Regulatory Update - Issue 1, 2014
2013 has seen further developments in regulatory agenda, with some of the key areas summarized below.
ESMA Guidelines on ETFs and other UCITs Issues
The European Securities & Markets Authority (“ESMA”) published consolidated Guidelines on ETFs and other UCITS issues (the “Guidelines”) in December 2012. The original Guidelines gave funds which were in existence at the time of publication 12 months to comply with the terms of the Guidelines. This period expires in February 2014 and funds should be actively working towards compliance, to the extent that they have not already met the required standards.
In addition to the original Guidelines, ESMA has published Questions and Answers (“Q&A”) on March 15, 2013 (updated on July 11, 2013 and November 27, 2013) regarding the practical application of the Guidelines. The Q&A provides responses to questions posed by the general public and competent authorities in relation to the practical application of the Guidelines. From a securities lending perspective, some of the key points contained in the Guidelines were:
- Aggregation of collateral thresholds and limits across both OTC derivative and securities lending transactions;
- Collateral received pursuant to a ‘title transfer’ should be held by the depositary of the UCITS;
- Specific diversification and concentration limits to apply to all types of collateral – cash & non-cash – together with a prohibition on rehypothecation;
- Requirement for funds to disclose fee splits in prospectus and annual reports, together with undertaking ‘stress testing’ if more than 30% of NAV is on loan;
- The Q&A documents have confirmed, amongst other things, that where collateral is provided via title transfer, the depositary can delegate the custody of the collateral to a sub-custodian provided that the depositary remains liable if the collateral is lost by the sub-custodian.
EU Financial Transaction Tax Proposal
The European Commission (“EC”) published proposals earlier in 2013 for an EU wide Financial Transaction Tax (“FTT”). The proposal covered 11 member states that had opted for ‘enhanced cooperation’ in order to move the matter forward, and the FTT was set at a minimum 0.1% on all share/bond transactions and 0.01% on all derivative transactions. Securities lending transactions are not exempt from the proposals, as they currently stand.
The EC originally hoped that the FTT would take effect from January 2014, however it stated on their website recently that it was more likely that it would take effect from “mid 2014” – most likely a reflection of the ongoing discussions that are taking place between member states regarding the scope and application of the FTT.
The securities lending industry is also actively seeking to discuss the proposals with individual member states and the EC, with the goal of obtaining an exemption for these transactions. The International Securities Lending Association (“ISLA”) recently published a position paper on the EU FTT.
Financial Stability Board (FSB) – Policy Framework for Securities Lending and Repo
On August 29, 2013 the Financial Stability Board published a document entitled “Strengthening Oversight and Regulation of Shadow Banking – Policy Framework for Addressing Shadow Banking Risks in Securities Lending and Repos”.
The report covers the main themes that the FSB had requested feedback on in their prior consultation in November 2012 – transparency; collateral policy (specifically cash collateral); and structural elements of the securities financing market. As part of the report the FSB also issued a public consultation on its’ proposed regulatory framework for haircuts on non-centrally cleared securities financing transactions (Annex 2).
The consultation on the proposed regulatory framework for haircuts and numerical floors closed at the end of November 2013 and J.P. Morgan participated with various industry associations / bodies in order to reply to the consultation.
What is in store for 2014....?
It is clear that the pace of regulatory change will continue unabated in 2014 with all of the areas highlighted above continuing to be developed. In addition it is expected that there will be further developments in the following areas:
- UCITS V – intended to deal with the tasks and liabilities of all depositaries acting on behalf of a UCITs fund and will potentially impact securities lending through the custodial delegation obligations of the depositary with respect to collateral;
- Foreign Account Tax Compliance Act (“FATCA”) – the delayed implementation of FATCA is scheduled for July 2014, so final review and compliance activities will be required – including the provision of new style US tax documentation for impacted clients;
- Capital Requirement Directive (“CRD4”) – further development of the Level 2 Technical Requirements, including the level of capital a bank must set aside to cover potential risks and the amount of risk weighted assets that need to provided in support of indemnified transactions.