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Buy-side seminar 2014: What to watch in the UK and EU Hannah Meakin and Imogen Garner - Partners Norton Rose Fulbright LLP 24 June 2014.

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Presentation on theme: "Buy-side seminar 2014: What to watch in the UK and EU Hannah Meakin and Imogen Garner - Partners Norton Rose Fulbright LLP 24 June 2014."— Presentation transcript:

1 Buy-side seminar 2014: What to watch in the UK and EU Hannah Meakin and Imogen Garner - Partners Norton Rose Fulbright LLP 24 June 2014

2 Introduction

3 The domestic picture: –focus on thematic issues The European dimension: –AIFMD –UCITS V & VI –MiFID II and MiFIR –EMIR Client assets 3

4 The domestic picture

5 Focus on thematic issues

6 The wider context: the FCA one year on… One year on from legal cutover, is the FCA really “a very different animal” to its predecessor? –Martin Wheatley, ABI Biennial Conference, 9 July 2013 Recent FCA speeches have highlighted a “sea change” in the attention being paid by firms to the conduct agenda –Clive Adamson, Building Societies Association, 12 May 2014 A strong and demonstrable conduct focus, including at executive management and board level, will therefore be essential Outcomes-focussed regulation: How are businesses actually run, and what is the impact of their activities on consumers and markets? Second-line controls are not enough… Pre-emptive and judgement-based regulation – firms should mirror this approach The FCA will want to demonstrate what it has achieved since its creation, and firms should expect a tough stance if they fall short 6

7 Much of the FCA’s recent thematic work has relevance for the buy-side: –October 2013 – TR 13/9 on ABC/AML controls in asset management and platform firms –November 2013 – TR 13/10 on outsourcing in the asset management industry –March 2014 – TR 14/1 on risks to customers from financial incentives –March/April 2014 – TR1 14/5 and 14/6 on firms’ implementation of RDR −February 2014 – TR 14/1 on transition management −April 2014 – FCA TR 14/7 on clarity of fund charges FCA expectations and key themes: –Firms are expected to be aware of and consider the FCA’s findings –Senior management should satisfy itself that firms’ practices are appropriate, and should ensure proper oversight and control –Firms should consider published examples of good and poor practice, and benchmark themselves against expected standards: what do you have that demonstrates you have done this? –Role of industry guidance (e.g. the OWG’s Guiding Principles and Considerations) −Follow-up work through routine supervision, but further policy action is possible where insufficient progress made −Note that the FCA is not afraid to devote resource to looking at smaller market sectors, which may have been under the radar to date −Common themes include conflicts of interest, transparency and communication with clients/client understanding, asset managers’ agency responsibilities, and close scrutiny of firms’ arrangements and contracts 7 Thematic issues: what have we seen so far?

8 Thematic issues: what is on the agenda? 8 Asset managers’ role as trusted agents: –are asset managers acting as good agents and taking proper account of investor interests? Fairness and transparency as a key theme: –conflicts of interest remain a significant area of focus, and are at the heart of a number of themes in conduct regulation –spotlight on use of dealing commission: “asset managers [should] spend their clients’ money as though it was their own and manage costs with as much tenacity as they produce returns” (Clive Adamson, October 2013) –consistency of investment decisions with investors’ stated objectives, clarity of information on risks and costs Market abuse controls – FCA is already looking at market conduct controls within asset managers Conduct risk continues to be at the fore: –FCA is actively engaging with firms on this –How can your firms demonstrate their understanding of what conduct risk means in the context of their business? –How are you identifying, assessing, managing and monitoring conduct risk?

9 The European dimension

10 AIFMD

11 AIFMD: are we there yet? AIFMD has been transposed in most Member States, and co- operation agreements are in place between the competent authorities of most EU Member States and key third countries UK AIFMs seeking authorisation by 22 July 2014 should have submitted a complete application by 20 June 2014 Transitional AIFMs submitting a complete application by 22 July 2014 can continue managing their AIFs: –but, until authorisation is received, note potential for business disruption as passports are not available – in any case, uncertainty around the passport for MiFID add-ons has led some firms to restructure Firms have focused their efforts on areas that are time critical: –for non-EU firms, this means many are still getting to grips with regulatory reporting and annual report requirements –some firms that did not use the transitional period are now reporting: what are the lessons? –the reverse solicitation “exemption”: a misnomer but we are seeing renewed interest –service provider contracts: impact of the impending deadline on negotiations 11

12 UCITS V & VI

13 UCITS V: state of play 3 July 2012 – European Commission published its legislative proposal for UCITS V Directive 15 April 2014 – European Parliament approved UCITS V. Adoption of UCITS V subject to formal approval by the Council of the EU 2 December 2013 – Council of EU compromise proposal published November 2012 – European Parliament’s Committee on Economic and Monetary Affairs published draft report on the European Commission’s legislative proposal July 2013 – European Parliament published a press release announcing the results of a plenary vote on UCITS V, along with the text of adopted amendments 11 January 2013 – European Parliament published amendments to the legislative proposal End 2015 – likely date from which UCITS V will apply, based on current status of negotiations (MS will have 18 months to transpose UCITS V into national law from date of publication in Official Journal of the EU) 13 Q Publication of UCITS V expected in Official Journal of the EU During 2014 – ESMA to develop UCITS V technical standards and guidelines

14 UCITS depositary function: –depositary duties –delegation –eligibility criteria –liability regime –redress Remuneration: –policies consistent with sound management of UCITS scheme and comply with minimum remuneration principles –remuneration disclosures in UCITS scheme’s prospectus, annual report and KIID Sanctions: –minimum administrative sanctions and measures –minimum list of sanctioning criteria –competent authorities and UCITS managers to establish whistle-blowing mechanisms –access to telephone and data records The Madoff fraud has revealed that the requirements of the UCITS Directive have been transposed in very diverging ways creating an unlevel playing field in the protection of retail consumers. Charlie McCreevy, Commissioner for Internal Market and Services, 2009 UCITS V: what’s new? 14

15 UCITS V: what’s next? 15 Depositaries: –Commission invited to analyse in which situations the failure of a UCITS depositary or a sub-custodian could lead to losses to UCITS unit holders which are non-recoverable to ensure high level investor protection and submit findings to EP and Council Remuneration: –ESMA to issue remuneration guidelines concerning the size of the management company and the UCITS schemes managed, their internal organisation and nature, the scope and the complexity of their activities and guidance on how remuneration principles are to be applied where employees or other categories of personnel perform services subject to different sectoral remuneration principles Sanctions: –All publicly disclosed sanctions will be reported to ESMA, which will publish an annual report on all sanctions imposed UK implementation: –FCA Business Plan 2014/2015 indicates that UCITS V transposition will take place during 2015

16 UCITS V: comparison with AIFMD Depositaries: –Eligibility – UCITS depositaries restricted to EU authorised credit institutions and MiFID investment firms that provide safe keeping and administration of financial instruments –Liability – UCITS depositaries may be strictly liable for loss of financial instruments, even when custody has been properly delegated to a third party – no option to transfer liability to sub-custodians –Effect on industry – increased costs borne by UCITS and their investors. May force smaller depositaries out of the market, resulting in market domination by a few global depositaries Remuneration: –ESMA guidelines to align UCITS V remuneration regime with AIFMD to furthest extent possible Sanctions: –UCITS V and AIFMD sanctions powers are similar in purpose 16

17 UCITS VI 26 July 2012 – Commission published a consultation paper seeking views on the UCITS regime, including on: –eligible assets and use of derivatives –efficient portfolio management –OTC derivatives –extraordinary liquidity management rules –depositary passport –money-market funds –long-term investments –improvements to UCITS IV September 2013 – Commission’s communication on shadow banking referenced UCITS VI and proposed a global assessment of the framework in which certain funds can operate Unclear when UCITS VI legislative proposal will be published (references removed from Commission’s 2013 legislative programme in November 2013) 17

18 MiFID II and MiFIR

19 MiFID II and MiFIR: timing November 2012: Note on progress of trialogue negotiations 13 December 2012: Council progress report on MiFID II 16 March 2012: Draft report from Committee on Economic and Monetary Affairs (ECON) 20 June 2012: First Council compromise proposals published 27 September and 5 October 2012: ECON unanimously adopts reports on MiFID II and MiFIR respectively October 2012: Parliament votes on amendments to draft legislation but then refers matter back to ECON for further consideration June 2013: General approach documents published by the Council 2 July: 24 months after entry into force: date of transposition and publication by Member States of legislation to implement MiFID II and Level 2 measures 15 April: MiFID II & MiFIR formally adopted by the Parliament 12 June: MiFID II & MiFIR published; enter into force after 20 days (2 July) 14 January: Parliament and Council reach political agreement on text 13 May: MiFID II & MiFIR formally adopted by the Council 22 May: ESMA publishes Level 2 Discussion Paper & Consultation Paper By 2 January: 6 months after MiFID II and MiFIR enter into force, ESMA provides technical advice to the Commission on Level 2 measures By 2 July: 12 months after entry into force – preparation, adoption of delegated acts & objection period for Parliament & Council begins By 2 December: objection period for Parliament & Council on delegated acts ends 2 January: 30 months after entry into force: date of application of MiFID II, MiFIR and Level 2 measures 30 month time frame 7-8 July: ESMA open hearing in Paris; 1 August is the deadline for comments on ESMA Discussion Paper and Consultation Paper Q1: ESMA Consultation Paper on draft Regulatory Technical Standards (follow up to May Discussion Paper)

20 A recap of the key sources 20 MiFID II (Directive 2014/65/EU) and MiFIR (Regulation no. 600/2014) were published in the Official Journal on 12 June 2014 The European Parliament and Council have delegated to the Commission the power to adopt delegated acts which supplement the high-level requirements of MiFID II/MiFIR ESMA also has a significant role in the Level 2 process by virtue of: –its mandates, in MiFID II/MiFIR, to prepare Regulatory Technical Standards (RTS) and Implementing Technical Standards (ITS) in a number of areas, and –its mandate from the Commission to provide technical advice to assist the Commission in its drafting of delegated acts Timeframes for ESMA deliverables: –ESMA must provide technical advice on Level 2 within 6 months of MiFID II/MiFIR entering into force: ESMA CP published on 22 May 2014 –RTS and ITS are due within 12 and 18 months of MiFID II/MiFIR entering into force, respectively: ESMA DP published on 22 May 2014, and seeks stakeholders’ views to inform a further CP which will include draft technical standards –Responses to both papers are due by 1 August 2014 –Open hearings in Paris on 7 and 8 July

21 MiFID II and MiFIR: initiating MiFID projects Macro theme 1: Strategic implications – group reorganisation necessary due to changes in exemptions and third country requirements? Macro theme 2: Conduct of business – many small amendments which add up to significant changes including amendments to terms of business Macro theme 3: Dealing effectively with the new markets requirements – OTFs, algorithmic trading, position limits, increased transparency etc Macro theme 4: Creating a project team – we are now moving onto detailed Level 2 measures shortly and the key question is how you keep track of the mass of paper 21

22 Key themes: conduct of business and investor protection

23 Key themes: fees, commissions and non-monetary benefits (1) 23 Services covered: –Investment advice on an independent basis –Portfolio management Starting point – Article 24 and Recital 52: –Firms ‘shall not accept and retain’ commissions or monetary or non-monetary benefits paid or provided by any third party of any person acting on behalf of a third party –All fees, commissions and any monetary benefits paid or provided by a third party must be returned in full to the client –Firm cannot offset any third-party payments from the fees due by the client –Client should be accurately and, where relevant, periodically, informed about all fees, commissions and benefits the firm has received in connection with the investment service provided –Firms providing independent advice or portfolio management should set up a policy to ensure that third party payments received are allocated and transferred to clients But: –Minor non-monetary benefits are allowed subject to certain conditions including that they do not, or are not likely to, impair the firm to act in the client’s best interests

24 Key themes: fees, commissions and non-monetary benefits (2) The requirement: –When providing investment advice on an independent basis and portfolio management, fees, commissions or non-monetary benefits paid or provided by a person on behalf of the client are allowed BUT only as far as the person is aware that such payments have been made on his behalf and that the amount and frequency of any payment is agreed between the client and the investment firm and not determined by a third party Cases which would satisfy the caveat: –Where a client pays a firm’s invoice directly or it is paid by an independent third party who has no connection with the investment firm regarding the investment service provided to the client and is acting only on the instructions of the client –Where the client negotiates a fee for a service provided by an investment firm and pays that fee To further protect consumers: –Investment firm that provides investment services to clients shall ensure that it does not remunerate or assess the performance of its staff in a way that conflicts with its duty to act in the best interests of its clients (Article 24 (6A)) 24

25 Fees, commissions and non-monetary benefits: key points from ESMA 25 Accept and not retain third party payments: Obligation to return to clients monetary third party payments received asap by transferral to client money account Obligation comprises all sums received in relation to independent advice and portfolio management No specific timeframe mandated, but firms need to establish policies Clients to be informed as part of regular periodic reporting Ban on non-monetary benefits that are not “minor” Minor non-monetary benefits: ESMA recommends an exhaustive list of minor non-monetary benefits: even these only permitted if reasonable, proportionate and unlikely to influence behaviour in ways detrimental to the client List to include: (a) information/documentation relating to FIs and investment services – general/personalised to reflect individual circumstances; (b) participation in conferences etc. on specific FIs/investment services; (c) de minimis hospitality – food/drink during meetings, seminars etc. Other investment services - disclosure requirements: Information on existence, nature and amount of payments to be disclosed upfront – method of calculation permitted where amounts cannot be ascertained But, exact amounts must be provided on an ex- post basis Annual disclosure of actual amount of payments/non-monetary benefits received Each investment firm in distribution chain to comply with obligations vis-à-vis its clients Other investment services - quality enhancement: ESMA recommends a non-exhaustive list of circumstances when quality enhancement test is not met Potential for further ESMA Guidelines and Recommendations in future Firms to be required to keep internal lists of commissions, fees and non-monetary benefits accepted, and to record how they use/intend to use commissions and fees in order to enhance the quality of their services

26 Key theme: best execution –In complying with its existing obligation to monitor the effectiveness of its order execution arrangements and to, where appropriate, correct any deficiencies, a firm will also be required to take into account the information published by trading venues, systematic internalisers and execution venues, under Article 27(2), on the execution quality of transactions and the summary of its top five execution venues for each class of financial instruments under Article 27(4a) (Article 27(5)) New obligations of best execution (Article 27): –Information on a firm’s order execution policy must now explain clearly, in sufficient detail and in a way that can be easily understood by clients, how orders will be executed by the firm for the client (Article 27(4) sub para 2) –A firm must now inform clients where there is a possibility that their order will be executed outside a trading venue and it must obtain prior consent from its client before doing so (Article 27(4) sub para 3). Under MiFID I, firms only have the obligation to do this where there is a possibility that their clients’ orders will be executed outside a regulated market or a multilateral trading facility (MTF) –A firm’s obligation to inform clients of material changes to its order execution arrangements has been limited to an obligation to inform clients with whom the firm has an ‘on-going relationship’ (Article 27(5)) –ESMA regulatory technical standards: – To determine the content and format of this information –Upon request, firms will not only be required to demonstrate to the regulator that they have executed their orders in accordance with their execution policy but also their general compliance with the best execution obligation in Article 27 (Article 27(6)) 26

27 Best execution: key points from ESMA (1) 27 Detail of execution/RTO/placing policies: Customisation, to reflect classes of instrument and type of services Policies to include list of factors used for selection, and their relative importance, and list of entities/venues used Information on execution factors/venues to be consistent with firm’s controls around demonstrating best execution Firms should be able to check the fairness of bespoke OTC product prices Disclosure and consent: Firms to answer reasonable and proportionate information requests from clients clearly and within a reasonable time RTOs/portfolio managers to provide appropriate information on their policies Prior express consent for transmitting/placing orders that may be executed outside an RM, MTF or OTF – but appropriate information must be given (including information on the execution policies of the entities selected to execute) Content of disclosure: Firms executing/transmitting/placing orders for execution outside an RM/MTF/OTF must clearly indicate this in their policies – as well as indicating the resulting counterparty risk consequences Retail clients must be given a summary of the policy, focussed on costs (including venue fees, clearing and settlement fees etc.) and including a link to each venue’s most recently published execution quality data Third party payments: Execution/RTO/placing policies to include clear information about payments received from venues, market makers and entities to which orders are transmitted Where more than one participant in a transaction can be charged, both parties should be aware of the fees paid to the firm (particularly if the fees are different) In addition, the execution policy must indicate this possibility, and specify fees charged for each leg of the transaction – and give a range/maximum where fees differ between clients

28 Best execution: key points from ESMA (2) 28 Transparency of venue selection: Where fees applied differ between execution venues/entities, policies should provide sufficient information to allow clients to understand the relative advantages and disadvantages of different venues/entities Information to be clear, fair and not misleading and sufficient to prevent clients choosing solely on the basis of the firm’s price policy “Material changes”: Firms need to review their policies annually and whenever there is a material change affecting its ability to obtain best execution “Material change” defined as a significant event or internal/external change that could impact parameters of best execution – firms to consider the materiality of changes to the relative importance of execution factors or to venues/entities on which it places significant reliance in meeting the overarching requirement Use of a single venue or entity: Firms can include a single venue or entity if they can show that this still allows them to satisfy the overarching best execution requirement Firms should reasonably expect that the venue/entity will enable it to obtain results that are at least as good as those it could reasonably expect from alternatives – the expectation needs to be supported by data or information published under Article 27, or by other internal analysis Publication of data by firms and trading venues: ESMA to develop RTS on the content, format and periodicity of execution data to be published by trading venues ESMA to develop RTS on the content and format of data to be published by firms

29 Key themes: suitability 29 MiFID I on suitability (MiFID Article 19(4)) When making a personal recommendation or providing portfolio management services to a client or potential client, a firm must obtain the necessary information regarding the client’s knowledge and experience, his financial situation and his investment objectives so as to enable the firm to recommend to the client or potential client the investment services and financial instruments that are suitable for him MiFID II on suitability (Article 25(1) and (5)) A firm must also obtain information about the client’s ability to bear losses and risk tolerance in order to ensure that investment services and financial instruments are recommended accordingly ESMA guidelines:To be developed specifying the criteria for assessing the knowledge and competence of the client

30 Key themes: appropriateness MiFID I on appropriateness (Article 19(5)): –When providing services (other than investment advice or portfolio management), a firm must ask their existing or potential clients to provide information regarding their knowledge and experience relevant to the specific type of service or product provided, to enable it to assess whether it is appropriate for the client MiFID I on execution only services (Article 19(6)): –Firms are not required to ask their clients to provide information or assess appropriateness if the service is ‘execution only’, namely, the service consists of execution and/or the reception and transmission of client orders with or without ancillary services, and provided that certain other conditions are satisfied such as the service relates to particular non-complex financial instruments MiFID II on appropriateness (MiFID II Article 25(3)): –The list of financial instruments that fall within the exempted ‘execution only’ regime, and in relation to which an appropriateness assessment is not required, now covers: –Shares admitted to trading on a regulated market, an equivalent third country market or a MTF, where these are shares in companies (except shares in non-UCITS collective investment undertakings and shares that embed a derivative) –Bonds and other forms of securitised debt admitted to trading on a regulated market, an equivalent third country market or a MTF (except those that embed a derivative or incorporate a structure which makes it difficult for the client to understand the risk involved) * –Money market instruments (except those that embed a derivative or incorporate a structure which makes it difficult for the client to understand the risk involved) –Shares or units in UCITS (except structured UCITS) –Structured deposits (except those that incorporate a structure which makes it difficult for the client to understand the risk of return or the cost of exiting the product before its term)* –Other non-complex financial instruments* * Subject to ESMA guidelines. 30

31 Suitability and appropriateness: key points from ESMA 31 Suitability assessments: ESMA recommendations are presented as clarifications Explicit requirements in MiFID II for investment firms to assess both a client’s ability to bear losses and a client’s risk tolerance Technical advice would supplement current requirements in a number of ways, including: more specific requirements around the reliability of client information obtained (in relation to the ways in which customer information is obtained and subsequently assessed and used by firms) requirements for firms to look through small entities/natural persons representing other natural persons in relation to financial situation and investment objectives (but not knowledge and experience) Suitability reports: MiFID II introduces a specific requirement to supply a written suitability report to retail clients where investment advice is given ESMA recommendations specific required content, which goes further than current UK requirements set out in COBS 9 Appropriateness: Further narrowing of the scope of execution-only business Instruments not specifically identified as being non- complex would need to meet two new criteria (in addition to those currently specified in the MiFID Implementing Directive) to be considered non- complex: they do not incorporate a clause, condition or trigger that could fundamentally alter the nature or risk of the investment or pay-out profile (e.g. conversion rights) they do not include any explicit or implicit exit charges that make the investment illiquid despite technically frequent opportunities to dispose/redeem Explicit clarification that the features listed in Article 38 of the MiFID Implementing Directive (i.e. frequent opportunities to redeem/dispose, availability of information) cannot be used as a means to pull instruments into the non-complex category

32 Key themes: conflicts of interest MiFID II will strengthen current rules by adding a new requirement to “prevent” conflicts In this, as in other areas, MiFID II addresses perceived failures in the implementation of MiFID I Firms should consider: –their record keeping practices and audit trail –conflicts policies: how comprehensive are they, and what level of detail will be expected in the new environment? –periodic reviews of their operations to identify new conflicts that need to be managed or disclosed –gifts and entertainments policies –remuneration structures –information and physical barriers, as well as electronic separation –staff training –restrictions on staff outside interests –independent management structures and reporting lines –personal account dealing policies –conflicts management committees

33 Conflicts: key points from ESMA 33 ESMA is proposing amendments to Article 22 of the MiFID Implementing Directive – intended to clarify/supplement, rather than replace, existing provisions – ESMA sees itself as addressing uncertainty Reiteration that disclosure to clients should be a measure of last resort – firm’s should not over-rely or use disclosure as a self-standing measure The first step for firms should be to consider what additional reasonable measures and arrangements can be put in place – NCAs requesting evidence from firms Disclosure should be used only where the firm’s arrangements are not sufficient to ensure, with reasonable certainty, that damage to client interests is prevented Where disclosure is required, disclosures must clearly state that the firm’s arrangements are not sufficient Disclosure must be made in a durable medium, and include a specific description of the conflict – taking account of the nature of the client NCAs have found disclosures to be too generic and unclear: not just an issue for the retail sphere Disclosures must explain the nature and/or sources of the conflict, the risks to the client and the steps taken to mitigate them – sufficient detail is needed to enable client to make informed investment decisions Proposal to formalise a requirement for periodic (and at least annual) review of conflicts policies ESMA sees this as a concretisation of existing business practice Feedback invited from stakeholders in relation to the continued appropriateness of existing requirements that: specify the situations firms must take into account when identifying conflicts (Article 21 MiFID Implementing Directive) specifically impose requirements relating to the provision of investment research, including additional organisational requirements (Articles 24 and 25 MiFID Implementing Directive)

34 Key impacts: markets issues affecting the buy-side

35 Key theme: algorithmic trading and direct electronic access 35 Algorithmic trading Where a computer automatically determines individual parameters of orders with limited human intervention Must notify relevant competent authorities – they may require information Must have systems and risk controls: –resilience, capacity, limits, continuity –do not contribute to disorderly market –cannot be used contrary to market rules –testing and monitoring of systems Extra requirements where using high frequency techniques Direct electronic access Where member of trading venue permits a person to use its trading code to electronically transmit orders directly to trading venue Requirements on firms providing DEA will mean that firms using DEA will be: –assessed for suitability upfront and periodically –subject to trading and credit thresholds –monitored and subject to risk controls to ensure compliance with MiFID II, market abuse and market rules –required to enter into a written agreement with DEA provider

36 Key theme: post-trade transparency Shares and equity-like instruments Extended to equity-like instruments such as depositary receipts, exchange traded funds and certificates –Investment firms must make public trades through an Approved Publication Arrangement –Applies in respect of instruments traded on a trading venue but if venue can defer, this should also apply to OTC trades –Make public volume, price and time of transaction Other instruments New regime extended to bonds, structured finance products, emissions allowances and derivatives Investment firms must make public transactions traded on a trading venue through an Approved Publication Arrangement Competent authority can permit deferral, or restricted or aggregated disclosure, and can suspend and this also applies to OTC trades Further detail to be set out in RTS 36

37 Key theme: transaction reporting Transaction reporting Financial instruments which are: –admitted to trading or traded on a trading venue –where underlying is a financial instrument traded on a trading venue –where underlying is an index or basket of financial instruments traded on a trading venue even if transaction is not carried out on a trading venue No later than close of following working day Firms that execute: any action that results in a transaction –ESMA proposes broad concept of execution for these purposes Firms that transmit orders must either transmit specified details or report them –ESMA suggests an agreement between transmitter and receiver is needed New fields will include: –Client ID –Trader ID –Algorithm ID Reports can be made by firm or through an ARM or trading venue Transaction reports to a trade repository under EMIR will count provided (i) the trade repository is also an ARM and (ii) the reports contain all information required by MiFIR 37

38 Key theme: mandatory on-platform trading Mandatory on-platform trading for derivatives under MiFIR Derivatives that are subject to clearing obligation in EMIR which: –are traded on at least one RM, MTF, OTF or third country trading venue; and –are considered sufficiently liquid to only trade on these venues The Commission and ESMA will define eligible derivatives through technical standards ESMA also has an own initiative power to identify derivatives that are not CCP cleared or traded on a trading venue for this purpose If within scope then must be traded on an RM, MTF, or equivalent third country venue Same scope as EMIR in relation to counterparties: –trades between financial counterparties and in-scope non-financial counterparties; –trades between an EU captured entity and third country entities that would be subject to EMIR; –trades between third country entities that would be subject to EMIR if they were established in the EU where their transactions could have a direct, substantial and foreseeable effect within EU or where necessary to avoid evasion; and –excludes certain intra-group transactions 38

39 EMIR

40 EMIR Q1: what is the difference between accounts? NB: Each account offered by a CCP is different and exact risk depends on how that CCP operates – need to check CCP disclosure documents and rules – some accounts may involve extra documentation 40 Omnibus segregationIndividual segregation In CCP’s books and records CM’s positions and assets are distinct from client’s positions and assets Positions and assets of each client are distinct from one another as well as from CM’s positions and assets Assets in one account cannot be used to cover losses in another account Any client within account could be taking risk on other clients in same account No fellow client risk Excess marginCM can hold excess margin itselfCM must post any margin in excess of CCP’s requirement to CCP Likelihood of portingLikely to be more difficultShould be more achievable but still many challenges Other risksNeither of these accounts (in their plain form) mitigate other risks such as: transit risk: exposure to CM before it transfers margin to CCP CCP risk: exposure to failure of CCP

41 Omnibus segregation Clearing Member (books + records) CCP (books + records) Client 1 Client 2 Clients 1, Client 2 Client 3 41

42 Individual segregation Client 1 Client 2 Client 3 Clearing Member (books + records) CCP (books + records) Client 1 Client 2 Client 3 Client 1 Client 2 Client 3 42

43 Additional information to be armed with 43 Costs and credit CCPs and CMs must disclose levels of protection and costs - must be on reasonable commercial terms Any collateral on a client account can be ported so CMs may be less ready to pre- fund or provide credit Jurisdictional scope Applies to all CMs of EU CCPs CMs of non-EU CCPs need not comply Consider your client’s obligations – where do they need to clear? It is possible your client may need an LSOC account instead Title transfer v security interest CM and CCP can decide basis on which they want to take collateral – it need not be the same Title transfer (credit risk) –outright transfer of legal and beneficial interest –obligation to return equivalent assets Security interest (no credit risk) –provider retains beneficial ownership –taker can enforce if provider defaults –if provider exercises right of use assets become taker’s assets Client money v non-Client money (cash only) CM must provide client money unless there is a carve out: –banks –title transfer (TTCA) Cash is not held as client money by CCP but client money and TTCA must be kept separate at CM and CCP levels Can have any combination of: –ISA v OSA –Client money v TTCA

44 EMIR Q2: how does porting work? CM CCP Client(s) Back-up CM Positions Assets Collateral Cleared Contracts Client Transactions If CM becomes insolvent and client so requests, transfer client positions and assets to another CM, which has agreed to step in Principal to principal model –for English CCPs and English CMs, can be achieved under default rules –sometimes supported by security interest Part VII Companies Act 1989 should prevent challenge to actions taken by CCPs, pursuant to their default rules: –to settle contracts or transfer them to a Back-up CM –to transfer Client Transactions to that Back- up CM Collateral Cleared Contracts Collateral Client Transactions Security Interest (may be tri-party and may include a security trustee) 44 CCPs must commit to trigger procedure for porting CCPs can actively manage their risks by liquidating positions and assets if this cannot be done within a pre-defined timeframe

45 Consequences of Clearing Member default 2.Return balance to Client Not part of notional pool Notional Client money pool ‘For account of Clients’ Defaulting CM: Defaulting CM: Individual Client account Omnibus Client account (net) CCP: Full sum minus costs Sum rateable to Client money entitlement Client: Client money Not Client money All accounts Omnibus Client account (gross) 1.Port positions and margin 3.Return balance to defaulting Clearing Member 45 In accordance with CCP or CM information minus costs

46 A typical client clearing structure and documentation map CCP CM Security Trustee OTC derivative counterparty/ Executing Broker CCP MembershipAgreement and Rules Client Execution Standard Terms Non-clearing master agreementand collateral document Clearing MasterAgreement Client ClearingAgreement CCP’s Client Clearing Documentation Back-up CM CCP’s Client Clearing Documentation Clearing Master Agreement Client Clearing Agreement Also: CCP and CM Disclosure Documents on protections and pricing for different accounts Security Trust Deed CCP’s Security Interest Documentation CCP’s Membership Agreement + Rules CCP’s Client Clearing Documentation 46

47 EMIR Q3: what are the new client clearing agreements? ISDA Addendum/ FOA Module - designed as amendment to ISDA Master Agreement/ FOA Terms of Business Document relationship between CM and Client for clearing derivatives on principal to principal CCPs Designed as templates – CMs may adapt Can be used for: –different CCPs and services provided by them –both individual and omnibus Client accounts Client Transaction arises between CM and Client which is identical to transaction between CM and CCP save that: –subject to terms of agreement as supplemented –if CM was buyer in CM/CCP transaction, it is seller in Client Transaction (and vice versa) Client agrees: –CCP’s Mandatory Provisions will prevail if there is any conflict –in Addendum, to be bound by CCP’s Core Provisions (and facilitate CM’s compliance) 47

48 What do the client clearing agreements do? Sit alongside and amend existing client documentation in respect of cleared transactions only Client cannot default CM (any rights are disapplied) Alternatively, under Addendum, client can ask CM to: –transfer Client Transactions and CM/CCP transactions and related collateral to a new CM: –CM is obliged provided no CCP or CM default and any Transfer Conditions are satisfied –in accordance with CCP’s rules Clear an Offsetting Transaction –CM is obliged subject to any Offsetting Conditions –CM must then compress CM/CCP transactions However, if CCP defaults CM, or CCP itself defaults: –Client Transactions are automatically terminated at same time and given same value as CCP determines for CM/CCP transactions –Cleared Set Termination Amount is calculated for each Cleared Transaction Set (defined by reference to Agreed CCP Service) –CM may set off against any amounts owed to client 48

49 EMIR Q4: what will bilateral collateralisation require? Scope of PrincipalProposal Counterparties FCs and NFCs+ Variation margin All counterparties must exchange full amount daily Effective on 1 December 2015 – only applies to new contracts entered into after that date Scope All counterparties must exchange EUR 50m threshold applies to consolidated group Calculated by reference to a model or standardised schedule – models can consider risk within netting sets and asset but must be notified to relevant supervisor Must exchange gross initial margin All margin transfers subject to de minimis margin transfer amount not exceeding EUR 500,000 Timing for initial margin To be phased in between 1 December 2015 and 1 December 2019 depending on aggregate notional amount of group’s non-centrally cleared derivatives entered into with counterparties At end of phase in, firms will only be subject to requirements if they exceed minimum level of non-cleared derivatives – EUR 8 bn gross notional outstanding Eligible collateral Should be highly liquid and, after haircutting, be capable of holding value in financial stress and not be exposed to excessive credit, market or FX risk unless an appropriate haircut Examples include cash, high quality government securities, high quality corporate and covered bonds, equities in major indices and gold Should not correlate with creditworthiness of counterparty or value of portfolio Initial margin Margin requirements may not apply to physically settled FX forwards and physically settled FX swaps Exemptions Intra-group transactions 49

50 ESAs principles for margin requirements Requirements for holding collateral: –margin must be immediately available on posting counterparty’s default –margin arrangements must protect posting entity’s bankruptcy –protection will need to be supported by legal opinions –Variation Margin can be re-hypothecated IM cannot be re-hypothecated, re-pledged nor otherwise re-used –This is a deviation from the BCBS- IOSCO principles that allows re- hypothecation if certain conditions are met. According to ESAs these restrictions appear to be limited of use within EU market, and ruling out this possibility will simplify the overall framework 50

51 Client assets

52 Changes to client assets regime From 1 July 2014 Clarifying the application provisions Removing auditor’s confirmation for alternative reconciliation Changes to right to use arrangements Changes to money ceasing to be client money Amending rules applying to trustee firms Prohibiting placement of client money in 30+ day unbreakable term deposits Clarifications on payment of interest Changes to client money held by third parties A revised definition of the ‘standard method of internal client money reconciliation’ Clarification of CFTC Part 30 Exemption Order Clarifications to client money distribution rules Introducing multiple client money pools Alternative approach/non-standard reconciliation method –but firms using these as of 30 November 2014 can continue until 1 June 2015 From 1 December 2014 With transitional until 1 June 2015 for arrangements in place as at 30 November 2014: –written custody agreements –acknowledgement letters –banking exemption –TTCA – written agreements –DvP commercial settlement systems –information to be provided to clients before the provision of investment service With no transitional provisions: –unclaimed custody assets –unclaimed client money –transfer of client business – handling client money 52 From 1 June All firms to comply with all requirements but firms can comply with any requirements ahead of time

53 Clearing member client money sub-pools 1 CMs may offer sub-pools in relation to net omnibus accounts at CCPs authorised or recognised under EMIR Assumes some client money is held at CM level: –if CM defaults, IP would be able to make it available to back-up CM –if not ported, CM must keep separate from main client money pool and return to clients within sub-pool rateably CM must segregate client money, do separate reconciliations and keep separate records Disclosure document to be given to client reminding client that it will have no claim on any other client money pool: –firms may use template provided –client must return signed copy –at least 2 months’ notice of material amendments FCA requires at least 2 months’ notice of any new sub-pool 53

54 Clearing member client money sub-pools 2 54

55 Information for clients 55 Provide COBs information to all client money and custody clients before providing services Reminder of obligation to send a statement at least annually: –but firm must provide statement or copy of information when requested –copy must be provided within 5 business days –any charge must be agreed and correspond to costs –must be clear which assets are protected under CASS Firms holding cash as banker must set out in terms of business any circumstances in which cash will become client money Title transfer arrangements must be in written agreement and set out terms on which ownership returns to client Need client’s written agreement to use of DvP exemption Firms must have written custody agreements, even where only arranging custody Client Assets Disclosure Document is on hold but will be kept under review

56 Client money acknowledgement letters 56 New template letters must be countersigned and returned before client money can be held: –save that firms just need to send them to authorised CCPs –no grace period, regardless of where accounts are held Guidance on use: –only variable text can be amended but not in a way that would change meaning of letter –can choose non-UK governing law and jurisdiction provided letter remains effective –must use reasonable endeavours to ensure signatory is authorised to bind counterparty and need evidence –accounts must be clearly identified in body of letter, including any abbreviations –electronic signatures can be used provided admissible in evidence Review at least annually and replace whenever details change or an error or mis-spelling is discovered All Client accounts to be re-papered

57 Pegasus: Our guide to MiFID II 57

58 AIFMD expert: Our guide to the AIFMD 58

59 Key contacts in London Hannah Meakin Partner, Norton Rose Fulbright LLP Hannah Meakin is a partner in the financial services team in London. She advises clients, mostly on the wholesale side of the industry, on a wide range of regulatory matters. Hannah has particular expertise in investment management, custody, brokerage, clearing and outsourcing related issues. Hannah also has experience of advising clients on perimeter issues, compliance with FCA Rules and implementation of European legislation (the Markets in Financial Instruments Directive and the Capital Requirements Directive). She also advises on regulatory structuring issues involving fund set ups and transfers of business. She has also provided clients with training on various regulatory topics and provided regulatory audits for FCA authorised clients. Imogen Garner Partner, Norton Rose Fulbright LLP Imogen Garner is a partner in the financial services group, where she advises a broad range of clients on the UK and EU financial services regimes. Imogen’s areas of practice include advising on perimeter issues, the regulatory aspects of acquisitions and disposals and clients’ on-going compliance with anti-money laundering and other financial services law and regulation. She also frequently drafts and negotiates investment management and other client agreements. Imogen has particular experience advising asset managers, and has also worked with a number of asset management industry trade bodies. She spent nine months on secondment to the FSA’s (as it then was) General Counsel’s Division, where she advised the FSA’s CIS Policy Team and HM Treasury on the AIFMD. 59

60 Global coverage 60

61

62 Disclaimer Norton Rose Fulbright LLP, Norton Rose Fulbright Australia, Norton Rose Fulbright Canada LLP, Norton Rose Fulbright South Africa (incorporated as Deneys Reitz Inc) and Fulbright & Jaworski LLP, each of which is a separate legal entity, are members (‘the Norton Rose Fulbright members’) of Norton Rose Fulbright Verein, a Swiss Verein. Norton Rose Fulbright Verein helps coordinate the activities of the Norton Rose Fulbright members but does not itself provide legal services to clients. References to ‘Norton Rose Fulbright’, ‘the law firm’, and ‘legal practice’ are to one or more of the Norton Rose Fulbright members or to one of their respective affiliates (together ‘Norton Rose Fulbright entity/entities’). No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any Norton Rose Fulbright entity (whether or not such individual is described as a ‘partner’) accepts or assumes responsibility, or has any liability, to any person in respect of this communication. Any reference to a partner or director is to a member, employee or consultant with equivalent standing and qualifications of the relevant Norton Rose Fulbright entity. The purpose of this communication is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of any Norton Rose Fulbright entity on the points of law discussed. You must take specific legal advice on any particular matter which concerns you. If you require any advice or further information, please speak to your usual contact at Norton Rose Fulbright. 62


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