2009, the year which followed the collapse of Lehman Brothers was one of intense reflection during which all the players concerned, both public and private, became aware that the world in general and the finance sector in particular would never be as we once knew them. The players devoted themselves to understanding the situation revealed by the financial and economic crisis in order to draw lessons from it and to define new principles, which should in the future underlie the establishment of a new world order.
It was during that year that the G20 decided in Pittsburgh to set up a framework for supervising financial institutions which represent systemic risk and for managing cross-border failures (resolutions). The framework also included reforming clearing practices so as to increase financial stability and improve the efficiency of the OTC derivative markets, strengthening capital and liquidity requirements imposed on financial institutions in order to limit excessive leveraging effects and reduce the effects of economic cycles. It was at this time that the US began its work on the Dodd Franck Act and a number of European reforms were initiated such as the introduction of a new European system of supervision, EMIR (the compensation of financial transactions and the organisation of OTC derivative markets) and AIFM (alternative investment fund management). These initiatives also coincided with the revisions of the MiFID (investment services) and of the CR Directive (capital requirements).
In parallel with these initiatives there was widespread awareness in Europe of the need to reform the regulatory framework and the post-trade European market. This justified, in particular, the pursuit of restructuring projects such as T2S (TARGET2- Securities, the Pan-European securities settlement platform) and CCBM2 (single management platform for Central Bank collateral).
It must be noted that although the activity in European institutions has remained very intense, few new texts have been effectively adopted and published in the Official Journal. The best is therefore yet to come.
Eric de Nexon
2010 was a year of intense regulatory activity during which the European authorities prepared many texts. 2010 was however marked by few formal adoptions of directives or regulations. For all that, the will to succeed was obvious, particularly in the course of 2011, thus reflected in the provisional schedules submitted by the European Commission, as we referred to in February 2011.
Where do we stand one year later? It must be noted that although the activity in European institutions has remained very intense, few new texts have been effectively adopted and published in the Official Journal. The best is therefore yet to come.
Let us review the main initiatives which SGSS is monitoring:
EMIR (European Market Infrastructures Regulation)
This text was proposed by the European Commission (EC) on 15th September 2010 and the objective for the end of the year 2010 was adoption in April 2011, with the regulation to come into force during the second half of 2012. At the end of 2011, it was clear that the complexity of the subjects being considered and the need to ensure the consistency of the European text with its American equivalent somewhat delayed the progress of the work in the EC. The new schedule specifies adoption at the start of 2012, followed up with work by ESMA aimed at compiling the technical standards and proceedings by the end of June 2012.This would enable the regulation to come into effect before the end of 2012, in line with the schedule set by the G20.
Regulation of short selling and certain aspects of Credit Default Swaps
The text, which was approved by the European Parliament on 15th November 2011, must now be formally adopted by the European Council in order to come into effect in November 2012, the date currently set.
The objective of this regulation is to build a preventive framework (made of permanent measures complemented by temporary measures that can be activated by the competent authorities), that is rational (the draft does not question the benefits that short selling can provide in normal market conditions and exempts certain activities) and harmonised, aimed at regulating the short selling of shares and of sovereign debt, as well as the use of CDS’s. Such a framework is only meaningful if it is accompanied by; a strengthening of the powers assigned to the competent local authorities and to ESMA, and by an increase in transparency, which is necessary for the exercise of their function. The text therefore specifies the roles of the various competent authorities and stresses the need for cooperation between them.
The European Union wishes to increase the cost on purely speculative transactions. A proper system would be set up in order to allow non-financial companies to use derivative products for « legitimate» hedging reasons…
Essentially aimed at the investor (corporate entity or individual), the text deals with short selling from two aspects: a declarative (potentially public) obligation and the obligation to have taken all the necessary steps in order to enable the settlement of the sale on time. With regard to CDS’s, it prohibits “naked” short selling.
The text also requires the Central Counterparties (CCP) to put in place penalties on settlement fails and a harmonised Buy-in procedure (triggered 4 business days after the intended settlement date). It should be noted that this proposal is in line with the one contained in the draft regulation on Central Depositaries (CSD’s). Moreover, it is not the only instance of a connection between the proposals in EC texts. The earmarking of short selling orders, which was envisaged in this regulation for a while, seems to have been finally abandoned in favour of the marking of transactions which could be easily achieved using Transaction Reporting as specified in the future MiFIR regulation.
CSD Regulation (Central Securities Custodians)
The main objective of the text is to harmonise the regulatory framework applying to CSD’s in Europe, which is completely new. Furthermore, it deals with various harmonisation topics, particularly relating to T2S, like Settlement Disciplines and settlement cycles.
The work had begun with discussions amongst the Member States on 15 July 2010. The proposed text was to be published on 30 November 2011. This publication will undoubtedly be deferred to the beginning of 2012. At that date the co-decision (trilogues) phase will begin. The regulation can then be voted on in the following 12 months, before ESMA devotes itself to producing the many application decrees specified by the text. On this basis, it is envisaged that the regulation will come into force in 2014.
SLD (Securities Law Directive)
You will remember that the main objectives of this directive, which has now been in discussion for several years, are to facilitate crossborder investments by tackling the heterogeneity of the securities laws and the rules for the conflict of laws that apply in Europe, but also to support the harmonisation work in progress on corporate actions. This follows the example of many other harmonisation projects being conducted in the post-market area, intending to facilitate the implementation of the T2S project. At the end of the year 2010, it had been indicated that a proposal in this domain was expected in June 2011. Today a date is no longer indicated and the EC’s financial regulation programme for 2012 makes no reference to it…
MiFID II (Markets in Financial Instruments Directive)
The Markets in Financial Instruments Directive, or MiFID, came into effect in November 2007. It governs investment services in the financial instruments field (such as brokerage, advice, dealing, portfolio management, subscription services, etc.) supplied by the banks, and the functioning of regulated markets and other trading platforms (referred to as “multilateral trading facilities”).
The SEC is considering whether new requirements should be imposed on high frequency trading and what benefits market makers should get for meeting those obligations. In the meantime the CFTC moves forward to protect swaps user margin from peer (...)
A proposal to review this directive was announced for 2011. The EC has kept to its commitment and both a directive proposal and a regulation proposal have been submitted for consultation on 20October 2011. The aims of these proposals are to make the financial markets more efficient, more resilient and more transparent, but also to strengthen investor protection. The new regulation will expand its cover to the trading platforms which were not regulated hitherto. It will harmonise the rules that apply to regulated markets and MTFs and will set up a framework regulating algorithmic trading activity. It will also increase the transparency of market participants trading equities and introduce new transparency regime for bonds, structured products and derivatives. It will then strengthen the role and the powers of the regulatory authorities, especially in terms of regulation and supervision of activities on commodities. Lastly, the revised MiFID will define stricter requirements for portfolio management, investment advice and offers of complex financial products like structured products.
The proposal has been transmitted to the European Parliament and to the European Council. The legislative process should last more than a year, definitive publication of the texts being forecast for the third or even fourth quarter of 2013. Transposition of the Directive should occur in the Member States by the end of 2015. As the regulation is not by nature a text subject to transposition, it could see its application delayed to the Directive’s transposition date for reasons of consistency.
AIFM Level 2 Measures (Execution measures of the Directive on managers of alternative investment funds)
The AIFM Directive was published on 1 July 2011 in the Official Journal of the European Union. Beyond the rules applicable to fund managers, the AIFM Directive (and its implementing measures) regulates in detail the missions of the alternative investment fund depositary by defining its functions relating to cash monitoring, assets in custody (a broad definition has been adopted, bringing back into the field of custody, in particular, financial instruments registered or held directly or indirectly in the name of the depositary), record keeping and depositary oversight duties. The directive also establishes a principle of liability in the case of the loss of assets by the depositary or one of its sub-custodians. The entity can only exonerate themselves in case of an external event beyond its reasonable control (limited cases like sovereign acts or natural disasters) or, in the case of insolvency, only if the local insolvency law does not recognise the effects of the segregation of assets.
The AIFM Directive will have to be transposed in all Member States by 22 July 2013. In parallel, the European Commission has launched the legislative process for the level 2 measures by asking ESMA for its technical advice, which was delivered on 16 November 2011. The Commission foresees the definitive adoption of the level 2 measures in July 2012 with transposition in July 2013, at the same time as the framework Directive.
UCITS V (Consultation of the European Commission on the custodian function and the remuneration of managers)
In December 2010, the European Commission launched a European consultation in order to clarify the UCITS depositary’s regime and that of the remuneration of UCITS managers. Since that date, the work on the AIFM directive has taken precedence over that of UCITS V and an alignment of the two texts in terms of the functions and responsibility of the depositary has been firmly envisaged by the European Commission.
If alignment is confirmed, the provisions of the AIFM Directive and in particular its future implementing measures should be found in the future text on UCITS V. One new item should be introduced: minimum sanctions for managers who do not play the game and therefore contravene European legislation.
Certain rumours mention a possible expansion of the field of application of UCITS V to eligible assets and to complex/noncomplex UCITS’s, which would be likely to delay the publication of the draft directive. But that has not been confirmed by the European Commission. For the time being, UCITS V is the order of the day for the 2012 EC’s work programme and an initiative concerning the subjects mentioned above (depositaries, remuneration of managers and sanctions) should emerge during 2012.
SOLVENCY II (Directive on the solvency of insurance companies)
On 16 November 2011, EIOPA (European Insurance and Occupational Pensions Authority), officially confirmed the deferral for one year of the new prudential rules issued in the Solvency II Directive.
A significant reliance on third parties for data, sophisticated risk modelling requirements and obtaining sufficiently detailed fund data were among the challenges identified by European insurers in order for them to meet Solvency II requirements, according to new research (...)
The European Parliament and the European Council finally accepted that the Directive be applied gradually, i.e. that the Member States should transpose the Directive before 1 January 2013, the new regime would only fully apply to insurers from 1st January 2014. You will remember that the objective of Solvency II is to better adapt the solvency requirements for insurance and reinsurance companies to the real economic risks incurred by their activity (like the CRD adopting the provisions defined by the Basle Committee for banks). Despite this deferral, the schedule remains tight. EIOPA hopes that the Omnibus 2 Directive which is to partially modify the Solvency Framework Directive can be voted on during the first half of 2012, given that EIOPA intends to launch in parallel in May 2012 a consultation on the Solvency II application measures.
