EBF a.i.s.b.l ETI Registration number: 4722660838-23 Avenue des Arts 56, B-1000 Brussels +32 (0)2 508 37 11 Phone +32 (0)2 511 23 28 Fax www.ebf-fbe.eu EBF Ref.: D2654D-2013 Brussels, 25 March 2013 Launched in 1960, the European Banking Federation is the voice of the European banking sector from the European Union and European Free Trade Association countries. The EBF represents the interests of some 4,500 banks, large and small, wholesale and retail, local and cross-border financial institutions. Together, these banks account for over 80% of the total assets and deposits and some 80% of all bank loans in the EU alone. EBF response to IOSCO consultation on protection of client assets Key Points The European Banking Industry supports the IOSCO initiative and is in favour of global principles with the aim of enhancing the protection of client assets which is an essential element in restoring confidence in global financial markets. The EBF would like to recall that at European level, the Markets in Financial Instruments Directive (MiFID), the Alternative Investment Fund Managers Directive (AIFMD) and the UCITS Directive have already introduced highly resilient standards on the protection of client assets. The EBF strongly believes that the IOSCO principles should clarify that holding client assets in omnibus accounts remains acceptable. Clients invest worldwide in financial instruments and for a majority of intermediaries it is impossible to assess all client asset regimes and arrangements in the relevant foreign jurisdictions. Intermediaries should be able to rely on sub-custodians directly or indirectly used by the intermediary. These sub-custodians should be selected with due care. The EBF highlights that the definition of intermediaries is too broad and creates legal uncertainty. In case that the definition is meant to cover (central securities) depositories, the EBF points out that the key role of the depository is to properly hold and facilitate the exchange of securities. Therefore, IOSCO should clarify that the decision to invest in a specific security in a specific jurisdiction is not the responsibility of the depository. The primary responsibility for evaluating the risks associated with segregation and conducting cross border business should remain with the client. Intermediaries have very limited scope to apprise the client in the context of their investment decisions from a client asset perspective, and although an intermediary may provide risk warnings or general information to clients, the operation of insolvency laws, circumstances specific to the client and other regulation are likely to be such that only the client can have a full picture of the risk profile of its crossborder business. The EBF understands that the problems related to client asset protection caused by the collapse of Lehman Brother and MF Global derived mainly from a poor state of book-keeping and from specific issues in connection with the re-hypothecation of assets under prime brokerage agreements. The EBF would therefore welcome evidentiary clarity between the concerns associated with these two failures and the IOSCO recommendations. Otherwise, there is a risk that the IOSCO recommendations will apply to intermediaries and situations unrelated to the collapse of these entities. The EBF believes that IOSCO s principles should differentiate between: (i) types of intermediaries such as depositories, custodians, settlement agents, asset manager and prime brokers, (ii) types of assets, at least between financial instruments and cash, (iii) types of services provided and (iv) types of clients (professional or retail). Finally, the EBF and its members support international cooperation between regulators, which of course is the prime mandate of IOSCO. Such international co-operation will be key to meeting these regulatory objectives, avoiding regulatory arbitrage and ensuring successful implementation of these recommendations.
Specific remarks: Principle 1: An intermediary should maintain accurate and up-to-date records and accounts of client assets that readily establish the precise nature, amount, location and ownership status of client assets and the clients for whom the client assets are held. The records should also be maintained in such a way that they may be used as an audit trail. The EBF believes that this principle should be refined to make it clear that holding client assets in omnibus accounts remains acceptable, as it is a well-established practice that promotes efficiency, which benefits clients, and reduces operational risks. If this principle was to be applied to depositaries, the EBF notes that reconciliations to central depositories should be made on a daily basis which is already the case in some EU jurisdictions. However for non-cash collateral this new reconciliation requirement may be onerous on both firms and their clients. The Federation would appreciate further clarity around the ownership status referred to in the proposed means of implementation number one. It should apply between proprietary and client assets and not between individual clients. Any information given by the intermediary in the client account can only reflect the ownership status as determined by civil law but not itself create any ownership or encumbrances. Furthermore national regulatory regimes that define ownership aspects of client assets differ significantly and according to local law, client s right can be classified as direct, indirect or coownership. Instead of using ownership status of client assets, a more neutral wording such as proprietary status of client assets as between the intermediary and client would be welcome. The EBF also draws attention to the fact that most intermediaries will tell clients what liens they take - if there are local regulations allowing brokers or systems to maintain liens, the EBF questions why the intermediary should be responsible for providing this information. A more sensible approach would be to accept that this is a reasonable assumption of risks when investing in the relevant market and one that requires the investor to perform their own due diligence. As regards the proposed means of implementation number four stating that: The records and accounts should enable an intermediary to, at any time and without delay, specify each client s rights and the intermediary s obligations to each client with respect to client assets, this provision could only be applied between the intermediary and its client, as there may be a delay caused by operational requirements, such as the need to clear reconciliation breaks, before it can be definitively established whether assets are in accounts and who they are allocated to. The EBF therefore calls on IOSCO to clarify that ownership status won t be recorded other than as between the intermediary and its client. 2
Principle 2: An intermediary should provide a statement to each client on a regular basis, as well as on request, detailing the client assets held for or on behalf of such client. The EBF believes that the requirement to provide a statement to each client on a regular basis would be problematic for certain types of intermediaries and especially in light of the bespoke nature of many of the contractual arrangements. It would be extremely difficult for clearing brokers to track and record the ownership status of margin collateral on client statements, and it is not market practice to do so. As certain markets take collateral by title transfer and others do not, tracking the ownership status of collateral through these transformations and inserting that information into client statements would be onerous and unnecessary. The Federation supports a more practical approach in this area where the client should be able to access their account information on request, rather than have an obligation to generate and deliver statements. In case a client requests a statement, it should not be impossible to charge fees for the statement requested. Concerning the proposed means of implementation number two, the EBF questions the need to regularly remind the client in each statement that he has signed up to an express consent to be waived out of the regime. Principle 3: An intermediary should maintain appropriate arrangements to safeguard the clients rights in client assets and minimise the risk of loss and misuse. The EBF would like to underline that at EU level, strict requirements on due diligence and on-going monitoring for depositaries are already included in the AIFMD and the UCITS-directive. The future UCITS V Directive also introduces further provisions on the monitoring of assets. If this principle was to be applied to depositaries, the EBF recalls that the role of depositaries or custodians is not to advise the client of any associated risks around the levels of asset protection but rather hold and facilitate the exchange of securities. The EBF believes that the intermediary shall deploy the most appropriate network of sub-custodians working with high and similar standards; however, the intermediary cannot be responsible for decisions taken by the client. Therefore, the primary responsibility for evaluating market risk must remain with the client/investor and not with the intermediary. Concerning the proposed means of implementation number three, the EBF has the following observations: The reference to all due skill and care may suggest a level of fiduciary responsibility and it would therefore be more practical if this was expressed as Reasonable Care. The requirement to have more than one depositary may not necessarily lead to a reduction of risks. It should be recalled that at the European level, corporate/market standards which will be implemented in the coming years, proposes that information and instructions flow down and up the intermediary chain. A demand necessitating multiple depositories for the same ISIN might create reconciliation challenges and additional operational risks. Instead, the EBF believes that the possibility to have more than one depositary could be part of contingency plans preparing for situations where the use of a back-up depositary could be relevant. 3
As mentioned under the key points, this Principle seems to be tailored to the specific issues that were identified by IOSCO when analysing the failure of Lehman Brothers and MF Global. Therefore, if it remains unchanged, Principle 3 should only apply to very specific cases. Principle 5 An intermediary should ensure that there is clarity and transparency in the disclosure of the relevant client asset protection regime(s) and arrangements and the consequent risks involved. As already noted under Principle 3, the EBF would like to clarify that the information/advice on risks involved with safekeeping of client assets should be part of the information/advice that clients receive in relation to their decision on investing in foreign securities and should not be a part of depositary obligations. While many custodians do provide a level of information for clients about custodial risks, often supported by legal opinion, it remains the responsibility of the client to form their own views about the client asset protection arrangements and make appropriate judgments as to what protections they are willing to accept. Therefore, the responsibility for evaluating the risks of a jurisdiction lies primarily with the client who decides to invest in that market or not. The point must be made that where the client chooses to invest cross-border, it should not be incumbent on the custodian/intermediary to take on a fiduciary style obligation to advise the client of the consequences of its decisions. There should be no suggestion that an intermediary should furnish its clients with a legal opinion on the risk profile of a given jurisdiction or segregation arrangement. In regards to the proposed means of implementation number three, the EBF would like to point out that the reference to clear language free of legal or financial jargon could be in contradiction to legal principles that may be inherently complex. Moreover, this provision is particularly inappropriate for professional clients who perfectly understand legal and financial terms. Concerning the proposed means of implementation number four, the EBF believes it shall be clarified that custodians do not place securities in a market; rather, they hold them in a post-trade context. As such, disclosing this information in advance of an event is difficult to undertake. Principle 6 Where the regulatory regime permits clients to waive or to modify the degree of protection applicable to client assets or otherwise to opt out of the application of the client asset protection regime, such arrangements should be subject to the following safeguards: (a) The arrangement should only take place with the client s explicit, written consent. (b) Before such consent is obtained, the intermediary should ensure that the client has been provided with a clear and understandable disclosure of the implications of giving such consent. (c) If such arrangements are limited to particular categories of clients, clear criteria delineating those clients that fall within such categories should be defined. The EBF believes that IOSCO should differentiate between professional clients and retail clients. It questions whether it is appropriate for client disclosures in relation to client assets to be removed from 4
contracts, especially where agreements are with wholesale clients. Generally the EBF observes that these principles are more appropriate to unadvised retail clients. This principle would require splitting the waiver of client asset protection from existing product s terms of reference and contracts into two separate documents. The EBF notes that this is already the case in some jurisdictions (i.e. in the EU MiFID) when dealing with retail clients. However, requiring professional clients to sign additional documents will prove administratively burdensome for the intermediary. Whilst the EBF agrees that disclosure is key, a separate document for professional clients is unnecessary and doesn't add anything from the client's perspective. Furthermore, this principle seems to cover (collateral) arrangements concluded under prime brokerage agreements which could be in contradiction to the regimes of many jurisdiction where the provision, use and re-use of financial collateral is permitted (i.e. Financial Collateral Arrangements Directive). Therefore, Principle 6 may have a considerable adverse effect on most globally common arrangements that apply to or include the use of financial collateral such as centrally cleared or non-centrally cleared (OTC) derivatives, repurchase agreements (repos) or transactions by funds or financial trusts. The rapid operation of such arrangements used by professional parties typically public authorities, central banks, financial institutions and central counterparties/settlement agents/clearing houses would be rendered impossible, even though they are used in order to safeguard and maintain financial stability, ensure adequate liquidity and limit contagion in the event of default. Principle 7 Regulators should oversee intermediaries compliance with the applicable domestic requirements to safeguard client assets. The EBF believes that a rigorous and well-functioning supervisory regime for client assets underpins investor confidence. Crucial to the achievement of this objective is the principle that regulators should cooperate internationally as a matter of priority, both in the development of specific regulation, their implementation and their compliance. However, the Federation believes that IOSCO should carefully assess the cost-benefit analysis of requesting additional information. In this respect, the Federation notes that producing information is costly and only relevant and useful information for the authorities should be requested to be produced. In addition, it shall be made clear that information reported shall serve to monitor the compliance with custody rules and shall not be used for other purposes infringing data protection rules. The proposed means of implementation number two, suggests that the risk-based approach should be used by regulators to supervise intermediaries that pose the greatest regulatory concerns. In this respect, the EBF believes that client asset regimes should not be calibrated to reflect the value or volume of assets held by an intermediary. Any loss of client assets would seriously damage the market and the depositary industry and therefore it is inappropriate to permit smaller market participants to operate under less strict requirements. Therefore, the client protection regime must be the same for all intermediaries. This does not imply, however, that different types of intermediaries may not be subject to different (additional or stricter) requirements when offering different services as long as the categories are clearly distinguishable and each category is treated equally. 5