C HAPTER B. Introduction. Capital Markets and Securities Law

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1 77 C HAPTER B Introduction The approach to establishing an internal market in the securities sector is similar to that in other financial services areas. It consists of harmonisation of essential standards, mutual recognition by the national supervisory authorities of the controls applied in the country in which the head office is situated and the coordination of the work of supervisory authorities by the home country. A number of measures that form the basis for an integration of securities markets on a European level date back more than 20 years. Among these measures are the Listing Admission Directive and the Listing Particulars Directive, which were merely a first step towards the establishment of a genuine single market, since Member States remained responsible for the formalities and scrutiny required for the admission of securities to their stock exchanges. The principle of home-country control was introduced to the securities sector in 1985 by the UCITS Directive harmonising existing rules on certain undertakings for collective investment in transferable securities (UCITS). Provisions on information on major holdings and on insider trading were adopted in 1988 and The liberalisation of transactions in securities moved forward significantly with the entry into force of the Investment Services Directive on 1 January The Directive brought about the right of establishment and freedom to provide services in all countries of the EU in this sector. In 1997, the Investor Compensation Directive was adopted, which is in accordance with the Deposit Guarantee Schemes Directive applicable in the banking sector. The Stock Exchange Law Directive of 2001 codifies four earlier basic Directives and their amending Directives, and combines them into a single text, including the Listing Admission Directive, the Listing Particulars Directive, the Interim Reports Directive, and the Major Holdings Directive. In 1999, the EU Commission launched the Financial Services Action Plan (FSAP) with the aim of achieving a single market for financial services by no later than The FSAP, amongst other things, contained a number of measures to harmonise further the EU securities legislation. These measures included, inter alia: the Market Abuse Directive;

2 78 INTRODUCTION the Prospectus Directive; the Transparency Directive; the Markets in Financial Instruments Directive (MiFID) being the modernised version of the Investment Services Directive. These new Directives provide the framework for more technical pieces of legislation. The Directives are enacted in the extended comitology procedure, the so-called Lamfalussy procedure, as a speedier and more flexible lawmaking process. Technical details are handled through implementing measures in the form of Directives or Regulations. After the completion of the Financial Services Action Plan, the Commission published its White Paper on Financial Services Policy ( ) at the end of According to this paper, dynamic consolidation was chosen to be the leitmotiv of the Commission in the coming years. The Commission intended to concentrate its efforts on the implementation and enforcement of the FSAP measures. New lawmaking was to be undertaken in targeted areas only. With regard to the capital markets, this concerned above all UCITS and rendering clearing and settlement of securities more efficient. A closer cooperation with consumer organisations in Europe was also envisaged. With regard to the legislative process, the Lamfalussy procedure was targeted to be made more efficient. Finally, the Commission identified improved EU regulatory and supervisory structures as point of action. Being shaken by the financial crisis intensifying in the second half of 2008, the Commission in November 2008 mandated a High Level Group chaired by Jacques de Larosière to propose recommendations for a reform of the financial system, with a particular focus on supervision. The group presented a set of 31 recommendations offering a comprehensive set of concrete solutions for regulatory, supervisory and global repair action on 25 February The recommendations became starting point for the Commission s March 2009 Communication Driving European Recovery as well as for its legislative proposals on a new supervisory architecture including the supervision of securities markets and market participants in September and October To deal with the crisis and prepare for recovery besides the supervision topic, the Communication announced with a view to increasing the transparency of capital markets and ensuring their stability to complete European legislation on hedge funds and private equity and to deal with derivatives and other complex structured products, to work on retail investment products, to reinforce investor protection and to ensure more effective sanctions against market wrongdoing.

3 INTRODUCTION 79 In its Communication Regulating Financial Services for Sustainable Growth of June 2010 the Commission highlighted the importance of keeping up a speedy continuation reforming the financial system, articulated around the four main principles of enhanced transparency, effective supervision and enforcement, enhanced resilience and financial stability and strengthened responsibility and consumer protection. For the capital markets, the Commission outlined the necessity of completing the work in progress concerning the supervisory architecture and the managers of alternative investments funds. With regard to the forthcoming proposals, the Commission voted for focusing on the adjustment of credit rating agencies to the future supervisory framework, the functioning of derivatives markets, improvements to pre- and post-trade transparency, measures against the abuse of certain financial instruments or techniques, increasing the protection of investors and promoting consumers interests.

4 80 ESMA-REGULATION B.I. TEXTS ADOPTED BY THE EU B.I.1. REGULATION (EU) NO 1095/2010 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL OF 24 NOVEMBER 2010 ESTABLISHING A EUROPEAN SUPERVISORY AUTHORITY (EUROPEAN SECURITIES AND MARKETS AUTHORITY), AMENDING DECISION NO 716/2009/EC AND REPEALING COMMISSION DECISION 2009/77/EC Content The European Commission introduced the European Securities and Markets Authority, ESMA, as part of the new supervisory structure proposed on 23 September ESMA, as the other European supervisory authorities, took on all the tasks of the European supervisory committees, but in addition was equipped with significantly increased responsibilities, defined legal powers and greater authority. ESMA is responsible, with minor exemptions, for the scope of the following Directives and Regulations (Art. 1(2)): Investor Compensation Schemes Directive (97/9/EC); Settlement Finality Directive (98/26/EC); Stock Exchange Listing Directive (2001/34/EC); Financial Collateral Arrangements Directive (2002/47/EC); Financial Conglomerates Directive (2002/87/EC); Market Abuse Directive (2003/6/EC); Prospectus Directive (2003/71/EC); Takeover Bids Directive (2004/25/EC); MiFID (2004/39/EC); Transparency Directive (2004/109/EC); Anti-Money Laundering Directive (2005/60/EC); Distance Marketing Directive (2002/65/EC); Shareholders Rights Directive (2007/36/EC); Capital Adequacy Directive (2006/49/EC); UCITS Directive (2009/65/EC); AIFM Directive (2011/61/EU); Reg. (EC) 1060/09 on Credit Rating Agencies; further legally binding Union acts which confer tasks on the Authority.

5 ESMA-REGULATION 81 The Commission suggested ESMA having the following tasks (Art. 6(1)): Contribute to the establishment of high quality common regulatory and supervisory standards and practices; Contribute to a consistent application of Community legislation (Preventing regulatory arbitrage; Mediating and settling disagreements between competent authorities; Promoting a coherent functioning of colleges of supervisors; Taking decisions in emergency situations); Facilitate the delegation of tasks and responsibilities between competent authorities; Cooperate closely with the ESRB; Conduct peer review analysis of competent authorities; Monitor and assess market developments; Future tasks might be added. The tasks would allow ESMA to execute the following powers (Art. 6(2)): Develop draft technical standards (Art. 7); Issue guidelines and recommendations (Art. 8); Issue recommendations in specific cases to competent authorities (Compliance with Community law) (Art. 9(3)); Take individual decisions addressed to competent authorities (Action in emergency situations, the existence of the situation determined by the European Commission; Settlement of disagreements between competent authorities) (Art. 10, 11); Take individual decisions addressed to financial market participants (Compliance with Community Law; Action in emergency situations; Settlement of disagreements between competent authorities) (Art. 9(6), 10(3), 11(4)); Issue opinions to the European Parliament, Council, European Commission (Art. 19); Execute exclusive supervisory powers over entities with Community-wide reach or economic activities with Community-wide reach (Art. 6(3)). For the general design of the supervisory architecture see Chapter A. Procedure In October 2008 the Commission mandated a High Level Group chaired by Jacques de Larosière to give advice on the future of European financial regulation and supervision. The Group presented its report on 25 February 2009 and its recommendations were endorsed by the Commission in its Communication to the Spring European Council of March 2009 ( Driving European Recovery ).

6 82 ESMA-REGULATION The European Commission adopted a specific Communication on Financial Supervision in Europe on 27 May 2009 ( European Financial Supervision ). The Communication proposed a set of ambitious reforms to the current architecture of financial services committees, with the creation of a new European System of Financial Supervisors (ESFS), composed of new European Supervisory Authorities, and a European Systemic Risk Board (ESRB). The Commission published on 23 September 2009 its proposals on the new supervisory architecture including the draft Regulation on ESMA as well as a draft Directive amending various European legal acts in respect of the powers of the new authorities including ESMA (Omnibus I-Directive). The European Parliament adopted the Regulation on 22 September 2010, the Council followed on 17 November The Regulation was published in the Official Journal of the EU on 15 December The new Authorities were in power on 1 January Already on 19 January 2010 CESR had introduced new working structures to increase efficiency and to prepare for a smooth transition to ESMA. References COM (2009) 503 of 23 September 2009 (not published in the Official Journal of the EU). COM (2009) 576 of 26 October 2009 (not published in the Official Journal of the EU). 1095/2010/EU of 24 November 2010, Official Journal of the EU, L331/84 of 15 December /78/EU of 24 November 2010, Official Journal of the EU, L331/120 of 15 December 2010.

7 CREDIT RATING AGENCIES REGULATION 83 B.I. TEXTS ADOPTED BY THE EU B.I.2. REGULATION (EC) NO. 1060/2009 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL ON CREDIT RATING AGENCIES Content After a number of financial scandals, in February 2004, the European Parliament adopted a Resolution on Credit Rating Agencies (CRAs), calling on the European Commission to produce an assessment on the need for legislative intervention in this field. The Commission responded to this call by issuing a Communication on CRAs on 9 January 2006 setting out its decision not to propose legislative measures at this point in time, based on the belief that the existing financial services Directives applicable to CRAs particularly the Market Abuse Directive, the Capital Requirements Directive (CRD) and the Markets in Financial Instruments Directive combined with self-regulation by the CRAs based on the IOSCO CRA Code were sufficient to answer all the major issues of concern raised by the European Parliament. In December 2004, the International Organisation of Securities Commissions (IOSCO) had issued its Code of Conduct Fundamentals for CRAs, called the IOSCO CRA Code. The IOSCO CRA Code, while not legally binding, is intended to be applied by rating agencies of all sizes and business models and in every jurisdiction. CRAs are expected to incorporate all the provisions of the IOSCO CRA Code into their own internal codes of conduct. In 2005, the Committee of European Securities Regulators (CESR) set up a dialogue with CRAs on the basis of voluntary participation, monitoring compliance with the IOSCO CRA Code. Following the financial market turmoil which started in the second half of 2007, the rating agencies came again under enhanced scrutiny. The European Commission proposed a Regulation on CRAs in November 2008 which was adopted by the European Parliament in April 2009 and by the Council in July 2009 and published in the Official Journal of the EU on 17 November Due to its nature, the provisions of the Regulation are legally binding. The Regulation sets up an obligation for all CRAs wishing to operate in the EU to register and comply with a set of rules. The provisions aim at enhancing

8 84 CREDIT RATING AGENCIES REGULATION transparency, independence and good governance of credit rating agencies, thus improving the quality and reliability of credit ratings and consumer s trust. Analysts and persons approving credit ratings should be subject to a rotation mechanism. The rotation takes place on an individual basis rather than changing the entire team of the company. ESMA (formerly CESR) was charged with registering CRAs according to the new rules. This provides a single point of entry for the submission of applications and thus cost reduction for agencies. National authorities will take the decision on CRAs registration and compliance with the rules and on the possibility of withdrawing an agency s registration should the rules be breached. A college of supervisors provides a platform for an exchange of supervisory information among national authorities and to improve coordination of their activities. Non-European ratings have to be endorsed by ESMA. ESMA is responsible for determining and monitoring on an on-going basis whether rating activities of non-eu CRAs comply with the requirements. For smaller non-eu agencies, which have no presence in the EU, a specific certification regime is established. The Commission will decide, on a case by case basis, on the equivalence of the legal framework of the third country with EU rules and therefore on the possible use of that rating within the Community. Each CRA has to disclose to the public the methodologies used to adopt their ratings. With regard to structured products, CRAs should either use different rating categories when rating structured finance instruments or provide additional information on the different risk characteristics of these products. CRAs also have to publish annually a transparency report including information on ownership, the outcome of the annual internal review of the independence compliance and a description of the management and analyst rotation policy. In the framework of the CRD, CRAs can be recognised as External Credit Assessment Institutions (ECAIs) which can provide external credit ratings to credit institutions under certain conditions. For this purpose and as required by the CRD, competent authorities have to consider whether the methodologies of rating agencies meet the requirements of objectivity, independence, ongoing review and transparency and that their ratings meet the requirements of credi-

9 CREDIT RATING AGENCIES REGULATION 85 bility and transparency. Furthermore, they have to consider which of the risk weights should be attached to the ratings (the mapping ). The Committee of European Banking Supervisors (CEBS) to this end published guidelines on the recognition of ECAIs by national supervisory authorities. The guidelines contain general principles on the recognition process, a common understanding of conditions for recognition as well as criteria for mapping external credit assessments to the CRD risk weights. Supervision of Credit Rating Agencies (Regulation amending the CRA Regulation of 2 June 2010): The Regulation was already revised and adapted to the new European supervisory structures in As rating services are not linked to a particular territory and the ratings issued by a CRA can be used by financial institutions all around Europe, credit rating agencies should come under a more centralised system for supervision. ESMA is entrusted with exclusive supervision powers over CRAs registered in the EU. This includes the European subsidiaries of rating agencies situated in third countries. ESMA received powers to request information, to launch investigations, and to perform on-site inspections. Issuers of structured finance instruments such as credit institutions, banks and investment firms have to provide all other interested CRAs with access to the information they give to their own CRA, in order to enable them to issue unsolicited ratings. These changes mean that CRAs would operate in a much simpler supervisory environment than the existing varied national environments and would have easier access to the information they need. Users of ratings were expected to be better protected as a result of centralised supervision of all CRAs and increased competition among CRAs. Procedure In September 2003, IOSCO issued its Statement of Principles Regarding the Activities of CRAs ( IOSCO CRA Principles ). This statement was followed by a Code of Conduct Fundamentals for CRAs ( IOSCO CRA Code ) in December In February 2004, the European Parliament adopted a Resolution on CRAs. In 2005, CESR set up a dialogue with CRAs concerning the IOSCO CRA Code on the basis of voluntary participation.

10 86 CREDIT RATING AGENCIES REGULATION The European Commission issued a Communication on CRAs on 9 January 2006, deciding not to regulate CRAs at this stage. The Commission s communication is based on an advice rendered by CESR in March CESR s first report to the Commission on the compliance of CRAs with the IOSCO CRA Code was submitted on 4 January A second report on the compliance of CRAs with the IOSCO CRA Code was issued on 19 May This report also included CESR s findings on the role of CRAs in structured finance. Prior to that, CESR had consulted on 22 June 2007 (until 10 September 2007) and 13 February 2008 (until 31 March 2008) on the issue. On 26 March 2008, IOSCO launched a consultation on the role of CRAs in structured finance markets. The consultation included proposed changes to the IOSCO CRA Code. An updated version of the Code along with a report on the role of CRAs in structured finance markets was published in May In March 2009 IOSCO published a review of the implementation of the IOSCO CRA Code. On 15 June 2009, the Joint Forum (IOSCO, Basel Committee on Banking Supervision, International Association of Insurance Supervisors) released a paper on the stocktaking on the use of credit ratings. To address recent regulatory initiatives that impact or will shortly impact CRAs, IOSCO consulted on the regulatory implementation of the IOSCO CRA Principles from May 2010 until 6 August With regard to the revision of the CRA principles, IOSCO published a report on 24 February 2011 on the extent to which the principles have been incorporated into legislation. From 25 May to 9 July 2012, IOSCO organised a consultation on certain internal controls and procedures of CRAs. This refers to the description of operational practices of CRAs which must correspond to the IOSCO Code of Conduct. External Credit Assessment Institutions (ECAIs) CEBS issued guidelines on the recognition of ECAIs under the CRD on 20 January CEBS reviewed the guidelines in 2010 with a public consultation from 11 March 2010 until 9 April In August 2006 supervisory authorities across Europe reached a shared view on the Fitch Ratings, Standard & Poor s Ratings Services, and Moody s Investors Service eligibility for regulatory capital purposes and on the mapping of their credit assessments.

11 CREDIT RATING AGENCIES REGULATION 87 CRA I On 4 June 2008 the European Securities Markets Expert Group (ESME) delivered its report on The Role of credit rating agencies to the European Commission to which is was mandated on 28 November The report examines the importance of ratings in the financial markets, in particular in the field of structured finance, and the current regulation of CRAs. Its purpose was to provide the Commission with technical background knowledge to be able to examine the rating process following the recent developments in the financial markets. From 31 July 2008 until 5 September 2008 the Commission consulted publicly on policy proposals regarding CRAs. This consultation was followed by the concrete proposal of a regulation on CRAs on 12 November The European Parliament adopted the regulation on 23 April 2009 and the Council on 14 July The regulation was published in the Official Journal on 17 November 2009 with a Corrigendum on 29 December CRA II In its working plan for 2010 the Commission announced a revision of the regulation on CRAs to provide for direct centralised supervision of CRAs by ESMA. The draft Regulation to amend the Regulation on Credit Rating Agencies was published on 2 June On 15 December 2010, the EP adopted the Amending Regulation. The Council of Ministers followed on 12 April The Amending Regulation was published in the Official Journal of the EU on 31 May The AIFM Directive 2011/61/EU amended the CRA Regulation in so far as alternative investment funds too may use ratings for supervisory purposes only of rating agencies established and registered in the EU. Corresponding information must be contained in the issue prospectus. CRA II implementing measures ESMA delivered its technical advice with regard to fees charged by ESMA to CRAs for their supervision to the European Commission on 17 May The Commission elaborated the Commission Delegated Regulation (EU) No 272/ 2012 of 7 February 2012 ( ) with regard to fees charged by [ESMA] to credit rating agencies, which was published in the Official Journal of the EU on 28 March 2012.