Including updates on AIFMD, mortgage lending and benchmark reform


Get ready for AIFMD

Hedge fund managers and private equity funds will be subject to a pan-European regulatory regime from 22 July, as the Alternative Investment Fund Managers Directive (AIFMD) comes to life. Last month, regulators made the final touches to the Directive.

Two further AIFMD Implementing Regulations were published in the Official Journal:

The first Implementing Regulation establishes criteria to allow non-EU AIFMs to determine which country they should consider as their Member State of reference in a number of different situations.

The second Implementing Regulation sets out how Member States should authorise out-of-scope AIFMs that choose to opt-in to gain access to the AIFMD marketing passport. The procedure for authorising these AIFMs will be the same as for authorising in-scope AIFM. The Implementing Regulations came into force on 4 June 2013 and apply from 22 July 2013.

On 24 May, the European Securities and Markets Authority (ESMA) issued final guidelines on key concepts of the AIFMD. The guidelines clarify the definition of an ‘AIF’ under AIFMD, in particular what is meant by using the terms ‘collective investment undertaking’, ‘raising capital’, ‘number of investors’ and ‘defined investment policy’.

ESMA made a number of changes to its initial guidelines to reflect industry feedback. Additionally, ESMA clarified that if a Member State deems a vehicle located in that Member State is an AIF, then it is subject to full AIFMD requirements (including use of the marketing passport). This applies even if another Member State does not deem that type of vehicle as being within scope. ESMA also clarified that if one investment compartment of a fund vehicle (e.g. an umbrella fund or a protected cell company) is deemed to be within scope of AIFMD, then the whole fund is in scope.

On 24 May, ESMA published Consultation paper: guidelines on reporting obligations under Article 3 and Article 24 of the AIFMD on 24 May 2013. ESMA is also requesting feedback on the suggested reporting schema that institutions will use for to regulators under these Articles.

As expected, ESMA recommended that reporting obligations should be aligned with the calendar year, and not an AIFM’s individual accounting period. Whilst this approach will allow regulators to compare different AIFs and AIFMs, it does increase the reporting burden on some AIFMs by imposing different reporting periods to their usual financial reporting.

ESMA also recommends that AIFMs be authorised or registered at 23 July 2013 and thereafter should commence reporting under AIFMD from January 2014. So AIFMs will need to report for the first time to regulators by 31 January 2014 for the period 23 July 2013 – 31 December 2013.

Finally, on 30 May 2013, ESMA published an update on the cooperation agreements it has arranged under AIFMD with third countries. This latest update reflects ESMA has reached agreements now with over 30 non-EU countries, including with regulators in countries that are critical in the alternative fund universe.

Interestingly only the Federal Reserve and Securities Exchange Commission in the US have reached agreement with ESMA - no agreement is in place with Commodity Futures Trading Commission (CFTC) as yet. This gap may provide challenges in future for funds that are only registered with the CFTC, because they will be unable to market their funds in the EU. However, we do expect more agreements to be signed in the coming months, which hopefully will include the CFTC.


Is consensus holding up reforms?

Worried European Parliamentarians adopted a resolution on 13 June, calling into question Member States’ commitment to overhauling the financial system. The slow pace of regulatory reforms is breeding uncertainty which European Parliament (EP) believes is “holding up sustainable economic growth and job creation”—causing a sort of paralyses of decision making at financial institutions.

The EU Council (Council) is the biggest bottleneck, according to the resolution. On a number of issues, the EP had adopted its position or a mandate for negotiations a long time ago but those issues have not progressed in the Council - such as Deposit Guarantee Schemes, Investor Compensation Schemes and the review of the Markets in Financial Instruments Directive (MiFID II). On 21 June, Council finally agreed a proposed general approach for MiFID II after 18 months of negotiations. In particular, the EP blames the Council for holding up agreement on draft rules to guarantee deposits, which it sees as a key underpinning for the banking union proposals.

Rather than decide by consensus, the Council should “shoulder its political responsibility and vote its positions by a qualified majority”, the adopted text says. If Council moved from "intergovernmental mode" of negotiations aiming at consensus that would certainty speed-up the legislative process but it could lead to difficulties further down the line when national supervisors are asked to apply rules which they don’t believe are appropriate for their financial systems.

The Council came out strongly against the criticism levelled at it by the EP. Lucinda Creighton, Minister of State for European Affairs of Ireland, said that the Council is continuing to make significant progress in very complicated negotiations. She suggested that adoption of good legislation was a joint effort of all three institutions and often a matter of delicate compromise.

Parliamentarians would certainly agree with this assertion, they just want Council to move more swiftly. The EP also noted that the European Commission (Commission) is also the blame for some of the delays. The resolution calls on the Commission to table proposals that it said it would, such as the draft securities law directive which is already two years late.

With only 10 months to go before it is dissolved, this EP is likely to increase the heat on the Commission and Council as its elections draw ever closer. Having so many legislative texts currently being negotiated (or shortly to be proposed) significantly increases the risk that some key pieces of legislation may fail to get on the statute books in time. But the other side of the coin is that quick adoption could lead to future uncertainties, as suggested by the Council, through legal challenges to important elements of the legislation. The EP’s resolution is a clear sign of increasing frustration on their part but it is yet to be seen whether this message will provide the required encouragement to the Council and the Commission to keep up - or ideally increase - the pace.


Responsible mortgage lending

The European Banking Authority (EBA) published two Opinions on good practices for (i) responsible mortgage lending and (ii) for the treatment of borrowers in mortgage payment difficulties on 13 June 2013. Both Opinions are aimed at promoting common practice, with the ultimate view of enhancing consumer protection and contributing to the stability, integrity and effectiveness of the financial system across the EU.

While a mortgage is likely to be the greatest individual financial commitment of a borrower, it can also give rise to risks that can affect creditors as well as more generally, the stability of the financial system. The huge ramp-up of mortgage credit in Spain and Ireland during the 2000s stimulated a property bubble, the ultimate bursting of which forced both governments to seek outside support to fend off systemic consequences. Many consumers in these counties are now facing the reality of negative equity and banks are left with loan books which are heavily exposed to the declining property market. The Irish Central Bank recently announced that, despite ongoing work to deal with impairments and repair banks’ balance sheets, 12.3% of current stock of mortgages are in arrears –a huge ticking time bomb that could go off once interest rates start to creep up.

Against this backdrop, the EBA adopted the two Opinions on good practices to ensure that potential risks associated with mortgage lending and with borrowers in mortgage payment difficulties are managed adequately by credit institutions, and to contribute to the development of consistent practices in this area.

In particular, the Opinion on responsible mortgage lending sets out good practices on the following aspects:

  • verification of information provided by the mortgage applicant
  • reasonable debt service coverage
  • appropriate loan-to-value ratios
  • lending and supervisory processes.

The Opinion on the treatment of borrowers in mortgage payment difficulties, in turn, sets out good practices on the following aspects:

  • general principles
  • policies and procedures
  • provision of information and assistance to the borrower
  • resolution process.

The two Opinions complement the related provisions in the soon to be adopted EU Directive on Credit Agreements Relating to Residential Property.


EU benchmark guidelines are finalised

It’s been a year now since the LIBOR and Euribor scandals first broke. The scandals demonstrated the fragility of certain benchmarks in terms of both their integrity and the continuity of provision. Regulators are keen to bring the administration and setting of benchmarks inside their purview, starting with the most important, to close the loopholes that made the rate-setting process vulnerable to manipulation.

The UK government was the first out of the blocks with the Wheatley Review in September 2011 and a subsequent regulatory regime which came into force in April this year. Other regulators are now following suit with new rules in a manner which is “unprecedented” according to the International Organization of Securities Commissions (IOSCO).

In a pan-EU context, ESMA and EBA published their final Principles for Benchmark-Setting Processes in the EU on 6 June 2013.The Principles are designed to buttress the integrity of benchmark-setting process. Firms that “exercised judgement” in estimating the price at which they might have borrowed money in Europe’s opaque and illiquid inter-bank lending market during the crisis had incentives to manipulate submissions to protect the image of their own creditworthiness or improve their trading positions at various times.

To address that, IOSCO stipulates that, for a benchmark to be robust and credible, it should be based on actual data collected from diverse sources based on transactions executed in a well-regulated and transparent market, supported by appropriate governance and compliance procedures and monitoring.

The Principles provide a general framework for setting, submitting, administering and using benchmarks. They are broadly in line with the principles recommended in the Wheatley review, including:

  • Rate-setting: actual market transactions should be used as a basis for a benchmark where appropriate. The methodologies for the calculation of a benchmark should be documented and be subject to regular scrutiny and controls to verify their reliability.
  • Submission: banks should have in place internal policies covering the submission process, governance, systems, training, record keeping, compliance, internal controls, audit and disciplinary procedures, including complaints management and escalation processes.
  • Administration: the benchmark administrator should ensure the existence of robust methodologies for calculating the benchmark, appropriately oversee its operations and ensure that the market gets an appropriate level of transparency regarding the rules of the benchmark.
  • Calculating agents: the benchmark calculation agent should ensure a robust calculation of the benchmark and the existence of appropriate internal controls over the benchmark calculations it makes.
  • Users: benchmark users should regularly assess the benchmarks they use for financial products or transactions, and verify that the benchmark used is appropriate, suitable and relevant for the targeted market.
  • Continuity: benchmark administrators and users should put in place robust contingency provisions in case market liquidity dries up, insufficient transactions or quotes are available or the benchmark is otherwise unavailable. ESMA and EBA have added a new principles to their January consultation to ensure that contingency provisions are in place if the continuity of a benchmark is at risk.

ESMA and EBA will review the Principles after 18 months, but they both plan to carry out further work on possible transaction-based alternatives in the near future.