EU Regulatory Update
On 20 April, the Joint Committee of the European Supervisory Authorities (ESAs)published its spring 2017 report on risks and vulnerabilities in the EU’s financial system. The main risks that the report identified include: (i) low profitability of financial institutions; (ii) “valuation risks around [the] search for yield and repricing of risk premia”; (iii) interconnectedness within the financial system; and (iv) “cyber risks and other risks derived from information and communication technologies (ICT).”
o Low Profitability: The report found that insurance companies face challenges arising from the following factors: (i) a prolonged period of low interest rates; (ii) reinvestment risk that may be exacerbated by a potential lack of long-term (over 10-year maturity) fixed-income instruments; and (iii) divergence between returns on fund shares and the RoE of some asset managers raised concerns about the appropriateness of available marketing channels and the availability of adequate cost and performance information to fund clients.
o Valuation Risk: The report found that: (i) valuation risk increased as a result of “increased asset price volatility coupled with continuing liquidity concerns”; (ii) volatility increased in money, sovereign, and corporate bond and commodity markets; (iii) “rapidly growing price-earnings ratios for equity” suggest that valuation risk will persist; (iv) valuation risks are exacerbated by political uncertainties, such as Brexit and the U.S. election; and (v) a sudden substantial increase of the interest rate might expose insurance companies to an increasing probability of cancellation of coverages due to non-payment of premiums.
o Interconnectedness within the Financial System: The report found that: (i) “interconnectedness, in particular via asset price contagion and direct financial exposure, adds to financial sector risks”; (ii) “high co-movements in equity prices for insurers and banks, and high exposures of EU insurers to EU banks indicate risk concentration within those two sectors”; (iii) banking sector risks may drive an increase in fund industry risks as, during 2016, the exposure of EU hedge funds to EU banks grew “substantially”; and (iv) “increasing interconnectedness implies a higher potential for materialisation of systemic risks.”
o Cyber Risks and Other Risks Derived from ICT: The report found that: (i) “cyber risk appears as a major risk and is on the rise”; (ii) “cyber risk threatens data integrity and business continuity in an interconnected financial system”; and (iii) “demand for cyber insurance is expected to grow while cyber coverage products are still relatively new in the market, with limited underwriting experiences.”
FSB Review of Corporate Governance
On 28 April, the Financial Stability Board (FSB) published a thematic peer reviewon FSB member implementation of the G20 and Organization for Economic Co-operation and Development’s Principles of Corporate Governance for publicly listed, regulated financial institutions. As the release explains, “the peer review found that while all FSB members have a comprehensive corporate governance framework, its effectiveness can be impacted if the division of responsibility among financial regulators is unclear or if the various corporate governance requirements overlap, leave unwarranted gaps, or are otherwise not well aligned with each other.” It continues: “although FSB members’ corporate governance frameworks generally provide some degree of proportionality, other factors such as ownership and control structure, geographical presence, and stage of development could also be better considered.” The report concludes with 12 recommendations to FSB members, standard setting bodies, and financial institutions which cover, among other topics: (i) ensuring the basis for an effective corporate governance framework; (ii) disclosure and transparency; (iii) responsibilities of the board; (iv) rights and equitable treatment of shareholders and key ownership functions; and (v) role of stakeholders in corporate governance.
G20 Financial Regulatory Reforms
On 11 April, the FSB published for consultation the proposed framework for post-implementation evaluation of the effects of the G20 financial regulatory reforms. The framework will guide the analysis of whether the G20 core financial reforms are achieving their intended outcomes, and help to identify any material unintended consequences. The consultation is seeking comments regarding: (i) the objective and scope of the framework and whether other core elements should be included; (ii) the challenges of evaluating, identifying, and measuring the consequences of the reforms; (iii) the proposed approaches to evaluating the consequences of the reforms; (iv) data issues and information availability and sharing; (v) stakeholder engagement; and (vi) the prioritization of topics to be evaluated under the framework. The consultation period closes on 11 May 2017, and the FSB intends to publish the framework before the G20 Summit in July 2017.
Compensation Practices in the Securities Sector
On 6 April, the FSB and International Organization of Securities Commissions (IOSCO) published for consultation a summary of a joint roundtable held on 13 December 2016 regarding compensation practices in the securities sector. The participants of the roundtable discussed issues regarding: (i) the design and governance of compensation practices and models; (ii) “financial stability risks that could emerge from compensation structures and whether or how securities firms could align their compensation practices with long-term risk taking”; (iii) “how oversight of misconduct risk and investor protection mechanisms are organized within firms”; and (iv) “regulatory provisions or restrictions related to compensation in the securities sector, particularly the differences and commonalities between the securities and banking sectors.” The FSB indicated that further details on compensation practices will be included in its fifth progress report on implementing the FSB principles for sound compensation practices, to be published in advance of the G20 Summit in July 2017. The consultation period closes on 16 May 2017.
AIFMD and UCITS V
On 7 April, ESMA published a report on the findings of its thematic study on the operation of national authorities’ responsibilities under the Alternative Investment Fund Managers Directive (2011/61/EU) (AIFMD) and Undertaking for Collective Investment in Transferable Securities Directive (2009/65/EU) (UCITS IV). The study focused on the notification and passporting frameworks contained in the UCITS IV and AIFMD. The report found that: (i) although the passporting frameworks have been established for a number of years, the extent to which they are being used varies extensively across member states; (ii) the cross-border marketing of UCITS plays a significantly bigger role than the cross-border management of UCITS; (iii) alternative investment fund (AIF) managers make significantly less use of AIFMD passports as compared to the overall usage of UCITS passports; and (iv) the notification frameworks and their administrative procedures are generally well-established and functioning at the national authorities level on a daily basis. ESMA also identified a number of other issues around the notification frameworks which did not form part of the assessment, which will be further examined by ESMA in the future.
On 6 April, ESMA published two sets of updated Q&As on the AIFMD and UCITS V.
o AIFMD: The updated Q&As cover cross-border marketing of EU AIFs by EU AIFMs, clarifying that the AIF marketing passport may only be used for marketing to professional investors as defined in AIFMD.
o UCITS V: The updated Q&As cover cross-border activities by UCITS management companies clarifying that a UCITS management company can notify cross-border activities without having to identify a specific UCITS.
On 21 April, EIOPA issued a consultation on proposed amendments to adopted Solvency II (2009/138/EC) technical standards on reporting and disclosures. The consultation will cover draft amendments related to: (i) implementing technical standards (ITS) regarding the templates for the submission of information to supervisory authorities; (ii) ITS regarding the procedures, formats, and templates of the solvency and financial condition report under Solvency II; (iii) guidelines on reporting for financial stability purposes; and (iv) guidelines on the supervision of branches of third-country insurance undertakings. EIOPA indicated that the amendments may also affect the Solvency II XBRL Taxonomy. The consultation period closes on 8 May 2017.
On 26 April, EIOPA issued a call for evidence on the treatment of unlisted equity and debt without external rating in the standard formula. The call for evidence follows the European Commission’s second request for EIOPA to provide technical advice on the review of specified items in the Solvency II Delegated Regulation (2015/35/EU), including criteria for unrated debt and criteria applicable to portfolios of unlisted equity from the European Economic Area. EIOPA issued the call for evidence to allow stakeholders to provide their initial views and ideas and to collect initial evidence, and indicated that it intends to issue a consultation on draft advice to the European Commission in November 2017. The consultation period closes on 24 May 2017.
Consumer Protection Issues in the Unit-Linked Market
On 26 April, EIOPA published the results of a thematic review on consumer protection issues in the unit-linked market due to business interlinkages between providers of asset management services and insurance undertakings. The review focused on potential conflicts of interest created in the unit-linked products by monetary incentives and remuneration paid to insurance undertakings by asset managers. As the report’s release explains, the review found that: (i) “payments between asset managers and insurance undertakings are widespread as 81% of participating insurance undertakings received monetary incentives and remuneration from asset managers”; (ii) “around 70% of participating insurance undertakings do not disclose to policyholders the monetary incentives and remuneration received”; (iii) “around 60% of participating insurance undertakings retained the monetary incentives and remuneration received”; (iv) “insurance undertakings invest a significant proportion of unit-linked assets in funds that pay higher levels of monetary incentives and remuneration”; (v) “insurance undertakings typically have general policies in place to ensure they act in the best interests of customers, with specific reference made to conflicts of interest, [but] the implementation of these policies varies significantly”; and (vi) “the selection of asset managers and investments is in some cases constrained by existing business relations with asset managers and do not follow proper governance processes.” EIOPA is now assessing whether further regulatory or supervisory actions are needed so that the conflicts of interest identified are avoided or properly mitigated.
Ultimate Forward Rate
On 4 April, EIOPA published the methodology for deriving the ultimate forward rate (UFR) under the Delegated Regulation on Solvency II (2015/35EU). The methodology will be applied for the first time in the calculation of the risk-free interest rates of January 2018, to be published in February 2018.
Capital Markets Union
On 11 April, the European Commission held a public hearing on the CMU mid-term review. Overall, the participants agreed that the CMU is more important following Brexit and that it needs to come into effect as soon as possible. The most popular solution for the way forward was supervisory convergence and boosting the capabilities of the ESAs. Several participants did not agree with the proposition of the twin peak approach, which includes having both a prudential regulator as well as a dedicated market regulator.
o ESMA Chair Maijoor outlined the benefits of the CMU as: (i) diversifying the sources of funding; (ii) “increas[ing] the levels of equity financing”; and (iii) “more competitiveness and improved transmission of monetary policy to the real economy.” He focused his discussions on supervisory convergence and highlighted its importance as “more interconnected financial markets imply bigger risks” and supervisory convergence would lead to “achieving greater financial stability and investor protection in the EU.” He argued that the rationale for supervisory convergence is to ensure that cross-border financial markets do not create national supervision concerns and to enable the analysis of “whether national regulators sufficiently assess and address risks that their supervised entities might be creating outside their jurisdiction.” He recommended that ESMA be given more authority regarding supervisory convergence, including: (i) the authority to collect information on emerging supervisory convergence issues; and (ii) increased convergence powers in the area of asset management to reduce cross-border barriers and to ensure consistent authorization across the EU. He also stated that “ESMA is in a unique position to contribute to the design of a common EU financial data strategy.”
o At the hearing, European Commission Financial Stability, Financial Services, and CMU Financial Markets Director Bassi stated that the Commission is currently shaping the new agenda for the second phase of the CMU. He indicated that the Commission is planning a mix of legislative and non-legislative initiatives and tools to promote public markets for equity and debt. He also identified FinTech as a mode of accelerating the re-orientation of private capital and acknowledge the potential of digitalisation to change business models through data driven solutions.
o European Commission Vice President Dombrovskis outlined the progress made so far as part of the CMU Action Plan but emphasised that further work needs to be done and asked for more commitment in developing the project by the Member States and the European Parliament. He indicated that there will be a legislative proposal to tackle obstacles to the EU cross-border passporting of funds, and highlighted the fact that these projects are long-term and so the benefits of the CMU may not be visible yet. He stated that next steps need to focus on timely financial reporting, clear and standardized contracts, and effective supervision. He also supported the ESAs’ efforts to strengthen supervisory convergence and to address possible gaps in the national implementation of the CMU.
On 6 April, ESMA published its response to the European Commission’s consultation paper on the Capital Markets Union (CMU) mid-term review. ESMA stated that it “fully supports the Commission’s commitment to accelerate the integration of European capital markets,” especially in light of Brexit, but proposed further steps to support the CMU regarding: (i) supervisory convergence; (ii) financial data; (iii) small and medium-sized enterprises; and (iv) crowdfunding. Among other things, ESMA suggested that the Commission should (i) “clarify [national authorities’] obligations to respond to requests for information made by ESMA”; and (ii) grant ESMA and national authorities the ability to “suspend temporarily the application of a particular rule if its application could lead to unintended consequences or requires guidance or technical specifications that are not yet available.”
On 7 April, the European Commission published a consultation paper on the conflict of laws rules for securities ownership and third-party effects of the assignment of claims. The consultation aims to gather stakeholders’ views in the practical problems and types of risks caused by the current state of harmonization of these conflict of laws rules and seeks to identify possible improvements to the rules where possible, especially in relation to improving the CMU. The Commission is seeking comments particularly from those affected by the practice of factoring, securitization, and collateralization. The consultation period closes on 30 June 2017.
MiFID II and MiFIR
On 6 April, ESMA published a final report for the guidelines on the calibration of circuit breakers and publication of trading halts under MiFID II. As the release explains, these “guidelines are addressed to trading venues that allow or enable algorithmic trading on their systems and to national authorities,” and provide guidance relating to: (i) the parameters that trading venues should consider when calibrating mechanisms to manage volatility, such as circuit breakers; (ii) the disclosure trading venues must make when triggering the mechanisms to manage volatility on a specific trading venue; and (iii) the procedure and format for national authorities to report trading halt parameters to ESMA. National authorities subject to the guidelines must notify ESMA whether they intend to comply with the guidelines within two months of the date of the publication of the guidelines in all EU languages.
On 6 April, the European Commission published for consultation a draft Delegated Regulation under MiFIR (EU/600/2014) extending the exemption from pre- and post-trade transparency requirements for transactions for which (i) the counterparty is a member of the European System of Central Banks and (ii) the transaction is for the performance of monetary, foreign exchange, and financial stability policies. The consultation period closes on 4 May 2017.
On 5 April, ESMA published several updated Q&As with regarding to MiFID II and MiFIR, including: (i) Q&As on MiFID II and MiFIR market structure; (ii) Q&As on MiFID II and MiFIR commodity derivatives; and (iii) Q&As on MiFID II and MiFIR transparency.
On 26 April, the European Parliament did not object to the adoption of aDelegated Regulation (C(2017) 1658) under EMIR (648/2012/EU). The Regulation extends the date of application of the clearing obligation for counterparties in “Category 3” from 21 June 2017 and 9 February 2018 (depending on the type of transaction) to 21 June 2019. The Council of the EU has also indicated that it does not object to the adoption and the Delegated Act will now enter into force once it is published in the Official Journal.
On 21 April, the European Systemic Risk Board (ESRB) published a report on a revision of EMIR. The ESRB indicated that no fundamental changes to the EMIR core requirements are necessary at present, but identified certain aspects of EMIR that could be improved regarding: (i) clearing obligations and trading reporting, such as “introducing a mechanism to suspend the clearing obligation,” the scope of the central clearing obligation, and increasing the maximum thresholds for fine which can be imposed on trade repositories; (ii) “enhancing procyclicality-limiting tools,” such as establishing binding guidance on limits to the procyclicality of margins; and (iii) other general issues, such as “systemic risks for mandatory clearing purposes by ESMA,” “consistency with internationally agreed regulations or standards,” and “previous ESRB proposals on CCPs.”
regarding CCPs under EMIR, with the Reserve Bank and the Financial Markets Authority of New Zealand.
On 5 April, the European Parliament adopted at the first reading the proposed Prospectus Regulation (COM(2015)0583). As part of the Capital Markets Union initiative, the proposed Regulation will establish uniform rules on the information provided in investor prospectuses aimed at assisting investors in making an informed assessment of assets, liabilities, profits, losses, and rights attached to investment products. The proposed Regulation now passes to the Council of the EU for voting.
On 5 April, the European Parliament decided not to object to the European Commission’s revised Delegated Regulation of 8 March 2017 supplementing the PRIIPs Regulation (1286/2014/EU). The Delegated Regulation sets out regulatory technical standards regarding the presentation, content, review, and revision of key information documents and the conditions for fulfilling the requirements to provide such documents under the PRIIPs Regulation.
CRA Regulation: Small CRAs
On 6 April, ESMA issued a supervisory briefing to clarify certain aspects of requirements under the Credit Rating Agency Regulation (1060/2009/EC) (CRA Regulation) that requires issuers or related third parties to consider appointing a smaller CRA when appointing two or more CRAs for the rating of an issuance or entity and to assist nationally appointed Sectorial Competent Authorities in their supervision and enforcement of such requirements. Specifically, the briefing: (i) clearly establishes “who should be prioritized for supervision and enforcement under these circumstances;” (ii) clarifies the status of issuers and related third parties under these circumstances; and (iii) provides a standardized form for documenting an issuer or related third party’s decision not to appoint a smaller CRA under these circumstances.
MAR Regulation: Accepted Market Practices on Liquidity Contracts
On 25 April, ESMA published an opinion on points for convergence regarding accepted market practices on liquidity contracts under the Market Abuse Regulation (596/2014/EU) (MAR). The agreed points include: (i) the scope of covered financial instruments; (ii) format of the contracts; (iii) performance of the contracts; (iv) “the need to take into account the liquidity of instruments covered” by the accepted market practices; (v) trading conditions; and (vi) “limits to the resources to be allocated to the performance of the contracts.” These points are expected to be used as a reference in the assessment of the MAR accepted market practices on liquidity contracts that national authorities may submit to ESMA after a domestic consultation and on which ESMA will have to issue an opinion.
On 5 April, ESMA published an opinion on the European Commission’s proposalfor a Regulation on CCP Recovery and Resolution. The Commission’s proposal gives national authorities supervision and early intervention powers over CCPs under their jurisdiction in relation to CCP recovery and asks member states to designate National Resolution Authorities (NRAs) to develop CCP resolution plans. ESMA’s opinion proposes to: (i) introduce additional requirements regarding NRAs’ recovery plans in order to ensure a higher level of convergence, while providing the necessary flexibility to CCPs to select those recovery tools which best fit their business situations; (ii) consider a more effective mediation mechanism and lower the 2/3 majority needed to activate a mediation process; and (iii) consider the implications of ESMA’s involvement with the recovery and resolution processes with respect to ESMA budget, such as allowing ESMA to provide a budgetary impact assessment.
On 10 April, ESMA published an opinion on portfolio margining requirements for CCPs under EMIR. ESMA’s opinion clarifies when two contracts can or cannot be considered as the same instrument for the purposes of portfolio margining. The opinion also states that CCPs must limit the reduction in margin requirements when portfolio margining for different instruments.
Shareholder Rights Directive
On 5 April, ESMA published a report containing the results of a recent study on shareholder identification and transmission of information between issuers and shareholders under the Revised Shareholder Rights Directive (2007/36/EC) (SRD II). The report’s findings and recommendations focused on the harmonization of: (i) processes for shareholder identification; (ii) processes for shareholder communication; and (iii) the format and tools used to communicate shareholder information. ESMA indicated that it has also submitted the report to the European Commission to provide input on the Commission’s preparation of the implementing acts to specify minimum requirements on the process, format, and timeline for shareholder identification and transmission of information under SRD II. SRD II is expected to be published in the Official Journal in June 2017.
FINTECH AND MARKET REGULATION
FinTech and the Influence of Technology Report
On 25 April, the ECON voted to adopt a report on FinTech and technology’s influence on the future of the EU financial sector. The report urges the Commission to establish a set of rules that would develop a comprehensive FinTech Action Plan in the framework of the CMU and Digital Single Market regarding: (i) cybersecurity and data protection; (ii) easing access for new entrants and preventing regulatory arbitrage among member states; (iii) interoperability and passporting among member states; and (iv) creating room for controlled innovation and fostering financial education and IT skills. The European Parliament is scheduled to vote on the report on 16 May 2017.