As custodian of EU market functioning, stability, and investor protection, ESMA it all too aware that Covid-19 pandemic is causing firms a number of operational difficulties with regulatory compliance. ESMA initial response has been to publish a number of statements to keep compliance on track. Elsewhere, record-breaking intraday volatility has had adverse impacts on the more vulnerable retail investors, such as those approaching retirement. We examine a number of ESMA’s Covid-19 statements, and comment upon their impacts for firms and investors.
First and most important, all of us at deltaconX wish that our clients, readers, and their families remain in the best of health in these difficult times. Our deepest condolences go out to those who have lost loved ones. It’s quite unreal how quickly Covid-19 has moved over the past three months, or even over the past two weeks. Our support goes out to all healthcare workers in the front-line.
Covid-19 notwithstanding, the world of European regulatory compliance continues to function. ESMA has stated that throughout the pandemic, it will continue, in concert with NCAs, to monitor developments in financial markets and is prepared to use its powers to ensure the orderly functioning of markets, financial stability and investor protection. ESMA has made some concessions, although has stopped short of substantial relaxation. In this Blog, we examine those statements.
The biggest new regulation commencing operations in 2020 is of course SFTR. It’s the essential final piece of the jig-saw puzzle of regulations governing transaction reporting. For some firms, reporting starts in April, and for others, in July. In a recent press release (1) ESMA stated it was well aware of the disruption Covid-19 was causing to SFTR preparation, not least of which was the diversion of technical staff into the more pressing matters of supporting remote working. ESMA stopped short of a full official postponement, opting instead for allowing some slippage or ‘grace period’ by suggesting that NCAs do not focus too hard on the April 2020 deadline, and apply a proportionate response to the late compliers. ESMA stated that it didn’t consider it necessary to register any Trade Repository before the April reporting deadline, nor did it appear ready to receive SFT data gathered from the April deadline. The focus has now shifted to being ready for the July deadline, which will come as a relief to all liable firms.
Regarding public consultations, ESMA has extended the response date for all those closing on or after 16th March 2020 by four weeks (2). This may sound trivial, but we must remember that the consultation process plays a very important role in the way ESMA draws up a whole range of things from strategic policy down to its RTSs and ITSs. There are some big consultations out there in 2020, including MiFID II and now the Benchmark Regulation. Right now, market participants will have many other things on their mind other than corresponding with ESMA over regulatory esoterica, but this crisis will end and firms do need to get their opinions heard, or risk policy being made by default. Our advice to firms is to lobby hard to get ESMA to grant a further extension to these deadlines.
Many firms’ commercial activities require mandatory call-taping and surveillance. Given the move to remote working, Covid-19 has probably caught most companies on the hop with people having to work from home without recording and surveillance technology fully implemented on their devices. Unfortunately, under a Covid-19 lockdown, staff from both counterparties are likely to be working remotely, so a temporary reliance on the counterparty taping the call probably will not work. And if the counterparty is a retail client, they certainly won’t tape or document the call.
ESMA stated a few days ago that, “Firms are expected to deploy all possible efforts to ensure that the above measures remain temporary and that recording of telephone conversations is restored as soon as possible.” Furthermore, ESMA also expects firms to mitigate the risks they face related to the lack of recording (3). ESMA states that this could include the use of written minutes or notes of telephone conversations when providing services to clients, subject to the client being adequately advised of the reason. In these circumstances, firms should also ensure enhanced monitoring and ex-post review of relevant orders and transactions. ESMA stressed the temporary nature of these arrangements, so firms must to be able to recover the relevant data from all devices supporting remote working and prevent user-tampering, especially where used in market surveillance.
Regarding the stability of markets, when markets plunge, short-selling comes back under the spotlight as a contributor to excess market volatility. The Covid-19 crash is no exception and already, a number of NCAs have stepped in to temporarily suspend short-selling and requested ESMA’s blessing. ESMA has duly published its opinions and agreed with the actions of the NCAs. Market purists say short-selling is a legitimate trading strategy, the mirror image of ‘long-buy’. Furthermore, bear markets are known for vicious ‘rip-your-face-off’ rallies, as happened during the writing of this Blog (4), so may act as a natural deterrent to excessive shorting. ESMA appears not to agree, so some traders may want to ponder the implications of ESMA’s actions if they rely on this strategy.
Staying on the theme of increased market volatility, it will be interesting to see ESMA’s report(s) on the functioning and stability of the European financial markets once the Covid-19 pandemic is over. Intraday volatility records continue to be broken, such that by 25th March 2020, equity markets under Covid-19 had already seen some of their biggest daily falls and rises in their entire history.
Under Covid-19, the global equity markets have clearly ‘functioned’ in the sense that bids and offers have been submitted and trades executed, even if the net result was violent intraday market moves. It will be interesting if ESMA can publish what proportion of those trades originated from short-term event-driven ‘herd’ algos, as opposed to longer-term position-taking by human asset managers adjusting their core portfolios (5), and comment on the causes of the extreme volatility.
What will concern ESMA and the NCAs is if modern market ‘functioning’ includes an element that actually exacerbates market volatility while re-pricing risk. They will need to consider if this ‘functioning’ is actually ‘desirable’ in the sense of its impact on retail investors, especially those approaching retirement who have to crystallise their funds in the middle of this volatility. Questions will have to be asked if it is in the best interests of imminent retirees to be exposed to a market mechanism that can wipe 30% off the value of their funds in a matter of days, then whipsaw them to the point of a nervous breakdown. Of course, this is not a new issue – defined-contribution pension funds have always been at risk of a bear market in their final years, hence the need for de-risking as the investor approaches retirement. Even so, the recent trend is for retirees to be offered the choice of leaving their pension-pots invested in higher-risk assets, and drawing down as their needs dictate. What Covid-19 has shown us is that a vicious bear market can come out of nowhere and last less than a month, leaving the ‘draw-down’ approach looking acutely vulnerable to any market mechanism that exacerbates volatility.
The threat of severe external shocks like Covid-19 will stalk markets for ever, but at the same time, market volatility itself seems to be on an uptrend, in that with each passing decade, markets respond more and more violently to these shocks in terms of bigger percentage intraday moves.
Post-Covid-19, we think ESMA will need to look closely at the causes and impacts of this volatility. In furtherance of investor protection, will we see more circuit-breakers, more moves to suspend certain types of trading believed to amplify volatility, or even compulsory pension fund de-risking? ESMA will have a busy end to 2020.
Whatever happens, it will take more than a global pandemic to derail full regulatory compliance!
(1) ESMA 19th March 2020 https://www.esma.europa.eu/press-news/esma-news/esma-sets-out-approach-sftr-implementation
(2) ESMA 20th March 2020 https://www.esma.europa.eu/press-news/esma-news/esma-extends-consultations-response-dates
(3) ESMA 20th March 2020 https://www.esma.europa.eu/press-news/esma-news/esma-clarifies-position-call-taping-under-mifid-ii
(4) On 24th March 2020, major global equity markets rallied between 8% and 11%, causing the ‘shorts’ more than a small amount of grief.
(5) We are aware that in US markets, questions are being asked as to who sold during the crash – ‘man or machine’ – because many humans (including retail investors) claim to have bought!
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