ECON holds MiFID II/MiFIR public hearing
The European Parliament’s Economic and Monetary Affairs Committee (ECON) held a public hearing on 5 December 2011 to discuss the key objectives of the draft directive and regulation published on 20 October 2011, which are designed to replace MiFID.
The hearing was lead by Marcus Ferber, the lead rapporteur for MiFID II, and attended by a panel of industry experts. Ferber also released a questionnaire in November to canvas industry opinion prior to commencement of EU legislative negotiations. Responses to the questionnaire are due by 13 January 2012.
Topics raised in the hearing included:
- High frequency trading: the discussion focussed on the distinction between market-makers which are liquidity providers and mere trend-followers and questioned whether the obligation to provide liquidity should apply across the board.
- OTF: views were mixed on whether separate regulation of OTFs is necessary. Trading captured by OTFs could be accommodated instead under systematic internalisation (SI) or as a subset of the MTFs classification.
- Product intervention: respondents expressed different views about when it is appropriate for supervisors to intervene, citing concerns about pre-offering intervention.
- Inducements: some felt a full ban was not beneficial as certain inducement arrangements can lower portfolio management costs.
- Independent advice: the panel commented that, if the ban of inducements is introduced, under certain circumstances advice should be categorised as “fee based advice” and not “independent advice”.
- Execution-only rules/complex products: criticism was raised of the proposed split between complex and non-complex UCITS, in particular that the distinction was not relevant or appropriate to retail trading in some national retail markets.
- OTC trading: panelists believed that a legally enforceable definition of OTC trading needs to be agreed.
- Position limits on commodity derivatives: the panel gave a mixed response, with some suggesting that derogation should exist for commodity firms placing hedge trades. Others noted that it would be unfair to allow only some market participants derogation for hedging.
The first ECON debate to discuss the MiFID II draft legislation is scheduled for 13 February 2012.
ESMA releases three guidelines on MiFID
While MiFID II is hogging most of the headlines, guidelines that support the existing MiFID regime are continuing to evolve and will likely to do so over the next few years. With the creation of ESMA, these ‘Level 3’ measures have more impact than their predecessors, as the Regulations creating the ESAs specifically requires them to support supervisory convergence through the development of guidelines in relation to existing legislation. National regulators are obliged to comply with the guidance or explain publicly why they are unable to do so (‘comply or explain’).
On 22 December 2011, ESMA released its final guidance on systems and controls for automated trading environments, following a broad consultation earlier in the year. It also launched two new consultations on guidelines relating to suitability requirements for investment advice and on compliance function responsibilities in investment firms with respect to MiFID. ESMA’s guidelines on systems and controls in automated trading environments create a comprehensive regime for the operation of electronic trading systems by trading venues and brokers. They will apply to automated trading of all financial instruments covered under MiFID. These guidelines address three areas:
- regulated markets and multilateral trading facilities (MTF) that operate electronic trading systems
- investment firms using electronic trading systems, including trading algorithms, to deal on their own accounts or execute orders for clients and
- investment firms providing direct market access or sponsored access to clients as part of their order execution service.
ESMA previously published a consultation paper in July 2011, and held an open hearing in September 2011. The final guidelines contain few changes from the consultation proposals, although ESMA has clarified some areas including that the guidelines apply to trading any MiFID financial instrument traded in an automated environment, not just equity instruments. The guidelines will become effective one month after publication by national regulators on their websites, although ESMA expects market participants to comply from 1 May 2012.
In terms of the new consultations, ESMA believes that recent evidence and supervisory experience suggests that firms are not complying consistently with MiFID suitability requirements across the EEA, citing information gathering, assessment of client information, risk profiling, and record keeping practices as weak areas. Therefore, to address these weaknesses, the draft guidelines consider the following areas:
- information to clients about the suitability assessment
- arrangements necessary to understand clients and investments
- qualifications of investment firm staff
- extent of information to be collected from clients
- reliability of client information
- updating client information
- client information for legal entities or groups
- arrangements necessary to ensure the suitability of an investment and
- record keeping.
In terms of the consultation paper looking at compliance functions, ESMA states that the financial crisis highlighted the need for investment firms to provide better and tighter monitoring and risk management, including managing reputational risk, and to have a more comprehensive and proactive compliance strategy. Therefore, the guidelines seek to “enhance clarity and foster convergence in the implementation of the MiFID organisational requirements relating to certain aspects of the compliance function”. The consultation contains:
- draft guidelines for firms on compliance monitoring, reporting and advising
- draft guidelines for firms on the organisational requirements of the compliance function (standards of effectiveness, permanence and independence, and the interaction between compliance and other risk functions) and
- proposed approaches for competent authorities reviewing compliance functions.
Both consultations close for comments on 24 February 2012. ESMA expects to publish its final guidelines on suitability and compliance in Q2 2012.
European Parliament releases CRD IV draft report
The all-encompassing Credit Requirements Directive (IV) and the related Regulation (together CRD IV) continue their progress through the EU legislative process. On 22 December, ECON published its draft report on the Regulation.
Lead rapporteur, Othmar Karas’ annexed explanatory statement outlines his views on, and explains his proposed amendments to, some of the important parts of the CRD IV Regulation, namely:
- Definition of capital: Member States must avoid any deviation or ‘front running regulations’ impacting or weakening the principle of maximum harmonisation of Pillar 1 of Basel II (as amended by Basel III).
- Liquidity standards: stakeholders need to co-operate with competent authorities and provide them with the ‘necessary data so that essential elements such as the eligibility of assets and run-off rates can be assessed and the ratios finally set’.
- Leverage ratio: Karas believes that this is ‘a useful, simple and hard to manipulate backstop against the building of excessive leverage and excessive risk’. He suggests that the leverage ratio should ‘serve as a backstop mechanism under Pillar II and not be disclosed before a final decision on its introduction has been taken’.
- Credit value adjustment (CVA). Given that the Basel Committee on Banking Supervision (BCBS) is work on the methodological and technical issues regarding CVA, Karas believes an observation period should be brought-in until BCBS has finished its work.
- Management and capitalisation of counterparty credit risk: Karas is concerned about the alignment of the proposed requirements in this area with the Regulation on OTC derivatives, central counterparties and trade repositories (EMIR) (such as the default waterfall principle, the authorisation and recognition requirements for Central Counterparties). He states that CRD IV will have to be adjusted once EMIR is adopted.
2012 will be a very important year for CRD IV. The EBA, for its part, is planning to publish 76 regulatory technical standards, 32 implementing technical standards and 20 guidelines on CRD IV alone this year, according to their 2012 work programme which was released last week. We will endeavour to keep you abreast of the myriad of changes anticipated throughout the year, so you can lobby, plan and respond to the changing regulatory landscape.
EC releases Gender Directive guidelines
In March 2011 the European Court of Justice ruled that insurers could not use gender as a risk factor which results in different premiums and benefits for men and women, with effect from 21 December 2012.
On December 2011 the European Commission (EC) published its guidelines on the interpretation of this ruling, to facilitate compliance with the ruling at a national level. The guidelines clarify that the ruling applies only to new contracts concluded from 21 December 2012. However, the guidelines indicate that the concept of a new contract should be applied consistently throughout the EU - which is arguably in conflict with some Member States’ positions (e.g. the UK) that the usual principles of contract law in each Member State should apply. Under the EC’s guidelines the following are new contracts:
- contracts concluded for the first time as from 21 December 2012 and
- agreements between insurer and insured to extend contracts concluded before 21 December 2012 which would otherwise have expired.
However, the following do not give rise to new contracts:
- the automatic extension of a pre-existing contract, if no notice is given by a certain deadline, under the terms of that pre-existing contract
- the adjustments made to individual elements of an existing contract, such as premium changes, on the basis of predefined parameters, where the consent of the policy-holder is not required
- taking out, by the policyholder, of top-up or follow-on policies (e.g. an increase of the amount invested through a life insurance product) whose terms were pre-agreed in contracts concluded before 21 December 2012, provided the policyholder unilaterally decided to take out the policy and
- the transfer of an insurance portfolio from one insurer to another.
The guidelines also provide examples of gender-related insurance practices which are compatible with the principle of unisex premiums and benefits, and therefore will not be affected as a result of the ECJ's decision.
CRAs face enhanced supervisory oversight
The European Securities and Markets Authority (ESMA) has finalised four sets of regulatory technical standards (RTS) on credit rating agencies (CRA) disclosures to ESMA, for registration and ongoing supervisory purposes, in line with the CRA Regulation (Regulation 1060/2009). The finalised standards have been submitted to the EC for final approval, and assuming no concerns arise, the EC will then endorse the RTS through their adoption as delegated acts.
Each report sets out a summary of responses received by ESMA to its September 2011 consultation and describes any changes to the proposed RTS (which were not significant). It also includes clear and concise assessments of the costs and benefits of the choices ESMA has made.
The RTS cover four specific areas:
- the information to be provided by a CRA in applying for registration or certification and the associated assessment of its systemic importance
- the structure, format, method and period of reporting of CRAs to ESMA’s central repository (CEREP)
- the assessment of the CRA’s compliance with the requirements on credit rating methodologies and
- the content and format of ratings data to be provided as part of CRA periodic reporting.
The RTS seek to target specific inadequacies in the supervisory process which have come to light since the release of the initial CRA Regulation. On registration, national authorities and ESMA have been working from Guidance produced by ESMA’s predecessor the Committee of European Securities Regulators (CESR) in June 2010. This has now been formalised with the inclusion of some additional measures, such as fitness and appropriateness tests for senior management and other important personnel at CRAs. The RTS on periodic reporting builds on the CESR Guidance paper from August 2010 but sets out precise standards for the ratings data to be reported.
Users of credit ratings should review these new standards carefully, to evaluate how they will affect their businesses and whether or not they will achieve the intended results of ensuring that ratings in the future enhance stability in the financial markets.
The approach adopted by ESMA in adopting these four RTS may set a precedent for future supervision. Responsibility for the registration, certification and ongoing supervision of CRAs operating in the EU has been centralised in ESMA’s hands since 1 July 2011. ESMA is currently the only European Supervisory Authority (ESA) to have a direct supervisory role.
In addition to public consultation, it sought feedback from the European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA) and the ESMA Stakeholder Group before submitting finalised draft regulatory technical standards (RTS) to the EC.
In a separate development, ESMA announced that it was extending the transitional period for the use of non-EU credit ratings to 30 April 2012. This decision allows the continued use of credit ratings issued by non-EU CRA within the EU while the processes of convergence with the EU requirements and endorsement are completed.
ESRB update on risks facing the European financial system
At its December 2011 meeting, the ESRB provided an update on its views of the current EU financial situation and its recent activities. The ESRB reaffirmed the need for banks to strictly adhere to the EBA’s recapitalisation criteria agreed last year, to restore confidence to the fragile European financial system. The ESRB is continuing work on developing the basis for pan-European macro-prudential policy to deal with systemic risks, and is examining relevant EU legislative initiatives with a view to providing its macro-prudential perspectives on the establishment of the new regulatory framework. The ESRB also identified a number of risks to financial stability stemming from volatility in US dollar funding markets and called on banks to manage their funding strategies carefully in 2012.