market sounding, confirmation from the receiving individual that they are the person entrusted by the recipient institution to receive the sounding and, if possible, an estimation of when the information will cease to be inside information. ESMA has published Guidelines98 on the market soundings rules. These will apply from 1 January 2017. MAR also introduces new requirements in relation to persons discharging managerial responsibilities ("PDMRs") and requires PDMRs and persons closely associated with them to notify the issuer and the relevant competent authority of certain transactions relating to the shares or debt instrument of that issuer or to derivatives or other financial instruments linked to them.
ESMA was required to prepare various draft RTS and ITS on MAR, which it published in a final Report99 in September 2015. The EU Commission subsequently adopted a Delegated Regulation100 giving effect to such RTS and an Implementing Regulation101 giving effect to such ITS which became effective at the same time as MAR. The Delegated Regulation covers rules regarding indicators of market manipulation, minimum thresholds for exemption of certain participants in the emission allowance market from the requirement to publicly disclose inside information, notification of delays in disclosures, permission for trading during closed periods, types of notifiable managers' transactions and exemption from MAR for certain third countries' public bodies and central banks. ESMA has also issued Guidelines102 on the circumstances in which it may be acceptable for firms to delay the public dissemination of inside information.
The UK has exercised its powers under the Lisbon Treaty to opt out of measures governing EU criminal law and thus has not signed up to CSMAD. All other member states (with the exception of Denmark, who also opted out) were required to transpose the CSMAD provisions into national law by 3 July 2016. UK firms operating across member states' borders should be aware of the provisions since they could incur liability in those jurisdictions subject to CSMAD.
18. Possible New Covered Bond Framework
Further to the EU Commission's CMU initiative referred to above, in September 2015, the EU Commission published a Consultation Document103 launched a consultation to assess the assessing the merits of a potential harmonised EU covered bond framework. The Consultation Document considers that such framework could either be achieved through the voluntary convergence of covered bond legislation through non-legislative co-ordination measures or, alternatively, EU legislation providing a regulatory framework in respect of covered bonds including harmonisation as to issuance structures, licensing, segregation of assets in the cover pool, eligibility requirements for cover pool assets, hedging and other risk mitigation requirements and coverage requirements and administration and supervision of the cover pool following segregation of the cover pool assets.
98 https://www.esma.europa.eu/sites/default/files/library/2016-1477_mar_guidelines_-_market_soundings.pdf 99 https://www.esma.europa.eu/sites/default/files/library/2015/11/2015-esma-1455_-_final_report_mar_ts.pdf 100 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R1052&from=EN 101 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R1055&from=EN 102 https://www.esma.europa.eu/sites/default/files/library/2016-1478_mar_guidelines_-_legitimate_interests.pdf 103 http://ec.europa.eu/finance/consultations/2015/covered-bonds/docs/consultation-document_en.pdf
Subsequently on 20 December 2016, the EBA published a Report104 in relation to harmonising covered bond frameworks in the EU. The EBA proposes that, for this purpose and to continue to obtain favourable capital treatment under CRDIV, covered bonds should be required to meet harmonised structural, credit risk and prudential standards. The EBA recommends that this framework should be established by a new EU Directive and that necessary amendments are made to the CRR provisions relating to risk weighting of covered bonds.
It remains to be seen whether, and how quickly, the EU Commission decides to move forward with a harmonised framework and whether it seeks to do so through a legislative framework under an EU Directive. This route is likely to take some time and it is questionable whether the EU Commission would be able to publish draft legislation during 2017.
UCITS funds in the EU are currently regulated pursuant to the existing UCITS Directive ("UCITS IV")105 as amended by an amending Directive ("UCITS V"),106 which was published in the OJ on 28 August 2014. EU member states had until 18 March 2016 to transpose UCITS V into their national laws. The principal amendments made by UCITS V seek to make some of the rules for UCITS funds more consistent with those applicable to alternative investment funds under the AIFMD, including changes to the provisions relating to the appointment of a depositary in respect of a UCITS fund, rules setting out the terms on which the depositaries' safekeeping duties can be delegated and a revision of the eligibility criteria for depositaries.
The EU Commission is required to publish and implement various delegated acts and technical standards and guidance under UCITS V, particularly in relation to depositories. In April 2016, a Delegated Regulation107 came into force (and applied with effect from October 2016) that provided, among other things:
minimum requirements to be included in the contract between the depositary and the management / investment company;
certain duties and obligations on the depositary including safe-keeping, custody and ownership verification, oversight and record-keeping;
provisions relating to insolvency protection of the assets of the UCITS, including due diligence and asset-segregation obligations when appointing delegates to perform safe-keeping duties; and
liability of the depositary in circumstances where custody assets are lost by the depositary or a third party.
In addition, on 31 March 2016, ESMA published its final Report108 setting out Guidelines on sound remuneration policies under UCITS V and the AIFMD. These Guidelines aim to clarify the specific provisions in UCITS V in relation to remuneration to ensure a consistent application with the equivalent provisions in the AIFMD and to provide guidance on certain provisions, including those relating to proportionality, the governance of remuneration, risk alignment and disclosure. The final Guidelines are largely consistent with the AIFMD Remuneration Guidelines with certain amendments on the grounds of proportionality. The Guidelines apply with effect from 1 January 2017. However,
104 http://www.eba.europa.eu/documents/10180/1699643/EBA+Report+on+Covered+Bonds+%28EBA-Op-2016-23%29.pdf 105 Directive 2009/65/EC, http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2009:302:0032:0096:en:PDF. 106 Directive 2014/91/EC, http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32014L0091&from=EN. 107 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016R0438&from=EN 108 https://www.esma.europa.eu/sites/default/files/library/2016411_final_report_on_guidelines_on_sound_remuneration_policies_under_the_ucits_directive_and_aifmd.pdf
the relevant AIFMD Guidelines have not yet been amended to reflect the UCITS Guidelines pending clarification of the principles of proportionality. In particular, in a letter to the EU Commission in March 2016,109 ESMA set out its view that the proportionality principles could result in the remuneration payout requirements not being applied in certain circumstances. It also suggested that certain funds (below a certain value or with limited activities) should be excluded from having to apply requirements in relation to the pay-out process. The Commission has yet to respond to these proposals.
In June 2016, ESMA published a Call for Evidence110 in relation to asset segregation and custodial services under UCITS V and AIFMD following on from a previous consultation. It is expected to clarify its proposed next steps during the early part of 2017.
More generally, in relation to UCITS, in April 2016 ESMA published a Discussion Paper111 in relation to UCITS share classes. This followed-up on a previous Discussion Paper published in December 2014. In its latest paper, ESMA suggests a principles-based framework in respect of share classes. It invited responses on its proposed principles by June 2016. ESMA is expected to publish its revised framework sometime in 2017.
20. EU Deposit Insurance Regulation
The recast Deposit Guarantee Schemes Directive112 protects EU deposits up to EUR100,000 through national Deposit Guarantee Schemes ("DGS") throughout the EU and requires each credit institution authorised in the EU to become a member of its home state's DGS. The Directive imposes various obligations on the establishment, supervision and operation of DGSs.
In connection with the establishment of the SSM and the SRM, it was originally envisaged by the EU Commission that a single deposit guarantee scheme for member states participating in the SRM/SSM would be one of the main elements of the banking union established thereby. Although these proposals were deferred, in June 2015, in the "Five Presidents' Report" on completing monetary union within the Eurozone President Jean-Claude Junker of the EU Commission, proposed the launch of a European Deposit Insurance Scheme ("EDIS").
On 24 November 2015, the EU Commission published a draft Regulation to amend the Regulation for the SRM to establish the EDIS.113 The draft Regulation envisages that the EDIS will be operated by the Single Resolution Board and will provide additional funding for DGSs established in member states participating in the SRM. The draft Regulation envisages EDIS being established in three successive stages:
Reinsurance for the first three years, EDIS will reinsure participating DGSs and cover a limited share of the loss of a participating DGS and will provide funding in the event of a liquidity shortfall at a DGS;
Co-insurance for four years after the reinsurance period, participating DGSs will be coinsured by the EDIS. The percentage of loss covered by the EDIS under such co-insurance will commence at 20% and rise by 20% each subsequent year; and
Full insurance after the co-insurance period, participating DGSs will be fully insured by the EDIS. It is intended that this will occur by 2024.
109 https://www.esma.europa.eu/sites/default/files/library/2016412_letter_to_european_commission_european_council_and_european_parliament_on_the_proportionality_principle_and_re muneration_rules_in_the_financial_sector.pdf 110 https://www.esma.europa.eu/sites/default/files/library/2016-1137_call_for_evidence_asset_segregation.pdf 111 https://www.esma.europa.eu/sites/default/files/library/2016-570_discussion_paper_on_ucits_share_classes_2016_0.pdf 112 http://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:32014L0049&from=EN 113 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52015PC0586&from=EN
In April 2016, the ECB published an Opinion114 in relation to the Proposed EDIS Regulation. It was generally supportive of the proposals but was concerned that requirements to have risk mitigation measures fully in place before progressing EDIS could lead to delays. Its view is that progress on these measures should be made in parallel with establishing the EDIS. Also in April 2016, the European Forum of Deposit Insurers raised a number of concerns on the proposals, including whether individual depositors would have the same level of confidence in a central authority as in a local scheme and the need for further measures to address potential conflicts of interest.
In June 2016, the EU Parliament published a working document on the EDIS Regulation which generally supported the proposal but highlighted concerns in relation to work on risk reduction and the calculation of risk based contributions (currently proposed by the EU Commission to be dealt with in technical standards). In November 2016, ECON published its draft report115 on the Regulation and suggested amendments, including deferring the initial reinsurance phase to 2019 and extending that period to five years. This phase would provide up to 100% of liquidity shortfall to participating DGSs.
In December 2016, the EU Council of Ministers published a progress report116 on its work in relation to the Regulation noting that some member states still have objections to the proposal and the proposed timetable. It therefore seems unlikely that progress will be rapid during 2017, and the EU Parliament and EU Council will continue their work in seeking to reach political agreement on the proposals. The EU Commission's current proposed timetable of having the EDIS established by July 2017 therefore seems unlikely and the ECON's proposed 2019 commencement seems more realistic.
21. PSD II
The Payment Services Directive ("PSD") became law in most of the EU in 2009 and aimed to harmonise the regulatory regime for payment services across the EU by enabling a new type of regulated financial institution (a "payment institution") to compete with banks in the provision of payment services. It established an EU-wide licensing regime for payment institutions, as well as harmonised conduct of business rules.
The EU Commission published proposals for an amended payment services Directive in July 2013 and the final approved text of such Directive (referred to as "PSD II")117 was published in the OJ on 23 December 2015 and entered into force on 12 January 2016. EU member states are required to transpose PSD II into national laws by 13 January 2018.
PSD II makes certain extensions to the geographical scope and the currencies covered by the PSD. The PSD is limited to payment services provided in the EU where both the payer's and payee's payment service provider are located in the EU. Under PSD II, certain provisions (primarily in respect of transparency of terms and conditions and information requirements) will apply to transactions where only one of the payment service providers is located in the EU. PSD II will also now apply the provisions relating to transparency and information requirements to all currencies, not only EU currencies, as is currently the case.
The definition of payment services will also be widened to cover (i) payment initiation services enabling access to a payment account provided by a third-party payment service provider where the payer can be actively involved in the payment initiation or the third-party payment service provider's software or where payment instruments can be used by the payer or payee to transmit the payer's credentials to the account servicing payment service provider and (ii) an account information service
114 http://www.ecb.europa.eu/ecb/legal/pdf/en_con_2016_26_f_sign.pdf 115 http://www.europarl.europa.eu/sides/getDoc.do?type=COMPARL&reference=PE592.334&format=PDF&language=EN&secondRef=03 116 http://data.consilium.europa.eu/doc/document/ST-14841-2016-INIT/en/pdf 117 http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32015L2366&from=EN
where consolidated and user-friendly information is provided to a payment service user on one or several payment accounts held by the payment service user with one or several account servicing payment service providers.
In addition, a number of the existing exemptions available under the PSD are narrowed or removed, and various amendments are made to the conduct of business requirements. The exemptions affected include:
the "commercial agent" exemption relating to payment service providers acting as a commercial agent. This exemption will now only apply where the agent is acting solely for either the payer or payee, but not both parties;
the "limited network" exemption where a payment instruction can only be used to purchase a limited range of goods or services within a limited network of service providers. Under PSD II, any services relying on the exemption must be based on specific instruments designed to address precise needs that can only be used in a limited way. Also, if the monthly volume of transactions exceeds EUR1 million, the payment service provider must obtain clearance from its competent authority to be able to utilise the exemption; and
the exemption under the PSD for digital content or telecom payments applying to payments executed through mobile phones and the internet is, under PSD II, limited to ancillary payment services carried out by providers of electronic communication networks or services. The exemption is also no longer available for any individual transaction exceeding EUR50 and is subject to an overall limit of EUR300 in a billing month.
A number of other conduct-of-business requirements are amended by PSD II and it contains some provisions aimed at increasing competition by facilitating the use of third-party payment service providers ("TPPs"). PSPs will be prohibited from denying TPPs access to bank accounts and PSPs, that provide account servicing cannot discriminate against TPPs.
The PSD II requires the EBA to develop RTS and/or guidelines in relation to certain aspects of PSD II. The EBA has published consultation papers in relation to various matters, including draft Guidelines on major incidents reporting,118 the authorisation of payment institutions119, criteria on the minimum monetary amount of professional indemnity insurance120 and passporting notifications.121
In the UK, in February 2016, the FCA published a Call for Input122 on its approach to PSD and its transposition into UK law by January 2018. It subsequently published a Feedback Statement in November 2016, indicating that respondents were broadly happy with its existing guidance in relation to the PSD but thought an update was needed to reflect recent developments. The FCA is expected to publish a consultation paper in 2017 to set out its specific proposals.
118https://www.eba.europa.eu/documents/10180/1688810/Consultation+Paper+on+the+Guidelines+on+Major+Incidents+Re porting+under+PSD2+%28EBA-CP-2016-23%29.pdf/1db1cbdc-648c-434f-b31c-1d37d402802d 119https://www.eba.europa.eu/documents/10180/1646245/Consultation+Paper+on+draft+Guidelines+on+authorisation+and+ registration+under+PSD2+%28EBA-CP-2016-18%29.pdf/b8d49c1c-be4f-4b36-a5ce-e6710e00383c 120 https://www.eba.europa.eu/documents/10180/1586019/EBA-CP-201612+%28Consultation+Paper+on+draft+Guidelines+on+PII+under+PSD2%29.pdf/f573498f-7e2c-4351-8cb3-a92bd58fc2ee 121 https://www.eba.europa.eu/documents/10180/1694291/Final+draft+RTS+on+passporting+%28EBA-RTS-201608%29.pdf/7a77aa22-dcc8-44a7-89ec-5779eb1c4bbc 122 https://www.fca.org.uk/publication/call-for-input/call-for-input-payment-services-regime.pdf
22. EU Consultation in Relation to Combined Impact of Financial Regulation
In September 2015, the EU Commission launched a public consultation in the form of a Call for Evidence123 relating to the EU regulatory framework for financial services. It stated that in view of the huge amount of financial legislation put in place since the crisis, it sees merit in understanding the combined impact of such legislation and identifying any unintended consequences. In particular, the EU Commission sought views on areas of regulation that firms regard as imposing excessive burdens, costs or complexity out of proportion with the intended policy objectives. Specific questions included:
whether any legislation produced undue obstacles to the ability of the wider financial sector to finance the economy, in particular in relation to SME financing, long-term innovation and infrastructure projects and climate finance;
whether, and to what extent, the regulatory framework has had any major positive or negative impacts on market liquidity and on investor and consumer protection and confidence; and
whether the new rules been appropriately adapted to the diversity of financial institutions in the EU.
There were almost 300 responses to the Call for Evidence, including from many regulators, governments and central banks. In a Summary of Contributions to the Call for Evidence,124 the EU Commission highlighted a number of themes that had come out of the responses including:
a significant increase in compliance costs due to the scale and pace of regulatory change and a perceived overlap of different layers of regulation. Concerns were raised as to poorly aligned and tight timelines for implementation and the complexity of the overall framework;
the need for improvements in financing conditions for SMEs. Many respondents suggested extending capital relief for banks' investments in bonds and equities issued by SMEs;
possible adverse consequences of the LCR and its potential negative impact on corporates' cash management;
specific pieces of legislation and the cumulative effect of certain rules have given rise to a detrimental impact on market liquidity, particularly in corporate bond markets; and
disclosure rules are seen as inconsistent across different pieces of relevant legislation.
Subsequently, in November 2016 the EU Commission published a further Call for Evidence125 in relation to the EU regulatory framework for financial services. The EU Commission states in the Call for Evidence that it is a key contribution to its "Better Regulation" agenda and the Regulatory Fitness and Performance programme ("REFIT") aimed at ensuring EU legislation "delivers results for citizens and businesses effectively, efficiently and at minimum cost". In relation to its earlier consultation, the EU Commission stated that, having regard to the responses received, its view was that overall the financial services framework is working well. It states that the feedback from the previous consultation has already been integrated into existing reviews and legislative initiatives including the
123 http://ec.europa.eu/finance/consultations/2015/financial-regulatory-framework-review/docs/consultationdocument_en.pdf 124 http://ec.europa.eu/finance/consultations/2015/financial-regulatory-framework-review/docs/summary-ofresponses_en.pdf 125 http://ec.europa.eu/finance/general-policy/docs/general/161123-communication_en.pdf
recent proposals to amend the CRR and CRD IV summarised above and will be important in the development of the CMU. In terms of follow-up action, the Commission states that this will include:
reducing unnecessary regulatory constraints on financing the economy in this regard it notes the importance of retaining banks' ability to finance the wider economy and to ensure SME financing;
enhancing the proportionality of rules without compromising prudential objectives;
reducing undue regulatory burdens (it indicates the EMIR review will focus on reducing reporting burdens for non-financial counterparties); and
making the regulatory framework more consistent and forward-looking.
In terms of the next steps, the EU Commission states that certain adjustments to the financial regulatory framework will be taken forward through:
fitness checks and legislative reviews as part of REFIT, including reporting requirements;
calibration measures at both the legislative and implementation levels;
ongoing policy work, including refining and accelerating measures under the CMU; and
input from the EU Commission on work on global initiatives to measure and evaluate the combined effect of reforms.
In addition to the above work, in August 2016, the EU Commission published a Consultation Document126 entitled "Review of the EU Macro-Prudential Policy Framework." It notes in the paper that the macro-prudential framework has evolved through a piecemeal approach of many years that has resulted in an overlapping toolset of macro-prudential instruments available in the EU with inconsistencies in the way such instruments are activated and on overly complex process for coordinating relevant measures. It also notes that the role of the European Systemic Risk Board ("ESRB") has evolved into a co-ordination and analytical hub for macro-prudential policy which is a much broader role than initially envisaged.
On 21 December 2016, the EU Commission published a Feedback Statement127 and Executive Summary128 in relation to this consultation, giving a summary of responses received. The Commission states that there was broad support amongst stakeholders for some revisions to the macro prudential toolset, and stakeholders also supported simplifying the use of certain macro prudential instruments, either by amending the pecking order of use or amending the activation mechanisms associated with certain instruments. Stakeholders expressed some support for an expansion of the macro prudential toolset beyond the banking sector. The Commission states that the Feedback Statement is a summary of the responses it received to the consultation and should not be seen as reflecting its position. It, however, seems likely that the Commission will publish proposals to deal with some of the issues raised during 2017.
126 http://ec.europa.eu/finance/consultations/2016/macroprudential-framework/docs/consultation-document_en.pdf 127 http://ec.europa.eu/finance/consultations/2016/macroprudential-framework/docs/summary-of-responses_en.pdf 128 http://ec.europa.eu/finance/consultations/2016/macroprudential-framework/docs/executive-summary_en.pdf
23. Final Thoughts
As can be seen from the above summaries, the European regulatory agenda remains packed even though we are now many years on from the onset of the financial crisis. Whilst most of the ongoing work relates to implementation of regulation that has been many years in the making, new developments continue. In particular, the Capital Markets Union project of the EU Commission is still in its relatively early days. Despite some initial doubts as to whether this project would survive the Brexit vote, the EU Commission has reavowed its commitment to CMU and further developments are likely in the coming years although some elements of the project may take on a different complexion without the influence of the UK. Brexit itself will add complexity to the EU regulatory landscape and has the potential to slow down the regulatory agenda to some extent as resources are focused on the negotiations with the UK once it serves the Article 50 Notice. We would, however, expect that one year from now as we sit down to compile the outlook for 2018 there will still be plenty of activity for us to reflect on and much to ponder for the coming years ahead.
Peter Green London +44 (20) 7920 4013 firstname.lastname@example.org
Jeremy Jennings-Mares London + 44 (20) 7920 4072 email@example.com
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