UK/EU Investment Management Update (August 2020)

The Commission says in the Communication that it “will not adopt an equivalence decision in the short or medium term” (emphasis added) for certain legislation set out in footnote 21 of that Communication. Footnote 21 refers, among other things, to

Regulation (EU) No 600/2014 on markets in financial instruments (MIFIR)… Art. 47(1) — Investment firms providing investment services to EU professional clients and eligible counterparties

It is unclear what “short or medium” terms means, but the fact that the Commission says that it “will not” adopt an equivalence decision, with no suggestion, for example, that it is continuing to work with the UK towards an equivalence decision, suggests that equivalence is not going to be granted before the Brexit transition/implementation period expires on 31 December 2020.

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.

As discussed previously, a no-deal Brexit will have implications for fund marketing carried on by UK MiFID firms for U.S. managers/alternative investment fund managers (AIFMs) as well as introduce complications to the share trading obligation and derivatives trading obligation under MiFID II.

Temporary equivalence granted for UK central clearing counterparties (CCPs)

The same Communication above states that the Commission is considering a time-limited equivalence for UK central clearing counterparties (CCPs), allowing them to continue providing clearing services for EU entities when the Brexit transition period expires on 31 December 2020.

Despite widespread fears of European businesses being shut off from UK CCPs, UK CCPs would be allowed to carry on serving their EU-based clients under the proposed temporary equivalence decision for UK rules on derivatives clearing. This is particularly relevant as clearinghouses need to give three months’ notice to customers that they can no longer use their services.

The length of the equivalence recognition is not stated in the Communication, and the Commission notes that equivalence decisions can be unilaterally withdrawn at any time, in particular if third country frameworks diverge and the conditions for equivalence are no longer fulfilled.

Still no equivalence granted for UK trading venues 

Note, however, that although the above equivalence for UK CCPs is helpful for the obligation of EU firms to clear their derivative transactions on EU CCPs or “equivalent” third country (non-EU) CCPs such as those in the UK, there is still no equivalence for UK trading venues for purposes of the MiFID II derivatives trading obligation and share trading obligation.

This lack of equivalence for UK trading venues is made clear in the Commission’s Markets in Financial Instruments Stakeholder Notice, revised on 13 July 2020 (originally published on 8 February 2018). The Stakeholder Notice specifically notes the loss of authorisation for UK trading and execution venues:

[T]he Commission is empowered to declare third-country trading venues equivalent for the purposes of the EU share and derivatives trading obligations. While the assessment of the UK’s equivalence in these areas is ongoing, the assessment has not been finalised. All stakeholders thus have to be informed and ready for a scenario where shares and derivatives subject to the EU trading obligations can no longer be traded in the UK trading venues. In both cases, EU counterparts need to reassess their trading arrangements to ensure continued compliance with their obligations under the MiFID framework

Please see the sections “ISDA Brexit Cliff-Edge Paper” and “Report on MiFIR Transparency regime — share trading obligation (STO)” below for implications of the above lack of equivalence for the MiFID II derivatives trading obligation and share trading obligation, respectively.

ISDA Brexit cliff-edge paper

On 31 July 2020, the International Swaps and Derivatives Association (ISDA), the European Banking Federation (EBF), Assosim (the Italian Financial Markets Intermediaries Association), the Danish Securities Dealers Association, and the Swedish Securities Dealers Association published an update to their Brexit cliff-edge paper.

The paper sets out reasons why a “no-deal” Brexit scenario could create a disruptive “cliff-edge” change in the EU regulatory requirements that apply to over-the-counter derivatives business in a way that might adversely affect EU or UK firms and their EU and UK clients and counterparties (going beyond those effects resulting from the loss by UK and EU firms of their single-market passports).

In particular, the potential delay or refusal by the EU to grant equivalence decisions in a number of areas under the UK and EU’s regulatory and supervisory frameworks could lead to market participants’ facing huge operational challenges, and the paper urges EU national competent authorities (NCAs) to take action to mitigate these adverse effects by extending existing exemptions to UK entities, adopting equivalence decisions, and approving applications for recognition or endorsement, including granting recognition to UK CCPs (see above for temporary equivalence).

Commission Asset Management Stakeholder Notice

On 7 July 2020 the Commission published an Asset Management Stakeholder Notice (originally published on 8 February 2018).

The notice addresses the fact that UK-authorised Undertakings for the Collective Investment in Transferable Securities (UCITS) and alternative investment funds (AIFs) will no longer benefit from EU passporting post-Brexit, and their management companies (Mancos) and AIFMs, respectively, will be treated as third country (non-EU) managers. Therefore, all collective investment undertakings registered or authorised in the UK will become non-EU AIFs and will be treated accordingly in EU member states under the Alternative Investment Fund Managers Directive.

The stakeholder notice also informs participants that UCITS Mancos and AIFMs must take appropriate steps to inform investors of the consequences of the end of the Brexit transition period.

Further, the Notice states that delegation of portfolio management or risk management by an AIFM or a UCITS Manco to a UK-based provider may still be undertaken, provided a cooperation arrangement/memorandum of understanding (MoU) between the NCA of the AIFM or UCITS Manco and the FCA is in place (see below).

Memoranda of Understanding between the FCA, ESMA, and EU NCAs

On 17 July 2020, the FCA and the European Securities and Markets Authority (ESMA) published statements (FCA and ESMA statements, respectively) confirming that the FCA, ESMA, and EU national securities regulators agreed Memoranda of Understanding (MoUs) in early 2019. These MoUs, which covered cooperation and exchange of information in the event that the UK left the EU without a withdrawal agreement in March 2019, remain relevant and will come into effect at the end of the transition period on 31 December 2020.

These MoUs are important because they are needed for EU firms, such as AIFMs and UCITS Mancos, when delegating portfolio management or other services to UK firms.

Luxembourg regulator clarifies “provision of investment services in Luxembourg” for third country firms

On 1 July 2020, the Luxembourg Commission de Surveillance du Secteur Financier (CSSF) published a new Regulation and Circular (CSSF Regulation No 20-02 and CSSF Circular 20/743, respectively) aimed at clarifying the legal regime for third country firms intending to provide investment services in Luxembourg, under Article 32-1 of the 1993 Law on the Financial Sector (the LFS).

The Circular clarifies the concept of services provided “in Luxembourg” under Article 32-1 of the LFS. Investment services are deemed to be provided in Luxembourg where

• the third country firm has an establishment (for instance, a branch) in Luxembourg, the third country firm provides an investment service to a retail client established or located in Luxembourg, or
• the place where the “characteristic performance” of the service is provided, that is, the essential service for which payment is due, is Luxembourg.

The Regulation provides for a list of “equivalent third countries” pursuant to Article 32-1(1) of the LFS. This list includes Canada, Switzerland, the United States, Japan, Hong Kong, and Singapore. These jurisdictions are considered as applying LFS-equivalent supervision and authorisation, and firms in these jurisdictions are permitted to provide investment services in Luxembourg on a cross-border basis. Notably, the list does not include the UK for the time being.

Please note Sidley Austin LLP does not practice Luxembourg law; we would be happy to introduce clients to Luxembourg counsel to elaborate on the above.

To ensure that SMCR deadlines remain consistent and to provide additional time for firms that need it, the FCA also proposes delaying the deadline for training staff in the Conduct Rules and reporting Directory Person data to 31 March 2021.

Firms have until 14 August 2020 to submit comments to the FCA consultation.

New FCA webpage on communicating with firms

On 24 July 2020, the FCA published a new webpage explaining how it communicates with firms it regulates.

The FCA uses a range of different channels to communicate with firms, including sending letters to senior individuals in firms, using social media platforms, such as Twitter and LinkedIn, hosting industry roundtable events and speeches by senior FCA staff.

In addition, the FCA writes “portfolio letters” where it supervises firms that are members of a portfolio of firms that share a common business model. The webpage lists and provides links to all the portfolio letters the FCA has published to date, including the Alternative Investment Firms letter, published on 20 January 2020. Whenever the FCA sends a portfolio letter, it will add it to the webpage.

The new webpage also hosts a link to the FCA’s “Dear CEO letters” (perhaps confusingly, some of the “portfolio letters” mentioned are addressed to CEOs of firms).

FCA launches enhanced Financial Services Register

On 27 July 2020, the FCA replaced its existing Financial Services Register with a newer, enhanced Financial Services Register. The FCA announced its launch in a press release on 9 July 2020 and advised firms to update any hyperlinks they may have on their websites to the enhanced register.

In its press release, the FCA also announced that the planned launch of its new directory of certified and assessed persons, which will form a part of the enhanced register, has been delayed to later this year, to allow for the disruption of the COVID-19 pandemic and certain operational challenges. The previous deadline of 9 December 2020 for solo-regulated firms to submit information to the FCA for this directory has been extended to 31 March 2021. (See above section “Deadline extension of SMCR implementation for solo-regulated firms.”)

Update to FCA EMIR breach notification form

On 14 July 2020, the FCA published an updated version of the EMIR breach notification form. This is of relevance to UK AIFMs where their funds (wherever established) act as a counterparty to derivative transactions, as well to other UK derivative counterparties (including UK funds and UK trading vehicles used by a non-EU manager).

For UK AIFMs/UK derivative counterparties to which the European Market Infrastructure Regulation (EMIR) breach notification form is relevant, it is of note that the FCA has included a new information field for firms to identify which Senior Manager within the firm is accountable for EMIR reporting. The FCA might well take a similar approach with respect to MiFIR transaction reporting and SFTR reporting in future, requiring in-scope UK firms to identify the Senior Manager within the firm who is accountable for such reporting obligations. Accordingly, UK firms should identify which Senior Manager is responsible for EMIR, SFTR, and MiFIR transaction reporting (as relevant) if they have not already done so.

New process for cancellation of authorisation for UK FCA-regulated firms

On 20 July 2020, the HM Treasury published a Policy Statement announcing a more streamlined process for cancelling authorisation of UK financial firms that do not pay regulatory fees or file returns. This additional process would enable the FCA to more quickly remove inactive firms from the Financial Services Register, particularly where they suspect that they are no longer carrying out authorised activity.

Under this additional process, the FCA will notify firms that have failed to pay fees or file returns. In the event that a company does not reply, further notices will be sent after 28 days and authorisation cancelled after a further month. At any stage of the procedure, until cancellation, the firm in question can notify the FCA in writing that it is carrying on a regulated activity, and the FCA will then end the procedure and remove any public notice placed.

The areas to be amended, at a high-level, include the following:

Quick Fix 1

• Costs and charges disclosure. The Commission is proposing an exemption for eligible counterparties and for professional clients for services other than investment advice and portfolio management. Subject to certain conditions, in case of distance communication, all clients using all services would be able to receive costs and charges information just after the transaction. Given that this exemption carves out investment advice and portfolio management, this exemption is unlikely to be of much use to investment management firms.
• Ex-post reporting (the end-of-day loss reporting) requirement. The Commission is proposing an exemption for providing the end-of-day loss reporting to eligible counterparties and professional clients; however, professional clients can still opt in to receive such reports.
• Best execution reports. The Commission is proposing to suspend Regulatory Technical Standards (RTS) 27 best execution reports (for at least two years) to reduce the burden of producing those reports, pending a thorough analysis with regard to a possible streamlining of the reports. The Commission will assess whether the requirement to publish the report should be deleted permanently or if the reports need to be reintroduced in a revised manner. Note that there is no proposal to suspend RTS 28 reports, which would be the report made by MiFID investment managers (as opposed to RTS 27 reports, which are made by EU trading venues).
• Cost-benefit analysis. The Commission is proposing an exemption combined with a possibility to opt in for professional clients. Currently, as part of the suitability assessment, firms are required to obtain information about the client in order to perform a cost-benefit analysis in case they “switch” between products in the course of an ongoing relationship.
• Product governance. The Commission is proposing an exemption for corporate bonds with make-whole clauses.
• Own account dealing in commodity derivatives (ancillary activity exemption). The Commission is proposing to delete all quantitative elements of the MiFID II Article 2(1)(j) exemption.
• Position limits. The Commission is proposing to amend Article 57 with respect to commodity markets such that the position-limits requirements would be limited to agricultural commodity derivatives or commodity derivatives designated as significant or critical. The Commission is also proposing to exclude securitised derivatives from the position limits regime.

Quick Fix 2

• Research unbundling. The rule on research unbundling will not be required for research on small- and mid-cap issuers, and research on fixed income. Small- and mid-cap companies would be defined as companies that have a market capitalisation of up to €1 billion, calculated over a 12-month observation period. The removal of the research unbundling for fixed income will be welcome by many fixed-income managers, given that fixed income research costs have tended simply to be borne by most managers out of their own funds.

Note that the above Quick Fixes will apply only to EU firms; the UK FCA has not announced any reaction to the Commission Quick Fixes, and it is possible that the UK MiFID II regime is not fixed in the same way or at all.

ESMA Q&A on transaction reporting

On 8 July 2020, ESMA published an update to its Q&As on data reporting under the MiFIR.

The update clarifies a question raised by market participants in relation to transaction reporting under Article 26 of MiFIR and RTS 22. The result of the update is, in essence, that where firm A executes a reportable transaction through an execution algorithm provided by firm B (e.g., a broker algorithm), it should populate field 59 (execution within firm) with the person or algorithm identifier within firm A that is primarily responsible for using firm B’s algorithm. It should not populate any code with firm B’s algorithm.

ESMA report on MiFID II sanctions

On 13 July 2020, ESMA published its second report on sanctions and measures imposed under MiFID II.

The report provides an overview of the applicable legal framework and the sanctions and measures imposed by NCAs under the MiFID II framework during 2019. Fifteen European Economic Area member states applied a total of 371 sanctions during this period. These measures consisted primarily of administrative fines but also include criminal sanctions, temporary bans on holding managing positions, and written warnings.

ESMA report on MiFIR transparency regime — share trading obligation (STO)

On 16 July 2020, ESMA published its first review reports on the MiFID II/MiFIR transparency regime and proposing amendments aiming to simplify it and increase the transparency available.

The first report reviews the regime for equity instruments and proposes amendments to four provisions: (i) pretrade transparency obligations for trading venues, (ii) the systematic internaliser regime, (iii) the double volume cap mechanism, and (iv) the share trading obligation (STO).

In particular, the first report recommends amending Article 23 MiFIR to clarify that the STO applies only to shares with the main pool of liquidity in the EU based on the International Securities Identification Number (ISIN) of the share. In addition, ESMA recommends that trading on third country trading venues should be deemed in compliance with the STO when undertaken in the third country domestic currency.

Note that the UK FCA has yet to announce its position on the UK’s version of the STO after the end of the Brexit transition period.

ESMA guidance on third country trading venues and transparency under MiFID II

On 28 July 2020, ESMA published a press release announcing that it has updated information about transparency opinions for third country trading venues (TCTVs) under the MiFID II/MiFIR regime from its initial June 2020 publication.

The update contains new guidance providing additional information about trading venues with positive assessments and partially positive assessments plus an updated Annex to ESMA’s June 2020 opinion determining TCTVs for the purpose of transparency under MiFIR.

The ESMA webpage contains links to all of the transparency opinions and annexes and explains that ESMA remains open to assessing additional TCTVs.

Notably, there are no UK trading venues on the list.

Among other things, the SMSG has advised that EU securities market regulators should clarify who can impose short selling bans and exactly what the bans mean. The advice to ESMA comes after substantial debate over whether national or pan-EU authorities should be able to impose short selling bans.

See our Sidley Update EU Bans on Short Positions — Implications for Market Participants for a discussion of the short selling bans imposed by six EU member states between 17 March and 18 May 2020.

The PRIIPs Regulation sets the requirements for a standardised disclosure document, known as the Key Information Document (KID), that must be provided to retail investors when they purchase particular packaged investment products, known as PRIIPs. For more information on the PRIIPs regime, please refer to our Update EU PRIIPs Regulation — Impact on EU and Non-EU Fund Managers.

HM Treasury intends to make the following changes to the onshored PRIIPs Regulation:

• an amendment enabling the FCA to clarify the scope of the PRIIPs Regulation through its rules; this will enable the FCA to address existing, and potentially future, ambiguities in relation to certain types of investment product (the definition of a PRIIP will remain unchanged)
• an amendment to replace “performance scenario” with “appropriate information on performance” in the PRIIPs Regulation; the existing methodology for calculating performance scenarios under the PRIIPs Regulation has been criticised for producing misleading performance scenarios across a wide range of products, and HM Treasury proposes an amendment to replace the term “performance scenario” with “appropriate information on performance” in the PRIIPs Regulation, after which the FCA will be able to amend the RTS to clarify what information on performance should be provided in the KID
• an amendment enabling HM Treasury to further extend the exemption in place for UCITS funds, which are exempted from the requirements of the PRIIPs Regulation until 31 December 2021; HM Treasury proposes an amendment to further extend the exemption for UCITS for up to a maximum of five years

In the longer term, HM Treasury intends to conduct a more wholesale review of the disclosure regime for UK retail investors.

European Supervisory Authorities’ review of Commission PRIIPs proposal

On 21 July 2020, the European Supervisory Authorities (the European Banking Authority (EBA), ESMA, and the European Insurance and Occupational Pensions Authority (EIOPA) (together, the ESAs)) published the outcome of their review of the Commission’s proposal for a revised KID under the PRIIPs Regulation. The ESAs informed the Commission that they were unable to approve new standards for a revised KID for PRIIPs under the PRIIPs Regulation.

The revised document was designed to address regulatory issues in order to help retail investors better understand the risks and rewards of PRIIPs (see “UK amendments to the PRIIPs Regulation” above regarding the issue with “performance scenarios”). Members of the ESAs’ board called for a comprehensive review of the PRIIPs Regulation itself, before any amendments to its delegated acts, and for the incorporation of past performance graphs for investment fund KIDs.

The proposal, if accepted, would further delay the entry into force of the RTS on settlement discipline, which has already been postponed from 13 September 2020 to 1 February 2021 (subject to nonobjection from the European Parliament and Council until 8 August 2020).

ESMA aims to publish the final report on further postponing the date of entry into force of the RTS on settlement discipline by September 2020.

The initiative is intended to reorient investments towards sustainable projects and activities in order to meet the EU’s climate and energy targets for 2030 and reach the objectives of the European Green Deal.

This initiative, once enacted as a Commission Delegated Regulation under the recently adopted Taxonomy Regulation (Regulation (EU) 2020/852), will assist asset managers with their own sustainability and ESG disclosures, as it will make available the environmental, social, and governance (ESG) profiles of the issuers of the securities that are held by such managers’ investment funds/accounts.

The Commission is seeking views on the roadmap for the initiative until 8 September 2020.

For more information on the new EU ESG regime, please refer to our Update ESG Disclosures for Asset Managers Under the EU Sustainable Finance Disclosure Regulation and Taxonomy Regulation.