Featured Image

Regulatory Update: February 2020


By Barrie C. Ingman  |  February 4, 2020

Each month, FactSet's Regulatory team offers a rundown of the most important developments in compliance and regulatory news. Read on to see which stories dominated the conversation last month.


Regulators Turn Up Heat on LIBOR Transition Arrangements

In a letter on January 23, 2020, the New York Department of Financial Services gave regulated entities until March 23, 2020, to submit details of their LIBOR transition plans. Two weeks prior, on January 9, 2020, FINRA’s 2020 Risk Monitoring and Examination Priorities letter, stated that "FINRA will engage with firms—outside the examination program—to understand how the industry is preparing for LIBOR’s retirement at the end of 2021, focusing on firms’ exposure to LIBOR-linked financial products; steps firms are taking to plan for the transition away from LIBOR to alternative rates such as the Secured Overnight Financing Rate (SOFR); and the impact of the LIBOR phase-out on customers."

These letters follow a December 30, 2019, SEC statement on the "Role of Audit Committees in Financial Reporting and Key Reminders Regarding Oversight Responsibilities," which emphasized the importance of timely LIBOR transition arrangements, the risks associated with inadequate measures and the risk-management implications, and related responsibilities for audit committees.

Meanwhile, in the UK, in a letter published on January 16, 2020, the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) set out their expectations for firms’ LIBOR transition arrangements throughout 2020, emphasizing the need for firms to engage with industry and regulatory transition efforts immediately, while tacitly threatening the use of "supervisory tools" in the event of insufficient progress.

Underlining this message, in a letter to ISDA on January 20, 2020, the FCA further confirmed that following an announcement of a planned cessation, any subsequent period over which a non-representative LIBOR would be published would be a few months at most and the FCA would also not seek to sustain LIBOR beyond 2021 by requiring panel-bank submissions. Against this backdrop, the FCA once again encouraged ISDA to permit derivatives contracts to include pre-cessation fallback triggers.

Finally, in a media briefing on January 17, 2020, a spokesperson for the Hong Kong Monetary Authority (HKMA) also stressed the importance of stepping up transition measures immediately, echoing the comments made from their counterparts in America and Europe.

In short, regulators across the globe are dialing up the pressure on firms to commence transition arrangements now with regular, strongly worded messaging.


Final Tranche of Technical Documents Published Ahead of SFTR Reporting Commencement

On January 6, 2020, the European Securities and Markets Authority (ESMA) published the following documents in relation to the imminent first go-live date for transaction reporting under the Securities Financing Transactions Regulation (SFTR):


Final Report

LEI Statement

Updated Validation Rules

The Final Report provides extensive analysis of the feedback received on the proposals set out in its May 2019 consultation paper, the results of which populate the Guidelines.

In turn, the Guidelines clarify certain provisions within the regulatory texts, together with practical guidance on several aspects of SFTR reporting including the reporting date when transactions are executed outside of non-business days, the number of reportable securities financing transactions (SFTs), directions on populating fields for different types of SFT and margin data, the approach used to link SFT collateral with SFT loans, the population of reporting fields for collateral reuse, guidance on reinvestment and funding sources data and details on the provision of feedback from Trade Repositories where reported data is rejected and in cases of "reconciliation breaks."

The LEI Statement clarifies expectations in respect of the use of LEIs for issuers of securities used in SFTs, together with expectations on the steps to be taken by supervisory authorities in this context.

Finally, ESMA has updated its SFTR validation rules so that they concord with the LEI Statement and with the Updated XML Schemas, which ESMA published in December 2019.

SFTR transaction reporting will commence on April 11, 2020, for credit institutions, investment firms, and relevant third country-entities with a series of further phase-in dates for funds, CCPs, CSDs, IORPs, insurance firms, non-financial counterparties, and relevant third country-entities.


Prosecuting Insider Dealing Cases in the U.S. Just Became Much Easier

In a majority-verdict judgment handed down on December 30, 2019, in Manhattan, upholding the convictions of political consultant David Blaszczak and others, the Second Circuit ruled that insider-trading cases can be brought under the 2002 Sarbanes-Oxley Act (SOA).

SOA cases are grouped with wire and mail fraud under Title 18 of the U.S. Criminal Code rather than Title 15 as for 1934 Securities Exchange Act cases, which is important since, as the judgment declares, the requirements are not the same with the Exchange Act—the historical route for such cases—requiring a more challenging evidential burden of proving benefit to the discloser of the relevant information.

The defense had sought to rely on the fact that the supplier of the inside information had not received a "personal benefit" in return for the disclosure in the case at hand, which the Supreme Court had long ruled was a necessary requirement for a successful prosecution under 1934 Act cases. Moreover, the same court hearing the present case had gone even further when in 2014, it ruled that prosecutors had to show that the recipient knew that the discloser was benefiting, placing an even stricter burden on prosecutors, especially for cases where information had been passed through intermediaries.

However, this argument was rejected in the Blaszczak judgment, where the court held that the personal-benefit requirement did not apply to the SOA fraud provisions. The defense attorneys claimed that this would lead to inconsistency in the law between Title 15 and 18 cases and that the case should be dismissed on this basis. The Court rejected this argument for dismissing the case while acknowledging the inconsistency. The consequence is that prosecutors will now undoubtedly channel prosecutions through this less taxing route unless the government otherwise steps in and modifies the law or the Supreme Court overrules the Appeals Court on the point, if the defense decides to appeal. 

The ruling also broadens the type of information prosecutors can invoke in such cases with Blaszczak convicted for using sensitive government information rather than corporate information, which is typically the subject of such cases. In the present instance, government information was also held (on a majority basis) to be “property” for the purposes of federal fraud laws as with corporate information.

SEC Takes Next Step in Bid to Overhaul Equity Market Data Arrangements

In a press release on January 8, 2020, the U.S. Securities and Exchange Commission (SEC; the Commission) announced it was publicly consulting on a proposed order to modernize the arrangements (the National Market System (NMS) Equity Data Plans) that govern the publication of trading venue trade and quote data and consolidated equity market data.

The proposed order discusses in some detail several changes in the equity markets since the adoption of Regulation NMS in 2005, noting in particular the emergence of high-frequency trading and the transition of exchanges from member-owned entities to shareholder-owned corporates.

The Order emphasizes the risks associated with those with a regulatory obligation to disseminate market data also having conflicting commercial interests in selling faster, richer proprietary data products and latency reduction technology. Within this context, it is noted that the public data feeds governed by the plans have not kept pace with the proprietary products and at the same time, the exchanges have formed “exchange groups” which consolidate voting power over and control of the equity data plans. 

Currently, the exchanges and the Financial Industry Regulatory Authority (referred to as Plan Participants) together collect, consolidate, and disseminate the relevant data pursuant to three separate plans. The proposed order would direct the Participants to create a single plan that overcomes the moral hazard and structural conflicts within the present arrangements. 

After considering any comments received, the Commission will consider whether to issue a final order requiring the Participants to file a new plan after which the new plan would be published for public comment. Thereafter, the Commission would decide whether to approve a new plan.

In the meantime, the Commission is also publishing for comment proposed amendments to the existing equity data plans that would mandate conflicts of interest disclosures and establish a policy regarding the confidential treatment of any data or information generated, accessed, transmitted to, or discussed by the operating committee.

Comments must be submitted 45 days following publication of the Proposed Order in the Federal Register.


FCA Calculates Latency Arbitrage Siphons off $5 Billion Annually in "Tax" on Investors

Following on from the SEC’s bid to overhaul equity market data arrangements (which are claimed to favor high frequency traders [HFTs] at the expense of investors), on January 27, 2020, the FCA published analysis undertaken with Professor Eric Budish of the University of Chicago on the wider costs of high frequency traders’ (HFT) millionths of a second "latency races."

Claiming to be the first empirical study on the question of the cost to investors and the wider market of latency arbitrage, the regulator states “we believe we have an answer. After years of work and analysis over billions of high frequency data points on a new kind of dataset, we conclude the sums at stake are about $5 billion a year in global equities and that the cost of liquidity for investors could be reduced by 17% by addressing the problem.”

Based on nine weeks of message data from the London Stock Exchange from 2015, the team calculated that for the average FTSE 100 stock, there is about one latency race a minute, accounting for 22% of average daily trading volume with just six firms accounting for more than 80% of the flow and with the winners of the races beating competitors by between just five to 10 millionths of a second—a thousand times quicker than the blink of an eye. And the direct cost to the market is an eye-watering $5 billion annually according to the study. The report also identifies baked-in indirect costs too, which include 17% in diminished liquidity. Moreover, the study emphasizes that it only calculates the costs for trading in equities, noting that the "same phenomenon extends to other asset classes that trade on electronic limit order books such as futures, currencies, U.S. Treasuries, and more."

The study concludes that while "ordinary households are not significantly impacted by the costs of this activity in their retirement and savings decisions…at the same time, flawed market design significantly increases the trading costs of large investors, and generates billions of dollars a year in profits for a small number of HFT firms, who then have significant incentive to preserve the status quo."

While the report does not make explicit recommendations for legislative change, speed bumps and frequent batch auctions are both discussed as measures that could potentially mitigate the activities of latency races. However, as the report notes, these races were first exposed in the popular media over half a decade ago and yet no regulatory intervention has been forthcoming. Meanwhile, the data arrangements that facilitate these races remain hardwired into EU regulation through Article 13(1) of MiFIR,  as elsewhere noted by this author (See Ingman, B. ‘What Lurks Behind MIFID II’s Opaque Transparency Regime,’ Journal of International Banking Law & Regulation, [2019] Vol. 34 Issue 7).

The matter is the subject of ESMA’s first eport into MiFID II, where the argument between investors and exchanges on the cost of market data is laid out systematically. ESMA is seeking to overcome the problem in part with a real-time equities consolidated tape as reported on in last month’s update. So, change may finally be coming but given the challenge associated with a real-time tape, it will take a long time to emerge. 

Meanwhile, underlying the global nature of the phenomenon, Singapore’s regulator, MAS, is also focused on latency, but rather than seeking to ameliorate its effects, it is seeking to attract faster trading infrastructure in order to further develop its FX and derivatives market and draw liquidity from competing hubs by openly encouraging firms to establish matching engines and related infrastructure in the city-state to enable market participants to "benefit from better latency, pricing, and liquidity in FX and OTC derivatives trading."

FCA Issues Trilogy of Dear CEO Letters for AMs, AIFs, and Financial Advisors

In late January 2020, the UK financial Conduct Authority (FCA) published Dear CEO letters to the following firm types:

Asset Managers

Alternative Investment Firms

Financial Advisors

The letter to asset managers sets out the FCA’s supervisory priorities for these firms which include, unsurprisingly, liquidity management, effective governance and compliance with the Senior Managers and Certification Regime (SMCR), a focus on product governance compliance, LIBOR transition, consideration of the impact of Brexit, and conducting the value for money assessments, the rules for which recently went live.

The letter to Alternative Investment Firms sets out as priorities reviews of suitability and appropriateness arrangements in terms of retail investor exposures, client asset rules (CASS) compliance, market abuse systems and controls, risk management controls, anti-money laundering (AML) and anti-bribery and corruption (ABC) rules, and Brexit preparations.  

Finally, the letter to Financial Advisors set out supervisory priorities for these firm types including suitability of advice and fee disclosures (with a particular emphasis on pension transfers), due diligence and oversight to prevent facilitation of scams, compliance with prudential requirements, and SMCR compliance with a particular focus on senior managers.

The Financial Advisor letter was accompanied by a statement on Assessing Suitability Review 2, where the FCA confirmed it would commence a second review on pensions and investment advice with a Report setting out conclusions due in 2020.

AMLD 5 Goes Live / FCA Becomes Crypto Regulator

In response to the go live date of Directive (EU) 2018/843 (AMLD 5), on January 10, 2020, the FCA announced it had become the anti-money laundering and counter terrorist financing (AML/CTF) supervisor for businesses carrying out certain types of cryptoasset activities.

From January 10, among other requirements, cryptoasset businesses are now required to register with the FCA, identify and assess AML/CTF risks that affect their business, maintain policies, procedures and systems and controls to mitigate the risk of their business being used for AML/ CTF purposes, appoint a board member or senior manager to take responsibility for compliance with the amended UK regulations (where appropriate to the size and nature of the business), comply with due diligence obligations, and undertake ongoing monitoring.

New businesses carrying out in-scope cryptoasset activity will also have to be registered with the FCA before conducting businesses, whereas existing businesses undertaking cryptoasset activities must register by January 2021, submitting a completed application for registration to the regulator by June 2020. Existing regulated firms, e-money institutions, and payment service businesses undertaking cryptoasset activity will also need to apply for registration to undertake crypto-asset regulated activity. To assist firms further, the FCA has created a dedicated webpage on cryptoasset regulation.

FCA Publishes Report into Technology and Cyber Resilience

Following its November 2018 Technology & Cyber Resilience Questionnaire, on January 13, 2020, the FCA published a eport into how asset managers select, use, and oversee risk modelling and other portfolio management tools with a particular focus on their capacity to respond to systems failures or service interruptions. The report identifies several process and control problems in the sector, especially in relation to risk model oversight and contingency planning.

Among several concerns raised, the FCA notes in particular the challenges that arise from functionality, delivery, or resilience requirement changes due to external factors such as regulatory change or evolving cyber risks and the lack of, and need for, adaptable "risk-based and outcome-oriented" vendor reviews and vendor audit and management programs to respond effectively to such occurrences.

The FCA also found that firms had generally not given enough consideration to how they would manage vendor outages of extended lengths, despite the critical importance of portfolio management tools and associated services, including data packages, to their day to day operations. This resulted in insufficient contingency arrangements that failed to meet the actual levels of risk with particular weaknesses identified in relation to the frequency, timing, synchronization, and storage of data back-ups.

The report is a toe in the water of a much broader pool of operational resilience initiatives the FCA, PRA,  and Bank of England are collectively working on as outlined in last month’s regulatory update, following a series of damaging outages that occurred over recent years in the UK.

KYC Journey

Barrie C. Ingman

Regulatory Advisor




The information contained in this article is not investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.