Category Archives: Regulators

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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Regulatory Enforcement Update

(1) The European Commission said in a press release on 4 February 2015 that it fined UK brokerLawEnforcement ICAP €14.9 million for having breached EU anti-trust rules by facilitating several cartels in the sector of Yen (JPY) interest rate derivatives (YIRD).  The anti-competitive conduct concerned discussions between traders of various participating banks on certain JPY LIBOR submissions.

(2) Alex Hope (7 years’ imprisonment) and co-defendant Raj Von Badlo (2 years’ imprisonment) were sentenced following their conviction for defrauding investors and operating an unauthorised collective investment scheme, which was closed by the FCA in April 2012.  Over 100 investors gave Hope over £5.5 million to purportedly trade in forex markets although most of it was not traded and instead diverted to fund his lifestyle.  Von Badlo promoted Hope’s scheme to many investors.

(3) Meanwhile, the City of London Police announced on 5 February 2015 that they had concluded there is not sufficient evidence to progress a criminal investigation of payday lender Wonga.  The main allegations against Wonga were that it had deceived its customers by sending letters falsely purporting to be from lawyers with the aim of recovering their outstanding debts.

FCA signs MoUs with other UK regulators the ICO and ASA

IMG_0101On 28 January 2015, the UK’s Financial Conduct Authority (FCA) published a Memorandum of Understanding (MoU) dated 29 September 2014 that it has entered into with the Information Commissioner’s Office (ICO) in relation to their “separate but overlapping mandates” as regulators.  It covers the following areas:

  • Roles and responsibilities of the FCA and ICO
  • Co-operation
  • Information sharing
  • Policy and rule-making
  • Investigation and enforcement
  • Confidentiality

The MoU will facilitate co-ordination between the FCA and the ICO in relation to their responsibilities under the Financial Services and Markets Act 2000 (FSMA), the Data Protection Act 1998 (DPA), the Freedom of Information Act 2000 (FOIA), the Privacy and Electronic Communications (EC Directive) Regulations 2003 (SI 2003/2426) (PECR), the Environmental Information Regulations 2004 (SI 2004/3391) (EIR) and the INSPIRE Regulations 2009 (SI 2009/3157).

The FCA has also entered into an MoU with the Advertising Standards Authority (ASA) dated 3 December 2014, which covers the following areas:

  • Roles and responsibilities of the FCA and ASA (including the ASA’s remit over financial advertising)
  • Co-ordination
  • Information sharing
  • Policy and rule-making
  • Investigation and enforcement
  • Confidentiality

The MoU will facilitate co-ordination between the FCA and the ACA in relation to FSMA, UK Code of Non-broadcast Advertising, Sales Promotion and Direct Marketing (CAP Code), UK Code of Broadcast Advertising (BCAP Code) and other relevant legislation.