UK/EU Investment Management Update (March 2021)

Contents:

1. Brexit
2. MiFID II
3. Market Abuse and Financial Crime
4. ESG/EU Sustainable Finance Disclosure Regulations (SFDR)
5. Cayman Islands Added to FATF Increased Monitoring List
6. EU Investment Firm Directive (EU IFD)
7. EU Strategy on Nonperforming Loans (NPLs)
8. LIBOR Transition
9. EURIBOR Fallback Rates
10. Crypto-assets

1. Brexit

Provisional application of the EU-UK Trade and Cooperation Agreement (the TCA) extended while the Council requests European Parliament’s consent to conclude the TCA

The provisional application period for the EU-UK Trade and Cooperation Agreement (the TCA) has been extended by agreement between the EU and the UK to 30 April 2021 to allow more time for its ratification by the European Parliament. Prior to this extension, the TCA had applied on a provisional basis for a limited period between 1 January 2021 and 28 February 2021, following a decision adopted by the Council of the EU on 30 December 2020.

The UK Parliament has already ratified the TCA by passing the European Union (Future Relationship) Act 2020, which came into effect on 31 December 2020. However, without ratification by the European Parliament, the TCA will not apply on a permanent basis. In a letter to the European Commission communicating its agreement to the extension, the UK government indicated that it expects the additional two months will be sufficient for the EU to satisfy its internal requirements, so the UK does not expect to extend the period of provisional application further.

The decision of the TCA Partnership Council to extend the provisional application of the TCA entered into force on 26 February 2021 and has been published in the Official Journal of the EU.

The EU ratification process is progressing; on 26 February 2021, the Council of the EU formally requested the European Parliament’s consent to its decision on the conclusion of the TCA and associated agreements. Once the European Parliament has conducted legal-linguistic revision of the TCA in all 24 official languages of the EU and given its consent to the Council of the EU, the Council of the EU will be able to adopt the decision on the conclusion of the agreements and allow their entry into force.

As noted in our January 2021 Investment Management Update, 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).

City Minister John Glen MP comments on future UK and EU memorandum of understanding on post-Brexit financial services

As also noted in our January Update, the TCA includes a number of declarations, including a Joint Declaration on Financial Services Cooperation. According to this declaration, the UK and EU will, by March 2021, agree on a memorandum of understanding establishing a framework for financial services cooperation and that discussions between the UK and the EU will address “how to move forward on both sides with equivalence determinations […] without prejudice to the unilateral and autonomous decision-making process of each side.”

However, John Glen MP, the Economic Secretary to the Treasury and City Minister, was reported to have said, at a conference of British insurers on 18 February 2021, that the memorandum of understanding on financial services will not itself include equivalence assessments. Instead, the processes for such assessments will run separately and unilaterally, and the memorandum of understanding is expected to provide for the mechanics of future dialogue between the UK and EU.

Without positive equivalence decisions in favour of the UK, UK firms will be unable to access the “third country” provisions of certain EU financial services sectoral legislation such as the Alternative Investment Fund Managers Directive (AIFMD) and MiFID II. There had been hope in some quarters that the memorandum of understanding would incorporate constructive steps towards granting of equivalence.

So far, the European Commission has granted only temporary equivalence in respect of UK central clearing counterparties to clear EU derivatives trades until 30 June 2022 and to UK central securities depositories to issue and settle EU securities until 30 June 2021.

2. MiFID II

EU MiFID II “Quick Fixes”

On 1 March 2021, a Directive making certain targeted amendments (referred to as “quick fixes”) to the EU MiFID II was published in the Official Journal of the EU (MiFID II Quick Fix Directive), following its adoption by the Council of the EU as part of the EU’s Capital Markets Recovery Package (CMRP). EU member states have until 28 November 2021 to adopt national laws necessary to comply with the MiFID II Quick Fix Directive, and such amendments will apply from 28 February 2022.

Please see our January Update for further information on the EU MiFID II quick fixes that are likely to be of most relevance to investment managers. These include quick fixes to research unbundling provisions and to certain client information requirements.

The EU MiFID II 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.

FCA publishes report on MiFID II product governance review

On 26 February 2021, the FCA published the findings of its review of product governance. The review examined how eight UK asset management firms took the MiFID II product governance regime (as implemented in the FCA’s Product Intervention and Product Governance (PROD) rules) into consideration when manufacturing and providing products and the extent to which such firms considered the interests of end consumers throughout the product lifecycle. Overall, the FCA noted that a number of asset managers are not acting in accordance with PROD, and there is therefore significant scope for asset managers to improve their product governance arrangements.

In general, PROD is unlikely to be relevant to UK investment management firms that act exclusively as a sub-advisor to an affiliate in their group. This is because such firms do not generally act as product manufacturers or product distributors with investors as MiFID “clients” for the purposes of PROD. Nonetheless, the FCA’s review contains some important observations regarding the relationship between asset managers and intermediaries employed to distribute products and the FCA’s view as to what acting in the best interests of investors means in practice for asset managers. Among other things, changes in the practices of UK distributors could have an impact on non-UK firms (such as U.S. AIFMs) that act as product manufacturers, in terms of information requests by such distributors.

As such, investment managers that do not fall within PROD may nonetheless wish to reflect on the FCA’s observations in the context of their own businesses.

FCA publishes revised Statement of Policy on their use of the Double Volume Cap

As covered in our January Update, in December 2020, the FCA published a Supervisory Statement to explain the FCA’s approach to the UK MiFID regime after the end of the Brexit transition period, including in relation to the Double Volume Cap (DVC).

On 4 March 2021, the FCA published a revised version of its Statement of Policy on the DVC.

The DVC sets limits on the level of trading on trading venues that can operate with the benefit of pre-trade transparency waivers (i.e., the DVC limits the level of dark trading). UK MiFIR gives the FCA temporary powers to make and renew suspensions of waivers under the DVC without undertaking and publishing the calculations of whether trading has exceeded the 4% and 8% thresholds.

The FCA’s Supervisory Statement indicates that it expects to rely on its temporary powers for the DVC in 2021 rather than undertaking calculations of dark trading every month and publishing the results; however, the FCA does not expect regular suspensions to be necessary for any of the instruments covered by the DVC. Accordingly, firms that trade on dark venues benefiting from pre-trade transparency waivers are likely to be able to continue to do so throughout 2021.

In December, the FCA announced that it would not automatically apply the DVC to UK equities. According to its March update, the FCA is extending its approach to all equities. However, in its revised Statement of Policy, the FCA notes that it is willing to use its temporary powers flexibly and to amend its approach to the DVC if another jurisdiction makes an equivalence decision in respect of the UK.

3. Market Abuse and Financial Crime

Insider dealing: FCA commences criminal proceedings against Stuart Bayes and Jonathan Swann

On 11 February 2021, the FCA announced that it had commenced criminal proceedings against Stuart Bayes and Jonathan Swann for insider dealing. Bayes is also charged with improperly disclosing inside information or encouraging another, whilst being an insider, to engage in dealing.

The proceedings relate to alleged conduct occurring during 2016 and related to trading in shares of British Polythene Industries plc (BPI), a polythene packaging company, immediately prior to an announcement that BPI was to be acquired by RPC Group plc (RPC). Bayes was reportedly employed by RPC at the time. The FCA’s press release suggests that approximate profits from the conduct totalled £138,700.

Both men appeared at Westminster Magistrates Court on 11 February 2021. The case has been sent for trial to Southwark Crown Court. The outcome of the proceedings is to be determined.

Insider dealing and fraud: FCA commences criminal proceedings against Mohammed Zina and Suhail Zina

On 16 February 2021, the FCA announced that it had commenced criminal proceedings against Mohammed Zina and Suhail Zina for fraud (contrary to the Fraud Act 2006) and insider dealing.

The proceedings relate to alleged conduct occurring between July 2016 and December 2017 and involved trading in the shares of ARM Holdings plc, Alternative Networks plc, Punch Taverns plc, Shawbrook plc, HSN Inc, and Snyder’s Lance Inc. The total profit from the alleged insider dealing was approximately £142,000.

The fraud charges relate to personal loans from Tesco Bank totalling £95,000, stated to be taken out for home improvements though used instead to fund the alleged insider dealing.

The FCA notes that at the time, Mohammed Zina was employed by an international investment bank and Suhail Zina was a solicitor at an international law firm.

Both men appeared at Westminster Magistrates Court on 16 February 2021. The case has been sent to trial at Southwark Crown Court. The outcome of the proceedings is to be determined.

Market abuse: FCA fines Adrian Geoffrey Horn for market abuse involving “wash trading”

On 4 March 2021, following an investigation, the FCA announced that it had fined Adrian Geoffrey Horn, formerly a market making trader at a UK brokerage firm, £52,500 for market abuse and prohibited him from performing any functions in relation to regulated activity.

The FCA investigation found that Horn had engaged in market abuse by executing wash trades with himself in the shares of McKay Securities Plc (McKay) (a client of his firm) for the purposes of ensuring that a minimum number of shares were traded in McKay each day, which Horn believed was a requirement to ensure that McKay remained in the FTSE All Share Index. The FCA found that through his wash trading Horn gave false and misleading signals to the market as to demand for and supply of McKay shares.

As Horn had demonstrated a high level of cooperation during the FCA’s investigation (including making significant admissions during an early interview with the FCA), the FCA reduced the financial penalty by 25% and provided an additional 30% settlement discount.

FCA publishes webpage on enforcement fines

On 4 March 2021, the FCA published a webpage providing information about enforcement fines imposed in 2021. The only entry to date is the £52,500 fine issued to Adrian Geoffrey Horn, as noted above. Fines imposed in previous years are also available from that webpage.

4. ESG/EU Sustainable Finance Disclosure Regulation (SFDR)

EU SFDR application commences 10 March 2021

From 10 March 2021, financial market participants that offer financial products in the EU will be subject to requirements to disclose information on their approach to certain sustainable finance-related matters to prospective EU investors on a precontractual basis and to a the public via the firm’s website. 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.

European Supervisory Authorities (ESAs) publish joint supervisory statement on the application of the EU SFDR

On 25 February 2021, the ESAs (i.e., the EBA, European Insurance and Occupational Pensions Authority (EIOPA), and European Securities and Markets Authority (ESMA)) published a joint supervisory statement containing recommendations on the effective and consistent application and national supervision of the EU SFDR.

Noting the delayed application date (likely 1 January 2022) of the regulatory technical standards (RTS) under the SFDR on the content, methodologies, and presentation of disclosures under the EU SFDR, the ESAs are concerned to mitigate the risk of divergent application by EU national competent authorities of the SFDR requirements between 10 March 2021 (when most of the provisions on sustainability-related disclosures in the EU SFDR will apply) and the application date of the RTS.

The joint supervisory statement recommends that EU national competent authorities use the draft RTS under the EU SFDR as a reference point in the interim period.

The joint supervisory statement also contains a reminder of the application timeline of certain provisions of the EU SFDR, the EU Taxonomy Regulation, and the related RTS. Specifically, these are the application timelines for (i) entity-level principal adverse impact statements and (ii) products’ periodic reporting.

In its press release, ESMA outlined the next steps for the relevant RTS and for taxonomy-related product disclosures under the EU Taxonomy Regulation. The Commission is required to endorse the RTS within three months of their publication. The Commission will then adopt these by three months after its endorsement, provided the European Parliament and the Council of the EU raise no objections.

The ESAs intend to launch a consultation in March on taxonomy-related product disclosures under the EU Taxonomy Regulation.

For financial market participants that do not take account of the principal adverse impacts of their investment decisions on sustainability factors (for the purposes of Article 4 and 7 of the SFDR) and whose financial products do not promote one or more environmental or social characteristics (under Article 8) or have sustainable investment or a reduction in carbon emissions as their objective (under Article 9), the draft RTS under the SFDR and the pending RTS under the Taxonomy Regulation will be of limited relevance. This is because the substantive disclosures for such firms fall under Articles 3, 5, and 6 of the EU SFDR, which are not supplemented by any delegated RTS.

International Organization of Securities Commissions (IOSCO) calls urgently for global consistency in sustainability standards

On 24 February 2021, IOSCO published a press release calling for improvements to the consistency, comparability, and reliability of sustainability reporting, initially with respect to climate change-related risks and subsequently extending out to other sustainability issues. The press release followed the IOSCO Board’s discussion of work done by its Sustainable Finance Task Force (STF) over the past year.

IOSCO observes from the STF’s work in relation to issuers’ disclosures that there is unmet demand from investors for sustainability-related information; companies often report such information selectively and with reference to different frameworks. To increase the quality and availability to financial markets of sustainability disclosures, IOSCO have identified the following areas as priorities for improvement:

• encouraging a globally consistent set of standards
• promoting greater emphasis on comparable, industry-specific, quantitative metrics
• driving international coordination and consistency in the approaches taken to sustainability disclosures

Given recent global trends and, in particular, anticipated developments on climate change and sustainability under the Biden administration, investment managers (as well as public companies) are likely to be subject to an ever-increasing disclosure burden with respect to sustainability over the next few years; IOSCO’s work in seeking to ensure consistency between regulatory regimes will therefore be very important. Investment management firms should follow IOSCO’s work in this area closely.

5. Cayman Islands Added to FATF Increased Monitoring List

On 25 February 2021, the FATF announced that it had added the Cayman Islands to its “grey” list of jurisdictions under increased monitoring by FATF. Such countries are countries that are actively cooperating with the FATF to address strategic deficiencies in their anti-money laundering (AML), counter-terrorist financing (CTF), and counter-proliferation financing regimes.

The inclusion of the Cayman Islands on the list of countries subject to increased monitoring by FATF should not cause any particular issues for Cayman funds under the AIFMD from a marketing perspective, as the AIFMD refers to managers/funds not being on FATF’s list of noncooperative countries or territories (i.e., FATF’s “blacklist”). However, firms with Cayman funds will need to check whether they have side letters that refer to the increased monitoring list or whether any EU member state into which they market their funds somehow prohibits the marketing of funds that are domiciled in a country on the increased monitoring list.

In February 2020, the Cayman Islands was added to the EU’s list of noncooperative jurisdictions for tax purposes; however, the Cayman Islands was removed from the EU list after it adopted new reforms to its framework on Collective Investment Funds in September 2020.

6. EU Investment Firm Directive (EU IFD)

EBA public hearing on draft guidelines on sound remuneration policies and internal governance under the EU IFD

On 17 February 2021, the EBA held a public hearing on in connection with its consultations on draft Guidelines on remuneration policies and its draft Guidelines on internal governance under the EU IFD that were published in December 2020. Both consultations are open for responses until 17 March 2021. The Guidelines are both due to apply from 26 June 2021.

Speaking mainly in relation to its Guidelines on remuneration policies, the EBA stated that

• it will clarify the definition of “financial institution” as it is currently too broad and captures non-MiFID firms
• a “Class 2” firm’s remuneration policy should be applied in line with the Guidelines for the performance year starting post-31 December 2021
• it will consider including a table in the final Guidelines stating which requirements apply to all members of staff (the sound remuneration requirements) and which apply only to identified staff (the variable remuneration requirements)
• it will provide for subsidiaries in a group to be able to apply their applicable sectoral remuneration policies, as is currently allowed under the EU CRD
• member states will have discretion to set expectations on the ratio between fixed and variable remuneration; this will depend on a firm’s activities and business model alongside the relevant staff member
• it will clarify the Guidelines in relation to the application of the de minimis waiver from the payout process
• remuneration policies must be gender neutral in that they must provide for equal pay for equal work

Given that the UK is no longer part of the EU, the UK is not subject to the EU IFD and the accompanying Investment Firm Regulation. Instead UK-authorised firms will be subject to the UK’s Investment Firms Prudential Regime (IFPR), which is scheduled to take effect from 1 January 2022. At present, it is unclear whether the FCA will take the same approach under the UK IFPR as set out in the draft EBA Guidelines. However, the FCA is also in the process of consulting on its new regime (see our January Update for information on the IFPR and the FCA’s first consultation, published in December 2020), and final rules will be published later this year.

7. EU Strategy on Nonperforming Loans (NPLs)

European Parliament publishes an analysis on nonperforming loans (NPLs)

On 12 February 2021, the European Parliament published an in-depth analysis of the EU’s regulatory and supervisory response to addressing nonperforming loans (NPLs). This analysis follows the publication, in December 2020, of the European Commission’s strategy to prevent a future buildup of NPLs across the EU as a result of the coronavirus crisis.

The Commission’s strategy document proposed a series of actions with four main goals, as discussed in our January Update. The Parliament’s analysis highlights that NPLs remain a key priority in the context of the coronavirus crisis.

As noted by the Parliament’s analysis, in January 2021, the European Parliament’s Committee on Economic and Monetary Affairs agreed on the text of the draft Directive on Credit Services and Credit Purchasers and voted in favour of commencing negotiations with the Council and the European Commission on the draft text.

8. LIBOR Transition

FCA announces end dates for LIBOR submissions; the Bank of England, ICE Benchmark Administration (IBA), and International Swaps and Derivatives Association (ISDA) respond

On 5 March 2021, the FCA announced the dates that panel bank submissions for all LIBOR settings will cease, after which representative LIBOR rates will no longer be available

• immediately after 31 December 2021, in the case of all sterling, euro, Swiss franc, and Japanese yen settings, and the one-week and two-month U.S. dollar settings
• immediately after 30 June 2023, in the case of the remaining U.S. dollar settings

At present, there are 35 LIBOR benchmark settings published by IBA.

The FCA’s announcement confirms that the FCA does not intend to use its proposed powers (under the Financial Services Bill) to compel IBA to continue to publish 26 of the 35 LIBOR settings as “synthetic LIBOR”. However, the FCA will consult in 2021 on the use of such powers to require continued publication on a synthetic basis for some sterling LIBOR settings and, for one additional year, some Japanese yen LIBOR settings. The FCA will also consider using these powers for some US dollar LIBOR settings. Nonetheless, these synthetic LIBOR rates will not be representative for the purposes of the Benchmarks Regulation and they will not be permitted for use in new contracts. Synthetic LIBOR settings are intended for use in “tough legacy contracts” only. The FCA will also consult later in 2021 on which legacy contracts will be permitted to use any synthetic LIBOR rate. IBA confirmed on 5 March 2021 that, in the absence of the exercise of such powers by the FCA, it will cease publishing all LIBOR settings on the relevant dates.

The FCA notes that the announcement itself may serve as a contractual trigger for the calculation and future application of fallbacks that are activated by pre-cessation or cessation announcements made by the FCA.

In a statement published on 5 March 2021, ISDA confirmed that the FCA’s announcement constituted an index cessation event under the ISDA 2020 IBOR Fallbacks Protocol (Fallbacks Protocol) and IBOR Fallbacks Supplement (Fallbacks Supplement) for all 35 LIBOR settings. As a result of ISDA announcing an index cessation event, the fallback spread adjustment, which is published by Bloomberg, is fixed as of the date of the announcement for all euro, sterling, Swiss franc, US dollar and yen LIBOR settings.

The announcement serves as a reminder to firms for the need to complete the transition from (non-U.S. dollar) LIBOR by the end of 2021 and the Bank of England has joined the FCA in urging market participants to continue preparations.

Please see our February Update for a discussion of the recent publications by the FCA, Bank of England, and the Bank of England’s Working Group on Sterling Risk-Free Reference Rates (RFRWG) relating to the LIBOR transition.

RFRWG publishes pathway to ending new use of GBP LIBOR-linked derivatives

On 24 February 2021, the RFRWG published a paper to help market participants meet upcoming recommended milestones for ending new use of GBP LIBOR in derivatives.

The paper highlights that the RFRWG’s key expectation for all market participants is that (subject to certain exceptions) new GBP derivatives that expire after the end of 2021, entered into after the recommended milestones, be based on sterling overnight interbank average rate (SONIA).

The RFRWG’s milestones are

• end-Q1 2021, firms to have ceased initiation of new GBP LIBOR-linked linear derivatives that expire after end-2021
• end-Q2 2021, firms to have ceased initiation of new GBP LIBOR-linked nonlinear derivatives that expire after end-2021
• during Q2 and Q3 2021, firms to cease initiation of new cross-currency derivatives with a LIBOR-linked sterling leg that expire after end-2021
• end-Q3 2021, firms to have progressed active conversion of all legacy GBP LIBOR contracts where viable

The paper notes that the Bank of England and the FCA continue to work closely with firms to support a smooth transition and that senior managers with responsibility for LIBOR transition should expect close supervisory engagement on how they are ensuring their firm’s progress relative to the recommended timelines.

9. EURIBOR Fallback Rates

ECB Working Group on Euro Risk-Free Rates publishes summaries of responses to its public consultations on EURIBOR fallback

On 15 February 2021, the ECB Working Group on Euro Risk-Free Rates (the ECB Working Group) published summaries of responses to its public consultations on (i) EURIBOR fallback trigger events and (ii) euro short-term rate-based (€STR-based) EURIBOR fallback rates.

In relation to EURIBOR fallback trigger events, the ECB Working Group noted that there was near-unanimous agreement on proposed trigger events and that the same set of trigger events should apply to all asset classes. A significant majority of respondents agreed that trigger events should include any announcement on the non-representativeness of EURIBOR by the benchmark supervisor; any situation in which the use of EURIBOR becomes unlawful; and EURIBOR’s permanently ceasing to be published in the absence of any prior official announcement.

In relation to €STR-based EURIBOR fallback rates, the ECB Working Group noted that there was a split among respondents as to the most appropriate fallback methodology.

10. Crypto-assets

ECB publishes Opinion on the MiCA proposal

On 19 February 2021, the ECB published an Opinion on the Commission’s proposal for an EU Markets in Crypto-Assets Regulation (MiCA). Please see our Update Analysis of the Proposed EU Markets in Crypto-Assets Regulation for a discussion on the MiCA proposal.

While the ECB welcomed the Commission’s work to bring crypto-assets and related activities and services within the regulatory perimeter and the Commission’s desire to facilitate an innovation-friendly, risk-based approach, the ECB noted four key areas relating to the responsibilities of the ECB, the Eurosystem, and the European System of Central Banks that require further adjustments to MiCA, particularly in the context of so-called stablecoins:

• the conduct of monetary policy
• the smooth operation of payment systems
• the prudential supervision of credit institutions
• financial stability

In particular, the ECB states that where an asset-referenced arrangement (i.e., a stablecoin) is “tantamount to a payment system or scheme, the assessment of the potential threat to the conduct of monetary policy, and to the smooth operation of payment systems, should fall within the exclusive competence of the ECB” and that the “the ECB’s intervention should not be limited to the issuance of a non-binding opinion.” In other words, in respect of stablecoins, the ECB is advocating for itself a stronger role than currently provided for under the MiCA proposal.

In addition, relevant to the ECB’s ongoing work relating to a possible “digital euro,” the ECB suggested that MiCA should clarify that it will not apply to the issuance by central banks of central bank money based on distributed ledger technology (DLT). This would include a DLT-based central bank digital currency (CBDC).

The above highlights that proposals for the future European regulatory landscape on crypto-assets is contentious not only between market participants and policy makers but between policy makers and regulators. Given the fast-moving nature of the crypto-assets sector and the contentious issues at stake, the final form of the MiCA regime (should it come into force) is likely to be quite different from the original proposal.

For investment managers monitoring crypto-asset markets (or already investing in them), the future European regulatory landscape could have a significant bearing on market structures as well as the potential viability of investment strategies relating to crypto-assets.