The regulatory transformation is not over
The regulatory transformation that followed the financial turmoil of 2007-2008 is not over. While asset managers and institutional investors are recovering from the implementation of large-scale regulation such as MiFID 2 or GDPR, new trends are emerging. The regulatory transformation is entering a consolidation phase of supervisory enforcement and new areas of legislative focus.
Asset managers and institutional investors across the European Union and Switzerland are getting ready for a new set of regulations in 2019 and beyond. Monitoring these regulatory developments with tracking dashboards to ensure a helicopter view has become essential to identify cross-sector regulatory trends. Below is a basic example of such dashboard, displaying the preparation period before go-live and the impact level of upcoming regulations.
For instance, the combined effects of the CMU proposals, the end of the PRIIPs transition period for funds and the AIFMD review announce significant changes in cross-border product distribution. While the CMU legislative proposals tackle long-awaited simplifications, such as aligning national marketing requirements and regulatory fees , or harmonising the conditions under which investment funds may exit a national market and allowing European asset managers to engage in pre-marketing activities , product manufacturers must constantly adapt their product strategy. This cross-sector regulatory approach allows to go beyond mere compliance and identify opportunities.
In addition to tracking upcoming pieces of legislation, asset managers and institutional investors must pay attention to the enforcement of the regulatory transformation by the supervisory authorities.
Market supervisors are giving signs of increased survey regarding the implementation of recent regulation. Subsequent to the application date of MiFID 2 and MiFIR on 3 January 2018, the Financial Conduct Authority (FCA) in the United Kingdom announced six months later the launch of a probe on asset managers, focusing on research costs and corporate access. In October 2018, the Autorité des Marchés Financiers (AMF) in France published the summary of five inspections carried out relating to clients’ investment knowledge and experience. This was part of the #Supervision2022 strategy: AMF is carrying out new types of inspection, known as SPOT (Supervision des Pratiques Opérationnelle et Thématique - operational and thematic supervision of practices).
In other words, national supervisors are consolidating the new regulatory framework through enforcement. As relayed by market participants, enforcement ostensibly starts within a short period after the application date of new legislative instruments. Supervisors may occasionally grant official or unofficial grace periods, but asset managers and institutional investors in the European Union and in Switzerland must prepare nevertheless to the new pace and intensity of monitoring.
For institutional investors, the ranking of the most impacting regulations may differ from asset managers. In 2019, the top list of regulations monitored by institutional investors is expected to include the new transparency standards around beneficial ownership, the phasing-out of LIBOR and the sustainable finance framework.
Shifting gear on beneficial owner transparency
The growing pressure on governments and companies to increase transparency has resulted in a global shift towards increased disclosure around beneficial ownership. The European Union has recently revisited its legal framework on anti-money laundering and counter-terrorist financing with the Fourth and the Fifth Anti-Money Laundering Directives. AMLD 4 entered into force in June 2017. While transposition of AMLD 4 was still ongoing, AMLD 5 was adopted in May 2018 and it must be transposed by the EU Member States into national law by January 2020.
Amongst other headways, AMLD 4 requires the EU Member States to establish a central register on the beneficial ownership of companies and other legal entities incorporated within their jurisdiction. Companies, including Luxembourg SICAVs, must provide the central register with certain personal data of their ultimate beneficial owners, including name, surnames, nationality, place of birth and country of residence. Individuals whose share in capital or voting rights of a company exceed 25% or those who wield similar influential power must be reported to the register. AMLD 5 will push transparency one step further by making the registers accessible to the public.
Beyond Europe, other countries are also following suit in an attempt to increase transparency. A recent study shows that thirty-four jurisdictions around the world have beneficial owner registration laws, and eleven more by 2020 . In most cases, beneficial owner registries of companies also have to be publicly available. The most recent advocacy for a beneficial owner register was in the Bahamas, where the government presented in December 2018 the freshly drafted Register of Beneficial Ownership Bill. While public access to the beneficial owner registers may be a source of socio-economic debates, investors must prepare for this new paradigm in a growing number of jurisdictions.
Bracing for LIBOR replacement
Further to the manipulation scandal of 2012, the London Interbank Offered Rate (LIBOR), used as the basis for interest rates all over the world for more than thirty years, will be discontinued at the end of 2021. There is an estimated USD 260 trillion in outstanding contracts for loans and other financial instruments tied to LIBOR benchmark rates (e.g. CHF LIBOR, EUR LIBOR, Euribor, GBP LIBOR and USD LIBOR). LIBOR is currently used by financial institutions in financial instruments, for risk measurement, as performance indicator for financial products and to calculate loan rates.
Financial institutions and regulators around the world are getting ready by developing alternate rates such as USD Secured Overnight Financing Rate (SOFR), GBP Sterling Overnight Index Average (SONIA), JPY Tokyo Overnight Average Rate (TONAR) and CHF Swiss Average Rate Overnight (SARON). Progress towards identifying alternative reference rates, determining conversion rates and spreads for each currency is at different stages of completion.
Industry players will need to apply the new reference rates to new contracts but also decide how to modify legacy contracts and financial instruments. In Switzerland, since January 2019, the Financial Market Supervisory Authority (FINMA) is contacting supervised institutions that are particularly affected . In particular, FINMA is reviewing the adequacy with which risks associated with a possible replacement of LIBOR are identified, limited and monitored.
Seizing opportunities in the sustainable growth framework
Further to the Paris Agreement of 2015, the European Union aims to redirect capital flows towards sustainable investments, taking into account environmental, social and governance (ESG) considerations. In May 2018, the European Commission adopted a package of measures including a proposal for a regulation on the establishment of a framework to facilitate sustainable investment and a proposal for a regulation on disclosures relating to sustainable investments and sustainability risks. Meanwhile, the Directive on the encouragement of long-term shareholder engagement must be implemented by EU Member States by 10 June 2019.
In Switzerland, a second round of climate compatibility tests is due to be initiated in 2020, for pension funds, insurance companies, asset managers and banks, under PACTA coordination (Paris Agreement Capital Transition Assessment). The results will support the current reflexions of the Swiss Federal Council for potential future regulation on sustainable finance.
The investors’ demand for ESG solutions is on the rise. More than a quarter of the $88 trillion assets under management globally are now invested according to ESG principles, a McKinsey & Co. study found . As the new regulatory framework will shed light on the commitment of financial institutions towards sustainable finance and corporate stewardship, major players are already deploying investment solutions that integrate ESG criteria.
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Proposal for a regulation of the European Parliament and of the Council on facilitating cross-border distribution of collective investment funds and amending Regulations (EU) No 345/2013 and (EU) No 346/2013
Proposal for a directive of the European Parliament and of the Council amending Directive 2009/65/EC of the European Parliament and of the Council and Directive 2011/61/EU of the European Parliament and of the Council with regard to cross-border distribution of collective investment funds
Directive (EU) 2015/849 of the European Parliament and of the Council of 20 May 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, amending Regulation (EU) No 648/2012 of the European Parliament and of the Council, and repealing Directive 2005/60/EC of the European Parliament and of the Council and Commission Directive 2006/70/EC
Directive (EU) 2018/843 of the European Parliament and of the Council of 30 May 2018 amending Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, and amending Directives 2009/138/EC and 2013/36/EU
A. Knobel, M. Harari, M. Meinzer, 27 June 2018, The state of play of beneficial ownership registration: A visual overview, EU Horizon 2020 Project
FINMA Guidance 03/2018, LIBOR: risks of potential replacement, 17 December 2018
S. Bernow, B. Klempner, C. Magnin, October 2017, From ‘why’ to ‘why not’: Sustainable investing as the new normal, McKinsey & Company