The well-known quote from U.S. Supreme Court Justice Louis Brandeis, extols the benefits of openness and transparency and is frequently cited in support of regulation through disclosure obligations.
In the eyes of the European Commission, current reality does not match Justice Brandeis’ vision. Regulators are therefore focusing on enhancing disclosure requirements and enforcing transparency rules at an early stage, in an attempt to complement overall efforts to improve standards of corporate governance.
In a move to ensure greater consistency across the European Union, the existing Transparency Directive from 2004 was amended in November 2013 and these changes must be implemented by member states by 26th November 2015. The evolution of transparency requirements for investors demonstrates that stricter rules have been applied throughout the EU and convergence of the rules has already started.
Pan-European Convergence
Ownership rules are not always vigorously enforced. Despite a convergence to a stricter 5% initial reporting threshold, the laxity of disclosure enforcement means that the identity of the ultimate owner may still remain undisclosed. This is further exacerbated by the complexities of share class structures, indirect holdings due to ETFs & derivatives and the thorny issue of index look-through.
The revised transparency directive aims to provide a common definition of the shareholding that triggers disclosure. The main changes are the required disclosure of all financial instruments, physical as well as cash settled, and the harmonised aggregation methods of shares and financial instruments. This implies that holdings of all financial instruments with the same economic effect as direct holdings of shares or giving entitlements to acquire shares must be disclosed, preventing financial instruments being used to achieve “hidden ownership” of shares and “empty voting”.
Several member states, such as the United Kingdom, Italy and France, have already adopted disclosure rules in line with the amended directive. However, due the nature of European directives, which allow national implementations and variations, the EU has further work to do to achieve the desired unified reporting framework. It will remain possible for individual member states to establish tighter initial reporting thresholds than those specified in the directive - some countries have already set their thresholds at 3%, for example. In addition, scope and format of the actual filing document will still vary from country to country, as does the timeframe for submission.
Post implementation, the regulatory environment will correspond better to the needs of the investors and a pan-European approach will improve the legal certainty. Nonetheless, it can be expected that, despite the long path to implementation, a number of member states will miss the deadline and will have to continue progress towards these goals well beyond November 2015.
There can be no guarantee of harmonisation within the EU, never mind globally.
Administrative Burden
The short and mid-term impact on the administrative burden and costs of compliance can be expected to be significant. The complexities of managing disclosure requirements globally in accordance with local requirements are causing massive headaches for compliance officers. For most organisations, complying with dozens if not hundreds of global regulatory agencies constitutes a complex, predominantly manual set of tasks.
Ultimately, manual processes expose companies to risk and force them to escrow capital against future fines.
In April 2014, Invesco Perpetual was fined £18.6m by the UK’s Financial Conduct Authority for failing to comply with its regulatory obligations. Among the practices the FCA uncovered, along with risk limit breaches and communication failures, was the use of old-fashioned pen and paper methods to record trades. The FCA says: “The failure to record trades on a timely basis resulted from deficiencies within the front office control environment resulting from Invesco Perpetual’s failure to invest adequately in the systems in place.”
This is not the first time the FCA has imposed a fine for a failure to comply, but the FCA’s press release suggests it will henceforth be looking closely at breaches caused by neglect or failure to have the right systems in place. One month later in May Deutsche Bank was fined HK$1.6m (US$206,000) by Hong Kong’s Securities and Futures Commission (SFC) for “regulatory breaches and internal control failings”. And to complete an annus horribilis for regulatory fines, in September, the US Securities and Exchange Commission announced 34 enforcement actions related to failures to promptly report information about insider holdings and transactions in company stock.
For many financial services firms, the reputational damage caused by such negative publicity may be significantly more detrimental than the fine itself.
Increasing Regulatory Burden
Whilst staying up to date with the regulatory changes and remaining compliant may seem daunting, there can be no doubt that this burden will dramatically increase in the future.
Increasing regulatory complexities will be reflected in new and increased workloads – automated processes that allow for monitoring of the regulatory changes and linking those changes immediately to systems that provide visibility to management will become essential. Authorities will require more information be disclosed when the notification is made. Turnaround times will become shorter and penalties for non-compliance will no doubt increase.
It appears certain that ownership disclosure requirements will continue to evolve in line with financial innovation and hence remain an on-going challenge.
One of many.