The UK's Implementation of the new Market Abuse Directive (MAD 2) and Market Abuse Regulation (MAR)

The new Market Abuse Regulation (MAR) (Regulation (EU) No 596/2014) is due to take direct effect in the European Union (EU) this 3rd July 2016. It will certainly bring in many new operational requirements for banks and financial services firms operating in the EU. At the same time the new Market Abuse Directive (Directive 2014/57/EU) (MAD 2) is required to be transposed and implemented by EU Member States by 3 July 2016. The United Kingdom (UK) has opted out of MAD 2 and is instead intending to update the existing Market Abuse operational framework via the Financial Services and Markets Act 2000 (Market Abuse) Regulations 2016 (2016 No. 0000) (MARS 2016). These are currently in draft form and have not yet been finalised but are available to view below. I will provide a very brief overview of some of the most pertinent provisions.

Regulation 5 (Delayed public disclosure of inside information)

This provides that where an issuer or emission allowance market participant (EAMP) has delayed the disclosure of information further to Article 17(4) of the MAR, it is only required to provide a record of its written explanation of how the conditions in that Article were met, upon request by the Financial Conduct Authority (FCA). In reality it would clearly be best practice for issuers and EAMPs to develop pro forma templates that document in detail how each of the three conditions in Article 17(4) MAR were met:
(1) immediate disclosure is likely to prejudice the legitimate interests of the issuer or emission allowance market participant;
(2) delay of disclosure is not likely to mislead the public;
(3) the issuer or emission allowance market participant is able to ensure the confidentiality of that information.

Regulation 6 (Applications under the market abuse regulation)

This provides that any applications to the FCA under MAR must be made in such manner that the FCA may direct and with all information that the FCA may reasonably require. TheFCA may also require an applicant to provide such further information as the FCA reasonably considers necessary to enable it to determine an application.

The MARS 2016 will also amend parts of the Financial Services Act 2000 (FSMA 2000).

[NEW] Section 122A. (Power to require information from issuers etc.)

This empowers the FCA to require:
(1) an issuer;
(2) an emission allowance market participant;
(3) a person discharging managerial responsibilities (PDMR);
(4) a person closely associated (PCA) with a PDMR to provide any information that the FCA reasonably requires in order to protect:
(1) the interests of investors;
(2) the orderly operation of the financial markets;
(3) the orderly operation of auctions of emission allowances and products based on emission allowances on auction platforms authorised as regulated markets.

It also empowers the FCA to require such persons to provide any information or explanation the FCA reasonably requires to verify whether Article 17 (public disclosure of inside information) or Article 19 (manager's transactions) MAR is being or has been complied with.
The FCA has discretion to require this information to be delivered in respect of:
(1) TIMING (before such reasonable period specified by FCA);
(2) LOCATION (such place specified by FCA);
(3) FORMAT (such form reasonably required by FCA);
(4) VERIFICATION (such manner as required by FCA).

  • PDMR means members of the administrative, management or supervisory body of an issuer, EAMP, or entity referred to in Article 19(10) MAR, or a senior executive (not a member of these bodies) but who has regular access to inside information relating directly/indirectly to that entity and power to take managerial decisions affecting the future developments and business prospects of that entity.
  • PCA means a spouse; civil partner; dependent child (18 years, unmarried, no civil partner, including stepchild); relative (sharing house for at least one year on date of transaction); and legal person, trust or partnership (managerial responsibilities discharged by PDMR or by spouse, civil partner, dependent child, relative, which is directly/indirectly controlled by them, which is set up for the benefit of such person, or the economic interests of which are substantially equivalent to those of such a person.

[NEW] Section 122B. (General power to require information)

This empowers the FCA to require a person to provide:
(1) specified information;
(2) information of a specified description;
(3) specified documents;
(4) documents of a specified description.
The FCA must reasonably require the information and/or documents for the purpose of exercising its functions under the MAR.
The FCA has the power to require this in respect of TIMING, LOCATION, FORMAT, and VERIFICATION requirements.

[NEW] Section 122C. (Power to require information: supplementary)

The FCA is empowered to require persons producing documents, or any relevant person (ARP), to provide an explanation of the document. If that person fails to do so, the FCA may require the person to state, to the best of the person's knowledge and belief, where the document is.

  • ARP means (1) a person who is, is proposed to be, or has been, a director or controller of that person; (2) is, or has been, an auditor of that person; (3) is, or has been, an actuary, accountant, or lawyer appointed or instructed by that person; (4) is, or has been, an employee of that person.

Now, this is where the new MARS 2016 begins to get interesting. For starters, the FCA's new power to require a person or ARP to provide an explanation of the document might, in some circumstances, involve legally breaching confidentiality clauses contained within those documents or pertaining to those documents. Furthermore, it also opens up the question of what will happen in circumstances where such documents are subject to legal professional privilege, whether that is advice privilege or litigation privilege. There is an exception whereby legal professional privilege will not be extended to documents forming part of a criminal or fraudulent act (R v Cox & Railton (1884) 14 QBD 153). However, the displacement of legal professional privilege requires prima facie evidence (O'Rourke v Darbishire [1920] AC 581).

Also, if under FSMA 2000, s.122c(3) the FCA requires a person to state, to the best of the person's knowledge and belief, where the document is, and that person fails to comply with that requirement, the FCA may certify that fact in writing to the court ([NEW] Section 122F. (Offences) FSMA 2000). If the court is satisfied that the person failed without reasonable excuse to comply with the requirement, the court has the power to deal with that person as if they were in contempt of court (this includes directors or other officers where the person is a company). So under the Contempt of Court Act 1981, s.14(1), the courts have the power to imprison someone for up to 2 years (committal by superior court) or one month (committal by inferior court), or to a fine of up to £2,500 (committal by inferior court). If a person provides information which the person knows to be false/misleading in a material particular, or recklessly provides information which is false/misleading in a material particular, they will also commit an offence. The penalty is up to 3 months imprisonment, a fine, or both (summary conviction), or up to 2 years imprisonment, a fine, or both (conviction on indictment).

Under the new section 122c.(5) FSMA 2000, a person ("P") may not be required to disclose information or produce a document in respect of which P owes an obligation of confidence by virtue of carrying on the business of banking. In effect this refers to the duty of confidentiality that banks owe to their customers at common law (Tournier v National Provincial and Union Bank of England [1924] 1 KB 461). Yet in Tournier this duty of confidentiality was held not to be absolute, but subject to four qualifications:
(1) where disclosure is under compulsion of law;
(2) where there is a duty to the public to disclose;
(3) where the interests of the bank require disclosure;
(4) where the disclosure is made by the express or implied consent of the customer".
Compulsion of law generally refers to where the court orders disclosure or where legislation mandates disclosure. However, new section 122c.(5) FSMA 2000, also provides that information may be disclosed or documents produced, where:
(1) the FCA suspects that P (or a member of P's group) has contravened any provision of MAR;
(2) the FCA suspects that the person to whom the obligation of confidence is owed (or a member of that person's group) has contravened any provision of MAR.
So, technically under Tournier disclosure under section 122c.(5) FSMA 2000 will be under compulsion of law. But in reality this can be seen as a complete dilution of the force of law. Disclosure ordered by the courts reflects public and open democratic rights of accountability, but disclosure where the FCA simply suspects something, may in actuality be thwarting principles of democratic accountability. There is no built in accountability for the FCA to objectively justify its suspicions to the public, to the courts, or in fact to anyone.

The FCA's powers are further extended by new section 122D. (Entry of premises under warrant) FSMA 2000. Under this section the FCA may apply to the court to enter premises under warrant. The warrant may be executed by any constable and any persons authorised to accompany the constable, i.e. FCA officers. The warrant authorises the FCA officers (supervised by a constable):
(1) To enter the premises;
(2) To use such force as may be reasonably necessary;
(3) To search the premises and take possession of any documents/information appearing to be documents/information of a kind in respect of which the warrant was issued (Relevant Kind);
(4) To take any other steps which may appear necessary for preserving them or preventing interference with them;
(5) To take copies/extracts from documents/information appearing to be of the Relevant Kind;
(6) To require any person on the premises to provide an explanation of any document or information appearing to be of the Relevant Kind or to state where it may be found.
Under [NEW] 122F(5) FSMA 2000 if someone intentionally obstructs any rights under the warrant, they will be guilty of an offence and subject to imprisonment for up to 3 years, a fine, or both (summary conviction). So for example, an employee who unwittingly but intentionally refuses to cooperate or explain documents or information, will be guilty of an offence.
One of the difficulties with this section is that the breadth of power contained within this type of warrant is constrained only by the stipulation of the Relevant Kind of documents stated in the warrant. But in reality it is difficult to see how this section is not tantamount to providing the FCA with carte blanche discretion over the purview of the documents/information sought.

[NEW] S.131B (Reporting of infringements) FSMA 2000

This section provides that employers must have in place appropriate internal procedures for their employees to report contraventions of MAR or any directly applicable EU regulation made under MAR. In order for employees to be able to report contraventions of MAR, it is likely that employers will be obliged to train their employees on the new and quite extensive MAR obligations.

RZ

Case Study on the Challenges of Implementing FATCA in Latin America

IMPLEMENTATION PROBLEMS AND OBSTACLES IN LATIN AMERICA

Operational Issues

  • A lack of automated AML/KYC information at FFIs (particularly newly defined or small FFIs).

  • Many different methods of capturing client information may be in place, and may differ across departments, business units, offices, or affiliates.

  • For many smaller to medium sized financial businesses across Latin America, understanding the detailed FATCA regulations in English and the IRS tax terminology may be difficult. The may also have to get client FATCA briefing materials and authorization forms translated into other languages such as Spanish or Portuguese.   

  • For LATAM organisations operating across multiple jurisdictions, there may also be:

    • A variation in AML/KYC standards.

    • A lack of a centralised AML/KYC data depository.

    • A lack of an interconnected/automated compliance system.

    • A lack of synchronization among multiple operating systems.

    • Reliance on legacy IT systems which rely on siloed data sources.

    • The absence of scalable or sufficient flexible IT platforms.

    • A lack of regular re-evaluation or updating of client information.

    • Potential deficiencies in compliance standards (e.g., under-staffed, under-budgeted).

    • Potential differences in reporting standards (e.g., XBRL v. ISO).

    • Potential differences in accounting standards and quality of accounting data (e.g., IFRS v. US-GAAP)[1].

    • Customer Data Profiling (system data quality issues).

Domestic Laws

  • Bank Secrecy Laws.

  • Data Protection Laws (e.g., a potential legal conflict because of the obligation to file Internal Revenue Service (IRS) Reports with private and confidential client information).

  • Banking, Trust and Fiduciary Laws prohibit closure of some types of financial accounts (i.e. Legal Conflict with Recalcitrant Accounts).

  • Consumer Rights Legislation.

  • National Tax Laws.

  • National Constitutions.

  • Domestic laws may require that certain types of person have 'statutory rights' to hold financial accounts.

  • Domestic laws may prevent financial institutions from withholding and remitting tax on behalf of a foreign government.

Example Problems

  • U.S. based investment vehicles (not defined as FFIs) but will be considering Withholding Agents (WAs) and required to withhold on certain payments made to foreign investors (which are considered to be Non-Compliant FFIs or NFFEs).

Hidden Agendas

  • FATCA and IGAs may be seeking to indirectly provide the first steps in re-opening negotiation channels for 'Bilateral Income Tax Treaties' (BITTs) with Latin American countries.

  • FATCA and IGAs may be seeking to indirectly provide the first steps in re-opening negotiation channels for 'Double Taxation Agreements'. 

Money Laundering/Tax Evasion in Latin America

  • "At Risk" Money Laundering Jurisdictions.

  • Many Latin American countries have continuing high tax burdens.

  • Personal Risk and/or Threats of Physical Harm to Employees.

  • Bribery Risk and Sanctions.

Table 1: Comparison of Rates of VAT and Income Tax Evasion (Percentages) in Latin America (Sabaini and Jiménez 2012)[2]

CASE STUDY: BRAZIL

  • Brazil has a reciprocal Model 1A IGA, meaning that Brazilian FFIs must provide FATCA information directly to the Receita Federal Brasileira (RFB), not the IRS.

  • FFIs must therefore act in accordance with existing Brazilian laws (i.e. the Brazilian Federal Constitution). In theory there are five areas which might impact Brazilian FFIs when adhering to FATCA requirements.

    1. Principle of Sovereignty.

    2. Principle of Public Order.

    3. Secrecy.

    4. Equality.

    5. Tax System.

    6. Financial System Regulation.

Sovereignty

  • FATCA is not a legally binding international treaty or convention, and therefore is not enforceable in domestic jurisdiction courts.  It is a U.S. domestic law with extraterritorial reach or application and only the Brazilian government has sovereignty over Brazilian citizens as well as sovereignty over those individuals who are legally resident in Brazil.

Principle of Secrecy

  • Applicable to all telegraphic, mail, data, and telephonic communications.[3]

  • Article 5 of the 1988 Brazilian Constitution (BC 1988) states inter alia:

    • "All persons are equal before the law, without any distinction whatsoever, Brazilians and foreigners residing in the country being ensured of inviolability of the right to life, to liberty, to equality, to security and to property, on the following terms:

    • 10. the privacy, private life, honour and image of persons are inviolable, and the right to compensation for property or moral damages resulting from their violation is ensured;

    • 12. the secrecy of correspondence and of telegraphic, data and telephone communications is inviolable, except, in the latter case, by court order, in the cases and in the manner prescribed by law for the purposes of criminal investigation or criminal procedural finding of facts;"

  • Infra-constitutional Complementary Law 105 (LC 105, 2001) allowed Brazilian financial institutions to provide client information in certain define circumstances, (e.g. where there has been administrative proceedings).

  • Judicial Decision of 15 December 2010 of the Federal Supreme Court (Supremo Tribunal Federal)[4] stated that tax authorities cannot obtain access to bank information of taxpayers without prior court authorisation. So LC 105, 2001 should be interpreted in conformity with Article 88 of the Federal Constitution (protects bank secrecy).

  • Tax Information Exchange Agreement (TIEA) signed between Brazil and the U.S. in March 2007 was ratified on 13 March 2013 (but no double tax treaty in place).[5]

Equality

  • Article 5 BC 1988 upholds the equality of all persons, Brazilians and foreigners, which means that unequal or prejudicial treatment is unconstitutional.

  • Differences in treatment of U.S. and non-U.S persons could be constitutionally challengeable.

Tax System

  • FATCA requires Brazilian P-FFIs to withhold tax on payments made from Brazil to third parties and to periodically deposit the withholding amounts with the IRS in the U.S.

  • Complementary Law n° 4.595/64 – sonly the Brazilian government has the authority to impose the obligation to collect taxes such as withholding income tax in domestic investment transactions.

  • FATCA withholding is not recognised as a tax in Brazil under the National Taxation Code.[6]

  • Brazil is currently preparing legislation which has been likened to FATCA, aiming to strengthen the requirements for providing information on ultimate beneficial owners of assets held by Brazil tax residents in funds and companies outside of Brazil.  

Financial System Regulation

Consumer Protection Code – bank clients have protections:

  • Discriminating against customers is prohibited;

  • Unilateral changes tocontracts are prohibited;

  • Closing client accounts without a reasonable or legal basis would be legally challengeable by Brazilian Consumer Associations and/or Brazilian Public Prosecutors;

  • Brazilian banking authorities[7] might punish bank administrators if Brazilian banks and financial institutions apply FATCA in breach of Brazilian laws. 

Foreign Capital – protections in the 'Foreign Capital Law' and the GC 1988:

  • Under the 'Foreign Capital Law'[8], foreign capitals are goods, machines and equipment imported to Brazil with no initial disbursement of foreign currency, for the production of goods or services, as well as financial or monetary resources introduced in the country for use in economic activities. In both cases, foreign capitals must belong to companies or individuals with permanent residence or headquarters in foreign countries.

  • Article 172 BC 1988 "The law shall regulate, based on national interests, the foreign capital investments, shall encourage reinvestments and shall regulate the remittance of profits".

  • Article 172 BC 1988 protects Brazilians and foreigners equally, and any tax that treats foreign capital unequally is per se unconstitutional.

  • Article 2 Foreign Capital Law: "To foreign capital invested in the country will be given equal legal treatment to that given to national capital, in equal conditions, any discrimination not foreseen in this statute being prohibited."

  • Brazilian FIs already provide the Brazilian Tax Authority with annual information on financial accounts, such as: name of the account holder; Brazilian TIN (CPF/CNPJ); account number; name and identification number of the Reporting FI; balance (certain fixed income investments); fixed and variable income earnings; gross proceeds of variable income investments; balance in current accounts; total gross amount of interest paid for depositary accounts.  Therefore the difficulty for Brazilian FFIs will be to identify, transform, and use this information for FATCA purposes, and to adapt existing financial reporting systems to incorporate FATCA U.S. person identification (U.S. indicia) and due diligence obligations.  

Data Protection in Brazil

  • No single statute, but governed by Federal Constitution, Brazilian Civil Code, and specific laws (e.g., Internet Act 2014, Consumer Protection Code, Labor Laws).

  • No legal definition of "Personal Data" in Brazil, but in practice may include information related to an individual, including name, age, sex, profession, address, religion, sexual orientation, criminal background, and any personal communication such as emails.

  • No legal definition of "Sensitive Data" or equivalent in Brazil.

  • Brazil does not have a national data protection authority like the UK's 'Information Commissioner's Office', so there enforcement may occur through costly civil suits or other administrative procedures. Public authorities may impose fines and/or revoke licenses or permits.

  • There is no obligation for FFIs to appoint a data protection officer under Brazilian law.

  • There are no express restrictions under Brazilian statute for cross-border transfer of data, but many other general principles may apply

POTENTIAL FATCA LOOPHOLES AVOIDANCE STRATEGIES

The high rates of reported and unreported tax evasion and money laundering in Latin American countries means that FFIs and their employees need to be particularly aware of potential FATCA loopholes and avoidance strategies that may be used by U.S. tax evaders. The following 5 areas highlight potential areas of weakness.

  1. Aggregated value of accounts – TARGET

     FATCA reporting thresholds require aggregation of account balances in different accounts only when the accounts are held at the same financial institution. Consequently a key FATCA avoidance strategy is for U.S. taxpayers to open foreign financial accounts at a larger number of unaffiliated banks and financial institutions. This effectiveness of this strategy is significantly increased by using the much higher joint spouse reporting thresholds under FATCA.

  2. Below Due Diligence Trigger multiple accounts

    U.S. tax avoidance strategies may include devising new "chains of low value accounts" to avoid trigger the due diligence requirements for U.S. persons. In this way, instead of using foreign financial accounts as methods of accumulating foreign holdings, foreign financial accounts can be used as low value funnel accounts to channel foreign cash holdings into non-FATCA jurisdictions but ensuring that all transactions are below the reportable due diligence trigger amounts on financial account balances at any time throughout the year, i.e. FATCA does not identify volume of cash and/or financial instruments transactions, only the amount at specific times. 

  3. Identification of specific FFIs in specific jurisdictions in which to open accounts (based on IGA status; systems capabilities; enforcement risks, etc.) – "race to the bottom".

    It is inevitable that during the first few years of FATCA compliance implementation there will be jurisdictions and FFIs that have lower or even lax FATCA compliance standards. These may not be discovered by the IRS until up to a few years later because of the phase-in nature of FATCA obligations, and because the IRS may not initially have full capacity to be able to efficiently and effectively monitor and police the FATCA reporting and withholding system. Even then potential IRS investigations may mean that the IRS resources are stretched to the limit.  This means that it may be possible for avoidance strategies to target FFIs in jurisdictions where there is a lower quality of FATCA compliance levels and/or investigation and enforcement risks. 

  4. FATCA Avoidance or Tax evasion through structuring of Active NFFEs

    Short term FATCA avoidance or tax evasion strategies may make use of the Active NFFE exemption.  For example, this may include a FI posing as a Non-Profit Organisation, a NFFE that is not yet operating a business (with nor prior operating history), but is investing capital into assets with the intent to operate a business other than a FI (this exception lasts 24 months only). Alternatively a FI may seek to structure or falsify its operational criteria so that it technically (on paper) falls under the less than 50% of the NFFEs' gross income for the preceding year is passive income (dividends, interest, royalties, annuities, rent), and less than 50% of assets held are assets that produce or are held for the production of passive income.

  5. Falsification of FATCA Status Self-Certification Documentation

     FATCA is orientated or geared towards the long-term identification and targeting of U.S. persons or entity tax evasion. Therefore FATCA is not currently prepared or orientated towards short-term of one-off tax avoidance schemes or strategies. Where tax evaders wish to carry out one-off or short-term tax avoidance schemes or strategies simply in order to avoid a 30% withholding tax, then they may seek to obtain falsified FATCA documentation relating to entities that fall under a FATCA exemption through self-certification, e.g. Certified Deemed-Compliant FFI with only low value accounts.   

[1] Recent research showed that Latin American firms presented a lower level of accounting quality, even when only those firms cross-listed in the U.S. (global players) were compared (Santana, V.D.F., Rathke, A.A.T., Lourença, I.M.E.C., and Dalmácio, F.Z. (2014). IFRS Accounting Quality in Latin America: A Comparison with Anglo-Saxon and Continental European Countries and the Role of Cross-Listing in the U.S., University of São Paulo and Lisbon University Institute).

[2]  Sabaini, J.C.G. and Jiménez, J.P. (2012). Tax structure and tax evasion in Latin America, (February), Economic Commission for Latin America and the Caribbean, p.35.

[3] There are limited exceptions and the principle has been upheld and applied to banking information by the Brazilian Federal Supreme Court.

[4] Recurso Extraordinário n. 389.808. Relator. Min. Marco Aurélio (Dec. 15, 2010).

[5] The TIEA requires Brazilian authorities to provide information on the payment of inter alia income taxes (IRPF) (Imposto de Renda de Pessoas Físicas); excise tax (IPI) (Imposto sobre Produtos Industrializados); the social contribution tax on net profits (CSLL) (Contribuição Social sobre o Lucro Líquido das Pessoas Jurídicas); company social security financing tax (COFINS) (Contribuição Social para o Financiamento da Seguridade Social); legal entity gross revenue tax (PIS) (Contribuição para os Programas de Integração Social e de Formulação do Patrimônio do Servidor Público); the financial operations tax (IOF) and the rural property tax (ITR) (Imposto Territorial Rural).

[6] Article 3 of the National Tax Code (Código Tributário Nacional) states: "Art. 3º Tributo é toda prestação pecuniária compulsória, em moeda ou cujo valor nela se possa exprimir, que não constitua sanção de ato ilícito, instituída em lei e cobrada mediante atividade administrativa plenamente vinculada."

[7] These are: (1) The National Monetary Council (Conselho Monetário Nacional (CMN)); (2) The Brazilian Central Bank (Banco Central do Brasil (Central Bank)); and (3) The Brazilian Securities and Exchanges Commission (Comissão de Valores Mobiliários (CVM)).

[8] Law No. 4.131 of September 3, 1962 (Foreign Capital Law), Article 1.