UK/EU Investment Management Update (February 2021)

1. Brexit update

Regulatory changes for firms upon end of the Brexit transition period

On 4 January 2021, the FCA issued a press release concerning the regulatory changes for firms now that the Brexit transition period has ended.

The FCA notes that passporting between the UK and European Economic Area (EEA) states has now ended and that the UK temporary permissions regime (TPR) has entered into effect for firms and funds that notified the FCA of their intention to enter the regime.

The press release also refers to the UK financial services contracts regime (FSCR), which is now in place. Under the FSCR, EEA firms that previously passported into the UK and are not part of the TPR may continue to service UK contracts entered into prior to the end of the transition period (or prior to entering the FSCR) for a limited period in order to conduct an orderly exit from the UK market.

As mentioned in our January 2021 Update, the FCA has obtained and applied its temporary transitional powers (TTP) on a broad basis to assist firms with adapting to regulatory changes brought about by Brexit. However, in its press release, the FCA reminds firms that there are some key exceptions where firms need to comply with the changed requirements now. Firms should check the implications of these for their business.

AMF senior regulator questions the need for share trading equivalence

During a virtual conference on 14 January 2021, the deputy head of the regulatory policy and international affairs directorate at the Autorité des Marchés Financiers (AMF), Natasha Cazenave, questioned the need for offering third countries an equivalence determination under EU share trading rules, after ESMA clarified the application of the rules to non-EU shares late last year.

As mentioned in our November 2020 Update, ESMA issued a public statement on 26 October 2020 clarifying the application of the EU share trading obligation (EU STO) under Article 23 of MiFIR following the end of the Brexit transition period on 31 December 2020. The statement outlines that the trading of shares with an EEA International Securities Identification Number (ISIN) on a UK trading venue in GBP by EU investment firms is not expected to be subject to the EU STO. This avoids EU investment firms’ being prevented from trading UK stocks on UK venues.

However, the UK was not provided with a positive equivalence determination for the EU STO prior to the expiry of the Brexit transition period. While EU market participants shifted trading of EU shares from London-based venues to alternative EU-based venues on 4 January 2021 (the first business/trading day of 2021), UK authorities and market participants still hope there may be a deal on equivalence between the EU and UK. The comments of the AMF senior regulator may however, cast doubt on whether such equivalence will be granted for the EU STO.

European Commission communication on fostering openness, strength, and resilience of the European economic and financial system

On 19 January, the European Commission published a communication on the European economic and financial system: fostering openness, strength, and resilience.

The Communication outlines how the EU can achieve “strategic autonomy in the macro-economic and financial fields by promoting the international role of the euro, strengthening the EU’s financial market infrastructures, improving the implementation and enforcement of EU’s sanctions’ regimes, and increasing the EU’s resilience to the effects of the unlawful extra-territorial application of unilateral sanctions and other measures by third countries.”

Though not expressly linked to Brexit, the Communication alludes to perceived risks to the EU financial markets from the UK (as well as identifying risks from other third countries). Notably, there is a clear statement that EU firms should move their euro-denominated cleared positions to EU clearinghouses. This threatens the position of LCH Limited (UK) status as the main clearer of EUR-denominated interest rate swaps, and it seems possible that the temporary UK central clearing counterparties (CCPs) equivalence decision — the only UK equivalence decision adopted so far — may not be made permanent.

The Communication also raises concerns of reliance by EU firms/markets on non-EU banks, and the European Banking Authority (EBA) is mandated to study in more detail EU dependence on non-EU financial operators and banks’ dependence on funding in foreign currencies in 2021. Further, non-EU foreign exchange swap markets (e.g. the UK) are mentioned as a source of risk to the EU.

The Communication does not have legally binding effect but is an indication that the Commission may consider legislative proposals to address these concerns.

2. ESMA statement on reverse solicitation

On 13 January 2021, ESMA issued a public statement reminding firms of the requirements under MiFID II regarding the provision of investment services to retail or professional clients by firms not established or situated in the EU.

Article 42 of MiFID II enables a non-EU firm to provide investment services or activities to a client established or situated in the EU without being subject to MiFID requirements relating to establishing a branch, where the client initiates, at its “own exclusive initiative,” the provision of such services or activities (known as “reverse solicitation”). ESMA’s statement notes that some questionable practices surrounding reverse solicitation have emerged upon the end of the Brexit transition period. This includes using online pop-up boxes or standard contractual disclaimers to prompt clients to state they initiated contact.

ESMA reminds firms that “where a third country firm solicits clients or potential clients in the Union or promotes or advertises investment services or activities together with ancillary services in the Union, it should not be deemed as a service provided at the own exclusive initiative of the client.” This is true “regardless of any contractual clause or disclaimer purporting to state, for example, that the third country firm will be deemed to respond to the exclusive initiative of the client.”

According to ESMA, press releases, online advertising, and phone calls could all constitute evidence that a UK company had solicited trade in the EU market, in breach of MiFID II, regardless of the person through whom it is issued. This would include such marketing carried out by intermediaries on behalf of investment funds or fund managers.

ESMA also highlights that firms providing investment services in the EU without proper authorisation in accordance with applicable EU and national Member State laws risk facing administrative or criminal proceedings for the application of relevant sanctions.

ESMA’s statement indicates the narrow view taken by the watchdog with respect to what marketing is allowed following the end of the Brexit transition period. UK firms in particular should take care to assess their post-Brexit business practices to ensure they are not in contravention of MiFID II.

Although ESMA’s statement is targeted at reverse solicitation in the context of post-Brexit activity by UK firms, the statement also serves to give insight into how EU regulators might approach the topic of reverse solicitation in other contexts, including the marketing of funds under the Alternative Investment Fund Managers Directive (AIFMD). Note that under the new EU Cross Border Distribution of Funds Regulation (see this Sidley Update), the European Commission is required to submit by 2 August 2021 a report to the European Parliament and to the Council of the EU on reverse solicitation in the context of fund marketing.

3. COVID-19 – FCA updates

As noted in previous Sidley Updates, the FCA is updating its COVID-19 webpages on a regular basis. Firms should monitor the Covid-19: Information for firms webpage, which sets out the FCA’s expectations for firms during the pandemic, for future changes.

FCA revises its expectations on market trading and reporting

On 8 January 2021, the FCA updated its Covid-19: Information for firms webpage with revised expectations on market trading and reporting.

At start of the pandemic, the FCA asked firms that moved to an alternative site or a working-from-home arrangement to consider the broader control environment in view of the new circumstances. The FCA now expects firms to record all relevant communications (including voice calls) when working outside the office in light of the extensive duration of alternative working arrangements in response to the pandemic. See also the “FCA Market Watch 66 newsletter” section below.

The FCA reminds firms to continue to take all steps to prevent market abuse risks and submit regulatory data without undue delay. The FCA will continue to monitor for market abuse and, if necessary, take action.

Firms should inform the FCA if they have any concerns about meeting their obligations due to COVID-19.

FCA Market Watch 66 newsletter

On 11 January 2021, the FCA published the 66th edition of its Market Watch newsletter. The newsletter follows from the update of 8 January 2021 to the market trading and reporting statement on the FCA’s Coronavirus (Covid-19): Information for firms webpage, as noted above. It sets out the FCA’s expectations for firms on recording telephone conversations and electronic communications in the context of alternative working arrangements, including increased homeworking, due to COVID-19.

Please see our Sidley Update “UK FCA Expectations on Call Recording in a Remote Working Environment — Market Watch 66” on the above Market Watch newsletter.

FCA confirms the expiry date for statement on expectations on financial crime systems and controls

On 8 January 2021, the FCA updated its Financial crime systems and control during coronavirus situation webpage, which contains a statement on the FCA’s expectations on how firms should apply their systems and controls to combat and prevent financial crime during the COVID-19 pandemic.

The FCA originally published the statement on 6 May 2020 and reminded firms of the importance to maintain effective systems and controls to prevent money laundering and terrorist financing in the current climate. Firms were asked to remain vigilant to new types of fraud and amend their control environment where necessary to respond to new threats. Among other things, the FCA’s statement set out specific expectations in relation to operational challenges and client identity verification requirements.

The updated webpage informs firms that the FCA’s statement will expire on 7 February 2021.

FCA survey on financial resilience

On 8 January 2021, the FCA released a statement announcing that it will be conducting a third survey of regulated firms to help the FCA obtain a more accurate view of firms’ financial resilience as a result of COVID-19.

The FCA launched the first phase of its COVID-19 impact survey in June 2020 and repeated the survey in September 2020. The aim of the third phase of the survey is to help the FCA understand the change in firms’ financial positions over time. It was emailed to the relevant firms on 13-19 January 2021, and its completion is mandatory.

Firms that have received the survey and have any questions with respect to it can contact the FCA’s Supervision Hub.

4. FCA authorisation – FCA reminds firms to regularly review regulatory permissions

On 18 January 2021, the FCA published a statement reminding firms to regularly review their regulatory permissions under Part 4A of the Financial Services and Markets Act 2000 to ensure that these are up to date and removed where not needed.

The FCA expects firms to notify it of any material changes and to apply to make any necessary changes to regulatory permissions in a timely way. The FCA notes that it has the power to cancel a firm’s Part 4A permission if it has not carried on a regulated activity for at least 12 months.

Firms that have a Part 4A permission but have not carried on any regulated activities for 12 months or more and have no current plans to do so should apply for cancellation of the permission. Firms holding a Part 4A permission that have not used and no longer need some of the permissions should apply to remove the permissions no longer needed through the completion and submission of a Variation of Permission application.

Firms are also reminded that they must provide the FCA with an annual attestation that the information held on the firm on the FCA’s Financial Services Register are accurate.

5. UK HM Treasury call for input on the review of the funds regime

On 26 January 2021, HM Treasury issued a call for input on issues across tax and regulation as part of its review of the UK funds regime. The deadline for comments is 20 April 2021.

The call for input sets out the scope and objectives of the review and invites stakeholders to provide views on which reforms should be taken forward and how these should be prioritised.

The overarching objective of the review is to identify options that will make the UK a more attractive location to set up, manage, and administer funds and that will support a wider range of more efficient investments better suited to the needs of investors.

6. EU IFD/IFR – EBA publishes final draft RTS on risk takers and variable remuneration

On 21 January 2021, the EBA published two final draft Regulatory Technical Standards (RTS) under the EU Investment Firms Directive (IFD) on

• the criteria to identify all categories of staff whose professional activities have a material impact on the investment firm’s risk profile or assets it manages (so-called risk takers)
• the classes of instruments that adequately reflect the credit quality of the investment firm and possible alternative arrangements that are appropriate to be used for the purposes of variable remuneration

Risk takers will be identified based on a combination of qualitative and quantitative criteria specified in the RTS. Members of staff are identified as having a material impact on the institution’s risk profile as soon as they meet at least one of the qualitative or quantitative criteria in the RTS or, where necessary due to the specificities of their business model, additional internal criteria. The qualitative criteria were revisited to enhance the application of proportionality following feedback received during the EBA’s consultation phase, launched in June 2020. The final draft RTS also clarify how the criteria should be applied on a consolidated and individual basis.

The final draft RTS on variable remuneration introduce requirements for investment firms regarding additional Tier 1, Tier 2, and other instruments used for the purposes of variable remuneration to ensure these appropriately reflect the credit quality of the investment firm and to specify possible alternative arrangements for the payout of variable remuneration where investment firms do not issue any of the instruments referred to in Article 32 of the IFD. The provisions under the draft RTS are aligned with Commission Delegated Regulation 527/2014 on classes of instruments that are appropriate to be used for the purposes of variable remuneration under the CRD IV Directive. Groups of credit institutions and investment firms will therefore be able to use a common set of instruments for remuneration purposes.

The final draft RTS have been submitted to the European Commission.

Given that the UK is no longer part of the EU, the UK is not subject to the EU IFD/IFR. However, the EBA RTS above may inform how the UK decides to approach its own implementation of the new UK Investment Firm Prudential Regime (IFPR), which will take effect from 1 January 2022. Please refer to our January 2020 Update for information on the IFPR and the corresponding FCA consultation paper launched in December 2020.

7. Short Selling Regulations (SSR) – UK Short Selling (Notification Thresholds) Regulations 2021 published

On 6 January 2021, the UK published the Short Selling (Notification Thresholds) Regulations 2021 (SI 2021/5) (UK SSR) alongside an explanatory memorandum.

The UK SSRs lower the initial notification threshold for the reporting of net short positions to the FCA in respect of shares admitted to trading on a UK regulated market or multilateral trading facility (MTF), from 0.2% to 0.1%. The lower threshold took effect on 1 February 2021 and will apply indefinitely.

The explanatory memorandum states that the reduced threshold will result in the UK requirements differing from the EU requirements. The UK 0.1% threshold will apply in respect of both shares admitted to trading on UK regulated markets and on UK MTFs. Under the ESMA decision of March 2020, a temporarily reduced notification threshold of 0.1% applies only in respect of shares admitted to trading on EU regulated markets.

As mentioned in our January 2021 Update, ESMA renewed its decision to reduce the net short reporting threshold for a third time on 17 December 2020. The lower 0.1% threshold continues to apply until 19 March 2021, unless ESMA decides to further extend it. For further information on ESMA’s decision to reduce the net short reporting threshold, please refer to our Sidley Update “European Union Net Short Position Reporting Threshold Reduced to 0.1% (Updated 17 December 2020).”

8. MiFID II/MiFIR

ESMA consultation on draft guidelines on aspects of appropriateness and execution-only under MiFID II

On 29 January 2021, ESMA launched a consultation paper on draft guidelines on the application of certain aspects of appropriateness and execution-only requirements under MiFID II.

The MiFID II appropriateness and execution-only framework requires investment firms to ask clients for information on their knowledge and experience, to assess whether the investment service or product envisaged is appropriate for them and to issue a warning if it is deemed inappropriate. The execution-only framework covers the exemption to this assessment if certain conditions are met, including that the firm issues a warning to the client.

The consultation paper takes into account the outcome of ESMA’s 2019 common supervisory action on the application of the MiFID II requirements on the assessment of appropriateness and builds on relevant parts from ESMA’s guidelines on certain aspects of the MiFID II suitability requirements.

The feedback period is open until 29 April 2021. ESMA will consider the feedback provided with a view to issue final guidelines in Q3 2021.

9. Derivatives (EMIR and MiFID II)

EU decision on equivalence of U.S. SEC regime for the purposes of EMIR

On 27 January 2021, the European Commission announced its adoption of an implementing decision on the equivalence of the U.S. regulatory framework for CCPs authorised and supervised by the Securities and Exchange Commission (SEC) to the requirements of EU EMIR. The text of the adopted decision was published alongside.

In-scope U.S. CCPs will be able to apply for recognition by the ESMA and, once recognised, will be able to provide central clearing services in the EU. The decision applies only to SEC-regulated covered clearing agencies and is conditional. To be allowed to offer services in the EU, U.S. CCPs must have rules in place with respect to certain risk management requirements specified in Article 1 of the decision (i.e., liquidation periods and anti-procyclicality measures).

The decision complements the existing equivalence decision for U.S. CCPs regarding the U.S. Commodity Futures Trading Commission that was adopted in 2016. It will enter into force on the 20th day following that of its publication in the Official Journal.

Equivalence determination for BX Swiss AG and SIX Swiss Exchange AG for the purposes of the UK share trading obligation

On 13 January 2021, the UK Markets in Financial Instruments (Switzerland Equivalence) Regulations 2021 (S1 2021/28) were published alongside an explanatory memorandum.

The Regulations determine that the legal and supervisory framework for stock exchanges in Switzerland meet at least equivalent outcomes to the corresponding regime of the UK.

Investment firms subject to the share trading obligation (STO) contained in Article 23(1) of the Markets in Financial Instruments Regulation (MiFIR) as retained as UK law by the European Union (Withdrawal) Act 2018 (EUWA) and as amended by domestic UK legislation (UK MiFIR), will therefore be able to trade shares that fall within scope of the UK STO on the Swiss trading venues BX Swiss AG and SIX Swiss Exchange AG.

The Regulations will come into force on 3 February 2021.

ESMA Working Paper on Funds and single-name CDS

On 11 January 2021, ESMA published a working paper on funds and single-name credit default swaps (CDS). The paper offers a comprehensive view of drivers behind the use of single-name CDS by UCITS investment funds, based on a review of EU regulatory data on derivatives.

The paper reviews fund characteristics associated with the use of single- and multiname CDS and concludes that the results call into question industry claims that the main purpose of single-name CDS usage by funds is to hedge credit risk. It further notes that the number of funds taking net sell positions in CDS should be of concern to supervisors from both a financial stability standpoint and an investor protection standpoint, due to the resulting credit exposure of such transactions.

However, few single-name corporate CDS are currently centrally cleared, and the paper overlooks the requirement for funds to bilaterally collateralise over-the-counter CDS pursuant to article 11(3) of EU EMIR. While there has been no indication of a reaction to ESMA’s findings by any EU legislators yet, if such were deemed necessary, a likely result may be that more funds are brought within the scope of initial margin requirements for such transactions.

EMIR – ESMA publishes updated Q&As on the implementation of EMIR

On 28 January 2021, ESMA published updated Q&As on practical questions regarding reporting issues under EU EMIR.

The updated Trade Repository Q&A 3b explains how to report the direction of derivatives in specific cases that are described. A new Q&A for Trade Repositories clarifies the steps to be taken for the due termination of derivatives when the reporting counterparty ceases to exist. It also specifies how to deal with nonterminated reports of inactive (dissolved) counterparties to ensure that accurate information is provided to the authorities.

ESMA will continue to periodically review and update the Q&As where required. For information on the previous version of the Q&As, please see our January 2021 Update.

10. SFTR – ESMA publishes updated Q&As on data reporting

On 28 January 2021, ESMA published updated Q&As on complying with reporting requirements under the EU SFTR.

As mentioned in our December 2020 Update, ESMA published its first set of Q&As in November 2020. The updated Q&As clarify

• reporting of events that were not duly reported on time
• updates to records of outstanding securities financing transactions by trade repositories based on reports made by counterparties
• operational aspects concerning the reporting by financial counterparties on behalf of small nonfinancial counterparties under Article 4(3) of EU SFTR

11. Anti-money-laundering

Brexit impact on JMLSG AML and CTF guidance

On 14 January 2021, the Joint Money Laundering Steering Group (JMLSG) issued a press release highlighting the impact of the end of the Brexit transition period on the JMLSG anti-money-laundering (AML) and counterterrorist financing (CTF) guidance.

The JMLSG notes that the guidance is based on the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (as amended) (MLRs). The JMLSG explains that there are remaining references in the guidance based on the premise of the UK’s membership of the EU, which were based on provisions in the MLRs prior to legislative amendments made to take Brexit into account. The JMLSG confirms that these references are no longer appropriate and will be amended in due course.

The JMLSG considers that the end of the Brexit transition period has not in itself increased the inherent AML/CTF risks.

12. ESG / EU SFDR

ESAs send letter to the European Commission on issues relating to application of the SFDR

On 14 January 2021, the European Supervisory Authorities (ESAs) published a letter (dated 7 January 2021) sent to the European Commission regarding the application of the EU Sustainable Finance Disclosure Regulation (SFDR).

The letter sets out stakeholder questions raised during the consultation process on the draft regulatory technical standards that the ESAs are producing. The letter notes that the following issues would benefit from urgent clarification to facilitate an orderly application of the SFDR from 10 March 2021:

• the application of the SFDR to non-EU alternative investment fund managers (AIFMs) and registered AIFMs
• application of the 500-employee threshold for principal adverse impact reporting on parent undertakings of a large group
• the meaning of “promotion” in the context of products promoting environmental or social characteristics
• the application of Article 9 SFDR
• the application of SFDR product rules to portfolios and dedicated funds

Each of these issues is set out in more detail in an annex to the letter.

AIFMs may particularly wish to note the ESAs’ question: “Does SFDR apply to non-EU AIFMs, for example when they market a sustainable EU Alternative Investment Fund under a National Placement Regime?” Based on previous guidance from the European Commission, the investment funds industry has been proceeding on the basis that the SFDR disclosure obligations apply to non-EU AIFMs that market their AIFs into the European Union. Given the upcoming 10 March 2021 start date for the SFDR, it may be prudent for non-EU AIFMs to work on the current industry assumption until further clarification is provided by the Commission. For information on key actions non-EU fund managers should take, please see our Sidley Update “EU Sustainable Finance Disclosures Required From 10 March 2021 – Action Points for non-EU Fund Managers.”

The ESAs also request further clarification regarding the scope of products promoting environmental or social characteristics (Article 8 SFDR) and products with sustainable investment or carbon emissions reduction objectives (Article 9 SFDR). Among other things, the ESAs ask whether, in the absence of active advertising of an environmental or social characteristic of the product, an intrinsic characteristic of the product, such as a sectoral exclusion, that is not advertised, also qualifies as “promotion” under Article 8 SFDR. Any clarification on the scope of Article 8 and 9 products will be of particular interest to firms that may not consider their products to actively have an ESG focus.

ESMA calls for legislative action on ESG ratings and assessment tools

On 29 January 2021, ESMA published a letter (dated 28 January 2021) sent to the European Commission sharing its views on the main challenges in the area of ESG ratings and assessment tools. ESMA highlights the need to match the growth in demand for these products with appropriate regulatory requirements to ensure their quality and reliability.

ESMA’s letter builds on its response to the Commission’s July 2020 consultation on the Renewed Sustainable Finance Strategy, where ESMA raised specific issues in relation to ESG ratings and assessment tools.

ESMA notes that the current absence of regulation and supervision of the market for ESG ratings and other assessment tools gives rise to increased risks of greenwashing, capital misallocation, and products mis-selling, when combined with increasing regulatory demands for consideration of ESG information.

ESMA’s letter outlines a potential future legal framework to address these issues. Among other things, ESMA suggests that a common definition of ESG ratings should be introduced that covers the broad spectrum of possible ESG assessments currently on offer. It also suggests adapting the supervisory and regulatory regime to the current market structure and accommodating both large multinational providers that may be subject to existing regulatory frameworks as well as smaller entities.

First delegated act to the EU Taxonomy delayed

On 26 January 2021, the European Commission published the opening remarks of Mairead McGuinness, European Commissioner for Financial Services, Financial Stability, and Capital Markets Union, at a meeting of the European Parliament’s Economic and Monetary Affairs Committee. McGuiness’ remarks include a discussion of the EU Taxonomy regulation and states that the first delegated act, on climate mitigation and adaption, will be delayed.

Under Article 10(6) of the Taxonomy Regulation, the Commission was to adopt the first delegated act by 31 December 2020 with a view to ensuring its application from 1 January 2022. The Commission has taken the decision to delay the first delegated act due to the number of replies received to its public consultation, which closed on 18 December 2020.

13. LIBOR Transition

FCA, BoE, and RFRWG set out steps firms must take to complete sterling LIBOR transition by end-2021

On 11 January 2021, the FCA and the Bank of England (BoE) issued a press release highlighting the need for firms to complete the transition from sterling LIBOR by the end of 2021. The Bank of England issued an identical press release on the same day.

As mentioned in our December 2020 Update, LIBOR’s administrator, the IBA, is consulting on ceasing publication of all sterling LIBOR settings at end-2021. The FCA and the BoE have set out clear expectations for regulated firms to remove their reliance on LIBOR in all new business and in legacy contracts, where feasible.

In support of this, the Working Group on Sterling Risk-Free Reference Rates (RFRWG) published in January an updated version of its priorities and roadmap for the final year of transition. The RFRWG’s key priority is for markets and their users to be fully prepared for the end of sterling LIBOR by the end of 2021. It has made a number of recommendations to this end, including:

• From the end of March, sterling LIBOR is no longer used in any new lending or other cash products that mature after end-2021. Existing contracts linked to sterling LIBOR should be actively transitioned throughout the remainder of 2021, where possible.
• Firms no longer initiate new linear derivatives linked to sterling LIBOR after the end of March 2021, other than for risk management of existing positions or where they mature before end-2021.

The RFRWG has also welcomed the development of term SONIA reference rates (TSRRS) and engaged closely with the FICC Markets Standards Board (FMSB) regarding the development of a market standard for appropriately limited use of TSRRS. The proposed FMSB standard is under stakeholder review and expected to be released for public comment in February 2021.

The FCA and the BoE continue to work closely with firms to secure a smooth transition. Supervisors of regulated firms will continue to expect transition plans to be executed in line with industry-recommended timelines across sterling and other LIBOR currencies. Senior managers with responsibility for the transition should expect close supervisory engagement on how they are ensuring their firm’s progress relative to industry milestones.

FMLC responds to FCA consultation on LIBOR transition powers

On 19 January 2021, the Financial Markets Law Committee (FMLC) published its response to the FCA’s consultation on its approach to powers relating to LIBOR transition.

As mentioned in our December 2020 Update, the FCA will acquire transition powers in under the Financial Services Bill 2019-2020, which amends the UK Benchmarks Regulation, to manage the orderly transition from LIBOR. The consultation period on the FCA’s potential approach regarding the use of these proposed powers was launched on 18 November 2020 and closed on 18 January 2021.

FMLC’s response highlights two areas of concerns it considers should form a key component of the FCA’s analysis regarding use of its powers:

• The practicalities of intervention and the scale of so-called “tough legacy” contracts. Among other things, the FMLC warns that the FCA’s powers permitting the publication of a transition LIBOR in respect of the wind-down of tough legacy contracts may give rise to mixed messages concerning successor rates, possibly setting transition LIBOR up against other successor rates being used by market participants.
• Issues concerning the use of LIBOR in foreign jurisdictions. In particular, the FMLC refers to the potential for conflict and overlap between legislative approaches taken by the UK, the EU, and the United States in relation to tough legacy contracts, and associated risks.

Application of ISDA IBOR supplement to new contracts

As covered in our November 2020 Update, the International Swaps and Derivatives Association (ISDA) has published a new supplement to the 2006 ISDA definitions containing fallback methodology for the case that an interbank offered rate (IBOR) referenced in a derivative contract cannot be obtained or otherwise applied.

As of 25 January 2021, the supplement has been automatically incorporated into all new derivatives contracts that reference the 2006 ISDA Definitions (unless the parties specifically agree to exclude them). This includes most standard form interest rate derivative contracts. In contrast, the fallbacks will be included in legacy derivative contracts only if the parties have agreed to include them or have both adhered to the 2020 IBOR Fallbacks Protocol. Firms will need to consider carefully whether any basis risk exists between derivatives contracts incorporating the new ISDA fallback methodology and hedged instruments that reference IBOR rates.

ISDA published the Protocol in October 2020, and it remains open for adherence. Further information on fallbacks and adjustment methodology is available here. Information on benchmark reform is also available on ISDA’s website.

FCA speech on preparedness for life without LIBOR published

On 26 January 2021, the FCA published a speech of Edwin Schooling Latter, Director of Markets and Wholesale Policy, regarding being ready for life without LIBOR from end-2021.

Schooling Latter set out the following points, among others:

• 12,500 firms have now signed the ISDA protocol, which remains open for signature. Firms with LIBOR derivative positions that remain exposed to risk of LIBOR ceasing or becoming unrepresentative are reminded that it is not too late to sign up to the protocol.
• Firms should not underestimate the challenges associated with managing other LIBOR outstandings, notably in bond, securitisation, loan, and mortgage markets.
• The IBA consultation on proposed end-dates for 35 LIBOR currency tenor settings has now closed. If the FCA is satisfied that the benchmark can be ceased in an orderly fashion and confirms a policy that would not envisage compelling continued production on a changed methodology basis of a relevant setting, then the FCA could announce that these settings will cease.
• Where the FCA envisages requiring continued publication of a LIBOR setting on a synthetic basis, this will be subject to a further consultation and decision on the specific settings. If IBA confirms it has determined to bring the relevant currency panel to a stop at the end of 2021, the FCA would want to launch such consultations in a timely way so as to minimise uncertainty. Decisions could then be made once the FCA’s new powers under the Financial Services Bill 2019-21 were on the statute book, perhaps in summer 2021 subject to Parliamentary approvals.