• The Financial Services Firms Law (No. 148 (I) of 2002)
  • September 29, 2003 | Author: Elias Neocleous
  • Law Firm: Neocleous, Andreas, & Co LLC - Limassol Office
  • The Financial Services Firms Law (No.148(I) of 2002) Elias A. Neocleous, Partner and Head of the Corporate & Commercial Department of Andreas Neocleous & Co, provides a brief overview of the regulatory changes as they affect investment firms in Cyprus. Cyprus's Financial Services Firms Law of 2002 (the 'Law') was enacted last July, in order to regulate the provision of financial and investment services in Cyprus. Although the Law initially targeted Cypriot stockbrokers, it affects the regulation of International Financial Companies ('IFCs') currently supervised by the Central Bank of Cyprus. The licensing and supervision requirements will now change. The Law will regulate all future Investment Firms ('IFs'), including companies incorporated in Cyprus, wishing to provide investment services from and in Cyprus and will also regulate the provision of such investment services in Cyprus by companies incorporated outside Cyprus. The Law will regulate investment services provided either by a Cypriot IF or by branches of foreign companies registered in Cyprus, or even cross-border transactions provided in Cyprus by a company incorporated outside Cyprus and without the establishment of a branch. Such IFs will now be supervised by the Capital Markets Commission ('CMC'). The Law is supplemented and implemented by Resolutions (issued by the CMC or Central Bank, as the case may be) and Regulations (issued by the Council of Ministers). Aims The Law aims to harmonise current Cypriot legislation with European Union law, pending Cyprus' forthcoming accession, by introducing the free movement of investment services and reforming the Cyprus Stock Exchange. With the enactment of the Law, the legislature sought to regulate the operations and licensing pre-requisites of companies that offer investment services in Cyprus, as well as to introduce rules relating to the precautionary supervision and professional conduct of such companies. The law also regulates the operation of cross-border transactions undertaken by such businesses outside Cyprus. The maintenance and security of the minimum capital required to cover liabilities and the operation of a fund to compensate investors have also been introduced. Scope Whilst the Law governs the provision of services in Cyprus, and from persons established within Cyprus, it also extends to the provision of services from outside Cyprus to residents or persons domiciled in Cyprus provided the offer reaches those persons while they are in Cyprus, or the transaction is concluded in Cyprus. IFs registered outside Cyprus who provide services either through a branch in Cyprus or on a cross-border basis under the free provision of services régime set out in the Law (referred to as the 'passport benefit', which comes into effect following Cyprus' accession to the EU), will be authorised to operate within Cyprus. A Cypriot IF may, with notice to the CMC, establish a branch in Cyprus or provide the services through a representative, who is domiciled or established in Cyprus, provided that the Cypriot IF assumes, in writing, full liability for the acts or omissions of the representative. A representative may not act in that capacity for more than one IF. A Cypriot IF may collaborate with an 'Intermediary Company' (discussed below) which may receive and transmit orders. Application The Law applies to what it terms 'Investment Services' and 'Non-Core Services.' Investment Services means: · the receipt or transmission, on behalf of investors, of orders in relation to one or more financial instruments, or the execution of such orders, other than for their own account · the dealing in financial instruments for their own account · the management of investment portfolios in accordance with mandates given by investors on a client-by-client basis, where such portfolios include one or more financial instruments · the underwriting of issues of any financial instruments. Non-Core Services means: · the safekeeping and administration of one or more financial instruments · safe custody services generally · the granting of credits or loans to clients to enable them to carry out transactions involving one or more financial instruments, where the firm granting the credit or loan is involved in the transaction · advice to undertakings on capital structure, industrial strategy and related matters or advice and service relating to mergers and the buy-out of undertakings · services connected with underwriting · investment advice concerning one or more financial instruments · foreign exchange services where these are connected with the provision of investment services. 'Financial Instruments', under the Law, is taken to mean transferable securities and shares in collective investment undertakings, money-market instruments, financial futures contracts including equivalent cash-settled instruments, forward interest rate agreements, interest rate currency and equity swaps and options to acquire or dispose of these instruments including equivalent cash-settled instruments and currency, and interest rate swaps. Currently Currently IFCs are, and will remain until effective transfer to the CMC, under the regulation and supervision of the Central Bank, according to the terms and conditions of their permits initially granted under the Exchange Control Law. The Central Bank has, as a matter of policy, decided to transfer the regulation of all IFCs to the CMC. The Central Bank will continue to regulate activities pending the approval or refusal of a new licence by the CMC. Naturally this will only apply to companies which actually require a licence. The provisions of the Exchange Control Law permit and the applicability or validity thereof will continue until it is formally revoked by the Central Bank. In view of this, companies must continue to comply with the existing regulatory requirements of the Central Bank. This was confirmed by the Central Bank in a circular issued in February 2003. Licence If an IFC wishes to continue its operations in Cyprus or from within Cyprus, it must apply to the CMC for a licence. The application from existing IFCs must be submitted to the CMC on or before 30 June 2003. In its application, the IFC must submit inter alia: · a list of the services it wishes to provide · a business plan setting out the full operational schedule · the preliminary or draft Memorandum and Articles of Association of the IFC to be adopted once the licence has been granted, incorporating the intended services · curricula vitae, details of convictions if any, and certificates of non-insolvency of the members of the board of directors, executives and shareholders, together with the questionnaire to be provided by the CMC · a draft of the internal regulations detailing the internal controls and risk management mechanisms · a draft organizational schedule of the IFCs · a description of the IT infrastructure · draft anti-money laundering measures. The CMC will take into account the adequacy and soundness of the proposed operation, the protection offered to investors and the markets, the prevention of possible conflicts of interest and the management of risks. The CMC has to approve or refuse a licence application within 3 months of a duly completed application, although existing IFCs should be informed on or before 31 August 2003. Once a licence has been granted, a Cypriot IF may amend any of the information submitted to the CMC by notifying the CMC at least 10 days prior to introducing the amendment. The CMC will not object provided the proposed amendment will not, in the CMC's opinion, affect the direction, structure or sound operation of the Cypriot IF, the regular operation of the market or the interests of the investors. Should a Cypriot IF wish to extend its range of services, it must submit an additional similar application. Any Cypriot IF which only provides Non-Core Services will not require a licence under the Law with the possible exception of investment advice concerning one or more financial instruments. Once the licence has been granted, the existing IFCs will have to ensure that their company details comply with the Law. Memoranda and Articles of Association must include investments services in their objects. Under the Companies Law (Chapter 113), a company's memorandum may only be amended with the confirmation of the courts. The name of the IFC must also be amended to include the term 'Investment Firm'. If the IFC is a member of the Cyprus Stock Exchange, the term 'Stock Exchange' must be included before the word 'Firm'. Further, the IFC's minimum share capital, dependent on the investment services it is licensed to provide, must be fully paid up. Capital Depending on the scope of the services to be provided, a Cypriot IF is obliged to have a minimum paid-up share capital, in Cypriot Pounds, of: · £125,000, where it receives and transmits or executes orders on behalf of clients in relation to financial instruments · £150,000, where a Cypriot IF manages a client's investment portfolio · £600,000, where a Cypriot IF sells and purchases financial instruments for its own account or underwrites the issue of financial instruments. This does not include the holding of non-trading book positions in financial instruments for own fund investments. In their normal operations, and as will be determined by the CMC from time to time, IFs must at all times ensure that they dispose of their own funds on a daily basis to cover the following capital requirements: · position risk and settlement and counter-party risk, on the basis of their respective trading book business · large exposures, on the basis of their respective trading book business · short foreign exchange positions risk, on the basis of their business activities · solvency ratios on the basis of their business activities in total but excluding trading book business and non-realisable (fixed) assets on conditions determined by the CMC · transactions which do not fall within the scope of the Law but which involve similar risks to those covered by the Law and the CMC. The Law sets out general principles for evaluating the capital requirements for the cover of risks and large exposures, which will be supplemented by the Resolutions of the CMC detailing the principles and methods of determination and valuations of own funds and solvency ratios. The own funds requirements of a Cypriot IF can never be less than 25% of the preceding year's fixed overheads. Conduct The Law provides various rules on how IFs should conduct their business and advertise their services. IFs are free to advertise through any medium of communication provided they adhere to the Control of Misleading and Comparative Advertisement Law of 2000. All advertisements must be submitted within 2 days to the CMC, who may demand that it be altered. The licence number must appear on all advertisements, documents, announcements etc. Further, IFs are required to: · take all necessary measures and act in good faith in exercising their activities in accordance with good business practices, in order to promote the best interests of their clients, and to uphold the proper operation of the market · act with due skill, care and professional diligence · possess and employ all necessary resources and procedures · procure the appropriate information from their clients regarding their financial situation, investment experience and objectives · adequately disclose relevant material information to their clients, such as the organisation and operation of the IF and any potential conflicts of interest · use their best efforts to avoid conflicts of interest and, where they exist, resolve them as objectively as possible. Prudential Rules In addition to the general rules on conduct, the Law sets out various 'Prudential Rules' (the 'Rules'), to be supplemented from time to time by Ministerial Regulations or by Resolutions of the CMC. The Rules are in line with similar or existing practices of IFCs with a few new introductions. IFs will not be permitted to use client/investor capital in their possession for their own account, and the investors' funds and instruments must be segregated from the Ifs' assets in case of bankruptcy. Further, sound administrative and accounting procedures, as well as controls and safeguard arrangements for electronic data, must be implemented. Records of transactions executed must be kept, and the risk of conflicts of interest must be minimised. An important new element is that the Minister of Finance may, by Ministerial Circular, define the qualifications of and special procedure for approving employees and executives. If, and when, such a Circular is issued and the employees and executives possess the necessary qualifications, they will further be obliged to sit and pass an annual examination, thereby ensuring uniformity of standard across the industry. Transfer of Shareholding A Cypriot IF shareholder who wishes to transfer shares in a Cypriot IF will have to notify the CMC one month prior to the transfer of shares if, following the transfer, the shareholder's holding in the Cypriot IF falls below 10%, 20%, 25%, 50% or 75% of the total share capital or of the voting rights threshold, or if the Cypriot IF ceases to be a subsidiary of the shareholder. Notification will also need to be made by a purchaser acquiring a holding in a Cypriot IF which exceeds the thresholds referred to above. Passport The Law was enacted to harmonise Cyprus law with the relevant EU law. The forthcoming accession of Cyprus to the EU will provide the most significant and possibly the most advantageous changes to the regulation of the investment industry. The following provisions come into effect upon accession to the EU on 1 May 2004. An IF which is licensed by the competent authority in a Member State of the EU may operate within Cyprus through a branch without a licence from the CMC. Such an IF will only be entitled to operate within Cyprus if the competent authority of its home state gives the CMC certain information regarding the business plan, organizational structure, compensation schemes etc. Furthermore, an IF licensed by the competent authority in a Member State may commence the free provision of cross-border services without even opening a branch, provided its competent authority notifies the CMC of the business plan the IF intends to implement in Cyprus. The quid pro quo of this is that Cypriot IFs will have reciprocal rights in other EU states, hence the 'passport benefit'. The CMC will have the same duties and obligations as those of its counterparts in other Member States. The CMC will be entitled to refuse to provide its EU counterpart with the relevant notice if it believes that by providing such notice for a Cypriot IF, it will put the investors or the orderly operation of the Cypriot IF at risk. Intermediary Company The Law has introduced the concept of the 'Intermediary Company' whose exclusive object is to receive and transmit orders in relation to transferable securities and shares, which may only be transmitted to IFs. Such Intermediary Companies are obliged to have a minimum share capital of £40,000, be audited, apply the Code of Business Conduct observed by IFs and have appropriate internal controls for the protection of their clients' interests. Compensation An Investor Compensation Fund has been established, to which Cypriot IFs will have to contribute. The fund covers people who are not professional investors and the compensation is limited to £15,000. IFs will have to inform clients about the fund and the cover provided, prior to the conclusion of any transaction. The Fund will commence operation upon the issuing of Regulations setting out the form, management, organization and overall operation of the Fund. Further Regulations will set out the scope, procedure and period within which a claim may be lodged. Situation in the UK Whilst the Financial Services Authority (FSA) in the United Kingdom has a far wider remit, which came into force in its present state on 1 December 2001, it is analogous in certain limited ways to the CMC. It will be possible to gain limited guidance on the future approach of the latter by examining that of the former. The FSA's stated goal is to 'maintain efficient, orderly and clean financial markets and help retail consumers achieve a fair deal'. The four statutory objectives of the FSA are to maintain market confidence, promote public understanding of the financial system, secure appropriate consumer protection and reduce financial crime. The approach is stated to be based on a clear statement of the realistic aims and limits of UK regulation, and recognises both the proper responsibilities of consumers and of firms' own management, and the impossibility and undesirability of removing all risk and failure from the financial system. Whereas the UK legislation contains similar requirements for investment firms, the policing role of the FSA began very recently, and has not been exercised for a sufficient period of time for a body of regulatory thinking to have accumulated. Undoubtedly, however, the CMC will look to the FSA for guidance in future. Conclusion Cyprus is going through a period of dynamic and exciting change. These changes introduce their own potential pitfalls which, with the appropriate information and advice, may become prime opportunities. The Law is no exception. The Law lays the foundation for a better regulated and more balanced investment market which should reduce the exposure of the investor to extraordinary risks. The principal attraction of the Law is the easier penetration of the European market. The time to prepare for accession is now. Please feel free to contact us at any time should you wish to discuss any aspect of the above or wish us to address any concerns you may have with regard to the Law. Andreas Neocleous & Co Tel +357 25 362818 199, Arch. Makarios III Ave. Fax +357 25 359262 PO Box 50613 [email protected] Cy-3608 Limassol, Cyprus www.neocleous.com IMPORTANT NOTE: This communication is intended to provide general information about recent and future developments of interest. It is not intended to be comprehensive nor does it provide legal advice and should not be acted or relied upon as such. Specific and appropriate professional advice should always be obtained. © ANDREAS NEOCLEOUS & CO May 2003