French Financial Institutions Litigation & Regulation Update, Issue 4
The French Financial Institutions Litigation & Regulation Update is a periodic newsletter featuring the latest news in the financial services field in France.
LEGISLATION AND REGULATION
Threshold for Ring-Fencing of Certain Proprietary Trading Activities Contained in Law Relating to the Separation and Regulation of Banking Activities Is Set
Among the key provisions set out in the law relating to the separation and regulation of banking activities no. 2013-672 dated July 26,2013 is the mandatory ring-fencing of certain proprietary trading activities into a segregated subsidiary. The ring-fencing requirement applies only where trading activities in financial instruments exceed exposure thresholds to be set by way of secondary legislation. Such secondary legislation was published in the form of Decree no. 2014-785 published on July 10, 2014, whereby the ring-fencing requirement applies where the carrying amount of trading activities in financial instruments exceeds 7.5 percent of the balance sheet of the relevant entity. Where international accounting standards ("IAS") apply, the carrying amount of trading activities in financial instruments is to be construed as fair value assets appearing on the profit and loss account. The materiality threshold of EUR 90 billion in terms of size of balance sheet (below which segregation would not be required) once envisaged has eventually not been applied.
Institutions exceeding such threshold are due to transfer relevant activities within 12 months of this accounting year-end. In a number of circumstances, including where proprietary trading activities in financial instruments is related to the provision of investment services to clients, such activities would not have to be transferred.
Tender Offer Rules Have Been Amended
The proposed amendments to the AMF Rulebook with respect to tender offer regulations referred to in the previous issue of the Update were adopted in final form on June 27, 2014.
Changes notably include the introduction of a mandatory acceptance condition in all tender offers subject to some exemptions, changes to mandatory bid triggering events, a greater role of the works council, and an end to the statutory board passivity rule.
POSITIONS AND GUIDANCE FROM AUTHORITIES
Securities Regulator Anticipates MiFID 2 Changes to AIFMD
Directive 2014/65/EU ("MiFID 2") amended Directive 2011/61/EU ("AIFMD") by extending the scope of the activities that may be carried out by passported alternative investment fund managers. Under previous rules, activities that could be passported under the AIFMD did not include MiFID investment services and ancillary activities, and managers of AIFs could not obtain a license to carry out MiFID activities. Following recommendations from ESMA set out in its Q&A relating to the application of the AIFMD dated June 27, 2014, the AMF has anticipated this change of regulations. As a result, an alternative fund manager may now passport under the AIFMD the following additional activities: (i) discretionary portfolio management, (ii) investment advice, (iii) safekeeping and administration of shares/units of collective investment undertakings, and (iv) reception and transmission of orders.
ESMA recommends in its Q&A member states to permit similar arrangements.
Securities Regulator Clarifies Best Execution Requirements
The AMF issued position no. 2014-07 on August 2, 2014 on best execution, drawing on its consultation paper referred to in a previous issue of the Update. The position focuses on nonexhaustive listed qualitative factors (i.e., transparency for price formation process, use of clearing house); monitoring of execution order system effectiveness on a regular basis and review of execution policy; best selection and its connection with best execution.
Securities Regulator Clarifies Consequences of Investor Payment Default in the Subscription of Collective Investment Scheme
An updated position dated July 29, 2014 clarifies consequences arising from failures along the subscription chain of UCITS or AIFs. It is common practice in France for an agent known as a centralizer to receive subscription (and redemption) orders with respect to collective investment schemes. The centralizer checks that the orders that he has received conforms with the prospectus or the distribution agreements and subsequently transfers the consolidated orders to the depositary of the collective investment scheme that will proceed with the settlement–delivery.
In order for the scheme to be attractive to investors, asset managers typically invest the amount committed by investors upon reception of subscription orders (in T) before the effective payment is actually made by the investor (in T+3 only). This places the centralizer at risk in the period between T and T+3 in the event of a potential default from the investor. To mitigate this risk, the AMF stated in its updated position that the management company will be required to disinvest the subscription amount when it is certain that the order will not be settled although the subscription order is legally irrevocable. The AMF further clarified that the consequences of this default should be borne by the fund and mutualized among fundholders, which is in line with international standard practice.
Securities and Banking Regulators Clarify Content of Distribution Agreements to be Entered Into Between Manufacturers and Distributors of Financial Products
Under French law, "manufacturers" of financial instruments or life insurance products (asset managers, issuers of securities described in a prospectus approved by the French Securities Regulator, and various regulated statuses of insurance undertakings) resorting to distributors are required to enter into distribution agreements with distributors. Such agreements must include an obligation for distributors to submit all draft versions of marketing materials created by them to the manufacturers for approval before they may be distributed.
The AMF and the French Banking Regulator (the ACPR) in Recommendations DOC-2014-05 and 2014-R-01 respectively further clarified the content of such distribution agreements in terms of obligations of each party to the agreement (with respect to the promotional document validation process and transmission of the information required for the client to assess the characteristics of the financial instruments) and the role of distribution agreements in the marketing chain.
The recommendations are due to take effect on January 1, 2015.
Securities Regulator Consults on Provisions With Respect to High-Frequency Trading
Among the key provisions set out in the law relating to the separation and regulation of banking activities, some relate to automated orders and direct market access. The law entrusted the French Securities regulator (the AMF) with issuing secondary legislation in this respect. To this effect, the AMF launched a public consultation on July 13, 2014 on proposed amendments to its Rulebook broadly consisting of:
- Recognition of a trading venue as a regulated market would be conditional on the applicant market proving that it has sufficient capacity to cope with periods of market stress in the case of high volatility.
- Erroneous trade orders or trade orders with price and volume limits that exceed the thresholds previously established must be rejected; trading of financial instruments should be suspended in the case of high price variation; and trade cancellation should be possible in exceptional cases.
- Procedures to prevent market disruption should be established, and steps must be taken to limit the number of unexecuted trade orders.
Comments for this consultation are expected by September 26, 2014.
Securities Regulator Anticipates Shortening of Maximum Settlement Period From Three to Two Trading Days
In anticipation of the EU Central Securities Depositories Regulation, the AMF has consulted on proposed changes to its Rulebook in order to reduce the delivery–settlement period from three to two trading days and amend accordingly other provisions having to do with market infrastructure. Such changes are to take effect on October 6, 2014 (while the EU Regulation is due to come into force on January 1, 2015).
Investment Firm's Liability for Default of Hedging
Substantial litigation derives in France from the liability incurred by investment firms as a result of their failure to hedge transactions on the Deferred Settlement Service (i.e., a mechanism allowing French investors to take a long or short leveraged position).
By way of example, in a decision dated June 24, 2014 from the French Supreme Court (Cour de Cassation), an investment firm on the Deferred Settlement Service providing the MiFID investment service of reception and transmission of orders was held liable for having authorized its client to keep on operating under the Deferred Settlement Service without liquidating the investor's position or requiring appropriate hedging despite a debit balance account.
It is also noteworthy that prevailing case law is to the effect that failure of investment firms to liquidate the investor's positions despite a debit balance account may be used by the investors before courts to demonstrate a default from the investment that could therefore trigger the investment firm's liability.
Securities Regulator's Enforcement Committee Imposes Sanctions on Asset Managers for Regulatory Breaches
On June 27, 2014, the AMF Enforcement Committee sanctioned two asset managers and their common chief executive officer for failure to comply with a number of requirements, including conditions of their authorizations delivered by the AMF, un-notified changes to shareholding, and changes to key aspects of their programs of operations. Similarly, the Enforcement Committee criticized the failure to comply with organizational requirements, such as internal control system and compliance. Lastly, breaches of rules of conduct regarding client profiling and adequacy of the associated management services were highlighted by the Enforcement Committee. One asset manager was fined EUR 80,000, the other was fined EUR 70,000, and their common chief executive officer was fined twice for the amount of EUR 20,000 for each of its two CEO positions.
Administrative Supreme Court Confirms Sanction Levied in Bond Misselling Case
The French Administrative Supreme Court (Conseil d'Etat) confirmed on July 16, 2014 sanctions levied by the AMF Enforcement Committee against a financial intermediary. The representative of the intermediary visited a number of potential investors at their homes for the purpose of recommending the subscription of debt securities, which under French law constitutes solicitation. French law prohibits the solicitation of investors in France for the purchase of unlisted securities. On this basis and other grounds (disclosure of erroneous and misleading information, misselling, and nondisclosure of conflicts of interest), the Conseil d'Etat confirmed sanctions initially levied against the financial intermediary (permanent ban on providing services) but reduced the amount of the sanctions initially incurred by the employee (from EUR 50,000 to EUR 20,000).
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