Investment Funds Update
UK/EU Investment Management Update (April 2020)
In this Update we cover guidance from various sources on COVID-19 which are relevant for investment managers, the EU short selling bans, London interbank offered rate (LIBOR) transition, UK Financial Conduct Authority (FCA) proposals for new climate-related disclosures, European Market Infrastructure Regulation (EMIR) reporting best practices, and the new UK Financial Services Regulatory Initiatives Forum.
Please feel free to contact a member of our UK/EU Financial Services Regulatory Group if you would like to discuss any of the topics discussed in this Update.
1. COVID-19 – MiFID II – ESMA statement on best execution reports
ESMA asks the NCAs to consider the possibility that:
- Execution venues unable to publish RTS 27 reports due by 31 March 2020 may only be able to publish them as soon as reasonably practicable after that date and no later than by the following reporting deadline (i.e., 30 June 2020).
- MiFID investment firms may only be able to publish the RTS 28 reports due by 30 April 2020 on or before 30 June 2020.
ESMA encourages NCAs not to prioritise supervisory action against execution venues and firms in respect of the deadlines of the general best execution reports. However, ESMA recommends that firms and execution venues keep records of the internal decisions taken in relation to the expected delay.
2. COVID-19 – MiFID II – ESMA clarification on telephone recording
Firms are expected to deploy all possible efforts to ensure that any disruption to telephone recordkeeping is kept to a minimum and that recording of telephone conversations is restored as soon as possible.
ESMA will continue to monitor developments in financial markets in coordination with national competent authorities, including the application of relevant EU requirements by market participants, as a result of the COVID-19 situation and is prepared to use its powers to ensure financial stability, orderly functioning of EU markets and investor protection.
3. COVID-19 – SFTR – ESMA statement on new reporting start date
ESMA acknowledges the challenges that TRs and their counterparties may face in SFTR implementation and expects TRs to be registered sufficiently ahead of the next phase of the reporting regime — 13 July 2020 — for credit institutions, investment firms, central clearing counterparties and CSDs and relevant third-country entities to start reporting as of that date but no earlier than 13 April 2020.
ESMA will continue to monitor the implementation of SFTR by the relevant market participants as well as the impact of the relevant measures taken with regards to COVID-19 to ensure alignment of SFT reporting requirements and supervisory practices in the EU.
For more information, please refer to our Update of 28 February 2020, EU SFTR Reporting for Investment Managers — Top Five Things to Know.
4. COVID-19 – UK FCA “Dear CEO” letter – best execution and 10% depreciation rule
Although the letter is addressed to firms providing services to retail investors, there are two points of general application to investment managers in the wholesale sector, including hedge funds.
First, referring to item 1 (COVID-19 – MiFID II – ESMA statement on best execution reports) above, the FCA states:
“[W]e have no intention of taking enforcement action where a firm:
- does not publish RTS 27 by 1 April 2020, provided it is published no later than 30 June 2020
- does not publish RTS 28 and Article 65(6) reports, provided they are published by 30 June 2020”
Secondly, under the FCA rules (implementing MiFID), firms providing portfolio management (and certain other) services are required to inform investors where the value of their portfolio falls by 10% or more compared with its value in their last periodic statement, and for each subsequent 10% fall in value. Given the highly volatile market, the FCA states:
“We have no intention of taking enforcement action where a firm: …
- chooses to cease providing 10% depreciation reports for any professional clients”
The FCA will adopt this approach for a period of 6 months (to 1 October 2020).
5. COVID-19 – UK FCA Guidance
Amongst other things, the FCA has made it clear (here) that “only those workers who cannot work from home, continue to travel to and from work,” and that it is the responsibility of senior managers at the firm (under the Senior Managers and Certification Regime) to ensure that the firm is in compliance with the FCA’s expectations under the current health crisis.
As for the FCA’s expectations on firms in terms of their ongoing regulatory obligations, the FCA notes the following:
- Firms should continue to record calls (as required by the FCA rules), but the FCA accepts that some scenarios may emerge where this is not possible. Firms should make the FCA aware if they are unable to meet these requirements.
- Firms may experience difficulties in submitting their regulatory data, in which case the FCA expects firms to maintain appropriate records during this period and submit the data as soon as possible.
- Firms should continue to take all steps to prevent market abuse risks. This could include enhanced monitoring or retrospective reviews.
6. EU bans on short selling under the EU Short Selling Regulation
Please refer to our Updates EU Bans on Short Positions — Implications for Market Participants and European Union Net Short Position Reporting Threshold Reduced to 0.1 Percent for an analysis of those measures.
7. LIBOR Transition – COVID-19
The FCA, Bank of England (BoE) and the Working Group on Sterling Risk-Free Reference Rates (RFRWG) have discussed the potential impact of the pandemic on the plan to transition away from LIBOR over the coming months, but noted: “The central assumption that firms cannot rely on LIBOR being published after the end of 2021 has not changed and should remain the target date for all firms to meet.”
8. LIBOR Transition – UK FCA and BoE “Dear CEO” Letter
On 9 March 2020, the BoE and FCA published a joint letter addressed to chairs and CEOs of trade associations on how the transition away from LIBOR to alternative ‘risk-free’ rates will affect members and stakeholders. The key takeaways:
- The LIBOR benchmark will be discontinued at the end of 2021. As it relies on estimates from banks of their borrowing costs in markets that are no longer active, it is no longer considered sufficiently robust or sustainable given its widespread use. Continued use of this benchmark creates risks such as a lack of clarity over the legal position and interest payments due for contracts that refer to LIBOR rates.
- This change may affect some trade associations’ members, stakeholders or clients. For example, LIBOR may be used in bank loans to companies or in contracts between nonfinancial companies that have arrangements for payments that add interest.
- The working group established by the FCA and BoE to oversee this change (RFRWG) has chosen the Sterling Overnight Index Average (SONIA) as its preferred successor for UK wholesale financial markets. SONIA is based on transactions that firms report to the BoE. It reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial institutions.
- By the end of September 2020, banks and lenders are to stop making new LIBOR-based loans that mature beyond the end of 2021. Firms with existing LIBOR-based arrangements that mature after 2021 will have to convert them to new benchmarks such as SONIA.
- For more information on the LIBOR transition and next steps, see this factsheet published by the RFRWG.
9. ESG – FCA proposals to enhance climate-related disclosures by listed issuers and clarification of existing disclosure obligations
The proposals set out in the Consultation Paper build upon the recommendations of the TCFD, an existing global standard. The FCA aims, through the new rule, to provide the transparency the market needs to be able to assess how well companies are adjusting to the risks of climate change.
In addition to comments on the new rule, the FCA is also seeking feedback on clarifications to how existing requirements applicable to all listed companies already require climate and other sustainability-related disclosure. The FCA is asking for any feedback on the Consultation Paper to be provided by 1 October 2020.
10. EMIR – ISDA reporting best practices
On 3 March 2020, the International Swaps and Derivatives Association (ISDA), European Fund and Asset Management Association (EFAMA) and a number of other associations jointly published a set of best practices for derivatives trade reporting under EMIR. The best practices are available to all market participants to access and implement.
The document complements the EMIR reporting RTS and Implementation Technical Standards and sets out best practice standards for reporting fields that are most commonly mismatched, based on feedback from trade repositories. It covers 87 data points across 61 reporting fields including both over-the-counter and exchange-traded derivatives. Other fields may be added over time, if required. They aim to facilitate greater standardisation in how firms complete certain data fields when reporting under EMIR and reduce compliance costs.
11. CSDR – ICMA FAQs on CSDR mandatory buy-ins and securities financing transactions (SFTs)
12. UK government announces new regulatory body
The forum will comprise the BoE, the Prudential Regulation Authority, the FCA, the Payment Systems Regulator and the Competition and Markets Authority. The UK Treasury will act as an observer member.
13. FCA – potential changes to liquid asset rules for UK mutual funds (UCITS)
On 19 March 2020, Edwin Schooling Latter, Director of Markets and Wholesale Policy at the FCA, delivered a speech on potential changes for UCITS funds. Key takeaways:
- Certain funds might no longer be considered liquid merely because they invest in listed securities.
- Whilst daily redemption promises are attractive for many fund investors, this is not appropriate for all fund structures.
- The availability of daily redemptions in open-ended funds creates a risk when fund assets cannot be liquidated without material loss of value, that is, where this is an asset-liability mismatch. This risk becomes especially apparent in times such as these when phenomena such as COVID-19 create a precarious financial environment.
- This mismatch can be addressed either through the asset side or the liability side:
- Asset-side management would mean restricting the assets daily dealing open-ended funds may invest in to those that have sufficient liquidity to be sold same day without material loss of value. The FCA believes this is unlikely to be the optimal solution, given the importance of promoting long-term investment in achieving stable economic growth.
- Liability-side management can be achieved through the use of swing pricing mechanisms and notice periods. Swing pricing, used in a fair and appropriate manner, can benefit investors by preserving liquidity while removing first mover advantage, whilst notice periods help to promote investor understanding of the risks involved with investing in less-liquid assets and discourage panic-selling.
- From 9 December 2019, almost all FCA solo-authorised firms became subject to the Senior Managers and Certification Regime (SMCR). That serves to reinforce the responsibility of senior management and boards at authorised fund managers. It is the responsibility of relevant managers in authorised firms selling and operating funds to make sure they are designed and run so that the promises made to investors are met.
- The FCA and BoE continue work to evaluate potential policy measures to achieve greater consistency of fund redemptions and welcome input from industry members into this work.
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