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Regulatory Update: October 2019


By Barrie C. Ingman  |  October 8, 2019

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.




United Nations and 130 Banks Launch ‘Principles for Responsible Banking’

On September 22, 2019, the United Nations launched its Principles for Responsible Banking, developed in a partnership with 30 banks and the ‘United Nations Environment Programme – Finance Initiative.’ In the press release, it was announced that 130 banks holding $47 trillion in assets—one-third of the global banking sector—signed up. The Principles commit banks to strategically align their business with the goals of the Paris Agreement on Climate Change and the UN’s Sustainable Development Goals. The Principles are supported by a robust implementation framework that defines accountability and requires each bank to set, publish, and work towards ambitious ESG and sustainability-related targets.

The list of signatory banks includes household names from across Europe, Asia, and Africa such as Credit Suisse, Deutsche Bank, ING, Mizuho, Santander, Société Générale, Standard Bank Group, Standard Chartered, and UBS.

The six principles as follows:

  1. Alignment of strategy to the UN Sustainable Development Goals, the Paris Climate Agreement, and relevant national and regional frameworks
  2. Set and publish targets to increase the positive and reduce the negative impact of their business
  3. Work with clients and customers to encourage sustainable practices
  4. Proactively engage with stakeholders to achieve social and sustainable goals
  5. Embed social and sustainable goals within the firm’s culture and governance structures
  6. Implement transparency and accountability measures to review and report on the firms’ progress and impact.



Four Down One to Go: Agencies Back Volcker Roll Back

The Volcker Rule, which prohibits banks from engaging in proprietary trading or sponsoring, taking interests in, or entering specific relationships with private equity or hedge funds (‘covered funds’) is in the process of being significantly loosened.

The Office of the Comptroller Currency (here), the Federal Deposit Insurance Corporation (here), the Securities Exchange Commission (SEC) (here), and the Commodity Futures Trading Commission (here) have all recently adopted amendments to the Volcker Rule that liberalize its proprietary trading restrictions, simplify associated compliance requirements, and clarify or modify certain exemptions in relation to covered funds. Notably, the new definition of ‘trading account’ reduces by up to half the number of financial instruments subject to proprietary trading restrictions.

As with many recent U.S. deregulation initiatives, support for the changes has been split along partisan lines with dissenters suggesting that the initiative will emasculate the capacity for agencies to supervise and enforce a rule set intended as a bulwark against the moral hazard and risk-seeking behavior that contributed to the financial crisis. By contrast, proponents have hailed the tailored, risk-based approach the rules introduce.

The Federal Reserve has yet to approve the final rule, after which it will be published in the Federal Register. Banking institutions are set to comply with the new final rule from January 1, 2021. Proposals for additional changes to the rules governing covered funds are also set to be published in due course.

SEC Adopts New Rule to Modernize Regulation of Exchange-Traded Funds

On September 26, 2019, the SEC announced it had adopted a new Rule 6c-11 under the Investment Company Act of 1940 and a new broker-dealer Exemptive Order under the Securities Exchange Act of 1934, together with modifications to related Forms N‑1A and N‑8B‑2. The changes are designed to modernize the regulation of open-ended exchange-traded funds (ETFs).

Non-transparent, leveraged, inverse and unit  investment trust ETFs—together with ETFs structured as a share class of a multi-class fund—will not be subject to the new rules.

The package of measures is designed to establish a clear and consistent framework for most ETFs and facilitate a swifter time to market by dispensing with the need to obtain individual exemptive relief for each fund; the new measures will have the effect of replacing the swathe of individualized exemptive orders with a single rule. 

Form N-1A, used by open-end ETFs to register and offer securities under the Securities Act, will be amended so that disclosures to investors who purchase ETF shares on an exchange are more focused.  Equally, Form N-8B-2 will be modified so that the same disclosure requirements apply to ETFs structured as unit investment trusts.

Under the new rule and associated exemptive relief, ETFs will have to comply with existing investor protection rules and new associated transparency requirements such as website disclosures of historic premiums, discounts, bid-ask spreads, and daily portfolio data.

Amongst other changes, additional policies and procedures will be required where a fund invests in custom baskets that deviate from a pro-rata representation of the fund and ETF funds will be prohibited from establishing master-feeder structures in future.

The rule and form amendments and related exemptive relief will be effective 60 days after publication in the Federal Register. There will be a one-year transition period for compliance with the form amendments.




ESMA Issues Fund Liquidity Stress Tests Guidance for Firms and Simulation Frameworks for Supervisors

On September 2, 2019, ESMA published guidelines on liquidity stress tests that UCITS and AIF investment funds must comply with when seeking to demonstrate that they can meet redemptions under extreme market conditions. The rules also promote convergence of supervisory practices in relation to stress tests.

At the request of the European Systemic Risk Board, the guidelines are based on current market practice and stress testing requirements in the Alternative Investment Fund Managers Directive (AIFMD).

The guidelines come at a time when redemption pressures have surfaced at a number of EU asset managers, several of which have seen billions of euros in outflows and have been forced to impose redemption suspensions in some instances. 

Under the new guidelines, fund managers will need to follow a comprehensive set of rules in relation to establishing stress scenarios, which may require the development of new models, systems, and data requirements. The guidelines also impose rules on depositaries, requiring them to verify that fund managers have documented procedures for liquidity stress testing.

The guidelines supplement the liquidity stress testing requirements within AIFMD and UCITS. They will apply from September 30, 2020.

Related to the Guidelines, on September 5, 2019, ESMA also published a stress test simulation framework for regulators, which must be followed when assessing fund stress test simulations.

ESG, Closet Indexing, and MIFID II Market Data Concerns Raised at ESMA Stakeholder Meeting

ESMA recently published summary conclusions of the ‘Joint Meeting of the Board of Supervisors and the Securities and Markets Stakeholder Group.’

The joint meetings often provide indications of what policy drivers and regulators have in mind in terms of regulatory developments over the short to medium term.

In the present instance, in addition to familiar topics such as investor protection and Brexit, several other less common topics were given prominence. Notably, MIFID II market data, transparency, and access was raised on a number of occasions with the topic of speed bumps expressly mentioned for the first time, together with discussions on the impact of algorithmic traders on competition, liquidity, and market access.

The debate follows the publication by ESMA in July on a consultation paper discussing the cost of market data and the need for a post-trade consolidated tape for equity instruments. ESMA’s consultation into the matter closes on September 6, 2019, and based on stakeholder feedback, ESMA will prepare a final report, which it plans to submit to the European Commission by December 2019.

ESG, sustainable investments, and green-washing risks were also given prominence during the joint meeting; a topic also covered by the SMSG in its recent Advice to ESMA on August 15, 2019.

Finally, the joint meeting saw an extensive analysis of closet-indexing by funds, with three regulators in particular—the CBI, FCA, and CSSF—discussing measures they were taking in relation to such practices, which include an extensive pipeline of cases currently under investigation. Despite these measures, the Stakeholder Group still declared that little had been done in this area aside from a handful of sanctions in the UK.

EU ESG Taxonomy Regulation One Step Closer to Enactment

In a press release published on September 25, 2019, the European Council announced that it had agreed to a position on a unified ESG classification system that would provide a common language identifying economic activities considered environmentally sustainable across the Union. Specifically, the proposal defines the following six EU environmental objectives:

1) climate change mitigation

2) climate change adaptation

3) sustainable use and protection of water and marine resources

4) transition to a circular economy—including waste prevention and recycling

5) pollution prevention and control

6) protection and restoration of biodiversity and ecosystems

In order to qualify as environmentally sustainable, economic activities would have to fulfill the following requirements:

  • contribute substantively to at least one of the six environmental objectives listed above
  • not significantly harm any of the environmental objectives
  • be carried out in compliance with minimum social and governance safeguards
  • comply with specific technical screening criteria

Under the proposal, the commission would be delegated the task of establishing ‘technical screening criteria’ for each relevant environmental objective through delegated legislation that includes sector classifications and quantitative and qualitative thresholds to be met by the economic activity in order to attract the relevant classification.

In accordance with the council’s position, the taxonomy should be established by the end of 2021 in order to ensure its full application by end of 2022. The European Parliament voted on its position on this file in March 2019. Negotiations between the council and the parliament will commence shortly, after which, a final version of the regulation can be expected to make its way on to the Official Journal in due course.

ESMA Reports Challenging Asset Management Outlook & Emphasizes Risks in Growing CLO Market

On September 10, 2019, ESMA published its second Trends, Risks, and Vulnerabilities report for 2019. The report presents a deteriorating outlook for the asset management industry, especially in terms of market risk. In particular, it notes that recent trade tensions have triggered renewed volatility with the prospect of a no-deal Brexit—a key driver of market risk in the future. Other operative factors contributing to the outlook include gloomy economic growth predictions, flattening yield curves, and the risk of a search for yield within a low interest rate environment triggering inflated prices.

ESMA also commented that credit and liquidity risks remain high with deteriorating quality of outstanding corporate debt and growth in leveraged loans and collateralized loan obligations (CLOs) warranting further attention. CLOs and leveraged loans were singled out in particular in a study embedded within the report with ESMA noting a growth in issuance has been accompanied by ‘looser underwriting standards, higher indebtedness of borrowers, and compressed credit spreads,’ which have led to deteriorating credit ratings that in turn (taken together) magnify vulnerability in the market more broadly. Consequently, ESMA has committed to undertake a further review of this issue including the rating methodologies for CLOs.

Other issues discussed included the recent underperformance of managed equity versus passive equity funds and the critical difference costs played in the delta between the performance of the two fund types.




FCA Issues Press Release on the Potential for Polling Information to Constitute Inside Information

Following a series of high-profile stories in the press on hedge funds purchasing and trading on unpublished polling data ahead of the Brexit referendum result, the FCA has recently issued a press release setting out when such information might constitute inside information and what steps should be undertaken under those circumstances.

The press release emphasizes that where polling information constitutes inside information, disclosure otherwise than in the normal exercise of one’s employment, profession, or duties constitutes a criminal offense; as does trading on in-scope instruments on the back of such information. Nevertheless, the FCA confirmed that for data that does not meet the definition of inside information, there are no restrictions on its collection or reception, even where relevant to financial market prices and even while polls remain open. 

The FCA further noted that while trading in spot FX is not in-scope for insider dealing provisions, FCA principles for business and other legislation could apply, and that trading in spot FX can constitute market manipulation where the the trading has an impact on other in-scope instruments such as certain spot FX options. 

UK Firm Fined £7.8m for AML Failings

On September 3, 2019, Her Majesty’s Revenue and Customs (HMRC) published a list of firms that had failed to implement certain requirements in the UK Money Laundering Regulations 2017 (which implement the fourth EU Anti-Money Laundering Directive) for the tax year 2019 to 2020. Most notable was the £7.8 million fine handed to Touma Foreign Exchange Ltd. for a series of failures in relation to customer due diligence, risk assessments, record-keeping, and staff training among other matters.

While the regulations are new, this level of fine represents a development in terms of enforcement, given that its size represents an order of magnitude increase over the largest previous fine of £215,000 handed down to the estate agent, Countrywide. The fine is evidence of the agency’s commitment to ramp up AML enforcement activity, bolstered by new powers flowing from the recent suite of domestic and EU AML regulations.

FCA Announces New Rules for Funds Invested in Illiquid Investments

The risks associated with funds that invest in illiquid assets were cast in sharp relief following the results of the UK’s EU Referendum in 2016 when several property funds had to suspend dealing. The recent suspension of the LF Woodford Equity Income Fund provides a more recent example. To mitigate such risks, on September 30, 2019, the FCA announced new rules applicable to non-UCITS retail schemes (NURSs) that invest in inherently illiquid assets such as property.  

The rules are designed to reduce the likelihood of runs on funds and subsequent asset fire sales which can benefit early redeemers at the expense of other investors in a fund. The rules introduce a new category of ‘funds investing in inherently illiquid assets’ (FIIA), which will be subject to additional requirements such as increased disclosure on liquidity management, new standard risk warnings in financial promotions, enhanced depositary oversight, and a requirement to produce liquidity risk contingency plans. The requirements will not apply where a fund matches the dealing frequency of its shares to the liquidity of its assets.

Under the new rules, NURSs that invest in inherently illiquid assets will have to suspend dealing where the fund’s independent valuer determines there is material uncertainty regarding the value of more than 20% of the fund’s assets, save for where it has been agreed with the fund’s depositary that it is in the investors’ best interests for dealing to continue.

The new rules come into effect on September 30, 2020, and are principally achieved through supplements to the FCA COLL and COBS sourcebooks. The new rules are set out in Appendix I to the FCA’s policy statement 19-24.




Hong Kong SFC Issues Consultation Paper on Proposals to Regulate Depositaries of Funds

On September 27, noting that trustees and custodians of public funds in Hong Kong are currently not subject to specific licensing requirements or direct regulatory supervision of their functions for public funds, the Securities and Futures Commission (SFC) issued a consultation paper proposing such a regime. The SFC’s proposal to regulate the activity of trustees and custodians is part of a broader effort to buttress Hong Kong as a full-service asset management center in the international market.

The proposals in the consultation paper are largely familiar measures relating to the safe custody of assets for investor protection. Key proposals include defining the regulated activity of acting as a depositary of a collective investment scheme with attendant licensing, capital, indemnity insurance, and conduct and internal controls requirements.

The SFC invites market participants and interested parties to submit written comments on the proposals no later than December 31, 2019.

KYC Journey

Barrie C. Ingman

Regulatory Advisor




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