Financial Services Europe and International Update - December 2010 - Structured Finance

Regulatory Developments

This DechertOnPoint summarises regulatory developments in the UK, the European Union and internationally in the investment funds and asset management sector during recent weeks.

UK Developments

The New UK Financial Services Regulatory Structure

The FSA has announced that HM Treasury will now be publishing a second consultation paper on the new UK financial services regulatory structure in February 2011.

This consultation is expected to include a draft of a Financial Services Regulation Bill, with a view to bringing forward the Bill in Parliament in mid-2011. The Government aims to complete the passage of the primary legislation during 2012.

HM Treasury has also recently published a speech given on 17 November 2010 by the Financial Secretary, which clarifies the future of the FSA's function as the UK Listing Authority ("UKLA"). In its July 2010 consultation paper, HM Treasury suggested that the UKLA function could be merged with the Financial Reporting Council to form a new companies regulator. It also stated that the Government would consult on whether to transfer the FSA's current responsibilities for prosecuting criminal offences involving insider dealing, other forms of market abuse and other criminal law breaches to a new Economic Crime Agency ("ECA").

The Financial Secretary's speech confirmed that, following industry responses to the earlier consultation paper, the Government has now decided to keep the UKLA in the CPMA's Markets Division. The Government has also now decided to keep the criminal prosecution of insider dealing within the CPMA, rather than to transfer it to the proposed ECA.

Revision of the FSA's Remuneration Code and Consultation on Remuneration Disclosure

The FSA has confirmed that the policy statement in response to its July 2010 consultation paper on revising its remuneration code (CP10/19), setting out the final Handbook rules, has been delayed, and will not now be published in November 2010 as originally planned, but is now likely to appear in December 2010. (This results from delays in finalising the Committee of European Banking Supervisors' (CEBS) guidelines on implementation of the remuneration principles in the amendment to the Capital Requirements Directive (2006/48/EC and 2006/49 EC) (CRD3) now also due in mid-December 2010.)

On 10 November 2010, the FSA published a consultation paper on remuneration disclosure (CP10/27) in which it outlined its proposals to implement the requirements of CRD3 relating to the disclosure of remuneration. CRD3 will require firms to disclose information on their remuneration on an annual basis (under the Basel Pillar 3 framework). Among the matters on which the FSA is now consulting are:

items to be disclosed: this includes information on the remuneration decision-making process, the design characteristics of a remuneration system and aggregate quantitative information on total remuneration, variable remuneration, deferred remuneration and sign-on and severance payments;
the frequency of disclosures: the FSA proposes to require firms to make their first disclosures in respect of 2010 remuneration as soon as practicable, but no later than 31 December 2011;
the form of disclosure: disclosure is proposed to take the form of a stand-alone report or it may be included in the firm's annual report and accounts; and
proportionality: CRD3 allows regulators to apply its requirements on a proportionate basis, taking into account a firm's size and complexity, and the FSA proposes to divide firms into four tiers for this purpose, based principally on their regulatory capital and type of permission, each tier being subject to a different degree of disclosure.

The FSA is also considering extending the scope of the disclosure requirements to non-EEA firms operating as branches in the UK, and depending on the responses to the present proposals, it may consult on this issue separately in Q1 of 2011.

FSA Consultation on Delivering the RDR and Other Issues for Platforms and Nominee-related Services

On 17 November 2010, the FSA published a consultation paper on delivering the retail distribution review ("RDR") and other issues for platforms and nominee-related services (CP10/29).

CP10/29 contains proposals which aim to ensure that platform services used to buy and manage investments are aligned with the standards required by the RDR. Its publication follows a March 2010 FSA discussion paper on delivering the RDR for platforms.

Key proposals relate to adviser charging, independent advice, platform remuneration and rebates.

Adherence to the Stewardship Code

The FSA has now announced that with effect from 6 December 2010, it will become a regulatory requirement that asset managers disclose clearly on their websites, or if they do not have a website in another accessible form, their commitment to the Stewardship Code or their alternative investment strategy. This requirement does not apply to venture capital firms which are managing investments for professional clients that are not natural persons. For details of the Stewardship Code, see " UK Stewardship Code for Corporate Investors", DechertOnPoint (July 2010).

The Financial Reporting Council has also published some examples of wording used by asset managers in respect of commitment to the Stewardship Code on its website: www.frc.org.uk/corporate/ stewardshipstatements.cfm

New UK Authorised Fund Regime for Tax Transparent Vehicles

On 23 November 2010, the Financial Secretary to the Treasury announced that the Government intends to launch a new authorised fund regime for tax transparent vehicles, in order to take advantage of the master-feeder fund structure across the EU, which is a key feature of the UCITS IV Directive, and for use as a preferred structure for cross-border pooling of pension funds, and possibly also for life insurance funds. (A contractual common fund structure is currently being considered for these purposes).

EU and International Developments

The New EU Supervisory Framework: the ESRB and ESAs

In June 2009 the European Council approved the reform of the EU's supervisory structure, building on the de Larosiere Report and in September 2009 the Commission brought forward a package of proposals to set up the two new bodies, the European Systemic Risk Board ("ESRB") and the European System of Financial Supervisors ("ESFS"). On 27 September 2010 the European Parliament approved the proposed reforms of the EU's supervisory framework.

The EU Council has now recently given its final approval to the regulations establishing the ESRB, which will provide macro-prudential oversight of the financial system, and the three new European Supervisory Authorities ("ESAs"). In addition, the Council has adopted a regulation giving the European Central Bank ("ECB") specific tasks with regard to the day-to-day running of the ESRB and a Directive amending existing EU legislation in respect of the powers conferred on the ESAs (the so-called Omnibus Directive).

The new bodies will be part of the European system of financial supervisors, which will also include the supervisory authorities of the Member States. The ESRB and the EIOPA (the insurance and pensions authority) will be based in Frankfurt, the EBA (the banking authority) in London and the ESMA (the securities and markets authority, replacing CESR) in Paris. The ESRB's role will be to monitor and assess potential threats to the stability of the financial system. Where necessary, it will issue risk warnings and recommendations for action and will monitor their implementation. The ESAs will replace the three existing committees of supervisors at EU level (CEBS, CEIOPS and CESR), and their principal responsibility will be ensuring that a single set of harmonised rules and consistent supervisory practices are applied by the supervisory authorities of the Member States.

The EU, however, will need to reach a deal on its budget for next year to ensure the new bodies are funded and operational from 1 January 2011. An attempt to reach agreement on the 2011 EU budget failed on 15 November 2010 due to reluctance by Member States to grant MEPs extra powers in future budget negotiations. The European Commission will therefore now have to draft a new proposal, whilst in the first months of 2011 funding the new system on the basis of the 2010 budget.

Ministers at a recent ECOFIN meeting held this month also gave initial approval to tightening up from 2011 onwards the supervision of financial conglomerates which have banking and insurance activities in more than one Member State. The legislation will enable financial supervisors to apply banking, insurance and supplementary supervision concurrently so as to address loopholes identified during the recent financial crisis.

IOSCO's Final Report on Private Equity and Conflicts of Interest

On 15 November 2010, IOSCO published its above report following a May 2008 report which identified conflicts of interest as a potential key risk in private equity sponsored transactions.

The final report focuses on the risks posed to fund investors and the efficient functioning of financial markets from the conflicts of interest which can exist within private equity firms or private equity funds. In particular, the report examines the potential conflicts of interest that the managers of such funds can face.

The report contains a set of eight principles for the effective mitigation of conflicts of interest in private equity firms. Although the principles were developed for multi-fund, multi-strategy private equity firms, the report explains that they can be applied to all private equity firms.

SEC and CESR Members to Continue Close Co-operation on New Regulatory Reform Initiatives

The USA's Securities and Exchange Commission announced on 16 November 2010 that it and the Committee of European Securities Regulators (CESR) have held high-level meetings in Paris with the chairmen of all 29 CESR members' regulators to discuss regulatory reform activities in the United States and the EU, which focus on new and wide-ranging rules designed to address regulatory concerns arising from the recent financial crisis. These include the regulation of OTC derivatives and the oversight of credit rating agencies, the managers of hedge and private equity funds, market structure issues, systemic risk, and issues relating to the convergence of IFRS and US GAAP.

European Commission Announcements on UCITS, PRIPs, MiFID and Central Securities Depositories

On 19 November 2010, the European Commission published a record of the meeting of the European Securities Committee held on 9 November 2010, which provided information on forthcoming Commission legislative initiatives, including:

amendments to UCITS IV (2009/65/EC) relating to the UCITS depositories regime and remuneration policies for UCITS managers;
the Commission's review of MiFID (2004/39/EC);
the Commission's workstreams for its packaged retail investment products ("PRIPs") initiative, including separate consultations on sales rules for MiFID and for non-MiFID products; and
a consultation on central securities depositories ("CSDs") relating to the Commission's work on the legal certainty of securities holding and dispositions.

On UCITS IV, the Commission intends to publish a consultation on changes to the UCITS depositories regime and remuneration policies for UCITS managers by the end of November 2010 and to publish a legislative proposal by July 2011. The Commission may also take the opportunity to make technical amendments to UCITS IV.

The Commission intends to provide UCITS investors with at least the same level of protection as will be granted to investors in alternative investment funds by the Alternative Investment Fund Managers Directive (the "AIFMD"). (The Commission is also considering strengthening protections for investors in UCITS beyond those provided by the AIFMD in respect of depositories' liability.)

On MiFID, the Commission has confirmed that its consultation on amendments to MiFID should be published by the end of 2010, with a legislative proposal expected in April 2011.

On PRIPs, the Commission intends to publish three separate consultations:

a consultation on product transparency rules and the scope of the PRIPs initiative;
a consultation on sales rules, in the context of the MiFID review (this consultation will relate to MiFID products); and
a consultation on sales rules, in the context of the review of the Insurance Mediation Directive (2002/92/EC) (this consultation will consider applying MiFID-style rules on conflicts of interest and conduct of business to insurance-based PRIPs).

The two consultations on sales rules will also address non-PRIPs issues.

On CSDs, the Commission intends to publish a consultation in December 2010 and a legislative proposal in June 2011. This consultation will relate to the Commission's work on the legal certainty of securities holding and dispositions.

CESR Consultation on Structured UCITS Risk Measurement and Global Exposure Guidelines

On 18 November 2010, CESR published a consultation on guidelines on risk measurement and the calculation of global exposure for certain types of structured undertakings for collective investment in transferable securities ("UCITS").

CESR published guidelines in July 2010 on risk measurement and the calculation of the global exposure and counterparty risk for UCITS and received feedback on those guidelines which requested it to develop a similar methodology for structured UCITS funds. CESR has not developed a specific regime for the calculation of the global exposure of structured UCITS however. Instead, it has created an alternative approach for the calculation of global exposure for structured UCITS. The proposed guidelines will apply to structured UCITS that meet the criteria set out in the guidelines themselves which will explain how global exposure should be calculated and include case studies.

(When these guidelines are adopted, they will be incorporated into the July 2010 guidelines.)

The consultation period ends on 31 December 2010.

Other EU Developments

Three other European Union developments of wide application are also worth noting:

Eurozone Economic Governance and Treaty Amendment

In March 2010, the European Council established a Task Force, led by Council President Herman van Rompuy, on developing an improved crisis resolution framework and better budgetary discipline for the EU. Preliminary conclusions were agreed to at the June 2010 European Council and a report was prepared for the end October European Council.

At the end of October, 2010 Germany and France agreed to a deal establishing that Member States would not face automatic sanctions if they break the new rules, but the Germans secured from the French an agreement to negotiate changes in the EU Treaty to create a permanent crisis resolution mechanism. This has paved the way in practice for a permanent European Monetary Fund to replace the existing European Financial Stability Facility ("EFSF").

The European Council also agreed at the end of October, 2010 to the creation of a permanent bailout fund for Eurozone Member States to replace the EFSF and to be put in place temporarily in the Spring of 2010 until 2013. President Van Rompuy was given the task of working out the details on how the fund will be structured, and whether and how it will co-operate with the IMF. Key among the issues is whether private bondholders will be made to bear losses in the event of a Eurozone Member State default.

A Treaty change will also be required. It was originally felt that this could be done by a change to the Treaty on the next accession of a new EU Member State, but the view in Brussels now appears to be that a simplified Treaty revision requiring Parliament-only ratification by the Member States may be possible instead. A simplified provision, enshrined in Article 48, Section 6 of the Lisbon Treaty at present allows Member States to unanimously adopt a decision amending all or part of the main elements of the Treaty. Such a procedure would avoid the need to call a constitutional convention and also opens up possibility of streamlined ratification. (This approach has also been assisted by the fact that Germany did not win support for its calls that Member States' voting rights should be suspended in the event of their breaching Eurozone rules as this would have required a more substantial Treaty change.)

Accordingly President Van Rompuy will now prepare changes to the Lisbon Treaty with a view to their being agreed at an EU summit to be held in December 2010.

Bank Levies and Financial Taxes

In June 2010 the European Council agreed that Member States should introduce a system of levies and taxes on financial institutions to ensure fair burden-sharing and to set incentives to contain systemic risk. It was further agreed that such levies or taxes should be part of a credible resolution framework and that work was required on their main features, level playing field issues and the cumulative impacts of various regulatory measures. The European Council invited the Council and the Commission to take this work forward and to report back in October 2010. The Council at the end of October 2010 issued a report on the subject stating that in view of the need to better anticipate and defray the cost of a possible crisis, there was now broad agreement at the international level that the financial sector should make a 'fair and substantial' contribution towards paying for any burdens associated with government interventions, where they occur, to repair the financial system or fund resolutions. It considered that a range of policy options could be pursued, including levies and taxes and that although not mutually exclusive, their impact on the banking sector needed to be considered together with other measures currently in the process of being introduced, in particular the new capital and liquidity requirements, as well as measures aiming at adequate funding of Deposit Guarantee Schemes.

On bank levies, the Council's report acknowledged the fact that whilst there is a growing consensus in the EU on the base and scope for such levies, this is not the case at this stage on either their objectives or on the allocation of the proceeds of such levies. Looking at next steps, the report proposes that given that Member States are already now moving ahead by introducing country specific systems of levies with differing parameters, a two-step process should be pursued: first, problems of double charging and co-ordination should be addressed, and second, a debate on the more structural aspects of levies linked to the setting up of crisis resolution structures should continue once the Commission has presented its proposal in respect of an EU framework for crisis management.

On financial taxes, the report argues that a Financial Transaction Tax (a "FTT") might contribute to ensuring that the financial sector makes a fair and substantial contribution to public finances provided it is properly calibrated and applied globally. However, it accepts that reaching agreement in this respect at the global level may be difficult and, considering the global nature of financial markets, applying such a tax at the EU level alone may result in significant distortion of competition and any relocation of financial activity within the global financial system resulting in reduced fiscal revenues. The report therefore recommended further careful consideration of the options in that respect, and in order to carry this debate forward at the EU and international level, a comprehensive analysis should be carried out by tax experts on what the conditions would be for implementing such a tax. The report is even vaguer in respect of a Financial Activity Tax (a "FAT"), noting merely that these taxes already exist in some Member States in a broad variety of forms in order to allow specific taxation of the financial sector.

On bank levies the Council has now invited the Economic and Financial Committee to look into the possibilities for EU-wide and bilateral solutions to ensure the necessary co-ordination between the different national schemes currently in place to avoid double charging of EU bank entities. The Committee is to report back to the European Council in December 2010.

On financial taxes the Council has taken note of the Commission communication on the taxation of the financial sector of 7 October 2010 and of the intention of its Taxation Policy Group to examine different options. It concludes (again rather vaguely) that a Council High Level Working Party should examine the options and prepare conclusions, where appropriate.

Commission Communication: Towards a Single Market Act

President Barroso commissioned Mario Monti to produce the report on the relaunch of the Single Market and this was published in June 2010. The European Parliament also produced its own report on the Single Market which stressed that market integration is not irreversible and the continued existence of the Single Market should not be taken for granted. Commissioner Michel Barnier had also made it clear that he sees great importance in making the Single Market relevant and beneficial to EU citizens following the financial crisis. The Commission has been working on how to respond to these varying concerns.

At the end of October it published a Communication ("Towards a Single Market Act") setting out key proposals over the next two years which it regards as essential to ensuring the success of the single market. Many of the fifty or so proposals which it contains are focused on services and goods but some relate directly to financial services.

The key financial services proposals in the Commission's Communications are:

a review of the accounting directives in 2011 to simplify financial reporting obligations and to reduce administrative burdens, particularly for SMEs;
by 2012, venture capital funds set up in any Member State should be able to operate and invest freely within the EU (if necessary by adopting a new legislative framework) and any tax treatment that disadvantages cross-border activities should be eliminated;
an action plan on improving SME access to the capital markets, including measures to develop efficient listing and disclosure requirements, is in preparation;
the co-ordination of national tax policies through a Directive introducing a common consolidated corporate tax base in 2011 is proposed (emphasis added);
a re-examination of the pension funds directive is proposed in 2011 to remove obstacles to mobile workers;
a Green Paper on corporate governance is proposed in 2011/12;
a legislative initiative on access to certain basic banking services is proposed in early 2011, and call will be made on the banking sector to develop self-regulatory initiatives aimed at improving the transparency and comparability of bank charges by the end of 2011; and
a directive to create a single integrated mortgage market, with a high level of consumer protection, is proposed in 2011.

The Commission will now seek formal endorsement by the European Parliament and Council of the final version of the Single Market Act after further consultation.

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UK: Financial Services Europe and International Update - December 2010