FTT battle lines being hardened
On 23 May 2012, the European Parliament (EP) plenary session voted by 487 to 152 to adopt a resolution supporting the controversial proposal for a Financial Transaction Tax (FTT) Directive. The proposed FTT Directive, presented by the European Commission (EC) in September 2011, seeks to apply a tax from 1 January 2014 to all transactions in financial instruments if one of the parties involved is established in the EU. The vote in the EP, the only institution within the EU directly elected by EU citizens, mirrors the recent Eurobarometer survey, which showed 66% of European citizens support the implementation of the FTT. Although the EP’s resolution will not determine the outcome on the FTT, it is likely to influence the debates in Council of Economic Finance Ministers (Council).
The EP’s adopted text differs from that proposed by the EC in that it will capture a larger number of firms. The EP added an ‘issuance principle’, so that firms located outside the EU would be subject to the FTT if they trade securities that were originally issued in the EU. The EP also linked paying the FTT to legal ownership of securities, meaning institutions would only own a security once the FTT was paid. The only winners in the deliberations were pension funds, who the EP would exempt from paying the FTT.
Now the Council will have to determine the fate of the FTT. The Council has exclusive legislative power over taxation issues in the EU and any legislation requires its unanimous approval for EU-wide implementation. Getting unanimous approval looks unlikely at this stage, with David Cameron, the British Prime Minister, who has vigorously opposed the FTT. Cameron appears willing to use Britain’s veto to block the FTT, which may alienate the new French President Francois Hollande, who has voiced strong support for the proposal.
However, Council may yet strike a compromise. Wolfgang Schäuble, the German Finance Minister, who suggested that Europe could adopt a tax similar to the UK’s stamp duty tax. Alternatively, if the FTT is rejected in the Council, selected countries could still decide to implement the FTT under the enhanced cooperation procedure, allowed for by the Lisbon Treaty. The enhanced cooperation procedure allows at least nine EU Member States to agree to proceed with a proposal even if all Member States don’t agree to implement it. That approach is unlikely to be optimal, potentially resulting in confusion over where the obligation to pay FTT applies as well as being administratively challenging for both EU and non-EU institutions.
EC officially delays Solvency II
On 16 May 2012, the EC proposed a further delay to the implementation date of Solvency II. Currently EU Member States would be required to transpose Solvency II by 31 October 2012, unless legislative action is taken. The EC has proposed a new Directive that would move the transposition date to 30 June 2013 and change the date that Solvency II will apply to firms to 1 January 2014. It would also postpone the repeal of the Solvency I regime until 1 January 2014.
EC puts focus on consumer agenda
The EC published a communication looking at the European consumer agenda on 22 May 2012, underlining that realising the consumer agenda is a key contributor to meeting the Europe 2020 objective for growth.
The communication provides a broad-based, cross industry overview of the consumer agenda. However the EC is keen to highlight how the financial services industry can continue to drive the Single Market forwards to growth. The EU believes that improving consumer confidence in banks and overcoming the sovereign debt crisis would make consumers more willing to spend, which will increase growth. The EC thinks that the best way to achieve this will be through further convergence of regulatory regimes.
The EU has focussed much more on the needs of since the financial crisis. In the financial sector, the EU has initiatives already underway on deposit guarantee and investor compensation schemes (although legislative negotiations are not progressing well). Proposals for common rules on residential property are advancing more quickly. UCITS IV, and the proposed revision of the Markets in Financial Instruments Directive, also reinforce investor protection through, amongst other things, enhanced disclosure. This ambitious consumer protection reform agenda will be capped by the EC’s ‘consumer package’ to be released in the coming weeks, including proposals for a regulation on Packaged Retail Investment Products (PRIPs), a revised Insurance Mediation Directive and further revisions to the UCITS regime (UCITS V) to address the problems experienced in Europe through the Madoff scandal.
The legislative reform agenda is supplemented by increased attention on improving financial literacy with a view to putting consumers in a better position, over time, to protect their own interests. Will we face ongoing recalibration of all these consumer protection regimes as financial literacy improves? Possibly, but the EC at this stage at this does not seem to be thinking that far ahead.
IOSCO reviews integrity and conflicts management in CRAs
The International Organisation of Securities Commissions (IOSCO) published a consultation report on 25 May 2012 looking at the controls and procedures established by credit rating agencies (CRAs) to promote the quality and integrity of their credit rating process and to manage conflicts of interest.
IOSCO identified four steps CRAs follow when determining credit ratings, along with the internal controls they use to ensure quality and integrity within each step:
- Preparatory phase – where information is gathered about the issuer of the security being rated and the security itself. Some CRAs use internal policies to determine the type and quality of information they should gather for any particular credit rating. IOSCO asks for feedback now on the auditor-type processes that CRA’s have established to verify the information gathered and how these can be improved.
- Assessment phase – here the analyst applies the CRA’s models and methodologies to the information gathered. Several CRAs stated that it is the responsibility of the lead analyst and rating committee chair to select an appropriate model or methodology to use to determine a credit rating. CRAs will review credit ratings after the event to test whether the correct model or methodology was used in assigning a given credit rating. Such a role is often provided to the internal audit function to ensure appropriate oversight and review.
- Decision phase – where the rating committee considers the rating outcome of the assessment phase and settles on the final credit rating. Several different policies are used here by CRAs. CRAs stated that they seek to facilitate an open and frank discussion before voting on the credit rating takes place, allowing dissenting voices during this discussion. IOSCO has asked for more feedback on how CRAs actually allow these dissenting voices to be heard by others, to ensure a groupthink approach is not adopted.
- Dissemination phase – where the final credit rating is publicly announced. CRAs stated that they review any press release published with the credit rating, sometimes with the rating committee chair to ensure that there are no factual inaccuracies. Some CRAs provided this to the issuer for whom they are determining the credit rating before publication to allow them to proof-read and check for factual inaccuracies. If the issuer believes there are factual inaccuracies or material information not taken into account by the CRA then they can have the credit rating reviewed before it is published.
IOSCO noted many CRAs have established independent compliance functions to maintain the integrity of the credit rating process, and that the remuneration of the compliance function is not linked to the financial performance of the CRA to remove a conflict of interest from its role. However, IOSCO believed that smaller CRAs have not been so successful in establishing independent control or compliance functions due to their size. IOSCO has asked for feedback on what these smaller CRAs could be further doing to ensure appropriate oversight of credit ratings.
In looking at the processes to manage conflicts of interest within CRA, IOSCO noted most CRAs believe the best way to manage conflicts is through the reporting lines of employees. Another popular method used by CRAs is to separate the credit rating and analysis portion of the firm from the business element, requiring that no-one within the credit rating side is allowed to discuss commercial activities with issuers, to prevent this influencing the credit rating provided.
The consultation provides no new regulatory development for CRAs at this time. However IOSCO may use feedback from the consultation to inform future amendments to its code of conduct that CRAs follow. The consultation provides an in-depth and interesting insight into processes established by CRAs to protect the quality and integrity of the credit rating they issue and their management of conflicts of interest. Publication of this consultation at this time will also inform final negotiations on CRA3 in the EU. Trilogue negotiations on CRA3 between the Council, the EP and the EC are due to start shortly with a view to early adoption of the revised regime.