1. MiFID bluesNews about MiFID has been strangely absent recently, perhaps because firms had been seeing its adoption as inevitable.

But is there a bigger picture? Is there a strong enough consensus between firms and even regulators that MiFID II is too impractical in some important requirements ever to be implemented? Such as in bond pre- and post-trade price transparency damaging liquidity in both corporate and sovereign bond markets; or that some of the transaction reporting requirements require data that does not exist and even if it did, that the regulators could not consolidate or even use it; that product governance does not work with execution only platforms, and many more problems. More significantly, is there a growing consensus that the totality of regulatory changes is damaging economic growth? The Capital Markets Union is one example of this. However, changing a Level I Directive painfully agreed by the Commission, the Parliament and the Council is a difficult and controversial process, rarely done.

So, what is the future for MiFID II? Perhaps that it is likely to happen, but that some of the more impractical requirements will be diluted or even dropped – for example through the use of the ‘proportionality’ approach; and that its implementation will be staggered over several years, with conduct of business requirements starting in 2018.
What should firms do now? Each is affected differently by MiFID II, but you could make a roadmap of the relevant areas, how long preparations will take to meet the earliest likely date and to keep in place an implementation team to watch developments closely.
2. The renewed focus on anti-money launderingThe release of the Panama Papers after the HSBC Swiss private bank disclosures has spurred on the growing clampdown on money laundering by regulators worldwide. The Financial Conduct Authority (FCA) has understandably made enforcement of its anti-money laundering (AML) rules a priority, with warnings to banks about new customers, which has resulted in long onboarding times and in them increasing their monitoring of politically exposed persons (PEPs – including those from the UK), with pressure growing on even small ones to adopt automatic surveillance systems for PEPs. However, it is asset managers who are increasingly expected to have robust AML procedures, particularly those with international high-net-worth retail clients. This follows from London’s success as a global asset management centre. Smaller firms with such clients may find it increasingly costly to reach the “highest possible standards” mandated by the FCA, eg, in performing due diligence on new customers and monitoring them regularly for ‘red flags’ (which can give larger asset managers a cost advantage).
In the UKThe Bank of England and Financial Services Act 2016 introduces a more risk-based approach to the PEPs regime in the UK. In response to criticism of disproportionate application in practice to medium-ranking and junior officials, the Act requires the FCA to issue guidance on the definition of a PEP, which may require firms to take a proportional, risk-based and differentiated approach to different categories, and empowers the Government to regulate the FCA’s handling of complaints about the way in which firms have interpreted their obligations under the PEP regime. This follows the extension of the PEP regime under the Fourth EU Money Laundering Directive (4MLD), which will see UK officials fall within the PEP definition (although many would say the FCA already expects firms to do this anyway). The FCA’s PEP guidance is expected later this year.

In the EUThe Fourth EU Money Laundering Directive will introduce significant changes, such as a public register of people with significant control (more than 25%) directly or indirectly of private companies, which the UK has already recently introduced (however, firms whose sole shareholder is a foreign company are not caught by the public register) in advance of the Financial Action Task Force’s (FATF’s) review of the UK’s AML regime later this year. The Treasury plans to issue a consultation on how it will implement 4MLD also in late 2016.
3. The new Market Abuse rules are about to startThe EU’s new Market Abuse Regulation will start on 3 July this year. There are many significant changes in it, such as: extending the scope of securities covered to commodity derivatives; extending the scope territorially; and to orders where there is no transaction; guiding firms to use automatic transaction and communications monitoring systems, and requiring records to be kept for five years.

Firms are also concerned about more sector specific points, such as restrictions on market soundings (corporate finance), the wide definition of ‘recommendations’ which includes some trade ideas and requires many disclosures, such as the writer’s name (the sell-side) and tougher rules on managers’ transactions (corporate brokers). There is fixed income criticism that the regulators have adopted an equity approach to a market which functions in a different way.
4. Mass file check to review advice suitabilityResponding to criticism from the National Audit Office on how effective the FCA is in preventing and dealing with poor advice, the FCA has launched a mass file check of retail advisory firms to see if there is indeed a serious problem. The questionnaires have a pensions focus but extend to financial planning and securities advice as well. Over 700 firms covering different types of advice have been asked to provide a wide range of data at fairly short notice on the number of suitability assessments made, including samples of them, the use of single or multiple fact finds and more. Assuming the Retail Distribution Review approach, these will be subject to a desk-based review, with visits to specific firms made to obtain more practical detail across a representative sample, with a report published to inform those and other firms of the extent of any misselling. The FCA has previously published examples of good and poor suitability practice.

Model portfolios are also under review. A study by FE, an investment ratings and research agency, found that the majority of advisers use only one model portfolio service for all their clients. This has raised concerns that consumers may be ‘shoehorned’ into unsuitable models (and investments). The advisers suggested a lack of transparency and inadequate holdings information made the comparison of different portfolio services difficult and time consuming. The FCA earlier commented on the need for advisers to perform sufficient due diligence on providers in connection with “asset-allocation tools and model portfolios”. It is clear that model portfolios are here to stay as a good outsourced solution for some discretionary managers, but advisers need to be very aware of the regulators’ expectations and of clients’ cost disclosures.
5. How do managers make decisions under the Senior Managers Regime?The introduction of the Senior Managers Regime (SMR) has raised this important question. Many firms expect employees to act on decisions to the best of their ability, once made by senior management or a parent company. How does this sit with the SMR, which gives individual managers responsibility for any decision they carry out, without them necessarily having any internal authority to question or even refuse it? The individuals’ Statements of Responsibility tend to be just that – placing responsibility only. To the credit of the regulators, they have in parallel boosted the ‘whistleblowing’ structures in firms (new rules start on 7 September 2016) through requiring firms to put in place internal whistleblowing arrangements able to handle all types of disclosure from all types of person. However, this is a ‘nuclear’ option which few want to use. So managers will need to decide how far to protest a decision internally.

The drive towards individuals taking personal responsibility for their corporate actions will require a major adjustment in the expectations of senior management of firms and parent companies if the regulators carry out their responsibility under the SMR with enforcement actions. Overseas-owned firms where the home country does not have this concept will find it particularly difficult. This is an issue for all types of firms, not just banks, since the plan is for all firms to come under the Senior Managers and Certification Regime (SMCR) in 2018.

Apart from this general trend, banks are still working their way through the practicalities of the new regime. Some practical issues are in handover certificates where there is no template and there is a conflict of interest between the outgoing employee (who wants maximum disclosure) and the incoming one (who wants the minimum) and the care needed to agree the new individual’s Statement of Responsibility (this last can lead to it taking several months to appoint a new manager when the outgoing manager may only have a short notice period). Firms may therefore decide to lengthen employee notice periods.
6. How safe are contingent convertible bonds?The simple answer is that contingent convertible bonds (cocos) are as safe as the issuing bank. The possibility that these perpetual bonds (formally Additional Tier 1 bonds) may be converted into equity or coupons suspended or even capital cancelled, depends upon the bank continuing to meet its debts and its prudential requirements, and upon the regulator supervising it to achieve this. These bonds have been popular with both institutional buy-side wanting higher than normal yield, and banks required to hold more capital under the EU’s Capital Requirements Directive IV (CRD IV) – nearly €100bn has been issued. As a new class of instrument, risk is unclear and market sentiment has shifted dramatically – at some times the new issue market has closed. Indeed the FCA has banned banks’ retail sales.

There are several big unknowns. The first is how investors will react when an issuing bank comes close to the ‘trigger’ of suspending coupons or equity conversion or capital cancellation. The product is designed to create market stability in such an event. Some fear that investors will dump all cocos and this will result in a market collapse. There have been some early experiences. In February this year the market fell sharply when institutions feared that a large bank would not be able to pay its coupons. The European Central Bank is rumoured to be so concerned that it has discouraged some banks from issuing them, and the European Commission is working on proposals to resolve some of the uncertainties around them. Other experiences in Italy and Spain have shown how difficult it is politically for governments to let retail investors take a hit – and how they have avoided the ‘triggers’, eg, through setting up a bail-out fund to buy doubtful debts from struggling banks. Institutions and banks need to very careful.
7. Lots of enforcement developmentsHere is a small selection from a large choice:

• The FCA will use pre-emptive powers, eg, preventing the Bank of Beirut from onboarding new customers for 128 days; and removing regulated activities from a firm.

• Reduction in the number of formal Section 166 Skilled Person Reviews, with only a few (2% in 2013–14) ending in enforcement. That said, these powers are not subject to judicial review.

• The apparent failure by the FCA to verify many firms’ attestations; however, recurrence of the problem covered could expose the individual attestor to penalties.

• Increase in the amount of fines to deter others, such as the fine of £27m in addition to disgorgement of profit against Barclays Bank for not applying enhanced due diligence to PEPs.

• The two year period for customers to claim PPI misselling. There is likely to be a flurry of claims before the largest ever misselling is finished.

• The closing of the Serious Fraud Office’s (SFO’s) large investigation into claims of fraudulent conduct in the forex market because, although there were “reasonable grounds to suspect the commission of offences involving serious or complex fraud”, the evidence is not strong enough to obtain criminal convictions. The US Department of Justice is continuing and the FCA will assist it. The FCA has also decided to stop its inquiry into bank culture.

• The change in enforcement procedures by the FCA following the Treasury’s review. These include a “streamlined” process for “focused resolution agreements”, better communications to the firm or individual from the FCA, eg, on its early intervention work, and speeding up the time between a warning notice and any decision notice. The FCA has, however, refused to incentivise firms to make earlier settlements, because it does not know the extent of any breach.

• Confirmation (for PRA firms) that the FCA will continue to be the primary enforcer, although the PRA reserves its use of such powers, eg, against Qatar Islamic Bank (UK) for prudential failings.

• A large increase (80%) in the number of cases referred by firms to the Regulatory Decisions Committee. The RDC has overturned the FCA’s findings occasionally (three times in 2015).

8. A new world for forex dealingSubstantial progress has been made in the global code of conduct for forex markets developed by the forex working group chaired by Guy Debelle. This initiative is designed to remove uncertainties and inconsistent practices for dealers and for the buy-side. It results from the forex trading scandals which led to many dealers being suspended or dismissed by their firms. The UK, led by the Bank of England, has been very active in designing the code, with 35 sell-side and buy-side firms joining the various work streams. The code addresses such practices as the last look, fix pricing and code adherence. It will replace six existing forex codes and is a remarkable example of global co-operation not driven by the G20.

The code will affect both sell-side and buy-side institutions which had the opportunity to comment on it to the forex working group in May in New York, and which continue to be able to do so. Once agreed it is likely that regulators will expect firms to adhere to it, although its status may be guidance rather than strict regulation.

Meanwhile there have been a number of employment tribunal cases brought by individuals dismissed in the forex investigations. Many of these have been won by the employees.
9. How will the FCA use its new competition powers?The FCA has launched market studies (the first step in a competition investigation) into six areas: investment banking; asset management; cash savings; retirement income; credit cards and general insurance. The result of its investigation into primary equity markets is an interesting example. It has banned contractual clauses tying in corporate customers from giving first refusal for valuable equity and debt issuance business, in loans and corporate broking services. It stopped short of banning the provision of such services in agreements.

The FCA has other competition powers which enable it to take action against specific firms for breaching competition law. It is now proposing to use these. Deborah Jones, Head of Competition at the FCA, said in a recent speech: “For the last year, we have been talking about enforcement cases in the future tense. Very recently, that has changed and I can now confirm that we are taking active steps towards the opening of Competition Act investigation.” Among other powers, the FCA can issue ‘on notice’ letters – sent if the FCA has concerns, but instead of conducting a full investigation, asks what the firm will do to resolve these. A possible example is meetings among distributors where they appear “to operate without any competition compliance protocol to prevent the disclosure of commercially sensitive information”. Trade bodies are aware of this potential problem.

More generally, the FCA has the problem of internal conflict of priorities. As it makes new rules it is increasing the cost of regulation for firms, resulting in smaller firms dropping out or merging, and increasing the barriers to entry for new ones, for example in asset management and deposit taking.
10. Who should pay for market data?Traditionally, members have provided market data to trading venues, such as exchanges, and then paid to buy the consolidated result from the venue or information provider. Clearly there is a cost in consolidating, but firms argue that it is often overpriced. Indeed, exchanges have increasingly relied upon data sales for their profits rather than on fees for matching orders (which some venues do not even charge for – The Intercontinental Exchange (ICE) CEO recently said: “The matching engine that was so valuable that started this company at the height of the dotcom boom – today others are not only giving it away for free but will pay people to use it”). The tension between market participants and venues has increased with the regulatory extension to over-the-counter (OTC) derivatives, where exchanges are keen to provide. The regulators are observing this question in order to decide whether to intervene or not. Recently the FCA did see this need in the case of benchmarks, where there is an obligation to provide data access at reasonable cost. However this applies to specific data rather than generally. As exchanges consolidate (for example the LSE/Deutsche Börse merger proposal), these pressures will increase.
11. Regulators demand more capitalThe UK has long had a reputation for gold-plating global and EU requirements, and nowhere is this clearer than in prudential capital. The Bank of England/PRA/FCA has anticipated many of the Basel III/CRD IV requirements, and sometimes required specific firms to hold more capital and to increase their liquidity because of perceived risks. Banks are the main firms affected, with the latest change being the proposed increase in capital to cover risks in the trading book. (this has long been an area of different practices in countries, but the Fundamental Review of the Trading Book will align these, resulting in some CRD IV firms – both banks and capital markets – having to increase their trading book buffer; in one case by 800%). The Financial Stability Board (FSB) has also now made its policy recommendations on the total loss absorbing capacity (TLAC) of globally significant banks which may increase the amount of capital these banks need by €2.1tn by 2022. The FSB accepted that this may reduce the amount of credit available, but expected this to be “very limited”. Other commentators think it may have a more profound impact.

As well as banks and the sell-side more generally, some UK fund managers have also received regulatory demands for them to increase both capital and credit lines to enable them to cope with mass redemption requests. This in itself has increased the cost pressure on fund managers at a time when the sector’s charges are under regulatory review.

This was originally published in the July 2016 print edition of The Review.