The relevance paradigm…a preview of 2012’s regulatory landscape

For capital market participants, 2012 is likely to feel very similar to the last few years in regulatory terms, only more so as the various political and regulatory responses to the financial crisis are now in full swing. Many of the principal changes, like AIFMD, still remain ahead of us.

However, as discussed in this article, some measures are already in place and with others the focus has shifted to agreeing and preparing the detail of the provisions and how they will be implemented.

Our review/preview considers the regulatory developments that we are aware of (“known knowns”), those that we know about, but are awaiting the detail of (“known unknowns”) and concludes with the residual ability of regulators to occasionally surprise us (“unknown unknowns”). It should have already become apparent that 2011 was the last year in which the post crisis tsunami of regulatory change (and please forgive use of this now ubiquitous expression) could be ignored.

For a regulatory timeline of 2012 please click here.

Known knowns

• 2011 commenced with the introduction of new rules on remuneration applicable to around 2,600 firms in the UK, an increase on the previous year’s version of the “Rem Code” which applied only to the UK’s 26 largest financial institutions. The year also saw the commencement of operations of several new EU supervisory authorities, including the European Securities and Markets Authority (ESMA) which replaced The Committee of European Securities Regulators (CESR).

• The new UK Bribery Act came into force on 1 July 2011. Although this legislation has application far broader than the regulated financial services industry, such firms must consider and meet the FSA’s expectations to have suitably robust systems and controls to identify, mitigate and manage their risk of bribery, and also other financial crimes.

• On 14 November 2011 the FSA rule requiring the recording of certain telephone calls was extended to mobile phones.  Impacted firms are now either bedding down their technology or will have banned the use of mobile phones for trading.

• 2011 was reminiscent of 2008 in the sense that certain countries imposed national short selling restrictions, prohibitions and/or disclosure requirements.  A European Union wide harmonised regime in relation to short selling “and certain aspects of credit default swaps” is due to come into force on 1 November 2012.  This regime requires disclosures of short positions above certain thresholds, restricts naked short sales and prohibits uncovered CDSs in the sovereign debt of an EU member state.

• In 2012 the extraterritoriality of US financial services regulation will result in dual registration for some with Dodd Frank significantly increasing the jurisdiction of the SEC. Many non-US fund managers with US investors and/or clients will have to register fully with the SEC – for which the deadline is effectively 14 February 2012 – while those able to avail of a partial exemption will need to make a filing by 30 March 2012. Impacted firms should have already been getting to grips with the similarities and divergences between the SEC and FSA and the rulebooks of each.

• Speaking of the FSA, 2012 will be its final full calendar year of operation.  An amendment to the current legislation (“FSMA”) will abolish the FSA and replace it from early 2013 with new bodies the Financial Conduct Authority (“FCA”) which will supervise market conduct and the Prudential Regulatory Authority (“PRA”) which has responsibility for the prudential regulation of 2,500 (comparatively more) systemically significant firms.

Known unknowns

• On 21 July 2012 the US “Volcker Rule”, another component of Dodd Frank legislation, comes into effect. Although primarily aimed at prohibiting US banks, bank holding companies and their affiliates from owning private equity or hedge funds and from engaging in proprietary trading, it could significantly impact asset managers and non-US funds as, under currently drafts, the Volcker Rule treats all non-US funds as if they were US private equity or hedge funds.

• The AIFMD was finally “passed” in July 2011 and we “look forward to” to its implementation in 2013. We now have a much better idea as to the likely final shape of its provisions – in particular following the publication of ESMA’s advice to the Commission last November - which have already improved significantly from the dark days of 2009. Many aspects remain open to ongoing consultation on rule-making and national implementation. The next material milestone will be the publication (expected March) by the EU Commission of the final draft of the Level 2 technical standards and we await with acute interest its contiguity to the ESMA advice. Meanwhile, venture capital firms keenly await the outcome of a recent European proposal potentially allowing them to raise capital freely throughout the EU from certain types of investors without having to meet the more demanding provisions of AIFMD.

• Perhaps the most potent development emerging from leftfield is the US Foreign Account Tax Compliance Act (“FATCA”) which currently has an implementation date (for certain of its requirements) of 30 June 2013.  This will require fund managers to report information to the IRS relating to their US investors.  A huge lobbying effort is under way.

• 2012 is a landmark year for Over The Counter (“OTC”) derivatives.  In September 2009 the G20 leaders met in Pittsburgh and made a number of commitments including “that all standardised OTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by the end of 2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements”.  These obligations are to be implemented in Europe through two separate legislative initiatives, namely the European Market Infrastructure Regulation (or “EMIR”) and also subsequent amendments to MIFID. However, a lot of the important details are still to be drafted at, which makes it difficult to assess EMIR’s full impact or precise timing.

• Regulatory developments that will figure in conversations and progress in 2012 but with implementation dates in subsequent years include the European Commission’s proposed changes to MiFID and the Market Abuse regime.  And, much as we would like to, let’s not forget about the European Commission’s expressed desire from 2014 for a Financial Transaction Tax (“FTT”) to be levied on all transactions in financial instruments carried out between financial institutions when at least one party is located in the EU.

Unknown unknowns

In a regulatory context, unknown unknowns include unforeshadowed policy proposals or statements of best (hence “required”) practice by regulators. These should be rare as the EU bodies and the FSA publish their work programmes in advance and the FSA has already said publicly that its “own initiative” policy agenda is comparatively thin given the current size of the EU agenda and also the imminent change to the UK regulatory regime.  However, you can never rule out sudden regulatory developments that respond to market volatility (these are usually the worst types of regulation by far) should such volatility continue in 2012.  The best (or perhaps worst) examples of these to date have been the national, ad hoc short selling measures.

Enforcement cases will remain a great barometer of the regulators’ mood and mindset.  However, given that an enforcement case takes from one year to up to three or more start to finish, every single case concluded in 2012 will have commenced in 2011 or earlier. In 2012 FSA enforcement cases featuring market abuse and client money are likely to continue to be prominent. Cases against individuals under the Code of Conduct for Approved Persons are likely to increase in number in 2012 as are the fines meted out under the relatively new framework for their calculation. Having been criticised over RBS, the FSA will wish to deliver on its stated policy of holding senior managers personally accountable for regulatory and corporate governance shortcomings at regulated firms.

Conclusion

Participants in the financial services industry are certainly facing a period of unprecedented regulatory change. While regulatory change should be regarded as inevitable, the pace and scale of such change appears to be determined by the health and direction of the capital markets.  In that the markets have boom and bust, regulation has similar cycles of deregulation and regulatory waves, even tsunamis.

IMS will continue to provide news of regulatory developments during 2012, both via our periodic newsletters and bulletin announcements, where there is a development of particular significance and impact to our clients.

If you have any questions regarding the subjects raised in this briefing, please contact Peter Moore, Stephen Burke or Alan Leale-Green. Alternatively telephone 020 7408 2448 to speak to your usual IMS contact.