UK/EU Investment Management Update (January 2021)

The UK Parliament ratified the TCA on 30 December 2020 by passing the European Union (Future Relationship) Act 2020, which came into effect on 31 December 2020.

On 30 December 2020, the Council of the European Union adopted a decision authorising the signature of the Agreement and its provisional application for a limited period between 1 January 2021 and 28 February 2021, pending ratification of the Agreement by the European Parliament (the Provisional Period). The Provisional Period may be extended by mutual agreement between the EU and the UK.

The TCA is very limited in respect of its treatment of financial services. Importantly, it does not provide for cooperation or access by UK financial services firms into the EU (and vice versa). Additionally, no further transition period for financial services (until equivalence is granted by either side) has been announced. UK firms should therefore be aware that other than the time-limited equivalence already granted by the EU to UK central counterparty clearinghouses (CCPs) and securities settlement, they have lost the ability from 11 p.m. UK time on 31 December 2020 to carry on MiFID and other financial services in the EU. In this regard, UK firms will be subject to local financial services regimes and/or exemptions (if any) at member state level.

The declarations accompanying the TCA include a Joint Declaration on Financial Services Cooperation. This states that the UK and EU will, by March 2021, agree on a Memorandum of Understanding establishing a framework for financial services cooperation. It specifies that discussions will include “how to move forward on both sides with equivalence determinations […] without prejudice to the unilateral and autonomous decision-making process of each side.”

A summary and the full text of the TCA, alongside the declarations, are available on the UK government website.

FCA modifies the UK’s DTO to avoid post-Brexit conflict

On 31 December 2020, the FCA published a statement on the use of its temporary transitional power (TTP; see further below) to modify the UK’s derivatives trading obligation (UK DTO) to avoid conflicts between UK firms subject to the UK DTO and EU firms subject to the EU DTO. However, where UK firms trade with UK clients or non-EU clients, the UK DTO will still apply.

Where firms (including UK branches of EU firms) that are subject to the UK DTO trade with, or on behalf of, EU clients that are subject to the EU DTO, they will be able to transact or execute those trades on EU venues provided that:

• firms take reasonable steps to be satisfied the client does not have arrangements in place to execute the trade on a trading venue to which both the UK and EU have granted equivalence; and
• the relevant EU venue has the necessary regulatory status to do business in the UK (i.e., it is a Recognised Overseas Investment Exchange (ROIE), a venue that has been granted the relevant temporary permission, or a venue that benefits from the Overseas Person Exclusion).

The FCA indicates that it will consider by 31 March 2021 whether market or regulatory developments warrant a review of its approach.

FCA publishes list of third-country markets considered as equivalent to UK regulated markets under UK EMIR

On 17 December 2020, the FCA published a list of third country markets that have been assessed as equivalent to UK regulated markets under article 2a of the UK’s onshored version of the European Market Infrastructure Regulation (UK EMIR). UK firms may continue to treat derivatives traded on third-country markets (including EU markets) in the FCA’s list as exchange-traded derivatives, rather than OTC derivatives.

The distinction between exchange traded derivatives and OTC derivatives under EMIR is relevant for the purposes of determining (i) whether small financial counterparties have breached the clearing threshold to become financial counterparties (FCs) or (ii) whether non-financial counterparties (NFCs) have breached the clearing threshold to become NFC+s. .

The FCA’s list includes EU markets such as Euronext Brussels, Nasdaq Copenhagen, and the Frankfurter Wertpapierbörse. It also includes major non-UK and non-EU markets (in general, mirroring ESMA’s comparable list relating to EU EMIR in this regard).

Notably, the European Commission has not yet made comparable equivalence decisions in respect of UK markets under EU EMIR. As such, no UK market features in the above-mentioned ESMA list, and UK markets are not considered equivalent to EU-regulated markets for the purposes of EU EMIR.

ESMA updates its EMIR Q&A: UK-traded derivative contracts will be deemed OTC for purposes of EMIR NFC clearing threshold

As noted, the European Commission has not yet made equivalence decisions in respect of UK markets under EU EMIR for the purposes of determining whether derivatives traded on UK markets are treated as exchange traded derivatives rather than OTC derivatives for the purposes of the EMIR clearing threshold.

However, on 21 December 2020, ESMA updated its Q&A document on EU EMIR to confirm that until such equivalence decision is made in favour of UK markets, such derivatives contracts are considered to be OTC derivative contracts under Article 2(7) of EU EMIR.

The Q&A also confirms that outstanding derivative contracts, the execution of which took place in a UK regulated market that was not yet a third-country market at the time of execution, do not fall in the definition of OTC derivatives under EU EMIR.

FCA Multilateral Memorandum of Understanding with EU/EEA NCAs covering delegation arrangements

On 4 January 2021, the FCA updated its website to remind firms that the multilateral memorandum of understanding (MMoU) that it had previously agreed with EU/EEA national competent authorities (NCAs) on 1 February 2019, covering consultation, cooperation, and exchange of information, has now come into effect following the end of the transition period.

Importantly, the MMoU means that a cooperation agreement is in place between the FCA and each of the EU/EEA NCAs for the purposes of the delegation provisions in AIFMD and the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive. This means that delegation arrangements from EU AIFMs/UCITS Management Companies to UK firms can continue following the end of the transition period.

The MMoU sets out the basis on which the FCA will cooperate with EU/EEA NCAs and, in relation to delegation, provides that the FCA and the EU/EEA NCAs may request assistance from each other in undertaking their supervisory tasks in relation to delegate firms, receive information on the supervisory regime of delegate firms’ home jurisdiction, and ensure that delegates are effectively supervised.

The FCA website also refers to other memoranda of understanding entered into by the FCA including with ESMA covering supervision of credit rating agencies and trade repositories, and with the European Insurance and Occupational Pensions Authority (EIOPA), the Prudential Regulation Authority, and EU insurance supervisors covering supervisory cooperation and exchange of information.

FCA publishes its temporary transitional power directions

On 22 December 2020, the FCA published its temporary transitional power (TTP) directions setting out how and where the TTP applies to legislation and the FCA rules. The TTP applies transitional provisions to financial services legislation for a temporary period from 1 January 2021. Under the TTP, firms are generally not required to comply in full with regulatory changes brought about by Brexit immediately after the transition period’s expiry. The TTP will apply on a broad basis until 31 March 2022, but there are some areas where the TTP will not apply.

In particular, the TTP does not apply to MiFID II transaction reporting requirements, EMIR reporting obligations, or Securities Financing Transaction Regulation (SFTR) reporting obligations. In such areas, firms are generally expected to comply with new requirements immediately from 1 January 2021. The FCA has published a webpage, “Key requirements of firms,” that sets out the key areas in which the TTP does not apply.

Notably, the FCA publication emphasises that it intends to act proportionately to the scale, complexity, and magnitude of some of regulatory changes not covered by the TTP. Accordingly, it does not intend to take enforcement action against firms for not meeting all new requirements immediately, where there is evidence that such firms had taken reasonable steps to prepare to meet the new obligations by 31 December 2020.

We have set out below further detail on certain aspects of the FCA’s Supervisory Statement, but firms may wish to familiarise themselves with further aspects of it, as it is broad in scope and may contain additional information relevant to particular firms.

• Financial Instruments Reference Database (FCA FIRDS). FCA FIRDS identifies which financial instruments are traded on trading venues and are inside the scope of the trade reporting obligation. FCA FIRDS replaces the ESMA FIRDS system for UK firms. FCA FIRDS became available on 4 January 2021.
• Financial Instruments Transparency System (FCA FITRS). FCA FITRS replaces ESMA FITRS and contains reference and quantitative transparency data. FCA FITRS also performs the transparency calculations and publishes the results. Calculations published through FCA FITRS are used by trading venues to determine liquidity classification, transparency thresholds, and tick sizes of financial instruments. On 2 January 2021, FCA FITRS carried over and published all calculations from ESMA FITRS for equities, bonds, and derivatives traded on a UK trading venue.
• Trade reporting. From 1 January 2021, the FCA does not require UK investment firms to publish details through a UK approved publication arrangement (APA) of transactions on trading venues outside the UK. In addition, until April 2022, UK investment firms will not be required to make public OTC transactions concluded with non-SI EU investment firms where the UK investment firm is the seller.
• Submission of transparency data. APAs and trading venues will only need to report data to the FCA for instruments that are traded on a trading venue in the UK, but the submission of transparency data will otherwise remain unchanged.
• DVC. The DVC operates by the monthly (or twice-monthly) publication of information on the level of dark trading in individual equities. It lists the equities subject to suspensions under the DVC that cannot be traded under the reference price and negotiated trade waivers from pre-trade transparency. Waiver suspensions under the DVC in force at the end of the transition period will continue to operate within the UK until the completion of the relevant six-month suspension period. The Supervisory Statement indicates that the first time after the end of the transition period that the FCA may publish details of new DVC suspensions will be in March 2021.
• Equity transparency. As noted, equity transparency calculations will be published through FCA FITRS. For new equity instruments admitted to trading, the FCA will make estimates of the calculations that will be updated using actual trading data, within six weeks of admission to trading, using information provided by trading venues. The FCA notes that trading venues should continue to provide data to its Market Data Processor, to enable the FCA to make these calculations.
• Bond transparency. ESMA’s most recent bond transparency calculations will expire on 15 February 2021; however, the FCA will not make bond transparency calculations until May 2021. As such, between 16 February and 15 May 2021, the only bonds that will be determined to be liquid in the UK will be newly issued bonds considered liquid according to their initial class of financial instruments determination.
• Derivatives and other non-equity transparency. The FCA will not undertake calculations to make new liquidity determinations or set new thresholds for derivatives and other non equity instruments in 2021 but will make assessments in line with our temporary powers. The FCA intend to discuss further with market participants its use of its temporary powers in this context.
• Transparency waivers and deferrals. The way in which trading venues apply for the use of waivers and deferrals will not change after the end of the transition period. 
• Commodity position limits. The FCA confirms that it does not intend to take supervisory or enforcement action from 1 January 2021 for breaches of commodity position limits where the breach arises from a position held by a liquidity provider. The FCA reiterates that commodity derivative contracts traded on trading venues outside the UK should not be considered as economically equivalent OTC contracts and so will not count towards the UK position limit regime.

EU MiFID II “Quick Fixes”

On 16 December 2020, the Council of the EU announced that the compromise text on amendments to EU MiFID II as part of the EU’s Capital Markets Recovery Package (CMRP) had been provisionally agreed with the European Parliament. The compromise text includes a number of “quick fixes” to EU MiFID II.

For investment managers, the quick fixes that are likely to be of most relevance are as follows:

• an exemption from research unbundling provisions for research relating to small and mid-cap issuers (meaning issuers not exceeding a market capitalisation of EUR 1 billion during the 36 months preceding the provision of that research);
• exemptions from certain information to client requirements for professional investors, and a professional investor opt-in for other such requirements;
• a “review clause” requiring the European Commission to assess and, where necessary, submit legislative proposals on various aspects of the MiFID II regime by 31 July 2021;

The quick fixes will apply only to EU firms; the UK FCA has not announced any formal discussion or consultation paper regarding similar changes to the UK MiFID II regime.

Should the European Parliament adopt the compromise text at first reading, formal adoption of the amendments to EU MiFID II is expected in February 2021.

The letter from the Permanent Representatives Committee (COREPER) to the European Parliament confirming the Council’s agreement to the compromise text also highlights the Council’s agreement to the proposed changes under the CMRP to the Prospectus Regulation and Securitisation Regulation. These changes, alongside the amendments to EU MiFID II outlined above, are designed to provide immediate support for the economic recovery from the COVID-19 pandemic by facilitating access to finance for EU companies, with a particular emphasis on small and medium sized enterprises.

From 1 January to 1 February 2021, the notification threshold for issued share capital of a company that has shares admitted to trading on a UK trading venue will be 0.2%. However, during this period position holders are able to make notifications to the FCA at the lower 0.1% threshold if they wish to do so.

See below regarding the EU SSR net short position reporting threshold.

EU SSR – ESMA further renews its decision to reduce the EU net short position reporting threshold to 0.1%

On 17 December 2020, ESMA announced the renewal of its 16 March 2020 decision to temporarily reduce the net short position reporting threshold under the EU SSR for shares traded on an EU regulated market from 0.2% to 0.1%. The extension applies for a period of three months from 19 December 2020. Accordingly, the lower 0.1% threshold continues to apply until 19 March 2021.

The lower threshold could continue to apply beyond 19 March 2021 if ESMA further extends it.

For further information on ESMA’s decision to reduce the net short reporting threshold, please refer to our Update European Union Net Short Position Reporting Threshold Reduced to 0.1% (Updated 17 December 2020).

The consultation is open to responses, including on the proposed template and guidance, until 5 February 2021. The IFPR is due to be introduced on 1 January 2022.

UK-authorised MiFID firms should take note, as the FCA emphasises that the IFPR will represent a “major change” for in-scope firms. It views their adequate preparation for the IFPR as “critical.”

During November and December 2020, many UK MiFID firms received an IFPR Survey from the FCA requesting data on the various K-factors set out under the IFPR to assist the FCA in its cost-benefit analysis for the implementation of the IFPR.

The IFPR will expand the focus of prudential requirements and expectations from risks faced by a firm, to include harms posed by that firm to consumers and markets.

This consultation is the first in a programme of consultation papers and policy statements that the FCA plans to issue to introduce the IFPR on 1 January 2022, subject to progress and amendments to the Financial Services Bill (FS Bill).

The present consultation sets out specific proposals for changes to the existing prudential regime in respect of the following:

• Categorisation of firms. The consultation proposes a new categorisation of in-scope firms as either “small and non-interconnected” (SNI) or otherwise. Prudential requirements would be scaled to the size and complexity of a particular firm.
• Prudential consolidation for in-scope investment firm groups. The consultation proposes new instructions for how requirements should be calculated on a consolidated basis and a group capital test for investment firm groups not wishing to be subject to prudential consolidation.
• Own funds eligibility. The consultation proposes that own funds of in-scope firms should be made up solely of common equity tier 1 capital, additional tier 1 capital, and tier 2 capital.
• Own funds requirements. The consultation proposes a new permanent minimum requirement based on the activities an in-scope firm undertakes and an increased initial capital requirement for FCA authorisation. It also proposes a new K-factor approach to calculating capital requirements and details proposed methodologies for certain K-factors.
• Concentration risk. The consultation proposes new concentration risk monitoring requirements for all in-scope firms and rules on maximum concentration risk levels permitted for trading book exposures.
• Data collection and related reporting requirements.
• Currency. All fixed amounts in the above changes use the absolute amounts in the EU IFR (defined below) but in Sterling.

EU Investment Firms Regulation and Directive

On 16 December 2020, the European Banking Authority (EBA) published its final draft regulatory technical standards (RTS) on the prudential treatment of investment firms in anticipation of the EU Investment Firms Regulation (IFR) and Investment Firms Directive (IFD) implementation on 26 June 2021. The RTS will apply from 26 June 2021.

The RTS are part of the EBA’s phase 1 mandate under its roadmap for the implementation of the new prudential regime under the IFR and IFD. For more information on the EBA’s roadmap, please refer to our July Update. For more information on the IFR and IFD themselves, please refer to our Update New EU Investment Firm Prudential (Capital and Remuneration) Regime – Analysis of Final Text.

Significantly, the EBA’s final draft RTS have replaced the term “financial entity” in its original proposal with the term “financial sector entity”, a term defined in the EU Capital Requirements Regulation (CRR) to include a “third country undertaking” with a main business comparable to the any of the other in-scope financial entities. See further below for the implications of this new approach.

The RTS are designed to ensure a proportionate, non-disruptive, and harmonised implementation of the new prudential treatment of investment firms, taking into account their different activities, sizes, and degrees of complexity. In particular, they set out the key aspects of the new regime in relation to the:

• calculation of regulatory capital requirements;
• methodologies to be applied by all types of investment firms;
• criteria for the identification of investment firms that will be required (on the basis of their systemic importance) to apply the CRR banking rules after the entry into force of the IFR and IFD; and
• information required for the credit institution authorisation of large investment firms trading on own account or underwriting on a firm committed basis.

As noted above, the EBA has replaced the term “financial entity” (as used in its original proposal) with “financial sector entity”, which is defined to include a “third country undertaking” with a main business comparable to the any of the other in-scope financial entities. This is especially important for non-EU investment firms with EU investment firm delegates, as the term “financial sector entity” will be used in respect of delegation arrangements for K Assets Under Management (K-AUM) calculations. With this amendment, which would appear to include comparable non-EU entities, it seems that an EU investment firm that is a delegate of a non-EU “financial sector entity” could take the position that its AUM for IFR and IFD purposes is zero.

At present, it is unclear whether the FCA will take the same approach under the UK IFPR. If it does, such a change might result in a UK MiFID sub-advisor to a U.S. manager (or other non-UK manager) being able to take the view that its AUM for IFPR purposes is zero. The FCA has announced that it intends to detail its proposals for K-AUM calculations in its next IFPR consultation paper.

Note that in any event, even if a firm could consider that its AUM is zero where it is a delegate of a “financial sector entity”, the UK IFPR and EU IFR both require that AUM from “non discretionary arrangements constituting investment advice of an ongoing nature” be included. The interplay between a firm that carries on both portfolio management and non discretionary investment advice is not entirely clear at this point.

In assessing leverage-related systemic risk, under ESMA’s guidance NCAs are to follow a two-step approach that follows the IOSCO Recommendations for a Framework Assessing Leverage in Investment Funds:

• first, identifying AIFs that are more likely to pose risks to the financial system based on their level, sources, and usages of leverage, and, where appropriate, their AUM; and
• second, evaluating the AIFs identified at step one in terms of the potential leverage-related systemic risk they pose, including in relation to market impact, fire sales, direct spillover to financial institutions, and interruption in direct credit intermediation

The guidance also sets out guidelines for NCAs on leverage limits. These specify that when deciding whether to impose leverage limits on an AIF manager (AIFM), NCAs should consider the risks posed by the managed AIFs according to their type and risk profile and by common exposures within that type/risk profile. Where such common exposures exist, leverage limits should be imposed in a similar or identical manner across all AIFs within that type/risk profile. Prescriptive requirements relating to the timing, phasing in and out, and level of leverage limits are also set out.

ESMA’s final guidance will now be translated into the official languages of the EU. Following publication of those translations, NCAs will have a two-month period during which they must inform ESMA of their compliance or intention to comply with the guidance. The guidance will become applicable on the expiry of that two-month period. Note that ESMA’s guidance will not become applicable at this point in relation to the UK.

Any future changes to the Overseas Framework will likely be of interest to investment managers in the EU, U.S. and Asia. Given HM Treasury’s stated desire to attract liquidity and activity to the UK, such firms may be able to take advantage of a more permissive cross-border access to the UK market.

HM Treasury notes that the Overseas Framework currently consists of a number of related but distinct regimes and that there is scope to improve consistency and navigability between them. HM Treasury seeks views, in particular, on:

• the overseas persons exclusion;
• investment services equivalence under Title VIII of the UK version of the Markets in Financial Instruments Regulation (UK MiFIR), which has considerable overlap with the activities covered by the Overseas Persons Exclusion;
• Recognised Overseas Investment Exchanges (ROIEs); and
• the UK financial promotions regime in general, and specifically in relation to the distribution of certain overseas long-term insurance products in the UK.

HM Treasury notes, in particular, that it is keen to receive feedback on how an equivalence determination under Title VIII of UK MiFIR may affect market participants’ decisions to undertake regulated activities in the UK.

The Call for Evidence is open to responses until 11 March 2021.

The total for 2019 was significantly higher than the total for 2018 (c. €10 million); however, as ESMA noted, owing to the “intrinsic difficulty” for NCAs to demonstrate market abuse and the extensive investigations often involved in suspected market abuse cases, many NCAs did not impose financial sanctions in 2019. Accordingly, it is not possible to extract clear conclusions from the 2019 data. In addition, as previously noted in ESMA’s MAR Review Final Report (please refer to our October Update), as it can take more than four years to complete investigations into market abuse, some parallel sanctions under the previous Market Abuse Directive were still being issued in 2019.

Of the 2019 total, approximately €82 million in financial penalties were levied for administrative sanctions, while €6 million was imposed in relation to criminal infringements of MAR.

For the final time, the report also includes information in relation to MAR administrative and criminal sanctions and measures in UK, albeit the UK did not impose any financial penalties for administrative or criminal sanctions under MAR in 2019.

Market Manipulation: FCA publishes final notice for Corrado Abbattista

On 15 December 2020, the FCA published a final notice imposing a £100,000 financial penalty on Corrado Abbattista, a former portfolio manager, partner, and chief investment officer of a UK asset manager for market manipulation. The final notice follows a decision notice the FCA published in September 2020.

The FCA found that the individual had created a false and misleading impression as to the supply and demand for equities between 20 January and 15 May 2017. For further information on the FCA’s findings, please refer to our October Update.

The FCA emphasised that it considers the fine and prohibition to reflect the serious nature of the breach. It further noted that they should act as a deterrent to other market participants.

Insider Dealing: UK Court of Appeal upholds the conviction of Fabiana Abdel-Malek and Walid Choucair

On 16 December 2020, the FCA reported that the UK Court of Appeal had upheld the convictions of Fabiana Abdel-Malek and Walid Choucair for insider dealing.

Following an FCA investigation, each individual was convicted of five offences of insider dealing at Southwark Crown Court in June 2019 and sentenced to three years’ imprisonment.

On appeal against their convictions, the Court of Appeal found there had been no irregularity or unfairness in the FCA’s disclosures before, during, and after trial, as had been alleged. For further information on the conviction in the case of R v Fabiana Abdel-Malek, and subsequent FCA confiscation order against Abdel-Malek, please refer to our September Update.

ESMA issues its 2020 annual report on accepted market practices under MAR

On December 22, 2020, ESMA published its annual report on the application of accepted market practices (AMPs) in accordance with MAR.

ESMA concluded that the importance of AMPs remains limited, with the exception of AMPs in France and Spain. ESMA reported a slight increase under the French MAR AMP, and a slight decrease under the Spanish MAR AMP, in terms of volume, as compared with last year’s figures.

ESMA further noted that MAR requires NCAs to revise their existing AMPs every two years. It therefore expects the French and Spanish NCAs to revise their AMPs in the course of 2021.

The Commission’s action plan pursues four main goals:

• developing secondary markets for distressed assets, allowing banks to move NPLs off their balance sheets;
• reforming EU corporate insolvency and debt recovery legislation with a view to convergence among EU member states;
• supporting the establishment and cooperation of national asset management companies at the EU level; and
• encouraging implementation of precautionary public support measures where needed.

The Commission identifies that key to the first and second goals will be to quickly reach an agreement on the Commission’s proposal for a directive on credit servicers, credit purchasers, and the recovery of collateral adopted in March 2018. The European Parliament’s position on the proposed directive is expected to be voted upon in early 2021.

The Commission also proposed targeted improvements to the EU securitisation framework for banks’ non-performing exposures in relation to which COREPER has confirmed the Council’s agreement to as part of the changes introduced under the CMRP (discussed above).

Firms should note that any adoption of the measures outlined in the European Commission’s action plan would not apply within the UK, although they will have an indirect impact on UK firms that trade in EU NPLs on the secondary market.