Including updates on EMIR, banking restructuring and short selling


EMIR moves forward

A significant hurdle has been cleared in the negotiation of ‘level 1’ text on the Regulation on OTC derivatives, central counterparties and trade repositories (dubbed ‘EMIR’). On 24 January, the EU Council adjusted its position on key areas to ‘facilitate rapid agreement’ with the European Parliament and ensure the regulation to be adopted in first reading.

The main change relates to authorising of central counterparties (CCPs), in particular the powers of the CCP’s ‘home’ member State versus those of the college of supervisors and ESMA. The Council wanted to give the majority of power to the ‘home’ member State; Parliament was pushing for a stronger role for the college of supervisors and ESMA.

In an attempt to bridge the gap, the Council has introduced two additional safeguards, whereby:
  • following a negative opinion of the college, with ‘unanimity minus one’, the ‘home’ member state can refer the matter to ESMA for binding mediation
  • when a ‘sufficient’ majority (two-thirds of college members) in the college opposes authorisation of a CCP, this "sufficient majority" may then decide to put the issue to ESMA for binding mediation.
Negotiations between the Council and the European Parliament on EMIR have made significant strides in recent weeks--spurred on by impending international deadlines to implement OTC derivative reforms. We now expect final political agreement on the text to be made soon. After which, ESMA will begin drafting over 50 detailed technical standards and guidelines by 30 June 2012. Firms affected need to carefully examine these documents, as they could bring far-reaching changes to their businesses. Even an extension, mooted by some, to 30 September 2012, will still make it difficult for firms to adequately digest these proposals, and build systems and controls to react to these changes.


Restructuring European banks

Two weeks ago, we wrote about the establishment of a high level working group by the European Commission to investigate the structural aspects of the EU banking sector, a report from which is expected this summer.

However bank restructuring is not necessarily a medium term project. Decisions about the future structure of the Union’s banking system are already being taken in the corridors of the European Commission-- largely driven by competition policy and State-aid rules.

Since the crisis, the Commission has approved national schemes in 20 EU countries totalling around €1.6 trillion. Around three quarters of rescue packages constitute guarantees with the rest through public capital injections.

The Commission is keen that State support doesn’t distort the market and increase moral hazard. Therefore, under special crisis rules for State-aid to banks introduced at the end of 2008, the Commission has required 39 banks to restructure their businesses with 24 further cases currently under review.

As part of these plans, some banks have been required to move away from unsustainable business models (i.e. Northern Rock) which are based on excessive leverage and an over-reliance on short-term wholesale funding. Other banks have been requested to downsize their operations (i.e. ING and Commerzbank). In some cases restructuring has been more fundamental and changes the entire banking system. State-aid in Spain is being used not only to rescue individual banks, but also to help restructure the savings bank sector – or Cajas – transforming them into stronger, and more sustainable, banking entities.

Any bank which turns to the State for assistance in 2012 will have to submit detailed restructuring plans to the Commission. However, not all banks will have to radically restructure. The Commission will give a proportionate assessment on a case-by-case basis.

On 24 January, Joaquín Almunia, Vice President of the European Commission responsible for Competition Policy, gave an overview of some of the criteria the Commission will be looking for when making its assessment:
  • whether a bank is short of capital essentially because of a loss in confidence due to the sovereign debt crisis or for other reasons
  • whether the public capital put into the bank is limited to the amount necessary to reach the temporary capital ratio of 9% set by EBA after marking to market of sovereign bonds
  • whether the bank is otherwise viable and has not taken excessive risk in acquiring sovereign debt.
If there are positive answers to questions like these, the Commission will ‘not require further divestments and balance-sheet reductions’, according to Almunia. In such cases, a package of behavioural constraints may be required instead. However, if its assessment reveals that a bank needs to radically change its business model, the Commission will continue to request ‘a fully fledged restructuring’ process.

The current patchwork framework on state-aid rules for the banking system will not remain in place in the longer term. The Commission will keep the situation in the financial markets under check and will take steps towards more permanent rules for state aid used for rescue and restructuring of banks, as soon as market conditions permit. This raises questions about how closely the Competition Commissioner’s redefined rules will dovetail with the still pending proposals from the Internal Market and Services Commissioner on crisis management and bank resolution. It also means EU banks would be well advised to address any capital shortfalls now.


ESMA publishes technical standards on short selling of CDSs

On 24 January, ESMA launched a consultation on draft technical standards on the EU regulation on short selling and certain aspects of credit default swaps (CDS), following the adoption, late last year, of the Regulation which will apply from 1 November 2012. In spite of the importance of this consultation, firms were given just three weeks to respond (13 February 2012), given the pressure on ESMA to deliver its guidance in good time for adoption by the Commission in June this year.

The areas of the Regulation which the technical standards address can be categorised under three headings: transparency, uncovered short sales and exemptions from disclosure of significant net short positions in shares.

In terms of transparency, the Regulation states that short positions in shares should be notified to the regulator at the threshold of 0.2% (of the issued share capital) and disclosed to the market at the threshold of 0.5%. All short sale orders in shares on trading venues should also be flagged as 'short' by persons executing orders and the trading venue should publish on a daily basis a summary of the volume of orders marked as short orders.

The consultation paper sets out technical standards specifying:
  • the information on net short positions to be notified to competent authorities and disclosed to the public.
  • the means by which such information may be disclosed to the public.
  • details of the information to be provided to ESMA by competent authorities in a summary form on a quarterly basis on net short positions in shares and sovereign debt and the additional information which ESMA may request at any time from competent authorities.
  • the format of information to be provided to ESMA by competent authorities.
On uncovered short sales, the Regulation stipulates that, in order to enter a short-sale, an investor should have borrowed the instruments concerned, entered into an agreement to borrow them, or have an arrangement with a third party who has located and reserved them so that that they are delivered by the settlement date. This is known as a 'locate rule'.

To mitigate settlement failures, trading venues should also ensure that there are adequate arrangements in place to buy in shares or sovereign debt when a settlement fails, as well as for fines and a prohibition on short-selling for late settlement.

The consultation outlines that agreements or enforceable claims should meet a number of criteria, including:
  • ensure the amount of shares or sovereign debt subject to the short sale will be made available to the investor (a natural or legal person) for the settlement of that short sale.
  • be legally binding for at least the duration of the contract.
  • cover at least the exact quantity to be sold short by the investor.
Under the regulation, there is no requirement to disclose significant net short positions in shares whose principal trading venue is outside the EU. Market making activities are also exempt (because of their beneficial impact on liquidity). Moreover, primary market operations should also be exempt as they are considered legitimate functions that are important for the proper functioning of primary markets.

The consultation paper sets out technical standards in relation to exemptions specifying:
  • methods for calculating turnover to determine the principal venue for the trading of a share
  • date on which, and period in respect of which, any calculation determining the principal trading venue is to be made
  • date by which the relevant competent authority shall notify ESMA of those shares for which the principal trading venue is outside the EU
  • date from which the list of exempted shares is to be effective following publication by ESMA.
ESMA will consider the feedback from this consultation in February/March and expects to publish a final report and to submit the draft technical standards to the European Commission by 31 March 2012 for endorsement.

The short-selling and CDS regulation will apply in less than 9 months; firms need to now escalate their change strategies to ensure they are ready when the Regulation goes live. ESMA, and national supervisors, will be carefully monitoring compliance with the Regulation; firms should take note.


EIOPA publishes 2012 work programme

EIOPA’s 2012 work programme sets out its plans to expand its role as a European Supervisory Authority alongside the European Banking Authority (EBA) and European Securities and Markets Authority (ESMA).

Developing Solvency II implementing measures remains a key policy priority for EIOPA in the coming year. In 2012, EIOPA plans to deliver regulatory and implementing technical standards as well as guidelines to complement the regulations to be issued by the European Commission in terms of ‘Level 2’. The proposed timing of this work is as follows:
  • Pre-consultation process – Prior to the public consultation Timing?
  • Public consultation process – May/June 2012
  • Final delivery of standards and guidelines – September 2012
The final scope and scheduling of EIOPA’s work depend on the timing of a final decision on the Omnibus II Directive and the subsequent approval of the final Delegated Acts implementing Directive 2009/138/EC (Solvency II). It remains to be seen how the delays to Omnibus II may impact EIOPA’s planned timetable. Indications are now that Omnibus II will not be adopted until the end of this year. Gabriel Bernardino, EIOPA Chair, wrote to Michel Barnier, EU Commissioner for Internal Markets and Services, on 31 January 2012 clearly expressing concerns that further delays in finalising changes to the Directive through adoption of Omnibus II threaten the quality of the EIOPA’s work in that preparation time will be dramatically squeezed if the proposed application date of 1 January 2014 is maintained.

From the end of 2012, EIOPA plans to collect data from national supervisors based on the Solvency II reporting requirements, further develop its analytical strength and coordinate more closely the work between national supervisors in preparing for the day-to-day supervision under the new regulation. EIOPA is also planning systems to exchange Solvency II data with European Systemic Risk Board from 2013.

Other policy areas where EIOPA envisages undertaking work in 2012 include further input on changes to the IORP Directive, and the establishment of a harmonised, if not identical approach, to the European pensions sector. It will also look at further harmonisation of consumer protection between countries and across sectors which should lay the groundwork for further work on amendments to the Insurance Mediation Directive in 2013.