The Impact of New Financial Regulation on Investment Banks

The results of a study into the impact of EU regulation in the wake of the financial crisis have been published. New rules introduced since the 2007/09 financial crisis required banks to hold more capital for trading activities, making these areas less profitable and prompting cuts to trading desks. This has led investment banks’ balance sheets supporting trading markets to decrease by 20% since 2010, and by 40% in risk-weighted asset teams. It is estimated that European investment banks will shrink by another 14% on aggregate in the next two years.

The report also said that “for banks, the diminishing returns on capital from market-making call for more and fast structural change,” and estimated that for banks to improve their return on equity to above 10%, they would need to deliver 2 to 3 percentage points of return on equity improvement from restructuring.

European Commission Plans to Vet Gas and Energy Contracts and Its Approach to Russian Suppliers

A proposal to grant the European Commission a role in vetting gas supply contracts across the EU has been met with fierce resistance from the member states. The current proposal is another element of the EU’s broader initiative to create an “energy union,” as recommended by the Commission in its framework strategy in late February this year and initially approved on Thursday, March 19, 2015 to lower prices and improve the security of its gas and electricity supplies. The latest draft proposal suggests involving the Commission in all agreements with external suppliers that may affect EU energy security.

FCA Publishes Structured Products Review

The UK Financial Conduct Authority (“FCA”) has published a review of structured product governance, in which it has criticized the ways in which instruments are developed and sold. The review contained six key points:

  1. Retail consumers generally struggle to understand the relative merits of structured products and the factors driving potential returns, finding it difficult to compare alternatives and to make full use of analytical information. The FCA has claimed that it is up to firms to remedy this.
  2. Firms’ senior management must do more to put customers at the forefront of their approach to product performance, identifying a key target market during product design, which should then inform each subsequent part of product development and distribution.
  3. Structured products should have a reasonable prospect of delivering economic value to customers in the target market, to be determined and evidenced by robust stress testing as part of product approval.
  4. Firms need to provide customers with clear and balanced information on each product and any risks.
  5. Manufacturers need to strengthen the monitoring of their products, including ensuring distributors have enough information about the manufacturer’s product to sell it appropriately.
  6. Firms need to do more to ensure fair treatment of customers throughout the lifecycle of a structured product.

While these points are quite broad, the FCA has warned that failure by firms to improve in respect of the above may lead to new binding rules.

European Commission Unveils Tax Transparency Package

The European Commission has laid out its plans in a new Tax Transparency Package to clamp down on tax deals made between EU governments and multi-national corporations. As of next year, EU members would have to declare their cross border tax rulings every three months, as well as divulging information on existing deals. The Package comes during ongoing investigations into a number of member states’ tax regimes, and concerns that tax rulings which give a low level of taxation in one member state can entice companies to shift profits there artificially, leading to serious erosion of possible tax revenues for other member states.

In particular, the Commission is investigating deals between multinationals and governments in Luxembourg, Ireland, the Netherlands, and Belgium, and whether some of these agreements amounted to state aid. Last year, allegations emerged that around 340 multinational companies had tax avoidance deals with Luxembourg.

Prospectus Directive: Commission Consultation

On February 18, 2015, the European Commission published a consultation paper on the review of the Prospectus Directive (2003/71/EC). Matters on which the Commission seeks views include:

When a prospectus is needed. In particular, views are sought as to whether the current exemption thresholds should be adjusted so that a larger number of offers can be carried out without a prospectus; whether there should be an exemption for secondary issues under certain conditions, in addition to the proportionate disclosure regime for rights issues; and whether a prospectus should be required when securities are admitted to trading on an MTF.

The information that a prospectus should contain. Questions include whether the proportionate disclosure regime should be modified or extended; whether there should be a simplified prospectus for SMEs and companies with reduced market capitalization admitted to trading on an SME growth market; and whether there should be a maximum length for prospectuses.

How prospectuses are approved, including the role of national competent authorities in the approval process of prospectuses and the equivalence of third-country prospectus regimes. In particular, the Commission asks whether the scrutiny and approval procedure should be made more transparent to the public and flexible for issuers, for example by making public the first draft prospectus filed with a competent authority for review and by allowing the issuer to carry out certain marketing activities, going beyond advertising, in the period between the first submission of a draft prospectus and the approval of the final version.

Responses must be received by May 13, 2015. The Commission intends to decide in the next months how the Prospectus Directive should be amended. It plans to prepare amendment proposals in the second half of 2015, to be presented to the European Parliament and Council of the EU, together with its review of the application of the Directive, in early 2016 at the latest.

European Parliament Adopts ELTIF Regulation

On March 10, the European Parliament published a press release announcing that it has adopted the proposed Regulation on European Long-Term Investment Funds (ELTIF Regulation). The adopted text has not yet been made publicly available.

ELTIFs are vehicles designed to boost non-bank investment in the real economy across the EU. ELTIF investment funds will have to apply for authorisation, have a regulated structure and comply with uniform rules to ensure that they offer long-term and stable returns. ELTIF investors will have to make a long-term commitment as they will not be able to withdraw their money easily. However, to protect retail investors, the Parliament and the Council of the EU agreed “redemption” rules that would enable an ELTIF that has enough liquid assets to return an investor’s money at the investor’s request.

The ELTIF Regulation now needs to be formally adopted by the Council. The press release states that the ELTIF Regulation should apply six months after its entry into force.  Press Release.

European Parliament Adopts MIF Regulation

On March 10, 2015, the European Parliament published a press release announcing that it has adopted the proposed Regulation on interchange fees for card-based payment transactions (MIF Regulation). The adopted text has not yet been made publicly available.

Among other things, the MIF Regulation is intended to lead to transparent fee-capping for cross-border and domestic retail purchases. It is hoped that the lower costs will benefit retailers and shoppers.

The MIF Regulation now needs to be formally adopted by the Council. The press release states that the MIF Regulation should apply six months after its entry into force.  Press Release.

European Court Rules in Favor of the UK in ECB Dispute Over the Relocation of Clearing Houses

After a three year dispute over the place of the City of London in Europe’s single market, the EU General Court has ruled that the European Central Bank (“ECB”) lacked the legal powers to enforce a ban on clearing and settlement of euro-denominated deals in the UK. The ECB’s 2011 policy required all clearing houses that handle more than €5 billion euros per day per product category to move inside the Eurozone, claiming this would make it easier to oversee the clearing and settlement activities of such organizations. Though never implemented in practice, the policy was challenged by the UK on grounds that it went against the single market.

For the UK an unsuccessful challenge would have forced the London Stock Exchange’s LCH. Clearnet clearing house, which clears about €250 billion euro-denominated instruments every day, and ICE Clear Europe, the world’s largest processor of credit default swaps, to shift large portions of their euro-denominated operations to continental Europe, resulting in the loss of London’s financial center’s influence to the Eurozone and further ammunition for anti-EU campaigners in the lead up to the May national elections.

The General Court found that the ECB policy went beyond oversight to regulating market infrastructure companies – a power the ECB does not have as its competence is limited to payment systems under Article 127 (2) of the Treaty on the Functioning of the European Union. The Court did not address the question of whether the ECB policy had discriminated against UK operators or undermined the fundamental freedoms on which the EU single market is based. These issues could be further considered in the event of an appeal by the ECB to the Court of Justice of the European Union, or a proposal to grant the ECB the necessary authority through EU legislation.

Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2015

On February 25, 2015, the Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2015 (SI 2015/369) was published with an explanatory memorandum.

The Order comes into force on April 1, 2015, and implements the recommendations of the Fair and Effective Markets Review (set out in a report dated August 2014) to extend the existing UK regulatory and legislative framework for benchmarks to include the additional benchmarks, which are used in the fixed income, commodity and currency markets .The order therefore amends:

  • Schedule 5 to the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544) by extending the existing UK regulatory and legislative framework, in addition to governing the London Interbank Offered Rate (LIBOR), to apply also to ISDAFIX, Sterling Overnight Index Average (SONIA), Repurchase Overnight Index Average (RONIA), WM/Reuters (WMR) 4pm London Closing Spot Rate, London Gold Fixing, LMBA Silver Price and ICE Brent Index; and
  • The Financial Services Act 2012 (Misleading Statements and Impressions) Order 2013 (SI 2013/637), which specifies the relevant activities, investments and benchmarks for the purposes of a criminal offence in section 91 of the Financial Services Act 2012 (that is, making false or misleading statements in relation to benchmarks), to bring the additional benchmarks into its scope.

The FCA has consulted on bringing the additional benchmarks into its regulatory and supervisory regime and intends to publish a policy statement and final Handbook text in the first quarter of 2015 with a view to the relevant provisions being in force when the Order takes effect.

ECB Launches Landmark €1.1 Trillion Quantitative Easing Program

The ECB announced on Thursday that it would start its purchase of sovereign bonds on March 9 to support an accelerating economic recovery in the Eurozone, and would continue to do so until there was a “sustained adjustment in the path of inflation”. It is expected that this scheme will push GDP expansion to 1.5% this year, 1.9% in 2016, and 2.1% in 2017, compared with December projections of 1% and 1.5% for 2015 and 2016 respectively, and will also drive inflation back up to 1.8% by the end of 2017.

The announcement has already had an impact on the bond market, as buyers drove the yield on Italy’s 10-year benchmark down to a new record low of 1.34%, and the German equivalent to 0.34%. Some analysts have argued that the program could further distort the bond market where the shorter-term debt of several countries already has negative yields. However, ECB President Mario Draghi said that the ECB would continue to buy bonds provided the yields were above the central bank’s deposit rate of minus 0.2% (in effect limiting the price the ECB would pay for government debt).