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02 May 2018
In recent years Cyprus companies have sought, albeit not often, to generate financing outside the regular banking system through unconventional non-bank credit activities (ie, so-called 'shadow banking', which are backed by quasi-security arrangements). Shadow banking takes the form of, among other things:
This has created a large sector parallel to the banking system, resulting in a call for strengthened regulations to mitigate risks and support financial stability.
The EU Securities Financing Transactions Regulation (2015/2365) and the EU Over-the-Counter Derivatives, Central Counterparties and Trade Repositories Regulation (648/2012) (EMIR), which apply to Cyprus as an EU member state, must be considered as regards shadow banking.
The EU Securities Financing Transactions Regulation responds to the need to enhance the transparency of securities financing markets – and thus of the financial system – with the aim of reducing the risks associated with the use of securities financing transactions (SFTs) in shadow banking systems. It covers SFTs in the form of:
The EU Securities Financing Transactions Regulation creates, among other things, a framework under which details of SFTs can be efficiently reported to trade repositories. It addresses the need to:
The EU Securities Financing Transactions Regulation also establishes strict rules for counterparties concerning re-use. It applies to:
Cyprus companies that enter into such SFTs must observe:
Certain EU Securities Financing Transactions Regulation provisions already apply. The transaction reporting obligation is expected to come into effect in the second quarter of 2019, so Cyprus companies entering into such transactions must keep this in mind. The Cyprus Securities and Exchange Commission (CySEC) is the competent authority for the implementation of the regulation.
Failure to comply with the regulation will result in the imposition of administrative and criminal penalties.
In parallel to the EU Securities Financing Transactions Regulation, the EMIR has also introduced reporting, clearing and operational risk management obligations, which may apply to non-financial counterparties (ie, a mere limited liability company). The EMIR also directly applies in Cyprus. As specified by CySEC, it aims to identify the risks associated with over-the-counter (OTC) derivatives, which generally lack transparency, as they are privately negotiated contracts and any information concerning them is usually available only to the contracting parties, as they create a complex web of interdependence which can make it difficult to identify the nature and level of risk involved.
Cyprus companies entering into OTC derivative transactions must carefully consider their requirements under the EMIR, as they not only apply to financial counterparties, but also to non-financial counterparties (NFCs) – for example, liability companies which constitute none of the following:
The EMIR introduces:
All NFCs (irrelevant of the clearing threshold) must have appropriate procedures in place to ensure that they can confirm the details of their non-cleared derivatives contracts with counterparties. An NFC must ensure that it exercises due diligence and appropriate procedures and that arrangements are in place to:
Unlike the reporting obligations under the EU Securities Financing Transactions Regulation, obligations under the EMIR are already in force and must be complied with or fines will apply. As the competent regulatory authority, CySEC may impose an administrative fine not exceeding €350,000. In case of repeated violation, an administrative fine not exceeding €700,000, depending on the seriousness of the violation, may be imposed. If it is proven that the party responsible for the violation received illicit gain exceeding the amount of the administrative fine, CySEC may impose an additional fine of up to double the amount of the gain. The fine will be for each party that fails to comply with the requirements.
As Cyprus is a popular jurisdiction for establishing special purpose vehicles with an increased involvement in shadow banking, it is important to highlight the significance of the newly introduced regulations analysed above, which now bring non-financial counterparties, such as limited liability companies, into the ambit of transparency reporting.
For further information on this topic please contact Angeliki Epaminonda at Patrikios Pavlou & Associates LLC by telephone (+357 25 87 15 99) or email (firstname.lastname@example.org). The Patrikios Pavlou & Associates LLC website can be accessed at www.pavlaw.com.
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