Fitting it altogether: Other initiatives for the buy-side

Fitting it altogether: Other initiatives for
the buy side
Jonathan Herbst
Norton Rose Fulbright LLP
30 July 2013
Other key buy side issues
• The EU agenda:
Timings and how the key proposals fit together
MiFID for the buy side
A word on EMIR
• The reality of the FCA for managers and custodians and how to
deal with it
Timeline: EMIR, MiFID and UCITS V
2012: EMIR
enters into
20 June
Council of
the EU
considers legislative
proposals in plenary
and refers them to
ECON for
reconsideration 2526 October 2012
15 March
2013: Most
to enter
into force
First half
2013: ESMA
expected to
consult on
18 June
Council of
the EU
November 2012: ECON
draft report on
legislative proposals
Mid-2014: First
expected to
3 July 2013:
European Parliament
adopts amended
version of ECON
24 April 2013:
European Parliament report and publishes
results of plenary
publishes report
containing draft
legislative resolution
with proposed
From 1 January
2014 at the
obligations for
credit and IRS
1 July 2015:
Trades start
to be
reported to
ESMA where
there is no
Summer 2015:
of MiFiD II
proposals (at
the earliest)
10 December
Parliament to
vote on
11 December
Council of
the EU
From 1 July
2013 at the
for credit and
IRS apply
Q4 2013: FCA
expected to publish
CP on UK
implementation of
Q4 2013: ESMA
expected to publish
technical advice,
guidelines and
technical standards
End 2015:
Implementation of
UCITS V (at the
Remuneration: An example of how the rules fit
• The CRD IV is a comprehensive review
of the EU's prudential requirements
• Applies to authorised AIFMs
• Same objectives as CRD III - view that
CRD III was implemented incorrectly
• Applies to MiFID investment firms and
credit institutions
• Regulates the remuneration policies
and practices for the AIFM and their
‘identified staff’
• Includes a bonus cap
• Applies to AIFMs when undertaking
ancillary services set out in Article 6(4) of
MiFID Guidelines
• Focused on ensuring investor
• Focuses on undertakings for collective
investment in transferable securities
• Applies to UCITS management
companies and UCITS investment
companies that do not designate a
management company
• Detailed ESMA guidance expected Q4
2013 on application of rules
protection when investment services
are provided under MiFID
• Applies to MiFID investment firms and
those AIFMs performing ancillary
services under Art 6(4) of AIFMD
• Bottom up approach with regard to
‘relevant persons’
Where have we got to?
• Council of the EU:
– 18 June 2013: Council published General
– 23 compromise proposals so far: Latest
published on 10 June 2013
– For several months negotiations have
been held in working group at the
Council: Council working group in early
September and then trialogue dates fixed
through September
– Disagreement among Member States
appears to be on three primary issues:
Transparency, non-discriminatory access
to CCPs and trading platforms and the
new OTF category: Limited relevance to
buy side
– Lithuania is new Presidency in Q3 and
finds MiFID II in its in tray
• Level 2 drafts:
– ESMA working paper due in early August
– ESMA work will then gather pace
• European Parliament:
– October 2012: Parliament adopted
amendments to the legislative proposals
but postponed plenary session vote and
instead referred them back to ECON for
further consideration
– Parliament plenary vote now scheduled
for 10 December 2013
The thicker layer of EU law: Best execution
• General concern that the best execution regime has not been the
agent for change it should have been
• Well functioning pre-and post-trade transparency regime vital to
assessing execution quality
• Execution venues to produce public data on quality of execution of
– Improvements in delivering best execution to different category of clients
– Improvement in the ability of supervisors to monitor firms' compliance with best execution
• Investment firms to produce annual public data on top 5 execution
venues for execution of client orders for each class of financial
• Commission to produce guidance on relative importance of
different execution factors
• ESMA to develop draft implementing technical standards on
content and format for execution venues and investment firms –
ties to concern that current policies are too generic
– Superficial view that no change on COBS ignores the Level 2 powers
Inducements – Advised sales of funds
• Independent investment advisers prohibited from accepting
payments or benefits from product providers:
– Limited non-monetary benefits permitted e.g. training
– Services related to research: Query exact meaning?
– But even permitted benefits cannot cut across obligation to act in the best interest of the
• Await to see how these proposals tie in with RDR:
– The key question is whether the UK regime is super-equivalent
• Further provision in Council text:
– Provides that Member States may in exceptional cases impose additional requirements
on investment firms – will have to be objectively justified and proportionate
• In reality probably not much change from RDR regime with new
FCA extensions to execution only sales of products
Inducements – The big change in management
• Inducements regime amended to ban receipt of third party
– Receipt of commissions by portfolio managers from product providers has
attracted attention by regulators, due to the discretionary nature of this service
– Going back to CESR, EU regulators have commented re conflict between
inducements and duty to act in the best interest of the clients
– National approaches vary, e.g. Italian market reaction through reduction in the
use of inducements has resulted in an increase in charges on investors
– Commission argued that customer would have borne these charges implicitly
as the product provider would have charged higher fees to the manager and
these fees would have been deducted from the investment returns achieved
• Portfolio manager must not accept or receive fees commissions or
any monetary benefit:
– A lot of issues on the classic fund distribution structures, e.g. payments to
distributors and also the problem of dual relationships with discretionary client
and with investors to whom units/shares are sold by distribution arm
– This may lead to distribution arms being placed in separate entities
Inducements – The big change in management
• Relevant to institutional management as well as retail sector
• Unbundling obligation:
– ESMA to develop guidance on cross selling: Firm to tell clients about possibility
of unbundling and to provide evidence of costs and charges or each component
• On a separate track to MiFID
• Reminder of headlines:
– Very relevant to any retail buy side distribution
– All ‘investment product manufacturers’ regardless of sector will have to prepare
and maintain a KID for each investment product
– Whoever sells an investment product to a retail investor has the obligation to
provide him/her with the KID
– Definition of ‘investment product’ to include all investment funds, retail
structured products and investments packaged as insurance policies
– Only investment products that are sold to retail investors will be covered and
KIDs should be accurate, fair, clear, short, concise and written in non-technical,
jargon-free language
– Very low loss burden of proof: The manufacturer will be held liable for any loss
suffered by a retail investor due to the use of a KID which does not comply with
the requirements of the Regulation
– Transitional provisions allow UCITS to continue to use the UCITS-KIID in
accordance with the UCITS Directive for five years from the entry into force of
• Next steps:
– 18 November 2013: Indicative plenary sitting date for European Parliament
– Mid 2015: Date by which the Regulation on KIDs for PRIPs could apply,
depending on the date it enters into force
PRIPs: How does it all fit together?
ECON draft report on PRIPs proposals 20 December 2012
Execution only
• A variation on the theme that retail investors are being sold risky
products without protections: Carve out from appropriateness
• Addressing the uncertainty in execution-only market between
complex and non-complex products
• Broader scope of complex products:
– Shares in non-UCIT collective investment schemes
– Shares that embed derivatives
– Bonds that embed derivatives
– Bonds with a structure which makes it difficult for a client to identify the risk
– Money market instruments that embed derivatives/structure which makes it
difficult for a client to identify the risk involved
– Structured UCITS providing algorithm-based payoffs linked to performance
Execution only
• Appropriateness regime already well established for CFDs:
Warning if not appropriate will continue but no ban on trading
• Execution-only services where client is provided with credit or
loans to carry out transaction will be treated as complex
• Credits or loans such as current accounts and overdraft facilities
are not captured
The best ex link to the markets debates: OTFs
• MiFID in many ways a tale of two halves: Radical change in the
markets space and incremental change on most of COBS
• Asset managers will need to revisit their best ex policies in the
light of new regulatory concepts
• Political background is the broker crossing system debate: View
against unregulated trading venues and close link to the SI
• Broadly defined: All types of organised execution and arranging
of trading which does not correspond to RM or MTF
• Includes:
– Broker crossing systems which execute client orders
against other client orders
– Systems eligible for trading clearing-eligible and
sufficiently liquid derivatives
• Does not include:
– Facilities where there is no genuine trade execution or
arranging taking place in the system, such as bulletin
boards, entities aggregating or pooling potential interests
or electronic post-trade confirmation
– Bilateral systems
• Key question will be inclusion in policies and the evidence
needed to prove best execution from a buy side perspective
Extension of transparency regime – May impact asset
Shares and equity-like instruments
Probably not relevant to buy side as only applies
to SIs: Extended to equity-like instruments such
as depositary receipts, exchange traded funds
and certificates traded on a trading venue
Some amendments including minimum quote
size, two way quotes and price improvement for
retail as well as professional clients
Other instruments
Applies where investment firm concludes
transaction on behalf of clients so can apply to
buy side firms
Investment firms must make public trades
through an Approved Publication Arrangement
Applies to instruments traded on a trading venue
but if venue can defer, this should also apply to
OTC trades
Make public volume, price and time of
Unclear how this will work in buy/sell side chains
of firms
Probably not relevant to buy side as new SI regime
extended to bonds, structured finance products,
emissions allowances and derivatives
Must provide quotes where liquid market and asked
by clients
Must make available to other clients and trade if up
to certain size
Price improvement permitted in justified cases
Applies where investment firm concludes
transaction on behalf of clients so can apply to buy
side firms
Investment firms must make public trades through
an Approved Publication Arrangement
Detailed information requirements to be set by Level
Competent authority can permit deferral, or
restricted disclosure and can suspend and this also
applies to OTC trades
Unclear how it applies to lookalikes
EMIR overview: Obligations and participants
Sell side
CCP clearing
Requirements for
non-CCP cleared
Buy side
Financial counterparty: Any firm authorised under EU FS legislation
– MiFID investment firms
– CRD credit institutions
– Insurance, assurance and reinsurance undertakings
– UCITS and their managers
– AIFs managed by AIFMs
– Institutions for occupational retirement provision
OTC derivatives subject to
OTC derivatives subject to
All financial counterparties
Intra-group exemptions
All financial counterparties but
transitional provisions for pension
Intra-group exemptions
End users
Non-financial counterparty: Any other
undertaking established in EU
In-scope non-financial counterparty is
one whose net positions exceed
thresholds to be set by ESMA:
– 30 working days
– Count OTC derivatives entered into
by other non-financial entities in
– Don’t count positions that are
objectively measurable as reducing
risks directly related to commercial
or treasury financing activity
OTC derivatives subject to obligation
In-scope non-financial counterparties
subject to possible phase-in
Intra-group exemptions
All non-cleared OTC derivatives
All non-cleared OTC derivatives
All non-cleared OTC derivatives
All financial counterparties
All financial counterparties
Intra-group exemptions
Pension scheme transitional
provision does not apply
Some provisions apply to all end users;
others just to in-scope non-financial
Intra-group exemptions
Intra-group exemptions
All derivatives
All derivatives
All derivatives
All financial counterparties
All financial counterparties
All counterparties
UCITS V: A recap
• European Commission published UCITS V legislative proposals in
July 2012. Key proposals relate to:
• UCITS depositary function: Single appointment similar to AIFMD
– Depositary duties: Similar list of duties
– Delegation: Same approach as AIFMD on objective reasons and ongoing
monitoring of delegate
– Eligibility criteria: EEA authorised credit institution or other investment firm
– Liability regime: Similar to AIFMD on reversal of the burden for assets in
– Redress: Creating a level playing field across the EEA
UCITS V: A recap
• Remuneration
– Controversial area: The fixed bonus cap was defeated but a lot of other tough
provisions, e.g. not less than 50% of variable in units, considerable clawback
required in case of negative performance of fund and at least 25% deferred
over life cycle of redemption policy of the UCITS with this normally 3 to 5 years
and going up to 60% if variable particularly high
– Disclose the amount of remuneration in each financial year in the UCITS fund’s annual
• Sanctions:
– Minimum catalogue of administrative sanctions/measures, a minimum list of
sanctioning criteria and competent authorities/UCITS managers to establish
whistleblowing criteria
UCITS V: Where have we got to?
• 3 July 2013: European Parliament adopted amended version of an
ECON report on UCITS V and published results of plenary vote
indicating that agreement reached on:
– Depositaries
– Remuneration
– Sanctions
• Negotiations on the final text are on-going with the European
Parliament and the Council of the EU
• Latest Council of the EU compromise proposals published 11
December 2012
UK implementation:
• FCA Business Plan 2013/14: FCA is actively participating with HM
Treasury in the on-going negotiations between the European
Parliament and the Council of the EU
• FCA expects Level 1 text to be agreed Q3/Q4 2013 and will
consult on any necessary changes to its rules “shortly thereafter”
The reality of the FCA for managers and custodians
and how to deal with it
The new philosophy: What it means for the buy side
• Regulatory objectives:
– A lot of work within FCA on
competition objective: Competition
within financial services in interests
of consumers in regulated financial
services and markets
– Particularly relevant to retail
distribution but will also impact
wholesale COBS: Also institutional
asset management often has
underlying retail beneficiaries, e.g.
pension schemes
– Must insofar as possible advance
consumer protection and integrity
objective to promote effective
– Unclear yet how policy will be
shaped in this area but questions
already much more focussed for
firms on competition issues
• Threshold conditions:
– FCA threshold conditions for FCA
authorised firms: Effective
supervision, appropriate resources
and business model threshold
conditions being used to the full
– Key point is the breakdown of the
compliance versus commercial
distinction in the new world
– Ties closely into forward looking
regulatory intervention and product
– Already plenty of evidence on how
seriously the FCA is taking this in
relation to both asset managers and
The end of certainty? - Themed visits
• The key message:
– Certainty on the cycle of visits and communications has gone: FCA will be preemptive and tough and firms can expect much more challenge
• Reminder of FCA firm categorisation:
– C1 and C2 to be fixed portfolio firms with a nominated supervisor
– C3 and C4 to be flexible portfolio supervised by a team of sector specialists and
no nominated supervisor: A lot of firms have or are losing their supervisor
• The FCA three pillar supervisory approach:
– Firm Systematic Framework (FSF), event-driven work and issues and products
– FSF assesses the firm’s conduct risk and aims to answer the question: Are the
interests of customers and market integrity at the heart of how the firm is run?
– Fewer supervisors allocated to specific firms means more flexibility to assign
resources to pillars 2 and 3
– Issues and products: Sector risk assessment which provides an assessment of
the conduct risks across a sector
– The reality of sector risk assessment is that firms without supervisors never
know when the theme arc light may shine on them
Practical reality of themed visits
• The new world makes life difficult for those firms who have lost
their supervisor in particular
• FCA will identify an area about which it has concerns or wishes to
find out more: Areas may be identified by supervisors, policy work,
or by looking at trends in complaints
• Ties into FCA comments on wholesale conduct focus: CASS
compliance, broker research, conflicts, best execution and
distribution all possible areas for themed visits
• Objectives of a themed visit: Identify good practice, address
identified risks or determine the scale of risks identified from
intelligence or surveillance
• In reality, tight timing for documentation requests and visit shortly
after that: Appears designed to stop “creation” of documentation
• Message is to do proper trend analysis and have documentation
and people ready at any time: Dawn raid prep is a good
Practical reality of themed visits
• Key issue for firms is to avoid 166 or disciplinary action:
– Much more commercial focus with linkage to the new business model threshold
condition: Firms need to be clear how their business model meets the needs of
clients and customers
– The focus on approved persons
– Already seen results in investment managers ABC/AML, conflicts and transition
management visits
• A new NRF product: The Complete Themed Visit Response
– A copy can be found in your seminar packs
CASS as an example
• FCA is interested in clarity on the role of an asset manager:
– Is it holding client money for CASS 7 purposes or just operating mandates?
– Is the custody nexus clear: A lot of confusion in the markets about when a
manager is arranging custody, providing custody or excluded from both
regulated activities?
• Do the legal documentation, disclosure material and internal
processes all tie together?
• In the case of custodians the list of areas to cover is large:
– Use of sub-custodians and clarity on territorial scope of CASS
– Questions where activities take place from another branch of the entity
– Account naming conventions
– The quality of the internal documentation
– The legal documentation and disclosures to clients
• Both managers and custodians should be ready with all their
documentation at any time
The twist in the tail: Lessons from event driven work
• The official position:
– SUP 1A.3.4 definition: Dealing with problems that are emerging or have crystallised, and securing
customer redress or other remedial work (e.g. to secure the integrity of the market) where
– Covers everything from deals where there has been a problem to whistleblowing allegations to
spikes in reported complaints at a firm
• FCA Business Plan 2013/14:
– Delivering consumer protection FCA moving from a reactive approach to a more proactive one
– Complex Event-Driven Crystallisation Team aims to resolve issues quickly and decisively
• The reality:
– Vital for firms to consider Principle 11 and breach notifications carefully as they may trigger referral
to crystallisation team
– A firm without a supervisor may suddenly find itself the subject of a lot of attention
– Even for firms with supervisors the old world in which the supervisor was in control is largely gone:
Other forces at work within FCA which have key input on outcomes
Pegasus: Our MiFID II online technical resource
OTC Oracle: Our EMIR online technical resource
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