EUROPEAN MARKET INFRASTRUCTURE REGULATION ("EMIR")
(i) ESMA informs European Commission of its intention to ease certain frontloading requirements under EMIR
On 8 May 2014 ESMA sent a letter to the European Commission proposing to limit the scope of the frontloading requirement under EMIR.
The frontloading requirement imposes an obligation on counterparties to clear OTC derivative contracts which have been executed after a central counterparty ("CCP") has been authorised under EMIR (the first of which was authorised on 18 March 2014) and before the date of application of the clearing obligation (i.e. the date specified for the clearing obligation to apply by ESMA in the relevant regulatory technical standards).
In this way under the frontloading rules an OTC derivative contract concluded after the authorisation of a CCP might at a later date become subject to the clearing obligation before its expiration date. According to Recital 20 of EMIR, the objective of the frontloading requirement is to ensure a uniform and coherent application of EMIR and a level playing field for stakeholders when a class of OTC derivative contracts is declared subject to the clearing obligation.
The period during which frontloading is relevant can be divided into two separate periods:
- Period A: the period between the notification of the classes to ESMA and the entry into force of the relevant regulatory technical standards ("RTS") on the clearing obligation; and
- Period B: the period between the entry into force of the RTS and the date of application of the clearing obligation.
In the letter, ESMA observes that the frontloading procedure creates uncertainties for OTC derivatives end-users because counterparties will not know whether the notified class of derivatives will be subject to the clearing obligation; i.e. an OTC derivative contract entered into after the authorisation of a CCP might become subject to the clearing obligation during Period A. ESMA informed the European Commission that it intends to establish the frontloading requirement in a manner that will minimise uncertainty. At the start of Period B these uncertainties will no longer be present.
ESMA has suggested that the frontloading requirement should not apply to transactions that are entered into during Period A and should only apply to transactions entered into during Period B. ESMA has stated that further details on this rule will be outlined later this summer.
ESMA's letter to the European Commission is available at this link:
http://www.esma.europa.eu/content/Letter-European-Commission-Frontloading-requirement-under-EMIR
(ii) Updated EMIR implementation Q&As
On 21 May and 23 June 2014, ESMA published an updated version of its questions and answers ("Q&A") document on the implementation of EMIR. The updated version of the Q&A includes a table detailing which questions and answers have been added or updated and also includes a table which indicates the relevant Article in EMIR to which the questions relate.
Areas covered by the updated Q&A (whether as a new question or as a revision to an existing question) include:
- Whether an umbrella fund or its sub-funds should be treated as a counterparty under EMIR;
- Status of counterparties under EMIR as defined by reference to AIFMD;
- Intra-group exemptions;
- Calculation of the clearing threshold;
- Public register;
- Treatment of non-EU non-exempt central banks;
- Segregation and portability and CCP organisational requirements;
- Risk committee requirements for a CCP;
- Prudential requirements of a CCP;
- Reporting of collateral; and
- Reporting of valuations.
The latest set of EMIR implementation Q&As can be found here:
http://www.esma.europa.eu/content/QA-IX-EMIR-Implementation
(iii) Treatment of FX Forwards under EMIR
As reported in our previous Legal and Regulatory Update, the treatment by regulators of FX Forwards under EMIR varies across the European Union. The reason for these diverging approaches is the fact that a derivative under EMIR is defined by reference to Directive 2004/39/EC (the "MiFID Directive") and Member States transposed the MiFID Directive differently; i.e. different transpositions of the MiFID Directive across Member States mean that there is no single, commonly adopted definition of a derivative or a derivative contract in the European Union.
Concerns have been expressed about the lack of consistency between EU Member States with regards to the definition of an FX Forward. Indeed, ESMA published a letter (dated 14 February 2014) which it wrote to the European Commission whereby it asked the European Commission to clarify the exact definition of what constitutes a forward for EMIR purposes, in particular for FX Forwards with a settlement date up to 7 days and FX Forwards concluded for commercial purposes.
In light of this letter, the European Commission launched a short consultation paper on FX Forwards regarding the delineation between FX Forward contracts and FX spot contracts under MiFID (the "Consultation Paper"). Ten questions were raised in the Consultation Paper as follows:
- Do you agree that a clarification of the definition of an FX spot contract is necessary?;
- What are the main uses for and users of the FX spot market? How does use affect considerations of whether a contract should be considered a financial instrument?;
- What settlement period should be used to delineate between spot contracts? Is it better to use one single cut-off period or apply different periods for different currencies? If so, what should those settlement periods be and for which currencies?;
- Do you agree that non-deliverable forwards be considered financial instruments regardless of their settlement period?;
- What have been the main developments in the FX market since the implementation of MiFID?;
- What other risks do FX instruments pose and how should this help determine the boundary of a spot contract?;
- Do you think a transition period is necessary for the implementation of harmonised standards?;
- What is the approach to this issue in other jurisdictions outside the EU? Where there are divergent approaches, what problems do these create?;
- Are there additional implications to those set out above of the delineation of a spot FX contract for these and other applicable legislation?; and
- Are there any additional issues in relation to the definition of FX as financial instruments that should be considered?
The European Commission received 79 responses to the Consultation Paper including responses from the Investment Management Association ("IMA"), ESMA's Securities and Markets Stakeholder Group ("SMSG") and the Financial Markets Law Committee ("FMLC"). The complete list of the responses received can be found at this link:
http://ec.europa.eu/internal_market/consultations/2014/foreign-exchange/contributions_en.htm
It is interesting to note that the Alternative Investment Management Association ("AIMA") in its response suggests a definition of FX spot contracts which include any instruments with a settlement period of T+7 or less. This is because the Central Bank have indicated on their website that all FX transactions with settlement beyond the Spot date are to be considered Forward contracts and therefore are subject to the requirements of EMIR. In this regard the Central Bank has stated that for the vast majority of currency pairs the market convention for settling spot transactions is T+2, accordingly the Central Bank have stated that any trade with settlement T+3 should be treated as a Forward transaction ((except in those rare cases where the market convention for the specific currency pair is unequivocally different from T+2).
It is hoped that the responses received by the European Commission will help formulate the European Commission's formal proposal on this area.
(iv) European Commission extends CRR transitional period to 15 December 2014
Under the Capital Requirements Regulation (Regulation 575/2013) ("CRR"), exposures to qualifying central counterparties ("QCCPs") attract a lower charge than exposures to CCPs that do not have QCCP status. While many third country CCPs obtained QCCP status under a transitional provision in the CRR, that transitional period is due to expire on 15 June 2014. In order to achieve such QCCP status, third country CCPs must register with ESMA in accordance with EMIR. In order to register with ESMA, the European Commission must have adopted a positive equivalence determination in respect of the clearing rules of the CCP's home jurisdiction. As yet, no third country CCPs has registered with ESMA because the European Commission has not adopted a positive determination in respect of any jurisdiction.
On 4 June 2014, the European Commission updated its webpage to announce that on 3 June 2014, it adopted the implementing Regulation (Regulation 591/2014), (the "Regulation") on the extension of transitional periods related to own funds requirements for exposures to CCPs. In this way the European Commission extended the deadline relating to QCCP status until 15 December 2014. This extension now permits institutions to consider a CCP as a QCCP for an additional period up to 15 December 2014.
The text of the Regulation was published in the Official Journal of the European Union on 4 June 2014.
MARKETS IN FINANCIAL INSTRUMENTS DIRECTIVE ("MIFID II")
(i) An update on MiFID II
MiFID II comprises of:
- MiFID II Directive which is largely an amendment and restatement of the original MiFID I Directive; and
- MiFID II Regulation setting out the requirements relating to trade transparency and the mandatory trading of derivatives on organised venues (together "MiFID II").
On 12 June 2014, the text of MiFID II was published in the Official Journal of the European Union. This means that MiFID II entered into force on the 2 July 2014. MiFID II was previously approved by European Parliament and the Council of the EU on the 23 April and 13 May 2014 respectively.
The MiFID II Directive will require national implementation within a 30 month timeframe after its entry into force; (i.e. January 2017). The MiFID Regulation will not require national implementation and will apply from 2 January 2017. The MiFID II Regulation will be directly applicable in all Member States and it is hoped that this will minimise the scope for divergences in the interpretation of its requirements.
The new rules contained in MiFID II can be summarised as follows:
- Introduction of new trading venue concept called the Organised Trading Facility ("OTF") so as to ensure that trading takes places on a regulated platform wherever possible;
- Restriction on the exemptions that a number of firms currently rely on in order to ensure that they are outside the scope of MiFID. For example MiFID II will restrict the "dealing on own account exemption";
- The introduction of wide ranging reforms to the regulation of derivatives in Member States; e.g. MiFID II will require certain classes of derivatives to be traded on a Regulated Market ("RM"), Multilateral Trading Facility ("MTF"), OTF or on a third country trading venue which the European Commission has confirmed meets an equivalency test;
- Extension of the current pre and post trade transparency requirements;
- Extension of the current transaction reporting regime;
- Introduction of controls for firms that engage in algorithmic trading;
- Introduction of high-level organisational and conduct of business standards to all investment firms (e.g. client order handling rules, best execution requirements, requirements when providing investment advice, rules regarding inducements, client classification rules, appropriateness and suitability tests, etc);
- New regime for third country firms who want to provide investment services to clients in the European Union; and
- Introduction of a harmonised administrative sanctions regime.
From a funds perspective, all UCITS had been classified as non-complex financial instruments and therefore had not been subject to appropriateness tests under MiFID. MiFID II introduces the concept of a "structured UCITS" which will be treated as a complex financial instrument. This means that investment firms selling these products (i.e. structured UCITS) will be required to obtain information from retail investors to ensure that the product is appropriate to him/her.
MiFID authorised investment firms should be aware of the provisions in MiFID II so that they can take steps to ensure compliance where impacted by MiFID II. In addition, firms which currently avail of certain of the exemptions within MiFID will need to consider whether they will need to become authorised under MiFID II to continue providing such services.
(ii) Level 2 Implementing Measures
The European Securities Markets Authority ("ESMA"), as part of the Lamfalussy process has been asked by the European Commission to draft more detailed "level 2" rules over the next eighteen months. In this regard it is expected that ESMA will produce and prepare a number of regulatory technical standards, implementing technical standards, various recommendations, guidelines and other technical advice, (hereinafter the "Level 2 Measures") over the next while.
In order to achieve these objectives ESMA launched a consultation paper (the "Consultation Paper") and a discussion paper (the "Discussion Paper") on MiFID II. This is the first step with regards to the preparation of the Level 2 Measures and represents an important part of the process of translating the MiFID II requirements into practically applicable rules and regulations.
The Consultation Paper covers all of the topics on which the European Commission has formally requested ESMA to provide technical advice for the adoption of delegated acts by the European Commission. Therefore the Consultation Paper focuses on; (i) investor protection; (ii) transparency; (iii) data publication; (iv) micro-structural issues; (v) requirements applying on and to trading venues; (vi) commodity derivatives; and (vii) portfolio compression. As ESMA is required to deliver its technical advice to the European Commission by December 2014, it is therefore subjected to a condensed consultation process. On the other hand, the Discussion Paper focuses on more innovative or technically complex topics in order to receive feedback from stakeholders for the preparation of regulatory technical standards and implementing technical standards. The feedback received on the Discussion Paper will provide the basis of a further consultation on the issues raised in the Discussion Paper.
In advance of this deadline, ESMA will host three public hearings in relation to secondary markets, investor protection and commodity derivatives which are scheduled for 7 and 8 July 2014. The deadline for responses to the Consultation Paper and the Discussion Paper is 1 August 2014.
(iii) Request for technical advice from the European Banking
Authority ("EBA")
The European Commission has published a letter which it sent to the EBA requesting technical advice on possible delegated acts concerning product intervention by competent authorities. Under MiFID II, the European Commission is empowered to adopt delegated acts specifying criteria and factors to be taken into account by ESMA, EBA and competent authorities in determining when there is a significant investor protection concern and threat to the orderly functioning and integrity of the financial system of the European Union.
The European Commission has already asked ESMA to provide advice on measures specifying the criteria and factors to be taken into account by competent authorities in determining when there is a significant investor protection concern or a threat to the orderly functioning and integrity of the financial system of the European Union. As the MiFID II Regulation establishes an identical framework for EBA intervention powers in respect of structured deposits, the factors and criteria to be taken into account for the exercise of such powers for structured deposits should be similar (if not identical) to those set for ESMA with respect to financial instruments.
The EBA has been requested to provide its technical advice within six months of MiFID II coming into force; i.e. the EBA has until January 2015 to provide its technical advice.
A copy of this letter can be found at the link below;
To read this Update in full, please click here.
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