POST GLOBAL FINANCIAL CRISIS REGULATIONS: E.U. AND FRENCH REGULATORY EFFORTS

Origins of the crisis

To understand the profusion of regulations issued since 2008, it is necessary to recall the main factors contributing to the development of the subprime crisis and the importance of the financial crisis that has resulted in:

• Failure to properly advise customers lead to take risks that she could not control.

• Lack of transparency in the creation of financial instruments, particularly credit default swaps (“CDS”).

• Inadequate capital of financial institutions: the then existing regulations allowed to exclude securitized loans placed in off-balance sheet during the formation of regulatory capital.

• Lack of cash of financial institutions to cope with the influx of customer demands who wanted to recover its deposits.

• Not taking into account the systemic importance of large institutions (« too big to fail ») in the context of a crisis, with insufficient capacity of states to intervene in their governance.

Regulatory measures implemented

Drawing lessons from the crisis, European and French authorities have enacted many regulations aimed at strengthening the control and prevent such crises from happening again.

The regulations implemented over the last 6 years meet several objectives of regulators in Europe:

Strengthening the soundness of financial institutions and providing the European banking market a responsive and efficient governance in case of crisis: CRR regulation (Capital Requirement Regulation)1 and the CRD IV Directive (Capital Requirement Directive)2, adopted June 26, 2013 adapt at European level the « Basel III » international agreements.

They strengthen and harmonize capital requirements and introduce liquidity standards for the banking sector to limit leverage, take full account of the risks associated with securitization instruments or financial instruments such as CDS and limit the risk of cash shortage during a crisis. The new requirements also introduce a notion of systemic risk strengthening the requirements for institutions of significant size.

In addition, regulations require that the competence of management and supervisory bodies be strengthened and they allow regulators to intervene in the management of these institutions in case of a crisis, with sanctioning powers and the ability to suspend or release their managers.

Finally these regulations introduce the implementation of a unique supervisory mechanism in Europe (MSU) with the creation of a specific resolution fund.

Confining the proprietary activities of banks: in France, the law of July 26, 2013on separation and regulation of banking activities requires banks to establish an ad hoc subsidiary to consolidate all the proprietary activities of the bank on financial markets, thus avoiding risks of contagion to other activities of the bank; it limits compensations to avoid excessive risk taking. But the Governor of the Banque de France challenged the project of the EU Commissioner Michel Barnier, who aimed at imposing more stringent constraints.

Developing transparency on the derivatives market (OTC): EMIR4 regulations aim for increased transparency in the OTC markets via the creation of trade repositories and counterparty risk reduction through the clearing obligation via central counterparties for certain derivatives.

Reinforcing client protection: the MIFID 2, MIFIR, UCIT V and AIFM, PRIIPS regulationsreinforce the banks’ obligations on advice given to clients, transparency requirements in all documentation and other media providing information on financial instruments to the general public, reviewing the categories of financial products according to the risks they represent for the client, limiting and structuring the practice of commissions and incentives.

Limiting speculative transactions through the introduction of a tax on financial transactions (FTT) and introducing rules on high-frequency trading.

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CRR / CRD IV – Basel III

Context

The CRD IV package, including regulation 575/2013(EU), known as CRR (Capital Requirement Regulation) and directive 2013/36/EU known as CRD IV (Capital Requirement Directive), was adopted on June 26, 2013. These texts constitute the European deployment of the international accords known as “Basel III”, which reinforce and harmonize capital funds requirements and introduce liquidity standards for the banking sector. The CRD IV directive also establishes new governance requirements.

Principal measures

 Reinforcement of prudential requirements, translation of Basel III:

• Quantitative reinforcement of capital funds: raising of CET1 (Common Equity Tier 1) and Tier 1 ratios;

• A more restrictive definition of capital funds and a “focus” on core capital (CET1);

• Introduction of new capital buffers: capital conservation buffers, countercyclical buffers and systemic buffers;

• Improvement in risk coverage: counterparty risks in derivatives;

• New liquidity ratios: LCR and NSFR;

• A leverage ratio;

• Strengthening disclosure requirements: all of the above mentioned measures are to be accompanied by reinforced disclosure requirements imposing more detailed reports, increased frequency of reports, shorter deadlines for transmission of reports.

 Governance:

Managers: they must satisfy certain conditions of knowledge, skills, experience and availability;

Organization and internal audits: credit institutions must have governance measures in place including a clear organizational structure, efficient procedures for holding and monitoring risk, adequate provisions for internal auditing, viable administrative and accounting procedures and a compensation policy that favors good risk management;

Compensation policy and practice: the compensation structure for risk-takers introduced by the CRD III directive is reinforced with specifically a cap on variable compensation;

Specialized committees: the major credit institutions depending on their size and their internal organization and the nature, scale and complexity of their activities, must create risk and nomination committees in addition to the compensation committee implemented during the transposition of the CRD III directive.

 Implementation of a single supervisory mechanism in Europe (SSM), with an extension of the powers of the European Central Bank and the national supervisory bodies (ACPR):

• The national supervisory body for the banking system is transferred from the domestic to the European level, the ECB becoming the relevant authority for all significant financial institutions;

• A single bank resolution fund will be constituted over five years and a single resolution mechanism in Europe will be implemented to enable the European authority to proceed efficiently with the restructuring of an institution in difficulty without an overly significant impact on the taxpayer or the real economy. 55 billion Euros over 5 years.

• The list of parties subject to ACPR control is completed with notably mixed holding companies which are, in this respect, subject to a fixed contribution for auditing costs;

• The credit institutions must implement a reporting procedure that specifically enables their employees to report to the ACPR any violation or breach of the regulations defined in the CRD IV package;

• The ACPR may require any subsidiary of any entity for which it is the overseer and any third party to which such entity has outsourced a portion of its activities to produce any document necessary for the accomplishment of its missions;

• In the event of a failure to comply with the regulations established in the CRD IV package, credit institutions will risk financial sanctions for a maximum amount of 10% of the parent company’s annual turnover or twice the gains received due to such failure;

• When the liability of the “effective managers” and officers is established, they risk temporary suspension, resignation from their office or financial sanctions for a maximum amount of 5 million Euros or twice the gains received due to such violation.

Further information on the Single Resolution Mechanism

The COM (2013) 520 text aims to implement a single resolution mechanism (SRM) in the context of the banking union. This mechanism will supplement the single supervisory mechanism (SSM). Under this mechanism, the European Central Bank (ECB) will be directly responsible for banking supervision in the Euro zone and in the other Member States that elect to join the banking union. In the event that a bank subject to the SSM encounters considerable stress, the single resolution mechanism will enable it to effect resolution efficiently, without overly significant impact on the taxpayer or the real economy. This system aims specifically to avoid the situations encountered in Ireland, Spain or Cyprus, where the intervention of States to recapitalize the banks led to a derailment of public finances.

In the context of the SRM, the ECB, as the supervisory authority, will report if a bank in the Euro zone or established in a Member State participating in the banking union encounters financial difficulties that require it to proceed with resolution. This resolution would be prepared by a Single Resolution Board, constituted of representatives from the ECB, the European Commission and the national authorities concerned.

Based on the recommendations of the Single Resolution Board, or on its own initiative, the Commission will decide whether the bank should undergo a resolution procedure, and when, and will put into place a structure for the implementation of the resolution instruments and the Fund. Under the Single Resolution Board’s oversight, the national resolution authorities will be responsible for the implementation of the resolution plan. In the event that a national resolution authority does not comply with the Single Resolution Board’s decisions, it may send enforcement orders directly to the banks in difficulty.

A Single Resolution Fund for the banks should also be put into place under the control of the Single Resolution Board in order to guarantee that medium-term financial support is available during the bank’s restructuring. It will be funded by contributions from the banking sector. These contributions will replace the domestic resolution funds of the Member States in the Euro zone and the Member States participating in the banking union, as provided in the draft directive on banking recovery and resolution.

The creation of the SRM and the bank resolution funds is the logical extension of the bank union plan, lead notably by France. In the context of a transnational banking market, reinforcement of European oversight constitutes genuine added value and must, in the future, prevent the risk of a banking crisis evolving into a liquidity crisis for the States. The role of the European Commission in the resolution procedure and the conditions for supplying the resolution fund call for debate and in-depth review.

Law n° 2013-672 of July 26, 2013 on separation and regulation of banking activities

The main purpose of this law is to make sure that activities of certain credit institutions and financial companies which are useful to the financing of the economy will be separated from their speculative activities.

Separation of activities

 Objectives are:

• To guarantee financial stability,

• To reinforce the solvency of banks with regards to depositors,

• To prevent conflicts of interest with clients and,

• To support the financing of the economy.

 Institutions concerned: credit institutions, financial companies and mixed financial and holding companies whose financial instrument trading activities exceed the thresholds established in a decree issued by the Conseil d’Etat (French Supreme Court of the Administrative Order).

 Principle of separation of the two types of activities into two branches:

(i) Transactions on own account with hedge funds:

Principle: Prohibition for a credit institution to enter into own account transactions with leveraged mutual funds other than through a dedicated subsidiary if certain conditions are not fulfilled.

Conditions: the credit institution is secured and such security must meet certain requirements: quantity and quality standards, availability, and oversight by the Autorité de Contrôle Prudentiel et de Résolution (the “ACPR” is the French prudential control and resolution authority, an independent administrative authority, which ensures the preservation of the stability of the financial system and the protection of customers,policyholders, subscribers, and beneficiaries of the entities under its control).

Scope: Leveraged mutual funds or other similar investment vehicles meeting characteristics established by decree of the French minister of the economy, mutual funds that are themselves invested in or exposed, above a threshold set by decree, in leveraged mutual funds.

The credit institution will provide the ACPR with the information on its commitments with these mutual funds.

(ii) Trading activities concerning financial instruments involving a credit institution’s own accounts

Principle: Prohibition for a credit institution to carry out, other than through the intermediary of a dedicated subsidiary, trading activity involving its own accounts.

Exceptions: Providing investment services for clients, clearing of securities, coverage by the bank of its own risks, market-making (activity useful to the financing of the economy), sound and prudent management of cash, group investment transactions.

Strict confining of dedicated subsidiaries

• The subsidiaries are strictly confined. They must use corporate and commercial names that are distinct from those of the group’s credit institutions. They are approved by the ACPR as an investment institution or credit institution.

• When the subsidiaries are approved as credit institutions, they may not received secured deposits nor provide payment services to clients whose deposits are secured.

• The subsidiaries must comply with management standards under the conditions established by decree.

Supervision of “direct market access” and algorithmic trading

• Supervising “direct market access” practices for investment firms.

• Obligation of all parties to declare to the AMF (French Financial Market Authority) the use of data management systems and to maintain traceability of market orders and algorithms used

• Ability for platforms to manage periods of market strain.

EMIR

The E.U. reflection of the undertakings made at the G20 summit in Pittsburgh in September 2009 concerning the systemic risk associated with the massive use of over the counter (OTC) derivatives is called EMIR (European Market Infrastructure Regulation), the European equivalent of part of the Dodd-Frank Act provisions in the United States.

This regulation appeared in the European Union’s Official Journal on 27/07/2012 (EU regulation n°648/2012 of the European Parliament and Council of July 4, 2012).

EMIR focuses mainly on:

• enhancing transparency of OTC derivatives markets via the creation of trade repositories in charge of collecting and maintaining records of these derivatives;

• reducing counterparty risk via a clearing obligation: financial and non-financial counterparties exceeding certain thresholds must centrally clear OTC contracts with an authorized central counterparty.

As an EU regulation, it is applicable immediately in all Member States.

Context

OTC derivatives, and more specifically Credit Default Swaps (CDS), have been factors of the financial crisis notably due to the lack of transparency concerning the positions held by the various financial players regarding these instruments, which did not fall under the then-existing disclosure and information E.U. requirements (MIFID).

Structural inadequacies identified concerning the infrastructure for management of systemic risk forced the G20 members to make the commitments set forth in this regulation, which specifically provides for:

• Clearing of standardized OTC derivatives contracts via the intermediary of central counterparties in order to reduce the counterparty risk;

• Implementation of risk management procedures for OTC derivatives that are not cleared;

• A need for additional own funds for contracts that have not been cleared;

• Obligation to declare all OTC derivatives contracts to trade repositories. The trade repositories are required to publish the aggregated positions by derivatives category, making it possible for the players to have a clearer view of the derivatives market;

• Reinforcement of the role of the European Securities and Markets Authority (ESMA) in the oversight of trade repositories and the granting or withdrawal of their registration.

The provisions of the regulation

They concern primarily the following areas:

• The clearing obligation for OTC derivatives transactions and the implementation of risk management procedures for non-cleared contracts.

The eligible derivatives are treated via clearing houses. These clearing houses will limit the counterparty risk as they act as intermediaries between the buyer and the seller of the derivative. They ensure the solvency of the participants by requiring security deposits (collateral) that are constituted in function of the evolution of the commodity price (margin calls).

The criteria for eligibility defined by the ESMA to identify the categories of derivatives eligible for the clearing obligation depends specifically on the degree of standardization of the derivatives contracts, the assessment of the reduction of systemic risk on the financial system, the liquidity of the contracts, the daily availability of information on contract prices. The finalized draft for regulatory technical standards6 and implementation was deployed by the ESMA on 28 September 2012. The definition of the asset categories was established in 2013.

The regulation is applicable to financial and non-financial institutions, with the definition of the rules for exemption concerning coverage transactions and intra-group transactions7.

• The obligation to declare:

This obligation is applicable to all OTC derivatives transactions, whether or not they are cleared through transmission of details of the transactions to a trade repository.

It takes place no later than the day after its execution, clearing or modification.

It may be delegated by the final investor or a clearing member, its central counterparty or a designated external agent, or even the other counterparty.

It is applicable to all contracts entered into or existing as of 16/08/2012.

MIFID2 – MIFIR

Draft MIFID II directive of October 20, 2011, repealing the 2004/39/EC framework directive and its implementation measures: 2006/73/EC framework directive and application regulation n° 1287/2006.

Context:

The first MIF Directive concerning the Financial Instruments Market was adopted on April 21, 2004 and entered into effect on November 1, 2007. This directive defined the rules for markets and financial intermediaries (ex: procedure for execution of orders) as well as rules for consumer protection (ex: client’s right-to-know and right-to-information obligation incumbent on the bank, obligation to offer products adapted to its circumstances …).

Seven years after its implementation, the results are mixed:

• the markets are more fragmented and less transparent (lack of liquidity and misuse of the principle of transparency–dark pools and crossing network);

• the post-trade quality of information with regard to investors is not satisfactory;

• lack of coordination among supervisory authorities (in cases of default by counterparties).

In light of these findings, the MIF 2 Directive focuses on the following issues:

• organizing pre-trade and post-trade transparency for securities other than shares and regulating OTC transactions;

• reinforcing investors’ protection;

• strengthening the powers of the European supervisory authorities.

The draft amendment is constituted of a regulation (MIFIR), which will be directly applicable as such in the Member States, and a Directive (MIFID II), which will need to be transposed in the Member States.

Both texts (Directive and regulation) constitute together the legal framework governing the requirements applicable to investment institutions, regulated markets (RM), and data provision services (Reuters,…).

Principal measures:

MIFIR

• Expansion of the rules to financial instruments that are similar to shares (certificates of deposit…) and financial instruments other than shares (bonds, structured financial products…);

• Reinforcement of pre-trade and post-trade transparency rules for trading platforms;

• Reinforcement of pre-trade and post-trade transparency rules for investment institutions trading OTC instruments (ex: obligation to publish firm bid and offer quotes);

• Extension of the scope of application of transactions disclosure by investment institutions, regulated markets, multi-lateral trading facilities (MTF), and Organized Trading Facilities (OTF), including an obligation to keep recordings of transactions (for investment institutions) made on behalf or in the name of a client and recordings of all transaction orders (for platforms) for 5 years. Post-trade reporting on transactions completed is extended to financial instruments traded in a MTF or OTF, and the level of detailed information that must be transmitted in the trade order (introduction of a Trader ID and a Client ID) is increased;

• Introduction for derivatives of an obligation to trade on electronic platforms (RM, MTF or OTF) and to clear derivatives trades on regulated markets (OTC derivatives must be traded on RMs: this obligation concerns both financial and non-financial counterparties that exceed the clearing threshold set by the EMIR);

• Interoperability: non-discriminatory access for market infrastructure, clearing houses and central securities depositories to the financial instruments trading platform flow of information

MIFID II

• The provisions retained preserve the option of linking payment of commissions to the sale of financial instruments;

• The institutions must take reasonable measures in order to ensure that the product is sold to the appropriate category of clients;

• The institutions which market investment products are also required not to compensate their employees, or assess their performance, in any way that might create an interest that is not in the best interests of their clients;

• Investment advisors and salespersons must have an appropriate level of knowledge and understanding of the products they are marketing;

• The list of complex products is dense: certain products considered in the MIF I as simple (such as shares, bonds or funds) may be considered as complex if they include a derivative;

• Keeping a custody account will become an investment service that is provided as a principal service.

AIFM (Alternative Investment Fund Managers): European Directive 2011/61/EC of June 8, 2011

Context

The 2011/61/EU Directive of the European Parliament and Council of June 8, 2011 on alternative investment fund managers (the AIFM Directive), was transposed into the Monetary and Financial Code by Decree n° 2013-676 of July 25, 2013, Decree n° 2013-687 of July 25, 20138 and the decree of August 8, 2013 ratifying the amendments to the general regulations of the Financial Markets Authority.

This Directive provides for increased oversight and regulation of alternative investment funds and their managers. In exchange, it offers new opportunities through a European passport that allows them to provide their management services and distribute their funds in all EU Member States.

Principal measures

The main objectives of the AIFM’s Directive are the following:

• To regulate the managers of alternative investment funds that manage and/or market these funds and not the funds themselves, given the extreme variations in this type of funds. All funds not subject to the UCITS Directive are considered as alternative investment funds falling within the scope of the AIFM Directive;

• To put into place a passport for the European managers and for the funds, which would take effect as soon as it became effective in 2013, and which would be offered to non-EU managers and funds as from 2015;

• To mandate a single depositary for each fund managed by a manager, like the UCITS funds;

• To define a harmonized framework at the European level for the depositary’s missions, and to establish the principle of liability of the depositary, with regards to the fund it manages, in the event of loss of assets in its custody.

UCITS V:

The 2014/91/EU Directive amending the 2009/65/EC Directive.

Context

On July 3, 2012, the European Commission published a legislative package that sought to improve the protection of consumers in the financial services sector.

Principal measures

This package consists of three legislative proposals:

• A proposal to regulate key information concerning retail investment products (RIP);

• An amendment to the Directive on intermediaries in the insurance sector (IMD);

• A draft of the Directive amending the UCITS IV Directive integrating the provisions on depositary functions, remuneration policies and sanctions of money market fund managers (UCITS V).

The European Commission, in its draft UCITS V Directive, focused on harmonizing the role, missions and responsibilities of the depositary banks of harmonized funds.

In this respect one will note a number of similarities with the Level 1 of the Alternative Investment Fund Managers Directive (AIFM Directive), such as:

• the description of the depositary’s missions (oversight of cash flow, conservation, depository control, custody delegation rule…);

• a liability regime based on restitution in the event of loss of assets under custody.

The initial draft of the UCITS V Directive also contained areas of divergence with the AIFM Directive, certain of which were however the subject of draft amendments by the European Council on December 4, 2014, in order to move toward greater harmonization of these two texts.

These differences primarily concerned the following:

• the criteria for eligibility of entities that can offer depositary services;

• the rules on reusing securities in a fund by the depositary;

• the consequences of insolvency of the depositary on the protection of assets;

• the conditions for delegation to a sub-custodian without the possibility of a transfer of liability to such sub-custodian.

On these points, the European Council, which approved the general approach of the draft UCITS V Directive, suggested amendments in order to improve harmonization of the criteria for eligibility of the depositaries, their missions (monitoring of cash flow, custody, depositary control, delegation of custodial regime) and their liability regimes (reconciliation with the depositary regime introduced in the AIFM Directive).

In addition, the European Council proposed amendments on the regulations for determining compensation for mutual fund managers and harmonization of administrative sanctions imposed by various regulators.

The reform enacted by the 2014/91/EU Directive of July 23, 2014 amends Directive 2009/65/EC (OPCVM IV) on three essential points:

• The depositary function;

• Compensation within the management company;

• The sanctions regime applicable to trade professionals.

The amendments specifically enable a reconciliation of these subjects, the regime resulting from themutual funds directive and that from the AIFM Directive (Dir. 2011/61/EU, 8 June 2011: JOEU, 1 July), governing managers and depositaries of alternative investment funds.

The deadline for transposition of the new provisions by Member States is set at March 18, 2016, and it will take effect as of this same date (Dir. 2014/91/EU, art. 2).

PRIIPS (Packaged Retail Investment and Insurance Products): draft regulationn° 2012 0352 of 3 July 2012

Context

The PRIIPS regulation was adopted by the European Parliament on April 15, 2014. Its objective is to ensure uniformity of the pre-contractual information provided to non-professional investors for products whose performance is a function of the underlying assets (structured notes, mutual funds and AIF, structured deposits, unit-linked life insurance contracts, derivatives, convertible bonds…). The regulation is also applicable to titles or shares of special purpose vehicles.

In order to attain this objective, the Regulation requires the initiator/designer of the product to provide:

• a “key information document” (KID), in a clear and concise form, constituted of different sections that enable the retail investor to have access to sufficiently clear basic information in order to be able to understand the products (whether they are financial, bank or insurance products), and to make comparisons between these products.

• sectors concerned: bank – capital markets, insurance and asset management for third parties;

• products concerned: all “retail investment products and insurance-based [investment products]” that fall within the definitions provided by the PRIIPS regulation:

− retail investment product: an investment, including instruments described under special purpose vehicles, regardless of their legal form, for which the amount that is repayable to the investor is subject to fluctuations because it depends on reference values or the performance of one or several assets which are not purchased by the investor directly;

− insurance-based investment product: an insurance product that has a maturity or surrender value that is partially or fully exposed, directly or indirectly, to market fluctuations.

• excluded products:

− non-life insurance;

− life-insurance contracts when the services provided under the contract are payable only in the event of death or disability due to an accident, illness or infirmity;

− deposits other than structured deposits defined in article 4 of the MIF Directive;

− securities described in article 1 paragraph 2, points b) to g), i) and j), of the 2003/71/EC Directive (Prospectus directive)9. This concerns the securities exempted from prospectus with the exception of issuances of securities appearing in an offer when the total amount of the offer is less than 5 million Euros;

− retirement products, which are considered under domestic law as existing primarily to provide the investor with income when he/she is retired, and which entitle the investor to certain services; professional retirement regimes that are officially recognized and fall within the scope of application of the 2003/41/EC directive or the 2009/138/EC Directive10;

− individual retirement products for which a financial contribution by the employer is required under domestic law and the employer or employee cannot choose the retirement product or provider;

Principal measures

• Drafting by the providers of the retail investment products and insurance-based investment products of key information documents for the products they design and which fall within the scope of application of this regulation;

• Provision by the sellers (developer, distributor) to the client concerned of a key information document, prior to the conclusion of a transaction involving a retail investment or insurance product affected by this regulation;

• Implementation by the producers of retail investment and insurance-based products of a claims management procedure that is efficient and suitable, in order to respond to claims by investors relating to the key information documents.

Taxes on financial transactions

Context

France has created a tax on financial transactions (the “FTT”), consequent to the first amended law on finances of 2012 and affecting (at the rate of 0.2 %) the purchase of shares in a company whose registered offices are located in France and for which market capitalization exceeds one billion Euros. The European Commission has proposed a directive aiming to establish a common FTT system, which would be the subject of enhanced cooperation among the eleven Member States (the “Cooperation”), including France.

Principal measures

The European FTT provision under consideration aims to tax all financial transactions, regardless of the market, instrument or institution, if there is any territorial link with the “FTT zone”, such link being essentially based on the residence of one of the parties to the transaction or, incidentally, at the site of issue of the financial instruments exchanged. Even if the tax rates provided are left to the discretion of each State involved, they will be set, according to the provisions, at, at minimum, 0.1 % for shares and bonds and at 0.01 % for derivatives.

The opinion issued by the European Parliament voting in a plenary session on July 3, 2013 recommends, specifically, the application of reduced rates for sovereign bonds and financial instruments issued by pension funds until 2017, as well as exemptions for intra-group transactions and certain market-making activities.

While according to the non-binding opinion published by the European Council’s legal experts on September 6, 2013, the drafted European FTT would be legally incompatible with the European treaties, in France, the authors are exploring the relationship between the French FFT and the European FFT.

At the end of the ECOFIN Council meeting of May 6, 2014, ten Member States of the Cooperation (with the exception of Slovenia) signed a joint declaration to implement the FTT progressively, focusing initially on the taxation of shares and certain derivatives (without specifying which). This initial phase was to be implemented no later than January 1, 2016.

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POST GLOBAL FINANCIAL CRISIS REGULATIONS: E.U. AND FRENCH REGULATORY EFFORTS

NYSBA 2015 ANNUAL MEETING

CHAOS IN THE FINANCIAL SKY

 Failure to properly advise customers lead to take risks that financial institutions could not control

 Lack of transparency in the creation of financial instruments, particularly credit default swaps (“CDS”)

 Inadequate capital of financial institutions

 Lack of cash of financial institutions to cope with the influx of customer demands who wanted to recover its deposits

 Not taking into account the systemic importance of large institutions (« too big to fail ») in the context of a crisis, with insufficient capacity of states to intervene in their governance

E.U. / FRENCH IMPROVEMENTS IN REGULATING THE FINANCIAL SKY

 Banking Union: Single Supervisory Mechanism (SSM) + Single Resolution Mechanism (SRM) + Single Resolution Fund (SRF) / Deposit Guarantee Schemes (DGS)

 Bank Recovery and Resolution Directive (BRRD)

CRD IV package: CRR regulation 575/2013(EU) (Capital Requirement Regulation) + CRD IV directive 2013/36/EU (Capital Requirement Directive)

 French Law n° 2013-672 of July 26, 2013 on separation and regulation of banking activities

 EU regulation n°648/2012 of the European Parliament and Council of July 4, 2012: European Market Infrastructure Regulation (EMIR)

 MIFID II directive of October 20, 2011 + MiFIR regulation

 EU Directive 2011/61/EC of June 8, 2011: Alternative Investment Fund Managers (AIFM)

EU Directive 2014/91: Undertakings for the Collective Investment In Transferable Securities (UCITS V)

 Draft regulation n° 2012 0352 of 3 July 2012: Packaged Retail Investment and Insurance Products (PRIIPS)

 Taxes on Financial Transactions (FTT)

SETTING UP RADARS AND WARNING LIGHTS TO DETECT PROBLEMS

The E.U. adapted the Basel III international agreement in its Capital Requirement Regulation (CRR) and its Capital Requirement Directive (CRD IV) in order to better control and thus reduce the risk for banks to damage the economy by taking excessive risks.

Measures include:

 Introducing ratios to be respected by banks in an effort to reinforce their capital funds: liquidity ratios, leverage ratios…

 Strengthening disclosure requirements: more detailed reports, increased frequency of reports, shorter deadlines for transmisssion of reports…

 Improving governance for credit institutions: clear organizational structure, efficient procedures for holding and monitoring risk, adequate provisions for internal auditing, viable administrative and accounting procedures, and compensation policies that favors good risk management (including cap on variable compensation)

 Implementating a single supervisory mechanism in Europe (SSM), with an extension of the powers of the European Central Bank (ECB) and the national supervisory bodies (ACPR) to oversee large banks

AVOID ENGINE OVERHEATING BY LIMITING POWER

Drawing lessons from the “too big to fail” premise which proved wrong during the crisis and the systemic risk induced, several reports (Volcker, Vickers, Liikanen) have pleaded for either a prohibition or a limitation of the capacity of such banks to speculate.

 “You no longer can”: a ban on proprietary trading by commercial banks (Volcker rule; Barnier EU draft regulation; New Belgian Banking law)

 “You need to split”: separating speculative activities of certain credit institutions and financial companies from their activities which are useful to the financing of the economy (the UK, German and French approach)

 Example: French Law n° 2013-672 of July 26, 2013 on separation and regulation of banking activities

REINFORCED SAFETY MEASURES TO BETTER PROTECT PASSENGERS

 MIFIR regulation and MIFID2 directive: improved rules for consumer protection (ex: client’s right-to-know and right-toinformation obligations incumbent on the banks, obligation to offer products adapted to its circumstances , obligation for banks to avoid employees’ compensation structures which might create an interest inconsistent with to that of their clients…)

 UCITS V directive: includes a proposal to regulate key information concerning retail investment products (RIP) as well as provisions on depositary functions, remuneration policies and sanctions of money market fund managers

 PRIIPS (Packaged Retail Investment and Insurance Products): Its objective is to ensure uniformity of the precontractual information provided to non-professional investors for products whose performance is a function of the underlying assets

A “BLACK BOX” TO RECORD OTC TRADING

 OTC derivatives, and more specifically Credit Default Swaps (CDS), have been factors of the financial crisis notably due to the lack of transparency concerning the positions held by the various financial players regarding these instruments

 EMIR (European Market Infrastructure Regulation) aims at:

• enhancing transparency of OTC derivatives markets via the creation of trade repositories in charge of collecting and maintaining records of these derivatives;

• reducing counterparty risk via a clearing obligation: financial and non-financial counterparties exceeding certain thresholds must centrally clear OTC contracts with an authorized central counterparty.

CROSS-BOARDER TRANSACTIONS: WHICH REGULATIONS APPLY?

In spite of obvious similarities, especially in the objectives pursued, Dodd-Franck and EMIR differ in their approach on several issues:

 They both include clearing obligations, transaction reporting and risk mitigation provisions applicable to certain counterparties active on the OTC derivatives market

 But they differ in several ways:

• The scope of derivatives products subject to these new regulations is not defined in the same manner in the E.U. and the U.S.

• The type of entities subject to these new regulations is essentially the same though compliance obligation do not completely overlap

• There are differences in the central clearing obligation related to thresholds, types of counterparties, exemptions and timing

• The reporting requirements differ as well (who reports, real-time v. end-of-day…)

 Extraterritoriality reach / recognition of comparable regulatory regimes

CENTRALIZED CONTROL TOWERS

Under the single supervisory mechanism (SSM), the European Central Bank (ECB) will be directly responsible for banking supervision in the Euro zone and in the other Member States that elect to join the banking union

 Clearing of standardized OTC derivatives contracts must be done via the intermediary of authorized central counterparties in order to reduce the counterparty risk

 Reinforcement of the role of the European Securities and Markets Authority (ESMA) in the oversight of trade repositories (in charge of collecting and maintaining records of OTC derivatives) and the granting or withdrawal of their registration

 The 2011/61/EU Directive (AIFM) provides for increased oversight and regulation of alternative investment funds and their managers in exchange of a “European passport” that allows them to provide their management services and distribute their funds in all EU Member States

EMERGENCY MEASURES TO ANTICIPATE AND PREVENT FINANCIAL CRASH

In the event that a bank of the Euro zone subject to the single supervisory mechanism (SSM) encounters considerable stress, the single resolution mechanism (SRM) will enable it to effect resolution efficiently, without overly significant impact on the taxpayer or the real economy:

In the context of the SRM, the ECB, as the supervisory authority, will report if a bank in the Euro zone or established in a Member State participating in the banking union encounters financial difficulties that require it to proceed with resolution.

Based on the recommendations of a Single Resolution Board, or on its own initiative, the Commission will decide whether the bank should undergo a resolution procedure, and will put into place a structure for the implementation of the resolution instruments

A Single Resolution Fund for the banks should also be put into place under the control of the Single Resolution Board in order to guarantee that medium-term financial support is available during the bank’s restructuring. It will be funded by contributions from the banking sector and will replace the domestic resolution funds of the Member States in the Euro zone and the Member States participating in the banking union

TAX ON FINANCIAL TRANSACTIONS

 France has created a tax on financial transactions (the “FTT”), consequent to the first amended law on finances of 2012 and affecting (at the rate of 0.2 %) the purchase of shares in a company whose registered offices are located in France and for which market capitalization exceeds one billion Euros.

 The European Commission has proposed a directive aiming to establish a common FTT system. The European FTT provision under consideration aims to tax all financial transactions, regardless of the market, instrument or institution, if there is any territorial link with the “FTT zone”

 At the end of the ECOFIN Council meeting of May 6, 2014, ten Member States of the Cooperation (with the exception of Slovenia) signed a joint declaration to implement the FTT progressively, focusing initially on the taxation of shares and certain derivatives (without specifying which). But this European FTT is still under discussion and some thought it would be buried

1 Capital Requirement Regulation No 575/2013 dated June 26, 2013 : http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32013R0575&rid=4

2 Capital Requirement Directive No 2013/36/EU dated June 23, 2013 : http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/uri=CELEX:32013L0036&rid=4

3 Loi de séparation et de régulation des activités bancaires en date du 26 juillet 2013, n°2013-672 :http://www.legifrance.gouv.fr/affichTexte.docidTexte=JORFTEXT000027754539&fastPos=2&fastReqId=1146283491&categorieLien=id&oldAction=rechTexte

4 EMIR Regulation No 642/2012 dated July 4, 2012 : http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32012R0648&rid=6

5 MIFID 2 Directive No 2014/65/EU dated May 15,2014 : http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32014L0065&rid=3

MIFIR Regulation N°600/2014 dated May 15, 2014 : http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32014R0600&rid=2

UCITS V Directive No 2014/91/EU dated July 23, 2014 : http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32014L0091&rid=1

AIFM Directive No 2011/61/EU dated June 8, 2011: http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32011L0061&rid=6

PRIIPS Regulation No 1286/2014 dated November 26, 2014: http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=OJ:L:2014:352:FULL&from=FR

6 Risk management procedures, which specify specifically the levels and types of security (collateral), the segregation provisions, the level of capital required to manage uncollateralized risk…

7 Contract entered into with one financial or non-financial counterparty belonging to the same group, provided that both counterparties are included in the same consolidation.

8 Decree n° 2013-687 of July 25, 2013: http://www.legifrance.gouv.fr/affichTexte.do?cidTexte=JORFTEXT000027769564&fastPos=1&fastReqId=1148254540&categorieLien=cid&oldAction=rechTexte

9Prospectus Directive No 2003/71/EC dated November 4, 2003 : http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32003L0071&rid=8

10 Directive 2003/41/EC dated June 3, 2013 : http://eur-lex.europa.eu/legalcontent/EN/TXT/PDF/?uri=CELEX:32003L0041&rid=7; Directive 2009/138/EC dated November 25, 2009 : http://eurlex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32009L0138&rid=9