GLOBAL FINANCIAL MARKETS INSIGHT Products  •  Analysis  •  Visionary Ideas FINTECH – REDEFINING THE FINANCE SECTOR RECENT DEVELOPMENTS IN PROJECT FINANCE: GROWTH IN PROJECT BONDS THE IMPLEMENTATION OF THE BRRD IN ITALY: REMARKS ON THE BAIL-IN TOOL LIFE ON THE MARGIN: US MARGIN RULES FINALISED AT LAST PEER-TO-PEER LOAN SECURITISATION: WILL 2016 SEE THE UK’S FIRST PEER-TO-PEER LOAN SECURITISATIONS? BONDING INTO CLIMATE CHANGE SOLUTIONS SECURITISATION AND COVERED BONDS IN PORTUGAL: AN UPDATE THE MAN WHO SOLD THE WORLD – BOWIE, BONDS AND IP SECURITISATION THE NEW SPANISH MAJOR SHAREHOLDING DISCLOSURE REGIME AND ITS IMPACT ON EQUITY DERIVATIVES CENTRAL COUNTERPARTIES AND MANDATORY CLEARING: ENSURING RISK MITIGATION RATHER THAN RISK CREATION EUROPEAN COMMISSION PROPOSES NEW PROSPECTUS REGULATION www.dlapiper.com  |  Issue 9 Q1 2016 www.dlapiper.com | 01 . 02  |  Global Financial Markets Insight . Contents Foreword 05 FINTECH – REDEFINING THE FINANCE SECTOR 09 RECENT DEVELOPMENTS IN PROJECT FINANCE: GROWTH IN PROJECT BONDS 11 THE IMPLEMENTATION OF THE BRRD IN ITALY: REMARKS ON THE BAIL-IN TOOL 14 LIFE ON THE MARGIN: US MARGIN RULES FINALISED AT LAST 18 PEER-TO-PEER LOAN SECURITISATION: WILL 2016 SEE THE UK’S FIRST PEER-TOPEER LOAN SECURITISATIONS? 21 BONDING INTO CLIMATE CHANGE SOLUTIONS 25 SECURITISATION AND COVERED BONDS IN PORTUGAL: AN UPDATE 27 THE MAN WHO SOLD THE WORLD – BOWIE, BONDS AND IP SECURITISATION The beginning of 2016 has proved uncomfortable for markets. The fall in oil prices, the downturn of the Chinese markets and the continued uncertainty over Europe continue to drive a negative and uncertain outlook. With interest rates at rock bottom (or even negative) and quantitative easing (“QE”) achieving less and less it might be hoped that policy makers are finally looking at readdressing and supporting some of the financial structures that have been unfairly damaged by inappropriate regulation. The securitisation market continues to perform through a dire regulatory environment. It is now widely accepted that default rates on European securitisation through most asset classes remained low with deals well-structured and credit tranches performing as appropriate. Improving the capital regime to increase the use of securitisation techniques would support consumer lending and SME growth through properly structured funding rather than trying to do this through a continued flood of cheap central bank money. We look how securitisation can be used for a range of underlying asset types such as peer-to-peer, IP and in the Portuguese market. Opening the European capital markets to a wider range of investors should help reduce reliance on bank lending.

Efforts through the Prospectus Regulation to simplify and shorten the prospectus and to focus investor attention on key risks rather than all possible risks are certainly worthy objectives. Reducing costs and procedural administration should also be welcomed by issuers. How these aspects are implemented through secondary legislation will however be the real test.

A desire by regulators to control process needs to be balanced by a flexible regime that can allow for the full range of capital market issuance. Whilst banks continue to successfully reform lending and reduce asset exposures though portfolio sales as a result of the regulatory headwinds, it could be that new technology is the greatest threat to their continued viability. We are seeing increasingly successful new entrants bringing user-friendly and effective technologies for providing finance. These new players operate without the property and staff infrastructure costs of banks and are not faced with the regulatory overlay of previous activity and older technology platforms. Banks need to change quickly and utilise their opportunities to benefit from scale and technology to head off these threats. – Martin Bartlam 26 THE NEW SPANISH MAJOR SHAREHOLDING DISCLOSURE REGIME AND ITS IMPACT ON EQUITY DERIVATIVES Contributors 31 CENTRAL COUNTERPARTIES AND MANDATORY CLEARING: ENSURING RISK MITIGATION RATHER THAN RISK CREATION Martin Bartlam Partner, London T  +44 (0)207 796 6309 martin.bartlam@dlapiper.com Mark Dwyer Partner, London T  +44 (0)207 796 6005 mark.dwyer@dlapiper.com 34 EUROPEAN COMMISSION PROPOSES NEW PROSPECTUS REGULATION Ronald Borod Senior Counsel, Boston T  +1 617 406 6003 ronald.borod@dlapiper.com Leigh Ferris Associate, London T  +44 (0)207 796 6098 leigh.ferris@dlapiper.com Edward Chalk Trainee, London T  +44 (0)207 796 6604 edward.chalk@dlapiper.com Claire Hall Partner, Los Angeles T  +1 310 595 3037 claire.hall@dlapiper.com www.dlapiper.com | 03 .

Contributors (Continued) Marc Horwitz Partner, Chicago T  +1 312 368 3433 marc.horwitz@dlapiper.com Luciano Morello Partner, Rome T  +39 06 68 880 525 luciano.morello@dlapiper.com Mariel Luna Trainee, Birmingham T  +44 (0)121 281 3801 mariel.luna@dlapiper.com Bradley Phipps Senior Associate, Philadelphia T  +1 215 656 2472 bradley.phipps@dlapiper.com Vincent Keaveny Partner, London T  +44(0)207 796 6303 vincent.keaveny@dlapiper.com Ricardo Plasencia Legal Director, Madrid T  +34 91 790 1708 ricardo.plasencia@dlapiper.com Steven Krivinskas Senior Associate, London T  +44 (0)207 796 6524 steven.krivinskas@dlapiper.com Aureilia Storey Associate, London T  +44 (0)207 796 6919 aureilia.story@dlapiper.com Ronan Mellon Partner, London T  +44 (0)207 796 6770 ronan.mellon@dlapiper.com Mei Mei Wong Associate, London T  +44 (0)207 153 7657 meimei.wong@dlapiper.com 04  |  Global Financial Markets Insight . FINTECH – REDEFINING THE FINANCE SECTOR Financial technology has already changed the finance market – it is just a question of how fast financial institutions can change to deal with this. Technology is redefining the finance sector and in particular delivery of consumer finance. This is providing banks and traditional consumer finance providers with the difficult choice of either change fast and accept the associated costs relating to embedded technology and physical infrastructure, or lose business to more advanced technology models. A number of large institutions are already funding investment, setting up incubator businesses and tech venture funding – but is this enough? Regulators are also faced with a stark choice between encouraging or stifling innovation in technology-driven financial products. Concepts such as the UK’s Financial Conduct Authority’s (“FCA”) sandbox may give some space for new financial products and systems to evolve. The financial technology sector, collectively abbreviated by the buzzword “FinTech”, has seen exponential growth over recent years. Most recently valued at an estimated £20 billion in annual revenues1, it is attracting interest from investors and regulators alike. FinTech is providing customers with quicker, direct and more convenient services delivered at lower costs.

The sector is redefining the way in which consumers pay for goods and services, transfer money and apply for credit and finance. Early adopters as customers tend to be younger, higher-income individuals particularly in high-concentration urban areas such as London, New York and Hong Kong.2 Reasons for adopting include ease in setting up accounts, more attractive rates, access to different products and a better online experience. The main reasons for not adopting tend to be a lack of awareness of availability highlighting the importance of first mover advantage as established participants, or new entrants competing to establish brand recognition and loyalty in emerging FinTech services sectors. The government’s recent report, FinTech Futures3 , indicates a positive approach towards the FinTech community, and in particular towards the start-ups behind the ‘tech’ aspect of FinTech, whom the government hopes will make the UK a hub for start-up technology companies to develop and grow. There is a need now to balance the government’s desire to encourage technological developments, with a view to making the UK a world-leader in FinTech, against the need to ensure financial electronic transactions and products   UKTI and EY, Landscaping UK Fintech (2014) 1   EY FinTech Adaption Index 2   FinTech Futures – The UK as a World Leader in Financial Technologies (Report by the UK Government Chief Scientific Adviser) 3 www.dlapiper.com | 05 . are appropriately regulated. This is particularly pertinent in the wake of the widespread distrust in financial institutions following the 2008 financial crisis, and highlighted by the government’s careful approach to introducing regulation to address the FinTech sector. IDENTIFYING FINTECH AND THE OPPORTUNITIES IN THE FINTECH SECTOR FinTech is generally considered to include large-scale data analytics and data mining (e.g. for credit and credit scoring), digital currencies and BlockChain, online platforms, peer-to-peer lending, smart contracts, and use of artificial intelligence for financial planning, asset management and trading. By far the element of FinTech which has seen the most success is in relation to e-payments.

A recent report by Statista highlighted that electronic payments currently account for over 90% of the FinTech market. On the other hand, comparison sites and use of lead aggregation are not considered to be true FinTech. Put simply, FinTech relates to activity that is likely to result in the technological disruption of the traditional banking model. There are many ways in which institutions both large and small can innovate and make use of FinTech to develop product offerings, and to better serve widespread consumer types, as, for example, the telecommunications providers and the retail sector have already done for many years.

Financial services providers need to concentrate on applying FinTech to improve their business model and profitability, rather than focusing on negative implications of disruption to existing business. RESPONSES OF FINANCIAL SERVICE PROVIDERS Financial service providers are playing catch-up to more technologically advanced partners in the tech sphere. Banks are naturally risk-averse, and historically have been reticent to give up on established infrastructure and systems. It is easy to see why banks have little appetite to replace their current expensive infrastructure, particularly where this has not yet been significantly impacted by FinTech competitors in the market4. The danger is, however, that by waiting for FinTech to be developed enough to be considered a secure investment, they may react too late. Successful banks will be those which adapt and utilise more advanced and increasingly inexpensive technology to compete more effectively in the marketplace. The most successful FinTech products are those focused on single products targeting previously under-serviced areas of the market.

The FinTech companies making the most mainstream progress are those which are utilising technology, and in particular automation, to provide services to consumers who would otherwise be unable to access similar services and products using traditional banking models. Successful FinTech start-ups have been able to offer competitive prices in contrast to established financial institutions. TransferWise and TransferGo are prime examples of this, offering services to transfer money abroad at a tenth of the price of banks by focusing on peer-to-peer transactions and circumventing the high fees usually charged. Larger financial institutions have seen the benefit of this, and have used advances in technology to reduce costs and streamline products.

We see this with the move towards a digitised banking system involving a much reduced face-toface banking experience. This removes expensive branch and staff costs, but there is significantly more progress that can be made. Certain financial institutions such as Barclays and Visa have already taken steps by setting up, respectively, their Accelerator and Collab programmes, with an aim to ‘harness FinTech talent and foster a culture of innovation’5. This limited initial action, however, is still seen by some as evidence of banks reacting too slowly and taking too conservative an approach, with these innovation “hubs”, for example, strategically placed outside the organisation. In its March 2015 report6 , The Government Office for Science predicts that established financial service providers are unlikely to disappear or be beaten out by FinTech competitors, but rather will identify high-value ways to participate in the new system.

Germany is an example in this respect, as recent statistics show that 28.2% of FinTech companies in Germany co-operate with banks, and four out of the top five German banks have co-operated with such companies, with two of those banks operating their own investment incubators. Financial technology has the potential to reinvigorate an industry which has been traditional in its approach, and slow to adapt to technological advances. The question is not whether or not they are prepared, but rather how quickly UK financial institutions can put themselves in the best possible position to take advantage of the opportunities FinTech brings, so that they remain competitive with new entrants and competitors on the world stage. THE RESPONSE OF THE REGULATOR With such change comes the need for relevant and effective regulation to promote growth, but also to protect consumers. The FCA, unlike some other similar regulators, has a competition mandate.

This means that it does not only deal with the largest market players, but also assists new   MagnaCarta Communications, FinTech Disruptors Report – Startup Banking page 25 (November 2015) 4  MagnaCarta, FinTech Disruptors Report – Startup Banking page 7 5   Ibid. 3 6 06  |  Global Financial Markets Insight . Diagram 1 entrants and innovators. One way in which the FCA has promoted innovation and competition is through the launch of “Project Innovate” and its Innovation Hub, which went live in October 2014. The project looks at emerging issues and barriers to entry in the FinTech industry, and its two main goals were to support innovative firms trying to launch in the marketplace, providing them with a means to open dialogue with the regulator, and also to promote innovation in relation to FCA policy. It also has a focus on developing new technologies to help firms better manage and comply with regulatory requirements (“RegTech”).

A call for input in relation to RegTech was launched at the end of 2015, and there is clearly a focus on not only ensuring relevant regulation, but also using technology to ensure effective compliance. The biggest development of the project was the launch of a regulatory sandbox. This provides a safe space for firms operating in the FinTech space to test out ideas. A report published by the FCA in November 2015 looked at how best to implement the sandbox.

The intention is to open the sandbox to proposals from spring 2016. Interestingly, the sandbox received a cautious reception. It is not a safe harbour and only offers informal guidance and help to launch initiatives; firms could still be caught by current regulations, even if operating within the sandbox.

It seems, however, to be a fairly unique idea and promotes a proactive approach on both the part of the regulator and the firms developing FinTech ideas. What is clear is that the FCA is looking at issues facing the entire industry affecting both small and large players alike. NEXT STEPS AND PREDICTIONS Whilst encouraging innovation should drive efficiencies, growth, diversity and competition in the financial space, it will also be monitored and controlled through regulation to ensure stability. To the fullest extent possible, it is important that regulation promotes rather than restricts innovation. In June 2015, the FCA launched a call for input as to views about specific rules and policies which are restricting innovation and asked what other policies should be introduced to facilitate innovation. The aim is to develop effective and relevant regulation in the FinTech space, allowing companies to develop and promote ideas within an effective regulatory background. The introduction of the EU Payment Services Directive 2 (“PSD2”) provided the means to create an EU-wide market for payments, increasing security and the ease with which cross-border payments can be made. The PSD2 will take effect in 2016 and affects e-money institutions as well as traditional credit and payment institutions.

E-money and e-payments have been a key part of FinTech developments to date. The PSD2 also brings into its scope innovative payment products and services which were excluded from the original Payment www.dlapiper.com | 07 . Services Directive. The introduction of PSD2 could provide significant opportunities to FinTech companies by opening up access to the banks’ payment and information systems. BlockChain ledger technology continues to develop, and there is likely to be a push in the next year to use this for launching large-scale initiatives. BlockChain is being considered by large institutions as a viable means to provide a back-bone for their digital products as they can now effectively and securely record series of transactions. This was seen most recently in the use of a BlockChain system developed by NASDAQ to document and record through NASDAQ share issuance in a BlockChain company. Technology and regulation need to evolve at the same pace to make it easier for both small and large firms to launch new ideas and innovate in the finance space. We are already seeing large strides in the application of technology in the consumer finance sector.

Innovators both small and large should be able to take advantage of the new ideas, and progress is currently being made. The onus is on large institutions to assess which technologies will work within the current and proposed regulatory landscape, and to roll out programmes to make these technological platforms work, if they are to preserve market share in an increasingly competitive finance market. CONCLUSION Investment in FinTech has picked up over the last few years, and confidence in the sector noticeably grew in 2015 as companies perfected their product offerings. Currently, the FCA does not view FinTech developments as a threat to the traditional banking model.

The Director of Competition at the FCA, stated that “traditional financial services may be facing ‘Uber-style’ competition but not yet ‘music streaming-style’ demise.” With the increasing number of FinTech products and successful financings for FinTech companies, all current incumbents will need to remain vigilant to the speed and nature of change or risk a rapid demise. We have advised a number of high-profile clients on a range of cutting-edge projects in recent months, in which FinTech was a key element. From this, it is clear that FinTech will challenge traditional ideas, but it is also able to improve profitability and encourage growth for existing market participants by diversifying their product range, improving efficiencies and reaching a wider consumer base. Recognition by the FCA, the EU and the UK government that regulatory support is required to ensure growth and development of ideas will allow further progress in 2016, and may be the much-needed stimulant for European economic growth. We welcome participants of all sizes that may be interested in testing out the FCA sandbox concept for the development of new and innovative product ideas and concepts. Authored by:  artin Bartlam, Aureilia Storey and M Mariel Luna 08  |  Global Financial Markets Insight .

RECENT DEVELOPMENTS IN PROJECT FINANCE GROWTH IN PROJECT BONDS A global shortfall in infrastructure investment has been identified in the post-financial crisis environment, including by the likes of the European Investment Bank (“EIB”) and the World Economic Forum. This has resulted in the introduction of various initiatives to encourage capital market investment and lending, including EIB’s Europe 2020 Project Bond Initiative and the HM Treasury’s UK Guarantee Scheme. Traditionally, bank debt has been the “go-to” source of project finance. In contrast, the popularity of project bonds has fluctuated over the past decade, reflecting the changing environment in which project bonds have been issued. Prior to 2008, project bonds were commonly insured and “wrapped” by monoline insurance companies. This means that those insurance companies would insure, and act as financial guarantor for, the bond issuance.

Project bonds benefitting from such credit enhancement would accordingly appear more attractive to institutional investors. In 2008 however, those monoline insurance companies started to experience rating downgrades, which contributed to their demise. Project bonds decreased in popularity immediately following this time.

As monoline insurance companies controlled most aspects of construction, their demise also created a void as to how projects were controlled. The post-financial crisis environment has been characterised by heightened capital regulatory requirements, notably those introduced under the “Basel III” framework. As a result, banks have developed stricter lending requirements and a more selective approach to lending and how they deploy their balance sheet. The constriction of available bank funds, together with the shortfall in infrastructure investments, has led a resurgence in the popularity of project bonds. PwC reported that in 2013 there were landmark projects with capital markets involvements in Brazil, Spain, Holland, the UK and France.

In 2014, the first project bond in Italy was issued by a solar company. In 2015 DLA Piper advised, and continues to advise, on a number of project bond issuances and/or projects with capital markets involvement. We have seen that project bonds are more commonly issued alongside and pari passu to senior bank debt, rather than being the sole source of funding for a project. WHY PROJECT BONDS? From the sponsor’s perspective, incentives to obtain funding by way of project bonds may include the lower cost of debt, availability of longer tenure, the ability to directly access capital markets and the ability to gain wider access to funds. From an investor’s perspective, the potential returns of the project bonds (which are usually issued at senior secured level) may outweigh the perceived risk.

Historically, institutional investors have been perceived to be more passive than bank lenders in the funding process, and have experienced difficulties in obtaining the resources required   PricewaterhouseCoopers LLP, ‘Capital Markets, The Rise of Non-Bank Infrastructure Project Finance’, https://www.pwc.com/gx/en/deals/swf/publications/ assets/capital-markets-the-rise-of-non-bank-infrastructure-project-finance.pdf, October 2013 1 www.dlapiper.com | 09 . to undertake the necessary due diligence for project bonds. Post-2008, we have seen parties such as asset managers and fund managers step in to facilitate the negotiation and due diligence aspects for one or more institutional investors. CONSIDERATIONS Finance structures involving project bonds, particularly those issued alongside bank debt, can be complex. For the purposes of this piece we will highlight two key areas to which particular consideration should be given. STRUCTURAL CONSIDERATIONS From the outset it should be noted that bonds typically operate differently to bank facilities with respect to what is traditionally known in bank lending terms as “drawdown”. Whilst parties can agree for bank facilities to be drawn upon a borrower’s request, bonds are typically issued in full and in one issuance on the issue date for the purposes of pricing certainty. The bullet issuance may result in what is commonly referred to as “negative carry” from the issue date. At the time of issue, the bonds will start incurring interest. “Negative carry” refers to the interest that an issuing project company (“ProjectCo”) would incur on funds that are not required at that point in time. There have been a few methods employed to address the issue of negative carry. One such approach has been to enter into an arrangement whereby immediately following the issuances of the bonds by ProjectCo to investors, the bonds are bought back by ProjectCo and held in custody until they are re-purchased over a period of time by the investors. This requires ProjectCo and the investors to commit to purchasing the bonds at specified points in time.

Another approach is for the bonds, following issuance, to remain uncommitted until they are sold to investors at the prevailing market price. Other structural considerations that should be given to project bonds are those which should be given to any bond issuance – including: (i) in what circumstances should mandatory or optional redemption be allowed?; (ii) in what circumstances should make-whole apply?; and (iii) will the bonds be cleared via a clearing system? From a commercial perspective, the answers to the above may result in cost implications. From a legal perspective, those answers would impact the suite of legal documents required to be put in place. In the pre-financial crisis environment monoline insurance companies, in addition to providing credit enhancement, generally also held all the voting rights in intercreditor arrangements. As a result, the challenges that are currently faced with respect to the administration of project bonds were less prevalent at that time. In the current environment, considerations relating to administration of the voting relating to amendments, waivers and consents should include: (i) how the votes will be weighted; (ii) what the voting procedure will be for each creditor group (institutional investors for example are perceived to be more passive than bank lenders); and (iii) how each creditor group will be represented. Administration of intercreditor arrangements may be challenging particularly where there are a large number of bondholders, particularly if held through a clearing system. Tailored approaches can be used to address the intercreditor requirements of the funding group, including where there are a large number of bondholders.

Tailoring may include: â– â–  appointing a different agent for each creditor group, with those agents feeding through to a common agent; â– â–  establishing entrenched rights for certain creditor groups which are exercisable without the consent of the common agent; â– â–  dividing matters requiring voting into: (i) minor matters that the common agent may make a decision in respect of without creditor vote (with notification of the decision being sufficient); (ii) matters that require majority resolution; and (iii) matters that require unanimous resolution; â– â–  designating a “controlling creditor” (with reference to priority of each finance party); and â– â–  deferring certain decisions to the advice of independent experts. MOVING FORWARD With the continued shortfall in infrastructure investment and regulatory constraints faced by bank lenders, we expect to see a continued increase in market activity with respect to project bond issuances. If a sponsor or ProjectCo chooses to proceed with a project bond issuance, particular consideration needs to be given to matters such as, without limitation, the structure of the bond and interaction of bondholder’s rights with other creditors. INTERCREDITOR CONSIDERATIONS Special consideration should be given to intercreditor arrangements, especially where there is more than one source of funding. 10  |  Global Financial Markets Insight Authored by: Ronan Mellon and Mei Mei Wong . THE IMPLEMENTATION OF THE BRRD IN ITALY REMARKS ON THE BAIL-IN TOOL On 16 November 2015, Italy implemented the European Bank Recovery and Resolution Directive (“BRRD”)1 through the publication in the Italian Official Gazette of the Legislative Decrees no. 180 and no. 181 (the “Decrees” and, respectively, the “Decree 180” and “Decree 181”). While Decree 180 is aimed at implementing BRRD provisions on resolution, and identifies Bank of Italy as the resolution authority for Italian banks, Decree 181 amends certain provisions of the Italian Consolidated Banking Act 2 and the Italian Consolidated Financial Act3, dealing in particular with recovery plans, early intervention and creditors’ hierarchy in bank insolvency proceedings. In broad terms, the Decrees seem to be very much in line with the BRRD provisions. Among the different resolution tools provided in the BRRD, the bail-in tool has a potential adverse impact directly on bondholders’ rights and banks’ funding costs on the markets. The bail-in tool enables authorities to recapitalise a failing bank through the write-down of liabilities and/or their conversion to equity4.

The write-down will follow the ordinary allocation of losses and ranking in insolvency. Equity has to absorb losses in full before any debt claim is subject to write-down. After shares and other similar instruments, it will first, if necessary, impose losses on holders of subordinated debt and then evenly on senior debt-holders. The Decrees contain some noteworthy details, namely an “extended” depositor preference in the insolvency ranking, and a specific provision concerning the institutional protection schemes’ and cooperative mutual solidarity systems in the bail-in context.   Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms 1   Legislative Decree No.

385 of 1 September 1993 2   Legislative Decree No. 58 of 24 February 1998 3   Resolution authorities shall not exercise the write down or conversion powers in relation to liabilities excluded under article 44(2) BRRD, i.e. deposits protected by a deposit guarantee scheme, secured liabilities backed by assets or collateral, short-term inter-bank lending or claims of clearing houses and payment and settlement systems (that have a remaining maturity of seven days), client assets, or liabilities such as salaries, pensions, or taxes.

Resolution authorities may also exclude other liabilities from bail-in, subject to certain conditions set out in article 44(3) BRRD 4 www.dlapiper.com | 11 . Diagram 2 Ranking of senior unsecured debts until 31 December 2018: Common Equity Tier 1 Additional Tier I Tier 2 Capital THE “EXTENDED” DEPOSITOR PREFERENCE The Decree 1815 amends rules concerning creditors’ hierarchy in bank insolvency proceedings. In accordance with article 108 BRRD, preference is granted to covered deposits (i.e. those benefitting from the protection of the deposit guarantee schemes provided by Directive 2014/49/EU) and non-covered deposits by individuals and small and mediumsized enterprises. The rationale for this extended depositor preference seems to be twofold. On one side, it should facilitate the bail-in of the unsecured debt instruments ranking below all deposits, shielding the resolution authority from claims for violation of the “no creditor worse off” principle6 .

On the other side, the bail-in of such unsecured debt instruments is perceived to carry a lower contagion risk and to have a less disruptive impact on the real economy when compared to the bail-in of a more stable source of funding such as deposits. Nonetheless, to be eligible for the purposes of the forthcoming Total Loss Absorbing Capacity (“TLAC”) requirement, such unsecured debt instruments should be subordinated to all TLAC excluded liabilities, not only deposits7. The statutory subordination to all deposits other than those covered by article 108 BRRD will enter into force in resolution and liquidation proceedings commenced after 1 January 20198. As suggested by CONSOB and by the Italian Banking Association (ABI), such a postponement should partially reduce the negative impact on holders of bank debt instruments who have purchased such securities before the Subordinated Debt Senior Unsecured Debt Deposits exceeding EUR 100,000 (art. 108 BRRD) – from natural persons , micro enterprises , and small and medium-sized enterprises. – from natural persons, micro enterprises, and small and medium-sized enterprises made in branches of EU banks outside EEA. Diagram 3 Ranking of senior unsecured debts from 1 January 2019: Common Equity Tier 1 Additional Tier I Tier 2 Capital OWN FUNDS However, Decree 181 goes beyond the preferential treatment afforded by article 108 BRRD, by establishing also that all other deposits (i.e.

not only those preferred pursuant to article 108 BRRD) shall rank senior to other unsecured debt, immediately after covered deposits, deposit guarantee schemes and the part of individuals’ and SMEs deposits exceeding the guaranteed threshold (i.e. EUR 100,000). This will result, for example, in senior unsecured bondholders’ claims ranking below all deposits, including large corporate and interbank deposits. OWN FUNDS In addition, with a view to spot further particularities of the Italian implementation of the bail-in tool, it is worth mentioning the recent warnings issued by the Italian securities and markets regulator (CONSOB) in respect of the impact of BRRD rules (particularly in relation to bail-inable instruments) on investment services. Subordinated Debts Senior Unsecured Debt Deposits exceeding EUR 100,000 (Decree 181) – rom enterprises other than SMEs and f micro enterprises. – nterbank deposits with a maturity > 7 days i Deposits exceeding EUR 100,000 (art. 108 BRRD) – from natural persons , micro enterprises , and small and medium-sized enterprises. – rom natural persons, micro enterprises, and f small and medium-sized enterprises made in branches of EU banks outside EEA.   See article 91 (1-bis) of the Italian Consolidated Banking Act, as amended by Decree 181 5   See article 34(1) g) BRRD, which states that “no creditor shall incur greater losses than would have been incurred if the institution […] had been wound up under normal insolvency proceedings[…]” 6   In these terms, see the Opinion of the European Central Bank of 16 October 2015 on recovery and resolution of credit institutions and investment firms (CON/2015/35), paragraph 3.7.2. 7   The preferential treatment for deposits covered by article 108 BRRD is instead applicable from the entry into force of the Decrees 8 12  |  Global Financial Markets Insight .

entry into force of the Decrees. The diagrams illustrate the pecking order applicable in Italy before and after 1 January 2019 respectively. THE INSTITUTIONAL PROTECTION SCHEMES AND COOPERATIVE MUTUAL SOLIDARITY SYSTEMS ROLE IN THE BAIL-IN CONTEXT The Decree 180 provides a specific paragraph apparently relating to the role of the institutional protection scheme (IPS) and cooperative mutual solidarity system in the context of the application of the bail-in tool. Article 52, paragraph 7 of Decree 180 provides that, unless otherwise specified, in case of liability subject to the bail-in tool, the exercise of the bail-in tool does not affect the rights of the creditor against any jointly liable debtor, any guarantor or other third party obliged to fulfill the obligation relating to such written-down liability. Moreover, the right of recourse by such joint debtor or guarantor against the entity under resolution, or against entities that are part of the same group, is permitted within the limits of the amounts due after the application of the bail-in tool. Such paragraph seems to take into account the important function played by banks’ mutual solidarity system. For example, in July 2015, during the liquidation process of Banca Romagna Cooperativa, a small Italian mutual bank, shareholders and junior bondholders were “bailed-in” but did not suffer any loss as the Italian mutual sector’s Institutional Guarantee Fund decided to reimburse them to preserve the reputation of the sector 9. Such guaranteed liabilities cannot be considered as secured liabilities excluded by the application of the bail-in tool. Indeed, as clarified by the European Banking Authority (“EBA”)10 “guarantees or liabilities guaranteed by third party are not considered as secured liability in the meaning of article 43(2)(b) [of BRRD] because that concept must be interpreted as covering only liabilities secured/guaranteed by assets of the institution under resolution”. Such a provision seems thus to meet the concerns raised by co-operative banks in order to consider the peculiarities of their mutual solidarity system and is also consistent with BRRD provisions11. THE IMPACT OF THE BRRD RULES ON THE PROVISION OF INVESTMENT SERVICES Following the first application of the rules envisaged in the Decrees12, CONSOB has stepped in and issued Communication no.

0090430 dated 24 November 2015 (the “Communication”) with a view to warning market operators of the impact of the BRRD rules in the context of the provision of investment services to clients. Pursuant to the Communication, bail-inable securities issued by Italian issuers or foreign issuers subject to other European resolution authorities must be clearly identified by the intermediaries. These should alert their customers about the potential risks and consequences relating to write-down and conversion to equity measures in the case of application of a resolution tool. The aim of this provision is to allow the investor to evaluate and understand the bail-in risks in order to take informed investment decisions.

Investors (and prospective investors) should also be informed that public support to failing financial institutions must only be used after the application of the resolution tools. The degree of information to be provided may vary according to the status of the client (professional or retail). While the intermediaries are free to choose the most suitable means to deliver the information, to minimise compliance risks, they should keep records in order to be able to show the delivery of such information to the clients. Pre-contractual information shall be supplemented and updated if necessary, for both new and current clients. This duty relating to the update of the contractual information is also applicable to the ancillary service of safekeeping and administration of financial instruments. In the case of portfolio management, the service provider can inform their clients through the periodic statement, while in the case of new contracts the clients can be informed during the pre-contractual phase. Furthermore, according to the Communication, intermediaries shall also review their internal procedures for the evaluation of suitability and appropriateness, considering the features of each type of financial instrument potentially affected by the BRRD rules. Authored by: Luciano Morello   See, for further details, the press release by Fitch Ratings https://www.fitchratings.com/site/fitch-home/pressrelease?id=988610 9   See EBA Q&A 2015_1779 10 11   Particularly with Recital 14 of BRRD, pursuant to which “Authorities should take into account the nature of an institution’s business, shareholding structure, legal form, risk profile, size, legal status and interconnectedness to other institutions or to the financial system in general, the scope and complexity of its activities, whether it is a member of an institutional protection scheme or other cooperative mutual solidarity systems[…] in the context of recovery and resolution plans and when using the different powers and tools at their disposal, making sure that the regime is applied in an appropriate and proportionate way and that the administrative burden relating to the recovery and resolution plan preparation obligations is minimised” 12   Reference is made here to the resolution of the following four banks: Banca Marche, Banca Popolare dell’Etruria e del Lazio, Cassa di Risparmio di Ferrara, and Cassa di Risparmio di Chieti.

For a brief summary of the resolution scheme see the note produced by the Bank of Italy here: https://www.bancaditalia. it/media/approfondimenti/documenti/info-banche-en.pdf?language_id=1 12   See, for further details, the press release by Fitch Ratings https://www.fitchratings.com/site/fitch-home/pressrelease?id=988610 www.dlapiper.com | 13 . LIFE ON THE MARGIN US MARGIN RULES FINALISED AT LAST In December 2015, over five years after the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), the US Commodity Futures Trading Commission (“CFTC”) adopted a final rule regarding margin for uncleared swaps (the “CFTC margin rule”) and an interim final rule exempting non-financial and certain other end-users who are eligible for the end-user clearing exception from the scope of the CFTC margin rule. Accordingly, non-financial end-users who rely on the enduser exception are exempt from margining requirements. The CFTC’s final rule supplements the final margin rule adopted in October 2015 by a group of US “prudential regulators”, namely the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation and the Farm Credit Administration and the Federal Housing Finance Agency (the “Bank margin rule”). The CFTC deferred to the “prudential regulators”, such that any swap entered into by a swap dealer (“SD”) or major swap participant (“MSP”) that is regulated by a prudential regulator is subject to the Bank margin rule and not the CFTC margin rule. While the two rules are not identical, the CFTC indicated in its discussion that the CFTC margin rule “essentially provide[s] for the same treatment as the [Bank margin rule] with a few exceptions”1. The CFTC margin rule and the Bank margin rule are collectively referred to herein as the “margin rules”. WHAT TRADES ARE COVERED? The margin rules apply only to uncleared swaps entered into after the applicable compliance date. Based on the Secretary of Treasury determination in 2012 to exempt foreign exchange swaps and deliverable foreign exchange forwards from the definition of “swap” for purposes of application of margin rules and for certain other purposes, transactions in these products are not required to be margined under the margin rules.2 Cross currency swaps3 are covered, but initial margin calculated using a model need not recognise any risks or risk factors associated with the fixed, physically-settled foreign exchange transactions associated with the exchange of principal embedded in the uncleared cross-currency swap.4 Non-deliverable foreign exchange forwards and currency options are considered swaps and are covered by the margin rules.   81 Fed.

Reg. 638 (January 6, 2016) 1   Foreign exchange swaps and deliverable foreign exchange forwards are counted in the calculation of “material swaps exposure” for the purposes of calculating initial margin requirements 2   a cross-currency swap, one party exchanges with another party principal and interest rate payments in one currency for principal and interest rate In payments in another currency, and the exchange of principal occurs upon the inception of the swap, with a reversal of the exchange of principal at a later date that is agreed upon at the inception of the swap 3   17 CFR §23.154(b)(2)(iv) 4 14  |  Global Financial Markets Insight . The margin rules require bilateral margining by both SDs and MSPs and their counterparties who are subject to the margin rules. WHAT TYPES OF ENTITIES ARE COVERED? The margin rules apply to covered swaps if (i) both parties are SDs or MSPs or (ii) one party is an SD or MSP and the other party is a “financial end-user”. Financial end-users are non-SDs and non-MSPs and include, but are not limited to: â– â–  Banks and other depository institutions; â– â–  Bank holding companies; â– â–  State-licensed credit or lending entities, including finance companies, money services businesses and currency dealers; â– â–  Securities holding companies, brokers, dealers, investment companies and investment advisers; â– â–  Private funds5; â– â–  Commodity pools, commodity pool operators and commodity trading advisors; â– â–  Employee benefit plans, including ERISA plans; â– â–  Insurance companies; and â– â–  Entities or arrangements that raise or accept money for clients or investors or use their own funds for investing or trading in loans, securities, swaps funds or other assets. Securitisation vehicles that fit within any of the enumerated categories are covered. The following entity types are excluded from the definition of “financial end-user”: â– â–  Sovereign entities; â– â–  Multilateral development banks; â– â–  The Bank for International Settlements; â– â–  Captive finance companies whose swaps are exempt from clearing; and â– â–  Treasury affiliates whose swaps are exempt from clearing or otherwise exempt from the CFTC margin rule by rule. WHAT ABOUT INTER-AFFILIATE SWAPS? Inter-affiliate swaps are treated differently under the two margin rules. CFTC MARGIN RULE Under the CFTC margin rule, initial margin generally is not required to be posted if the conditions set forth for a clearing exemption in the CFTC’s 2013 final rule entitled “Clearing Exemption for Swaps Between Certain Affiliated Entities” are satisfied.6 However, SDs and MSPs that are subject to the CFTC margin rule must collect initial margin from non-US affiliates that are not subject to comparable initial margin requirements on these affiliates’ swaps with third party financial end-users. In addition, SDs and MSPs trading with affiliates that are subject to the Bank margin rule must post initial margin as required by that rule. Variation margin must be posted to and collected from each affiliate that is a SD, MSP or financial end-user. BANK MARGIN RULE Under the Bank margin rule, a covered SD or MSP must collect initial margin from its affiliate counterparties that are SDs, MSPs or financial end-users, and must post initial margin only to SD and MSP affiliates, in each case subject to a US$20 million threshold.

If the covered SD or MSP is not required to post initial margin, it still must calculate daily the amount of initial margin that would have been required if its counterparty was not an affiliate. Variation margin must be posted and collected to and from each affiliate that is a SD, MSP or financial end-user. WHAT ARE THE INITIAL MARGIN REQUIREMENTS? SDs and MSPs must collect initial margin from, and post initial margin to, financial end-users that have “material swaps exposure” and to other SDs and MSPs regardless of exposure. An entity has material swaps exposure if the average daily notional amount of its uncleared swaps, including securitybased swaps, deliverable foreign exchange forwards and foreign exchange swaps, exceeds US$8 billion during June, July and August of the previous year. Initial margin may be calculated using an approved risk-based model or based on a standardised table that sets minimum gross margin requirements based on product type and trade duration. SDs and MSPs may apply an initial margin threshold of up to US$50 million on a consolidated entity level including all affiliates of both parties, subject to a minimum transfer amount (“MTA”) not to exceed US$500,000 in aggregate with the MTA applied to variation margin.

Initial margin must be held   The term “private fund” refers to the definition of that term in Section 202(a) of the Investment Advisers Act of 1940, as amended, and means an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940, but for the exclusions provided in Section 3(c)(1) or 3(c)(7) of that Act (e.g., hedge funds, private equity funds, and other privately offered investment funds) 5   17 C.F.R. § 50.52. 6 www.dlapiper.com | 15 . for the duration of the transaction with a qualifying custodian under the applicable custodian rules and may not be offset against variation margin collected from the counterparty. WHAT ARE THE VARIATION MARGIN REQUIREMENTS? On a daily basis, SDs and MSPs must collect variation margin from, and post variation margin to, financial end users and to other SDs and MSPs, in each case regardless of exposure. No threshold is permitted, although an MTA not to exceed US$500,000 may be employed to the extent not used in the determination of initial margin. WHAT TYPES OF COLLATERAL CAN BE POSTED? The margin rules specify permissible collateral types for initial and variation margin. Variation margin must be posted in cash in any major currency or a currency of settlement of the swap. The permissible collateral types for initial margin are broader and include US Treasuries and other enumerated securities. The margin value of securities posted as collateral must be reduced by haircuts of at least the amounts set forth in the margin rules. WHAT DOCUMENTATION IS NEEDED? Each SD and MSP must execute documentation with each counterparty that complies both with the CFTC’s swap trading relationship documentation rules and the margin rules.

The CFTC’s swap trading relationship documentation rules require credit support arrangements including initial and variation margin requirements, if any, eligible collateral types with haircuts, investment and rehypothecation terms, and custodial arrangements.7 When an SD or MSP enters into uncleared swaps with another SD or MSP or a financial end-user, margin documentation must contain initial and variation margin terms that comply with the requirements of the margin rules. Margin documentation must contain specified valuation, initial margin calculation, and dispute resolution procedures.8 Title transfers such as those effected under the ISDA Credit Support Annex (“CSA”) subject to English law published in 1995 would not be effective margin transfers under the margin rules.9 As expected by the industry, it is likely that parties will be required to use new collateral documentation tailored specifically for the margin rules.   17 CFR §23.504(b)(3) 7   17 CFR 23.158(b) 8   81 Fed. Reg. 672 (January 6, 2016) 9   81 Fed.

Reg. 686 (January 6, 2016) 10 11   See 81 Fed. Reg.

670 (January 6, 2016) 16  |  Global Financial Markets Insight HOW IS NETTING APPLIED? In order to net exposures for both initial and variation margin, parties subject to the margin rules must have an “eligible master netting agreement”. The CFTC indicated in its discussion of the CFTC margin rule that it intended the criteria for an “eligible master netting agreement” to be “consistent with industry standards currently being used”10 for determining eligibility for netting for bank regulatory capital purposes. This requirement would foreclose netting when SDs and MSPs trade with financial end-users organised in jurisdictions in which industry standard legal opinions are not available and with counterparty types where the SD or MSP cannot (or does not) obtain required netting and enforceability opinions. The margin rules contemplate that swap participants may create separate margining portfolios under a single eligible master netting agreement, with margining occurring on a net basis within each separate margining portfolio.

For example, parties could use their existing pre-compliance collateral documentation, if any, to margin (or not margin) all swaps executed prior to the relevant compliance date, and use post-compliance collateral documentation to margin only a portfolio of post-compliance trades. However, the margin rules require that each swap under a separate margining portfolio be margined in accordance with the margin rule requirements if at least one swap in the portfolio is a covered by the rule. That is, if separate margining portfolios are not created, then the margin rules will apply to both pre-compliance and post-compliance swaps. It does not appear mandatory that the netting and enforceability opinions required for an “eligible master netting agreement” set forth the differences under applicable insolvency law, if any, between the treatment of separate margining portfolios under a single eligible master netting agreement and such an agreement with a single margining portfolio. WHAT ARE THE CUSTODIAN REQUIREMENTS? The margin rules do not require any variation margin to be held with a custodian.

However, all initial margin posted and collected under the margin rules must be held with an unaffiliated custodian pursuant to an enforceable custody agreement and may not be rehypothecated. Accordingly, SDs and MSPs will need to obtain enforceability opinions on its custody agreements in the jurisdictions of both the custodian and its counterparty.11 . WHEN ARE THE COMPLIANCE DATES? â– â–  The margin rules contain phased compliance dates based on the magnitude of the parties’ swap positions. The compliance dates are as follows: 1 September 2017, for initial margin, if the ADANA exceeds US$2.25 trillion during March, April and May of 2017; â– â–  1 September 2018, for initial margin, if the ADANA exceeds US$1.5 trillion during March, April and May of 2018; â– â–  1 September 2019, for initial margin, if the ADANA exceeds US$0.75 trillion during March, April and May of 2019; and â– â–  1 September 2020, for all other initial margin. â– â–  â– â–  1 September 2016, if the average daily aggregate notional amount of both parties’ and their qualifying affiliates’ uncleared swaps, including security-based swaps, deliverable foreign exchange forwards and foreign exchange swaps (collectively, the “ADANA”), exceeds US$3 trillion during March, April and May of 2016; 1 March 2017, for variation margin between SDs and MSPs and any other counterparty; Authored by: Marc Horwitz, Claire Hall and Bradley Phipps www.dlapiper.com | 17 . PEER-TO-PEER LOAN SECURITISATION WILL 2016 SEE THE UK’S FIRST PEER-TO-PEER LOAN SECURITISATIONS? The peer-to-peer lending industry in the UK is going through a period of rapid growth. As it becomes a more mainstream source of borrowing for consumers and SMEs, market participants have been examining the possibility of securitising portfolios of peer-to-peer loans as a means of driving further growth. Peer-to-peer lending was originally seen as a way of one individual or company lending to another without the involvement of a bank or other financial institution. As the sector has evolved, a large proportion of the lenders on these platforms are now hedge funds, asset managers, banks and other institutions.

As a result, this type of lending is increasingly (and perhaps more accurately) referred to as “marketplace lending”. Marketplace lenders typically use centralised electronic platforms to automate loan origination and servicing, which means that they generally have a lower cost base than traditional lenders. This has enabled them to pass on cost savings to customers and take market share from the banks. As the marketplace lending industry grows, participants are looking at ways to increase the availability of capital, and diversify their funding options. 18  |  Global Financial Markets Insight US LEADING THE WAY The first securitisation of marketplace loans was closed in October 2013. This deal was put together by Eaglewood Capital Management in the US, who sourced loans from LendingClub and securitised them in an unrated deal. This was followed in 2015 by the launch of the first rated transactions, including the Consumer Credit Origination Loan Trust 2015-1 transaction arranged by BlackRock Financial Management, which pooled loans originated by Prosper Funding.

The issuance of rated notes further opened up the sector in the US, enabling investors such as insurers and pension funds to gain exposure to assets that would otherwise be outside the scope of their investment remit. The rating agencies have noted significant levels of interest in this sector, primarily for transactions such as the BlackRock deal, which involve third party investors acquiring loans from a platform with a view to securitising them, but also for origination platforms seeking to securitise their loans directly. Some consider it to be just a matter of time until these types of transaction cross the Atlantic. Jonathan Kramer, director . of sales at Zopa, was quoted in CityAM late last year as saying “Securitisation is coming to Europe, and that’s a good and healthy thing.” THE BENEFITS FOR MARKETPLACE LENDERS Securitisation allows institutions that otherwise would not have a mandate to invest in marketplace loans to gain exposure to this asset class. Financial institutions have been buying loans themselves, extending warehouse credit to buyers or, in some cases, partnering with platforms directly, such as Citigroup’s tie up with Prosper in the US. These institutions often cannot or will not make these types of loans themselves, but want to gain exposure to this market and the yields it offers. Gaining access to additional liquidity and raising funds in a way that represents an efficient cost of capital also allows marketplace lending platforms to offer better products and rates to their customers, which further drives the growth of the business. It is worth noting that the marketplace lending industry encapsulates a broad spectrum of assets and models. Many differences exist in the focus, type of lenders, borrowers and policy in terms of loan size as well as credit criteria and operational setup. Not all of them will lend themselves to securitisation – we have already seen that certain platforms have attracted more investment from institutional investors than others.

The level of diligence undertaken by these institutions gives comfort to other investors as to the model used by these platforms, and can serve as a legitimisation of the platform. The marketplace lenders hope that this effect would be even more pronounced for any platform that embarks on a securitisation of its loans, because the process of executing a securitisation transaction would involve the marketplace lender opening itself up to high levels of scrutiny by the arranging banks and credit rating agencies. CREDIT ISSUES ARISING FROM MARKETPLACE LENDING One concern that is often raised in relation to marketplace lending is that many platforms are still evolving, and that we have not yet seen how they perform through a significant downturn in the credit cycle. Some may argue that traditional SME or consumer loan portfolios provide an appropriate indication of historical performance of this asset class. However, the rating agencies have taken a fairly conservative view on this, and see limits in comparing different asset classes in past economic scenarios to determine future performance, citing the fact that performance data for meaningful origination volumes may only exist for two to three years.

If the term of the loans is three to five years, this is not a sufficient timeframe to define a robust performance benchmark. They argue that data from non-marketplace lenders does not provide a direct comparison because of the differences in origination channels and possible borrower behaviour. The speed of evolution may also give rise to operational risk. In the US, loan volumes have not been able to keep up with demand and some are concerned that increases in the number of loans extended might mean that origination will outpace the development of the underlying infrastructure. Sound operational frameworks are critical to the success of marketplace loans, as a securitisation asset class as the fundamental requirement of uninterrupted cash flows hinges on this aspect of the lender’s business. Another element of operational risk relates to servicing. Marketplace lenders are typically smaller and have considerably shorter track records than servicers of the traditional asset classes.

However, this risk can be mitigated by putting in place an effective back-up servicing arrangement. It is likely that any securitisation of marketplace loans would require a backup servicing arrangement, which includes a warm backup servicer from the outset with appropriate trigger events for ratcheting up to a hot backup servicer should defaults occur. It is hoped that many of the risks that are specific to marketplace lending can be mitigated by the large amounts of data that marketplace lenders provide to investors, as this differentiates them from their traditional counterparts. Many lenders post their loan books online, so investors are able to analyse the quality and performance of their debt on a loan by loan basis. Any indication of a rise in bad debts would be immediately apparent.

In the UK three leading lenders – Zopa, RateSetter and Funding Circle – have made their loan book details available to the public through analyst AltFi Data. This enables borrowers, lenders and other interested parties to see exactly where the money is going, as well as the risk levels and potential returns. In spite of the vast amounts of data that is made available, a further obstacle to securitisation may be a perceived lack of transparency. Some platforms base origination decisions on algorithms, others on analysis of historical data. Algorithms that determine a borrower’s creditworthiness are proprietary, and there is a limit to how much information platforms are willing to divulge, which means there may be question marks over various aspects – such as the use of social media data for scoring purposes.

Where lenders only provide general details on the underwriting criteria that have been considered without disclosing the precise process followed to reach a credit decision, investors may seek more representations and warranties with respect www.dlapiper.com | 19 . to the underlying loans than would have been the case in a traditional consumer loan securitisation. The more transparent origination and servicing methods are, the easier it will be to securitise the loans. Concerns have been expressed about marketplace lending platforms not having “skin in the game”, because their own balance sheet is not being used to originate loans. The fact that the platform’s balance sheet is not being used to originate loans is indeed one of the distinguishing features of this asset class, but this does not necessarily mean that they do not have anything at stake. The platforms would argue that this is mitigated by transparency.

If origination standards were to drop, this would be immediately obvious through the online platform, and investor demand would drop. Any structures will also need to address the regulatory requirements for risk retention. platforms to dramatically increase available capital, and as more platforms develop the critical mass and operational history required to support this kind of transaction, it appears to be a matter of time before a securitisation of UK marketplace loans is successfully executed. However.

whether wider economic headwinds and market developments mean this happens in 2016 remains to be seen. There is a perception that to date, the marketplace lending sector has had less regulatory scrutiny than other parts of the finance industry. This leads to a concern that securitisation may lead to an increased focus, and new rules being imposed by the regulatory authorities. However, it is hoped that the existence of a specific regulatory regime for marketplace lending in the UK would at least help to mitigate this in the UK. OUTLOOK FOR UK DEALS The development of the wider ABS market in the UK over the next twelve months is likely to be a critical factor in determining whether we see the successful launch of the first UK marketplace loan securitisation deal.

A substantial volume of loans has been and continues to be divested by the large UK financial institutions, and assuming that a proportion of these portfolios will be refinanced by way of securitisation, the potential supply of Sterling denominated ABS paper in 2016 may make it difficult for this new asset class to achieve the pricing levels that would make the transaction viable – particularly in light of the conservative approach that appears likely to be taken by the credit rating agencies. If there is capacity to enter into currency swaps this may be less of an issue, but either way, the price discovery process is likely to be a challenge for the early transactions. As the marketplace lending platforms continue to originate more loans and gain market share, it is inevitable that they will seek to further diversify their sources of funding. Securitisation of marketplace loans is one way for marketplace lending 20  |  Global Financial Markets Insight Authored by: Steven Krivinskas .

BONDING INTO CLIMATE CHANGE SOLUTIONS With the recent successful completion of COP21, the Paris Global Climate Change Conference, resulting in a global climate accord, worldwide attention is now being focused on follow-through measures by the various countries of the world to achieve the ambitious carbon-reduction goals of the accord and to expand on these goals over the next five years. In addition to the governments of all of the major developed and emerging economies of the world that assembled in Paris, there is increasing buy-in by large corporations around the world to the notion of becoming a part of the solution rather than a contributor to climate change. Companies as diverse as Coca-Cola, Bank of America, Goldman Sachs, Citibank, Kellogg, DuPont, General Mills, HP, Total, Unilever, BP and Royal Dutch Shell not only attended the Paris conference but have pledged to be part of the solution to climate change. In addition to pledges of financial support from the developed nations to assist the developing countries in making the transition to a low-carbon economy, technological and financial innovation were highlighted in the accord as two of the keys for achieving the targeted carbon reductions. Large financial institutions like Goldman Sachs and Citigroup are making major commitments to sustainability. Goldman Sachs recently announced that it was tripling the goal set in 2012 for clean-energy finance and investment arrangements, and that its new goal was US$150 billion of clean energy finance and investment arrangements by 2025. Kyung-Ah Park, the head of Goldman Sachs Environmental Markets, stated that “Environmental issues have become increasingly relevant to our clients and our investors, and have become core to our business.” Citigroup, in a report entitled “Energy Darwinism II— Why a Low Carbon Future Doesn’t Have to Cost the Earth,” published in August of 2015, estimated that energy efficiency and renewable energy will require capital investment of US$13.5 trillion and US$8.8 trillion, respectively, over the next 20 years.

(Standard & Poor’s has recently estimated that it will require US$13.5 trillion of capital investments by 2030 to achieve the international goal of avoiding a two degrees centigrade increase of average global temperatures.) The Citi report concluded that there are adequate capital reserves to fund these investments, but the missing link is lack of availability of investment vehicles of sufficient quality (i.e. investment grade). www.dlapiper.com | 21 . Viewed in the context of this challenge, the acceleration of securitisation activity in the solar energy sector in the US can be seen as a concrete positive step toward creating investment grade vehicles to address climate change. Solar is, of course, only one of many mechanisms that must be deployed to meet the goals of COP21. To do so will require the creation of financial instruments covering all aspects of renewable energy, energy efficiency, natural resource allocation and preservation and carbon sequestration, to name a few. However, a closer look at some of the obstacles that have to be overcome in order for solar projects to gain access to the capital markets and some of the solutions used to overcome those obstacles provides a useful roadmap for the territory ahead. One of the primary catalysts for the growth of the solar securitisation market in the US was the Solar Access to Public Capital (“SAPC”) working group organized in late 2012 by the National Renewable Energy Laboratory (“NREL”). Backed by a three-year funding facility from the US Department of Energy (“DOE”), NREL was instrumental in organising the solar, legal, banking, capital markets, engineering and other relevant stakeholder communities around the common purpose of identifying barriers to entry inhibiting solar projects from gaining access to the lower-cost financing of asset-backed securitisation. Some of the initial projects of SAPC included standardized solar leases and power purchase agreements, statements of best practices, and aggregation of data on the financial and technological performance of solar assets. The scarcity of data was a major impediment to obtaining investment grade ratings from the rating agencies, and Standard & Poor’s, which took the lead among the rating agencies in developing rating methodologies for solar assets in the US, proclaimed early in the process that because of the scarcity of data, the highest rating that could be assigned in the foreseeable future to solar securitisations was BBB+.  However, as significant as the scarcity of data was, the major presence of tax equity in the typical capital structure of solar projects loomed at least as large as another impediment to entering the capital markets. In both residential and commercial/industrial solar finance structures, tax equity usually occupies a significant portion of the capital stack, ranging from 40% to 50%. Tax equity is usually provided by large financial institutions or operating companies with sufficient tax exposure to utilize the investment tax credits in particular, as well as the depreciation and other tax benefits that, together with cash returns, comprise their overall yield. In order to realize the tax benefits from solar projects, tax equity investors must have either a real or deemed ownership interest in the assets generating the energy credit and other tax attributes. Tax equity usually acquires this in the form of participation in a partnership or limited liability company.

Because the energy tax credit which tax equity receives upon the commissioning of the solar assets, which 22  |  Global Financial Markets Insight is equal to 30% of the tax basis in the assets, is subject to recapture in the event of a disposition of the assets over a five-year period, tax equity investors are resistant to subjecting those assets to the liens of indebtedness which could result in a foreclosure and therefore a deemed disposition for tax purposes. Moreover, tax equity often negotiates for protection against an Internal Revenue Service audit of the valuation used in computing the energy tax credit, by requiring the sponsor/developer of the solar project to indemnify the tax equity investor against a reduction of the credit resulting from a reduction in the value on which the credit was based. Finally, tax equity investors require certain control rights over major decisions of the entity owning the solar assets. These requirements, both separately and in the aggregate, run counter to the requirements of noteholders in an asset securitisation transaction.  These noteholders normally require that the assets securing their notes be encumbered by a first lien position in their favor, and that they be given rights to foreclose and sell the assets in the event of a default in the payment of their notes. Moreover, noteholders require control rights upon the occurrence of default events which give them the right, through the indenture trustee, to take various steps with respect to the collateral. Finally, noteholders in securitisation transactions are dependent upon cash flow generated from the assets being available to them to service their debt and to fill any reserve requirements under the indenture. Therefore, the existence of a potential indemnification liability on the part of the issuer of the notes creates a serious cloud over the viability of these cash flows. A further cloud is created by the fact that the tax equity investor normally is entitled to a priority claim on cash flows up to a level sufficient to give it a minimum cash return to supplement the tax benefits which it realizes on the investment. Although this priority cash return is small relative to the total cash flow in most transactions, it is a further encroachment on cash flow that otherwise would be available to the securitisation noteholders. It was these headwinds – insufficiency of historical data and inconsistent requirements of tax equity – that prevented several companies with sufficient assets to support a securitisation transaction from issuing rated solar assetbacked securities, until SolarCity, the largest residential solar installer in the U.S., issued its first securitisation in November of 2013.

However, this securitisation, like the two that followed in April and July of the following year also issued by SolarCity, sidestepped the tax equity problem by selecting solar assets that were not involved in tax equity structures. During the same period of time, the SAPC working group undertook an additional project-the submission to the statistical ratings agencies of simulated rating requests based on hypothetical portfolios of solar assets that were based on actual portfolios with a distribution of pool characteristics that was representative of those present in solar portfolios of the leading solar developers which had . shared their data on an anonymised basis with the SAPC working group. The legal structures presented in these mock rating submissions were developed by the legal team working on the mock rating project based on their best judgment of how a solar ABS transaction should be optimally structured, and these structures were presented in significant detail through definitive term sheets, transactional diagrams, and flow of funds charts. The central goal of the mock ratings project was to engage the ratings agencies, which were at various stages of developing solar ratings methodologies, in a productive dialogue that would provide a two-way information flow between the ratings community and the distributed solar industry and which would thereby accelerate the evolution of thinking on how solar ABS transactions should be structured to minimise risk, maximise ratings levels, minimise the cost of capital and at the same time maximise the advance rates achievable in rated solar ABS transactions.  Two different mock filings were developed – one for a hypothetical residential solar portfolio and one for a hypothetical commercial and industrial portfolio. The residential securitisation was envisaged as providing funds for the sponsor to buy out the tax equity investor after the 5-year recapture period, thus, as in the first three SolarCity securitisations referred to above, finessing the problem of detangling the Gordian knots that were impeding securitising from tax equity structures.

However, the mock commercial securitisation was structured with the tax equity remaining in the structure and thus was forced to confront the friction points described previously.  In addition to accelerating the learning curve for both the solar installer and the rating constituencies and the resulting development of ratings methodologies and transaction structures that are defining the solar ABS market, the SAPC mock ratings project produced a recommended structure for combining tax equity with securitisation, called the “Tandem Tax Equity/Securitisation” structure. Under this structure, the inverted lease format, which is used by some (but not all) tax equity investors currently in the market, has been tweaked to isolate tax equity in the lessee entity and the developer-issuer in the lessor entity, and thereby remove some of the friction currently present in the partnership flip structure where the tax equity and the developer are required to co-exist in the same partnership or limited liability company. More or less concurrently with the mock ratings process, work was progressing on two new solar securitisations – one sponsored by Sunrun Inc., another large solar developer in the U.S., and the other sponsored by SolarCity. These two transactions hit the market at approximately the same time and were closed in the summer of 2015.

Both transactions, like the three SolarCity securitisations which preceded them as well as the two SAPC-sponsored mock ratings discussed, involved collateral in the form of solar photovoltaic equipment installed on primarily residential rooftops, with the sponsors retaining title to the solar systems and either leasing them to the homeowners under fixed rate leases with periodic adjustments and power production guarantees or entering into power purchase agreements with the homeowners. www.dlapiper.com | 23 . Thus, the cash flows to service the securitisation debt were derived from lease revenues or PPA off-taker payments. However, what was different about these two transactions from the three that preceded them was that both involved solar assets that were financed in part by tax equity. The SolarCity transaction was layered on top of partnership flip structures and the Sunrun transaction involved solar assets that were subject to an inverted lease structure.  The SolarCity transaction addressed the conflicting lien issue discussed previously by pledging only the sponsor’s interest in the managing member of each LLC that owned the actual solar assets and thus only the cash flow that was distributable to the sponsor was assigned in a bankruptcy “true sale” to the issuer of the securitisation notes and pledged under the indenture to the note holders (this is known as a “backleverage” structure). The same transaction addressed the tax indemnity issue by having SolarCity, agree to guarantee the indemnity obligation of the issuer. By providing insurance policies from rated issuers insuring up to 35% of any tax indemnity liability resulting from an IRS audit, this would provide added protection in the event that SolarCity failed to cover the indemnity obligation.

The Sunrun transaction addressed the competing lien issue by having the issuer pledge its interest in the lessor entity to secure the notes and the tax indemnity issue by having the tax equity investor agree to look only to the sponsor – Sunrun – for any tax indemnity payment. With the recent extension of the energy credit by the U.S. Congress for another five years beyond the end of 2016, tax equity will remain a significant component of the capital structure of solar assets for the foreseeable future, and thus additional solutions will have to be developed through the cooperative relationship between the tax equity provider community and the solar developer community. The Solar Energy Finance Association, which has been formed to carry on the mission of SAPC on increasing the distributed generation solar industry’s access to the capital markets and identifying and ameliorating the friction points inhibiting the growth of the solar industry in the U.S., has announced its intention to act as convener of the tax equity and developer constituencies to come up with actionable and practical solutions to these friction points. To date, over US$660 million of solar ABS transactions have been issued and more are in the works as of this writing.

Each of these transactions was rated investment grade by either S&P or Kroll, and the two 2015 issuances received an A rating from Kroll. However, in the context of total annual ABS issuance, this is not a large number. And solar energy as a percentage of total installed energy capacity in the U.S.

remains under 10% despite the fact that solar installations are growing at a rate of over 24% year-to-year and solar installation costs perKWh continue to decline.  For solar power to achieve the scale necessary to meet its potential for addressing the U.S.’s Climate Change goals, other headwinds must be overcome. These include: (i) elimination of the regulatory uncertainty surrounding efforts by the utility industry to cause state utility regulatory bodies to reduce the price at which excess power generated by solar facilities can be sold back to the grid (so-called “net metering”); (ii) development of the capacity to store unused solar energy to eliminate the need for a net metering regime and to create more reliability of solar power for users which require uninterrupted power flow; and (iii) creation of products or policies which eliminate or mitigate the risk that the price of energy from the grid will fluctuate to a level below the price of solar energy, thereby putting into jeopardy the long-term value proposition on which the growth of distributed solar is based. Authored by: Ronald S. Borod 24  |  Global Financial Markets Insight .

SECURITISATION AND COVERED BONDS IN PORTUGAL AN UPDATE Since 2001, Portugal has had the benefit of a robust and flexible legal regime for securitisations, and for covered bonds since 2006. Portuguese banks were frequent issuers of assetbacked securities in the international markets in the pre-crisis period, and continued to use securitisation through the height of the crisis to obtain repo funding from the European Central Bank. Covered bond issuance, although slower to appear, rapidly became a funding tool used by most of the major Portuguese banks. While these banks were not able to access the public markets in the crisis years, the recent improvement in economic conditions in Portugal, and slowly returning confidence in the Portuguese financial sector, has led to increasing investor appetite for Portuguese bank debt. A number of negative factors continue to constrain the market for these securities, but 2015 saw the public placement of several asset-backed transactions and a renewed engagement with the covered bond market by Portuguese banks. This included the structuring of Portugal’s first conditional pass-through covered bond programme in the public markets. SECURITISATION – THE LEGAL STRUCTURES The Portuguese Securitisation Law (Decree-Law no.

453/99 of 5 November 1999, as amended) came into force in 2000. This was accompanied by the enactment in 2001 of the Securitisation Tax Law (Decree-Law no. 219/2001 of 4 August 2001, as amended). The Securitisation Law provides for the issue of asset-backed securities through two forms of Portuguese entities: â– â–  credit securitisation funds (fundos de titularização de créditos) (“FTCs”); and â– â–  The lag in the completion of the Securitisation Tax Law in 2000 prevented early issues through the STC structure, which required certain tax issues to be addressed by statute before the structure could be fully implemented.

This led to the FTC structure becoming the preferred issuance model for the early transactions. In recent years, however, issuance has been exclusively on the basis of the STC structure. FTCs are established as segregated portfolios of assets that are transferred to the FTC by the originator entity. The segregated fund is managed by a specialist fund manager under the terms of a fund regulation, which is required to be approved by the Portuguese securities regulator, the Comissao do Mercado de Valores Mobiliários (“CMVM”). A number of fund management companies operate in Portugal providing fund management services on a commercial basis.

The FTCs are required to hold their assets with a custodian: a credit institution that meets certain capitalisation and other regulatory requirements. Although the custodian is required to act in accordance with the fund management company’s instructions, it also has certain obligations to ensure the fund’s compliance with the Securitisation Law. An FTC issues “units”, which represent the undivided ownership interest in the assets held by the FTC. To facilitate placement with investors in the public markets a two-tier structure was developed, where the units issued by an FTC were held in their entirety by a special purpose company (usually incorporated in Ireland), which then issued tranched, secured asset-backed securities in the international markets. credit securitisation companies (sociedades de titularização de créditos) (“STCs”). www.dlapiper.com | 25 . STCs are Portuguese commercial companies (sociedades anominas) established under the supervision of the CMVM for the sole purpose of carrying on securitisation transactions. They are subject to certain capitalisation and other requirements. Several STCs have been established, offering their services on a commercial basis to originator entities. Each STC operates, in effect, as a multi-compartment vehicle, with each securitisation transaction constituting a segregated portfolio within the STC that is funded by the related note issue. Holders of notes issued by an STC with respect to one portfolio of assets do not have recourse to any other portfolio held by the STC. loans. In 2015 the market welcomed the public placement by Banif of a €336 million note issue backed by residential mortgage loans in March (Atlantes Mortgage No.

3) followed in July by a €440 million note issue backed by SME loans (Atlantes SME No. 5). Another successful transaction in 2015 was a €500 million securitisation of electricity tariff deficit receivables for EDP – Energias de Portugal (Volta III). A number of Portuguese banks are understood to be considering a return to the market with asset-backed transactions in 2016. Since 2007/8, securitisation transactions in Portugal have almost invariably adopted the STC model.

This is due to an increased level of investor familiarity and comfort with the STC structure and the legal basis for securitisation issuance directly from on-shore Portuguese vehicles, and the CMVM’s encouragement of direct issuance into the markets by securitisation vehicles that fall under its regulatory oversight. Recent note issues by STCs have generally been listed on Euronext Lisbon, where the approval of the prospectus is also the responsibility of the CMVM. The CMVM is, therefore, able to exercise a high level of supervision over Portuguese securitisations. The Portuguese Covered Bonds Law (Decree-Law no. 59/2006 of 20 March 2006, as amended) provides for a statutory framework for the issuance of asset covered bonds. A number of supplementary regulations have been made by the Bank of Portugal providing for the segregation of the cover pool from the insolvency estate of the issuer, with the cover pool subject to a statutory special creditors’ privilege in favour of the covered bondholders. These regulations also set out valuation and LTV criteria, and the requirements for a cover pool monitor to monitor compliance with the financial and prudential requirements laid down in the Covered Bond Law.

The appointment of a “common representative” (similar to an English law note trustee) to represent the interests of the covered bondholders is required. The Securitisation Law provides for a number of helpful legal features, which include amendments to provisions of the Portuguese Civil Code and the Insolvency Code that would otherwise apply to the transaction and the parties. These helpful provisions include a simplified basis for assignments of receivables to a STC/FTC, provision for the isolation of the assigned receivables in the event of the insolvency of the servicer, and limitations on the exercise of set-off against the originator entity by an obligor under a receivable following an assignment of the receivable to a STC/FTC. The Securitisation Tax Law provides a number of equally helpful derogations from the Portuguese tax regime. These include provision for the absence of withholding tax on collections relating to the receivables made by a servicer on behalf of the STC/FTC, and exemptions from stamp duty on the assignment of the receivables and the issue of the asset-backed securities. THE UNIVERSE OF ASSETS Portuguese securitisation has embraced a wide range of asset classes in the 15 years since the Securitisation Law came into force.

A significant reduction in bank origination of mortgage and consumer loans has led, since 2011/12, to a fall-off in the number of transactions backed by such assets, although a number of retained and synthetic transactions were closed. Other transactions completed in this period included private placements of non-performing consumer and auto 26  |  Global Financial Markets Insight COVERED BONDS While many of the leading Portuguese financial institutions have set up covered bond programmes, in recent years the opportunity for issuance under these programmes has been limited. A significant development in 2015 was the establishment by Novo Banco, S.A. of its €10 billion Conditional Pass-Through Covered Bond Programme.

The “conditional pass-through” structure, pioneered by Dutch bank NIBC in 2013, and followed in mid-2015 by UniCredit, retains the bullet repayment of principal at maturity that is a feature of traditional covered bond structures, but in the event of certain conditions being met, such as the issuer’s insolvency, the conditional pass-through covered bonds will convert to an amortising principal repayment basis. This addresses the risk of maturity mismatch to which traditional covered bonds are exposed, with the resulting risk of default on the bullet repayment. Novo Banco has yet, at the time of writing, to undertake a public issue of conditional pass-through covered bonds under its programme.

Such an issue in 2016 would be a significant landmark in the return of the Portuguese banks to another sector of the international capital markets. Authored by: Vincent Keaveny . THE MAN WHO SOLD THE WORLD BOWIE, BONDS AND IP SECURITISATION The loss of David Bowie at the start of this year prompted much discussion of his musical legacy, but less well-publicised was his contribution to finance. In 1997, rather than renew a long-term record label contract, LA banker David Pullman convinced Bowie to securitise the rights to receivables from his back catalogue into what quickly became known as “Bowie Bonds”. Paying 7.9% over ten years (compared to 6.4% from comparable US treasury bonds at the time) the US$55 million issue allowed Bowie to buy out an old manager who retained a large stake in his songs. Fans who hoped to own a piece of Ziggy Stardust were disappointed, however, as the entire issue was sold to Prudential Insurance. Bowie’s move, as so often, was prescient. Whereas mortgages had been packaged into financial instruments since the 1970s, the Thin White Duke was the first musician to use future royalties to underpin a bond. Other big names including James Brown, Marvin Gaye and even Iron Maiden soon followed suit, forming part of a new wave of securitisations in the early-to-mid 2000s backed by ever-more innovative income streams. Another such front-runner in this burst of IP securitisation was the film industry.

Studios have always sought to reduce their exposure to the volatility of box office performance, and securitisation provided a means of shifting some of that risk onto the credit market, with studios issuing an aggregate par of more than US$14 billion in film-backed bonds between 2005 and 2010. The bonds were funded by rights to a portion of the revenues from a slate of upcoming films, often supported by a library of older movies whose long-term income from channels such as pay-per-view and merchandising were more established. Film bonds, however, demonstrate an issue common to a number of forms of IP securitisation, including music royalties, in that as an operating or future flow asset (as opposed to a financial asset such as an auto loan) they are especially dependent on the ongoing input of the collateralising IP’s creator. Whereas Ford, having provided the initial finance, has little direct control over whether borrowers ultimately pay for their Fiestas, a major studio often controls almost every element that determines a film’s financial success – from pre-production budgeting right through to free television distribution some five or more years later. www.dlapiper.com | 27 .

This degree of control allowed for a gradual divergence of interests between investors and studios, which eventually caused film bonds to lose popularity. Paramount’s US$300 million 2004 bond was the first to be issued unwrapped with a Moody’s rating of less than Aaa (Baa2 in this case), and as the popularity of such products increased, fur ther risk was transferred to investors whose acceptance of such was due in no small par t to the perceived glamour of the industry. The reimbursement of often uncapped studio costs – especially the notoriously expensive and malleable “P&M” (Prints and Marketing) – moved above bondholders in the payment waterfall. Doubts also arose over revolving structures which committed investors to buying those of a studio’s films which met given criteria such as budget or age rating, with a perception that filmmakers were tailoring the most attractive blockbusters to fall outside those profiles whilst plucking turkeys to fit. This problem was exacerbated because whilst most other securitisations might include performance triggers that terminate fur ther funding of assets when early purchases underperform, rever ting to a rapid payment waterfall, with film this made mezzanine and equity debt too difficult to sell.

The result was that when, following a film’s underperformance, senior debt holders wanted to stop funding new movies and take advantage of the protection of mezzanine and equity debt, those junior investors would instead push to acquire as many new rights as possible in the hope of financing a success. The most recent securitisations, such as last year’s US$250 million issue by Miramax (the company behind hits such as Pulp Fiction and Shakespeare in Love) have tended to try to avoid these issues by focusing on film libraries rather than upcoming slates. Similar problems of misaligned interests are evident with Bowie, who issued his bonds whilst simultaneously predicting the death-by-Internet of the copyright systems that underpinned them. “Music,” he told the New York Times, “is going to become like running water or electricity”.

Two years later, 1999 saw the music industry’s global revenues peak at US $39.7 billion. That summer, Sean Parker and Shaun Fanning launched Napster. By 2004 piracy and a shift in consumer tastes from HMV albums to iTunes singles prompted Moody’s to downgrade the bonds from A3 to Baa3.

By contrast Bowie had already, in his words, turned to face these strange changes and was using some of the proceeds of his issue to invest in an Internet service provider and online banking platform, whilst focusing his musical efforts on the remaining reliable revenue stream – live performance (the receipts of which were not included in the bond). 28  |  Global Financial Markets Insight Few music royalty-backed securitisations have followed the initial flurry after Bowie Bonds, partly because of the issues already covered, but also because few musicians have the back catalogue to sustain repayments. Those that do – the Beatles, for example – rarely enjoy straightforward ownership of the rights involved. More success has been found in financing the receivables of the rights of the songwriter (the other major right besides the musician’s in a piece of music), as these are more often owned directly. However, ownership issues have impeded attempts to securitise IP receivables from a variety of popular sources, for example sports stars whose image is often tied to a range of sponsorship deals.

Added to this more recently is a tighter regulatory environment, with some even seeing Bowie Bonds as emblematic of the appetite for ever-more exotic structures that eventually fed into the financial crisis. Evan Davis, the BBC’s economics editor and presenter of Newsnight, has even suggested (tongue only partly in cheek) that David Bowie caused the Credit Crunch. Despite these setbacks, some financiers continue to look for ways to adapt such securitisations for the next credit cycle. A San Franciscan company has demonstrated that tradable sports star-backed securities can work on a small scale, whilst securitisation has even been mooted as a solution to student debt, where students would sell rights to their future earnings in return for upfront payments to cover their education. As a means of diversification, where performance is not directly linked to the financial markets, variations on Bowie’s idea continue to capture investor interest. Authored by: Edward Chalk . NEW SPANISH MAJOR SHAREHOLDING DISCLOSURE REGIME IMPACT ON EQUITY DERIVATIVES Royal Decree 878/2015 of 2 October (“RD 878/2015”) implements in Spain Directive 2013/50/EU of the European Parliament and of the Council of 22 October 2013 amending, amongst others, Directive 2004/109/EC of the European Parliament and of the Council on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market (the “Transparency Directive”). In particular, RD 878/2015 modifies Royal Decree 1362/2007 of 19 October on transparency requirements (“RD 1362/2007”), with respect to major shareholding disclosure requirements in relation to shares of issuers for which Spain is the home Member State and which are admitted to trading on a Spanish regulated market or in any other EU regulated market (“Spanish Equities”). This new disclosure regime entered into force on 27 November 2015 and has an impact on disclosure of derivatives on Spanish Equities. In the following sections we summarise the main changes with respect to disclosure of derivatives on Spanish Equities. DISCLOSURE OF LONG POSITIONS IN CASH SETTLED EQUITY DERIVATIVES Under RD 1362/2007, financial instruments on Spanish Equities had to be disclosed (if the relevant thresholds were crossed – with minimum threshold at 3% and 1% if the investor was domiciled in a tax haven) if on maturity they granted the right to acquire, on the holder’s own initiative alone, under a formal agreement, issued shares to which voting rights were attached. The instrument holder would have enjoyed either the unconditional right to acquire the underlying shares or the discretion as to the right to acquire such shares or not. Therefore, only physically settled derivatives on Spanish Equities needed to be disclosed. The amendments introduced by RD 878/2015 extend the disclosure obligation on Spanish Equities to include any financial instrument other than those already covered by RD 1362/2007 that have similar economic effect to the above, irrespective of whether or not they confer a right to physical settlement. www.dlapiper.com | 29 .

This means that, as of 27 November 2015, all financial instruments that confer a long position in respect of shares must be disclosed. In other words, derivatives such as cash settled call options (the buyer or holder being required to disclose) and put options that can be cash or physically settled (the seller or grantor being required to disclose) shall also fall under the disclosure obligation. CALCULATION OF VOTING RIGHTS RELATED TO DERIVATIVES Voting rights are calculated differently depending on how derivatives on Spanish Equities are settled. â– â–  Where derivatives provide for physical settlement, the number of related voting rights is calculated by reference to the full notional amount of underlying shares. â– â–  Where derivatives provide for cash settlement only, the number of voting rights is calculated by multiplying the notional amount of underlying shares by the delta of the instrument (the delta indicates how much a financial instrument’s theoretical value would vary in the event of variation in price of the underlying shares). Specific rules for calculating voting rights are laid down in Commission Delegated Regulation (EU) 2015/761 of 17 December 2014, supplementing the Transparency Directive. They mainly relate to financial instruments referenced to a basket of shares or an index and to financial instruments providing exclusively for a cash settlement. AGGREGATION OF POSITIONS IN SHARES AND DERIVATIVES Another significant change in the disclosure regime of Spanish Equities is the aggregation of shares and derivatives for the purposes of the calculation of the relevant disclosure threshold. Until 27 November 2015, in order to determine whether it was necessary to disclose a particular shareholding, shares and financial instruments with underlying shares of the same issuer had to be considered separately. Acquisitions or disposals of voting rights regarding shares were disclosed separately to those of financial instruments. Therefore, an investor could acquire shares for 2.99% of the voting rights of an issuer and hold a physically settled call option over a further 2.99%, (almost 6% of the voting rights in total) without having to make any disclosure. The new rules extend the disclosure obligation to those cases where an investor reaches, exceeds or falls below any of the relevant thresholds as a result of aggregating voting rights held related to shares and voting rights held related to the relevant financial instruments. Therefore, a holding of a 1.5% stake in shares and a 1.5% long position on a derivative – either physically or cash settled – on an issuer will be subject to disclosure. Question 20 of the European Securities and Markets Authority (“ESMA”) Questions and Answers document on the Transparency Directive (Document ESMA/2015/1595) includes a practical example of different scenarios in which the aggregation of holdings in shares and derivatives trigger disclosure. INFORMATION TO BE INCLUDED IN NOTIFICATIONS The information to disclose on major shareholdings shall include a breakdown of the number of voting rights attached to holdings of shares and the number of voting rights related to holdings of financial instruments. In respect of financial instruments, a distinction needs to be made between (a) those which, on maturity, grant the unconditional right to acquire, on the holder’s own initiative alone and under a formal agreement, issued shares to which voting rights are attached, and (b) other disclosable instruments.

Within (b), financial instruments that are physically settled need to be distinguished from those that are cash settled. On 24 November 2015, the Spanish securities regulator, the Comisión Nacional del Mercado de Valores (“CNMV”) issued a proposal for a Circular regarding the standard forms for notification of major shareholdings. The proposal follows the standard notification form issued by ESMA on 22 October 2015 (Document ESMA/2015/1597) with some country specific adaptations. Once the new Circular is published and enters into force (it is likely that it will be published soon and will apply from Q2 2016), major shareholdings in Spanish Equities will need to be notified through such standard forms.

Until then, major shareholdings in Spanish Equities will need to be notified through to the existing standard forms provided under the CNMV Circular 2/2007, of 19 December. Authored by: Ricardo Plasencia 30  |  Global Financial Markets Insight . CENTRAL COUNTERPARTIES AND MANDATORY CLEARING ENSURING RISK MITIGATION RATHER THAN RISK CREATION In 2009 G20 leaders considered the failings which led to the 2008 financial crisis and proposed new methods of mitigating risk to ensure global market prosperity. In the EU, this was achieved in the derivatives market through the introduction of the European Market Infrastructure Regulation (“EMIR”)1, which included the obligation to clear certain classes of “over-the-counter” derivatives (“OTC Derivatives”) through central counterparties (“CCPs”) (Article 4, EMIR “Clearing Obligation”). A CCP interposes itself between counterparties to a trade, reducing counterparty risk. Given that they clear trades for clearing members (“CMs”) who are the largest global financial institutions, CCPs are key systemic cogs and any failure could have ramifications for the global financial markets. Following the publication of the EMIR clearing standards on 1 December 2015, the date for official clearing of certain classes of interest rate swaps by category 1 counterparties (CMs) is now set at 21 June 2016, with a frontloading window operating from 21 February 2016.

The imminence of increased clearing in the market has meant that the undisrupted operation of CCPs is now more important than ever; imposed clearing should not create more risk than it is intended to avoid. WHAT ARE THE RISKS? One of the biggest risks both of and to clearing is failure of a CCP. A suspension of clearing or collapse of a CCP could leave CMs unable to execute trades, affecting liquidity and leading to further defaults. This could spread market contagion (a sort of “domino effect” – see IMF Working Paper WP/15/21: “Central Counterparties: Addressing their too important to fail nature”).

It is therefore essential to make sure that CCPs are resilient against market pressures. Many of these bodies, who were previously owned by CMs, are now profit-making entities whose interests arguably lie in making a return for shareholders and they may be willing to take greater risks in order to provide such returns. The market resembles an oligopoly; only those mandated by the relevant authority (in the EU this is the European Securities and Markets Authority) can clear trades and only then for the specific products for which they have been authorised. In the EU, as of 30 October 2015, only 16 CCPs had been mandated to clear and there were a number of products for which only one or two CCPs were authorised. This concentrates risk in the hands of a few CCPs. Should   Regulation No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade EU repositories 1 www.dlapiper.com | 31 .

a CCP, which is the sole provider of a product, find itself in difficulty, it may lead to a suspension in the market for such a product, as there is no means to clear. This article will focus firstly on the potential failure of CCPs in the event of a CM default, but will further consider other reasons for failure below. MITIGATION OF THE RISKS: DEFAULT WATERFALLS In 2012, the Committee on Payments and Markets Infrastructures, together with the International Organization of Securities Commission and the Financial Stability Board produced Principles for Market Infrastructures (“PFMIs”) to better manage risk in key infrastructures. The regulators oversee these infrastructures using the PFMIs as indicators, however, a framework for recovery and resolution is not prescribed by the PFMIs and each CCP has their own. Clearing through CCPs is intended to reduce counterparty risk by ensuring that trades are always matched as each party trades with the CCP rather than each other. Counterparty risk is then held at CCP level. When a CM defaults, CCPs usually try to recover losses in the order set out below: 1. Defaulting CM’s collateral The initial margin posted by a CM is used to cover CCP losses in the first instance. 2. CMs’ guarantee fund Losses are usually then recovered through contributions made by the defaulting CM to a separate guarantee fund, established to assist with resolution upon default.

The contributions of non-defaulting CMs to this fund are then called upon. 3. CCP contributions CCPs usually make a contribution before or after the guarantee fund is utilised. 4. Further contributions from non-defaulting CMs Should further resources be required, CCPs allocate the loss (either to a predefined or uncapped amount) to the remaining CMs (through the request for additional contributions or variation margin haircutting). Only where the methods invoked by the CCP fail to ensure its survival will a resolution authority step in. PROPOSALS OF MARKET PARTICIPANTS In their July 2015 letter to the European Commissioner for Financial Stability (“Investment Letter”), various investment managers asked CCPs to take greater responsibility on default. They believe members who had deposited money in good faith should not be subject to providing additional contributions or be subject to haircuts, as this would lead to “perverse systematic consequences 32  |  Global Financial Markets Insight which will undermine financial stability”. If a CCP is entitled to keep the margin posted in order to transact, this would “fundamentally alter the market’s view of cleared products”; collateral should only be used where a CM itself has defaulted and not where another CM defaults as this is contrary to the purpose of client clearing and segregation of assets in EMIR.

They asked for the buffer provided by CCPs (see point 3 above) to be increased, through risk-based contributions. This additional “skin-in-the-game” would help ensure that CCPs limit the risks they take. CCPs play an important role in avoiding the volatility seen following the 2008 crisis. One only has to look at the CM failure of HanMag on the Korea Exchange (“KRX”) following a trading error to see that CM default waterfalls do work to preserve the efficacy of the markets.

However, it seems unfair KRX’s resources were the last to be tapped here and the default was ultimately satisfied by non-defaulting CMs (see “Bridging the Week” by Gary DeWaal: December 1 to 5 and 8, 2014); greater CCP “skin in the game” should be maintained to promote fairness as well as continued operability. By contrast, LCH.Clearnet in its white paper on CCP recovery argued against such additional contributions stating that “(t)he resources of the CCP operator are designed to protect against operational and business risks and, if necessary, to manage an orderly wind-down.” The risk of CM default should lie with the CMs as the CCP is merely a “mutualised risk structure”. This is difficult to align with EMIR; the clearing of OTC derivatives was supposed to remove counterparty risk. By increasing CMs’ exposure to each other through these additional contributions, counterparty risk is increased once again.

Furthermore, CCPs are profitmaking businesses and arguably should take responsibility for ensuring continuation of the clearing services they are paid to provide. CCPs carry out stress-testing based on their own criteria. Standardised stress-testing across CCPs would provide an effective method to reduce market risk. CCPs and CMs would better understand their ability to withstand market pressures and market confidence should also increase as participants appreciate the risks and interdependencies of CCPs. CCPs could accurately quantify the total loss absorbing capacity they require and align capital to meet this.

One possibility is the use of scenario analysis software to establish interdependencies, chances of default and risk of failure. Due to the global nature of the financial markets, implementation should be on an international basis. In January 2015, the International Swaps and Derivatives Association (“ISDA”) proposed a CCP recovery framework, focussing on auctioning the defaulting CM’s portfolio to non-defaulting CMs and funding potential losses through pre-defined default resources. Auctioning positions avoids resorting to default funds, although whether this is possible is .

questionable, particularly given a default of a CM is likely to be due to issues or market conditions which affect other CMs and thus limit their capacity to take on a trade. Additionally, for certain products, there are only a few market players, further restricting the ability to auction positions. RECAPITALISATION VS LIQUIDATION JP Morgan Chase & Co in its September 2014 perspective on CCP resolution suggests that recapitalisation should be preferred over liquidation. They believe this is necessary given the risk of price volatility and lack of replacement CCPs should a CCP fail. They advocate a separate recapitalisation fund, funded by CCPs and CMs.

The applicable government agency would then “bail-in” the CCP using this fund in exchange for equity. The investors, however, in their Investment Letter, suggested that “recovery of a CCP at all costs should not be the only option on the table”. They argue that CCPs should have plans in place for a swift liquidation of a CCP, allowing CMs to recover margin and re-establish positions elsewhere. It may not always be possible or prudent to recapitalise a CCP. Given the oligopolistic structure of the clearing market, the failure of a CCP could lead to widespread market disruption. Whilst CCP liquidation should not be avoided at all costs, it is easy to see why efforts must be made to recapitalise a CCP without resorting to the tax-payer.

Methods need to be developed to ensure that where liquidation is required, continuity of trading is maintained. OTHER REASONS FOR CCP FAILURE Although CCPs are subject to regulation and market standards, they are profit-making institutions with the usual risks this brings. CCPs also take on other roles (custodian, liquidity provider or otherwise), creating additional risk. In the event that a CCP is wound up for a reason other than CM default, it is difficult to see how the CCP can call on CMs’ contributions (particularly where such assets have been segregated). The only recovery tool is likely to be an independent guarantee fund, which has been funded by CCPs and CMs.

The use of insurance options could also help to reduce this risk, although the viability of such options would need to be considered in depth, particularly given that insurers may also be affected by existing market conditions as well as the likely high value of the claim. requirement to avoid market-inoperability. A requirement for two CCPs to be mandated to clear a product before it is subject to the clearing requirement may also be prudent. Should a CCP be unable to clear a product for any reason, CMs would transfer their positions to another mandated CCP, possibly linked with an auction process to clear trades through other venues, as well as a fast-tracked authorisation process, to ensure speed and effectiveness. CM default is usually due to market-wide issues, meaning that many CMs are at risk of default. This could mean that guarantee funds are insufficient.

Standardised stress-testing may also help as the markets would better understand repercussions and mitigation techniques to ensure they have sufficient capital to survive. In the banking sector there has been a move towards stress-testing and capital assessment. Given the significance of CCPs, it may be wise to look at introducing similar requirements for CCPs. CCPs reduce counterparty risk by ensuring trades do not remain unexecuted. CCPs, however, could potentially magnify risk as trading is concentrated through a few institutions with a few participants.

Measures therefore should be put in place to mitigate systemic and market risk particularly where there are adverse market conditions. Greater focus is required on the recoverability and resolution of CCPs to avoid increased risk and market contagion. The current methods and waterfalls to mitigate risk do not appear to go far enough, focussing on single CM default and not considering wider issues affecting the marketplace.

CCPs need to not only operate in the event of a CM default or other adverse market conditions but also ensure that they are not culpable in causing such conditions through the concentration of risk. As well as the issues regarding default waterfalls and data collection for capital purposes discussed above, insurance options or provision for the fall-back execution of trades bilaterally should be considered to ensure trading continuity. Given the interdependency of CCPs and CMs, a unified, international approach should be taken to better understand the risks of mandatory clearing through CCPs and promote market confidence. Until this approach has been clarified, CMs should take the opportunity to review CCP rulebooks and understand how they may be called upon to contribute in the event of a default. CMs and CCPs should also consider their resilience to default of another CM or collapse of a CCP to ensure they are able to continue to trade and access liquidity in the marketplace. As noted, the failure of a CCP could lead to suspension of clearing.

There is an argument in such a case for emergency bilateral trading, effectively suspending the clearing Authored by: Aureilia Storey www.dlapiper.com | 33 . EUROPEAN COMMISSION PROPOSES NEW PROSPECTUS REGULATION On 30 November 2015, the European Commission (“EC”) released a proposal (the “Proposal”) as part of the EC’s capital markets union project for an overhaul of the Prospectus Directive1 by introducing a draft new Prospectus Regulation. The Proposal is focused on creating greater opportunities for investors as the EC continue their plans to create a more accessible and competitive public market. The proposal also recognises the need for flexibility and cost effectiveness for SMEs and smaller issuers. But how will large issuers react? This remains to be seen with a proposal that is still far from complete. In the seventh edition of GFMI, we addressed the latest EC green paper and the Review of the Prospectus Directive consultation paper through which the EC sought to establish key changes to the current Prospectus Directive based on the needs of the market. The closing date for responses was 13 May 2015, with a total of 181 responses being received.

The EC have focused on a number of key themes in the Proposal which stem from the responses. This article summarises the key changes which appear in the Proposal from the perspective of investors and SMEs and other issuers, and offers some insight into the background to these changes and the potential impact they may have on the market and its participants.   Directive 2003/71/EC of the European Parliament and of the Council of 4 November 2003 on the prospectus to be published when securities are offered to the public or admitted to trading and amending Directive 2001/34/EC 1 34  |  Global Financial Markets Insight . SUMMARY OF KEY CHANGES 1. Investors â– â–  Greater liquidity and access to the market for smaller investors through removal of wholesale exemption (for securities with a €100,000 minimum denomination) for larger issuers – although there will still be an exemption based on the minimum consideration payable per investor â– â–  Shorter, more concise prospectus summaries (maximum six pages) which will now be required for all issues with the wholesale exemption removed â– â–  More specific material and categorised risk factors with a limit on the number of risk factors included in the summary â– â–  Central electronic database for prospectuses 2. SMEs â– â–  No requirement to produce a prospectus for offers of securities with a total value of less than € 500,000 over a 12 month period (increased from € 100,000) â– â–  ‘Light’ prospectus concept for SMEs provided they have no securities admitted to trading on a regulated market, including an optional ‘questionnaire’ format 3. Other Issuers â– â–  Fast track “Universal Registration Document” for regular issuers, which allows for more concise public offer process â– â–  A new minimum disclosure regime for secondary issuances, which replaces the old proportionate disclosure regime â– â–  No prospectus requirement for an issue of new securities of up to 20% of the same class as those already issued on a regulated market FURTHER CONSIDERATIONS Investors A.

Removal of Wholesale/Retail distinction The motivation for this change comes from what the EC believes are the “unintended consequences” of allowing a lesser standard of disclosure for non-equity securities with a denomination of more than € 100,000. This has amounted to “favourable treatment” for one category of issuer in the eyes of the EC, with the result that many investors are effectively locked out of some of the most financially sound bonds on the market. The result is that issuers will now have a single standard under which prospectuses must be issued – which could increase the administrative burden for some issuers in the short term.

This is to be mitigated however by the suggestion of a “unified prospectus template”, to be defined through secondary legislation. This change will be welcomed with open arms by smaller investors in the market. This is also consistent with the strategy of the Capital Markets Union (“CMU”) to make the EU financial system more competitive and also increase options for savers across the EU. However, the greater administrative burden associated with a full prospectus and also the enhanced competition for high-end investors will be looked upon with frustration by the most sophisticated market players.

However if these proposals are introduced issuers would have access to a deeper and more open market for securities which could prove to be beneficial in the long term and may lead to lower interest rates which would more than offset any increase in issuance costs. The administrative burden may also be mitigated by the new Universal Registration Document, which is discussed below. It is also worth keeping in mind that larger issuers can still rely on the other existing exemptions for a prospectus, for instance the qualified investor exemption, and also the small investor pool exemption (fewer than 150 investors who are not qualified investors). www.dlapiper.com | 35 . B. Shorter Summaries C. More specific risk factors One of the key findings from the public consultation was that prospectus summaries under the current regime are not fit for purpose. Summaries have therefore been redesigned in the Proposal in question and answer format to be a maximum of six sides of A4 paper when printed using characters of readable size.

It remains to be seen how the length requirements will work in practice – they are likely to be overly restrictive for many complex issues. The new form of summary looks to align the regime with the Regulation on key information documents for packaged retail and insurance-based investment products (“PRIIPS Regulation”). If the securities offered fall under the scope of the PRIIPS Regulation, the issuer can use the key information document required under the PRIIPS Regulation, which will avoid duplication and unnecessary delay.

There is also an allowance of three supplementary pages per additional security covered in the summary – so long as that security is sufficiently similar to the others being offered. The Proposal suggests that risk factors which are included in the prospectus should be “limited to risks which are specific to the issuer and/or the securities and are material for making an informed investment decision”. The aim here is that issuers spend more time thinking about the key risks of the securities, instead of effectively covering all known risks, however remote, by a great number of broad risk factors in the prospectus. Interestingly, risks shall also be allocated across a maximum of “three distinct categories” based on probability and magnitude of impact. This is a sensible solution and along with the shortening of summaries is an important step in making the market more user friendly.

However, it remains to be seen if six pages will be sufficient for the issuer to cover the necessary information “that investors need in order to understand the nature and risks of the issuer, the guarantor and the securities being offered” and that “aids investors when considering whether to invest in such securities” (Article 7(1) of the Proposal). Closely linked to this will be the requirement under the Proposal to include only the five most material risk factors in the summary – which may be extremely challenging with regard to the most complex securities. It will also raise challenges for issuers who also intend to offer their securities in other markets (such as the capital markets of the United States) where longer form documents are usual – even if such issuers resort to separate documents for issues in other markets, questions around adequate disclosure will arise in the event of investors suffering a loss for a reason described in a document in one market but omitted from documents in the European market. On the one side, this is great news for investors who, in theory, will no longer have to sift through countless risk factors in order to establish key concerns.

However, it is difficult not to have sympathy for an issuer who must weigh up probability against magnitude in order to categorise each risk. There is an inherent risk here itself in both overvaluing or undervaluing a particular risk factor which in any event may never occur. Under the Proposal, the European Securities and Markets Authority (“ESMA”) is tasked with developing guidelines on assessment of materiality and the categorisation of risk factors; a document which should make for interesting reading when published.

Ironically, in moving towards a more universal market and removing the wholesale exemption, it is more likely that less sophisticated investors will participate in issues and such investors would be the most likely to benefit from some of the “boilerplate” risk factors which are currently commonplace in offering documents. D. Central Electronic Database for Prospectuses It is proposed that ESMA shall publish all prospectuses through a storage mechanism, and shall provide the public with free access to this database. This would negate the need to publish a prospectus in a newspaper or store a printed prospectus at the offices of the issuer, which are now outdated options and have been removed in the Proposal. These changes will again be welcomed by investors and align with the objectives of the CMU in making the markets work more effectively, making connections between issuers and investors more efficient and effective. Continued on Page 38 36  |  Global Financial Markets Insight .

www.dlapiper.com | 37 . SMEs Other Issuers A. No prospectus for offers under €500,000 A. The Universal Registration Document Issuers will not be required to produce a prospectus if the total value of the securities on offer are below €500,000 over a 12 month period. Member states are then given freedom to further exempt the prospectus requirement for domestic offers with a total value between €500,000 and €10,000,000. The EC and the capital markets union project have also recognised the administrative burden imposed on issuers who are required to draw up a new prospectus on an annual basis for issuing securities – referred to in the Proposal as “frequent issuers”.

Under the Proposal, an EU issuer can file a “Universal Registration Document” – akin to a US shelf registration – which includes a description of the “company’s organisation, business, financial position, earnings and prospects, governance and shareholding structure”. This is then submitted to the competent authority for approval and once approved, only a securities note and summary are required to be submitted for any offer of securities to the public. This again is a sensible move by the EC and recognises the cost benefit argument against producing a prospectus for very small offers. The effect here is that SMEs will view the bond market as a more attractive and accessible option for financing, which again increases competition and liquidity in the market.

There is also more than enough flexibility for member states who may have different views on the threshold for an exemption based on local market sentiment. However, it must be remembered that SMEs will not be exempt from producing adequate disclosure for any offering which is exempt from the requirements for a prospectus; this will depend on the size and nature of the offering and the regulations of the home member state. B. Light Prospectus for SMEs There will be an option for SMEs to follow minimum disclosure rules for the drawing up of a prospectus provided that they have no securities admitted to trading on a regulated market. The exact information and nature of the disclosure will be set out in secondary legislation, but the Proposal does provide that the information shall be adapted to the size and track record of the issuing company. There will also be an option for SMEs with certain securities to draw up a prospectus in the form of a questionnaire with standardised text.

ESMA will also produce a set of guidelines for issuers who elect for the questionnaire format. It is clear that access to financing for SMEs has been seen as being of fundamental importance to the EC in developing the Proposal. This is another change which is designed to make the bond market more appealing to smaller issuers, especially in light of the low-cost questionnaire format of prospectus. In order for this to be successful however, it will be crucial that standardised questions are clear, easy to follow and at the same time capture the level of detail required for investors. ESMA will have a difficult task in constructing guidelines which will have the aim of making a very complex process relatively simple. The ideal scenario will be the creation of a low cost, simple disclosure mechanism which works in practice.

This will probably take some trial and error on the issuer side, however it is a concept which will certainly prove popular among smaller and first time issuers. Furthermore, once an issuer has had a Universal Registration Document approved by the competent authority for three consecutive financial years, subsequent Universal Registration Documents may be submitted without prior approval. There are a number of major benefits to the Universal Registration Document. For instance, issuers who have an approved Universal Registration Document will benefit from a fast-track approval mechanism (five working days instead of ten). The new system is also expected to be much lower cost, more efficient and could allow frequent issuers to take advantage of changes in the market by preparing offering documents in a much shorter timeframe.

The issuer may also, under certain circumstances, fulfil their disclosure obligations under the Transparency Directive2 at the same time as submitting their Universal Registration Document, so long as they include their annual and half-yearly financial reports in the submission. Larger issuers may be concerned that they will lose submission privileges in the event that they do not file a Universal Registration Document in any financial year, however aside from this, issuers will welcome this initiative. “Universal Registration Document and Base Prospectuses” Under the Proposal, all non-equity securities can now be issued through a tripartite prospectus (i.e. a separately drafted registration document, securities note and summary, which can be drafted at different times).

The Universal Registration Document can also be used in conjunction with all prospectuses. This is good news for financial institutions, who will be one of the main groups taking advantage of “frequent issuer” status and who often utilise base prospectuses when offering securities to the public.   Directive 2013/50/EU of the European Parliament and of the Council of 22 October 2013 amending Directive 2004/109/EC of the European Parliament and of the Council on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market. 2 38  |  Global Financial Markets Insight . Once a frequent issuer has a Universal Registration Document approved, this will reduce the time and cost for that issuer to produce a base prospectus. However, there is one other important change to the base prospectus: the issuer will be required to produce an “issue specific” summary for each issue of securities, to be annexed to the final terms when those are filed. This does entail slightly more administration for the issuer, however it is probable that one issue summary will form the basis for subsequent summaries. Moreover, the requirement to draw up an initial summary of the base prospectus (if the final terms are not contained therein) is removed, meaning again more efficient access to the market. Overall therefore, issuers using the base prospectus regime are also likely to benefit from the Proposal. B.

Minimum disclosure regime for secondary issuances Like the minimum disclosure rules for SMEs, the Proposal offers a specific form of disclosure for companies undertaking a secondary issuance, provided that the issuer’s securities have been admitted to trading on a regulated market or an SME growth market for at least 18 months. Like much of the new Proposal, the EC will adopt secondary legislation which will set forth the minimum disclosure regime for secondary issuances. However, at this stage the EC have suggested that the document will contain financial information from the last financial year and they have recognised the need for investors to be provided with sufficient information on the terms of the offer, use of proceeds, risk factors, board practices, remuneration, shareholding structure and related party transactions. This amendment is a sensible one – the EC have commented that around 70% of prospectuses approved annually are drawn up by companies who would qualify for the lighter prospectus approach set out in the Proposal. The balance to be struck will be the creation of a regime which provides real financial and administrative efficiency for issuers, whilst providing enough disclosure to satisfy investors.

We have already witnessed a hiccup with the old proportionate disclosure regime (which is to be abolished under the Proposal) and unless the benefits are clear, issuers may decide to stick with the full disclosure programme. This may be the most difficult task for the EC under this Proposal but there is certainly no doubt that there is a huge appetite for minimum disclosure, provided it works in practice. C. No prospectus for supplementary issues below 20% of existing securities The Proposal specifies that a prospectus will not be required for securities fungible with securities already admitted to trading on the same regulated market, provided that they represent, over a period of 12 months, fewer than 20% of the number of securities already admitted to trading on the same regulated market (increased from 10%).

This amendment could represent significant cost savings for issuers, and will again be conducive to the creation of a more effective and efficient securities market. However, the existing exemption for securities issued following conversion of convertible securities will also be capped at 20% of the class already admitted to trading which may impact on the size of convertible issues possible without a prospectus. Conclusion In short, it seems that the initial draft of the Proposal has been prepared to provide advantages for each major category of market participant, with the intention that an initial reaction should be positive from all sides. However, it is clear that smaller investors and SMEs benefit the most from the initial proposals which, given the key objectives of the CMU project to create a more liquid, versatile and competitive market, hardly comes as a surprise. It remains to be seen how large and frequent issuers will seek to address some of the main changes in the Proposal, but the new Universal Registration Document and the re-worked minimum disclosure regime should reduce the impact of a reform which looks out largely for the smaller investor. Overall, the changes proposed seem well calculated and a regime akin to that in the Proposal should lead to a more liquid and diverse market but, as mentioned above, we have yet to see the final detail of the proposals. It will be interesting to see whether the secondary legislation succeeds in treading the fine line between more accessible documentation and full disclosure sufficient to protect issuers. Authored by: Mark Dwyer and Leigh Ferris www.dlapiper.com | 39 .

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