The following posts provide a snapshot of the principal U.S., European and global financial regulatory developments of interest to banks, investment firms, broker-dealers, market infrastructures, asset managers and corporates.
Basel Committee on Banking Supervision Provides Brief Update on Various Workstreams
The Basel Committee on Banking Supervision has published a press release summarizing the outcome of its meeting on September 19-20, 2018. The Committee committed to consider Pillar 1 and Pillar 3 measures to prevent banks adjusting their balance sheets around regulatory reporting dates to manipulate reported leverage ratios. In addition, the Committee intends to further analyze banks' exposures to crypto-assets to reach a conclusion on whether action is needed to address the risks that these assets may present.
The Basel Committee will publish the following before the end of the year:
- an updated 2018 list of global systemically important banks, along with the high-level indicator values of all the banks that are within the G-SIB assessment exercise;
- final revisions to the market risk framework (towards the end of the year);
- a consultation paper (in October 2018) on whether the exposure measure should be revised to alleviate its impact on client clearing, including presenting options for revising this; and
- the revised Principles on Stress Testing (in October 2018).
The Basel Committee also published responses to Frequently Asked Questions on the treatment of settled-to-market derivatives under the Liquidity Coverage Ratio and Net Stable Funding Ratio.
View the press release.
View the FAQs.
EU Disagreement on EU Technical Standards for Reporting of Securities Financing Transactions
The European Securities and Markets Authority has published an Opinion on the European Commission's proposed amendments to the final draft Implementing and Regulatory Technical Standards on reporting under the Securities Financing Transactions Regulation. Various parts of the SFTR came into effect on January 12, 2016. However, the new reporting obligation for SFTs is not yet in force. Securities financing transactions involve the use of securities to borrow cash or other higher investment-grade securities, or vice versa. Such transactions can include repurchase transactions, securities lending and sell/buy backs. The SFTR requires, amongst other things, all securities financing transactions to be reported to EU recognized trade repositories, including details on the composition of collateral, whether collateral is available for reuse or has been reused, the substitution of collateral and any haircuts applied. The reporting obligation will apply to financial and non-financial counterparties, subject to exceptions for central banks and similar bodies.
European Securities and Markets Authority Intends to Extend Product Intervention Measures for Binary Options for a Further Three Months
The European Securities and Markets Authority has announced its intention to adopt a Decision to extend the prohibition on the marketing, distribution and sale of binary options to retail investors for a further three-month period from October 2, 2018. ESMA has previously adopted intervention measures for binary options, with the current Decision set to expire on October 1, 2018.
ESMA has power under the Markets in Financial Instruments Regulation to impose prohibitions or restrictions on certain financial instruments, financial activities or practices. This may be done when, among other conditions, the exercise of ESMA's power addresses a significant investor protection concern in the Union. Product intervention measures imposed by ESMA under MiFIR must be reviewed at appropriate intervals and at least every three months. If a measure is not renewed after three months, it will expire. In reviewing the current Decision, ESMA has agreed to exclude from the scope of product intervention certain types of binary option that are less likely to lead to a significant investor protection concern.
Commodity Futures Trading Commission Proposes Clearing Requirement Exemptions for Certain Financial End Users
The Commodity Futures Trading Commission has proposed exempting certain bank holding companies, savings and loan holding companies and community development financial institutions from swap clearing requirements. The proposed exemptions, issued in response to comments made through the CFTC's Project KISS initiative, codify prior no-action relief provided under CFTC Staff Letters 16-01 and 16-02.
Commodity Futures Trading Commission Finalizes Amendments to Rules Governing Chief Compliance Officer Duties and Annual Reporting Requirements for Certain Registrants
The Commodity Futures Trading Commission has unanimously approved final amendments to clarify and simplify its regulations governing the duties and annual reporting requirements for chief compliance officers at futures commission merchants, swap dealers and major swap participants. The amendments, first proposed in May 2017, are designed to clarify certain requirements (including as to the annual CCO report) as well as harmonize the CFTC's requirements with similar Securities and Exchange Commission rules that will be applicable to security-based swap dealers.
Global Authorities Consult on Governance for OTC Derivatives Data Elements
The Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions have published a consultation paper on governance arrangements for OTC derivatives data elements other than the Unique Transaction Identifier and the Unique Product Identifier. Critical data elements are an important aspect of reporting derivatives transactions to a trade repository. The consultation paper proposes the key criteria for the CDE maintenance and governance, the different areas of CDE governance and governance functions and allocation of the governance functions to different bodies.
Responses to the consultation should be submitted by September 27, 2018 using the dedicated response form, available through the links below.
View the press release.
View the consultation paper.
Financial Stability Board Consults on Implementation of the Legal Entity Identifier
The Financial Stability Board has launched a thematic peer review on implementation of the Legal Entity Identifier and is inviting feedback on implementation of the LEI at the same time. The objective of the LEI system is for unique identifiers to be held by all legal entities participating in financial markets across the globe. It is envisaged that the LEI system will lead to better data aggregation, enhance systemic risk monitoring and reduce costs to market participants.
Using the peer review, the FSB will: (i) consider the approaches and strategies used by FSB members to implement the LEI, including its adoption for regulatory requirements; (ii) assess whether current levels and rates of LEI adoption are sufficient to support the ongoing and anticipated needs of FSB member authorities; (iii) identify the challenges in further advancing the implementation and use of the LEI; and (iv) if appropriate, make recommendations for addressing any challenges.
EU and UK Authorities Clarify Trading Obligation Expectations for Pension Schemes
The European Securities and Markets Authority has published a further statement on the transitional exemption from the clearing obligation for pension scheme arrangements under the European Market Infrastructure Regulation and delegated regulations. Transitional provisions provide for PSAs to be exempt from the clearing obligation until August 16, 2018. There is no provision in EMIR that would allow for a further extension of this exemption period. It is proposed that this exemption will be further extended under the proposal to amend EMIR, known as EMIR Refit. ESMA issued a statement on July 3, 2018 stating that national regulators are expected not to prioritize "their supervisory actions towards entities that are expected to be exempted again in a relatively short period of time and to generally apply their risk-based supervisory powers in their day-to-day enforcement of applicable legislation in a proportionate manner."
This new statement clarifies that ESMA does not expect national regulators to focus on any non-compliance by PSAs with the related trading obligation under the Markets in Financial Instruments Regulation. Financial counterparties that are exempt from the clearing obligation under EMIR are also exempt from the trading obligation under MiFIR. It is likely that the clearing obligation exemption will expire before it is extended under EMIR Refit and therefore the trading obligation exemption would also lapse.
Global Bodies Consult on Incentives to Centrally Clear OTC Derivatives
A consultation paper on incentives to centrally clear OTC derivatives has been jointly published by the Financial Stability Board, the International Organization of Securities Commissions, the Basel Committee on Banking Supervision and the Committee on Payments and Market Infrastructures. The paper is part of the FSB's post-implementation evaluation of the effects of the G20 financial regulatory reforms. The consultation paper sets out the results of an evaluation of the reforms that have been implemented to incentivize central clearing of OTC derivatives, including mandatory clearing requirements, capital, liquidity and margin requirements, as well as the reforms to CCP resilience, recovery and resolution. The evaluation found that:
- the changes observed in OTC derivatives markets are consistent with the G20 Leaders' objective of promoting central clearing as part of mitigating systemic risk and making derivatives markets safer.
- the relevant post-crisis reforms, in particular the capital, margin and clearing reforms, taken together, appear to create an overall incentive, at least for dealers and larger and more active clients, to centrally clear OTC derivatives.
Upcoming Priorities for the Global FX Code
The Global Foreign Exchange Committee has published a paper entitled: "The FX Global Code at One Year: a Look Back and a Look Ahead." The FX Global Code was published by the GFXC in May 2017. It superseded and substantively updated existing guidance for participants in FX markets previously provided by the Non-investment Products (NIPs) Code. The Code comprises a set of global principles of good practice for the FX market, covering a broad range of areas, including ethics, governance, execution, information-sharing, risk management, compliance, trade confirmation and settlement.
The paper discusses the achievements of the GFXC and the way in which the Code has been received by market participants over the past year. These include increased awareness of and commitment to the Code, further integration of the Code into the business practices of FX market participants and evolution of the Code with changes in the FX market, in particular for transparency and disclosure.
The GFXC's upcoming priorities are outlined in the paper. These include:
- continuing the existing GFXC working groups - the disclosures working group and the cover and deal working group; and
- establishing two new GFXC working groups - one on buy-side outreach and the other to further integration of the Code.
View the paper.
UK Conduct Regulator Reminds Firms of Obligations on Selling High-Risk Products to Retail Clients
The U.K. Financial Conduct Authority has issued a statement on selling high-risk speculative investments to retail clients following the European Securities and Markets Authority's product intervention on contracts for difference products.
ESMA issued decisions in March and June 2018 to temporarily prohibit the marketing, distribution or sale of binary options and to impose restrictions on the marketing, distribution or sale of CFDs to retail clients. In the CFD decision, ESMA had clarified that turbo certificates were outside the scope of the CFD restrictions. However, in its recently updated Q&A on its product intervention, ESMA acknowledges that turbo certificates have comparable features to CFDs, such as leverage.
International Swaps and Derivatives Association Publishes ISDA 2018 US Resolution Stay Protocol to Facilitate Compliance with US Stay Regulations
The International Swaps and Derivatives Association has published the ISDA 2018 U.S. Resolution Stay Protocol. The protocol was developed to facilitate compliance with regulations issued by the Federal Reserve, Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency that require global systemically important banking organizations to include contractual stays on early termination rights within in-scope qualified financial contracts, including swaps and repurchase agreements.
Adherence to the protocol will allow covered entities to comply with the U.S. stay regulations by amending in-scope QFCs to ensure that they are consistent with the limits on counterparties' exercise of default rights under Title II of Dodd-Frank and the Federal Deposit Insurance Act. The protocol will also limit counterparties' ability to exercise cross-default rights based on the insolvency or resolution of an affiliate of a covered entity.
ISDA members and non-members may adhere to the protocol beginning from the second half of August 2018. ISDA also announced it would also publish frequently asked questions to provide market participants with additional background information on the protocol and the U.S. stay regulations.
The first compliance date for the U.S. stay regulations is January 1, 2019.
View the protocol.
View ISDA's press release.
View Shearman & Sterling's client alert regarding the U.S. stay regulations.
European Commission Requires Drafting Amendments to Proposed Technical Standards for Reporting of Securities Financing Transactions
The European Commission has published a Communication announcing its intention to adopt, with amendments, the Regulatory Technical Standards and Implementing Technical Standards prepared by the European Securities and Markets Authority under the Securities Financing Transactions Regulation. ESMA submitted final draft RTS and ITS to the Commission in March 2017.
The Commission has amended the draft RTS on the details of Securities Financing Transactions to be reported to Trade Repositories and the draft ITS on the format and frequency of reports on the details of SFTs to TRs. The draft RTS and ITS had contained wording to the effect that ESMA would have the power to endorse global unique trade identifiers for transactions or the global legal identifier system as it applies to the branch of an entity. This wording would have had the effect of delegating regulatory powers on potential future reporting requirements directly to ESMA, which is not possible under the legal framework for the European Supervisory Authorities. The Commission has made amendments to clarify that the Commission, rather than ESMA, has the responsibility to introduce changes to the reporting requirements, on the basis of a proposal by ESMA.
US Federal Reserve Vice Chairman Randal Quarles Discusses the SOFR Reference Rate
U.S. Board of Governors of the Federal Reserve System Vice Chairman for Supervision, Randal Quarles, discussed the evolution of reference rates at the Alternative Reference Rates Committee (ARRC) Roundtable at the Federal Reserve Bank of New York. Vice Chairman Quarles stated his view that certain markets relevant to some LIBOR tenors are relatively illiquid. He contrasted this with the newly established secured overnight financing rate (SOFR). SOFR is the product of a collaborative effort by the Federal Reserve Bank of New York, the Federal Reserve Board and the U.S. Office of Financial Research, and was created in response to the ARRC's interest in establishing a Treasury repo rate benchmark that would span the widest possible scope of the market. Vice Chairman Quarles further noted that the implementation timetable for SOFR is ahead of schedule, that market participants have begun offering clearing of SOFR overnight index and basis swaps, and that futures markets for SOFR have been introduced on the Chicago Mercantile Exchange.
View full text of Vice Chairman Quarles’s remarks.
Financial Stability Board Consults on Initial Evaluation of the Impact of Regulatory Reforms on Infrastructure Finance
The Financial Stability Board is seeking feedback on an initial evaluation of the effects of the post-financial crisis regulatory reforms on infrastructure finance. The initial evaluation focuses on infrastructure finance provided by the financial sector, for which the financial regulatory reforms are of immediate relevance. The FSB has established a framework for assessing whether the reforms are achieving their intended outcomes and whether there are any material unintended consequences to be addressed.
The initial evaluation shows the results of a qualitative and quantitative analysis of the Basel III reforms to regulatory capital and the OTC derivatives reforms. The results of a qualitative analysis of reforms that are at an earlier stage of implementation, such as investment funds rules and accounting standards, are also presented.
Feedback on the initial evaluation is invited by August 22, 2018. The FSB will consider the feedback in finalizing its report to the G20, due to be published towards the end of November 2018.
View the consultation paper.
Bank of England Consults on Term SONIA Reference Rates
The Bank of England's Working Group on Risk-Free Reference Rates has launched a consultation on term reference rates for the Sterling Overnight Index Average.
The Working Group is tasked with facilitating the transition across sterling bond, loan and derivatives markets from the use of sterling LIBOR to the use of SONIA. The Working Group notes that SONIA is an overnight rate, while LIBOR is commonly referenced in longer tenors of three or six months. Some end-users in loan and debt capital markets have reported that term rates are essential for their business needs.
The consultation focuses on how a term SONIA reference rate (TSRR) can be constructed to facilitate sterling LIBOR transition in markets where term rates better suit users' needs. The Working Group seeks feedback on how the development of TSRRs could be catalyzed. The Working Group notes that the International Swaps and Derivatives Association is simultaneously consulting on preventing derivatives market disruption in the event a key IBOR is discontinued and that the Financial Stability Board has also recently stressed the importance to financial stability of transitioning most derivatives to robust overnight risk-free rates.
Comments on the consultation are invited by September 30, 2018. The Working Group anticipates that a number of steps would be required to produce robust and reliable TSRRs by the second half of 2019.
View the consultation paper.
View details of the ISDA consultation on IBOR fallbacks for OTC derivatives contracts.
View details of the Financial Stability Board's position paper.
Financial Stability Board Welcomes ISDA Consultation on Fall Backs Risk-Free Rates for Derivatives
The Financial Stability Board has published a statement welcoming the consultation by the International Swaps and Derivatives Association on fall backs based on overnight risk-free rates for certain derivative contracts. The statement has been issued to provide market participants with the FSB's views ahead of the consultation by ISDA. The FSB's view is that overnight RFRs are more robust than interbank or term rates because they are based on active and liquid underlying markets. Overnight RFRs are considered by the FSB to be a better choice than term rates for markets where participants do not need forward-looking term rates. The FSB stated that for those markets where the IBOR may cease, citing the example of LIBOR, a transition to new reference rates will be crucial. The FSB acknowledges the work to reform some IBORS excluding LIBOR. It is therefore unclear whether the FSB has factored in the recently announced changes to LIBOR methodology in making this assessment and reaching these conclusions.
International Swaps and Derivatives Association Consults on Fall Backs Based on Overnight Risk-Free Rates for Certain Derivatives
The International Swaps and Derivatives Association has launched a consultation in which it proposes to amend its standard documentation to implement fall-backs based on alternative risk-free rates for certain key Interbank Offered Rates - GBP LIBOR, CHF LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR and BBSW. ISDA states that the back-ups will apply if the relevant IBOR is permanently discontinued, based on defined triggers.
ISDA is seeking feedback on the approach to address certain technical issues arising from the necessary adjustments that will apply to the RFRs if the fall backs are triggered.
ISDA intends to consult on the technical issues for these changes for derivatives referencing USD LIBOR, EUR LIBOR and EURIBOR at a later date. It requests preliminary feedback on the technical issues associated with fall-backs for these benchmarks in this consultation.
Responses to the consultation should be submitted by October 12, 2018. ISDA will determine which approach to adopt based on the feedback and will publish the final approach for review and comment before implementing any changes to the ISDA standard documentation.
The FSB issued a statement on the same day welcoming ISDA's consultation and encouraging market participants to respond to the proposals.
View ISDA's consultation.
View details of the FSB's statement.
EU Consultation on Extending the Exemption From the Clearing Obligation for Intragroup Transactions with Third Country Group Entities
The European Securities and Markets Authority has opened a consultation on the exemption from the clearing obligation for intragroup transactions with a third country group entity. There are three Regulatory Technical Standards made under the European Market Infrastructure Regulation that provide for the clearing obligation of interest rate derivatives and credit derivatives - the RTS on the clearing obligation for IRS denominated in G4 currencies, the RTS on the clearing obligation for IRS denominated in certain other currencies and the RTS on the clearing obligation for CDS. Each of the RTS also exempt intragroup derivative transactions with third country group entities that meet certain conditions from the clearing obligation where one of the counterparties is a third-country group entity and there is no relevant equivalence decision. An equivalence decision enables parties subject to both the EU and a third country's clearing obligation to only comply with one jurisdiction's requirements.
Each of the RTS sets a different expiry date for the exemption period. These dates are:
- December 21, 2018 in the RTS on the clearing obligation for IRS denominated in G4 currencies (RTS 2015/2205);
- May 9, 2019 in the RTS on the clearing obligation for CDS (RTS 2015/592); and
- July 9, 2019 in the RTS on the clearing obligation for IRS denominated in certain other currencies (RTS 2016/1178).
ESMA is proposing to extend the exemption period by amending each of the RTS to have one unified expiry date of December 21, 2020.
Comments on the proposals should be provided by August 30, 2018. ESMA will consider the feedback in finalizing the draft amending RTS for submission to the European Commission.
View the consultation paper.
EU and UK Authorities Clarify Clearing Obligation Expectations for Pension Schemes
The European Securities and Markets Authority has published a statement on the transitional exemption from the clearing obligation for pension scheme arrangements under the European Market Infrastructure Regulation and delegated regulations. Transitional provisions provide for PSAs to be exempt from the clearing obligation until August 16, 2018. There is no provision in EMIR that would allow for a further extension of this exemption period. It is proposed that this exemption will be further extended under the proposal to amend EMIR, known as EMIR Refit. The length of the extension is yet to be agreed as part of the EMIR Refit legislative process between the European Parliament (which advocates a two-year extension) and the Council of the European Union (which supports a three-year extension). Parliament is also proposing to backdate the application of the new transitional period to August 16, 2018 if EMIR Refit enters into force after the expiry of the existing exemption so as to prevent a gap between the two exemptions periods, providing legal certainty for PSAs and their counterparties.
US Commodity Futures Trading Commission Approves Proposed Amendments to Self-Regulatory Organization Surveillance Programs for Futures Commission Merchants
The Commodity Futures Trading Commission has proposed to simplify its standards for a self-regulatory organization's financial surveillance program for futures commission merchants. The proposed amendments result from the CFTC's Project KISS initiative to simplify and modernize the Commission's regulations.
Under CFTC Regulation 1.52, a third-party examinations expert is required to evaluate an SRO's FCM supervisory program and the application of the program at least once every three years. The proposed amendments would narrow the scope of this evaluation to only consider whether the SRO's FCM examination standards are consistent with auditing standards issued by the Public Company Accounting Oversight Board. The proposal would also reduce the frequency of reviews by an examination expert, to once every five years or after the issuance of new or amended audit standards by the PCAOB that require material changes to the SRO's FCM examination standards.
Comments on the proposed amendments are due September 4, 2018.
View the CFTC’s press release.
View the proposed amendments.
US Commodity Futures Trading Commission and the Securities and Exchange Commission Approve New Arrangements to Harmonize Title VII Rulemakings
The U.S. Commodity Futures Trading Commission and the Securities and Exchange Commission have approved a new Memorandum of Understanding between the two agencies. The MOU, which updates and enhances an MOU approved by the agencies in 2008, is aimed at fostering cooperation and information sharing in order to harmonize joint rulemakings mandated under Title VII of Dodd-Frank, which governs the regulation of swaps and security-based swaps.
The MOU outlines several measures intended to increase coordination. These include holding inter-agency meetings and consultations to enhance coordination and cooperation, sharing information relating to firms registered with both agencies and specific incidents that are of common regulatory interest to both agencies, and informing the other agency in advance of developments that may impact its regulatory interests.
CFTC Chairman J. Christopher Giancarlo said the MOU will enhance the agencies' "oversight efforts and reduce unnecessary complexity, and lessen costs on both regulators and market participants," and SEC Chairman Jay Clayton added that the agreement will support a "coherent and coordinated approach to regulation."
The MOU will become effective on the date of its signing and will remain effective unless terminated by either agency. Revisions and modifications may be made upon agreement or as required by changes in law.
View the joint press release.
View the MOU.
European Securities and Markets Authority Issues Opinion on CCP Liquidity Risk Assessment
The European Securities and Markets Authority has published an Opinion on the liquidity risk assessment that a CCP must undertake under the European Market Infrastructure Regulation. The Opinion is addressed to national regulators that supervise CCPs.
EMIR requires a CCP to measure its potential liquidity needs on a daily basis and to ensure that it has access at all times to adequate liquidity to perform its services and activities. A CCP must, therefore, ensure it has access to credit lines or other arrangements with liquidity providers in case the financial resources at its disposal are not immediately available. In measuring its liquidity needs, a CCP is required to take into account the liquidity risk generated by the default of at least the two clearing members to which it has its largest exposures (the liquidity risk "Cover-2" test). EMIR and related delegated legislation provide detail on how a CCP should assess the liquidity risk arising from each of its relationships with its clearing members and its liquidity providers.
European Securities and Markets Authority Publishes Annual Report
The European Securities and Markets Authority has published its Annual Report, dated June 15, 2018. The report sets out ESMA's key achievements against its 2017 objectives of promoting supervisory convergence, assessing risks to investors, markets and financial stability, completing a single rulebook for the EU financial markets and directly supervising trade repositories, credit rating agencies and third-country CCPs. The report also discusses ESMA's contributions to the work of the Joint Committee of the European Supervisory Authorities.
The report does not consider the focus areas for ESMA in 2018, which are set out in ESMA's work programes. However, ESMA indicates that in 2018 it will be, among other things: (i) issuing further opinions on pre-transparency waivers under the Markets in Financial Instruments package; (ii) engaging with credit rating agencies and trade repositories on their strategy, governance, operational matters and preparations for Brexit; and (iii) continuing its work to finalize the technical standards and technical advice under the EU Prospectus Regulation.
View ESMA's Annual Report.
EU Report on Penalties Under the European Market Infrastructure Regulation
The European Securities and Markets Authority has published its first annual report on penalties imposed by national regulators for infringement of obligations under the European Market Infrastructure Regulation. The report focuses on supervisory measures and penalties imposed by EU national regulators in relation to the EMIR clearing obligation, the reporting obligation, obligations on non-financial counterparties and the risk mitigation techniques for uncleared derivatives. The obligations on CCPs and Trade Repositories are out of scope of the report.
The report has been provided to the European Commission, the Council of the European Union and the European Parliament. ESMA notes that the report can be used to identify best practices as well as areas which might benefit from increased harmonization.
Commodity Futures Trading Commission Proposes to Maintain $8 Billion Swap Dealer De Minimis Threshold and Approves Proposed Changes to the Volcker Rule
At the Commodity Futures Trading Commission's open meeting on June 4, 2018, the CFTC voted to propose rules that would permanently maintain the swap dealer de minimis registration threshold at $8 billion. The Commission voted 2-1 to issue the proposal, with Chairman J. Christopher Giancarlo and Commissioner Brian Quintenz voting in favor and Commissioner Rostin Behnam dissenting.
Under the proposed rule, firms with less than $8 billion in notional value of OTC derivatives would be exempted from the CFTC's swap dealer registration requirements, as under the current regime. The proposed rule also would exclude swaps of insured depository institutions made in connection with loans from a firm's notional calculation. The proposal seeks comment on a number of other potential exclusions from the de minimis threshold, and Chairman Giancarlo stated that the CFTC is exploring with its counterparts at the Securities and Exchange Commission and prudential regulators further potential exclusions from swap dealer registration.
European Securities and Markets Authority Extends Product Intervention Measures for Contracts for Difference and Binary Options for a Further Three Months
The European Securities and Markets Authority has adopted two Decisions on the provision of Contracts for Difference and binary options to retail investors. The effect of the Decisions is to prohibit the marketing, distribution and sale of binary options to retail investors and to impose a number of restrictions on the marketing, distribution and sale of Contracts for Difference to retail investors. Both CFDs and binary options are considered to have given rise to significant investor protection concerns, due to their complexity, the lack of transparent information at the point of sale, the risk of significant loss for investors and the deployment of aggressive marketing techniques by providers and distributors of the products.
European Securities and Markets Authority Finalizes Guidelines on Anti-Procyclicality Margin Measures for CCPs
The European Securities and Markets Authority has published a Final Report, setting out Guidelines for national regulators of CCPs on the application of rules under the European Market Infrastructure Regulation that require CCPs to adopt anti-procyclicality margin measures.
EMIR requires CCPs to impose, call and collect margins to limit their credit exposures from clearing members. A CCP must also regularly monitor and, if necessary, revise the level of its margins to reflect current market conditions taking into account any potentially procyclical effects of those revisions. Procyclicality of margin is the term used to describe the fact that margin requirements for the same portfolio are higher in times of market stress and lower in calm conditions. Regulatory Technical Standards under EMIR set out requirements for CCPs to use at least one of three options to limit procyclicality to the extent that the financial soundness of the CCP is not negatively affected. This has been controversial, since U.S. regulators impose no such requirements in practice on U.S. CCPs, leading to more expensive margin requirements in Europe. The Guidelines seek to clarify and ensure consistent application of the requirements across the EU.
EU Secondary Legislation Published on the Exclusion of Transactions With Non-EU Non-Financial Counterparties From Credit Valuation Adjustment Risk Charges
A Commission Delegated Regulation has been published in the Official Journal of the European Union, setting out Regulatory Technical Standards on procedures for excluding from the own funds requirement for credit valuation adjustment risk transactions with non-financial counterparties that are established in a third country and that do not hold positions over the clearing threshold under the European Market Infrastructure Regulation (so called NFC-s). The RTS supplement the requirements of the Capital Requirements Regulation.
Under the CRR, transactions between an institution and a NFC- are excluded from the own funds requirements for CVA risk, irrespective of whether that NFC- is established in the EU or in a third country. As NFC-s established in third countries are not subject directly to EU regulation, the RTS clarify that EU firms are responsible for: (i) taking the necessary steps to identify all NFC-s under this exemption and calculating accordingly their own funds requirements for CVA risk; (ii) ensuring that exempt counterparties established outside the EU would qualify as NFC-s if they were established in the EU; and (iii) ensuring that counterparties calculate the clearing threshold according to the relevant provisions in EMIR and do not exceed those thresholds.
EU Supervisory Authorities Consult on Aligning EMIR Clearing and Risk-Mitigation Obligations For Securitizations With Those For Covered Bonds
The Joint Committee of the European Supervisory Authorities has published two consultations on proposed amendments to: (i) Regulatory Technical Standards on the clearing obligation under the European Market Infrastructure Regulation for certain classes of OTC derivatives; and (ii) RTS on risk-mitigation techniques for OTC derivative contracts not cleared by a CCP. The proposed changes aim to incorporate the provisions of the Securitization Regulation (also known as the STS Regulation), which entered into force on January 17, 2018.
The Securitization Regulation notes that there is a degree of substitutability between covered bonds and securitizations. The Securitization Regulation therefore amends EMIR, among other things, to ensure consistency of treatment between the regime for derivatives transactions associated with covered bonds and the one for securitizations, with respect to the clearing obligation and the margin requirements for non-centrally cleared OTC derivatives. The ESAs have been mandated to make the necessary changes to existing RTS to effect consistent treatment.
US Treasury Counselor to the Secretary Craig Phillips Discusses Regulatory Reform
U.S. Treasury Counselor to the Secretary, Craig Phillips, spoke at the International Swaps and Derivatives Association’s 33rd annual general meeting regarding regulatory policies of relevance to ISDA members.
Clarification on Scope of EMIR Obligations for Public Entity Clearing Members Needed
The Chair of the European Securities and Markets Authority, Steven Maijoor, has written to the European Commission recommending that clarification of certain provisions of the European Market Infrastructure Regulation should be made during the current revision of EMIR. EMIR requires clearing members of CCPs to provide initial margin and default fund contributions. ESMA has noticed that CCPs across the EU, as well as their national regulators, are adopting different approaches to these requirements for public entities. Some CCPs and national regulators exempt public entity clearing members from the requirement to provide initial margin and default fund contributions while others grant no exemptions.
ESMA requests the Commission to consider whether the scope of EMIR needs to be clarified and whether a specific amendment could be made to EMIR during the current review process.
The European Commission published legislative proposals to amend EMIR in May - the technical revisions in so-called EMIR 2.1 - and June 2017 - the Brexit-driven CCP "location policy" or so-called EMIR 2.2, which attempts to force the relocation of UK CCPs to the Eurozone. The legislative procedures to finalize those changes are ongoing.
View the letter.
View the Commission's technical amendments legislative proposal.
View the Commission's location policy legislative proposal.
Financial Stability Board Publishes Second Consultation on Governance of the Unique Product Identifier
The Financial Stability Board has opened a second consultation on governance of the Unique Product Identifier. The FSB identified UPIs in September 2014 as a critical element towards a mechanism to produce and share global aggregated derivatives reporting data, along with the development of a unique transaction identifier and the harmonization of other key data elements. The receipt of aggregated derivatives reporting data will enable national regulators to better assess systemic risk and perform other market oversight functions.
The purpose of the UPI is to uniquely identify OTC derivatives products that regulators require, or may require in the future, to be reported to trade repositories. The UPI system will assign a code to each OTC derivative product which maps to a set of data elements describing the product in a corresponding reference database, the UPI Reference Data Library. The Library will be administered by either one or a number of UPI Service Provider(s).
This second consultation paper seeks feedback on specific issues relating to the UPI Governance Arrangements, including fee models and cost recovery, intellectual property, standardization and potential restrictions on the activities of a UPI service provider. The FSB is also asking for feedback on whether a single UPI service provider model would be more suitable than having a competitive multi-UPI service provider model.
The consultation closes on May 24, 2018. The FSB intends to finalize the UPI governance arrangements and identify one or more UPI service provider(s) by mid-2019.
View the consultation paper.
European Securities and Markets Authority Seeks Clarity on the Ancillary Activity Exemption under MiFID II
The European Securities and Markets Authority has published a letter from its Chair, Steven Maijoor, to the European Commission seeking clarification on how to interpret the ancillary activity exemption under the revised Markets in Financial Instruments Directive.
MiFID II exempts non-financial entities that deal on own account, or provide investment services to clients, in commodity derivatives from having to obtain authorization as an investment firm under MiFID II provided that, among other things, this activity is ancillary to their main business. The provisions of MiFID II are supplemented by a Commission Delegated Regulation setting out the Regulatory Technical Standard on the criteria to establish when an activity is considered to be ancillary to the main business. The wording of both MiFID II and the RTS suggest that the tests for whether activity is ancillary should be carried out at the level of the entity's group. However, some drafting amendments that were introduced by the Commission have led to uncertainty as to whether the tests should be carried out at the level of the entity rather than at group level.
ESMA states that it would not be appropriate for it to address this uncertainty through its usual Questions and Answers and invites the Commission to provide further guidance on the interpretation and implementation of the ancillary activity criteria, in particular on the level at which the tests should be applied.
View the ESMA letter.
View the Commission Delegated Regulation (2017/592).
Final Global Technical Guidance on Critical OTC Derivatives Data Published
The Committee on Payments and Market Infrastructures and the Board of the International Organization of Securities Commissions have published final Technical Guidance on the harmonization of critical OTC derivatives data reported to trade repositories. The Technical Guidance does not cover the Unique Transaction Identifier and Unique Product Identifier. The Financial Stability Board identified the development of a UTI, UPI and other key data elements as critical for a mechanism to produce and share global aggregated derivatives reporting data. The Technical Guidance sets out the definition, format and allowable values of critical elements that would facilitate consistent aggregation of reported data at global level. It does not specify which data elements must be reported because those requirements are set by the relevant authorities in each jurisdiction. The Guidance is for national authorities to use and it is not intended to function as a set of rules for market participants.
View the Technical Guidance.
UK Financial Conduct Authority Confirms Regulatory Status of Cryptocurrency Derivatives
The Financial Conduct Authority has published a statement confirming the regulatory requirements applicable to firms engaged in cryptocurrency derivatives. The FCA does not regulate cryptocurrencies, provided that they do not form part of other regulated services or products. However, the FCA states that cryptocurrency derivatives may be categorized as financial instruments under the revised Markets in Financial Instruments Directive II and that firms carrying out regulated activities in cryptocurrency derivatives should comply with the FCA's Handbook rules as well as the directly applicable EU provisions. The FCA points out that dealing in, arranging transactions in, advising on or providing other services that are regulated activities in relation to derivatives that reference cryptocurrencies or tokens issued through an Initial Coin Offering will require FCA authorization.
View the FCA's statement.
European Securities and Markets Authority Confirms Product Intervention for Contracts for Difference and Binary Options
The European Securities and Markets Authority has confirmed that it will use its product intervention powers under the Markets in Financial Instruments Regulation to prohibit the marketing, distribution and sale of binary options to retail investors. It will also impose a number of restrictions on the marketing, distribution and sale of Contracts for Difference to retail investors. Both CFDs and binary options have given rise to significant investor protection concerns, due to their complexity, the lack of transparent information at the point of sale, the risk of significant loss for investors and the deployment of aggressive marketing techniques by providers and distributors of the products.
European Securities and Markets Authority Issues Final Guidelines for Position Calculation by Trade Repositories
The European Securities and Markets Authority has published finalized Guidelines on position calculation by trade repositories under the European Market Infrastructure Regulation. ESMA consulted on a draft version of the Guidelines at the end of 2017.
EMIR requires that derivatives contracts are reported to a trade repository by the parties to the contract or by the CCP. Reporting parties do not have to report their trades to the same trade repositories. Instead, trade repositories must take steps to reconcile records among one another. Trade repositories are required to calculate the positions by class of derivatives and the reporting entity, based on the reports received. Trade repositories are also required to publish aggregate positions by class of derivatives.
ESMA has introduced new Guidelines to provide a framework for trade repositories to provide the relevant calculations in a common format and follow a consistent methodology and timeline. This will promote the provision to relevant authorities with more consistent and harmonized position data in relation to derivatives and higher standards as regards the data that is made available to authorities.
Financial Stability Board Launches Survey on Legal Barriers to Reporting OTC Derivatives Trades
The Financial Stability Board has launched a survey seeking feedback from financial institutions and other reporting entities on legal barriers that prevent or hinder them from reporting full transaction information on over-the-counter derivatives trades to Trade Repositories.
Legal barriers that can prevent full trade reporting include blocking laws, client confidentiality laws, data protection laws and related requirements or restrictions. Trade reporting is an important component of the comprehensive reforms of OTC derivatives markets agreed by the G20 in 2009. A thematic peer review of derivative trade reporting conducted by the FSB in 2015 revealed a number of legal barriers to trade reporting. These barriers can hamper national regulators in carrying out their regulatory obligations, such as monitoring and analyzing systemic risk and market activity. The FSB has previously published progress reports in 2016 and 2017 setting out steps FSB member jurisdictions have taken and are planning to take. FSB member jurisdictions have committed to take action to remove legal barriers by June 2018.
European Securities and Markets Authority Issues Opinion on Application of MiFIR Trading Obligation to Package Orders
The European Securities and Markets Authority has published an Opinion on the treatment of package orders in the context of the trading obligation for derivatives under the Markets in Financial Instruments Regulation. The trading obligation requires that the trading of certain derivatives must take place on a regulated market, multilateral trading facility, organised trading facility or on an equivalent third-country trading venue.
Package orders are used by investment firms and their clients to conduct trades for risk management and hedging purposes. They are composed of two or more financial instruments that are priced as a single unit. The execution of each component is simultaneous and contingent upon on the execution of all the other components. Under MiFIR, the trading obligation is designed to apply at instrument level, not package level – the obligation attaches to the components of a package, but not to the package as a whole. Difficulties may arise where a package order contains a mixture of instruments, where some are subject to the trading obligation while others are not. ESMA considers that the components of a package need to be executed on a trading venue only where it is feasible to do so without creating undue operational or execution risk.
Federal Reserve Bank of New York Announces Plans to Begin Publication of Treasury Repo Reference Rates on April 3, 2018
The Federal Reserve Bank of New York has announced it will begin publication of three Treasury repo reference rates on April 3, 2018. The rates will reflect data from the previous day and will be published each day at approximately 8:00 a.m. Eastern Time.
These rates include the Secured Overnight Financing Rate (SOFR), which will be based on triparty repo data from Bank of New York Mellon and cleared bilateral and GCF Repo data from the Depository Trust & Clearing Corporation; the Triparty General Collateral Rate (TGCR), which will solely include triparty repo data; and the Broad General Collateral Rate (BGCR), which will be based on triparty repo data and GCF Repo data. In December, the Alternative Reference Rates Committee recommended SOFR as an alternative to U.S. dollar LIBOR in certain new U.S. dollar derivatives and other financial contracts.
Further, the New York Fed announced that on April 3, 2018 it will publish additional information regarding the administration of the reference rates, including contingency plans related to data sufficiency, the revision policy and oversight of the rates.
View the Federal Reserve Bank of New York's statement.
US Commodity Futures Trading Commission Chief of Staff Provides Project KISS Update
The Commodity Futures Trading Commission Chief of Staff Michael Gill provided an update on the CFTC's Project KISS initiative at the CFTC KISS Policy Forum in Washington, D.C. He said that after a thorough review of public comments received through the initiative, the Commission has broken the recommendations down into three tiers: (1) simple housekeeping changes with no discretionary policy adjustments; (2) suggestions reducing regulatory burdens with minor policy implications; and (3) initiatives that have more significant policy implications. Through the Project KISS review process, the CFTC is only focused on the first two tiers, although suggestions in the third tier will be addressed at a later date, Gill said.
The proposals cover a wide range of policy issues across the CFTC's divisions. The Division of Clearing and Risk is examining the process through which the CFTC grants exemptions from derivatives clearing organization registration, amendments to various DCO regulations and extensive proposed amendments to current Part 190 regulations.
US Commodity Futures Trading Commission Fines Investment Bank for Attempted Manipulation of Benchmark Swaps Rate
The US Commodity Futures Trading Commission has issued an order settling charges against the US investment arm of an international bank for attempted manipulation of the US dollar International Swaps and Derivatives Association Fix (USD ISDAFIX), a global benchmark that indicates the prevailing mid-market rate for the fixed leg of a standard fixed-for-floating interest rate swap.
The order alleges that from at least January 2007 through May 2012, the firm attempted to manipulate the USD ISDAFIX by bidding, offering and executing transactions in targeted interest rate products near the time of the benchmark's daily publication in order to influence the final published rate and improve the firm's positions. The order also alleges that certain employees of the firm who were responsible for making USD ISDAFIX submissions attempted to manipulate the published rate by submitting rates that were false and misleading in order to move the USD ISDAFIX to a more desirable level that would benefit the firm's positions.
The firm agreed to a $70 million fine to settle the charges. In the order, the CFTC recognized the firm’s cooperation with the investigation and remedial actions taken by the firm to strengthen internal controls and policies relating to all benchmarks, including the USD ISDAFIX.
View the CFTC's press release.
US Commodity Futures Trading Commission Proposes New Measure to Calculate Size of Interest Rate Swap Markets
The US Commodity Futures Trading Commission is considering a new measure to calculate the size of the interest rate swap (IRS) markets. Under the methodology proposed in a paper by CFTC Chief Economist Bruce Tuckman, the value of the IRS markets would be determined by the calculation of what the paper refers to as "Entity-Netted Notionals" (ENNs) instead of the current gross notional measure used today, which the paper argues overstates risk transfer in the markets.
ENNs would be calculated by: (1) converting the long and short notional amounts of each counterparty to five-year risk equivalents; (2) netting longs against shorts in a given currency within pairs of legal entities; and (3) summing the resulting net longs or shorts across counterparties. Under this calculation, the value of the current IRS markets would be approximately $15 trillion, which represents roughly 8% of the current $179 trillion market valuation under the current notional calculation.
In a speech introducing the paper, CFTC Chairman J. Christopher Giancarlo argued that the new measure would ensure the IRS markets are more easily compared to other markets, and, in particular, that it would bring their value closer to other fixed income markets, such as the markets for US Treasuries, corporate bonds, mortgages and municipal securities. However, he also acknowledged that ENNs are not intended to measure counterparty or operational risk and said his intention is not necessarily to use the calculation to rethink regulatory thresholds, such as the swap dealer de minimis registration threshold.
The CFTC is looking for market reaction to the ENNs proposal.
View the Office of the Chief Economist's paper.
View Chairman Giancarlo's speech.
Proposed EU Guidelines on CCP Requirement for Anti-Procyclicality Margin Measures
The European Securities and Markets Authority is consulting on proposed guidelines for national regulators of CCPs on the application of the rules requiring CCPs to adopt anti-procyclicality margin measures.
The European Market Infrastructure Regulation requires CCPs to impose, call and collect margins to limit its credit exposures from clearing members. A CCP must also regularly monitor and, if necessary, revise the level of its margins to reflect current market conditions taking into account any potentially procyclical effects of those revisions. The Regulatory Technical Standards on requirements for CCPs provides that CCPs must use at least one of three options to limit procyclicality to the extent that the financial soundness of the CCP is not negatively affected.
During the EMIR Review, ESMA highlighted that the implementation of these requirements differs across CCPs and that the effectiveness and supervision of these measures could be improved. The draft guidelines seek to clarify and ensure consistent application of the requirements across the EU.
Commodity Futures Trading Commission Discusses Approach to Virtual Currency Futures Markets
The Commodity Futures Trading Commission has released a backgrounder on the federal oversight of virtual currencies and its approach to regulating the virtual currency derivatives markets. Because virtual currencies have been deemed a commodity, certain derivative and other transactions in virtual currencies may be subject to CFTC oversight under the Commodity Exchange Act.
The CFTC outlined its 5-pronged approach to the regulation of derivatives involving virtual currencies, which will focus on (1) consumer education; (2) asserting legal authority; (3) market intelligence; (4) robust enforcement; and (5) government-wide coordination.
Final Global Governance Arrangements for Unique Transaction Identifier Published
The Financial Stability Board has published the Governance Arrangements for the Unique Transaction Identifier and a recommended implementation plan for the arrangements following its consultation in March 2017. The UTI is a critical element for the production and sharing of global aggregated derivatives reporting data. The purpose of the global UTI would be to uniquely identify each OTC derivative transaction required by authorities to be reported to trade repositories, thus minimizing the potential for the same transaction to be counted more than once.
The FSB has designated the International Organization for Standardization as the body responsible for publishing and maintaining the UTI data standard. The Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions have been designated on an interim basis as responsible for the governance functions relating to the UTI. The FSB would like the UTI to have a common governance framework and governance body with the unique product identifier and will make the final permanent designation once the governance of the UPI is finalized. The FSB intends to consult further on the UPI governance arrangements in 2018.
The FSB recommends that the UTI is implemented by no later than the end of 2020.
View the FSB's governance arrangements for the UTI.
EU Derivatives Trading Obligation Enters Into Force
A Commission Delegated Regulation on the derivatives trading obligation under the Markets in Financial Instruments Regulation has been published in the Official Journal of the European Union.
The trading obligation is applicable to classes of derivatives that: (i) have been declared subject to the clearing obligation under the European Market Infrastructure Regulation, (ii) are admitted to trading or traded on at least one EU trading venue (a regulated market, multilateral trading facility, organized trading facility or a third country equivalent trading venue) and (iii) are sufficiently liquid. The trading obligation applies to financial counterparties and to non-financial counterparties. Where a class of derivatives is determined to be subject to the MiFIR trading obligation, such derivative may only be traded on a third country trading venues if it has been determined to be equivalent by the European Commission.
European Supervisory Authorities Publish Final Draft Technical Standards Amending Margin Requirements for Non-Centrally Cleared OTC Derivatives
The Joint Committee of the European Supervisory Authorities has published a final report containing final draft Regulatory Technical Standards amending the requirements for risk-mitigation techniques for uncleared OTC derivative contracts where those contracts relate to physically settled FX forwards. The European Market Infrastructure Regulation requires counterparties to uncleared OTC derivative transactions to implement risk mitigation techniques to reduce counterparty credit risk. The RTS prescribe required margin amounts to be posted and collected and the methodologies by which the minimum amount of initial margin and variation margin should be calculated, as well as listing securities eligible as collateral, such as sovereign bonds, covered bonds, some securitization instruments, corporate bonds, gold and some equities. The variation margin requirements have applied to all counterparties since March 1, 2017 although they will only be applicable for physically-settled FX forwards from January 3, 2018.
Market participants have experienced difficulties in exchanging VM, in particular, in transactions with end-users. In addition, the EU's implementation of the international standards on margin exchange is more extensive than that in some other jurisdictions.
European Securities and Markets Authority Issues Revised Guidance on Post-Trade Transparency and Position Limits When Transacting on Non-EU Trading Venues
The European Securities and Markets Authority has published two revised Opinions providing further guidance on the post-trade transparency and position limits requirements relating to transactions on non-EU trading venues under the revised Markets in Financial Instruments Directive and the Markets in Financial Instruments Regulation. ESMA first published the Opinions in May 2017.
The first Opinion sets out ESMA's view on determining third-country trading venues for the purpose of transparency under MiFIR. MiFIR requires EU investment firms to make information on transactions in financial instruments traded on a trading venue public. Details of actual transactions must be made public as close to real time as possible – for equities, within one minute of trading, and for non-equities, within 15 minutes (reducing to five minutes in 2020). The Opinion sets out ESMA's view of which transactions between EU and non-EU firms, and which transactions conducted on third-country trading venues should be subject to these post-trade transparency requirements. The Opinion provides objective criteria for identifying those third-country venues that have similar post-trade transparency requirements as EU trading venues. Trades on third-county venues that satisfy the criteria will not need to be made transparent post-trade.