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Continuing our series of educational, somewhat introductory blog posts, below you will find a handy guide covering the main European, American, and global financial regulations all compliance officers should know inside and out.

Not all rules made the list but this should be a good start if you’re looking to jump into the world of compliance in the financial services sector.

Markets in Financial Instruments Directive (MIFID I & II) and MIFIR (EU)

MiFID was introduced by the European Securities and Markets Authorities (ESMA) in 2007 (with an updated version in 2018 –  Directive 2014/65/EC (MiFID II)) and is applicable to investment firms (IFs) operating within the EU member states and wider within the European Economic Area (EEA).

The main purpose of MiFID is to: 1) harmonise regulation across EU financial markets, making them more efficient, resilient, and transparent; 2) increase competition; 3) ensure appropriate levels of investor protection, and 4) strengthen supervisory powers.

MiFID II’s main aim is to protect clients, introducing, among others, clients’ classification (retail, professional and eligible counterparty), an obligation to execute orders on terms most favourable to clients/best execution, product governance, reporting/disclosure requirements, rules on suitability, appropriateness and reporting to clients, rules on remuneration/inducements, passporting rights, organisational requirements, and management of conflict of interest. In general, MiFID II has established obligations for investment firms to act in the clients’ best interest, placing clients’ interests above that of the company’s interest.

Regulation (EU) No 600/2014 (MiFIR) is applicable to Over the Counter (OTC) transactions executed on the EEA Regulated Exchanges, Multilateral Trading Facilities (MTFs) and Organised Trading Facilities (OTFs). Transactions are reported no later than the close of the next working day of the execution of the relevant transaction.

Reporting under MiFIR requires the counterparties to provide detailed information about the transactions, including a unique number that identifies each legal entity, also known as the Legal Entity Identifier (LEI) or National Identifier for natural person.

Best Execution

Under these rules, investment firms and trading venues are required to comply with the following requirements regarding best execution.

Investment firms

IFs are required to publish information about the top five execution venues, used for the execution of clients’ orders, for each class of financial instruments. Routing orders to a particular execution venue due to the fact that the IF may receive a remuneration, discount, or monetary benefit is prohibited. The information is published annually, through the website.

Execution venues

Execution venues, like the IFs, are required to inform clients about the factors related to execution of their orders, that being the price, costs, speed, and likelihood of execution. The information is published annually.

Product Governance

MiFID II imposes stricter obligations for both product manufacturers and distributors of financial products.

Product manufacturers

Manufacturers are required to set a product approval process for each product offered. Therefore, the manufacturers need to identify the “target market” of “end clients”, assess the risks related to the distribution of products to the targeted market as to avoid distribution of products to the clients for whom the product is not compatible.

Product distributors

Distributors, similar to the manufacturers, are required to ensure that the products and the distribution strategy are consistent with the needs of the identified target market, and perform ongoing review of the distribution methods, in order to avoid provision of products to the end clients for whom the product is not compatible. Moreover, the distributors shall perform regular review of distribution strategy as to ensure the provision only to the identified target market.

Information to Clients

Clients shall be provided with the “appropriate information” and “in good time”.

Information on the service provided

IFs are required to provide, in good time, the detailed information to clients about the services provided, including the investment advice. The information should be clear and not misleading and, in cases of investment advice, the explanation should include whether the advice is provided on an independent basis or not and whether it is based on a broad or more restricted analysis of the financial instruments.

Information on the financial instruments

IFs are required to provide to retail clients, in good time, the clear warnings and guidance of the risks associated with the financial instruments and of whether the financial instrument is intended for retail or professional clients.

Information on costs and charges

IFs are required to provide to retail clients, in good time, disclosure about cost and charges related to the provision of investment and ancillary services, including the cost of investment advice, the cost of the financial instruments, and methods via which such costs and charges are applied. The clear explanation should be provided to clients in order to be able to understand the overall costs and their effect on return of the investments.

Passporting

The MiFID II passporting regime applies to a range of activities, services, and financial instruments whereby the IFs are authorised to provide services, throughout the EEA, without the need for local presence through a branch or tied agents. Via the passporting regime, IFs have the ability to:

  1. Extend the range of the investment services provided whereby the IFs can obtain an authorisation in one EU Member state (home state) while providing investment services in another EU member state (host state), without obtaining local authorisations.
  2. Apply the home state (rather than host state) rules on cross-border services for IFs using passporting provisions.

Financial Instruments

The below-mentioned instruments are offered by IFs both through operations in a home country as well as through passporting rights:

  1. Receipt and transmission of orders in relation to one or more financial instruments.
  2. Execution of orders on behalf of clients.
  3. Dealing on own account.
  4. Portfolio management.
  5. Investment advice.
  6. Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis.
  7. Placing of financial instruments without a firm commitment basis.
  8. Operation of Multilateral Trading Facilities (MTFs).
  9. Operation of Organised Trading Facilities (OTFs).
EMIR

European Market Infrastructure Regulation (EMIR) (EU)

Regulation (EU) No 648/2012 (EMIR) was introduced in 2012 with the main aim to increase the transparency of derivative markets.

The intention of EMIR is to reduce the operational risks caused by derivative markets and their influence on financial crises. Prior to the introduction of EMIR, neither the participants nor the turnover of derivative contracts were clear.

EMIR obliges the relevant companies to report derivative transactions, both exchange tradable (ETD) and contracts not executed on regulated markets, specifically OTC, to Trade Repositories (TRs) and clear derivative contracts through Central Counterparties (CCPs).

For transparency purposes, the reporting obligation is applied to both sides of the transactions, i.e., the “buying” and “selling” party. If both parties to the transaction are subjected to reporting obligations, i.e., both parties are financial institutions, then each party needs to report the transaction separately. However, if one party is not subjected to the reporting requirements, the other party shall report both sides of the transaction. Natural persons are not required to report.

Reporting under EMIR requires the counterparties to 1) use LEI, and 2) use Unique Trade Identifier (“UTI”) for each reportable instrument, as per ESMA rules.

The main obligations under EMIR are:

  1. Reporting to TRs (registered by ESMA) directly, by delegating reporting to a counterparty or by delegating reporting to a third-party.
  2. Clearing through CCP (authorised or recognised by ESMA) as a direct clearing member, a client of a clearing member, or indirectly through a clearing member.
  3. Risk mitigation (operational and counterparty risks) through:
  • Timely confirmation (the day following the transaction).
  • Formalised process (manage risks, identify and resolve disputes on time, and monitor values of outstanding contracts).
  • Portfolio reconciliation.
  • Portfolio compression for parties that are netting trades.
  • Dispute resolution (procedures to identify, record, and monitor disputes).
  • Monitoring the value (daily monitoring of mark-to-market values).

 Sarbanes-Oxley Act (SOX) (U.S.)

SOX was introduced in 2002 following the collapse of major U.S. corporations (such as Enron and WorldCom) in order to improve the financial reporting process and restore investors’ confidence in the U.S. financial markets. The Act is applicable to U.S. public companies, their global subsidiaries, joint ventures, and foreign companies whose shares are listed on U.S. stock exchanges.

The objective of the Act is “to protect investors by improving the accuracy and reliability of corporate disclosures”.

SOX defines the responsibility of the subjected companies’ management for the establishment and maintenance of the internal controls rules in regard to the annual financial reporting requirements, whereby the internal control report shall include the assessment of the internal controls’ structure, procedures and effectiveness, attested by management and further by the independent audit function.

SOX’s major elements include:

Element

Requirements

Public Company Accounting Oversight Board (PCAOB)

PCAOB provides independent oversight of public accounting firms providing audit services (auditors).

Auditor Independence

In order to avoid conflict of interest, external auditors must be independent and be restricted from providing audit and non-audit services (e.g., consulting) to the same company.

Corporate Responsibility

Defines the individual responsibility of senior executives for the accuracy and completeness of corporate financial reports and interaction of the external auditors with the relevant company’s audit committee. The Chief Executive Officer (CEO) and Chief Finance Officer (CFO) of the reporting companies are responsible for ensuring that internal controls are in place and approve financial disclosures on a quarterly basis.

Financial Disclosures

Internal controls of financial reports and controls require enhanced disclosure of financial transaction, including off-balance-sheet transactions, pro-forma figures, and stock transactions, as well as material changes in financial condition.

Conflicts of Interest

Includes measures designed to help restore investor confidence and requires disclosure of knowable conflicts of interest.

SEC Resources and Authority

Defines the SEC’s authority to censure professionals from practicing as a broker, advisor, or dealer.

Studies and Reports

Relates to studies and reporting regarding the consolidation of public accounting firms, the role of credit rating agencies, securities violations, and enforcement actions.

Corporate and Criminal Fraud Accountability

Describes specific criminal penalties for manipulation, destruction or alteration of financial records, interference with investigations, and provides certain protections for whistle-blowers.

White Collar Crime Penalty Enhancement

Increases the criminal penalties associated with white-collar crimes and conspiracies and defines failure to certify corporate financial reports being a criminal offense.

Corporate Tax Returns

CEO is required to sign the relevant company’s tax return.

Corporate Fraud Accountability

Defines the corporate fraud and records tampering being criminal offenses and subjected to specific penalties. It also revises sentencing guidelines and strengthens their penalties

Breaches of the rules for certification of Periodic Financial Reports, accompanied by a written statement by the CEO and CFO are subject to fines:

Certifying statement

Not more than $1,000,000, imprisonment for up to 10 years, or both.

Wilfully certifying statement knowing that the report does not meet all the requirements

Not more than $5,000,000, imprisonment for up to 20 years, or both.

Dodd Frank

Dodd-Frank Wall Street Reform & Consumer Protection Act (Dodd-Frank) (U.S.)

Following the 2008 financial crisis, the U.S. government introduced the Dodd-Frank Act in 2010 as a comprehensive reform, with the key objective being the promotion of the financial stability of the U.S.

The concept of “too big to fail” came to an end via the Dodd Frank Act, whereby new rules were introduced with the aim of protecting the American taxpayer (ending bailouts), as well as consumers from abusive financial services practices by improving accountability and transparency in the financial system, specially related to derivatives and swaps, registration requirements for hedge fund and private equity fund advisers, and new rules for credit rating agencies, as well as enhanced oversight and regulation of banks and non-bank financial institutions.

Dodd Frank provided for the new requirements to enhance investors protection, related, among others, to transparency, rigorous standards and supervision, compliance, reporting, recordkeeping, increased capital and liquidity requirements, rules for executive compensation and corporate governance, prohibitions and restrictions, collateral, risk management, portfolio reconciliation, portfolio compression, clearing, settlements, margins, and conflict of interest.

Dodd Frank changed the regulatory structure through the introduction of new agencies (while merging and removing others) in an effort to restructure the regulatory process, increasing oversight of specific institutions that pose a systemic risk.

The new agencies are either granted explicit power over a particular aspect of financial regulation, or that power is transferred from existing agencies. The following agencies are empowered to implement regulatory actions:

  1. The Commodity Futures Trading Commission (CFTC)
  2. The Securities and Exchange Commission (SEC)
  3. The Financial Industry Regulatory Authority (FINRA)
  4. The Financial Crimes Enforcement Network (FinCEN)
  5. The National Futures Association (NFA)
  6. The Federal Deposit Insurance Corporation (FDIC)
  7. The Federal Housing Finance Agency (FHFA)
  8. The Federal Reserve System – Central bank of the United States
  9. The Federal Trade Commission (FTC)
  10. The Financial Stability Oversight Council (FSOC)
  11. The Department of Housing and Urban Development (HUD)
  12. The National Credit Union Administration (NCUA)
  13. The Office of the Comptroller of the Currency (OCC)
  14. The Office of Treasury (OT) including the Office of Financial Research (OFR) and the Office of National Insurance (ONI)
  15. The Consumer Financial Protection Bureau (CFPB)

The Foreign Account Tax Compliance Act (FATCA) (U.S.)

FATCA was enacted by the U.S. in 2010 in efforts to combat tax evasion by U.S. persons holding investments in offshore accounts.

In accordance with FATCA, U.S. taxpayers holding financial assets outside the US are required to report those assets to the Internal Revenue Service (IRS). Furthermore, Foreign Financial Institutions (FFIs) and certain other non-financial foreign entities are required to report on the foreign assets of U.S. taxpayers or by foreign entities in which U.S. taxpayers hold a substantial ownership interest, held in accounts within their institutions.

Altough firms outside the U.S. are not directly subject to U.S. legislation, due to the intergovernmental agreements made between the U.S. and local authorities, FFIs are required to register with local authorities for the reporting purposes. Those FFIs operating in countries that are not covered by intergovernmental agreements are required to register with the IRS directly.

FFIs are required to register with IRS and report the account holders for certain U.S. taxpayers on an annual basis, with exception of majority of governmental entities, non-profit organisations, certain small-local financial institutions, and retirement entities.

FFIs failing to register with IRS and report on accounts held by U.S. taxpayers are subjected to 30% withholding tax on certain U.S. source payments made to them.

FCPA

Foreign Corrupt Practices Act (FCPA) (U.S.)

The FCPA was enacted in 1977 and is applicable worldwide, in general to companies whose securities are traded in the U.S. and to foreign companies and persons who, either directly or through agents/intermediaries, facilitate or carry out corrupt payments in the U.S., as well as persons with a certain degree of connection to the U.S., including U.S. nationals, citizens, and residents acting in corrupt manner, whether or not physically present in the U.S.

The FCPA requires relevant companies to meet certain accounting provisions, including accurate and transparent financial records and internal accounting controls. Through the anti-bribery provision, it is unlawful to make payments to foreign government officials (foreign political candidates, foreign political parties), who would, in return, assist in obtaining and/or retaining business.

The FCPA prohibits an act of corrupt payment “in furtherance to any offer, payment, promise to pay, or authorization of the payment of money or anything of value to any person, while knowing that all or a portion of such money or thing of value will be offered, given or promised, directly or indirectly, to a foreign official to influence the foreign official in his or her official capacity, induce the foreign official to do or omit to do an act in violation of his or her lawful duty, or to secure any improper advantage in order to assist in obtaining or retaining business for or with, or directing business to, any person.”

The FCPA is applicable to payments, however, the restriction is not related to monetary payments only and may include anything of value, whether cash or non-cash items. The FCPA, however, introduced a provision which may permit reimbursement for the promotion of products.

The big challenge was for companies that operate internationally and engage third parties. The risk related to operations through intermediaries gave rise to the introduction of anti-bribery/anti-corruption (ABAC) solutions in order to combat the relevant risk and help companies protect themselves from fines and reputational damage.

Any company found in violation of the provisions may be subjected to fines, amounting up to $1 million.

Common Reporting Standard (CRS) (Global)

The CRS is the global standard developed by the Organisation for Economic Co-operation and Development (OECD).

The CRS defines the requirements for the due diligence procedures (i.e., tax residence of each client) and for the Automatic Exchange of Information (AEOI) on “reporting” accounts held by Financial Institutions (FIs) for taxpayers domiciled within the subjected jurisdictions.

The information is exchanged on an annual basis by the tax authorities, and, in accordance with the CRS, FIs are required to report to local tax authorities the information about the funds held by clients’ accounts in relevant FIs.

In order to be applied, the subjected countries have signed the Multilateral Competent Authority Agreement (MCAA) for the AEOI, specifying the information which should be exchanged. Up to date, 110 countries have signed the MCAA, including all EU Member states.

The reporting includes the following information:

  1. Name, address, Taxpayer Identification Number(TIN), and date and place of birth of each Reportable Person
  2. Account number
  3. Name and identifying number of the reporting FI
  4. Account balance or value as of the end of the relevant calendar year or at its closure, if the account was closed
  5. Capital gains, depending on the type of the account (dividends, interest, gross proceeds/redemptions, other)

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