Circular 5/2011 of the CNMV modifying Circular 12/2008 on solvency and Circular 7/2008 on accounting standards for investment service companies

OFFICIAL STATE BULLETIN No. 301 Thursday, December 15, 2011 Sec. I. Page 137335 I. GENERAL PROVISIONS SPANISH NATIONAL SECURITIES MARKET COMMISSION 19550 Circular 5/2011, of December 12, of the Spanish National Securities Market Commission, modifying Circular 12/2008, of December 30, on the solvency of investment service companies and their consolidatable groups, and Circular 7/2008, of November 26, on accounting standards, annual accounts and reserved information statements of investment service companies, management companies of collective investment institutions and management companies of venture capital entities.

Circular 5/2011, of December 12, of the Spanish National Securities Market Commission, modifying Circular 12/2008, of December 30, on the solvency of investment service companies and their consolidatable groups, and Circular 7/2008, of November 26, on accounting standards, annual accounts and reserved information statements of investment service companies, management companies of collective investment institutions and management companies of venture capital entities.

STATEMENT OF MOTIVES This Circular aims to modify Circulars 12/2008, regarding solvency norms, and 7/2008, regarding accounting norms, both applicable to investment service companies and their consolidatable groups. Regarding solvency, concepts related to elements composing own funds (preferred shares and participations, hybrids), large risks, trading portfolio, and internal models for these purposes are modified, and finally, remuneration policies. Regarding accounting, provisions related to business combinations and accounting consolidation are incorporated into its norms.

With regard to Circular 12/2008, of December 30, of the Spanish National Securities Market Commission, on the solvency of investment service companies and their consolidatable groups, this Circular carries out the final transposition of Directives 2009/111/EC of the European Parliament and of the Council, amending Directives 2006/48/EC and 2006/49/EC and 2007/64/EC, as well as Directive 2010/76/EU, also of the European Parliament and of the Council, which again amends the aforementioned Directives 2006/48/EC and 2006/49/EC. This transposition began first with Law 2/2011, of March 4, on the Sustainable Economy, secondly with Law 6/2011, of April 11, modifying Law 13/1985, of May 25, on investment coefficients, own resources and information obligations of financial intermediaries, and finally with Royal Decree 771/2011, of June 3, 2011, modifying Royal Decree 216/2008, of February 15, on own resources of financial entities.

Regulatory developments in the matter of solvency have not finished. It is foreseeable that during the current year the European Commission will present new draft Directives and Regulations on the solvency of financial entities. Nevertheless, considering the transposition period provided for the Directives mentioned in the previous paragraph, October 31, 2010 for Directive 2009/111/EC and December 31 of that same year or January 1, 2011, depending on the matter, for Directive 2010/76/EU, Circular 12/2008, of December 30, of the CNMV, on the solvency of investment service companies and their consolidatable groups, must be modified to comply with the transposition obligations contained in the two aforementioned Directives and independently of necessary changes that may be required in the future.

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OFFICIAL STATE BULLETIN No. 301 Thursday, December 15, 2011 Sec. I. Page 137336 The aforementioned Directives modify Directives 2006/48/EC and 2006/49/EC of the European Parliament and the Council, the content of which was transposed into our law through Law 24/1988, on the Securities Market, Royal Decree 216/2008, on own resources of financial entities, and finally, through the aforementioned Circular 12/2008, of December 30, of the CNMV.

The Circular incorporates the content of Directive 2009/111/EC of the European Parliament and of the Council regarding concepts related to elements composing own funds (hybrids) and the regime of large risks.

This Circular also partially incorporates, as explained below, the content of Directive 2010/76/EU of the European Parliament and of the Council, the second of the Directives transposed through the modification of Circular 12/2008, whose content can be summarized in modifications to the trading portfolio and internal models for this purpose, the regime of "retitizations" and remuneration policies. In this Circular, no changes are proposed regarding the concepts that modify the determination of own resource requirements for credit risk of securitizations or "retitizations", as this is regulated for investment service companies by reference to Circular 3/2008, of May 22, of the Bank of Spain, on the determination and control of minimum own resources. Regarding remuneration policies, this Circular develops the content of Royal Decree 771/2011, of June 3, 2011, modifying Royal Decree 216/2008, of February 15, on own resources of financial entities. Additionally, in accordance with Recital 4 and the dispositive part of the Directive, section 1 of Annex 1, reflected in turn in number 1 of Article 116 of the aforementioned Royal Decree, the Circular establishes the necessary proportionality for the practical application by the sector of investment service companies of the requirements in the matter of remuneration.

Finally, this Circular refers to the European Banking Authority (EBA), as a recent European supervisory agency, which has come to replace one of the previously called third-level committees: in this specific case, the European Banking Authority (European Banking Authority) which replaces the European Committee of Banking Supervisors, whose functions it will gradually assume in the terms provided by its creation regulation [Regulation (EU) No. 1093/2010 of the European Parliament and of the Council, of November 24, 2010].

With regard to Circular 7/2008, of November 26, of the Spanish National Securities Market Commission, on accounting standards, annual accounts and reserved information statements of Investment Service Companies, Management Companies of Collective Investment Institutions and Management Companies of Venture Capital Entities, which incorporates among its norms the provisions related to business combinations and consolidation, the Statement of Motives already stated that "reforms in the accounting matter for the modernization and international harmonization of Spanish accounting will also require a specific development of Norms for the Formulation of Consolidated Annual Accounts, which will inevitably demand the review of the consolidation norms included in this Circular."

Commission Regulations (EC) 494/2009 and 495/2009 adopted for the European Union the modification of International Accounting Standard (IAS) 27 "Consolidated and Separate Financial Statements" and International Financial Reporting Standard (IFRS) 3 "Business Combinations".

The publication of Royal Decree 1159/2010, of September 17, approving the Norms for the Formulation of Consolidated Annual Accounts and modifying the General Accounting Plan approved by Royal Decree 1514/2007, of November 16, and the General Accounting Plan for Small and Medium-sized Enterprises approved by Royal Decree 1515/2007, of November 16, requires the review of the consolidation norms included in this Circular.

Nevertheless, and due to its lesser relevance for investment service companies, it has been decided to regulate the specific and concrete matters related to business combinations and consolidation, whose principles are of transcendental importance for credit entities, by direct reference to Circular 4/2004, of December 22, of the Bank of Spain, to credit entities, on public and reserved financial information norms and models of financial statements.

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OFFICIAL STATE BULLETIN No. 301 Thursday, December 15, 2011 Sec. I. Page 137337 The content of this proposal has been structured into two norms and an additional provision, a transitional provision and a final provision. The first norm incorporates the modifications provided for in the matter of solvency from the Directives being transposed. The norms of this Circular, and consequently the modifications of the corresponding articles, are ordered according to the numbering of the original Circular's articles. In some cases, it has been decided to group modifications on the same matter or article collected in different sections of the same Directive or in changes from both Directives, into a single point of a norm, as they are changes on the same concept, with the aim of facilitating the understanding of the modification.

The second norm incorporates the proposed modifications considered necessary for a more efficient practical application of the current Circular 7/2008, of November 26, of the Spanish National Securities Market Commission, on accounting standards, annual accounts and reserved information statements of Investment Service Companies, Management Companies of Collective Investment Institutions and Management Companies of Venture Capital Entities, clarifying and specifying some concepts and modifying others to facilitate the application of accounting norms, which are also ordered according to the numbering of the norms of the original Circular.

Both norms include small modifications, corrections or additions that do not come from the Directives being transposed or from the content of Royal Decree 1159/2010, but rather as a product of practical experience in the application of both circulars, aiming to clarify concepts, improve wording or give regulatory rank to criteria currently being used in the supervision of investment service companies.

Finally, an additional provision is included that incorporates the Directives being transposed, a transitional provision foresees the compliance with information obligations referred to 2010, and a final provision the entry into force date of the circular.

Consequently, in exercise of the powers conferred in this matter, in accordance with the Council of State, prior report of the Bank of Spain, the General Directorate of Insurance and the Institute of Accounting and Auditing of Accounts and in accordance with what is established in Article 15 of Law 24/1988 of July 28, The Securities Market Commission has ordered:

Norm 1. Modifications of Circular 12/2008, of December 30, of the Spanish National Securities Market Commission, on the solvency of investment service companies and their consolidatable groups with origin in Directives 2009/111/EC and 2010/76/EU of the European Parliament and of the Council.

1. The wording of Article 1 regarding the scope of application is modified, which will be worded as follows:

"Article 1. Scope of Application.

1. This Circular shall apply to investment service companies defined in Articles 62 and 64 of Law 24/1988, of July 28, on the Securities Market and their corresponding consolidatable groups, as defined in Article 86 of the aforementioned Law and its development regulations.

2. The consolidatable groups of investment service companies are those in which there is a unit of decision either because a situation of control exists, or because there are systematic concerted actions, as indicated in Article 86 of Law 24/1988, of July 28, on the Securities Market and its regulatory developments. Control shall be presumed when an entity, which will be classified as dominant, is in relation to another company, which will be classified as dependent, in any of the situations provided for in Article 42 of the Commercial Code. Additionally, consolidatable groups of ISCs (Investment Service Companies) shall be considered those in which two or more Spanish consolidatable entities by their activity, fall under the same unit of decision through channels other than control, provided that at least one of them is an ISC and without the unit of decision necessarily having to be established by contract or by statutory clauses.

3. For the purpose of clarifying the concept of control, when two or more entities each possess a significant number of voting rights of the same entity, the rest of the factors determining the existence of control must be analyzed to determine which is the dominant entity. To determine the voting rights of the dominant entity, those it possesses directly shall be added to those corresponding to other dependent entities or through persons acting in their own name but on behalf of the dominant entity or other dependents, or those with which it acts concertedly with any other person. In the calculation of voting rights, both current and potential ones shall be taken into account, such as call options acquired on equity instruments or forward purchase contracts of such instruments, including those held by other entities or persons, which are currently convertible or exercisable, taking into account the facts and circumstances affecting the conversion or exercise conditions. Accordingly, in the valuation of the contribution of potential voting rights for the existence of a group, the entity shall take into consideration all facts and circumstances affecting the same, such as the conditions of their exercise. On the contrary, the intention of the board of directors or equivalent body nor the financial capacity of the entity to convert or exercise them shall not be taken into consideration. The obligation to consolidate must be carried out even when the participation in the consolidatable entities is held through entities of the non-consolidatable economic group.

4. Notwithstanding the provisions in the previous paragraphs, consolidatable groups of ISCs that do not have to comply with their own resource determination obligations on a consolidated basis, such as those groups that meet the requirements provided for in section 2 of Article 42 of the Commercial Code, must comply with the accounting obligations applicable to them as provided in commercial legislation.

5. The provisions contained in this Circular shall not apply to financial advisory companies, which shall adjust their own resources to what is provided in Royal Decree 217/2008, of February 15, on the legal regime of investment service companies and other entities providing investment services and partially modifying the Regulation of Law 35/2003, of November 4, on Collective Investment Institutions, approved by Royal Decree 1309/2005, of November 4."

6. Modification of number 1 of the article and incorporation of a new number 7 to this article.

"1. For the purpose of complying with the own resource requirements of investment service companies and their consolidatable groups, as established in this Circular, own resources shall be composed of the following concepts: a) Share capital plus the corresponding share premium account, to the extent that it has been paid, serves fully to absorb losses in normal situations and, in case of bankruptcy or liquidation, has lower priority than all other claims. b) Effective and express reserves. c) Current year results, during the year and, upon its closure, until the application of results takes place, provided that the following conditions are met: – That there is a formal commitment to apply results by the entity's governing body. – That the accounts in which said results are reflected have been verified with a favorable report by the entity's external auditors. – That it is proven, to the satisfaction of the Spanish National Securities Market Commission, that the portion of results to be counted is free from any foreseeable charge and, in particular, tax burdens and dividends. c bis) Instruments other than those contemplated in letter a) that meet the requirements provided for in letter h) of this number and in number 7 of this article. d) Regularization, updating or revaluation reserves of assets that were countable before the entry into force of Circular 7/2008 of the CNMV on accounting standards, annual accounts and reserved information statements of investment service companies, management companies of collective investment institutions and management companies of venture capital entities, as well as those derived from the formulation of accounts with the principles collected in the aforementioned circular provided they are duly registered in the accounting and correspond to freely disposable assets. Reserves of this nature associated with merger processes shall not be accounted for as own resources before the registration of the merger in the Commercial Registry, subtracting meanwhile from the revalued assets for the purpose of calculating own resource requirements. e) Funds allocated to the set of risks of the entity, whose provision has been made separately within the income statement or charged to profits, and provided that their amount appears separately in the entity's public balance sheet. f) The part of share capital corresponding to non-voting shares and redeemable shares whose duration is not less than that provided for for subordinated financing collected in the following letter g), regulated in the Capital Companies Law. g) Subordinated financing received by the investment service company that meet the requirements established in the subsequent paragraphs of this article. h) Subordinated financing of indefinite duration, in the part effectively paid, that meet the following conditions: i. That the issuance conditions establish the possibility of deferring interest, and of applying the debt and pending interest to the absorption of losses without the need to proceed to the dissolution of the entity. ii. That they cannot be reimbursed without prior authorization of the Spanish National Securities Market Commission. iii. That they are subordinated in their entirety to the claims of non-subordinated creditors. i) The percentages indicated below of the gross amounts of capital gains (net of capital losses) that are accounted for as valuation adjustments of financial assets available for sale within equity as collected in Circular 7/2008 of the CNMV on accounting standards, annual accounts and reserved information statements of investment service companies, management companies of collective investment institutions and management companies of venture capital entities. These gross amounts shall be constituted by the credit balance of each of the accounts of the adjustments derived from debt or equity instruments, plus the tax correction applied for their integration into said accounts: – 35 percent of the valuation adjustments corresponding to capital gains in debt-representing securities. – 45 percent of the valuation adjustments corresponding to capital gains in equity-representing securities. To the extent that entities or their groups do not integrate the percentages of the aforementioned capital gains into their countable own resources, or integrate them partially, the value of the asset, or rather the value of the position to be considered, both for the purpose of own resource requirements and for the purpose of deductions or limits to large risks, the gross amounts of the capital gains that have contributed to increasing own resources shall be considered. That is, only the amount resulting from multiplying the total amount of capitalized capital gains by the proportion that the effectively counted capital gains represent over the total that, at most, could have been counted according to this letter i). This counting option shall be entirely free for entities or their groups, although it must be communicated to the Spanish National Securities Market Commission, while it is maintained, together with the statements provided for in Article 155 of Chapter XII of this circular, through an annex with the calculations and adjustments made regarding this. j) Only in the case of consolidated groups, in addition to the aforementioned concepts shown in the consolidated financial statements, the following concepts: – Participations representing the minority interests of the consolidated group, in the part that is effectively paid. – Reserves in consolidated companies. In the case that the instruments provided for in letter c bis) give rise to minority interests, they must also comply with the requirements provided for in the aforementioned letter h) and those described in number 7 of this article."

"7. In order to be considered as countable own resources, the instruments referred to in section c bis) of number 1 of this article must meet the following requirements: a. They shall have no maturity date or their initial maturity shall be at least 30 years. They may include one or more call options at the discretion of the issuer, but they shall not be redeemable before five years have passed from their issuance date. In the event that the issuance conditions of indefinite duration instruments incorporate some incentive for redemption by the entity, in the opinion of the Spanish National Securities Market Commission, said incentive cannot be effective before ten years have passed from their issuance date. In the case of instruments with maturity, no redemption incentive is permitted on a date other than their maturity date. Instruments, with or without a maturity date, can only be redeemed or reimbursed with prior authorization of the Spanish National Securities Market Commission, which may grant it if the financial or solvency conditions of the entity are not unduly affected, cve: BOE-A-2011-19550