The business of relationships.SM
Financial Industry Regulatory Update
December 2014r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 i
Table of Contents Page
2. The Financial Services (Banking Reform) Act 2013 .....................................................................................................1
3. Proprietary Treading and Ring Fencing (EU)................................................................................................................6
4. Shadow Banking ...........................................................................................................................................................7
5. Mobile Banking and Payments......................................................................................................................................8
6. Stress Testing and Asset Quality Reviews ...................................................................................................................8
7. CMA/FCA Review into Competition in PCA and SME Banking..................................................................................10
8. Capital Requirements Regulation and Directive .........................................................................................................10
9. Markets in Financial Instruments Regulation (MIFIR) and Directive (MIFID II) ..........................................................14
10. Market Abuse ............................................................................................................................................................15
11. Benchmark Manipulation...........................................................................................................................................16
12. Consumer Credit .......................................................................................................................................................17
13. Retail Distribution Review .........................................................................................................................................17
14. Packaged Retail Investment and Insurance Products ..............................................................................................17
15. Payment Services .....................................................................................................................................................18
16. OTC Derivative Reform.............................................................................................................................................19
17. Promotion of Structured Products.............................................................................................................................20
18. UK Implementation of the Mortgage Credit Directive ...............................................................................................20
19. FCA Review of Client Assets Regime.......................................................................................................................21r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 1
International regulatory bodies, working alongside their regional and national counterparts, have spent over six years
attempting to mend the global financial system by strengthening its stability and resilience. This financial industry
regulatory update sets out the key financial industry reforms, and proposals for reform, in the international, European
and UK spheres.
This update sets out the position as at December 2014. It should be noted that, as this is an ever-changing regulatory
landscape, care should be taken when reading the update as it will become out of date relatively quickly.
2. The Financial Services (Banking Reform) Act 2013
The Financial Services (Banking Reform) Act 2013 (the “Banking Reform Act”) received Royal Assent on 18
Below is a summary of some of the key provisions introduced by the Act.
(a) Ring fencing
In the UK, the Banking Reform Act introduces new measures for all firms accepting deposits as a core activity unless:
It is exempted (e.g. building societies and credit unions)
Its operations fall within a de minimis exception for small banks
It has structured its operations so that it does not accept core deposits
Core deposits do not include deposits from high net worth individuals and large companies that have chosen to
deposit outside of the ring fence.
The Banking Reform Act requires ring fenced banks (RFBs) to separate their retail and small and medium-sized
enterprise (SME) deposit taking business from their wholesale and investment banking activities. RFBs will also be
prohibited from carrying out “excluded activities” and from certain conduct, including having exposures to particular
financial institutions and having non-European Economic Area (EEA) branches and subsidiaries carrying out certain
A “ring-fencing transfer scheme” is also introduced by the new legislation. The scheme permits the transfer to another
body of all or part of a bank’s business without obtaining the consent of those affected by the transfer where such
changes are required to comply with the new regime.
The Prudential Regulatory Authority (PRA) will be responsible for regulating the RFB regime and is currently
developing the detailed rules relating to its implementation. Although these rules are yet to be finalised, in early
October 2014 the PRA published a Consultation Paper on the implementation of ring-fencing (PRA CP 19/14) (the
CP), which provides an indication of what the new regime will consist of. r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 2
The CP sets out the PRA’s proposed ring-fencing policy, including rules and supervisory statements, in three main
The legal structure of banking groups
Continuity of services and facilities
Under the latest proposals, the PRA’s expectation is that an RFB should not have an ownership interest in any entity
which undertakes excluded or prohibited “investment banking” activities. Instead, RFBs and entities that can conduct
excluded or prohibited activities are expected to be structured as separate clusters of subsidiaries beneath a UK
holding company. This is known as a “sibling structure”. By creating legally and operationally separate units to house
their retail and commercial banking businesses away from their investment banking divisions, the PRA expects that
risks to an RFB’s provision of core services will be reduced by preventing losses related to “riskier” activities from
being passed to an RFB from a subsidiary. The PRA also expects that the rules will prevent an RFB becoming
financially dependent on the income or profits of such activities.
Regarding governance, the Banking Reform Act requires the PRA to make rules on board membership for group ringfencing
purposes. In the CP, the PRA proposes the following rules on the membership of the RFB’s board:
At least half of an RFB’s board, excluding the chair, must be independent non-executive directors (NEDs)
The chair of an RFB must be independent during his or her tenure as chair
The chair of an RFB must not hold another chair position in another group entity board
No more than one third of an RFB’s board members may be current employees or directors of another entity in the
An RFB executive director on the board of an RFB must not hold other executive director positions on the board of
another entity in the group that carries out excluded or prohibited activities
An RFB must have its own risk, nomination, audit and remuneration non-executive board committees
In relation to continuity of services and facilities, the CP states that the existing regulatory framework fulfils, to a
certain extent, the PRA’s objective of ensuring that RFBs have appropriate arrangements in place in this area. The
PRA proposes imposing additional restrictions in relation to:
Any intragroup service arrangements an RFB may have
Service arrangements an RFB may have with non-group entities where those arrangements may be affected by
the financial position of a group entity
The PRA states that these proposals should be read in conjunction with the PRA Discussion Paper DP1/14 (the DP),
which sets out the PRA’s current proposals for the principles that all deposit-takers (excluding credit unions) and PRAdesignated
investment firms should follow to demonstrate operational continuity in resolution and facilitate recovery
and post-resolution restructuring.
Consultation on other areas of the ring-fencing rules will follow in 2015. The current proposals are due to come into
effect from 1 January 2019. This would be in accordance with the Independent Commission on Banking’s timetable for
(b) Approved persons
The Banking Reform Act introduces a new senior persons framework. On 30 July 2014, the PRA and FCA jointly
issued a consultation paper outlining the new regulatory framework (FCA CP14/13/PRA CP14/14) (the Joint CP).
The Joint CP proposes the introduction of new rules to change the way in individuals employed by UK banks, building
societies, credit unions and PRA-designated investment firms (“relevant firms”) are assessed and held accountable for
the roles they perform. The current powers and procedures of the PRA and FCA for approving individuals are
described in the consultation paper as operating “largely as two parts of a whole”. The new regime will operate in a
similar way, although each regulator’s approach will vary according to its differing statutory objectives. For this reason,
the PRA and FCA have set out their respective proposals in the same consultation paper, with chapters divided into
PRA and FCA sections where required.r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 3
Senior managers regime
The main proposals outlined in the Joint CP include the introduction of a new “senior managers regime” for holders of
significant management functions at firms outlined above. Holders of significant management functions will need to be
regularly vetted for their fitness and propriety. When applying for regulatory pre-approval for these individuals, firms
subject to the new regime will have to include a statement of responsibilities setting out the areas of the firm that the
prospective senior manager will be responsible for managing. These firms will also be required to prepare, maintain
and update a responsibilities map, a single document that describes a firm’s management and governance
arrangements. The purpose of the senior managers regimes is to focus accountability on a narrower number of senior
individuals in a firm than the current approved persons regime.
This regime will require firms to assess and review, on an annual basis, the fitness and propriety of certain employees
in positions, known as significant-harm functions, where the decisions they make may pose a risk of significant harm
to the firm or any of its customers. The certification regime will apply to employees of relevant firms who are not
performing senior management functions, but who nevertheless meet certain criteria set by each regulator. Holders of
significant harm functions will not need regulatory approval before they are able to perform their roles, and instead the
senior management will assume responsibility for carrying out an internal certification process. There is some concern
that the absence of an external vetting and pre approval process for holders of “significant-harm functions” may result
in employees holding these functions being able to “hide” from the FCA and avoid the scrutiny of the regulator. There
is also a concern that certification holders will be less able individuals who would not have been able to be authorised
under the current approved persons regime.
New conduct rules
The new rules take the form of brief statements of high-level principles, setting out the standards of behaviour for
employees. These rules will replace the existing Code of Practice for Approved Persons (APER) for firms covered by
the new rules. The FCA will also apply these rules to most employees of relevant firms based in the UK or who deal
with customers in the UK.
Reverse burden of proof
Under the regime, a new reverse burden of proof will be introduced in order to make it easier for the regulator to
successfully bring an enforcement action against the senior manager. Senior managers will be guilty unless they can
prove otherwise. This, together with public warnings for those individuals facing enforcement action and the increase
of attestations as a supervisory tool, will increase the risk of individual enforcement and may lead to difficulties with
The Joint CP states that the PRA and FCA each plan to publish one or more policy statements containing their
respective final rules and relevant guidance and supervisory statements “around the end of this year”. However, a
related press release states that the PRA and FCA aim to publish the final rules in early 2015.
What does this mean for firms?
Aside from changing the approved persons regime for firms falling within the scope of the new regime, it is likely that
the new framework will be a sign of things to come in this area in the coming years. Rules initially apply to banks,
building societies and credit unions may be extended to other regulated firms if the PRA/FCA deems the new regime
to be successful.
(c) Payment Systems Regulator
The Banking Reform Act provided for a Payments Systems Regulator (PSR) to be established by the Financial
Conduct Authority (FCA). The PSR will be a competition-focused regulator with the power to investigate and impose
sanctions, including fines. Amongst other things, the new regulator will have the power to amend agreements relating
to payment systems and require banks to enter into agreements with smaller institutions to process transactions on
their behalf. The PSR’s powers will come into force in late 2014.r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 4
(d) Publication of updated list of G-SIBs
On 6 November 2014, the Financial Stability Board (FSB) published an update on the list of banks identified by it and
the Basel Committee on Banking Supervision (BCBS) as global systemically important banks (G-SIBs).
The FSB and the BCBS updated the list using end-2013 data and the updated assessment methodology published by
the BCBS in July 2013. One bank, Agricultural Bank of China, has been added to the list of G-SIBs that were identified
in 2013, increasing the total number from 29 to 30.
The BCBS has published separately the denominators used to calculate banks’ scores and the cut-off score and
bucket thresholds that were used to allocate them to buckets. The FSB states that the denominators will be updated
annually using the most recently collected data, while the cut-off score and bucket thresholds will remain fixed until the
first review of the methodology, due to be completed by November 2017. The FSB has also published a technical
summary that further explains the methodology.
The changes in the institutions included in the list and in their allocation across buckets reflect the combined effects of
data quality improvements, changes in underlying activity, and the use of supervisory judgement.
The FSB will next update the list of G-SIBs in November 2015.
(e) Primary loss-absorbing capacity requirements
In order to make G-SIBs more resilient, the new legislation introduces requirements for G-SIBs to hold loss-absorbing
capacity to satisfy their capital requirements.
On 10 November 2014, the FSB issued a public consultation (the Consultation) containing policy proposals
consisting of a set of principles and a detailed term sheet on the total loss-absorbing capacity (TLAC) of G-SIBs, with
the goal of reducing both the probability and impact of failure of “too big to fail”, systemically important firms.
The FSB has put forward proposals to achieve the availability of adequate loss-absorbing capacity for G-SIBs in
resolution by setting a new minimum requirement for TLAC. The minimum Pillar 1 TLAC requirement is a requirement
for loss-absorbing capacity on both a going concern and gone concern basis, incorporating existing Basel III minimum
capital requirements and excluding Basel III capital buffers. The aim is to establish a framework that is consistent with
the Basel capital framework and continues to set appropriate incentives for firms to be well-capitalised. The FSB has
proposed that a single specific minimum Pillar 1 TLAC requirement be set within the range of 16 to 20 percent of RiskWeighted
Assets (RWAs) and at least twice the Basel III Tier 1 leverage ratio requirement.
The final calibration of the common minimum Pillar 1 TLAC requirement will take account of the results of the
consultation and the quantitative impact study and market survey which will be carried out in early 2015. To help
ensure that there are sufficient resources available in resolution, there is an expectation that TLAC in the form of debt
capital instruments and other TLAC-eligible liabilities that are not regulatory capital will constitute an amount equal to
or greater than 33 percent of the minimum Pillar 1 TLAC requirement.
The Consultation also goes on to consider:
Eligibility of liabilities as TLAC: location of TLAC within group structures a crucial consideration of a resolution
strategy’s effectiveness is the availability of sufficient amounts of loss-absorbing capacity at the right location(s)
within a G-SIB’s group structure. In determining the individual requirements for specific firms, authorities have to
take into account their preferred resolution strategies and identify the entity or entities within a group to which
resolution tools would be applied (resolution entity or resolution entities).
Internal TLAC: one of the main objectives of the new TLAC standard is to provide home and host authorities with
confidence that G-SIBs can be resolved in an orderly manner and thereby diminish any incentives to ring-fence
assets domestically. The FSB has proposed that subsidiaries located outside of their resolution entity’s home
jurisdiction that are identified as material and that are not themselves resolution entities are subject to an internal
TLAC requirement in proportion to the size and risk of the material subsidiaries’ exposures. The FSB has also
proposed a quantum of internal TLAC for review in the quantitative impact study that must be pre-positioned at
material subsidiaries be equivalent to 75-90 percent of the TLAC requirement that would apply to a material
subsidiary on a standalone basis.r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 5
Public disclosures: the FSB will work with the Basel Committee on Banking Supervision to specify the disclosure
Regulation of investors: to reduce the risk of contagion, the FSB term sheet has proposed rules on deductions
from G-SIBs’ own TLAC or regulatory capital equal to their exposures to TLAC liabilities issued by other G-SIBs.
The FSB intends to submit a final version to the G20 by the 2015 summit.
In early 2015, the FSB will, with the participation of the BCBS and the Bank for International Settlements (BIS),
undertake comprehensive impact assessment studies to inform the calibration of the Pillar 1 element of the TLAC
requirement for all G-SIBs. It is expected that the conformance period for the TLAC requirement will be informed by
the quantitative impact study, but will not be before January 1, 2019.
What does this mean?
The purpose of the TLAC proposals is clear: to require that “too big to fail” banks hold enough additional lossabsorbing
capital so that the chances of them requiring tax payer support or government bail outs are reduced to
almost nothing. This means that the moral hazard associated with being “too big to fail” will have been removed, which
will count as a political victory in the eyes of many. Some consider that politicians and policy makers are, by setting
the capital bar so high, indirectly seeking to drive a reduction in the size and complexity of the biggest of financial
GSIBs will need to review their businesses to ensure that they are able to cope with the practical realities of higher
capital requirements and enforced structural change. It is likely that G-SIBs will take matters into their own hands and
restructure as a result of strategic decision rather than political and regulatory coercion.
(f) Bail-in stabilisation option
The Banking Reform Act amends earlier legislation (the Banking Act 2009) to establish a new bail-in power. The Bank
of England (BoE) will be able to impose losses on shareholders and certain creditors with the aim of reducing the
need to resort to public money where a bank or investment firm fails.
(g) Depositor preference
Amendments to the Insolvency Act 1986 mean that insured deposits will be made preferred debts with effect from 1
January 2019. Deposits that are eligible for protection under Financial Services Compensation Scheme (FSCS) will be
deemed to be preferential debts which will rank ahead of the claims of other unsecured creditors in the event of a
This preference will not extend to debts relating to pension liabilities, overseas deposits and deposits placed by
groups such as local authorities or charities.
(h) Fees for financial services firms
New sections will be added to the Financial Services and Markets Act 2000 (FSMA) which will permit HM Treasury to
order the FCA, the PRA and the BoE to charge the firms that they regulate a fee in respect of expenses incurred by
the Treasury in maintaining its membership within international bodies concerned with financial stability.
(i) Payday loans and high cost short term credit
The Banking Reform Act imposes a new duty on the FCA to implement rules capping the cost of high-cost short term
credit, including “payday loans”. On 11 November 2014, the FCA published a policy statement on the price cap on
high-cost short term credit (PS14/16), together with the final rules following its July 2014 consultation (CP14/10).
Most of the proposals the FCA consulted on will be implemented, subject to some changes and clarifications in
response to points raised in the consultation. The price cap structure and levels remain unchanged, and are as
Initial cost cap: for new loans, or loans rolled over, interest and fees must not exceed 0.8% per day of the amount
borrowedr e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 6
Fixed default fees: if borrowers do not repay their loans on time, default charges must not exceed £15. Interest on
unpaid balances and default charges must not exceed the initial rate
Total cost cap: borrowers must never have to pay back more in fees and interest than the amount borrowed
The new rules come into force on 2 January 2015. The instrument adds a new chapter 5A (cost cap for high-cost
short-term credit) to the FCA’s Consumer Credit Sourcebook (CONC).
An attestation is a request from a regulator such as the FCA to a senior individual at an authorised firm for
confirmation that a particular set of circumstances exists, usually in relation to the state of affairs at a regulated firm.
For example, the FCA may ask a senior individual to attest that a firm’s systems, controls and procedures are
sufficiently robust in a particular area. The signed attestation will then provide the FCA with a mechanism by which
they can hold the senior individual to account should it transpire that this is not the case. Attestations are also a useful
method of ensuring that senior management turn their minds to a firms systems, controls and procedures.
The FCA has recently clarified that it expects to use attestations in the following situations:
When there is an emerging risk, an appropriately senior manager at the firm will be asked to notify the FCA if the
risk changes in nature or extent
Where the FCA requires a firm to undertake a particular action, a manager will attest that this will be done within a
A person may be asked to certify that a particular risk has been mitigated
A person may be asked to confirm that the firm has taken specific action, and that action has been verified
The FCA has made clear that breach of an attestation could constitute a breach of the Statements of Principles for
3. Proprietary Treading and Ring Fencing (EU)
On 30 January 2014, the European Commission (EC) published a new regulation on structural measures improving
the resilience of EU credit institutions. The regulation targets EU banks and parent undertakings identified as being of
“global systemic importance” or exceeding a specified financial threshold.
Prohibition on proprietary trading
Proprietary trading in financial instruments and commodities will be prohibited for affected credit institutions. Such
institutions will also be prevented from investing in:
Alternative investment funds
Investment products referencing such funds
Entities engaging in proprietary trading
Entities investing in alternative investment funds
However, targeted banks will be permitted to invest in unleveraged and close-ended funds, for example private equity
and venture capital funds. Notably, banks caught by the regulation will still be able trade EU government bonds and
buy and sell money market instruments for cash management purposes.
Separation of trading activities
To avoid the risk that banks will continue to engage in proprietary trading disguised through other transactions,
competent authorities in Member States must monitor, and will be given the power to require the separation of, other
high-risk trading activities. Market making, securitisation and trading in derivatives if not done for risk management
purposes are specifically mentioned by the regulation in this regard.
In assessing trading activities, competent authorities will be required to use certain metrics e.g. leverage of trading
assets and importance of market risk. In addition to considering these factors, the relevant authority will assess r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 7
whether there is a threat to the financial stability of the firm in question or the EU financial system as a whole.
Following a decision by a national authority that separation should occur, a firm will have six months to submit a
As the UK has already introduced ring-fencing provisions through the Banking Reform Act 2013 (see section 2(a)
above) the Commission is widely expected to grant the UK derogation from the separation rules.
The proprietary trading ban is due to apply from 1 January 2017 with separation of other trading activities from 1 July
4. Shadow Banking
Regulators have focused increasingly on the shadow banking sector since the financial crisis. Shadow banks are often
highly leveraged and are exposed to similar risks as regulated institutions, yet lack the equivalent regulation and
The Financial Stability Board (FSB) published various policy recommendations on shadow banking in August 2013.
The FSB later published a roadmap towards strengthened oversight and regulation of shadow banking. This
publication sets out steps to be taken between 2013 and 2015 when the FSB will review the implementation of its
policy framework in Member States.
On 4 September 2013, the European Commission (EC) published a roadmap for tackling the risks inherent in shadow
banking. The roadmap, which is broadly consistent with the FSB’s aims, states that regulatory measures may need to
be introduced in the following areas:
Enhancing the regulatory framework for investment funds
Reducing risks in securities financing transactions
Strengthening prudential banking framework to limit contagion and arbitrage risks
Greater supervision of the shadow banking sector
As part of its aim to enhance the regulatory framework for investment funds, the EC plans to strengthen the
Undertakings for Collective Investments in Transferable Securities (UCITS) framework. It has also proposed new rules
for money market funds (MMFs). Key provisions of the new MMF measures include:
Prescribed levels of daily and weekly liquidity so that MMFs can satisfy investor redemptions
Clear labelling on whether the fund is a short-term MMF or a standard one;
A capital buffer of 3% for constant net asset value funds
Customer profiling policies to help anticipate large redemptions
Internal credit risk assessments to be carried out by MMF managers (to avoid overdependence on external credit
Alongside the EC’s proposals for structural reform (as discussed at above), the EC published further proposals on the
reporting and transparency of securities financing transactions (STFs). The proposed regulation will apply to
counterparties engaging in STFs or using client or counterparty assets provided as collateral. Investment funds will
also be subject to additional disclosure requirements.
The new measures include:
Reporting requirements for STF transactions
Transparency requirements, including disclosure requirements going further than the existing requirements in
Alternative Investment Fund Managers Directive (AIFMD) and the UCITS Directiver e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 8
Informed consent and other requirements are to be introduced where firms engage in “rehypothecation” – the use
of client or counterparty assets provided as collateral
5. Mobile Banking and Payments
The FCA is responsible for regulating the mobile banking market in the United Kingdom. Over the past few years, this
responsibility has become increasingly important, as the way in which individuals make everyday payments and do
banking is changing.
Customers who use mobile banking facilities engage with their bank up to three times more than those who bank
online, and twenty times more than those who bank in-branch. These interactions are usually for shorter periods of
time and involve comparatively simple tasks, such as checking a bank balance and making small payments. Mobile
banking has allowed banks to reduce their costs.
The Financial Conduct Authority (FCA) recently published its Thematic Review TR14/15 regarding mobile banking
and payments (the Review). The purpose of the Review was to determine how firms are achieving good outcomes for
consumers in the sector, following the publication by the FCA of an interim report (TR13/6) in August 2013 (the
Interim Report) and a subsequent assessment of a sample of firms offering mobile banking and payment services.
In the Review, the FCA outlined five key areas which are relevant to the mobile banking sector to determine whether
customers receive good or bad outcomes. These were:
How easy it is for consumers to understand their legal rights and obligations when using mobile banking products
and services, and what firms are doing to aid consumer education
How firms ensure that the knowledge and understanding of key decision makers in the business is in line with the
pace of innovation
How firms ensure consumers’ sensitive personal data and funds are secure, and technology is sufficiently robust
to cope with changes in consumer behaviour when making payments
How firms providing mobile banking products and services retain oversight of third parties and outsourced
functions involved in the delivery of their product offering to consumers
How new entrants to the mobile payments arena ensure they have adequate knowledge and understanding of the
regulatory framework surrounding payments
The FCA did not find any evidence of crystallised consumer harm in the Review, and were also satisfied that other
areas of focus highlighted in the Interim Report, such as fraud against firms and anti-money laundering, are
adequately addressing these areas. The next steps will involve the FCA working with the industry to ensure firms have
a clear understanding of the key areas identified in the Review.
6. Stress Testing and Asset Quality Reviews
(a) The European Central Bank’s Comprehensive Assessment
The European Central Bank (ECB) assumed its single supervisory mechanism (SSM) role on 4 November 2014 for
credit institutions in the Eurozone and other participating EU member states. In its new role, the ECB will primarily
supervise “significant” banks1.
Prior to formally assuming its role, the ECB published a note in October 2013 (updated 3 February 2014) on the
comprehensive assessment of significant banks. The two main areas covered by comprehensive assessment, and
highlighted in the note, are:
A bank is deemed significant is it has total assets exceed €30 billion; it is one of the three most significant credit institutions in a
participating Member State; the ratio of its total assets over GDP of the participating state exceeds 20% (unless its total assets are
below €5 billion); the ECB decides that it is significant (subject to specific conditions); or public financial assistance has been
request or received by the institution directly from the EFSF or the ESM. r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 9
Stress tests – The ECB stress tests were undertaken in cooperation with the European Banking Authority (EBA) to
ensure that banks would not fail if economic conditions worsen
Asset quality reviews (AQR) – the AQR is, in broad terms, an audit of the value of each significant bank’s balance
sheet. The AQR aims to determine the appropriate valuation of collateral and assess adequate provisioning for
credit exposure. It also assess the valuation of complex instruments and high-risk assets on bank balance sheets
On 31 January 2014 the EBA announced the key components of its 2014 EU-wide stress test. The EU wide stress
test was designed to provide supervisors, banks and market participants with a common exercise that facilitates the
creation of benchmarks to compare how EU banks will react to adverse market conditions. The EU-wide stress test
was coordinated by the EBA in coordination with the ECB, the European Systemic Risk Board (ESRB) and the
European Commission (EC). The exercise was conducted by national authorities on a sample of banks covering at
least 50% of the national banking sector in each EU Member State
The test was focused on the assessment of the impact of risk drivers on the solvency of banks. Whilst competent
authorities may include additional risks, the common risks that must be tested are:
Cost of funding
The test assumes a static balance sheet. Other issues covered by the communication include hurdle rates, details
about how capital will be defined and risk-specific methodologies.
The final ECB methodology and scenarios were published in April 2014 and the results of the stress test were
announced in October 2014. Twenty five of the Eurozone’s largest banks failed the stress test, with banks in Italy,
Cyprus and Greece giving rise to the greatest cause for concern. However, the ECB noted that most banks have
successfully repaired their finances, to the extent that their capital holes have to a large extent been filled. The ECB
vice President Vitor Constancio suggested that these results may encourage banks to increase their lending.
In order for banks to pass the stress test, the ECB required them to meet the minimum capital threshold of a CET1
ratio of 8% in the baseline scenario, and a CET1 ratio of 5.5% in the adverse scenario. Banks which were found to
have a capital shortfall had a period of two weeks in which to explain how they will address the shortfall, followed by a
period of nine months in which they must take remedial action.
It is worth noting that the stress tests fail to test the banking system’s resilience to a period of sustained economic
deflation in the Eurozone. Although the adverse scenario does entail material downward pressures on inflation, it does
not represent a prolonged deflationary environment. Given the possibility of significant periods of deflation in the
Eurozone, the absence of a deflation scenario from the stress test is surprising.
Asset quality reviews
The results of the AQRs were also announced in October 2014, in conjunction with the results of the stress tests. The
AQR showed that, as of the end of 2013, the book values of significant banks’ assets need to be adjusted by €48
billion. These adjustments will be reflected in the banks’ accounts or prudential requirements. It was also found that,
using a standard definition for non-performing exposures (any obligations that are 90 days overdue, or that are
impaired or in default), banks’ non-performing exposures increased by €136 billion to a total of €879 billion.
(c) Bank of England
In March 2013, the Bank of England’s Financial Policy Committee (FPC) recommended that regular stress testing of
the UK banking system should be developed to assess the system’s capital adequacy. In a Discussion Paper
published in October 2013, the Bank of England set out proposals for the main features of a framework for annual and
concurrent stress-testing of the UK banking system.
On 29 April 2014 the Bank of England set out details of the scenario for the stress tests for the eight major UK banks
and building societies. The UK stress-testing exercise built on the EU-wide stress test, announced in January 2014 by r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 10
the EBA (the results of which are set out above). The Bank of England added a number of additional UK layers to the
EBA stress test (UK variant) which explore vulnerabilities facing the UK banking system.
The Bank of England has received firms’ initial stress testing submissions and is in the process of analysing the
results. The FPC and the PRA Board have discussed the analysis over the autumn. Final decisions on the results of
the stress tests will be made by both committees on 15 December and will be fed back to the firms involved on the
same day. The UK variant stress test results will be published alongside the Financial Stability Report on 16
7. CMA/FCA Review into Competition in PCA and SME Banking
On 18 July 2014 the Competition and Markets Authority (CMA) completed two market studies into: (i) the provision of
personal current accounts (PCAs), and (ii) the provision of banking services for small and medium-sized enterprises
(SMEs). The CMA’s work on SME banking was conducted jointly with the FCA. Following the completion of the
review, the CMA announced that it is consulting on its provisional decision to launch an in-depth investigation into
markets for personal current accounts and SME banking. The findings of the market studies have led the CMA to
believe that essential parts of the UK retail banking sector lack effective competition and do not meet the needs of
personal consumers or SMEs.
The CMA has found that the market for the retail supply of banking services to PCA customers is characterised by the
features of high levels of concentration, barriers to entry and expansion, low switching and lack of transparency; all of
which are closely interrelated and mutually reinforce one another, resulting in competition being more limited than it
would otherwise be.
In relation to SMEs, the CMA concluded that the sector is one in which a perceived lack of choice of providers
combines with, and reinforces, SME inertia, apparently resulting in suboptimal outcomes for SMEs. In particular, the
providers with the highest customer satisfaction scores are not winning significant market share, while the banks with
the lowest satisfaction rates are barely losing market share, which are not the outcomes that would be expected in a
well-functioning, competitive and dynamic market. The CMA invited responses on its provisional decision to make a
market investigation reference in the consultation. The CMA confirmed that it would make a market investigation
reference on 4 November 2014 and will now ask its Market Reference Group to conduct an in-depth investigation.
The Market Reference Group will be appointed shortly and will publish a timetable for the various stages of the
investigation and develop and consult on an issues statement, which will set out the investigation’s proposed focus.
8. Capital Requirements Regulation and Directive
The phase in of CRD IV – comprised of the EU Capital Requirements Regulation (CRR) and a revised Capital
Requirements Directive (CRD IV) – began on 1 January 2014. CRD IV is the EU implementation of Basel III, a
package of proposals agreed by global leaders in response to the financial crisis.
CRD IV includes enhanced requirements for quality and quantity of capital, a basis for new liquidity and leverage
requirements, new counterparty rules, and new macroprudential standards including a countercyclical capital buffer
and capital buffers for systemically important institutions. CRD IV also reforms rules on corporate governance, and
introduces standardised EU regulatory reporting referred to as COREP and FINREP.
Capital is required to absorb losses that a firm does not expect to make in the ordinary course of business; the
“minimum own funds requirement” in the CRD stipulates the amount of capital a firm is required to hold as a
percentage of its assets. Assets are weighed according to how risky they are (risk-weighted), and in broad terms, the
more risky the assets, the more capital a firm needs to hold according to its minimum own funds requirement.
A firm’s capital is split into different tiers according to the level of risk associated with holding such capital. In broad
terms, Tier 1 capital is capital that allows the firm to continue to operate as a going concern, while Tier 2 capital
ensures that depositors and creditors are repaid in the event the firm fails.
The main changes to the capital rules under CRD IV are:r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 11
Quality: CRD IV tightens the definition of “common equity” (the main component of Tier 1 capital). The definition of
what amounts to tier 2 capital was simplified, with all sub-categories (such as upper tier 2 and lower tier 2)
Quantity: Minimum ratios for Tier 1 capital have increased from four per cent to six per cent of Risk Weighted
Assets, although the minimum capital ratio has not changed:
The minimum requirement for Common Equity Tier (CET) 1 has increased from two per cent to 4.5 per cent
These capital ratios shall be calculated as a percentage of the total risk exposure amount.
A capital conservation buffer requires relevant firms to maintain common equity Tier 1 equivalent to 2.5% of
their total risk exposure. Firms failing to implement the buffer will be restricted from making discretionary
A countercyclical buffer requires relevant firms to build up capital during periods of excess credit growth. The
countercyclical capital buffer rate set by designated Member State authorities must be between 0 per cent and
2.5 per cent, unless the designated Member State authority considers that the countercyclical capital buffer
rate should exceed 2.5 per cent. Firms that do not meet the countercyclical buffer will be constrained in their
discretionary distributions of earnings.
Systemic risk buffers of between one per cent and three per cent for all exposures and up to five per cent for
domestic and third country exposures can be applied by Member States without prior approval of the
There will be mandatory buffer requirements for global systemically important institutions (GSIIs); the buffer
requirements will vary depending on how systemically important the institution is. The buffer requirements for
other systemically important institutions (OSIIs) are voluntary, and will be capped at two per cent.
Counterparty credit risk (CCR)
Counterparty credit risk is the risk of the counterparty defaulting on transactions involving bilateral credit risk. Article
194(1) CRR introduces a requirement for lending institutions to obtain legal opinions in respect of any credit risk
mitigation technique. The legal opinion needs to establish that the relevant credit risk mitigation techniques are “legally
effective and enforceable in all relevant jurisdictions”. There are no specific requirements as to the form of the opinion;
the CRR requires only that they are “independent, written and reasoned”.
An institution is required to establish and maintain a CCR management framework which consists of:
Policies, processes and systems to ensure the identification, measurement, management, approval and internal
reporting of CCR
Procedures for ensuring those policies, systems and processes are complied with
This management framework must take account of market, liquidity, legal and operational risks associated with CCR.
Institutions must conduct regular independent reviews of its CCR management system through its internal auditing
Institutions are required to institute a routine and rigorous programme of stress testing, which must be reviewed
periodically by senior management. Institutions must have in place sound stress testing processes for use in the
assessment of capital adequacy for CCR. Stress measures shall be compared against risk appetite and considered by
Credit valuation adjustment risk (CVA risk)
CVA is an adjustment made to the market value of an over the counter (OTC) derivative contract to take into account
the credit risk of the counterparty. Credit valuation adjustment can be defined as the difference between the
“hypothetical” value of the derivative transaction, in which it is assumed that the counterparty is risk free, and the true
value of the derivative transaction, which takes into account the possibility of changes in the creditworthiness of the
counterparty. r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 12
Under the CRR, credit institutions and investment firms are required to hold additional own funds due to CVA risk
when entering an OTC trade referred to as the “CVA Risk Charge”. Details of the calculation of the charge are set out
in Articles 381 to 386 of the CRR.
CRD IV imposes a leverage ratio which aims to restrict the level of leverage that an institution can take out to ensure
that an institution’s assets are in line with its capital and to act as a safeguard for existing risk-based capital
The leverage ratio is defined as an institution’s Tier 1 capital divided by a measure of non-risk weighted assets.
From 1 January 2015, firms will be required to disclose information on the leverage ratio, with full implementation of
the leverage ratio expected for 1 January 2018.
The CRR introduces two new liquidity buffers: the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio
The LCR, which is intended to improve short term resilience of the liquidity risk profile of firms, requires institutions to
hold a buffer of unencumbered high quality liquid assets (HQLAs) to meet net liquidity outflows under a stress
scenario lasting 30 days. The objective of the LSR is to ensure that, during a period of market wide stress, institutions
will be able to use the buffer to cover outflows.
The LCR will be phased in with institutions obliged to hold 60% of their LCR in 2015 with incremental increases on a
year to year basis until 2018, at which time institutions will be expected to maintain a LCR of at least 100%. The CRR
also imposes a general requirement on firms to hold liquid assets sufficient to cover their net cash outflows in stressed
conditions over a 30 day period.
The NSFR is intended to ensure that a firm has an acceptable amount of stable funding to support its assets and
activities over the medium term. The NSFR addresses long term mismatches and is aimed at incentivising institutions
to use stable sources of funding in the long term. The NSFR will measure the amount of stable funding available to a
firm against the required amount of stable funding. The CRR does not contain provisions directly relating to the NSFR,
the Commission aims to introduce it from 1 January 2018.
Implementation in the UK
In the UK, The FCA is responsible for implementing CRD IV for FCA firms with the PRA implementing the legislation
for banks, building societies and designated investment firms. Both the FCA and the PRA published policy statements
in December 2013 which contained final rules and supervisory statements by the regulators. On 30 April 2014, the
PRA published its policy statement, rules and supervisory statement on CRD IV capital buffers.
Corporate governance and remuneration
CRD IV’s remuneration provisions are to apply to staff whose professional activities have a material impact on an
institutions risk profile. The EBA published its final draft regulatory technical standards on qualifying staff on 16
December 2013. Staff will be identified as material risk takers if they fulfil one of the following:
Broadly, the qualitative criteria aim to identify those staff which have a material impact on an institution’s risk profile.
The criteria cover:
Members of the management body in its management or supervisory function
Employees in senior management rolesr e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 13
In relation to independent risk management functions, compliance functions or internal audit functions, those with
managerial responsibility and those responsible or accountable to the management body for the activities of those
In relation to material business units, heads of those units or individuals who have material responsibility within
such a unit and report directly to the head of the unit
Heads of functions responsible for legal affairs, financing (including tax and budgeting), HR, remuneration policy,
IT or economic analysis
Those responsible, individually or as part of a committee, for the management of a risk category described in
Articles 79 to 87 of CRD IV other than credit risk and market risk
In relation to credit risk exposures of a nominal amount per transaction representing 0.5% of the institution’s
Common Equity Tier 1 capital (and at least €5 million), those who, individually or as part of a committee
Are responsible for initiating or structuring credit products which can result in such exposures or
Have authority to take, approve or veto a decision on such exposures
Those with managerial responsibility for a group of staff members who have individual authorities to commit the
firm to transactions where the aggregate of those transaction exceeds certain thresholds
Those with authority, either individually or as part of a committee, to take, approve or veto a decision on
transactions on the trading book which in aggregate exceed certain thresholds
Individuals with authority to take decisions to approve or veto the introduction of new products, either individually
or as part of a committee
Those with management responsibility for any individuals covered above
The quantitative criteria focus on an individual’s remunerations, both in absolute and relative terms. Employees
earning over €500,000 and employees which fall in the 0.3% of staff with the highest remuneration are caught. Those
awarded equivalent or higher remuneration than staff caught by certain qualitative criteria described above will also be
The regulatory technical standards included a new exclusion not previously consulted on. Firms will be able to exclude
employees who are not in fact material risk takers despite being caught by the qualitative criteria. Individuals may be
excluded on the basis that their activities or authorities pertain to a non-material business unit or that their professional
activities have no material impact on the risk profile of a material business unit. The competent authority will have to
be notified or consulted with, depending on the total remuneration of the individual in question.
Affected individuals face a bonus cap of 100% of their salary. This cap can be raised to 200% with shareholder
approval, if a quorum of shareholders representing 50% of shares vote, and 66% of them support the proposal. Even
without the quorum, the proposal can also be approved if it is supported by 75% of the shareholders present. The
bonus cap became effective on 1 January 2014. The cap applies to the staff of subsidiaries operating outside the
European Economic Area (EEA) and the European Free Trade Area (EFTA). Firms will also have to disclose the
number of individuals being remunerated €1 million or more per financial year.
HM Treasury lodged a legal challenge with the European Court of Justice (ECJ) on 25 September 2013 on the CRD
IV rules relating to remuneration. In the meantime, the UK is proceeding with implementation. Amendments to the
Senior Management Arrangements, Systems and Controls Sourcebook (SYSC) rules have been made through the
Capital Requirements Directive (Governance and Remuneration) Instrument 2013 and have been in force since 1
Role of the Board and Senior Management
The Basel Committee set out revised guidelines on corporate governance principles for banks; one of the primary
objectives of the revision was to reinforce the collective oversight and risk governance responsibilities of the board.
The revised guidelines provide greater detail on what constitutes a good corporate culture, and require that the board
set the “tone from the top”. This shall be established by:
The board adhering to corporate values for itself, senior management and other employees which create
expectations that business is conducted in a legal or ethical mannerr e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 14
Promoting risk-awareness, and conveying the board’s expectation that it does not support excessive risk-taking
Communicating corporate values throughout the bank
Ensuring employees, including senior management, are aware that sanctions will follow transgressions
The revised rules make clear that as well as directing senior managers, the board must oversee their work. Senior
managers must actively carry out and manage the bank’s activities, not merely ensure the bank’s activities are
consistent with risk profile and strategy. Senior managers also have a general reporting duty to the board, and must
keep the board informed of material matters, including:
Changes in business strategy
Bank performance and condition
Breaches of risk limits or compliance rules
Internal control failures
Legal or regulatory concerns
There is a degree of overlap between corporate governance requirements and the ring-fencing provisions. The board
of the parent company is expected to ensure that there is adequate corporate governance across the group, while the
bank’s board is expected to have an understanding of the overall operational structure and the risks it poses.
9. Markets in Financial Instruments Regulation (MIFIR) and
Directive (MIFID II)
On 14 January 2013, political agreement was reached on MiFID II and its accompanying Regulation, MiFIR.
Summarised below are some of the key newly agreed areas:
The MiFID II text will extend the definition of commodity derivatives to physically settled contracts traded on organised
trading facilities, except for wholesale energy products covered by the Regulation on wholesale energy market
integrity and transparency (REMIT) (i.e. natural gas and electricity contracts). In addition, the broad exemptions for
firms trading commodity derivatives are being narrowed (see Investor protection, below).
The final text will set mandatory position limits to help prevent market abuse. The new regime will include:
Spot month limits
Limits to net positions aggregated at group level
A hedging exemption for positions held by or on behalf of non-financial entities
Details of positions must be reported to trading venues on a daily basis, and these will be sent to ESMA each week.
ESMA will publish reports which distinguish between the positions held by commercial firms and by financial firms.
More detail on calculation methodologies and other aspects of the regime will be set by ESMA through regulatory
technical standards (RTS).
A selection of the changes already agreed for MiFID II:
The new legislation will ensure that more trading takes place on regulated platforms. To help facilitate this new move,
a new category of trading venue, Organised Trading Facilities (OTF) will be created. This category can include
discretionary brokerage services in non-equity investments such as bonds, derivatives and structured products.
Certain requirements will be imposed on those who operate OTFs. Any transactions which take place in this venue will
be subjected to pre- and post-trade transparency provisions. With regard to pre-trade transparency, trading venues
will need to make information about trading interest available to the public, and post-trade details of transactions must
be published as close to real-time as possible, although under certain circumstances deferred publication will be
possible. MiFID II will also implement new requirements for algorithmic and high frequency trading activities.r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 15
Increased transparency rules will apply to equity markets. The legislation will also extend pre-and post-trade
transparency obligations to non-equity instruments such as derivatives and bonds for the first time. Trade reports will
need to be published through Approved Publication Arrangement (APA) firms. These will be subject to authorisation
and organisational requirements. Furthermore, the process by which an investment decision was arrived at will be
recorded through the capturing of data which identifies the individuals or algorithms responsible for the decision.
New requirements for product and product intervention by European Securities and Markets Authority (ESMA) and the
EBA will be introduced. A greater range of products will be subjected to an appropriateness test. Advice from
investment firms will have to comply with two criteria in order to be considered independent: they must not accept
inducements from third parties, and they must advise on a broad range of products. Furthermore, detailed information
on fees and commissions paid and received by the firm will be provided to the client. The definition of non-complex
instruments will be narrowed to exclude structured products, including structured Undertakings for Collective
Investment in Transferrable Securities (UCITS). The exemption for firms trading commodity derivatives alluded to in
the commodities subsection (above) is being narrowed, with the effect that commercial firms will only be able to
benefit from this exemption where this activity is “ancillary” to their main business and financial services is not their
The MiFID II Directive and the MiFIR Regulation came in to force on 2 July 2014. EU Member States now have until 3
July 2016 to implement the MiFID II Directive into their national law. The provisions must be enforceable in the
Member States by 3 January 2017.
10. Market Abuse
The European Parliament (EP) adopted the EC’s proposal for a new regulation on market abuse (MAR) in September
2013. The regulation imposes restrictions on market conduct and, through a Market Abuse Directive (MAD II)
increases authorities enforcement powers. The UK has opted out of MAD II.
MAD II and MAR extend the scope of the new regime in the following ways:
Market abuse framework: MAR extends the scope of the market abuse framework to any financial instrument
admitted to trading on a multilateral trading facility (MTF) or OTF, as well as to any related financial instruments
traded OTC which can have an effect on the covered underlying market. Related financial instruments, which are
currently only subject to insider dealing will be caught by market manipulation as well.
Commodities and derivatives: the legislation is extended in various ways to cover commodity and related
High frequency trading (HFT): MAR provides an indicative list of HFT strategies which will be considered market
Benchmark manipulation: MAR also ensures the manipulation of benchmarks (including non-financial
benchmarks) is an offence by prohibiting it expressly.
The following changes will be made to the enforcement rules under the new regime:
Whistleblowing: Member States will have to provide whistleblowing mechanisms whereby actual and potential
breaches of MAR can be reported. MAR will also prohibit attempted market abuse making.
Investigatory powers: new supervisory powers are given to regulators to investigate possible cases of market
Sanctions: with regard to sanctions such as fines, common principles are proposed.
The adoption of MAR is dependent on the MiFID II timetable. It is therefore likely that the regime will take effect from 3
January 2017. r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 16
11. Benchmark Manipulation
Investigations into the manipulation of benchmarks such as LIBOR and EURIBOR as well as gas and oil prices has
put benchmarks firmly on the regulatory agenda.
(a) International regime
The International Organization of Securities Commission’s (IOSCO) July 2013 report sets out principles to guide
financial benchmark administrators in areas including governance, benchmark quality, methodology and accountability
mechanisms. This report follows IOSCO’s Principles for Oil Price Reporting Agencies. Since this report was released,
IOSCO has encouraged benchmark administrators to take measures to comply with the principles by July 2014.
The FSB announced in June that it had created an official sector steering group composed of regulators and central
banks. The group will investigate, amongst other things, whether international standards surrounding benchmarks are
being met in the financial industry.
IOSCO continues to consult with the industry, particularly with regard to the question of whether there should be a
separate reform of financial and commodity benchmarks.
(b) EU regime
The EC published a draft regulation on the Production and Use of Indices serving as Benchmarks in Financial and
other Contracts (the Benchmark Regulation) in September 2013.
The proposed regulation would bind EU supervised entities, including credit institutions, investment firms, trade
repositories, Alternative Investment Fund Managers (AIFMs) and UCITs.
Under the new regulation:
Benchmark administration will be subject to authorisation
EU supervised entities will be prohibited from using unauthorised benchmarks
EU supervised entities will be prohibited from using non-EU benchmarks unless there has been an equivalence
ruling for the regime in question
Conduct of business obligations will be imposed for authorised administrators and contributors
National competent authorities and a new college of supervisors for “critical” benchmarks will take on an increased
The Benchmark Regulation has been passed to the European Parliament and the Council of the EU for consideration
under the ordinary legislative procedure throughout 2014. The European Parliament was scheduled to consider the
Benchmark Regulation during its plenary session in April 2014. However, the process was delayed.
The proposals for the Benchmark Regulation are currently being discussed by the European Council’s Working Party
on Financial Services (the Working Party). The Working Party has been meeting regularly throughout 2014 to
continue its examination of the Benchmark Regulation. Prior to meetings, compromise proposals on the Benchmark
Regulation have been published, in which proposed changes and deletions to the text of the Commission’s legislative
proposal have been marked up. On 28 October 2014, the Presidency of the Council of the EU published the latest
compromise proposal (dated 27 October 2014) on the Benchmark Regulation, ahead of the Working Party meeting on
17 November 2014.
It is expected that this process will continue into early 2015.r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 17
12. Consumer Credit
On 1 April 2014 the FCA took over responsibility from the OFT for all consumer credit regulation.
The licensing and regulatory framework of consumer credit regulation from the Consumer Credit Act 1974 (CCA) was
replaced by FSMA (as modified by the Financial Services Act 2012).
The new rules are included in a new sourcebook within the FCA Handbook: the Consumer Credit sourcebook
(CONC). The CONC includes both conduct requirements for consumer credit firms and prudential requirements for
debt management firms.
The new regime requires firms to comply with:
An approved persons regime
Periodic reporting requirements, including providing data on consumer loans
Enhanced complaints reporting and publication rules
Financial promotions rules
A client assets regime (debt management firms and large not-for-profit debt advice bodies only)
The client assets regime requires relevant firms to comply with prudential standards requiring them to hold the higher
of £5,000 or 0.25% of their relevant debts under managements. Such firms must also ensure that their prudential
resources exceed their requirements at all times
To determine the level of regulatory scrutiny, firms are categorised as undertaking low risk activities or high risk
activities. Low risk firms enjoy more limited reporting requirements and less proactive supervision.
Certain professional firms may be supervised by their Designated Professional Body, rather than the FCA. Selfemployed
agents and appointed representatives of authorised firms also need not apply for full authorisation.
Existing consumer credit licences expired on 31 March 2014. Before April 2014, consumer credit firms were required
to either apply for interim permission or interim variation permission (FCA registered firms). Firms without interim
permission on 1 April 2014 will be required to immediately register for full authorisation. Firms with full authorisation
will have to comply fully with all of the new requirements missing out on a number of transitional benefits available to
firms with interim permission. The FCA will consider firms with interim permission for full authorisation between 2014
13. Retail Distribution Review
On 31 January 2014, the FCA published a policy statement on referrals to discretionary investment managers and
adviser complaints reporting. The new rules will form part of the FCA’s Retail Distribution Review (RDR).
The new rules will:
Ban new referral payments by a discretionary investment manager to an adviser when the adviser recommends
that a client places additional money with the same discretionary investment manager from whom they receive
payments following a pre-RDR referral
Prohibit referral payments where an adviser firm does not provide personal recommendations to particular clients,
but provides other services to them
The new rules on referral payments will come into force on 31 December 2014.
14. Packaged Retail Investment and Insurance Products
In July 2012, the EC proposed a new regulation requiring a “Key Information Document” (KID) to be produced for
packaged retail investment and insurance products (PRIIPs). PRIIPs are investment products marketed to retail
investors which offer investors exposure to underlying assets in packaged forms. As such they involve an element of
engineering which alters the client’s exposure compared with direct holdings. r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 18
The main aim of the regulation was to address two specific market failings relating to: (1) asymmetries of information
between retail investors and those producing and selling investments to them, and (2) conflicts of interest between
manufacturers, distributors and investors, e.g., as a result of commission payments.
The regulation prescribes uniform rules on the format and content of the KID and uniform rules on the provision of the
KID to retail investors. It sets out the overall principles on the approach and content of the KID, and will be supported
by detailed delegated and implementing acts which will standardise the presentation of the information required by the
The KID is a new pan-European pre-contractual disclosure document that all retail investors should receive when they
are considering purchasing certain types of investment products, including investment funds, retail structured products
and certain types of insurance contracts used for investment purposes. A KID is, in essence, a short document
presented in a consumer-friendly way that sets out clear information that the average investor would require to make
an informed decision on the PRIIP in question.
The regulation does not apply to:
Non-life insurance products
Life insurance contracts whose benefits are only payable upon death or in the event of incapacity due to injury,
sickness or infirmity
Deposits other than structured deposits and securities
Officially recognised pension schemes
Pension products whose primary purpose is to provide the investor with a retirement income
Individual pension products for which an employer contribution is required
On 10 November 2014, the European Council adopted the regulation without discussion. The regulation is likely to
come into force in December 2014 once it has been published in the Official Journal of the European Union, and is
likely to apply to firms two years after it comes into force, which is likely to be in late 2016.
15. Payment Services
On 24 July 2013 the European Commission proposed repealing the PSD and replacing it with a new directive (PSD2)
combined with a regulation on interchange fees for card-based payment transactions.
The PSD2 will:
Narrow the scope of existing exemptions, including the “commercial agent”, the “digital download” and “limited
Third party providers of payment initiation services and account information platforms will be required to be
authorised as payment institutions
Remove the “independent ATM operator” so that such operators will become subject to the PSD2
Lower the threshold for being a small payment institution (subject to a less onerous regime)
Apply existing transparency rules to transfers and money remittances outside the EU and when making payments
in non-EU currencies, in respect of those parts of the payment transaction carried out in the EU (one-leg
The PSD2 will:
Require stronger customer authentication for payments to increase online security
Increase consumer protection against fraud and provide a lower maximum that consumers may be charged in the
event of an unauthorised card payment
Provide an unconditional refund right for consumers in a disputed payment transaction, unless the good or service
has already been consumedr e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 19
The proposed regulation on interchange fees would ban surcharges on transactions using consumer debit and credit
cards, and it would impose a maximum limit on interchange fees using these types of cards. The cap will initially apply
to cross-border payments transactions and it will eventually be applied to domestic transactions.
16. OTC Derivative Reform
The European Markets Infrastructure Regulation (EMIR) came into force on 16 August 2012. The regulation
introduces requirements primarily aimed at improving transparency and the reduction of risk associated with the
derivatives markets. In addition, it establishes rules applicable to the organisational framework required to deliver
those objectives. It does this by imposing rules on market participants and minimum organisational, capital and
conduct of business standards on clearing houses (central clearing counterparties or CCPs) and trade repositories
Broadly speaking, EMIR applies to entities that are established (which regulators take to mean directly “incorporated”)
in the EU2 who enter into derivatives trades as principal. EMIR classifies firms as either financial counterparties (FC)
or non-financial counterparties (NFC). NFCs whose OTC derivative volumes exceed the clearing threshold are
classified as NFC+. FCs and NFCs+ are required to clear their OTC derivatives trades, as discussed below.
A high level summary of EMIR’s main requirements on market participants is set out below. These requirements are
subject to phased implementation and are set out below in the order in which they are expected to apply.
Risk mitigation requirements (non-collateral related)
Risk mitigation requirements aim to ensure that parties entering into OTC derivatives contracts that are not centrally
cleared have appropriate procedures and arrangements in place to measure, monitor and mitigate operational and
counterparty credit risk.
The requirements include:
Timely confirmation (the documented agreement of the counterparties to all of the terms of a transaction – there
are prescribed time limits by which this agreement should be acknowledged dependent on the classification of the
parties to the relevant trade)
Portfolio reconciliation (the process whereby the counterparties periodically confirm that their records of the key
terms of trades between them are the same)
Portfolio compression (netting trades to maintain the same risk profile whist reducing the number of contracts.
This is not a “hard” obligation and applies to counterparties who have a very large number of trades outstanding
with each other at any time)
Dispute resolution procedures and processes.
Transaction reporting began on 12 February 2014. Counterparties are required to report any derivative contract that
they have concluded, modified or terminated to a trade repository registered or recognised by ESMA by the close of
the following day. Whilst a party may rely on its counterparty – or on a third party – to report for it, responsibility for the
reporting obligation itself cannot be delegated. This applies to both OTC and exchange traded derivatives (e.g.
OTC derivatives (other than intragroup trades) entered into by FCs and NFC++ exceeding certain thresholds must be
centrally cleared. The earliest central clearing is likely to come into effect is late 2014.
This will change to the EEA when it finally adopts EMIRr e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 20
Risk mitigation requirements - Valuation and collateral
FCs and NFC+s must also comply with requirements to conduct daily mark-to-market (or “mark-to-model”) valuations
and to exchange appropriately segregated collateral on uncleared OTC derivatives.
17. Promotion of Structured Products
The FCA’s ban on the promotion of unregulated collective investment schemes and equivalent pooled vehicles to
retail investors came into effect on 1 January 2014.
In its policy statement on restricting the retail distribution of unregulated collective investment schemes and close
substitutes (PS 13/3), in which the FCA announced the final restrictions on the promotion of Non-Mainstream Pooled
Investments (NMPIs), the FCA also announced its intention to consult on introducing marketing restrictions for other
products which it did not consider to fall within the definition of NMPIs.
In particular, the FCA highlighted that banks and building societies were beginning to introduce a range of securities
(including contingent convertibles (CoCos), building society deferred shares and similar instruments) as a means of
raising loss-absorbing capital to meet enhanced prudential requirements. In the FCA’s view, these products carried
risks unfamiliar to and inappropriate for many ordinary retail investors.
In August 2014, the FCA announced the introduction of temporary product intervention rules restricting the retail
distribution of CoCos. These rules entered into force on 1 October 2014. Shortly thereafter the FCA announced a
consultation on the introduction of permanent rules to replace the temporary product intervention powers when they
expire on 1 October 2015 (CP 14/23).
18. UK Implementation of the Mortgage Credit Directive
The Mortgage Credit Directive (2014/17/EU) (MCD) came into force on 21 March 2014. Member states have until 21
March 2016 to implement the MCD. The MCD applies to first and second charge mortgages. Its purpose is to ensure
that consumers who purchase a property or take out a loan secured against their home are adequately informed and
protected against the risks of doing so.
In September 2014, HM Treasury published a consultation on the transposition of the MCD, together with a draft
impact assessment (a final stage impact assessment will be published when the legislation is finalised) and draft
Mortgage Credit Directive Order 2015.
The FCA published a separate consultation paper on implementing the MCD and its proposed regime for second
charge mortgages (CP14/20), which will move from being regulated under the consumer credit regime to the
mortgage regulation regime in order to comply with the MCD. The deadline for responses is 29 December 2014. The
FCA has stated that it will publish a policy statement with its final rules by the end of March 2015. To allow firms time
to adjust to the proposed changes, the FCA stated in the consultation paper that firms can choose to start applying the
MCD rules to new business from 21 December 2015.
Whereas, for some EU Member States, the implementation of the MCD could have far-reaching effects for mortgage
providers, the impact of the MCD is likely to be less significant due to the existing rules and guidance in the FCA’s
Mortgages and Home Finance Conduct of Business sourcebook (MCOB) and the reforms introduced in April 2014 as
a result of the FSA’s mortgage market review (MMR).
However, there are a number of changes to the existing rules that the FCA proposes to make to harmonise the current
rules with the MCD requirements. These include:
Expanding the definition of a “regulated mortgage contract” under the RAO to include for example, certain buy-tolet
mortgages and second charge lending, the latter of which is currently part of the FCA’s consumer credit regime
Introducing a new product disclosure document for all mortgages. Firms must provide all customers with an
European Standard Information Sheet (ESIS)
New requirements on firms to calculate the APRC using the method set out in the MCD and providing a second
APRC where borrowing is on a variable rater e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 21
Further changes to the definition of a “regulated mortgage contract” are proposed. HM Treasury does not anticipate
that these changes will have a significant impact on UK firms. These changes relate to:
Equitable mortgages: these are not currently caught by the definition of a “regulated mortgage contract” but will be
brought within the FSMA regime to comply with the requirements of the MCD.
Secured lending on timeshare properties: lending secured on timeshare accommodation is currently excluded
from the scope of UK mortgage regulation, but falls within the MCD. Although HM Treasury has indicated that this
type of lending does not exist within the UK, it is being brought within the scope of the new rules.
Secured lending to consumers by government: mortgage lending undertaken by the government is generally
exempt from the scope of the FSMA regime, as is the intermediation for such activity. The government intends to
change the legislation so that it limits the exemption as far as this is required by the MCD. This may bring some
government schemes within the scope of the new rules. However, this is unlikely because the MCD only seeks to
limit lending to consumers by governments in circumstances where there is no benefit to the consumer over what
is provided by the market.
Location of the property: the existing regime is limited to mortgages secured on property located in the UK. This
limitation will be removed, although this change is not expected to have a significant impact on UK firms as it is
rare for lenders in the UK to provide mortgages on properties located outside of the UK.
Changes to the activity of arranging a mortgage contract: the government intends to add further detail to the
definition of the regulated activity of arranging regulated mortgage contracts
Limiting certain existing exemptions: the existing regime provides a number of exemptions from FCA mortgage
regulation for certain activities by mortgage lenders and intermediaries. These exemptions are not mirrored by the
MCD and it may be necessary to reduce the scope of these exemptions. For example, an unauthorised person
who makes arrangements for a borrower to enter into a mortgage through an FCA-authorised person is currently
exempt under the FSMA regime, but may no longer be exempt under the new rules.
The implementation of the MCD means that lenders, administrators and intermediaries in both the first and second
charge mortgage markets need to review their policies, processes, systems and staff training to ensure that they are
ready for the new regime on 21 March 2016.
19. FCA Review of Client Assets Regime
On 10 June 2014, the FCA published a policy statement setting out final rule changes following its review of the client
assets regime for investment business (PS14/9), as well as a guide summarising the key FCA Handbook changes
being introduced and the dates on which they come into force.
PS14/9 summarises the comments the FCA received on its proposals to amend the rules in the Client Assets
sourcebook (CASS) which were set out in a July 2013 consultation paper (CP13/5) and the FCA’s response to them.
The proposals in CP13/5 were intended to address specific risks and clarify the existing CASS requirements with a
view to improving the protection of client money and custody assets held by investment firms
The changes to CASS set out in PS14/9 cover the entire operation of the client money and custody rules for
investment firms (including loan-based crowdfunding firms) that hold client money, custody assets, collateral and/or
mandates in relation to investment business (or rely on an exemption contained within CASS).
The final rules reflect a rewrite of the client money rules in CASS 7, and substantial changes to the custody rules in
CASS 6. They also include changes to the mandate rules in CASS 8 and the rules relating to client reporting and
information in CASS 9. The FCA is also introducing provisions allowing clearing member firms operating net margined
omnibus client accounts (OCA) at EMIR-authorised or recognised central counterparties (CCPs) to offer multiple client
money pools to their clients.
The key CASS changes and the dates on which they will come into effect are set out in chapter 2 of PS14/9. The
changes are being introduced in three stages:
1 July 2014: clarifications of existing rules and guidance and the introduction of optional arrangements that firms
may choose to comply with or impose minimal regulatory burdens have been in force since this date. This
includes the introduction of the option to operate multiple client money pools.r e e d s m i t h . c o m Banking Industry Regulatory Update | December 2014 22
1 December 2014: requirements relating to the provision of information to, or obtaining the agreement of, new
clients and the documenting of agreements and arrangements with any new counterparties with whom firms
deposit or otherwise place custody assets or client money, have been in force since this date.
1 June 2015: this is the date on which the majority of the new rules come into force.
The requirements that come into force before 1 June 2015, will only apply to new arrangements and existing
arrangements that have been materially altered after this date. After that date, firms will need to fully comply with the
rules being introduced in PS14/9 for both existing and new counterparties and clients.
In its policy statement, the FCA made clear that it was not proceeding with most of the changes to the client money
distribution rules which it originally proposed in its consultation paper. These proposals were intended to speed up the
distribution of client money on a firm’s insolvency. This decision was taken following feedback from stakeholders on
potential issues with the speed proposals. In addition, the FCA acknowledged that any changes made would need to
work with the recommendations published in the final report on the independent review of the special administration
regime (SAR) for investment banks commissioned by the government (the Bloxham report). The recommendations
made in the Bloxham report include changes to the SAR legislation and to CASS, some of which are addressed in
PS14/9 including in relation to recordkeeping, reporting, a better understanding of the FCA client assets regime and
clarity regarding certain intra-group relationships.
The FCA is also liaising with the European Commission in respect of notifications under Article 4 of the MiFID
implementing Directive (2006/736/EC), which are necessary regarding CASS rules that are or may be considered to
be beyond the provisions of that Directive. The FCA will publish the notifications in due course.
Michael BerrymanNEW YORK
The business of relationships.