UK/EU Investment Management Update (April 2024)
HM Treasury provides progress update on SRF
The SRF, announced in December 2022 (as part of the UK Chancellor’s Edinburgh Reforms), is the process through which retained EU financial services law will be replaced and repealed by rules determined by the FCA and the Prudential Regulation Authority (PRA) of the Bank of England.
On 21 March 2024, HM Treasury published an update on the progress of the SRF, noting that as of February 2024, the government had removed 44% of retained EU financial services law, totalling 344 different legislative instruments. Additionally, the government has made or laid statutory instruments to replace regulations in a number of key areas including the Prospectus Regulation, the Data Reporting Services Regulations, and the Securitisation Regulation.
Draft replacement regulations have been published for technical feedback on the Short Selling Regulation and the Packaged Retail and Insurance-based Investment Products Regulation, as discussed in our December 2023 Update.
The next phase of the SRF, Tranche 3, will focus on the largest and most complex policy areas, including the:
- AIFMD, focusing on the priority areas outlined in Ashley Alder’s (FCA Chair) speech of 12 October 2023, covered in our November 2023 Update;
- Undertakings for Collective Investment in Transferable Securities Directive (UCITS Directive);
- Markets in Financial Instruments Directive, and related regulation (MiFID II and MiFIR), focusing on organisational requirements and transaction reporting; and
- European Market Infrastructure Regulation (EMIR), starting with provisions on central counterparties.
For each of the above files, HM Treasury will undertake a policy review, where necessary, to determine what should be retained in legislation and the respective future roles of HM Treasury and the FCA.
FCA publishes 2024-25 Business Plan
On 19 March 2024, the FCA published its Business Plan for 2024-25, setting out its priorities for the year in line with the 13 commitments made in its 2022-25 Strategy (Strategy).
The FCA intends to prioritise the following three commitments this year:
- Reducing and preventing financial crime: The FCA intends to continue investing in intelligence and data systems to detect fraudulent activity, strengthen proactive assessments of firms’ anti-money-laundering controls, and work with the National Economic Crime Centre to reduce financial crime in the UK.
- Putting consumers’ needs first: The FCA intends to engage in various supervisory activities over the next 24 months, targeted at ensuring the proper implementation of the Consumer Duty (effective from 31 July 2023), including multifirm work, market studies across sectors, and reviews of firms’ treatment of vulnerable customers.
- Strengthening the UK position in global wholesale markets: The FCA intends to encourage innovation and evolving markets by supporting industry work on T+1 settlement, fund tokenisation, and finalising the design and implementation of the consolidated tape for bonds, before deciding on the approach for equities.
The FCA intends to continue work on its other 10 Strategy commitments, including:
- Taking assertive action on market abuse: increasing resources, using analytics to detect cross-asset class abuse, and monitoring fixed income and commodities markets.
- Reducing harm from firm failure: using data and horizon-scanning to pre-empt firm failures and protect consumers and markets.
- Minimising operational disruptions: engaging industry on operational resilience practices and mitigating risks from critical third parties.
- ESG priorities: rolling out and expanding sustainability disclosure requirements and working with the government and PRA on sustainable finance regulation more generally.
FCA publishes findings from 2023 AIFM hosting review
On 25 March 2024, the FCA published its findings from its review of AIFMs using the host AIFM model to manage AIFs. This follows previous supervisory work published by the FCA in 2019.
The FCA’s review focussed on assessing AIFMs using the host model and their understanding of and compliance with their regulatory responsibilities, particularly in situations where secondees from appointed representatives (AR) were placed with an AIFM principal firm.
The FCA identified the following potential harms and set out guidance for firms operating the AIFM host model with respect to these:
- Lack of oversight of seconded staff. The FCA found that in most cases seconded employees from third parties were supervised remotely and were not physically working at the offices of the AIFM, potentially increasing the risk of harm. The FCA encourages firms to implement robust monitoring processes to review the secondees’ fund-related activities and transactions and notes that where an AIFM is principal for an AR, it must inform the FCA about proposed secondments when adding new ARs on Connect.
- Insufficient involvement in investor due diligence. The FCA found that AIFMs employing secondees were typically not involved in onboarding checks for investors into funds and instead typically used third parties. The FCA emphasised that AIFMs must have appropriate systems and controls to counter the risk of the firm’s being used to facilitate financial crime, including money laundering risks. If not directly involved in the due diligence process, AIFMs should undertake regular reviews and audits of the files of any third parties to which these functions are delegated.
- Inadequacies in capital adequacy calculations. The FCA found that most firms did not directly factor in the number of AIFs or ARs when calculating their capital requirements. The FCA noted that while there is no explicit requirement for AIFMs to hold more capital when taking on new ARs, they should fully consider the risks when assessing adequate financial resources and preparing their internal capital and risk assessment.
FCA issues interim update on asset management and alternatives supervisory strategy
On 1 March 2024, the FCA published a portfolio letter addressed to the CEOs of asset management firms and alternatives portfolios providing an interim update on its supervisory strategy. Among the supervisory priorities the FCA highlights for the asset management sector for this year:
- Change management. The FCA will assess firms’ preparedness for complying with the new sustainability disclosure requirements and investment labels. The FCA notes, where firms promote their environmental, social, and governmental (ESG) credentials, their boards and other governance bodies should be appropriately structured to oversee and review management information about those activities, the third-party ESG information providers used, and the claims made by their firms. The FCA will be concerned if firms make exaggerated or misleading sustainability-related claims.
- Valuation practices for private assets. The FCA will conduct a multifirm review (targeted at UK asset managers) examining valuation practices for private assets, including the governance of valuation committees and oversight by relevant boards.
- Supporting innovation. The FCA will support the UK Asset Management Taskforce to identify and harness potential innovative new technologies, such as fund tokenisation.
- Policy priorities. The FCA will undertake work to implement the government’s SFR (as discussed above) with a focus on UK MiFID, AIFMD, and UCITS.
HM Treasury reinstates thresholds for high net worth and sophisticated investors financial promotions exemptions
On 5 March 2024, HM Treasury published the Financial Services and Markets Act 2000 (Financial Promotion) (Amendment and Transitional Provision) Order 2024 (the 2024 Order), which amends the high net worth individual exemption and self-certified sophisticated investor exemption (the FPO Exemptions) in the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005.
The 2024 Order follows significant stakeholder concerns raised about the potential unintended effects of changes previously made to the eligibility criteria for the FPO Exemptions by the Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) (No. 2) Order 2023 (the 2023 Order). For an overview of the changes made by the 2023 Order, see our December 2023 Update.
Key amendments to the FPO Exemptions made by the 2024 Order:
- Reducing the financial thresholds for the high net worth individual exemption, to an income of at least £100,000 in the last financial year or net assets of at least £250,000 throughout the last financial year, thereby reinstating the thresholds in place prior to the 2023 Order.
- Amending the criteria for the self-certified sophisticated investor exemption, by reinstating the criteria in place prior to the 2023 Order, with respect to the number of transactions that must be made in an unlisted company in the previous two years, and the company turnover, required to qualify for the exemption.
The 2024 Order provides for a transitional period (running to 30 January 2025) for investor statements complying with the 2023 Order, after which investor statements that comply with the 2023 Order will have no effect.
UK government consults on PISCES
On 6 March 2024, HM Treasury published a consultation on the proposed creation of PISCES, a new financial market infrastructure sandbox offering private companies an intermediate step on the road to public markets. Under the proposal, PISCES would allow private companies to trade shares on an intermittent basis in a controlled environment, with an accompanying bespoke disclosure and market abuse regime tailored to the specific risks of the model.
Key features of the proposed PISCES framework:
- Only shares in private companies or public companies whose shares are not admitted to trading on a public market in the UK or abroad can be traded on PISCES.
- Access will be limited to institutional investors and potentially self-certified sophisticated retail investors, high net worth investors, and employees of participating companies. General retail investors will not be permitted access.
- PISCES will operate intermittent trading windows (e.g., monthly, quarterly, biannually), with bespoke disclosure requirements applying only during the trading windows. There will be no requirement for information to be disclosed to the public. Instead, information would only be made available to investors that may trade during the trading window.
- A tailored market abuse regime will apply during the trading windows, focusing on the key market abuse risks in the context of the PISCES model, such as false or misleading statements in company disclosures.
PISCES operators will need to apply to the FCA to participate in the sandbox. The sandbox will allow the government to test and refine the new regulatory framework over a period of up to five years before making the regime permanent.
The consultation closes on 17 April 2024. Subject to the outcome of the consultation, the government intends to lay legislation to establish the PISCES sandbox by the end of 2024.
FCA consults on draft Q&As for UK EMIR Reporting
On 1 March 2024, the FCA and the Bank of England published a joint consultation on draft Questions and Answers (Q&As) to provide guidance on the revised UK EMIR Article 9 derivative reporting requirements that will apply from 30 September 2024.
The Q&As cover various topics, including the following.
- Transitional arrangements: The new requirements will apply to all newly entered or modified derivative trades from 30 September 2024. For derivative trades entered into before this date, there will be a six-month transition period until 31 March 2025 to update outstanding derivative reports to the new requirements.
- Reconciliations: The Q&As clarify how Trade Repositories (TRs) should perform reconciliations for derivatives with two legs, the frequency of reconciliations, and the information TRs should provide entities responsible for reporting to support the identification of reconciliation breaks.
- Errors and omissions: Entities responsible for reporting are expected to remediate all errors and omissions, including for live and matured trades. Any material errors or omissions should be notified to the FCA as soon as practicable.
The consultation closed on 28 March 2024. The FCA intends to publish the finalised Q&As in due course and consult on additional Q&A topics later in spring 2024.
FCA position on cETNs for professional investors
On 11 March 2024, the FCA published a statement updating its position on cETNs for professional investors.
The FCA notes that it will not object to requests from Recognised Investment Exchanges (RIEs) to create a UK-listed market segment for cETNs, provided these products are made available only to professional investors, such as authorised investment firms and credit institutions. The FCA further notes that RIEs will need to ensure that sufficient controls are in place for orderly trading and proper investor protection and that cETNs must meet all UK Listing Regime requirements.
The FCA believes that with a longer period of trading history now available, exchanges and professional investors should now be able to better assess whether cETNs meet their risk appetite.
AIFMD2 final text published in the EU’s Official Journal
On 26 March 2024, the Commission published the final legislative text of AIFMD2 in the Official Journal of the EU. This follows the publication of the final compromise text on 10 November 2023, which we covered in our December 2023 Update.
We have published our analysis of AIFMD2 in our Sidley Update EU AIFMD2 - Implications of the Final Text.
EU Council publishes compromise text for CS3D
On 15 March 2024, the Council of the EU (Council) published a compromise text for the EU CS3D following its unsuccessful endorsement in February 2024 of the version the Council and the European Parliament reached provisional agreement on in December 2023 (the Provisional Agreement). For more detail and commentary on the Provisional Agreement, see our Sidley Update, New EU ESG Legislation Will Affect Non-EU Companies With Significant EU Revenues.
The compromise text deviates significantly from the Provisional Agreement, including crucially with respect to the scope of CS3D. The scope of companies that would be caught under CS3D has been significantly reduced, to the following:
- EU companies with more than 1,000 employees (doubled from the 500-employee threshold contained in the Provisional Agreement) and a net global turnover in excess of €450 million (tripled from the €150 million figure proposed by the Provisional Agreement). This change is expected to cover about 5,000 companies in the EU, a reduction in scope of approximately 60% compared with the original proposal, which would have covered almost 13,000 companies;
- non-EU companies with a net global turnover in excess of €450 million (compared with €150 million in the Provisional Agreement) generated inside the EU; and
- EU or non-EU companies that have franchising or licensing agreements with EU companies delivering annual royalty payments in excess of €22.5 million (compared to €7.5 million in the Provisional Agreement) and with a net global turnover in excess of €80 million (compared to €40 million in the Provisional Agreement).
The compromise text has eliminated the lower employee and net turnover thresholds for EU and non-EU companies operating in high-impact sectors (e.g., textiles, clothing, footwear, agriculture, forestry). However, the need for a high-risk sector approach has been added to the review clause, ensuring that the issue can be revisited no later than six years after the entry into force of the directive and every three years thereafter.
The European Parliament is due to vote on the final text of CS3D on 24 April 2024. If approved, Member States will have up to two years to transpose the directive into national law. The directive will be implemented in phases, with the largest EU and non-EU companies being the first to comply.
Commission publishes draft interpretative notice on the transitional provision of the MiFIR review
As discussed in our Sidley Updates of March 2024 and February 2024, EU MiFIR has been revised to enhance financial market data transparency, optimise orderly trading, and prohibit payments for forwarding client orders (Revised MiFIR). Revised MiFIR was published in the Official Journal of the EU on 8 March 2024 and entered into force on 28 March 2024.
With the Revised MiFIR entering into force on 28 March 2024, ESMA and the Commission each published guidance, on 27 March and 28 March respectively, to clarify the transitional provisions and application of the new rules for market participants.
ESMA’s public statement provides practical guidance on the application of certain MiFIR requirements, while the Commission’s draft interpretative notice focuses on the interpretation of the transitional provisions under Article 54(3) of the Revised MiFIR.
Both documents clarify that in areas where the Revised MiFIR provisions are to be supplemented by new/amended delegated regulations and cannot be adequately supplemented by existing delegated regulations, the existing provisions and delegated regulations will continue to apply until the new delegated regulations enter into application. This includes the following:
- The volume cap mechanism: The rules on the double volume cap continue to apply until the single volume cap becomes applicable under the new delegated regulation.
- Deferred publication of transactions: The current deferral rules continue to apply until the entry into application of the new delegated regulations on deferral schedules.
- Obligation to make pretrade and post-trade data available on a reasonable commercial basis: The current obligation continues to apply until the entry into application of the new delegated regulation.
- Systematic internaliser quotation rules in equity instruments: The current quotation rules continue to apply until the entry into application of the new delegated regulation.
- Transaction reporting obligation: The current rules continue to apply until the entry into force of the new delegated regulation.
The guidance aims to ensure legal certainty and a smooth transition for market participants pending the finalisation and application of the new delegated regulations supplementing the Revised MiFIR.
ESMA publishes feedback on shortening the settlement cycle
On 21 March 2024, ESMA published a feedback statement on its call for evidence on shortening the securities settlement cycle in the EU from the current T+2.
The feedback statement summarises responses received from 81 stakeholders. While there are mixed views on moving to a T+1 settlement cycle, respondents almost unanimously reject T+0 as too costly and complex to implement in the short to medium term.
Key challenges identified include the significant compression of the post-trade window, lack of automation, inventory management, complex cross-border transactions, FX trading, corporate actions, and securities lending.
Respondents suggest that benefits of T+1 could include harmonised settlement cycles globally, reduced counterparty and settlement risk, and lower margin requirements but warn of uneven distribution of costs and benefits.
ESMA aims to publish a final report in Q3/Q4 2024, providing an assessment of the appropriateness, costs, and benefits of moving to T+1. It will outline how this could be achieved, address any legislative barriers, and reflect lessons learned from T+1 implementation in other jurisdictions including the U.S.
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