Welcome to the first in our monthly summary of regulatory news from around the world: reviewing the most relevant activity from key regulators, authorities, standard-setters and supervisors around the world.
CONTENTS:
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FCA head Nikhil Rathi calls for international approach to benefits and issues around AI
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FCA launches digital sandbox
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BoE recommends extending exemption for options from UK bilateral margining requirements
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ESMA finds use of STORs ‘consistent’ across 2021/2022
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ESMA analysis reveals lack of convergence regarding anti-procyclicality tools across EU CCPs
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ESMA notes NCAs have improved compliance function set out under MiFID I since 2017
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SEC proposes new rules around data analytics and AI to prevent firms’ conflicts of interest
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CFTC outlines number of final and proposed rules regarding derivatives, swaps, certifications and margin requirements
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SEC proposes amendment to broker-dealer reserve deposit requirement rule
UK
FCA head Nikhil Rathi calls for international approach to benefits and issues around AI
Financial Conduct Authority (FCA) CEO Nikhil Rathi has said in a speech that the use of AI can benefit markets but could also affect the integrity, price discovery and transparency and fairness of markets if left unfettered.
Rathi, calling for an international approach, said misinformation fuelled by social media can impact price formation across global markets, citing an incident in May this year in which a suspected AI-generated image purporting to show the Pentagon in the aftermath of an explosion spread across social media just as US markets opened. “It jolted global financial markets until US officials quickly clarified it was a hoax,” Rathi said.
The regulator has also observed how intraday volatility has doubled and amplified compared to during the 2008 financial crisis. “This surge in intraday short-term trading across markets and asset classes suggests investors are increasingly turning to highly automated strategies.”
Another area the regulator is examining is the ‘black box’ nature of AI models. Many in the financial services industry feel they want to be able to explain their AI models – or prove that the machines behaved in the way they were instructed to – in order to protect their customers and their reputations..
Large asset managers in the US are also edging towards unleashing AI based investment advisors for the mass market, Rathi said, with some arguing that autonomous investment funds can outperform human led funds.
This is occurring against a backdrop of “considerable” competitive and cost pressures, Rathi added, with a PwC survey citing one in six asset and wealth managers expecting to disappear or be swallowed by a rival by 2027.
While the FCA plays “an influential role” across the world, “one thing we know about AI is that it transcends borders and needs a globally coordinated approach”.
Rathi also outlined a number of regulations already in place that can address many of the issues associated with AI, such as The Consumer Duty and the Senior Managers & Certification Regime.
FCA launches digital sandbox
The FCA has opened up its digital sandbox to a wider range of businesses, start-ups and data providers.
The digital sandbox is a testing environment that enables the FCA to support firms at the early stage of product development by enabling experimentation through proof of concepts. Data providers can also apply to list their data on the platform and gain traffic and insights on its usage.
The FCA said the sandbox will also support economic growth and international competitiveness.
Through the digital sandbox, participants will have access to high-quality datasets and Application Programming Interfaces (APIs); robust data security protection; a collaborative platform: and an observation deck that enables interested parties such as regulators, incumbents and others to observe in-flight testing at a technical level.
Firms in banking, investment, lending, pension, wholesale buy-side, wholesale sell-side, among others, are welcome to apply.
BoE recommends extending exemption for options from UK bilateral margining requirements
The Bank of England released a consultation paper setting out the Prudential Regulation Authority’s (PRA) and Financial Conduct Authority’s (FCA) proposal to extend the temporary exemptions for single-stock equity options and index options from the UK bilateral margining requirements between 4 January 2024 and 4 January 2026.
The PRA and the FCA will then consider whether an exemption remains appropriate for these products as part of a permanent framework.
The consultation is aimed at banks, building societies, and PRA-designated investment firms in scope of the margin requirements under UK EMIR as well as all FCA solo-regulated entities and non-financial counterparties in scope of the margin requirements under UK EMIR.
The proposal would result in changes to the UK version of the Commission Delegated Regulation (EU) 2016/2251 of 4 October 2016 and the regulatory technical standards for risk-mitigation techniques for over-the-counter (OTC) derivative contracts not cleared by a central counterparty (Binding Technical Standards (BTS) 2016/2251).
Initiated by the G20, as part of a raft of post-financial crisis reforms aimed at mitigating systemic risk and incentivising central clearing, the standard requires counterparties to exchange initial margin and variation margin on uncleared derivatives.
The proposals aim to maintain the status quo, allowing the PRA and the FCA to gather the evidence necessary on current market practices and risks to create a permanent regime, as well as set out the PRA’s and the FCA’s approach to model pre-approval in relation to bilateral initial margin models.
The PRA and the FCA believe the proposed extension “strikes a proportionate balance in meeting the objectives of prudential safety and soundness, maintaining consistency of approaches and a level playing field across jurisdictions”.
The PRA and the FCA believe the proposal to temporarily extend the exemption is compatible with supporting the medium to long-term growth and international competitiveness of the UK economy as it “maintains a level playing field with other major jurisdictions”, as well as supporting market stability while the PRA and the FCA collect more information.
EUROPE
ESMA finds use of STORs ‘consistent’ across 2021/2022
An overview of Suspicious Transactions and Order Reports (STOR) by the European Securities and Markets Authority (ESMA) over 2021 and 2022 has found their use to be “rather consistent”.
The report considers the use of STORs, “a key information tool in market abuse investigations” and which are made by national competent authorities (NCAs) to report orders and transactions that could constitute insider dealing and market manipulation, across different jurisdictions, and how this has evolved over the period 2021/2022 and before Brexit.
For the report, ESMA received responses from 30 NCAs, covering the entirety of the European Economic Area (EEA). It found that in 2021, 6,125 STORs were received. In 2022, the figure was 5,833.
The country that received most of these notifications in 2021 was Germany (3,228), accounting for more than 43% of the total. A similar trend was also observed in 2022 where Germany received 2,756 notifications (40% of the total). Both in 2021 and 2022, France received most of the notifications after Germany (929 and 878, accounting for 12% and 13% of the total, respectively), followed by the Netherlands and Sweden in 2021 (5%) and Hungary in 2022 (6%).
When comparing the number of STORs received in 2021 and 2022 with those received in previous years (particularly before 2019), a substantial number of those were received by the UK, and therefore, the total number of STORs has significantly decreased after 2018.
“In 2017 and 2018, the UK accounted respectively for 50% and 43% of the total number of the STORs received and thus this sharp decrease appears mainly due to the impact of Brexit,” the report said.
The past two years have been consistent in terms of volume, with the majority of notifications in both years (73/74%) received by investment firms. The majority concern equities (87% in both years) followed by bonds (7%). Most notifications (52%) covered cases of alleged market manipulation, while insider trading cases have been declining in recent years.
ESMA analysis reveals lack of convergence regarding anti-procyclicality tools across EU CCPs
ESMA has published an analysis of EU central clearing parties’ regulatory and supervisory framework, particularly over the Covid-19 pandemic.
The regulator said that while CCPs have performed well overall throughout the crisis, its analysis revealed a lack of convergence regarding the implementation of anti-procyclicality (APC) tools across EU CCPs.
However, ESMA believes this can be partly addressed by enhancing the Regulatory Technical Standards on requirements for CCPs in the EMIR Delegated Regulation which defines the APC tools and their use.
ESMA has also conducted further research to ensure that the potential changes to the APC provisions proposed in January 2022 remain valid following the market developments in 2022 due to Russia’s invasion of Ukraine, notably in the commodities space, and has made some additional proposals, in order to further enhance the resilience of EU CCPs.
ESMA notes NCAs have improved compliance function set out under MiFID I since 2017
ESMA published its follow-up report to the peer review on certain aspects of the compliance function under MiFID I, revealing that the National Competent Authorities (NCAs) assessed improved their practices following the 2017 peer reviews findings and recommendations.
The regulator said the NCAs included in the report – CySEC (CY), HCMC (EL), CBI (IS), AFM (NL) and ATVP (SI) – made progress by strengthening their supervisory frameworks, undertaking investigations and thematic reviews and making use of their enforcement tools to deter poor behaviour by firms.
In 2012, ESMA issued Guidelines to promote the effective and consistent performance of the compliance function and enhance the related NCAs’ supervisory approach. These guidelines were the basis of the peer review that ESMA conducted in 2017 covering all NCAs in their supervision of investment firms.
This latest review identifies that all NCAs have made progress since the peer review in addressing points of partial or insufficient compliance. NCAs have strengthened supervisory practices and frameworks, undertaken investigations and thematic reviews, introduced sample checks, and taken enforcement actions.
US
SEC proposes new rules around data analytics and AI to prevent firms’ conflicts of interest
The US Securities and Exchange Commission (SEC) has proposed new rules that would require broker-dealers and investment advisors to address conflicts of interest around their use of predictive data analytics.
The regulator is concerned that technologies that allow for the optimisation, prediction, guidance, forecasting and provision of greater market access, efficiency and returns, could also be used to place firms’ interests before investors.
SEC chair Gary Gensler said: “We live in an historic, transformational age with regard to predictive data analytics, and the use of artificial intelligence. Today’s predictive data analytics models provide an increasing ability to make predictions about each of us as individuals. This raises possibilities that conflicts may arise to the extent that advisers or brokers are optimising to place their interests ahead of their investors’ interests.”
The proposed rules would require a firm to evaluate and determine whether its use of these new technologies in investor interactions results in the firm’s interests being placed ahead of investors’ interests.
Firms would be required to remove, “or neutralise”, the effect of any such conflicts. The proposed rules would also require a firm to have written policies and procedures to achieve compliance with the proposed rules and to make and keep books and records related to these requirements.
CFTC outlines number of final and proposed rules regarding derivatives, swaps, certifications and margin requirements
The Commodity Futures Trading Commission (CFTC) has approved a final rule and outlined three proposed rules, around reporting requirements for derivatives clearing organisations; swap confirmation requirements for swap execution facilities; amendments to how registered entities submit self-certifications; and margin requirements for uncleared swaps for swap dealers and major swap participants, respectively.
The final rule proposed amends certain reporting and information regulations applicable to derivatives clearing organisations (DCOs), updating information requirements associated with commingling customer funds and positions in futures and swaps in the same account, revising certain daily and event-specific reporting requirements, and codifying the fields a DCO is required to provide on a daily basis.
The proposed swap confirmation rule would amend the regulator’s swap execution facility (SEF) regulations related to uncleared swap confirmations, as well as associated conforming and technical changes.
The proposed rule on amending regulations around registration covers how firms submit self-certifications, and requests for approval, of their rules, rule amendments, and new products for trading and clearing, as well as the CFTC’s review and processing of such submissions.
The proposed rule concerning margin requirements for uncleared swaps would effectively relieve swap dealers (SDs) and major swap participants (MSPs) from the requirement to post and collect initial margin with certain eligible seeded funds for their uncleared swaps for a period of up to three years from the date on which the eligible seeded fund’s asset manager first begins making investments on behalf of the fund (trading inception date).
The CFTC is also proposing to eliminate a provision disqualifying securities issued by certain pooled investment funds (money market and similar funds) that transfer their assets through securities lending, securities borrowing, repurchase agreements, reverse repurchase agreements, and similar arrangements from being used as eligible initial margin collateral, thereby expanding the scope of assets that qualify as eligible collateral.
SEC proposes amendment to broker-dealer reserve deposit requirement rule
The US Securities and Exchange Commission (SEC) proposed an amendment to the broker-dealer customer protection rule that would require certain broker-dealers to compute their customer and broker-dealer reserve deposit requirements on a daily basis, rather than weekly.
The regulator said the current weekly calculation raises the possibility of situations where market movements resulting in the net amount of cash owed by large carrying broker-dealers to customers — including cash owed to other broker-dealers in so-called “PAB” accounts — to be substantially greater in amount than what is held in the pertinent reserve bank accounts.
Additionally, the ability of broker-dealers to track these calculations on a daily basis appears to be less costly than in the past and that keeping reserve bank accounts up-to-date on a daily basis can provide better customer protection and ameliorate systemic risk.
©Markets Media Europe 2023
