This DechertOnPoint summarises regulatory developments in the European Union and the UK in the investment funds and assets management sector during the past four weeks.
EU and International Regulatory Developments
Prospectus Directive: ESMA Call for Evidence on Request for Technical Advice
The European Securities and Markets Authority ("ESMA") issued a request for interested parties to submit views on aspects or areas that it should consider in its advice to the European Commission on possible delegated acts concerning the Prospectus Directive (2003/71/EC) (as amended by Directive 2010/73) towards the end of January 2011. ESMA has been asked to deliver certain parts of the requested advice on 30 September 2011. To enable it to fulfil the request for advice, ESMA has set up a Prospectus Level 2 Task Force. The advice requested by the European Commission included the following matters:
- the format of final terms to a base prospectus;
- the format of the summary and content and format requirements of the key information to be included in the summary of a prospectus;
- the proportionate disclosure regime in relation to certain rights issue prospectuses and prospectuses in relation to issues by SMEs, companies with reduced market capitalisation and certain issues of non-equity securities by credit institutions;
- the criteria for assessing equivalence of the regulatory framework of third country markets in connection with the extended employee offer exemption from the requirement for a prospectus; and
- the consent requirements in connection with the use of a prospectus in a retail cascade.
The Commission has also asked ESMA to consider certain amendments to the disclosure requirements in the Prospectus Regulation, including in relation to:
- the information on taxes on income from securities withheld at source;
- the requirement for an independent report for a profit forecast or estimate; and
- the period covered by the audited financial information.
Responses to this initial call for evidence should be received by 25 February 2011 (ESMA intends to publish a consultation paper in July 2011). Thereafter, the advice to the European Commission is expected to be signed off by ESMA in September 2011 and the Commission will then prepare the delegated acts from October to December 2011, with adoption of the delegated acts by the Commission expected in late December 2011. March and June 2012 will be the end of the objection period for the Parliament and Council and the transposition period for the implementing directive will end on 1 July 2012.
Commodity Markets: European Commission Communication
The European Commission presented earlier this month an integrated strategic vision to tackle challenges in commodity markets and on raw materials. The Communication includes measures to improve the transparency of financial and commodity markets. (The report has been delayed after the French President Nicolas Sarkozy criticised an earlier version, which said it had found no evidence of "a correlation between the substantial increase in index fund positions and commodity futures prices." In the final version the section has been removed. Instead, the Commission said that "while it is clear that there is a strong correlation between positions on derivatives markets and spot prices, it is still difficult to assess fully the interactions and the impact of movements in the derivative markets on the volatility of the underlying physical markets.")
In its Communication the Commission presents an overview of developments in financial and physical markets and proposes a series of measures which include improving the integrity, transparency and stability of commodity derivatives markets, inter alia through a review of the Market Abuse Directive and MiFID.
The Commission's Communication also notes that further work is necessary to understand fully the interlink between physical and financial markets, and it intends to continue working on this in the framework of the G20-debate taking place at the global level.
IOSCO Final Report on Point of Sale Disclosure Principles for Collective Investment Schemes
The International Organisation of Securities Commissions ("IOSCO") published its final report on point of sale ("POS") disclosure principles for collective investment schemes ("CISs") on 2 February 2011.
In the report, IOSCO explains that transparency in the market place, particularly the disclosure of information to investors, has always been a high priority and the goal of regulators in seeking to ensure that markets run efficiently and with integrity. The financial crisis highlighted the critical role that accurate, understandable and meaningful disclosure can play.
The report considers issues arising from requiring key information disclosures to be made to retail investors relating to CISs and their distribution prior to the POS, setting out principles for the disclosure of key information relating to CISs prior to the POS. The principles are designed to help markets and regulators when they are considering POS disclosure requirements. Key points made in the report are that:
- no matter what POS disclosures are required, they will not have the intended effect if the investor does not read or understand the information provided and as a result, regulators should consider steps to improve retail investor education;
- new POS disclosure requirements should not be imposed without the benefit of consumer testing or assessment, to help to determine the likely effectiveness of any new requirements; and
- the principles in the report may also be applicable to non-retail investors.
IOSCO is aware that some members of the CIS industry believe that if CIS products are subject to enhanced POS disclosure requirements, this may place them at a competitive disadvantage in relation to other financial products; however, IOSCO has not considered the merits of this argument in great detail in the report, due partly to the difficulty in identifying truly comparable products that are as popular with retail investors.
The report does not consider issues relating to the suitability of CISs. Also, it does not purport to describe or address all intermediary disclosure obligations. Although the report, and the principles, apply to CISs, IOSCO encourages regulators to consider how the principles could be adopted for similar products.
CRD 4: Commission Consultation on Counterparty Credit Risk
As part of its work on developing a wholesale revision of the Capital Requirements Directive ("CRD") to reflect the Basel 3 concordat, the European Commission is currently seeking views on different aspects of the revision. It has already consulted on counter-cyclical buffers and is expected to publish its proposed amendments to CRD in July 2011. Basel 3 also introduces capital requirements for exposures to CCPs, which previously were set at zero if certain conditions were met, and at the same time, in line with the G20, OTC derivatives that are not cleared are to be subject to higher capital charges to reflect the increased perceived risk.
The Commission recently launched a public consultation on counterparty credit risk generated by derivatives, repo and securities financing activities. It addresses two specific questions:
- capital requirements for exposures to CCPs; and
- treatment of incurred credit valuation adjustments.
The objective is stated as ensuring higher capital charges to encourage the clearing of OTC derivatives. The CCPs themselves would be divided between "qualifying" CCPs, which meet international standards and the Commission suggests also EU regulations, to which modest capital requirements would apply, and "non-qualifying" ones that would face higher charges.
Responses are required by 9 March 2011. The full formal proposals to amend the CRD are then expected in July 2011. Part of the revision is likely to see some aspects of the CRD transformed into Regulations.
UK Regulatory Developments
FSA Consultation on Product Disclosure
The FSA published a consultation on product disclosure for retail investments (CP11/3) on 2 February 2011.
CP11/3 brings together a number of product disclosure issues and proposals to:
- amend the key features illustrations ("KFIs") firms are required to provide to clients in respect of advised sales of retail investment products (which includes individual personal pensions) and group personal pensions; this is to reflect the Retail Distribution Review (the "RDR") ban on commission, and product providers will need to amend their KFIs to reflect these requirements by the end of 2012;
- introduce new KFI disclosure requirements in respect of personal pension schemes marketed as self-invested personal pensions ("SIPPs") by clarifying the nature of a SIPP and improving the quality and usefulness of personal pension scheme disclosure; (however, the FSA is not proposing any disclosure rule changes for other packaged products in view of the European Commission's consultation on packaged retail products (PRIPs) and intention to put forward detailed proposals in the context of its reviews of MiFID (2004/39/EC) (MiFID) and the Insurance Mediation Directive (2002/92/EC); and
- potentially amend pension KFIs to replace monetary projections with inflation-adjusted projections for personal and stakeholder pensions (both individual and group).
The FSA intends to publish a policy statement, including feedback on its CP 11/3 proposals, in the second half of 2011 and any final rules in relation to the RDR adviser and consultancy charging requirements will come into force on 31 December 2012 and any final rules on pension scheme disclosures will come into force on 6 April 2012.
AIC Guidance for Investment Company Boards on Managing Custody Risk
The Association of Investment Companies (the "AIC") published guidance for boards of investment companies on managing custody risk on 4 February 2011.
Custody risk is described as the risk that an investment company's assets which are held in custody are lost, or access to them is compromised, as a result of the custodian's misuse of assets, fraud, poor administration or inadequate record-keeping. The guidance paper notes that the custody market is dominated by a smaller number of global institutions, including major banks, which hold a wide range of assets, including equities, government and corporate bonds, warrants and derivatives.
The guidance note covers the following areas:
- the role of an investment company's board;
- board review of custodial arrangements; and
- reporting to shareholders.
The potential for counterparty failure has become more apparent in recent years, particularly in view of the collapse of Lehman Brothers in 2008. This has resulted in new regulation and legislation designed to clarify depositaries' responsibilities and set higher standards. In this respect, the guidance note draws attention to the provisions in the AIFM Directive relating to depositary arrangements, which will come into effect in 2013.
The guidance paper also refers to proposed new depositary rules for UCITS funds (under the European Commission review of the UCITS Directive (2009/65/EC)), which may have wider implications for the products and services offered by custody service providers in other sectors of the market. (In Spring 2011, the European Commission intends to present a legislative proposal (known as "UCITS V") which will update the current framework applicable to UCITS depositaries and introduce new provisions on the remuneration of UCITS managers).
Since the nature of custody provision is likely to undergo significant change over the coming years, the AIC is encouraging investment company boards to review their existing custody arrangements and consider, as far as possible, whether current arrangements will be sufficient to meet future regulatory and legislative changes.
FSA Policy Statement on Implementing the 2nd Electronic Money Directive
The FSA published a policy statement on 10 February 2011 on implementing the second Electronic Money Directive (2009/110/EC) ("2EMD") (PS11/2) which reports on the feedback the FSA has received to its October 2010 consultation paper on implementing 2EMD (CP10/25) and its October 2010 consultation paper on regulatory fees and levies (CP10/24).
PS11/2 includes confirmation of the following issues:
- Perimeter guidance: the FSA will publish amended guidance in the FSA's Perimeter Guidance manual (PERG) about the scope of the Electronic Money Regulations 2011 (SI 2011/99) and intends to publish an e-money approach document by the end of February 2011;
- Reporting requirements: the FSA intends electronic money institutions ("EMIs") to report on their e-money and payment services business using manual returns, details being contained in chapter 16 of the Supervision Manual (SUP);
- Dispute resolution: the FSA's proposals are being implemented unchanged from its consultation in CP10/25 (which means that the compulsory jurisdiction of the Financial Ombudsman Service will cover all e-money issuers within the scope of 2EMD for disputes concerning the issuance and redeemability of e-money and related payment services);
- Enforcement: the FSA will take enforcement action consistent with its stated enforcement policies in the Decision Procedure and Penalties manual (DEPP) and the Enforcement Guide (EG); and
- Application Fees: the FSA has also confirmed which e-money issuers will be exempt from paying application fees and the level of fees authorised EMIs and small EMIs will need to pay, the fees being finalised in the FSA's consolidated fees policy statement which is due to be published in May 2011.
Changes to the FSA Handbook to implement the new rules and guidance are set out in the Electronic Money and Payment Services Instrument 2011 (FSA 2011/7), included in Appendix 1 to PS11/2. (Different parts of the instrument will come into force on three dates: 10 February 2011, 30 April 2011 and 30 April 2012.)
Bank Levy for 2011
HM Treasury announced on 8 February 2011 that the full bank levy rates (0.075% for short-term liabilities and 0.0375% for long-term equity and liabilities) are to apply for the calendar year 2011. However, because reduced rates were set for January and February 2011 (0.05% for short-term liabilities and 0.025% for long-term equity and liabilities), the rates for March and April 2011 are increased to take account of the shortfall (0.1% for short-term liabilities and 0.05% for long-term equity and liabilities).
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