Regulatory Update - 1Q 2013
The securities lending regulatory environment continues to evolve, as multiple jurisdictions and regulators propose and implement new policies. Activity in the past few months has focused on new guidelines for UCITs funds and the proposal of financial transaction taxes in Europe.
ESMA Guidelines on UCITs Securities LendingDuring December 2012, the European Securities and Markets Authority ("ESMA") published consolidated guidelines for ETFs and UCITs, which included specific points addressing the manner in which securities lending, repos and reverse repos (collectively referred to as 'efficient portfolio management' ("EPM")) should be handled. The guidelines became applicable from February 18, 2013, with existing UCITs having a maximum of 12 months to implement the majority of the provisions. You can access the ESMA guidelines by visiting http://www.esma.europa.eu/content/Guidelines-ETFs-and-other-UCITS-issues.
Some of the key elements of the guidelines to consider are:Prospectus requirements: the guidelines outline new information that a UCITs fund should include in its prospectus. This includes a statement of the collateral policy together with a statement of the funds'' EPM risk policy.Collateral diversification: the guidelines lay down a number of requirements on allowable collateral for EPM transactions, the key ones being:
- Sufficient diversification of collateral, with an explicit 20% threshold for collateral from any single issuer;
- Aggregation of collateral received across OTC derivative and EPM transaction when applying the diversification requirements;
- A requirement for collateral received via title transfer arrangements to be held by the depository (see note below regarding ESMA Q&A for clarification on this point);
- A prescription on the acceptable forms of reinvestment for cash collateral.
Disclosure requirements: the guidelines set out a number of additional criteria for which disclosure is required by the UCITs in its annual report.ESMA issued a further set of Q&A notes on March 15 which provided additional clarification on certain points within the guidelines. This included confirmation that the depository can delegate the holding of collateral received via a title transfer arrangement, to a third party custodian provided certain conditions are met. You can access this Q&A by visiting http://www.esma.europa.eu/content/QA-ESMAs-guidelines-ETFs-and-other-UCITS-issues.
The guidelines are now subject to incorporation into the regulations of each Member State of the European Union.
Financial Transaction Taxes
The past few months have seen the introduction of financial transaction taxes ("FTT") in both France and Italy, together with a revised proposal from the European Commission ("Commission") for an EU wide FTT.The FTT took effect in France on August 1, 2012, with specific additional reporting for securities lending transaction starting on January 1, 2013 (for more information, please reference the Country Profile: France). The FTT in Italy took effect on March 1, 2013 with the first reports not due until early 2014. In both cases, securities lending activities are exempt from the tax charge, although reporting is required in France. The reporting requirement in Italy is still unclear, as a further clarification from the Authorities is required.The Commission originally proposed an EU wide tax on financial transactions in September 2011. This proposal was debated at several European Council meetings during 2012 and the overall proposal became delayed once it was clear that certain European Members were opposed to the idea of an EU wide FTT. Following further negotiation, 11 member states agreed to move forward under the 'enhanced cooperation' process and as a result the Commission published an updated proposal on February 14, 2013. The key elements of the revised proposal include:
- The rate of the tax was set at 0.1% of the taxable amount of the financial transaction, and 0.01% for an financial derivative transactions;
- The tax will apply to any financial transaction carried out by an institution established in one of the 11 members states;
- In addition, the tax will apply to any financial transaction involving a security which is issued from one of the 11 member states;
- Securities lending transactions are not exempt under the proposal.
The current proposal will replace the FTT already established in France and Italy.Within the proposal, the participating member states must adopt the laws, regulations and administrative provisions necessary to comply by January 2014. However the current draft is still subject to negotiations between the Commission and the member states. The securities lending industry is also actively seeking to discuss the proposals with individual member states and the Commission, with the goal of obtaining an exemption for these transactions.Other regulatory developmentsFinancial Stability Board Shadow Banking Consultation: The Securities Lending and Repo working group published a consultation at the end of 2012, and responses were submitted in January 2013. J.P. Morgan participated in the industry responses, covering key areas such as cash collateral reinvestment, central trade repositories and haircut methodologies.Dodd-Frank: Consultations are underway on a number of sections including the setting of limits for counter-party exposure, increased transparency for lenders and borrowers and rules around the orderly liquidation of assets on a default.