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28 April 2014

European Financial Regulation 'Super Tuesday'

On 15thApril, the European Parliament, adopted a range of EU regulations and directives on financial services, all of which will have a fundamental impact on the way financial institutions operate. These reforms have been in discussion for some time, but now that they have been formally adopted by the Parliament, all that remains now is their adoption by the European Council and subsequent publication in the EU Journal.

Which reforms have been adopted?

MiFIR/MiFID II: This complex package of regulations covers a range of areas, including investor protection measures, mandatory trading of standardised products on execution venues, improved pre- and post- trade transparency, algorithmic trading controls and position limits for commodities. The breadth of scope of this piece of reform means that all financial market participants will be impacted heavily. (Proposal 12)

  • MAR/MAD II: Market manipulation and insider trading will carry criminal sanctions, and the definition of market abuse will cover benchmark manipulation as well. This regulation/directive also interacts with MiFID II as firms will need to implement more advanced market abuse controls on algorithmic trading and derivatives trading on venues, as covered by MiFID II. (Proposal 12)   
  • Single Resolution Mechanism (SRM): The aim of this reform is to take the burden of bank bailouts away from taxpayers and shift it to the banking industry. It will apply to all Eurozone countries initially, but non-Eurozone countries have the option of participating in it as well, although the UK has chosen to opt out. Banks will have to contribute to a Single Resolution Fund (SRF), which will be used by EU authorities for bank recovery and resolution. (Proposal)  
  • Bank Recovery and Resolution Directive (BRRD): This directive provides detail on how failing banks should be resolved. EU authorities will have the power to intervene in banks' operations and their capital structure to minimise losses on depositors. (Proposal)   
  • Deposit Guarantee Schemes (DGS): EUbanks will need to contribute to a fund that will insure deposits up to £100,000 in case a bank fails, and repayment will take place within 7 days. The fund will amount to at least 0.8% of all covered deposits in each member state, dropping to 0.5% in countries with more concentrated banking sectors. (Proposal)  
  • UCITS V: The definition of depository institutions for UCITS funds has been tightened, and they will now have to comply with more stringent client asset segregation requirements. New rules governing remuneration policies and liabilities in case of losses to client assets have also been introduced. In many respects, UCITS V rules are aligned with those in the AIFMD, and essentially extend those regulations to traditional fund managers. (Proposal
  • Packaged Retail Investment Products (PRIPS): This regulation requires firms marketing investment products to retail clients to provide information on expected returns, costs and risks in a user-friendly format. (Proposal)
  • Central Securities Depository Regulation (CSD): The directive requires shorter settlement periods for transferable securities, penalties for settlement failures, enhanced conduct and access requirements and more stringent rules for depositories engaging in banking services across the EU. (Proposal)
  • Payment Accounts Directive (PAD): Banks will not be able to refuse access to a bank account to any consumer, and they will need to make it easier for clients to compare costs across different providers, switch accounts or open new ones in another EU state. (Proposal)  

What does this mean for firms?

  • Market Structure (MiFID II, CSD) – By requiring a range of products to be traded on execution venues, MiFID II will have a deep impact on market structure.  Margins on these products should be significantly lower, so firms will be looking to streamline their operational processes and infrastructure for efficiency gains. On the other hand, greater electronification under MiFID II has also made the market structure much more complex, which threatens the objective of streamlining operational processes. Thus, firms should be exploring how to strike the right balance between simplification of their trade processes and adapting to a complex market structure. 
  • Conduct/Investor Protection (SRM, BRRD, DGS, MiFID II, MAD II, PRIPS) – These regulations require firms to record and maintain a significantly larger amount of data for transparency purposes, so the cost of improving the operational processes for data capture and maintaining detailed records will be high. Furthermore, these regulations also require firms to develop a profile of each client's unique requirements and tailor their products and services accordingly. For many firms, this means the rationalisation of data repositories and infrastructures across the entire group so that a holistic picture of each client's requirements is available.
  • Structural Reform (SRM, BRRD) – The ability of regulators to intervene in a bank's capital structure could have a profound impact on business strategies, as the cost of funding may rise considerably. An important piece for banks based in non-SRM countries, such as the UK, is determining the interaction between the home country's rules and the BRRD, particularly the degree to which funding from the central bank in times of stress can be availed. This will be a particularly important issue when conducting stress tests, as stress scenarios will need to incorporate an additional element of uncertainty. 

Last week's developments were a hugely significant milestone for the EU reform agenda given the sheer number of regulations that were adopted. Firms will need to direct their efforts towards further impact analyses and delivery efforts over the next three years, while minimising duplication and undue costs. This will require them to make sure that each programme has a clear, identifiable and traceable link to these regulatory reforms, and to address them thematically.

Unfortunately, regulatory uncertainty will also remain an issue for these firms during this period, as ESMA and the EBA need to specify over 200 technical standards to facilitate implementation. This means that firms must also be able to engage with regulators and prioritise different regulations effectively so that compliance can be achieved cost-effectively and on time. 

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