The Committee of European Securities Regulators (CESR) has published a report on the market impact of the Lehman Brothers default. The report begins with a brief discussion of the causes of the bankruptcy of Lehman Brothers Holdings Inc. It then sets out some of the regulatory and industry responses to the challenges in the securities field:
- Oversight of cross-border groups. CESR notes that global regulatory responses and effective global co-ordination between supervisors are essential when dealing with cross-border groups.
- Harmonised regulatory conditions. CESR notes that instruments with an equivalent risk/reward profile should be subject to equivalent regulatory conditions in order to create a level playing field across product classes. A task force has been established within CESR to address these issues further.
- Effective application of the Prospectus Directive. Here CESR states that close cooperation between Home and Host State regulators is essential where instruments are approved for passporting under the Prospectus Directive.It also notes that the manner in which some issuers combine the 'base prospectus' and 'final terms' concept in the Prospectus Directive and its implementing measures for structured debt does not always meet the requirement according to which the information must be provided in an easily available and comprehensible form (article 5(1) Prospectus Directive).
- Convergence of application of the Markets in Financial Instruments Directive. Here CESR looks at complex/non-complex financial instruments, suitability, sales process for structured products, re-hypothecation, documentation of investments and complaints handling.
- Clearing and settlement. CESR notes that LCH Clearnet’s default rules allowed it to handle the Lehman Brothers default smoothly. However, CESR also states that there are challenges that exchanges, clearing houses and other market participants have to face. Issues include the handling of unsettled transactions and the establishment of a central counterparty for standard, liquid CDS products such as indices.
- Settlement Finality Directive. CESR notes that notifications made under article 6 of the Settlement Finality Directive should be timely and clear in content.
- Master netting agreements. CESR notes that participants in the secondary debt market will have to consider the introduction of master netting agreements between counterparties in order to allow netting across all debt trades between the relevant entity and the financial institution in question.
- Valuation of structured notes. CESR suggests that in the future, it is possible that market participants will be more wary of structures where the valuation agent is an affiliate of the issuer. Some notes include terms stating that pay-off will be determined by a named valuation agent, which poses a particular problem where the agent was a Lehman Brothers affiliate, as the terms didn’t cover the possibility of both issuer and valuation agent going into administration.
- Insolvency regime for investment firms. CESR notes that there is no winding up directive for investment firms at the European level, in contrast to the position for credit institutions and insurers.