UK: Financial Services Europe And International Update - April 2011

Last Updated: 6 April 2011
Article by Martin Day

Regulatory Developments

This DechertOnPoint summarises current regulatory developments in the European Union and the UK and certain other EU member states in the investment funds and asset management sectors in the past four weeks.

EU and Supranational Regulatory Developments

European Commission Extends Deadline for Receipt of ESMA Advice on AIFM Directive Level 2 Implementing Measures.

The European Commission published on 4 March 2011 a letter dated 27 February that it had sent to the European Securities and Markets Authority ("ESMA") relating to the proposed Alternative Investment Fund Managers Directive (the "AIFMD").

In the letter, the Commission explains that it has learnt from the lawyer linguists of the European Parliament and the Council of the European Union that the AIFM Directive will most likely not enter into force before June 2011. As a result, the Commission has decided to extend the deadline for receipt of ESMA's advice on AIFM Directive level 2 implementing measures by two months to 16 November 2011.

Short Selling and Credit Default Swaps: EU Proposals

The European Commission came under political pressure in the summer of 2010, notably from Germany and France, to accelerate its planned work in the area of short selling. In 2009, the Commission had included in its consultation on the review of the Market Abuse Directive questions on the possible establishment of a European short selling regime. In September 2010, the Commission published a proposal for a regulation on short selling and certain aspects of credit default swaps ("CDS"). The Commission did not recommend any prohibition of naked short selling but rather focused on enhanced transparency requirements, with low thresholds for notification to the regulator and higher ones for disclosure to the market.

The more controversial part of the proposal was the granting of emergency powers to impose temporary restrictions on short selling and CDS transactions. ESMA, as it now is, was given power to issue opinions to competent authorities when to intervene, as well as the power to adopt temporary measures itself restricting or prohibiting short selling, with national regulators proposed to have the power, if the price of a financial instrument falls by a significant amount during a trading day, to restrict short selling in that instrument until the end of the next trading day.

On 7 March 2011, the EU Parliament's Committee on Economic and Monetary Affairs ("ECON") voted on a draft report on the Commission's proposal for a regulation on short selling and CDS.

Despite the EU's own investigation demonstrating that short selling and CDS did not cause the EU debt crisis the Parliament has voted to ban certain short trades in sovereign bonds and supports rules requiring traders to settle their uncovered positions by the end of each trading day.

Trialogue meetings between the Parliament, Council Commission will now take place to negotiate a mutually acceptable compromise deal, to be tabled for a plenary vote provisionally scheduled to be held in May 2011. The European Council is also now finalising its own position on the issue of sovereign CDS, although to date, it has not supported the proposed ban on sovereign CDS positions.

Comment: Restricting sovereign CDS is likely to increase the price for government funding and reduce investors' appetite for new issues of EU government debt and thus risks, making the current Eurozone debt crisis worse than it is at present.

The European Commission's PRIPs Consultation: The UK's Official Response

A joint response from the FSA and HM Treasury to the European Commission's November 2010 consultation (which closed for responses on 31 January 2011) on packaged retail investment products ("PRIPS") was published in March 2011.

In the response, the FSA and HM Treasury express concern with the proposed legislative approach for the PRIPs initiative. In broad terms, the Commission proposes to introduce into the Insurance Mediation Directive (2002/92/EC) ("the IMD") rules on the sales of PRIPs which are consistent with those in the Markets in Financial Instruments Directive (2004/39/EC) ("MiFID"), while separately developing a PRIPs regime for MiFID products. The FSA and HM Treasury believe that this raises a significant risk of discrepancies arising between the IMD and MiFID, which could in turn undermine the consistency of the new selling practices regime which the PRIPs initiative is designed to establish. In particular, they argue that the proposed split approach could lead to the creation of two separately harmonised and distinct selling regimes, which could have a negative impact and reduce clarity for consumers.

In addition, the FSA and HM Treasury believe it would be inappropriate to have a single selling regime covering PRIPs and other insurance products in the IMD. The response therefore urges the Commission to reconsider its proposed legislative approach and adopt "a more consolidated and ambitious approach" to avoid continuing sectoral differences and promote a level playing field between substitutable products.

The FSA and HM Treasury also make a number of specific comments in the response in relation to the questions posed by the Commission in the consultation. They also suggest that the Commission further develop the selling practice proposals which are set out in its MiFID review consultation, in order to drive choice and competition and lead to better consumer outcomes.

The AIFM Directive and Issues for ESMA

The FSA has published a speech dated 17 March 2011 by Sheila Nicoll, Director of Conduct Policy, on the Alternative Investment Fund Managers Directive (the "AIFM Directive") and key issues facing the task forces of the European Securities and Markets Authority ("ESMA").

The speech includes the following points of interest:

  • Ms Nicoll takes the view that the legal form (i.e., either directives or regulations) of the subordinate measures adopted by the European Commission relating to the AIFM Directive will be very important. Directives would provide member states with the ability to consider domestic factors and the market characteristics during national implementation, whereas regulations will be directly applicable.
  • To ensure consistency, ESMA should use certain rules of the Markets in Financial Instrument Directive (2004/39/EC) ("MiFID") (which itself is now under revision by the Commission) and the UCITS Directives when providing its advice to the Commission. (However, critical thinking will need to be applied to determine whether a regime designed for retail investors readily applies itself to professional fund management).
  • The AIFM Directive is unclear as to who is an "alternative investment fund manager". There should be flexibility for different legal and operation structures and delegation requirements.
  • In relation to the requirement to appoint a depositary, ESMA needs to explain when certain financial instruments held by an alternative investment fund are "lost". It also needs to set out how the custody, prime broker and depositary relationship will work as a function of the custody or verification responsibilities of depositaries. It will also need to explain how the relationship between service providers will work as a function of the oversight and cash monitoring duties imposed on the depositary.

The FSA now expects that the deadline for implementing the AIFM Directive to be in mid-2013. (This assumes there is no further slippage).

EMIR Compromise Proposal

The Hungarian Presidency of the Council of the EU published on 18 March 2011 a compromise proposal dated 17 March 2011, relating to the proposed European Market Infrastructure Regulation ("EMIR") which contains the proposed Regulation on over-the-counter derivative transactions, central counterparties and trade repositories.

Solvency II Directive: Impact on Asset Managers

The Investment Management Association in the UK issued a helpful paper on this subject in March 2011.

Readers may be aware that the Solvency II Directive ("Solvency II") redefined the capital requirements imposed on all EU insurers, and although directed primarily at insurance firms, its requirements will have implications for any asset management firm which manages assets on behalf of an insurer or receives investment from any insurer. Whilst Solvency II was published as long ago as November 2009, the exact details relating to the frequency and specific calibration of the capital requirement calculations and the reporting obligations imposed on insurers have still to be finalised. In July 2010, the European Commission initiated its fifth Quantitive Impact Study ("QIS5") of the proposed quantitive requirements of Solvency II. Feedback from industry and regulators was recently only published, and the proposals are now being recalibrated prior to finalisation. Only after consideration of this feedback and the publication of an implementing Directive will insurers, and thus also asset managers, be able to understand fully the detailed requirements being imposed on them. (However, in order to alert asset managers to the need to consider the likely new requirements resulting from Solvency II, this overview has now been provided).

In order to identify their capital requirements, all European insurers will need to calculate the Solvency Capital Requirement ("SCR"), which determines the overall capital requirement for all risks arising from assets and liabilities. Insurers can either utilise a standard calculation or implement an internal model (which should deliver a more risk sensitive outcome) for this purpose. (Although regulatory approval is needed for an internal model, it is expected that only small insurers in the UK are likely to follow the standardised approach). The SCR must formally be calculated once a year, but an insurer must monitor changes to it on continuing basis. It has been suggested that this will necessitate that the insurer performs the calculation on at least a quarterly basis, but this could be more frequent. In order to complete the calculation, however the insurer will need to rely on information obtained from third parties, including relevant asset managers.

Where assets of an insurer are invested in a collective investment scheme, the insurer must look through to the underlying securities in order to determine its capital requirements. This will include, for example, looking to the underlying instruments within any structured product (for example, assetbacked commercial paper). The requirements imposed on the insurer in relation to the data used as part of the capital requirement calculation are that such date must be accurate, complete and appropriate.

The calculation carried out by the insurer in order to determine the SCR will be complex, with various modules depending on the nature of the risks. These revisions to the capital calculation may also present insurers with an opportunity to reassess their asset allocation if appetite exists to lower capital requirements (particularly as the Q1S5 methodology imposes a lower capital charge on bonds than on equities).

In addition to altering capital calculations, Solvency II also requires insurers to provide annual disclosure to markets in order to increase transparency. Core information will also need to be reported to their regulatory supervisors on a quarterly basis. This will necessitate that asset managers (and other third parties) are able to facilitate the data provision required within short periods after the end of each quarter.

Given these requirements, the onus is being placed on asset managers to ensure they can provide accurate, timely and robust data to any insurance customer to enable it to comply with the new Solvency II obligations. It will therefore be important for asset managers to understand the exact data needs of their insurance customers and develop a solution that is acceptable in practice in each case.

With the carrying out of look-through for a collective investment scheme, the data requirements of the insurer will depend on the nature of the underlying securities, for example, the treatment of equities within the capital calculation will differ to that of fixed income instruments. Although, as indicated above, the exact requirements have yet to be finalised, it is clear that the data needs will be far greater than simply the name of the security, the amount held and its current price, and could include details relating to the counterparty, credit rating, maturity and yield.

Solvency II is due to be implemented by the member states on 1 January 2013.

Thus as a practical matter, asset managers will need to ensure that they can provide suitable data to insurance clients. The nature of such data requested may vary from one insurer to another and will also vary from investment fund to fund. Engagement with all insurance customers in regard to their Solvency II requirements should therefore be initiated sooner rather than later in order that asset managers understand fully the likely data needs of their customers and work jointly towards a solution that is practicable for all parties as well as in compliance with the new legislation and the rules governing any collective investment scheme concerned and its operation.

IOSCO Consultation on Suspension of CIS Redemptions

On 8 March 2011, the International Organisation of Securities Commissions ("IOSCO") published a consultation report on Principles on Suspension of Redemptions in Collective Investment Schemes which considers how the regulatory regimes in different jurisdictions address the suspension of redemptions by open-ended collective investment schemes ("CISs"). It contains proposed principles providing general standards for regulatory regimes on how to approach and oversee suspension of CIS redemptions.

The proposed principles:

  • cover all types of open-ended CIS offering continuous redemption rights;
  • apply irrespective of whether such rights are offered to institutional or retail investors;
  • are addressed to the entities responsible for the overall operation of the CIS, notably its compliance with the legal and regulatory framework in the relevant jurisdiction;
  • may not be circumvented by the delegation of activities as they should be complied with directly and by third parties alike; and
  • may vary in implementation across jurisdictions.

(Comments may be submitted to IOSCO until 30 May 2011.)

UK Regulatory Developments

Government Consultation on Exceptions to the Age Discrimination Ban: Financial Services Implications

The Government Equalities Office published a consultation paper on specific exceptions to the age discrimination ban under the Equality Act 2010 (the "EA") on 3 March 2011, two days after the decision of the European Court of Justice (the "ECJ") by the Test-Achats case requiring insurance premiums to be equalised between the genders and arguable of a wider application to other forms of discrimination that are considered to be incompatible with EU fundamental rights.

The EA contains provisions banning age discrimination in the provision of services and the exercise of public functions, and by private clubs and other associations. HMG plans to bring this new ban into effect in April 2012. However, before doing so, it wants to ensure that the new law does not ban the many instances of beneficial and justifiably different treatment. To avoid this, HMG plans to set out in secondary legislation the circumstances in which it will remain lawful to use age as a reason to treat people differently. Some general exceptions are already included in the EA. In this consultation HMG has set out its proposals for specific exceptions. (The main advantage of specific exceptions is that they provide legal certainty for service providers and service users.)

Among the proposals, HMG is planning to make a specific exception available for providers of financial services. This means that providers of financial services, may still be allowed to use age when assessing risk and deciding on product prices. The use of age banding and age limits is still proposed to be permitted. However, any use of age will have to be based on relevant information from a source on which it is reasonable to rely and will need to take into account the decision of the European Court of Justice in the Test-Achats case referred to above. The financial services exception is included in the draft Equality Act 2010 (Age Exceptions) Order annexed to the consultation paper.

HMG also wishes to improve transparency in the financial services sector so consumers can be confident that age is not being misused. As a result, HM Treasury has asked the Association of British Insurers to publish aggregate data for the insurance industry as a whole, which shows how age is used when assessing risk and pricing products. This will be dealt with by way of an industry-level agreement as HMG does not believe that legislation, presumably not having taken into account the wider implications of the recent ECJ's decision in the Test-Achats case. In addition, HMG wishes to improve access to insurance products. If a provider is unable to provide assistance to a person because of their age, it will be obliged to refer that person to a provider who can meet their needs, or a dedicated sign-posting service. This will also be achieved by way of an industry-level agreement, so HMG proposes.

Comments can be made on the proposals until 25 March 2011. HMG plans to lay the Order before Parliament later in 2011, to ensure businesses have sufficient time to comply with the new provisions before they come into force in April 2012.

Prospectus Directive – Consultation on Early Implementation of Amendments

HM Treasury launched on 17 March 2011 a consultation on the early implementation of amendments to the Prospectus Directive. As previously proposed, the two measures that the Government intends to implement in advance of the 1 July 2012 deadline, are as follows:

  • increasing the total consideration of the offer for which the Prospectus Directive does not apply from EUR2.5 million to EUR5 million; and
  • increasing the minimum number of investors for which a prospectus is required from 100 to 150.

(Comments should be submitted by 9 June 2011. The Government intends that the two measures will come into force in the summer of 2011.)

The FSA's Business Plan 2011/2012

The above plan sets out the FSA's priorities for 2011/12, together with major initiatives which are already underway, and identifies the implications for the FSA's budget. No new discretionary initiatives are planned for the coming year. The plan also explains how the FSA intends to manage the transition to the new UK regulatory regime, including developing new processes and structures appropriate to the FSA successor bodies, i.e., the Prudential Regulation Authority (the "PRA") and the Financial Conduct Authority (the "FCA").

Highlights from the Business Plan also include a projected 2 per cent reduction in fees charged by the regulator to firms resulting from increased revenue from penalties (from £33.2million in 2009/2010 to over £79 million in the year to January 2011). Margaret Cole, the current director of enforcement of the FSA is to be appointed the temporary head of the new FCA when it is formed in April 2011. The plan also reveals that the FSA's funding requirements have risen to in excess of £500 million and the authority continues to retain approximately 4,000 employees, notwithstanding that the bulk of financial services regulation now emanates from the European Commission and the new European regulatory authorities. Around a thousand of its staff are likely to transfer to the PRA. Apparently, a current freeze on recruitment at the FSA will not prevent it from replacing FSA staff regarded as "too junior to challenge banks" (to use the words of the Bank of England Governor, Mervyn King), with new people more in line with the Governor's vision. (In that context it may be noteworthy that no new roles yet appear to have been accepted in the UK's proposed new regulatory architecture by either the present Chairman of the FSA, Lord Taylor, nor, Sir Howard Davies).

Under the plan, until the new financial services regulatory structure comes into force (expected by HMG to be at the end of 2012 or in early 2013), the FSA will continue to do the following:

  • maintain ongoing effective prudential supervision: the current key financial stability risks and the prudential implications for firms and the FSA are described in more detail the FSA's Prudential Risk Outlook 2011 that was published on 17 March 2011;
  • implement major EU and global policy initiatives: the two most significant policy initiatives are Solvency II and influencing the international prudential reform agenda, notably in respect of the now widely criticised Basel III concordat. The plan also identifies that the three European supervisory authorities (the European Banking Authority, the European Securities and Markets Authority and the European Insurance and Occupational Pensions Authority) are likely to play an increasing role in setting the rules within which regulated firms will be forced to operate and which the future UK regulatory authorities will have to enforce (although the FSA does not propose any significant staff reductions or at its successor UK regulatory bodies to take that into account);
  • develop and deliver a new regulatory approach to consumer protection: the two major current conduct risk initiatives are the FSA's retail distribution review and its mortgage market review. The plan also refers to the FSA's current thinking on product intervention, as outlined in its January 2011 discussion paper on the subject (DP11/1) and its new approach to identifying emerging and potential risks, as described in its Retail Conduct Risk Outlook published on 28 February 2011;
  • maintain and build on markets regulation and enforcement strengths: the FSA remains committed to its "credible deterrence agenda" (whatever that may embrace). The plan also refers to a number of key European policy initiatives which are either taking place or are currently being considered, including in relation to OTC derivatives, the review of MiFID and the regulation of the commodity markets; and
  • improve the FSA's operating systems and the quality of its employees: the FSA will be moving to a new management structure in April 2011, with the aim of establishing a structure which will more closely resembles that proposed for the FSA's successor bodies, the PRA and the FCA. Major operational system programmes for 2011/12 will relate to enhancing the systems supporting the FSA's market surveillance operations and its supervisory analysis.

New Significant Influence Controlled Functions

The FSA announced on 25 March 2011 that it has deferred implementing changes to the approved persons regime relating to significant influence functions ("SIFs"). It will be recalled that in September 2010, the FSA published a policy statement on the approved persons regime (PS10/15) introducing a new framework for SIFs, involving the introduction of six new governing functions. The new regime for SIFs was due to take effect from 1 May 2011. The FSA had intended that firms would submit applications or notifications concerning individuals performing the new SIFs through its Online Notification and Applications ("ONA") system. However, the FSA has been unable to make the necessary changes to ONA to allow it to accept these applications from 1 May 2011 and has therefore deferred the implementation of the SIF changes to the approved persons regime until further notice.

The UK Budget 2011

Below is a brief summary of the announcements by the Chancellor of the Exchequer and HM Treasury on 23 March 2011 that are likely to be of relevant to our readers in the financial services industry. Please contact our Tax Group if you would like further information.

Investment Trusts

The Finance Bill 2011 will include legislation reforming the tax rules for investment trust companies (following the recent consultation). Draft regulations will be published in April 2011 setting out the detailed operational rules. UCITS IV The Finance Bill 2011 will enable UK managers to take advantage of the UCITS IV management company passport. The legislation will ensure that foreign UCITS funds are not treated as resident and taxable in the UK by reason of having a UK resident fund manager.

Tax Transparent Funds

Legislation will be introduced in the Finance Bill 2012 (although trade associations had been pressing the Chancellor to legislate this year) to establish a tax transparent fund vehicle. It is intended that the new vehicle will support the competitiveness of the UK fund industry following implementation of UCITS IV. The Government will now consult on this measure in June 2011.

Real Estate Investment Trusts

A consultation is to commence on reducing the barriers to entry into the REIT regime and reducing the regulatory burden for existing REITs. It is proposed that legislation will be introduced in the Finance Bill 2012.

Corporation Tax Rates

The main rate of corporation tax will fall to 26% from 1 April 2011. This is an additional 1% fall on previous announcements. The rate will continue to fall by 1% each year for the next three years - to 23% from 1 April 2014.

Bank Levy

The bank levy was introduced from 1 January 2011 as a tax on the balance sheets of banks. The rate of bank levy will increase from 1 May 2011 and then again from 1 January 2012. The rates from 1 January 2012 will be 0.078% for short term chargeable liabilities and 0.039% for long term chargeable equity and liabilities.

Controlled Foreign Companies

As a part of the ongoing reform of the UK's controlled foreign companies rules, interim improvements will be introduced in the Finance Bill 2011. The changes will introduce certain exemptions for groups with minimal connection to the UK. Further measures will be included in the Finance Bill 2012.

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