ESMA writes a letter to the European Commission regarding the reform of the AIFMD

A letter to the European Commission dated 18 August 2020 from the European Securities and Markets Authority (ESMA) has been published. Ostensibly relating to the upcoming review of the Alternative Investment Fund Managers Directive (AIFMD), it is, true to recent EU legislative form, expansive in its ambition and has raised a number of questions around potential impacts on the whole of the fund management industry, including the Undertakings for Collective Investment in Transferable Securities (UCITS).

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Addressing concerns around ‘global stablecoins’: FSB proposes an extensive regulatory framework

First published on Thomson Reuters Regulatory Intelligence on 13 May 2020

In April, the Financial Stability Board (FSB) published, in response to a request from the G20, its awaited consultation on the regulatory, supervisory and oversight challenges raised by “global stablecoins” (GSCs). Given the FSB’s remit, the focus of the consultation is on the impact of GSC arrangements on international financial stability, together with market integrity and consumer protection. It expressly does not address matters ranging from monetary policy, monetary sovereignty and currency substitution to data privacy, competition or taxation.

Overview: what are global stablecoins and why do they raise financial stability concerns for the FSB?

Nature of the instrument and arrangement

The FSB defines stablecoins as “a crypto-asset that aims to maintain a stable value relative to a specified asset, or a pool or basket of assets”.(The stabilisation mechanism of a stablecoin could alternatively be algorithm-based, attempting to maintain a stable value via protocols that provide for the increase or decrease of the supply of stablecoins in response to changes in demand.) A GSC is a stablecoin “with a potential reach and adoption across multiple jurisdictions and the potential to achieve substantial volume”.

The focus of the FSB is on a stablecoin arrangement as a whole, which is described as “an arrangement that combines a range of functions (and related specific activities) to provide an instrument that purports to be used [as] a means of payment and/or store of value”. This is particularly with respect to privately-issued GSCs primarily used for retail purposes and that may be widely used as a means of payment and/or store of value. The FSB notes that the matters it raises may also be relevant to other types of stablecoin or crypto-asset arrangements.

Illustration of functions and activities within a stablecoin arrangement

Concerns raised

Where a GSC has achieved systemic importance, GSC arrangements could affect financial stability in a number of ways. For example, any fluctuations in value could affect spending decisions and economic activity. If widely used for payments, any operational disruption could significantly impact economic activity and financial system functioning; and exposures of financial institutions might increase in scale and change in nature – particularly if they perform multiple roles in a GSC arrangement (e.g., as resellers, wallet providers, managers or custodians/trustees of reserve assets). Large-scale redemptions of GSCs could mimic the impact of bank runs.

Given the potential impact on financial stability, the FSB is concerned about how GSC arrangements are designed and performed, and whether they can withstand shocks. It notes that:

“… depending on the facts and circumstances, the decentralised nature of GSC arrangements could pose governance challenges; stabilisation mechanisms and redemption arrangements could pose market, liquidity and credit risks; and, the infrastructure and technology used for recording transactions, and accessing, transferring and exchanging coins could pose operational and cyber- security risks“.

Currently, regulators tend to apply existing regulation to the activities of, and entities involved in, GSC arrangements. This is in line with the “same business, same risks, same rules” principle, and indeed, if GSCs take hold, then existing regulation may adapt to accommodate them. (Across the 51 jurisdictions that responded to the FSB’s survey, the “most common approach [to regulatory classification] is to identify the activity performed by a stablecoin arrangement and the participants involved, and apply the relevant existing regulation for that activity or entity according to the “same business, same risks, same rules” principle”.)

As they stand, however, existing regulatory regimes are not sufficient to capture GSC arrangements in a holistic way and would not address all risks associated with them. To illustrate, the functions and activities that are most likely in scope of current regulation include issuance and redemption of stablecoins, managing reserve assets, providing custody/trust services for reserve assets, exchanging and trading, and storing the private keys for wallets. Governance and control over the whole stablecoin arrangement, operation of the infrastructure of a stablecoin arrangement and the validation of transactions tend to fall outside the scope of existing regulation, however.

Addressing concerns raised

There are two main obstacles that can be identified within the gaps and challenges identified by the FSB:

  • First, sector-specific regulation does not map neatly onto GSCs. GSCs which bundle attributes may cut across sectoral regulations, resulting in a patchwork.
  • Second, the cross-border nature of GSC arrangements gives rise to the potential for regulatory arbitrage between regimes.

The FSB proposes 10 high-level recommendations (see box below) to promote consistent and effective regulation, supervision and oversight. The intention is that the recommendations support responsible innovation (by being technology neutral) and allow domestic flexibility in implementation, whilst mitigating the risks arising from GSCs that are used as a means of payment and/or store of value. Whilst the recommendations are addressed to national authorities, substantively they split between obligations on authorities and requirements applicable to GSC arrangements.

Authorities: facilitating effective regulation and oversight Private GSCs: achieving appropriate structure, design and regulatory compliance
Powers and tools

Recommendation 1: Authorities should have and utilise the necessary powers and tools, and adequate resources, to comprehensively regulate, supervise, and oversee a GSC arrangement and its multi-functional activities, and enforce relevant laws and regulations effectively.

Comprehensive governance framework

Recommendation 4: Authorities should ensure that GSC arrangements have in place a comprehensive governance framework with a clear allocation of accountability for the functions and activities within the GSC arrangement.


Functional and proportionate approach

Recommendation 2: Authorities should apply regulatory requirements to GSC arrangements on a functional basis and proportionate to their risks.

Effective risk management frameworks

Recommendation 5: Authorities should ensure that GSC arrangements have effective risk management frameworks in place especially with regard to reserve management, operational resiliency, cyber security safeguards and AML/CFT measures, as well as “fit and proper” requirements.

Comprehensive cross-border and cross-sector regulation and co-operation

Recommendation 3: Authorities should ensure that there is comprehensive regulation, supervision and oversight of the GSC arrangement across borders and sectors. Authorities should cooperate and coordinate with each other, both domestically and internationally, to foster efficient and effective communication and consultation in order to support each other in fulfilling their respective mandates and to facilitate comprehensive regulation, supervision, and oversight of a GSC arrangement across borders and sectors.

Robust data systems

Recommendation 6: Authorities should ensure that GSC arrangements have in place robust systems for safeguarding, collecting, storing and managing data.

Ensuring compliance: before operations commence and on an ongoing basis

Recommendation 10: Authorities should ensure that GSC arrangements meet all applicable regulatory, supervisory and oversight requirements of a particular jurisdiction before commencing any operations in that jurisdiction, and construct systems and products that can adapt to new regulatory requirements as necessary.

Recovery and resolution plans

Recommendation 7: Authorities should ensure that GSC arrangements have appropriate recovery and resolution plans.

Transparency, particularly of stabilisation mechanism

Recommendation 8: Authorities should ensure that GSC arrangements provide to users and relevant stakeholders comprehensive and transparent information necessary to understand the functioning of the GSC arrangement, including with respect to its stabilisation mechanism.


Recommendation 9: Authorities should ensure that GSC arrangements provide legal clarity to users on the nature and enforceability of any redemption rights and the process for redemption, where applicable.

Design-inherent ability to adapt to new regulatory requirements

Recommendation 10: Authorities should ensure that GSC arrangements meet all applicable regulatory, supervisory and oversight requirements of a particular jurisdiction before commencing any operations in that jurisdiction, and construct systems and products that can adapt to new regulatory requirements as necessary.


Important challenge for national regulatory authorities: developing and implementing appropriate cross-border cooperation mechanisms

An important challenge will be to give national authorities the ability to supervise and oversee a stablecoin arrangement holistically, rather than in a piecemeal framework based on its component functions and activities. This is likely to require legislative change, followed by a fundamental change in regulatory approach. Authorities will need to consider their own regulatory frameworks and how the arrangement interacts across jurisdictions. Arrangements for information-sharing and co-operation will be needed. Arrangements akin to those in place for Global Systemically Important Financial Institutions (G-SIFIs) may be an appropriate model. Traditional cross- jurisdictional supervisory approaches will generally not work when applied to GSC arrangements, for two reasons.

First, stablecoin arrangements may be a loose network of unrelated entities only held together by common policies, standards and agreements about respective roles. This would present challenges for identifying the “home” jurisdiction. Secondly, functions of stablecoin arrangements are a hybrid of traditional financial groups and financial market infrastructures (FMIs).

While there are existing examples of internationally-agreed standards that apply in a cross-border context, e.g., the CPMI/IOSCO Principles for Financial Market Infrastructures, the challenge will be to move from a patchwork approach to a model where all the various aspects can be dealt with together to ensure that from the outset – and on an ongoing basis – a GSC arrangement can function appropriately in the economy. The FSB envisages cooperation arrangements in different forms, including supervisory colleges, fora or networks. In terms of structure, the FSB refers to general bilateral and multilateral memoranda of understanding covering cooperation and information sharing, and crisis management and resolution, which are complemented by single focus mechanisms (e.g., on cyber security).

It appears that a holistic approach model would be a prerequisite for an authority being able to satisfy FSB’s recommendation 10. It will be interesting to see how an authority can satisfy itself that all requirements in its jurisdiction in relation to a whole GSC arrangement are met, particularly for example if resellers, custodians and wallet providers are located in its jurisdiction but the governance and stability mechanisms are located in other jurisdictions; and if an authority is not so satisfied, how it could enforce a prohibition on operation in its jurisdiction.

GSC arrangements to be subject to substantial and wide ranging regulatory obligations

Prior to mid-2019, the prospect of a detailed regulatory regime being developed for stablecoins might have been met with a degree of surprise and scepticism.

Governance framework and permissible degree of decentralisation

Given the interconnectedness, GSC arrangements will need to have in place governance structures and accountabilities covering the whole arrangement – activities, functions and participants. The FSB expects such governance structures and accountabilities would:

  • have one or more governance bodies or equivalent mechanism facilitating appropriate oversight, governance and safeguards. It could be challenging to satisfy these requirements if fully permissionless ledgers are used;
  • be based on a sound legal basis;
  • be clear and transparent, and disclosed to users and other stakeholders;
  • show allocation of accountabilities among different entities in different jurisdictions; and
  • show limits on accountability and legal liability on a per jurisdiction basis.

Similar to the rules on traditional outsourcing, where a GSC arrangement relies upon a third party, the GSC governance body must demonstrate that this reliance does not impede its ability to meet regulatory requirements and expectations. However, it is unclear what would be caught here given the separate entities with loose connections that may form part of a GSC arrangement.

Risk management frameworks

Similarly, all functions and activities of GSC arrangements must be subject to appropriate risk management. A GSC arrangement will need appropriate policies, procedures and processes, covering at least the following risks: operational; AML/CFT; cyber; market risks; and those idiosyncratic risks presented by permissionless or anonymous networks. These risk management arrangements will need to be evidenced prior to commencing operations (in line with recommendation 10).

Under the heading of ‘risk management’, four further categories of requirements are set out:

  • Testing: continuous risk assessments, contingency preparedness and continuity planning.
  • Assurance of settlement finality: evidence of how the technology model and rules for transferring coins achieve settlement finality.
  • Financial requirements:
    • Strict rules on management of reserve assets, covering:
      • duration, credit quality, liquidity and concentration of reserve assets;
      • increase or decrease in reserve assets corresponding to issuance and destruction of GSC (asset-linked stabilisation mechanisms); and
      • increases and decreases in reserve assets being managed to avoid impacts on the broader market.
    • Adequate capital and liquidity buffers.
  • Fit and proper: individuals involved in the management and control of the GSC arrangement, and those exercising significant power or discharging significant responsibilities in relation to GSC activities, must satisfy “fit and proper” standards.

Robust data systems

Data management systems within GSC arrangements will need to satisfy certain requirements, including:

  • recording and safeguarding relevant data and information in a discoverable format;
  • complying with all applicable data privacy requirements;
  • safeguarding the integrity and security of on-chain and off-chain data; and
  • data being accessible to authorities in a complete and timely manner.

Recovery and resolution plans

GSC arrangements will need to have in place plans to support an orderly wind-down or resolution, which should include continuity or recovery of any critical functions and activities within the GSC arrangement. The implementation of these plans will need further consideration, taking into account the entities within a GSC arrangement and their geographical distribution.


A lack of transparency has been a cause of failure in stablecoins to date, particularly where it leads to a lack of confidence. This recommendation relies on transparency to bolster confidence and mitigate failure risk. There is an extensive list of aspects of a GSC arrangement to be disclosed, including:

  • governance structure;
  • allocation of roles and responsibilities assigned to operators or service providers;
  • design of the stabilisation mechanism and how it maintains the stablecoin’s value;
  • operation of the stabilisation mechanism;
  • investment mandate for the reserve assets;
  • custody arrangement and applicable segregation of reserve assets;
  • dispute resolution mechanisms or procedures for seeking redress or lodging complaints;
  • mechanisms in place to protect users in event of modification of GSC arrangement which could have a material impact;
  • amount of GSC in circulation (subject also to independent audit); and
  • value and composition of assets in the reserve backing the GSC (subject also to independent audit).


This recommendation concerns not only legal clarity, but also transparency, in relation to redemption rights. Redemption rights may not feature in all GSC arrangements. To the extent they do, they will have to comply with the following requirements:

  • Cost of redemption
    • Predictable and transparent rates of exchange.
  • Disclosures:
    • Nature and enforceability of redemption rights.
    • Any claims users and intermediaries may have on underlying reserve assets.
    • Any claims users and intermediaries may have against the issuer or guarantors.
    • How claims may be treated in insolvency or resolution.
    • Process for redemption and enforcement of claims.
    • Recovery avenues for user who loses access to his/her wallet and private key due to cyber-attack/other operational incident.
  • GSC widely used for payment purposes:
    • Prudential standards comparable to those applicable to financial institutions performing the same economic functions and posing similar risks to be followed.
    • Redeemable at par into fiat (where authority considers it appropriate).

Adaptability of design to accommodate new regulatory requirements

This last recommendation effectively requires GSC arrangements to:

Prior to launch:

    • Proactively engage with relevant authorities, and meet all applicable regulatory, supervisory and oversight requirements in all jurisdictions of operation; and
    • obtain any necessary licenses or registrations.

On a continuing basis:

    • Be designed in such a way so as to be able to maintain that level of compliance, even where regulatory requirements change.


Clive Cunningham
Clive Cunningham
Partner, London
+44 20 7466 2278
Wendy Saunders
Wendy Saunders
Senior Associate, London
+44 20 7466 2373

UK and EU set out their stalls on equivalence and the future trade deal (or no deal…?)

On 26 February 2020, the UK Government published its approach to UK’s future relationship with the EU.

The sections on financial services in the UK’s approach document are set out below:

Chapter 16: Financial Services

  1. The Agreement should promote financial stability, market integrity, and investor and consumer protection for financial services, providing a predictable, transparent, and business-friendly environment for cross-border financial services business.
  1. The Agreement should include legally binding obligations on market access and fair competition, in line with recent CETA precedent.
  1. The Agreement should also build on recent precedent, such as the EU-Japan EPA and international best practice, by establishing regulatory cooperation arrangements that maintain trust and understanding between our autonomous systems of regulation as they evolve. This could include appropriate consultation and structured processes for the withdrawal of equivalence findings, to facilitate the enduring confidence which underpins trade in financial services.

Equivalence in Financial Services

  1. The UK and the EU have committed to carrying out unilateral equivalence assessments for financial services, distinct from the CFTA. The fact that the UK leaves the EU with the same rules provides a strong basis for concluding comprehensive equivalence assessments before the end of June 2020.

Unsurprisingly, these are brief and outcomes-focused in nature, reflecting the Government’s approach more generally and the desire for “autonomous systems of regulation” (as preserved under the EU-Japan Economic Partnership Agreement)  rather than close alignment. The comments on equivalence do serve as a reminder to the EU that the UK will nonetheless be starting from a position of close alignment, but as ever, there are no guarantees that this challenging deadline for completing assessments will be achieved.

On the same date, the European Commission has also published a speech delivered by Michel Barnier, the EU’s chief negotiator on its future relationship with the UK, addressing the potential for UK/EU co-operation post-Brexit. The tone of the speech is characteristically challenging of the UK’s perceived desire to preserve sovereignty and regulatory autonomy while maintaining access to EU markets. Mr. Barnier’s discussion of equivalence indicates the lack of appetite from the EU to develop a more extensive and durable form of equivalence for cross-border market access, as explained in the following extract:

[Equivalence in financial services]

“… The EU will have the possibility to grant equivalences. We will do so when it is in the interest of the EU; our financial stability; our investors and our consumers. But these equivalences will never be global nor permanent. Nor will they be subject to joint management with the UK. They are, and will remain, unilateral decisions.

I read in the Financial Times recently that London must retain its primacy as a hub for wholesale financial markets without becoming a rule-taker of European regulation. As a former Commissioner in charge of financial services, allow me to question that. Why should we accept that the profits stay in London while the EU carries the risks?

The UK may not want to be a rule-taker. But we do not want to be the risk-taker. When the next financial crisis strikes, who will foot the bill? I doubt the UK will foot it for the EU. That is why the EU must take the responsibility for its financial regulation, supervision and stability.”

Clive Cunningham
Clive Cunningham
Partner, London
+44 20 7466 2278
Katherine Dillon
Katherine Dillon
Of Counsel, London
+44 20 7466 2522
Patricia Horton
Patricia Horton
Professional Support Lawyer, London
+44 20 7466 2789

Regulation in Focus Podcast Episode 1 – November 2019

In October, we launched a brand new podcast channel, Financial Services Disputes & Regulation, providing regular bite-sized broadcasts covering both litigation and regulatory developments for banks and other financial institutions. You can subscribe to the new channel here, or on all the usual platforms including Apple and Spotify.

We are pleased to announce the release of the first episode of Regulation in Focus, our podcast series of short, sharp insights into regulatory issues that matter to you. Our first episode, a bumper cross-border edition featuring partners Hannah Cassidy (Hong Kong), Natalie Curtis (Singapore) and Chris Ninan (London), focuses on information flows in cross-border regulatory investigations.

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Herbert Smith Freehills launches updated guide to cross-border financial services investigations

Financial services firms conduct their business activities across markets and borders, often performing services and holding data in locations other than those in which they interact with their clients.  Over a decade after the financial crisis, their regulators remain under sustained public and political pressure to improve customer outcomes and punish poor conduct.  When issues arise, those regulators frequently need to seek assistance from their global counterparts to be able to unravel what has occurred, irrespective of where it took place.

Understanding how and when regulators interact with each other and with firms across borders, how firms are required, or expected, to respond, and how to handle multiple proceedings in different jurisdictions, is more critical than ever.

This fourth edition of “The Long Arm of Regulation: Responding to Cross-Border Financial Services Investigations”, Herbert Smith Freehills’ guide to cross-border financial services investigations, gives an overview of how to approach these issues, and aims to assist firms in navigating the differing regimes across 15 key jurisdictions, including, for the first time in this edition, South Africa. The guide covers a range of important topics, including the regulators’ breadth of powers, mechanisms for obtaining – and withholding – information, consequences for failing to comply, and the management of competing confidentiality and reporting obligations.

In producing this publication, we have drawn on the expertise of our financial services regulation practice across our international network of offices and through our formal alliance with Prolegis (Singapore). In addition, we are enormously grateful for contributions from law firms Anderson Mori & Tomotsune (Japan), Stibbe (the Netherlands) and Homburger (Switzerland).

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Preparing for Brexit: EEA Firms – UK Temporary Permissions Regime (“TPR”)

The UK FCA and PRA propose to implement the TPR if the UK leaves the European Union on 29 March 2019 without an implementation (or transitional) period, to ensure that EEA firms currently operating under an incoming passport (either from a UK branch or on a cross-border services basis into the UK) can continue to carry out regulated activities in the UK until they receive new direct authorisation by the UK regulators. For more information, please see our HSF briefing – UK Temporary Permissions Regime placemat