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.
The international transition from inter-bank offered rates (IBORs) to “risk-free-rates” (RFRs) has gained significant momentum in recent months with a host of developments and publications across jurisdictions from an IOSCO statement to stakeholders, updates and warnings from the Bank of England and the FCA, to the launch of a public consultation in Japan and a new European Central Bank (ECB) Guideline on the new EU short term RFR published in the Official Journal.
In the U.S., the NY Federal Reserve began publishing an RFR—the Secured Overnight Rate (SOFR)—as of April 2018 as a successor to U.S. LIBOR, which has seen increasing take-up across markets. While in the UK, the Bank of England (BoE) has been publishing a UK RFR since 2018 - a modified Sterling Overnight Index Average Rate (SONIA), which is intended to eventually replace GBP LIBOR, with progress on developing a Term RFR (as opposed to an overnight RFR such as SONIA) underway. Meanwhile, the transition away from the Euro Overnight Index Average (EONIA) to an EU RFR is gathering pace as preparations are underway for the launch of the euro short-term rate: €STR (sometimes styled ESTER); due to be published October 2, as confirmed by the European Central Bank (ECB).
This move follows the private sector Working group on Euro Risk-Free Rates’ recommendations in March, directing stakeholders to transition from EONIA—a private sector benchmark published by the European Money Market Institute (EMMI)—to €STR. A transitional EONIA will continue to be published in tandem with €STR once the latter goes live and will be calculated at an 8.5 basis point premium above €STR until its planned cessation at the start of 2022.
In anticipation of the October 2 deadline, on July 27, ECB Guideline (EU) 2019/1265 was published in the EU’s Official Journal setting out the obligations of the ECB and national EU central banks in relation to the new rate.
Recital (1) of the guideline questions the compliance of EONIA with EU Benchmark Regulation requirements, suggesting it may be prohibited in future. For this reason, Recital (1) states that €STR is necessary as a replacement and as an interim backstop reference rate in the event of a discontinuation of EONIA.
The guideline was published shortly after a flurry of documents and press releases were published on the EMMI website. These included a press release on July 24, confirming the daily publication timing of the “transition EONIA” rate following the launch of €STR and the publication of EMMI’s EURIBOR Benchmark Statement on July 17, pursuant to the Benchmark Regulation (EURIBOR being the primary term rate in the EU currently).
Moreover, within days of the publication of the ECB Guideline, on July 31, IOSCO published a Benchmarks Transition Statement, encouraging benchmark users and other relevant stakeholders to transition away from IBORs to RFRs as quickly as possible. Specifically, the statement emphasizes the importance of deploying robust fallbacks to IBORs, noting however, that the best risk mitigation against the cessation of an IBOR rate is the immediate transition to an RFR and that more generally, it is prudent risk management to engage in early preparation for transitioning in anticipation of post 2021 LIBOR cessations.
Meanwhile, on July 30, ISDA published preliminary results of its Supplemental Benchmark Fallbacks Consultation, as part of the work it is undertaking pursuant to a request from the FSB OSSG. The publication sets out the spread and term adjustments that would apply to RFR fallback rates were they to be triggered for derivatives referencing U.S. dollar LIBOR, Hong Kong’s HIBOR, and Canada’s CDOR. These adjustments are part of transitional arrangements designed to ensure legacy derivatives that reference an IBOR continue to function as close as possible to what was intended and do not promulgate a cascade of inadvertent contractual winners and losers and associated litigation. The adjustments reflect differences between IBORs and RFRs such as the absence of multiple tenors and credit risk premia in the latter.
The ISDA Supplemental Consultation follows a similar exercise last year covering sterling LIBOR, Swiss franc LIBOR, yen LIBOR, yen TIBOR, euroyen TIBOR, and the Australian Bank Bill Swap Rate. ISDA will publish further consultation on the final parameters of the adjustments in due course with the aim of publishing amendments to ISDA definitions by the end of 2019.
Specifically, ISDA fallbacks are to be included in the 2006 ISDA Definitions for interest rate derivatives and will also apply to all new IBOR referenced trades. ISDA will also publish a protocol to allow participants to include the fallbacks within legacy IBOR contracts. In the preliminary results, ISDA stated that it expects to launch a similar supplemental consultation at the end of 2019 or in early 2020 in relation to EURIBOR and EUR LIBOR.
Rounding out global developments, on July 2, Japan’s Cross-Industry Committee on Japanese Yen Interest Rate Benchmarks also released a public consultation on key transition steps for Japanese market participants needing to prepare for the discontinuation of LIBOR at end-2021.
All the aforementioned bodies have pointed out that transitioning from IBORs to RFRs will require legal repapering of millions of contracts and the deployment of new systems, procedures, risk models, valuation methodologies, and hedging arrangements for impacted stakeholders, all of which take time and money, hence the “hurry-up” from the global policy community. The warnings also reflect a concern that a lumpy or rushed transition could lead to a variety of risks include pricing volatility, which could impact funding and financial stability more broadly. As such, the global financial and regulatory policy community are singing from the same hymn sheet: the end of LIBOR is imminent so firms need to prepare now to avoid financial and operational risk and regulatory liability in the coming years.
On August 8, the U.S. Securities and Exchange Commission (SEC) once again announced a proposed new rule to update Regulation S-K, following its amendments in August 2018 and March 2019. In line with the SEC’s “principles-based approach” to regulation, the objectives of the proposals are to make disclosures more digestible and relevant by cutting out repetitive, generic, and immaterial disclosures, which in turn should diminish the compliance burden for companies. The proposals address the following three disclosures:
Item 101 Description of Business
Item 103 Legal Proceedings
Item 105 Risk Factors
Stakeholders have 60 days from publication in the Federal Register to respond with any comments.
In a press release published on August 21, the SEC announced the results of a vote, on partisan lines, for the release of new guidelines for investment advisors conducting proxy votes. The guidelines steer institutional investors on how to proceed when conducting proxy votes.
The guidelines direct proxy voters to review factual errors, lapses, or potential methodological weaknesses or inconsistencies within proxy advice in line with their fiduciary obligations. They also address related issues of how often to review the recommendations and services of proxy advisors and how to evaluate proxy advisory services more generally. The rules also contain guidance on when and whether to vote on a proxy to best demonstrate that voting is in a clients’ best interest.
In a separate SEC vote on an interpretation held on the nature of proxy advisory services, it was deemed that proxy advisors should consider disclosing the methodology used to formulate advice, particularly where it deviates from previously announced guidelines and further disclose any third-party sources used and the extent to which that material is relied on to support their analysis. Finally, all conflicts of interest should be explained in reasonably sufficient detail in the context of providing advice on specific votes.
The guidance and interpretation will take effect once the documents are published in the Federal Register.
The SEC have released Q&A guidance on Rule 606 of Reg NMS to assist broker-dealers with new order-handling disclosure requirements that were published in November 2018, and that enter into force on Oct 1, 2019. There are 32 detailed questions and answers provided in the guidance covering multiple technical disclosure requirements.
On July 29, just a few months after the dispute that led to the removal of Swiss stocks from EU exchanges and just a few months before the UK is due to leave the EU (potentially without a deal), the European Commission published a formal communication on “Equivalence in the Financial Services Sector.”
The growing proliferation of equivalence provisions (currently around 40) across EU regulatory texts and Equivalence Decisions (280 across over 30 countries) as well as recent and proposed updates to equivalence measures (such as those in EMIR 2.2, the proposed Omnibus Regulation, and Investment Firms Regulation and Directive), clearly warranted a response in this area. However, it is difficult not to see this communication as also triggered by Brexit and the recent withdrawal of equivalence with Switzerland.
The commission emphasized that while there are measures and procedures that constrain it in its equivalence decision making process, at the same it retains “discretion” and “flexibility” and will be guided by the best interests of the community. The communication further emphasizes the importance of monitoring for equivalence including “on-site” visits.
On August 1 and 7, ESMA released new quarterly bond liquidity and double volume cap data. For the period covered, there are 594 liquid bonds. With respect to the double volume caps, there are 84 new breaches. Trading under waivers for all new instruments in breach of the DVC thresholds is to be suspended to February 11, 2020. ESMA reports that as of August 7, there are a total of 267 instruments suspended.
The Financial Conduct Authority (‘FCA’) has announced a plan that gives the payments and e-commerce industry extra time to implement Strong Customer Authentication (‘SCA’). The new EU rules, under the Payment Services Directive II, start to apply from 14 September 2019 and will impact the way in which banks and payment services providers verify customers’ identity and validate specific payment instructions, with an emphasis on multi-factor authentication. These new Strong Customer Authentication rules seek to enhance the security of payments and limit fraud.
On 13 August 2019, the FCA announced an 18-month plan to implement SCA with the e-commerce industry of card issuers, payment firms and online retailers. The plan reflects the recent Opinion of the European Banking Authority (EBA) which confirmed that more time was needed given the complexity of the requirements, an observed lack of preparedness across the industry and the potential for a significant impact on consumers.
The FCA plan involves regulatory forbearance in terms of enforcement activity where there is evidence that firms have taken the necessary steps to comply with the plan. At the end of the 18-month period, the FCA expects all firms to have made the necessary changes and undertaken the required testing to comply with the new rules.
On 31 July 2019, the UK’s Investment Association (‘IA’) published a document snappily entitled: ‘MiFID II Product Governance: Qualitative Information Requirements for the Regular Product Review - A Pragmatic Guide to the Distribution Information required to meet the Product Manufacturers Regular Product Review Obligation under MiFID II and FCA PROD Rules’. As with other industry templates such as the EMT, EPT and TPT, the IA have filled in the last remaining regulatory gap with an industry template for disclosing information necessary to enable product manufacturers to review their products in compliance with MIFID II and FCA Sourcebook PROD rules. Despite the prospect of Brexit discoloring an initiative led by a private sector UK consortium, this comprehensive set of Guidelines, compiled with industry consultation and input from subject matter experts, is like to serve as the template for future disclosures in relation to this specific aspect of MIFID II compliance.
In an effort to align Singapore’s regulatory regime with those of other international financial centers, the Monetary Authority of Singapore (MAS), published a pithy consultation paper on August 5 entitled: “Requirements on Controls Against Market Abuse.” The paper sets out proposed rules designed to assist MAS’ supervisory and enforcement functions by enhancing record keeping and client due diligence requirements across the sector. The consultation remains open for responses until September 5.
In relation to client identification, it is proposed that firms should implement measures to ensure ultimate beneficial ownership information can be provided to MAS, or any other law enforcement agency, within five business days on request including beneficial owners of omnibus accounts. In particular, it is proposed that firms enter into formal written agreements with clients that establish an obligation to provide beneficial ownership information on request, irrespective of the domestic privacy or secrecy laws in a specific client’s jurisdiction.
In terms of order and execution record keeping, it is proposed that records of all forms of communications between trading representatives and those providing order and execution instructions for any capital market products be retained for five years, even if the communication does not ultimately result in a transaction. The rules extend to orders routed through personal electronic devices, in relation to which firms must have the functionality to record the original communication, which includes instant messages. Moreover, for such orders, trading representative must be able to call back the person delivering instructions on the firm’s recorded telephone for each order. In the case of mobile apps, the device’s unique identification provided by the specific application must be recorded.
Finally, to enhance both market abuse investigations and anti-money laundering arrangements, the paper proposes that firms establish and maintain a centralized, electronic register of all payments received in cash or from third-parties into client accounts with specific fields to record the identity of the third-party providing cash/ other payment type and the reason for processing payments by other means.