2 EFAMA's reply to ESMA's Consultation on the revised Transparency Directive

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1 EFAMA Reply to the Draft Regulatory Technical Standards on major shareholdings and indicative list of financial instruments subject to notification requirements under the revised Transparency Directive EFAMA 1 welcomes the opportunity to respond to ESMA s Consultation for draft Regulatory Technical Standards on diversification of the revised Transparency Directive. General remarks While the original Transparency Directive was introduced to enhance both investor protection and market efficiency through the disclosure of accurate, comprehensive and timely information about security issuers, its revision seeks to improve the effectiveness of the existing regime in particular with respect to the disclosure of corporate ownership. Before providing you with our comments on the questions of this consultation, we would like to take this opportunity to also provide some important high level comments. In order for ESMA to provide effective means to improve the existing transparency regime, we consider it key that the following two aspects are taken into account in the implementation of the revised Directive. Firstly, the application of the Directive must be as harmonised as possible throughout all Member States If Member States are allowed to implement their own regimes the very idea of facilitating easier understanding of information by market participants in different jurisdictions will become lost. Market participants will then no longer be able to compare and contrast information. We therefore support the use of Regulatory Technical Standards and we would advocate these as an appropriate mechanism to ensure that all Member States implement similar obligations. For more detailed remarks, please refer to our answer to question 22. Secondly, proportionate standards are necessary in order to deliver the desired level of transparency and avoid the imposition of undue burden on market participants. In this sense we want to convey some important remarks regarding the disclosure of financial instruments referencing to cash settled instruments and in particular those referring to an index. We would strongly suggest that ESMA clarifies in the final RTS that the notification obligations with respect to cash settled instruments should only apply in specific circumstances that give holders enhanced possibilities to acquire the 1 EFAMA is the representative association for the European investment management industry. EFAMA represents through its 27 member associations and 62 corporate members about EUR 15 trillion in assets under management of which EUR 9.8 trillion managed by 55,000 investment funds at end December Just over 35,600 of these funds were UCITS (Undertakings for Collective Investments in Transferable Securities) funds. For more information about EFAMA, please visit

2 2 shares underlying the index or to exercise any of the voting rights attached thereto. (For further explanations, please refer to our answers of questions 9, 10 and 12). Furthermore, we consider that the required disclosures should be provided only in cases where the relevant securities represent 1% or more of voting rights in the basket only (and not in the index) or 20% or more of the value of the securities in the basket/index or both, as is currently the case in some European countries. This proposal will ensure that relevant disclosure is provided without placing undue compliance cost burden on investors.

3 3 Specific remarks Q3: Do you agree with the ESMA proposal of aggregating voting rights held directly or indirectly under Articles 9 and 10 with the number of voting rights relating to financial instruments held under Article 13 for the purposes of calculation of the threshold referred to in Article 9(5) and (6)? If not, please state your reasons. Our primary concern lies with the interpretation of Article 13, as it suggests that a notification needs to be submitted each time a change in the composition of the equity interest (actual ownership and potential ownership) takes place as a result of either securities lending and repos transactions or collateral movements. We believe that the incorporation of collateral in the notifiable holding calculation would simply not be justified for three reasons. Firstly, it would create double accounting of the assets delivered as collateral. Indeed, asset delivered as collateral are delivered off balance (meaning that the delivery of collateral cash or securities does not impact the value of the portfolio), counting them in the balance of the collateral receiver would duplicate the impacts on the market as the assets delivered would remain in the records of both collateral giver and collateral taker.. Secondly, non cash collateral is received on a random basis. Even if based on a precise set of eligible collateral, the collateral exchanged is focused on the delivery of a strict list of issued securities. The collateral receiver does not actively request or solicit specific collateral securities, except if otherwise agreed between the counterparties. This is particularly true for triparty collateral, where a third party collateral manager randomly assigns collateral to the collateral receiver according to an opaque allocation algorithm. Thirdly, although it is true that the legal ownership is transferred to the collateral receiver, while the economic ownership stays with the collateral giver, the collateral receiver has the ownership of the assets as long as the transaction lasts or provided that there is a default of the collateral giver. The mechanism is based on the generally accepted notion that the pledge (gage in French) is only enforceable when it is out of reach of the debtor. The exact same principle applies to collateral. The transfer of ownership of the pledged assets is the mechanism that ensure that there is no dispute to seize and use the pledge should the collateral giver/debtor is in default or bankrupt. This mechanism is applied in an even more remote reach of the collateral taker when the assets are exchanged through a Triparty agreement as the collateral giver has no direct access to the collateral under a triparty collateral agreement and the collateral receiver can generally neither re use nor rehypothecate the collateral received. Additionally, only the collateral manager can select and move the collateral independently. Furthermore, daily submission of notifications for composition changes due to securities lending transactions and collateral movements would be too onerous on the financial institutions. We urge a

4 4 lenient timeframe for reporting composition changes of notifiable holdings, as is already the case in some EU member states. 2. Q9: Do you agree with the proposal that financial instruments referenced to a basket or index will be subject to notification requirements laid down in Article 13(1a)(a) when the relevant securities represent 1% or more of voting rights in the underlying issuer or 20% or more of the value of the securities in the basket / index or both of the above? The consultation paper confirms that the intention of these two thresholds is to guarantee that only relevant disclosures are required, resulting in a small number of notifications per year and thus minimising compliance costs for investors. While we support its intention, we consider that the required disclosure should be provided in those cases in which the relevant securities represent 1% or more of voting rights in the basket only (and not in the index) or 20% or more of the value of the securities in the basket/index or both, as is currently the case in some European countries. The condition that, at least, one of the thresholds is met will ensure that only relevant disclosure is provided and, as ESMA notes, their existence in a number of Member States will deliver the required outcome without placing undue compliance costs on investors. In practice, the proposal should exempt financial derivatives on indices commonly used by the asset management industry, with specific reference to managed UCITS, where the economic position is taken on the specific market the index refers for an efficient portfolio management and not used to build significant positions in a single underlying security. Such disclosures could lead to meaningless notification and not create an enhanced transparency to the market. We suggest therefore a change in the wording of Article 4(1) as follows: Voting rights in the case of a financial instrument subject to notification requirements laid down in Article 13(1) and which is referenced to a basket of shares or an index shall be calculated on the basis of the weight of the share in the basket or index and if at least one of the following conditions apply: a) the shares in the basket or index represent 1 % or more of voting rights attached to shares of the specific issuer; or (b) shares in the basket or index represent 20 % or more of the value of the securities in the basket or index. If our understanding on the method of calculation on 1% threshold is wrong, and, thus, the reference to index also requires the calculation of synthetic equities position in well diversified indices with a look through approach for all EU traded securities on regulated market (these synthetic positions should be then aggregated with the others to determine whether the 5% threshold is reached), it should be then carefully considered, if the expected benefits from the proposed requirements would outweigh the increased costs. 2 For example, the Dutch Financial Supervision Act (WFT), and the Guidelines for Shareholders by the Dutch regulator (AFM) only require that composition changes due to securities lending activities (with right of recall) are to be reported only by the end of the year.

5 5 In this case, investors, and not only asset managers, would incur recurrent cost, as they are supposed to purchase both the daily components and the weights in the index from the index provider. At the moment, the majority of market indices publish their constituents together with their respective weightings, free of charge, after each rebalancing and not on daily basis. Furthermore, additional cost could arise from adapting the IT procedures required to manage information. In addition, there would be recurrent costs for the running and management of the necessary procedures and for staff training. In case ESMA is unable to accept our above suggestions, we would at least urge it to take into consideration our suggestions as laid out in our answer of Q21 below. As a final point, we would like to mention that ESMA should take account the fact that many index providers charge for real time access to index components. Asset managers should be able to rely on the latest publicly available information as to the composition of the relevant index as already specified in Article 3(3) of the Short Selling Regulation (No. 236/2012). Q10: Are there any other thresholds we should consider? While ESMA requests a 1% threshold for a look through approach for the method of calculation in case of financial instruments referenced to an index (please see Q9), we suggest to consider a higher threshold to avoid unnecessary costs to the investors and to diminish an excessive disclosure of positions 3. In case ESMA is unable to accept our suggestions as laid out above, we would at least urge it to take into consideration our suggestions as laid out in our answer of Q21 below. Q12: Do you agree that a financial instrument referenced to a series of baskets which are under the thresholds individually but would exceed the thresholds if added and totalled should not be disclosed on an aggregated basis? We agree that the aggregation of holdings in this instance should not be performed. ESMA s justification for its position is correct in that it would not be cost effective to build a stake through obtaining small positions in different baskets before aggregating them. Additionally, we would suggest also to also include a reference to indices in article 4(2), as it currently only refers to baskets. The proposal is as follows: By derogation from paragraph 1, financial instruments referencing a series of baskets or indices which are individually under the thresholds mentioned in paragraph 1 but would exceed the thresholds if added and totalled are not subject to notification requirements. In case ESMA is unable to accept our suggestions as laid out above, we would at least urge it to take into consideration our suggestions as laid out in our answer of Q21 below. 3 For example, under the current regime in Italy a combination of a 2% exemption threshold on cash settled derivatives and a 10% notification threshold for long position has, in general, avoided meaningless notifications.

6 6 Q13: Do you agree that our proposal for the method of determining delta will prevent circumvention of notification rules and excessive disclosure of positions? If not, please explain. We appreciate the proposed approach that allows investors to use generally accepted industry standard pricing model to calculate voting rights in the case of financial instruments which are exclusively cash settled. Asset managers owned by banking groups that are already caught under CRD IV already use models to calculate delta in place (CESR/ and Regulation (EU) 231/2013). We agree that the proposed approach from ESMA should prevent circumvention of notification rules but without requiring excessive disclosure of positions. Q14: Do you agree with the proposed concept of generally accepted standard pricing model? We also agree with the proposed concept of generally accepted standard pricing model. This should remain a concept as the imposition of a more granular definition risks limiting the models which could be used as any definition would not be able to keep pace with market developments. This concept also gives enough flexibility for the accepted model to avoid additional costs that may be needed if there were more prescriptive requirements. Q15: Are these three types of client serving exemptions all appropriate in terms of avoiding excessive or meaningless disclosures to the market? Please provide quantitative evidence on the additional costs borne by financial intermediaries should any of these ex emptions not be adopted. We consider that the full application of the three client serving exemptions is necessary in order to avoid excessive or meaningless disclosures to the market. Q16: Can these three types of client serving exemption allow for a potential risk of circumvention of major shareholdings disclosure regime? We do not see any meaningful risk that the three client serving exemptions can be used to circumvent the major shareholdings disclosure regime. Q17: Do you agree with our analysis that applying the current exemptions can ad dress certain notification requirements for cash settled financial instruments introduced by Article 13(1)(b)? We agree that applying the current exemptions can address some but far from all notification requirements for cash settled financial instruments. See answer to question 18. Q18: In your opinion, is the application of current exemptions sufficient to achieve the aim of this provision (i.e. avoiding unmeaningful notifications to the market)? We do not consider that the application of the current exemptions is sufficient to achieve the aim of avoiding meaningless notifications to the market. The scope of these exemptions is too limited and would have the result that the vast majority of an entity s trades with clients to serve their needs would not fall within a specific exemption. We support the position taken earlier by CESR that there should

7 7 be a separate exemption for client serving transactions. We therefore support ESMA s proposal of Article 6 of the draft RTS (paragraph 153). Q19: Do you agree that the client serving exemption should cover MiFID authorised entities as well as a natural or legal person who is not itself MIFID authorised but is in the same group as a MiFID authorised entity and is additionally authorised by its home non EU state regulator to perform investment services related to client serving transactions? Can you foresee any additional cost in case the exemption does not also cover non EU entities within the group? If yes, please provide an estimate? We agree with the ESMA s suggestion with respect to the MiFID authorisation. However, we think that the notification formalities imposed by the proposed text of Article 7 of the draft RTS are unnecessary and do not create any additional comfort that a bank is not abusing the client serving exemptions. As soon as an investment firm is authorised under MiFID, it should be assumed that it would seek to benefit from the client serving exemption and, in so doing, has no intention to intervene or exert influence on the management of any issuer. It should be sufficient that it maintains appropriate systems and controls to ensure ongoing compliance with this requirement and that the competent authority has the possibility to check this at all times. We therefore propose the following simplified text for the proposed Article 7 of the draft RTS: Article 7 The client serving entity seeking to benefit from the exemption provided for in Article 6 above shall ensure that it has appropriate systems and controls allowing (a) to identify its dealings in financial instruments and interests which fulfil orders received from clients, respond to a client s request to trade otherwise than on a proprietary basis, or hedge positions arising out of such dealings and its proprietary trading dealing and interests, and (b) to demonstrate that it neither intervenes in nor exerts influence on the management of any issuer concerned. Q20: Do you think that the proposed methods of controlling client serving activities are effective? Do you envisage other control mechanisms which could be appropriate for financial intermediaries who wish to make use of the exemption? Please refer to our answer of Q19. Q21: When does a financial instrument have an economic effect similar to that of shares or entitlements to acquire shares? Do you agree with ESMA s description of possible cases? From a practitioner s point of view it is hard to agree with ESMA s position that a financial instrument has similar economic effect to that of entitlements to acquire shares, when such instrument exposes the holders to the benefits/damages of market movements. The meaning of what constitutes similar economic effect should at all times be tied to the driving rationale of the Transparency Directive, which is to create transparency on the allocation of voting

8 8 rights. Physically settled derivatives, to the extent that they allow the holder a right, discretion or mere possibility (as in the case of writing a put option) to actually acquire the shares, effectively meet this requirement. However, this is not the case for cash settled derivatives, which only allow the holder access to shares in rare and very specific circumstances. An example is the Rubicon case mentioned in paragraph 172 to 174, where the holder of a cash settled equity derivative had previously sold the underlying shares to the bank for the purpose of substituting them with an equity swap. Other than in such truly exceptional circumstances, the fact that a party enters into a cash settled derivative will not put it in a position which facilitates its acquisition of the shares or makes such acquisition more likely. By defining similar economic effect with reference to exposure to market movements rather than to an enhanced possibility to acquire shares, ESMA disregards its own declared position in respect of the Rubicon case, where it makes explicit reference to the fact that the party benefited from special knowledge that the shares held by the banks would most probably be available throughout the contract s duration and on termination. Before derivative instruments should be categorised as falling under Article 13(1)(b) in the absence of a formal agreement being concluded, the preliminary requirement should always remain that they have economic effect similar to that of shares or entitlements to acquire shares, which under the Transparency Directive can only mean allowing the party enhanced access to voting rights. Notification of cash settled financial instruments puts a disproportionate burden on the market (without serving any useful transparency purpose) in the absence of special (truly exceptional) circumstances whereby, in spite of the agreed cash settlement, the holder has an enhanced possibility to acquire or control the voting rights. The holder should not be deemed to be in a privileged position to acquire shares simply by the fact that it entered into a cash settled transaction. Apart from the situation where the underlying shares initially originated from the party itself (giving it special knowledge), there is no reason to assume that the mere fact of having entered into a cash settled transaction in any way enhances the possibility of such holder to acquire shares. It does not make any sense from a transparency perspective on the contrary, it will only submerge the markets in a lot of misleading information on the control of voting rights if the notification of shares underlying cash settled financial instruments is made the rule, rather than the exception in only very special circumstances which, in practice, should be exceedingly rare. We therefore suggest that notification of cash settled financial instruments should remain the exception, which in turn requires a very narrow and consistent interpretation of the term similar economic effect. For this reason, we would strongly suggest that ESMA clarifies in the final RTS that the notification obligations in respect of cash settled instruments should only apply in the presence of special tradespecific circumstances that effectively result in an enhanced possibility for the holder to acquire the shares underlying or hedging the trade or to exercise any of the voting rights attached thereto. In order to prevent the possibility of exceptional abuse, ESMA could further consider installing a specific control mechanism similar to that to be installed in the context of Article 6. We suggest the following proposed language:

9 9 Article XX For the purpose of applying article 13(1)(b), a party that enters into cash settled financial instruments referenced to individual shares shall notify these instruments if and as soon as there are trade specific circumstances, occurring either at the inception or during the term of such instrument, that effectively result in an enhanced possibility for such party to acquire the shares underlying or hedging the trade or to exercise or control any of the voting rights attached thereto. For the purpose of controlling compliance with the obligation under the previous paragraph, a party that enters into cash settled financial instruments referenced to individual shares shall ensure that it has appropriate systems and controls allowing the competent authority (a) to identify its dealings in cash settled financial instruments referenced to individual shares, and (b) to verify the absence of any special circumstances enhancing the possibility for such party to acquire the shares underlying or hedging the trade. The above paragraphs make explicit reference to individual shares. Indeed, we do not see any ground on which financial instruments referenced to a basket of shares or to an index can ever be categorized under Article 13(1)(b), as there is no practical way that such collective instruments can ever lead to acquiring control over the voting rights of a specific share. In addition, such extremely broad interpretation goes would lead to insurmountable practical difficulties: while the shares included in a basket may still be identifiable, this is not the case for an index whose composition is by definition continuously subject to fluctuations. In case ESMA does not agree with our above suggestions, it should at least take into consideration an alignment with our propositions, as suggested in Q9, Q10 and Q12 above. Q22: Do you think that any other financial instrument should be added to the list? Please provide the reasoning behind your position. It would be useful if ESMA could spell out further those financial instruments which do not fall within the scope of Article 13(1b), e.g. securities held as collateral, on the basis that the collateral agreement does not give the holder the unconditional right to acquire the securities. The final text should therefore explain what is meant by the Commission Regulation. Furthermore, we are of the opinion that paragraph 204 entirely undermines the harmonisation and clarity otherwise provided by the list. If Member States are going to take different interpretations which impact the validity of the list, they should be required to inform ESMA, who could then make this information available on the list, possibly as footnotes. Brussels, 30 May 2014 [ ]