Financial services MIG updater

9 March 2012

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Introduction

What is MIG?

The Markets Infrastructure Group (MIG) provides clients involved in brokerage and market infrastructure with access to a group which focuses specifically on their area of business.

Every month MIG publishes an updater which covers the latest regulatory developments that affect those involved in brokerage and market infrastructure. Welcome to the March 2012 edition of the MIG updater.

Highlights include:

  • EBA Discussion Paper on Draft Regulatory Technical Standards on the capital requirements for CCPs under EMIR
  • ESMA Discussion Paper - Draft technical standards for EMIR

Clearing & settlement

Final Report - Requirements for mandatory clearing

In October 2010, the Financial Stability Board published a report entitled Implementing OTC Derivatives Market Reforms which recommended that the International Organisation of Securities Commissions (IOSCO), working with other authorities, should co-ordinate the application of central clearing requirements on a product and participant level, and any exemptions from them as a means of minimising the potential for regulatory arbitrage as the G20 commitments on central clearing are implemented.

IOSCO has now published a final report entitled Requirements for mandatory clearing (the Final Report). The Final Report outlines recommendations that national authorities should follow in establishing a mandatory clearing regime for standardised over-the-counter derivatives in support of the G20 commitments to improve transparency, mitigate systemic risk and protect against market abuse in these markets.

The recommendations outlined in the Final Report relate to the:

  • Determination of whether a mandatory clearing obligation should apply to a product or set of products.
  • Consideration of potential exemptions to the mandatory clearing obligation.
  • Establishment of appropriate communication among authorities and with the public.
  • Consideration of relevant cross-border issues in the application of a mandatory clearing obligation.
  • Monitoring and reviewing of the overall process and the application of the mandatory clearing obligation.

The Final Report outlines two general approaches to the determination that a product or set of products should be subject to a mandatory clearing obligation:

  • The bottom-up approach considers products that a central counterparty (CCP) proposes to or is authorised to clear.
  • The top down approach considers products that should be assessed for a mandatory clearing obligation, but where there may be no CCP clearing or seeking to clear that product.

View Final Report - Requirements for mandatory clearing, 29 February 2012

EP-Council deal on rules for a safe and transparent derivatives market

On 9 February 2012, the European Parliament published a press release announcing that it had reached an agreement with the Council of the European Union and the European Commission on the proposed European Market Infrastructure Regulation (EMIR).

Werner Langen MEP, EMIR's rapporteur, stated that the agreement was a "big step towards a more transparent and safe market for OTC derivatives".

The press release set out the key elements of the agreement, including:

  • Obligatory clearing for OTC derivatives. OTC derivative contracts will need to be cleared through central counterparties (CCPs).
  • Obligatory reporting for all derivatives. All derivative contracts will need to be reported to central data centres (known as trade repositories).
  • A strong role for ESMA. This provides for binding mediation by ESMA in disputes between national authorities regarding authorisation of CCPs.
  • Recognition of third country CCPs. CCPs from third countries will gain recognition if the legal regime in the particular third country provides an effective equivalent system for recognition.

The agreement now requires final approval from the European Parliament and the Council of the European Union. The legislation will then enter into force 20 days after publication in the Official Journal.

View EP-Council deal on rules for a safe and transparent derivatives market, 9 February 2012

Commission acts to increase the safety and efficiency of securities settlement in Europe

The European Commission has issued a legislative proposal in the form of a draft Regulation which is intended to harmonise both the timing and conduct of securities settlement in Europe and the rules governing central securities depositories (CSDs) which operate the infrastructure enabling settlement.

The Commission has proposed this legislation on the basis that while generally safe and efficient within national borders, cross-border settlement presents higher risks and costs for investors.

The Commission believes that it is important to have a harmonised set of measures across Europe for settlement as well as for the institutions responsible for settlement, the CSDs. CSDs are currently regulated at national level but lack a common set of prudential, organisational and conduct of business standards at European level.

The Commission argues that these problems are important and need to be solved, as cross-border transactions in Europe continue to increase and CSDs become increasingly interconnected. These trends are expected to accelerate with the advent of Target2 Securities (T2S), a project launched by the Eurosystem to provide a common technical platform for securities settlement in Europe, which is scheduled to start in 2015.

The key elements of the proposal are:

  • The settlement period will be harmonised and set at a maximum of two days after the trading day for the securities traded on stock exchanges or other regulated markets (currently two to three days are necessary for most securities transactions in Europe).
  • Market participants that fail to deliver their securities on the agreed settlement date will be subject to penalties, and will have to buy those securities in the market and deliver them to their counterparties.
  • Issuers and investors will be required to keep an electronic record for virtually all securities, and to record them in CSDs if they are traded on stock exchanges or other regulated markets.
  • CSDs will have to comply with strict organisational, conduct of business and prudential requirements to ensure their viability and the protection of their users. They will also have to be authorised and supervised by their national competent authorities.
  • Authorised CSDs will be granted a passport to provide their services in other Member States.
  • Users will be able to choose between all 30 CSDs in Europe.
  • CSDs in the EU will have access to any other CSDs or other market infrastructures such as trading venues or central counterparties, whichever country they are based in.

View Commission acts to increase the safety and efficiency of securities settlement in Europe, 7 March 2012

View Commission proposal on improving securities settlement in the EU and on central securities depositories, 7 March 2012

View Proposal for a Regulation on improving securities settlement in the European Union and on central securities depositories and amending Directive 98/26/EC, 7 March 2012

Joint Discussion Paper on Draft Regulatory Technical Standards on risk mitigation techniques for OTC derivatives not cleared by a CCP under EMIR

The European Banking Authority, the European Securities and Markets Authority and the European Insurance and Occupational Pensions Authority (together the ESAs) have published a Discussion Paper on draft regulatory technical standards (RTS) under the proposed Regulation on over-the-counter (OTC) derivatives, central counterparties (CCPs) and trade repositories (EMIR).

The Discussion Paper follows the political agreement reached by the European Commission, the European Parliament and the Council of the EU, in relation to EMIR, during the Trilogue meeting on 9 February 2012.

Under Articles 6 and 8 of EMIR, the ESAs are required to draft RTS specifying the requirements on risk mitigation techniques for OTC derivative contracts not cleared by a CCP. The purpose of the Discussion Paper is to set out the ESAs' preliminary views on this topic and to gather the stakeholders’ opinions at an early stage in the process.

The Discussion Paper contains:

  • Preliminary considerations regarding collateral (margin) and capital requirements.
  • Potential options regarding combinations of collateral and capital requirements.
  • The application of variation and initial margins.
  • Information on identifying eligible collateral and collateral valuation.
  • Potential issues related to transactions with counterparties outside of the EU.
  • Risk management procedures, operational processes for the exchange of collateral and minimum transfer amounts as well as intra-group exemptions.
  • A data request for the cost-benefit analysis.

Comments on the Discussion Paper should be submitted by 2 April 2012.

View Joint Discussion Paper on Draft Regulatory Technical Standards on risk mitigation techniques for OTC derivatives not cleared by a CCP under the Regulation on OTC derivatives, CCPs and Trade Repositories, 6 March 2012

EBA Discussion Paper on Draft Regulatory Technical Standards on the capital requirements for CCPs under EMIR

The European Banking Authority (EBA) has published a Discussion Paper on draft regulatory technical standards (RTS) under the proposed Regulation on over-the-counter (OTC) derivatives, central counterparties (CCPs) and trade repositories (EMIR).

Under Article 12 of EMIR the EBA is required to draft RTS on the capital requirements that a CCP should meet. The purpose of the Discussion Paper is to set out the EBA’s preliminary views on these issues and to gather stakeholders’ opinions at an early stage in the process.

The EBA states that its preliminary view is that the capital of a CCP, including retained earnings and reserves, should be at all times at least equal to the higher of: (1) the CCP’s operational expenses during an appropriate time span for winding-down or restructuring its activities; and (2) the capital requirements for those risks that according to EMIR must be covered by appropriate capital.

The EBA also states that risk exposures and capital requirements should be calculated using the approaches set out for banks in the Capital Requirements Directive. Also, any capital held under international risk-based capital standards should be included to avoid double regulation.

Comments on the Discussion Paper should be submitted by 2 April 2012.

View EBA Discussion Paper on Draft Regulatory Technical Standards on the capital requirements for CCPs under the draft Regulation on OTC derivatives, CCPs and Trade Repositories, 6 March 2012

ESMA Discussion Paper - Draft technical standards for EMIR

On 16 February 2012, the European Securities and Markets Authority (ESMA) published a Discussion Paper on draft technical standards for the European Market Infrastructure Regulation (EMIR).

The publication of the Discussion Paper followed the trialogue meeting on 9 February at which the European Commission, European Parliament and Council of Ministers reached political agreement on EMIR.

The Discussion Paper sought stakeholders' views on the regulatory and implementing technical standards ESMA is required to draft under EMIR and submit to the Commission by the end of September 2012. The Commission will then endorse them in the form of Commission Regulations, which will be legally binding instruments directly applicable in all Member States.

The Discussion Paper followed the structure of EMIR, with the first section focusing on over-the-counter (OTC) derivatives and in particular the clearing obligation, risk mitigation techniques for contracts not cleared by a central counterparty (CCP) and exemptions to certain requirements. The second part focuses on CCP requirements, where a number of provisions need to be specified through technical standards. The third part deals with trade repositories and in particular the content and format of the information to be reported to trade repositories, the content of the application for registration to ESMA and the information to be made available to the relevant authorities.

The deadline for comments on the Discussion Paper is 19 March 2012.

View ESMA Discussion Paper - Draft technical standards for the Regulation on OTC Derivatives, CCPs and Trade Repositories, 16 February 2012

MiFID/MiFIR and transparency for OTC derivatives

On 15 February 2012, the International Swaps and Derivatives Association (ISDA) published a paper which describes the nature of trading structure and liquidity formation in over-the-counter (OTC) derivatives markets and the implications for framing pre-trade transparency obligations under the MiFID review proposals.

In summary the ISDA made the following points:

  • Exchange trading relies on the existence of large number of buyers and sellers.
  • OTC derivatives are traded infrequently. Trading is overwhelmingly bilateral.
  • Pre-trade transparency differs according to the nature of a given trading model.
  • Pricing is very competitive for liquid OTC derivatives products.
  • Pre-trade transparency should be calibrated by trading model.
  • Request for Quote trading systems should be adequately accommodated.
  • The systematic internaliser (SI) regime is inconsistent in respect of different asset classes.
  • The SI regime could undermine liquidity provision and the quote sharing obligation should be removed.
  • Effective price formation can be supported through better targeted measures, specifically a requirement that firms establish quoting policies.

The ISDA recommended:

  • Redrafting or replacing Article 7 of the proposed Markets in Financial Instruments Regulation (MiFIR) to accommodate trading systems other than order book systems without relying on the waiver process.
  • Removing the quote-sharing obligation from Article 17 of MiFIR and put in place measures that support competitive pricing.

ViewMiFID/MiFIR and transparency for OTC derivatives, 15 February 2012

T2S online - winter 2012 edition

Target2 Securities (T2S) is a project launched by the Eurosystem to provide a common technical platform for securities settlement in Europe, which is scheduled to start in 2015.

The European Central Bank (ECB) has now published the winter 2012 edition of the T2S OnLine Quarterly Review. The Review starts with an editorial by Jean-Michel Godeffroy, Chairman of the T2S Programme Board, who discusses what it will mean to be part of the T2S community for those central securities depositaries and central banks that will soon enter into a contractual agreement regarding T2S with the Eurosystem.

The Review then provides:

  • Information on how the members of the TS2 community will cooperate.
  • A description of the T2S planning, monitoring and reporting framework.
  • A general update on the progress made by T2S over the last few months.
  • An interview with two T2S Network Service Providers, SWIFT and a consortium composed of SIA and Colt who discuss their motivation in becoming part of the T2S project, their offers for prospective T2S customers and the next steps of their preparation for T2S.

View T2S online - winter 2012 edition, 6 March 2012

Supreme Court judgment: In the matter of Lehman Brothers International (Europe) (In Administration)

On 29 February 2012, the Supreme Court judgment In the matter of Lehman Brothers International (Europe) (In Administration) UKSC 2010/0194 was published. The Supreme Court dismissed the appeal by a majority (Lords Hope and Walker dissenting as to the second and third issues): the statutory trust under CASS 7 arises on receipt of client money; the primary pooling arrangements apply to client money in house accounts; and, participation in the client money pool is not dependent on the segregation of client money.

View Supreme Court judgment: In the matter of Lehman Brothers International (Europe) (In Administration), 29 February 2012

View Press summary: In the matter of Lehman Brothers International (Europe) (In Administration), 29 February 2012

Transactions in flex derivatives contracts conducted through Eurex OTC

On 17 February 2012, the FSA published a memo entitled Transactions in flex derivatives contracts conducted through Eurex OTC. In this memo, the FSA discusses the guidance on reporting transactions in derivatives concluded through clearing platforms of derivatives markets (ISIN and Aii), which it set out in issue 40 of its Market Watch newsletter.

The memo confirms that the FSA and the approved reporting mechanisms (ARMs) will obtain instrument reference data for Eurex flex derivatives contracts enabling it to identify and accept the instruments for those transactions. Therefore, from 31 March 2012, firms must report transactions in flex derivatives contracts conducted through Eurex OTC by using the respective Aii code issued for those contracts.

Prior to 31 March 2012, firms are not required to report transactions in flex derivatives contracts conducted through Eurex OTC. However, if firms choose to do so, they have 3 options:

  • Use the equivalent Aii code of standardised derivatives contracts.
  • Use the Aii code issued by Eurex to the parties to the trade. However, these will be rejected, as the FSA and ARMs will not obtain the reference data prior to 31 March 2012, but they do not need to be re-submitted.
  • Report as an OTC derivative contract.

View Transactions in flex derivatives contracts conducted through Eurex OTC, 17 February 2012

Finalised guidance - FSA reviews of counterparty credit risk management by central counterparties

On 31 January 2012, the FSA published finalised guidance concerning reviews of counterparty credit risk management by central counterparties.

The finalised guidance looks at specific aspects of counterparty credit risk management, namely risk models and associated governance, processes and procedures.

The finalised guidance provides further information as to how the FSA assesses compliance with the Financial Services and Markets Act 2000 and the Recognition Requirements set out in chapter 2 of the Recognised Investment Exchanges and Recognised Clearing Houses sourcebook (REC). However, the FSA stated that while it has outlined the typical approach it takes, it is important to note that any review will necessarily be customised to the specifics of the proposed clearing service.

The finalised guidance is designed to be consistent with the CPSS-IOSCO Principles for Financial Market Infrastructures and may be revised when these principles are finalised. It will also be revised in due course to ensure that it is consistent with the Technical Standards for CCP Requirements to be defined by the relevant European Supervisory Authorities when the proposed European Market Infrastructure Regulation is finalised.

View Finalised guidance - FSA reviews of counterparty credit risk management by central counterparties, 31 January 2012

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FSA Handbook

Policy Development Update No. 143

On 27 January 2012, the FSA published its latest FSA Policy Development Update (no. 143).  In this Update the FSA briefly discussed recent publications including Policy Statement 12/02: Client assets: custody liens.

The FSA also set out information about recent Handbook-related and other developments. In particular the FSA lists recent guidance consultations and finalised guidance.

At the end of the Update the FSA sets out a table describing forthcoming publications for 2012. In particular the FSA states that in Q1 2012 it will publish a Policy Statement to Consultation Paper 11/16: Recovery and Resolution Plans.

View Policy Development Update No. 143, 27 January 2012

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Market abuse

Ministerial statement - Criminal Sanctions Directive on Market Abuse

On 20 February 2012, there was published a written ministerial statement by the Financial Secretary, Mark Hoban MP, which stated that the Government had decided at this time not to opt into the European Commission’s proposal for a criminal sanctions Directive on insider dealing and market manipulation, although it hopes to be in a position to do so in the future.

The ministerial statement provides that the Government’s decision not to opt in at this stage is a reflection of the sequencing of the Commission’s proposal, rather than particular concerns as to the substance. The proposed Directive is dependent on the draft Market Abuse Regulation and the draft recast Markets in Financial Instruments Directive, both of which are in the early stages of negotiation. The Government believes that it is difficult to assess the implications, scope and way this proposal may develop considering the broader uncertainty of the market abuse framework being simultaneously subject to a major review.

View Ministerial statement - Criminal Sanctions Directive on Market Abuse, 20 February 2012

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Money laundering

FATF steps up the fight against money laundering and terrorist financing

The Financial Action Task Force (FATF) is an inter-governmental body established in 1989 by the ministers of its member jurisdictions. FATF’s mandate is to set standards and to promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and the financing of proliferation, and other related threats to the integrity of the international financial system.

The FATF Recommendations provide a framework of measures which countries should implement in order to combat money laundering and terrorist financing, as well as the financing of proliferation of weapons of mass destruction.

After working with member countries for over two years the FATF has updated its Recommendations. Changes include:

  • Improved transparency to make it harder for criminals and terrorists to conceal their identities or hide their assets behind legal persons and arrangements.
  • Stronger requirements when dealing with politically exposed persons.
  • Expanding the scope of money laundering predicate offences by including tax crimes.
  • An enhanced risk-based approach which enables countries and the private sector to apply their resources more efficiently by focusing on higher risk areas.
  • More effective international cooperation including exchange of information between relevant authorities, conduct of joint investigations and tracing, freezing and confiscation of illegal assets.

View FATF steps up the fight against money laundering and terrorist financing, 16 February 2012

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Regulation and compliance

Regulation adopted on short selling and credit default swaps

On 21 February 2012, the Council of the European Union issued a press release stating that it had adopted the proposed Regulation on short selling and certain aspects of credit default swaps. The Regulation introduces common EU transparency requirements and harmonises the powers that regulators may use in exceptional situations where there is a serious threat to financial stability.

Adoption of the Regulation follows agreement reached with the European Parliament in first reading on 18 October 2011, and subsequent approval by the Permanent Representatives Committee on 10 November 2011.

The Regulation should be applicable from 1 November 2012.

View Regulation adopted on short selling and credit default swaps, 21 February 2012

MiFID II: A Regulator’s viewpoint

On 30 January 2012, the FSA published a speech by David Lawton (Acting Director, FSA) entitled MiFID II: A Regulator’s viewpoint.

At the start of his speech Lawton stated that generally the Markets in Financial Instruments Directive (MiFID) had been a success for the trading environment, increasing competition and reducing trading costs and therefore there was no need for a radical re-think. However, some important changes are needed to address certain areas so that the framework continues to foster market integrity, enhance market transparency while promoting market liquidity and deliver market stability.

In relation to fostering market integrity Lawton made the following points:

  • Regulators need to have appropriate powers to properly supervise markets and their participants, and take action where necessary.
  • Regulators need access to information that is comprehensive, accurate, focused on important risks, provided on a timely basis and in a format that can be easily used for analysis.
  • Regulators need to be given the appropriate authority to consider the interaction between financial markets and any underlying physical markets.
  • That the extension of the transaction reporting obligations to over-the-counter derivatives is long overdue.
  • Improvements to the content of transaction reports sent to regulators are also necessary to facilitate surveillance.

In relation to transparency Lawton stated that currently there are shortcomings in the quality, standardisation and consolidation of equity post-trade data. Whilst acknowledging that some important details still need to be fleshed out the FSA believes that the Commission’s approach in this area is heading in the right direction and it welcomes the involvement of the European Securities and Markets Authority in the calibration of the regime.

Lawton stated that the big question is whether the transparency regime for equities should be applied to other asset classes and that here pre- and post-trade requirements need to be considered separately. Lawton further stated that the FSA believes that there is a case for greater post-trade transparency but that it will need to be carefully calibrated.

In the final part of his speech Lawton touched on third countries. He stated that the FSA welcomes the granting of passporting rights to branches of third country firms under a single branch authorisation procedure. However, it fears that the current scope of access restrictions will curtail investor choice and competition.

View MiFID II: A Regulator’s viewpoint, 30 January 2012

FCA supervision

In the Treasury paper A new approach to financial regulation - securing stability, protecting consumers the Government stated that payment, settlement systems and central counterparties each have a primary role of managing and reducing systemic risk, making the Bank of England the appropriate regulator.  Regulation by the Prudential Regulation Authority (PRA) would only be appropriate for recognised clearing houses that are central counterparties.  

The Government believes that it is more appropriate for trading infrastructure to be regulated by the Financial Conduct Authority (FCA) which will be responsible for regulating the conduct of authorised persons who use recognised investment exchanges or multilateral trading facilities to deal for their own account or the account of their customers.

On 25 January 2012, the FSA published a speech by Clive Adamson (Director of Supervision, Conduct Business Unit, FSA) entitled FCA supervision. In his speech Adamson gives an insight into how the FCA will supervise firms.

He began by discussing conduct strategy and mentions that one of the building blocks is the FSA’s revised conduct strategy which was launched in 2010. This, in essence, set out the key change in approach which was to move from a primarily reactive to a pre-emptive style of retail conduct supervision. The FCA’s approach will build on this and will emphasise five main elements to:

  • Be more forward looking in its assessment of potential problems.
  • Intervene earlier when it sees problems including earlier intervention in the development or marketing of retail products.
  • Attack the underlying causes of problems it sees, not just the symptoms, on the basis that this will be more effective and efficient in the longer term for consumers and firms.
  • Secure redress for consumers if failures occur.
  • Take meaningful action against firms that fail to meet standards through fines that will have a deterrent effect.

Adamson then turned to the supervision model that is being developed to deliver more intensive conduct supervision. The key components of this model are:

  • A clearer sector-based approach.
  • Greater use of forward looking analysis to understand what is happening in particular sectors and to help in determining risks.
  • More focus on intelligence and data.
  • Greater use of thematic reviews.
  • Continued, but more focused, programme of firm level assessments.
  • More responsive and flexible use of resources with fewer firms having a fixed team facing off against them.

Adamson also touched on the firm assessment aspect of the supervision model. At the moment this is conducted through the ARROW process for large firms and through the Revised Approach to Small Firm Supervision for smaller firms. According to Adamson the intention is to keep a firm assessment framework across the firm population but to replace the ARROW framework with a new process that is easier to communicate to the senior executives and boards of firms so that they can align good business practice with good regulatory practice.

According to Adamson the new framework will focus much more on the main drivers of conduct risk at the firm level, but the overall assessment, which will continue to be in the form of a letter to the board, will be based on all the work that has happened on the firm, including thematic work. At the most intensive end of the spectrum the firm’s business model and strategy will be reviewed to see whether these deliver good outcomes for consumers.

The key message is that the FCA will be a conduct focussed regulator to ensure that firms do not trade consumer treatment off against financial performance or prudential strength. The FCA will look at product design and delve into sales to see whether firms have appropriate systems and controls in place to ensure the delivery of fair outcomes to consumers. The FCA will also look to firms’ boards and other governing bodies to set, put in place and maintain a culture that will bring about good outcomes for their customers.

Adamson also discussed wholesale conduct and the FCA’s focus here will be to ensure the integrity and resilience of wholesale markets rather than to seek to introduce concepts of detriment and redress that it will use in the retail markets. However, the FCA will place more emphasis on three areas where:

  • Wholesale products filter down or are distributed to retail consumers.
  • Certain behaviours in wholesale markets can cause damage to market integrity.
  • Market structures can result in participants being disadvantaged or the market being inefficient.

In the final part of his speech Adamson discussed the transition from the FSA to the FCA. A key milestone for the FSA occurred last April with the creation of the Conduct (CBU) and Prudential business units within the FSA. At that time the FSA moved all firms that will be solo regulated in the future into the Supervision Division within the CBU. The next milestone is the splitting of conduct and prudential supervision of firms that will be dual regulated in the future and the move of these into CBU Supervision for conduct purposes.

View FCA supervision, 25 January 2012

Delivering twin peaks within the FSA

On 6 February 2012, the FSA published a speech given by Hector Sants (Chief Executive, FSA) entitled Delivering twin peaks within the FSA.

At the start of his speech Sants stated that implementing a twin peaks model is the next stage in the FSA’s reform process and that such model will be introduced from 2 April 2012.

The FSA intends to move as close as possible, subject to the framework imposed on it by the Financial Services and Markets Act 2000, to the new style of regulation outlined by the Government. Namely, that firm-specific supervision for banks, insurers and major investment firms will be carried out by two separate entities, one for prudential and one for conduct regulation.

Sants then discussed some of the general principles of the new model noting its high level operating characteristics:

  • There will be two independent groups of supervisors for banks, insurers and major investment firms covering prudential and conduct supervision. All other firms (i.e. those not dual regulated) will be solely supervised by the conduct supervisors.
  • The supervisors will make their own, separate, set of regulatory judgements against different objectives.
  • They will coordinate internally to maximise the exchange of information which is relevant to their individual objectives, but to be clear, they will act separately when engaging with firms. The FSA has termed this “independent but coordinated regulation”.
  • The FSA will retain the principle of seeking to ensure that regulatory data is only collected once. It will retain its common, current data infrastructure.

Sants also mentioned that the move to twin peaks is an opportunity to drive home and further embed the move to forward-looking, proactive, judgement-based supervision.

Sants then discussed some of the operational changes. From a firm’s perspective the key operational change will be that the existing ARROW risk mitigation programme will be split between those actions which are relevant to the conduct supervisory group’s objectives and those that relate to the prudential supervisory group. From 2 April 2012 onwards, the two supervisory units will run their own risk mitigation programmes and firms will have two separate sets of mitigating actions to address. Sants also stated that in the remaining lifetime of the FSA, it will retain the current ARROW cycle so that if a firm is due to complete an ARROW assessment before spring 2013 it will still be subject to a supervisory review.

However, there will be two particular consequences of the new approach. First, each supervisory group may ask similar questions, but it needs to be understood that the purpose will be different. Second, in the twin peaks world there will not be a consolidated list of the required actions arising from the two supervisory groups. Firms will be expected to address each set of actions arising from the prudential and conduct reviews with equal focus.

In addition, the supervisory models of each group will diverge in a number of ways particularly in terms of allocation of supervisory resource and in the mechanism that each supervisor will use to reach judgements. In relation to the latter prudential supervisors will introduce the concept of a set of questions, which will be focused on ensuring the institution is minimising the risk of disorderly failure. In the conduct area, ARROW will be replaced by a more focussed assessment of conduct risk.  In addition in the conduct space there will be more focus on thematic work.

Sants then discussed behavioural changes stating that it is not just supervisors but also firms that need to adopt a new approach. If the new approach is to work Sants argued that firms should also:

  • Recognise the importance of aligning their goals with those of the supervisors and with society as a whole. Firms are encouraged to avoid gratuitous regulatory arbitrage.
  • Show greater willingness to proactively comply with supervisory judgements.
  • Recognise that there are times when both firms and the regulator will make judgements which in hindsight are wrong.
  • Recognise that this new approach will require greater resources and expertise than the previous reactive model.

Sants also reminded firms that one of the key messages relates to the importance of boards managing their institutions responsibly.

In the final part of his speech Sants mentioned that the FSA and the Bank of England will publish, later this year, two further documents setting out in more detail the functionality of the supervisory regimes of the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA).  He also mentioned the principal areas of focus for further work over the next 12 months:

  • Threshold conditions need to be recast to align them with the twin peaks model.
  • Both the FCA and the PRA need to commence work on designing a new operating platform to support their new approaches to supervision.
  • Both need to complete the detailed design work on their supervisory risk framework which will replace ARROW. For the PRA this includes documenting the detail of the new “proactive intervention framework” and for the FCA the “firm systematic framework”.
  • The draft memorandum of understanding laying out how the FCA and PRA will coordinate has been published but the detailed procedures need to be agreed.
  • The rulebook will need to be split between the responsibilities of the PRA and the FCA.
  • Work needs to be undertaken to ensure that staff are effectively equipped to deliver the new model.

The FSA has also published a press release concerning the speech.

View Delivering twin peaks within the FSA, 6 February 2012

View Delivering a twin peaks regulatory model within the FSA, 6 February 2012

Update on the transition to the new regulatory structure: Implementing ‘twin peaks’ within the FSA

On 6 February 2012, the FSA published a Dear CEO letter which provided an update on the transition to the new regulatory structure and the implementation of ‘twin peaks’ within the FSA.

The Dear CEO letter repeated many of the comments that Hector Sants (Chief Executive, FSA) made in an earlier speech entitled Delivering twin peaks within the FSA. In particular, Sants made the same points concerning the supervisory changes firms will see.

The Dear CEO letter also reminded firms that in the twin peaks world there will not be a consolidated list of the required actions arising from the two supervisory groups. Central to the concept of genuine twin peaks is that both sets of regulatory objectives are different and determined by Parliament to be of equal importance. Firms will be expected to address each set of actions arising from the prudential and conduct reviews with equal focus.

View Update on the transition to the new regulatory structure: Implementing ‘twin peaks’ within the FSA, 6 February 2012

Update on the regulatory reform agenda

On 7 February 2012, the FSA published a speech by Hector Sants (Chief Executive, FSA) entitled Update on the regulatory reform agenda.

In the first part of his speech Sants discussed the UK’s reform programme and the move to twin peaks supervision. Much of the discussion repeats the comments Sants made in an earlier speech entitled Delivering twin peaks within the FSA.

In the second part of his speech, Sants discussed the challenge of Europe. He started by stating that engaging with the European regulatory process is central to delivering financial regulation in the UK. He also stated that it needs to be recognised that, in respect of prudential regulation, and increasingly over the longer-term in respect of conduct regulation, the rules will be made by Europe and the role of the Prudential Regulation Authority and the Financial Conduct Authority will primarily be one of supervision and enforcement. Essentially, the UK is moving to become a ‘supervisory arm’ of Europe.

Sants then turned to the European Supervisory Authorities (ESAs) and discussed how they will operate and how this will impact on the FSA. He started by stating that the FSA supports the concept behind the ESAs and the necessity of them being strong and independent organisations. He added that the ESAs will also bring profound changes for both the policy function and firm supervision.

In terms of policy function Sants referred to the shift in the FSA’s rule making authority to European bodies and that this trend has increased with the Commission opting to use Regulations as opposed to Directives and the further increase of detail through ESAs issuing binding technical standards.

In relation to firm supervision Sants made two points. Firstly, that there is pressure to harmonise the way that supervision is carried out. Secondly, the by-product of seeking to have common standards, which underpins the concept of the single financial market, runs the risk of removing supervisory discretion in terms of the measures supervisors can take to address firm-specific risk.

Sants acknowledged that there is momentum to have a common supervisory procedure manual and supports the importance of the ESAs having a role in maintaining standards and in doing so they need to be able to participate in peer reviews and have a full understanding of the way a supervisor assesses risk. However, he argued that supervision needs to be delivered locally and be tailored to a particular set of circumstances. Good supervision needs to be based on forward-looking judgements and a deep understanding of firm-specific circumstances. He warned that care needs to be taken to ensure that the philosophy of harmonisation does not undermine this principle. Sants did, however, make clear his strong support for colleges and data sharing. In particular, he states that cooperation is crucial to establishing effective recovery and resolution regimes.

View Update on the regulatory reform agenda, 7 February 2012

Regulating certain bidders in auctions of EU emissions allowances

On 14 February 2012, HM Treasury published a consultation paper entitled Regulating certain bidders in auctions of EU emissions allowances (the Consultation Paper).

The Consultation Paper sets out proposed implementing Orders and amendments to existing financial services legislation to implement elements of the EU regulatory framework applicable to certain bidders in Government auctions of aviation and phase III EU emissions allowances under the EU Emissions Trading System (EU ETS).

Implementing the changes will result in the creation of a new regulated activity under the Financial Services and Markets Act 2000 (FSMA). In most cases this will lead to the FSA having to authorise relevant persons who wish to bid in auctions of emissions allowances irrespective of the permissions or exemptions that they current hold. This will involve amending secondary legislation made under FSMA and some minor additions to the Act itself.

The deadline for responding to the Consultation Paper is 10 April 2012.

View Regulating certain bidders in auctions of EU emissions allowances, 14 February 2012

An update on the FSA’s investigations and enforcement regime

On 23 February 2012, the FSA published a speech given by Tracey McDermott (acting director of the Enforcement and Financial Crime division, FSA) entitled An update on the FSA’s investigations and enforcement regime.

In her speech McDermott looked at recent FSA enforcement action and then discussed the proposed enforcement responsibilities of the Financial Conduct Authority (FCA).

In particular McDermott stated that credible deterrence is here to stay. The FCA will carry on the enforcement work of the FSA, maintaining and strengthening its outcomes. Where it does not see improvements from its action, the FCA will be willing to take tougher action just as the FSA has done in prosecuting insider dealing.

McDermott also stated that the FCA will be clear on expectations. Consumers can expect it to be more accessible and to communicate proactively, so they understand what they can expect from firms and the regulatory system. The FCA will seek to view issues through the eyes of consumers and understand the drivers of their behaviour as well as that of firms. Firms can expect more challenge from the FCA and more willingness to intervene.

In addition McDermott explained that central to the FCA’s approach will be a focus on early intervention, looking to take action before risk crystallises. She noted that early intervention can take many different forms including the proposed power for the FCA to ban products where it considers the risk of mis-selling those products significantly outweighs any benefit. However, early intervention will also include a willingness to take action - supervisory or enforcement - earlier in the cycle. Consumers might expect to see the FCA take action, including enforcement action, where its judgement is that a particular aspect of the firm’s business model - its product selection, its remuneration practices, its training or recruitment, for instance - is likely to give rise to poor consumer outcomes.

McDermott further stated that the FCA will have a lower tolerance for firms bumping along at the bottom - firms that only fix things when the FCA tells them to, and then do only enough to fix the specific problem. The FCA will be swifter and more willing to take action to restrict, or even prevent, such firms from doing business.

View An update on the FSA’s investigations and enforcement regime, 23 February 2012

The PRA’s approach to consultation

The Bank of England and the FSA have co-produced a note which responds to the Government’s request for an explanation as to how the proposed Prudential Regulation Authority (PRA) will consult. The note will be reviewed by the board of the PRA once the PRA has been established.

The PRA’s general approach to consultation will be to give the firms it regulates, their representatives and other interested parties the opportunity to express views. In particular, it will look to expert practitioners to offer technical and detailed feedback on the different means to achieve the PRA’s aims. The PRA will want to seek from the consultation process informed views from firms as to how the proposed means of achieving its objectives on particular fronts will affect their particular business.

The PRA will not establish a standing practitioner panel comprising a fixed group of practitioners. However, the PRA will on occasions draw together temporary groups, comprising practitioners and other experts, where it judges that a focussed discussion of technical points will be helpful.

View The PRA’s approach to consultation, 28 February 2012

FESE position on the MiFID II proposal

The Federation of European Securities Exchanges (FESE) has published a position paper concerning the European Commission’s legislative proposals revising the Markets in Financial Instruments Directive (MiFID).

FESE reports that its members generally welcome the Commission’s proposals and in particular supports:

  • Recognition that Europe’s main legislation on trading should ensure that all the market participants active in trading ultimately serve the real economy.
  • The Commission’s overall approach to ensure that qualifying over-the-counter (OTC) derivatives are traded in a well regulated environment.
  • Proposals to extend transparency requirements to bonds and derivatives.
  • Measures to ensure the transparency and supervisory oversight of commodity markets.
  • That the proposals accepts technological advances in trading speed as fact, and includes mostly sensible solutions to reduce systemic risks, counter potential of market abuse and ensure fair treatment of clients.

However, FESE also proposes certain changes to the proposals including that:

  • There should be a clear definition of OTC.
  • The MiFID review should maintain the existing protections designed for all types of trading platforms. In particular, multilateral trading of equities, bonds and standardised derivatives should only happen on platforms that provide identical transparency, non-discretionary execution, non-discretionary access, and full market surveillance capabilities.
  • Systematic Internalisers should remain classified as “regulated” trading venues and not move into the OTC classification.
  • Conflicts of interest arising from the combination of roles of investment firms should be better managed.

View FESE position on the MiFID II proposal, 31 January 2012

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Seminars

40 minute briefing series - January 2012 to April 2012

We are pleased to announce that the invitation for the next series of 40-minute briefings is now available.

If you cannot access this link, please copy and paste the address below into your web browser.

http://www.nortonrose.com/invitations/2011/your-guide-to-the-key-regulatory-challenges-in-2012-60409.aspx

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