Circular 1/2017 of the National Securities Market Commission on Liquidity Contracts

OFFICIAL STATE GAZETTE
No. 111 Wednesday, May 10, 2017 Sec. I. Page 37692
I. GENERAL PROVISIONS
NATIONAL SECURITIES MARKET COMMISSION
5084 Circular 1/2017, of April 26, of the National Securities Market Commission, on liquidity contracts.

Regulation (EU) No 596/2014 of the European Parliament and of the Council, of 16 April 2014, on market abuse (hereinafter referred to indistinctly as "Regulation (EU) No 596/2014" or, by its English acronym, "MAR", as it is commonly known in the sector) establishes in its Article 15 the general prohibition of market manipulation or attempted market manipulation by any person, describing the specific activities constituting market manipulation in Article 12 thereof. However, Article 13 of Regulation (EU) No 596/2014 provides that the aforementioned prohibition shall not apply if the transaction, order, or conduct in question is supported by a legitimate reason and if it conforms to the figure of "accepted market practices". Article 13 of Regulation (EU) No 596/2014 establishes the criteria that competent authorities must take into account for their approval and regulates the procedure for communication to the European Securities and Markets Authority (hereinafter, "ESMA", by its English acronym, as it is commonly known in the sector) and its publication.

The figure of accepted market practices was already contemplated by Directive 2003/6/EC of the European Parliament and of the Council, of 28 January 2013, on insider dealing and market manipulation. In turn, Article 231.1 a) of the consolidated text of the Securities Market Law, approved by Royal Legislative Decree 4/2015, of 23 October, already recognized this figure in our legal order. More specifically, Royal Decree 1333/2005, of 11 November, developing Law 24/1988, of 28 July, on the Securities Market, in matters of market abuse, defined accepted market practices and provided that the CNMV would accept or reject them through the approval and publication of the corresponding Circular.

To date, the CNMV has accepted a single market practice which was reflected in Circular 3/2007, of 19 December, of the National Securities Market Commission, on liquidity contracts (the "Circular 3/2007"). This Circular replaces Circular 3/2007, in order to comply with what is established in Regulation (EU) No 596/2014 and to introduce improvements in its configuration in light of the experience gathered regarding liquidity contracts that have been operational in recent years under the protection of Circular 3/2007 and the public consultation carried out for this purpose. As in Circular 3/2007, the liquidity contracts regulated by this provision aim to provide liquidity by a financial intermediary who, acting on behalf of an issuer under a contract, carries out purchase and sale operations of the issuer's shares.

In compliance with the procedure established in Article 13 of Regulation (EU) No 596/2014 and in Delegated Regulation (EU) 2016/908 of the Commission of 26 February 2016, supplementing MAR by establishing regulatory technical standards on the criteria, procedure, and requirements for establishing an accepted market practice, as well as the requirements to maintain it, derogate it, or modify the conditions for its acceptance, the CNMV has carried out a public consultation process regarding liquidity contracts directed mainly to issuing companies, investment service firms, credit institutions, investor associations, market governing bodies, and other competent authorities. Likewise, the CNMV has communicated to ESMA its intention to consider liquidity contracts subject to this Circular as an accepted market practice. In response to this communication, ESMA has issued an opinion regarding the establishment of the market practice in which it concludes that the market practice communicated by the CNMV is compatible with Article 13.2 of Regulation (EU) No 596/2014 and contains various mechanisms to limit threats to market confidence. The CNMV has taken this opinion into account when drafting this Circular.

The main changes with respect to the previous regulation, to which this Circular refers, essentially concern: i) the extension of the scope of application of the market practice to multilateral trading systems; ii) the establishment of a threshold associated with the average daily volume traded that may be executed within the framework of the liquidity contract, which will be different depending on whether the shares subject to the contract have or do not have a liquid market as defined in Article 2.1.17 of Regulation (EU) No 600/2014 of the European Parliament and of the Council, of 15 May 2014, on markets in financial instruments (MIFIR); iii) the inclusion of a maximum level of resources that may be assigned to the liquidity contract; iv) the obligation that the financial intermediary executing the market practice be a market member; v) the need to maintain long-term the necessary balance between the volume of purchases and sales within the framework of the liquidity contract; vi) the conditions for the introduction or modification of orders during auction periods, referred mainly to the price and volume of such orders; vii) the conditions for carrying out block trades or other negotiated bilateral transactions, formalized in accordance with current legislation, such that they will only be permitted if the execution of the order in question is at the request of a third party different from the issuer of the shares and the financial intermediary acting on its behalf; viii) the conditions resulting from the application to the operations developed under the liquidity contract with shares traded in the fixing contracting modality; and ix) the cases in which the operation of the liquidity contract must be suspended.

In virtue of all the foregoing, the Council of the CNMV, prior to the report of its Advisory Committee, and under the provisions of Article 13 of Regulation (EU) No 596/2014, in its meeting of April 26, 2017, has ordered the following:

First Rule. Accepted Market Practice.

1. The execution of operations under a Liquidity Contract, as defined in section 2 of this First Rule, shall be considered an accepted market practice, provided that the requirements established in this Circular are met.
2. Companies whose shares are admitted to trading on a regulated market or on a Spanish multilateral trading system (the beneficiary of the Liquidity Contract, hereinafter the "Issuer") may subscribe a liquidity contract with an investment service firm or credit institution that is a member of the market where the market practice is executed (the entity executing the Liquidity Contract, hereinafter the "Financial Intermediary") whose object will be described in section 3 of this First Rule (hereinafter the "Liquidity Contract", or "Liquidity Contracts").
3. The Liquidity Contract shall define the terms and conditions under which the Financial Intermediary will operate on behalf of the Issuer, buying or selling its shares, with the sole objective of favoring the liquidity of transactions and the regularity of the quotation of its shares and within the limits established in the authorization granted by its General Meeting of Shareholders for the acquisition of own shares.

Second Rule. Requirements of Liquidity Contracts.
Liquidity Contracts subject to this Circular must in all cases meet the following requirements:

1. Exclusive Object: The Liquidity Contract must have as its exclusive object the one mentioned in section 3 of Rule 1st.
2. Independence and Exclusivity of the Financial Intermediary: The Liquidity Contract must establish the independence of the Financial Intermediary's operation as a liquidity provider with respect to the Issuer, such that the latter cannot give it any instruction aimed at orienting its interventions regarding the purchase and sale operations of its own shares.

The Financial Intermediary must have an internal organizational structure that guarantees the independence of the employees responsible for making decisions regarding the operations to be carried out under the Liquidity Contract with respect to the portfolio management area. In the event that these employees develop their activity in the area of proprietary account management or third-party order management, they cannot participate in any decision or management related to the Issuer's securities.

The conditions of the remuneration of the Financial Intermediary, which will be paid by the Issuer, will be fixed in the Liquidity Contract. The conditions of the remuneration of the Financial Intermediary, which must consist of a fixed amount, not linked to variables, shall in no case undermine the principle of independence of the latter, nor encourage said Financial Intermediary to artificially influence the price or volume of quotation by carrying out operations on its shares.

In no case shall the Financial Intermediary use its own financial resources to carry out the operations subject to the Liquidity Contract, nor shall its remuneration be based on the number of operations carried out, without prejudice to the possibility of agreeing to reimburse the expenses incurred by the Financial Intermediary in their execution.

The Liquidity Contract shall establish the necessary mechanisms to avoid possible conflicts of interest between the Issuer and the Financial Intermediary.

The Issuer may only subscribe the Liquidity Contract with a single Financial Intermediary.

3. Operation in Regulated Markets and Multilateral Trading Systems: Operations carried out under a Liquidity Contract may only be carried out in the regulated markets and Spanish multilateral trading systems in which the Issuer's shares are admitted to trading or are traded, through their electronic contracting means.

The Financial Intermediary, in the performance of its liquidity provision activity, will operate in the regulated markets and Spanish multilateral trading systems, in accordance with the contracting rules of said trading centers and within their usual trading hours.

4. Identification of Orders and Operations, Accounts Associated with the Liquidity Contract, and Registration: Operations carried out under a Liquidity Contract must be registered by the Financial Intermediary in two accounts, a securities account and its corresponding cash account, both opened for this purpose in the name of the Issuer and destined solely for the registration and execution of these operations.

The Financial Intermediary must maintain for a period of at least 5 years a record of orders introduced, modified, or canceled and operations carried out under the Liquidity Contract, establishing the necessary mechanisms that allow it to identify these orders and transactions distinguishing them from other trading operations.

Furthermore, the Financial Intermediary must have internal procedures that allow it to identify activities related to the Liquidity Contract and make available to the CNMV those records of orders and operations that the CNMV requests from it within the applicable timeframe in accordance with current regulations.

5. Continuity of Activity: The Liquidity Contract must be executed in such a way as to ensure its continuity, maintaining for this purpose the necessary long-term balance between the volume of purchases and sales. The Financial Intermediary may decide not to operate if, as a consequence, the continuity in the provision of this service would be compromised due to the eventual exhaustion of the shares and/or cash contributed by the Issuer.

When the balances of the accounts associated with the Liquidity Contract prove insufficient to ensure the execution of operations, the Financial Intermediary will consult with the Issuer to determine the measures to be taken to regularize this situation. In particular, the Issuer may decide to make additional contributions to the accounts.

When the account balances prove excessive, the Issuer, in agreement with the Financial Intermediary, may reduce them, being this the only case in which the Issuer may make withdrawals from the cash account. Regarding the securities account, the Issuer may withdraw shares at any time by transferring them to an account under its ownership unrelated to the Liquidity Contract; however, the number of shares withdrawn cannot exceed the total number of shares contributed minus those deducted.

The Intermediary, in agreement with the Issuer, shall in all cases proceed to sell in the market the balance of shares that exceeds the number of shares contributed and that the Issuer has not withdrawn in accordance with the aforementioned paragraph.

Sales made by the Financial Intermediary with the aim of eliminating the excess of shares deposited in the securities account will not be subject to what is established in section 1 of Rule 3rd but will be subject to the remaining rules provided in Rule 3rd and to the criteria and recommendations that the CNMV may have established in matters of discretionary treasury stock operation and must be communicated to the CNMV.

6. No Disposition of Securities: The own shares assigned by the Issuer to a Liquidity Contract or acquired under its protection may only be disposed of, and therefore debited in the securities account, as a consequence of operations carried out under the corresponding Liquidity Contract.

7. Resources Associated with the Liquidity Contract.
   7.1 Limit of Resources Associated with the Liquidity Contract.
   When the Liquidity Contract has been subscribed by an Issuer whose shares subject to the Liquidity Contract have a liquid market in accordance with Article 2.1.17 of Regulation (EU) No 600/2014 of the European Parliament and of the Council, of 15 May 2014, on markets in financial instruments (MIFIR) and its development regulations, the cash and shares contributed to the Liquidity Contract may not jointly exceed the cash and shares that the Financial Intermediary would need if during 13 trading sessions it operated exclusively, either on the purchase side or on the sales side, concentrating the maximum daily volume referred to in section 3 of Rule 3rd, with a limit in any case equivalent to 20 million euros.

When the Liquidity Contract has been subscribed by an Issuer whose shares subject to the Liquidity Contract do not have a liquid market in accordance with Article 2.1.17 of Regulation (EU) No 600/2014 of the European Parliament and of the Council, of 15 May 2014, on markets in financial instruments (MIFIR) and its development regulations, the cash and shares contributed to the Liquidity Contract, jointly, may not exceed at least one of the following limits:
a) the cash and shares that the Financial Intermediary would need if during 20 trading sessions it operated exclusively, either on the purchase side or on the sales side, concentrating the maximum daily volume referred to in section 3 of Rule 3rd; or b) the result of multiplying 1% of the Issuer's share capital by the closing price of the share quotation on the day prior to the formalization of the contract.

In any case, when the Liquidity Contract has been subscribed by an Issuer whose shares do not have a liquid market in accordance with Article 2.1.17 of Regulation (EU) No 600/2014 of the European Parliament and of the Council, of 15 May 2014, on markets in financial instruments (MIFIR) and its development regulations, the cash and its equivalent in shares may not be greater than 1 million euros.

7.2 Balance and Proportionality of Shares and Cash.
The balances of the accounts associated with the Liquidity Contract must maintain a balance with each other and, in turn, be proportional to the objective established therein.

Notwithstanding what is established in section 1 of Rule 2nd, to ensure the balance between shares and cash and the proportionality of the balances with respect to the contract's objective, the conditions under which the Financial Intermediary may proceed simultaneously or alternatively to:
a) Buy or sell Issuer shares in order to ensure relative balance regarding the balances of shares and available cash, taking into account the evolution prospects of the Liquidity Contract. The operations carried out will not be subject to what is established in section 1 of Rule 3rd but will be subject to the remaining rules provided in Rule 3rd and to the criteria that the CNMV may have established on discretionary treasury stock operation and must be communicated to the CNMV. b) Transfer a certain amount from the cash account to another account designated by the Issuer.

7.3 Prior Acquisition of Shares to Deposit in the Securities Account.
In cases where, at the time of formalizing a Liquidity Contract, the Issuer does not deposit shares in the securities account or does so in an insufficient quantity to initiate the operations subject thereto, there must be a prior period during which the Financial Intermediary may only buy Issuer shares until reaching the volume previously determined in said contract. Said prior period will be determined by agreement between the Issuer and the Financial Intermediary and will be reflected in the Liquidity Contract.

These acquisitions will have the exclusive purpose of allowing the Financial Intermediary to initiate the operations subject to the Liquidity Contract and will not be subject to what is established in section 1 of Rule 3rd but will be subject to the remaining rules provided in Rule 3rd and to the criteria and recommendations that the CNMV may have established in matters of discretionary treasury stock operation and must be communicated to the CNMV.

In the event of the conclusion of the prior period without having reached the volume referred to in the previous section, the Issuer and the Financial Intermediary may:
a) extend the prior period for a period not exceeding half of the initially indicated; b) terminate the Contract; or c) establish a lower volume of shares necessary for the provision of the service under the Liquidity Contract.

8. Cancellation of Accounts Associated with the Liquidity Contract: When the Liquidity Contract is terminated, regardless of the reason motivating it, the accounts associated with it must be canceled according to the following procedure:
   a) Cash Account: The Financial Intermediary will transfer its balance to another indicated by the Issuer. b) Securities Account: The Financial Intermediary will proceed to sell the shares that are currently listed in it. These sales will not be subject to what is established in section 1 of Rule 3rd but will be subject to the remaining rules provided in Rule 3rd and to the criteria and recommendations that the CNMV may have established in matters of discretionary treasury stock operation and must be communicated to the CNMV.

Nevertheless, the content of letter b) of this section shall not apply when:
(i) The shares are transferred to another Financial Intermediary responsible for the application of another Liquidity Contract that meets the requirements established in this Circular.

OFFICIAL STATE GAZETTE
No. 111 Wednesday, May 10, 2017 Sec. I. Page 37693

(ii) The Issuer wishes to recover the availability of a number of shares, in which case, it cannot be greater than the number of shares deposited by it, once deducting any dispositions it may have made during the validity of the Liquidity Contract.

Third Rule. Conditions for Operation.

1. The Financial Intermediary, in the performance of its liquidity provision activity, will operate in the regulated markets and Spanish multilateral trading systems, through the order market, in accordance with the contracting rules established in the corresponding trading center and within their usual trading hours, without prejudice to what is established in section 2 of this Rule.

2. The Financial Intermediary may buy or sell via block trades or other negotiated bilateral transactions, formalized in accordance with current legislation, exclusively when they are initiated by a third party different from the Issuer and the Financial Intermediary.

3. The Financial Intermediary must never exercise a dominant position in the contracting of the Issuer's shares. For these purposes, in no case will the daily volume executed by the Financial Intermediary under the Liquidity Contract exceed 15% of the daily average of the volume traded in the order market of the regulated market or the Spanish multilateral trading system in the previous 30 sessions when the Liquidity Contract has been subscribed by an Issuer whose shares subject to the Liquidity Contract have a liquid market in accordance with Article 2.1.17 of Regulation (EU) No 600/2014 of the European Parliament and of the Council, of 15 May 2014, on markets in financial instruments (MIFIR) and its development regulations. This limit will be 25% in the case that the Liquidity Contract has been subscribed by an Issuer whose shares subject to the Liquidity Contract do not have a liquid market, as defined in accordance with Article 2.1.17 of Regulation (EU) No 600/2014 of the European Parliament and of the Council, of 15 May 2014, on markets in financial instruments (MIFIR) and its development regulations.

For the purposes of determining said percentage, within the number of daily shares contracted...