UK/EU Investment Management Update (May 2023)

1. UK — FCA Updates

2. EU — ESG

3. EU — MiFID

4. EU — MiCA

1. UK — FCA Updates

FCA publishes its Business Plan 2023/24, setting out its priorities

On 5 April 2023, the FCA published its Business Plan for 2023/24, setting out its priorities for the year in line with the 13 commitments made in its 2022-25 Strategy.

Of its 13 commitments for 2022-25, the FCA intends to prioritise the following four this year: (i) preparing financial services for the future; (ii) reducing and preventing financial crime; (iii) putting consumers’ needs first; and (iv) strengthening the UK’s position in global wholesale markets. The FCA’s plans in each of these areas are summarised below.

• Preparing financial services for the future

The FCA intends to work with HM Treasury to establish the new financial services regulatory framework proposed in the Financial Services and Markets Bill (FSM Bill). For details on the FSM Bill, please see our August 2022 Update.

Key activities for the year in this regard are to progress the replacement of firm-facing requirements in retained EU law with FCA rules and to implement changes to the FCA’s objectives, regulatory principles, and accountability arrangements as a result of the FSM Bill.

• Reducing and preventing financial crime

Financial crime will be a significant focus for the FCA this year. The FCA intends to continue to strengthen its authorisation process, increase the volume of its proactive assessments of regulated firms’ anti-money-laundering systems and controls, and increase resources in its Enforcement and Market Oversight Division.

• Putting consumers’ needs first

The FCA intends to continue to make the Consumer Duty an integral focus of its regulatory approach at every stage of the regulatory lifecycle. For a discussion of the Consumer Duty, please see our Updates of February 2023, January 2023, and May 2022.

• Strengthening the UK’s position in global wholesale markets

The FCA intends to update the UK regulatory framework for wholesale markets to align with the FSM Bill and the government’s wider policy objectives.

This is expected to include changes to the UK rules implementing MiFID and the UK versions of the Markets in Financial Instruments Regulation (MiFIR), the Prospectus Regulation, the Securitisation Regulation, and the Short Selling Regulation as well as proposals relating to the regulation of asset management (as to which, please see our Sidley Update FCA’s Post-Brexit Review of the UK Asset Management Regime).

In relation to the FCA’s broader set of commitments, key points for asset managers are set out below.

• Delivering assertive action on market abuse

The Business Plan includes a significant section on market abuse, noting the FCA’s aims to ensure firms are more resilient to market abuse and have robust systems and controls, high-quality reporting practices, and a strong anti-market-abuse culture.

The FCA’s plans for the year in this regard include:

• significantly improving its capability to detect and prosecute fixed income and commodities market manipulation through increased data capture, improved analytics, a dedicated non-equity-manipulation team, and increased enforcement resources; and
• implementing a coordinated approach across the FCA on very high-risk firms where multiple regulatory failures, including market abuse, undermine market confidence.

• Continuing to embed the Investment Firm Prudential Regime (IFPR)

The FCA intends to continue publishing findings from initial IFPR implementation amongst relevant firms, including examples of best practice.

The FCA has already published initial observations relating to the internal capital adequacy and risk assessment (ICARA) process and reporting under the IFPR on 27 February 2023, as discussed in our April 2023 Update.

• Improving oversight of appointed representatives (ARs)

The FCA intends to test that principal firms of ARs are properly embedding the new AR rules, by increasing engagement with prospective principal firms at the point of application and on an ongoing basis. This enhanced scrutiny of principal firms will be of particular interest to asset managers using AR models, such as under regulatory hosting arrangements. For further details on the new AR rules, please see our Sidley Updates of December 2022 and August 2022.

• Collaborate with all its stakeholders to build its environmental, social, and governance (ESG) regulatory framework

The FCA intends to continue to actively monitor how effectively firms are implementing climate-related financial disclosures as well as finalise and publish its rules on the UK’s Sustainability Disclosure Requirements (SDR) and investment labels. For a discussion on the FCA’s prior Consultation Paper on SDR, please see our Sidley Update Financial Conduct Authority Consultation on UK Sustainability Disclosure Requirements — Five Key Takeaways for Asset Managers (November 2022).

FCA publishes final rules on reforms to UK equity secondary markets

On 3 May 2023, the FCA published its policy statement on improving equity secondary markets (PS23/4). This forms part of the Wholesale Markets Review, the review of UK wholesale financial markets that the FCA has been conducting with HM Treasury.

In PS23/4, the FCA summarises feedback to its consultation paper (CP22/12) and sets out its final changes to technical standards in relation to post-trade transparency, the introduction of the new ‘designated reporter regime’ (DRR), pre-trade transparency waivers, and the tick size regime.

The new post-trade transparency requirements will enter into force in April 2024. The changes to pre-trade transparency waivers and to the tick size regime will apply immediately.

We summarise the changes likely to be of most relevance to asset managers below.

Post-Trade Transparency — exemptions and report contents

The FCA will proceed with its proposed modifications to certain exemptions from post-trade transparency requirements. This includes the following changes:

- Inter-fund transfers. The FCA is modifying the inter-fund transfers exemption to clarify that it applies to investment firms carrying out portfolio management. In response to feedback, it will also make amendments to the exemption to clarify that it may still apply where another investment firm is party to the transaction, provided this is solely for operational purposes, and that the exemption applies to segregated mandates as well as collective investment undertakings.

- Give-ups/ins. The FCA is extending the exemption for give-up/in transactions to include request for market data give-up/in transactions.

- Inter-affiliate transactions. The FCA is introducing an exemption for inter-affiliate transactions for intra-group risk management purposes. In contrast with the original proposal, the FCA will not require such transactions to be carried out as part of a centralised booking model.

The FCA also received support from respondents on, and will continue with its proposals relating to, the deletion of various reporting flags that do not provide meaningful information.

Post-Trade Transparency — designated reporter regime (DRR)

The FCA will proceed with its proposed DRR. This will allow firms to opt to register themselves with the FCA as a designated reporter (DR) for trade reporting purposes. This is intended to replace and simplify the existing rules under which the trade reporting obligation is determined, which, among other matters, requires counterparties to determine whether one of them is a systematic internaliser (SI) at the level of the relevant instrument.

The FCA will proceed with applying the DR designation at entity level, rather than asset-class level, despite feedback from sell-side firms that this would require expansion of their publication arrangements under the existing SI regime (which applies at instrument level) to cover asset classes in which they do not currently classify as SIs. On the contrary, this will be a welcome decision for buy-side firms, which will not be required to check whether instruments they trade with liquidity providers are within an asset class for which the provider is registered as a DR.

The FCA will however amend its initial proposal to provide the option for DRs to bilaterally agree, explicitly and in advance, which party shall fulfil the reporting obligation. The seller will always have the regulatory obligation to report but may discharge this by entering into an agreement with the buyer whereby the buyer agrees to report on its behalf.

Tick Size Regime

The FCA will proceed with allowing trading venues to adopt the minimum tick size of the primary market (i.e., the trading venue where the share was first admitted to trading) located overseas when that tick size is smaller than the one determined based on calculations using data from UK venues.

Trading venue market outages

The FCA plans to form a subcommittee to work on good practices involving relevant stakeholders and provide confirmation to industry guidance if appropriate. The FCA will assist trading venues in developing communication protocols for handling outages and propose amendments to the waivers regime, allowing reference prices to be derived from multiple markets.

FCA decides to fine for Banque Havilland £10 million and three former employees in market manipulation case

The FCA has published Decision Notices imposing fines on Banque Havilland (the Bank), three of the Bank’s former employees, as well as banning those former employees from working in financial services, in relation to findings of market manipulation.

According to the Decision Notices, the Bank acted without integrity by creating and disseminating a presentation in late 2017 that contained improper advice for potential investors by recommending manipulative trading strategies aimed at creating a false or misleading impression as to the market in, or the price of, Qatari bonds. The objective of this was to devalue the Qatari riyal and break its peg to the U.S. dollar, thereby harming the economy of Qatar.

Although the strategy was not found to have been carried out, the FCA note that the trading could have been a criminal offence had it taken place in the UK.

The FCA considers the Bank to have had the intention of making the presentation available to representatives of countries it considered might have reasons to want to put economic pressure on Qatar, including the United Arab Emirates, as a way of marketing its services.

The FCA found that Edmund Rowland, former London branch CEO of the Bank, tasked Vladimir Bolelyy, a former London branch employee, to draft the presentation and that David Weller, a former London branch senior manager, made a significant contribution to the content. Later, Mr Rowland and Mr Bolelyy were found to have disseminated the presentation, including by providing a copy to a representative of an Abu Dhabi sovereign wealth fund.

The FCA has decided that all three individuals failed to act with integrity and are not fit and proper persons to perform any function in relation to any regulated activities. The actions of Mr Rowland and Mr Weller are viewed as particularly serious due to their positions of significant influence involvement in the creation of the presentation.

The FCA has decided to fine the Bank £10 million, Mr Rowland £352,000, Mr Weller £54,000, and Mr Bolelyy £14,200.

The Bank and each individual other than Mr Weller have referred their Decision Notices to the Upper Tribunal, where they will each present their case.

FCA publishes Market Watch 72 on its peer review into CFD providers

On 26 April 2023, the FCA published Market Watch 72, in which it discusses its findings from a market abuse peer review into firms that offer CFDs and spread bets (CFD providers). Whilst the review is of direct relevance to CFD providers, certain findings and recommendations will be relevant to participants in the CFD market more broadly, including asset managers.

The FCA notes that CFDs are particularly vulnerable to being used for insider dealing due to the speculative and leveraged nature of the products and are a major source of Suspicious Transaction and Order Reports (STORs).

The FCA makes the following observations from its review:

• Market abuse risks. While all firms recognised insider dealing in single stock equities as the predominant market abuse risk, there was little consideration of CFDs in non-equity asset classes in firms’ market abuse risk assessments and limited detail about market manipulation across all asset classes. The FCA notes that the risk of manipulation can differ within asset classes as well as between asset classes (e.g., trading in less liquid stocks, such as alternative investment market (AIM) stocks, could offer a greater opportunity for manipulation). Firms should therefore consider how market abuse could occur in all asset classes traded via CFDs.
• Market abuse surveillance responsibilities. The FCA notes that, in smaller firms, it may be proportionate for market abuse surveillance responsibility to rest with teams or individuals outside of Compliance rather than with an independent Compliance function. Where this is the case, more effective arrangements involve conflicts being considered and mitigated (e.g., through independent oversight and quality assurance).
• Surveillance systems. Firms are advised to adequately consider how long inside information might exist for and use an appropriate ‘lookback period’ in their surveillance systems to identify instances of suspicious trading and ensure that the coverage of such systems is adequate to cover non-equity asset classes.
• Surveillance alert investigations. When reviewing alerts for insider dealing, firms should use all relevant information available to them. Factors such as increased option volumes, blog articles, analyst recommendations, and stock sentiment may be relevant, but trading history is also an important factor to consider to sufficiently assess reasonable suspicion of market abuse. For example, when firms look at the publication of a blog article, or increased options volumes, considering the probability of a client consistently trading only in those stocks where a blog article/increased options volume was followed by a significant news story and movement in price would be helpful in detecting market abuse.
• Front office and tipping-off risk. Firms’ Compliance functions were found to be generally reluctant to provide feedback to front office on surveillance matters, such as a STOR submission, due to concerns about tipping off. However, the FCA sees a need to strike a balance in this regard. In particular, while the submission of a STOR should be shared only on a need-to-know basis, Compliance should challenge and educate front office staff to improve their understanding of the requirements.

FCA issues further guidance on enhancing resilience in Liability Driven Investment

On 24 April 2023, the FCA published guidance and recommendations for Liability Driven Investment (LDI) managers on enhancing resilience in the LDI sector. This follows the FCA’s collaboration with UK and international regulators on enhancing resilience in the LDI sector, as well as its engagement with asset managers, as discussed in our November 2022 Update.

The FCA stated that across the LDI sector, issues such as risk management, stress testing, communication, and operational arrangements contributed to the market dysfunction and financial instability of September 2022.

The guidance recommends a broad set of operational arrangements for LDI fund managers to follow, including ensuring effective stress testing accounting for various scenarios, enhanced ability to deliver collateral to clients (with a stated delivery timeframe of five days), and obligations on managers to review potential conflicts of interest with their clients.

LDI managers are expected to improve operating practices to address identified deficiencies. The FCA will work with firms to assess progress and compliance with guidance from other authorities.

2. EU — ESG

European Commission responds to ESAs’ questions on the interpretation of SFDR

On 14 April 2023, the ESAs published questions and answers (Q&As) setting out the Commission’s responses to a series of questions the ESAs had posed in September 2022 regarding the interpretation of SFDR. Minor amendments to previous Q&As were published in parallel.

Certain key points arising out of the Commission’s responses are summarised below.

• Sustainable investments
  • The definition of a “sustainable investment” under SFDR does not prescribe any specific approach or methodology to determine the contribution of an investment to environmental or social objectives. Financial market participants (FMPs) must however ensure that their chosen methodology is disclosed.
  • Further, the notion of sustainable investment can be measured at the level of a company and not only at the level of a specific activity. The reference to an “economic activity” in the sustainable investment definition does not imply that funding instruments must specify a specific project or activity or that an investee company must be engaged in one type of activity only. Sustainable investments could include funding instruments that do not specify a use of proceeds, such as the general equity or debt of an investee company.
• DNSH
  • For the purposes of assessing whether an investment does no significant harm (DNSH) to any environmental or social objective, establishing that an investee company has a transition plan aiming to mitigate harms to such objectives may not be considered sufficient.
• Carbon emissions reduction
  • An Article 8 product may promote “carbon emissions reduction” as an environmental characteristic, rather than products having such an aim being required to be treated as, and therefore comply with the disclosure requirements of Article 9(3) SFDR.
  • A product with an objective of reduction in carbon emissions can fall within the scope of Article 9(3) SFDR whether it applies an active or passive investment strategy.
• PAIs
  
  • Product-level disclosures of the consideration of principal adverse impacts (PAI) under Article 7 SFDR should include both a description of the adverse impacts themselves and the procedures the FMP has in place to mitigate those impacts.
  • The definition of “employee” for the purposes of the 500-employee threshold requiring mandatory consideration of PAIs at entity level should be determined by reference to the definition of employee under the applicable national law.
• Portfolio manager reporting
  • Portfolio managers reporting to clients on a quarterly basis in accordance with their obligations under MiFID must include the annual reporting information required under Article 11 SFDR in every fourth quarterly report.

ESAs publish joint consultation paper on SFDR RTS

On 12 April 2023, the ESAs published a joint consultation paper setting out proposed amendments to the SFDR RTS.

The ESAs proposed amendments to numerous aspects of the SFDR RTS with an aim of broadening the disclosure framework and enhancing transparency for investors.

Feedback is requested by 4 July 2023. There is no current indication on the timing for publication of final rules. Certain of the more significant proposals are summarised below.

Extending the list of social PAI indicators

The ESAs propose to introduce new mandatory and voluntary social PAI indicators. The proposed new mandatory social PAI indicators are:

• amount of accumulated earnings in non-cooperative tax jurisdictions;
• exposure to companies involved in the cultivation and production of tobacco;
• interference in the formation of trade unions or election of worker representatives; and
• share of employees earning less than the adequate wage.

Additional voluntary social PAI indicators include excessive use of non-guaranteed-hour employees in investee companies, insufficient employment of persons with disabilities within the workforce, and lack of grievance/complaints handling mechanism for communities affected by the operations of investee companies. The ESAs are also seeking feedback on how to extend the social PAI indicators to investments in real estate assets.

Technical revision of the PAI framework

Several changes are proposed to the existing PAI indicators and their calculations, including:

• adjusting certain PAI indicators and introducing new formulae for PAI indicators that do not currently have them;
• clarifying that the inclusion of information on investee companies’ value chains in the PAI calculations is required only where the investee company reports them; and
• requiring the inclusion of any derivative with an equivalent long net exposure to count towards the numerator of PAI indicator calculations, unless the FMP can show that the derivative does not ultimately result in a physical investment in the underlying security by the counterparty or any other intermediary in the investment chain. This would not affect the denominator, which should always include derivatives.

DNSH test for sustainable investments

The ESAs note their concern with the discretion given to FMPs, and consequent lack of consistency in the market, in relation to DNSH frameworks and how these are disclosed to investors. The ESAs note that this risks undermining the comparability of financial products and could lead to greenwashing of sustainable investments.
The ESAs propose several alternative approaches in response to this:

• maintaining the status quo, avoiding potential market disruption and significant implementation efforts for the industry, but noting that this preserves the weaknesses of the current framework;
• requiring more specific DNSH disclosures, including disclosure of quantitative thresholds relating to the PAI indicators used to assess DNSH of sustainable investments in FMPs’ product-level website disclosures as well as an indication in the pre-contractual and periodic disclosures that these thresholds are available on the website;
• providing an optional safe harbour for Taxonomy-aligned investments, allowing such investments to be deemed sustainable investments; or
• shifting to a single Taxonomy-based system for DNSH, such that the technical screening criteria (TSC) under the Taxonomy form the basis of DNSH assessments under SFDR.

Commission consults on criteria for four remaining environmental objectives under EU Taxonomy

On 5 April 2023, the Commission launched a four-week consultation on a draft delegated act setting out TSC for the four remaining (non-climate) environmental objectives under the EU Taxonomy (Taxo 4). The Taxo 4 are the objectives of:

• sustainable use and protection of water and marine resources;
• transition to a circular economy;
• pollution prevention and control; and
• protection and restoration of biodiversity and ecosystems.

The consultation also proposed a draft delegated act making targeted amendments to the existing Taxonomy Climate Delegated Act, which specifies the TSC for the objectives of climate change mitigation and climate change adaptation. The changes including the addition of certain economic activities to those objectives.

The proposed delegated acts build on the recommendations of the Platform on Sustainable Finance, which were submitted to the Commission in March and November 2022.

The consultation closed on 3 May 2023. The Commission will now decide whether to make any changes to the drafts and adopt the delegated acts, which are expected to apply from 1 January 2024.

Assuming finalization of the delegated acts by this date, financial market participants would be able to disclose the Taxonomy alignment of their products against the Taxo 4 objectives (and the newly added activities for the existing climate objectives) from 1 January 2024.

Commission launches EU Taxonomy Navigator

Alongside its consultation on Taxo 4 and the Taxonomy Climate Delegated Act, on 5 April 2023 the Commission launched its EU Taxonomy Navigator. The EU Taxonomy Navigator provides three online tools to support users in navigating the EU Taxonomy.

The tools are as follows:

• EU Taxonomy Compass. A visual representation of sectors, activities, and criteria included in the EU Taxonomy, aiming to make the contents of the EU Taxonomy easier to access for a variety of users. It enables users to check which activities are included in the EU Taxonomy, to which objectives they substantially contribute, and what criteria have to be met for economic activities to be considered Taxonomy-aligned;
• EU Taxonomy Calculator. A step-by-step guide on reporting obligations, which is intended to help users understand their reporting obligations under Article 8 of the Taxonomy Regulation and filling out the required templates the Disclosures Delegated Act. This calculator is focused on requirements for non-financial undertakings but may be relevant for managers’ portfolio companies; and
• FAQs repository. An overview of questions and answers related to the EU Taxonomy, its delegated acts, and the TSC.

The Commission also announced it will publish an EU Taxonomy User Guide, which will help explain what the EU Taxonomy is and how it fits within the wider EU sustainable finance regulatory framework.

3. EU — MiFID

ESMA publishes translations of guidelines on MiFID remuneration and suitability requirements

On 3 April 2023, ESMA published the official translations of two sets of guidelines: on certain aspects of the remuneration and on suitability requirements under MiFID.

The guidelines on certain aspects of the MiFID remuneration requirements relate to the application of ex-post adjustment mechanisms. The guidelines on certain aspects of the MiFID suitability requirements aim to integrate sustainability factors, risks, and preferences into certain organisational requirements and operating conditions for investment firms.

The publication of the translations triggers a two-month period during which EU national competent authorities must notify ESMA whether they comply, or intend to comply, with each set of guidelines.

Both sets of guidelines will apply six months after the date of their publication on ESMA’s website in all EU official languages, that is, from 3 October 2023.

4. EU — MiCA

On 20 April 2023, the European Parliament voted to adopt the text of MiCA as well as the regulation on information accompanying transfers of funds and certain crypto-assets.

MiCA will establish an EU-wide regulatory framework for the issuance, offering to the public, and admission to trading of crypto-assets and the provision of certain crypto-asset services. For further detail on the requirements to be introduced by MiCA, please see our Sidley Update How Will the EU Markets in Crypto Assets Regulation Affect Crypto and Other Financial Services Firms?

It is expected that MiCA will be published in the Official Journal by the end of June 2023 and enter into force in July 2023. The provisions relating to the regulation of stablecoins will apply from July 2024. The remaining provisions will apply from January 2025.