UK/EU Investment Management Update (April 2023)
1. UK — FCA Updates
2. UK — Investment Research Review
3. UK — SMCR
4. UK — IFPR
5. UK — ESG
6. UK — Market Abuse
7. UK — Cryptoasset Regulation
8. EU — Market Abuse
9. EU — ESG / Securitisation Regulation
10. EU — MiFID II
11. EU — European Long-Term Investment Funds Framework
Consumer Duty — FCA feedback to Consultation Paper
As discussed in our January 2023 Update, under the rules adopted by the FCA, the Consumer Duty does not apply to “non-retail financial instruments,” which are (amongst other things) financial instruments with a minimum denomination or otherwise a minimum investment of £50,000. In CP22/26, the FCA proposed to amend this exclusion so that it would not be available with respect to investment funds.
However, in response to stakeholder responses to the Consultation, the FCA has decided not to include the changes to the £50,000 exemption at this stage, noting that respondents had raised concerns with the proposed amendments, which the FCA intends to consider more fully.
So for the time being, investment funds with minimum subscriptions £50,000 are effectively outside of the scope of the Consumer Duty.
It is possible that the FCA will decide to introduce an amendment at a later date to remove the exemption, but the FCA also noted that if the proposal were to be taken forward, the FCA would grant an appropriate implementation period for any changes made to the rules.
FCA authorisations — FCA update on operating service metrics
On 21 March 2023, the FCA published an update on its authorisation metrics, which follows on from its previous update published in October 2022, where the FCA recognised deficiencies in meeting its timelines for authorisations and outlined a programme of investment in authorisations.
The latest metrics set out the percentage of FCA applications that are processed within their target timelines and show a general trend of improvement in performance over the past two years, as Covid-19 backlogs were cleared and the FCA increased its headcount.
The FCA expects to see further improvement and to be substantially meeting its targets by the end of March 2023. The FCA is continuing its programme of investment in authorisations and has now recruited 125 additional permanent colleagues. The FCA also noted that from their peak in December 2021, caseloads have now fallen by almost 60% and are approaching more sustainable levels. Further, their new processes are reducing the time it takes to allocate a case to a case officer and allowing straightforward cases to be determined quicker.
As a reminder, the FCA is required by the UK Financial Services and Markets Act 2000 to determine applications for authorisation (as well as variations of permission) within six months of receiving a completed application (if the application is incomplete, the FCA must make a decision within 12 months).
FCA enforcement — London Metal Exchange (LME) nickel trading suspension
On 3 March 2023, the FCA announced that it had opened an enforcement investigation in relation to the LME’s decision to suspend trading on its nickel market in March 2022.
From 7 March to 8 March 2022, in just over 24 hours, the price of nickel increased by 250% on the exchange. The rapid price movement was blamed on several factors, including large, exposed short positions and a rise in the price of metals following Russia’s invasion of Ukraine. The volatility in price prompted the LME to step in and suspend the market on 8 March 2022, in addition to cancelling nearly US$4 billion of transactions going back to the previous evening. The suspension has been subject to widespread criticism by stakeholders in the market, including legal action taken against the LME.
In its announcement, the FCA noted that it had “reviewed the events surrounding the suspension of the nickel market and has opened an enforcement investigation into some of the LME’s conduct and systems and controls in place in the period between 1 January 2022 and the time of suspension on 8 March 2022. The FCA has confirmed an investigation in light of the public interest in these matters and will not make any further comment in line with normal policy.”
As has been widely reported, a number of investment managers have taken legal proceedings against the LME in connection with the suspension of the nickel market.
AML (anti-money-laundering) — FCA to collect Treasury’s economic crime levy from July 2023
On 9 March 2023, the FCA announced that the UK Government had introduced an economic crime levy (ECL) to fund the UK’s fight against economic crime. The levy will be collected for the Government by HM Revenue and Customs, the FCA, and the Gambling Commission.
The ECL will apply to all AML-regulated businesses, including:
- credit institutions
- financial institutions
- auditors, insolvency practitioners, external accountants, and tax advisers
- independent legal professionals
- trust or company service providers
- estate and lettings agents
- high-value dealers, casinos, auction platforms, and art market participants
- cryptoasset exchange providers and custodian wallet providers
The FCA is responsible for collecting the levy from those firms that are regulated by or registered with FCA. Affected firms (i.e., those subject to the money laundering regulations between 6 April 2022 and 5 April 2023) will see the new levy appear on invoices from July 2023. The levy will be paid annually and determined by a firm’s UK revenue.
UK Investment Research review – Call for Evidence
On 3 April 2023, the UK government launched a Call for Evidence in relation to financial services investment research. This call for evidence is the first step in the independent review of financial services investment research and its contribution to UK capital markets competitiveness, as announced by the Chancellor in December 2022.
The review will gather information and evaluate options to improve the UK market for investment research and provide recommendations on how to improve the UK research landscape with the aim of making the UK a more attractive location for companies looking to list and access capital.
The Call for Evidence sets out a list of non-exhaustive questions on which views are sought, including questions on the market position of UK investment research services relative to other major international financial services centres, sector specific issues relevant to UK investment research services, the perceived impact of EU law on the UK market, and pain points under the current UK legislative and regulatory framework.
All interested parties, including buy-side and sell-side firms, listed and unlisted companies, investors, independent research firms, trading venues, and legal and academic professionals, are invited to provide their views. The Call for Evidence response window closes on 24 April 2023.
Senior Managers & Certification Regime - Call for Evidence
On 30 March 2023, the UK government launched a Call for Evidence in relation to the Senior Managers and Certification Regime (SMCR). The Call for Evidence has been launched alongside joint Discussion Paper of the FCA and Prudential Regulation Authority (PRA), which will review operational aspects of the SMCR. These reviews will provide the government and the regulators with a shared evidence base for identifying the most effective way for the regime to deliver on its core objectives.
The review calls for industry stakeholders and representatives to provide more evidence on whether the SMCR is delivering against its original objectives and whether longstanding concerns, including on delayed regulatory authorisations, are harming the UK’s international competitiveness. At this stage, the review does not propose any radical reform to the regime.
The Call for Evidence highlights concerns that stakeholders have raised about specific parts of the regime, including areas such as the compliance requirements for authorizing the appointment of new Senior Managers, the differing levels of scrutiny applied to different firms, and the interaction of the SMCR with other regulatory regimes. The regulators note that they have taken action to address these issues, including reducing the backlog of authorizations and improving their processes, and called for responses to its paper to provide more information on whether industry concerns have been addressed.
The FCA and PRA’s joint Discussion Paper said that the regulators will continue to look for opportunities to improve the regime and remain open to suggestions on what further improvements could be made. The Call for Evidence and the Discussion Paper response window closes on 1 June 2023.
FCA publishes IFPR implementation observations
On 27 February 2023, the FCA published its initial observations on how firms are implementing requirements on the internal capital adequacy and risk assessment (ICARA) process and reporting under the IFPR.
The FCA’s review focused on capital adequacy, liquidity adequacy, and wind-down planning. This included reviewing how firms assessed their threshold requirements through their ICARA process and what framework they had adopted to manage financial resources.
The FCA selected a sample of investment firms and investment firm groups covering various business models for inclusion in the review. Included were some of the largest and best-resourced investment firms or firm groups. The review included:
- bilateral discussions with firms, including with senior members of the board and management teams, on their approach to assessing risks and harms, quantifying own funds and liquid assets threshold requirements, and the framework applied to managing own funds and liquid asset resources
- review of ICARA documentation and other relevant information
- review of the quality of data submitted by firms to comply with the prudential sourcebook of rules for MiFID investment firms’ reporting requirements
The FCA made a number of key observations, including identifying a number of commonly seen deficiencies in the ICARA processes, firms’ wind-down plans, and the quality of data submitted by firms:
- In relation to the ICARA process, the FCA noted that there was often a lack of adequate assessments of threshold requirements for individual investment firms within investment firm groups. Further, there was an absence of unified and integrated assessments, inadequately explained reductions in risk capital, a lack of comprehensive own funds and liquid assets triggers and limits framework, and insufficient governance and board and executive involvement in ICARA.
- In relation to firm’s wind-down plans, the FCA found that firms generally did not pay sufficient attention to wind-down plans, with issues including failure to consider a stress backdrop, wind-down dependencies in a group membership context. Certain firms also had incomplete analysis of the wind-down requirements, which did not specifically assess activities or circumstances unique to the firm.
- In relation to data quality, the FCA observed a number of firms providing inaccurate or incomplete data in their regulatory submissions. The FCA noted that it considers the poor quality of regulatory data submissions to be an indicator of weaknesses in firms’ systems and controls and that the transition to IFPR is an opportunity for firms to review their regulatory reporting practices and ensure that all regulatory reporting submissions are accurate.
Firms subject to the IFPR should review these observations to help them understand the FCA’s existing policy and should consider whether to apply any of these observations to their processes.
FCA to delay final policy statement on SDR and Investment Labels Consultation
On 29 March 2023, the FCA published a statement outlining its feedback on the SDR and Investment Labels Consultation (CP22/20) and its next steps. The FCA asserted that consumers are at the heart of their proposals for SDR and investment labels, and that the proposals are aimed at ensuring that the UK market functions competitively and effectively for the benefit of consumers, so that consumers are able to trust sustainable investment products.
The FCA noted that it had received around 240 written responses to the Consultation, that there was broad support for the proposed regime, and it had received constructive feedback on some of the detail.
In CP22/20, the FCA had stated its intention for the final rules and policy statement in relation to the SDR to be published by the end of H1 2023. The FCA has now updated this timing and intends to publish its policy statement in Q3 this year, with the proposed effective dates adjusted accordingly. When the FCA publishes its policy statement, it will also clarify matters such as the fact that primary and secondary channels for achieving sustainability outcomes are not prescribed and that the rules do not require independent verification of product categorisation to qualify for a label.
In relation to the approach taken by other jurisdictions on labelling sustainable investments, the FCA noted that it had sought international coherence with other regimes and will continue to consider how to further support compatibility while emphasising that robust standards are needed for the UK to remain at the global forefront of sustainable investment. The FCA will continue to engage with its Disclosures and Labels Advisory Group and other stakeholders, including consumer groups, in developing the proposals further.
For more information on the FCA’s proposals, please see our Sidley Update Financial Conduct Authority Consultation on UK Sustainability Disclosure Requirements — Five Key Takeaways for Asset Managers.
UK Treasury committee criticises FCA approach to fund sustainability labelling
On 9 March 2023, the Parliament’s Sub-Committee on Financial Services Regulations published a letter sent to the FCA’s chief executive, Nikhil Rathi, branding the FCA’s plans to prevent investment funds from greenwashing “lop-sided.” The letter addresses the FCA’s proposals to create a traffic-light system to classify the sustainability of funds, asserting that the cost to consumers of UK fund sustainability labelling rules had not been adequately considered and should be reviewed.
In the letter, the Sub-Committee said it is concerned that the existing cost-benefit analysis undertaken by the regulator falls short and fails to take into account the substantial costs to the consumer of the measures included within the FCA’s proposals.
The cost-benefit analysis relates to the SDR and Investment Labels Consultation Paper (CP 22/20) set out by the FCA in October 2022, which identify three categories showing different sustainability levels of a product: sustainable focus, sustainable improvers, and sustainable impact. The regulator has said it estimates one-third of investment funds will qualify and apply for a new label. Two-thirds will have to change their marketing practices or risk being accused of “greenwashing” — erroneously claiming their products are climate-friendly.
The letter expresses the Sub-Committee’s skepticism over the FCA’s estimates and also concern that there will be a significant cost to consumers of applying the rules, noting that at a hearing on 22 February 2023, FCA officials had confirmed the cost would not be zero, but the cost-benefit analysis does not consider the impact on consumers.
In particular, the Sub-Committee outlines three ways in which customers could incur costs in relation to the proposals:
- the cost of time spent reconsidering which products they wish to invest in or divest from and the transaction costs of moving their funds;
- the fact that consumers will be exposed to buy/sell spread when reallocating funds; and
- the potential change in the fundamental price of a fund that is no longer able to market itself as “sustainable.”
The letter requests the FCA to provide a new cost-benefit analysis that considers the costs to consumers of the proposals. The letter also sets out five further questions for response from the FCA, including how it will enforce against firms misleading customers and how the rules will compare with those in other jurisdictions.
HM Treasury consults on the future regulatory regime for environmental, social, and governance (ESG) ratings providers
On 30 March 2023, HM Treasury published a new consultation paper on whether regulation for providers of ESG ratings should be introduced and on the potential scope of a regulatory regime.
The UK’s approach to financial services is based on the Financial Services and Markets Act 2000 (FSMA). FSMA establishes a framework whereby any person (whether an individual or firm) can carry out a regulated activity only if it is authorised by the appropriate regulator or is exempt from the authorisation requirement. Under this framework, HM Treasury determines which activities are regulated activities by specifying them in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO).
The core policy proposal set out in the consultation is that a new regulated activity is brought into the RAO: “the direct provision of an assessment of environmental, social, or governance factors to a user in the UK, where the assessment is used in relation to a specified investment in the RAO, unless an exclusion applies.”
The consultation seeks views on initial policy proposals. As such, it seeks to gather views on support for the regime, appropriate descriptions of ESG ratings, exclusions, and scope. The consultation does not include any settled positions or proposed legal drafting, which will be worked up using input from this consultation, if HM Treasury decides to pursue regulation for ESG ratings providers following receipt of stakeholder feedback. The consultation will close on 30 June 2023.
HM Treasury and FCA publish joint statement on the Criminal Market Abuse Regime
On 24 March 2023, HM Treasury and the FCA published a joint statement on their completion of the review of the Criminal Market Abuse Regime (the Criminal Regime Review), which HM Treasury and the FCA had committed to jointly reviewing in 2019 as part of the Economic Crime Plan 2019-22.
The Criminal Regime Review has identified a number of areas where the government believes it would be appropriate to update the criminal regime. This sits alongside the government’s acceptance of the recommendations of the Fair and Effective Markets Review in relation to market abuse, where the government will lay secondary legislation in 2023.
The Criminal Regime Review has been undertaken within the wider context of regulatory reforms in UK financial services, known as the Future Regulatory Framework (FRF) Review. The FRF Review was established to determine how the financial services regulatory framework should adapt to the UK’s new position outside of the EU and how to ensure that the framework is fit for the future.
As part of the FRF programme, the Government also intends to repeal the civil market abuse regime and replace it with UK-specific legislation. The Government will consider changes to the criminal and civil regime in parallel and will therefore consider how to take forward the recommendations from the Criminal Regime Review once both reviews are complete. A timeline will be set out in due course.
UK Government publishes new legislation and updates policy statement on cryptoasset financial promotions
On 27 March 2023, the UK Government published draft legislation that will expand the scope of the financial promotions regime in the FSMA to capture promotions relating to certain cryptoassets. Alongside the new draft legislation, the Government published an update to its policy statement on its approach to cryptoasset financial promotions regulation.
The updated policy statement notes that HM Treasury had received feedback regarding the implementation of the measure for qualifying cryptoassets and potential unintended consequences for industry. The feedback indicated that the requirement to be authorised means most cryptofirms will not be able to communicate their own promotions, unlike other financial services firms, which are typically required to be regulated to carry on their activities. Further, there is evidence of a lack of suitable authorised persons in the market willing and able to approve cryptopromotions.
As such, the effect of the above issues would in practice be to significantly restrict, or amount to an effective ban on, cryptoasset financial promotions because there are unlikely to be authorised persons willing to approve the promotions of unauthorised firms. This was not the intended outcome of the legislation, and the government recognises growing industry concern about this risk.
In response to the stakeholder feedback received by HM Treasury, the new draft legislation includes an exemption for qualifying cryptoassets. This exemption will enable cryptoasset businesses registered with the FCA under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (AML/CTF Regulations), who are not otherwise authorised persons, to communicate their own financial promotions in relation to qualifying cryptoassets.
This exemption will ensure that cryptoasset exchange providers or custodian wallet providers registered under the AML/CTF Regulations will be able to communicate their own promotions in relation to qualifying cryptoassets.
The detailed FCA rules for the cryptoasset financial promotions regime will be set independently by the FCA. As mentioned in our March 2023 Update, the FCA has warned that all cryptoasset firms marketing to UK consumers, including firms based overseas, will soon need to comply with the new UK financial promotions regime and that firms must start preparing for this regime.
ESMA raises concerns with the proposed changes to the insider list regime
On 10 March 2023, ESMA sent a letter to the European Parliament and Council raising concerns with proposed changes to the insider list regime in the Markets Abuse Regulation.
The proposed changes, which were put forward by the European Commission in December 2022 as part of the Listings Act proposal, mean that insider lists would include only persons who have regular access to inside information, not those who may have access to such information on a case-by-case basis.
The letter outlines how the proposed changes may lead to detrimental effects for National Competent Authorities and their ability to enforce against market abuse, as well as for issuers, who use insider lists to manage the flow and access to inside information.
ECB and the ESAs call for enhanced climate-related disclosure for structured finance products
On 13 March 2023, the ESAs, together with the ECB, published a Joint Statement on climate-related disclosure for structured finance products. The Joint Statement recognises that investment in financial products meeting high ESG standards is becoming increasingly important in the EU, and as such the ESAs and ECB are working towards enhancing the disclosures standards for securitised assets by developing new disclosure templates that include ESG-related information.
The Joint Statement notes that there is currently insufficient climate-related data on the assets underlying structured finance products. As securitisation transactions are often backed by assets that could be directly exposed to climate-related risks, the value of these underlying assets could be affected by climate-related events, so the ESAs and the ECB share the view that the reporting on existing climate-related metrics needs to improve.
The lack of climate-related data also poses an obstacle for the classification of products and services under the EU Taxonomy Regulation and the Sustainable Finance Disclosure Regulation (SFDR) and hinders the proper assessment and management of climate-related risks. As such, the new disclosure templates will also need to satisfy the reporting standards stemming from the Taxonomy Regulation and the SFDR.
While mandatory disclosure requirements are not yet in place, the ECB and the ESAs are nonetheless already calling on originators to collect, at the time of loan origination, the data that investors need to assess the climate-related risks of the underlying assets. In the case of securitisation, originators and sponsors should fill in the voluntary climate-related fields in the existing securitisation disclosure templates.
Finally, the introduction of new climate change-related disclosure requirements for securitisations may become also relevant for similar funding instruments backed by the same type of underlying assets, such as covered bonds. Consistent and harmonised requirements for these instruments are necessary for properly assessing and addressing climate-related risks and would ensure a level playing field across similar asset classes, foster comparability for investors, and facilitate equal treatment by EU supervisors.
ESMA updates its guidance on product governance
On 27 March 2023, ESMA published its Final Report on Guidelines on MiFID II product governance guidelines.
The main amendments introduced to the guidelines concern:
- the specification of any sustainability-related objectives a product is compatible with;
- the practice of identifying a target market per cluster of products instead of per individual product (“clustering approach”);
- the determination of a compatible distribution strategy where a distributor considers that a more complex product can be distributed under non-advised sales;
- the periodic review of products, including the application of the proportionality principle.
The product governance requirements introduced by MiFID II have proven to be one key element of the MiFID II investor protection framework, aiming at ensuring that financial instruments and structured deposits (“products”) are manufactured and/or distributed when this is in the best interest of clients.
By pursuing the objective of ensuring a consistent and harmonised application of the product governance requirements, the guidelines will make sure that the objectives of MiFID II can be efficiently achieved.
ESMA conducted a public consultation on these Guidelines to gather the views of relevant stakeholders. The report published today contains a feedback statement summarising the responses received and highlighting the amendments and clarifications introduced in the final guidelines to consider the feedback received during this consultation.
The Guidelines will be translated into the official languages of the EU and published on ESMA’s website. The publication of the translations will trigger a two-month period during which national competent authorities must notify ESMA whether they comply or intend to comply with the Guidelines. The Guidelines will apply two months after the date of the publication on ESMA’s website in all EU official languages.
The UK, having left the EU, is not subject to ESMA Guidelines, but UK MiFID firms may nonetheless wish to familiarise themselves with them, particularly where such UK MiFID firms have EU-based investors/clients.
Council of the European Union (the Council) adopts revised framework for European long-term investment funds
On 7 March 2023, the Council announced that it had adopted a redesigned regulatory framework for European long-term investment funds (ELTIF) that makes these types of investment funds more attractive. The Commission presented its capital markets union package including the ELTIF proposal on 25 November 2021, and negotiations among the European Commission, the Council, and the European Parliament ended in agreement on 19 October 2022. The new regulation will apply from 10 January 2024.
The new regulation is part of the EU’s capital markets union plan, a plan to create a single market for capital to encourage investments and savings across all EU Member States. ELTIFs are currently the only type of funds dedicated to long-term investments that can be distributed on a cross-border basis to both professional and retail investors. Because ELTIFs are designed to channel long-term investments, they are well placed to help finance green and digital transitions.
The reforms remove a number of regulatory obstacles for ELTIFs, making it easier to invest in innovative European projects and companies, including small and medium-size companies.
Separately, on 9 March 2023, the FCA announced that it had authorised its first fund under the UK counterpart to the ELTIF, the Long Term Asset Fund (LTAF). The LTAF is a new category of open-ended authorised fund designed to invest efficiently in long-term assets. The FCA LTAF regulatory regime came into force in 2021.
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