Master Class: Index Regulation and Outsourcing Index Administration

Transcription

1 Master Class: Index Regulation and Outsourcing Index Administration Thursday, July 28, :30 a.m. 9:30 a.m. Morrison & Foerster LLP 250 West 55 th Street New York, NY Speakers: Lloyd Harmetz, Partner, Morrison & Foerster LLP Mark Schaedel, Managing Director, IHS Markit 1. Presentation Index Administrators: The U.S. and European Regulatory Background 2. Morrison & Foerster Client Alert Setting the New Benchmark: EU Regulation on Financial Benchmarks 3. Morrison & Foerster Newsletter Structured Thoughts Volume 7, Issue 7 4. Morrison & Foerster Newsletter Structured Thoughts Volume 7, Issue 6 5. Morrison & Foerster Newsletter MoFo Tax Talk Volume 9, Issue 1 6. Morrison & Foerster User Guide The Long Long Game: The EU Financial Regulatory Agenda Into 2016 and Beyond

2 mofo.com Index Administrators: The U.S. and European Regulatory Background July 28, 2016 Presented By Lloyd Harmetz Morrison & Foerster LLP ny

3 Developments that Are Shaping the Index Administration Function U.S. and European regulations. Enhanced regulatory focus. Compliance culture and conflicts of interest. Reputational questions global media attention. Investor expectations? 2

4 U.S. Compliance Aspects 3

5 Proprietary Indices Proprietary index information If an affiliate of the investment bank, or a group within the investment bank, creates or maintains the index, then that index provider must be walled off from those who structure and market the product Those who create and market the structured product cannot influence the index features or its components NYSE Arca Equity Rule 5.2(j)(6)(C): If the value of an Index-Linked Security listed under Rule 5.2(j)(6) is based in whole or in part on an index that is maintained by a broker-dealer, the broker-dealer shall erect a firewall around the personnel responsible for the maintenance of such index or who have access to information concerning changes and adjustments to the index, and the index shall be calculated by a third party who is not a broker-dealer A separate group within the investment bank is typically responsible for any index development Who owns the index within the investment bank once it has been created? 4

6 Proprietary Indices (cont d) Window cleaning If the index concentrates in a few equity securities (i.e., a narrow-based index), the issuer of the product and the broker-dealer selling the product should perform "window cleaning" procedures Window cleaning procedures are comparable to those used when issuing a product linked to a small basket of stocks, or when linking to a non-proprietary index that has a high concentration in a particular security These procedures should prevent the issuance of a product linked to a security with respect to which the broker-dealer possesses material non-public information, or as to which the broker-dealer's research arm has a negative rating or recommendation o Concerns diminish somewhat when there are a large number of index constituents 5

7 Third-Party Indices If the index was initially generated by a third-party provider Perform diligence on the third-party provider o o o What is the provider s experience in the area? Does the provider conduct internal reviews to ensure that the index methodology is consistently and accurately applied? What is the index s history? Is the third-party provider a regulated entity? o To the extent the third party is itself a broker-dealer or an RIA, compliance and diligence process likely will be more easily addressed Ensure that the index sponsor has protections in place against the misuse of material, nonpublic information 6

8 Regulatory Hot Buttons FINRA Report on Conflicts of Interest Focuses on potential conflicts arising when an index calculation agent is an affiliate of the issuer or the underwriter Highlights that in the context of a structured product the performance of which is linked to a proprietary index (created and maintained by the product issuer) there may be hidden costs, which may be high and may be difficult for an investor to assess Assessing the structure and composition of the index will become more of a focus o o o o Are there any index adjustment factors or fees that might suggest that the index is a managed index? Are there other embedded fees? If there are roll costs or transaction costs incorporated in the index that are designed to replicate cost of investing in the strategy directly, then confirm that those costs do not include any broker-dealer compensation If there are costs incorporated into the index that are intended to account for hedging, then ensure that mid-market prices are used 7

9 Index Governance Regardless of whether ESMA-EBA guidance or EU legislation will be applicable to your institution, conducting an audit of indices is useful Consider, among other things, the following: Formalizing in policies and procedures the approval process for a new index Review existing indices o Identify who owns the index within the bank o Ensure that there is a process for periodic index reviews o Is there a written index methodology? Who reviews and maintains? o Do policies and procedures address changes to the index, consultation regarding index changes and publication of changes, etc.? o Is there a policy in place to ensure any quotes or pricing data is obtained from third party sources? Is this audited or reviewed? o If internal sources are used for pricing purposes, is this disclosed? o Is there a third party calculation agent? o Is there written calculation agreement? 8

10 Index Governance (cont d) Is there a stated purpose for the index? How is the index used? Is it used to benchmark performance of funds? To replicate a strategy? Was the index created at the request of a client? Does client maintain any discretion over the index? Are the appropriate information walls in place? Are these tested? Have all of the actual/potential conflicts of interest been identified and disclosed? 9

11 European Union: Benchmark Regulation 10

12 Background Focus on financial benchmarks following investigations into manipulation of setting of LIBOR, EURIBOR and other financial benchmarks UK Wheatley Review led to reform of LIBOR In the UK, the FCA has subsequently brought other specific benchmarks into its regulatory ambit: SONIA (Sterling Overnight Index Average) WM/Reuters closing spot rate ISDA FIX London gold fixing and LMBA silver price ICE Brent Index 11

13 Background (cont d) In July 2013, IOSCO published a Final Report on Principles for Financial Benchmarks In September 2013, the EU Commission published a draft Regulation seeking to regulate benchmark administrators, contributors and users EU Regulation was adopted by the EU Parliament in April 2016 and subsequently adopted by the EU Council on 17 May 2016 Published in the EU Official Journal on June 29, 2016 became effective the following day June 30, 2016 Most provisions of the Regulation will be implemented 18 months after it comes into force (January 1, 2017) except: certain specified provisions will come into effect immediately (principally related to critical benchmarks ) provisions amending the Market Abuse Regulation ( MAR will apply from 3 July

14 Scope of the Regulation Definition of Benchmarks Regulation applies to benchmarks which include: in relation to financial instruments or financial contracts, any index by reference to which the amount payable under such instrument or contract is determined or by which the value of a financial instrument is determined in relation to investment funds, any index that is used to measure the performance of any such fund with the purpose of tracking the return of such index or of defining the asset allocation of a relevant portfolio or in computing performance fees 13

15 Scope of the Regulation Other Definitions Index is defined as any figure that is: published or made available to the public; and regularly determined entirely or partially by the application of a formula or any other method of calculation, or by an assessment and on the basis of the value of one or more underlying assets or prices, actual or estimated interest rates, quotes and committed quotes or other values or surveys ESMA believes an index is available to the public if it is: accessible by a large or potentially indeterminate number of recipients; or provided or is accessible to one or more supervised entities to allow use of the index in the EU 14

16 Scope of the Regulation Other Definitions (cont.) A financial instrument is any instrument listed in Annex I(C) to MiFID II that is either: traded on a trading venue as defined in MiFID II; or is the subject of a request made for admission to trading on a trading venue; or traded via a systematic internaliser (typically an investment bank/broker-dealer) under MiFID II A financial contract is any credit agreement within the ambit of the Consumer Credit Directive or the Mortgage Credit Directive (EU consumer credit agreements and residential mortgages) An investment fund is: an AIF as defined in the AIFMD; and a UCITS funds as defined in the UCITS IV Directive 15

17 Scope of the Regulation - Exemptions There are certain entities to whom the Benchmark Regulation will not apply including: central banks public authorities contributing data or having control over the provision of a benchmark for public policy reasons CCPs in their capacity of providing reference prices or settlement prices used for risk management purposes and settlement the provision of a single reference price for any financial instrument commodity benchmarks based on submissions from contributors where the majority are nonsupervised entities if the benchmark is referenced by financial instruments traded (or the subject of a trading application) on a trading venue and the total notional value of financial instruments referencing the benchmark does not exceed 100 million the provider of an index that is unaware and could not reasonably have been aware that the index is used as a benchmark (These exemptions aren t particularly helpful as to structured products.) 16

18 Benchmark Administrators An administrator is any natural or legal person that has control over the provision of a benchmark: no specific guidance as to meaning of control Any benchmark administrator located in the EU must apply to its relevant competent authority for authorisation if it provides or intends to provide indices for use as benchmarks under the Regulation Benchmark administrators supervised under the relevant EU financial regulation only need to be registered with the relevant competent authority Transitional provisions apply to entities already providing benchmarks on the date the Benchmark Regulation comes into force: such entities have 42 months to apply for authorisation or registration transitional rules only apply in relation to indices being provided at the time the Regulation came into force 17

19 Benchmark Administrators (cont.) Benchmark administrators are subject to a number of requirements aimed at maintaining the integrity and reliability of the relevant benchmarks including: robust governance requirements including in relation to identification and prevention or management of conflicts of interest oversight function requirements control framework requirements accountability framework requirements recording keeping requirements controls over outsourcing of functions requirements in relation to input data requirements relating to benchmark methodology reporting of infringements code of conduct to be developed for each contributor to a benchmark 18

20 Commodity Benchmarks Administrators of commodity benchmarks are subject to additional requirements Benchmark administrator must formalise, document and make public any methodology the administrator uses for the benchmark calculation Administrator must also specify the criteria that define the physical commodity that is the subject of a particular methodology Priority to be given to concluded and reported transactions in respect of input data Commodity benchmarks cannot benefit from the regime applicable to significant or non-significant benchmarks Commodity benchmarks with gold, silver or platinum as the underlying asset that are critical benchmarks can comply with the general rules rather than the specific commodity rules 19

21 Interest Rate Benchmarks Specific requirements also apply for interest rate benchmarks The priority of use of input data for such benchmarks is: a contributor s transactions in the underlying market that the benchmark is intended to measure (or, if not sufficient, in related markets) a contributor s observation of third party transactions in such markets committed quotes indicative quotes or expert judgments Administrators of interest rate benchmarks must have in place an independent oversight committee Additional record keeping requirements 20

22 Regulated Data Benchmarks A regulated data benchmark is determined by the application of a formula from input data contributed entirely and directly from certain regulated venues Regulated data benchmarks are exempt from certain of the governance and control requirements that would otherwise apply, including: requirements relating to input data the need to develop a code of conduct for contributors 21

23 Critical Benchmarks EU Commission must adopt implementing legislation to establish and review a list of critical benchmarks provided by benchmark administrators located in the EU: review must be at least every two years A benchmark is a critical benchmark if one of the following applies: the benchmark is used directly or indirectly within a combination of benchmarks as a reference for financial instruments or financial contracts, or for measuring the performance of investment funds, having a total value of at least 500 billion on the basis of all the range of maturities or tenors of the benchmark; or the benchmark is based on submissions by contributors, the majority of which are located in one member state, and is recognised as being critical by the relevant competent authority in accordance with criteria specified in the Benchmark Regulation; or the benchmark fulfils all of the following: o o it meets all the criteria specified in relation to the first bullet point above but with a total value of at least 400 billion it has no, or very few, appropriate market-led substitutes 22

24 Critical Benchmarks (cont d) o if the benchmark ceases to be provided or is provided on the basis of input data no longer fully representative of the underlying market or economic reality or on the basis of unreliable input data, there would be a significant and adverse impact on market integrity, financial stability, consumers, the real economy or the financing of households and businesses in one or more member states Critical benchmarks are subject to additional requirements: the relevant competent authority must establish a supervisory college in respect of each critical benchmark, comprising the competent authority of the administrator, ESMA and the competent authority of all supervised contributors to the benchmark the administrator must take adequate steps to ensure the licences of, and information relating to, the benchmark are provided to all users on a fair, reasonable, transparent and non-discriminatory basis the administrator must, at least every two years, submit to its relevant competent authority an assessment of the capability of the benchmark to measure the underlying market or economic reality 23

25 Critical Benchmarks (cont d) An administrator of a critical benchmark is subject to specific rules if it intends to cease providing the benchmark: must notify relevant competent authority within four weeks, it must prepare an assessment of how such benchmark is to be transitioned or cease to be provided competent authority will liaise with supervisory college and make its own assessment competent authority may require administrator to continue to provide benchmark until transitioned to a new administrator or if the benchmark has ceased to be provided in an orderly manner or is no longer critical such requirement can be for up to 12 months (and may be extended by a further 12 months) These rules will apply from the date the Benchmark Regulation comes into force 24

26 Critical Benchmarks (cont d) A supervised contributor to a critical benchmark must notify the administrator if it intends to cease to contribute input data in respect of the benchmark: administrator must notify relevant competent authority within 14 days, the administrator must submit assessment to competent authority of the implications of the benchmark to continue to measure the underlying market or economic reality without contributions from such contributor competent authority can require contributor to continue to provide input data during this period (but no obligation to trade) competent authority will make its own assessment in consultation with the supervisory college on basis of such assessment, the authority can require supervised entities to continue to provide input data for up to 12 months (which can be extended by a further 12 months) These rules will apply from the date the Benchmark Regulation comes into force 25

27 Significant and Non-Significant Benchmarks A benchmark that is not a critical benchmark will be regarded as a significant benchmark if: it is used directly or indirectly within a combination of benchmarks as a reference for financial instruments or financial contracts, or for measuring the performance of investment funds, having a total average value of at least 50 billion on the basis of all the range of maturities or tenors of the benchmark over a period of six months; or it has no or very few appropriate market-led substitutes and, if the benchmark were to be no longer provided or provided on the basis of input data not representative of the underlying market or economic reality, there would be a significant and adverse impact on market integrity, financial stability, consumers, the real economy or the financing of households or businesses in member state(s) Any benchmark that is not a critical or significant benchmark is a non-significant benchmark 26

28 Significant and Non-significant Benchmarks (cont d) Administrators of a significant benchmark may, on a comply or explain basis, seek not to apply certain provisions of the Benchmark Regulation including: the need to operationally separate the provisions of a benchmark from parts of its business for conflicts of interest purposes provisions relating to diligence of employees and contributors Competent authority may, however, determine that one or more of such provisions should still apply to the relevant administrator Administrators of non-significant benchmarks can seek to disapply on a comply or explain basis a wider list of provisions, including many specific requirements relating to the oversight function and the control function: administrator must prepare a compliance statement setting out reasons to disapply such provisions competent authority must review compliance statements and can require changes 27

29 Contributors A contributor is a natural or legal person contributing input data in respect of a benchmark Where a benchmark is based on input data from contributors, the administrator must develop a code of conduct for the benchmark, setting out the contributor s responsibilities in relation to the contribution of input data Code of conduct must contain certain elements including: clear description of the input data to be provided and the requirements necessary to ensure it complies with requirements of the Benchmark Regulation identification of persons that may contribute input data policies to ensure a contributor provides all relevant input data systems and controls a contributor is required to have in place 28

30 Contributors (cont d) Contributors that are supervised entities are subject to certain requirements, including: a requirement to ensure that the provision of input data is not affected by any existing or potential conflict of interest establishment of a control framework ensuring the integrity, accuracy and reliability of input data establishment of effective systems and controls to ensure the integrity and reliability of all contributions of input data 29

31 Restrictions on Use of Benchmarks in the EU A supervised entity will only be permitted to use a benchmark in the EU if it is provided by an administrator authorised or registered under the Benchmark Regulation Use of a benchmark means: issuance of a financial instrument which references an index or combination of indices determination of the amount payable under a financial instrument or a financial contract by referencing an index or combination of indices being a party to a financial contract which references an index or a combination of indices providing a borrowing rate calculated as a spread or mark-up over an index or combination of indices, solely used as a reference in financial contract(s) measuring the performance of an investment fund through an index or combination of indices for the purpose of tracking the return thereof or defining the asset allocation of a portfolio or computing performance fees 30

32 Restrictions on Use of Benchmarks in the EU (cont d) Supervised entities are not prevented from acquiring, holding or trading a financial instrument that references an index where the administrator is non-compliant with the Benchmark Regulation Parties to an OTC derivative referencing a benchmark are considered to issue a financial instrument Supervised entities that use a benchmark must produce robust written plans setting out the actions they would take if the benchmark should materially change or cease to be provided 31

33 Non-EU Benchmarks Where a non-eu administered benchmark is already used in the EU on the date the Benchmark Regulation comes into force, the Benchmark Regulation grandfathers the use of the benchmark for existing financial instruments, financial contracts or investment funds for 42 months Where grandfathering is not available, there are three alternative routes through which a benchmark administrator located outside the EU can facilitate the use of their benchmarks in the EU: equivalence recognition endorsement 32

34 Non-EU Benchmarks Equivalence ESMA may register a non-eu benchmark administrator and the benchmark if: an equivalence decision is adopted by the EU Commission for the jurisdiction where the administrator is located; the administrator is authorised or registered and subject to supervision in such jurisdiction; the administrator notifies ESMA of its consent to the benchmark(s) being used by supervised entities in the EU; and co-operation arrangements are in place between ESMA and the relevant authority in the administrator's jurisdiction (must cover at least the mechanism for exchange of information between ESMA and competent authority in the non-eu jurisdiction and procedures concerning the coordination of supervisory activities) 33

35 Non-EU Benchmarks Equivalence (cont d) The EU Commission may make an equivalence decision if: administrators authorised or registered in the non-eu jurisdiction comply with binding requirements equivalent to those under the Benchmark Regulation; or it is satisfied that binding requirements in the relevant jurisdiction with respect to specific administrators or specific benchmarks are equivalent to the requirements under the Benchmark Regulation taking into account whether the legal framework and supervisory practice complies with the IOSCO principles In each case, the EU Commission must be satisfied that such administrators are subject to effective supervision and enforcement on an ongoing basis At present, there may be limited scope for equivalence decisions to be made 34

36 Non-EU Benchmarks Recognition Until an equivalence determination is made in relation to a non-eu jurisdiction, benchmarks administered in that jurisdiction may be used by supervised entities in the EU provided the non-eu administrator obtains prior recognition by its member of state of reference in the EU Member state of reference is determined by various criteria including: location of affiliated supervised entities location of relevant trading venues for financial instruments referencing relevant benchmarks location of supervised entities using the benchmarks Relevant non-eu administrators will need to comply with the vast majority of the obligations that apply to EU administrators under the Benchmark Regulation: this may be fulfilled by compliance with the IOSCO Principles if the relevant EU national competent authority determines such principles to be equivalent to compliance with the Benchmark Regulation 35

37 Non-EU Benchmarks Recognition (cont d) The non-eu administrator must have a legal representative to perform an oversight function in respect of such benchmarks: legal representative is accountable to competent authority of member state of reference Challenges for recognition process: identification of member state of reference obtaining certification of compliance with IOSCO principles appointment of legal representative 36

38 Non-EU Benchmarks Endorsement A non-eu administrator can register benchmarks for use in the EU if there is an application to the relevant competent authority to endorse the use of the relevant benchmark in the EU by: a benchmark administrator supervised in the EU; or another supervised entity located in the EU with a clear and well-defined role within the control or accountability framework of the non-eu administrator; and which, in each case, is able to monitor effectively the provision of the relevant benchmark The relevant competent authority must be satisfied as to the satisfaction of certain conditions before it can make such an endorsement including: the endorsing administrator or other supervised entity has verified and is able to demonstrate on an ongoing basis to the competent authority that the provision of the benchmark fulfils (on a mandatory or voluntary basis) requirements at least as stringent as under the Benchmark Regulation 37

39 Non-EU Benchmarks Endorsement (cont d) the endorsing administrator or other supervised entity has the necessary expertise to monitor the provision of the benchmark and manage the associated risks there is an objective reason to provide the benchmark in the non-eu jurisdiction and for it to be endorsed for use in the EU In determining whether the provision of the benchmark fulfils requirements at least as stringent as under the Benchmark Regulation, the competent authority may take into account whether the provision of the benchmark complies with the IOSCO principles. 38

40 Supervision and Enforcement National competent authorities have wide-ranging powers to ensure compliance with the Benchmark Regulation including: right to request documents and data ability to carry out on-site inspections and investigations right to require corrective statements about past contributions ability to suspend trading of any financial instrument that references a benchmark Competent authorities have the power to impose sanctions upon entities or individuals that breach the Benchmark Regulation including: withdrawal or suspension of an authorisation disgorgement of profits imposition of fines 39

41 Amendments to MAR and other Legislation The Regulation makes amendments to the Market Abuse Regulation ( MAR ), including exempting persons discharging managerial responsibilities in relation to an issuer of securities from the requirements to disclose transactions in financial instruments linked to securities of the issuer where such securities provide an exposure not exceeding 20% of the issuer s shares or debt instruments. Mortgage Credit Directive amended: lenders must disclose the name of any benchmarks referenced in relevant mortgage loans, the name of the benchmark administrator and potential implications to the consumer from use of the benchmark. 40

42 ESMA Consultation Paper ESMA Discussion Paper February 2016 ESMA Consultation Paper on 27 May 2016 set out proposals in relation to technical advice to be provided to the EU Commission in relation to: certain elements of the definitions, including when a benchmark is made available to the public and what constitutes the issuance of a financial instrument for the purpose of defining the use of a benchmark in the EU. measurement of the reference value of a benchmark criteria for identification of critical benchmarks framework for endorsement of benchmarks provided by a non-eu benchmark administrator transitional provisions Responses to Consultation Paper were due by 30 June 2016 ESMA expected to publish a further Consultation Paper with draft RTS and ITS in Q3 or Q

43 Client Alert 13 June 2016 Setting the New Benchmark: EU Regulation on Financial Benchmarks Background The integrity of benchmarks used in financial transactions has been the subject of increasing focus from regulators since the investigations into manipulation of the setting of LIBOR, EURIBOR and other benchmarks. Action was taken in the UK following the Wheatley Review of LIBOR 1 to reform the setting and usage of LIBOR, and the UK Financial Conduct Authority (FCA) has subsequently taken action to regulate additional specific financial benchmarks 2. At an international level, in July 2013, the International Organisation of Securities Commissions (IOSCO) published its Final Report on Principles for Financial Benchmarks 3. Shortly thereafter, the EU Commission published a draft regulation seeking to establish a pan-european approach to the regulation of benchmark administrators, contributors and users. The subsequent legislative process has been lengthy and has involved significant amendments to the initial draft. However, on 17 May 2016, the European Council of Ministers formally adopted the final version of the Regulation on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds (the Benchmark Regulation ) which had previously been adopted by the EU Parliament. It published what is expected to be the final version of the Benchmark Regulation on 10 June The Benchmark Regulation will come into force the day after it is published in the Official Journal of the EU. This is expected to happen in June or early July Most of its provisions will not, however, be implemented until 18 months after such date (so December 2017 or January 2018) with the exception of some provisions that will apply immediately upon it coming into force and provisions amending the Market Abuse Regulation 5 (which will apply from 3 July 2016 to dovetail with the Market Abuse Regulation becoming effective). 1 finalreport_ pdf. 2 SONIA (Sterling Overnight Index Average), RONIA (Repurchase Overnight Index Average), WM/Reuters London 4pm Closing Spot Rate, ISDAFIX, London Gold Fixing, the LMBA Silver Price and the ICE Brent Index Regulation 596/2014, Attorney Advertisement

44 Scope of Regulation The Benchmark Regulation will apply to a very wide range of indices, including proprietary indices, which are used as benchmarks in financial instruments. The key definitions in this context include the following: Benchmark: There are two elements to this definition: in relation to financial instruments or financial contracts, any index by reference to which the amount payable under such instrument or contract is determined, or by which the value of a financial instrument is determined; in relation to investment funds, any index that is used to measure the performance of any such fund with the purpose of tracking the return of such index or of defining the asset allocation of a relevant portfolio or in computing performance fees. Index: This is defined as any figure that is: published or made available to the public; and regularly determined (i) entirely or partially by the application of a formula or any other method of calculation, or by an assessment, and (ii) on the basis of the value of one or more underlying assets or prices including estimated prices, actual or estimated interest rates, quotes and committed quotes, or other values or surveys. In draft technical advice referred to further below, the European Securities and Markets Authority (ESMA) provides that an index should be deemed to be made available to the public if (i) it is accessible by a large or potentially indeterminate number of recipients, or (ii) it is provided or is accessible to one more supervised entities to allow use of the index in the EU. Financial instrument: Any instrument listed in Annex I(C) to MiFID II 6 that is either traded on a trading venue (as defined in MiFID II) or is the subject of a request made for admission to trading on a trading venue or via a systematic internaliser 7. The instruments listed in Annex I(C) of MiFID II are very wide and include transferable securities, money-market instruments, UCITS, a very wide range of derivative transactions and financial contracts for difference. Financial contract: Any credit agreement within the ambit of the Consumer Credit Directive 8 or the Mortgage Credit Directive 9 (basically EU consumer credit agreements and residential mortgages). Investment fund: An alternative investment fund (AIF) as defined in the Alternative Investment Fund Managers Directive (AIFMD) 10, or a UCITS fund as defined in the UCITS IV Directive The recast Markets in Financial Instruments Directive, Directive 2014/65/EU, 7 investment firms which, on an organised, frequent, systematic and substantial basis, deal on own account by executing client orders outside a regulated market, MTF or organised trading facility as defined in MiFID II. 8 Directive 2008/48/EC, 9 Directive 2014/17/EC, 10 Directive 2011/61/EC, 11 Directive 2009/65/EC, 2 Attorney Advertisement

45 The Benchmark Regulation therefore diverges from the existing approach to regulation of benchmarks by the FCA and other regulators which have to date focused on a small number of key benchmarks that are widely used in the financial markets and which are regarded as systemically important. In contrast, the Benchmark Regulation will, subject to limited exceptions, apply to all indices used in financial securities or derivatives traded on a regulated venue in the EU or traded outside such a venue, using an investment firm designated as a systematic internaliser under MiFID II. Although the definition of index limits the scope of the Benchmark Regulation to indices that are published or made available to the public, this is likely to be construed widely with the draft ESMA technical standards recommending that an index should be considered as being made available to the public even if only provided to supervised entities to allow use of the index in the EU. To ameliorate the impact of the vastly increased number of benchmarks to become subject to regulation and supervision in the EU under the Benchmark Regulation, the Regulation distinguishes between critical, significant and non-significant benchmarks as specified further below with differing standards of regulatory requirements applying to each category. The Benchmark Regulation will not, however, apply to the following: central banks; public authorities, in respect of such an authority contributing data to or having control over the provision of benchmarks for public policy purposes (e.g., indices measuring employment, economic activity or inflation); central counterparties (CCPs) in their capacity of providing reference prices or settlement prices used for CCP risk-management purposes and settlement; the provision of a single reference price for any financial instrument; commodity benchmarks based on submissions from contributors, the majority of which are non-supervised entities, provided that the benchmark is referenced by financial instruments for which a request for admission to trading has been made on only one trading venue or which are traded on only one trading venue, and the total notional value of financial instruments referencing the benchmark does not exceed 100 million; an index provider, in respect of an index provided by it where such provider is unaware and could not reasonably have been aware that the index is used as benchmark within the scope of the Benchmark Regulation. Regulation and Supervision of Benchmark Administrators One of the key elements of the Benchmark Regulation is a new regulatory and supervisory regime that will apply to administrators of benchmarks that fall within the scope of the Benchmark Regulation. For these purposes, an administrator is any natural or legal person that has control over the provision of a benchmark. There is no guidance as to the meaning of control for this purpose, but the definition is likely to be construed fairly widely so any person or entity involved in producing a financial benchmark should consider whether it comes within the scope of the Benchmark Regulation as a benchmark administrator. Title VI of the Benchmark Regulation requires any benchmark administrator that is located in the EU to apply to its relevant competent authority for authorisation to act in such capacity if it provides or intends to provide 3 Attorney Advertisement

46 indices for use as benchmarks within the scope of the Benchmark Regulation. There is a registration regime for entities supervised under other relevant EU regulation (including credit institutions, MiFID investment firms, insurance and reinsurance undertakings, UCITS funds and managers, AIFs regulated under the AIFMD and CCPs and trade repositories regulated under EMIR 12 ). Benchmark administrators only need to be registered (rather than authorised) with their competent authority if they are only providing indices that are non-significant benchmarks (see further below). There are also transitional provisions for benchmark administrators that are already providing benchmarks on the date the Benchmark Regulation comes into force. Such entities will have 42 months from such date to apply for authorisation or registration, as applicable. Until the end of that 42-month period (or, if earlier, until any application for authorisation or registration during that time is refused), such existing administrators may continue to provide such existing benchmark(s). If such administrator wants to provide a new benchmark after the Benchmark Regulation becomes effective, it will need to obtain appropriate authorisation or registration prior to doing so. Benchmark administrators are subject to a number of requirements under the Benchmark Regulation aimed at maintaining the integrity and reliability of relevant benchmarks, including: Governance and conflicts of interest: benchmark administrators are required to have in place robust governance arrangements including a clear organisational structure with well-defined transparent and consistent roles and responsibilities for all persons involved in the provision of a benchmark. Administrators will also be required to take adequate steps to identify and prevent or manage conflicts of interest and to ensure that where any judgment or discretion is required in the benchmark determination process, it is exercised independently and honestly. The provision of the benchmark must be operationally separated from any part of the administrator s business that may create an actual or potential conflict of interest. Oversight function requirements: benchmark administrators will be required to establish and maintain a permanent and effective oversight function to ensure oversight of all aspects of the provision of their benchmarks. They will be required to develop and maintain robust procedures regarding their oversight function and make this available to the relevant competent authorities. Control framework requirements: it will be necessary for benchmark administrators to have in place a control framework that ensures benchmarks are provided and published or made available in accordance with the Benchmark Regulation. The framework must be reviewed and updated as appropriate and made available to the relevant competent authority and, upon request, users of the benchmark. Accountability framework requirements: benchmark administrators will be required to have in place an accountability framework covering record-keeping, auditing and review and a complaints process. Record-keeping: record-keeping requirements provide that benchmark administrators must keep various records, including records of all data, the methodology used for the determination of a benchmark, exercises of judgment or discretion by the benchmark administrator and changes in or deviations from standard procedures and methodologies, including those made during periods of market stress or disruption. Records should be kept for a period of at least five years. 12 European Market Infrastructure Regulation ( EMIR ), Regulation 648/2012, 4 Attorney Advertisement

47 Outsourcing: benchmark administrators must not outsource functions in the provision of a benchmark in such a way as to impair materially the administrator s control over the provision of the benchmark or the ability of the relevant competent authority to supervise the benchmark. The administrator must comply with certain specified conditions when outsourcing any functions, including ensuring that the service provider has the ability, capacity and any applicable authorisations to perform the outsourced functions, services or activities reliably and professionally. Input Data: various requirements apply to input data, including that it should be sufficient to represent accurately and reliably the market or economic reality that the benchmark is intended to measure. The input data must be transaction data if available and appropriate. If transaction data is not sufficient or is not appropriate to represent accurately and reliably the market or economic reality that the benchmark is intended to measure, input data which is not transaction data may be used, including estimated prices, quotes and committed quotes or other values. ESMA is required to develop draft regulatory technical standards to specify further how to ensure that input data is appropriate and verifiable. Methodology: benchmark administrators are required to use a methodology for determining a benchmark that is robust and reliable, has clear rules identifying how and when discretion may be exercised in the determination of that benchmark and is rigorous, continuous and capable of validation including, where appropriate, back-testing against available transaction data. The methodology must also be resilient in a wide set of possible circumstances and be traceable and verifiable. The benchmark administrator must also develop, operate and administer the benchmark and methodology transparently. Reporting of infringements: benchmark administrators will be required to report to the relevant competent authority any conduct that may involve manipulation or attempted manipulation of a benchmark under the Market Abuse Regulation and in this regard must monitor input data and contributors in order to be able to make any such notifications. Code of conduct for contributors: where a benchmark is based on input data from contributors, the benchmark administrator must develop a code of conduct for each benchmark clearly specifying contributors responsibilities with respect to the contribution of input data. This code of conduct shall contain the elements specified in the Benchmark Regulation. ESMA is required to develop draft regulatory technical standards to specify further the elements of the code of conduct. Requirements for Specific Types of Benchmark Commodity benchmarks: administrators of commodity benchmarks will be subject to additional requirements set out in Annex II of the Benchmark Regulation. These require the benchmark administrator to formalise, document and make public any methodology that the administrator uses for the benchmark calculation. It must also specify the criteria that define the physical commodity that is the subject of a particular methodology and give priority to concluded and reported transactions in respect of its input data. A commodity benchmark also cannot benefit from any of the exclusions relating to significant or non-significant benchmarks specified below. However, if a commodity benchmark which has gold, silver or platinum as the underlying asset is a critical benchmark, it will be able to comply with the rules generally relevant to financial benchmarks rather than the specific commodity rules. 5 Attorney Advertisement

48 Interest rate benchmarks: specific requirements set out in Annex I of the Benchmark Regulation will apply to interest rate benchmarks. These provide that the general priority of use of input data for such benchmarks will be: a contributor s transactions in the underlying market that the benchmark is intended to measure or, if not sufficient, in related markets; a contributor s observations of third-party transactions in such markets; committed quotes; indicative quotes or expert judgments. The administrator of an interest rate benchmark must also have in place an independent oversight committee and ensure that a contributor s systems and controls include specific matters set out in Annex I. Additional record keeping requirements also apply, including in relation to input data and names and responsibilities of submitters (defined as a natural person employed by a contributor for the purpose of contributing input data). Regulated data benchmarks: a regulated data benchmark is one that is determined by the application of a formula from input data contributed entirely and directly from certain regulated venues as specified in the Benchmark Regulation. Such benchmarks will be exempt from certain of the governance and control requirements that would otherwise apply under the Benchmark Regulation, including in relation to input data and the need to develop a code of conduct for contributors. Regulated data benchmarks may benefit from the provisions relating to significant and non-significant benchmarks if used as a reference for financial instruments or financial contracts or for measuring the performance of investment funds, having a total value of up to 500 billion on the basis of all the range of maturities or tenors of the benchmark, where applicable. Critical Benchmarks The EU Commission is required to adopt implementing legislation to establish and review, at least every two years, a list of critical benchmarks provided by benchmark administrators located in the EU. To be categorised as a critical benchmark, one of the following requirements must apply: the benchmark is used directly or indirectly within a combination of benchmarks as a reference for financial instruments or financial contracts or for measuring the performance of investment funds having a total value of at least 500 billion on the basis of all the range of maturities or tenors of the benchmark; or the benchmark is based on submissions by contributors, the majority of which are located in one member state and is recognised as being critical by the relevant competent authority in accordance with criteria specified in the Benchmark Regulation; or the benchmark fulfils all of the following: (i) it meets all the criteria specified in relation to the first bullet point above but with a total value of at least 400 billion, (ii) the benchmark has no, or very few, appropriate market-led substitutes and (iii) in the event that the benchmark ceases to be provided or is provided on the basis of input data no longer fully representative of the underlying market or economic reality or on the basis of unreliable input data, there would be a significant and adverse impact on market integrity, financial 6 Attorney Advertisement

49 stability, consumers, the real economy or the financing of households and businesses in one or more member states. Critical benchmarks will be subject to additional requirements: the relevant competent authority shall establish a supervisory college in respect of each critical benchmark comprising the competent authority of the administrator, ESMA and the competent authorities of all supervised contributors to the benchmark; if the administrator of a critical benchmark intends to cease providing such benchmark, it must immediately notify its competent authority and within four weeks submit an assessment of how such benchmark is to be transitioned to a new administrator or is to cease to be provided. The administrator shall not cease to provide the benchmark during this four-week period. During this time the relevant competent authority shall liaise with the relevant supervisory college and make its own assessment of how the benchmark should be transferred to a new administrator or cease to be provided. At the end of this period, the competent authority has the power to compel the administrator to continue providing the benchmark until the benchmark has been transitioned to a new administrator or has ceased to be provided in an orderly manner or is no longer critical. The period in respect of which the competent authority may compel the administrator to continue to provide the benchmark cannot exceed 12 months (which period can be extended by a further 12 months); the administrator is required to take adequate steps to ensure that the licenses of, and information relating to, the benchmark are provided to all users on a fair, reasonable, transparent and non-discriminatory basis; administrators of a critical benchmark are required to submit to their competent authorities every two years an assessment of the capability of such benchmark to measure the underlying market or economic reality; if a supervised contributor to a critical benchmark intends to cease contributing input data in respect of the benchmark, it shall notify the administrator who shall also notify the relevant competent authority. The administrator must, within 14 days, submit to such competent authority an assessment of the implications of the benchmark to continue to measure the underlying market or economic reality. During this time, the competent authority has the power to require contributors to continue contributing input data (provided that this shall not impose an obligation on supervised entities to trade or commit to trade). The competent authority shall liaise with the relevant supervisory college and make its own assessment as to the capability of the benchmark to continue to measure the underlying market or economic reality. On the basis of such assessment, the authority can require supervised entities to continue to provide input data for a period not exceeding 12 months (which period can be extended by a further 12-month period). The above rules in relation to mandatory administration and contribution to critical benchmarks will take effect on the date that the Benchmark Regulation comes into force. Significant and non-significant benchmarks A benchmark that is not a critical benchmark will be regarded as significant if either: it is used directly or indirectly within a combination of benchmarks as a reference for financial instruments or financial contracts or for measuring the performance of investment funds having a total average value of at 7 Attorney Advertisement

50 least 50billion on the basis of all of the range of maturities or tenors of the benchmark over a period of six months; or it has no or very few appropriate market-led substitutes and, in the event that the benchmark would cease to be provided or would be provided on the basis of input data no longer fully representative of the underlying market or economic reality or unreliable data, there would be a significant and adverse impact on market integrity, financial stability, consumers, the real economy or the financing of households or businesses in one or more member states. Any benchmark that is not a critical or significant benchmark is regarded as a non-significant benchmark. The administrator of a significant benchmark may choose not to apply certain provisions of the Benchmark Regulation that would otherwise apply, including the need to operationally separate the provision of a benchmark from parts of its business for conflict of interest reasons, certain of the provisions relating to diligence of employees and personnel and contributors on a comply or explain basis if it considers that complying with such provisions would be disproportionate, having regard to the nature or impact of the benchmark or the size of the administrator. The competent authority may, however, decide that one or more of such provisions should apply to the administrator on the basis of certain specified criteria set out in the Benchmark Regulation. Administrators of non-significant benchmarks may choose not to apply a wider list of provisions from the Benchmark Regulation, including many of the specific requirements relating to the oversight function and control function. Again, this is on a comply or explain basis and requires the preparation of a compliance statement by the administrator explaining why it considers it appropriate not to comply with the relevant provisions. The relevant competent authority may request additional information and may require changes to the compliance statement to ensure compliance with the Benchmark Regulation. Use of Benchmarks in the EU Subject to the provisions relating to non-eu benchmarks below, a supervised entity will only be permitted to use a benchmark in the EU if the benchmark is provided by an administrator authorised or registered under the Benchmark Regulation. The Benchmark Regulation provides that use of a benchmark means: issuance of a financial instrument which references an index or a combination of indices; determination of the amount payable under a financial instrument or a financial contract by referencing an index or a combination of indices; being a party to a financial contract which references an index or a combination of indices; providing a borrowing rate calculated as a spread or mark-up over an index or a combination of indices that is solely used as a reference in a financial contract to which the creditor is a party; or measuring the performance of an investment fund through an index or a combination of indices for the purpose of tracking the return of such index or combination of indices, or defining the asset allocation of a portfolio or of computing the performance fees. 8 Attorney Advertisement

51 The definition does not therefore prevent a supervised entity from acquiring, holding or trading a financial instrument that references an index within the ambit of the Benchmark Regulation. However, parties to an OTC derivative referencing a benchmark would appear to be regarded as issuing a financial instrument so where a supervised entity enters to such a derivative that is traded on a trading venue or where the counterparty is a systematic internaliser, entry into such derivative will be regarded as the use of a benchmark for the purpose of the Regulation. Supervised entities that use a benchmark must produce robust written plans setting out the actions they would take if the benchmark should materially change or cease to be provided. Such plans must be provided to their relevant competent authority upon request. Benchmark Contributors The Benchmark Regulation defines a contributor as a natural or legal person contributing input data in respect of a benchmark. For this purpose, input data must be data not readily available to a benchmark administrator required in connection for the determination of the relevant benchmark. A supervised contributor is any supervised entity that contributes input data to a benchmark administrator located in the EU. Article 15 of the Benchmark Regulation provides that where a benchmark is based on input data from contributors, the benchmark administrator is required to develop a code of conduct for each benchmark clearly specifying the contributors responsibilities with respect to the contribution of input data and shall ensure that such code of conduct complies with the Benchmark Regulation. Administrators must be satisfied that contributors adhere to the code of conduct on a continuous basis. The code of conduct is required to contain certain elements including: a clear description of the input data to be provided and the requirements necessary to ensure it is provided in accordance with the requirements of the Benchmark Regulation relating to input data; identification of the persons that may contribute input data to the administrator and procedures to verify the identity of a contributor; policies to ensure that a contributor provides all relevant input data; and the systems and controls that a contributor is required to provide. Supervised contributors are also subject to certain requirements including: a requirement to ensure that the provision of input data is not affected by any existing or potential conflict of interest; the contributor has in place a control framework that ensures the integrity, accuracy and reliability of input data; it has in place effective systems and controls to ensure the integrity and reliability of all contributions of input data to the administrator including controls as to who may submit input data to an administrator, appropriate training for submitters, measures for the management of conflicts of interest and appropriate record keeping. 9 Attorney Advertisement

52 Non-EU Benchmarks The ability for benchmarks administered outside the EU to continue to be used within the EU has been one of the most difficult and controversial issues during the drafting and negotiation of the Benchmark Regulation. As the EU is significantly ahead of other jurisdictions, including the US, in developing benchmark regulation, and having regard to the very wide scope of the Benchmark Regulation compared to the approach in other jurisdictions, there is a concern that any regime based on allowing non-eu benchmarks to be used in the EU only if subject to equivalent regulation in a non-eu jurisdiction would exclude a vast number of non-eu benchmarks from use in the EU. To deal with some of these concerns, where a non-eu administered benchmark is already used in the EU on the date the Benchmark Regulation comes into force, the Benchmark Regulation provides for the grandfathering of existing financial instruments, financial contracts or investment funds referencing the benchmark for a period of 42 months after such date. In relation to new benchmarks, the Benchmark Regulation provides three alternative routes through which a benchmark administrator located outside the EU can seek to facilitate the use of their benchmarks in the EU as set out below: Equivalence: ESMA may register a non-eu benchmark administrator and the benchmark if (a) an equivalence decision is adopted by the EU Commission in respect of the jurisdiction in which the administrator is located, (b) the administrator is authorised or registered and subject to supervision in such jurisdiction, (c) the administrator notifies ESMA of its consent that the benchmark(s) may be used by supervised entities in the EU and (d) cooperation arrangements between ESMA and the relevant authority in the administrator s jurisdiction are operational. Such cooperation agreements must cover at least the mechanism for exchange of information between ESMA and the competent authorities in the non-eu jurisdiction, mechanisms for notification to ESMA where the administrator is in breach of its conditions of authorisation in its home jurisdiction and the procedures concerning the coordination of supervisory activities. The EU Commission may make an equivalence determination if either (i) administrators authorised or registered in the non-eu jurisdiction comply with binding requirements equivalent to the requirements under the Benchmark Regulation and such requirements are subject to effective supervision and enforcement on an ongoing basis in such jurisdiction or (ii) it is satisfied that binding requirements in the relevant jurisdiction with respect to specific administrators or specific benchmarks or families of benchmarks are equivalent to the requirements under the Benchmark Regulation (taking into account whether the legal framework and supervisory practice in such jurisdiction complies with the IOSCO principles) and such specific administrators or specific benchmarks or families of benchmarks are subject to effective supervision and enforcement on an ongoing basis. At present, it is not clear that there will be any jurisdictions with equivalent provisions to the Benchmark Regulation at the time it becomes effective in respect of the same wide range of benchmarks within the scope of the Regulation. The ability for the EU Commission to determine equivalence where the relevant jurisdiction only regulates a limited category of administrators or benchmarks provides more scope for an equivalence determination. However, even with such increased flexibility, it seems likely that at the time when the Benchmark Regulation becomes effective, there will be relatively little scope for equivalence determinations to be made. Recognition: Until such time as an equivalence determination is made in relation to any non-eu jurisdiction, a benchmark provided by an administrator located in such jurisdiction may be used by 10 Attorney Advertisement

53 supervised entities in the EU, provided that the non-eu administrator obtains prior recognition by the competent authority of its member state of reference in the EU. The member state of reference is to be determined by various criteria, including the location of affiliated supervised entities, the location of relevant trading venues for financial instruments referencing their benchmarks and the location of supervised entities using their benchmarks. For a non-eu administrator to obtain such recognition it will need to comply with the vast majority of the obligations that apply to EU administrators under the Benchmark Regulation. Such compliance may be fulfilled by compliance with the IOSCO Principles, provided that the relevant national competent authority determines that the application of such principles is equivalent to compliance with the requirements under the Benchmark Regulation (it may rely on an assessment by an independent external auditor or a certification by the competent authority in the relevant non-eu jurisdiction for such purpose). The non-eu administrator must also have a legal representative to perform an oversight function in relation to the provision of benchmarks by the administrator within the scope of the Benchmark Regulation which representative shall be accountable to the competent authority of the member state of reference. Although the recognition process does provide greater scope for non-eu administrators to provide benchmarks for use in the EU, it is not a straightforward process. In particular, it may not be easy to identify the member state of reference and to obtain certification of compliance with the IOSCO principles. In addition, obtaining a legal representative to provide the functions required under the Benchmark Regulation may not be straightforward and is likely to involve considerable cost. Endorsement: A non-eu administrator will be able to register benchmarks for use in the EU under the Benchmark Regulation if a benchmark administrator supervised in the EU or another supervised entity located in the EU with a clear and well-defined role within the control or accountability framework of the non- EU administrator and which is able to monitor effectively the provision of a benchmark, applies to its relevant competent authority to endorse a benchmark or a family of benchmarks provided in the relevant non-eu jurisdiction for use in the EU. Such application is dependent upon the satisfaction of specified conditions including: o o o the endorsing administrator or other supervised entity has verified and is able to demonstrate, on an on-going basis, to its competent authority that the provision of the benchmark or family of benchmarks to be endorsed fulfils (on a mandatory or voluntary basis) requirements at least as stringent as those under the Benchmark Regulation; the endorsing administrator or other supervised entity has the necessary expertise to monitor the provision of the benchmark and to manage the associated risks; and there is an objective reason to provide the benchmark or family of benchmarks in the non-eu jurisdiction and for them to be endorsed for use in the EU. In determining whether the provision of the benchmark(s) fulfils requirements at least as stringent as under the Benchmark Regulation, the competent authority may take into account whether the provision of the benchmark(s) complies with the IOSCO principles. The endorsement process was introduced as an alternative to the equivalence and recognition procedures above due to some of the challenges related to those regimes as outlined above. However, the endorsement route also presents challenges, not least the need to ensure that there is an appropriate supervised benchmark administrator or other supervised entity willing and able to perform the endorsing role. In particular, the requirement for such 11 Attorney Advertisement

54 entity to have a clear and well-defined role within the control or accountability framework of the non-eu administrator may give rise to practical challenges. Supervision and Enforcement by Competent Authorities National competent authorities will have wide-ranging powers to ensure compliance with the provisions of the Benchmark Regulation, including the ability to request relevant information, documents and data and to carry out onsite inspections and investigations. They will also have the ability to require corrective statements to be published about past contributions to a benchmark or the published level of a benchmark. Competent authorities will also have the ability to suspend trading of any financial instrument that references a regulated benchmark. Competent authorities will also have the power to impose various sanctions upon entities or individuals breaching the Benchmark Regulation, including disgorgement of profits, imposition of fines or withdrawal or suspension of a regulated entity s authorisation. Amendments to the Market Abuse Regulation and Other Legislation The Benchmark Regulation makes amendments to the Market Abuse Regulation, including exempting persons discharging managerial responsibilities in relation to an issuer of securities from the requirement to disclose transactions in financial instruments linked to securities of the issuer where those securities provide an exposure not exceeding 20% of the issuer s shares or debt instruments. Amendments are also made to certain other financial services legislation, including amending the Mortgage Credit Directive to require that lenders making loans regulated under such Directive disclose to consumers the name of any benchmarks referenced in such loans, the name of the relevant benchmark administrator and the potential implications to the consumer from the use of the benchmark. Next Steps and Impact of Benchmark Regulation The Benchmark Regulation requires ESMA to produce drafts of a significant number of implementing and regulatory technical standards (some of which are highlighted above) the EU Commission will then consider whether to adopt such technical standards. In addition, the EU Commission has requested that ESMA provide technical advice on certain aspects of the Benchmark Regulation. Whilst the draft Benchmark Regulation was still going through the EU legislative process, ESMA published a Discussion Paper in February Following responses in relation to the Discussion Paper, ESMA published a Consultation Paper on 27 May setting out its proposals in relation to the relevant technical advice (but not the draft technical standards). The technical advice covers the following issues: certain elements of the definitions, including when a benchmark is made available to the public and what constitutes the issuance of a financial instrument for the purpose of defining the use of a benchmark in the EU; the measurement of the reference value of a benchmark; the criteria for identification of critical benchmarks; Attorney Advertisement

55 framework for the endorsement of benchmarks provided by a non-eu benchmark administrator; and transitional provisions. Responses to the Consultation Paper should be made by 30 June ESMA must provide its technical advice to the EU Commission within four months after the Benchmark Regulation comes into force. It is expected that ESMA will publish a further Consultation Paper in relation to its draft technical standards later in Although the bulk of the provisions of the Benchmark Regulation will not come into effect until late 2017 or early 2018 (depending upon when it is published in the Official Journal), it will have a profound effect upon financial instruments and contracts referencing benchmarks in the EU. Firms administering, contributing to or using financial benchmarks should already be considering the effect of the Regulation on their businesses and, in the case of administrators, making preparations for obtaining authorisation or registration under the Benchmark Regulation. Among the biggest concerns for market participants is the effect on benchmarks administered outside the EU. Although the final version of the Benchmark Regulation sought to address some of the concerns raised in this regard in previous drafts of the Regulation, there is a concern that many benchmarks administered outside the EU will cease to be used in the EU. The transitional provisions for benchmarks already in use when the Benchmark Regulation comes into force and the provisions for equivalence, recognition and endorsement of non-eu benchmarks outlined above are designed to facilitate the use of non-eu benchmarks within the EU. There are, however, challenges involved in all of these options, and it may be that certain non-eu administrators decide not to go down any of these routes. As a result of these challenges, there is a likelihood that many benchmarks, both those administered in and outside of the EU, will be discontinued in due course and many non-eu benchmarks may cease to be available for use in the EU, reducing investor choice. Authors Peter Green London +44 (20) pgreen@mofo.com Jeremy Jennings-Mares London +44 (20) jjenningsmares@mofo.com About Morrison & Foerster We are Morrison & Foerster a global firm of exceptional credentials. Our clients include some of the largest financial institutions, investment banks, Fortune 100, technology and life sciences companies. We ve been included on The American Lawyer s A-List for 12 straight years, and Fortune named us one of the 100 Best Companies to Work For. Our lawyers are committed to achieving innovative and business-minded results for our clients, while preserving the differences that make us stronger. This is MoFo. Visit us at Morrison & Foerster LLP. All rights reserved. For more updates, follow Thinkingcapmarkets, our Twitter feed: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. 13 Attorney Advertisement

56 Volume 7, Issue 7 July 6, 2016 Financing Subsidiaries and SEC Registration IN THIS ISSUE: Financing Subsidiaries and SEC Registration... 1 Cover Page Disclosures for Structured Notes... 2 FINRA s Remarks at the Complex Products Forum: Evaluating Contingencies... 4 More on Complex Products... 5 Investor Advisory Committee Recommends Proposals to the SEC to Enhance Information for Bond Market Investors... 5 Brexit and Securities Offerings in the United Kingdom and European Union... 6 The Federal Reserve s Proposed Rules for Financial Contracts of Global Systemically Important Banking Organizations and ISDA s Resolution Stay Jurisdictional Modular Protocol... 6 As readers of this publication know, in order to address the expected new U.S. regulatory capital requirements, a number of U.S. bank holding companies have been creating new finance company subsidiaries. This article discusses a variety of SEC rules and regulations that simplify the registration process for using these entities, as well as certain limitations. Using the Parent Company s Registration Statement. Under General Instruction I.C of SEC Form S-3, a wholly owned subsidiary of an S-3 eligible company can utilize the parent company s short form shelf registration statement for primary offerings of investment grade securities. This provision enables these subsidiaries to take advantage of the parent company s reporting status for purposes of effecting a shelf registration. This will be the case whether or not the parent corporation is a WKSI or a non-wksi (including a WKSI that has become an ineligible issuer ). Separate Financial Statements? Regulation S-X governs the financial statement requirements for registration statements and for periodic reports. Under Rule 3-10 of Regulation S-X, separate financial statements for a subsidiary with a parent guarantee are not required to be set forth in a registration statement if (a) that subsidiary is 100% owned (whether directly or indirectly) by the parent corporation, and if (b) the securities issued by the subsidiary are fully and unconditionally guaranteed by the parent corporation. Rule 3-10, as amended in 2000, builds upon some of the SEC s prior no-action guidance. The SEC reached this position due to its reasoning: if a finance subsidiary issues debt securities guaranteed by its parent company, full disclosure of the finance subsidiary's financial information would be of little value. Instead, investors would look to the financial status of the parent company that guaranteed the debt to evaluate the likelihood of payment. Attorney Advertising

57 Volume 7, Issue 7 July 6, 2016 What Is a Finance Subsidiary? A subsidiary will be a finance subsidiary if it has no assets, operations, revenues or cash flows other than those related to the issuance, administration and repayment of the security being registered and any other securities guaranteed by its parent company. If this condition is satisfied, then no financial information about it will be required in the parent company s financial statements. The parent company s financial statements must include a footnote stating that this entity is a 100%-owned finance subsidiary of the parent company and that the parent company has fully and unconditionally guaranteed the securities. New Form 10-K and Form 10-Q Requirements? When creating a new SEC registrant, the sponsor will of course ask whether or not it is creating a burdensome and potentially expensive ongoing disclosure obligation under the Exchange Act. However, this need not be the case under Rule 12h-5 under the Exchange Act, these financing subsidiaries are not required to file separate periodic reports. What Is a Full and Unconditional Guarantee? Under Rule 3-10, for a guarantee to be deemed unconditional, when an issuer of a guaranteed security fails to make a scheduled payment, the guarantor is obligated to make the scheduled payment immediately and, if it doesn't, any holder of the guaranteed security may immediately bring suit directly against the guarantor for payment of all amounts due and payable. However, under the rules, a guarantee will not be full and unconditional if it is not operative until some time after default. For example, a subsidiary guarantee would not satisfy this condition if the debt holder must first proceed against the parent issuer, and then only proceed against the subsidiary if a certain amount of time has passed without payment. Cover Page Disclosures for Structured Notes Overview We conducted an informal analysis about cover page disclosures for structured notes. We looked at the pricing supplements for offerings from two different issuers that each had a fairly common structure: index-linked. 3x upside to a cap. 1-1 downside. No interest payments. One pricing supplement expressed this structure with 1,133 words on the cover page. The other, did so with only 424 words. Industry participants would read these cover pages and quickly realize how similar these two products are. But if a retail investor had each pricing supplement in hand, that investor might not realize so quickly how similar these offerings are. At least at a superficial level, these two offerings might seem somewhat different. Of course, this quick study simply reveals what readers of this publication already know: disclosure documents and styles can vary significantly from issuer to issuer, and underwriter to underwriter. But what are the actual requirements of a structured note cover page? This article attempts to discuss that question. Regulation S-K Of course, in the context of a registered public offering, we look first to Regulation S-K under the Securities Act of 1933 to tell us the black letter law of cover page disclosures. These requirements are set forth in Item 501(b). The cover page must: set forth the issuer s name; set forth the title of the securities, 1 and the amount being offered; 1 Under the SEC s guidance, the name cannot be misleading. For example, debt securities should not be described as shares. And as readers of this publication know, the term principal protected in a title is somewhat problematic. 2 Attorney Advertising

58 Volume 7, Issue 7 July 6, 2016 provide a brief description of the terms of the securities; set forth the public offering price 2 and the underwriting discount; indicate whether the securities will be listed on a stock exchange, providing the trading symbol (if applicable); set forth a cross-reference to the risk factors section; set forth a legend that the SEC has not approved of the securities or the offering; identify the underwriters, 3 and, if the offering is not a firm commitment underwriting, describe the nature of the plan of distribution; and set forth the date of the prospectus. Item 501(b) requires the cover page to be limited to just that the cover page. Of course, this can be a bit of a challenge in the case of complex products or complex underliers. The SEC Weighs In As you know, the SEC has taken an active interest in cover page disclosures. As a result of the SEC s 2012 sweep letter and its aftermath, pricing supplement cover pages for structured notes now include: estimated value disclosures. a reminder that payments on the notes are subject to issuer credit risk. In addition, where the issuer is a bank holding company (and not a bank), the SEC has historically encouraged issuers to remind investors that these debt securities are not bank deposits, and are not insured by the FDIC. FINRA Corporate Financing Rule One additional small requirement emanates from the FINRA rules. Where the underwriter is affiliated with the issuer, in order to obtain the exemption from FINRA filing for investment grade securities, the cover page of the offering documents for a non-registered offering must indicate that the conflict exists, and cross-reference the Conflicts of Interest subsection of the Plan of Distribution section. (FINRA Rule 5121(a).) Many registered offerings follow this approach as well (in addition to the separate, but related, table of contents requirement that does apply under the FINRA rules to registered offerings). Additional Disclosures In addition to the required disclosures, some market participants have added a variety of additional provisions to their cover pages: suitability considerations; key risk factors, particularly the potential loss of principal (for non-principal protected notes); structuring costs and similar amounts; and explanations of the compensation that selected dealers will receive from underwriters. Regulatory capital changes in Europe (and expected ones in the U.S.) will potentially cause some types of structured notes to convert into equity securities in the event of a failure. This feature also has been added to cover pages. Additional Marketing Materials? Needless to say, different market participants have different views as to the best way to present all of the above information, and which of the optional information is best suited for a cover page. (The answer may depend upon the nature and sophistication of the investors.) That being said, the combination of regulatory requirements, and occasional 2 Which is usually par for structured notes, unless there is a bulk discount or a lower price for advised accounts. 3 Selling group members are not required to be specifically identified. They would often not wish to be identified, as doing so may increase the likelihood that they will be viewed as statutory underwriters for liability purposes. 3 Attorney Advertising

59 Volume 7, Issue 7 July 6, 2016 complexity of structured notes, often leads to cover pages that not everyone will agree are the optimal solution. Accordingly, many market participants also rely on additional marketing materials, such as term sheets and offering summaries, to help present information in the manner that they believe is most helpful. FINRA s Remarks at the Complex Products Forum: Evaluating Contingencies On June 16, 2016, Thomas Selman, FINRA s Executive Vice President, Regulatory Policy, delivered a speech at SIFMA s annual Complex Product Forum in New York City. The text of his speech can be found at the following link: Analogizing from a hypothetical menu of different options at a deluxe Parisian restaurant, Mr. Selman explained the potential difficulty that retail investors may have in understanding, selecting and comparing different complex financial products. The problem can be particularly significant where different contingencies may be difficult and time-consuming to value. Different contingencies can render it challenging to compare products with different features. For example, an investor may value principal protection differently than currency exchange risk. The problem can be exacerbated when a product involves multiple contingencies, such as, in Mr. Selman s example, a non-principal protected range accrual note in which both (a) the payment of interest depends upon the level of the applicable underlying asset at different times and (b) the payment at maturity may be less than par if the underlying asset decreases in value. The difficulty would be even more challenging in the case of a worst of structure that involves underlying assets with different risk profiles. Mr. Selman s analysis is noteworthy in part because of its discussion not only as to how a financial advisor can advise an investor as to a single individual product, but how a financial advisor may potentially need to understand and explain multiple products, with different terms, features and underlying assets, when advising a client. He noted: To summarize these points, the complexity of a financial adviser s investment selection often will depend upon the answer to three questions: How many approved investment choices is the adviser expected to consider? How many of these investment choices have one or more embedded options? How many of these embedded options refer to reference assets that are unrelated to the essential features of the product? In the course of his discussion, Mr. Selman also reviewed some of FINRA s historic guidance as to what features would render a product complex, and the need for financial advisors to understand products well enough to explain to investors their payoffs under different circumstances prior to offering them. Mr. Selman also reminded the audience to be sensitive to the possibility that a financial services company might be issuing complex products to retail investors in order to manage its own risk. He noted, [s]ome commenters have asserted that structured notes may be used as a mechanism to shift particular risks to retail investors. Such activity could present serious regulatory issues. Mr. Selman reiterated FINRA s position that it is not necessarily questioning the utility of complex products. However, FINRA will continue to focus on the need for heightened training and supervision of financial advisors who do offer them. 4 Attorney Advertising

60 Volume 7, Issue 7 July 6, 2016 More on Complex Products At the SIFMA Complex Products Forum, attendees also benefitted from the views of Laura Posner, Bureau Chief of the Office of the New Jersey Attorney General, New Jersey Bureau of Securities, and Thomas Grogan, Senior Vice President, Deputy of Member Regulation Sales Practice, from FINRA. Ms. Posner and Mr. Grogan participated in a panel on complex products. Mr. Grogan noted that FINRA Notice subsumed FINRA s prior guidance, which had been contained in various notices to members, relating to complex products. Although he did not foreclose the possibility of new guidance on complex products generally, Mr. Grogan noted that the guidance in Notice remained timely. Ms. Posner noted that the New Jersey Bureau of Securities remains focused on sales to retail investors of complex financial products, which may include a variety of products from variable annuities to structured products, to non-traded REITs and non-traded BDCs, to structured credit products. Mr. Grogan noted that, in connection with its exams, FINRA will want to see materials relating to the member firm s vetting and approval process for new products. As part of the new product approval process, it is presumed that there will be a discussion of the risks and rewards of the proposed product, the investment thesis for the product, the intended audience for the product, the channels through which the product will be distributed, and training and other requirements related to product sales. The panelists also discussed training and education for member firm registered representatives that sell complex products. Training is expected to be mandatory and to incorporate some means for assessing whether the registered representative understands the principal features of the product to a prospective client. Both Mr. Grogan and Ms. Posner commented on sales of complex products to at-risk investors, especially senior citizens and others on fixed incomes. These investors may not understand the lack of liquidity associated with certain products or may not understand the multiple product features, how these may interact, and how these may affect product returns. Similarly, it was noted that there may be some opaqueness with respect to fees and potential conflicts of interest that may arise in connection with complex products. To that end, Mr. Grogan noted that FINRA had conducted a sweep on compensation related conflicts of interest. Ms. Posner highlighted NASAA s model fee disclosure for retail investors as providing a template for broker-dealers. The panelists also commented on concentration issues and trading in and out of complex products in customer accounts. They noted that broker-dealers generally have supervisory and oversight policies and procedures in place, which result in exception reports. Oftentimes, however, they noted that there was a lack of follow up once problematic practices had been identified through the use of the exception reports. They noted that during exams, this was a routine area of focus that is, identifying the use of exception reports and noting the remedial actions taken by firms to the extent that the reports flagged problematic practices. Investor Advisory Committee Recommends Proposals to the SEC to Enhance Information for Bond Market Investors On June 7, 2016, the SEC s Investor Advisory Committee (the Committee ) 4 provided recommendations (the Recommendations ) 5 regarding certain proposals set forth in FINRA s Regulatory Notice and the Municipal Securities Rulemaking Board ( MSRB ) Regulatory Notice The Recommendations reflect the SEC s ongoing efforts to enhance transparency in the market for fixed income securities. FINRA Regulatory Notice was released in October 2015 and set forth proposed rules for FINRA members to disclose additional information on customer confirmations, such as requiring them to disclose the bond price that the member paid, if the member acquired the security near in time to the resale, so an investor could see the markup or 4 The Committee was created under Section 911 of the Dodd Frank Act to advise the SEC as to a variety of regulatory issues. 5 The Recommendations may be found at the following link: 6 FINRA Regulatory Notice may be found at the following link: MSRB Regulatory notice may be found at the following link: 5 Attorney Advertising

61 Volume 7, Issue 7 July 6, 2016 markdown on the customer confirmation. 7 The Recommendations advise the SEC to work with FINRA and MSRB to implement rules based on these proposals. The Recommendations further seek to provide enhanced disclosure of full transaction bond costs, enhanced access to material information prior to the investment decision and greater transparency in the bond market. First, the Committee recommends that the SEC work with MSRB and FINRA to require dealers to provide more price information to retail investors regarding the transaction costs of purchasing or selling bonds on both an agency and principal basis. 8 In the longer term, the Recommendations also ask the SEC to work with brokers, FINRA and the MSRB to provide full transaction cost information to investors prior to the purchase or sale of any bond. Brokers generally provide price and yield information to potential investors before a transaction occurs. The Recommendations would require that full transaction costs, including broker-dealer fees and commissions ( transaction costs ), be fully disclosed to potential investors with other bond-specific information prior to the transaction. Finally, the Committee is recommending that the SEC work with the MSRB and FINRA to improve and enhance investor access and transparency regarding recent transactions in the bond market for municipal, agency and corporate bonds. Currently, the MSRB manages the Electronic Municipal Market Access ( EMMA ) website, which provides information on recent municipal bond transactions, but is not necessarily easy to navigate. Similarly, the Recommendations suggest that FINRA s TRACE system could provide additional data to make it more useful to retail investors. Brexit and Securities Offerings in the United Kingdom and European Union In a recent alert, we discuss some initial thoughts on the potential impact of Brexit on issuers and distributors of securities in the context of the prospectus requirements that apply to offerings of securities in the United Kingdom and the European Union. Please review our alert: The Federal Reserve s Proposed Rules for Financial Contracts of Global Systemically Important Banking Organizations and ISDA s Resolution Stay Jurisdictional Modular Protocol Last month the Board of Governors of the Federal Reserve System (the Board ) issued proposed new rules (the Proposed Rules ) intended to reduce the potential risks posed to the U.S. financial system by too-big-to-fail banks. 9 The Proposed Rules would, among other things, require certain systemically important banks to include in their contracts provisions that would significantly limit their counterparties default rights in over-the-counter swaps, repurchase and reverse repurchase agreements, securities lending and borrowing transactions, commodity contracts, and forward agreements. The Proposed Rules, available here, are open to public comment until August 5, Contemporaneously with the Board s release of the Proposed Rules, the International Swaps and Derivatives Association, Inc. ( ISDA ) released its ISDA Resolution Stay Jurisdictional Modular Protocol (the JM Protocol ) intended to permit market participants to comply with the Proposed Rules (when adopted in their final form) and similar rules of foreign jurisdictions. We discuss the Proposed Rules and the related ISDA protocols, which would affect all issuers of structured products, in this alert: 7 We discussed some aspects of the proposal in our November 4, 2015 issue of this publication, which may be found at the following link: 8 Under the current MSRB regime in Rule G-15, dealers are only required to disclose on the customer confirmation certain remuneration received from the customer when the dealer is acting as an agent. There is no comparable disclosure requirement under the SEC s or MSRB s rules when the dealer is acting as principal. 9 Restrictions on Qualified Financial Contracts of Systemically Important U.S. Banking Organizations and the U.S. Operations of Systemically Important Foreign Banking Organizations; Revisions to the Definition of Qualifying Master Netting Agreement and Related Definitions, 81 Fed. Reg. 29,169 (May 11, 2016). 6 Attorney Advertising

62 Volume 7, Issue 7 July 6, 2016 Upcoming Events Brexit-Related Webinars On June 23, 2016, the UK electorate voted narrowly in favor of the UK leaving the European Union. The result of this vote will have broad and wide reaching economic and political consequences, and a major impact on businesses with operations in the UK/EU or that issue securities in the EU or contract with EU parties. These programs will provide an overview and discussion of the possible effect of a so-called Brexit on EU issuances of securities and transactions in other financial instruments. Speakers: Peter Green, Morrison & Foerster LLP and Jeremy Jennings-Mares, Morrison & Foerster LLP Brexit: Implications for Securities and Other Financial Transactions PLI Webinar Thursday, July 7, :00 a.m. to 12:00 p.m. EDT To register or for more information, click here. The European Securities Regime pre and post-brexit West LegalEdCenter Webinar Monday, July 18, :00 p.m. to 1:00 p.m. EDT To register or for more information, click here. CD Programs and Structured CDs Morrison & Foerster Teleconference Thursday, July 14, :00 a.m. to 12:30 p.m. EDT In this session, we will discuss CDs and CD programs, including many of the unique issues that relate to structured CDs. In particular, we will focus on: the banking and securities law rules that govern these products; frequently recurring issues that arise in structuring and documenting them; practical advice for creating and managing CD programs; and current trends in offerings from CD programs. Speaker: Lloyd Harmetz, Morrison & Foerster LLP To register or for more information, click here. Index Regulation and Outsourcing Index Administration Morrison & Foerster/Markit Master Class Thursday, July 28, :30 a.m. 9:30 a.m. EDT Morrison & Foerster LLP 250 West 55th Street New York, NY With the increased regulation of benchmark indices and index governance in Europe, market participants already are focused on compliance. Regulation and scrutiny likely will not be limited to indices that are true benchmarks, but may well also affect proprietary indices. Speakers: Mark Schaedel, Markit and Lloyd Harmetz, Morrison & Foerster LLP To register or for more information, click here. 7 Attorney Advertising

63 Volume 7, Issue 7 July 6, 2016 Join our Structured Thoughts LinkedIn Group Morrison & Foerster has created a LinkedIn group, StructuredThoughts. The group will serve as a central resource for all things Structured Thoughts. We have posted back issues of the newsletter and, from time to time, will be disseminating news updates through the group. To join our LinkedIn group, please click here and request to join or simply Carlos Juarez at cjuarez@mofo.com. Contacts Lloyd S. Harmetz New York (212) lharmetz@mofo.com Anna T. Pinedo New York (212) apinedo@mofo.com Bradley Berman New York (212) bberman@mofo.com For more updates, follow Thinkingcapmarkets, our Twitter feed: Morrison & Foerster was named the 2016 Equity Derivatives Law Firm of the Year at the EQDerivatives Global Equity & Volatility Derivatives Awards. Morrison & Foerster was named 2016 Americas Law Firm of the Year for the second year in a row by GlobalCapital for its Americas Derivatives Awards. Morrison & Foerster has been named Structured Products Firm of the Year, Americas by Structured Products magazine seven times in the last 11 years. Morrison & Foerster was named Best Law Firm in the Americas, 2012, 2013, 2014 and 2015 by Structured Retail Products.com. About Morrison & Foerster We are Morrison & Foerster a global firm of exceptional credentials. Our clients include some of the largest financial institutions, investment banks, Fortune 100, technology, and life sciences companies. We ve been included on The American Lawyer s A-List for 12 straight years, and Fortune named us one of the 100 Best Companies to Work For. Our lawyers are committed to achieving innovative and business-minded results for our clients, while preserving the differences that make us stronger. This is MoFo. Visit us at Morrison & Foerster LLP. All rights reserved. Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. 8 Attorney Advertising

64 Volume 7, Issue 6 May 31, 2016 Structured Notes Offered on an Agency Basis IN THIS ISSUE: Structured Notes Offered on an Agency Basis... 1 What Is a Proprietary Product?... 3 FINRA Proposes Amendments to its New Debt Research Rule... 3 It s Not a Culture War Yet?... 5 FDIC Extends Comment Period for Proposed Deposit Account Recordkeeping Rule... 5 Where Is the Underwriting Commitment Table? SEC Approves FINRA s Educational Communication Rule... 6 All of Your Favorite Index Definitions in One Easy-to-Reach Location... 6 In our last issue, 1 we discussed the potential impact of the Department of Labor s new rules on sales of structured products. In that article, we discussed some of the reasons why future sales of structured notes to retirement accounts may be preferable to effect on an agency basis, as opposed to on an underwritten basis. However, due to the predominance of underwritten offerings in the structured products space, we find that not all market participants are familiar with the agented format. Accordingly, in this article, we describe some of the aspects of these types of offerings, and how they vary from current practices. Underwritten Offerings Most of today s structured notes are offered on an underwritten basis. Under the underwriter s agreement with the issuer, 2 the underwriter is contractually obligated to purchase the relevant notes from the issuer, for its own account, for resale to investors. The underwriter, in turn, agrees with each investor at the time of purchase to sell the notes from its own account to the investor. Accordingly, the underwritten offering essentially consists of two different purchases and sales: (1) the underwriter purchasing the securities from the issuer and (2) the investor purchasing the securities from the underwriter. 3 1 Our last issue may be accessed here: 2 The agreement is typically a program agreement or similar agreement entered into under a medium term note program. 3 Additional purchases and sales may be occurring if, for example, the underwriter is selling the securities to third-party dealers, that are in turn purchasing for (a) further sale to other distributors or (b) the actual investors. Attorney Advertising

65 Volume 7, Issue 6 May 31, 2016 In an underwritten offering, the aggregate principal amount of the transaction (set forth on the cover page of the final prospectus) is usually determined based upon the amount of offers received. Subject to the satisfaction of the relevant conditions in the offering documents, the underwriter must purchase all of the notes covered by the applicable prospectus. If an investor fails to settle the purchase, or cancels its order between the pricing date and the settlement date, the underwriter will still be obligated to purchase the full amount of the notes. Traditionally, because of this risk borne by the underwriter, the underwriting commission may be higher than it would be for an offering in which the underwriter does not have this type of a commitment. Agented Offerings In an agented offering, the underwriter is acting contractually solely as the agent of the issuer. This type of broker-dealer does not have any obligation to purchase the relevant notes for its own account. The ultimate investors are effectively agreeing with the broker-dealer, acting as agent of the issuer, to purchase the notes from the issuer. Because the offering is agented, and the broker-dealer does not have an obligation to purchase any securities, the relevant underwriter doesn t need to use its regulatory capital for purposes of the offering. However, in terms of its potential liabilities, it is typically viewed as a statutory underwriter, with potential liability for misstatements or omissions in the prospectus. (Conversely, it would also potentially have a due diligence defense if the accuracy of the prospectus disclosure was challenged.) Some agented offerings of different types of securities require an escrow agent for the offering proceeds, due to the provisions of Rule 15c2-4 under the Exchange Act. This requirement is not applicable to most agented offerings under MTN programs, which are conducted on a so-called any or all basis. Versatility of Program Agreements Today, structured notes are typically issued in the U.S. under so-called medium-term programs. Not too many years ago, MTN programs were structured principally as agented offerings; accordingly, many of these arrangements refer to the relevant broker-dealers as agents or selling agents, as opposed to underwriters. However, over the years, most of these agreements, when used by frequent issuers, have been broadened to contemplate underwritten offerings as well. And, in practice, as noted above, most of the offering activity in fact takes place in underwritten offerings. Multi-Layered Distributions As noted above, in many distributions of structured products, the underwriter may be distributing the notes through third-party broker-dealers. These dealers will each typically be party to an MSDA (master selected dealer agreement) or similar agreement with the underwriter. (Such dealers may also be wholesalers, selling to other dealers, lengthening this distribution chain.) In many cases, it will be one or more of these dealers, and not the underwriter, that has the relationship with the relevant ERISA account. In this situation, this dealer would need to make the sale on an agency basis. Depending on the distribution arrangements, the dealer could, for example, act as agent for the underwriter. These arrangements would need to be carefully documented to ensure that the role and responsibilities of each of the parties is properly reflected. Transitioning from Underwritten Offerings to Agented Offerings In order to convert offerings from the underwritten format to the agented format, a variety of steps should be taken, for example: the issuer and the underwriter should review their program agreement or similar agreement (including the relevant administrative procedures memorandum, if applicable) to make sure that it provides for such an arrangement; the provisions of any relevant MSDAs may need to be revised to ensure that, where appropriate, the dealers are effecting sales on an agency basis; the plan of distribution and related disclosures in offering documents may need to be updated to reflect these arrangements; and confirmations furnished to investors would need to be revised to remove any references to the broker-dealer acting as principal. 2 Attorney Advertising

66 Volume 7, Issue 6 May 31, 2016 Any practice of underwriters holding the offering securities in inventory for potential sale to retirement accounts would likely cease, as those sales could not take place on a principal basis. What Is a Proprietary Product? In connection with the Department of Labor s new regulations, a new term has entered our lexicon: proprietary product. These products are subject to a variety of restrictions and disclosure requirements, which we discussed in our prior issue of this publication. In the structured products area, market participants are quite accustomed to the word proprietary in connection with so-called proprietary indices. In that context, this term is not a legal term, and is not defined by any statute or regulation. However, typically, it refers to an index developed by a financial institution in order to reflect the results of a particular investment strategy and/or to track specific types of assets. Under the new Department of Labor regulations, a proprietary product, refers to a financial product that is managed, issued or sponsored by the financial institution or one of its affiliates. (The initially proposed rule used a somewhat narrower definition, requiring that a product be managed by the financial institution or an affiliate.) Accordingly, we now have a U.S. regulation that creates a new legal term. The problem: in many cases, there is uncertainty as to how this definition should apply to many or most structured products. The terminology used in the definition is hard to apply to an unsecured debt security, which is the wrapper for most structured notes. Issued. We re pretty sure we understand what it means for a structured product to be issued by a financial institution or an affiliate. So, we ll leave that one alone here. Managed. In the case of an unsecured debt security, we would like to think that this term is inapplicable. Management sounds like a term from the investment company regime, where a fund manager manages the investments held by the entity. On the other hand, to the extent that an underwriter manages the distribution, makes a secondary market and provides pricing information, or determines the payments on the notes in its capacity as a calculation agent, does that render a product managed and, therefore, proprietary? We d like to think that the answer is no, and that is not what the new rules are attempting to reach. Sponsored. This is another term that seems to emanate from the investment company world, and shouldn t be applicable to structured notes. However, under a very broad use of the term, perhaps sponsor is broad enough to pick up creating the terms of an instrument, and marketing it? Again, we d like to think that this is too broad a reading of the term. During the next several months, industry participants are expected to seek guidance from the Department of Labor as to many definitional and substantive provisions of the new regulations. Questions will arise from virtually all segments of the securities markets. It is our hope that the issues raised by participants in the structured products market will be better understood as a result of these interactions. FINRA Proposes Amendments to its New Debt Research Rule On May 24, 2016, FINRA proposed amendments to its new debt research rule (Rule 2422). The amendments are intended to clarify Rule 2422 in four respects: (1) the consent requirement for institutional debt research reports distributed to non-u.s. investors by non-u.s. affiliates of members; (2) the consent requirement for institutional debt research reports distributed to specified persons for informational purposes unrelated to investing in debt securities; (3) the scope of the institutional exemption when distributing third-party debt research reports to eligible institutional investors; and (4) the disclosure requirements for debt research analysts in public appearances. 3 Attorney Advertising

67 Volume 7, Issue 6 May 31, 2016 Distribution to Non-U.S. Investors by Non-U.S. Affiliates of Members Rule 2242(j) exempts debt research reports distributed solely to eligible institutional investors from most of the provisions regarding supervision, coverage determinations, budget and compensation determinations, and all of the disclosure requirements applicable to debt research reports distributed to retail investors. Rules 2242(j)(1)(A) and (B) require either negative or affirmative written consent for eligible institutional investors to receive institutional debt research pursuant to the institutional exemption. The proposed amendments clarify the application of Rule 2242(j) to non-u.s. investors that are customers of a member s U.S. affiliate but not customers of the member. Specifically, the requirements of Rules 2242(j)(1)(A) and (B) will not apply to the distribution of an institutional debt research report by a non-u.s. affiliate of a member to a non-u.s. investor, provided that: (1) the non-u.s. investor is not a customer of the member; (2) the non-u.s. investor is a customer of the non-u.s. affiliate of the member; and (3) the non-u.s. affiliate of the member has a reasonable basis to believe that the customer meets the definition of institutional account in Rule 4512(c). Distribution to Persons for Informational Purposes The proposed amendments permit a member to distribute institutional debt research reports to specified persons for informational purposes unrelated to investing in debt securities, provided that the member does not distribute the reports prior to their publication and the member has disclosed that: (1) the member may provide to institutional investors debt research reports that are not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors; and (2) the debt research reports would be provided only for informational purposes and not for the purpose of making an investment decision related to debt securities. The proposed amendments also provide that if the person receiving institutional debt research does not contact the member to request that such institutional debt research reports not be provided, then the member may reasonably conclude that the person has consented to receiving debt institutional research reports. Institutional debt research may be distributed for informational purposes unrelated to investing in debt securities: (1) regulators for regulatory purposes; (2) academics for academic purposes; (3) issuers for the purpose of enhancing knowledge of their industry and competitors and market and economic factors; and (4) media organizations for news gathering purposes. Distribution of Third-Party Debt Research Reports to Institutional Investors The proposed amendments clarify that a member that distributes third-party debt research reports to institutional investors pursuant to the institutional exemption must establish, maintain and enforce written policies and procedures reasonably designed to comply with Rules 2242(g)(1), (g)(2), (g)(4) and (g)(6). The review requirements in Rules 2242(g)(2) and (g)(4) for third-party debt research reports and independent third-party debt research reports, respectively, would apply to reports distributed to retail investors or to institutional investors. Accordingly, third-party debt research reports distributed pursuant to the institutional exemption would be subject to the same review requirements as third-party debt research reports distributed to retail investors. With respect to disclosures, the proposed amendments clarify that third-party debt research reports distributed pursuant to the institutional exemption are not required to carry the specific disclosures applicable to retail debt research. Public Appearances by Debt Research Analysts Rule 2242(d) requires disclosures from debt research analysts in public appearances, including debt research analysts that only prepare debt research reports pursuant to the institutional exemption. The proposed amendments clarify that the public appearance disclosure requirements do not apply in such circumstances. The proposed amendments require that the member maintain records sufficient to demonstrate that attendance at the public appearance was limited to institutional investors eligible to receive institutional debt research. The proposed amendments also require that the records be maintained for at least three years from the date of the public appearance. The disclosure requirements of Rule 2242(d) would apply, however, where attendance at the public appearance was not limited to institutional investors eligible to receive institutional debt research reports. The text of the proposed amendments to Rule 2422 is available at: 4 Attorney Advertising

68 Volume 7, Issue 6 May 31, 2016 It s Not a Culture War Yet? On May 23, 2016, at FINRA s annual conference in Washington, D.C., Richard Ketchum, FINRA s chairman and CEO, delivered a speech that shed a little light on FINRA s recent sweep letter relating to firm culture (see our recent blog post for more information regarding the sweep letter). According to Mr. Ketchum, FINRA remains principally in a fact-finding posture at present, and is not yet ready to enact culture-related rules or engage in culture-related disciplinary actions. It remains to be seen, of course, whether such developments may occur in the future. Mr. Ketchum stated that While it isn t FINRA s goal to prescribe the culture for the industry or to determine the values a firm and reps should have, we think it s essential that the securities industry embrace a culture that puts investors first. He noted that the fiduciary evolution impacts how firms interact with clients, and placed FINRA s interest in firm culture in the context of its recent focus on conflicts of interest and compensation practices. Mr. Ketchum emphasized the importance of firm culture, stating that a culture that doesn t value ethical behavior has led to compliance failures for firms and significant harm to investors. In addition, he noted that [a] culture that consistently places ethical considerations and client interests at the center of business decisions helps protect investors and the integrity of the markets, thereby helping to maintain investor confidence in the markets. In particular, Mr. Ketchum said FINRA continues to examine: how a firm identifies and addresses deviations from its standards of conduct; hiring practices that result in some firms having substantial concentrations of representatives with a history of disciplinary problems; whether a firm s executive officers lead by example, setting the tone at the top and establishing and maintaining a proper culture; and compensation arrangements and supervisory structures that may be more likely to lead to a poor culture, with resulting harm to customers. Notwithstanding the lack of clear guidance regarding what a firm s culture should look like, it is clear that a firm s culture will remain an important part of FINRA s future monitoring of broker-dealers. FDIC Extends Comment Period for Proposed Deposit Account Recordkeeping Rule The FDIC has recently extended the comment period for proposed recordkeeping requirements for FDIC-insured institutions with at least 2 million deposit accounts. The FDIC s notice of proposed rulemaking from February 26, 2016 solicited comments from the general public and the industry regarding this proposal. After the 30-day extension, the comment period now will close on June 25, In our March 2016 article, we discussed this proposal, which is intended to facilitate quick payment of insured deposits if large insured banks fail: In addition, the FDIC has made its report on the estimated cost of compliance available, which is intended to aid commenters. The report may be found here. 5 Attorney Advertising

69 Volume 7, Issue 6 May 31, 2016 Where Is the Underwriting Commitment Table? The SEC s recent concept release relating to Regulation S-K 4 has resulted in, among other things, a renewed focus on how the regulation affects different aspects of offering documents. One question that has arisen from time to time relates to the Plan of Distribution section that appears in structured note offerings. Item 508(e) of Regulation S-K contemplates the inclusion in this section of a table that sets forth the underwriting commitments and discounts for each underwriter participating in an offering. These tables can be particularly long and detailed in the case of broadly distributed offerings of debt or equity securities, where a significant number of underwriters are involved, each taking responsibility for a specific portion of the securities to be offered. These tables may reflect the result of significant negotiation among the relevant underwriters. In contrast, most structured offerings are distributed in a different manner. Typically, one named underwriter will have the responsibility for distributing the entire offering. That underwriter may be selling the securities to investors that maintain a brokerage account with it, or it may be selling the securities to selling group members who have actual relationships with the relevant investors. In these cases, the structured note offering documents have typically omitted this table. Instead, textual disclosure is used to explain the fact that the relevant underwriter is receiving the relevant compensation. This disclosure will typically appear on the cover page, in the Plan of Distribution, or some combination of the two. Item 502 of Regulation S-K contemplates cover page disclosure of the aggregate underwriting discount and the net proceeds to investors. This underwriting discount may be repeated in the Plan of Distribution section. In addition, the Plan of Distribution section will also describe the nature of the compensation arrangements between the underwriter and any third-party distributors. This compensation disclosure is contemplated by Regulation S-K for inclusion in the Plan of Distribution section; however, some market participants prefer to include it on the cover page as well, in part to make it easier for the distributors to find. SEC Approves FINRA s Educational Communication Rule The SEC recently approved FINRA s new Rule 2273 (Educational Communication Related to Recruitment Practices and Account Transfers), which requires delivery of an educational communication prepared by FINRA to customers of a transferring representative. The rule will become effective on November 11, On May 16, 2016, FINRA released Regulatory Notice ( which provides an overview of the new Educational Communication Rule and includes the rule text and the form of educational communication required by FINRA. Our summary of the new rule may be found at: All of Your Favorite Index Definitions in One Easy-to-Reach Location Generic listing standards, broad-based, narrow-based, competing regulators what s a draftsperson to do when they want to check whether the latest index is kosher? Now there is a one-stop shop designed just for this purpose. We ve added a table of definitions of various broad-based indices to our website at: Use it in good health! 4 We discussed the concept release, and how it relates to structured notes, in a prior issue of this publication, which may be found at: 6 Attorney Advertising

70 Volume 7, Issue 6 May 31, 2016 Upcoming Events Financial Regulatory Briefing Morrison & Foerster Seminar Thursday, June 2, 2016 Morrison & Foerster LLP 250 West 55th Street New York, NY Please join Morrison & Foerster attorneys at our Financial Regulatory Briefing in New York City. Agenda: The SEC s Focus on the Use of Derivatives by Funds 8:30 a.m. to 9:30 a.m. Asset Management and Financial Stability 9:30 a.m. to 10:00 a.m. Fed s Long Term Debt, TLAC and Clean Holding Company Requirement and its Effects on Financial Institutions Issuers and the Debt Capital Markets 10:00 a.m. to 11:00 a.m. The Single Counterparty Exposure Reproposal, the Net Stable Funding Rule Proposal, and Incentive Compensation at Covered Financial Institutions 11:00 a.m. to 12:00 p.m. Lunch 12:00 p.m. to 12:15 p.m. A FinTech Discussion: An Overview of Legal and Regulatory Issues That Arise when Banks Work with FinTech Companies 12:15 p.m. to 1:15 p.m. For more information about this complementary CLE seminar, or to register, please click here. Ending Too Big to Fail: Bank Resolution Strategies and Counterparty Impacts IFLR Webinar Wednesday, June 8, :00 a.m. to 12:30 p.m. EDT As jurisdictions continue to move forward with strategies for resolving large banking organizations, recent turmoil in relation to European bank stocks has raised questions as to how markets will react to the initiatives and perceived differences between them. We will take stock of comparative bank resolution regimes and the stated strategies of the resolution authorities under those regimes. We will also look at pre-emptive measures such as structural changes and changes to the terms of bank instruments. From a market point of view, we will also discuss the effect that the above factors, the possibility of bail-in, and the need to raise TLAC/MREL/PLAC, will affect the market for bank capital and debt instruments as well as other banking transactions. Speakers: Doncho Donchev, Head of Long- and Medium-Term Funding London, Crédit Agricole Corporate and Investment Bank Oliver Ireland, Morrison & Foerster LLP 7 Attorney Advertising

71 Volume 7, Issue 6 May 31, 2016 Jeremy Jennings-Mares, Morrison & Foerster LLP For more information about this complementary CLE webinar, or to register, please click here. Setting the New Benchmark: EU Regulation on Financial Benchmarks Morrison & Foerster Teleconference Wednesday, June 15, :00 to 1:00 p.m. EDT The new EU Regulation on indices used as benchmarks in financial instruments and contracts is expected to enter into force very shortly and to apply from early It will introduce a new regulatory regime for firms that administer, contribute to or use financial benchmarks in the EU. It will also impact non-eu benchmarks which are used in the EU. The definition of financial benchmark is very wide and will include some customized proprietary indices. This presentation will look at the relevant provisions of the regulation and consider its practical implications for benchmark administrators, users and contributors. Speakers: Peter Green, Morrison & Foerster LLP Jeremy Jennings-Mares, Morrison & Foerster LLP For more information about this complementary CLE teleconference, or to register, please click here. SIFMA Complex Products Forum Morrison & Foerster Sponsorship Thursday, June 16, 2016 SIFMA Conference Center 120 Broadway, 2nd Floor New York, NY The Complex Products Forum is a collaborative event that brings together regulators, distributors, and manufacturers to discuss the issues, challenges, and opportunities related to the sale of complex products to retail investors. Partner Anna Pinedo will moderate a panel entitled Complex Products: Changing Regulatory Focus. This session will emphasize the importance customer suitability, financial advisor and investor education and due diligence play in the sale of complex products to individual investors while addressing how the industry prepares for continued regulation of complex products. Partner Jay Baris will speak on a panel entitled Regulatory Enforcement Overview: Complex Products 4.5 Years Later. This session will address regulation, compliance and responsibility of firms creating and distributing complex investment products to suit the financial needs of retail investors. For more information, or to register, please click here. 8 Attorney Advertising

72 Volume 7, Issue 6 May 31, 2016 Join our Structured Thoughts LinkedIn Group Morrison & Foerster has created a LinkedIn group, StructuredThoughts. The group will serve as a central resource for all things Structured Thoughts. We have posted back issues of the newsletter and, from time to time, will be disseminating news updates through the group. To join our LinkedIn group, please click here and request to join or simply Carlos Juarez at cjuarez@mofo.com. Our gratitude to Structured Products magazine for naming us Structured Products Law Firm of the Year, Americas, for the seventh time in 11 years is exceeded only by our appreciation for our clients, whose imagination, energy and efficacy inspires us to do our most innovative work. Contacts Lloyd S. Harmetz New York (212) lharmetz@mofo.com Anna T. Pinedo New York (212) apinedo@mofo.com Bradley Berman New York (212) bberman@mofo.com Ze -ev D. Eiger New York (212) zeiger@mofo.com Hillel T. Cohn Los Angeles (213) hcohn@mofo.com Kelley A. Howes Denver (303) khowes@mofo.com For more updates, follow Thinkingcapmarkets, our Twitter feed: Morrison & Foerster was named the 2016 Equity Derivatives Law Firm of the Year at the EQDerivatives Global Equity & Volatility Derivatives Awards. Morrison & Foerster was also shortlisted for 2016 Americas Law Firm of the Year, US Law Firm of the Year Transactions, and US Law Firm of the Year Regulatory by GlobalCapital for its Americas Derivatives Awards. In 2015, Morrison & Foerster was named Best Law Firm for Derivatives US by GlobalCapital at its Americas Derivatives Awards. Morrison & Foerster named Best Law Firm in the Americas, 2012, 2013, 2014 and 2015 by Structured Retail Products.com. About Morrison & Foerster We are Morrison & Foerster a global firm of exceptional credentials. Our clients include some of the largest financial institutions, investment banks, Fortune 100, technology, and life sciences companies. We ve been included on The American Lawyer s A-List for 12 straight years, and Fortune named us one of the 100 Best Companies to Work For. Our lawyers are committed to achieving innovative and business-minded results for our clients, while preserving the differences that make us stronger. This is MoFo. Visit us at Morrison & Foerster LLP. All rights reserved. Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. 9 Attorney Advertising

73 Morrison & Foerster quarterly news TaxTalk In this issue IRS Publishes Proposed Section 305(c) Regulations Page 2 Volume 9, No. 1 May 2016 Authored and Edited By Thomas A. Humphreys Anna T. Pinedo Stephen L. Feldman Remmelt A. Reigersman Shiukay Hung David J. Goett Nicole M. Humphrey Brennan W. Young IRS Backtracks on Recent Bad Boy Guarantee Memorandum Page 2 FAA F: Low-Risk Tax Credit Partnership Investor Isn t Bona Fide Partner Page 4 PLR Putting Bearer Student Loans Into a Limited Partnership to Create Registered Instruments for Federal Income Tax Purposes Page 4 Supreme Court Rules on REIT Diversity-of-Citizenship Jurisdiction Case Page 5 PLR : Property Sold by REIT as Part of a Liquidation Wasn t Held Primarily for Sale to Customers Page 5 PLR : Certain Subpart F and PFIC Inclusions Are Qualifying Income to a REIT Page 5 Updated Presidential Candidate Tax Positions Page 6 MoFo in the News; Awards Page 7 Editor s Note Things are getting crazy. No, we don t mean what s going on in the U.S. presidential campaign (although we do update you on the remaining candidates tax positions in this issue of Tax Talk), but what s happening on the administrative law side of the tax house. In Q1, the IRS continued its ramped up rulemaking with regulations on broker reporting on debt instruments and OID on tax-exempt bonds, nonrecognition transfers of loss property to corporations, and partnership allocations of creditable foreign tax expenditures. 1 Shortly after the quarter ended, surprise regulations under Section were issued as part of anti inversion guidance. As we reported in our Client Alert, 3 these regulations have potential to affect transactions far beyond inversions, however. Counterbalancing that IRS activity is a serious upswing in talk about challenging regulations. 4 While this issue has always been around, last summer s decision in Altera 5 stoked the fire. Looking around at what tax advisors are speaking and writing about, some are gearing up for a massive attack on regulations. Whether clients have the same fervor, litigation budget, and willingness to challenge the government is another question. 1 This follows last fall s avalanche of Treasury regulations, see Tax Talk Volume 8 Issues 3, available at 2 All section references are to the Internal Revenue Code of 1986, as amended, and the regulations promulgated thereunder. 3 Our Client Alert on the proposed Section 385 regulations is available at 4 See Marie Sapirie, Altera Alters the Landscape for Reg Challenges, Tax Notes Today 2015 TNT 158-1, (Aug. 17, 2015); Susan Simmons, Year in Review: Altera Changes the Game, Tax Notes Today, 2015 TNT (Dec. 28, 2015); Michael L. Schler, Altera and the Proposed Debt-Equity Regulations, Tax Notes Today2016 TNT 84-13, (May 2, 2016). 5 Altera Corporation and Subsidiaries v. Commissioner, 145 T.C. No. 3 (2015). continued on page 2

74 On a quieter note, this issue of Tax Talk covers two IRS rulings on real estate investment trusts, proposed Section 305(c) regulations that contain new rules for reporting and withholding when the conversion ratio is changed on convertible debt, the IRS reconsideration of a 2016 ruling on bad boy guarantees, and more. IRS Publishes Proposed Section 305(c) Regulations On April 12th, the IRS published proposed regulations under Section 305(c) that address the treatment of deemed dividends to holders of stock and rights to acquire stock. If finalized as proposed, these rules would impact issuers and holders of instruments that provide for adjustments in the case of corporate distributions, including convertible bonds and warrants. Under Section 305, a distribution of stock or stock rights by a corporation to its shareholders is generally not included in the shareholder s gross income, except in certain circumstances. For example, a distribution of stock rights to a holder of a convertible security that compensates the holder for an actual distribution to shareholders is generally considered a taxable deemed distribution and is subject to the general rules regarding taxable distributions and dividends. These types of adjustments are common for instruments that are convertible into corporate stock, such as convertible bonds. The regulations do not propose new rules regarding whether a conversion adjustment results in a taxable exchange the preamble to the proposed regulations states that it has been the position of the Treasury Department and the IRS for over 40 years that an increase in the conversion ratio of a convertible debt instrument is treated as a deemed distribution. Instead, the proposed regulations clarify the amount and timing of the deemed distribution. Under the current regulations, it is unclear whether a holder that receives additional rights to acquire stock must include in income the fair market value of the right or the fair market value of the underlying stock itself. The proposed regulations clarify that a deemed distribution of rights to acquire stock is best viewed as a distribution of additional rights to acquire stock, the amount of which is the fair market value of the right itself. However, the preamble states that, for deemed distributions that occur before final regulations are published, the IRS will not challenge taxpayers that use the fair market value of the underlying stock. The proposed regulations also clarify that the timing of a deemed distribution that results from a conversion adjustment is the time the adjustment occurs, in accordance with the terms of the instrument, but in no event later than the actual distribution that triggers the adjustment. Deemed distributions that result in taxable income to non-u.s. holders of convertible securities pose challenges to withholding agents, who are obligated to withhold and remit tax even though holders do not receive a cash payment. The proposed regulations provide a limited exception for withholding agents, who would not be required to withhold on deemed distributions unless either (i) the issuer of the instrument satisfies its reporting obligations with respect to the deemed distribution (for example, by providing notice to holders or by posting information on its website) or (ii) the withholding agent has actual knowledge of the deemed distribution. IRS Backtracks on Recent Bad Boy Guarantee Memorandum Earlier this year, a legal memorandum by the Internal Revenue Service ( IRS ) Office of Chief Counsel, CCA (the Memorandum ), concluded that a so-called bad boy guarantee provided by a sponsor of a real estate partnership could cause an otherwise non-recourse financing to be treated as recourse for tax purposes. The Memorandum came as a surprise to many in the real estate community as taxpayers typically have treated otherwise non-recourse loans as non-recourse for partnership basis and loss allocation purposes even if there was a bad boy guarantee, given the low risk that the events triggering the guarantee obligation would occur. Whether partnership liabilities are characterized as recourse or non-recourse is important because a partner s tax basis in its partnership interest includes the partner s share of partnership liabilities. A nonrecourse liability of the partnership generally increases the tax basis and at-risk investment of each of the partners in proportion to their share of profits or capital, whereas a recourse liability only increases the tax basis and at-risk investment of the partner who bears the risk of loss with respect to the liability. Liabilities are treated as being recourse to a partner if that partner bears the so-called risk of loss in the event that the partnership fails to satisfy the liability. In determining whether a partner bears the risk of loss with respect to a partnership liability, the partnership 2 Morrison & Foerster Tax Talk, May 2016 continued on page 3

75 tax rules look to whether a partner has an obligation to repay the liability upon a constructive liquidation of the partnership, taking into account all statutory and contractual obligations (including a partner s guarantee of the debt). However, under Treas. Reg. Section (b)(4), a partner s guarantee obligation is disregarded if, taking into account all the facts and circumstances, the obligation is subject to contingencies that make it unlikely that the obligation will ever be discharged (a Disregarded Guarantee ). Further, if an obligation would arise at a future time after the occurrence of an event that is not determinable with reasonable certainty, the obligation is ignored until the event occurs. In the Memorandum, partnership X and its subsidiaries incurred several non-recourse loans (the Loans ). In connection with the loans, one of X s members (the Guarantee Partner ) entered into a personal guarantee (the Guarantee ) that would be triggered upon any of the following conditions (the Conditions ): 1. The co-borrowers fail to obtain the lender s consent before obtaining subordinate financing or transfer of the secured property; 2. Any co-borrower files a voluntary bankruptcy petition; 3. Any person in control of any co-borrower files an involuntary bankruptcy petition against a coborrower; 4. Any person in control of any co-borrower solicits other creditors to file an involuntary bankruptcy petition against a co-borrower; 5. Any co-borrower consents to or otherwise acquiesces or joins in an involuntary bankruptcy or insolvency proceeding; 6. Any person in control of any co-borrower consents to the appointment of a receiver or custodian of assets; or 7. Any co-borrower makes an assignment for the benefit of creditors or admits in writing or in any legal proceeding that it is insolvent or unable to pay its debts as they come due. In analyzing the loan, the IRS concluded that, generally, a bona fide guarantee that is enforceable under local law is sufficient to cause the guaranteeing partner to be treated as bearing the risk of loss with respect to the applicable liability. In addition, the IRS argued that upon a constructive liquidation of partnership X, it would be reasonable to assume that one or more of the Conditions, more likely than not, would be met, in which case the Guarantee Partner would be personally liable to repay the Loans. Thus, the IRS concluded that the Guarantee was not a Disregarded Guarantee, and the Loans should be treated as recourse liabilities for partnership tax purposes and should only increase the tax basis and at-risk investment of the Guarantee Partner. 6 However, recently the IRS released AM , which represents a reversal of the prior Memorandum, and the IRS reasoning now aligns with the industry practice of treating these bad boy guarantees as contingencies unlikely to occur that are disregarded under Treas. Reg. Section (b)(4). In AM , the IRS considers the same bad boy guarantees as the prior Memorandum and concludes that an important aspect of these carve-outs is that the bad acts that they seek to prevent are within the control of guarantor. The IRS reasons, because it is in the economic self-interest of the guarantor to avoid committing the bad acts and subjecting itself to liability, the guarantor is unlikely to voluntarily commit such acts. However, the IRS explains that condition #7 deserves a further discussion because it could be interpreted as giving the lender the ability to cause the guarantor to commit one of the bad acts. For example, if a loan agreement required the borrower to provide the lender with periodic written financial reports, and those reports revealed that the borrower was insolvent, the lender might argue that those reports constituted a written admission of insolvency. The IRS suggests this is an inappropriate interpretation of such an event because, in the commercial real estate finance industry, bad boy guarantees are not intended to allow the lender to require an involuntary action by the guarantor or place the guarantors in circumstances that would require them to involuntarily commit a bad act. Rather, the fundamental business purposes behind these carve outs and the intent of the parties to such agreements is to prevent actions by the guarantor that could make recovery on the debt more difficult. Thus, the IRS concludes, bad boy guarantees should be interpreted consistently with that purpose and intent in mind, and because it is not in the economic interest of the guarantor to commit the bad acts described in the typical bad boy guarantees, it is unlikely that the contingency (the bad act) will occur and the contingent payment obligation should be disregarded under Treas. Reg. Section (b)(4). Therefore, unless the facts and circumstances indicate otherwise, a typical bad boy guarantee provision that allows the guarantor to avoid committing the enumerated bad act will not cause an otherwise nonrecourse liability to be treated as recourse for purposes of Treas. Reg. Sections 752 and (a) until such time as the contingency actually occurs. 6 For a fuller discussion of CCA , see 016/03/160322BadBoyGuarantees.pdf. 3 Morrison & Foerster Tax Talk, May 2016 continued on page 4

76 FAA F: Low-Risk Tax Credit Partnership Investor Isn t Bona Fide Partner In a heavily redacted Field Attorney Advice Memorandum (FFA F), the IRS concluded that a taxpayer did not own a bona fide partnership interest in an investment that allocated to the taxpayer Section 45 refined coal credits. The investment involved a limited liability company (LLC) taxed as a partnership that owned and operated a facility that produced refined coal. Under the LLC agreement, the taxpayer was allocated future refined coal tax credits and was obligated to make future contributions contingent on the amount of coal produced, and by extension, the amount of tax credits generated. Furthermore, the LLC agreement indemnified the taxpayer in the event that the tax credits were disallowed. The IRS used the Culbertson 7 test to examine whether the investment was a bona fide partnership interest for U.S. federal income tax purposes. Under the Culbertson test, an interest in an entity constitutes a partnership interest if, based on the facts and circumstances, the parties intended to join together in the present conduct of the enterprise. In looking beyond the form of the transaction and instead examining the facts and circumstances, the IRS referred to various cases, including Historic Boardwalk Hall, LLC v. Commissioner. 8 Factors such as contributions contingent on the production of coal and the tax credit indemnification supported a finding that the taxpayer lacked entrepreneurial risk and upside potential separate from receipt of the tax credits. Furthermore, the promotional materials provided by the parties strongly indicated that the parties were not interested in a joint endeavor to operate a profitable refined coal facility. The materials stated that the taxpayer was not expected to be out-of-pocket from the investment and calculated the taxpayer s benefits based on the tax benefit instead of any expectation of profit from the production of the refined coal. Finally, the IRS determined that the relationship between the parties was akin to a buyer and seller of tax credits, which also supported a finding that the taxpayer was not a bona fide partner. Based on these facts and circumstances, the IRS concluded that a taxpayer did not own a bona fide partnership interest. 7 Commissioner v. Culbertson, 337 U.S. 733 (1949). 8 Historic Boardwalk Hall, LLC v. Commissioner, 694 F.3d 425 (3d Cir. 2012). PLR Putting Bearer Student Loans Into a Limited Partnership to Create Registered Instruments for Federal Income Tax Purposes Recent Private Letter Ruling provided some guidance on whether interests held in a partnership that acquires and holds student loans be considered obligations in registered form. Section 163(f)(1) disallows a deduction for interest on any registration required obligation unless the obligation is in registered form. Section (a) provides, subject to some exceptions, no tax shall be imposed on interest paid to a non-u.s. person on an obligation in registered form. Thus, the answer to the question has important consequences for a foreign investor s ability to qualify for the portfolio interest exemption. According to Section 5f.104-1(c)(1), an obligation is considered in registered form if: (i) the obligation is registered as to both principal and stated interest with the issuer (or its agent) and transfer of the obligation may be effected only by surrender of the old instrument to the issuer in exchange for a new instrument or a reissuance by the issuer of the old instrument to a new holder; (ii) the right to the principal of, and stated interest on, the obligation may be transferred only through a book entry system maintained by the issuer (or its agent); or (iii) the obligation is registered as to both principal and stated interest with the issuer (or its agent) and may be transferred through most of the methods described in (i) and (ii) above. Section 5f.103-1(c)(2) provides that an obligation will be considered transferable through a book entry system if the ownership of an interest in the obligation is required to be reflected in a book entry which is a record of ownership that identifies the owner of an interest in the obligation. With respect to an interest in a grantor trust holding a pool of mortgage loans, Section T(d)(1) provides that an interest (a pass-through certificate ) in a trust that is treated as a grantor trust is considered to be an obligation in registered form if the pass-through certificate is in registered form without regard to whether any obligation held by the fund or trust to which 4 Morrison & Foerster Tax Talk, May 2016 continued on page 5

77 the pass-through certificate relates is in registered form. Thus, the registration required obligation is the certificate evidencing the interest in the entity rather than the underlying obligations. PLR involved a Taxpayer that used capital contributions from its owners to acquire interests in a limited partnership (the Partnership ) that would have the ability to acquire student loans and use principal pay downs on the loans it held to finance acquisitions of additional student loans. These student loans were not in registered form within the meaning of Section 5f.103-1(c); however, the interests in the Partnership were only transferable pursuant to procedures described in 5f.103-1(c)(1). For instance, under the terms of the limited partnership agreement, the general partner was obligated to keep a full and accurate register of the interests in the Partnership and only those persons that appeared on this register would be entitled to a distributive share of the Partnership s income with respect to the student loans. In addition, interests in the Partnership could only be transferred on the written consent of the general partner. Thus, the Partnership interests were similar to the pass-through certificate of a mortgage pool, except the Partnership was not treated as a grantor trust. Nevertheless, the PLR concluded that interests in a limited partnership were similar evidences of interest in a similar pooled fund under Reg T(d)(1), and such interests would be considered obligations in registered form if the requirements of Section 5f.103-1(c)(1) were satisfied. Supreme Court Rules on REIT Diversity-of- Citizenship Jurisdiction Case In our last issue of Tax Talk, 9 we reported that the Supreme Court had granted certiorari in Conagra Foods, Inc. v. Americold Logistics, LLC. In that case, the U.S. Tenth Circuit Court of Appeals held that the citizenship of a Maryland Title 8 Trust REIT must be determined by the citizenship of its shareholders for the purposes of determining whether a federal court has diversityofcitizenship jurisdiction. On March 7, 2016, the Supreme Court affirmed the Tenth Circuit s holding. 10 The Court reasoned that since in Maryland a real estate investment trust ( REIT ) is an unincorporated business trust or association in which property is held and managed for the benefit of any person who may become 9 See Volume 8, No. 4 January 2016 ( 2/160201TaxTalk.pdf). 10 Americold Realty Tr. v. ConAgra Foods, Inc., 136 S. Ct. 1012, 194 L. Ed. 2d 71, 84 U.S.L.W (2016). 5 Morrison & Foerster Tax Talk, May 2016 a shareholder, and similar to joint-stock companies or partnerships the shareholders of a Maryland REIT have ownership interests and votes in the trust, the shareholders are in a similar position to the shareholders of a joint-stock company or the partners of a partnership. The Court stated that since it has held that shareholders of joint-stock companies and the partners of a limited partnership are members of the relevant entities, and owners of Maryland REIT shares are in a similar position, a Maryland REIT s members include its shareholders for the purposes of diversity-of-citizenship jurisdiction. PLR : Property Sold by REIT as Part of a Liquidation Wasn t Held Primarily for Sale to Customers Private Letter Ruling addresses the issue of whether a proposed sale of a REIT s assets pursuant to a plan of liquidation was property held by the REIT primarily for sale to customers in its ordinary course of business and therefore a prohibited transaction pursuant to Section 857(b)(6)(B). Section 857(b)(6)(A) imposes a 100 percent tax on a REIT s net income from prohibited transactions. Section 857(b)(6)(B) defines a prohibited transaction as the sale or other disposition of property (that is not foreclosure property) held by the taxpayer primarily for sale to customers in the ordinary course of its trade or business. The taxpayer represented that (1) it acquired the properties with the intent to own for a long-term holding period, and to derive its profits from capital appreciation and rental income; (2) the disposition of the properties was pursuant to a plan of liquidation; (3) all rental properties had operated for at least two years at the time of the proposed sale; and (4) the taxpayer would use one or more independent third party brokers to dispose of the properties. Based on the facts, the IRS ruled that such proposed sale of assets did not constitute prohibited transactions. PLR : Certain Subpart F and PFIC Inclusions Are Qualifying Income to a REIT Private Letter Ruling addresses the issue of whether Subpart F inclusions and PFIC inclusions would be treated as qualifying income under Section 856(c)(2), the REIT gross income 95 percent test. The continued on page 6

78 taxpayer was a corporation that had elected to be taxed as a REIT and operated in foreign countries through foreign subsidiaries that were controlled foreign corporations ( CFCs ) or passive foreign investment companies ( PFICs ) for U.S. federal income tax purposes. Section 856(c)(2) provides that, in order for a corporation to qualify as a REIT, as least 95 percent of the corporation s gross income must be derived from certain enumerated sources, which include dividends, interest, rents from real property, gain from the sale or other disposition of stock, securities, and real property (other than property in which the corporation is a dealer), abatements and refunds of taxes on real property, income and gain derived from foreclosure property, and certain commitment fees. The IRS ruled that (i) under Section 856(c)(5)(J)(ii), the Subpart F inclusions were considered gross income that qualifies for purposes of Section 856(c)(2), and (ii) under Section 856(c)(5)(J)(ii), the PFIC inclusions were considered gross income that qualifies for purposes of Section 856(c)(2). IRS Issues Final Regs Covering Broker Reporting on Debt Instruments & OID on Tax-Exempt Obligations On March 7, 2016, the IRS published final regulations (T.D. 9750) under Sections 6045, 6045A and 6049, which provide guidance on information reporting by brokers for transactions involving debt instruments and options, including the reporting of original issue discount ( OID ) on taxexempt obligations, the treatment of certain holder elections for reporting a taxpayer s adjusted basis in a debt instrument, and transfer reporting for Code Section 1256 options and debt instruments. On March 13, 2015, the IRS published final regulations under these same sections, along with temporary and proposed regulations relating to information reporting. The 2016 final regulations generally adopt those proposed and temporary regulations, and have a few highlights. First, the final regulations adopt the rules in the temporary regulations covering broker reporting of the holder constant yield election for accruals of market discount. Under Section 1276(b)(2), a customer is permitted to elect to accrue market discount on the constant yield method rather than the ratable method. The final regulations provide that for debt instruments acquired on or after January 1, 2015, brokers are required to assume that a customer has elected to determine accrued market discount using a constant yield method unless the customer notifies the broker otherwise. If a customer doesn t want to use a constant yield method to determine accrued market discount, the customer must notify the broker in writing that the customer wants the broker to use the ratable method by the end of the calendar year in which the customer acquired the debt instrument in an account with the broker. Second, in order to coordinate the reporting of OID under Section 6049 with the reporting of basis for tax-exempt obligations under Section 6045, the final regulations provide that for taxexempt obligations acquired on or after January 1, 2017, a payor must report the daily portions of OID on a tax-exempt obligation. The payor must determine whether a tax-exempt obligation was issued with OID, and the daily portions are to be determined as if Section 1272 and Treas. Reg applied to the tax-exempt obligation. Since amortized acquisition premium offsets OID, the final regulations also require payors to report amortized acquisition premium on tax-exempt obligations. Brokers may either report a net amount of OID that reflects the offset of the OID by the amount of amortized acquisition premium allocable to the OID or a gross amount for both OID and amortized acquisition premium. Finally, the final regulations provide that a transferring broker is required to provide a transfer statement upon the transfer of a Section 1256 option to ensure that the receiving broker has all the information required for purposes of Section The transfer statement must include the original basis of the option and fair market value information to help ensure that the receiving broker is reporting an amount of realized, but unrecognized gain or loss from the prior year that is consistent with the amount reported in the prior year by the transferring broker. Updated Presidential Candidate Tax Positions The field of presidential candidates has narrowed since we last covered the candidates tax plans. 11 Below is additional information about the tax plans of the three remaining candidates. 11 See Volume 9, No. 4 January 2016 ( 2/160201TaxTalk.pdf). 6 Morrison & Foerster Tax Talk, May 2016 continued on page 7

79 Candidate Individual Income Tax Minimum effective tax rate of 30% for income above $1 million; 4% surcharge for income above $5 million Capital Gains Tax For individuals in the top tax bracket, capital gains tax rate of 39.6% for investments held for two years or less, with rates gradually decreasing to 20% for investments held for more than six years Estate Tax Increases the estate tax rate to 45% and reduces the exemption to $3.5 million Corporate Tax Not specified International Tax Not specified Hillary Clinton (D) 9 Bernie Sanders (D) 13 Adds four new income tax brackets for high-earning households, with rates up to 52% for income above $10 million Taxes capital gains at ordinary income rates Increases the estate tax rate to 45%-65% depending on value of the estate and reduces the exemption to $3.5 million Not specified Ends the deferral of tax on foreign income for corporations Donald Trump (R) 15 Four tax brackets for individual income tax, with top marginal rate of 25% on income above $150,000 for single filers ($300,000 for married filers) Taxes long-term capital gains and qualified dividends at a top marginal rate of 20% Eliminates estate tax Flat tax rate of 15%; taxes passthrough business income at 15% Ends the deferral of overseas corporate income; enacts a deemed repatriation of foreign income at a 10% rate wsj.com/washwire/2016/01/12/hillary-clintons-next-tax-target-estates/ ashleaebeling/2015/06/25/bernie-sanders-calls-for-65-top-estate-tax-rate/#5457dc0c41f1; MoFo in the News; Awards Morrison & Foerster was named the 2016 Equity Derivatives Law Firm of the Year at the EQDerivatives Global Equity & Volatility Derivatives Awards. Morrison & Foerster has been nominated for the 2016 Chambers USA Awards for Excellence in three categories, including Tax. These awards are based on Chambers & Partners research for the 2016 edition of Chambers USA: America s Leading Lawyers for Business and reflect a law firm s pre-eminence in key practice areas. Morrison & Foerster was also shortlisted for 2016 Americas Law Firm of the Year, US Law Firm of the Year Transactions, and US Law Firm of the Year Regulatory by GlobalCapital for its Americas Derivatives Awards. In 2015, Morrison & Foerster was named Best Law Firm for Derivatives US by GlobalCapital at its Americas Derivatives Awards. 7 Morrison & Foerster Tax Talk, May 2016 mycorporateresource.com awarded MoFo with the 2015 Client Content Law Firm of the Year Award in recognition of law firms that produce world-beating, client-facing content. On March 30, 2016, Senior Of Counsel Hillel T. Cohn hosted a teleconference session entitled Current Practices and Issues for Foreign Broker-Dealers Under Rule 15a-6 in Topics included: Summary of Rule 15a-6 requirements; risks and responsibilities of acting as a chaperoning broker; practical issues in intermediating Rule 144A and other transactions; benefits of an intermediary agreement; and dealing with retail customers under Rule 15a-6. On March 29, 2016, Partner James Tanenbaum led Session 5: Innovation at the Israel Dealmakers Summit 2016 in Redwood City, CA. The summit is the premier Israel-focused business event of the year representing a meticulously curated gathering of global corporations, investors, dealmakers, and entrepreneurs converging from around the world. On March 17, 2016, Partner Anna Pinedo, Partner Oliver Ireland, Partner Remmelt Reigersman, Partner Obrea Poindexter, Of Counsel Sean Ruff, and Of Counsel James Schwartz hosted Morrison & Foerster s continued on page 9

80 6th Annual Financial Services and Regulatory Conference in Charlotte, NC. Partner Remmelt Reigersman spoke on the Tax Developments and Emerging Issues panel. Topics included: Dividend equivalent discussion; the IRS basket notice; and other recent developments. Partner Obrea Poindexter and Of Counsel Sean Ruff hosted a panel entitled A FinTech Discussion. Topics included: Alternate lending platforms (e.g., Marketplace Lending, etc.); money transmission; digital wallets and related topics; an update on virtual currencies, cryptocurrencies, and ledger related technologies (e.g., Blockchain); and partnerships between nonbank FinTech companies and banks. During the Fed s Long Term Debt, TLAC and Clean Holding Company Requirement and its Effects on Financial Institutions Issuers and the Debt Capital Markets panel, Partner Anna Pinedo and Partner Oliver Ireland discussed: A review of comments submitted to the Federal Reserve Board on its notice of proposed rulemaking; single point of entry resolution; preparing to comply, including addressing near TLAC eligible securities, setting up new issuance platforms, etc.; the FSB principles and implementation of the FSB principles and the BRRD in Europe; and how the FRB s and the FSB s requirements will generally affect the bank-funding markets. Partner Anna Pinedo hosted the Other Basel and FSB Related Developments panel. Topics included: Basel focus on shadow banking; requirements for securities lending transactions; the Fed s countercyclical buffer proposal; securitization updates; and regulation of benchmark indices. Of Counsel James Schwartz hosted a panel entitled A Derivatives Update. Topics included: The margin rules for uncleared swaps and their effects on dealers; cross border developments and their effect on U.S. counterparties; the ISDA 2015 Universal Resolution Stay Protocol and related matters; and status of SEC rules for security-based swaps and what lies ahead. On March 15, 2016, Partners Anna Pinedo and Remmelt Reigersman spoke on a panel entitled Legal, Regulatory, Compliance and Tax Update at the Structured Products Association s 12th Annual Spring Conference on Structured Investments in New York, NY. This is the only conference that focuses on the voice of the distribution side of the structured investments industry. On March 14, 2016, Partner Jeremy Jennings- Mares spoke on a panel entitled The Regulatory Speed Round at the 9th Annual IMN Global Covered Bonds Conference in London, U.K. Topics included: Harmonization of the CB space: why? Challenges and opportunities for the European 8 Morrison & Foerster Tax Talk, May 2016 and global market participants; New regulatory environment: CRR, BRRD, Solvency 2, LCR what are the implications for the future of the CB space?; and global evolution of the product: should Basel capture and recognize the significance of the new global CB developments? On March 10, 2016, Partner Peter Green, Partner Jeremy Jennings-Mares, and Of Counsel James Schwartz hosted a teleconference entitled Cross- Border Derivatives Update. The session provided an update on the state of play of derivatives regulation on both sides of the Atlantic. Topics included: How U.S. and EU regulations approach the cross-border application of substantive requirements; the recent U.S.-EU accord regarding the regulation of central counterparties; and substantive regulatory requirements for uncleared swaps from a cross-border perspective, including clearing, exchange trading, and margin. On March 9, 2016, Partner Marty Dunn, Partner David Lynn, and Partner Anna Pinedo hosted a teleconference entitled FAST Act Securities Law Provisions. The speakers discussed the FAST Act, which amended certain provisions of the JOBS Act, the Securities Act and the Exchange Act. Topics included: The changes to the IPO on-ramp provisions and the Staff C&DIs; considerations for issuers planning their IPOs; forward incorporation in Form S-1 registration statement and the SEC s interim final rules; the harmonization of the Section 12(g) threshold for savings and loan holding companies and the related C&DIs; the new Section 4(a)(7) resale exemption; and deciding among available resale exemptions. On March 8, 2016, Partner Michelle Jewett and Partner Shane Shelley hosted a teleconference entitled PATH Act: Major Changes to the REIT and FIRPTA Rules. Topics included: Prohibition on taxfree REIT spinoffs by non-reit entities; exemption from FIRPTA for foreign pension plans and certain publicly traded companies investing in U.S. real estate; expansion of exemption for investors in publicly traded REITs; favorable technical changes, including the elimination of the preferential dividend rules for public REITs, the introduction of a new prohibited transactions safe harbor, a reduction in the recognition period for built-in gains on REIT conversions, the expanded use of REIT hedges and an expansion of the definition of qualifying real estate assets ; and liberalization of the use of taxable REIT subsidiaries ( TRSs ) in some situations but constriction of their use for REIT qualification purposes. continued on page 10

81 On March 3, 2016, Partner Ze -ev Eiger and Associate Brian Hirshberg hosted a teleconference entitled Foreign Issuers Filing a Form 20- F. The speakers discussed: Benefits available to foreign private issuers ( FPIs ); Form 20-F requirements and recent developments; accounting considerations; corporate governance considerations; specialized disclosure requirements; and recent SEC disclosure focus areas. On February 25, 2016, Partner James Tanenbaum and Partner Anna Pinedo hosted a seminar entitled Strategic Uses of PIPE Transactions in New York, NY. Topics included: The basics of PIPE transactions; the Nasdaq considerations; PIPEs for acquisition financing; PIPEs as part of a recapitalization; and PIPEs for selling stockholders. On February 24, 2016, Partner Anna Pinedo and Partner David Lynn hosted an IFLR webinar entitled The New Dynamic: Exempt Securities Offerings in the United States and Resales of Restricted Securities. Topics included: How the JOBS Act has affected private placements; late-stage private placements; the Regulation A market; the final crowdfunding regulations; other exempt offering developments, such as intrastate offering changes; and resales of restricted securities through private secondary market transactions as well as reliance on new Section 4(a)(7). On February 23, 2016, Partner Anna Pinedo hosted a seminar entitled Masterclass: Structured Alternatives to Structured Notes in New York, NY. Topics included: The issuance of structured notes from bank holding company subsidiaries that are finance companies, the issuance of structured notes through a repackaging vehicle and the disclosure and reporting requirements entailed in a bond repackaging, as well as potential Volcker Rule considerations, the issuance of custodial receipts, and the use of unit investment trusts. On February 17, 2016, Partner Anna Pinedo and Partner Oliver Ireland led a PLI webinar entitled Addressing the TLAC, the Long-Term Debt Requirement, and the Clean Holding Company Requirements. The session focused on the Federal Reserve Board s proposed long-term debt requirement, a TLAC requirement and a clean holding company requirement for U.S. G-SIBs, and the intermediate holding companies of foreign (non- U.S.) G-SIBs subject to an IHC requirement. Topics included: The FRB s proposed requirements; the principal comments raised by market participants and likely FRB responses; the principal differences 9 Morrison & Foerster Tax Talk, May 2016 between the FSB s and the FRB s approach; planning to comply; potential effects for foreign banks subject to both regimes; and anticipated effect on how banks will fund going forward. On February 12, 2016, Partner Jeremy Jennings- Mares led the Law Firm Roundtable at the 13th Annual Europe Structured Products & Derivatives Conference 2016 in London, U.K. Topics included: Product governance and Mifid 2: compliance, target market, and stress testing; priips and the Kid: and now every document needs to be in 12 languages: translating, scope of products, territoriality; updating existing products and implementing Priips intelligently; Prospectus Directive 3: was PD2 a waste of time and money?; and time to spend: implementation and the completion of stage 2 of the FCA review, and is this being done properly? On February 10, 2016, Partner Lloyd Harmetz hosted a teleconference entitled Free Writing Prospectuses: Legal Principles and Best Practices. Topics included: The SEC rules and guidance governing the use of these documents; the intersection of these SEC rules with applicable FINRA regulations; practices that have emerged in the marketplace in connection with the drafting and use of FWPs; and the limitations imposed on the use of these documents by reporting companies that have lost their WKSI status. On February 9, 2016, Partner Anna Pinedo and Partner Ze -ev Eiger hosted a teleconference entitled FINRA Research Rules. Topics included: FINRA s new equity research rule (Rule 2241), which took effect on December 24, 2015, and new debt research rule (Rule 2242), which was proposed to take effect on February 22, Additional topics included the analyst settlement, the SEC s research rules, as well as recent enforcement matters and other developments. On February 4, 2016, Partner Jay Baris, Of Counsel Kelley Howes and Of Counsel James Schwartz hosted a teleconference entitled The SEC Proposed Rules on Investment Company Use of Derivatives and Leverage: What It Could Mean for You. Topics included: Overview of rules; substantive limits on use of derivatives; derivatives risk management programs; new responsibilities for fund directors; and challenges for investment advisors and chief compliance officers and counsel. On February 4, 2016, Partner Anna Pinedo spoke at a symposium entitled The Role of the CFTC in the Market at The George Washington University Center for Law, Economics & Finance continued on page 11

82 in Washington, D.C. regarding key concerns surrounding systemic risk related to the instruments and entities impacted by the CFTC. On February 2, 2016, Partner Remmelt Reigersman presented on current developments in the legalregulatory-compliance landscape at the 8th Annual SPA and MoFo Structured Products Legal, Regulatory & Compliance Update 2016 in New York, NY. This presentation covered a wide range of topics related to structured products, including: Tax issues; addressing TLAC compliance through financing subsidiaries and other approaches; FINRA s and the OCIE s priorities for 2016; the use of derivatives by 40 Act entities; and what to expect in On January 25, 2016, Partner David Lynn chaired a session entitled Cybersecurity: A Call to Action at the 43rd Annual Securities Regulation Institute in Coronado, CA. Topics included: Assembling the cyber response team; corporate governance implications; prebreach and post-breach disclosure concerns; and necessary organizational and compliance measures. On January 27, 2016, Partner Marty Dunn chaired a session entitled Everything You Always Wanted to Know about Securities Law but Were Never Given the Chance to Ask. On January 22, 2016, Partner Anna Pinedo spoke on a panel entitled Key Considerations in Derivatives and Structured Products and Collateral at the New York City Bar Association s A How to Guide to Basic Derivatives, Swaps Clearing & Structured Products program. Topics included: Collateral posting and protection issues; bankruptcy and credit downgrade considerations; understanding netting of exposures, risk exposure, valuation, and risk: notional values, counterparty risk, pricing, and leverage; use of derivatives in M&A; and tax implications of various derivatives and structured notes. On January 21, 2016, Partner Brian Bates moderated a panel entitled Growing the Market v. Beating the Competition at the Private Placements Industry Forum in Aventura, FL. Partner Scott Ashton moderated the Real Estate Universities sector breakout session. About Morrison & Foerster We are Morrison & Foerster a global firm of exceptional credentials. Our clients include some of the largest financial institutions, investment banks, and Fortune 100, technology, and life sciences companies. We ve been included on The American Lawyer s A-List for 12 straight years, and the Financial Times named the firm number six on its 2013 list of the 40 most innovative firms in the United States. Chambers USA honored the firm as its sole 2014 Corporate/M&A Client Service Award winner, and recognized us as both the 2013 Intellectual Property and Bankruptcy Firm of the Year. Our lawyers are committed to achieving innovative and business-minded results for our clients, while preserving the differences that make us stronger. 10 Morrison & Foerster Tax Talk, May Morrison & Foerster LLP

83 Contacts United States Federal Income Tax Law Corporate + Securities Law Thomas A. Humphreys (212) thumphreys@mofo.com Remmelt A. Reigersman (212) rreigersman@mofo.com Nicole M. Humphrey (212) nhumphrey@mofo.com Anna T. Pinedo (212) apinedo@mofo.com Stephen L. Feldman (212) sfeldman@mofo.com Shiukay Hung (212) shung@mofo.com Brennan W. Young (212) byoung@mofo.com Lloyd S. Harmetz (212) lharmetz@mofo.com David J. Goett (212) dgoett@mofo.com Because of the generality of this newsletter, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations. 11 Morrison & Foerster Tax Talk, May Morrison & Foerster LLP

84 A pig in a poke. Whist, whist (Sir Joseph Mawbey, 1st Bt), by James Gillray, publisher Samuel William Fores (floruit 1841), published THE LONG LONG GAME: THE EU FINANCIAL REGULATORY AGENDA INTO 2016 AND BEYOND JANUARY 2016