Securities Services Regulatory Readiness Series - Edition 2
Standard Chartered Securities Services Regulatory Readiness Edition 2 – Preparing you for upcoming regulatory and compliance developments
*Securities Services* **Regulatory Readiness**
Edition 2
<br>Stepping up:
tackling the big issues
Stepping up: tackling the big issues
The securities services industry has a pivotal role to play in some of the major challenges facing not only the financial industry, but society as a whole. This has been recognised by financial regulators who are introducing measures to ensure greater shareholder oversight of the conduct of companies, improve transparency around ‘green’ investments and deliver greater transparency via instruments such as digital currencies.
In this second edition of the Standard Chartered Regulatory Readiness series for financial institutions, we look at three regulator-inspired changes influencing the securities services industry:
One of the lessons from the 2008 financial crisis was that shareholders, institutional investors and asset managers were not fully engaged in the corporate governance and performance of companies in which they invested. A revision of the 2007 Shareholder Rights Directive (SRD), SRD II seeks to facilitate shareholders’ long-term engagement in the companies in which they invest, increase transparency in the voting process both in relation to proxy voting and shareholder identification, and improve issuer-investor dialogue.
Climate change is one of the greatest challenges society faces and governments around the globe are seeking to reduce carbon emissions in their countries. An important element in this will be the facilitation of the low- and zero-carbon economy via sustainable finance. The EU Taxonomy Regulation establishes a standardised classification system that brings transparency to companies, project promoters and issuers about what activities and financial instruments can be classified as environmentally-friendly and a ‘green’ investment.
The European Commission describes the EU Taxonomy as one of the most significant developments in sustainable finance and one that will have wide-ranging implications for investors and issuers working in the EU, and beyond.
There has been an explosion of interest in digital currencies and digital assets in the past few years as the wider trend of digitalisation has taken root across most industries.
According to the Bank for International Settlements (BIS), 80 per cent of central banks are engaging in some work related to digital currencies. In wholesale finance, digital currencies are expected to improve domestic and cross-border payments efficiency, payments safety and financial stability. Many firms are readying their systems for the issuance and management of digital assets; a central bank digital currency (CBDC) is the final piece of the puzzle, providing a means of payment that will occur in near real-time.
These regulatory initiatives throw down the gauntlet to our industry to step up to the developments of the modern era. By acting now, firms can be ahead of the curve on many of the trends that in the near future will become commonplace.
There has been an explosion of interest in digital currencies and digital assets in the past few years as the wider trend of digitalisation has taken root across most industries. According to the Bank for International Settlements (BIS), 80 per cent of central banks are engaging in some work related to digital currencies.
Margaret Harwood-Jones
Co-Head, Financing & Securities Services, Financial Markets
Disclaimer
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Shareholder Rights Directive II: A catalyst for change
Shareholder Rights Directive II: A catalyst for change
The SRD II’s new requirements for more transparency and timeliness strengthens shareholder rights.
The regulatory recap
Improving shareholder engagement
Coming into force on 3 September 2020, the EU’s Shareholder Rights Directive II (SRD II) strengthens shareholder rights and imposes new requirements for intermediaries, institutional investors, asset managers and proxy advisors.
SRD II is a revision of the 2007 Shareholder Rights Directive, which was found wanting in the wake of the 2008 financial crisis. EU lawmakers had decided to act as the crisis revealed that in many instances, shareholders supported excessive short-term risk taking by their investment managers. Lawmakers also found clear evidence that the monitoring of investee companies by investment managers, and engagement by institutional investors and asset managers with the companies in which they invest, was often inadequate and focused too much on short-term returns, which may have led to suboptimal corporate governance and performance.1
1 Directive (EU) 2017/828 of the European Parliament and of the Council, 17 May 2017
In December 2012, the European Commission had published an Action Plan on European company law and corporate governance.2 The Action Plan set out a legal framework designed to encourage more engaged shareholders in sustainable companies, and included a number of actions to encourage long-term shareholder engagement and to enhance transparency between companies and investors.
SRD II is a part of the Action Plan and is intended to improve transparency regarding the investment strategy, the directors’ remuneration, the voting process in general meetings, and identification of shareholders.
The aim is to facilitate shareholders’ long-term engagement, increase transparency in the voting process both in relation to proxy voting and shareholder identification; and improve issuer-investor dialogue.
The aim is to facilitate shareholders’ long-term engagement, increase transparency in the voting process both in relation to proxy voting and shareholder identification; and improve issuer-investor dialogue.
2 Action Plan: European company law and corporate governance - a modern legal framework for more engaged shareholders and sustainable companies, European Commission (12 December 2012)
Scope, scale, structure
A European directive with global implications
SRD II applies principally to securities with voting rights issued by companies that have their registered office in a Member State of the European Economic Area (EEA) and that are admitted for trading on a regulated market within a Member State.
Focusing on issuers of securities with voting rights that are traded in the EU and EEA, the SRD II sets out requirements for intermediaries, institutional investors, asset managers and proxy advisors.
However, the Directive also explicitly outlines its applicability to non-EU/EEA intermediaries that provide services in relation to in-scope securities. Similarly, the Directive applies to all shareholders of in-scope securities, irrespective of the shareholders’ location.
Key requirements under the SRD II
One of the key requirements introduced by SRD II is the Shareholder Identification Request. This sets the right for listed companies to identify shareholders and mandates intermediaries, such as custodians, to take a role in this process. Custodians are expected to disseminate disclosure requests to their customers that are considered as intermediaries. Each intermediary in the chain must also submit disclosure information directly to the issuers or their appointed agents in a timely fashion.
The Directive also aims at facilitating voting and exercise of shareholders’ rights. It requires intermediaries to transmit ‘without delay’ corporate actions and announcements of general meetings or proxy voting and to lodge clients’ corporate actions responses and general meeting votes to the next intermediary/agent in the chain.
One of the key requirements introduced by SRD II is the Shareholder Identification Request. This sets the right for listed companies to identify shareholders and mandates intermediaries, such as custodians, to take a role in this process.
Building the blueprint for your firm
The challenge of diverse interpretations
As an EU Directive, SRD II must be transposed into national law across all EU member states. Transposition, however, can introduce variations as each jurisdiction may interpret requirements differently. For example, a shareholder is defined in certain markets as the end beneficiary, while in others, it is the legal holder of a security, which could include a nominee.
For firms operating across borders in Europe and elsewhere, dealing with these nuances will be challenging, particularly if they wish to automate processes.
There are also variations in the threshold set for shareholder identification disclosure.
SRD II sets a threshold range between 0.0-0.5 per cent, with each jurisdiction settings its own threshold. Those firms affected by the Directive and operating in multiple markets must adapt to this variation.
With SRD II coming into effect, firms need to focus on compliance with its requirements. For end investors, little action is required other than being aware of the Directive. For intermediaries, the SRD II’s impact is more significant and their preparations for its implementation would entail the following:
- Assessment. In looking at how the Directive might apply to them, the issues for the firm to consider include whether they are based in the EU/EEA. If outside the EU/EEA, the next question would then be whether they deal with affected securities, and if so, the volume of affected securities.
- Information transmission. All parties are required to transmit information from issuers to investors along the chain of intermediaries in a timely fashion. This should not be an issue for most intermediaries as this can be considered very much ‘business as usual’.
- Shareholder information request. This is the main challenge for most participants as it is a much more formalised process than existing disclosure requirements in most markets. Machine readable and automatable formats are required to be passed from issuers, investors, and intermediaries. Firms must examine their ability to handle these requests from issuers or from agents. They must also be able to provide that request to a client and respond on behalf of a client directly to the requester. All of this must be done without delay.
Building the blueprint for the industry
Time to move to ISO 20022?
There is increasing awareness of the requirements of SRD II and the industry is undergoing a period of adaptation, with the emphasis on ensuring compliance.
The Securities Market Practice Group (SMPG) and the SRD II ISO Taskforce have worked together to develop ISO 20022-based message standards to support the SRD II obligations in terms of information request transmission and proxy voting.3 The developments comprise updates on eight existing messages for general meeting (formerly known as proxy voting) and the creation of five new messages for Shareholder Identification Disclosure.
The new ISO 20022 messages for general meetings will ensure the industry has messages that comply with SRD II provisions, especially with reference to machine-readable formats which allow for interoperability and straight-through processing (STP). Additional changes in ISO 15022 following the advent of SRD II are likely as SWIFT is scheduled to introduce a new indicator to flag SRD II-related events in its November 2020 standards release.
Over the longer term, there is potential for distributed ledger technology (DLT) to be applied to the shareholder information request. While some specialist proxy voting and disclosure-handling companies are exploring the use of DLT as a more efficient way of sharing shareholder information, in the interim, firms are more focused on meeting the minimum requirements of the Directive.
However, with securities market infrastructures also moving towards the adoption of ISO 20022, SRD II may prove to be a catalyst of more widespread take up of the standard.
Championing change with Standard Chartered
A work in progress
As a custodian, we are well prepared for the SRD II coming into force and can assist our clients with understanding and complying with its requirements.
Currently, ISO 20022 has not been globally adopted in the securities services industry. As such, it is unlikely that all participants in the chain – especially those outside the EEA – will be fully compliant with these new ISO 20022 formats by September 2020.
Standard Chartered Bank Securities Services has opted for a pragmatic and proportionate approach to this requirement and will support alternatives to ISO 20022, including SWIFT ISO 15022 messages, the Bank’s proprietary Straight2Bank and automated emails / files transfers.
Standard Chartered will continue to engage with industry working groups, such as the Association of Global Custodians and the SMPG, to ensure the industry moves towards a solution that can be further automated and made even more efficient.
3 https://www.smpg.info/fileadmin/documents/SMPG_SRDII_ISO_Standards_Statement_20191203.pdf
<BR>EU Taxonomy:
Defining a green and sustainable future
EU Taxonomy: Defining a green and sustainable future
A huge development in sustainable finance with implications for investors and issuers globally.
The regulatory recap
Creating a carbon-free economy
The EU Taxonomy Regulation, which is part of the wider EU sustainable finance initiative, set out a classification system, the EU Taxonomy, for economic activity according to EU climate action goals. The EU aims to be an economy with net-zero greenhouse gas emissions by 2050. This objective is in line with the EU’s commitment to global climate action under the 2015 Paris Agreement.1 Other countries are also developing taxonomies to encourage green investment, including China, Malaysia, and Singapore.
The EU Taxonomy sets a series of performance thresholds for economic activities that contribute to one of six environmental objectives (and in doing so do not harm the other five, where relevant), and meet minimum safety standards on business and human rights.
The six objectives are:
- Climate change mitigation
- Climate change adaptation
- Sustainable use and protection of water and marine resources
- Transition to a circular economy
- Pollution prevention and control
- Protection and restoration of biodiversity and ecosystems.
The performance thresholds are designed to help companies, project promoters and issuers to access green financing to improve their environmental performance, as well as helping to identify which activities are already environmentally friendly.2 The EU hopes to encourage the growth of low-carbon sectors and decarbonise high-carbon emission sectors.
1 2050 long-term strategy, European Commission Energy, Climate change, Environment
2 Taxonomy: Final report of the Technical Expert Group on Sustainable Finance, EU Technical Expert Group on Sustainable Finance, March 2020
Scope, scale, structure
A complex landscape of regulations and directives
On 18 June 2020, the Taxonomy Regulation for climate change mitigation and adaptation was published in the Official Journal3. The technical specifications for the two are complex, running to 400 pages. While financial market participants will have to complete their first set of Taxonomy disclosures by 31 December 2021, companies only need to begin making disclosures during 2022. This timing presents a challenge as the accuracy and completeness of financial institutions’ disclosures are dependent to some extent on company disclosures.
The specifications concerning the other environmental objectives (sustainable use and protection of water and marine resources, circular economy, pollution prevention and control and protection and restoration of biodiversity and ecosystems) are planned to be adopted by the end of 2021.
3 Regulation (EU) 2020/852 of the European Parliament and of the Council, European Commission (18 June 2020)
The performance thresholds specified by the Taxonomy Regulation apply to three types of users:
- Financial market participants offering financial products in the EU, including occupational pension providers (this includes entities based outside the EU that are offering products to EU residents)
- Large companies that are required to provide a non-financial statement under the Non-Financial Reporting Directive4 (large public-interest companies with more than 500 employees, including listed companies, banks and insurance companies)
- The EU and Member States, when setting public measures, standards or labels for green financial products or green (corporate) bonds.
Economic activity covered by the Taxonomy Regulation includes projects, assets and financial products. Companies will be required to report how these activities align with the Taxonomy. Corporates are being asked to disclose the percentage of their revenues that are aligned to the Taxonomy while financial institutions are required to give a figure on the proportion of their assets that are aligned.
The main aim of the Taxonomy Regulation is to establish a common language that can be used by investors, financial institutions, companies and issuers to identify activities and financial instruments that can be classified as environmentally sustainable.
This common language is designed to tackle ‘greenwashing’ and a lack of comparability between the sustainability credentials of different financial institutions and products.
4 https://ec.europa.eu/info/business-economy-euro/company-reporting-and-auditing/company-reporting/non-financial-reporting_en
Building the blueprint for your firm
Act now to stay ahead of the curve
To comply with the Taxonomy Regulation a number of questions should be asked:
- Does the regulation apply to my firm?
- What is my investment strategy?
- What types of products do I want to offer?
- Who are my investors and investees?
- What is my risk appetite for disclosure?
- Do I rely on European capital flows?
Many firms already have sophisticated environmental, social and corporate governance (ESG) approaches, integrating these factors into investment decision making. These companies should study the details of the Taxonomy, determine the additional information requirements from investee companies and to what extent they are capturing these via ESG integration and mainstream due diligence activities. This will highlight where more work might need to be done.
If a firm is not yet interested in pursuing an ESG agenda, it may decide to take a low-risk and low-effort approach, reporting 0% alignment with the Taxonomy Regulation. However, it is worth noting that the promotion of green finance is the direction of travel of governments and regulators worldwide. In some countries the movement is being pushed by regulators, while in others the catalyst is the investor community.
The EU is reviewing its sustainable finance strategy, examining how to integrate sustainability considerations into its financial policy framework in order to mobilise finance for sustainable growth. For example, the EU Benchmarks Regulation is being reviewed with an aim to further support comparability between products, as well as regulations around disclosure of information to be made available to investors. It is likely that companies will be assessed on how readily available ESG data is and how it compares with other organisations. This will have an impact on operations and companies should assess the tools or proxies they use to gather relevant information.
At a policy level, companies should be making decisions now about how they will comply with the Taxonomy Regulation, bearing in mind that further regulation is in the pipeline. The Taxonomy Regulation should not be viewed as an ESG ‘side project’; it is a part of wider regulation and is one of the levers the EU is pulling in its commitment to a net zero carbon economy by 2050.
Building the blueprint for the industry
An opportunity for industry collaboration
The European Commission describes the Taxonomy as one of the most significant developments in sustainable finance and one that will have wide-ranging implications for investors and issuers working in the EU, and beyond. Given its complexity and scope, industry groups are collaborating to share best practices.
The European Banking Federation (EBF) and the United Nations Environment Programme Finance Initiative (UNEP FI) are assessing the extent to which the Taxonomy Regulation can be applied to core banking products.5
The objective of the project is to:
- Provide a high-level feasibility assessment of the EU Taxonomy Regulation to core banking products
- Share best practices
- Develop use cases where appropriate
- Issue recommendations based on the project findings.
A working group of 23 banks, five banking associations and four observers is developing guidelines. Recommendations are expected around Q4 2020.
The institutional investor industry body, ‘Principles for Responsible Investment (PRI)’, has established a practitioners’ group, which includes member institutions from the US and Japan. The group is developing case studies on Taxonomy implementation and will share best practice later in 2020.6
5 https://www.unepfi.org/banking/high-level-recommendations-on-the-voluntary-application-of-the-eu-taxonomy-to-core-banking-products
6 https://www.unpri.org
Championing change with Standard Chartered
Partnering for Taxonomy alignment
Many financial market participants are not traditional ‘green’ companies and will need education on how to comply with the requirements of the EU Taxonomy Regulation. With a strong global footprint, Standard Chartered Securities Services is well-placed to help companies diversify their revenue streams to more environmentally friendly sectors.
As a bank, we have also put ESG front and centre, committing to supporting clients to have less than 10% revenue from thermal coal by 2030, consistent with the goals of the Paris Agreement. We are also a member of the EBF/UNEP FI working group.
As a complex set of requirements, the Taxonomy Regulation requires a quantum of disclosure and we are able to collaborate with customers, exchanging ideas and ensuring compliance can be bespoke to individual companies.
Compliance with sustainable finance regulations will soon become a differentiator for issuers and financial institutions. During the past five years there has been a significant shift towards sustainable finance, and this will continue. Financial market participants must act now to keep on top of the significant amount of work that compliance will require.
<Br><Br>Central Bank Digital Currencies: A new frontier in digital payments
Central Bank Digital Currencies: A new frontier in digital payments
With 80% of central banks world-wide exploring the use of CBDCs, get ready for it to go mainstream.
The regulatory recap
Majority of world’s central banks working on digital currencies
The Bank for International Settlements (BIS) says 80 per cent of central banks are engaging in investigating central bank digital currency (CBDC).1 A CBDC is state-backed digital or electronic form of central bank money, and could be used as a means of payment, a unit of account and storage of value.
Fifty per cent of central banks have progressed from ‘conceptual’ to proofs of concept and have developed pilot projects. A number of the central banks that have progressed to development or a pilot project are based in emerging market economies.
One of the most advanced is The People’s Bank of China, the central bank of China, which began testing its digital currency in selected cities this year and plans to launch it nationwide though a firm date has yet to be set.2
The COVID-19 pandemic presented challenges to central banks as they sought to support monetary policy, particularly the disbursement of payments to citizens. The BIS observed that the pandemic has acted as a catalyst to the further development of CBDCs, particularly in the retail payments sector.3
1 CBDC, Central Bank Digital Currencies: foundational principles and core features, BIS (October 2020)
2 One day everyone will use China's digital currency, BBC News (September 2020)
3 Pandemic pushes central bank digital currencies into top gear, Reuters (11 June 2020)
There are two main types of central bank digital currency (CBDC): general purpose (ie. retail) and wholesale. The latter is a token-based digital currency that is a restricted-access digital token for interbank payments and securities settlement. The former is retail payments focused akin to a digital form of cash and can be based on tokens or accounts.
Motivations to develop CBDCs include improvement of domestic payments efficiency, payments safety and diversity, and financial stability (particularly important in emerging markets). In more advanced economies, central banks see CBDCs as a route to increased cross-border payments efficiency. There are also expected benefits in transparency, which will help fight financial crime as CBDCs will be easier to trace than physical money. Policy consideration of a direct (full retail) CBDC should take into account the possible concentration of risk, disintermediation of financial institutions and excessive government control of credit allocation.
Motivations to develop CBDCs include improvement of domestic payments efficiency, payments safety and diversity, and financial stability (particularly important in emerging markets). In more advanced economies, central banks see CBDCs as a route to increased cross-border payments efficiency.
Scope, scale, structure
Various distribution models under examination
To date, no commercial CBDCs have been issued in any major economies. However, as the BIS found, central banks are intensifying their efforts to develop CBDC. In Europe, Banque de France has selected eight firms with which it will work on its wholesale CBDC.4 The work will cover:
- New ways of exchanging financial instruments (including crypto-assets for central bank money
- Testing settlement in CBDC to improve execution conditions for cross-border payments
- Revising the arrangements for making central bank money available.
The Bank of Thailand has also taken a collaborative approach with its Project Inthanon.5 With eight commercial banks and technology partner R3 it has conducted a proof of concept of a decentralised real-time gross settlement system using a wholesale CBDC.
Central banks in the Caribbean are also exploring digital currencies to improve financial inclusion and explore the benefits including lower cost of cash and know your customer controls.6 Indeed, the first nationwide CBDC in the world has been launched by The Central Bank of The Bahamas after a successful 2019 pilot.7
4 https://www.banque-france.fr/en/communique-de-presse/banque-de-france-press-release-20-july-2020
5 https://www.bot.or.th/English/PressandSpeeches/Press/2019/Pages/n3962.aspx
6 https://www.bis.org/publ/bppdf/bispap107.pdf
7 Central Bank Digital Currency: The first nationwide CBDC in the world has been launched by The Bahamas, Forbes, (October 2020)
There are three distribution models for CBDCs: direct, indirect and hybrid.
Under the direct model, all parties wishing to transact with the digital currency will hold an account at the central bank. Payments will simply be a transfer from one account to the other and the claim will be on the central bank. The central bank will issue the currency and manage a permission system to clear transactions. Know your customer (KYC) and anti-money laundering (AML) compliance requirements will be met by the central bank.
In the indirect model, the central bank will pass the digital currency token to the commercial bank, which will then distribute the currency and also handle KYC and AML requirements. The claim for the currency will be on the commercial bank, not the central bank.
The hybrid model – on which most central banks are working – is based on the central bank distributing the digital currency to a commercial bank, which handles the transaction and the KYC and AML requirements. However, the claim is on the central bank.
The hybrid model – on which most central banks are working – is based on the central bank distributing the digital currency to a commercial bank, which handles the transaction and the KYC and AML requirements. However, the claim is on the central bank.
Building the blueprint for your firm
Digital assets will require CBDCs
At present, many firms are readying their systems for the issuance and management of digital assets. A CBDC or Stablecoin (digital currencies designed to maintain a stable value relative to another asset that are issued by commercially-run entities) enables settlement of digital asset transactions in near real-time This will significantly improve settlement times in the securities industry.
To prepare, firms should:
- Ensure back-end payment and settlement systems can interoperate with the imminent CBDC networks by running tests and proofs of concept
- Consider whether they may retain some liquidity in CBDCs if – based on the distribution model – the currency is interest-bearing. There is potential for CBDCs to change the way firms invest; if the CBDC is interest-bearing and the rate is good enough, some firms may opt to keep more of their assets in the digital currency to gain better liquidity
- Recruit and retain the right skills and talents for the new digital business model
- Ensure senior levels of the firm understand that CBDCs are a ‘when’ not ‘if’ and thus get management buy-in to support CBDC projects and ensure adequate resources are provided.
Building the blueprint for the industry
Private sector has a role to play
As CBDCs gain mainstream interest, financial institutions and market participants should ensure that they are engaging with central banks to help in the development of CBDCs.
A plethora of surveys have been issued by central banks, seeking the views of industry participants. It is important that the industry gets involved at this early stage of development to help frame the wider CBDC environment.
Central banks are cognisant that they are policy makers and should not dictate the technologies required to make CBDCs a success.
In addition to consultation, regulatory sandboxes and innovation hubs have been set up by central banks to enable technology firms, financial technology companies, and financial institutions to experiment with various options.
The industry should also collaborate on and agree CBDC-related standards, especially for cross-border transactions.
There is potential for disruption to the custody model as CBDCs will have full traceability, removing the need for clearing houses, for example. To stay relevant, custodians could offer safe-keeping and asset servicing of CBDCs and cryptocurrencies.
It is important that the industry gets involved at this early stage of development to help frame the wider CBDC environment. Central banks are cognisant that they are policy makers and should not dictate the technologies required to make CBDCs a success.
Championing change with Standard Chartered
Connecting clients and central banks in the new digital journey
As a global custodian with a strong presence in emerging markets, Standard Chartered Securities Services is well-placed to help clients make the most of the opportunities CBDCs will provide. We are providing education to ensure clients are ready for CBDCs and digital assets.
CBDCs will inevitably become the new landscape for payments, and we at Standard Chartered are making sure that we – and our clients – will be prepared and ready as CBDC become more widely used.
