UK/EU Investment Management Update (October 2021)
- FCA Compliance Matters
- EU SSR
- EU Alternative Investment Fund Managers Directive – EU CBDF Directive and Regulation
- ESG – Dutch Authority for Financial Markets Report on the EU Sustainable Finance Disclosure Regulation
- EU MiFID II
- EU Investment Firms Regulation
- EU CSDR
- EU Packaged Retail Investment and Insurance-Based Products (PRIIPs) Regulation
- UK EMIR
- UK LIBOR Transition
FCA consults on new powers to cancel and vary permissions
On 9 September 2021, the FCA published Consultation Paper 21/28, “New cancellation and variation power: Changes to the Handbook and Enforcement Guide” (the Consultation). The Consultation relates to the FCA’s powers to cancel or vary an authorised firm’s regulatory permissions in certain circumstances, including where the firm has not used a permission for a period of 12 months or more.
Please see our Update UK Financial Conduct Authority Consults on Powers to Cancel Firms’ Regulatory Permissions for a discussion of the Consultation and its implications for firms.
FCA faces change of control application backlog
The FCA is understood to be facing delays of several months in allocating case officers to applications for changes in control of FCA authorised firms, pointing to a backlog caused by the Covid-19 pandemic and an increase in submissions of applications.
Under section 178 of the Financial Services and Markets Act 2000 (FSMA), a person must give the FCA notice before making an acquisition or increasing “control” over a UK authorised person. Section 189(1) of FSMA provides that the FCA has a 60-working-day period to approve or object to the acquisition (the “assessment period”). However, this assessment period does not begin until the day on which the FCA “acknowledges receipt of the section 178 notice.” In practice, the FCA does not acknowledge receipt of an application until a case officer has been assigned. This means it is possible that the overall time to apply for and receive the approval could be six months or more.
Firms intending make acquisitions or disposals of interests in UK regulated firms will need to factor this delay into their deal planning and be ready to submit any required section 178 notices as early in the process as possible.
Upper Tribunal addresses FCA consideration of non-financial misconduct by regulated individuals
On 17 September 2021, the FCA announced that it had published a Final Notice in respect of Jon Frensham. Under the Final Notice, the FCA has (i) withdrawn the current approval given to Frensham to perform certain senior management functions and (ii) prohibited Frensham from performing any function in relation to any regulated activity.
The FCA Final Notice followed from the decision of the Upper Tribunal (the Tribunal) published on 31 August 2021 in respect of the case of Jon Frensham v. The Financial Conduct Authority. The FCA had sought to prohibit Frensham from performing regulated activities on the basis that he was not a fit and proper person, following his conviction for a sexual offence involving a child.
The Tribunal clarified that a conviction of a sexual offence on its own was not enough to establish an absence of fitness and properness and that there must be a clear link between the offence and the ability of the FCA to uphold its statutory objectives. The relevant objectives in this case were the FCA’s consumer protection objective and its market integrity objective.
The Tribunal nevertheless upheld the prohibition against Frensham on the basis of the facts surrounding the offence that demonstrated such a link. The facts were as follows:
- the offence was committed whilst Frensham was on bail;
- he had failed to be open and transparent with the Chartered Insurance Institute (CII) (of which he was a member);
- he had failed to be open and transparent with the FCA when the CII had not renewed his Statement of Professional Standing; and
- he had failed to show genuine remorse.
On an annual basis, as part of the Senior Managers and Certification Programme, firms must assess whether their senior managers and certified staff are fit and proper persons. This includes assessing any instances of non-financial misconduct.
We will be publishing, shortly, a detailed analysis of the Upper Tribunal decision.
This month sees a number of developments with regard to the EU SSR that are of note.
EC adopts Delegated Regulation on short selling thresholds
On 16 March 2020, ESMA exercised its emergency intervention powers under Article 28 of the SSR and issued a decision to lower the notification threshold for net short positions in shares admitted to trading on a regulated market from 0.2% to 0.1% for a period of three months. ESMA renewed that decision several times; however, when the final decision expired in March 2021, ESMA considered the basis for its continuing to exercise its emergency powers was no longer founded.
Consequently, ESMA issued an opinion to the European Commission recommending a permanent reduction of the notification threshold to 0.1% (and each 0.1% above that) and, on 27 September 2021, the European Commission adopted a Delegated Regulation that would permanently adjust the threshold in line with ESMA’s recommendations. The Delegated Regulation will now be scrutinised by the European Parliament and Council of the EU before its publication in the EU Official Journal. The Delegated Regulation will then enter into force 20 days after publication in the Official Journal.
ESMA publishes consultation paper on the SSR
On 24 September 2021, ESMA launched a public consultation on certain aspects of the SSR. The consultation sets out proposals for revisions of the SSR in the following areas:
- the calculation of net short positions, the prohibition of uncovered short selling, and the locate rule under which short selling trades can take place;
- the mechanism for transparency of net short positions and the proposal to publish aggregated net short positions per issuer based on all individual positions and the scope of the exemptions for shares more heavily traded in a third country; and
- the introduction of a centralised notification and publication system to reduce reporting burdens, increase cost efficiency, and foster ESMA’s monitoring capacity and coordination powers in case of potential threats at EU level.
The consultation will close on 19 November 2021, with a final report containing ESMA’s recommendations anticipated in Q1 2022.
ESMA publishes updated list of links for national notification procedures
Also on 24 September 2021, ESMA published an updated version of its consolidated list of links to national websites where the procedures for notification of net short positions are explained. This is a great resource for those needing to make notifications to multiple European Economic Area (EEA) regulators, with most (though not quite all) materials available in English.
Update on Member State implementation
As detailed in our CBDF Update (June 2021), the EU’s new Directive and Regulation on the CBDF amends the existing EU Alternative Investment Fund Managers Directive (AIFMD) with the objective of harmonising the ability for EU alternative investment fund managers (AIFMs) to distribute alternative investment funds (AIFs) across the EU, including by introducing a new regime for “pre-marketing” with respect to EU AIFs.
Although the CBDF Directive is stated to only apply to EU AIFMs, a recital in the directive states that “national [EU] laws ... should not in any way disadvantage EU AIFMs vis-à-vis non-EU-AIFMs.” With the CBDF Directive having to be transposed into each Member State’s local law, it will be left to each Member State to determine how its local implementation will not “in any way disadvantage EU AIFMs vis-à-vis non-EU AIFMs.”
EU Member States were required to implement the Directive by 2 August 2021. However, a number of them have not met this deadline, with national legislation still under development. Of those Member States that have already implemented the Directive, a number have chosen to extend the pre-marketing regime to non-EU AIFMs. These include Germany and Luxembourg, with Finland, the Netherlands, and Sweden expected to follow a similar approach once their rules are implemented.
As the UK has exited the EU, it will not be implementing the CBDF Directive and Regulation. UK AIFMs would thus be treated as non-EU AIFMs in the same manner as U.S. and other non-EU AIFMs.
On 14 September 2021, the Dutch Authority for Financial Markets (AFM) published a report on the implementation of the EU Sustainable Finance Disclosure Regulation (the SFDR) by managers of Dutch funds. For an overview of the SFDR, please see our Update EU ESG Disclosures Required from March 10, 2021 — Action Points for Non-EU Fund Managers.
In its report, the AFM expressed concern as to the manner in which the SFDR has been implemented by Dutch funds. In particular, the AFM found the following:
- Integration of sustainability risks in investment policy could be more clearly stated. The information provided on how sustainability risks are integrated in the investment policy is generic and in many cases and frequently is not specific to the fund concerned.
- Observance of the transparency obligations in Article 8 or 9 could be clearer. The information provided on the basis of Article 8 or 9 is lacking in detail and could be more specific. Especially for funds with sustainable investment as their objective, a sufficiently detailed description of the fund’s sustainability objective is lacking.
- Objective of the fund is frequently too vaguely defined. The AFM has questions regarding the sustainability classification applied by managers for a significant proportion of the funds reviewed, particularly with respect to funds classified as having sustainable investment as their objective. The AFM notes that the objective of many of these funds appears to be broader than sustainable investing alone and that the investment portfolio is not usually aimed exclusively at sustainable investments.
The AFM concludes by saying that in the coming period, it will continue to exercise ongoing supervision of compliance with the SFDR requirements and the implementation of the regulatory technical standards (RTS) and in this supervision will take account of the extent to which managers incorporate its review findings.
ESMA Consultation on MiFID II Best Execution Reports
On 24 September 2021, ESMA published a consultation paper on best execution reports under the MiFID II. The consultation is open for feedback until 23 December 2021.
The changes consulted on aim to fix the perceived problems with the current MiFID II best execution regime, which have led to a temporary suspension in enforcing the requirements under RTS 27 (but not RTS 28) under the EU’s MiFID “Quick Fix” (as discussed in our March 2021 Update).
ESMA’s proposals include technical changes to:
- RTS 27, aimed at reducing the granularity and volume of data to be reported by execution venues and moving to a set of seven key metrics to disclose “meaningful information” to help firms to assess venues’ execution quality; and
- RTS 28, aimed at clarifying the requirements for firms that transmit client orders or decisions to deal to third parties for execution.
Because ESMA’s technical proposals can be implemented only after the relevant provisions of MiFID II have been amended, the outcome of this consultation will not lead to any immediate change of the existing RTSs 27 and 28.
However, ESMA will use the responses to the consultation to support the European Commission in its assessment of the best execution reporting obligations under the MiFID II “Level 1” text and any subsequent technical work.
Note that the ESMA consultation would apply only to MiFID firms authorised in the EU. UK MiFID firms are subject to the UK’s own “Quick Fix,” as discussed in our July 2021 Update.
ESMA Final Report on Algorithmic Trading
On 28 September 2021, ESMA published its final report on algorithmic trading in the context of the European Commission’s broader review of MiFID II. The report follows a public consultation conducted by ESMA in 2020 and concludes that overall, the current rules relating to algorithmic trading as set out under MiFID II are generally achieving their objectives.
However, ESMA does propose that a number of legislative adjustments be made in this area, as well as with regard to certain requirements for EU firms accessing EU venues indirectly via direct electronic access (DEA). ESMA also notes that it may consider some of the more technical aspects of the MiFID II requirements in these areas more closely in a further review of the relevant RTS.
Notably, ESMA proposes the following:
- Requirements for Systematic Internalisers (SIs). ESMA recommends developing tailored requirements for SIs who use algorithmic techniques.
- Authorisation of DEA Users. ESMA has proposed that EU DEA users dealing only on own account and not sub-delegating access should no longer be required to be authorised as investment firms. This change is aimed at levelling the playing field with non-EU DEA users who are not required to be authorised.
- Non-EU High Frequency Trading (HFT) Firms. ESMA proposes requiring third-country HFT firms accessing EU trading venues (either directly or through DEA) to be authorised as investment firms. However, ESMA further proposes developing a specific equivalence framework that would allow non-EU HFT firms to access EU venues without authorisation where they are subject to equivalent supervision in their home territory.
- Annual Self-Assessment. ESMA proposes that the annual self-assessment by a firm of its compliance with the Article 17 algorithmic trading requirements of MiFID II should be made bi-annual, with a possibility for EU Member State national competent authorities (NCAs) to require more frequent assessments. Additionally, ESMA proposes that the Article 17 assessment be submitted to NCAs.
- Trading Venue Outages. ESMA “invites” trading venues to improve their communications with participants with respect to the management of outages and commits to developing formalised guidance in this regard.
The consultation closes on 12 March 2021.
European Commission Adoption of RTS on “K-Factors”
On 28 September 2021, the European Commission adopted RTS relating to certain aspects of the EU Investment Firms Regulation (IFR), including certain of the K-Factors that firms will need to apply when calculating their capital requirements under the new regime:
- RTS specifying the amount of total margin for the calculation of the K-factor “clear margin given” (K-CMG)
- RTS specifying the notion of segregated accounts to ensure client money’s protection in the event of an investment firm’s failure
- RTS specifying the methods for measuring the Risk-to-Client and Risk-to-Firm K-factors
Any firms needing to calculate K-CMG should note that the European Commission has made a number of substantive amendments to the RTS compared with the draft RTS included in the European Banking Authority’s final report.
These RTS must now be scrutinised by the European Parliament and Council of the EU before entering into force.
Note that the IFR applies only to EU authorised firms; it does not apply to UK firms authorised by the FCA, which will be required to comply with the new UK Investment Firm Prudential Regime from 1 January 2022. Please see our Update UK Investment Firm Prudential Regime — 10-Step Plan for Investment Managers.
ESMA recommends delay of mandatory buy-in rules
On 23 September 2021, ESMA wrote to the European Commission, asking it to consider delaying implementation of the mandatory buy-in element of the settlement discipline regime under the CSDR.
In this letter, ESMA described the potential collision between the European Commission’s final legislative proposal for the review of the CSDR, which is expected by the end of the year, and the entry into force of the buy-in provisions on 1 February 2022.
ESMA observed that market participants are ready to implement settlement fails reporting and cash penalties, two key elements of the CSDR settlement discipline regime, but not the mandatory buy-in element where market participants face “serious difficulties” in implementation. This is because there is because of a lack of clarity as to how certain aspects of the requirements are to be applied and uncertainty surrounding to what extent the European Commission’s final legislative proposal will seek to amend regime.
It remains to be seen whether the European Commission or ESMA will now take further action to delay enforcement of the mandatory buy-in regime.
Adoption of revised regulatory technical standards
As we reported in our July 2021 Update, the European Commission had communicated that it would delay the application of the revised RTS under the Packaged Retail Investment and Insurance-Based Products (PRIIPS) Regulation until 1 July 2022.
The European Commission has now adopted the revised RTS (and the all-important accompanying Annex) that confirm this implementation date. The RTS, which will introduce specific requirements for Undertakings Collective Investment in Transferable Securities (UCITS) whilst aiming to improve investor usability of key information documents overall, must now be scrutinised by the European Parliament and Council of the EU before being published in the EU Official Journal.
Bank of England Amends UK Clearing Obligation
Following its consultation in May 2021, the Bank of England (BoE) has finalised its amendments to the UK’s derivatives clearing obligation (UK DCO) in the context of benchmark reform. The UK DCO applies to UK financial counterparties and UK non-financial counterparties that exceed certain thresholds (respectively, FC+ and NFC+), including when they transact with non-UK counterparties that would be FC+ or NFC+ if established in the UK.
Certain interest rate swaps referencing the soon-to-be discontinued euro overnight index average (EONIA), JPY LIBOR, and GBP LIBOR will no longer be mandated for central clearing under the UK European Market Infrastructure Regulation (EMIR); however, the clearing obligation will now extend to certain contracts referencing €STR and sterling overnight index average (SONIA).
The BoE has issued a further consultation with regards to extending the clearing obligation to interest rate swaps referencing tenge overnight index average overnight index swap and expects to consult on amendments with regards to USD LIBOR based contracts in 2022.
On 29 September 2021, the FCA published a statement on LIBOR transition, noting that the sterling, Japanese yen, Swiss franc, and euro LIBOR panels are ceasing on 31 December 2021. To avoid disruption to legacy contracts that reference the one-, three- and six-month sterling and Japanese yen LIBOR settings, the FCA will require the LIBOR benchmark administrator to publish these settings under a “synthetic” methodology, based on term risk-free rates, for the duration of 2022. These six LIBOR settings will be available only for use in some legacy contracts and are not for use in new business.
At the same time, the FCA published a consultation paper on the FCA’s proposed decision on which legacy contracts can use these synthetic LIBOR rates.
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