The Financial Action Task Force (FATF) has, following its June 2019 Plenary Session, updated its list of jurisdictions identified as having "strategic AML/CFT deficiencies with a FATF Action Plan" and its list of deficient jurisdictions for which a "call for action applies". The FATF, in July 2019, also published Terrorist Financing Risk Assessment Guidance. FATF lists and guidance inform the AML/CFT laws of numerous regions including the EU, with Recital 28 of AMLD IV specifically directing the European Commission to take into consideration FATF publications when publishing its own periodic AML/CFT Risk Assessments.
EU and U.S. ESG Policy Emphasized in Recent Legislative Developments
In a press release the European Commission announced new guidelines on reporting climate-related information, by way of a supplement to existing guidelines on non-financial reporting. The guidelines integrate Financial Stability Board recommendations on climate-related financial disclosures and take account of the forthcoming taxonomy on sustainable activities currently under development, which includes the recent Technical Report on EU Taxonomy and a Call for Feedback, open until September 13, 2019. The press release includes a colorful two-page summary which emphasizes the "not legally binding" nature of the guidelines.
Meanwhile, on July 10, the U.S. House Committee on Financial Services held a hearing on five draft bills pertaining to environmental, social and governance disclosures, including the ESG Disclosure Simplification Act of 2019, the Shareholder Protection Act of 2019, the Corporate Human Rights Risk Assessment, Prevention and Mitigation Act of 2019, a public company tax disclosure measure, and the Climate Risk Disclosure Act of 2019. Witnesses at the hearing included representatives of the Global Reporting Initiative (GRI), CalPERS, Ceres, Patomak Global Partners and Decator Capital Management, Inc. The hearing represents increasing momentum in the U.S. to address climate risk and ESG topics at the U.S. federal level.
MiFID II 2018 Sanctions Activity
On July 17, 2019 ESMA published a Report into enforcement activity (‘sanctions and measures’) undertaken across the Union in 2018 under MIFID II. In total 45 sanctions or measures were reported. In total, taking all cases together, less than €1.2 million in fines was imposed. No MiFID II related enforcement activity was undertaken in Germany, France, Ireland, Italy, or Spain. Only 9 Member States and Norway reported sanctions or measures, constituting just a third of all in-scope countries. In contrast, many large firms have reported individual costs of implementing MiFID II far exceeding the annual cross-EU fine tally for non-compliance in 2018.
It is too early to attach any significance to the fine data but, as the regulation beds in and regulators become more familiar with the new landscape, more enforcement activity can be anticipated. Moreover, larger financial regulatory enforcement cases typically take a long time to conclude: for instance, several recent high profile FCA cases that attracted large fines addressed conduct that occurred a decade ago. However, the recent fecundity of EU financial regulation has not been matched by an equivalent growth in supervisory personnel, constraining their scope to bring additional enforcement cases.
New Legislation and a Raft of Reports Reshape EU AML/CFT Landscape
On July 11, 2019 Directive (EU) 2019/1153 was published in the EU’s Official Journal. The Directive is a stand-alone level 1 legislative text that complements AMLD IV and associated instruments by imposing rules that facilitate the use of financial and other information between law enforcement agencies for the prevention, detection, investigation and prosecution of specified criminal offences. The new rules liberalize and speed up current information exchange processes and are in response to a proliferation of cross-border AML/CFT cases and to the increasing sophistication of actors involved in terrorist financing and money laundering. A summary of the new rules is set out in an EU Council press release.
The Directive comes just weeks after the publication of Commission Delegated Regulation (EU) 2019/758, which, pursuant to Article 45 of AMLD IV, sets out minimum action and additional measures to be undertaken in relation to third countries which restrict the implementation of group-wide AML/CFT policies and procedures through, for instance, strict data protection or banking secrecy laws. The Regulation applies from September 3, 2019.
Meanwhile, at the end of July 2019, the European Commission announced that it had adopted a communication and four Reports on AML/ CFT. The Communication is not-so-pithily entitled "Towards a better implementation of the EU's anti-money laundering and countering the financing of terrorism framework." It provides an overview of the four reports and emphasizes the urgent need for all Member States to fully implement AMLD VI and V. The Communication also sets out existing and emerging risks and structural shortcomings that still need addressing and which are likely to shape the future EU AML/ CFT legislation in the near term.
Of the four reports, one Report provides a post-mortem of recent money laundering cases following a request from the Council in its AML Action Plan. The Report sets out structural weakness in the current AML/ CFT framework and is excoriating in its criticism of the banks involved and also of the regulators and of certain Member States who have been slow to implement and apply AMLD IV.
The Commission also published an updated version of its Risk Assessment Report, mandated under Article 6 of AMLD IV. This report is part of a wider cascade of risk assessments, which start at the international level with FATF reports and flow down to individual firms. The Report highlights existing AML/ CFT vulnerabilities including proliferation of anonymous products, problems with the identification of beneficial ownership, the emergence of new unregulated products such as virtual assets and supervisory fragmentation that can lead to cases falling between gaps.
Additionally, the commission has published a Financial Intelligence Units Report and an Interconnection of Central Bank Account Registries Report, which both identify shortcomings in supervision and cooperation in relation to their respective subject matter, and which suggest ways to address these shortcomings through, amongst other proposals, enhanced information sharing protocols and the deployment of enhanced technology, including in relation to importing and exporting data through the FIU.net platform.
Finally, in its press release, the commission confirmed that it had launched infringement procedures against certain Member States that had failed to adequately transpose AMLD IV.
In summary, in the space of two months, EU institutions have undertaken supervisory, legislative and enforcement activity across all levels of the Lamfalussy legislative architecture as well as undertaking additional measures, which together provide a framework for another round of legislative developments in the AML/CFT arena.
Three New EU Texts Liberalize Cross-Border Pension and Fund Distribution
Following an announcement by the European Council on new Capital Markets Union (CMU) driven legislative texts designed to facilitate cross-border access to pension products and investment funds, on July 25, Regulation (EU) 2019/ 1238 was published in the Official Journal, establishing a Pan European Pension Product (PEPP). PEPPs will have features that are the same throughout the EU and can be offered by a wide range of providers, such as insurance firms, banks, occupational pension funds, investment firms and asset managers. Providers will benefit from an EU passport, allowing them to sell PEPPs in different member states. PEPPs will also be portable across member states, benefit from specific consumer protection arrangements, and provide a new EU-wide option that complements state-based, occupational and national personal pension schemes. The application of the Regulation will occur 12 months after the publication of various Delegated Acts.
As part of the same CMU package of initiatives, Directive (EU) 2019/1160 and Regulation (EU) 2019/1156 were published in the EU’s Official Journal in July. These legislative texts seek to facilitate the cross-border distribution of funds (including UCITS and Alternative Investment Funds) by eliminating regulatory barriers and reducing the costs of distribution across the union.
Key changes within the Directive include the removal of the requirement for a local entity to undertake payment and information disclosure obligations in relation to funds distributed to retail investors; the liberalization of rules triggered when funds no longer seek to market a fund in a member state (the denotification process) and finally, the implementation of uniform rules for pre-marketing of AIFs to professional investors.
By contrast, the Regulation contains a smattering of tweaks to various fund rules and a number of process innovations including: harmonization of certain marketing rules; a deadline extension for PRIIPs-KIDs publications in specified circumstances; a truncated deadline for host regulator marketing material reviews and a requirement for host regulators to publish summaries on local requirements in English on their websites. ESMA must also create a central database of local requirements and, by February 2, 2022 must publish databases providing overviews of local regulatory fees and requirements and a central UCITS and AIF register, listing all cross-border distributed funds and the countries they are marketed in. These databases will be updated in accordance with periodic reporting from local Member State regulators.
The bulk of the Regulation will apply from August 1, 2019, save for a number of discrete requirements that come into force over a longer timeframe. The Directive must be implemented by Member States by August 1, 2021.
The EU Recalibrates Solvency Capital Requirement Calculations Under Solvency II
On 18 June 2019, Delegated Regulation (EU) 2019/ 981 was published in the EU Official Journal, amending a host of provisions in Delegated Regulation (EU) 2015/35, which sets out the calculations of capital requirements for insurance and reinsurance undertakings. The list of changes is too lengthy to summarize here, but they fall broadly into four categories: (i) leveling the playing field as between prudential requirements for insurers and prudential requirements for credit and financial institutions, (ii) optimizing capital requirement calculations for asset classes such as high quality unlisted equity investments and privately placed debt to accord with the InvestEU Programme and CMU Action Plan, (iii) reducing the burden on insurers in carrying out capital requirements calculations, in line with the principle of proportionality (for example, by enabling a wider range of simplifying assumptions), and (iv) harmonizing the treatment of the same or similar exposures irrespective of investment structures.
ESMA Issues Guidelines on MMF Stress Testing and Regulatory Reporting
In a July 2019 Press Release, ESMA announced new Guidelines on Stress Tests and Guidelines on Regulatory Reporting under the Money Market Funds Regulation. The Reporting Guidelines provide MMF managers with directions on how to fill in the regulatory reporting template. The results of the stress tests must also be submitted though the regulatory reporting template.
The initial stress test guidelines require managers to model hypothetical scenarios involving changes in a MMF’s liquidity, redemption levels, credit, and interest rate risks widening/narrowing of spreads among indexes to which interest rates of portfolio securities are tied, and macro-economic shocks. The Stress Test Guidelines will be updated at least annually to take account of market developments. The inaugural reporting season for reports and stress test disclosures commences Q1 2020.
EU Bond Distribution Initiative
The ECB are Consulting with stakeholders on the European Debt Distribution Initiative (EDDI), a proposed electronic platform designed to modernize bond issuance.
ESMA Announce Consultation Paper on Retail Performance Fees
On July 16 , ESMA announced a Consultation Paper on performance fees under the UCITS retail fund regime, soliciting feedback on its draft guidelines proposing common criteria in the following areas: (i) general principles on performance fee calculation methods; (ii) consistency between the performance fee model and the fund’s investment objectives, strategy and policy; (iii) frequency for the performance fee crystallisation and payment; (iv) the circumstances where a performance fee should be payable; and (v) disclosure of the performance fee model. ESMA also published a Call for Evidence on the inducements and costs and charges rules under MIFID II.
Two Delegated Regulations Have Been Published Amending the Prospectus Regulation
The following texts were published in the Official Journal, introducing a number of changes to prospectus content and requirements, depending upon the issuer and the asset class of the issue:
ESMA Intensifies Scrutiny of Dividend Arbitrage and Withholding Tax Schemes
In July 2019, ESMA published a Report on its preliminary findings into withholding tax (WHT) reclaim schemes, following a request from the European Parliament. It has now launched a Formal Inquiry under Article 22(4) of the ESMA Regulation to gather further evidence from Member State regulators on supervisory practices regarding WHT schemes that operate across the Union.
In its report, ESMA identified best practices that could be deployed by Member State regulators but noted that co-operation with tax authorities was required to properly oversee such activity, which would require a ‘clear legal basis’, strongly suggesting that the twinkle of new Regulation was in the eye of EU policy makers.
ESMA Consults on Market Data Costs and a Consolidated Tape for the Equities Market
In July, ESMA issued a press release announcing a Consultation Paper on market data and on the need for a post-trade consolidated tape for equity instruments. In its press release ESMA states that "MiFID II/MiFIR aims at ensuring fair access to and lowering the cost of market data." Somewhat euphemistically, ESMA concedes in its Paper that "it appears that MiFID II has so far not delivered on its objective to lower the prices of market data."
The same debate is being played out in the U.S. through an SEC review into the cost of market data and through high-profile litigation against trading venues in relation to their market data and order type arrangements; litigation which is magnifying the spotlight on market data arrangements.
ESMA’s Consultation Paper focuses on, among other issues, the requirement to publish market data ‘on a reasonable commercial basis’ and also considers the proliferation of new data streams that MiFID II has precipitated, such as "fees for SIs consuming data, fees for data used for risk management and market abuse monitoring purposes."
The Consultation closes on September 6, 2019 and, based on stakeholder feedback, ESMA will develop a final report, which it plans to submit to the European Commission by December 2019.
FCA Ramps Up Convictions, Fines, Enforcement & AML/ CFT Investigations
At the end of June, the FCA issued a press release announcing the successful prosecution of a Compliance Officer, Fabiana Abdel-Malek, and her friend, Walid Choucair, a trader, for insider dealing offences. Both were sentenced to three years' imprisonment. In its press release the FCA emphasized the importance of its collaboration with the National Crime Agency in securing a successful outcome.
The case is the FCA's first large insider dealing trial to reach a jury in the past three years. In sentencing, the FCA confirmed that confiscation proceedings will be pursued against both defendants. The case is particularly interesting since it is the first instance in which a Compliance Officer has been jailed on insider dealing related offences.
On August 1, 2019, the FCA discussed this case in depth in the 60th Issue of its Market Watch publication, which warned of poor behaviour in the management of insider lists that it had identified following a recent review of investment bank inside information management processes.
This publication followed the FCA’s publication, on July 9, 2019, of its Enforcement Annual Performance Report, which showed that whilst the number of fines had remained the same as the previous year, the total amount imposed had jumped from £60.9 million in 2017/2018 to £227.3 million over the same period for 2018/2019. The Enforcement Report was published simultaneously with the FCA’s AML Report where it was confirmed that the FCA has over 60 ongoing AML investigations..
In a First, FCA Acknowledges Industry FX Guidance
In late June, the Financial Conduct Authority (FCA) confirmed its recognition of two voluntary market codes of best practice: the FX Global Code, maintained by the Global Foreign Exchange Committee, and the UK Money Markets Code, maintained by the Money Markets Committee.
The FX and MM Codes are the first voluntary industry codes to be recognized by the FCA under its codes recognition scheme.
UK Law Commission Recommends changes to AML Suspicious Activity Report Process
Following a review into anti-money laundering legislation, the UK Law Commission (an independent state body responsible for reviewing and recommending reform of existing laws), has published a report entitled Anti-Money Laundering: The SARs Regime, where it concludes that at present too many "low-quality" Suspicious Activity Reports (SARs) are being submitted, which undermine the entire process. As such, the Commission has recommended a new Advisory Board of experts from the public and private sector be stablished to oversee the effectiveness of the regime, the drafting of guidance and the provision of advice to the Secretary of State on appropriate improvements and how best to respond to emerging threats.
The Commission further recommends a new online SAR form that makes reporting easier and promotes greater consistency in information provided in a more accessible format. Finally, the Commission recommends publication of Statutory Guidance to be issued by the Secretary of State, aimed at reducing confusion and uncertainty around a number of key legal concepts, whilst ensuring reporters understand their legal obligations when reporting suspicious activity.
The findings are relatively non-contentious and the proposals are modest and so it is expected that the measures will be adopted by the government in due course.