Category Archives: Regulation

CRD V: Proposals for bank intermediate EU parent undertakings – retaliation to US measures?

On 23 November 2016, the European Commission (EC) outlined proposals to amend the Capital Requirements Regulation (EU/575/2013) (CRR) and the Capital Requirements Directive (2013/36/EU) (CRD) (and together referred to as CRD IV).  These proposals are likely to form part of the next version of these measures i.e. CRD V.  Links to the proposals are here (CRR) and here (CRD).

One proposed CRD V measure is a requirement for non-EU banking groups (including US groups) operating in the EU to consolidate their subsidiaries under a single “Intermediate Parent Undertaking (IPU)” in the EU, which will need to be separately authorised and capitalised.  I discuss this and similar measures introduced by the US for non-US banking groups operating there.  I also consider the impact of the proposals in relation to Brexit.

EC Proposals

The EC proposals would see a new Article 21b added into CRD to cover IPUs, which would stipulate that:

  1. if a third country group (i.e. a non-EU group) has two or more institutions (i.e. banks or investment firm subsidiaries) in the EU, it must have an EU-based IPU above them;
  2. such an IPU must be separately authorised and be subject to EU capital requirements or be an existing bank or investment firm authorised under CRR;
  3. there must be a single IPU for all subsidiaries that are part of the same group; and
  4. the threshold for this requirement to apply would be if: (a) the total value of assets in the EU (both subsidiaries and branches) of the non-EU group is at least Euro 30 billion; or (b) the third country group is a non-EU G-SII (i.e. global systemically important institution or bank – see list maintained by the FSB).

These proposals would require non-EU banking groups to hold EU bank and broker-dealer (investment firm) subsidiaries through a single EU-based IPU that would be subject to capital, liquidity, leverage and other prudential standards on a consolidated basis.

The IPU requirement may have been added late into the draft CRD V proposals and it seems to have been included without following the usual discussion and impact assessment process for such measures.  It has been suggested that this is a retaliatory action to similar measures introduced by the US (discussed below).  It is possible that EU Member States will decide to alter or even drop this measure before CRD V is adopted into law.

Possible Effect of the EC Proposals on US Banking Groups

Due to strict limitations on transactions between a US Federal Deposit Insurance Corporation (FDIC)-insured bank (and its subsidiaries – the “bank chain”) on the one hand and its bank holding company parent and sister companies (the “non-bank chain”) on the other, the large US bank holding companies operate their US broker-dealer subsidiaries as sister companies of their FDIC-insured banks and often do the same with their non-US broker-dealer subsidiaries.

Such large US bank holding companies operate in the EU through branch offices of their FDIC-insured banks as well as through locally-incorporated bank subsidiaries of those banks and separate (non-bank chain) broker-dealer subsidiaries.

To comply with the EC poposals on IPUs, a US bank holding company would need to transfer its EU bank subsidiaries so that they and the EU broker-dealer subsidiaries become indirect subsidiaries of the parent bank holding company via a single EU IPU. Doing so, could severely limit transactions between the US FDIC-insured bank including its EU branch offices and the EU bank subsidiaries (as well as the other EU subsidiaries) of the US bank holding company.

All this is likely to mean that US banking groups may have to totally rethink their existing holding structures in Europe – they may already be doing so due to Brexit (see below).

US Intermediate Holding Company Rule

Title 12 of the US Code of Federal Regulations (12 CFR Part 252.153) introduced a similar rule in March 2014 requiring  that any foreign banking organisation with US non-branch assets (i.e. subsidiaries) of USD 50 billion or more must establish a US intermediate holding company (US IHC) or designate an existing subsidiary as such.

As you can see, the US IHC rule has a much higher threshold (USD 50 billion) than that of the corresponding EC proposal (Euro 30 billion) and the US threshold only considers assets of subsidiaries, whereas the EC proposal also counts branch assets.

The US IHC rule was viewed as addressing the capital position of large US broker-dealer subsidiaries of non-US banking groups because such subsidiaries were not otherwise subject to US prudential banking regulations including on risk and leverage.  In the EU however, broker-dealer (investment firm) subsidiaries of US banking groups are currently subject to Basel-based prudential requirements.

Brexit

The EC may or may not have had Brexit in mind when it came up with this proposed IPU measure.  Post-Brexit, depending on any negotiated arrangements, the UK will be outside the EU and thus, on the face of it, UK banking groups will be in the same boat as other non-EU groups with regard to the CRD V proposals and may need to establish IPUs in the EU to hold their EU subsidiaries.  Some UK and non-EU banking groups that are not G-SIIs may review the scope of their activities in the EU in light of these requirements.

Also, from the point of view of US and other non-EU banking groups who currently operate in Europe out of the UK, the need for a separately capitalised holding company in Frankfurt or Luxembourg, for example, could make London a less attractive headquarters for European operations.  Given that most banking groups are currently looking at their structures in light of Brexit, the EC proposals on IPUs will add a further layer of complexity to these considerations.

Next Steps and Conclusion

The EC intends that the CRD V proposals will apply two years after the legislative text is finalised. This would take us well into 2019 at the earliest and therefore, the IPU measure is unlikely to be applicable when the UK leaves the EU – assuming that the UK invokes Article 50 of the Lisbon Treaty in early 2017 and leaves the EU in the two year period provided.

The EC proposal for IPUs will probably be welcomed by European banking groups that have found themselves on an uneven playing field with US rivals.  However, most banking groups are reluctant to hold multiple pools of capital around the world, overseen by different regulators, which they see as less efficient than a centrally managed capital pool regulated by their home bank regulatory authority.

Whether or not the EC proposals on IPUs are adopted into law as they are currently drafted, there does seem to be a growing regulatory trend towards a fragmentation in financial rules, as key jurisdictions like the EU and the US seek to assert control and seem comfortable taking tit-for-tat action even at the risk of duplicating or complicating internationally-settled regulatory measures.

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MiFID II: Jargon-buster

The EU Markets in Financial Instruments Regulation EU/600/2014 (MiFIR) and Markets in Financial Instruments Directive 2014/65/EU (together referred to as MiFID II) will apply from 3 January 2018.  This date is much closer than it seems and banks and investment firms are currently scrambling to implement MiFID II-compliant measures in their systems, controls and client documentation.

MiFID II replaces and partially recasts the existing MiFID regime under the directive 2004/39/EC (MiFID I) and in many places introduces new concepts or extends the meaning of existing concepts.

In this piece, I consider some of the main new MiFID II concepts and the inevitable jargon that goes with them.

Algorithmic or high-frequency trading (HFT): trading in financial instruments by a computer algorithm with limited or no human intervention.  MiFID II will require such trading to be conducted by authorised investment firms, be supervised and have controls and other safeguards to ensure it does not cause any disruption in the market.

APA (Approved Publication Arrangement): MiFID II introduces the concept of an APA who will assist in price discovery by publishing post-trade transparency data.  An APA could be a new market participant or a new activity conducted by Trading Venues such as exchanges.  An APA will be subject to authorisation and organisational requirements.

ARM (Approved Reporting Mechanism): a new concept introduced by MiFID II for enabling transaction reporting by investment firms to regulators.  An ARM will be subject to authorisation and organisational requirements.

CTP (Consolidated Tape Provider): MiFID II envisages a new provider that will consolidate post-trade disclosures and make them publicly available (a continuous electronic live data stream providing price and volume data).  A CTP  will be subject to authorisation and organisational requirements.

DRSP (Data Reporting Service Provider): an APA, ARM or CTP.

Financial Instruments: this is a wider concept under MiFID II and refers not only to shares and other “transferable securities” but also to money-market instruments, units in collective investment schemes, emission allowances and derivatives such as options, futures, swaps and forward rate agreements.

Independent Advice: the provision of personal recommendations to a client.  MiFID II will oblige firms to ensure that staff are not remunerated or assessed in a way that could conflict with the duty to act in a client’s best interest.

OTF (Organised Trading Facility): a trading venue for bonds, structured products or derivatives (i.e. non-equity financial instruments).  This is a new concept and MiFID II will now regulate OTF platforms (e.g. broker crossing networks).

MTF (Multilateral Trading Facility): a venue where financial instruments can trade outside of a regulated market e.g. an internal matching system at a firm that executes client orders in shares.  This is a MiFID I concept but MTFs (as also OTFs) will now need enhanced financial resources, measures for risk management and conflicts of interest identification.

Post-trade transparency: publication of transaction data via an APA by the operators of Trading Venues or SIs immediately following a trade – to be available on commercial terms immediately or for free after 15 minutes.

Pre-trade transparency: continuous publication of bid and offer prices of financial instruments by operators of Trading Venues (e.g. exchanges) or publication of firm quotes by SIs, in either case, before a trade takes place.

Regulated Market: a stock market or exchange regulated by an EU member state for trading in publicly-listed financial instruments e.g. the London Stock Exchange.

SME Growth Market: a new category of MTF that will enable small and medium-sized entities (SMEs) to access capital.  At least 50% of the issuers on such an MTF must be SMEs.

SI (Systematic Internaliser): traditionally called “market maker” this is an investment firm which routinely deals on its own account by executing customer orders in shares outside a Trading Venue such as an exchange.  MiFID II will extend this concept to cover all financial instruments not just shares.  SIs will also need to publish firm quotes and post-trade data.

Trading Venue: an OTF, MTF or Regulated Market.  MiFID II will require Trading Venues to have better systems, controls and circuit-breakers and there will be rules on minimum tick size (price increments).  They will also need to publish annual data on execution quality.

Transaction Reporting: MiFID II envisages the reporting of transaction data by investment firms that execute transactions in financial instruments to the regulator (e.g. the FCA) within 1 day of the trade via an ARM.

TTCA (Title Transfer Collateral Arrangement): this not a MiFID concept as such but MiFID II prohibits firms from entering into TTCAs with retail clients and obliges firms to consider the appropriateness of a TTCA for the other categories of clients – i.e. professional clients or eligible counterparties.

 

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Brexit: we don’t know what we don’t know

A lot has been written and speculated about how Brexit will play out so I thought I’d write something about what we don’t know.  I’ve avoided using the adjectives hard or soft and the focus of this piece is primarily on the financial services market.

1 – We don’t know PM Theresa May’s plans.

This is not necessarily a bad thing. It would be unusual for a deal negotiating team at a bank, corporation or law firm to give and take briefings about how they are negotiating a particular deal with all their colleagues.

2 – We don’t know who is going to scrutinise the Brexit negotiations.

To me, planning for and negotiating to exit the EU is akin to planning for a battle and as John Travolta’s character in Broken Arrow so eloquently put it, “[Battle] is a highly fluid situation. You plan on your contingencies, and I have. You keep your initiative, and I will. One thing you don’t do is share command.” Decisive planning and leadership is probably more important than a negotiation by general consensus.  Theresa May’s term in office will be characterised by one thing – how she leads the UK through Brexit.

3 – We don’t know if the City of London will keep passporting rights after Brexit.

People argue that much depends on the UK keeping the passporting rights currently available under EU single market legislation such as the Markets in Financial Instruments Directive (MiFID), Alternative Investment Fund Managers Directive (AIFMD) or Insurance Mediation Directive (IMD), which enable cross-border financial services regulated in the UK to be provided into EU member states. This is probably true.

However, the reverse proposition also needs to be considered: many EU (or EEA) firms also passport in to access the UK market – a developed global financial services market with a deep pool of capital and the second highest GDP in Europe after Germany.  Wouldn’t these firms want the EU to keep these rights?  According to figures from the Financial Conduct Authority (FCA), there are over 8,000 firms passporting into the UK (especially investment firms and insurance companies).

4 – We don’t know if London will lose its position as the leading global forex trading hub.

London’s share of global forex trading fell from 41% to 37% according to the last triennial survey conducted by the Bank for International Settlements (BIS) in 2016.  This market share may be under further threat post-Brexit with some currency trading (e.g. the Euro) moving out of London.  However, London’s global share far outweighs second-placed New York (19%) and the combined share of Frankfurt and Paris (4.5%).

5 – We don’t know what the future holds for the UK outside the EU.

If the UK leaves the EU and there isn’t any negotiated access to the EU single market then, assuming there is no dramatic change in current laws or regulations post-Brexit, the UK could be viewed as a country that has an equivalent financial services regime to the EU.  There is a list of countries (e.g. Australia, the USA and Singapore) that the EU deems equivalent in relation to their regulation of banks, investment firms and exchanges.  The UK could be part of such a grouping in the future and thereby gain market access to the EU.

6 – We don’t know how upcoming elections in France and Germany will affect the EU landscape.

Brexit is above all a political move.  Elections in 2017 in France (April – May) and Germany (September) will have some bearing on who is at the table negotiating Brexit or what cards they have in their hands.

7 – We don’t know how far the Pound will fall.

In the wake of the Brexit vote, we saw the Pound dramatically and then steadily fall from close to $1.50 to $1.22 (midday 12 January 2017).  It doesn’t seem that long ago when the Pound was $2 (September 2007).  How much further will it fall?  Prices that depend on imports will go up but, at the same time, UK exports will become more competitive globally and this may help create jobs.  Has the UK managed to devalue its currency by the back door?

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New Market Abuse Regime: ESMA advises European Commission on implementation

On 3 February 2015, the European Securities and Markets Authority (ESMA) published its technical advice to the European Commission on possible delegated acts under the Market Abuse Regulation (Regulation 596/2014) (MAR) in a Final Report.

The draft technical advice covers recommendations in the following areas:

  • examples of practices that may constitute market manipulation as well as proposing additional indicators of market manipulation.
  • minimum thresholds for the purpose of the exemption for certain participants in the emission allowance market from the requirement to publicly disclose inside information.
  • how to determine to which regulator delays in disclosure of inside information need to be notified.
  • clarification of the enhanced disclosure of managers’ transactions.
  • clarification of the transactions that can be allowed by the issuer during a closed period when normally trading by managers is prohibited.
  • procedures and arrangements to ensure sound whistleblowing infrastructures.

In some cases, ESMA has modified its technical advice in the light of comments received in its consultation in July 2014 on MAR.

Next steps

ESMA will send this technical advice to the European Commission for its consideration in drafting its implementing standards regarding MAR.  ESMA’s regulatory technical standards (RTS) on MAR are intended to be delivered in July 2015.  Under European law, these delegated acts should be adopted by the European Commission so that they enter into force 24 months after the entry into force of MAR.  MAR entered into force on 2 July 2014 so the delegated acts would need to be in force by July 2016.

ESMA publishes list of Non-EEA CCPs under EMIR + HK MoU

On 25 January 2015 the European Securities and Markets Authority (ESMA) published an updated list of non-EEA Central Counterparties (CCPs) who have applied for recognition under Article 25 of the European Market Infrastructure Regulation (EMIR) (EU No 648/2012) on OTC derivatives, CCPs and trade repositories.

CCPs are entities that sit between counterparties to a derivative contract, becoming the buyer to every seller and the seller to every buyer.  This makes CCPs the focal point for derivative transactions and, according to ESMA, this helps in increasing market transparency and reducing the risks inherent in derivatives markets.

The non-EEA CCPs list is not exhaustive because it only includes those who expressly agreed to have their name mentioned publicly and is also subject to further updates.

These non-EEA CCPs include the following:

  • ASX Clear (Australia)
  • Canadian Derivatives Clearing Corporation (Canada)
  • Chicago Mercantile Exchange (USA)
  • NASDAQ Dubai (Dubai, UAE)
  • Hong Kong Securities Clearing Company (Hong Kong, China)
  • National Securities Clearing Corporation (India)
  • LCH.Clearnet (USA)
  • Tokyo Financial Exchange (Japan)

The entire list can be accessed here.

ESMA also maintains a list of European CCPs under EMIR that are authorised to offer services and activities in the EU (last updated on 22 January 2015).  This list can be accessed here.


Effective from 19 December 2014, ESMA and the Hong Kong Securities and Futures Commission (SFC) announced that they entered into a Memorandum of Understanding setting out co-operation arrangements relating to CCPs established in Hong Kong that have applied for recognition under Article 25 of EMIR.  It is understood that ESMA and other non-EEA authorities are discussing similar cooperation arrangements.

Beyond LIBOR: UK to extend manipulation offence to 7 more benchmarks

The LIBOR fixing scandal led to the establishment of a new regime and regulation governing how the benchmark LIBOR (London Inter-Bank Offered Rate) is calculated and administered and an offence of benchmark manipulation under the Financial Services Act 2012  that is punishable by up to 7 years’ imprisonment.

On 22 December 2014, the UK’s HM Treasury published the government’s response to their September 2014 consultation on extending this new regulatory regime to these seven other benchmarks:

  • WM/Reuters’ FX benchmark rates (WMR) – the main global forex benchmark
  • Sterling Overnight Index Average (SONIA) & Repurchase Overnight Index Average (RONIA) –  reference rates for unsecured Sterling overnight funding administered by WMBA
  • ISDAFix – principal benchmark for swap rates and spreads for interest rate swaps administered by ICE
  • ICE Brent Index – the crude oil futures benchmark
  • LBMA Gold Price (currently London Gold Fix whose administration is being taken over by ICE in early 2015)
  • LBMA Silver Price (administered by CME Group and Reuters)

HM Treasury intends to lay draft legislation before Parliament in early in 2015 so that changes can be debated and the new legislation can commence on 1 April 2015.

Alongside these measures, the UK’s Financial Conduct Authority (FCA) as the regulator with oversight of the benchmark regime, has launched a consultation on how it proposes to regulate the various firms administering these benchmarks.  This outlines the FCA’s proposed changes to the Market Conduct sourcebook (MAR) and the Supervision manual (SUP) of the FCA Handbook.  The consultation is open until 30 January 2015.

It is expected that this regulatory regime may in the future be modified or superseded by the EU’s Benchmark Regulation that is currently being debated by the European Council but it is not expected to be in place in the near future.