UK/EU Investment Management Update (December 2020)

The NPPR registration process in some EU member states can take several weeks. UK AIFMs should therefore plan accordingly.

New FCA webpage compiling Brexit information from EEA regulators

On 6 November 2020, the FCA launched a new webpage, compiling a nonexhaustive list of links to dedicated Brexit websites hosted by the national competent authorities (NCAs) of EU member states.

The FCA notes that firms may also want to check with the relevant NCA whether it is planning any transitional measures and/or to discuss the implications of any of the schemes listed below.
Should UK investment managers require advice on local contingency regimes in the EU, as a more practical approach (as NCAs may not respond as promptly as necessary), UK managers may wish to seek advice from local counsel in the relevant EU member states. We would be happy to coordinate such advice as needed. 

MiFID Derivatives Trading Obligation — ESMA final position

On 25 November 2020, the European Securities and Markets Authority (ESMA) released a public statement clarifying the application of the EU derivatives trading obligation (EU DTO) under Article 28 of the Markets in Financial Instruments Regulation (MiFIR), following the end of the Brexit transition period on 31 December 2020.

ESMA’s statement concerns the potential situation in which an equivalence decision is not made by the European Commission (the Commission) in respect of the UK, meaning in-scope derivatives (currently only certain single-currency interest rate swaps and certain index credit default swaps) traded on a UK trading venue would not automatically satisfy the EU DTO. The result is that EU investment firms — including UK branches of such EU firms — would not be able to trade in-scope derivatives on UK trading venues even if those contracts have to date mainly been traded on UK trading venues.

As discussed in our October 2020 Update, on 14 September 2020, the International Swaps and Derivatives Association (ISDA) had called for the UK and EU to recognise the equivalence of each other’s derivatives trading venues before the end of the Brexit transition period. Otherwise, ISDA warns that UK and EU counterparties subject to the UK DTO and EU DTO, respectively, will face conflicting requirements when wishing to trade with each other.

This is relevant to investment managers (whether based in the UK, EU, or otherwise) that have UK or EU funds or trading vehicles engaging in derivatives trades, as well as to UK AIFMs managing non-EU AIFs engaging in derivatives trades. In some cases the obligation will be that (in effect) of the investment manager, but there may also be an impact on funds/special purpose vehicles (SPVs) of an investment manager where such funds/SPVs trade derivatives with EU dealers/counterparties. There may also be a fragmentation in the liquidity of UK/EU exchange-traded derivatives.

Reporting under UK EMIR and UK SFTR

On 24 November 2020, the FCA published an updated note on its expectations of UK Trade Repositories (TRs) and counterparties using them, in relation to the derivatives reporting obligation under the UK “onshored” version of the European Market Infrastructure Regulation (UK EMIR), which takes effect on 1 January 2021.

This is relevant to UK AIFMs, amongst others, who will be required to report derivatives trades entered into by their AIFs under UK EMIR from 1 January 2021.

This is not relevant to non-UK AIFMs unless they manage UK AIFs or UK trading vehicles that trade derivatives.

Amongst other things, the FCA clarifies that

- all new derivative trades entered into by in-scope counterparties on or after 11 pm on 31 December 2020 are subject to the UK EMIR reporting regime and must be reported to an FCA-registered, or recognised, TR

- all outstanding derivative trades entered into by in-scope counterparties on or after 16 August 2012 must be held in an FCA-registered, or recognised, TR from 11 pm on 31 December 2020 onwards

- UK counterparties should use the updated UK EMIR validation rules when submitting derivative transactions entered into, or amended, from 11 pm on 31 December 2020 onwards

On the same day, the FCA published a statement containing equivalent expectations of TRs and counterparties using them for the purposes of reporting securities financing transactions (SFTs) under the UK onshored version of the SFTR (UK SFTR), which takes effect on 1 January 2021. This is not relevant to managers without any UK-based SFT counterparties, given the difference in scope between the UK SFTR and UK EMIR reporting regimes.

For further information about the EU SFTR (from which the UK SFTR is derived), please refer to our Update EU SFTR Reporting for Investment Managers — Top Five Things to Know.

ESMA final report on EMIR RTS on bilateral margin requirements

On 23 November 2020, ESMA, European Banking Authority (EBA), and European Insurance and Occupational Pensions Authority (EIOPA) (together, the ESAs) published a revised version of the final report on new draft regulatory technical standards (RTS) on the bilateral margining requirements under EMIR (originally published on 19 December 2019) (the Final Report).

These proposals are relevant to investment managers with EU AIFs and/or EU trading vehicles that enter into derivatives trades.

As a reminder, the EMIR initial margin requirement takes effect in stages. In light of COVID-19, the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) announced in April 2020 their agreement to delay the final stages of implementation of the EMIR initial margin rules until September 2021 (for phase 5) and September 2022 (for phase 6). The Final Report has been updated to take into account the BCBS and IOSCO agreement. For further information on the BCBS and IOSCO agreement, please refer to our Update Final Implementation Phases of Initial Margin for Uncleared Derivatives Set for Deferral.

Additionally, the draft RTS in the Final Report maintain (from the last version of the Final Report) the proposed exemption of physically settled foreign exchange (FX) forwards from the EMIR variation margin requirement (in certain situations). The proposed exclusion has also been extended to include physically settled FX swaps.

The draft RTS in the Final Report similarly maintains the proposed temporary exemption of single-stock equity options and index options from the variation and initial margin requirements, with the exemption period being extended from one to three years.

Lastly, the ESAs propose to allow uncleared OTC derivatives contracts, entered into prior to the EMIR margin requirements having come into effect, to remain outside the scope of EMIR margin requirements provided their novation occurs during a 12-month window from when the RTS is finalised and takes effect. 

UK EMIR — notifying FCA of clearing thresholds

On 30 November 2020, the FCA updated its webpage on UK EMIR.

When UK EMIR comes into force at the end of the Brexit transition period, UK financial counterparties (UK FCs) and UK nonfinancial counterparties (UK NFCs) must notify the FCA if they exceed the clearing thresholds under Article 4 of UK EMIR. This includes UK FCs/UK NFCs that choose not to calculate their open OTC derivatives positions and, hence, will be automatically regarded under UK EMIR as exceeding the clearing threshold.

This is of relevance to UK AIFMs (and, if any, UK AIFs and UK trading vehicles) that trade in-scope derivatives.

The notification must be made via the FCA notification system (Connect) by 17 June 2021.

The legislative proposal in the ECON report does not substantively deviate from the MiFID II Quick Fixes published by the Commission on 24 July 2020, as discussed in our August 2020 Update.

The MiFID II Quick Fixes will apply only to EU firms; the FCA has not announced any reaction to the Commission’s MiFID II Quick Fixes, and it is possible that the UK MiFID II regime will not be fixed in the same way or at all.

ESMA launches consultation on draft guidelines on market data obligations

On 6 November 2020, ESMA published a consultation paper on its draft guidelines on the MiFID II/MiFIR market data obligations.

The consultation builds on ESMA’s 5 December 2019 first review report on the development of prices for market data and on the consolidated tape for equity.

In particular, the draft guidelines contain guidance on the requirements for “market data providers” (such as multilateral trading facilities (MTFs), approved publication arrangements (APAs), consolidated tape providers, (CTPs) and systematic internalisers (SIs)) to provide market data on a reasonable commercial basis and to ensure non-discriminatory access to that data, and for trading venues to make market data available free of charge 15 minutes after publication.

The consultation is open for feedback until 11 January 2021. Responses will feed into ESMA’s final report and finalised guidelines, which it expects to publish by Q2 2021.

Whilst investment managers will not be directly subject to the finalised guidelines, those guidelines may eventually have a positive effect on how managers in general consume data from EU market data providers and on greater transparency in relation to data costs.

Previously, the FCA had set June 2021 as its target implementation date (being when the EU Investment Firm Regulation and Directive, which contains new prudential requirements for EU investment firms, will take effect). However, industry feedback expressed concerns about the volume of reform targeted for 2021. Therefore, alongside the resultant delay, the FCA has committed to endeavour to provide industry with as much advance sight of the final rules as possible to support preparations for compliance.

This follows the FCA discussion paper on the UK IFPR, published on 23 June 2020, as discussed in our July 2020 Update.

On 30 November 2020, ICE published a similar announcement with respect to USD LIBOR. In particular, ICE announced that IBA will consult on its intention to cease the publication of the one-week and two-month USD LIBOR settings immediately following the LIBOR publication on 31 December 2021 and to cease the remaining USD LIBOR settings immediately following the LIBOR publication on 30 June 2023.

These developments follow the FCA’s announcement in July 2017 of its intention that it would no longer be necessary to persuade, or compel, banks to submit to LIBOR after 31 December 2021.

IBA stated that it expects to make a separate announcement following the outcome of the consultations.

LIBOR Transition — new powers for the FCA

As mentioned in our July 2020 Update, the UK government intends to legislate to amend the existing regulatory framework for benchmarks in order to ensure that, by the end of 2021, the FCA has the appropriate regulatory powers to manage an orderly transition from LIBOR. This would assist in particular with so-called “tough-legacy” contracts, which lack robust fallbacks and are unamendable ahead of the LIBOR discontinuation, as the FCA’s powers will enable it to direct the administrator of LIBOR to change the methodology used to compile the benchmark.

The UK government intends to take the legislative changes forward in the upcoming Financial Services Bill (FS Bill).

On 18 November 2020, the FCA launched a public consultation on its potential approach to using its proposed powers under the FS Bill, seeking industry feedback. The consultation is open until 18 January 2021.

The FCA also acknowledged the ICE/IBA announcement on GBP, EUR, CHF, and JPY LIBOR settings as published on the same day.

On 30 November 2020, the FCA published a separate statement acknowledging the ICE/IBA announcement on USD LIBOR settings as published on the same day.

ISDA responds to IBA and FCA LIBOR announcements

On 18 November 2020, ISDA published a statement responding to IBA’s and the FCA’s announcements on GBP, EUR, CHF, and JPY LIBOR settings as published on the same day.

ISDA’s statement confirms the following:

- Neither of these announcements constitutes an index cessation event under the IBOR Fallbacks Supplement or the ISDA 2020 IBOR Fallbacks Protocol. Therefore, these announcements will not trigger the fallbacks under the supplement or protocol (i.e., to the adjusted risk-free rate plus spread) or have any effect on the calculation of the spread.

- These announcements will also not trigger fallbacks under the 2018 ISDA Benchmarks Supplement or its protocol.

On 30 November 2020, ISDA published a similar statement in relation to USD LIBOR settings, in response to IBA’s and the FCA’s announcements on USD LIBOR settings as published on the same day.

FCA updates Q&As on conduct risk during the LIBOR transition

On 20 November 2020, the FCA updated its Q&As for firms about conduct risk during the LIBOR transition.

The Q&As, originally published in December 2019, respond to firms’ questions about the FCA’s core transition expectations and emphasise the FCA’s overarching expectation for firms to have a strategy in place and to treat customers fairly.

The update introduces two new Q&As:

• The first new Q&A pertains to treating customers fairly given that the spread between LIBOR and the sterling overnight index average (SONIA) will vary. The FCA notes that substantial consensus has been established across multiple jurisdictions that a fair way to approximate the expected future difference between LIBOR and risk-free rates (RFRs) (such as SONIA) is to take a historical median of that difference. The FCA also notes the existence of multiple examples of mutually agreed, fair conversions across bond and loan markets. Most important, the FCA reiterates its two core principles: first, that LIBOR should not be used to move customers with continuing contracts to replacement rates expected to be higher than LIBOR would have been, and second, that firms receiving LIBOR-linked interest should not be expected to give up the difference resulting from the term credit risk premium built into LIBOR but not into other rates such as SONIA.
• The second new Q&A pertains to whether LIBOR contracts can be converted to “bank rate” (the Bank of England’s monetary policy rate) plus an appropriate spread rather than SONIA plus an appropriate spread. The FCA confirms that counterparties may agree to convert to bank rate plus a spread. However, the FCA’s key expectations continue to apply, and firms will need to be able to demonstrate that their approach is fair to the customer, particularly when choosing the applicable spread.

The reports provide aggregated figures of penalties and measures imposed during the relevant periods, broken down by EU member state, and by obligation breached.

Under the AIFMD, ESMA observed the following:

- The number of financial penalties decreased substantially between 2018 and 2019.

- The total amount (in financial terms) of financial penalties doubled in 2019 to 9 million EUR, due to high cumulative sanctions issued in France and Poland.

- A small number of NCAs is responsible for the majority of sanctions (in particular, Hungary and the Czech Republic).

- No sanctions were issued in 11 member states, including Germany, Ireland, Norway, Sweden, and the UK.

Amongst others, breaches relate to Annex IV reporting (Italy), delegation (Belgium, Liechtenstein, Luxembourg, Netherlands, Poland), investor and other disclosures (Finland, Italy, Netherlands), annual reporting (Liechtenstein), and the conditions for EU AIFMs managing non-EU AIFs not marketed in EU member states (France). Unhelpfully, the report contains no further details on the facts surrounding specific breaches and penalties.

Of note to non-EU AIFMs, no penalties or sanctions had been imposed during 2018 and 2019 by an NCA with respect to a breach of the fund marketing rules under the Article 42 AIFMD NPPR.

Under the UCITS Directive, ESMA observed the following:

- No sanctions were issued in nine member states from 2016 to 2019, including Germany, Ireland, Norway, and the UK.

- Sanctioning powers are not equally used among NCAs, and, besides a few NCAs (such as France, whose total amount (in financial terms) of financial penalties from 2016 to 2019 vastly outweighs those of the other NCAs combined), the number and amount of sanctions issued seems relatively low.

FCA penalties for nonfinancial misconduct

On 3 November 2020, the FCA issued final notices to three individuals for nonfinancial misconduct, prohibiting them from working in the regulated financial services industry. Each of the three individuals had been convicted of serious indictable offences while working as approved persons in the financial services industry. These offences included sexual assault, controlling and coercive behaviour, and voyeurism.

The FCA concluded that the three individuals are not “fit and proper” and “lack the necessary integrity and reputation to work in the regulated financial services sector”. In the FCA’s view, the prohibitions are appropriate in view of its operational objectives to enhance consumer protection and the integrity of the UK financial system.

In its press release, the FCA took the opportunity to emphasise its expectations of “high standards of character, probity and fitness and properness” for all those operating in the financial services industry. These prohibitions reinforce its commitment to take action to ensure such standards are maintained.

ESMA’s draft guidelines expand on the requirements in the CBDF Regulation, taking into account the online aspects of marketing communications (including social media platforms).

The consultation is open for feedback until 8 February 2021. ESMA intends to issue final guidelines, which would be immediately applicable, by 2 August 2021.

For further information on the CBDF Regulation and corresponding directive, please see our Update EU AIFMD: New Rules on Pre-Marketing and Reverse Solicitation.

The guidelines apply only to UCITS and to EU-authorised AIFMs who market their funds to retail investors, and are therefore not relevant for fund managers who market only to institutional investors.

The guidelines provide comprehensive guidance to fund managers on the design of performance fee models for the funds they manage, including on assessing consistency between the performance fee model and the fund’s investment objective, policy, and strategy, particularly where the fund is managed by reference to a benchmark. The guidelines are intended to harmonise how fund managers charge performance fees to retail investors and the circumstances in which performance fees can be paid. ESMA considers that the harmonised requirements will enable convergence in the supervision of performance fees models by NCAs and in disclosures across the EU.

The FCA will begin to publish data from solo-regulated firms on 14 December 2020. Data will then be published incrementally, as it is submitted. Solo-regulated firms that wish to have their data published on 14 December 2020 (i.e., from the outset) must submit data by the end of 9 December 2020 when using the single entry submission form.

Firms with more than 10 directory persons, using the multiple-entry submission form, should submit data between 11 January and 18 March 2021 (or between 26 November and 4 December 2020, if wishing to submit before the earliest publication date).

The consultation and draft texts are available here.

The Taxonomy Regulation establishes a harmonized classification framework to define environmentally sustainable economic activities. For further information on EU rules on ESG-related disclosures, please refer to our Update ESG Disclosures for Asset Managers Under the EU Sustainable Finance Disclosure Regulation and Taxonomy Regulation.

UK Taskforce on Climate-Related Financial Disclosures — Interim report

On 9 November 2020, HM Treasury published the interim report of the UK Taskforce on Climate-Related Financial Disclosures (TCFD). This sets out an indicative roadmap towards mandatory climate-related disclosures for seven categories of organisation (including “asset managers”, broadly meaning MiFID investment firms providing portfolio management services, AIFMs, and UCITS management companies) over the next five years.

In relation to UK-authorised asset managers, the FCA envisages publishing a consultation paper in the first half of 2021, detailing its proposals. At present, these are likely to include rules to promote TCFD-aligned disclosures directed at clients and end-investors by firms responsible for setting investment strategy and making investment decisions. These rules are anticipated to include strategy and policy disclosures at the firm level, alongside more targeted disclosures at the fund or portfolio level.

The FCA aims to finalise these rules by end-2021, with the rules coming into effect in phases (depending on the size of the firm) beginning in 2022.

The other categories of organisation contemplated by the report are UK-listed commercial companies with a premium listing; UK-registered large private companies; UK-regulated banks and building societies; UK-regulated insurance companies; life insurers and UK-regulated pension schemes; and UK-regulated occupational pension schemes.