The European Commission has adopted a number of limited measures designed to reduce some of the burdens which firms face under MiFID II and in relation to securitisations.
These measures form part of a wider Capital Markets Recovery Package – in itself a part of the Commission’s overall coronavirus recovery strategy. They contain targeted amendments to various rules with the aim of facilitating the economic recovery in the EU following the COVID-19 pandemic.
None of the changes will take effect until after 31 December 2020 (when the UK-EU transitional period will almost certainly end). It is likely that the MiFID changes will not take effect until the second half of 2021. Therefore, the impact on UK firms is uncertain and will depend on whether and to what extent the UK government makes corresponding amendments to the UK MiFID II and UK securitisation regimes.
On the face of it, therefore, all the measures are labelled as being designed to help and support the economic recovery from the COVID-19 pandemic, although a number of them reflect concerns that have been widely discussed by stakeholders and ESMA for some time.
In outline, the package includes changes to:
- MiFID II and the MiFID II Delegated Directive addressing information and reporting requirements, product governance, commodity derivative position limits and the research regime for small and mid-cap issuers;
- the Securitisation Regulation and CRR in order to promote the further development of the EU securitisation market;
- the Prospectus Regulation, including the introduction of a slim-line ‘EU Recovery Prospectus’ (not covered in this briefing but see our separate Funds, Corporate and M&A briefing here).
The changes are all ‘targeted’, meaning that by and large they are focused on very particular circumstances and types of firms. They have been described in the press (particularly in relation to MiFID II ) as a ‘quick fix’ initiative, rather than a fundamental overhaul of the legislation. MiFID II will be subject to a full review in 2021, while the securitisation framework is scheduled to be reviewed by January 2022. The various fixes may not be as quick as they first appear.
1. The Headlines
We summarise the key elements of the proposals in sections 2 and 3 below. The Headlines are as follows:
- The default requirement for client information to be sent in paper form will be phased out
- Portfolio managers will no longer be required to report a 10% loss in the value of the portfolio to their professional clients (although they may opt-in)
- Firms will not be required, as part of the suitabilty requirements, to conduct a costs benefit analysis when a professional client wants to switch products (although it may opt-in)
- The temporary suspension of the RTS 27 reporting requirement for execution venues has not been extended to the RTS 28 reporting requirement for firms
- The changes to the product governance regime are very narrow – they only apply to plain vanilla corporate bonds with ‘make-whole clauses’
- The changes to the research regime are also very narrow – they only apply where the research is provided to small and mid-cap issuers in relation to their fixed income instruments
- The changes to the securitisation framework very broadly effect changes in relation to two things which have been the subject of much disussion over the previous few months – i.e. the extension of the STS framework to on-balance sheet synthetic securitisations and a liberalisation of the regulatory framework for the securitisation of non-performing exposures
- The changes to MiFID II, in particular, will require transposition in EU Member States and will therefore not become effective until 12 months after publication of the amending instruments in the Official Journal
2. Amendments to the MiFID II regime
Changes to the information requirements
The proposed amendments to MiFID II are here
The current position, whereby information may be sent out in a durable medium, but by default must be on paper, will come to an end. In future, all information which firms are required to send to clients and potential clients should be in electronic format. Retail clients will be able to request the information on paper, in which case the firm will have to comply, free of charge, and keep a record of the request.
Costs and charges disclosures – no relief for portfolio managers
Firms will not have to provide the ex ante costs and charges information currently required under MiFID to professional clients and eligible counterparties – but (and it’s a big but) this relief will not extend to investment advice and portfolio management.
Where an agreement to buy or sell a financial instrument is by way of distance communication, firms will be able to provide the costs and charges information in an electronic format without undue delay after the conclusion of the transaction, provided the client has agreed to receive the information this way, having been given the option of delaying the conclusion of the transaction until after it has received that information.
Ex-post reporting – periodic reports (including relief from 10% loss reporting)
The default position will be that firms will not have to provide periodic reports on the service (including the costs associated with that service) to professional clients and eligible counterparties. Professional clients will be able to ‘opt-in’.
This relief will extend to the 10% portfolio loss reports which portfolio managers currently have to provide (subject to the right of the professional client to ‘opt-in’).
Suspension of best execution reports – for execution venues, but not firms
At the moment, trading venues and systematic internalisers for financial instruments which are subject to the MiFIR share and derivatives trading obligations, and every execution venue for other financial instruments, must publish periodic reports on the quality of execution on the venue, containing details set out in RTS 27.
ESMA issued a public statement at the end of March 2020 urging national competent authorities not to prioritise supervisory action against execution venues in respect of meeting deadlines for their RTS 27 reports, nor against firms in respect of their ‘RTS 28’ best execution reports.
Under the ‘Quick Fix’ directive, the requirement for execution venues to publish their RTS 27 reports will be suspended for a period (the text proposes until 2 years after the amending directive comes into force). This will allow the Commission more time, within the full MiFID review in 2021, to decide whether the obligation should be dropped permanently.
Significantly, no corresponding suspension is proposed in relation to the requirement for firms to publish their RTS 28 best execution reports, even though they were subject to ESMA’s public statement (see above).
Suitability assessments – product ‘switching’
Firms that provide investment advice or portfolio management services involving the switching of financial products are currently required to conduct a costs benefit analysis in order to advise the clients as to whether the benefits of switching outweigh the costs. This requirement will be moved from the relevant Delegated Regulation to the Level 1 Directive but will not apply in the case of professional clients, unless they wish to opt-in.
Product governance – bonds with make-whole clauses
There will be a very narrow exemption from the MiFID product governance requirements in relation to corporate bonds with ‘make-whole clauses’. These are bonds which contain a clause which requires the issuer in case of early repayment to return to the investor the principal amount of the bond together with the net present value of the coupons the investor would have received if the bond had not been called.
Energy derivatives markets
Among other things, the Commission’s proposed amendments would ameliorate the position limit regime in the commodity markets (except for agricultural commodity derivatives or commodity derivatives designated as significant or critical) and exclude securitised derivatives from the position limit regime entirely. A narrowly defined hedging exemption would be introduced for firms trading for predominantly commercial groups.
Changes to research regime – small and mid-cap issuers – fixed income
The consultation draft of proposed amendment to the MiFID II Delegated Directive is available here.
The Commission proposes that firms will not have to comply with the detailed requirements of the MiFID payment for research regime in the MiFID II Delegated Directive where the research is provided to small and mid-cap issuers in relation, exclusively, to their fixed income instruments. A small/mid-cap issuer will be one whose market capitalisation has not exceeded EUR 1 billion during the period of 12 months before the provision of the research. Following on from that, the firm will be allowed, if it chooses, to pay for execution services and the provision of research jointly (i.e. bundling will be permitted) provided there is an agreement between the firm and the research provider identifying which part of the bundled payment is attibutable to research and the clients have been informed.
This part of the package (and only this part) is subject to consultation – this closes on 4 September 2020.
The Commission has published two legislative proposals on the EU securitisation framework.
Changes to CRR
- extend the Simple, Transparent and Standardised (STS) framework to on-balance sheet synthetic securitisations – this is essentially in line with the EBA final report on the STS framework for synthetic securitisation which was published on 6 May 2020 and recommended the establishment of a cross-sectoral EU framework for STS on-balance-sheet securitisation limited to on-balance sheet synthetic securitisation, based on a common set of eligibility criteria. It also recommended a targeted prudential treatment for STS on-balance-sheet securitisation exposures;
- remove regulatory obstacles to the securitisation of non-performing exposures (NPEs) – this includes the introduction of a simplified approach based on a flat 100% risk weight applicable to the senior tranche of traditional NPE securitisations and on a floor of 100% to the risk weights of any other tranches of both traditional and on-balance-sheet synthetic NPE securitisations that remain subject to the general framework for the calculation of risk-weighted exposures;
- amend the existing CRR provision relating to the minimum credit rating requirement for almost all types of eligible providers of unfunded credit protection, including central governments. The amendment will have the effect of removing that requirement in relation to, e.g. central governments, regional governments, local authorities and multilateral development banks, and instead apply it to other corporate entities with ECAI credit assessments. The Commission intends this amendment to galvanise national public guarantee schemes in assisting institutions seeking to securitise NPEs following COVID-19.
The overall aim is to encourage a broader use of securitisation in the post-COVID 19 recovery phase, by freeing up bank capital and supporting them in their lending activities. The changes to CRR provide a new prudential treatment, including with regard to capital requirements, designed to underpin the changes introduced to the Securitisation Regulation.
Changes to the Securitisation Regulation
The amendments to the Securitisation Regulation form part of, and interact with, the same legislative initiative behind the changes to the CRR summarised above. They therefore address:
- the regulatory framework for the securitisation of NPEs – there will be a new definition of ‘NPE securitisation’, a special regime for NPE securitisations as regarding the fulfilment of the risk retention requirement and clarification of the verification duties of originators in relation to securitising NPEs;
- the introduction of a new section setting out the criteria for STS balance-sheet synthetic securitisations.
4. What happens next?
As stated above, the proposals on the research regime relating to small and mid-cap issuers which issue fixed-income instruments are subject to consultation, which closes on 4 September 2020.
Otherwise, all the legislative proposals have been submitted to the European Parliament and the Council for their agreement. The European Commission hopes this will be by the end of 2020. After the adoption of the package and the entry into force of its components, when the changes will become effective depend on the nature of the legislative instrument:
- the changes to the securitisation framework in CRR and the Securitisation Regulation will apply and be effective in EU Member States twenty days after the publication of the amending instruments in the Official Journal;
- the changes to MiFID II and the MiFID II Delegated Directive will require transposition into national law – as currently drafted, the changes to MiFID II will apply from 12 months after the entry into force of the amending instrument.
Therefore, allowing for the time it will take for the EU institutions to agree and adopt the legislation and the fact that national transposition will be required, the changes to the MiFID II regime will not be quite the ‘quick fix’ advertised.
On top of that, none of the measures discussed in this briefing will become effective before the end of 2020 (which will almost certainly mark the end of the EU transitional period). Consequently, the extent to which the UK government makes corresponding amendments to the UK MiFID II and UK securitisation regimes remains to be seen.
5. How we can help
Our Financial Services and Markets Department has extensive experience in advising firms on the impact of MiFID II and the implications of the securitisation framework, particularly on investment managers. To find out how we can help, please speak to your usual Travers Smith contact or any of the partners below.