UK/EU Investment Management Update (March 2023)

1. UK — FCA Updates

2. UK — ESG

3. UK — Cryptoasset Regulation

4. EU — EMIR

5. EU — ESG

6. Global — ESG

7. European Parliament — Study on UK Financial Sector Regulation

1. UK — FCA Updates

FCA publishes Discussion Paper on updating and improving the UK regime for asset management

On 20 February 2023, the FCA published Discussion Paper 23/2 “Updating and improving the UK regime for asset management” seeking views about improving the current UK regime for regulating funds and asset managers. For an in-depth discussion of the proposals put forward by the discussion paper, please see our recent Sidley Update FCA’s Post-Brexit Review of the UK Asset Management Regime. The deadline for responses to the discussion paper is 22 May 2023.

FCA publishes “Dear CEO” Letter outlining its Asset Management Supervision Strategy

On 3 February 2023, the FCA published a “Dear CEO” letter to firms within its asset management portfolio. This letter outlines the harms to consumers or markets that the FCA perceives as most likely to arise from the business models of asset management firms, setting out how the FCA intends to supervise such firms to address these harms. It supersedes the FCA’s previous strategy letter of January 2020. The contents of this letter will be of particular interest to UK-based asset managers.

(This Dear CEO letter is directed at the general asset management industry, particularly those asset managers servicing retail investors. The FCA has a separate series of Dear CEO letters addressed to alternative asset managers, the last such letter being published on 9 August 2022 and the subject of our Update UK Financial Conduct Authority Warns Alternative Asset Managers of Enforcement Action in the Event of Investor Harm (September 6, 2022).)

This latest letter identifies five supervisory priorities:

1. Product Governance. A key risk is that the quality and value of product offerings, or the quality of communications with customers, do not deliver good outcomes for consumers or meet their needs.

To address this risk, the FCA expects in-scope asset managers to comply with the forthcoming Consumer Duty, which should shift how firms serve their customers. The FCA will conduct a review in 2024 to assess the embeddedness of the Consumer Duty.
Additionally, the FCA will follow-up its 2021 Assessment of Value review findings to identify outlier firms. This process will include a review of how firms have built maturity of ESG into their value assessment considerations.

For a discussion on the Consumer Duty, please see our Sidley Updates for February 2023, January 2023, and May 2022.

2. ESG and Sustainable Investing. With the increased prominence of ESG and sustainable investment products, there are risks that claims about ESG and sustainable investing may be misleading or inaccurate, which could negatively affect consumers’ confidence to invest.

The FCA’s supervisory activities will focus on the governance structures that oversee ESG and stewardship considerations to test whether firms deliver on claims made in their communications with investors.

For example, the FCA expects asset managers to (i) satisfy FCA expectations on the design, delivery and disclosure of ESG and sustainable investment funds as set out in its July 2021 Dear Chair letter to authorised fund managers (for a discussion on the Dear Chair letter, please see our August 2021 Update); (ii) publish Task Force on Climate-Related Financial Disclosures (TCFD)–aligned disclosures in H1 2023, where required (for more detailed information regarding TCFD-aligned disclosures, please see our Sidley Update New UK FCA Rules on Climate-Related Disclosures — Ten Key Points for Asset Managers (January 2022)); and (iii) appropriately consider net zero commitments in their transition planning.

3. Product and Liquidity Management. Open-ended funds can have a liquidity mismatch between the terms at which investors can redeem and the time needed to liquidate fund assets to meet redemption requests. In more volatile market environments, such liquidity risks are relevant across a broader set of products.

Although it is particularly focused on elements of the system that have shown liquidity vulnerability to market stress (e.g., money market funds), the FCA is also in the process of completing a multi-firm review of liquidity management. The FCA will expect firms to consider their own governance, oversight, and controls in reference to this review’s findings.

Currently, the FCA expects asset managers to work with stakeholders to ensure that operational systems and processes are (i) fit for purpose, (ii) can be executed at pace, and (iii) can be scaled to handle additional demand as needed.

4. Investment in Operations and Resilience. Underinvestment in operations can lead to service disruption or failure, with consequential loss to investors and detriment to markets.

Asset managers should therefore have appropriate measures to understand the operational health of their businesses and be capable of responding in a timely manner; where appropriate, this should include knowledge of third parties relied on for services. Firms should also ensure they meet their reporting obligations, particularly in circumstances where they are required to promptly notify the FCA (e.g., operational failures or cyber-attacks).

Asset managers should have already identified their important business services and set impact tolerances by 31 March 2022, as explained in PS21/3. Such firms are expected to remain within their impact tolerances by 31 March 2025.

The FCA will proactively monitor asset managers’ ability to comply with these regulatory requirements, which could involve selecting firms for further review through the FCA’s intelligence-led penetration testing scheme, CBEST.

5. Financial Resilience. Since the publication of its now superseded January 2020 letter, the FCA has increased its monitoring of the prudential health of asset managers and implemented the Investment Firms Prudential Regime (IFPR) for in-scope firms.

Although few asset management firms have failed in that timeframe, the FCA notes that disorderly firm failure has the potential to cause significant material detriment to consumers and markets. The FCA will therefore continue to assess firms’ prudential health and will conduct targeted monitoring visits as needed.

To address these risks, asset management firms should (i) ensure they have sufficient capital and liquidity to operate; (ii) ensure their governance processes allow for prudential health to be regularly and adequately assessed; (iii) review their wind-down procedures in reference to the Wind Down Planning Guide and the FCA’s Observations on wind-down planning: liquidity, triggers & intragroup dependencies; and (iv) follow the rules in the Client Assets Sourcebook if holding or controlling client money or safe custody assets as part of their business.

In H1 2023, the FCA also intends to publish its initial observations on firms’ implementation of the IFPR requirements. The FCA expects asset managers to consider these initial observations when reviewing and strengthening their processes.

The FCA cautions CEOs that in any future supervisory engagement, it will consider whether an asset management firm’s governing body and its senior managers have taken appropriate action to ensure that consumers and markets are adequately protected from the harms identified in this letter.

FCA publishes financial promotions data for 2022

On 3 February 2023, the FCA published its financial promotions data for 2022.

The data saw an increase in the FCA’s intervention activity following poor financial promotions compliance in authorised firms. Statistically, the regulator had 8,582 promotions amended/withdrawn, which led to a marked increase of 1398% in intervention activity compared with 573 in 2021.

Although the FCA’s activities have been focused on promotions directed at consumers, the data is a reminder that the FCA is continuing to take assertive action on financial promotions. Managers are reminded therefore that financial promotions should be fair, clear, and not misleading.

See also item 3 (UK — Cryptoassets Regulation) below on new rules for financial promotions of cryptoassets.

2. UK — ESG

FCA publishes Discussion Paper on finance for positive sustainable change: governance, incentives, and competence in regulated firms

On 10 February 2023, the FCA published Discussion Paper DP23/1 Finance for positive sustainable change: governance, incentives and competence in regulated firms, with the aim to encourage an industry-wide dialogue on regulated firms’ sustainability-related governance, incentives, and competences. The discussion paper will be of interest to regulated firms across the financial services sector.

In the first part of the discussion paper, the FCA:

• examines how governance, incentives, and competence are considered in the TCFD recommendations and how expectations in these areas are evolving with the work of the International Sustainability Standards Board, the UK’s Transition Plan Taskforce, and the Glasgow Financial Alliance for Net Zero;

• considers more deeply firms’ sustainability-related objectives and strategies and how these are supported by their governance and incentive arrangements;

• reflects on how asset managers and asset owners organise and govern their stewardship activities to influence positive change; and

• considers firms’ training and competence.

The second part of the discussion paper, the FCA includes commissioned articles. These articles, together with the FCA’s analysis, may help firms reflect on how their approaches to governance, incentives, and competence support positive change and encourage them to review their practices, even without the FCA setting further regulatory expectations.

The deadline for responses to the Discussion Paper is 10 May 2023.

International Financial Reporting Standards Foundation (IFRS) sustainability and climate reporting standards to take effect in 2024

On 17 February 2023, the IFRS International Sustainability Standards Board (ISSB) announced that the IFRS’s new sustainability and climate reporting standards, which are expected to be released by the end of Q2 2023, will become effective as of January 2024.

The ISSB also announced that the European Sustainability Reporting Standards would be referenced within an appendix to S1 — the ISSB’s general requirements standard — as a source of guidance that companies may consider, in the absence of a specific ISSB standard, to identify metrics and disclosures if they meet the information needs of investors.

This should represent another step forward for sustainability reporting in relation to companies. As a reminder, the UK government has made clear its intentions to adopt the IFRS’s new standards as the reporting standards for its TCFD-aligned disclosure regime. The UK government’s timeline surrounding the IFRS’s new standards will hopefully help with improving the availability of comprehensive and comparable ESG data in the asset management industry.

3. UK — Cryptoassets Regulation

FCA warns cryptoasset firms marketing to UK consumers to get ready for financial promotions regime

On 6 February 2023, the FCA published a statement on its website warning that all cryptoasset firms marketing to UK consumers, including firms based overseas, will soon need to comply with the new UK financial promotions regime. Firms must start preparing now for this regime.

On 1 February 2023, the UK Government published a policy statement on its approach to cryptoasset financial promotions regulation. Subject to Parliamentary approval, when the regime comes into force there will be four routes to communicating cryptoasset promotions to UK consumers:

1. The promotion is communicated by an FCA-authorised person.
2. The promotion is made by an unauthorised person but approved by an FCA-authorised person. Legislation is making its way through Parliament that, if made, would introduce a regulatory gateway that authorised firms will need to pass through in order to approve financial promotions for unauthorised persons.
3. The promotion is communicated by a cryptoasset business registered under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 with the FCA.
4. The promotion otherwise complies with the conditions of an exemption in the Financial Promotion Order.

For these purposes, a firm only authorised under the Electronic Money Regulations or the Payment Services Regulations is not considered an “authorised person” and so cannot communicate or approve financial promotions. This is set in legislation and cannot be modified by FCA rules.

Promotions that are not made using one of these routes will be in breach of Section 21 of the Financial Services and Markets Act 2000, which is a criminal offence punishable by up to two years’ imprisonment.

As a related matter, on 1 February 2023, HM Treasury published its consultation and call for evidence on the future financial services regulatory regime for cryptoassets. For a detailed discussion regarding that consultation, see our Sidley Update UK Proposes Regulatory Regime for Cryptoassets (February 2023).

4. UK — EMIR

FCA and Bank of England publish a Policy Statement on UK European Market Infrastructure Regulation (EMIR)

On 24 February 2023, the FCA and the Bank of England published a joint policy statement (PS23/2) on forthcoming changes under UK EMIR to derivatives reporting requirements, procedures for data quality, and the registration of trade repositories. The contents of this policy statement will be of particular interest to counterparties that are in scope of the reporting requirements under UK EMIR.

This policy statement follows a November 2021 joint consultation (CP21/31). For a discussion on the November 2021 consultation, please see our Update for December 2021. This joint policy statement summarises feedback received with respect to the November 2021 consultation and the regulators’ responses to that feedback.

Additionally, this policy statement sets out the FCA’s final rules and technical standards for derivatives reporting. The FCA notes that the finalised derivatives reporting framework under UK EMIR is predominantly aligned with the equivalent framework under EU EMIR. However, there are a small number of areas where the UK and EU regimes diverge.

The final rules will also be mostly aligned with the derivatives reporting requirements of other G20 jurisdictions that have proposed to align their frameworks with technical guidance on the harmonisation of critical data elements for over-the-counter derivatives that was published in April 2018 by the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions (CPMI-IOSCO).

The requirements set out in this policy statement will come into effect from 30 September 2024.

5. EU — ESG

SFDR RTS Annex Templates amended to incorporate nuclear and gas disclosures

On 17 February 2023, the European Commission published a Delegated Regulation (2023/363) to amend and correct the SFDR regulatory technical standards (RTS) and the pre-contractual and periodic disclosures for Article 8 and 9 funds.

The changes made include additional questions on the product’s exposure to investments in fossil gas and nuclear energy activities, as well as dealing with two erroneous cross-references in the previous version of the periodic disclosures.

The revisions entered into force on 20 February 2023, meaning that investment managers that publish precontractual disclosures or periodic reports from this date should rely on the new versions of the templates.

6. Global — ESG

PRI publishes 2023 Reporting Framework and updates on accountability

On 26 January 2023, the PRI published its Reporting Framework for 2023, which will be relevant for investment managers that are PRI signatories.

The materials released include an overview and structure guide to the Reporting Framework, the full Reporting Framework modules, and guidance such as the Reporting Framework glossary, high-level assessment methodology, and a diagram showing which modules are relevant to each signatory type (asset owner or investment manager).

Improvements made within the framework include the restructuring of some sections for a more aligned structure in accordance with other widely recognised frameworks (e.g., TCFD, Taskforce on Nature-Related Financial Disclosures) as well as the reduced reporting effort.

With regards to accountability updates, the existing minimum requirements will remain in place for the 2023 reporting cycle, and their review will continue in 2023. This is to allow the PRI to account for signatory feedback and reporting data that more accurately reflects their current signatory base and broader market developments. More information on the current requirements can be found on the Minimum Requirements page.

Signatories can expect further guidance over the coming months in preparation of the Reporting Tool’s opening. The three-month reporting cycle will begin in mid-May and close in mid-August. Before then, a webinar is scheduled for 15 March 2023 as well as the release of a mapping resource. This is to help signatories identify data points they can potentially re-use from the 2021 Reporting Framework in their 2023 reporting.

7. European Parliament — Study on UK Financial Sector Regulation

European Parliament publishes study on UK financial sector regulation and equivalence

On 9 February 2023, the European Parliament published a study on recent trends in the regulation of the UK financial sector. The study specifically addresses divergence among (i) the EU and the UK regulatory regimes; (ii) threats from such divergence for financial stability in the EU; and (iii) potential scenarios where future equivalence could be granted to the UK. The study will be of interest to all regulated firms across the financial services sector.

The UK’s approach to financial services regulation will lead to the transfer of most rules from the statutory level to the regulators’ rulebooks. This transition should fundamentally reinforce the existing regulatory and supervisory model set out under the Financial Services and Markets Act 2000.

The study also summarises a number of trade agreements the UK has concluded. Notably, the inclusion of Sustainable Finance Provisions in certain UK trade deals constitute the first provisions of their kind. The study notes that the success of these provisions will have to be assessed in the medium term as regards their effective implementation.

Three possible scenarios of divergence between the EU and UK financial services regulatory regimes are discussed in this study:

1. Low divergence. There would be adjustments to some UK regulations aimed to increase the “competitiveness” of the UK as a financial centre. However, there would not be major divergence.
2. Medium divergence. There would be more significant divergence and fewer attempts to converge on new rules. Divergence would be more likely, and more prominent, in areas where international standards are less important and the UK has not inherited any EU regulations, such as the regulation of green finance or cryptoassets.
3. High divergence. There would be an aggressive legislative and regulatory drive in the UK to diverge from EU rules. This would involve replacing existing EU rules with new regulation and adopting divergent rules where such rules have not been inherited.

The report notes that aggressive divergence is expected in areas where UK authorities see growth opportunities and where international cooperation initiatives are less constraining, such as the regulation of cryptoassets. For more information on potential differences between the proposed EU and UK regulatory frameworks for cryptoassets, see our Sidley Update (referenced above) UK Proposes Regulatory Regime for Cryptoassets.

Since the end of the Brexit transition period on 31 December 2020, the UK has been considered a third country under EU law. As such, the UK is subject to existing provisions in EU financial services and banking regulation that may provide for equivalence with third-country regimes. Such equivalence could give third countries access to the EU market and foster cross-border activities. The study notes four different types of equivalence the EU could adopt: (i) scope-limited and time-bound equivalence, (ii) scope-limited equivalence (also called partial equivalence), (iii) conditional equivalence, or (iv) provisional equivalence.

Generally, the study notes that the granting of equivalence to the UK is likely and feasible only for a limited number of financial sector segments. Further, the potential granting of equivalence is critically dependent on the broader political relationship between the EU and the UK, specifically the ongoing negotiations over the Northern Ireland Protocol at the time of this Update’s publication.

Ultimately, the report notes that equivalence is only one possible route capable of building a functional and efficient relationship between the EU and the UK, which suggests that asset managers should continue to keep abreast of overlaps and divergences between the EU and the UK.