UK/EU Investment Management Update (May 2021)

Contents:

1. UK Investment Firm Prudential Regime (IFPR)
2. UK MiFID II
3. Brexit
4. UK Financial Services Act 2021
5. UK SPACs Listing Rules
6. UK Market Conduct
7. FCA Business Plan
8. FCA Mini Bonds
9. EU Sustainable Finance
10. EU EMIR
11. EU SFTR / UK SFTR
12. LIBOR Transition

1. UK Investment Firm Prudential Regime (IFPR)

On 19 April 2021, the FCA published its second consultation paper (CP21/7) on the IFPR. This follows the FCA’s first consultation paper on the IFPR that was published in December 2020 (CP20/24).

Please see our Sidley Update UK Investment Firm Prudential Regime for the implications of CP21/7 for UK investment managers.

2. UK MiFID II

FCA consults on changes to conduct and organisational requirements under UK MiFID II

On 28 April 2021, the FCA published a consultation paper on proposed changes to conduct and organisational requirements under UK legislation implementing MiFID II. The consultation is part of the FCA’s joint efforts with HM Treasury to achieve capital markets reform.

The FCA notes that the issues raised by the consultation are areas that are covered by the EU’s MiFID II Quick-Fix package but with variances for UK markets. The FCA determines that other areas covered by the EU’s MiFID Quick-Fix relevant for the UK would be best achieved by, or would require, legislative change and that HM Treasury will propose changes to the delegated regulation in due course.

The proposed changes primarily relate to the FCA Conduct of Business sourcebook and include the following:

• Amendments to inducement rules. These amendments would broaden the list of what are considered minor non-monetary benefits to include research on small and medium-size enterprise (SMEs) with a market cap below £200 million and fixed income, currencies, and commodities research so that it is not subject to the inducement rules. The £200 million threshold contrasts with the rather larger threshold of £1 billion in the EU’s MiFID II Quick-Fix package.
• Amendments to best execution requirements. The FCA intends to revoke the requirement for UK investment firms to publish RTS 27 and (of particular relevance to UK MiFID investment managers) RTS 28 best execution reports. The FCA thus goes further than the EU’s MiFID II Quick-Fix package, which addresses only RTS 27 and leaves RTS 28 in place (for further information on the current status of RTS 27 and 28, see our April 2021 Update.)

The FCA consultation will close on 23 June 2021, with publication of any rules or guidance in a policy statement occurring in the second half of 2021 if the FCA decides to proceed. The rules changes could then take effect soon after that. Note that the EU’s MiFID II Quick-Fix package takes effect from 22 February 2022.

3. Brexit

FCA speech on the future of the UK as a global financial centre

On 13 April 2021, the FCA published a speech by Nausicaa Delfas, the FCA’s Executive Director of International, addressing the FCA’s approach to regulating the UK as a global financial centre.

In particular, with regards to post-Brexit regulation of UK financial markets, Delfas noted that the FCA is already looking to tailor its rules and practices in the wholesale market following the UK’s withdrawal from the EU.

Examples given by Delfas include:

• the FCA’s decision not to automatically apply the Double Volume Cap provision in UK MiFIR to trading in equities;
• the forthcoming Long-Term Assets Fund regime; and
• the upcoming introduction of the new UK Investment Firms Prudential Regime (for which the consultation was published on 19 April 2021 as discussed above).

The FCA intends to take measures that are proportionate, meet real needs and concerns, and give additional flexibility to market participants without compromising on protections considered necessary for both markets and consumers.

4. UK Financial Services Act 2021

On 29 April 2021, the UK’s Financial Services Bill was finalised and entered into law as the Financial Services Act 2021 (the Act). The Act presents a significant step in reshaping the UK’s regulation of financial services outside of the EU as it contains significant amendments to the existing UK legislation and certain on-shored EU legislation. In particular, the Act:

• establishes the legislative framework for the FCA to create rules for the Investment Firms Prudential Regime (see above);
• amends the UK’s on-shored packaged retail investment and insurance-based products (PRIIPs) regulation to provide the FCA with additional powers to clarify the scope of the regulations (i.e., whether certain investment products fall within scope) and amend the requirements within the PRIIPs Key Information Document;
• establishes the legislative framework for the Overseas Funds Regime to introduce a new equivalence regime for retail investment funds and money market funds;
• amends UK MiFIR to ensure that the FCA has an appropriate degree of oversight over the services and activities of third-country investment firms;
• introduces an additional streamlined mechanism for the FCA to cancel the authorisation of a firm where it suspects that a firm should no longer carry on any of its permitted activities;
• amends the UK Benchmarks Regulation to give the FCA greater oversight for an orderly transition away from the LIBOR benchmark; and
• increases the maximum sentence for criminal market abuse from seven to 10 years.

Some sections of the Act are already in force, with remaining sections coming into force on 29 June 2021 and on future dates HM Treasury specifies.

5. UK SPACs Listing Rules

FCA consults on changes to listing rules that apply to SPACs

On 30 April 2021, the FCA published a consultation paper on proposed changes to the UK listing rules for special purpose acquisition companies (SPACs). It aims to remove potentially disproportionate barriers for larger SPACs and create a more flexible regime as well as provide potential investors in SPACs with greater protections.

Under the existing rules, SPAC listings are typically suspended when the acquisition target is identified. Whilst the purpose of this suspension is to protect investors from disorderly markets as a result of a lack of available information, this can mean that investors are locked into a SPAC for months after the target is announced. Under the proposed changes, SPACs that can demonstrate higher levels of investor protections will be subject to less onerous rules.

To qualify for such rules, SPACs would be required to meet certain conditions, including:

• setting a minimum amount of £200 million to be raised when a SPAC's shares are initially listed, and setting a time limit on the offering period if no acquisition is completed;
• ensuring monies raised from public markets are ring-fenced to fund the acquisition or be returned to shareholders;
• ensuring shareholder approval for the proposed acquisition based on sufficient disclosure and declaration of any conflict of interest exists between SPAC directors and a target company;
• providing a “redemption” option allowing investors to exit a SPAC before any acquisition is completed; and
• maintaining transparency by providing adequate disclosures to investors throughout the SPAC’s lifecycle.

The FCA has noted that even with the proposed changes, SPACs remain a complex investment and that potential investors should understand the key risks and features of a particular SPAC before deciding to invest. The consultation closes on 28 May 2021.

6. UK Market Conduct

FCA enforcement priorities and focus on the fund management sector

On 26 April 2021, the Alternative Investment Management Association (AIMA) hosted a conference on the FCA’s Enforcement Division’s priorities and focus on the fund management sector, including a keynote speech and roundtable discussion with the FCA Director of Enforcement, Mark Steward.

Steward emphasised that rather than focussing on the categories of non-financial misconduct that might trigger compliance issues under the UK’s Senior Managers Regime (SMR), firms should consider what the FCA’s interest is in the first place, which is to ensure an individual’s fitness and properness to carry out regulated activities.

Referring to the FCA’s decision in November 2020 to ban three individuals from working in the financial industry following convictions for sexual offences, Steward said such conviction are “self-evidently serious” and relate to an individual’s integrity and properness even if financial probity isn’t involved.

The FCA keeps a high degree of scrutiny as part of its regulatory and supervisory process on financial firms. According to Steward, firms will be investigated for potential individual misconduct, and the FCA will pursue any cases involving gaps or weak systems and controls in relation to any financial criminal threats. While firms are reminded that the FCA is open to cases leading to civil or criminal court proceedings, Steward affirms that investigations are first and foremost fact-finding missions, and an investigation will not necessarily lead to enforcement action.

Firms should also refer to Steward’s speech on compliance, culture, and evolving regulatory expectations published by the FCA on 26 April 2021. Among others, the speech notes the following:

• The SMR has changed the ways firms allocate responsibilities, align these to relevant controls, and ensure oversight as to how such controls operate down the line.
• The 5 Conduct Questions (5CQ), which start with “tone from the top”, are increasingly focussing on “tone from within”. This requires every individual in an organisation to be personally accountable and engaged.
• Every employee of a regulated firm is subject to individual conduct rules, which impose broad obligations.
• The SMR and 5CQ require firms to think about how a system or function might fail because of non-compliance, and they inject a sharper focus on conduct risk into the fabric of an organisation.
• As demonstrated by enforcement cases, failures are not necessarily failures of compliance but the consequence of choices made by individuals.

7. FCA Business Plan

FCA delays publication of 2021/22 Business Plan

On 20 April 2021, the FCA announced that it would publish its 2021/22 Business Plan in July rather than April 2021.

The business plan will be published alongside the FCA 2020/21 Annual Report and Accounts and will include an update on plans for transforming the FCA.

8. FCA Mini Bonds

HM Treasury consultation on regulation of non-transferable debt securities

On 19 April 2021, HM Treasury published a consultation paper on proposals to bring the issuance of non-transferable debt securities (NTDS) within the scope of UK financial services regulation. The consultation is accompanied by an independent research report into NTDS and their role in the economy.

NTDS, commonly referred to as “mini bonds”, are unlisted bonds typically issued by companies to retail investors in order to raise finance. The issuance of NTDS is generally not a regulated activity for the purposes of FSMA, due to an exclusion under Article 18 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (RAO) for firms that issue their own securities. However, the marketing of such products falls within the scope of the UK Financial Promotions Regime.

HM Treasury’s consultation forms part of a review into the regulatory arrangements in place for the issuance of NTDS to retail investors that was prompted by the administration of London Capital & Finance plc (LC&F) in January 2019. LC&F had issued NTDS bought by over 11,000 investors with a total value of more than £230 million. An independent FCA investigation into the FCA’s supervision of LC&F was published in December 2020 and made specific recommendations for the government to consider regulating NTDS issuance.

The consultation proposes the following options for regulatory reform:

• making the direct-to-market issuance of certain NTDS, where the proceeds of the issue are used to on-invest or on-lend, a regulated activity;
• extending the scope of the UK Prospectus Regulation to cover NTDS, so that public offers of NTDS would require an FCA-approved prospectus; the issuance of an NTDS would therefore remain an unregulated activity; and
• relying on other FCA and HM Treasury measures, such as future changes to the financial promotions regime, without introducing any additional regulation regarding the issuance of NTS; this would address only the marketing of NTDS and mean there remains limited regulatory oversight in the design, governance, and functioning of NTDS.

The UK government believes that making the direct-to-market issuance of NTDS a regulated activity would best address the issues identified with the current regulatory framework. The consultation is open until 21 July 2021.

9. EU Sustainable Finance

EU Sustainable Finance Package

On 21 April 2021, the European Commission published a communication on a sustainable finance package, comprising a package of measures to help improve the flow of money towards sustainable activities across the EU.

The Communication includes the following package of measures:

• EU Taxonomy Climate Delegated Act. The delegated act contains a set of technical screening criteria that define which activities contribute to the first two environmental objectives contained in the Taxonomy Regulation: climate change adaptation and climate change mitigation. It includes sectors such as energy, forestry, manufacturing, transport, and buildings. Decisions on nuclear power and natural gas, which have attracted public debate, have been postponed. The delegated act will apply from 1 January 2022.
• Corporate Sustainability Reporting Directive (CSRD). The Commission adopted a proposal for the CSRD that would amend the existing reporting requirements of the Non-Financial Reporting Directive (NFRD). In particular, the CSRD would:
  • Extend the scope of the NFRD to all large companies and all companies listed on EU regulated markets (except listed micro-enterprises).
  • Introduce more detailed sustainability reporting requirements, applicable as of 1 January 2026. The requirements include “double materiality” reporting on the company’s impact on sustainability matters and on the impact of those matters on the company’s financial performance. The proposal also includes a requirement for the Commission to adopt mandatory EU sustainability reporting standards, to be based on the work of international standards for sustainability reporting as well as existing EU legislation such as the Sustainable Finance Disclosure Regulation and the Taxonomy Regulation. The Commission is expected to adopt a first set of such standards by 31 October 2022 and a second, complementary set at latest by 31 October 2023.
• Delegated legislation integrating sustainability into the UCITS Directive, the Alternative Investment Fund Managers Directive (AIFMD), MiFID II, Solvency II, and Insurance Distribution Directive. The European Commission adopted six Commission Delegated Regulations and Directives on fiduciary duties, investment, and insurance advice to ensure that financial firms (including advisers, asset managers, and insurers) include sustainability in their procedures and their investment advice to clients. The delegated acts also aim to clarify a number of implications resulting from the Sustainable Finance Disclosure Regulation and the Taxonomy Regulation. The Commission consulted on draft versions of the texts in June 2020, and the adopted acts will now be subject to the scrutiny by the European Parliament and the Council.

Amongst others, these proposals may be of relevance to non-EU fund managers (such as U.S. and UK fund managers) that market funds into the EU and, therefore, are caught in scope of the EU SFDR.

For information on the ESG disclosure rules to which non-EU fund managers may be subject, please see our Sidley Update EU Sustainable Finance Disclosures Required From 10 March 2021 – Action Points for Non-EU Fund Managers.

10. EU EMIR

European Commission Implementing Decision on equivalence of U.S. DCMs

On 9 April 2021, the European Commission updated its equivalence decision with respect to the U.S. designated contract markets (DCMs), which the European Commission considers to be equivalent to EU derivatives trading venues.

The effect of the decision is that contracts executed on the relevant DCMs can be excluded from the definition of “OTC Derivatives” for the purposes of EMIR and so can be discounted from the calculation of the EMIR clearing thresholds by derivatives users.

The DCMs that have been added are Bitnomial Exchange, LLC; KalshiEX, LLC; LedgerX, LLC; LMX Labs, LLC; and Small Exchange, Inc. Nasdaq Futures, Inc., is no longer on the list.

This is relevant to firms with EU derivatives trading vehicles and thus are subject to EU EMIR.

11. EU SFTR / UK SFTR

ESMA publishes updated statement on LEI reporting requirements for third-country issuers

On 13 April 2021, ESMA published an updated statement regarding the implementation of legal entity identifier (LEI) requirements for third-country issuers under the reporting regime for securities financing transactions as set out in the EU SFTR.

The updated statement maintains ESMA’s position as at 6 January 2020; however, it extends the timeline for reporting of LEIs of third-country issuers of securities used in securities financing transactions (SFTs) until 10 October 2022. During this period, ESMA expects the following:

• Trade repositories will not reject SFT reports of securities without a third-country issuer LEI that are lent, borrowed, or provided as collateral in an SFT.
• Counterparties and other entities participating in SFTs, such as agent lenders and triparty agents that lend, borrow, or use as collateral securities issued by third-country entities that do not have an LEI will liaise with third-country issuers to ensure they are aware of the requirements under the EU SFTR.

As LEI coverage remains unsatisfactory on a global scale, ESMA expects competent authorities to continue not to prioritise their supervisory actions in relation to reporting of LEIs of third-country issuers. ESMA will continue to engage with third-country competent authorities to make them aware of the EU SFTR LEI reporting requirement and solicit a broader coverage of LEIs in third countries. ESMA will give advance notice to market participants before 10 October 2022 regarding any potential revision to its position on third-country issuer LEI reporting.

The FCA announced on 6 April 2021 that LEIs of non-European Economic Area (EEA) third-country issuers will not need to be reported under the UK version of the EU SFTR (UK SFTR) until at least 13 April 2022. The reporting timeline for firms subject to the UK SFTR is thus now slightly shorter than that for reporting under the EU SFTR. In the interim, the FCA also expects reporting counterparties to continue engaging with non-EEA third-country issuers to obtain an LEI and to report an LEI for such issuers where available.

This may be of relevance to firms with an SFT trading vehicle that is established in the EU and/or UK, respectively.

ESMA publishes updated Q&As on data reporting under EU SFTR

On 6 April 2021, ESMA published an updated version of its Q&As on complying with reporting requirements under the EU SFTR. The updated Q&As clarify reporting of SFTs when an external portfolio manager is used.

12. LIBOR Transition

Working Group paper published to support the transition of GBP LIBOR legacy structured products

On 19 April 2021, the Working Group on Sterling Risk-Free Reference Rates (the Working Group), of which the Bank of England and the FCA are ex-officio members, published a paper to support the transition of legacy structured products where GBP LIBOR is in use.

To help market participants complete their operational transition plans for structured products by the end of 2021, the Working Group encourages participants to consider issuing new structured products based on compounded in arrears sterling overnight interbank average rate (SONIA). The Working Group also encourages market participants to amend their legacy GBP LIBOR referencing structured products now where it is feasible to do so.

For further information on the Working Group's priorities and roadmap for the final year of LIBOR transition, see our February 2021 Update.

Working Group statement on LIBOR transition and paper on fallbacks for uncleared derivatives

On 23 April 2021, the Working Group published a statement on the active transition of legacy GBP LIBOR contracts across bonds, loans, and derivatives. It suggests that by the end of Q3 2021, market participants should complete active conversion of all legacy GBP LIBOR contracts expiring after end-2021 or ensure that robust fallbacks are adopted where possible.

The Working Group also published a paper on fallbacks in uncleared linear derivatives. The paper sets out considerations for market participants on the operational aspects and preparation of fallbacks; these include, amongst other things, trade booking infrastructure, risk management, and regulatory reporting. Whilst the paper endorses the ISDA IBOR Fallbacks Supplement and 2020 IBOR Fallback Protocol, it also encourages market participants to consider active transition rather than reliance on the ISDA fallback.