On-site ESMA Inspections: Chancery Division Gives Procedural Guidance

3 05 2015

European Securities & Markets Authority (ESMA) v DTCC Derivatives Repository Ltd [2015] EWHC 1085 (Ch) (25 April 2015)

This is a first of a kind judgment given by Mrs Justice Rose. It involved the application of the European Securities and Markets Authority (ESMA) for authorisation to conduct an inspection at the premises of a trade repository, the DTCC Derivatives Repository Limited (DTCC), in England. Rose J began her judgment by clarifying that DTCC was not suspected of engaging in misconduct and that the intended inspection was simply part of ESMA’s general supervisory functions. DTCC, which was notified, agreed to cooperate fully with the visiting ESMA officials but the agency nevertheless required the High Court’s authority to proceed with the inspection. In light of the novelty of the situation, the court handed down a short judgment to set out the principles that apply to the exercise of ESMA’s power. The court reiterated the Chancellor’s guidance that future applications for authorisation by either ESMA or the Financial Conduct Authority (FCA) under regulation 17 of the Financial Services and Markets Act 2000 (Over the Counter Derivatives, Central Counterparties and Trade Repositories) Regulations 2013 (the Domestic Regulations) can be submitted for consideration on the papers in certain cases.

First, where the company subject to the inspection has been informed of the inspection and has indicated its intention to submit to the inspection. Second, where the application is made by ESMA, that the FCA has been informed and does not wish to be heard at a hearing of the application. Third, the application does not seek a power to seal business premises or books and records, does not include a request for records of telephone and data traffic and does not request the issue of a warrant. Her Ladyship also said that the judge or master, on considering the application, may indeed decline to deal with the matter on the papers and direct that a hearing should take place.

European Securities and Markets Authority

ESMA was established under Regulation (EU) No 1095/2010 or the “ESMA Regulation” and as recorded by the preambular paragraphs important shortcomings in financial supervision in relation to the financial system as a whole were exposed by the financial crisis in 2007 and 2008. Accordingly, greater unity in the European financial markets exacted moving towards more integrated European supervision. To that end, ESMA formed part of the new European system of financial oversight established to exercise supervisory powers to ensure a robust and uniform level of regulation and supervision.

In addition to the ESMA Regulation, other European Union (EU) legislation confers duties on ESMA. For example, Regulation (EU) No 648/2012 on over-the-counter (OTC) derivatives, central counterparties and trade repositories (also known as the European Markets Infrastructure Regulation or EMIR) aims to increase the stability of the OTC derivative markets throughout the Union. EMIR underscores that OTC derivatives lack transparency because they are privately negotiated contracts and any information in relation to them is usually only available to the contracting parties. OTCs thus create a complex web of inter-dependence that may make it hard to identify the nature and level of risks involved.

As a consequence, a risk to financial stability is posed. In light of this situation, the Pittsburgh summit of G20 leaders in September 2009 made a commitment that all standardised OTC derivative contracts should be cleared through a central counter-party and reported to trade repositories. The reporting requirement seeks to enable central storage of information on the risks inherent in derivatives markets and makes it easily accessible to ESMA and other regulators. The registration and supervision of trade repositories (to ensure that they are subject to strict operational, record-keeping and data-management requirements) is the responsibility of ESMA.

Trade repositories first made applications for registration to ESMA in March 2013 and subsequently ESMA evaluated their compliance with the framework laid down in EMIR. In November 2013, ESMA registered six trade repositories and these trade repositories can therefore be utilised by EU counterparties to derivative transactions to fulfil their trade reporting duties within the meaning of EMIR.

ESMA Powers Under EMIR

ESMA enjoys certain supervisory powers conferred on it under EMIR. Pursuant to article 61, information from trade repositories can be sought by ESMA “by simple request or by decision” if that information is necessary for ESMA to perform its duties. Article 62 empowers ESMA to conduct investigations by examining records, data and procedures, asking people for explanations of documents, interviewing people who agree to be interviewed and requesting records of telephone and data traffic. Article 63 states that ESMA may carry out on-site inspections at any business premises or land. In circumstances where the efficiency and proper conduct of the inspection demand ESMA may carry out the on-site inspection without prior announcement. Moreover, ESMA officials with authority to conduct the inspection may enter any business premises or land of persons who are subject to an investigation decision and enjoy a variety of powers including those relating to sealing premises, books and records.

Article 60 governs the exercise of these powers and it provides that the powers given to ESMA (or to those authorised by it) shall not be used to require the disclosure of information or documents which are subject to legal privilege. ESMA is required, under articles 61-63, to inform the national competent authority, in the instant case the Financial Conduct Authority, of its intention to exercise its power. Under article 63, rather than the on-site inspection being conducted by ESMA, the European authority can make the FCA conduct the inspection or to assist the ESMA agents carrying out an inspection. Moreover, ESMA not only has powers to impose fines on trade repositories that furnish incorrect or misleading information, it also has the ability to impose periodic penalty payments on those who refuse to submit to an on-site inspection: see article 65(1) and article 66(1)(b)(iii) EMIR.

Under EMIR some powers may be made subject by national rules relating to authorisation from a judicial authority in the member state and the requirement regarding judicial approval applies if (under article 62(1)(e)) a request for records of telephone or data traffic is made or (under article 63) an on site inspection is to be carried out. EMIR provides the role of the national court in these terms:

  • where authorisation is applied for, the national judicial authority shall verify that ESMA’s decision is authentic and that the coercive measures envisaged are neither arbitrary nor excessive having regard to the subject matter of the inspection;
  • in its control of the proportionality of the coercive measures, the national judicial authority may ask ESMA for detailed explanations;
  • such a request for detailed explanations may in particular relate to the grounds ESMA has for suspecting that an infringement of EMIR has taken place, as well as to the seriousness of the suspected infringement and the nature of the involvement of the person who is subjected to the coercive measures;
  • however, the national judicial authority may not review the necessity for the inspection or demand to be provided with the information on ESMA’s file;
  • the lawfulness of ESMA’s decision shall be subject to review only by the Court of Justice following the procedure set out in Regulation (EU) No 1095/2010.

On-Site Inspections

Under the Domestic Regulations the exercise of these powers needs the authority of the High Court and regulation 17 stipulates that ESMA must obtain authorisation from the High Court before an inspection pursuant to article 63 is undertaken by any official of ESMA or another person authorised by it (including the FCA if it is acting on ESMA’s behalf).

The terms of engagement as regards regulation 17 are that authorisation may be granted if the court is satisfied that:

  • ESMA has initiated an article 63 inspection;
  • the article 63 inspection would be neither arbitrary nor excessive having regard to the subject matter of the inspection; and
  • the High Court must conduct the assessment in accordance with article 63(9) of EMIR and may exercise the powers conferred by that paragraph for the purposes of making its assessment.

Moreover, under regulation 17 a mechanism also exists for the High Court to issue a warrant in the event it is satisfied that there are reasonable grounds for believing that a person whose business premises are to be inspected has refused or would refuse to comply with such an inspection in the absence of a warrant. Furthermore, a warrant of this nature empowers a constable to enter and search the premises, take copies of documents and use such force as may be reasonably necessary to execute the warrant.

ESMA’s application for authorisation was supported by the authority’s Executive Director Verena Ross and the February 2015 decision adopted by ESMA requiring DTCC to submit to an inspection (i) did not provide for the use of any coercive measures such as the power to seal business premises and (ii) did not grant the power to request records of telephone and data traffic. The decision – one which gave the location, date and subject of the inspection and provided the text of EMIR – provided details of the powers that the persons authorised can exercise and informed DTCC of the potential penalties under article 66 of EMIR as regards not submitting to an inspection or providing incorrect or misleading answers to questions. The decision also informed DTCC of its right to appeal to the Board of Appeal and from there to the Court of Justice of the European Union.

Rose J had had sight of the following documentary evidence:

  • an authorisation by ESMA of five named people who are vested with the powers set out in the decision; the authorisation again describes the purpose of the investigation and refers to the power to impose a periodic penalty if DTCC does not submit to the inspection;
  • an email exchange between ESMA and the Director of Legal & Compliance at DTCC demonstrating that DTCC have been informed of the date of the inspection and that they intend to cooperate with it; and
  • a letter from ESMA to the Chief Executive of the FCA informing him of the forthcoming inspection; its date, subject and location and explaining in general terms the two matters that will in particular be investigated.

In light of the above, the court granted the application but in the exercise of her discretion Rose J made an amendment to the draft order in order to ensure that the inspection would strike the right balance (i.e. it would be neither arbitrary nor excessive having regard to its subject matter). Considering that this important safeguard needed express reference on the face of the documents presented to the company, her Ladyship expressly stated in the order that the inspection is subject to article 60 (EMIR) relating to the non-disclosure of legally privileged information and documents.

ESMA’s Executive Director Verena Ross’s statement also drew attention to such applications being made on paper in the future and the court noted that such an application could be made under rule 23.8(c) of the Civil Procedure Rules 1998 which allowed the court the discretion to deal with an application without a hearing if it does not consider that a hearing would be appropriate. Moreover, Rose J also said that the Chancery Guide considered rule 23.8(c) to be a useful provision where the parties consent to the terms of the order sought. It is also useful where:

although the parties have not agreed to dispense with a hearing, and the order is not consented to, the order sought by the application is, essentially, non-contentious. In the latter case the order will be treated as being made on the court’s own initiative and will set out the right of any party affected by the application who has not been heard to apply to vary or set aside the order.

However, the guide explains that this is inappropriate where the matter is contentious and that:

It will normally be wrong to seek an order which imposes sanctions in the event of non-compliance without notice and without a hearing.

Rose J held that para 15 that a failure by a subject company to submit to an order of the kind she was making would not amount to a breach of that order because it would potentially attract the penalties set out in EMIR. The breach may also in certain circumstances prompt ESMA to return to court to get a warrant under regulation 17(5) – (9) of the Domestic Regulations. However, the breach would not amount to contempt of the court’s order.

Rose J reiterated the Chancellor’s indication that future applications pursuant to regulation 17 of the Domestic Regulations for authorisation by either ESMA or the FCA can be submitted to the court for consideration on the papers provided that:

  • the company subject to the inspection has been informed of the inspection and has indicated its intention to submit to the inspection;
  • in cases where the application is made by ESMA, that the FCA has been informed and does not wish to be heard at a hearing of the application;
  • the application does not seek a power to seal business premises or books and records, does not include a request for records of telephone and data traffic and does not request the issue of a warrant.

Rose J imparted guidance at para 17 that the application should be issued by ESMA and allocated a case number rather than treated as a pre-issue application. Moreover, her Ladyship also explained that the judge or master, on considering the application, may indeed decline to deal with the matter on the papers and direct that a hearing should take place.


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26 05 2015
mkp

Khan, Asad Ali, On-Site ESMA Inspections: Chancery Division Gives Procedural Guidance (May 25, 2015). Available at SSRN: http://ssrn.com/abstract=2610070

Abstract:
European Securities & Markets Authority v DTCC Derivatives Repository Ltd [2015] EWHC 1085 (Ch) (25 April 2015) is a first of a kind judgment given by Mrs Justice Rose. It involved the application of the European Securities and Markets Authority (ESMA) for authorisation to conduct an inspection at the premises of a trade repository, the DTCC Derivatives Repository Limited (DTCC), in England. Rose J began her judgment by clarifying that DTCC was not suspected of engaging in misconduct and that the intended inspection was simply part of ESMA’s general supervisory functions. DTCC, which was notified, agreed to cooperate fully with the visiting ESMA officials but the European agency nevertheless required the High Court’s authority to proceed with the inspection. In light of the novelty of the situation, the court handed down a short judgment to set out the principles that apply to the exercise of ESMA’s power. The court reiterated the Chancellor’s guidance that future applications for authorisation by either ESMA or the Financial Conduct Authority (FCA) under regulation 17 of the Financial Services and Markets Act 2000 (Over the Counter Derivatives, Central Counterparties and Trade Repositories) Regulations 2013 can be submitted for consideration on the papers in certain cases. Rose J imparted guidance that such applications should be issued by ESMA and allocated a case number rather than treated as a pre-issue application. Over the Counter Derivatives (OTCs) create a complex web of inter-dependence that may make it hard to identify the nature and level of risks involved. As a consequence, a risk to financial stability is posed. In light of this situation, the Pittsburgh summit of G20 leaders in September 2009 made a commitment that all standardised OTC derivative contracts should be cleared through a central counter-party and reported to trade repositories. The reporting requirement seeks to enable central storage of information on the risks inherent in derivatives markets and makes it easily accessible to ESMA and other regulators. The registration and supervision of trade repositories (to ensure that they are subject to strict operational, record-keeping and data-management requirements) is the responsibility of ESMA.

Number of Pages in PDF File: 12

Keywords: CPR 1998, Chancery Guide, DTCC, EMIR, ESMA, EU, FCA, OTCs

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