No unifying theme bridged last week’s most material developments in the financial services industry worldwide. In Europe, ESMA declined to find equivalency in the regulation of alternative investment fund managers and funds in the United States and in the European Union, and thus would not recommend at this time that the European Commission grant passport rights to US managers and funds to access EU professional investors without authorization by each member state where they propose to conduct business. Meanwhile, in the United States, three firms were fined in excess of US $2.6 million by FINRA for OATS trade reporting infractions; while in Hong Kong, a firm was fined approximately US $580,000 for not timely reporting information regarding an apparent rogue trader. As a result, the following matters are covered in this week’s edition of Bridging the Week:
- ESMA Says “No for Now” to Granting Passport Rights to US Fund Managers Under AIFMD (includes My View);
- BATS Exchange Seeks Expedited Authority to Suspend Alleged Spoofers (includes Compliance Weeds);
- FINRA Fines Three Broker-Dealers More Than US $2.6 Million for OATS Reporting Violations;
- HK SFC Fines Nomura International US $580,000 for Failing to Timely Disclose Activities of Rogue Trader;
- CME Group Exchanges Sanction Trader Who Allegedly Engaged in Wash Trades to Manage Tax Obligations:
- Phased Roll-Out of New Position Limits Called for at CFTC EEMAC Public Meeting;
- FCA Finds Continued Weakness in Firms’ Oversight of Benchmark Activities;
- Industry Participants Respond to ESMA’s Call for Input on Virtual Currencies and Distributed Ledger Technology and Discuss Potential Applications (includes Helpful to Getting the Business Done); and more.
ESMA Says “No for Now” to Granting Passport Rights to US Fund Managers Under AIFMD:
The European Securities and Markets Authority told the European Commission last week that it was premature to grant passport rights to US alternative investment fund managers (AIFMs) that would enable them to manage or market alternative investment funds (AIFs) in the European Union without authorization by each member state where they proposed to conduct business. This is because ESMA did not find equivalence in overall oversight and potential access rights under the EU and US regulatory schemes.
However, ESMA said that AIFMs and AIFs from Guernsey, Jersey and Switzerland should be permitted to benefit from passport rights because there is equivalence in regulation between those jurisdictions and the European Union.
According to ESMA, if passport rights were granted to relevant US entities at this time, US persons would have easier access to EU professional investors than equivalent EU entities would have to professional investors in the US due to registration requirements under the US framework.
Generally, ESMA found equivalence between the US and EU regulatory oversight of AIFMs and AIFs in most areas, although ESMA found that EU rules on remuneration are significantly more restrictive than in the United States, and that there is no ability under applicable EU rules for a mutual fund to act as its own custodian, as there is in the United States.
In addition to deciding to make no determination regarding US AIFMs and AIFs at this time, ESMA also deferred a decision to grant passport rights to AIFMs and AIFs from Hong Kong and Singapore. ESMA declined to consider at all at this time the equivalence of EU rules and the rules of 16 other jurisdictions, including Australia, Canada and Japan
In general, under relevant EU law – the Alternative Investment Fund Managers Directive – where ESMA finds equivalency in regulation regarding investor protection, market disruption, competition (i.e., equivalence in access) and the monitoring of systemic risk, it should recommend granting a passport. The AIFMD is an EU directive that was implemented in 2013 and regulates entities that manage or market alternative investment funds within the European Union.
(Click here to access additional information on this development in the article “AIFMD Marketing Passport: ESMA Provides European Commission With Advice on Its Possible Extension to Non-EU Jurisdictions” in the July 31, 2015 edition of Corporate & Financial Weekly Digest by Katten Much Rosenman LLP.)
My View: First there was the failure of the European Commission to find that the regulatory oversight of clearinghouses in the United States was equivalent to that in the European Union. This failure, if not resolved, will cause European banks to incur substantial capital charges for clearing on US-based clearinghouses. Now there is the reluctance of ESMA to find that the oversight and potential access of European alternative investment funds managers and funds to US institutional persons is equivalent to that of US AIFMs and AIFs. Soon, ESMA and the European Commission will need to determine whether the oversight of US-based high frequency traders and direct electronic access sponsors to EU markets is equivalent to the requirements for EU-based HFTs and DEAs under the Markets in Financial Instruments Directive II and the Markets in Financial Instruments Regulation. If not, access to EU markets by US-based DEA sponsors and HFTs will potentially require authorization by relevant EU member states. The more complicated it is to conduct international financial transactions, the more likely that fewer of such transactions will be conducted, with concomitant decreases in product liquidity and/or fragmentation of markets. Neither outcome is desirable, and regulators on both sides of the Atlantic should strive to avoid such an outcome.
- BATS Exchange Seeks Expedited Authority to Suspend Alleged Spoofers: The BATS Exchange, Inc. filed with the Securities and Exchange Commission for its approval a new rule and interpretation to expressly prohibit layering and spoofing-type activity. In addition, the BATs Exchange seeks to adopt a new rule to provide for expedited suspension proceedings in cases involving these types of disruptive practices. The BATs Exchange is seeking approval for an express prohibition against spoofing and layering activity by members, although it claims that it currently has sufficient authority to prosecute manipulative trading conduct under its existing rules, including its requirement that members observe “high standards of commercial honor and just and equitable principles of trade.” (Click here to access BATS Exchange Rule 3.1.) Under a proposed new interpretation, layering would include a “frequent pattern” where a party enters orders on one side of the market at various price levels, and following the layering orders (a) the level and demand for the security changes; (b) the party enters one or more orders on the other side of the market that are subsequently executed; and (c) following the execution, the original layering orders are cancelled. Spoofing would include “a frequent pattern” where a party narrows a spread by placing an order inside the national best bid and offer and the party then submits an order on the opposite side of the market that executes against a market participant that joined the new inside market established by the spoofing order. If authorized by the BATS Exchange’s chief regulatory officer, an expedited client suspension hearing alleging spoofing or layering activity would ordinarily be held by no later than 15 days after service of a notice initiating the enforcement action. After a hearing, within 10 days of its receipt of the hearing transcript, the hearing panel should issue a decision whether a suspension order should be imposed. The BATS Exchange claims that an expedited suspension hearing process is appropriate for layering and spoofing offenses because “the potential harm to investors is so large.” The public will have an opportunity to comment on the BATS Exchange’s proposed new rules and interpretation for 21 days following the SEC’s publication of it in the Federal Register.
Compliance Weeds: There are many differences between the regulatory approaches taken by US securities and futures regulators and self-regulators. Another one potentially now involves the definition of spoofing. Whereas futures self-regulators, drawing on applicable law, typically define spoofing in terms of potentially a single transaction (click here to access the 2013 Interpretive Guidance and Policy Statement regarding disruptive trading practices adopted by the Commodity Futures Trading Commission), the BATS Exchange seeks to make it expressly clear in its proposed new interpretation that spoofing or layering involves a “frequent pattern” of transactions. Moreover, while it is unlawful bidding or offering alone that could trigger a spoofing offense under the futures regulatory regime – without regard to whether any order is actually executed – BATS Exchange’s proposed interpretation would require an actual trade execution as part of a series of transactions in order to constitute an offense.
- FINRA Fines Three Broker-Dealers More Than US $2.6 Million for OATS Reporting Violations: Goldman Sachs Execution and Clearing, L.P., KCG Americas LLC and RBC Capital Markets LLC agreed to pay fines in excess of US $2.6 million in aggregate to resolve allegations by the Financial Industry Regulatory Authority that they failed to comply with Order Audit Trail System reporting requirements. (OATS is an integrated audit trail of order, quote and trade information for all national market system stocks and over-the-counter equity securities administered by FINRA. Under OATS, FINRA member firms must electronically capture and report to OATS specific data elements relating to the handling or execution of relevant orders.) According to FINRA, between July 2006 and July 2013, Goldman Sachs failed to transmit 6.3 billion reportable order events (or 6.1 percent of all reports it was required to transmit), and transmitted 42.1 billion inaccurate or incomplete order events (or 20.5 percent of all reports it was required to transmit) between July 2006 and March 2015, among other issues. FINRA also alleged that GETCO Execution Services, whose assets and obligations KCG purchased in December 2013, misreported almost 7 billion records from January 1 through December 1, 2013. This constituted 48 percent of all records the firm transmitted to OATS during the relevant time period. Likewise, RBC failed to report almost 2 billion required records from November 2011 through March 2014; this constituted almost 16 percent of all records the firm was required to transmit to OATS during the relevant time period. For their alleged offenses, Goldman Sachs agreed to pay a total fine of US $1.8 million, KCG, US $380,00 and RBC, US $425,000.
- HK SFC Fines Nomura International US $580,000 for Failing to Timely Disclose Activities of Rogue Trader: The Hong Kong Securities and Futures Commission fined Nomura International (Hong Kong Limited) HK $4.5 million (approximately US $580,000) for failing to disclose “significant misconduct” by an employee seconded from an affiliate. On June 11, 2013, Nomura disclosed to SFC that the trader had sustained a US $3.3 million trading loss and had been returned to the affiliate earlier in the month. However, at the time of the disclosure, Nomura already had allegedly detected discrepancies between the trader’s actual trading activities and the information he had provided to management. Among other matters, the trader had admitted to Nomura, charged the SFC, that “he had made manual adjustments in Nomura’s Hong Kong’s risk management system [on two days] to avoid showing the real level of loss of risk exposure from his trading activities on those days.” Subsequently, claimed SFC, Nomura further investigated the matter, and prepared an internal draft report of the trader’s activities by June 19. Nomura did not disclose the trader’s inappropriate conduct to the SFC until July 17 and only provided the draft report two days later. According to SFC, “Nomura … and other intermediaries, have a duty to report misconduct and suspected misconduct to the SFC immediately upon discovery, not when they have completed their own internal investigations into the matter.”
- CME Group Exchanges Sanction Trader Who Allegedly Engaged in Wash Trades to Manage Tax Obligations: The Chicago Board of Trade and the New York Mercantile Exchange fined and suspended from trading Ho Ming Yu for executing numerous buy and sell trades in the same futures contracts in two accounts he owned during November and December 2012. The purpose, claimed the exchanges, was tax-related. Mr. Yu was alleged to have engaged in matching buy and sell transactions involving 772 futures contracts on the CBoT and 1,561 contracts on NYMEX. Mr. Yu settled these disciplinary actions by agreeing to pay a fine of US $10,000 to CBoT and US $15,000 to NYMEX, and being suspended from all trading access to CME Group exchanges for 25 business days.
- Phased Roll-Out of New Position Limits Called for at CFTC EEMAC Public Meeting: Multiple speakers – including Commissioner J. Christopher Giancarlo of the Commodity Futures Trading Commission — called for a phased roll-out of any new position limits adopted by the CFTC during a public meeting of the agency’s Energy and Environmental Markets Advisory Committee held last week. The CFTC proposed new rules regarding position limits on 28 commodities and aggregation in November 2013. (Click here for details in the article “CFTC Proposes New Position Limit Rules: Addresses Absolute Limits of 28 Core Futures Products, Aggregation, and Bona Fide Hedging” in the November 5, 2013 edition of Between Bridges.) According to Commissioner Giancarlo, “proceeding in a phased approach would give all market participants the opportunity to adjust to the new process of tracking and reporting commodity swaps along with their futures and options. A phased approach would also be useful for the CFTC, which will then have additional time to obtain better data about the OTC market for physical commodities, as well as conduct additional research and analysis to determine whether federal position limits are appropriate and necessary at all outside of the spot month.” William McCoy, speaking on behalf of the Futures Industry Association, also argued that a phased approach could help mitigate against “unintended consequences.” Stephen Berger, speaking for the Managed Futures Association, said that the CFTC should adopt a two-phase approach in rolling out any new position limits. The first phase would include adopting spot month limits only; adopting a definition for a bona fide hedge position; and relying on and reviewing data from exchanges’ position accountability levels for non-spot months. The second phase would include the adoption of accountability levels for non-spot months based upon data gathered during the first phase. Ron Oppenheimer, on behalf of The Commercial Energy Working Group, argued that non-enumerated hedging exemptions should be granted by exchanges and not the CFTC (as proposed) because of the “depth and breadth” of exchanges’ experience in evaluating hedging strategies and exchanges’ “current oversight of market participant positions, particularly in the front month.”
- FCA Finds Continued Weakness in Firms’ Oversight of Benchmark Activities: The United Kingdom Financial Conduct Authority found inconsistent progress in firms’ oversight and controls related to contributing data and designing, managing, administering and trading involving financial benchmarks. This was despite the numerous recent enforcement actions worldwide regarding a range of benchmarks including the London Interbank Offered Rate, G10 foreign exchange spot rates and commodity fix related to gold. According to FCA, while some firms “had made significant changes to their approach, others were still at an early stage in the process.” In particular, FCA expressed disappointment that “most firms had not yet taken all appropriate steps to identify and then manage fairly and effectively relevant conflicts of interest.” The FCA made its findings after a thematic review conducted between August 2014 and June 2015 “to provide an early assessment of the extent to which firms had learnt the lessons from previous failures around benchmark activities and taken appropriate action in response.”
- Industry Participants Respond to ESMA’s Call for Input on Virtual Currencies and Distributed Ledger Technology and Discuss Potential Applications: The European Securities and Markets Authority published responses to its April 2015 consultation regarding virtual currency investments. (Click here for details regarding this consultation in the article “ESMA Seeks Industry Input on Investments Using Cryptocurrencies and Distributed Ledger Technology” in the April 26, 2015 edition of Bridging the Week.) The consultation attracted responses from a wide range of industry participants and potential participants including issuers, banks, settlement agencies, exchanges and clearing organizations. One respondent, the Euroclear Group, contemplated the potential uses of the distributed ledger (e.g., blockchain) that is used with cryptocurrencies: “simplification of the exchange of data to find counterparties, negotiate trades and settle transactions, reducing time, risk and capital,” as well as “creation of open and robust financial infrastructure for new types of assets and transactions (introducing DVP for more asset classes) enabling new, more open business models,” among other uses. Another respondent, Deutsche Bank AG, said, “we believe that [distributed ledgers and blockchain technology] presents a potential opportunity to realize a number of important benefits including more stable and resilient systems, faster processing of transactions and lower costs for bank customers.” According to CME Group, “[i]n addition to digital currency being a potential new fiat currency, digital currency presents the opportunity for a number of related products such as indices and derivatives, and blockchain as a technology to create a universal ledger.”
Helpful to Getting the Business Done: I am still personally agnostic when it comes to predicting the future success of Bitcoin. However, it is clear to me that more and more institutions are seeing a great potential in the technology behind the distributed ledgers associated with cryptocurrencies to have a material impact on the processing of financial transactions in the future. Others see an equally great potential in the future use of cryptocurrencies themselves. Review of just a few of the letters submitted to ESMA’s consultation will provide insight into what many see as the possible opportunities.
And more briefly:
- Dark Pool Operator International Trading Group Announces US $20 Million Reserve for SEC Enforcement Action Settlement: Investment Trading Group disclosed it had set aside more than US $20 million for a “probable settlement” with the Securities and Exchange Commission related to an investigation into the trading activities of its private stock trading platform – a so-called “dark pool.” According to a press release issued by ITG, the SEC’s investigation focused on a proprietary trading pilot operated within its AlterNet subsidiary for 16 months from 2010 through mid-2011. The firm said the investigation principally involved customer disclosures, regulatory filings with the SEC and customer information breaches related to the pilot’s trading activity for 16 months from 2010 through mid-2011. ITG and AlterNet are registered broker-dealers with the SEC and members of the Financial Industry Regulatory Authority.
- CFE Prepares for OCR Implementation: CBOE Futures Exchange issued a regulatory circular setting forth implementation details in connection with the roll-out of the Commodity Futures Trading Commission’s new Ownership and Control reporting requirements beginning next month. Most immediately, in connection with CFE futures products, beginning September 30, a reporting firm (i.e., CFE clearing members, future commission merchants and foreign brokers) must file with CFE by 9 a.m. on the business day following the business day an account first (1) becomes reportable (i.e., exceeds a specified amount of a futures position) a Form 102A or (2) exceeds a trading volume threshold a Form 102B. All forms must be filed in the electronic format mandated by CFE. This filing requirement with CFE is in addition to any Form 102 previously filed with the CFTC or any other exchange (although a copy of the same form may be filed with CFE).
- Australian Regulator to Consider Recovering Investigation Expenses Against Respondents: The Australian Securities and Investments Commission announced the factors it will consider in assessing the costs of an investigation against any respondent against whom it has prevailed in an enforcement proceeding. These factors include the degree of culpability and degree of cooperation of the respondent, and the likely effect on victims. Under Australian law, where ASIC has prevailed in an enforcement proceeding, it may assess against a respondent the salary costs of staff that conducted the relevant investigation, travel expenses and the costs of external legal counsel and experts.
- NFA Conforms Reporting Requirements to CFTC Staff Relief for CTAs Not Directing Trading: The National Futures Association implemented the exemption recently granted by staff of the Commodity Futures Trading Commission to commodity trading advisors who do not direct trading of accounts. Going forward, these CTAs do not have to fine a Form CTA-PR on an annual basis. (Click here for more information regarding this relief in the article “CFTC Exempts CTAs Not Directing the Trading of Client Accounts From Certain Filing Requirements” in the July 26, 2015 edition of Bridging the Week.) The NFA requires CTAs that intend to take advantage of this relief to respond “no” to the question “Does the firm currently direct any trading of commodity interest accounts?” on the CTA annual questionnaire.
- IOSCO Issues Progress Report in the Regulation of Derivative Market Intermediaries: The International Organization of Securities Commissions published a summary of the progress of 21 jurisdictions in adopting legislation, regulation and policies related to derivatives market intermediaries in six areas: the framework for regulation and definition of DMIs, registration/licensing, capital, business conduct, business supervision and recordkeeping standards. In general, IOSCO found that participating jurisdictions had made “significant progress” in adopting laws, regulations or policies in the six areas.
For more information, see:
Australian Regulator to Consider Recovering Investigation Expenses Against Respondents:
BATS Exchange Seeks Expedited Authority to Suspend Alleged Spoofers:
Phased Roll-Out of New Position Limits Called for at CFTC EEMAC Public Meeting:
CFE Prepares for OCR Implementation:
CME Group Exchanges Sanction Trader Who Allegedly Engaged in Wash Trades to Manage Tax Obligations:
Dark Pool Operator International Trading Group Announces US $20 Million Reserve for SEC Enforcement Action Settlement:
ESMA Says “No for Now” to Granting Passport Rights to US Fund Managers Under AIFMD:
FCA Finds Continued Weakness in Firms’ Oversight of Benchmark Activities:
FINRA Fines Three Broker-Dealers More Than US $2.6 Million for OATS Reporting Violations:
RBC Capital Markets:
HK SFC Fines Nomura International US $580,000 for Failing to Timely Disclose Activities of Rogue Trader:
Industry Participants Respond to ESMA’s Call for Input on Virtual Currencies and Distributed Ledger Technology and Discuss Potential Applications:
IOSCO Issues Progress Report in the Regulation of Derivative Market Intermediaries:
NFA Conforms Reporting Requirements to CFTC Staff Relief for CTAs Not Directing Trading:
The information in this article is for informational purposes only and is derived from sources believed to be reliable as of August 1, 2015. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.
© 2020 Katten Muchin Rosenman and Gary DeWaal. All Rights Reserved.