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Regulatory Update: May 2020


By Barrie C. Ingman  |  May 5, 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.


IOSCO Publishes Sustainable Finance Report

On April 4, 2020, the International Organisation of Securities Commissions (IOSCO) published a sustainable finance report, which reported on its broad survey of ESG regulatory measures at a national level, together with analysis of international and industry-led ESG initiatives. It concluded that there were several areas requiring improvement in the broader ESG regulatory landscape and that IOSCO was ideally positioned to assist in procuring such changes.

Unsurprisingly, the report discovered extensive market fragmentation arising from multiple frameworks, standards, and definitions across the ESG landscape that is leading to greenwashing and related investor protection considerations. Somewhat ironically, its solution is to establish yet another "Task Force" on Sustainable Finance.

However, this task force is aimed at fostering collaboration with other organizations and regulators to diminish duplication and enhance regulatory coordination rather than expand on the set of existing arrangements.

Korean Bank Fined $86M for Iranian Sanctions Violations

On April 20, 2020, the U.S. Attorney’s Office for the Southern District of New York (SDNY) announced that together with the New York Attorney General (NYAG) (see their press release) they had concluded a six-year investigation into the South Korean state-owned Industrial Bank of Korea (IBK) for sanctions violations.

The case involved transfers channeled through IBK’s New York branch of more than $1billion from Kenneth Zong and the companies he owned and/or controlled to Iranian entities, and ultimately to the Iranian government in violation of the International Emergency Economic Powers Act.

The case also involved a willful failure over many years to establish and maintain adequate anti-money laundering (AML) systems and controls within IBK’s New York branch in violation of the Bank Secrecy Act, despite frequent request from the branch Compliance Officer.

IBK admitted its unlawful conduct, entering into a Deferred Prosecution Agreement (DPA) with the SDNY and a Non-Prosecution Agreement (NPA) with the NYAG, and agreed to undergo regular reviews of its AML and sanctions compliance programs to resolve the matter.

Furthermore, as summarized in the DPA, “As a result of the conduct described in the Information and the Statement of Facts, IBK agrees to pay $51,000,000 to the United States (the “Stipulated Forfeiture Amount”) pursuant to this Agreement. IBK has further agreed to pay a $35,000,000 penalty to the New York State Department of Financial Services (DFS) in connection with its concurrent settlement of a related regulatory action (the “Consent Order”).”

Octogenarian Zong is not permitted to leave South Korea following several tax fraud convictions related to the present matter. He nevertheless has also been indicted by the U.S. Attorney’s Office in Anchorage, Alaska, for several other money laundering and related charges. Zong’s son has already been convicted in the U.S. as a co-conspirator in the matter.


CFTC Plans Shake-Up of its Bankruptcy Rules

In a press release published on April 14, 2020, the Commodity Futures Trading Commission (CFTC) announced that it had unanimously approved proposed amendments to Part 190 of its regulations that govern bankruptcy proceedings of commodity brokers. The proposed amendments comprehensively update the rules to “reflect current market practices and lessons learned from past commodity broker bankruptcies.”

The proposals cover a variety of disparate issues including how shortfalls in customer-segregated assets are covered, the treatment of "public" over "non-public" customers with the latter to be entitled to preferential interest pro rata distribution of their claims, maintenance of "porting" rather than liquidating of customer positions, new rules governing bankruptcy of derivatives clearing organizations, changes in the treatment of letters of credit posted as collateral so that they rank equivalent to cash and other assets, and the granting of enhanced powers of discretion to trustees, thereby electing expediency over accuracy in terms of importance in bankruptcy scenarios.

The proposed rule has a 90-day comment period that started on April 14, 2020.

SEC Proposes Rule 2a-5 to Overhaul Fund Fair Value Determinations

On April 21, 2020, the SEC proposed rule 2a-5, “Good Faith Determinations of Fair Value,” which would broadly update fair value determination standards for U.S. funds. As observed by the SEC, the proposed rule would potentially impact nearly the entire universe of U.S. registered investment companies. Highlights of the proposed rule components include: (i) rescinding previously issued guidance on the role of the board of directors in determining fair value and the accounting and auditing of fund investments (including ASR 113 and 118), (ii) identification of valuation risk, (iii) fair value methodology selection and testing, (iv) pricing sources, (v) fair value policies, procedures and roles, and (vi) record-keeping. Comments on the proposed rule are due by July 21, 2020. The proposed rule, if adopted, will have a one year transition period following publication in the Federal Register.

SEC Adopts New Rules Governing the Offering Process for Closed-End Funds

On April 8, 2020, with votes partly split along partisan lines, the SEC voted to adopt a final rule on "Securities Offering Reform for Closed-End Investment Companies" that modifies several existing rules and forms to further facilitating retail investment in small companies. Specifically, the proposals modify the registration, communication, and offering processes for registered closed-end investment companies and unregistered "business development company" (BDC) closed-end investment companies under the Securities Act of 1933.

The new rules will allow these investment companies to use the securities offering rules that currently apply to operating companies by expanding the definition of “well-known seasoned issuer.” These changes will have the result of “streamlining the registration process for these investment companies, including the process for shelf registration; permitting these investment companies to satisfy their final prospectus delivery requirements by filing the prospectus with the commission; and permitting additional communications by and about these investment companies during a registered public offering." The final rule also amends certain rules and forms to tailor the disclosure and regulatory framework to these investment companies.

The changes will expand the ability of certain registered closed-end funds or BDCs that conduct continuous offerings to make changes to their registration statements on an immediately effective basis or automatically effective basis for a set period after filing. Unlike operating companies, they will not, however, be required to file Form 8-K periodic reports.

Finally, the changes introduced extend the Securities Act Rule 138 research safe harbor for broker-dealers publishing research about specified issuers during a securities offer period to in-scope funds.

The rule and form amendments will enter into effect on August 1, 2020, with application and compliance dates for various of the measures set to go live between 2021 and 2023.


Commission Consults on Renewed Sustainable Finance Strategy

On April 8, 2020, the European Commission launched a consultation on its "Renewed Sustainable Finance Strategy" as part of the European Green Deal. Within the broader context of the European Green Deal Investment Plan, the renewed strategy seeks to establish a solid foundation from which to enable sustainable investment, together with full integration of climate and environmental risks into the financial system.

The strategy is extremely broad in its scope, covering insurance and banking prudential rules, proposals for a Green Bond Standard, credit ratings and research, accounting practices and corporate disclosures, together with several other related topics. The consultation will be open until July 15, 2020.

The consultation follows a January 2020 Commission publication of a study on "Due Diligence Requirements Through the Supply Chain," which considers the options for introducing an EU ESG due diligence obligation based on the definition in the UN Guiding Principles on Business and Human Rights (as also incorporated into other international frameworks such as the OECD Guidelines for Multinational Enterprises and the International Labour Organization Tripartite Declaration of Principles – the “MNE Declaration”), which defines the obligation as a duty to identify, prevent, mitigate, and account for adverse corporate impacts on human rights and the environment. The study investigates various options of achieving the integration of such an obligation, concluding, unsurprisingly, that a mandatory regime would be more effective, but more expensive, than a voluntary scheme and that the effectiveness of the regime will correlate to the degree of supervisory and enforcement resource dedicated to it.   

ESG Taxonomy Regulation Imminent

On April 24, 2020, the European Council published a communication from the commission to the European Parliament announcing its support and accepting the council’s adoption of a modified regulation "on the establishment of a framework to facilitate sustainable investment …," also known as the pending "Taxonomy Regulation." The Parliament is expected to adopt the draft in the coming weeks, after which it will be published in the Official Journal.

The proposed regulation establishes, amongst other issues, a classification system and criteria that "economic activities" must meet if investments in them are to be marketed as "environmentally sustainable," thereby providing a unified standard for such investments.

The changes made by the council to the commission’s original draft include expansion of the scope of application, additional disclosure obligations, the introduction of "enabling" and "transitional" activities as sub-classes of "environmentally sustainable" economic activities, an extension of the requirements for "minimum social safeguards" for "environmentally sustainable" economic activities and the introduction of two new expert groups to assist with the development of delegated legislation (among other tasks). Finally, the changes include modifications and expansions to the disclosures under the Sustainability Disclosure Regulation 2019/2088.

The text contains several implementation dates including for the adoption of Commission Delegated Acts on "technical screening criteria" for categories of "environmentally sustainable economic activities," the first of which are due by December 31, 2020, with entry into force set to occur from December 31, 2021, which is when the first of the substantive rules within the Taxonomy Regulation goes live.

EU Consults on proposed ESG Disclosure Delegated Legislation

In a press release of April 23, 2020, the European Supervisory Authorities’ Joint Committee announced it had published a consultation on proposed Regulatory Technical Standards (RTS) for entity level and at product level ESG disclosures under the Sustainability Disclosure Regulation 2019/2088 (SFDR) and proposals under the recently agreed Taxonomy Regulation on the do not significantly harm (DNSH) principle. The consultation is open until September 1, 2020.

The entity-level sustainability disclosures concern website notifications of the adverse impacts of investment decisions on sustainability factors, together with draft indicators of what constitutes an adverse impact.

The product-level sustainability disclosures relate to pre-contractual, periodic reporting, and website disclosures on how their products meet the sustainability characteristics or objectives they promote and how sustainable investments comply with the DNSH principle.

Commission Consults on Climate Benchmark Delegated Acts; ESMA Issues No-Action Letter

On April 8, 2020, the European Commission announced several consultations on delegated legislation pursuant to the Benchmarks Regulation (EU) 2016/1011, as amended by the Climate Benchmarks Regulation (EU)2019/2089.

Specifically, pursuant to Article 19a(2) of the Benchmarks Regulation, the Commission published a draft delegated regulation specifying minimum standards for "EU climate Transition Benchmarks" (EU CTBs) and "EU Paris-aligned Benchmarks" (EU PABs). The draft contains technical selection and methodology criteria for the two types of climate benchmarks, including details of reference temperature scenarios, minimum requirements on equity allocation constraints, details governing the calculation of greenhouse gas emissions, requirements relating to the decarbonization trajectory of climate benchmarks (including disclosure obligations), transparency requirements for estimations, and rules governing the accuracy of data sources among other measures.

Pursuant to Article 27(2b) of the Benchmarks Regulation, the Commission also published a draft delegated regulation together with two Annexes specifying disclosure requirements for ESG factors within the benchmark statement, which include granular details on ESG requirements such as references to "controversial weapons" and tobacco for "social" disclosures and the greenhouse gas emission intensity of the benchmark for the "environmental" section of the ESG disclosure.

Finally, pursuant to Article 13(2a) of the Benchmarks Regulation, the Commission published a draft delegated regulation on the information benchmark administrators must disclose in relation to how they build ESG factors into their calculations in terms of selection, weighting or exclusions, the source and any validation of data, and adherence to international standards as specified in a table annexed to the Regulation.

The feedback period for all three proposals ends on May 6, 2020. In the interim, on April 29, 2020 ESMA published a No Action Letter stating that National Competent Authorities should not prioritize supervision and enforcement of the rules until the more granular rules in the Delegated Acts are live. In the same announcement, ESMA published an opinion stating essentially, that the commission should get a move on in publishing the delegated acts.

EU Green Bond Standard "Usability Guide" Published

The EU’s Technical Expert Group (TEG) on Sustainable Finance, building on their June 2019 EU Green Bond standard report (which recommended a voluntary, non-legislative standard), published a usability guide in March 2020, which provides guidance on how to use the TEG’s proposed standard in practice. Specifically, the proposals recommend tying the "use of proceeds" of the funding of Green Bonds to Article 3 of the pending Taxonomy Regulation, which requires "economic activities" to contribute to a specified environmental objective, adhere to upcoming technical screening criteria, and to comply with "do no significant harm" (DNSH) principle and specified minimum social safeguards.

The usability guide also discusses independent verification of the use of proceeds—a recommendation that seeks to formalize and improve upon existing market practices, which were codified by the International Capital Markets Associations’ (ICMA) in their 2018  guidelines for green, social, and sustainable external reviews and formalized to a degree through the Climate Bonds Initiative accreditation scheme, which integrates ICMA’s green bond principles (GBPs). The recommendation essentially proposes an entirely new regulatory regime for independent verifiers of green bond assets.

Despite the TEG recommending a voluntary scheme and publishing its new usability guide, the European Commission has nevertheless stated on its green bond webpage (and in a March 2020 press release) that it will explore the possibility of a legislative initiative for an EU Green Bond Standard as part of its renewed sustainable finance strategy public consultation, as further set out in its 2020 work programme.

ESMA Publishes Fund Performance Fee Guidelines

On April 3, 2020, ESMA published a Report annexed with guidelines on "Performance Fees in UCITS and Certain Types of AIFs," which introduce minimum standards for performance fee models for in-scope funds. 

The guidelines apply two months after their publication in all EU official languages. The rules will then apply immediately for funds created after that date and to existing funds that introduce a performance fee after that date. Funds with pre-existing performance fees must apply the guidelines by the beginning of the financial year following six months from the Guidelines’ application date.

Guideline 1 specifies requirements for the calculation method of performance fees based on objective metrics. Guideline 1 also contains several general investor protection and conflicts of interest related principles. Guideline 2 specifies requirements for consistency between the performance fee model and the fund’s investment objectives, strategy, and policy.

Guideline 3 specifies that the fee crystallization frequency should not be more than once a year (subject to a few exceptions) and must align with proper manager incentive and performance principles. Guideline 4 specifies rules on fee calculation over periods when losses have accrued. Finally, Guideline 5 specifies rules in respect of disclosures of the performance fee model in prospectuses, annual, and semi-annual reports and in Key Investor Information Documents (KIIDs) including prominent warnings where appropriate in respect of the latter.

ESMA Publishes Final Report on MiFID II Inducements, Costs, and Charges Disclosures

On March 31, 2020, ESMA published technical advice to the commission on the impact of the inducements and costs and charges disclosure rules in MiFID II Article 24(4)(c) and Article 24 (9) para 2.

In relation to the Article 24 (9) inducement rule, ESMA recommends an assessment of the impact inducement bans have had in the Netherlands and the UK with the analysis and subsequent outcomes to be applied to all retail investment products, not just MiFID II financial instruments. In the meantime, ESMA proposes improvements to clients’ understanding of inducements and the effect they have on the distribution of investment products by modifying the existing disclosure requirements.

In relation to the Article 24(4)(c) costs and charges rules, ESMA sets out several recommendations including more flexibility in relation to eligible counterparts and professional clients including opt-out provisions. However, in relation to the regime more generally, ESMA concludes that "for retail clients and eligible counterparts and professional clients who do not opt-out of the MiFID II costs and charges disclosure requirements, the existing regime has proven effective and should be kept in place" subject to a few modifications such as the scope for more granular ISIN by ISIN disclosures in specified circumstances and measures to introduce "cross-sectoral alignment" with ESMA noting that "investment products with the same characteristics should be treated the same." Hence, not only financial instruments but also similar investment products (in particular, insurance products) should be subject to the costs and charges disclosure regime set forth by MiFID II.

ESMA Consults on Measures to Mitigate Systemic Risk posed by Leverage within AIF Sector

The European Systemic Risk Board (ESRB) recommendations published in April 2018 requested that ESMA, among other matters, provide guidance on Article 25 of Directive 2011/61/EU (AIFMD) on the framework to assess the extent to which leverage within the Alternative Investment Fund (AIF) sector contributes to the build-up of systemic risk in the financial system and further, to give guidance on the design, calibration, and implementation of macro-prudential leverage limits in this regard. In response, ESMA published a  consultation paper on March 27, 2020, appended with draft guidelines on harmonized measures that National Competent Authorities should undertake when monitoring the systemic risk posed by leverage in the AIF sector, including measures to impose leverage limits on AIFs that pose a risk to financial stability. ESMA will consider comments received on the proposals by September 1, 2020. The Guidelines are expected to be published shortly thereafter and apply two months after that.


German Court Convicts Former London Traders in CumEx  Scandal

Following ESMA’s July 2019 Report into withholding tax reclaim schemes (as summarized in our August 2019 update), "dividend arbitrate" schemes have once again captured column inches following a criminal judgement delivered in Germany on March 18, 2020, that is likely to have long term international repercussions.

After a previous interim ruling that CumEx trading was illegal per se, on March 18, 2020, Judge Roland Zickler, sitting in a regional Court in Bonn, delivered an expedited ruling in the trial of two former London traders for their part in a €400 million "Cum-Ex" dividend arbitrage tax evasion scheme. The ruling has sent shock waves through the financial sector given its potential to open the floodgates into related civil, criminal, and regulatory cases in several other jurisdictions.

German prosecutors have confirmed that they are currently investigating 600 suspects in 56 other investigations, including bankers, traders, consultancies (including one of the "Big Four") and even Magic Circle lawyers who charged outsized sums to deliver opinions confirming the legality of the trades.

Press reports have suggested that at least 130 banks are under suspicion of having taken part in these schemes with estimates for the loss to several states including Germany, France, and Italy in the high tens of billions of Euros.

The two men in the present case, Martin Shields and Nicholas Diable, managed to avoid jail by cooperating extensively with prosecutors but were nevertheless convicted, given suspended sentences and required to pay several million Euros in fines (Shields specifically was ordered to pay €14 million).

Despite these sizable fines, in the game of prisoners dilemma between those under investigation, the two "defecting" men in this ruling appear to have escaped lightly compared with others under investigation, since this degree of leniency is exceedingly rare in Germany cases of large-scale tax evasion.

The scheme in question, sometimes euphemistically called "dividend arbitrage" or "yield enhancement" involved lending shares at high speed on or just before the dividend record date so that two or more parties could claim a tax rebate on the same dividend, when, in fact, tax on the dividend had only been paid once.

The court also ruled against M.M. Warburg Group, the principal lender providing liquidity to facilitate the trades in the case, ordering them to repay €176 million, calculated as the profit they made from the arrangements. The bank has declared that it will appeal the decision.

The UK’s FCA 2017 Market Watch Newsletter  reported on an investigation it had undertaken back then into such arrangements, setting out conduct that could constitute market abuse, tax evasion, or otherwise in violation of its principles. Perhaps somewhat embarrassingly in hindsight, it concluded that no unlawful activity had been identified in its investigation despite what has now been uncovered as a systemic practice across the sector that was particularly endemic to London. That the UK does not have the same tax arrangements as Germany and other affected jurisdictions and so would not have been impacted by such activity. This should not have affected the outcome of the FCA review, even though some commentators have suggested that less priority may have been given to the matter since UK securities and taxes were not impacted.

To date, the FCA and UK’s Serious Fraud Office (SFO) have not commented on what steps, if any, they are taking in response to the unfolding scandal. However, law firms are publishing advertisements in the UK offering to represent anyone under investigation by the FCA or SFO in relation to the matter.

It is too early to tell whether the scandal will be as large as recent sagas such as those involving FX manipulation and Libor rigging. However, the signs are looking ominous.


UK Agency Imposes Unprecedented £20M Penalty for Russian Sanctions Violations

On February 18, 2020, a Treasury Minister upheld the Office of Financial Sanctions Implementation’s (OFSI) decision to impose penalties under the Policing and Crime Act 2017 (PACA) on Standard Chartered Bank (SCB) for breaches of EU Sanctions rules supporting the sovereignty and independence of Ukraine, concluding that on the balance of probabilities SCB had reasonable cause to suspect it was in breach of sanctions. SCB decided not to appeal the case to the Upper Tribunal.

The penalties, totaling £20.47 million, were discounted by 30% based on substantial cooperation with the investigation and its voluntary notification of the breach.

The penalty is the fourth imposed by the OFSI since it was established in early 2016 and dwarfs all of the others by some margin, with the former fines coming in at £5k, £10k, and just under £150k respectively. Unfortunately, there is little discernible detail as to why this case was differentiated in terms of penalty size, although on the facts of the case, the duration, number of breaches, and transaction sizes are all likely to have been material.

The sanctions in question targeted specified Russian banks, companies, and subsidiaries, preventing them from accessing the EU’s capital markets or obtaining financing from EU financial institutions.

The case involved 102 loans that SCB granted to Denizbank A.Ş. between April 2015 and January 2018, which at the time was all-but wholly owned by Sberbank of Russia—a sanctioned entity. As a majority-held subsidiary of sanctioned entity, the sanctions applied equally to Denizbank.

The EU Regulation in question provides an exemption for import and export finance that supports legitimate EU trade.  However, the OFSI found that 70 of the 102 loans, totaling over £266 million, did not fall with within the exemption and as such were in violation of the sanctions.

SCB sought a Ministerial review of the decisions under Section 147 of PACA that permits a Minister of the Crown to uphold or cancel a decision or modify the amount of the penalty. The Minister agreed it was a "most serious breach" but nevertheless wiped £11 million from the original OFSI penalty on the basis that insufficient weight had been given to the fact that willful breaches had not occurred, that SCB had acted in good faith, had intended to comply with the relevant restrictions, had fully co-operated with the investigation, and had taken prompt remedial steps after the breach.

On announcing the penalty, the OFSI emphasized the importance of continuously reviewing due diligence, sanctions  screening, and related compliance processes and reminded practitioners of the UK government’s consolidated list of sanctions and the availability of email alerts from the government notifying when updates to the list have been made.

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Barrie C. Ingman

Regulatory Advisor




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