European Regulatory Update

Transcription

1 European Regulatory Update by Virginie Saade NOVEMBER 2014 Contents MiFID II 1 FTT 3 Market manipulation 4 Rate swaps 5 T2S 6 French reporting requirements 8 Where does MiFID II stand now? The technical work on MiFID II s secondary legislation is currently continuing at Level 2 at the European Securities and Markets Authority (ESMA). ESMA is currently analyzing the 584 responses to its MiFID II Discussion and Consultation Papers following the deadline of August 1, KCG submitted a response to this consultation. ESMA must now prepare final technical advice for the European Commission on delegated acts by the end of December It is understood that December 17 has been set as the internal ESMA deadline for delivery of the advice. Following this date ESMA is expected to issue a further consultation in late 2014 or early 2015 on draft technical standards which would last until February of These draft technical standards will set out ESMA s proposed approach for secondary legislation. ESMA tasked to focus on some of the following areas: 1. Micro structure and HFT-related topics One microstructural issue that ESMA must now address is the testing of algorithms, algorithm flagging, record keeping, marketmaking agreements, and the provision of Direct Electronic Access (DEA) services. In its consultation, ESMA suggested mandatory testing methods for algorithms. ESMA also suggested a high-level approach for flagging algorithms, drawing inspiration on experience of the German HFT law. Industry has complained that both these approaches are overly onerous without yielding significant benefits in terms of surveillance data generated.

2 On record keeping for algorithms, the Commission has stated that it is concerned that senior management of HFT firms do not understand or know enough about the changes made to algorithms on a daily basis. It is therefore favoring having a mandatory paper trail for any changes to algorithms. On the issue of market making agreements, ESMA has sought to codify the existing commercial arrangements and expand the scope of entities covered by these. 2. Trading obligations and pre- and post-trade transparency ESMA has stated that it lacks enough data to reach a definition of large in size trades and liquid markets in order to calibrate the pre-trade transparency volume caps introduced in MiFID II for equities. To address this shortage of data, ESMA has sent an anonymous questionnaire to 2500 market participants across Europe asking for the value of the affected transactions and how long it would take to unwind them. The MiFID II per instrument pre-trade transparency caps of 4% per trading venue and 8% across the EU seek to reduce the amount of dark pool trading in Europe by setting hard limits on the amount of trading that can be carried out off exchanges. However, large in scale trades and trades in illiquid markets will be outside of the scope of the volume caps. If the threshold for large in scale is set too high this could have a significant effect on the ability of market participants to avail of the MiFID II pre-trade transparency waivers as trades that are no longer considered large in scale will be counted towards the new volume caps. 3. Dealing commission/unbundling The FCA and ESMA seem to be aligned to battle for tough new unbundling rules. ESMA proposed to require any significant research performed by brokers on behalf of institutional investors to be paid for out of asset managers own funds, rather than commissions. The position of the UK regulator is that the Level 1 text of MiFID prohibits inducements from being bundled with research and are seeking to convince others of this. Despite the critiques raised by stakeholders, this latest development is seen Continues on the next page. European Regulatory Update 2

3 by many as merely continuing a process that began nearly a decade ago when the FSA prohibited using so-called soft-dollars to pay for anything other than proprietary research. Industry groups are currently raising objections with regulators in France, Germany, and Sweden. They all think consequences could be quite adverse for the European fund management industry. In particular, it was argued that if industry groups will have to pay for the research directly, they would probably be more selective and will reduce the budget for research. Additionally this will have an impact on their long-term returns. Less research means lower returns for clients. A report published by Bank of America in June indicates paying for research directly rather than out of dealing commissions could add approximately seven basis points a year to the cost of managing equity mandates. This in turn could equate to 30 percent to 40 percent of the profit margin from equity mandates. Disagreement on FTT means no imminent deal foreseen The 11 participating Member States continue to disagree on several issues, including the scope of the FTT and the issuance vs. residence principle. However, any future deal is expected to follow the issuance principle, combined with a redistribution mechanism. The application of the FTT, as originally foreseen by participating Member States, in early 2016 is now no longer considered realistic and is more likely to slip towards the end of 2017 or even 2018 if a deal can be reached. Agreement on some issues Progress has been made on the issue of scope and the main taxation principle. With regard to scope, Member States have agreed on the inclusion of shares and equivalent instruments as well as some derivatives which are considered speculative, such as CDS. On the taxation principle, it is clear that Member States have agreed on adhesion to the issuance principle with some elements of the residence principle to add an element of fairness in the proposal. Continues on the next page. European Regulatory Update 3

4 Concerns The key remaining issue now is to finalize the calibration of the revenue sharing mechanism between Member States. This is a particularly sensitive issue given the questions of sovereignty involved in national tax redistribution. Overall the negotiations on FTT remain complex and fraught. Despite the efforts of Member States, serious concerns remain on the two main issues of derivatives and the redistribution of revenues. Nevertheless the negotiations have advanced compared to the state of play in May Market manipulation under the microscope On October 8, ESMA hosted an open hearing on the consultation papers on technical advice and technical standards under Market Abuse Regulation (MAR). ESMA aims to have all relevant guidelines and draft regulatory technical standards required under MAR submitted to the Commission by July 2015, in order to allow for all MAR requirements to apply from July 3, 2016 as planned. Indicators of Market Abuse? On the question of indicators of market manipulation, ESMA clarified that these were to be tools for National Competent Authorities (NCAs) to identify potential cases of market manipulation. However in each individual case the NCAs would have to prove the existence of market manipulation and merely referring to indicators would not be sufficient as evidence. ESMA have now published the list of responses to the MAR consultations on Technical Advice and Technical Standards, which closed on October 15, There are 70 responses on Technical Standards and 55 on Technical Advice that have been made public. At first glance there appears to be a good cross-section of industry participants engaging in the process. European Regulatory Update 4

5 Rate swaps rules getting finalized On October 1, ESMA published its final report on the draft technical standards on the clearing obligation for interest rate swaps (IRS) under EMIR. The draft Regulatory Technical Standards (RTS) set out the IRS contracts that will be subject to the clearing obligation, the categories of counterparties covered, and the phase-in periods for the application of the clearing obligation. The Commission could adopt a Delegated Act as early as November but could take until January Comment deadline: November 6, 2014 On the same date ESMA also published a Consultation Paper on the clearing obligation applicable to FX non-deliverable forward OTC derivatives contracts. The deadline to respond to the consultation was November 6, Finalized for Christmas holidays The EBA is aiming to finalize the draft technical standards on risk mitigation techniques under EMIR, including margin requirements, before the Christmas holidays. Given close involvement of the Commission in EBA work on the draft RTS, the Commission is expected to adopt the final RTS without undue delay. EMIR foresees the adoption of equivalence assessments on third countries by means of implementing acts by the Commission. On October 30 the first equivalence decisions were adopted under EMIR for the regulatory regimes of CCPs in Australia, Hong Kong, Japan, and Singapore and will enter into force on November 20. The adoption of the equivalence decisions means that the CCPs of these jurisdictions will be able to obtain EMIR recognition in the EU and therefore be used by market participants to clear OTC derivatives. Adoption of an equivalence assessment for the US is delayed given that the Commission is seeking further concessions from the US on the treatment of EU entities. Seeing the lack of progress in the bilateral negotiations between the Commission and the CFTC, it is uncertain whether the US will be judged equivalent to EU rules before the end of European Regulatory Update 5

6 Target 2 Securities platform The Target 2 Securities (T2S) project intends to build a pan- European domestic settlement marketplace, similar to MiFID for pre-trade and the Single European Payment Area (SEPA) initiative for payments. The platform, conceived in 2006, is designed to settle exclusively in central bank money (CeBM) over respective National Central Banks (NCBs) to achieve greater market efficiency and safe settlement. It will also be capable of settling securities transactions from non-euro markets, subject to the participation of the respective central banks. Designed to simplify and streamline The main characteristic of T2S is that it will make cross-border settlement identical to domestic settlement, in terms of cost, technical processing, and efficiency. A single set of rules, standards, and tariffs will be applied to all transactions in Europe, reducing the complexity of the current market infrastructure. The positive results of the quality assessment, carried out by the European Central Bank and known as Eurosystem Acceptance Testing, or EAT, have served to reinforce ECB confidence that T2S will go live on June 22, 2015, as planned. The T2S platform has been considered sufficiently stable for Central Securities Depositories (CSDs) and central banks were cleared to start their testing activities on October 1, Global inconsistency a problem for international investors The T2S introduction will have a significant impact on all market participants in the EU. Many concerns remain within institutions about budgets, implementation costs, and availability of resources of T2S and many global firms will have to prepare clients and be ready for each wave of migration. Please find on the next page a table summarizing the impact of T2S on market participants. Continues on the next page. European Regulatory Update 6

7 Impact of T2S on market participants Stakeholder Current scenario Post-T2S scenario Central Securities Depository (CSD) Handle settlements and depository functions. Gain significant wallet share of revenue from settlement. Handling of settlements by T2S; handling of depository functions only by CSDs. Significant change in the revenue mix, with a reduced share of settlement revenue. The need to expand the service catalog and identify alternative revenue sources to compensate for the loss of the settlement revenue. Consolidation, as market participants can choose to consolidate relationships with select CSDs. Ability to reap the advantages of T2S by rationalizing the existing IT infrastructure and re-design of existing systems. Global Custodians Provide custody administration services to institutional investors. US players operate in the European market via sub-custodians. Opportunity to gain the most, as T2S provides options to rationalize their settlement value chain. The need to make significant investments to achieve greater benefits (e.g., support for the ISO messaging standard to achieve direct connectivity to T2S). Opportunity to enter the market directly, without a subcustodian, resulting in in-sourcing some of the services currently provided by sub-custodians. Sub-Custodians Provide custody administration services to domestic clients. Also act on behalf of global custodians that may not have a local presence. Loss of revenues, as global custodians can connect directly to T2S (through a CSD). Increased competition, as CSDs in search of alternate revenue sources enter the traditional revenue terrain of sub-custodians, resulting in increased competition. Creation of niches by some providers that specialize in services such as tax services. Source: efinancialnews.com, Cognizant Business Consulting European Regulatory Update 7

8 French reporting requirements for January 2015 The regulation: The AMF regulation , effective January 1, 2015, was published by ministerial Arrêté on September 10, 2014 and is available here. It implements statutory principles set out by Article L of the Financial and Monetary Code. Scope: Defines automated trading devices as computer algorithms automatically generating orders with no or little human intervention. It explicitly exempts the smart order routers used for the purposes of achieving best execution (by referring to Article L of the Code). Pursuant to the statutory empowerment, the regulation refers to algorithms operating only on transferable securities (= stocks and bonds as opposed in the French legal framework to financial contracts, i.e., derivatives contracts). The trigger is for the company having issued the securities to have its headquarters in France. Reporting and audit trail requirements: Firms within the scope will have to notify the use of algorithms to AMF by mentioning the regulated market or MTF concerned, within one month following their first operational implementation, and maintain for possible inspection by the AMF an associated audit trail, including the algorithm itself, related transactions as well as unexecuted orders. Such audit trail must be kept for five years. Who is submitted to the requirements: Those requirements are applicable to all persons using automated trading. Firms located outside of France will be subject to the same obligation, including foreign participants if any of their algorithmic orders are to be transmitted on a French regulated market or MTF. Details of the registration form: The AMF has indicated its intention to draft a template registration form. The AMF did not release yet any information on the content of this form and the timing. European Regulatory Update 8

9 If you have questions or would like further information on any of the subjects covered in this review, please contact Virginie Saade at This material is not research and is not intended as such. It has been produced by personnel employed by KCG Holdings, Inc. and its subsidiaries (collectively KCG ). This material is intended only for clients of KCG. It is not intended for further dissemination in its present form or any other and may not be further disseminated beyond the initial recipient without express consent from KCG. This material is not intended to constitute an offer, or solicitation of an offer, to purchase or sell any security or financial instruments or to participate in any investment strategy. KCG assumes no liability to anyone as a result of the use of this material. This material provides the observations and views of the persons who prepared the material. These observations and views may be different from, or inconsistent with, the views of KCG or other Departments or persons within KCG. The observations and views expressed in this material may change at any time without notice. In the US, products and services are offered by KCGA, member FINRA/SIPC. In Europe, products and services are offered by KCG Europe Limited ( KCGE ) which is authorized and regulated by the Financial Conduct Authority. KCGA and KCGE are affiliates and are indirect subsidiaries of KCG. For additional information about KCG (NYSE: Euronext: KCG) please visit KCG Holdings, Inc. All rights reserved. kcg.com European Regulatory Update 9