Looking Ahead

Originally published in the December 2011 issue

In the US, the fourth quarter has seen the release of some heavily anticipated rulemakings, including final rules on commodity position limits and proposals for the Volcker Rule limitations for banking organizations on proprietary trading activities and restrictions on relationships with hedge funds or private equity funds. Also of note, regulators finalised new reporting requirements for registered investment advisers to private funds that will assist the Financial Stability Oversight Council (FSOC) in monitoring systemic risk in the US financial system.

In Europe, a barrage of legislative proposals has been published by the European Commission. They range from rules on market structure and transparency to obligations of investors to disclose interests in issuers. It will be a big effort for the industry and policy makers alike to keep on top of all developments. Meanwhile, the discussion on European rules on short selling and CDS has come to an end, with the European Parliament and the Council having come to a provisional agreement.

Form PF
In late October, the US Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) approved a rule requiring investment advisers that advise one or more private funds to complete “Form PF,” which will enable regulators to collect systemic risk data about hedge funds and other private funds.

The detail and frequency of reporting requirements are tiered based on whether advisers are considered “large private fund advisers” or “small private fund advisers.” The former category includes advisers with at least $1.5 billion in hedge fund assets under management, advisers with at least $1 billion in combined AUM attributable to liquidity funds and registered money market funds, and advisers with at least $2 billion in private equity AUM. The frequency of reporting requirements for these large private fund advisers will vary based on the types of funds managed; small private fund advisers will only be required to file Form PF annually. Advisers with less than $150 million in private fund AUM are not required to complete and submit Form PF.

The compliance date is 15th June 2012 for advisers with at least $5 billion hedge fund, private equity fund or combined liquidity and registered money market fund AUM. For all other advisers, the compliance date is 15th December 2012. An SEC fact sheet on Form PF, which includes more information regarding frequency of reporting and reporting requirements, can be found on the SEC’s website.

Volcker Rule proposals published
In late October, the US Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency and the SEC released for public comment Volcker Rule proposals which generally prohibit banking entities from engaging in proprietary trading and investing in hedge funds or private equity funds, subject to certain exemptions. Comments are due in January 2012 and final rules are not likely before late Q1 or early Q2 2012. While the proposals provide some direction on how the various restrictions and prohibitions will be defined, several areas require further clarification.

There is an exemption from the proprietary trading restrictions for activities conducted outside the United States by non-US banking organisations, although the permitted activities are defined fairly narrowly. Similarly, non-US banks can invest in covered funds, as long as those funds are offered solely to non-US residents.

Short selling and CDS
Although the European Council and the European Parliament still have to vote on it officially, they have reached agreement on the “European Regulation on Short Selling and certain aspects of CDS.” It will come into force in November 2012.

There was common agreement on the introduction of EU-wide disclosure requirements for short positions in shares and sovereign bonds as well as a “locate rule” that will prevent uncovered short positions.

With regard to a ban of uncovered CDS – put on the table by the European Parliament in the wake of high volatility numbers seen around Greek sovereign debt – there has been much debate. Several member states are extremely hesitant about intervening in the sovereign debt market for fear of diminishing liquidity. The compromise that was finally reached was that member states may temporarily opt out of the ban on uncovered CDS if this is justified under certain market circumstances. Also, existing CDS contracts may be held to maturity once the regulation is in force.

While we now know the general outline of the rules, much of the detail will be determined in implementing measures. The European Securities Markets Authority (ESMA) will play an important role in this. The implementing measures will come into force at the same time as the regulation.

In October, the European Commission finally published its long-awaited proposals for the review of MiFID. Reactions to the proposals are mixed. While certain elements are generally accepted some of the proposed requirements will have a significant impact on European securities markets and the way firms can do business and offer services. A part of MIFID will take the form of a “regulation” rather than a “directive”. As regulations do not have to be implemented in national laws but have direct effect, this will lead to more harmonisation across the EU.

As we indicated in an earlier version of this publication, the biggest changes regard market structure issues. The proposal introduces an “Organised Trading Facility” to regulate firms’ trading platforms and pre-and post-trade transparency requirements for fixed income. MiFID will also contain systems and controls for high frequency trading. A proposal that has surprised the industry greatly is the requirement that algorithms have to provide liquidity continuously (i.e. a market maker obligation). On the investor protection side, strengthened rules on the sale of investment products to retail clients will lead to significant cost increases.

MAD (and other) new proposals
The European Commission has also published a proposal for the review of the Market Abuse Directive (MAD, now: Market Abuse Regulation – MAR). Among other things, the proposal intends to harmonise national interpretations of MAD and extends the scope to commodities derivatives and spot commodities where they influence the price of commodities derivatives.

Additionally, a proposal for the review of the Transparency Directive was released. The Transparency Directive requires shareholders to disclose significant voting rights in listed firms in the EU. The biggest change that is proposed is the requirement for persons to disclose positions in derivatives and other financial instruments that lead to similar voting rights in an issuer. The proposal also includes a requirement that issuers active in extractive or forestry industries publish an annual report on payments made to governments in countries in which they operate.

The rule on the publication of interests in extractive and forestry industries is replicated in a proposed review of the Accountancy Directives. More generally, with the review of these directives the Commission aims to simplify the preparation of financial statements, thus making them more comparable, clearer and easier to understand. The Commission feels this would allow users of financial statements such as shareholders and banks to gain a better understanding of a company’s performance and financial position. Both the review of the Transparency Directive and the Accountancy Directives will serve to lessen the administrative burden of small and medium-sized companies.

EU legislative process
For all EU proposals mentioned above the EU legislative process has now started. Both the European Parliament and the European Council will aim to agree their own positions on the texts. Once they have done this, the two institutions and the European Commission will try to come to a common position in the so-called “trilogue”. If all goes well the text that comes out of this trilogue will be adopted as the final legislation.

Given the workload of the European institutions at the moment it is hard to predict when the respective texts will be adopted. For MiFID the general expectation is that the process might take a year or more, while for the smaller proposals, such as the Transparency Directive, agreement could be reached in six months.