European Union Legislative and Regulatory Update

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This new educational and informational resource offers users in depth information on the many legislative and regulatory issues facing the hedge fund and managed futures industries in the EU.

Along with current status and scope of the issues, the presentation also lists MFA’s views on the issues and key concerns. This extensive guide covers a number of issues, including:

Financial Transaction Tax
Markets in Financial Instruments Directive (MiFID) and Markets in Financial Instruments Regulation (MiFIR)
Market Abuse Directive (MAD) and Market Abuse Regulation (MAR)
Shadow Banking
Alternative Investment Fund Managers Directive (AIFMD)
European Markets Infrastructure Regulation (EMIR)
European Short Selling Regulation
European Union Member State Short Selling Bans

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European Union Legislative and Regulatory Update

  1. 1. European Union Legislativeand Regulatory UpdateManaged Funds Association, January 2013
  2. 2. 2Overview Index of IssuesBeginning in 2009 with the Alternative Investment Fund LegislativeManagers Directive (AIFMD), financial regulatory reform inthe European Union has become a top priority among I. Financial Transaction Tax (FTT) (p. 3)legislators and regulatory policy makers. II. Markets in Financial Instruments Directive (MiFID) and Markets in Financial Instruments Regulation (MiFIR)In addition to measures that sought to mandate the (pp. 4-6)supervision and oversight of alternative investment III. Market Abuse Directive (MAD) and Market Abusemanagers, the European Union released myriad legislative Regulation (MAR) (p. 7)proposals impacting a wide array of financial servicesareas, notably, OTC derivatives, short selling, systemic IV. Shadow Banking (pp. 8-9)risk, market structure, and market abuse. RegulatoryFor 2013, MFA will continue to be guided by principled V. Alternative Investment Fund Managers Directivesupport for a sensible, thoughtful approach to financial (AIFMD) (pp.10-12)regulatory reform, and will continue to engage with VI. European Markets Infrastructure Regulation (EMIR)European and International policy makers in its (pp. 13-16)educational, advocacy, and outreach efforts as as itdemonstrates this industry’s commitment to meaningful VII. European Short Selling Regulation (SSR) (p. 17)financial regulatory reform. VIII. European Union Member State Short Selling Bans (p.18)
  3. 3. 3I. Financial Transaction Tax (FTT)Over the last four years, many in Europe have come to see the financial sector as a major cause of the financial crisis, while also receiving significantgovernment support. The European Commission is seeking to implement an FTT as a way to ensure that the financial sector makes a fair contribution topublic finances and for the benefit of citizens, enterprises, and Member States.MFA Committees: International Affairs and TaxKey ConcernsEconomic The tax would result in a loss of jobs as the FTT would adversely affect investors and companies by increasing the cost of capital and divertingImpact valuable resources away from reinvestment, ultimately resulting in fewer jobs.Impact on The tax would negatively impact the value of financial assets, to the detriment of all investors, including retail investors and pension plans as theInvestors value of the asset would have to reflect the additional cost imposed by the tax.Revenue MFA believes that a transaction tax is unlikely to raise substantial revenues in that market participants will likely trade financial instruments not subject to the tax or trade in jurisdictions not subject to the tax.Current StatusEuropean Union On September 28, 2011, the European Commission released a proposal on a tax on EU financial transactions, which would levy a 0.1% tax on securities, and a 0.01% tax on bonds and derivatives. In June 2012, after months of discussions, EU Member States agreed to cease formal discussions on an EU-wide FTT, citing lack of widespread support. Interested EU Member States proceeded under an Enhanced Cooperation Agreement (ECA), whereby a group of Member States implement the tax among themselves. Currently 12 EU member States have officially supported a new FTT proposal, with a number of others voicing their support for an FTT. The European Parliament has also provided its support to the Council of the European Union to proceed with an ECA. Discussions are expected to begin in in the first quarter of 2013.France France’s FTT took effect on August 1, 2012. The FTT taxes (i) the sale of equity securities of large, French-based companies at 0.2%, including transactions that occur outside of France (ADR and EDR); (ii) High frequency trading (any two trades occurring under 0.5 seconds). A 0.01% tax will be applied on cancelled or modified orders exceeding 80% of the total trading in one day; and, (iii) Credit Default Swaps at 0.01% .Spain Spain is considering implementing a financial transaction tax, and has prepared draft language on the issue, however discussions have halted. Spain has indicated that it is awaiting results of the French FTT and the outcomes of the Council of the European Union ECA before proceeding.Italy Italy has passed an FTT as part of its 2013 budget law. The tax will The Tax will take effect on March 1, 2013.
  4. 4. 4II. Markets in Financial Instruments Directive (MiFID) and Markets in Financial Instruments Regulation (MiFIR)In 2007, the European Commission implemented MiFID in an attempt to integrate the European Unions financial markets and to increase the amount ofcross border investment orders. In 2011, the European Commission released a new MiFID proposal in order to update laws based on recenttechnological advances in the markets. The new MiFID proposal amends specific requirements regarding, among other topics, high frequency trading,position limits and reporting, data reporting and rules applicable to third-country firms. MiFIR introduces provisions among other topics, ontransparency for trading venues, transparency for investment firms trading OTC, and provision of services without a branch by third country firms.MFA Committees: International Affairs; Derivatives and Swaps; CTA, CPO, and Futures; and Trading and MarketsKey Market Structure ConcernsPosition Limits MFA is concerned that MiFID could require strict position limits on commodity derivatives. MFA is concerned that strict position limits are too rigid, and if set inappropriately, could raise commodity prices and costs for market participants who use commodity markets for risk mitigation.Tradie Reporting MFA is concerned that MiFID could require investment firms that engage in algorithmic trading to report at least annually to their homeRequirements competent authority a detailed description of the nature of their algorithmic trading strategies, trading parameters or limits, key compliance and risk controls in place and details with respect to systems testing. MFA is concerned that such a reporting requirement would impose an obligation on firms to provide competent authorities with intellectual property which is highly sensitive and confidential in nature and which is developed by market participants at great cost.Third Country MFA is concerned that MiFID could require that third country firms register with ESMA in order to provide services to or engage in activitiesIssues with eligible counter parties and professional clients. Further, in order to register with ESMA, the third country firm would have to be from an “equivalent” home regulatory regime, as determined by the EU Commission. MFA is concerned that such “equivalence” approach focuses on strict equivalence rather than outcomes-based equivalence; and that “reciprocal access” will not be effective in practice, because few states outside the EU have the same regulatory framework as the EU.Minimum Resting MFA is concerned that MiFID could require trading venues to have effective arrangements to ensure that orders entered into the systemPeriods remain valid for a minimum of 500 milliseconds and cannot be cancelled or modified during that period. MFA is concerned that such proposal will hurt investors, especially during times of increased or chaotic trading, by leaving orders that become stale exposed to other market participants, such as high frequency traders, to pick off. We are also concerned this would increase bid-ask spreads and raise costs for investors.
  5. 5. 5II. MiFID and MiFIR (con’t)Key OTC Derivatives ConcernsStraight-Through MFA supports the inclusion of language requiring straight-through processing (STP), which would allow parties in a derivative transaction toProcessing (STP) be informed in real time, or as close to real time as technologically practicable, whether or not their trade has been accepted for clearing, thus improving overall market function and reducing potential systemic risk. Inclusion of this language would also ensure consistency with the final rules on real-time acceptance for clearing adopted by the US Commodity Futures Trading Commission. Notably, the European Securities and Markets Authority (ESMA) embraced the concept of STP in the recitals to its Final Report on draft technical standards on EMIR.Access to CCPs MFA seeks to ensure that MiFID is consistent with EMIR, which provides that access to a CCP may only be refused if access would threaten the smooth and orderly functioning of the markets or adversely affect systemic risk. MFA supports the non-discriminatory access requirements to CCPs and trading venues, which will help dismantle existing vertical silos and create effective competition between providers. MFA also recommends the inclusion of “fair and reasonable” access requirements, to make it clear that access fees must be fair and reasonable.Definition of OTC In the text, without an explicit definition, it is possible that the EMIR definition may be applied by analogy, which would be inappropriate as itTrading covers all derivatives not traded on a regulated market. MFA recommends adding a definition that includes bilateral off-exchange trades, including block trades and trades in bespoke derivatives.Block Trade Without an explicit exemption, block trades in derivatives, customarily executed off-market would be subject to the trading obligation andExemption required to be executed on a regulated market, MTF, OTF, or a third country trading venue. In the interest of internal consistency with MiFIR’s transparency waiver for block trades, we believe there should be a waiver from the trading obligation for block trades. This approach would also be consistent with proposals by the U.S. Commodity Futures Trading Commission under the Dodd-Frank Act, in which block trades will be subject to a longer time delay for public reporting and can be executed bilaterally, including by voice, off of swap execution facilities and designated contract markets.OTF Definition The broad definition covers very different trading and execution platforms, and MFA is concerned that such a broad definition could create regulatory uncertainty for trading liquid derivatives.
  6. 6. 6II. MiFID and MiFIR (con’t)Current StatusEuropean Commission On October 20, 2011, the European Commission issued a legislative proposal on MiFID and MiFIR. The Council of the European Union and the European Parliament, each starting with the Commission’s proposal have been negotiating within their institutions and revising the proposal. Once the Council of the European Union and the European Parliament have issued their final drafts on MiFID and MiFIR, the three institutions will begin trialogue discussions to negotiate a final draft.Council of the Members of the Council continue to negotiate on MiFID and MiFIR. However, Members remain divided on a number of outstanding issuesEuropean Union such as position limits, the OTF category, and the standardized clearing obligation for OTC derivatives. Discussions in the Council of the European Union will resume in January 2013 under the Irish Presidency.European Parliament On October 26, 2012, after months of negotiations within the European Parliaments ECON Committee and then further negotiations by the full Parliament, the Parliament adopted its final draft of MiFID and MiFIR. During discussions on MiFID and MiFIR, Parliamentarians stressed the need for more stringent regulations on high frequency trading and position limits.
  7. 7. 7III. Market Abuse Directive (MAD) and Market Abuse Regulation (MAR) Adopted in early 2003, MAD introduced a comprehensive framework to tackle insider dealing and market manipulation practices, jointly referred to as “market abuse.” In 2011, the European Commission released a new proposal of MAD amending specific requirements such as scope and exemption of the scope; definitions of “insider dealing” and “market manipulation;” harmonization of criminal sanctions; and the liability and sanctions for legal persons. The new MAR proposal provides specific requirements regarding regulation of commodity derivatives and the related commodity spot contracts; public disclosure of inside information; and protection and incentive for whistleblowers. MFA Committees: International Affairs and Investment Adviser Key Concerns Algorithmic MFA believes that MAD/MAR should not contain a presumption that “algorithmic trading, including high frequency trading” shall be Trading/HFT considered to be market manipulation, where the trading is carried out “without an intention to trade” but for the purpose of, among other things, disrupting or delaying the functioning of the trading system. Extraterritoriality MFA is concerned by the extraterritorial effect of MAR, specifically the extent to which it applies to all transactions in the covered financial instruments concluded outside the EU. The potential result of this provision is that two non-EU counterparties trading non-EU listed financial instruments could become subject to MAR simply because the relevant shares also happen to be traded on an EU MTF or OTF. Scope of MFA welcomes language requiring ESMA to publish a list of all instruments subject to MAD/MAR. We support a mechanism for operators of Instruments regulated markets MTFs and OTFs to notify the relevant EU competent authorities/ESMA promptly of all financial instruments admitted to Covered trading on these venues to enable ESMA to publish such a list on its website. Inside Information MFA is concerned by the breadth of the definition of inside information. It is important that MAD should impose criminal offenses only for intentional conduct, such as when the relevant person had actual knowledge that the relevant information was inside information, and had obtained such information in the course of his employment, office or profession or as a result of criminal activities. Current Status European In the wake of the LIBOR scandal, the European Commission recently added language making the manipulation of benchmarks an criminal Commission offense. Trialogue with the European Parliament and the Council of the European Union is expected to begin in January 2013. Council of the EU The Council of the EU reached an agreement on MAR on December 5, 2012 and agreement on MAD on December 7, 2012. Trialogue with the European Parliament and the European Commission is expected to begin in January 2013. European In Summer 2012, the European Parliament updated the MAD/MAR dossier to include benchmarks. MEPs approved the dossiers in ECON Parliament on October 8, 2012 and vote in the European Parliaments Plenary session is expected in 2013. Trialogue with the European Commission and Council of the European Union is expected to begin in January 2013.
  8. 8. 8IV. Shadow BankingEuropean policy makers and regulators have expressed concern about the shadow banking system (bank like activities by non-bankentities), and are making attempts to better regulate activities they consider to have potential systemic significance, such as money marketfunds, securities lending, repos, and credit investment funds.MFA Committees: International Affairs and Systemic RiskKey ConcernsExisting Regulation The hedge fund industry is subject to a robust framework of existing regulations and will be subject to further regulation as pending regulatory reforms in the U.S. and the EU continue to be implemented going forward.Size of the Industry The global hedge fund industry is relatively small compared to other financial industries, such as mutual funds and banks, and relatively small compared to financial markets.Diversity and Lack of Hedge funds engage in a wide variety of investment strategies and invest in a variety of asset classes. There is also a wide dispersion ofConcentration assets among different managers, demonstrating that there is not a concentration of risk among relatively few funds or asset managers. This dispersion of assets among a broad group of managers and funds significantly reduces the risk that the failure of any one fund or manager would create systemic risk due to a lack of substitutes.Redemption Hedge funds are subject to investor redemptions; however, because of the redemption restrictions agreed to between funds and theirRights/Liquidity investors, hedge funds are not subject to “runs” the way other financial institutions that take demand deposit accounts are. Across theProtections industry, hedge funds are launched and liquidated regularly and fund liquidations over the past decade, including during the financial crisis, have not created systemic risk or required government intervention.Asset-Liability There are two sources of funds for a hedge fund: its investors and its bank/broker counterparties. The financing from counterparties isMatching/Maturity secured by collateral and limited both by regulation and by the sophisticated counterparties’ risk analysis. The UK’s Financial ServiceTransformation Authority’s reports on hedge funds and systemic risk consistently confirm that hedge fund borrowings are secured by collateral and hedge fund assets can be liquidated more quickly than liabilities are due. Most hedge funds also build strong liquidity protections into their contractual relationships with investors, who are subject to a variety of restrictions. These measures are designed to more closely match the term or expected liquidity of the fund’s assets with the terms of the fund’s financings and equity investors. As such, hedge funds generally do not engage in “maturity transformation,” unlike banks and other financial institutions that have significant differences in the liquidity of their assets and liabilities.Leverage Because hedge funds post collateral and margin in connection with their borrowings, hedge fund leverage has been and continues to be modest compared to other financial institutions. Recently adopted and pending regulatory reforms, such as rules regarding OTC derivatives, will impose additional restraints on the use of leverage by market participants, including hedge funds.
  9. 9. 9IV. Shadow BankingCurrent StatusEuropean Commission The European Commission released a Green Paper on Shadow Banking on March 2012 as well as a consultation on ETF and UCITS issues. The European Commission expects to begin work on shadow banking during the first quarter of 2013.European Parliament The European Released non-legislative Shadow Banking Report on August 24, calling for the creation of EU central database on Euro repo transactions, and legislative proposals on aspects of Shadow Banking by the beginning of 2013. The European Parliament approved its report on November 20, 2012.European Securities and ESMA has been supportive of regulation of the shadow banking industry, however, ESMA also notes that is important to consider thatMarkets Authority any new measures introduced should complement those already in place and, more generally, be targeted at those entities or activities(ESMA) for which the regulatory framework may currently be less comprehensive.Financial Stability Board The FSB released its shadow banking work stream consultations on November 18, 2012 and comments are due by January 14, 2013.(FSB)
  10. 10. 10V. Alternative Investment Fund Managers Directive (AIFMD)In April 2009, the European Commission released a proposal to create a regulatory and supervisory framework for Alternative Investment Fund Managers(AIFMD). The AIFMD was to provide harmonized regulatory standards for all AIFM within the scope and increase transparency of AIFM activities and theirfunds.MFA Committees: International Affairs and Investment AdviserKey ConcernsReporting MFA remains concerned about differences in the reporting form under the AIFMD and Forms PF and CPO-PQR. We encourage regulators to continue working to harmonize reporting obligations, to the greatest extent possible. Greater harmonization not only reduces unnecessary burdens on the industry, it increases the ability of regulators to compare information collected in different jurisdictions.Appointment of MFA is concerned that the European Commission’s draft will preclude many typical over-the-counter (“OTC”) transactions that AIFs enter intoCounterparties because these transactions often are with entities that are not directly subject to supervision, but are affiliated with supervised entities (e.g., an affiliate of a regulated prime broker). As such, we believe that the text should permit an AIFM or AIF to enter into a transaction with a counterparty that is an affiliate of a regulated prime broker if the transaction is entered into in connection with a contract with the regulated entity (e.g., the prime brokerage agreement or ISDA agreement entered into with the regulated prime broker). In the alternative, the text could be amended to permit an AIFM or AIF to enter into a transaction with the affiliates of a regulated prime broker, even if the affiliate is not directly subject to supervision (or clarifying language that an affiliate of a regulated prime broker will be deemed to be an entity subject to supervision for purposes of the AIFMD).Remuneration ESMA recently proposed guidelines to implement the remuneration provisions in the AIFMD. MFA is concerned about applying remuneration principles originally intended for banks and other large financial institutions to hedge fund managers, but we recognize that the AIFMD has taken that approach. In that light, we believe it is important for the European Securities and Markets Authority (ESMA) to provide Member States with flexibility to apply the principle of proportionality when applying the guidelines to fund managers. Proportionality in application is important to avoid unintended consequences, such as: conflicts in law across jurisdictions; creating tax liabilities for employees beyond cash remuneration amounts actually paid in a given year; and misaligning incentives between fund manager employees and fund investors.Depositaries – The text includes assets held in custody as being within the scope of custody assets for purposes of the depositary requirements, despite ESMAcustody assets having recommended that such assets should be excluded from the scope of custody assets. This raises particular operational (as well as depositary liability) concerns, as the custodian for collateral would have to become a sub-delegate of the depositary. We believe the European Commission should follow ESMA’s recommendation and exclude such assets from the scope of custody assets.Proportionality MFA notes and appreciates that the European Commission’s latest draft has incorporated the principle of proportionality with respect to some key provisions, such as risk management, consistent with ESMA’s recommendations. There remain key areas in the European Commission’s latest draft where the principle of proportionality has been excluded and we encourage the Commission to broadly include the principle of proportionality.
  11. 11. 11V. AIFMD (con’t)Key ConcernsCalculation of MFA remains concerned with the European Commission’s proposal that three times a fund’s net asset value is the simple threshold for whetherLeverage an AIF uses leverage on a substantial basis, particularly to the extent this approach might be used as precedent in other directives or regulations for purposes other than triggering a reporting requirement. We believe that a one-size-fits all threshold for AIFs does not provide an accurate measurement by which to compare the use of leverage by AIFs across the financial system. Whether leverage is being employed on a substantial basis depends on a number of factors, including the type of AIF, the nature of the assets, and the investment strategy being followed. To the extent the Commission’s proposed approach is intended to ensure reporting by AIFs, we believe the European Commission should consider alternative approaches to ensure appropriate reporting, particularly given the possibility that the threshold established in the AIFMD could be misapplied in other contexts. We believe the European Commission should adopt a more flexible approach that still ensures appropriate reporting by AIFMs; however, to the extent the European Commission maintains a simplified, bright line approach, it should make clear in the adopting regulations that this threshold is only for reporting purposes in the AIFMD and should not be viewed as establishing a threshold for determining whether is used on a substantial basis for other regulatory purposes. MFA appreciates the language in the recitals of the European Commission’s recent draft, which would permit the Commission to adopt further delegated acts allowing AIFMs to use an additional and optional method for the calculation of leverage, such as the Advanced Method. While we understand the desire to use the Gross and Commitment Methods for consistency, we believe a balanced approach that includes the Advanced Method as an additional reporting method will provide more accurate reporting of leverage in addition to the harmonized reports. We believe the European Commission should adopt a delegated act and permit the use of the Advanced Method as an additional method of calculating leverage.
  12. 12. 12V. AIFMD (con’t)Current StatusEuropean The final agreement on the Level I Directive was achieved in November 2010, and the European Commission published the final text on July 1,Commission 2011. The European Commission released its Level II delegated acts on December 19, 2012. EU Member States must transcribe the AIFMD into their respective national laws by July 22, 2013.European On November 16, 2011, ESMA published its technical advice to the European Commission on possible measures of the Alternative InvestmentSecurities and Fund Managers Directive.MarketsAuthority On June 28, 2012, ESMA issued a consultation paper on recommendations to implement the remuneration provisions in the AIFMD. On December 19, ESMA released two consultations on the AIFMD. The first helps to clarify what entities fall under the remit of the AIFMD, thereby providing for consistent application of the provisions throughout the European Union. The second aims at ensuring the uniform application of the AIFMD across the European Union. Responses to both are due by February 1, 2013.
  13. 13. 13VI. European Markets Infrastructure Regulation (EMIR)In response to the 2008 financial crisis, in September 2009, G20 leaders agreed to implement reforms necessary to reduce risk and increase transparency inthe over-the-counter (OTC) derivatives markets. To comply with its G20 commitment, in September 2010, the European Commission issued proposed EMIRlegislative text related to the regulation of OTC derivatives, central counterparties (CCPs) and trade repositories. The final EMIR text sets forth requirementsrelated to, among other things, reporting of derivatives contracts, central clearing of eligible OTC derivatives, governance of CCPs and trade repositories,segregation of client collateral, and risk mitigation techniques for non-cleared derivatives contracts.MFA Committees: International Affairs and Derivatives and SwapsKey ConcernsStraight-Through MFA supports the inclusion of language requiring straight-through processing (STP), which would allow parties in a derivative transaction toProcessing be informed in real time, or as close to real time as technologically practicable, whether or not their trade has been accepted for clearing, thus improving overall market function and reducing potential systemic risk. Inclusion of this language would also ensure consistency with the final rules on real-time acceptance for clearing adopted by the US Commodity Futures Trading Commission. Notably, the European Securities and Markets Authority (ESMA) embraced the concept of STP in the recitals to its Final Report on draft technical standards on EMIR.CCP Governance MFA recommended that European regulators: (1) mandate that, where a CCP committee makes a decision, consistent with general corporate governance principals, a CCP’s Board has the ability to review and overturn such decision; and (2) make it explicitly clear that all members of CCP governing bodies have fiduciary duties to the CCP, which would reinforce the alignment of interests between governing body members and the CCP.Portability MFA urged European regulators ESMA to draft technical standards to make clear that ceding clearing members must affect such transfers: (1) as promptly as technologically feasible; and (2) without imposition of fees or other conditions (e.g., additional documentation requirements) that could act as an unwarranted barrier or deterrent to portability.Segregation of EMIR provides clients the option between omnibus segregation and individual segregation for cleared swaps. MFA wanted greater detailCollateral about the legal and operational characteristics of these two models.Portfolio Margining MFA believes that explicitly allowing legally enforceable netting of initial and variation margin will enhance incentives to offset risk andand Netting centrally clear derivatives transactions generally, as well as reduce borrowing costs by maximizing capital efficiencies. As a result, we think it important for the European Supervisory Authorities (ESAs) technical standards to permit netting arrangements that allow parties to net initial and variation margin amounts across a broad range of exposures and assets. Such netting will reduce aggregate counterparty credit risk, lower trading costs, allow for efficient use of capital, provide better transparency as to counterparty risk and reduce complexity and settlement risk. Without permitting legally enforceable netting arrangements, liquidity will drain from the derivatives market as participants seek other execution strategies to prevent over-collateralization.
  14. 14. 14VI. EMIR (con’t)Key ConcernsContracts having a To avoid uncertainty by market participants, MFA encourages ESMA to draft technical standards that appropriately set out the jurisdictionalDirect, Substantial and scope of the mandate and set out clear, comprehensive and precise criteria about when it will consider a contract to have a “direct,Foreseeable Effect substantial and foreseeable effect within the European Union (EU)” as well as where it is necessary or appropriate to apply the clearingwithin the EU obligation to contracts between third country counterparties in order to prevent the evasion of EMIR. In particular, MFA would appreciate ESMA providing guidance considering each of the following: fund domicile, manager domicile, reference entity domicile, market location, reference security, underlying instrument and counterparty domicile. For example, ESMA should make it explicitly clear that transactions between two third country entities are not within the scope of EMIR simply because there is an EU reference security or other underlying instrument.Exchange of Initial Where ESMA’s technical standards provide an appropriate level of segregation and protection, MFA believes that the posting of IM by allMargin for Non- parties may be too costly to implement without commensurate benefit. Instead, if for clients initial margin (IM) there is appropriateCleared Trades segregation, MFA supports the collection of IM by only prudentially regulated financial counterparties (PRFCs) coupled with a threshold below which the PRFCs would not have to collect IM. However, where there is not appropriate segregation, then MFA submits that the technical standards must require posting of IM by all parties and permit legally enforceable netting arrangements so that each party can adequately manage its counterparty credit risk.Daily Exchange of MFA strongly supports measures that require daily, bilateral exchange of variation margin (VM) because such exchange is crucial to theVariation Margin for proper functioning of the derivative markets. In particular, the daily, bilateral exchange of VM: (i) is current market “best practice” forNon-Cleared Trades collateral management; (ii) reduces counterparty and systemic risk by preventing either party from accumulating substantial unsecured exposures; (iii) increases market transparency; and (iv) facilitates central clearing by creating symmetry between the margin posting requirements for cleared and non-cleared derivatives. Therefore, MFA believes that the ESAs should impose such a mandate, and to the extent the ESAs determine to provide any exceptions to this requirement, the ESAs should draw such exceptions narrowly.
  15. 15. 15VI. EMIR (con’t)Key ConcernsCalculation of Margin MFA believes that it is important that the ESAs’ technical standards promote margin practices that are fair and understood by all marketRequirements for Non- participants. In particular, margin methodologies must be transparent and replicable in a manner that allows both parties to determineCleared Trades independently the applicable margin because such transparency and replicability is fundamental to conducting effective capital planning. Thus, MFA supports the flexibility envisaged by the ESAs in both providing a standardized approach and allowing the use of internal models in appropriate circumstances. The parties should negotiate the selection of a calculation tool that is best suited to them, and having multiple options from which to choose will aid that process.Transparency into CCP MFA wants European regulators to require public disclosure of, and access to, CCP committee charters, procedural rules, governing bodiesGovernance and minutes (to the extent not prejudicial to its business secrets), information on CCPs’ designs and operations and information on the rightsOperations and obligations of clearing members and clients.Market Transparency MFA recommends that European regulators require trading venues to publish free of charge daily aggregate weighted average and end-of-and Data Availability day price by instrument as well as end-of-day settlement prices, volumes and open positions. However, because it is critical that publication be on an anonymous basis, MFA also strongly recommended that regulators work to protect the confidentiality of counterparty identities by prohibiting trade repositories from publicly disseminating counterparty identification information.
  16. 16. 16VI. EMIR (con’t)Current StatusEuropean Commission The EMIR, in line with G20 commitments, seeks to regulate OTC derivatives CCPs, and trade repositories. After months of discussions, the European Parliament and Council of the European Union agreed to a final text, which was published in the Official Journal of the European Union on July 27, 2012 and took effect on August 16, 2012. In the final EMIR text, the European Commission required certain specified European regulatory authorities to draft technical standards to implement EMIR as discussed below. The European Commission received ESMA’s final draft technical standards and delegated acts on September 27, 2012, and on December 19, 2012, the European Commission approved those technical standards without modification.European Securities ESMA was tasked with developing technical standards on regulation of OTC derivatives, CCPs and trade repositories to implement EMIR.and Markets Authority On February 16, 2012, ESMA released a discussion paper on this topic. On March 6, 2012, ESMA held an open hearing in Paris to receive public input on the questions in the discussion paper. As a follow-up, on June 25, 2012, ESMA released a consultation paper setting forth its proposed technical standards and on July 12, 2012 hosted an open hearing in Paris to receive further public feedback. ESMA released its final draft technical standards to the European Commission on September 27, 2012. Although in the February discussion paper ESMA sought guidance on the issue of which contracts have a “direct, substantial and foreseeable effect within the EU,” ESMA ultimately removed these technical standards from its final submission to the European Commission. Instead, ESMA will address this matter, which will be the equivalent of the CFTC’s proposed interpretive guidance on cross- border issues. In addition, on December 20, 2012, ESMA published a consultation paper on guidelines regarding the assessment of interoperability arrangements for CCPs, which clarifies the obligations for national regulators on how to assess existing or new interoperability arrangements between CCPs.European Supervisory The ESAs, which includes ESMA, the European Banking Authority and the European Insurance and Occupational Pension Authority areAuthorities jointly working on technical standards related to risk mitigation techniques for non-cleared derivatives. On March 6, 2012, the ESAs issued a joint discussion paper, which sets forth various options for proposed technical standards related to capital and margin requirements for non-cleared derivatives. The ESAs are expected to issue a consultation paper in the first quarter of 2013 setting forth the specific proposed technical standards on risk mitigation techniques based on the public comments they received on the March discussion paper and the feedback on the BASEL- IOSCO consultative document.
  17. 17. 17VII. European Short Selling Regulation (SSR)In September 2010, the European Commission released a proposal for a new framework to increase transparency and ensure coordination for short sellingand credit default swaps at an EU level. The new framework will place certain restrictions on short selling, and also require market participants to discloseshort positions over a certain threshold.MFA Committees: International Affairs and Trading and MarketsKey ConcernsRestrictions on The final regulation and implementing measures set out a list of agreements, arrangements, and measures that are designed to ensure thatUncovered Short Sales a share or sovereign debt will be available for settlement after a short sale. MFA remains concerned that restrictions that go beyond reasonable locate requirements could result in significant costs for investors.View of Hedging Using Ultimately, the final regulation states that a person may enter into an EU sovereign CDS transaction only if that transaction does not lead toSovereign CDS an uncovered position in a credit default swap. MFA maintains its view that an overly restrictive approach to the use of sovereign CDS for hedging will (i.) Make European companies and sovereigns less attractive to investors, thus increasing funding costs for European companies and sovereigns (ii.) Impair the ability of EU pension funds and insurance companies to hedge their mark to market exposure to which their portfolios are exposed through holdings in European companies and sovereigns (iii.) Result in an increase in EU sovereign debt yields and thus have a negative impact on EU sovereign deficit fundingCross-Border use of The final regulation generally precludes the cross-border use of sovereign CDS for hedging, and provides only a few narrow exceptions toSovereign CDS this rule. MFA notes that restricting the cross-border use of sovereign CDS will limit the ability of investors to use CDS for hedging. Investors often use sovereign CDS to hedge exposures to other EU countries, and the regulation should permit such hedging.Correlation Tests for The final regulation sets out both a quantitative and a qualitative test for an investor to determine whether sovereign CDS is sufficientlySovereign CDS correlated to other assets. MFA recommends a lower quantitative threshold and more flexibility in determining correlation.Public Disclosure The final regulation requires investors to report to regulators net short positions in shares and sovereign debt above a certain threshold and to publically disclose net short positions in shares above a higher threshold. MFA advocated for private reporting of short positions to regulators, and if necessary public disclosure of aggregated positions.Current StatusEuropean Commission In March 2012, after months of negotiations, the European Parliament and the Council of the European Union agreed to a final text regarding the European Short Selling Regulation, which places restrictions on short selling and certain aspects of credit default swaps (CDS). The European Commission released its final delegated acts on October 9, 2012. The regulation went into effect on November 1, 2012. The European Commission is expected to release a review of the regulation by June 30, 2013.
  18. 18. 18VIII. European Union Member State Short Selling BansSince 2008, citing volatile market conditions, certain European Union Member States have enacted emergency bans on the short selling of financial stocks.MFA Committees: International Affairs and Trading and MarketsKey ConcernsInvestor Restrictions on short selling further deteriorate investor confidence and increase volatility; impair the ability of investors to manage risk; freeze theConfidence ability of financial institutions to raise capital through convertible bond and convertible preferred security issuances by preventing investors to purchase the convertible products and hedge the risk with offsetting short sales. Finally, the absence of a consultation period undermines investor confidence and creates market uncertainty with respect to interpretive guidance and compliance efforts.Current StatusSpain Despite the implementation of the European short selling regulation, Spain’s market regulator, CNMV, extended an existing short selling ban until January 31, 2013 citing exceptional circumstances as the basis for the extension. The European Securities and Markets Authority (ESMA) issued an opinion on the measures adopted by CNMV, finding them appropriate and proportional to address the threats persisting in Spain.Greece Despite the implementation of the European short selling regulation, Greece’s market regulator, HCMC, extended an existing short selling ban until January 31, 2013 citing exceptional circumstances as the basis for the extension. ESMA issued an opinion on the measures adopted by HCMC, finding them appropriate and proportional to address the threats persisting in Greece.

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