The Global Regulatory Brief provides monthly insights on the latest risk and regulatory developments. This brief was written by Bloomberg’s Regulatory Affairs Specialists.
Risk, capital and financial stability regulatory developments
Recent periods of financial stress and the proliferation of risks across the financial system are fueling the development of regulatory initiatives to strengthen requirements and promote international best practice. From the Switzerland to the U.S., the following global developments in risk, capital and financial stability from the past month stand out:
- Switzerland: Authorities introduce a new fund category
- International: CPMI-IOSCO seek feedback on effective practices for streamlining variation margin in centrally cleared markets
- US: CFTC issues for public comment a package of proposed rules for SEFs, DCMs, FCMs and FBOTs
- EU: Co-legislators approve new legislative framework for fund sector
- EU: EIOPA publish insurance risk dashboard
- EU: EBA consults on technical aspects of FRTB
- US: Federal bank regulators seek comment on interagency effort to reduce regulatory burden
- US: SEC and CFTC adopt joint amendments on private fund reporting
- Netherlands: Authorities publish report on liquidity management of pension funds in stress scenarios
Switzerland introduces a new fund category exempt from FINMA authorization and supervision
The Swiss parliament and Federal Council have launched a new category of fund that is exempt from authorization from March 1, 2024.
In summary: The new Limited Qualified Investor Fund (L-QIF) are collective investment schemes that will not be authorized or supervised by FINMA.
- To be eligible, these funds must be offered solely to qualified investors and managed by entities that are supervised by FINMA
- The Federal Council is simultaneously amending the Collective Investment Schemes Ordinance, particularly in the area of liquidity management, along with several other ordinances
Background: The Swiss parliament voted to introduce a new fund category, the L-QIF, in December 2021 and amended the Collective Investment Schemes Act (CISA) accordingly.
CPMI-IOSCO seek feedback on effective practices for streamlining variation margin in centrally cleared markets
The Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) have published a joint report on examples of effective practices for streamlining variation margin (VM) in centrally cleared markets.
In more detail: The report sets out eight examples of effective practices for central counterparties (CCPs) to consider when designing their VMcall and collection processes. The examples include:
- Scheduling, frequency and timing of intraday VM calls
- Offsetting VM call requirements against other obligations where possible
- Pass-through of VM by CCPs
- Use of excess collateral to meet VM obligations
- CCP and clearing member transparency in VM requirements and processes
Wider context: The consultation comes as the Financial Stability Board (FSB) is conducting work to develop high-level, cross-sectoral policy proposals on non-bank market participants’ liquidity preparedness to meet margin and collateral calls. The FSB will publish a consultative report in the first half of 2024.
Looking ahead: Comments are due by April 14, 2024.
EU co-legislators approve new legislative framework for fund sector
The EU Parliament adopted rules updating the regulatory framework applicable to hedge fund and retail fund managers, the Alternative Investment Fund Managers Directive (AIFMD) and the Undertaking for Collective Investment in Transferable Securities Directive (UCITSD). Shortly after, the Council formally adopted the AIFMD revision agreement.
In more detail: The updated rules aim to remove discrepancies across the EU through a range of measures, including:
- Bolstering liquidity risk management by managers of open-ended alternative investment funds and retail funds, requiring them generally to have at least two liquidity management tools to cover situations when liquidity issues arise (such as when many investors wish to redeem their investments at the same time)
- Ensuring that the investment fund managers, which delegate their functions to third parties, adhere to the same standards applicable across the EU
- More information automatically provided at the time of a fund manager’s authorization about the delegation arrangements they intend to put in place
- Improving access to finance by introducing common minimal rules regarding direct lending by AIFs to companies to allow loan-originating funds to operate cross border and ensure that they can be an alternative source of funding for companies in addition to bank lending
Greenwashing: The updates also seek to fight ‘greenwashing’ and ensure that investors are not misled into investing into funds that pretend to be ‘green’. ESMA is tasked to produce guidelines on when the names of funds could be unfair, unclear or misleading to the investor.
Next steps: The directive will now be published in the EU Official Journal and enter into force 20 days later.
- Member states have 24 months after the entry into force to transpose the rules into national legislation
- ESMA plans to consult on implementing technical rules regarding the i) selection and characteristics of liquidity management tools and ii) open-ended loan-origination AIFs in Q2 and Q3 2024
CFTC issues for public comment a package of proposed rules for SEFs, DCMs, FCMs, and FBOTs
The three proposals, approved under the Commodity Futures Trading Commission’s (CFTC) seriatim process, include: (1) requirements regarding governance and the mitigation of conflicts of interest for swap execution facilities (SEFs) and designated contract markets (DCMs), (2) margin adequacy requirements for futures commission merchants (FCMs), and (3) amendments expanding foreign boards of trade (FBOTs) direct access to U.S.-based introducing brokers (IBs).
(1) Requirements regarding governance and the mitigation of conflicts of interest for SEFs and DCMs:
Conflicts of interest provisions: The proposal seeks to address conflicts involving “market regulation functions,” which include responsibilities related to trade practice surveillance, market surveillance, real-time market monitoring, audit trail data, recordkeeping, investigations, and disciplinary actions. It would require SEFs and DCMs to establish policies regarding the disclosure of potential conflicts in matters under consideration by its board of directors, committees, and disciplinary panels. Covered entities would also be required to establish and enforce policies to safeguard against the use and disclosure of material nonpublic information.
Governance provisions: The proposal would codify and expand various requirements relating to the composition, transparency, and accountability of a SEF or DCM’s board of directors and regulatory oversight committee. Additionally, the proposal would require enhanced notification requirements with respect to changes in the ownership or corporate or organizational structure of a SEF or DCM.
(2) Margin adequacy requirements for FCMs:
The proposal would require that FCM’s ensure customers are not permitted to withdraw funds if the withdrawal would result in an insufficient balance to meet the customer’s initial margin requirements. The proposal would also allow both clearing and non-clearing FCMs to treat multiple accounts owned by a single customer as separate entities for purposes of the new margin adequacy requirements.
(3) Expansion of FBOT direct access to U.S.-based IBs:
The proposal would add U.S.-based IBs to the list of CFTC-approved intermediaries that are permitted to enter orders to FBOTs on behalf of their customers. IBs would be required to submit their orders for clearing to a Commission-registered FCM or registration-exempt firm.
Public comment period: All three proposals are available for public comment through April 22, 2024.
EIOPA publish insurance risk dashboard
The European Insurance and Occupational Pensions Authority (EIOPA) published its February 2024 Insurance Risk Dashboard, which shows that insurers’ exposure to market risk is currently at a high level and represents the main concern for the sector. Macro and digitalization risks are still relevant but have decreased to medium levels, where the remaining risk categories are currently classified.
Important context: The Insurance Risk Dashboard is based on Solvency II data and summarizes the main risks and vulnerabilities in the EU insurance sector through a set of risk indicators of the third quarter of 2023 and end-2022.
In summary: EIOPA concludes the following:
- Market risks remain prominent given the elevated volatility in bond markets and a further decrease in commercial real estate prices
- Macro risks persist in the insurance sector but as a declining trend, primarily due to a reduction in forecasted inflation
- Credit risks remain at a medium level with no indication of significant changes
- Liquidity and funding risks remain at medium levels with an increasing trend driven in part by low catastrophe bond issuance in Q3-2023
- The median of the distribution of insurers’ cash holdings has slightly decreased compared to the previous quarter
- Profitability and solvency risks are at medium levels with the median SCR ratio for non-life undertakings showing an increase compared to the previous quarter while the distribution for life undertakings remained largely unchanged
- Interlinkages and imbalances risks as well as insurance risks are also stable at medium levels
- ESG risks remain at a medium level and insurers’ median exposure towards climate-relevant assets hovers around 3.3% of total assets, while their investments in green bonds are steady at around 7% of total green bonds outstanding
- Digitalization and cyber risks have decreased to medium level, but forward-looking assessments point to an increase in this risk category over the next 12 months. Cyber negative sentiment also indicates an increasing concern in the fourth quarter of 2023
EBA consults on draft technical standards on residual risk add-on hedges under the Fundamental Review of the Trading Book
The European Banking Authority (EBA) launched a public consultation on the technical conditions for determining whether an instrument attracting residual risk acts as a hedge under the Fundamental Review of the Trading Book (FRTB).
Context: These rules are part of the Phase 1 deliverables of the EBA road map on the implementation of the EU banking package in the area of market risk.
What is the residual risk add-on? The residual risk add-on (RRAO) is one of the pillars of the standardized approach (SA) under the new FRTB framework.
- The Capital Requirements Regulation (CRR3) introduces a provision in the RRAO framework allowing the exemption from the RRAO charge for instruments bearing residual risks that are taken to hedge instruments bearing residual risks too
- CRR3 also includes a mandate for the EBA to develop rules specifying when an instrument qualifies as a hedge for the purpose of the exemption and when not
What is the EBA proposing? The proposed draft requires institutions to identify whether the RRAO charge for which the institution seeks the exemption relates to a risk factor that is not shocked in the SbM (i.e. non-SbM risk factor), or if it is down to other reasons.
- When the RRAO relates exclusively to a non-SbM risk factor, the draft envisages conditions to verify that, as a result of the hedge, the sensitivity towards the non-SbM risk factor is significantly reduced
- On the other hand, where the RRAO charge is due to other reasons than the presence of a non-SbM risk factor, the RTS allow the hedging instrument to be recognized as hedge, and as such, exempted from the RRAO charge, only if it completely offsets the RRAO risk stemming from the hedged instruments
Timeline: The deadline for the submission of comments is May 3, 2024. A virtual public hearing will take place on March 6.
Federal bank regulators seek comment on interagency effort to reduce regulatory burden
The Federal Reserve Board, Federal Deposit Insurance Corporation, and Office of the Comptroller of the Currency announced the requests for comment, which are required once a decade under the Economic Growth and Regulatory Paperwork Reduction Act of 1996.
The details: The current request, which is the first in a series that will span the next two years, covers regulations in three categories: (1) Applications and Reporting, (2) Powers and Activities, and (3) International Operations.
Public comment period: Comments will be accepted for 90 days after publication in the Federal Register.
SEC and CFTC adopt joint amendments on private fund reporting
The SEC and CFTC jointly adopted amendments to Form PF, the confidential reporting form for certain investment advisers to private funds. Notable changes include:
- Enhanced reporting by hedge fund advisors with net asset values of more than $500 million
- Enhanced reporting of basic information about advisers and the private funds they advise
- Removal of the aggregate reporting requirement for large hedge fund advisers
- Amended reporting for funds with complex structures, including master-feeder arrangements and parallel fund structures
- Detailed reporting of hedge fund strategies, counterparty exposure, and trading and clearing mechanisms
Compliance Timeline: The amendments will become effective one year after publication in the Federal Register. The compliance date will be the same as the effective date.
Netherlands authorities publish study on liquidity management of pension funds in stress scenarios
The Dutch Central Bank (DNB) and the Netherlands Authority for the Financial Markets (AFM) published a study on liquidity management of pension funds in stress scenarios.
In summary: The study found that in the event of a large, sudden drop in the value of derivatives, Dutch pension funds do not need to resort to an extensive sell-off of assets.
- They have enough liquidity sources to meet margin calls, which are obligations arising from value changes in their derivatives
- They are, however, crucially dependent on money markets continuing to function smoothly, so they can raise cash at short notice
Further detail: The study also found the following:
- Pension funds use derivatives to mitigate market risk but this can bring liquidity risks
- The large size of the Dutch pension sector’s combined investment portfolio mean that their transactions can impact financial stability, and so the DNB and AFM asked a group of pension funds to calculate various stress scenarios
- The study shows that pension funds are able to meet margin calls under derivatives contracts in the different stress scenarios without resorting to an extensive sell-off of assets
- The scenario results show that pension funds depend on the smooth functioning of money markets for their liquidity management
- To safeguard financial stability a more robust framework encompassing buffer requirements on money market funds (and other non-bank financial institutions) could make this sector more resilient in times of stress
Clearing: The authorities note that newly introduced legislation will further increase pension funds’ need for liquidity in the coming years.
- The exemption for mandatory central clearing of derivatives ended in 2023
- In the case of centrally cleared contracts, margin calls must always be met in cash
- Since the clearing obligation applies solely to new transactions, the proportion of centrally cleared derivatives, and hence the need for liquidity, will gradually increase
Looking ahead: The authorities consider it to be important to repeat this analysis in a few years and continue to monitor liquidity risks closely as it is uncertain how liquidity needs will evolve going forward.
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