Shearman & Sterling LLP | FinReg | UK Financial Policy Committee Highlights Risks of Open-Ended Funds and Global Stablecoins
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  • UK Financial Policy Committee Highlights Risks of Open-Ended Funds and Global Stablecoins

    The Financial Policy Committee of the Bank of England has published its latest financial stability report. The report sets out the FPC's view of the resilience of the U.K. financial system and the main risks to the U.K.'s financial stability as well as the work being carried out to address those risks. The FPC states that the 2019 annual cyclical scenario stress test indicates that the U.K. banking system would be resilient to deep simultaneous U.K. and global recessions. Furthermore, the U.K. financial system is resilient to and prepared for any disruptions that may arise from a disorderly Brexit.

    Following a review with the Prudential Regulation Committee and the BoE of the structure and balance of capital requirements:
    • The U.K. countercyclical capital buffer rate will be raised from 1% to 2%, taking effect in one year;
    • The Prudential Regulation Authority will consult on proposals to reduce minimum capital requirements without affecting the overall loss-absorbing capacity in the banking system; and
    • The BoE is clarifying that in a bank resolution it expects all debt that is bailed in to be written down and converted to the highest quality of capital.

    The FPC has reviewed the initial findings of the joint review by the Financial Conduct Authority and the BoE on risks relating to open-ended funds and agrees that the mismatch between redemption terms and the liquidity of some funds' assets gives an advantage to investors redeeming before others, and that this has the potential to create systemic risk. The FPC considers that:
    • in line with the U.S. Securities and Exchange Commission's recently adopted measures, liquidity of funds' assets should be assessed as either the price discount required for a quick sale of a representative sample of those assets or the time period needed for a sale to avoid a material price discount;
    • redeeming investors should receive a price for their units in the fund that reflects the discount needed to sell the required portion of a fund's assets in the specified redemption notice period; and
    • redemption notice periods should indicate the time needed to sell the required portion of a fund's assets without discounts beyond those caught in the price received by redeeming investors.

    Following publication of the FPC's financial stability report, the BoE and FCA issued a joint press release stating that they would consider how these principles can be implemented and that the FCA will consider the final principles (to be released in 2020) in developing changes to its rules.

    The FPC has also adopted an approach to inform HM Treasury's review of how innovations in payment systems can support financial stability. The principles are:
    • regulation of payments should reflect the financial stability risk rather than the legal form of payments activities and firms that are systemically important should be subject to regulatory requirements that reflect the risk that they present;
    • the interconnectedness of payment firms should be considered when considering the systemic importance of a firm, including new unregulated firms;
    • all firms within a chain of payments should provide information to assist in identifying the systemically important firms;
    • payment chains that use stablecoins should be subject to the same standards of regulation to which traditional payment chains are subject and firms that are critical to the functioning of a stablecoin-based payment chain should be appropriately regulated; and
    • where stablecoins are used in systemic payment chains as money-like instruments, they should be subject to standards equivalent to those of commercial bank money in relation to stability of value, robustness of legal claim and the ability to redeem at par in fiat.

    The FPC considers that Libra is an example of a stablecoin proposal that could be systemically important and states that the regulatory framework that would apply to Libra must be clear and in place before Libra is launched.

    Finally, the FPC summarizes the steps being taken by the U.K. regulators and industry to ensure a smooth transition from LIBOR.

    View the FPC's financial stability report.

    View the BoE's report on the effectiveness of the stress-testing frameworks.

    View the joint BoE and FCA press release on rules for open-ended funds.

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