What are the priorities for financial markets?

MARCH 2011

This brochure looks at:

• the four priorities, as seen by the AMF, with a report on the progress already made at the initiative of the G20 and the work that remains to be done;

• the other ongoing work of the G20 with regard to financial markets and the AMF’s initiative on these

issues in France (supervision of hedge funds, regulation of OTC derivatives markets and strengthening regulation of credit rating agencies).

CONTENTS  PRIORITIES FOR FINANCIAL MARKETS ON THE 2011 G20 AGENDA P04. Improving market transparency, efficiency and integrity P08. Regulating commodity markets P10. Investor protection P12. Regulating shadow banking  ONGOING G20 WORK WITH REGARD TO FINANCIAL MARKETS AND THE AMF’S INITIATIVES ON THESE ISSUES P13. Supervision of hedge funds P15. Regulation of OTC derivatives markets P17. Strengthening regulation of credit rating agencies and reducing dependency on ratings

THE “HIERARCHY OF FINANCIAL STANDARDS”: FROM THE G20 PRINCIPLES TO THE AMF GENERAL REGULATION At the global level, the three top ranks of financial governance are made up of informal groups and organisations. The G20, made up of the Heads of State and Government. It sets out the main principles and priorities for global financial governance. The Financial Stability Board (FSB), which translates the G20’s decisions into actions and guides the work of international standards setters by issuing reports and recommendations. The standard setters, including the Basel Committee and the International Organization of Securities Commissions (IOSCO), which bring national financial regulators together to promote the convergence of regulations and to improve cooperation in supervision by defining the standards and methodologies that provide guidance for national regulators’ actions. The principles set out by the G20, the recommendations of the FSB and the standards set by IOSCO or the Basel Committee are not binding: It is up to each government or supra-national entity (primarily the European Union) to decide whether it will implement the standards set by the international standard setters into its own legislation. In Europe, standards set by IOSCO or the Basel Committee are introduced into national law through the adoption of European Regulations and directives, and through the introduction of technical measures by ESMA. In France, the AMF, which is responsible for ensuring the protection of investments in financial instruments, investor information and the orderly functioning of markets in financial instruments, has the power to adopt rules, which are subject to the approval of the Finance Minister and contained in the AMF General Regulation.

02

EDITORIAL by Jean-Pierre Jouyet, Chairman of the Autorité des marchés financiers The G20 Roadmap asks us, for the first time, to look at both the framework of macroprudential regulation and protection for retail investors, two areas at opposite ends of the regulatory spectrum. This reflects the fact that, to regulate fairly and effectively – and to ensure that finance serves the economy, rather than the other way round – we must reconcile the approaches taken in these two areas. The French Presidency and, by extension, the AMF, have made these G20 priorities their own, as explained below. The G20 has given us a mandate to improve market efficiency and integrity We have a historic opportunity to correct some of the most glaring problems on markets, which are becoming less organised, more fragmented and more opaque. Markets must once again become the place where issuers and investors meet to efficiently finance the real economy. To do that, we have to get back to basics of transparency and fairness. Different execution venues must provide equal treatment, “opaque areas” must be limited to what is strictly necessary, overthe-counter trades need to be brought onto transparent multilateral platforms, and pre- and posttrade transparency must be strengthened. We also have to take account of new trading techniques, most notably high-frequency trading. We have also been mandated to propose regulatory solutions for commodity markets Commodity markets are growing increasingly volatile, inflicting greater pain on producers and consumers than in the past. Moreover, these markets have a heavy financial component that is not captured by regulation. There is no reason why these markets should be left out of the broad push to re-regulate. The solutions being applied to financial markets should be introduced for these markets too, along with specific rules to ensure that producers, financial intermediaries and consumers can coexist harmoniously. At the same time, there will have to be regulatory changes for physical markets and disclosures relating to those markets, since regulation of financial commodity markets will not be enough to curb price volatility. We also have to consider the protection of investors, whose confidence is needed to get economic engines firing again. That means tightening marketing rules, doing a better job to guarantee the safekeeping of assets entrusted to financial market participants, and, most important of all, enhancing the quality of information provided to investors. The G20 has also asked us to shed more light on the question of shadow finance. We urgently need to get to grips with this issue, which has not been entirely addressed by the new hedge fund rules. We must work with prudential regulators to better grasp the scale of shadow finance and limit it, through new rules for money market funds and securitisation, for example. The G20 agenda obviously goes well beyond the AMF’s jurisdiction, although decisions on correcting macroeconomic imbalances and the monetary system will have a huge impact on financial markets. In any event, in all the areas where our expertise can be brought to bear, and which you can read about in this brochure, we will endeavour to play our part and contribute to the success of this G20 Presidency. Jean-Pierre Jouyet

03

Priorities for financial markets on the 2011 G20 agenda 1

IMPROVING MARKET TRANSPARENCY, EFFICIENCY AND INTEGRITY

AMBITIONS OF THE G20 On France’s initiative, the last G20 summit in Seoul in November 2010 gave IOSCO until June 2011 to make recommendations to the FSB to improve market integrity and efficiency and to reduce the risks posed by the latest technological developments, such as high-frequency trading.

IN EUROPE THE MIFID REVIEW IS AN OPPORTUNITY TO ADDRESS STRUCTURAL ISSUES Recent developments on markets show that a combination of technological innovation and gaps in regulations has resulted in a lack of transparency. In Europe, the consequences of the Markets in Financial Instruments Directive (MiFID) include:

• e nhanced competition between trading platforms, but also a fragmentation of markets and, hence liquidity, which potentially undermines market efficiency and stability;

• the development of non-transparent trading systems, such as so-called “dark pools” that now account for a growing share of equities trading;

• a lack of reliable and comprehensive information about trading; • a decline in transaction costs for some securities, but an overall increase in costs stemming in part from smaller trades and the rising cost of accessing a more fragmented market and in part from a lack of transparency on orders and prices for non-equity products (bonds, structured products, derivatives).

These mixed results call for European lawmakers and national regulators to think carefully about the evolution and organisation of European markets. The review of MiFID currently being spearheaded by the European Commission on the basis of a public consultation will be an opportunity to address some of the negative effects and to remedy some of the gaps that have been identified in regulations. The Commission is considering the following solutions to structural problems in these markets: A minimum regulatory framework for all trading systems The European Commission proposes to introduce a new category of “organised trading facility” (OTF) in addition to the other existing types of execution venues. Managing an OTF would be an investment service requiring regulatory authorisation.

04

PRIORITIES FOR FINANCIAL MARKETS ON THE 2011 G20 AGENDA IMPROVING MARKET TRANSPARENCY, EFFICIENCY AND INTEGRITY

1

These new facilities would have to meet a number of key criteria. After reaching an asset-specific threshold, yet to be determined, they would have to adopt “multilateral trading facility” (MTF) status, which would make them multilateral platforms. Strengthening pre-trade and post-trade transparency rules Improving and extending pre-trade transparency rules on equities markets are major concerns. Harmonised application of the exemptions from pre-trade transparency rules at the European level could help curb dark trading. ESMA could be given the necessary powers to monitor implementation of these new rules. Regarding post-trade transparency on equities markets, i.e. transparency about trades after they have been executed, the European Commission is considering whether to tighten the MiFID rules and demand that trades be made public as close to instantaneously as is technically possible. Generally speaking, maximum permitted delays for publication would be shortened so that most trades are published before the end of the trading day. These transparency rules for equities markets could be extended to cover equity-like instruments, such as depositary receipts, exchange-traded funds and certificates. On “non-equity” markets, the discussion centres on appropriate pre-trade and post-trade transparency rules. These rules would apply to bonds and structured products, which require a prospectus or which are admitted to trading on a regulated market or an MTF, and derivatives eligible for central clearing. To ensure pre-trade transparency, regulated markets, MTFs and organised trading facilities would be required to publish price and volume information continuously, and investment services providers trading OTC would have to publicly disclose prices and volumes and commit to a minimum quantity. To ensure more accurate and granular information about OTC trading, the Commission proposes using a system to flag OTC trades in post-trade transparency reports. The Commission has pointed to a critical need to consolidate trade data, especially for equities trading but also, possibly, for non-equity products. The Commission makes proposals for improving the quality of post-trade data, cutting the cost of data for investors and introducing a consolidated tape system. Regulating high-frequency trading The MiFID review is also an opportunity to define what is meant by high-frequency trading. The discussion has focused on a broad definition of automated trading, of which high-frequency trading (HFT) is a sub-category. Two types of measures have been envisaged for managing the impact of algorithmic trading and the risks of HFT. Some of these measures are aimed at high-frequency traders, others concern the practice itself. High-frequency traders could be required to obtain authorisation as investment services providers if they exceed a specified quantitative threshold; they could also be subject to liquidity requirements similar to those applicable to market makers. In addition, the HFT activity would be subject to specific rules on risk management. And ESMA could be given powers to oversee these matters.

05

PRIORITIES FOR FINANCIAL MARKETS ON THE 2011 G20 AGENDA 1

IMPROVING MARKET TRANSPARENCY, EFFICIENCY AND INTEGRITY

THE AMF’S PROPOSALS The AMF considers that the issues stemming from market structure and technological developments, along with the ensuing new market practices call for several initiatives: Apply the reasoning formulated by the G20 for the derivatives markets to all financial instruments: • require pre-trade and post-trade transparency; • promote trade execution on multilateral platforms; • improve the reporting of post-trade data to regulators and market participants. Take steps to ensure that all standardised and sufficiently liquid financial instruments are traded on multilateral platforms that meet high standards for pre-trade and post-trade transparency, governance and nondiscretionary open access, as shown in the diagram below.

FINANCIAL INSTRUMENTS

Not standardised or insufficiently liquid

Non-addressable liquidity

Standardised and sufficiently liquid

Organised multilateral platforms OTC trading

Dark trading for blocks

Lit trading

Source: AMF

06

PRIORITIES FOR FINANCIAL MARKETS ON THE 2011 G20 AGENDA IMPROVING MARKET TRANSPARENCY, EFFICIENCY AND INTEGRITY

1

Improve pre-trade and post-trade transparency: data quality must be improved, trade publication deadlines must be tight and post-trade data consolidation must be organised in Europe on the basis of a mandatory consolidated tape. Give regulators access to consolidated market data so that they can deliver effective supervision and develop appropriate tools for mutual cooperation in order to establish the necessary links between different supervisory zones. Give regulators rapid response capabilities to cope with technological developments on financial markets by ensuring that they:

• have the necessary powers to adopt binding standards, particularly with regard to the risk of order book

manipulation and the systemic risk potentially caused by high-frequency trading. A harmonised definition is needed of the respective roles of exchanges, trading platforms and regulators in this area. For example, measures that infrastructures take to prevent so-called flash crashes must be harmonised and coordinated in order to avoid a spill-over of orders and trades from one execution venue to another;

• have the means to monitor technological developments, such as the activity of high-frequency traders. This will call for improvements in the quality of the data collected.

Make markets more efficient so that they can fulfil their primary task of financing economic activity. On this point, the issue of financing small and medium-sized enterprises (SMEs) is a priority for the AMF, which is in favour of adapting periodic and ongoing disclosure requirements for small and medium sized firms by extending the approach of the “European Small Business Act” to securities law.

07

2

REGULATING COMMODITY MARKETS

Historically, commodity markets1 have been less regulated than financial markets. But in recent years these markets, especially those for agricultural commodities, have been attracting financial investors. The sheer size, volatility, complexity and concentration of commodity markets may lead to serious risks, including systemic risks, given the lack of transparency in certain transactions and the imbalance between investment flows and trading volumes on the physical market. France has therefore decided to make the regulation of commodity markets one of the priorities for its G20 Presidency.

AMBITIONS OF THE G20 The G20 Seoul summit, on a French initiative, asked IOSCO to submit a progress report and proposals on commodity derivatives markets to the FSB by April 2011. IOSCO’s mandate covers derivatives on all commodities, including agricultural commodities.

EUROPEAN INITIATIVES In line with the G20’s stance, the European Commission wants to strengthen regulation of these markets. The review of MiFID is an opportunity to: • e nsure that its rules on authorisation, organisation and conduct of business are applicable to all participants in commodity derivatives markets; • introduce a reporting requirement for positions in each type of contract, the types of traders (commercial or financial) and, potentially, the purpose of the contract (hedging or otherwise). In the specific case of energy markets (gas and electricity), the European Commission published a proposal for a regulation2 in December 2010 that would prevent price manipulation and insider dealing on wholesale energy markets not covered by the Market Abuse Directive3. The objective is to establish a framework that formally bans market abuse on the wholesale markets for electricity and natural gas. In the specific case of carbon markets: the Commission Regulation4 on the timing, administration and other aspects of auctioning of greenhouse gas emission allowances requires auction platforms to be regulated markets within the meaning of MiFID and to admit to trading any allowances and derivatives that have been auctioned on them. The regulation also requires the Member State hosting the platform to grant regulatory, supervisory and sanctioning powers to a competent authority, which is primarily the AMF in France.

Commodities can roughly be classified in four categories: energy (gas, oil, electricity, coal), metals, agricultural products and carbon. Proposal for a Regulation of the European Parliament and of the Council on Energy Market Integrity and Transparency (REMIT). 3 Directive 2003/6/EC of 28 January 2003 on insider dealing and market manipulation. 4 Regulation (EU) No 1031/2010 adopted on 12 November 2010. 1 2

08

PRIORITIES FOR FINANCIAL MARKETS ON THE 2011 G20 AGENDA REGULATING COMMODITY MARKETS

2

THE AMF’S PROPOSALS Apply the approaches used for financial markets to commodity derivatives markets:

• applying MiFID’s organisational and conduct of rules and developing prudential rules for firms specialising in commodities;

• clarifying the scope of the Market Abuse Directive with regard to commodity futures markets; • applying the requirements regarding clearing and trading on organised trading platforms to commodity derivatives; • establishing trade repositories to gather data on commodity derivatives; • enhancing the transparency of large positions in these products; • empowering authorities to impose position limits. Improve the functioning of the underlying physical markets by enhancing the transparency of physical markets (fundamentals and trading) and coordinating the action of the relevant national and international bodies. With regard to carbon trading, the Banking and Financial Regulation Act of 22 October 2010 drew on the recommendations of the Prada Report5 to strengthen the regulations that now apply to the spot market. The Act stipulates that the AMF and the energy regulator, the Commission de régulation de l’énergie (CRE), must collaborate to monitor carbon allowances, as well as the electricity and natural gas markets. The two authorities signed a memorandum of understanding to this effect at the end of 2010. Furthermore, the AMF has finalised the amendment of its General Regulation to allow the Bluenext trading platform to become a regulated market under its supervision. Regulate financial markets in agricultural commodities: i.e. cash-settled commodity futures or options traded through trading platforms or OTC. Regulate physical markets in agricultural commodities: i.e. trading of “spot contracts” in the physical commodity and OTC forward contracts that are settled solely by physical delivery. The AMF supports three main policies for improving the regulation of physical markets at the international level: • ensuring greater transparency on stocks and harvests; • developing coordinated stock management policies; • creating an “agricultural stability forum” and a supervisory body for physical markets in agricultural commodities.

5

Report dated 19 April 2010 on the regulation of CO2 markets by Michel Prada.

09

3

INVESTOR PROTECTION

AMBITIONS OF THE G20 The Seoul G20 of November 2010 summit tasked the FSB, in collaboration with the OECD and the relevant standard setters, with drafting a report on ways to improve investor protection, notably through transparency, education, protection against fraud, abuse and misleading information, and, ultimately through recourse and advocacy.

INITIATIVES WITHIN THE EUROPEAN UNION Work is under way at the European level to improve investor protection with regard to collective investment schemes (the Key Investor Document initiative), investment fund depositaries and packaged retail investment products (e.g. PRIPs initiative). Implementing the Key Investor Information Document (KID): on 1 July 2010, the European Commission finalised the European regulatory framework for UCITS with four instruments: two directives, which Member States will have to transpose into their national laws within 12 months, and two Regulations having direct application that enter into force on 1 July 2011. These four instruments deal with:

• k ey investor information, with the establishment of a new standard document, which is intended to help investors

make informed investment decisions regarding products covered by the UCITS Directive. The content and form of the KID must include clear and understandable language that refers to specific methods for calculating the risk-and-return indicator of the scheme and for calculating fees;

• o perating rules for UCITS management companies: organisational requirements and conduct of business rules for investment firms are aligned on standards that already apply to most financial services under MiFID;

•m  easures to protect investors in the event of mergers, including pan-European mergers, of UCITS and master and feeder funds;

• c ooperation between national regulators for the supervision of UCITS and management companies. Investment fund depositaries: depositaries play a key role protecting UCITS investors. The 1985 directive6 assigns two main tasks to the depositary:

• s afekeeping the UCITS’ assets; • e nsuring that the management company’s decisions comply with the law and the fund’s rules so that the only risk that investors incur is, in principle, market risk, which determines the performance of the fund.

Yet, interpretations of the directive’s provisions vary so much that this protection falls far short of the level of protection that retail investors in such funds deserve. This is a vital issue. At the AMF’s urging, the European Commission launched work on revising the UCITS Directive in order to harmonise and strengthen the principles underlying the rules applying to UCITS depositaries and to draft detailed implementing measures that leave no room for differing interpretations. The depositary issue is all the more important since, from 2013, the AIFM Directive will require hedge fund managers to name a depositary for each fund. The depositaries’ two main tasks will be the same (safekeeping assets and ensuring the lawfulness of the management company’s decisions).

6

10

Council Directive 85/611/EEC of 20 December 1985 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS).

PRIORITIES FOR FINANCIAL MARKETS ON THE 2011 G20 AGENDA INVESTOR PROTECTION

3

PRIPs Initiative: in 2009, the European Commission started work on establishing a framework that would enable retail investors to use a clear and concise information document to compare the characteristics of packaged retail investment products (PRIPs), regardless of their legal form (structured debt securities, funds, life insurance contracts, structured bank deposits), and on establishing conduct of business rules that apply to all distributors of PRIPs. The Commission’s work had three main objectives:

• d etermining the range of products concerned; • e nhancing transparency by borrowing ideas from the UCITS KID and extending this approach to other packaged retail investment products;

• imposing conduct of business rules that are similar or equivalent to those set out in MiFID for the distribution of PRIPs that are not covered by MiFID.

In December 2010, the Commission launched a consultation that should result in a series of legislative measures with these aims.

THE AMF’S PRIORITIES Restoring investor confidence in the wake of the crisis is a challenge for both market professionals and regulators. The AMF welcomes the formal inclusion of this objective in the G20 agenda. This involves: Supporting European initiatives to enhance the quality of investor disclosure: the AMF supports ongoing work at the European level to develop a simple, clear and concise investor information document for UCITS (KID initiative) and for packaged retail investment products (PRIPs initiative). For the sake of investors, the AMF proposes extending further the PRIPs initiative to cover products that are not packaged but can still be sold to retail investors, such as equities or bonds. In view of the impact of the Madoff affair on European asset management, the AMF convinced the European institutions of the need to strengthen and harmonise the rules for UCITS depositaries, which play a key role in protecting retail investors who buy such products. Making investor protection one of the regulator’s key tasks: the AMF has set up the Retail Investor Relations Division for this purpose and a joint unit with the Autorité de contrôle prudentiel for retail investors seeking information about all the products falling within the jurisdiction of the two authorities. Supervising professionals dealing with retail investors, particularly with regard to marketing of complex financial instruments: in its position dated 15 October 2010, the AMF urged investment services providers, investment management advisers and banking and financial direct marketers to refrain from selling customers certain highly complex structured funds or debt securities. The AMF considers that some UCITS may actually be complex products and that MiFID needs to be amended to remove the language stating that UCITS are noncomplex by definition. The AMF also believes that MiFID needs to be amended so that the requirement to act “honestly, fairly and professionally”, which applies to investment services providers dealing with the first two categories of investors defined in MiFID (retail investors and professional investors), also applies to their dealings with eligible counterparties, the third category of MiFID-defined investors.

11

4

REGULATING SHADOW BANKING

AMBITIONS OF THE G20 Acting on a French initiative, the Seoul G20 summit asked the FSB to work with other international standards bodies7 to present recommendations in mid-2011 on strengthening regulation and supervision of the shadow banking system. This term refers to the non-bank vehicles managing liquidity, maturity and/or risk transformation.

THE AMF’S PROPOSALS Higher capital requirements for banks are bound to increase reliance on market financing. This could lead to regulatory arbitrage and encourage new forms of shadow banking on the fringes of markets, without adequate transparency or proper supervision. For these reasons, it is vital for the AMF to have a better understanding of the risks related to shadow banking. The AMF proposes three courses of action: Continuing work on regulating the management of systemic risks related to alternative investment funds, including certain hedge funds8 and private equity funds, such as those that lend money to businesses. Considering the systemic aspects of money market funds: the crisis revealed that money market funds could pose systemic risks. In particular, run-to-the-fund situations, where a fund faces an increasing amount of redemptions, can destabilise the financial and banking sectors. These phenomena are exacerbated in the case of money market funds with constant net asset values, especially funds that are not backed by explicit commitments from a banking sponsor. The AMF considers that an international discussion should be engaged on managing these risks, including through stronger asset liquidity rules for money market funds. Regulating the securitisation market: a large number of non-bank institutions are financed through securitisation. However, the crisis has largely compromised this financing procedure, which is critical for companies’ growth. The AMF proposes establishing an international harmonised regulatory framework for securitisation products in order to restore investor confidence in these products.

7 8

12

Primarily the International Organisation of Securities Commissions (IOSCO) and the Basel Committee. See page 13.

 ngoing G20 work with regard to financial O markets and the AMF’s initiatives on these issues 1

SUPERVISION OF HEDGE FUNDS

AMBITIONS OF THE G20 At the Washington summit in September 2008, the G20 countries adopted a resolution stating the need to ensure that: “all systemically important institutions, markets and instruments are subject to an appropriate degree of oversight and regulation.” At their meeting in London in April 2009, the G20 leaders explained in detail how this principle should be applied to hedge funds, with three main thrusts:

• h edge funds or their managers will be registered and will be required to disclose appropriate information on an • •

ongoing basis to supervisors or regulators, including information on their leverage, which is needed to assess the systemic risks that they pose individually or collectively; the funds or their managers will be subject to oversight to ensure they have adequate risk management arrangements, and s upervisors should require institutions that have hedge funds as their counterparties to adopt effective risk management arrangements. These arrangements should be aimed at monitoring the leverage of hedge funds and setting exposure limits for risks incurred by a unique counterparty.

THE AIFM DIRECTIVE The European Parliament adopted the directive on Alternative Investment Fund Managers (AIFM) on 11 November 2010. At the same time, the European Council announced that it would adopt the directive as it stood. The directive regulates hedge fund managers; not the funds themselves. It actually applies to all fund managers (except those managing UCITS, which are covered by the UCITS Directive9). This includes hedge fund managers established in the European Union, regardless of where the vehicles under their management are located, and non-European managers of European hedge funds and/or sellers of European and non-European hedge funds within the European Union. The directive provides for exemptions for certain hedge funds, such as holding companies, companies that manage only the assets of their parent group, managers of small funds or funds that present minor systemic risks. In France, with a few exceptions, the AIFM Directive will apply to French management companies handling different types of alternative investment vehicles, such as funds with streamlined investment rules (including funds of funds), real estate investment funds (SCPI, OPCI) and venture capital funds (venture capital companies, venture funds). The directive has three objectives:

• increase supervision of alternative investment fund managers, especially hedge fund managers; • p rovide ESMA with tools to identify and manage systemic risks that could be caused or exacerbated by alternative investment funds, including hedge funds;

• a dopt a robust common approach to investor protection.

9

Directive 2009/65/EC.

13

ONGOING G20 WORK WITH REGARD TO FINANCIAL MARKETS AND THE AMF’S INITIATIVES ON THESE ISSUES 1

SUPERVISION OF HEDGE FUNDS

Increasing supervision of alternative investment fund managers, especially hedge fund managers: alternative investment fund managers, including hedge fund managers, will henceforth have to be authorised by the competent national authorities. Authorisations granted in one Member State will enable the manager to do business in all European Union countries and to market all the alternative investment funds they manage to professional investors under the European passport system. Alternative investment fund managers that are not covered by the AIFM Directive because they are exempt by virtue of their small size will still have to be registered and identified by the competent authorities of their home country. Starting in 2013, the AIFM Directive passport will initially be restricted to managers established in Europe managing alternative investment funds domiciled in Europe. After that, starting in 2015, two years after the directive comes into force, the passport system could be extended to the marketing of funds from third countries by European managers, as well as the marketing and management of European and non-European funds by managers from third countries. The authorisation procedure will enable competent authorities to ensure that managers provide adequate organisational and prudential safeguards. To obtain authorisation from the national authority, fund managers must provide information about their ownership structure, their organisation – and notably arrangements for valuation and custody of the alternative investment fund assets under management –, the identity of the members and good repute of the management team and the main characteristics of the funds under management. The AIFM Directive does not limit the use of leverage by alternative investment funds, but it does require managers to be more transparent. It requires them to set limits on the use of leverage for each fund under management and to report them to the supervisor, along with ESMA and the European Systemic Risk Board (ESRB), which will have the power to intervene in cases involving systemic risk. Providing ESMA with tools to identify and manage systemic risks that could be caused or exacerbated by alternative investment funds, including hedge funds: ESMA has a specific duty to detect and address the systemic risks relating to alternative investment funds, including hedge funds. In this respect, in cases of funds being managed without any authorisation, excessive concentration of risk factors or the existence of a threat to a systemically important institution, ESMA will be entitled to ask, but not compel, the competent authority of a Member State to take the necessary measures to ban an alternative investment fund or restrict its access to the European market. Similarly, when warranted to protect market integrity, national authorities may limit the use of leverage by an alternative investment fund if it poses a threat to financial stability, in which case, ESMA will be responsible for coordinating the national authorities’ actions. Adopting a robust common approach to investor protection: the AIFM Directive sets out transparency and disclosure requirements to improve investor protection. Alternative investment fund managers are required to make certain disclosures to investors in the alternative investment funds under their management. This information deals in particular with investment objectives and strategies, the investment techniques used and the related risks, the use of leverage and guarantees, investment restrictions, procedures for changing investment strategies and policies, and the procedure for valuing assets.

THE AMF’S PRIORITIES The AMF welcomes the new rules adopted by both the European Union and the United States to strengthen the surveillance of systemic risks relating to alternative investment funds, including hedge funds. Continue work on regulating the management of systemic risk stemming from hedge funds’ activities: more specifically, an international response is needed to deal with the problem of the potential transfer of banking risks to alternative investment funds. The AMF also believes that the FSB’s recommendations regarding the intensity and effectiveness of supervision of systemically important financial institutions should be extended to the supervision of potentially systemically important non-bank entities, such as alternative investment funds, including certain hedge funds, or to certain ETFs. Therefore, the AMF calls for international harmonisation of the rules applying to systemically important non-bank entities.

14

2

REGULATION OF OTC DERIVATIVES MARKETS

In addition to revealing the number and diversity of over-the-counter (OTC) markets, the crisis revealed that a very significant volume of trading is not supervised by regulators and that these transactions take place with inadequate transparency outside of the regulated and supervised markets with central counterparties, which may guarantee settlement of trades. There is now broad agreement that OTC derivatives markets need to be regulated.

AMBITIONS OF THE G20 At the Pittsburgh Summit in September 2009, the G20 Leaders stated that “all standardised OTC derivatives contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest. OTC derivative contracts should be reported to trade repositories. Non-centrally cleared contracts should be subject to higher capital requirements”. The report of the FSB “Implementing OTC Derivative Markets Reforms”, published in October 2010, translated these principles into 21 recommendations to the authorities on the implementation of the G20 statements. The most important recommendations are:

• increase standardisation of derivatives; • u se three specific criteria to determine whether a contract requires central clearing; • p romote trading on organised platforms • e stablish a mandatory reporting to trade repositories and ensure that the authorities have access to this data. At the Seoul Summit in November 2010, the G20 charged IOSCO with preparing three reports on OTC derivatives: the first, published in february 2011, deals with trading, the second, due in July 2011, deals with trade data reporting, and the third, due in January 2012, will set international standards for trading, reporting, clearing and supervision.

THE PROPOSED, EUROPEAN MARKET INFRASTRUCTURE REGULATION (EMIR) After the Pittsburgh G20 summit in September 2009, the European Union started work on regulation of OTC derivatives. On 15 September 2010, the European Commission published a proposal for a Regulation on OTC derivatives called the “European Market Infrastructure Regulation” (EMIR). The proposed Regulation covers every stage in the life of OTC derivatives, except trading. It deals with the eligibility criteria for central clearing, reporting to trade repositories and central counterparties. The rules relating to trading in OTC derivatives, which deal primarily with the requirement that all sufficiently liquid derivatives eligible for central clearing must be traded on regulated markets, multilateral trading facilities or organised trading platforms, are contained in MiFID.

15

ONGOING G20 WORK WITH REGARD TO FINANCIAL MARKETS AND THE AMF’S INITIATIVES ON THESE ISSUES 2

REGULATION OF OTC DERIVATIVES MARKETS

The European Commission’s proposal has four objectives that stem directly from the G20 objectives:

• e nsure that all derivatives eligible for central clearing are cleared through authorised or recognised central • • •

counterparties, with tighter governance and internal organisation requirements; c reate transparency by making it mandatory to report trading data to trade repositories and ensuring access to the data held by the trade repositories; e  nsure the security and soundness of central counterparties by establishing a harmonised legal framework for Europe; e  liminate obstacles to relations between market infrastructures, while establishing measures to manage the related risks.

The principle behind the central clearing requirement is that every eligible OTC derivative contract between financial counterparties must be cleared through one of the central counterparties authorised to clear it. This requirement will include non-financial counterparties under terms that have yet to be defined. The central clearing requirement also covers contracts where one of the counterparties is not domiciled in the European Union. From a procedural point of view, the proposal calls for competent authorities to notify ESMA as soon as they approve an application from a central counterparty to clear a specific type of derivatives and to ask ESMA to decide whether the central clearing requirement applies to that type of derivatives. ESMA, after consulting with the new European Systemic Risk Board, will also have the right to act on its own to identify contracts that require central clearing in its view. The regulation-makers are aware of the risks that will automatically be concentrated in central counterparties when they are placed at the heart of these arrangements and become indispensable for trading. Therefore the capital requirements for central counterparties will be increased. The EMIR proposal calls for central counterparties to have minimum capital of EUR 5 million. The requirements for internal organisation and risk management will also be tightened, along with conduct of business rules, by clearly establishing the principle of segregating the central counterparty’s assets from its clearing members’ assets, and recognising this segregation in the central counterparty’s accounts. The reporting requirement in the proposed Regulation means that financial entities must report all OTC contracts to a trade repository. The data reported must cover the initial contract, as well as any subsequent amendments to the contract and its termination. In addition, the proposal establishes that principle that all trade repositories must be registered by ESMA and the principle that each trade repository must be a legal entity registered in a European Union country. The proposal also deals with the principle of supervision of the trade repositories.

THE AMF’S PRIORITIES Reduce the volume of OTC trading in derivatives by promoting its transfer to regulated markets or organised markets. Support mandatory central clearing for standardised derivatives. Accordingly, the criteria used to determine whether central clearing is required are important. This calls for a small number of clear-cut criteria. The AMF wants central counterparties to be granted access to central bank facilities under terms to be set by the central bank. Reduce the share of OTC trading, while making sure that all adequately liquid standardised derivatives are traded on organised trading platforms. Support the principle of systematic reporting to a trade repository. The AMF welcomes the clear statement in the proposed EMIR of the principle under which financial counterparties must report all their contracts to a trade repository. The duties of the trade repositories still need to be specified however, in order to establish the reporting requirement per se and to develop technical standards for data reporting and criteria for the registration of trade repositories.

16

3

STRENGTHENING REGULATION OF CREDIT RATING AGENCIES AND REDUCING DEPENDENCY ON RATINGS

AMBITIONS OF THE G20 The London G20 summit in April 2009 called for registration and increased regulation of credit rating agencies (CRAs) to prevent conflicts of interest in particular. The statement made in Seoul in November 2010 reiterates this commitment and supports the recommendations made in the FSB report of October 2010, which is aimed at reducing reliance on CRAs. This objective of reducing reliance on CRA ratings concerns all market participants, both public and private: banks, asset managers and institutional investors, as well as central banks, regulators and supervisors. Each participant is urged to develop its own internal credit risk assessment capacities, both in terms of skills and processes. Private-sector participants should also disclose their credit risk management policies and their risk assessment methods, including the importance of agencies’ ratings under these policies. Public-sector participants are urged to review all of the regulatory references to CRA ratings, to eliminate them whenever possible and to replace them with references to other suitable credit risk assessment methods, if any. At the same time, the competent international bodies and national authorities should develop alternative credit risk assessment methods.

THE EUROPEAN UNION COMPLETELY RECAST ITS REGULATORY FRAMEWORK FOR CREDIT RATING AGENCIES The European Regulation10 on CRAs established a common regulatory framework for the issuance and use (notably for prudential purposes) of ratings in the European Union, as well as for the registration, organisation and supervision of agencies in order to promote their independence and prevent conflicts of interest. According to the Regulation, all CRAs that want their ratings to be used in the European Union must apply for registration. The applications must be submitted to ESMA and contain information about the agency’s head office, legal form, and rating methods, along with information about policies and procedures for managing the agency’s conflicts of interest. ESMA then forwards the application to the competent authority of the agency’s home country, which proceeds with the registration. Once CRAs have been registered, they must comply with strict rules to ensure that:

• their ratings are not affected by conflicts of interest; • they remain vigilant about the quality of their credit risk assessment method and the ratings per se; • they are acting in a transparent manner. ESMA has the power to require credit agencies to provide information, to investigate them and to carry out on-site inspections.

10

Regulation 1060/2009 of the European Parliament and of the Council of 16 September 2009 on credit rating agencies, as amended on 6 June 2010.

17

ONGOING G20 WORK WITH REGARD TO FINANCIAL MARKETS AND THE AMF’S INITIATIVES ON THESE ISSUES 3

STRENGTHENING REGULATION OF CREDIT RATING AGENCIES AND REDUCING DEPENDENCY ON RATINGS

These changes mean that CRAs will do business under a much simpler supervisory framework than the various national frameworks that currently apply and that they will have easier access to the information they need. Ratings users will also be better protected by centralised supervision of all CRAs within the European Union and by enhanced competition between the agencies. In November 2010, the European Commission launched a consultation for possible amendments to the Regulation on credit rating agencies relating to the following five issues:

•m  arket participants’ reliance on CRA ratings; • s overeign ratings; • the oligopoly of the credit rating agencies; • the legal liability of credit rating agencies; •m  odels for CRA compensation. THE AMF’S PRIORITIES International and European initiatives have already contributed to strengthening the regulation of credit rating agencies. The AMF considers that more still needs to be done. Making agencies more liable: the AMF considers that investors should be able to hold credit rating agencies liable for losses. In France, under the Banking and Financial Regulation Act of 22 October 2010, credit rating agencies can be held criminally and civilly liable towards their customers and third parties for losses caused by their negligence in implementing the requirements set out in the European Regulation on credit rating agencies. The law also stipulates that any agreement for the purpose of contractually assigning disputes concerning the provisions of the Regulation to the exclusive jurisdiction of the courts of a country outside of the European Union, even though EU courts would have had jurisdiction, shall be deemed null and void. It is important for the AMF that this rule be harmonised at the European level so that credit rating agencies are not tempted by forum shopping, i.e. seeking out the least strict national regulations. Encouraging and helping investors to conduct their own scrutiny: the AMF considers that wide and often automatic use of external ratings fuels pro-cyclical effects and calls for an intelligent reduction of overreliance on external ratings. The objective is to ensure that investors obtain and issuers provide full information in a timely manner. This information needs to be appropriate for the size of the investment and the sophistication of the products so that investors can make informed investment choices and conduct their own credit risk assessments. Making sovereign debt ratings more transparent: under the EU regulatory framework for credit ratings, which lays down the rules for disclosure and transparency, the AMF considers that additional measures should be taken to increase the transparency of sovereign debt ratings and ensure regular supervision of rating methods and processes. In this respect, the regularity and frequency of rating reviews are both vitally important. The AMF is in favour of a predefined schedule for reviewing credit ratings.

18

This brochure is intended for instructional purposes. It provides an overview of the issues and does not constitute a legal interpretation of them. The AMF may not be held liable in cases where issues have been summarised or condensed.

Contacts Communication Division

17, place de la Bourse – 75082 Paris Cedex 02 – France Tel.: +33 (01) 53 45 60 00 – Fax: +33 (01) 53 45 61 00 Site internet www.amf-france.org

Design and conception: avantgarde

Tel.: +33 (01) 53 45 60 25