Insights from Winston & Strawn
Asset managers should take note: March 2016 will be an important month in the European Union. More specifically, on March 18, 2016, the last amended version of the Undertakings for the Collective Investment in Transferable Securities (“UCITS”) Directive will go into effect, followed by its implementing regulations.
The UCITS Directive, along with the Alternative Investment Funds Managers Directive (“AIFMD”), in effect since July 21, 2011, is at the core of asset management regulations for the EU Member States. Conceived in 1985 to standardize all regulations applicable to investment funds, other than hedge funds, within the European Union, UCITS rules have drawn increasing attention since the 2008 crisis. Particularly, the focus has been on the need to keep investors better informed and protected and to further standardize the supervision of financial products and activities among the Member States’ supervisory authorities. These issues were addressed in the UCITS IV Directive 2009/65/EC, which for instance created the Key Investor Document (“KID”) that must be established for any UCITS. The UCITS IV also increased and simplified cooperation between Member States’ supervisory authorities. In the meantime, UCITS IV simplified its regime by permitting the funds to merge cross-border; be marketed cross-border; or become involved in cross-border master/feeder schemes.
The new version of the Directive, re-named UCITS V, aims to increase transparency for financial products to avoid such products being inappropriately sold to customers/investors. It aims to avoid new incidents such as the Madoff incident by implementing the safeguards that already exist in AIFMD. Concretely, the amendments concern three areas: first, defining the functions of the funds’ depositaries (mainly relating to tasks and liabilities, but also conditions for delegation); second, the introduction of new rules regarding funds’ staff remuneration policies; and finally, the standardization of administrative sanctions available to supervisory authorities for violations of the UCITS rules.
While the UCITS Directive, with its rules and obligations, places a burden on registered investment managers operating UCITS (as well as on service providers such as depositaries), it also represents an opportunity for investment managers attempting to collect significant amounts across multiple EU Member States. Since the UCITS IV Directive, investment managers can register in one Member State and market their funds across the whole EU territory with minimal procedures. As such, through the passport mechanism, an EU fund and/or manager registered and supervised in its native country is deemed to be compliant with the EU rules that also apply to the other Member States.
It should be noted that UCITS V and its pending implementing regulation will also be of interest to non-EU operators working with UCITS, especially those working for their depositaries under a delegation agreement, since the new rules may impact, for example, their liability or the scope of their functions, thus requiring amendments to the existing agreements.
Partners in our Brussels, London and Paris offices will continue to monitor this new Directive and its consequences as they unfold. Should you have any questions or comments, feel free to reach out.
Feature: UK Crowdfunding Industry Prepares for the Launch of the Innovative Finance ISA
As investors in the U.S. prepare for the opportunity to invest in securities-based crowdfunding when the Regulation Crowdfunding final rules become effective in May, UK investors are also anticipating the launch of a new kind of crowdfunding investment. On April 6, 2016, a new type of investment called an Innovative Finance Individual Savings Account (“ISA”) will be available to UK investors—this will permit crowdfunding investment platforms, known in the UK as peer-to-peer lending platforms, to offer investments through these tax-advantaged ISAs.
Although the opportunity to make peer-to-peer investments through ISAs is an innovation, as the name of the new account suggests, crowdfunding investments are well-established in the UK
While equity crowdfunding is in its infancy in the U.S., the practice has been permitted in the UK for the last five years, according to an article in Institutional Investor that compares the U.S. approach to regulating crowdfunding investments with UK regulations. And, by most accounts, peer-to-peer lending and investments in the UK have been a resounding success. A recent report published by the University of Cambridge and Nesta found huge growth in volume in the peer-to-peer industry last year, with a 295 percent increase in equity crowdfunding investments and an 84 percent increase across the industry for a total worth of £3.2 billion.
Some attribute the success of peer-to-peer investments in the UK to the approach taken by regulators, which has been described as a “simplified, ‘light touch’ regulatory approach.” Others in the crowdfunding industry credit the UK’s simpler rules for the success of peer-to-peer investments and place the UK’s approach in stark contrast to the restrictions established by the Securities and Exchange Commission (“SEC”) in Regulation Crowdfunding, leading several to speculate that equity crowdfunding in the U.S. will lag behind its UK counterpart.
With the introduction of the Innovative Finance ISA, the growth of peer-to-peer investments in the UK is expected to continue. While UK platforms are rushing to prepare for what they anticipate to be an onslaught of new investors, some platforms are encountering trouble clearing regulatory hurdles. The Financial Times reported in mid-February that the UK’s three largest peer-to-peer lending platforms have yet to receive authorization from the Financial Conduct Authority (“FCA”) for their proposals, which is required before they can apply to the UK tax authorities for permission to include their products as part of an ISA. The peer-to-peer providers are concerned that the delay will hamper their ability to offer their products to investors by April 6th.
The FCA has been actively preparing for the commencement of the Innovative Finance ISA. The regulator recently concluded two consultations on proposals related to peer-to-peer investments. In January, the FCA published a proposal that would change the application of the FCA’s client money rules, which require firms to segregate money held in relation to peer-to-peer agreements from all other funds, to loan-based crowdfunding platforms. The FCA notes that firms find the requirement burdensome because they do not have systems in place to distinguish between money held for peer-to-peer agreements and money held for unregulated business to business lending. Under the proposal, firms would be permitted to hold money for peer-to-peer agreements together with funds for unregulated business to business lending without violating client money rules. Firms would be required to segregate these funds from the firm’s own money and any other money.
At the beginning of February, the FCA issued a consultation paper on changes to its Handbook related to the introduction of the Innovative Finance ISA and the regulated activity of providing advice on investing in peer-to-peer agreements. In the consultation paper, the FCA set out proposals to add guidance on current disclosure rules to specify what information firms should disclose regarding the Innovative Finance ISA; apply rules regarding suitability and the prohibition on the payment or receipt of commissions to firms making recommendations regarding peer-to-peer agreements; and ensure the supervision and assessment of financial advisers who provide advice regarding peer-to-peer agreements. The FCA expects to publish final rules relating to both proposals in March.
Despite the enthusiasm in the UK for crowdfunding investments sparked by the introduction of the Innovative Finance ISA and illustrated in the exponential growth rates of these investments, there are concerns. Earlier this month, former chair of the Financial Services Authority Lord Turner warned that the peer-to-peer industry is not thoroughly assessing investors’ assets and financial competence, which he claimed will lead to losses “in the next 5 to 10 years that will make the worst bankers look like absolute lending geniuses.” Industry supporterscontend that the automated nature of online peer-to-peer lending platforms has not resulted in the industry taking shortcuts in performing appropriate credit underwriting.
As crowdfunding investments take off in the U.S. and boom in the UK, members of the International Organization of Securities Commissions (“IOSCO”) are beginning to consider the implications for cross-border investing. At the end of 2015, IOSCO released the results of its survey of its members regarding their current or proposed regulatory frameworks for investment-based crowdfunding and published a statement addressing the regulation of crowdfunding. In the statement, IOSCO noted that most regulatory regimes for crowdfunding are still fairly new and raised concerns that investors are not aware of the major risks associated with these investments. IOSCO pointed to the online presence of crowdfunding platforms in urging regulators to develop approaches to mitigate cross-border risks. The statement notes that “IOSCO has not proposed a common international approach to the oversight or supervision of crowdfunding.” Given the burgeoning popularity of crowdfunding investments, it seems likely that the appearance of such a proposal is on the horizon.
Banking Agency Developments
OCC to Host Credit and Compliance Risk Workshops in California
On February 22nd, the Office of the Comptroller of the Currency (“OCC”) announced that it will be hosting two workshops in Santa Ana, CA, at the DoubleTree Santa Ana-Orange County Airport, March 22-23, for directors of national community banks and federal savings associations supervised by the OCC. OCC Press Release.
Securities and Exchange Commission
Division of Trading and Markets Publishes Revised FAQs on Large Trader Reporting
The SEC’s Division of Trading and Markets updated its Responses to Frequently Asked Questions Concerning Large Trader Reporting on February 22nd. The updated guidance includes revisions to the discussion of how to calculate options for the purposes of the identifying activity level and provides new information regarding filing requirements for previously self-identified Large Traders that no longer meet the threshold. Large Trader Reporting FAQs.
Speeches and Statements
Chair White Addresses the Advisory Committee on Small and Emerging Companies
In her opening remarks at a meeting of the SEC Advisory Committee on Small and Emerging Companies on February 25th, SEC Chair Mary Jo White provided an update regarding recent SEC rulemaking activities relevant to small and emerging companies and emphasized the importance of the committee’s work in reviewing data regarding capital-raising by small businesses through unregistered securities offerings. White Remarks.
Investor Advocate Expresses Concern about Declining Listing Standards
SEC Investor Advocate Rick Fleming addressed the SEC Speaks conference on February 19th, discussing what he observes to be a growing trend among exchanges to weaken listing standards and lamenting the lack of public participation in commenting on rule changes proposed by the exchanges. Fleming suggested that the SEC may need to reconsider its current practice of allowing a “for-profit business to be entrusted with regulatory responsibilities of an SRO.” Fleming Remarks.
DERA Working Paper Examines Manipulation of Illiquid Asset Indexes
On February 26th, staff in the SEC’s Division of Economic Risk and Analysis (“DERA”) published a working paper entitled, “Manipulation of Illiquid Asset Indexes.” The working paper studies the manipulability of national municipal bond indexes subject to various bond size thresholds through the application of a model that measures the manipulability of an index to identify assets that are most susceptible to manipulation. DERA Working Paper.
No Mid-Year Adjustment to Section 31 Fee Rate
The SEC announced in a Fee Rate Advisory published on February 25th that a mid-year adjustment to the Section 31 fee rate for fiscal year 2016 will not be required. The fee rate announced in January of $21.80 per million for securities transactions will remain in place until the later of September 30, 2016, or 60 days after the enactment of a regular fiscal year 2017 appropriation. SEC Press Release.
DERA White Paper Analyzes Causes of ETF Trading Pauses on August 24th
The SEC published a DERA staff white paper on February 23rd that examines the causes of trading pauses in several exchange-traded funds on August 24, 2015. The paper found that a spike in trading volume and a pullback in liquidity supply contributed to the limit up-limit down pauses in ETFs, an ETF’s correlation with the S&P 500 index was a strong predictor of pauses, and an ETF’s turnover was negatively related to pauses. DERA White Paper.
SEC Seeks Comments on SIPC Board’s Determination for the Maximum Cash Advance Amount for SIPA Liquidation Claims
The SEC provided notice on February 22nd of a determination made by the Board of Directors of the Securities Investor Protection Corporation (“SIPC”) regarding the standard maximum cash advance amount available to satisfy customer claims for cash in a Securities Investor Protection Act (“SIPA”) liquidation proceeding. The Board has determined that the standard maximum cash advance amount will remain at $250,000 and will be set at that amount for a period of five years beginning on January 1, 2017. Comments should be submitted on or before March 11, 2016. SEC Release No. SIPA 174.
2015 Q3 Private Fund Statistics
The SEC’s Division of Investment Management released private fund statistics for the third quarter of 2015 on February 24th. Private Fund Statistics.
Commodity Futures Trading Commission
CFTC Requests Public Comment on Petition for Order Pursuant to Commodity Exchange Act
On February 25th, the Commodity Futures Trading Commission (“CFTC”) announced that it is requesting public comment on a petition submitted by LCH.Clearnet Ltd. requesting an order that would permit LCH.Clearnet and its clearing members that are registered futures commission merchants to commingle in an account subject to Section 4d(f) (a cleared swaps customer account) futures and foreign futures positions and cleared swaps positions, and related customer money, securities, and property; and portfolio margin futures and foreign futures contracts and cleared swaps contracts in the cleared swaps customer account. Comments regarding the request should be submitted on or before March 11, 2016. CFTC Press Release.
CFTC Advisory Committee Recommends That Regulator Drop Plan to Limit Futures Contracts
On February 24th, DealBook reported that the CFTC Energy and Environmental Markets Advisory Committee has recommended that the regulator abandon its plan to limit the amount of futures contracts that a trader can hold on certain commodities, including oil and natural gas. DealBook.
CFTC Staff to Host Public Roundtable on Residual Interest Deadline
On February 22nd, the CFTC announced that its Division of Swap Dealer and Intermediary Oversight and the Office of the Chief Economist will host a public roundtable at the CFTC’s Washington, D.C. headquarters on March 3rd at 10:00 am to discuss a report on the Residual Interest Deadline. CFTC Press Release.
Federal Rules Effective Dates
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Exchanges and Self-Regulatory Organizations
BATS Files Proposed Change to Limit Orders Eligible to Participate in IPO Auctions
On February 24th, the SEC provided notice of a proposed rule change filed by BATS Exchange, Inc. (“BATS”) that would amend the definition of Eligible Auction Orders to refine the types of orders that are eligible to participate in an IPO Auction for a BATS listed corporate security. Under the proposal, the types of orders eligible to participate in an IPO Auction would be limited to Limit Orders and BATS Market Orders. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of February 29. SEC Release No. 34-77222.
BATS Exchanges Propose New Early Trading Session
On February 23rd, the SEC requested comments on BATS and BATS Y-Exchange, Inc.’s (“BYX”) separately filed proposals to amend their respective rules to create a new Early Trading Session that will operate from 7:00 am to 8:00 am Eastern Time and to adopt three new Time-in-Force instructions. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of February 29, 2016.
Financial Industry Regulatory Authority
FINRA Proposal Would Require Identification of Certain Non-FINRA Member Broker-Dealers in OATS Reports
On February 19th, the SEC provided notice of a proposed rule change filed by the Financial Industry Regulatory Authority (“FINRA”) that would require FINRA members subject to Order Audit Trail System (“OATS”) rules to identify certain broker-dealers that are not FINRA members on their OATS reports after receiving an order from such a broker-dealer. Under the proposal, OATS reporting members that receive an order from either a U.S. broker-dealer that is not a FINRA member or a broker-dealer that is not registered in the U.S. but has received an SRO-assigned identifier must identify the broker-dealer when reporting receipt of the order to OATS. Comments should be submitted on or before March 17, 2016. SEC Release No. 34-77180.
FINRA Proposes Reducing Synchronization Tolerance for Computer Clocks Recording Events in NMS and OTC Equity Securities
On February 19th, the SEC requested comments on FINRA’s proposal to tighten the synchronization requirement for computer system clocks that record events in NMS securities and OTC Equity Securities by reducing the drift tolerance from one second to 50 milliseconds. Comments should be submitted on or before March 17, 2016.SEC Release No. 34-77196.
ICE Clear Europe Proposal Would Permit Clearing Members to Use Additional Government Securities to Satisfy Margin Requirements
On February 25th, the SEC provided notice of ICE Clear Europe Limited’s (“ICE Clear Europe”) proposed rule change that would allow ICE Clear Europe’s Clearing Members to provide additional types of securities, including treasury bills and inflation-linked government bonds, to ICE Clear Europe to satisfy margin requirements. Comments should be submitted within 21 days of publication in the Federal Register, which is expected the week of February 29. SEC Release No. 34-77234.
International Swap and Derivatives Association
ISDA Encourages Broad Focus on Similarities in Making Comparability Determinations between U.S. and EU Trading Platforms
On February 24th, the International Swaps and Derivatives Association (“ISDA”) published a set of principles for EU/U.S. trading platform recognition. In the paper, the ISDA encouraged the CFTC to follow the principles set out in IOSCO’s cross-border report and focus on similarities when determining whether EU trading venues are comparable with those in the U.S.. ISDA Press Release.
Municipal Securities Rulemaking Board
MSRB Issues Compliance Guide for Brokers, Dealers and Municipal Securities Dealers
The Municipal Securities Rulemaking Board (“MSRB”) published a Compliance Advisory for Brokers, Dealers and Municipal Securities Dealers on February 24th. The advisory provides an overview of the key compliance risks for brokers, dealers and municipal securities dealers, including failure to comply with best execution obligations, pay-to-play restrictions, and restrictions on gifts and other non-cash compensation, among other topics. The advisory also offers guidance on factors that should be considered by dealers in assessing the adequacy of their compliance programs. MSRB Press Release.
National Futures Association
Responsibility for Notices of Swap Valuation Disputes Shifts to NFA on March 1st
On February 26th, the National Futures Association (“NFA”) reminded members that, effective March 1, 2016, the NFA will assume responsibility for receiving and maintaining notices of swap valuation disputes in excess of $20 million on behalf of the CFTC. All swap dealers and major swap participants will be required to file notices of swap valuation disputes with the NFA beginning on March 1st. NFA Notice I-16-09.
SEC Institutes Disapproval Proceedings Regarding NYSE Arca’s Proposed Generic Listing Standards for Managed Fund Shares and Requests Comments on Amendment
On February 22nd, the SEC instituted proceedings to determine whether to approve or disapprove NYSE Arca, Inc.’s (“NYSE Arca”) proposal to adopt generic listing standards for Managed Fund Shares. The SEC also requested comments on an amendment to the proposal filed by NYSE Arca that clarifies that the generic listing standards will be applied on an initial and continuing basis and makes other technical corrections. Comments should be submitted on or before March 18, 2016. Rebuttal comments are due on or before April 1, 2016. SEC Release No. 34-77203.
Panel Dismisses Ponzi Scheme Suit Against PEMGroup CPAs
Appellant was appointed receiver for PEMGroup and related companies after PEMGroup’s former directors and managers used the companies to defraud investors of around $950 million in a “massive Ponzi scheme.” Appellant sued the CPAs who audited the financial statements for six of PEMGroup’s fraudulent offerings, contending that their reports materially misrepresented PEMGroup’s financial condition. The district court granted summary judgment for the CPAs and the Ninth Circuit affirmed on February 23rd, holding that appellant failed to show that either the companies or their investors relied on the audits. PEMGroup.
Director of SEC’s Office of Compliance, Inspections and Examinations States That His Division Analyzes Data From More Than 10% of Advisers.
In response to investor protection concerns regarding the fact that the SEC annually examines about 10% of the more than 12,000 investment advisers it oversees, the SEC is currently drafting a rule that would allow third parties to conduct examinations. On February 25th, InvestmentNews reported that Marc Wyatt, director of the SEC’s Office of Compliance, Inspections and Examinations, cautioned an audience of compliance professionals to not misread the 10% annual examination rate for investment advisers. InvestmentNews.
FASB Issues Final Rule Requiring Companies to Report Leases.
On February 25th, DealBook reported on the Financial Accounting Standards Board’s (“FASB”) issuance of a final rule that changes how companies account for most of their leases. The FASB, which sets accounting rules, issued the Accounting Standards Update (“ASU”) intended to improve financial reporting about leasing transactions. The ASU, which affects all companies and other organizations that lease assets such as real estate, airplanes, and manufacturing equipment, will require organizations that lease assets to recognize on their balance sheets the assets and liabilities for the rights and obligations created by those leases. DealBook.
SEC and Labor Department Clash Over Retirement Advice Rule.
On February 24th, Reuters reported that staffers at the SEC and the U.S. Labor Department clashed over a controversial plan to curb potential conflicts of interest among brokers who give retirement advice. The plan would require brokers to act in clients’ best interests when advising about individual retirement accounts (“IRAs”), a savings vehicle for millions of investors. Many Republicans and some Democrats oppose the plan, saying it would drive up customers’ costs and curb commissions. Reuters.