EU Regulatory Update - IMAS 5th Regulatory/Legal Round-up ... · Derivatives trading issues –...

EU Regulatory Update -

IMAS 5th Regulatory/Legal

Round-up Forum

Jason Valoti

Partner, Simmons & Simmons

Jonathan Quie

Of Counsel, Simmons &

Simmons

9 February 2018

12 February 2018. Simmons & Simmons is an international legal practice carried on by Simmons & Simmons LLP and its affiliated partnerships and other entities.© Simmons & Simmons LLP1 / L_LIVE_APAC1:5982166v1

EU Regulatory Update - key issues for non-EU

fund managers

MiFID2 - Implementation update

EU PRIIPS Regulation

EU Benchmark Regulation

EU General Data Protection Regulation

What we

are going to

cover today

MIFID2


MiFID2 Implementation

MiFID2 came into effect on 3 January 2018

– Comprises Regulation (EU) No 600/2014 (MiFIR) and Directive 2014/65/EU (also

MiFID2)

– 5 Delegated Acts, 35 RTS + 11 ITS adopted so far, more to come

– Lots of Level 3 measures being issued by ESMA (7 Guidelines, 8 Q&As/FAQs, 6

Opinions and 10 Instructions at latest count)

– EU Member State implementation – gold plating

– Third country reactions

Very broad application

– Applies across financial services industry – covers investment banks, private banks,

brokers, wealth managers, asset managers, exchanges, markets, data providers

– Direct and indirect impact on Non-EU third country firms

Implementation generally smoother than anticipated

– Some technological teething issues and other common difficulties


Some MiFID2 Themes/Trends affecting APAC

Greater disclosures of costs/charges and other information for funds

– Some non-EU funds opting out of EU fund of funds investments

– New target market information for specific funds leading to them being removed from

certain fund platforms

– Some EU fund managers dropping their MiFID status (i.e. focusing on fund

management only, which is not directly caught by MiFID2)

Contraction of EU research industry connected to research unbundling

– Much focus on commission sharing arrangements in APAC

– Need for additional local licences? e.g. Japan/South Korea/Taiwan?

– Market Commentary/Bloomberg Access?

Many consent forms provided and terms of business updated

Some exchanges moved out of EU (e.g. some ICE futures)

MiFID2 product governance legends

– Still trying to get an industry standard position (ICMA drafts)


Some Implementation Difficulties affecting APAC

Not all Member States have implemented all MIFID2 (~14 of 28 have not)

Legal Entity Identifiers (LEIs) behind schedule – 6 months grace

Some technology issues

– Connectivity issues between FCA (and other competent authorities) and approved

reporting mechanisms

– Teething issues with new IT platforms needing temporary manual work-arounds

Some ISIN discrepancies (e.g. FX forwards confusing cash v physical)

Derivatives trading issues

– Uncertainty on package orders

– Some traders uncertain if particular OTFs are authorised

– Some brokers reporting trading OTC when in fact SI

Regulatory interpretation uncertainties

– Flaws in methodology for calculating fund costs

– Some events badged as MiFID2 compliant but not consistent with inducement rules

EU Packaged Retail and

Insurance-based Investment

Products Regulation

(the “PRIIPs Regulation”)


EU PRIIPS Regulation: Overview

Came into force on 1 January 2018

The principal requirement of the PRIIPs Regulation is the provision of a key

information document (KID) to EU retail investors investing in PRIIPs.

– KIDs must be in a prescribed format, presenting various data on costs, risks

and rewards, according to set methodologies.

– The PRIIPs ‘Level 2’ Regulation1 sets out a template for the KID (not to

exceed three pages) and prescriptive requirements on the information that it

must contain.

UCITS managers are exempt from the requirement to produce a KID for their

UCITS funds until at least December 31, 2019.


Application to Non-EU Fund Managers

A PRIIP is an investment where, regardless of its legal form, the amount

repayable to the retail investor is subject to fluctuations because of exposure to

reference values or to the performance of one or more assets that are not

directly purchased by the EU retail investor.

– An investment fund share or unit would typically be classified as a PRIIP.

Although certain investment funds may typically be marketed only to

professional investors, EU retail investors might nonetheless be invested in

such funds. This could be the case where, for example, nominee vehicles in the

name of EU private banking or wealth management firms invest in the fund on

behalf of beneficiaries that are EU retail investors.

Although the PRIIPs Regulation is not explicitly stated to apply to non-EU fund

managers, the European Commission have stated that the PRIIPs Regulation

will apply to all PRIIP manufacturers, including non-EU manufacturers, if the

PRIIP is made available to EU retail investors.


What is a ‘Retail Investor’?

A retail investor, for purposes of the PRIIPs Regulation, is a ‘retail client’ as

defined under MiFID2

– in essence, a retail client is any client that is not a professional client.

‘Professional client’ is in turn defined under MiFID II to mean certain clients

that are professional by their status (e.g., financial institutions, pension

funds, governments, central banks and certain large entities), or retail clients

that elect (or ‘opt-up’) to be treated as professional clients.

In order for retail clients to be classified as professional clients, they must be

assessed as having expertise, experience and knowledge such that they are

capable of making the relevant investment decisions and understanding the

risks involved.

It should be noted that, under MiFID II, local authorities will be classified as

retail clients rather than professional clients.


Obligations of PRIIPs Manufacturers

The manufacturer of a PRIIP has the legal obligation to produce the KID.

– A fund manager would be considered to be the ‘manufacturer’ of its funds;

accordingly, to the extent that a fund is made available to EU retail investors,

the relevant fund manager will be required to produce a KID for that fund.

Separately, any person advising on, or selling, a PRIIP to EU retail investors

must provide a KID to those retail investors.

– Such a person might be the fund manager itself, or any distributor of the

fund. This will include EU financial institutions that are advising, or otherwise

acting for, EU retail investors.

The PRIIPs Regulation is not entirely clear on whether KIDs need to be

provided to existing EU retail investors in a fund.

– The prevailing market view appears to be that KIDs only need to be

provided to existing investors where such investors make new investments

from the time the PRIIPs Regulation applies; i.e., from January 1, 2018.

Equally, a KID would need to be provided to any new EU retail investors

investing in new or existing funds from January 1, 2018.


Next Steps

Fund managers that do not wish to prepare a PRIIPs KID will need to:

– ensure that any EU retail investors already invested in their funds either

make no further investments beyond January 1, 2018, or (where possible)

opt-up to be treated as professional clients before making any further

investments.

– consider amending their offering and subscription documents to make clear

that the fund is available only to professional clients (including beneficiaries

of investments made by such professional clients).

Fund managers that wish to continue to receive investments from EU retail

investors from January 1, 2018 onwards will need to:

– produce a KID in accordance with the PRIIPs Regulation. KIDs will need to

be published the KIDs on fund manager’s websites.

– Managers should also work with institutions distributing their funds (including

institutions that invest as nominees for underlying EU retail investors) to

coordinate the KIDs process, including establishing whether there is a need

to translate the KID into the national language of the investor.

EU Benchmark Regulation


EU Benchmarks Regulation (“BMR”): Overview

Came into force on 1 January 2018

– Regulation (EU) 2016/1011

– Many Level 2 regulations

– Subject to transitional provisions

Introduced following regulatory investigations into manipulation of setting

financial benchmarks including LIBOR and EURIBOR

Goes well beyond IOSCO Final Report on Principles for Financial Benchmarks

(“IOSCO Principles”) published in July 2013


The primary restriction

A supervised entity will only be permitted to use a benchmark in the EU if it is

provided by an administrator who is authorised or registered in the EU under the

BMR (BMR Art. 29, but note third-country provisions)

The list of supervised entities is very broad, including credit institutions,

investment firms, UCITS and AIFMs

The “use” of a benchmark includes:

a) issuing a financial instrument which references the benchmark

b) determining the amount payable under a financial instrument or financial contract

referencing the benchmark

c) being a party to a financial contract which references the benchmark

d) providing a borrowing rate calculated as a mark-up over the benchmark

e) determining the performance of an investment fund through an index or combination of

indices for the purpose of tracking the return thereof or defining the asset allocation of a

portfolio or computing performance fees

Authorisation/registration requires compliance with BMR provisions (BMR Art. 34)


What is a benchmark?

A benchmark is “any index by reference to which the amount payable under a

financial instrument or a financial contract, or the value of a financial instrument

is determined, or an index that is used to measure the performance of an

investment fund with the purpose of tracking the return of such index or of

defining the asset allocation of a portfolio or of computing the performance fees”

An index is:

“any figure:

(a) that is published or made available to the public;

(b) that is regularly determined:

(i) entirely or partially by the application of a formula or any other

method of calculation, or by an assessment; and

(ii) on the basis of the value of one or more underlying assets or

prices, including estimated prices, actual or estimated interest

rates, quotes and committed quotes, or other values or surveys.”


Example benchmarks

Interest rates: e.g. LIBOR, EURIBOR, HIBOR, TIBOR

Equities: e.g. FTSE 100, Hang Seng Index

Swap rates: e.g. ICE Swap Rate (formerly ISDAFIX)

Commodities: e.g. MSCI/GSCI indices

FX: e.g. WM/Reuters which cover multiple currency pairs

Probably not benchmarks:

– credit derivatives indices such as iTraxx/CDX as they are lists of names, though the

names are selected semi-annually based on market submissions

– … and used for pricing (e.g. credit spreads/upfront amounts and tradeable credit

fixings)

– IHS Markit is determining in line with IOSCO Principles anyway

– single price from index futures (BMR Art. 2(2)(d))


Who is affected by BMR?

• Person having control over the provision of a benchmarkAdministrators

• Person contributing input data to an administrator for the purposes of determining a benchmark

Contributors

• Person who (a) issues a financial instrument which referencesthe benchmark; (b) determines the amount payable under afinancial instrument or financial contract referencing thebenchmark; (c) is a party to a financial contract which referencesthe benchmark; (d) provides a borrowing rate calculated as amark-up over the benchmark; or (e) determines the performanceof an investment fund through a benchmark

Users


Benchmark significance

The extent to which administrators must comply with BMR varies according to

the significance of the benchmark.

Critical

• used as a reference for financial

instruments or financial contracts or

for the determination of the

performance of investment funds

having a total value of at least

EUR500bn; or

• based on submissions by

contributors, the majority of whom

are located in one EU member state

and is recognised as critical in that

member state by the relevant

competent authority; or

• (i) same as first point above but with

a value of EUR400bn; (ii) no or few

market led substitutes; and (iii)

cessation would have significant

and adverse consequences.

Significant

Does not satisfy all the criteria to be a

critical benchmark, but:

• is used as a reference for financial

instruments or financial contracts or

for the determination of the

performance of investment funds

having a total average value of at

least EUR50bn over a period of six

months; or

• has no or very few market-led

substitutes and its absence would

have a significant and adverse

consequences for amongst others

consumers or the financing of

households and corporations in one

or more EU member state

Non-significant

Does not fulfil the necessary criteria to

be a “critical” or “significant”

benchmark


Benchmark requirements

Critical

• Detailed requirements set out in

BMR Title II (Arts 4 to 16), e.g.:

• 4(1) : robust governance

arrangements, identifying/

managing conflicts of interest,

discretion “independently and

honestly exercised”

• 11(1): input data “sufficient to

represent accurately and reliably

the market or economic reality”

• 12(1): benchmark methodology

“robust and reliable” with clear

rules

• 15: administrators to develop code

of conduct

• Plus:

• Mandatory administration (Art. 21)

• Mitigation of market power (Art.

22)

• Mandatory contribution (Art. 23)

Significant

• Administrator may choose not to

apply certain provisions of BMR Title

II if “the application of one or more of

those provisions would be

disproportionate taking into account

the nature or impact of the

benchmark or the size of the

administrator” (BMR Art. 23(1)

• These provisions are BMR Arts: 4(2);

4(7) (c), (d) and (e); 11(3)(b); and

15(2), e.g.:

• 4(2): “The provision of a

benchmark shall be operationally

separated from any part of an

administrator’s business that may

create an actual or potential

conflict of interest.”

• 11(3)(b): if input data from front

office, those contributors to have

“adequate internal oversight and

verification procedures”

Non-significant• Administrator may choose not to

apply even more, with no

“disproportionality” requirement

• These provisions are BMR Arts: 4(2);

4(7) (c), (d) and (e); 4(8); 5(2); 5(3);

5(4); 6(1); 6(3); 6(5); 7(2); 11(1)(b);

11(2)(b) and (c); 11(3); 13(2); 14(2);

15(2); 16(2); 16(3), e.g.:

• 7(2): administrator to designate

internal function to review and

report on compliance with BMR

• 11(3)(a): input data from front office

to be corroborated against other

sources

• 16(2): supervised contributor to

have “effective systems and

controls to ensure the integrity and

reliability of all contributions of

input data”

• 16(3): policies on use of judgment

or exercise of discretion


Non-EU benchmarks

Third Country Provisions

Benchmarks provided by non-EU Administrators will need to be registered in the

EU by 1 January 2020 in order to be used after that date

Three modes of access:

– Equivalence

– Recognition

– Endorsement


BMR: Impact on Fund Managers

The BMR is a significant piece of legislation for the asset management industry.

The definitions of “benchmark” and “use of a benchmark” both refer to

“investment funds” (defined in the BMR as UCITS or AIFs).

– likely many UCITS and AIFs will be brought into scope of the BMR through

their “use of a benchmark” (e.g. many tracker funds will be “using” a

benchmark).

Fund managers are also at risk of being considered “administrators” if certain

levels they produce are “benchmarks” as defined in the BMR.


BMR: Impact in Asia

Use of many Asian benchmarks may be curtailed in EU after 1 January 2020

– Currently unlikely that any APAC jurisdiction would meet the “equivalence” test

– Difficulties with the “Recognition” and “Endorsement” regimes

– Singapore is consulting on the introduction of a benchmarks regulation regime

– HK at present has no intention to introduce a benchmarks regulation regime

Third country benchmark providers considering whether to withdraw their

benchmarks to avoid time and expense of compliance (smaller ones may not be

viable).

Contingency planning in documents means EU users already starting to move

away from use of APAC benchmarks?

EU General Data Protection

Regulation


EU General Data Protection Regulation (“GDPR”)

The GDPR comes into force automatically in each of the EU Member States

(“EU”) on 25 May 2018.

– seeks to align and bolster the data protection regime across the EU.

– implements more stringent operational requirements for processors and

controllers of personal data

– Significantly increase the extraterritorial reach of European data privacy

legislation.

– Significantly increases penalties for non-compliance (including fines of up to

the greater of EUR 20 million or 4% of the business’s worldwide annual

turnover).


GDPR: Key Concepts

What is “personal data”?

– data relating to a living individual (whether or not they are an EU citizen) (a

“data subject”) who can be identified from that data.

– includes both employee and investor data.

– examples of documents which contain personal data include: employment

agreements, anti-money laundering information and subscription

agreements.

Who are “data controllers”?

– organisations or persons who control personal data – they determine the

purposes for which the personal data is processed and decide what is done

with it.

– A fund’s manager and/or administrator (as applicable) would likely be

considered a controller.


GDPR: Key Concepts

Who are “data processors”?

– organisations or persons who process the personal data in accordance with

the instructions of the controller.

– processing is defined broadly and encompasses most kinds of actions

carried out with respect to the data, including obtaining, recording or holding

the data, or carrying out any operation or set of operations on the data, or

deleting, transferring or disclosing the data.

– likely that a fund’s manager would, in the ordinary course of business,

engage third-party processors of personal data (such as e.g. fund

administrators).


Who does the GPDR apply to?

Broadly, the GDPR applies to

– controllers and processors established in the EU as well as controllers

and processors not established in the EU where the activities the

controllers or processors carry out either involve

– (i) offering goods or services (such as interests in funds) to data subjects

in the EU, and/or

– (ii) monitoring data subjects’ behaviors in the EU.


GDPR: Key Changes

Breach Notification:

– Data controllers are required to notify the applicable data supervisory

authority of certain data breaches without undue delay and, where possible,

within 72 hours of awareness.

– Data controllers may also be required to notify data subjects if the breach is

likely to result in a “high risk” to the rights and freedoms of individuals.

Consent:

– More detailed conditions for using consent to enable data processing,

namely consent must be “freely given, specific, informed, and

unambiguous”. In cases of sensitive personal data it must also be “explicit”.

Data Subject Rights

– Data subjects will have expanded rights including the right to port personal

data between service providers and the right to object to automated

decision-making.

– Protocols for dealing with complaints and access to data updated.


GDPR: Impact for non-EU fund managers

There are two ways a non-EU fund manager may be brought into the scope of

the GDPR:

– if the non-EU fund manager has an establishment in the EU, then that

establishment would be subject to the GDPR. “Establishment” is not defined

in the GDPR. The determination whether a business has an establishment

in the EU must be determined based on the individual facts looking at the

nexus of the business with the EU.

– If a non-EU fund manager does NOT have an establishment in the EU, but

does either (i) offer goods or services (such as interests in the fund

manager’s funds) to data subjects in the EU, or (ii) monitor data subjects’

behavior in the EU, then the non-EU fund manager may be subject to the

GDPR. If the non-EU fund manager has no establishment in the EU, then

the non-EU fund manager may need to appoint an EU representative.



Non-EU fund managers who are within the scope of the GDPR would have to

meet the full requirements of the GDPR.

– would need to carry out a full GDPR gap analysis/compliance project and

put in place appropriate agreements with respect to any personal data

(including employee and investor data) that the fund manager processes.

– In addition, if any personal data that the non-EU fund manager processes is

transferred outside of the EU (e.g. to the non-EU manager’s home

jurisdiction), then unless that country ensures an adequate level of

protection in relation to the processing of personal data, a mechanism to

transfer that personal data will need to be put in place (such as a data

transfer agreement based on the model clauses).



Once within the scope of the GDPR, non-EU managers are required to

designate a representative in the EU unless:

– (i) the processing is occasional,

(ii) does not include on a large scale processing of special categories of

data (e.g., health data or race/ethnic data), and

(iii) is unlikely to result in a risk to the rights and freedoms of natural

persons, taking into account the nature, context, scope and purposes

of the processing.

– A non-EU fund manager that has EU investors must determine whether their

processing of investor personal data is merely “occasional”.


What next steps should a non-EU fund manager be taking

to prepare for GDPR?

A non-EU fund manager should:

– Determine the activities that it carries out either in the EU or in relation to

data subjects in the EU.

– Map the personal data that they collect, store or process in the EU (including

on any servers located in the EU) or in relation to data subjects in the EU,

and determine what it is used for and how long it is kept.

Depending on the activities that the non-EU fund manager carries out and

whether GDPR will apply to its activities, further steps may need to be taken

including:

– Reviewing and updating data protection policies and information security

policies, agreements in relation to the transfer of data, service provider

agreements and employment documentation.

– Review and update fund documentation to the extent necessary.

– Train staff on data protection practices and breach.

– Consider whether an EU representative will need to be appointed.


Questions?


Where can I find further information?

Welcome to elexica: www.elexica.com

Free access to our resources 24/7: articles, podcasts and specialist guidance

on our microsites

MIFID2 Manager

High quality legal and regulatory updates and current awareness alerts

Information on our suite of navigator on-line subscription services including:

– navigator: Funds (which covers the key issues which are relevant to entities

looking to offer funds to local investors on a cross border basis)

– navigator: Share Disclosure (which covers what the major shareholding

disclosure regimes look like in a variety of jurisdictions)

– navigator: Derivatives and FX (which covers the key issues relevant to

entities looking to enter into derivatives and FX spot contracts with

counterparties on a cross-border basis)

http://www.elexica.com/


Contact details:

Jonathan Quie

Of Counsel

Financial Markets, Singapore

T +65 6831 5 632

E [email protected]

Jason Valoti

Partner

Financial Markets, Singapore

T +65 6831 5 610

E [email protected]

This document is for general guidance only. It does not contain definitive advice. SIMMONS & SIMMONS and S&S are registered trade marks of Simmons & Simmons LLP. Simmons & Simmons is an international legal practice carried on by Simmons & Simmons LLP and its affiliated practices.

Accordingly, references to Simmons & Simmons mean Simmons & Simmons LLP and the other partnerships and other entities or practices authorised to use the name “Simmons & Simmons” or one or more of those practices as the context requires. The word “partner” refers to a member of

Simmons & Simmons LLP or an employee or consultant with equivalent standing and qualifications or to an individual with equivalent status in one of Simmons & Simmons LLP’s affiliated practices. For further information on the international entities and practices, refer to simmons-

simmons.com/legalresp. Simmons & Simmons LLP is a limited liability partnership registered in England & Wales with number OC352713 and with its registered office at CityPoint, One Ropemaker Street, London EC2Y 9SS. It is authorised and regulated by the Solicitors Regulation Authority.

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