UK/EU Investment Management Update (February 2023)
1. UK — FCA Updates
FCA publishes Dear CEO letter to wholesale broker firms
On 11 January 2023, the FCA published a Dear CEO letter addressed to wholesale broker firms, outlining the key risks for the sector and the FCA’s supervisory focus for the next two years.
Although the letter is addressed to wholesale broker firms, some of the issues discussed are instructive for other firms. In particular, Markets in Financial Instruments Directive (MiFID) investment management firms are, like wholesale brokers, also subject to the Investment Firm Prudential Regime (IFPR) and the Senior Managers and Certification Regime (SMCR), which are the focus of the letter.
The FCA identifies the following four key areas of focus for its supervisory work:
- Financial Resilience. The FCA has observed firms failing to develop their own competence on liquidity risk management or to recruit expertise externally, resulting in underestimation of their exposure to intraday liquidity risks in their own business, as well as from key clients and counterparties. To improve financial resilience, the FCA has urged firms to review the level of liquidity that they hold under the IFPR and ensure that their assessment is commensurate with the risks they face. The FCA notes its intention to carry out targeted work in this space and will take action where it identifies material weaknesses;
- Remuneration. The FCA refers to its 2019 Dear CEO letter to wholesale brokers, which had highlighted weak incentive and reward structures. Following the introduction of remuneration requirements under the IFPR, the FCA intends to focus on ensuring that firms are appropriately applying the IFPR requirements on deferrals, malus, and clawback. It notes that it will take action if required, including routinely imposing additional capital requirements to account for the increased risk that weak incentives pose;
- Governance and culture. The FCA encourages firms to embrace the SMCR in order to promote good decision-making and individual accountability. The FCA notes weaknesses observed in the consideration of regulatory references and appropriate risk mitigations where adverse information comes to light when hiring new certified staff. The FCA notes that boards should ensure they understand and are comfortable with risk-taking in hiring processes and that it intends to scrutinise the decision- making and board effectiveness of firms in this regard in its future work; and
- Control functions. The FCA expects firms to have adequately resourced risk management and control functions, with influence at board level. Weaknesses have been observed in firms’ client onboarding processes to control financial crime and money laundering, and the FCA intends to carry out further work in this area in the year ahead.
The FCA expects all CEOs to have discussed this letter with their fellow directors and/or board and agreed actions and next steps by the end of February 2023.
FCA review of Consumer Duty implementation plans
On 25 January 2023, the FCA published a review of various firms’ Consumer Duty (the Duty) implementation plans. Specifically, the FCA reviewed implementation plans from around 60 of the largest firms with fixed supervisory teams and that primarily operate in retail financial services markets. Although the FCA found that many firms have embraced the shift to delivering good customer outcomes under the Duty, it expressed some dissatisfaction with the lack of progress made by others.
In the remaining six months of the implementation period, the FCA identified several areas for firms to focus on:
- Firms should make sure they are prioritising effectively, with a focus on the areas that will make the biggest impact on outcomes for consumers;
- Firms should ensure they are making the changes needed so consumers receive communications they can understand, products and services that meet their needs and offer fair value, and the customer support they need; and
- Firms need to share information and work closely with their commercial partners to ensure they all deliver good customer outcomes. Some firms will need to accelerate this work to implement the Duty on time.
The FCA will write to firms in the coming weeks to highlight its key expectations in relation to implementation of the Duty and some of the key risks and consumer harms that will need to be addressed. The FCA is also expected to issue an additional survey to over 600 mostly small and medium-size firms to understand their plans to implement the Duty.
The Duty comes into force on 31 July 2023 for new and existing products or services that are open to sale or renewal and 31 July 2024 for closed products or services.
FCA publishes newsletter on market conduct and transaction reporting issues
On 11 January 2023, the FCA published its Market Watch 72 on market conduct and transaction reporting issues.
In this edition, the FCA outlined a number of observations on the quality of service provided by Approved Publication Arrangements (APAs) and Approved Reporting Mechanisms (ARMs), collectively known as Data Reporting Services Providers (DRSPs), to clients that use a DRSP to meet their regulatory reporting obligations under MiFID. APAs are used for the publication of trade reports (T+0) to the market, while ARMs are used for transaction reporting (T+1) to the FCA.
While most of the FCA’s observations relate to compliance issues for DRSPs, the FCA’s observations on unregulated services provided to DRSP clients will be of interest to investment firms that engage DRSPs directly.
In particular, the FCA notes that DRSP clients make use of unregulated services that are ancillary to the data reporting services offered by their DRSP. However, it has found several instances where it was not clear to clients that they were also using unregulated ancillary services offered by their DRSP or its wider corporate group. These unregulated ancillary services are not covered by systems and controls requirements under the DRSP regulatory framework. As such, and because accuracy and completeness obligations are the responsibility of the DRSP clients, DRSP clients are exposed to the regulatory risk of, and bear responsibility for, any errors or omissions introduced by these unregulated services.
Good practices identified by the FCA on the part of DRSP clients include performing due diligence on unregulated services their DRSP offers to ensure their own compliance with accuracy and completeness requirements for their MiFID post-trade reporting.
FCA definition of ‘significant SYSC firm’ following implementation of IFPR
On 27 January 2023, the FCA published Handbook Notice 106.
Amongst other changes, the notice updates the Handbook’s definition of a ‘significant SYSC firm’ so that only firms that would have been both significant IFPR firms and IFPRU investment firms under pre-IFPR arrangements fall under this definition. This implements the proposed clarification discussed in our September 2022 Update.
FCA update on changes to Firm Reference Numbers and Product Reference Numbers
On 26 January 2023, the FCA noted its plans to move to seven-digit firm reference numbers (FRNs) and product reference numbers (PRNs) for newly registered firms and funds.
The FCA currently uses six-digit FRNs to uniquely identify firms and six-digit PRNs to identify funds. It expects to reach the six-digit limit (999999) and start allocating seven-digit numbers during Quarter 2 of 2023.
Firms previously allocated a six-digit FRN or PRN will retain that number.
FCA launches criminal proceedings against five individuals for insider dealing and money laundering
On 25 January 2023, the FCA announced that it has started criminal proceedings against five individuals for conspiracy to commit insider dealing and money laundering.
The FCA alleges that between 17 December 2019 and 25 March 2021, one of the individuals used confidential inside information he had accessed as an analyst in his former role at Janus Henderson to enable timely and profitable trading in 49 companies through accounts held by his alleged co-conspirators.
Contracts for difference are alleged to have been used in relation to these companies, betting that the value of shares would go down after certain announcements.
The FCA alleges that they were able to realise profits of approximately £1.5 million.
All five are also charged with money laundering offences relating to over 170 cash deposits totalling approximately £200,000.
The FCA states that Janus Henderson has co-operated fully with its investigation.
For a discussion of the FCA’s increased action in relation to market abuse and financial crime in 2022, please see our Update UK Market Abuse and Financial Crime Roundup (2022).
HM Treasury launches consultation on the regulation of cryptoassets and publishes response to consultation on cryptoasset promotions
On 1 February 2023, HM Treasury launched its consultation and call for evidence on the future financial services regulatory regime for cryptoassets and published its response to its consultation on cryptoasset promotions.
We have published our analysis of the consultation in our Update UK Proposes Regulatory Regime for Cryptoassets.
European Commission seeks EBA’s advice on classification of asset-referenced and e-money tokens as “significant” under MiCA
On 21 December 2022, the European Commission (the Commission) sent the European Banking Authority (EBA) a provisional request for technical advice regarding the criteria for classifying asset-referenced tokens and e-money tokens as “significant” under the future EU Markets in Crypto-Assets Regulation (MiCA). Once such a token is classified as significant under MiCA, the EBA will in most cases directly supervise its issuer.
The request for advice also concerns a delegated act on supervisory fees to be charged by the EBA to the issuers of significant asset-referenced tokens or e-money tokens.
If the relevant parts of the compromise text are modified in the final text, the Commission will, if necessary, revise or supplement the provisional request.
The request notes that MiCA is at present subject to legal revision prior to its formal adoption by the European Parliament and the Council and that publication in the EU Official Journal is planned for spring 2023. For details on MiCA, please see our Update How Will the EU Markets in Crypto Assets Regulation Affect Crypto and Other Financial Services Firms?
EBA issues Opinion to the Commission on the draft ESRS under CSRD
On 26 January 2023, the EBA published an Opinion on the draft European Sustainability Reporting Standards (ESRS) developed by the European Financial Reporting Advisory Group (EFRAG) under the EU Corporate Sustainability Reporting Directive (CSRD).
For a discussion on the CSRD, please see our Update EU Corporate Sustainability Reporting Directive — What Do UK- and U.S.- Headquartered Companies Need To Know?
It is a condition for the adoption by the Commission of the ESRS that it request the opinion of the EBA, as well as ESMA and the European Insurance and Occupational Pensions Authority, on the technical advice provided by EFRAG.
In its Opinion, the EBA acknowledges that, overall, the draft ESRS are a significant improvement over the consultation versions and are consistent with international standards and other relevant EU regulation, including being better aligned with the Pillar 3 disclosure requirements reached at this stage. The EBA also highlights a few aspects for further consideration by the Commission.
As regards proportionality, the EBA supported the intention to implement phasing-in provisions into the draft standards as they allow for a better-balanced approach.
FinDatEx publishes EET V1.1.1
On 18 January 2023, FinDatEx published the European ESG Template (EET) Version 1.1.1. The EET is a financial data exchange template intended to facilitate the exchange of ESG-related disclosures required by certain EU regulations, including MiFID, the Sustainable Finance Disclosure Regulation (SFDR), and the Taxonomy Regulation.
This version of the EET is an originally unscheduled update intended to reflect upcoming changes amending the SFDR regulatory technology standards (RTS) to require disclosure on investments in fossil gas and nuclear. Supplementary data fields regarding such investments have been added to the template.
EET V1.1.1 will co-exist with V1.0 and V1.1 until 30 April 2023. Following the end of the transition period on 30 April 2023, V1.1.1 will be the only version of the EET that should be used. Later in 2023, the dedicated working group intends to revisit and restructure the EET and transfer the supplementary fields to the main structure of the EET.
6. EU — MiFID
ESMA launches Common Supervisory Action on marketing of financial products
On 16 January 2023, ESMA announced that it will launch a common supervisory action (CSA) with EU national competent authorities (NCAs) regarding the application by investment firms and credit institutions of MiFID disclosure rules with respect to marketing communications across the EU. The CSA will be conducted throughout the course of 2023.
ESMA’s aim is that this initiative, and the related sharing of practices across NCAs, will facilitate the consistent implementation and application of EU rules to enhance the protection of investors.
As part of the CSA, NCAs will review marketing communications (including advertisements) to determine whether they are fair, clear, and non-misleading. NCAs will also review how firms select the target audience for their marketing communications, especially when marketing riskier and more complex investment products. The CSA will also closely consider marketing and advertising by firms through distribution channels, including apps, websites, social media, and collaborations with affiliates such as social media influencers.
Additionally, the CSA will provide an opportunity for ESMA and NCAs to collect information about possible “greenwashing practices” observed in marketing communications and advertisements.
Although the CSA is expected to apply only to EU firms, non-EU firms may wish to pay attention to any stated expectations arising out of this exercise, as non-EU firms will want to be alive to the expectations of NCAs when non-EU firms market their financial products (e.g., investment funds) in the relevant EU member states.
ESMA consultation on MiFIR post-trade transparency manual
On 19 January 2023, ESMA launched a consultation on its proposed manual on post-trade transparency requirements under the EU Markets in Financial Instruments Regulation (MiFIR).
The consultation paper sets out ESMA’s proposals for a manual setting out guidance to improve the consistency and usability of the post-trade transparency information published and to clarify issues regarding reporting to the Financial Instruments Reference Data System.
ESMA proposes that the manual include in a single document all Level 1 to 3 provisions, previous ESMA questions and answers, and new Level 3 guidance relevant to this topic.
The consultation will close on 31 March 2023. ESMA is expected to publish a final report including its manual on post-trade transparency after the endorsement of the reviewed MiFIR RTS 1 and 2 by the European co-legislators (see European Commission adopts delegated acts amending MiFIR RTS 1 and RTS 2 below).
The manual will be relevant only to investment firms authorised in an EU member state. UK investment firms should refer to the relevant FCA rules for their compliance with post-trade transparency requirements under UK MiFIR.
European Commission adopts delegated acts amending MiFIR RTS 1 and RTS 2
On 17 January 2023, the Commission adopted two delegated acts amending EU MiFIR RTS 1 and RTS 2. These are the RTS specifying the pre-trade and post-trade transparency requirements for equity and non-equity instruments under MiFIR. These follow initial proposals made by ESMA in March 2022, as discussed in our April 2022 Update.
The delegated acts contain provisions to improve and further harmonise data quality of post-trade transparency reports as well as to increase the level of pre-trade and post-trade transparency. Notably, the following amendments will be introduced.
- With respect to both RTS 1 and RTS 2, amendments to:
o Harmonise the types of transactions considered as non-price forming;
o Clarify the data fields that should be provided for in post-trade transparency reports by APAs and trading venues; and
o Clarify the legal status of “hybrid systems”, which combine aspects of different trading systems.
- With respect to RTS 1 only, amendments to:
o Increase the threshold above which orders and transactions in exchange-traded funds benefit from the pre-trade transparency waivers and post-trade deferrals;
o Provide specifications on delivery of data to competent authorities in relation to calculations of the average daily turnover, average value of transactions, and which market is the most relevant market in terms of liquidity; and
- With respect to RTS 2 only, to provide specifications on delivery of data to competent authorities in relation to calculations of various thresholds, such as the large in scale threshold and the size specific to the instrument threshold, as well as the liquidity determination.
The Commission’s adoption of the delegated acts initiated a three-month period of scrutiny by the European Parliament and the Council of the EU. Provided they do not object to the texts, the delegated acts are expected to enter into force on the 20th day following their publication in the Official Journal of the EU and to apply from 1 January 2024.
The above amendments are relevant only to investment firms authorised in an EU member state. UK investment firms should refer to the relevant FCA rules for their compliance with pre- and post-trade transparency requirements under UK MiFIR.
ESMA publishes new technical standards for clearing and derivative trading obligations
On 1 February 2023, ESMA published its final report on the clearing obligation (CO) under the European Market Infrastructure Regulation (EMIR) and the derivative trading obligation (DTO) under MiFIR in view of the 2022 status of the EU’s benchmark transition.
The CO and the DTO require the clearing and trading on EU trading venues of certain classes of over-the-counter (OTC) derivatives referencing prescribed benchmarks.
The report presents draft RTS amending the scope of the CO and DTO for OTC interest rate derivatives denominated in EUR, GBP, JPY, and USD to reflect the benchmark transition away from the Euro Overnight Index Average (EONIA) and London InterBank Offered Rate (LIBOR) and onto alternative benchmarks, primarily Risk Free Rates such as Euro Short-Term Rate (€STR), Secured Overnight Financing Rate (SOFR), Sterling Overnight Index Average (SONIA), and Tokyo Overnight Average Rate (TONA).
The proposed RTS include:
- In respect of the CO, introducing the TONA Overnight Index Swap (OIS) (with maturities up to 30 years) class and extending the SOFR OIS class (up to 50 years); and
- In respect of the DTO, introducing certain €STR OIS classes.
The draft RTS have been submitted to the Commission for endorsement in the form of Commission Delegated Regulations.
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