Morrison & Foerster's latest update says there is little chance that the pace of regulatory reform will pick up much in 2014, especially with EP elections due for May. It gives a taste of what to expect in 2014 in the banking, securities, derivatives and structured products sectors.
EU Bank Structural Reform Proposals
The Commission’s legislative proposal may be published in early 2014, although with the European Parliament elections in May and the change of the Commission towards the end of 2014 it is possible that it may not be published until late in 2014 or even 2015. The UK, in particular, will need to consider the interaction of such proposals with those enacted nationally, such as the Financial Services (“Banking Reform”) Act 2013.
UK Financial Services (Banking Reform) Act 2013 (the “Banking Reform Act”)
The Banking Reform Act was enacted on 18 December 2013. It gives HM Treasury and the Prudential Regulation Authority powers to implement the principal recommendations made by the Independent Commission on Banking (“ICB”), or Vickers Commission, most notably those relating to ring-fencing retail banking services and holding additional primary loss-absorbing capacity (“PLAC”).
The government aims to implement all secondary legislation under the Act by 2015, and compliance with the ring-fencing requirements will be expected by 2019 at the latest.
European Implementation of Basel III
CRD IV, as a whole, will come into effect on 1 January 2014, although certain of its provisions will take effect at a later date or will be phased in only over a period of time. CRD IV contains specific mandates for the European Banking Authority (“EBA”) to develop binding technical standards, guidelines and recommendations (well over 100 of them) which will form part of the single European rulebook established by the CRD IV package. The EBA has already drafted a number of these technical standards and will continue to do so during the course of 2014. Market participants can also expect to see many more EBA consultation papers published in the next few months, and should be prepared to respond to these within a limited timeframe. More information on the progress with this work and consultations on the draft standards are available from the EBA. The EBA has also launched a Q&A tool to facilitate common understanding of provisions related to CRD IV.
Remuneration for Financial Institutions
Quite separately from its Basel III related provisions, CRD IV controversially introduces substantive restrictions on the executive compensation arrangements of banks and investment firms subject to CRD IV.
The EBA has published a final draft technical standard on the criteria to identify categories of staff whose professional activities have a material impact on an institution’s risk profile. The EBA intends to finalise the remaining draft technical standards on remuneration at the beginning of 2014 and submit them to the European Commission by 31 March, 2014.
UK Government Challenges Bonus Cap
In September 2013, the UK government lodged a legal challenge to the bonus cap contained in CRD IV with the European Court of Justice. The UK government is challenging the bonus cap on a number of grounds including that the legislation is not fit for the purpose of improving stability across the banking system, as the proposals will lead to an increase in fixed salaries. The challenge also covers the compatibility of the bonus cap provisions with the EU Treaty and the powers delegated to the EBA which powers, the government believes, “go well beyond its remit of setting technical standards”.
It is likely to take at least a year before the outcome of the UK government’s challenge is known. Notwithstanding its legal challenge, the UK government has confirmed that it will still be implementing the remuneration provisions of CRD IV as from 1 January, 2014.
EU Bank Recovery and Resolution Directive (“BRRD”)
The BRRD looks set to become law in the first half of 2014, with trialogue agreement reached, and a full vote of the European Parliament currently scheduled for 24 to 27 February 2014. The BRRD represents one strand of the EU’s approach to dealing with the too-big-to-fail issue in respect of systemically important banks and financial institutions, and it introduces a range of new regulatory powers.
At the time of writing, the final form of the BRRD is not available, though a 12 December press release from the European Parliament indicates that the BRRD will come into force on 1 January 2015 (except for the bail-in provisions, which will come into force on 1 January 2016). Of the liabilities subject to bail-in, shareholders and bondholders will be first in line to take losses and deposits not covered by a guarantee scheme would take losses last, after resolution funds and deposit guarantee funds had been applied.
European Single Resolution Mechanism (“SRM”)
Closely coupled with the BRRD is the European SRM. For those banks that are participating in the Single Supervisory Mechanism (i.e. all banks in the eurozone and in certain other participating member states – around 6,000 of them) whereby the European Central Bank is the single bank supervisory authority, the SRM further develops the “single rulebook” concept. It does this by adopting recovery and resolution mechanisms that essentially mirror those in the BRRD, and establishing a Single Resolution Board as the main resolution authority for all banks subject to the SSM.
Where a resolution procedure would affect both banks within and outside the scope of the SSM, then the BRRD will apply, with the SRB representing the national resolution authorities of the SSM–participating Member States.
A plenary vote of the European Parliament is currently planned for 10 to 13 March 2014 and following approval and publication in the Official Journal, the SRM is planned to come into force on 1 January 2015 (with the bail-in provisions coming into force on 1 January 2016), simultaneously with the BRRD.
On June 18, 2013, the Council of EU Ministers agreed the final drafts of the proposals and they will now be considered and finalised by the trialogue of the Council, European Commission and European Parliament. The aim is to agree the texts by early 2014 at the latest, to avoid the European Parliamentary elections.
EU Market Abuse Regime
Once MAD II is adopted, it is proposed that MAR will apply in all Member States from 24 months after its entry into force and that Member States will have the same time to implement CSMAD into national law. It is intended that the provisions will enter into force at the same times as the instruments implementing MiFID II, and ESMA is expected to play a key role in 2014 in preparing the regulatory technical standards that will set out the detail of how MAD II will be implemented in practice.
2014 will see the advent of EMIR’s reporting and clearing obligations. On the reporting side, Morrison & Foerster now understands that February 12, 2014 (the “Reporting Start Date”) is scheduled to be the date that the reporting of derivatives trades (under Article 9 of EMIR) becomes mandatory for all counterparties (this obligation does not apply to third-country entities).
In terms of the clearing obligation, a number of developments are predicted for the year ahead. Firstly, it is anticipated that the first CCPs will be authorised to clear particular classes of over the counter (“OTC”) derivatives by March 2014. Following such authorisation, ESMA will publish one or more consultation papers in order to present the classes of OTC derivatives which might be subject to the clearing obligation. During the consultation period (which may take up to six months) ESMA shall take into account each such class of derivative’s degree of standardisation (as regards its contractual terms and operational processes), volume, liquidity, and the availability of fair, reliable and generally accepted pricing information. It must then prepare Regulatory Technical Standards and submit them to the European Commission, who will have up to three months to conclude whether or not to endorse ESMA’s recommendations. Thereafter, the European Parliament and the Council of the European Union will have an opportunity to make any changes to the final rules. Once the final rules are published in the Official Journal, they will not come into force for a further 20 days thereafter.
Given the above, it seems very unlikely that we shall see a clearing obligation come into force until the latter stages of 2014 at the earliest. Such obligations are also likely to be subject to at least some degree of phase-in.
Regardless, however, derivative counterparties will still need to allow for the possibility of clearing (in the future) any relevant OTC derivatives traded after the date on which a CCP is first authorised to clear that particular class of OTC derivatives (the “Frontloading Date”). This is on the basis that any trades entered into from the Frontloading Date may eventually have to be centrally cleared, provided that they have a remaining maturity (measured from the date that the clearing obligation actually comes into force) over a certain threshold to be determined by the Commission.
Recovery and Resolution Plans for Non-Banks
2014 is expected to herald the publication of a European Commission legislative proposal for the recovery and resolution of financial institutions other than banks. Originally consulted upon by the Commission back in October 2012, the proposals are expected to address the potential risks to the economic system arising from the failure of one or more systemically important non-bank financial institutions.
At the present time, it is difficult to say with any certainty, which policy options will be employed. However, rather than applying a broad framework approach to all non-bank institutions, the Commission’s roadmap, provided in May 2013, suggests that specific tools will be developed in relation to each diverse sector (insurance, securities etc.). This is reflective of the fact that different non-bank entities are exposed to different types of risk. For CCPs, a number of suggestions have been proposed, including resolution powers (comprehensive powers of intervention in the management of the institution), reorganisation tools (e.g., transfer of operations to a healthy market player) and loss allocation and refinancing tools (application of haircuts to margin, liquidity calls, ex-ante insurance policies etc.). Hopefully 2014 will provide some much needed colour in respect of the Commission’s intended approach.
European Financial Transactions Tax
As a consequence of the conflicting issues and opinions, the outlook for the FTT in 2014 remains extremely uncertain. Some commentators have suggested recently that the FTT could be implemented in 2014, provided the FTT-11 agrees the terms of the directive. In contrast, others, including a spokesperson for the EU tax commissioner, Algirdas Ŝemeta, believe that this is unlikely. As representatives from the FTT-11 were due to meet again in mid-December and the German coalition parties have pledged swiftly to implement a broad tax covering financial instruments, the market awaits further news as regards whether any significant progress will be made in 2014.
The principal features of the proposed Directive and the issues likely to be of particular focus in the trialogue discussions are:
Purpose of the KID
Other product regulation proposals by the EU Parliament. The EU Parliament draft also includes a number of other proposals including a product approval process to be adopted by the manufacturer, new product intervention powers for regulators (even though the MiFID II draft contemplates equivalent powers), a risk management process to be adopted by the manufacturer to measure and monitor the product’s risk profile at any time and restrictions on the structure and methodology of the product’s payoff.
Interaction of the regular banking system with shadow banking
Securitisation and excess leverage
Regulation of securities lending and repos
Money market funds
Regulation of other shadow banking entities.
Work on all of these workstreams will continue into 2014 and beyond. The FSB is likely to continue to raise concerns in relation to differences in approaches in regulation between the EU and US and elsewhere, particularly if it believes this may lead to regulatory arbitrage. Of interest in 2014 will be progress on the EU’s proposed regulation on money market funds and the possibility of EU legislation to deal with issues relating to repos and securities lending raised by the FSB, particularly in relation to investment of cash collateral and rehypothecation.
The proposed “UCITS V” amendments to the existing UCITS directive (“UCITS IV”) continue to go through the EU legislative process and trialogue discussions between the EU Commission, Council and Parliament will seek to finalise these arrangements during 2014. The most significant outstanding issue is the extent of the proposed remuneration provisions, with the EU Parliament seeking to make these more consistent with the provisions in CRD IV and the AIFMD.
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