Debt capital markets - the effects of the regulatory challenges ahead
June 2013 | EXPERT BRIEFING | CAPITAL MARKETS
Capital markets lawyers are concerned with the regulatory framework and it is particularly clear that the so called ‘regulatory wave’ will continue to impact almost every niche of capital markets activity.
In many cases, there is still some uncertainty regarding the effects of implementation of this regulation. Set out below are some observations on the current state of play.
Prospectus Directive (Amending Directive)
With respect to disclosure requirements under the Prospectus Directive (PD), the effects of the Amending Directive on the architecture of prospectuses have been well-documented but are in some cases only now having to be tackled by corporate issuers during the annual update of their EMTN programs.
In the UK, companies face not only uncertainty relating to the new organisational structure of the regulator (the FCA and PRA) but need to be aware of newly revised approaches to the implementation of the PD. The pan-European regulator, ESMA, continues to provide a highly functional service in determining and clarifying the application of the PD (amongst other legislation); however the sheer volume of clarifications and consultations from ESMA indicate the pressures from the legislative pipeline which will take time to be worked through to satisfactory implementation.
The effect of the LCR on commercial paper (CP) is one interesting area. The introduction of the LCR will increase the cost of liquidity support (for example, letters of credit) provided by banks to certain commitments that can come due in less than 30 days. Under the LCR, banks would be required to hold highly liquid qualifying assets against such commitments. A solution is ‘callable CP’ – CP with a call option 35 days prior to maturity – which allows an issuer to call the paper before it reaches the 30 day time limit. We wait to see whether this solution willbe embraced wholesale by the market.
In securitisation, we all know what Basel III (through CRD IV) is proposing in terms of liquidity standards (LCR) and new capital buffer requirements, however the likely commercial effects on, for example, the long-term securitisation market closure and potential returns by banks are less clear.
MiFID II will be phased in from 2015. MiFID II needs to be assessed in light of the EU’s conception of an integral European market. Current trends on the continent indicate that the application of MiFID may not be uniform across Europe, further creating uncertainty as to how the Directive will be implemented in conjunction with national legislation. Recent discussions on market structure regulation in Germany and the introduction by France of a unilateral financial tax back in August 2012 suggest that true harmonising of the application of legislation at a European level may be unlikely, making an integral European market a more difficult concept to depend upon.
We need further clarity as to the scope of intervention in the market by national regulators and pan-European regulatory bodies. For example, with respect to the implementation of MiFID II, national regulators will have powers to permanently ban products, but also that ESMA itself will also be able to temporarily ban products. We do not know whether the approach taken by regulators will be interventionist from the start.
Financial transactions tax
It would be useful to have further thinking on the likely effects of the proposed financial transaction tax (FTT). At the moment the exemptions to the FTT are very restricted and while the charge might at first glance seem de minimis, think of the accumulation of FTT charges in a transaction which includes intermediaries and a complicated settlement chain. Aside from the potentially very significant effect on the activities of market-makers and broker-dealers (and significant industry bodies, including the International Capital Markets Association, have expressed concern about the effects of the FTT on products such as repos), the market needs more certainty as to how FTT will be dealt with in documentation as a matter of risk allocation. For example, what should happen when a bank seeks to retain the flexibility to transfer its lending commitment to another group company (intra-group transactions are not presently subject to the proposed exemptions)? In those circumstances, will the risk of payment of FTT be passed onto the borrower through an indemnity? In all likelihood we can expect FTT to be a key topic until January 2014 and beyond, in both the EU 11 countries themselves and in the UK.
Outlook for DCM in 2013
It is likely that in 2013 and 2014, bonds will continue to be seen as an alternative to traditional bank lending, especially as banks continue to deleverage their balance sheets in light of Basel III. In the UK, it would be encouraging to see the continuation of sterling as a safe haven currency and the sterling bond market as an attractive source of funding for international issuers, although all of this, of course, depends on the relative strength of the pound.
From the perspective of investors, there remains significant (and increasing) institutional appetite for high yielding fixed income instruments.
It seems self evident that the regulatory wave is a challenge for lawyers as well as their clients, but it is clear that there has been a general shift of focus by capital markets lawyers from pure transaction work towards regulatory advice and analysis. The challenge for lawyers is to explain with a degree of clarity, the specific effects of new regulation.
William Oliver is a senior associate at Gide Loyrette Nouel LLP. He can be contacted on +44 (0)20 7382 5587 or by email: firstname.lastname@example.org.
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