Financial Services Group. Regulatory handbook

Transcription

1 Financial Services Group Regulatory handbook -2014

2 Introduction Contents Regulatory timeline 4 Glossary 7 New Financial Services Regulatory Structure 8 Dodd-Frank Wall Street Reform and Consumer Protection Act 10 EU Financial Transaction Tax 12 The Foreign Account Tax Compliance Act (FATCA) 14 Basel Accords 16 Basel II 18 Basel Basel III 22 Basel III Fundamental Review of the Trading Book 24 Central Securities Depository (CSD) 26 The European Market Infrastructure Regulation (EMIR) 28 International Financial Reporting Standards 9 (IFRS 9) - Financial Instruments 30 Independent Commission on Banking 32 Market Abuse Directive (MAD) II 34 Mortgage Market Review (MMR) 36 Markets in Financial Instruments Directive (MiFID) 38 Short Selling Regulations (SSR) 40 Target 2 Securities (T2S) 42 CASS 5 Review 44 Solvency II 46 Retail Distribution Review (RDR) 48 The Alternative Investment Fund Managers Directive (AIFMD) 50 Undertakings for Collective Investment in Transferable Securities (UCITS) 5 52 Undertakings for Collective Investment in Transferable Securities (UCITS) 6 54 The global Financial Services industry is in the midst of the broadest and most sustained period of regulatory change of recent times. The 2008 financial crisis highlighted not only the vulnerability of the industry but its severe under-regulation. As a result, we have seen an influx of new regulatory bodies and regulations, many of which are subject to regular revision. What started as a global action plan, has since become a puzzle of diverging national agendas. A global policy response would be the ideal solution, however, legal harmonisation is not on the agenda and does not appear a realistic option. Complying with the wide range of regulatory requirements is a significant challenge, particularly for institutions with a global presence. Not only has there been a vast amount of change to the regulatory landscape, the complexity of much of the regulation has led to a lack of understanding by many of those working within the industry. Regulation is set to remain a dominant feature within the banking, insurance and investment management industries for the foreseeable future. In light of this and allied to the dynamic nature of the regulatory environment, it is imperative that members of the industry remain abreast of the regulatory agenda and its policies. FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

3 SEP OCT NOV DEC JAN FEB MAR APR Q3 Q MAY JUN JUL AUG SEP OCT NOV DEC JAN FEB MAR Q Q Q Q Dodd-Frank Act USA All Financial Services Mandatory clearing for Category 3 swaps begins Final bank lending limit becomes effective Resolution plans of foreign banks with less than US$100 billion in US non-bank assets due The application of the US securities laws to security-based swaps will become effective Volcker rule becomes effective FATCA USA All Financial Services FFI Agreement effective Last date to register with IRS to be included on FFI list Outstanding obligations/ accounts will be treated as pre-existing. Earliest effective date for a FFI agreement Deadline for FFIs to complete remediation on pre-existing entity accounts and on high value accounts Tax reporting begins CRD IV/Basel III EU/BCBS Banking and Securities Deadline FCA Deadline PRA consultation consultation on on CRD IV CRD IV implementation implementation Deadline for transposition of CRD IV CRD IV will apply Proposed introduction of Basel III Liquidity Coverage Ratio into Pillar 1 requirements Central Securities Depository EU Banking and Securities ESMA expected to draft technical standards Expected regulation deadline for implementation EMIR EU Banking and Securities Risk management of non cleared OTC derivatives through portfolio reconciliation, dispute resolution and trade compression Details of all classes of derivative contract must be reported to recognised trade repositories First clearing obligations applied (subject to authorisation of the relevant CCD) IFRS 9 EU Banking and Securities Effective date of IFRS 9 ICOB Independent Commission on Banking UK Banking and Securities Deadline for responses to consultation on Banking Reform Bill secondary legislation Government intends for Banking Reform Bill to receive Royal Assent by this date MAD II EU Banking and Securities The European Parliament endorsed the new Market Abuse Regulation proposals at its plenary session European Parliament to consider the Directive on criminal sanctions for insider dealing and market manipulation (CSMAD) Provisional date for proposals to take effect Mortgage Market Review UK Banking and Securities The majority of new rules come into effect MiFID II EU Banking and Securities European Parliament to consider MiFID II legislative proposals in plenary session ESMA is required to submit the draft regulatory technical standards and the draft implementing technical standards to the EC Earliest expected date that MiFID II will be implemented by Member States Target 2 Securities EU Banking and Securities Retail Distribution Review UK Investment Management AIFMD EU Investment Management FCA third consultation paper on UK implementation Transitional deadline for capital adequacy requirements FCA has suggested that companies should apply to them for the appropriate permissions by no later than this date End of AIFMD transitional period UCITS 5 EU Investment Management FCA to publish consultation paper on UCITS 5 implementation ESMA to publish technical advice, guidelines and technical standards UCITS 6 EU Investment Management The European Commission proposes draft regulation on money market funds The European Commission expected to publish its proposals regarding UCITS 6 4 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

4 Glossary AIF Alternative Investment Fund IRS Internal Revenue Service ARM Authorised Reporting Mechanism MCR Minimum Capital Requirement FATCA USA All Financial Services FATCA withholding begins on certain gross proceeds payments to noncompliant accounts BCBS CCP Basel Committee on Banking Supervision Central Counterparties MTF NST Multilateral Trading Facilities Non-Statutory Trust CRD IV/Basel III EU/BCBS Banking and Securities MiFID II EU Banking and Securities Target 2 Securities EU Banking and Securities Retail Distribution Review UK Investment Management UCITS 5 EU Investment Management T2S goes live including the first wave of implementation European Parliament to consider MiFID II legislative proposals in plenary session Second wave of implementation Personal Investment Firms must comply with new capital adequacy rules Predicted date for application of UCITS 5 ESMA is required to submit the draft regulatory technical standards and the draft implementing technical standards to the EC Third wave of implementation Fourth wave of implementation The Basel III Net Stable Funding Ratio will be introduced as a minimum standard CSD CDS CRM EC EIOPA ESMA ES FCA FFI FPC ICAS IGAs IRC Central Securities Depositary Credit Default Swaps Comprehensive Risk Measure European Commission European Insurance and Occupational Pensions Authority European Securities and Markets Authority Expected Shortfall Financial Conduct Authority Foreign Financial Institution The Financial Policy Committee Individual Capital Adequacy Standards Intergovernmental Agreements The Incremental Risk Charge ORSA OTF PRA QRTs RSR RWA SA SCR SFCR SIBS SPS SVaR TRs VaR Own Risk and Solvency Assessment Organised Trading Facility Prudential Regulatory Authority Quantitative Reporting Templates Regular Supervisory Report Risk Weighted Assets Standardised Approach The Solvency Capital Requirement Solvency and Financial Condition Report Systematically Important Banks Statement of Professional Standing Stressed Value at Risk Trade Repositories Value at Risk Status Proposed Drafted Definition Proposal pending consultation Consultation papers pending formal approval and enactment Formally established/implemented as an active piece of regulation, legislation or policy. Subject to compliance date 6 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

5 New Financial Services Regulatory Structure UK All Financial Services Bank of England PRA Subsidiary of the Bank of England Prudential regulation HM Treasury and Parliament Financial Policy Committee (FPC) Provide recommendation with regard to financial stability Work cooperatively Conduct regulation FCA FCA directly accountable to HM Treasury and Parliament Prudential and conduct regulation The Financial Services Act 2012 sought to reform the UK financial market regulatory framework. The Act came as a reaction to the 2008 financial crisis, which exposed the deficiencies of the previous structure in monitoring and regulating the financial markets. What was previously the Financial Services Authority (FSA), has now been replaced by the FCA and PRA. The new legislation also set up an independent monitoring body that is a committee of the Bank of England, the FPC. The Financial Services Act 2012 was published on 20 December 2012 with the majority of reforms becoming operative on the 1 April. The Financial Conduct Authority (FCA) is responsible for the regulation of conduct by both retail and wholesale Financial Services firms The Prudential Regulatory Authority (PRA) which is a subsidiary of the Bank of England, is responsible for the prudential supervision and regulation of banks, building societies, credit unions, insurers and investment firms. Its purpose is to improve the stability of the financial system through supervision and regulation The Financial Policy Committee (FPC) is a committee of the Bank of England responsible for the monitoring of the UK s economy. It focuses on monitoring the macro-economic and broader financial issues that threaten the stability of the financial system or long term growth Dual-regulated firms eg deposit takers, insurers and some investment firms All other regulated firms All other regulated Financial Services firms eg investment managers 8 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

6 Dodd-Frank Wall Street Reform and Consumer Protection Act USA All Financial Services The Dodd-Frank Act puts in place a wide-ranging reform of the US financial regulatory system, affecting most aspects of the financial industry. Many of the provisions of the Act allow the relevant federal regulatory agencies a period of time before they must issue new rules, implement regulations or instruct the applicable regulatory agencies to conduct studies examining particular issues before taking any action. As a result, clear timelines are hard to capture. The Dodd-Frank Act covers a wide range of reform and regulation across the US Financial Services industry. Many provisions affect UK entities directly, particularly any that do business in the US or with a US citizen. The Dodd-Frank Act was enacted into law on the 21 July 2010 but due to its wide-ranging nature and multiple compliance dates, no definitive timeline can be produced. The Volcker Rule The Dodd-Frank Act implemented the Volcker Rule, which generally prohibits certain banking entities (and their affiliates and subsidiaries) from engaging in proprietary trading and acquiring or retaining any ownership interest in, or sponsoring, a hedge fund or a private equity fund Regulatory structure includes provisions that overhaul the US financial regulatory system, including the creation of the Financial Stability Oversight Council, the elimination of the OTS and the overhaul of the Federal Reserve Bank, FDIC, OCC, Bureau of Consumer Financial Protection and other agencies Swaps and derivatives addresses perceived shortcomings in the over-the-counter (OTC) derivatives markets. The primary goals are to minimize systemic risk of derivatives trading, create transparency in derivatives markets and provide credit protection for derivatives traders Bank capital (Collins Amendment) minimum leverage capital and risk-based capital requirements for depository institutions and holding companies Credit rating agencies measures imposed on rating agencies relating to their internal controls, conflicts-of-interest, transparency and accountability Securitisation seeks to address certain perceived flaws in securitisation market practice Private equity and hedge funds imposes measures relating to hedge funds, private equity and venture capital funds and other private investment funds and the entities managing these funds Regulation of systemically significant financial institutions supervise and regulate banks and other financial companies that could pose a threat to the stability of the US financial system Corporate governance and executive compensation SEC Authority and Selected Securities Act and Exchange Act Provisions Resolution of failing financial institutions 10 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

7 EU Financial Transaction Tax EU Drafted All Financial Services In September 2011, the European Commission proposed a harmonised Financial Transaction Tax for the EU. This was in part due to member states expressing a desire to ensure the Financial Services sector was appropriately contributing to public finances. As well as this, the initiative was intended to be the first step to introducing a global financial transaction tax. The primary objectives of the proposal were: to encourage harmonisation across the Single Market and therefore avoid the fragmentation associated with separate legislations for each jurisdiction to ensure that the financial sector was contributing to public finances and repaying part of what it received from taxpayers during the financial crisis to discourage inefficient financial transactions Not all member states of the EU agreed to go ahead with the proposals so the European Commission has allowed a subgroup of Member States to engage in a harmonised Financial Transaction Tax amongst themselves. This subgroup comprises Austria, Belgium, Estonia, France, Germany, Greece, Italy, Portugal, Slovakia, Slovenia and Spain. The EU Council adopted a decision authorising eleven Member States to go ahead with the requested enhanced cooperation A levy of 0.1 per cent on stock and bond trades A levy of 0.01 per cent on derivatives transactions between financial institutions, if at least one institution is located in the EU An estimated annual revenue of 30 billion to 35 billion (0.4% to 0.5% of the GDP of the participating member states) The legality of the EU Financial Transaction Tax legislation has come under debate in a document leaked from the European Union s legal service. The document, dated 6 September, warned that the new regulation may not be compatible with existing laws and may be discriminatory against nonparticipating member states. This follows a challenge lodged by the UK at the European Court of Justice in April regarding extra-territorial aspects of the Commission s proposal. Although the FTT is already authorised, the legality debate may trigger legal action from other countries as well as second thoughts from those within the participating group where unanimity is required for the levy to go ahead The European Commission proposed a harmonised Financial Transaction Tax for the EU If agreement is found before the end of, the framework for an FTT could enter into force 12 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

8 The Foreign Account Tax Compliance Act (FATCA) USA All Financial Services The Foreign Account Tax Compliance Act (FATCA) is a set of requirements that was introduced to target US taxpayers using foreign accounts to avoid tax and any Foreign Financial Institutions (FFIs) helping them to do so. The purpose of the Act is to ensure the Internal Revenue Service (IRS) can identify and collect the appropriate tax from any US citizen holding financial assets outside of the US. FATCA legislation applies to any Financial Institution including banks, investment managers, funds and insurers and introduces ever higher levels of client identification and compliance to avoid the threat of reporting and/ or withholding FATCA written into law Final FATCA regulations issued Although some jurisdictions are signing up to IGAs, most will currently fall under the full regulations. This is where each institution will have to enter into a formal legal agreement with the IRS, withhold on the non-compliant and nominate a responsible officer to certify that the entity remains compliant. The effective date and withholding will start for US dividends and interest FFIs to avoid being withheld or reported on, FFIs must register with and agree to report to the IRS certain information about their US accounts, including accounts of certain foreign entities with substantial US owners. FFIs that enter into an agreement may be required to withhold 30% on certain payments to foreign payees if such payees do not comply with FATCA. Categories of FFIs that are exempt from FATCA include governmental entities and not for profit organisations. Unless otherwise exempt, FFIs that do not both register and agree to report can face a 30% withholding tax on certain US-source payments made to them Intergovernmental Agreements (IGAs) the US has collaborated with other governments to develop two model IGAs to implement FATCA. These demand that governments bring in primary legislation that will require all FFIs to identify US accounts and report information about these and any noncompliant persons/firms. The IRS has agreed or is negotiating more than 50 Model I IGAs and have agreed Model II with Switzerland and Japan. Model I is preferable as it assumes compliance and therefore removes the threat of withholding. Non-compliant entities and account holders will be reported to the IRS through their home authorities instead Impact the requirements of FATCA mark a seismic shift in account holder identification across Financial Services. Almost all companies will be affected, requiring registration, due diligence, changes to client onboarding, detailed reporting and, where not in a Model I IGA jurisdiction, 30% withholding on US income and gross proceeds (from sale of assets that produced interest or dividends) for the non-compliant IRS portal for reporting opens FATCA withholding begins on certain gross proceeds payments to non-compliant accounts 14 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

9 Basel Accords Global Banking and Securities The Basel Accords seek to enhance the resilience of banks and the financial system by adopting a consistent approach to prudential oversight of banks and focusing on the amount and quality of capital, liquidity and leverage that banks need to maintain. A key concept of Basel was to recognise the riskiness of assets via a weighting process to arrive at a Risk Weighted Assets (RWA) equivalent. A capital allocation was then applied to this. The Accords also address the supervisory framework for managing risks: developing a transparent system for reporting and disclosing information to the market. Basel I the emphasis was primarily on credit risk, specifically the amount of capital banks needed to hold against credit risk exposure Market Risk Amendment an amendment to Basel I that allowed banks to use value-at-risk models in making internal calculations of risk Basel II expanded on Basel I and the Market Risk Amendment by introducing the three pillars methodology to calculate and report on credit, market and operational risk capital Basel 2.5 emerged following the financial crisis, this brought into greater focus more sophisticated capital calculation requirements for trading book exposures Basel III represents the latest in the accords and emphasises the importance of the quality and amount of capital as well as introducing capital buffers. The Accord also introduces liquidity and leverage ratios to counter the effects of mismatched lending and to prevent excessive credit growth Basel I published Market Risk Amendment Basel II published Basel 2.5 reforms finalised Basel III implementation Basel 1 enforced by law Deadline for Basel II implementation Basel III reforms agreed 16 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

10 Basel II Global Banking and Securities Basel II was published by the BCBS The aim of Basel II was to ensure that capital requirements reflected more accurately the risks faced by the banking industry and that banks adopted stronger risk management practices to adapt to these more risk-sensitive capital requirements. In addition, Basel II was intended to be more flexible and promote a more forward-looking approach to capital supervision, encouraging banks to identify the risks they may face in the present and in the future, and to develop or improve their ability to manage those risks. Basel II was implemented across the EU under the Capital Requirements Directive (CRD). Basel II was implemented across the EU under the Capital Requirements Directive, which member states had to transpose into national law Core components Some of the key elements of the Basel I framework that were retained in Basel II include: The general requirement for banks to hold total capital equivalent to at least 8% of their RWA (Risk Weighted Assets) The basic structure of the 1996 Market Risk Amendment to Basel I regarding the treatment of market risk The definition of eligible capital The Basel II framework was based on three pillars and the key reforms were around: Pillar 1 this determined the minimum capital requirements banks had to meet to address credit, market and newly introduced operational risk Pillar 2 this introduced a supervisory review process, where supervisors assess whether the bank should hold additional capital against the risks not covered in Pillar 1 Pillar 3 this aimed to address market discipline by requiring banks to disclose details of their capital and risk management strategies FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

11 Basel 2.5 Global Banking and Securities The BCBS published a press release announcing that it would introduce a series of measures intended to make the banking system more resilient to financial shock The BCBS finalised these proposals with the publication of three papers The Basel Committee on Banking Supervision (BCBS) proposed Capital Basel 2.5 to strengthen the Basel II market risk requirements to address weaknesses that became apparent during the financial crisis. It proposed regulations requiring banks to hold greater capital against the market risks they ran in their trading operations. Core components Trading book the BCBS made targeted amendments to the existing capital requirement for trading books, imposing new capital charges: IRC: the incremental risk charge relating to credit migration risk for unsecuritised credit products Stressed value-at-risk (VaR): an additional charge for all banks that use VaR modelling for market risk capital. The SVaR uses data from extreme market stresses CRM: the comprehensive risk measure has been introduced for certain correlation trading activities Securitised products: eliminated Banking/Trading Book arbitrage Re-securitisations: increased capital requirements for re-securitisation positions Pillar 2 supervisory guidance the BCBS published additional supervisory guidance to assist banks in the identification and management of risks. Since July 2009, the BCBS has published further guidance on pillar 2 focusing upon corporate governance, supervisory and operational risk Pillar 3 disclosures Basel 2.5 required banks to make greater disclosures on their exposure to securitisation risks and the quality of the capital which they held. The BCBS has also introduced Pillar 3 disclosure requirements relating to remuneration which built on the Basel Pillar 2 supervisory guidance on compensation practices Basel 2.5 implementation 20 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

12 Basel III Global Banking and Securities The BCBS published Basel III Capital Basel III (implemented in Europe through CRD4) was a regulatory standard introduced after the financial crisis to address deficiencies identified in Basel II and 2.5. It addressed issues around bank capital adequacy, stress testing and market liquidity risk and leverage. The implementation of the requirements are being phased in from with full compliance in Proposed introduction of the Liquidity Coverage Ratio into Pillar I requirements The Net Stable Funding Ratio will be introduced as a minimum standard Core components Quantity and quality of capital measures to improve the loss-absorbency of bank capital and to provide investors with a clearer view of bank capitalisation Capital buffers an introduction of countercyclical capital buffers and capital conservation buffers Risk coverage Basel III strengthens the capital requirements for counterparty credit risk exposures Leverage ratio introduction of a non-risk based leverage ratio to prevent excessive credit growth, particularly in off-balance sheet structures (Capital/ Total Assets On/Off Balance Sheet) Liquidity ratio two new liquidity ratios (Liquidity Coverage Ratio 30 day and Net Stable Funding Ratio long term) Disclosure the new proposals require banks to increase disclosure on the quality of capital they hold, this is in relation to pillar 3 of the accords Systematically Important Banks (SIBS) banks that are classified as SIBS will be subject to higher capital requirements (an additional buffer of up to 2.5%) National implementation of capital requirements begins Proposed introduction of the leverage ratio into Pillar I requirements 22 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

13 Basel III Fundamental Review of the Trading Book Global Banking and Securities The Fundamental Review of the Trading Book (FRTB) seeks to address shortcomings in the overall design of the trading book, the market risk and regulatory capital regime and weaknesses in risk measurement, modelling and supervision. The consultative document was a response, by the Basel Committee on Banking Supervision (BCBS), to perceived shortcomings of Basel 2.5, particularly its failure to address the cyclicality of the market risk framework and the concept of measuring market risk, built upon the concept of Value-at-Risk (VaR). The principal operational impact for firms will be the requirement to maintain both Standardised Approach (SA) and internal risk model infrastructures. Regulators will face increased supervisory responsibilities and firms will be obligated to provide the Regulator with enhanced risk model metrics. Core components Trading book definition two new boundary definitions are being considered: Trading evidence-based boundary or Valuation-based boundary Stressed calibration the capital framework within trading will be reformed so it can deal with periods of significant market stress Moving from Value-at-Risk (VaR) to Expected Shortfall (ES) VaR is often criticised for not capturing the full picture of risks that a company is facing. Expected shortfall is more sensitive to the shape of the loss distribution in the tail of the distribution Incorporating market illiquidity risk with market risk as a key consideration in banks regulatory capital requirements for trading portfolios Hedging and diversification aligning the treatment of hedging and diversification benefits between the standard approach and the internal models-based approach Strengthening the relationship between internal models-based and standardised approaches Basel II published Basel 2.5 reforms finalised Basel III implementation Fundamental review of the Trading Book Deadline for Basel III implementation Basel III reforms agreed 24 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

14 Central Securities Depository (CSD) EU Proposed Banking and Securities In response to the systemic importance of CSDs and their strategic position at the end of the post-trading process, the EU Commission is aiming to introduce an appropriate regulatory framework for CSDs. The diversity in settlement practices across the EU has been perceived as hindering the development of a truly integrated European post-trade market. This new regulation will work alongside EMIR and MiFID to form a framework in which securities infrastructure will be subject to common rules on a European level. The Commission invited any interested parties to submit their comments in a public consultation The main objectives of the proposal are to: Increase the safety of settlements: by ensuring that buyers and sellers receive their securities and money on time and without risks Increase the efficiency of settlements: by introducing a true internal market for the operations of national CSDs Increase the safety of CSDs: by applying high prudential requirements in line with international standards The Commission adopted a proposal for a Regulation on improving securities settlement in the European Union and on Central Securities Depositories The establishment of a common regulatory framework for CSDs this may include, but is not limited to, common definitions of CSD services, common rules regarding authorisation on on-going supervision of CSDs, high prudential standards for CSDs and rules on access and interoperability The removal of barriers to cross-border post trading services barriers currently exist between issuers and CSDs, between CSDs themselves and between CSDs and other market infrastructures, such as CCPs (Central Counterparty Clearing House) or trading venues Dematerialisation for securities trade this would be an obligation for most securities to be recorded electronically in book-entry form through a CSD A common settlement period currently regulated markets settle two or three days after trading. A common settlement period would be across the EU and work to provide harmonisation of the system As this regulation has not been officially drafted and is only in proposal stage, there are no indicative implementation dates FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

15 The European Market Infrastructure Regulation (EMIR) EU Banking and Securities The European Market Infrastructure Regulation (EMIR) is an EU regulation on Over The Counter (OTC) derivatives, Central Counterparties (CCPs) and Trade Repositories (TRs), that aims to improve the management of counterparty credit risk and increase trade transparency within the derivatives market. EMIR, the EU equivalent of similar provisions made within the US Dodd-Frank Act, has been brought into force in response to weaknesses exposed in the global financial system after the default of Lehman Brothers, near-collapse of Bear Stearns and events surrounding AIG in The interconnectedness of OTC derivative participants and the default, or fear of default, led to liquidity problems, compounded by a lack of transparency of positions and exposures to both regulators and market participants. Key objectives of EMIR include: Reduce the interconnectedness between counterparties in the OTC derivatives markets, minimising systematic risk Provide the regulatory framework needed to improve counterparty risk management Create transparency for regulators and participants within the OTC derivatives market, minimising transparency risk Core components Imposing new clearing requirements for specified standardised OTC derivative trades mandating the clearing of eligible OTC derivatives through a CCP Introducing risk mitigation requirements for trades that are not centrally cleared by a CCP trades not cleared through a CCP (Non-Cleared) will incur collateral requirements and/or higher capital charges Setting a reporting requirement for all derivatives trades (exchange traded and OTC) reporting of derivative transactions to Trade Repositories (TRs) Introducing new obligations on Central Counterparties (CCPs) including an authorisation process, supervisory requirements and interoperability arrangements between CCPs Imposing new obligations on Trade Repositories (TRs) including a registration process and requirements on operational reliability, transparency, and protection and availability of trade data EMIR entered into force The technical standards on OTC Derivatives, Reporting to Trade Repositories and Requirements for Trade Repositories and Central Counterparties entered into force Details of all classes of derivatives contract must be reported to recognised trade repositories Non-financial counterparties falling below or exceeding the clearing threshold are required to contact the FCA from this date First clearing obligations applied expected around Q2 28 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

16 International Financial Reporting Standards 9 (IFRS 9) - Financial Instruments EU Banking and Securities IFRS 9 Financial Instruments issued International Financial Reporting Standards (IFRS 9) are an accounting standard, offering guidance on the appropriate measurement of liabilities and recognition of financial instruments. They seek to harmonise the classification and measurement of financial instruments and improve financial reporting standards. IFRS 9 will replace International Accounting Standard (IAS) 39, which dealt with the recognition of financial assets, and will be mandatory for all companies reporting using IFRS. Companies have the option to apply the older IAS 39 rules, or apply early the implementation of IFRS 9, prior to the January 2015 compliance date. Effective date of IFRS 9 Recognition and derecognition this determines when a financial asset and liability should either be recognised or derecognised in a company s financial statement Classification of financial assets and liabilities IFRS 9 will seek to classify financial assets measured at amortised cost (ie costs of an asset written off due to depreciation), or fair value (ie estimated value based on the price it could be sold in a free and transparent market). IFRS 9 will also seek to classify financial liabilities at fair value through profit or loss, or at amortised cost Hedge accounting hedge accounting refers to means by which companies attempt to limit volatility in their financial instruments. Hedge accounting under IFRS 9 will be made more aligned with risk management to make financial statements more representative of a company s risk profile, and ensure the board reviews hedge accounting requirements Impairment of financial assets IFRS 9 will introduce an impairment review for financial assets which are measured at fair value or amortised cost. It will seek to ensure the losses a company reports are appropriately captured and reported in their financial statements IFRS 9 updated to include accounting for financial liabilities 30 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

17 Independent Commission on Banking EU Banking and Securities The Independent Commission on Banking was established in the United Kingdom in June 2010 to consider structural and related non-structural reforms to the UK banking sector. The primary aim of the commission was to promote financial stability and competition. Key proposals included: A structural reform; ring fencing UK retail banking activities from wholesale activities Achieving greater loss-absorbency beyond Basel 3 requirements. They suggested a lossabsorbing capacity of between 17% and 20% of overall capital Recommendations to promote effective competition in Retail Banking. This included the introduction of 7-day account switching Core components As a response to the commission s proposals, the government announced The Banking Reform Bill, which is due to come into force in early Key changes include: Introducing a ring-fence the ring-fence is around the deposits of people and small businesses, to separate the high street from the dealing floor and protect taxpayers should any losses arise from trading Ensuring the new Prudential Regulation Authority can hold banks accountable for the method in which they separate their retail and investment activities this would entail giving the PRA powers to enforce the full separation of individual banks Giving depositors, protected under the Financial Services Compensation Scheme, preference if a bank enters insolvency Giving the government power to ensure that banks are more able to absorb losses The Independent Commission on Banking is set up The government responded to the commission s report The Bill was introduced to parliament Banks have until 2019 to implement the reforms The Commission s final report is published The draft Banking Reform Bill is published 32 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

18 Market Abuse Directive (MAD) II EU Banking and Securities The Market Abuse Directive (MAD) II seeks to establish a framework for the effective flow of information to the market, and increase confidence in the integrity of the European market. In doing so, it seeks to improve cross-border communication and standards between countries within the EU. The EU proposal comprises a regulation on insider dealing and market manipulation (MAR) and a directive on criminal sanctions for insider dealing and market MAD was originally implemented The European Commission (EC) adopted proposals for a revised Directive manipulation (CSMAD). Currently, the UK has decided not to opt into CSMAD. The proposals are in part a response to the rapid growth of commodity markets through the use of trading facilities and instances of market manipulation. It seeks to reduce the potential for regulatory arbitrage by assigning consistent safeguards across EU Members States and granting regulators increased supervisory powers. Trialogues commenced between the EC, European Parliament and Council of the European Union Political endorsement of MAR Extending the scope of MAD to incorporate and monitor more financial instruments, such as commodity derivatives traded on European multilateral trading facilities (MTF) and organised trading facilities (OTF) The scope of MAD was also extended into more financial markets, namely commodity markets. MAD II provides national regulators with greater powers to request information about commodity markets. This will include provisions for a suspicious transaction reporting proposal to be put in place Tightening the definition of insider information requiring firms to disclose inside information in a simple market-specific format More stringent safeguards around market manipulation and the related consequences, eg attempted market manipulation will be made an offence where an individual attempts to manipulate the market, but fails to execute the transaction in question Regulators will be granted greater investigative and discretionary powers, eg granting regulators with more market related information, such as detailed transaction reports relating to over-the-counter (OTC) derivatives The European Parliament voted through its plenary reports on the Commission s MADII proposals Political agreement was reached Provisional date for rules to take effect 34 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

19 Mortgage Market Review (MMR) UK Banking and Securities The FSA published the final rules The MMR was a review of conduct business regulation commissioned by the FSA in 2004 brought forward as a result of poor standards seen just before the credit crisis in The main objectives of the review were to have a mortgage market that is sustainable for all participants and a flexible market that works better for consumers. In addition to trying to improve the quality and standards within the residential mortgage market, the review also intended to ensure only those who can afford a mortgage are extended one. Most of the rules published by the FSA come into effect Responsible lending lenders must verify income in all cases taking into account a borrower s net income, committed expenditure and basic household expenditure. Lenders must also take into account the impact of future interest rate increases on the borrower s ability to make repayments. Other factors that lenders must consider include assessing a borrower s income beyond state pension age, adapting additional measures to protect credit-impaired customers and only providing interest-only mortgages where a borrower has a credible repayment strategy Distribution the FCA has further differentiated between the all interactive and execution-only mortgage sales processes. All interactive is advised for the majority of borrowers, and in the case of vulnerable customers mandatory, with the exception of customers who are of high net worth or mortgage professionals, where execution-only can be used. Execution-only is also allowed in purely non-interactive sales (postal and internet) Arrears management the FCA has limited the number of times fees for missed payments can be charged. The arrears charges and forbearance rules have been widened to cover all payment shortfalls. Lenders have also been prevented from removing borrowers from concessionary interest rates should they go into payment shortfall Prudential proposals for non-deposit taking mortgage lenders (non-banks) this includes a risk-based capital requirement, an increase in the quality of capital, a requirement for high-level systems and controls to manage liquidity risk and application on a solo-bases and not to firms that are in run-off FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

20 Markets in Financial Instruments Directive (MiFID) EU Banking and Securities The Markets in Financial Instruments Directive (MiFID) was originally introduced to promote competition to the EU trading landscape. It also provided a passport for trading venues and investment firms to operate throughout Europe, as well as introducing various investor protection measures. On 20 October 2011, the European Commission (EC) adopted a legislative proposal for the revision of MiFID. The Proposal was to create an updated piece of regulation (MiFID II) that addressed developments in the trading environment since the implementation of MiFID and the changes brought about by the financial crisis MiFID comes into force across the EU The key objectives of the updated regulation include: Strengthening investor protection The introduction of a more stringent framework for commodity derivatives market Making financial markets more efficient and resilient to changes such as those seen during the financial crisis Increased transparency of the markets Reinforcement of supervisory powers Adapting for developments in technology since MiFID was originally implemented European Parliament s ECON Committee releases draft MiFID II report with amendments 2015 Expected MiFID II implementation Third country firms there will be a new regime for the access of third country investment firms and market operators to the EU Organised trading facilities (OTF) this involves the creation of a new type of trading venue that will be monitored within the regulatory framework. OTFs are not currently monitored. OTFs will be under the same transparency rules as other trading venues all of which are now required to publish data on execution quality Consolidation of market data investment firms will be required to submit post-trade data to Authorised Reporting Mechanisms (ARMs), who will report the details of transactions to regulators Reinforced supervisory powers supervisors will be able to ban specific products, services or practices where there are threats to investor protection, financial stability or the functioning of markets. There will also be minimum rules to ensure that Member States apply appropriate administrative sanctions and measures to breaches of MiFID Commodity derivatives markets a reporting obligation will be introduced which will vary dependent on the category of trader. Regulators will also be able to monitor and intervene when necessary at any stage of trading Conduct of business requirements this includes but is not limited to: new requirements for advisors who wish to call themselves independent and enhanced information disclosure to different categories of client The European Commission begin to hold consultations to review MiFID European Parliament approves MiFID II in a plenary vote 38 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

21 Short Selling Regulations (SSR) EU Banking and Securities During the financial crisis and the subsequent period of market volatility, the European Securities and Markets Authority (ESMA) identified risks associated with short selling. The three main risks that were acknowledged were: transparency deficiencies, the risk of negative price spirals and the risk of settlement failure associated with naked short selling. Because of this, the European Commission adopted proposals for a reform to Short Selling regulation. The date for Short Selling compliance was the 1 November The EU commission has outlined several objectives for this reform: Increase the transparency of short positions held by investors in certain EU securities Ensure Member States have clear powers to intervene when financial stability and market confidence are under threat from short selling and CDS activities Enable the continued coordination between Member States and the European Securities Markets Authority Reduce settlement and other risks linked with uncovered or naked short selling Minimise risks to the stability of sovereign debt markets posed by uncovered CDS positions Disclosure: Applies to all holders of net short positions, in either shares or sovereign debt, requiring they make notifications to the EU Commission when certain thresholds are reached Regulators are to be notified at one threshold (0.1% of issued share capital), and disclosure to the public at a higher threshold (0.5%), for short positions in shares Short positions in sovereign debt are to be reported to national regulators, but there are no set thresholds for such reporting, leaving these to be specified in a delegated act Sale of Short Positions: Uncovered short positions are, effectively, banned The seller of a short position of shares or sovereign debt must either have, or have located, the shares or sovereign debt instrument for delivery on the intended settlement date Entering into uncovered sovereign CDS transactions is prohibited Suspension of Restrictions: Member States can suspend the restrictions or limits when an instrument suffers a price fall from the previous day s closing price 40 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

22 Target 2 Securities (T2S) UK Drafted Banking and Securities Target2-Securities (T2S) is a large infrastructure project that was launched by the Eurosystem in 2007 to stimulate cross-border settlement harmonisation. The Eurosystem is the monetary authority of the Eurozone, consisting of the European Central Bank and the central banks of the Member States that belong to the Eurozone. The current cross-border securities settlement method has been deemed expensive and complex therefore highlighting the need for updated methodology. The aim of T2S is to reform the European post-trading industry by providing a single pan- European platform for securities settlement in central banking money. The removal of differences between domestic and cross-border settlement by creating a single set of standards to be extended to all transactions across the EU A reduction in collateral and liquidity needs Direct account management by users A definition of new standards, not limited to the settlement system The progressive abolition of domestic specificities The T2S system will support central securities depositories (CSDs) Promotion of competition changing a settlement to become a commodity and providing a clear distinction between settlement and custody. Additionally, the fees associated with cross-border transactions will be lowered, with the intention of making the securities market more competitive and attractive T25 goes live including the first wave of implementation 3rd wave of implementation nd wave of implementation 4th wave of implementation 42 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

23 CASS 5 Review UK Drafted Insurance Intermediaries CASS 5 is chapter 5 of the FCA s Client Assets Sourcebook. This chapter sets out the client money rules for insurance intermediaries. The rules require firms to arrange adequate protection for clients money when they are responsible for it. The FCA is concerned that the current rules are not well understood, which could result in client money not being adequately protected. Therefore, on 28 August 2012 the FSA (the FCA s predecessor) issued a consultation paper (CP12/20) in which it proposed significant changes to the client money rules. It also proposed to delete the existing CASS 5 rulebook and replace it with the new, clearer and easier to apply CASS 5A. CASS 5A comprises new rules designed to enhance the protection of client money and clarify certain existing rules. The proposed new rules will require firms to adapt or implement new processes and designate further resources to CASS compliance. Increasing the frequency of the client money calculation from monthly to weekly calculations Restricting the length of time that credit can be advanced to clients and insurers under a non-statutory trust Prohibiting conditional risk transfer Allowing credit-write backs to be made for a limited period of time, after which new unclaimed money rules will come into effect The final rules are expected to be published in the second half of. Once published there is likely to be a 12 month period before implementation. The unclaimed money rules will come into effect after the credit-write back provisions expire. 44 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK

24 Solvency II European Insurance Solvency II is a European driven initiative, led by the European Insurance and Occupational Pensions Authority (EIOPA) designed to create a consistent risk based approach to calculating capital requirements for insurers and reinsurers. In addition, it seeks to establish a rigorous supervisory framework and clear reporting and disclosure system, thereby making it easier for insurers and reinsurers, within the EU, to operate across borders. Building on its predecessor Solvency I and the more recent Individual Capital Adequacy Standards (ICAS) regime, Solvency II introduces a more sophisticated regime which promotes a range of risk-based capital and solvency requirements. This is, in part, achieved by modernising the frameworks of risk management and corporate governance by introducing updated methods of combing risk and capital management. The overarching intention is to increase the level of policyholder protection, reduce the probability of customer loss, and minimise disruptions to the insurance market. Pillar 1: Capital Requirements quantitative requirements, such that insurers and reinsurers are mandated to have adequate financial resources to meet their solvency needs. The Solvency Capital Requirement (SCR) is the capital required to ensure that the insurance company will be able to meet its obligations over the next 12 months with a probability of at least 99.5%. In addition to the SCR a Minimum Capital Requirement (MCR) must be calculated which represents the threshold below which the national supervisor (regulator) would intervene. The MCR is intended to correspond to an 85% probability of adequacy over a one year period and is bounded between 25% and 45% of the SCR Pillar 2: Systems of Governance qualitative requirements, requiring an embedded risk management system which promotes prudent governance and the ability to manage, measure and identify material risks. Effective systems of governance must also be established around certain key functions, including: risk management, compliance, internal audit and actuarial. A key new element of Solvency II is the Own Risk and Solvency Assessment (ORSA). As a forward looking tool, the ORSA intends to align the risk profile of the firm with features such as risk appetite, business plans and capital requirements Pillar 3: Reporting and Disclosure in attempting to engrain market discipline and a consistent approach to disseminating information to the market and other stakeholders, firms are required to establish robust systems and controls to meet reporting and disclosure requirements. Key reports firms will need to comply with include the Solvency and Financial Condition Report (SFCR), the Regular Supervisory Report (RSR) and the Quantitative Reporting Templates (QRTs) No definitive implementation timeline for Solvency II has been produced, the Chairman of EIOPA Gabriel Bernardino, stated in October 2012 that the 1 January 2014 implementation date was completely out of reach. With the most likely implementation date coming in either 2015 or Whereas Andrew Bailey, CEO of the Prudential Regulation Authority (PRA), has indicated to firms that the regulator does not expect implementation until at least FINANCIAL SERVICES GROUP REGULATORY HANDBOOK 2014 FINANCIAL SERVICES GROUP REGULATORY HANDBOOK