Regulation
The information on this page is intended to highlight some of the most significant regulatory changes facing the SWIFT community today, and to provide details of sources of further information.
As the pace of regulatory change continues to increase, SWIFT has been monitoring the most significant developments to ensure that we contribute to our customers’ ability to comply with key aspects of the new regulation being introduced. We do this by ensuring that industry efficiency is optimised and that industry standards are utilised as far as possible in relevant processes.
We are always ready to discuss the changing regulatory environment as well your regulatory compliance requirements, and how SWIFT could support you more fully in the area of regulation.
- Proposed new regulatory structures
- Proposals to increase the safety of the derivatives markets
- UCITS IV
- MiFID update
- Alternative Investments Directive for Fund Managers
- Updates to the Capital Requirements Directive
Proposed new regulatory structures
The global financial crisis has created a preoccupation with strengthening financial supervision, one manifestation of which has been a series of proposals for new regulatory structures. These proposals have emerged at the global level (through the G20 process), at the EU level and at the national level. The summary below covers the most significant developments and proposals.
At the global level, summits of the G20 group of the world’s leading economies have led to the creation of the Financial Stability Board (FSB), the successor to the Financial Stability Forum. The FSB has a mission to “address vulnerabilities and to develop and implement strong regulatory, supervisory and other policies in the interest of financial stability”.
The FSB is made up of senior representatives of national financial authorities (central banks, regulatory and supervisory authorities and ministries of finance), international financial institutions, standard setting bodies, and committees of central bank experts.
As obligations of membership, members of the FSB commit to pursue the maintenance of financial stability, maintain the openness and transparency of the financial sector, implement international financial standards, and agree to undergo periodic peer reviews, using among other evidence IMF/World Bank public Financial Sector Assessment Program reports.
In the EU, there is a belief that the crisis has highlighted weaknesses in the EU's supervisory framework, which remains fragmented along national lines despite ongoing efforts to create a European single market. EU financial measures such as the Markets in Financial Instruments Directive (MiFID) have led to increased cross-border regulatory co-operation within the EU, but this appears not to have been sufficient in light of experiences during the financial crisis.
The European Commission has therefore proposed legislation to address perceived weaknesses. The legislation picks up on a series of measures proposed by the De Larosiere committee which reported in early 2009. The measures include creating a new European Systemic Risk Board (ESRB) to detect risks to the financial system as a whole. The ESRB has the ability to issue early warnings of systemic risks that may be building up, along with recommendations for actions to deal with them rapidly.
The heads of the ECB, national central banks, the new European Supervisory Authorities (see below) and national supervisors will participate in the ESRB. The creation of the ESRB is, says the Commission, in line with other initiatives at global level, including the creation of the FSB by the G20 (see above).
Also suggested by De Larosiere, and taken up in the proposed Commission legislation, are plans for a European System of Financial Supervisors (ESFS), composed of national supervisors and three new European Supervisory Authorities: the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA), and the European Securities and Markets Authority (ESMA).
The new authorities will:
- Develop proposals for technical standards, respecting better regulation principles
- Resolve cases of disagreement between national supervisors, where legislation requires them to co-operate or to agree
- Contribute to ensuring consistent application of technical community rules (including through peer reviews).
In the US market, legislation is now in place (the Dodd-Frank financial reform bill) to set up a Financial Stability Oversight Council to identify and neutralise systemic risks, and to give the government and the Federal Reserve extensive powers over financial institutions, both US domestic and international.
Under the legislation, the Fed would require systemically significant companies – including foreign groups that own a large or risky US subsidiary – to abide by “heightened prudential standards”. These include leverage limits, liquidity rules and the drafting of a resolution plan, or “living will”.
Companies would be placed in the new category if the council deemed that “material financial distress at the company could pose a threat to financial stability or the economy”.
The new law allows the Fed to require any systemically significant company to “sell or otherwise transfer assets or off-balance sheet items to unaffiliated firms, to terminate one or more activities, or to impose conditions on the manner in which the identified financial holding company conducts one or more activities”.
If this measure is not enough to save a systemically significant company, the government could seize the firm and then force rival banks to repay any taxpayer money used to do so. US regulatory authorities have now begun the process of detailed rulemaking to make the terms of the Dodd-Frank bill a reality.
For more information on the FSB, visit http://www.financialstabilityboard.org/
For more information on the ESRB, visit http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/09/405
For more information on the Federal Reserve visit http://www.federalreserve.gov/
Proposals to increase the safety of the derivatives markets
In the wake of the financial crisis, improving the safety of the derivatives markets has become a top priority, with both the European Commission and the G20 setting their sights on implementing changes to reduce market and counterparty risk, increase transparency and improve market integrity and oversight.
In October 2009, the European Commission published a communication outlining measures to ensure “safe and sound’ derivatives markets, and detailed legislative measures in this area are now part of the EU autumn 2010 legislative agenda. To avoid any risk of regulatory arbitrage, EU proposals are intended to be in line with the statement made by the G20 following its Pittsburgh summit, in which it promised to advance tough new financial market regulations, including taking steps to make the opaque over-the-counter (OTC) derivatives market far more transparent.
The Commission’s policy actions are designed to:
- Reduce operational risk by promoting standardisation of the legal terms of derivatives contracts and of contract processing
- Reduce counterparty risk by mandating central counterparty (CCP) clearing for standardised derivatives contracts, establishing common safety, regulatory and operational standards for CCPs, improving collateralisation of bilaterally-cleared contracts, and substantially raising capital charges for bilaterally-cleared as compared with CCP-cleared transactions
- Increase transparency by mandating market participants to record positions and all transactions not cleared by a CCP in trade repositories, regulating and supervising trade repositories, mandating trading of standardised derivatives on exchanges and other organised trading venues, and increase transparency of trading as part of the review of the Markets in Financial Instruments Directive (MiFID) for all derivatives markets including for commodity derivatives
- Enhance market integrity and oversight by clarifying and extending the scope of market manipulation as set out in the Market Abuse Directive (MAD) to derivatives and by giving regulators the possibility to set position limits.
During 2010 SWIFT is focusing on the standardisation of messaging in the clearing space and we believe this initiative will help our customers to more easily interact with CCPs. SWIFT is also keen to see that industry standard messages are used for communication into and out of trade data repositories. There is also regulatory interest in the increased use of electronic trade confirmation in the derivatives space, and it would certainly seem that an increased use of such processes would be beneficial across asset class.
For more information on proposals to increase the safety of the derivatives markets, see:http://ec.europa.eu/internal_market/financial-markets/derivatives/index_en.htm and http://www.g20.org/index.aspx
For more information on SWIFT’s Derivatives solution
For more information on SWIFT’s offering for clearing and CCPs
UCITS IV
On 13 January 2009, the European Parliament approved a reform of the Council Directive 85/611/ECC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (the UCITS Directive).
This new Directive is referred to as UCITS IV and repeals all other UCITS Directives.
The UCITS IV Directive is designed to make the UCITS market more efficient, especially in regard to the cross-border activities of management companies.
Member states have until July 2011 to implement UCITS IV into national law together with its implementing measures.
The main changes in UCITS IV are:
- The introduction of a “management company passport” allowing funds authorised in one Member State to be managed remotely by a management company established in another Member State and authorised by that Member State's financial supervisory authorities
- The simplification of the procedures for cross-border distribution, easing the process of registration and enabling the cross-border marketing of units of UCITS to start more quickly
- The creation of a framework for the domestic and cross-border mergers of UCITS, allowing consolidation of UCITS
- The introduction of master-feeder structures to facilitate (mostly tax-driven) asset-pooling, enabling UCITS to have increased economies of scale and lower operational costs, and making the framework more attractive for creating funds for institutional investors
- The replacement of the simplified prospectus with a key investor information document designed to present comprehensible information similar for the UCITS of each member state
Expected impacts of UCITS IV include:
- A decrease in the number of management companies, as a result of the introduction of the management company passport
- A wave of fund mergers to eliminate funds of sub-optimal size and high costs to investors
- Cost savings, easier access to markets and increased competitiveness
For more information on UCITS IV visit http://ec.europa.eu/internal_market/investment/ucits_directive_en.htm
For more information on SWIFT’s solutions to standardise and automate cross-border funds distribution
MiFID review
The European Commission has begun a review of the Markets in Financial Instruments Directive (MiFID), which came into force on 1 November 2007. The review will be comprehensive and seek to rectify the unintended consequences of MiFID that have come into play since its introduction. It will also look at bringing the OTC derivatives world fully under MiFID.
In a speech in September 2009, Charlie McCreevy, European Commissioner for Internal Market and Services, said while MiFID had stimulated greater competition in some areas, the move of trading to unregulated “dark pools” has raised questions as to whether there are unfair commercial advantages for the operators of these venues – and whether the trend undermines price discovery, market integrity and efficiency for the market as whole.
The Committee of European Securities Regulators (CESR) has also suggested the need for further regulation to address some of the unintended consequences of MiFID. In a 2009 report into the impact of MiFID on the functioning of equity secondary markets, CESR says the Directive has created challenges in the area of pre- and post-trade transparency, liquidity and data fragmentation, with a need for better quality post-trade data and a consolidated market data set.
CESR is preparing advice for the Commission during autumn 2010 on MiFID's impact on the over-the-counter marketsincluding moving to increase the standardisation of OTC derivatives contracts so that the majority of them can be exchange traded.
To download the CESR report, visit http://www.cesr.eu/index.php?page=document_details&id=5771&from_id=53
For more information on MiFID, visit http://www.cesr.eu/index.php?page=home&mac=0&id= and http://ec.europa.eu/index_en.htm
Alternative Investments Directive for Fund Managers
In April 2009 the European Commission proposed a Directive on Alternative Investment Fund Managers (AIFMs) as part of its response to the financial crisis.
Alternative Investment Funds (AIFs) are defined as all funds that are not harmonised under the UCITS Directive.
Authorities believed that the financial crisis had demonstrated that the activities of AIFMs were not sufficiently transparent, and that the associated risks were not sufficiently addressed by current regulatory and supervisory arrangements. In particular, the existing regulatory environment does not adequately reflect the cross-border nature of the risks posed: the fall-out of a problem in one Member State will therefore be felt beyond its national borders.
The Commission is aiming through the Directive to create a comprehensive and effective EU regulatory and supervisory framework for AIFMs – including managers of hedge funds and private equity funds, which managed around EUR2 trillion in assets at the end of 2008.
The Commission says the proposed AIFM Directive will:
- Adopt an 'all encompassing' approach so as to ensure that no significant AIFM escapes effective regulation and oversight, while recognising the legitimate differences in existing business models and providing exemptions for smaller managers for whom the requirements would be disproportionate. Therefore, the Directive will only apply to those hedge funds managing a portfolio of more than EUR 100 million (EUR 500 million for private equity funds). Roughly 30% of hedge fund managers, managing almost 90% of assets of EU domiciled hedge funds, would be covered by the Directive
- Regulate all major sources of risks in the alternative investment value chain by ensuring that AIFMs are authorised and subject to ongoing regulation and that key service providers, including depositories and administrators, are subject to robust regulatory standards
- Enhance the transparency of AIFMs and the funds they manage towards supervisors, investors and other key stakeholders
- Ensure that all regulated entities are subject to appropriate governance standards and have robust systems in place for the management of risks, liquidity and conflicts of interest
- Permit AIFMs to market funds to professional investors throughout the EU, subject to compliance with demanding regulatory standards
- Grant access to the European market to third country funds after a transitional period of three years. This should allow the EU to check whether the necessary guarantees are in place in the countries where the funds are domiciled (equivalence of regulatory and supervisory standards, exchange of information on tax matters).
Further debate is a certainty before the final version of this measure takes shape and SWIFT will monitor the development of the measures closely, with their potentially highly significant impact for our clients on the buy side or who offer depositary services.
For more information on the Directive, visit http://europa.eu/rapid/pressReleasesAction.do?reference=MEMO/09/211&format=HTML&aged=0&language=EN&guiLanguage=en
For more on SWIFT solutions for hedge funds
Updates to the Capital Requirements Directive
The European Commission has adopted a proposal to further amend the Capital Requirements Directives. The recent raft of changes follows numerous others in recent times. These directives stipulate how much of their own financial resources banks and investment firms must have in order to cover their risks and protect their depositors.
The proposed amendments address capital requirements for the trading book and re-securitisations, disclosure of securitisation exposures, and remuneration policies. They form part of the Commission's response to the financial crisis, which is based on strengthening the regulatory framework in those areas relevant to the causes of the crisis.
The main changes proposed are:
- Capital requirements for re-securitisations. These are complex financial products that played a role in the development of the financial crisis. In certain circumstances, banks that hold them can be exposed to considerable losses. The proposal will impose higher capital requirements for re-securitisations, to make sure that banks take proper account of the risks of investing in such complex financial products
- Disclosure of securitisation exposures. Proper disclosure of the level of risks to which banks are exposed is necessary for market confidence. The new rules will tighten up disclosure requirements to increase the market confidence that is necessary to encourage banks to start lending to each other again
- Capital requirements for the trading book. The trading book consists of all the financial instruments that a bank holds with the intention of re-selling them in the short term, or in order to hedge other instruments in the trading book. The proposal will change the way that banks assess the risks connected with their trading books to ensure that they fully reflect the potential losses from adverse market movements in the kind of stressed conditions that have experienced recently
- Remuneration policies and practices within banks. The proposal sets out to tackle perverse pay incentives by requiring banks and investment firms to have sound remuneration policies that do not encourage or reward excessive risk-taking. Banking supervisors will be given the power to sanction banks with remuneration policies that do not comply with the new requirements.
These proposals are similar to recommendations coming out of the G20, and to action proposed by some national regulators with the aim of boosting the capital strength of banks in relation to their business profile. Some authorities, for example, the UK Financial Services Authority (FSA) have also focused on banks liquidity and are in the process of instituting much tighter liquidity reporting regimes.
For more on the amendments to the Capital Requirements Directives, visit http://ec.europa.eu/internal_market/bank/regcapital/index_en.htm
For more on the UK FSA’s liquidity regime, visit http://www.fsa.gov.uk/pages/Library/Policy/CP/2009/09_13.shtml