The Current Regulatory Ecosystem

Driven by the credit crunch and financial crises in the banking sector, a number of new regulations have been introduced in recent years. Some of them originate from Europe, some from United States and in the hyper-competitive market they are all more or less applicable globally.

In Bearing, we help our clients analyze the impact of these regulations, and to implement them as applicable. Below is an overview of what is currently on the table.

 

BASEL III

Global Banking Rules

Timeline

  • G20 by end 2012: EU CRD IV; in US – Dodd Frank Act implications
  • Insurance: EU Solvency II by 2014 – same aim as B3 re capital; investor transparency (look through): asset allocation/corporate structure implications

Key Themes

  • Deleveraging: new global standards designed to strengthen capital and liquidity; stress testing; creating a more robust and resilient banking sector
  • Systemically important financial institutions (SIFIs) to have loss absorbing capacity beyond existing standards; “living-wills” resolution regime in case of wind down; measures to limit counterparty credit risk (CCP clearing)
  • Higher risk weightings on derivatives: 2% against initial margin posted to the CCP; clearing members to hold capital against exposure to clients
  • New thresholds for core capital
  Common Equity Tier 1 Capital Total Capital
  • Minimum

4.5%

6.0%

8.0%

  • Conservation buffer

2.5%

   
  • Joint

7.0%

8.5%

10.5%

  • Countercyclical buffer range

0-2.5%

   

 

EMIR

EU Market Infrastructure Regulation

Timeline

  • EMIR latest legislative proposal published in Oct 2011
  • Industry compliance targeted from Jan 2013 (G20 commitment)

Key Themes

  • Central clearing of OTC derivatives through a CCP similar to US Dodd-Frank; otherwise capital charges apply; review risk management
  • Common governance standards for CCPs and plan-EU requirements for CCP interoperability regarding equities; third country CCPs need to meet new EU standards if used by EU counterparties
  • Increased margin and collateral requirements: portability and eligibility of collateral not yet finalised, eg required is “highly liquid collateral”
  • Operationally need to review number and type of collateral relationships with clearing brokers factoring in all risk management aspects
  • Mandatory daily independent valuation and collateralisation of those trades that are not cleared through a CCP centrally
  • Trade repositories: mandatory registration of all contracts

 

MiFID II

EU Markets in Financial Instruments Directive

Timeline

  • MiFID II Regulation & Directive proposal published in Oct 2011
  • Industry compliance expected from July 2013 onwards

Key Themes

  • Derivatives on-exchange trading (ETD): new instruments, venues, activities captured: almost any type of derivatives; organised trading facilities (OTFs), “dark pools”; high frequency algo trading activities
  • Structured UCITS classified as complex products – marketing impact: MiFID sales and transparency rules will apply; this will increase operational complexity of distribution of structured v non-structured UCITS
  • Advisor commissions/inducements: ban of commission payments for independent advisors from 2013 (creating an unlevel playing field with insurance or other products, ie non-MiFID PRIPs)
  • Depositary: envisaged to be classified as “investment advice” instead of just “ancillary service” under MiFID increasing compliance requirements and costs

 

FATCA

US Tax Regime Reporting on US Investors

Timeline

  • Signed into law in March 2010
  • Effective from Jan 2014 for payments; from Jan 2015 for securities

Key Themes

  • Rationale: prevent tax evasion by US investor through off-shore accounts
  • Foreign Financial Institutions FFI defined as holding financial assets for the accounts of others; can enter into an agreement with US authority IRS by Jan 2013 to be identified as participating PFFI; entails duty to report to US authorities on any accounts held by US investors.
  • Non-participating N-PFF:s will be subject to 30% tax withholding of all US-sourced payments such as dividends/interest paid by US corporates
  • Operational challenges: to identify end-investors, to verify as US citizen through chain of intermediaries; new documentation and investor disclosure requirement towards US authorities; change of IT systems
  • Applies also to “pass-thru payments” including those “attributable to” withhold able payments/US sourced income resulting in a wide scope

 

DODD-FRANK-ACT/VOLCKER RULE

US comprehensive rules reforming financial services

Timeline

  • Signed into law in July 2010
  • Dodd-Frank effective from July 2011; Volcker Rule from July 2012

Key Themes

  • US/non-US investment advisors need to register with the US SEC if AUM greater than $100/25 million respectively attributable to US investors
  • Consequence are stricter record keeping, reporting requirements, oversight and inspection on eg AUM, capital leverage ratios, counterparty credit risk exposure, trading and investment positions, valuation policies, liquidity and short selling provisions, books and records retention
  • Volcker Rule mandates the segregation of banking and proprietary trading and from sponsoring or investing in Al management functions; leading to spin-offs of proprietary trading desks, HF/PE arms by banks
  • Central clearing of OTC derivatives similar to – but different and also coming into force earlier than – the European EMIR rules (G20)
  • Regulatory uncertainty as many implementing rules not yet finalised

 

AIFMD

EU Alternative Investment Fund Manager Directive

Timeline

  • Level 1 Directive in force since July 2011; compliance from July 2013
  • Level 2 legislation proposal expected for 1Q2012

Key Themes

  • Applicable: to non-UCITS funds, including hedge funds, private equity
  • EU domicile: applicable if the alternative fund (AIF) or manager (AIFM) or investor is domiciled in one of the EU 27 member states
  • Passport: EU managers can apply for a passport from July 2013 (equivalent concept to UCITS)
  • Third-country/marketing rules: non-EU funds eg domiciled in Cayman, Guemsey, Jersey, Switzerland etc will require prior authorisation
  • Investment rules: on investment strategies, risk management, governance, remuneration, reporting to regulators and investors
  • Delegation: similar to UCITS/MiFID, but aims to prevent any potential approach by service providers of “outsourcing risk or liabilities”
  • Depositary liability rules outlines below: a single depositary for each AIF needs to be appointed for all non-UCITS; impact on fund economics

 

UCITS IV/V

EU Mutual Funds

Timeline

  • Ucits IV in force and mostly implemented by EU 27 member states
  • UCITS V proposal expected for 1Q2012

Key Themes

  • Passport: in force for management companies
  • Marketing rules/KIID: Key Investor Information Document will be further standardised and have more information on risk, calculation methodology and charges
  • Master –feeder structures: a more harmonised approach across Europe may stimulate growth in cross-border pooling structures and mergers, but tax issues still remain
  • “NEWCITS”: HF managers offering more UCITS products since the possible inclusion of derivatives tapping into new investor segments
  • Depositary: new liability rules as in AIFMD expected to spill over into UCITS V whereby depositaries are
  • liable for the loss of financial instruments held in custody
  • have the obligation to return equivalent amount without undue delay
  • following that may prove – cumulative – that the loss is a result of 1) an external event Beyond its reasonable control 2) the consequence was unavoidable 3) despite efforts to the contrary

 

EU PRIPs/UK RDR

EU & UK Rules for Retail Fund Distribution

Timeline

  • EU PRIPs legislative proposal expected for 1Q2012
  • UK RDR industry compliance by Jan 2013

Key Themes

  • Definition Packaged Retail Investment Products – offer exposure to underlying financial assets but with a modified exposure compared to direct holdings; no clear-cut definition yet but aim to capture retail UCITS, insurance and structured or otherwise manufactured products
  • Marketing rules/PRIPs KIID: pan-EU regulation aims to raise standards for PRIPs distribution to better protect investors – capturing 1) the form/content of disclosure document (KIID) and 2) sales process (eg through MiFID)
  • UK RDR Retail Distribution Review: ban of commission payments for all advisors from 2013 (going beyond MiFID proposal)

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