UK/EU Investment Management Update (September 2020)

As discussed in our previous Update, given that a wider trade deal between the UK and EU is not generally focussed on financial services (and there has not been any meaningful progress on negotiations to date), investment management firms should ensure that they plan for a “no-deal” Brexit. A no-deal Brexit will have implications for fund marketing carried on by UK firms authorised under the Markets in Financial Instruments Directive (MiFID) for U.S. fund managers, as well as introduce complications to the share trading obligation and derivatives trading obligation under MiFID II.

Temporary permissions regime – FCA update and restructuring of guidance

On 20 August 2020, the FCA updated and restructured its webpage on the UK temporary permissions regime (TPR).

The TPR will enable relevant European Economic Area (EEA) firms and investment funds which passport into the UK to continue operating in the UK for a limited period once the EU passporting regime between the UK and EU/EEA countries falls away at the end of the transition period.

Among other additions, the FCA has added an update to the webpage to reiterate its July 2020 announcement that it will reopen the notification window for the TPR on 30 September 2020. This will allow EEA firms and EEA fund managers that have not yet notified to do so before the end of the transition period. There will also be an opportunity for fund managers to update their previously submitted notifications, if necessary.

The FCA intends to communicate further on this in September 2020.

Preparation of MiFID II firms for post-Brexit – FCA issue 64 of Market Watch

On 27 August 2020, the FCA published Market Watch 64, the 64th edition of the FCA’s newsletter on market conduct and transaction reporting issues.

The newsletter contains important information to assist UK MiFID firms in preparing for the end of the Brexit transition period.

In particular, the FCA has confirmed that a temporary transitional power will not be applied to the transaction reporting rules under MiFID II. UK MiFID firms and UK Approved Reporting Mechanisms (ARMs) must therefore comply with the changes to their regulatory obligations by the expiry of the transition period on 31 December 2020.

The FCA will require UK MIFID firms unable to comply by that time to be able to back-report missing, incomplete, or inaccurate transaction reports as soon as possible.

The ESMA Letter aims to “highlight some areas of AIFMD where improvements could be made” to the Commission, in the context of the Commission’s work in carrying on its review of the AIFMD.

Amongst other things, the ESMA Letter contains a significant section on the issue of delegation of investment management services (e.g., delegation by an EU-authorised alternative investment fund manager (AIFM) to a non-EU firm).

For further information about the ESMA Letter, please refer to our Update AIFMD 2020 – ESMA’s Recommendations on the AIFMD Review.

The Opinion sets out a list of third-country trading venues that ESMA considers to offer, in respect of specified classes of financial instruments, a sufficient level of post-trade transparency such that when trading on these venues, EU investment firms do not need to report these transactions to the public in the EU through an Approved Publication Arrangement (APA) as required under the post-trade transparency rules of MiFIR. As a corollary, transactions in in-scope financial instruments conducted on third-country trading venues not on this list will need to be made post-trade transparent (i.e., T+0 reported) from 3 October 2020.

This effectively overrides the prior position taken by ESMA in its 5 December 2017 Opinion with the same title (and which is no longer available on the ESMA/Europa website), being that transactions in in-scope financial instruments conducted on non-EU trading venues do not need to be made post-trade transparent while ESMA considers the matter further.

However, we understand that the FCA has reached out to industry bodies to confirm that the Opinion will not be part of its supervisory expectations for the time being. As such, the FCA will not expect UK investment firms to report transactions executed on a third-country venue through an APA from 3 October 2020 or otherwise.

Should the FCA’s position change, the FCA intends to communicate with market participants to understand the challenges of implementation prior to setting any supervisory expectations.

To this end, the new webpage clarifies that firms must submit a REP008 report through the FCA’s online regulatory reporting system, Gabriel. Firms will need to report whether they have taken disciplinary action for breaches of the Conduct Rules to which individuals were subject at the time of breach and provide further details.

Conduct Rule breaches by Senior Managers must be reported separately on FCA Connect (using Form D or Form C).

Firms will need to submit REP008 annually even if there have not been any Conduct Rule breaches resulting in disciplinary action. Failure to submit REP008 by the reporting deadline will incur a late return fee of £250.

FCA guidance on positive and negative indicators for staff training and fitness and propriety assessments

On 14 August 2020, the FCA updated its webpage for FCA firms to provide information on positive and negative indicators (i.e., good and bad practice) relating to training staff on the SMCR Conduct Rules and carrying out fitness and propriety (F&S) assessments.

With regard to training staff on the Conduct Rules, the FCA expects firms to, among other things, demonstrate appropriate involvement/oversight of training and provide interactive training using realistic scenarios. Training should further be reinforced regularly and built into onboarding, and the effectiveness of the training should be assessed.

Firms must also demonstrate that they are making regular, thorough, and consistent assessments of the fitness and propriety of senior managers and certification staff. The FCA expects that senior management functions actively oversee the F&S assessment process and ensure appropriate reporting, development plans are put in place as a result of the assessments, and regulatory references disclose misconduct/relevant concerns and are produced in a timely manner.

The FCA has noted that small firms may need to interpret some of the F&S assessment indicators in a proportionate way but should still give thought to the intention of the indicators. The interpretation taken should not reduce the effectiveness of firms’ F&S assessments or the Certification Regime.

Investment managers that trade within the scope of the SSR should monitor whether the threshold will revert to 0.2% on 17 September 2020 or whether ESMA will extend it again.

Among other things, the draft joint Guidelines

• clarify that the knowledge, experience, and skill requirements are important aspects in the fit and proper assessment of members of the management body and key function holders as they contribute to identifying, managing, and mitigating money laundering and financing of terrorism risks
• clarify that being a member of affiliated companies or affiliated entities does not in itself represent an obstacle for a member of the management body to acting with independence of mind
• specify that a gender-balanced composition of the management body is of particular importance
• provide further guidance on the recovery and resolution framework introduced by the Bank Recovery and Resolution Directive

As the Guidelines have yet to be finalised and will not take effect until after the Brexit transition period, the Guidelines will not apply directly to UK firms. The FCA may, however, reflect the same principles for the purpose of the fitness and proprietary assessments under the SMCR.

The new fallbacks are based on adjusted versions of the risk-free rates identified as alternatives to LIBOR and other IBORs in the relevant jurisdictions. ISDA has noted their critical importance to ensure that derivatives contracts continue to reference clear, transparent, and consistent rates if the IBOR they currently reference is discontinued or, in the case of LIBOR, becomes nonrepresentative.

From the statement, ISDA intends to soon publish a protocol (the IBOR Fallback Protocol) to facilitate inclusion of the new fallbacks in existing noncleared IBOR derivatives transactions between counterparties that both adhere to the protocol. The IBOR Fallback Protocol will be voluntary and will amend contracts only between two adhering parties. Market participants adhering to the protocol will agree that their legacy derivatives contracts with other adherents will include the amended floating rate option for the relevant IBOR and will therefore include the fallback.

FCA speech on critical tasks

On 3 August 2020, the FCA published a speech given on 14 July 2020 by the FCA Director of Markets and Wholesale Policy, Edwin Schooling Latter, on critical tasks in the second half of 2020 in relation to the transition away from LIBOR.

Latter noted that while LIBOR will continue to be published until the end of 2021, the four to six months ahead are arguably the most critical period in the transition away from LIBOR. The need to act on LIBOR transition has not been pushed back by the impact of COVID-19.

The speech reminds firms that want to adhere to the ISDA IBOR Fallback to ensure to sign the protocol within the four-month adherence period that ISDA will offer after the protocol is published. Latter explained why it is important for firms to sign the protocol, crucially noting that firms that do not sign risk being left with unworkable uncleared derivatives contracts.

However, Latter also noted that ISDA’s protocol is necessary but not sufficient. The FCA will expect firms to show that they have robust fallback documentation in place before LIBOR ceases or becomes unrepresentative.

The FCA also expects firms to have completed transition for all new business and have plans that make use of opportunities to reduce legacy LIBOR books before LIBOR terminates.

The European Supervisory Authorities (ESAs) recently issued a communication to the European Commission regarding their inability to agree on a revised PRIIPs draft RTS. For further information on the PRIIPs regime and on the ESAs’ review of the European Commission’s PRIIPs proposal, please refer to our Update of August 2020 and our Update EU PRIIPs Regulation — Impact on EU and Non-EU Fund Managers.

In its letter, EFAMA agreed with the ESAs that fundamental issues remaining with the PRIIPs Key Information Document (KID), cannot be solved through technical changes at Level 2 alone. EFAMA has therefore requested an immediate Level 1 review, as legally required by the PRIIPs Regulation.

EFAMA has also requested an extension for UCITS to have to start producing a KID (currently from 1 January 2022) until after any issues with the PRIIPs regime have been resolved.

The RTS on settlement discipline cover measures to prevent and address settlement fails including

• rules for the trade allocation and confirmation process
• cash penalties on failed transactions
• mandatory buy-ins
• monitoring and reporting of settlement fails

On 28 August 2020, ESMA published a final report on draft RTS definitively postponing the date of entry into force of the RTS on settlement discipline until 1 February 2022. (The European Commission had already delayed the RTS on settlement discipline to 1 February 2021).

Abdel-Malek had been convicted and sentenced to three years’ imprisonment in June 2019 after passing inside information to a friend with regard to a series of deals involving companies working with her employer. The amount under the confiscation order corresponds to the value the FCA ordered the former employee to turn over under the Proceeds of Crime Act 2002, having determined such amount to have been made by the former employee from bets placed by her day trader friend on the tips passed to him.

For further information on the conviction in the Southwark Crown Court case of R v. Fabiana Abdel-Malek, brought by the FCA, please refer to the FCA statement of 27 June 2019.