UK/EU Investment Management Update (July 2020)

30 June 2020 passed without the assessments having been made. The UK stated that it had been prepared to confirm a positive assessment, but the EU said the UK had not responded fully to the questionnaires it had sent to the UK, covering 28 areas where equivalence assessments are possible. In addition, in a speech on 30 June 2020, EU chief negotiator Michel Barnier said, 

“I will be blunt: [the UK’s] proposals are unacceptable.”

Given that the end-June 2020 date was aspirational, it is still possible for an equivalence assessment to be made and a decision adopted to grant such equivalence before the end of the Brexit transitional period (31 December 2020). However, it will clearly be more challenging to do so, given the limited time to carry out the assessment and for the necessary legislative steps to be taken.

Investment managers that were relying on equivalence (in particular under the Markets in Financial Instruments Directive (MiFID), as equivalence is not a concept provided for in the AIFMD) may wish, if they have not already done so, to activate any contingency plans needed to address the increasingly likely prospect of a “no-deal” Brexit.

Note that even in the event of a no-deal Brexit, some EU member states may individually pass laws to continue to allow UK firms to carry on investment services in those member states for a further period. However, there can be no guarantee that such local laws will be adopted.

No extension to Brexit transitional period

The UK/EU Withdrawal Agreement provides that any extension to the Brexit transitional period beyond 31 December 2020 must be made “before 1 July 2020.”

Given no such extension was requested or given, the Brexit transitional period will end on 31 December 2020.

The UK’s approach to financial services regulation post-Brexit

On 23 June 2020, HM Treasury published details of the UK’s intended approach regarding a range of important regulatory reforms in financial services in the process of being implemented at the international and European level.

The written statement of the UK Chancellor of the Exchequer, Rishi Sunak, sets out the UK government’s approach to implementing particular financial services regulatory reforms before the end of the Brexit transition period. The following points are worth noting for investment management firms:

• CSDR: The UK will not be implementing the EU’s new settlement discipline regime, set out in the Central Securities Depositories Regulation, which is due to apply in February 2021. UK firms should instead continue to apply the existing industry-led framework. 
• SFTR: The UK will not be incorporating the reporting obligation of the Securities Financing Transactions Regulation for nonfinancial counterparties into UK law. This obligation is due to apply in the EU from January 2021, as mentioned in our Update EU SFTR Reporting for Investment Managers — Top Five Things to Know. 
• EMIR REFIT: HM Treasury will publish legislation to complete the implementation of the European Market Infrastructure Regulation (EMIR) REFIT  to improve trade repository data and ensure that smaller firms are able to access clearing on fair and reasonable terms. Please see our Update EMIR REFIT: Impact on Asset Managers for general information on EMIR REFIT.
• MAR: HM Treasury intends to make amendments relating to the Market Abuse Regulation (MAR) to confirm and clarify that issuers, as well as those acting on their behalf, must maintain their own insider lists and to change the timeline issuers have to comply with when disclosing certain transaction undertaken by their senior managers.
• PRIIPs: HM Treasury plans to publish legislation to improve the functioning of the UK’s packaged retail and insurance-based investment products (PRIIPS) regime and to address potential risks of consumer harm. HM Treasury will publish more information in July 2020.

Similar approaches are also being taken to the Benchmarks Regulation and Solvency II.

Investment managers should further note the inclusion in the published details of a policy statement issued by HM Treasury on prudential standards in the Financial Services Bill 2019-2021 and the related statement on the Financial Conduct Authority’s (FCA) published discussion paper regarding the implementation of the new prudential regime for UK MiFID investment firms (see below).

The deadline for responses to the questions posed in the discussion paper is 25 September 2020. After the FCA considers the responses, it will publish a consultation paper, which will include proposed rules for the IFPR.

EU IFD/IFR – EBA roadmap and public consultation

On 4 June 2020, the European Banking Authority (EBA) published its roadmap for the implementation of the new EU regulatory framework for investment firms, comprising the IFD and IFR referred to above. Alongside the roadmap, the EBA launched a public consultation on its first set of regulatory deliverables on prudential, reporting, disclosure, and remuneration requirements. 

The roadmap outlines the EBA’s work plan and timeline for each of the mandates laid down in the IFR/IFD and sets out the key principles that the EBA will rely on during the development of the new framework. 

The public consultation launched by the EBA simultaneously with the roadmap consists of four consultation papers on draft regulatory technical standards (RTS) and implementing technical standards (ITS) that the IFD/IFR have mandated:

• Draft RTS on prudential requirements for investment firms
• Draft ITS on reporting and disclosures for investment firms
• Draft RTS on instruments for investment firms remuneration
• Draft RTS on pay out in instruments for variable remuneration under IFD

As noted, the UK is consulting on its own new investment firm prudential regime, albeit based on the IFD/IFR. It is therefore unclear the extent to which the EBA RTS and ITS will be reflected in the UK regime, but it is likely that the overall tenor of the rules will be similar to that under the IFD/IFR.

The consultation period for the EBA consultation papers is open until 4 September 2020.

To ensure that SM&CR deadlines remain consistent and to provide additional time for firms that need it, the FCA also intends to consult on extending the deadline for the following requirements from 9 December 2020 to 31 March 2021:

• the date the Conduct Rules come into force
• the deadline for submission of information about Directory Persons to the Register
• references in the FCA rules to the deadline for assessing Certified Persons as fit and proper (agreed by the UK Treasury) 

Conduct, culture, and COVID-19 — FCA insight

On 10 June 2020, the FCA published an article on conduct, culture, and COVID-19, centering on the challenges and opportunities posed by the transformed work life (referred to as the “new normal”) for corporate culture and conduct. The article provides insights on individual behaviour, culture, managing people working from home, and suggested approaches that all firms should consider.    

The article highlights the increased risk of misconduct carried by the combination of psychological stresses and financial pressures experienced by individuals (to differing degrees) during the pandemic. Focussing on creating a healthy workplace culture, which mandates a consideration of what culture means for firms and their employees in a dispersed environment, as well as driving the right behaviours are noted as fundamental to reducing such risk. 

According to the final notice issued to Redcentric, the FCA found that Redcentric committed market abuse by publishing false information about its net debt and holdings of cash and cash equivalents in unaudited interim results and audited final year results, materially misstating the company’s debt position and overstating its true asset position in circumstances where it knew or could reasonably have been expected to know that the information was false or misleading. When the company revealed its true position in November 2016, many investors who had purchased shares in the preceding 12 months suffered immediate loss, with losses to shareholders estimated at £43 million. The FCA issued the censure instead of a financial penalty on account of Redcentric’s agreement to compensate affected investors who purchased shares of the company during the relevant period and taking into account the risk to disruption to the company during the COVID-19 pandemic. This is the first time an Alternative Investment Market (AIM)-listed company has offered to implement its own scheme to compensate those affected by the harm it caused as a result of market abuse. 

In a separate action, the FCA has instituted criminal proceedings against three former employees of Redcentric for, amongst other things, making a false or misleading statement, contrary to section 89(1) of the Financial Services Act 2012. The findings against the firm are separate to the action being taken against the individuals, and no assumption should be made that a criminal offence has been committed. 

The public censure of Redcentric, and charges against certain individuals should serve as a reminder to all firms to ensure that any information provided to the public is accurate and has no potential to mislead as to the true position of the firm.   

FCA fines former Worldspreads CEO £658,900 for market misconduct

On 3 July 2020, the FCA published a Decision Notice in respect of Conor Foley, the former chief executive officer of Worldspreads, fining him £658,900 for market abuse and banning him from performing any roles linked to regulated activity.

Foley, the ex-CEO of WorldSpreads Limited (WSL), and its holding company WorldSpreads Group plc (WSG), was involved in drafting admission documentation ahead of WSG’s flotation on the AIM of the London Stock Exchange in August 2007.

The FCA considers that these documents contained misleading information and omitted key information that investors would have needed to make an informed decision about the company.

Foley is the third and last executive of WSL against whom the FCA has taken action following its collapse in March 2012. The FCA fined and banned WSL’s chief financial officer, Niall O’Kelly, and its financial controller, Lukhvir Thind, in April 2017 for falsifying critical financial information concerning WSL’s client liabilities and its cash position, which was passed to the company’s auditors.

Inside Information — UK FCA Primary Market Bulleting Issue No. 29

On 9 June 2020, the UK FCA published the 29th edition of the Primary Market Bulletin, in which the FCA discusses consultation feedback received on a best practice note on identifying, controlling, and disclosing inside information. The consultation was conducted in the FCA’s 25th edition of the Primary Market Bulletin in November 2019.

The best practice note sets out suggested approaches to systems and controls for handling inside information in accordance with obligations under the MAR. While the note is aimed at government departments, industry regulators, and public bodies, investment managers should familiarize themselves with the contents of the note in order to appropriately manage any receipt of government data and policies in advance of public disclosure to the market, due to the possibility of price sensitive information being contained therein.   

The consultation feedback obtained by the FCA related to the timing of market announcements, method of publication, the Freedom of Information Act, and controlling and handling inside information. Investment managers may take interest in the additional guidance provided by the FCA following the consultation feedback, which clarifies that it may be appropriate to take into account any circumstances involving issuers with financial instruments traded on other markets outside the UK, or in more than one jurisdiction involving different time zones, when planning the timing of a public announcement in order to minimise its impact. 

The FCA has further chosen not to be prescriptive about the recording of certain information, including any requirement to maintain a record of third parties to whom inside information is disclosed, due to some of the MAR’s provisions being directed at issuers and not legally binding the bodies falling within the scope of the best practice note.

The FCA’s guidance sets out the rationale for the requirement on firms to hold adequate financial resources, alongside the regulator’s expectations of practices firms should adopt within their assessments of adequate financial resources and the means by which the FCA assesses the adequacy of a firm’s financial resources. The FCA has confirmed that it does not intend to impose additional requirements on firms on account of the COVID-19 pandemic but that the current crisis underlines the need for all firms to have adequate financial resources in place and to assess how such needs may change in the future. 

The FCA’s overall expectation with respect to adequate capital resources is that firms should have an amount of capital that, at all times, is equal to or higher than its assessment of what is necessary. 

According to the statement, the government intends to legislate to amend the existing regulatory framework for benchmarks in order to ensure that, by end-2021, the FCA has the appropriate regulatory powers to manage an orderly transition from LIBOR. This would assist in particular with so-called “tough-legacy” contracts, which lack robust fallbacks and are unamendable ahead of the LIBOR discontinuation, as the FCA’s powers will enable it to direct the administrator of LIBOR to change the methodology used to compile the benchmark. 

The government intends to take the legislative changes forward in the upcoming Financial Services Bill. Following engagement with industry and global counterparts, the FCA will, where appropriate, issue a number of statements of policy relating to its approach to a range of new powers provided by the legislation before it exercises those new powers.

The guidelines replace previous guidelines issued by ESMA in 2012 on certain aspects of the compliance function requirements issued under MiFID I. The new guidelines include updates intended to foster consistent, efficient, and effective supervision of the compliance function requirements under MiFID II and greater convergence with regard to their implementation across EU member states. 

Broadly speaking, the 12 guidelines are these:

1. The compliance function shall, as part of its tasks, conduct a risk assessment to ensure that compliance risks are comprehensively monitored, and establish a risk-based monitoring programme on the basis of this assessment.
2. Where a firm is part of a group, responsibility for the compliance function rests with each firm in that group. A firm should therefore ensure that its compliance function remains responsible for monitoring its own compliance risk. This includes where a firm outsources compliance tasks to another firm within the group.
3. The mandatory compliance reports required by MiFID should cover all business units involved in the provision of investment services, activities, and ancillary services provided by a firm.
4. Firms should ensure that the compliance function fulfils its advisory and assistance responsibilities, including providing support for staff and management training; firms should promote and enhance a “compliance culture” throughout the firm and ensure that their staff are adequately trained.
5. When ensuring that appropriate human and other resources are allocated to the compliance function, firms should take into account the scale and types of investment services, activities, and ancillary services undertaken by the firm.
6. Firm’s compliance staff shall have the necessary skills, knowledge, and expertise to discharge their obligations; furthermore, the compliance function shall have the necessary authority, resources, expertise, and access to all relevant information.
7. The compliance function should perform its activities on a permanent basis and not only in specific circumstances.
8. Firms should ensure that the compliance function holds a position in their organisational structure that ensures that the compliance officer and other compliance staff act independently when performing their tasks.
9. Firms should decide which measures, including organisational measures and the level of resources, are best suited to ensuring the effectiveness of the compliance function in the firm’s particular circumstances.
10. A firm should favour an organisation where control functions are properly separated. The combination of the compliance function with other control functions may be acceptable if this does not compromise the effectiveness and independence of the compliance function.
11. Firms should ensure that all requirements applicable to the compliance function continued to be fulfilled where all or part of the compliance function is outsourced.
12. The competent authority should assess whether a firm’s compliance function is adequately resourced and organised and whether adequate reporting lines have been established.

NCAs must notify ESMA whether they comply or intend to comply with the guidelines during the two-month period following publication of the new, translated guidelines. Investment firms falling within the scope of the guidelines will, however, not need to report on their compliance with the guidelines.

The guidance has been developed on the basis of the current version of ESMA FIRDS and does not include the FIRDS currently being developed and in the testing phase by the FCA on account of Brexit (UK FIRDS). Whilst the logic underpinning transaction reporting will not change in the UK, reporting obligations will. With certain exceptions, UK trading venues will report transactions carried out on their venue by European Economic Area members. UK Finance and its members intend to review and assess any impact or updates to the guidance as required following the outcome of the Brexit negotiations.

The ESMA briefing is not subject to any “comply or explain” mechanism for NCAs and is nonbinding. Nonetheless, ESMA expects NCAs to consider the briefing when supervising cost-related issues, including in relation to the obligation of UCITS and AIFMs to prevent undue costs being charged to investors. 

The key takeaways for fund managers are as follows:

• The notion of “undue cost” should be primarily assessed against what should be considered the best interest of the fund or its unit holders. To this end, it should be ensured that
  • the costs charged to the fund or its unit holders are consistent with the investment objective of the fund and do not prevent the fund from achieving this objective, particularly — but not limited to — where these costs are paid to third parties, including depositary costs
  • the pricing process adopted by the management company allows a clear identification and quantification of all costs charged to the fund, whether those are paid to the management company or to third parties (e.g., depositary, external valuer, broker) and/or directly paid by the investors (e.g., entry and exit costs) in order to avoid hidden costs
• To allow for the appropriate supervision by NCAs regarding the charging of undue costs to investors, NCAs are expected to require that management companies develop and periodically review a structured pricing process addressing a range of elements, including whether the costs are proportionate compared to market standards and the type of service provided.
• To ensure that undue costs are not charged to investors, NCAs are expected to incorporate the review of management companies’ pricing processes in their supervisory activity at different stages. 

ESMA intends to cooperate closely with NCAs to promote the application of the briefing and to evaluate the level of convergence reached across the EU in 2021. 

Given that the UK is no longer part of the EU, the FCA would not be bound by the supervisory briefing; however, the FCA may decide to adopt the ESMA suggestions in its own way.

Many of the (proposed) new regulations apply directly to investment managers (including non-EU managers marketing financial products in the EU under a National Private Placement Regime), whereas others may apply indirectly by way of group or contractual obligations or by targeting investors or investees. Two regulations of particular mention for investment managers:

• The Sustainable Finance Disclosure Regulation (SFDR) (Regulation (EU) 2019/2088), which introduces entity and product level disclosures on financial market participants (including UCITS and AIFMs) and investment advisers regarding, amongst other things, the integration of sustainability risks, consideration of adverse sustainability effects and likely effects of sustainability risks on returns 
• The Taxonomy Regulation (Regulation (EU) 2020/852), which establishes a framework for a harmonised classification system to define environmentally sustainable economic activities and amends and supplements certain disclosure regulations under the SFDR; after experiencing initial difficulties in attaining political agreement between the European Parliament and the Council, the Taxonomy Regulation became the most recent addition to the emerging EU ESG-regulatory regime upon its adoption on 18 June 2020

For further information on the disclosure regime established by the Taxonomy Regulation and the SFDR to investment managers and status of the obligations in the UK, please refer to our Update ESG Disclosures for Asset Managers Under the EU Sustainable Finance Disclosure Regulation and Taxonomy Regulation. 

Sustainability-linked bonds — emergence of a new asset class

The sustainable finance landscape has also seen interesting developments at the product level. On 9 June 2020, the International Capital Market Association published the Sustainability-Linked Bond Principles (SLB Principles) regarding sustainability-linked bonds (SLBs), for which the financial and/or structural characteristics can vary depending on whether the issuer achieves predefined sustainability/ESG objectives. Back in September 2019, the Italian energy group Enel became the first, and to date only, issuer of SLBs. For further discussion of SLBs and whether the SLB Principles may incentivise further issuances of SLBs, please refer to our Update Sustainability-Linked Bonds — A New Feature of the Sustainable Finance Landscape.

CFRF guide on climate-related financial risk management

On 29 June 2020, the Climate Financial Risk Forum (CFRF), co-chaired by the FCA and the Prudential Regulation Authority (PRA), published its guide to climate-related financial risk management. The guide, written by industry for industry, is intended to assist firms in the management of climate-related financial risks through providing practical recommendations on climate-related financial risk disclosures, effective risk management, scenario analysis and opportunities for innovation in the interest of consumers.   

The guide contains four industry-produced chapters on disclosures, innovation, scenario analysis, and risk management in addition to a summary co-produced by the FCA and PRA. The guide complements work from both the FCA and PRA on addressing climate-related financial risk, including the FCA’s proposals to improve issuers’ climate risk disclosures through applying the recommendations of the Task Force on Climate-related Financial Disclosures. 

Key takeaways for investment managers:

• Risk management. The focus of this chapter is on the integration of climate risks in firm governance and at senior management level, alongside an overview of data and available tools, trainings, culture, and barriers and challenges to the management of climate-related risks. The ultimate goal is for firms to design and implement a governance approach for climate risks akin to established financial risks while addressing climate risk-specific nuances where necessary.
• Scenario analysis. This chapter centres on identification of firm exposure to climate-related risks and the development of suitable scenarios to manage firm exposures, alongside guidance on quantifiable risks and assessment of the financial impact of scenarios on the firm’s business. In particular, firms should measure the effect of climate-related financial risk drivers, either transition or physical or both, on their key financial metrics. 
• Disclosure. This chapter highlights that while investors will be primarily interested in product level disclosure (i.e., whether a financial product suits their financial needs as well as investment beliefs and/or values), institutional investors in particular will also look to firm-level disclosures to determine whether the firm as a whole has appropriate governance and risk management systems in place. The chapter contains an entire section (section 5) on disclosures at the firm and product level, including suggested specific metrics, by asset managers with which investment managers should familiarize themselves. Annex 1 and Appendix 1 further set out the UK legal frameworks for disclosure and UK entity-level reporting requirements, respectively, which include the EU Sustainable Finance Disclosures Regulation and Taxonomy Regulation as discussed.
• Innovation. This chapter comprises a set of recommendations for how financial institutions and regulators can start to deliver a step change in aligning private sector financial flows with climate goals and lists UK innovative initiatives, such as the Loan Market Association’s green loan principles and various initiatives on climate-related data. 

One interesting result is that the crypto futures traded on the MTF will become subject to the UK/EU MAR. That in turn raises the spectre of the market abuse regime being relevant for trading in cryptoassets, which to date have not been subject to any regulatory regime regarding insider dealing or market manipulation. 

EU plans for future regulation of cryptoassets

On 23 June 2020, EU financial services Commissioner Valdis Dombrovskis gave a speech at the Digital Finance Outreach 2020 conference, publicly remarking on the Commission’s plans for the regulation of cryptoassets in the EU. 

Dombrovskis comments provide an interesting insight as to how cryptoassets markets could be allowed to develop in the near future. As noted in previous Sidley client alerts (here, here, and here), some cryptoassets are already within the scope of the existing regulatory perimeter, but many are not. To facilitate the delivery of financial services through the use of cryptoassets and blockchain whilst maintaining market integrity and consumer protection, the Commission wants to introduce proposals to adjust pre-existing rules so they work better for cryptoassets. The Commission also plans to introduce legislation to create a bespoke regime for cryptoassets that are currently unregulated and an EU passport for markets in crypto-assets. 

Interestingly, Dombrovskis acknowledged that the level of regulation would be proportionate to the perceived level of risk associated with the relevant cryptoasset. He said this means “lighter rules for less risky projects” but that “global stablecoins” (generally perceived as shorthand for Facebook’s Libra project) should expect stronger regulation. 

Draft rules are to be published at the end of 2020 (following the conclusion of the Commission’s current consultation on cryptoassets).