Nels Ylitalo, VP, Director Product Strategy, Regulatory Solutions, also contributed to this article.
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.
ESG Update: Multiple Developments Launched and Taxonomy Regulation Published
On June 18, 2020, the Presidents of the European Council and Parliament announced in a Press Release that they had signed the EU Taxonomy Regulation into law. The regulation was published in the EU Official Journal four days later.
The Taxonomy Regulation will introduce a system to classify whether economic activities undertaken by corporates can be categorized as environmentally sustainable. It interfaces with the EU Sustainable Finance Disclosure Regulation (SFDR), supplementing its disclosure requirements with taxonomy-related requirements that will apply from January 1, 2022.
However, as noted by the European Supervisory Authorities (ESAs) in their April 23, 2020 Joint Committee Consultation Paper on the draft proposed SFDR delegated legislation, there are several discontinuities between several of the EU ESG legislative texts, including a disconnect between the ESG data corporates are required to publish under the Non-Financial Reporting Directive (NFRD), and the data required for the purposes of the SFDR and Taxonomy Regulation.
The ESA’s individually (see e.g. the responses of the European Banking Authority and European Securities & Markets Authority) and collectively responded on June 11, 2020 to the European Commission’s NFRD Consultation (published in February 2020), expressly endorsing several proposals in the consultation, including measures to harmonise NFRD disclosures with the requirements of the Taxonomy Regulation and the SFDR.
While the EU has been announcing these new ESG measures, the asset management industry in the U.S. has been pleading once again for the SEC to take similar measures in Recommendations submitted on 14 May 2020. As before, however, SEC Chair Jay Clayton has dismissed the recommendations, in the same Press Release announcing them, invoking his previous concern that conflation of ESG factors leads to insufficiently precise analysis for the purposes of meaningfully informing investment decisions.
Supplementing the Taxonomy Regulation and the other developments outlined above, the European Commission published two, somewhat similar, Q&A documents in mid-June, 2020, one on Sustainable Finance, the other on The Taxonomy & Green Finance.
Both papers outline the taxonomy, the proposed EU Green Bond Standard and several other related measures that interface with these initiatives. Both documents also set out the next series of steps that will be taken to roll out these measures over the medium term.
In terms of Green Finance, in mid-June 2020, the Commission also published an impact assessment for the proposed EU Green Bond Standard, paving the way for this measure to become operational from 2021. Meanwhile, updated versions of the global, non-regulatory, voluntary standards—the Green Loan Principles and Sustainable Linked Loan Principles—were published by the Loan Markets Association and associated trade bodies in May 2020.
Finally, several ESG developments relating to prudential legislation were recently published. Specifically, at the end of May, 2020 the European Central Bank (ECB) published non-binding supervisory Guidance on climate-related and environmental risk management practices and disclosures within the EU prudential regime, once again emphasising enhanced transparency in climate-related and environmental disclosures by cross-referencing the Commission NFRD Guidelines on Reporting Climate-Related Information. Meanwhile, from an insurance perspective, the European Commission launched a review of Solvency II, in relation to the integration of sustainability risks into the prudential process.
Starting with a New Blacklist, EU AML/CFT Rules Are Being Shaken Up Again
On May 7, 2020, pursuant to Article 9 of the 4th Anti-Money Laundering Directive, the European Commission published a new Delegated Regulation, (amending the ‘High-Risk Third Countries’ Delegated Regulation (EU) 2016/1675) updating the lists of jurisdictions it has identified as having strategic deficiencies in their AML/CFT regimes and which (therefore) pose a significant threat to the EU’s financial system.
Afghanistan, Pakistan, Iraq, Iran, Syria, Trinidad and Tobago, Yemen, North Korea, Uganda and Vanuatu remain on the lists. Whereas Bosnia-Herzegovina, Guyana, Lao PDR, Ethiopia, Sri Lanka and Tunisia are removed. The Bahamas, Barbados, Botswana, Cambodia, Ghana, Jamaica, Mauritius, Mongolia, Myanmar, Nicaragua, Panama and Zimbabwe have all been added to the lists.
This constitutes the biggest update to the lists since they were first published almost half a decade ago, with a third of names removed and an almost doubling of the length of the lists with the additions.
The Commission, also published the Revised Methodology it used in identifying these high-risk third countries. The new methodology, which will be used for all future updates, commences with an evaluation of FATF lists (Tier 1) and concludes with an evaluation of additional countries (‘Tier 2’, summarised here) using a new approach which considers a country’s AML/CFT arrangements against eight objective ‘building block criteria’.
In accordance with its roadmap for implementing the new methodology, the Commission distinguishes between 'Priority 1 and 2’ categories of countries, with Priority 1 countries (comprising 54 countries) to be assessed by the end of 2020 and with Priority 2 countries (comprising a further 78 countries) to be assessed as soon as possible thereafter, up until 2025.
As set out in our March 2019 Regulatory Update, the Commission was forced to revise its original methodology after it produced a ‘blacklist’ containing several EU political allies including four American jurisdictions and the Kingdom of Saudi Arabia. These jurisdictions do not appear on the new list.
Also on May 7, 2020, the Commission adopted a new AML/CFT Action Plan, (accompanied by a Public Consultation, open until 29 July 2020). The Action Plan is a response to the findings of the 2019 Anti-Money Laundering Package (summarised in out update August 2019 Regulatory Update), which identified fragmentation of rules, uneven supervision and extensive limitations in the cooperation among Financial Intelligence Units (FIU) across the EU, among other failings.
The new Plan is based on the following six ‘pillars’: 1. effective implementation of existing rules; 2. The development of a single EU rulebook; 3. EU-level supervision; 4. An FIU support and cooperation mechanism; 5. better use of information to enforce criminal law; and 6. ‘A stronger EU in the world’.
The Commission intends to deliver on each of these actions by early 2021. Such measures, if properly implemented and enforced could constitute a game-changer in the fight against financial crime in the Union, notwithstanding the original underlying concerns over the politicisation of certain aspects of the rules.
EBA Publishes Dividend Arbitrage Trading Investigation Findings and Next Steps
On May 12, 2020, the European Banking Authority (EBA) published the findings of its inquiry into ‘Dividend Arbitrage’ trading schemes, as requested by the European Parliament on November 28, 2018 (following public revelations relating to the CumEx Scandal, covered in our last update of May 2020).
The EBA asked Member states whether these ‘dividend arbitrate’ schemes amounted to (tax) crimes under national laws, for the purposes of establishing whether ‘predicate offences’ subject to the 5th and 6th Money Laundering Directives had occurred. Eight Member States confirmed that such schemes were criminal offences under national (statutory) law, and several others indicated that the schemes were criminal offences under case (i.e. common) law.
More generally the EBA inquiry found insufficient oversight, and a lack of alignment and co-operation between AML/CFT regulators and prudential regulators alike across the Union, in respect of the schemes.
In response to these findings, the EBA has published a 10 Point Action Plan, which includes either assessing, clarifying or enhancing several of its Guidelines, including those on internal governance, risk-based supervision, AML risk factors, and the Supervisory Review and Evaluation Process (SREP), as well as a commitment to amend its official Opinion on money laundering and terrorist financing risks.
The Action Plan also contains several measures to enhance EBA oversight (and to prepare reports on) prudential colleges and AML authorities in relation to the issues at hand.
Finally, the EBA has committed to carrying out an inquiry under Article 22 (4) of the EBA Regulation to assess the potential threat the conduct and the regulatory responses thereto might pose to the stability of the financial system.
In the interim, a large number of related criminal cases are making their way through the German courts, with other jurisdictions such as France and Italy expected to follow.
ESMA Publishes Guidelines on MiFID II Compliance Function
On June 5, 2020, the European Securities and Markets Authority (ESMA) published guidelines on the compliance function under MiFID II, replacing its 2012 guidelines on the same topics. The guidelines are addressed to investment firms and credit institutions (whether providing investment services and activities or selling or advising clients in relation to structured deposits), UCITS management companies and Alternative Investment Fund Managers (AIFMs).
ESMA has characterized the new guidelines as a clarification and refinement of its 2012 guidelines, for the purpose fostering convergence in both the implementation and supervision of new MiFID II compliance function requirements.
The new guidance consists of twelve guidelines covering topics such as: risk assessments, monitoring and reporting obligations, advisory and assistance, organizational, knowledge and expertise, and outsourcing.
As a next step, the guidelines will be translated in the official EU languages and published on ESMA’s website, which will trigger a two month period during which NCAs must notify ESMA whether they comply or intent to comply with the guidelines.
ESMA Publishes Updated Transparency and Position Limit Opinions on Third Country Venues
On June 3, 2020, the European Securities and Markets Authority (ESMA) published updated position limit and transparency opinions on third country trading venues (TCTVs).
In general, ESMA’s identification of 136 trading venues from 25 countries as “trading venues” for purposes of MiFID II and MiFIR post-trade transparency eliminates duplicate post-trade reporting of transactions by investment firms concluding transactions on TCTVs.
With respect to position limits, the newly published list of 7 venues from 4 countries have a fully positive assessment, meaning that commodity derivatives traded on such venues should not be considered as economically equivalent OTC contracts for the purpose of the position limits regime.
Annexes to the opinions list all of the relevant trading venues, including indications of a positive or partially positive assessment by instrument type.
Publication of Final Rule on Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds
On June 25, 2020, five U.S. financial regulators—OCC, Federal Reserve System, FDIC, SEC and CFTC—published the Final Rule amending the “Volcker Rule's” implementing regulations, which generally prohibit banking entities investing in or sponsoring hedge funds or private equity funds (so-called “covered funds”).
In general, the Volcker Rule prohibits banking entities from engaging in proprietary trading and from acquiring or retaining ownership interests in, sponsoring, or having certain relationships with hedge funds and private equity funds. The basic purpose of the Volcker Rule’s covered fund provisions was to ensure that banking entities could not accomplish indirectly that which they were not permitted to do directly. The finalized rule alters the status quo, primarily in three areas:
introducing exceptions to the “covered funds” definition for (i) credit funds, (ii) venture capital funds, (ii) family wealth management vehicles and (iv) customer facilitation vehicles;
simplifying eligibility criteria for existing exclusions from the definition of covered fund for (i) loan securitizations, (ii) foreign public funds and (iii) small business investment companies (SBICs); and
Expanding the scope of permitted activities deemed beyond the concerns of the original rule.