UK/EU Investment Management Update (June 2024)
1. UK — FCA Asset Management Agenda
3. UK — Enforcement (Insider Dealing)
8. UK — Diversity and Inclusion
9. UK — MiFID II (Commodity Derivatives)
15. EU — MiFID II (Commodity Derivatives)
18. EU — Market Abuse Regulation
1. UK — FCA Asset Management Agenda
FCA announces agenda for UK asset management
On 22 May 2024, Ashley Alder, Chair of the FCA, delivered a speech on the FCA's agenda for the UK asset management sector at the Bloomberg Buy-side Forum.
Key points from the speech are summarised below:
- Smarter Regulatory Framework. The FCA continues to work on its approach to reform asset management regulation in the UK post-Brexit (details of which are discussed in our Sidley Update, FCA’s Post-Brexit Review of the UK Asset Management Regime). The FCA recognised the benefits of maintaining the onshored Undertakings for Collective Investment in Transferable Securities (UCITS) framework for managers of retail products whilst the UK approach may diverge from that of the EU for alternative managers with a professional investor base.
- NBFI and valuations. The FCA is focussed on facilitating data-driven monitoring of non-bank financial intermediation (NBFI). The FCA has concerns about the potential manipulation of valuations by NBFI and that any NBFI regulation at the UK and global levels should curb such risks adequately.
- Retail investments. Following the withdrawal of the Packaged Retail and Insurance-Based Investment Products (PRIIPs) Regulation, the FCA intends to consult on a new regime that offers both better protection for investors and proportionality to the managers under compliance.
- Sustainability disclosure requirements. The FCA emphasised its continued efforts on the new UK disclosure and labelling regime, recognising investor interest and the importance of the agenda globally.
- Fund tokenisation. The FCA mentioned its focus on innovation and its role as observers to the Technology Working Group that is exploring the implementation of fund tokens in the UK. The status quo is that any tokenisation is unlikely to trigger a rehaul of existing legal and regulatory framework.
FCA Market Watch 79 — Market Abuse Surveillance
On 9 May 2024, the FCA published Market Watch 79, the latest edition of its newsletter on market conduct and transaction reporting issues. In Market Watch 79, the FCA discusses:
- failures of market abuse surveillance caused by issues such as data and automated alert logic; and
- its recent peer firm review of firm’s testing of front-running surveillance models.
The FCA reminds firms that, under the UK Market Abuse Regulation (UK MAR), they must identify and report instances of potential market abuse and must have effective arrangements, systems, and procedures in place to detect and report suspicious activity.
The FCA states that it has become aware of some firms’ surveillance alerts not working as intended or assumed by the firm. For example, surveillance failures can occur when new systems are put in place, without the firm having undertaken the necessary testing, as well as because of faults at the coding, design, and implementation stages.
The FCA also shares its findings from a peer review of firms’ testing of front-running surveillance models. The FCA sets out steps that firms could undertake to avoid surveillance failures and ensure that issues do not go unidentified for prolonged periods of time. Key steps include:
- reviewing data governance to ensure that relevant trade and order data are being captured accurately and comprehensively, with measures in place to conduct checks and identify issues;
- ensuring that governance arrangements around model testing are sufficiently robust, effective, and formalised, without impeding adequate and productive tailoring;
- ensuring that formalised and robust testing is undertaken before introducing or amending surveillance models.
The FCA encourages firms to be vigilant against surveillance failures and to mitigate the risks, noting the likelihood of future innovation within surveillance functions, such as AI.
3. UK — Enforcement (Insider Dealing)
Insider dealing — sentencing
On 10 May 2024, the FCA announced that a former site manager at UK plastic manufacturer RPC Group plc (RPC) was sentenced to 18 months’ imprisonment and suspended for two years after being convicted of two counts of insider dealing in a prosecution brought by the FCA.
Through his employment, Stuart Bayes obtained inside information that RPC were about to announce the acquisition of British Polythene Industries plc (BPI).
Ahead of the market announcement of the deal, Bayes traded BPI shares, which resulted in a profit of £132,000. He also encouraged another individual to trade in BPI shortly before the markets closed; this individual was not found guilty of insider trading.
The FCA has commenced confiscation proceedings against Bayes, and a hearing is listed for 4 October 2024.
FCA delays publication of Regulatory Initiatives Grid following announcement of UK General Election
On 30 May 2024, the FCA updated its webpage on the Regulatory Initiatives Grid (RIG) to note that the eighth edition of the RIG has been delayed following the UK Government’s announcement of the General Election on 4 July. Members of the Financial Services Regulatory Initiatives Forum will consider when best to publish an update on the regulatory pipeline and initiatives later this year.
The RIG sets out the regulatory initiatives pipeline for the next 24 months. It is published twice a year to help firms and other stakeholders plan for forthcoming initiatives.
FCA update on operating service metrics
On 15 May 2024, the FCA published a report on its authorisations operating service metrics for 2023/24 Q4, with data covering January to March 2024.
The FCA reports this data to provide transparency on its performance and efficiency in processing authorisation applications.
As noted in our April 2023 Update, the FCA is required to determine applications for authorisation (as well as variations of permission) within six months of receiving a completed application. If the application is incomplete, the FCA must make a decision within 12 months.
Overall, the data reveals a high level of efficiency and effectiveness in meeting statutory deadlines, with 98.1% of applications across all metric areas determined within the statutory deadlines.
Additionally, the FCA published the lower, mean and upper quartile of the range of calendar days taken for determination in each category of application. It noted that the complexity of some cases means statutory targets are not always met, and this is due to taking further time to scrutinise and engage with firms.
The FCA also noted that there continue to be incomplete and poor-quality applications and that firms should review its authorisation pages for guidance.
FCA publishes first set of finalised UK EMIR reporting Q&As
On 2 May 2024, the FCA published its first set of finalised UK EMIR reporting Q&As (Q&As).
The Q&As provide guidance on implementing the recent changes made to the UK EMIR reporting framework. For further detail on these changes, see our Sidley Update 2024 European Market Infrastructure Regulation Refit — Changes to the EMIR Reporting Regime.
The Q&As are applicable from 30 September 2024, in line with the majority of the changes to the UK EMIR reporting framework.
The FCA has launched another consultation on a second set of draft UK EMIR reporting Q&As, closing on 12 June 2024.
FCA publishes Dear CEO letter to asset management firms
On 16 May 2024, the FCA published a Dear CEO letter addressed to asset management firms to support their implementation of the Consumer Duty for closed products and services by 31 July 2024.
Closed products are those entered into contractually with retail customers before the Consumer Duty came into effect on 31 July 2023 and that have not been distributed to retail customers (including by renewal) since that date. Firms were given an additional year to implement the Consumer Duty in respect of closed products.
With the deadline now less than two months away, the FCA highlighted five key areas firms should already be considering that are more likely to be widespread or acute for closed products: gaps in a firm’s customer data; fair value; treatment of consumers with characteristics of vulnerability; gone-away or disengaged customers; and vested contractual rights.
The FCA advises any firms that do not think they will be substantially compliant in respect of their closed products by 31 July 2024 to contact their normal supervisory contact at the FCA as soon as possible.
For a discussion of the Consumer Duty and how it applies to asset managers, see our Sidley Updates of March 2024, February 2023, January 2023, and May 2022.
FCA’s Sarah Pritchard delivers speech on capital market reforms
On 20 May 2024, Sarah Pritchard, Executive Director for Markets and International of the FCA, delivered a speech at City Week 2024 on capital market reforms entitled “Aiming for calm seas in our market reforms.”
Pritchard stated that the FCA is committed to making sure that regulation supports the UK's position in global wholesale markets while facilitating economic growth and competitiveness.
The package of reform, which Pritchard stated has an “ambitious agenda,” includes significant changes to the UK’s listing regime (as discussed in our March 2024 Update) and changes to the research payment rules applicable to UK asset managers to allow for a new bundled payment option (as discussed in our May 2024 Update).
Additionally, Pritchard noted that the FCA has shifted to outcomes-focussed regulation as it believes this approach will help to keep pace with innovation and changing markets.
AI was highlighted as an example where the FCA will apply an outcomes-driven approach. To provide certainty and encourage the safe adoption of AI in UK finance markets, the FCA intends to look at digital infrastructure, resilience, consumer safety, and data.
Pritchard also addressed concerns about the FCA’s new approach to publicization of enforcement actions, set out in its Consultation Paper (CP24/2) published in February 2024. Pritchard noted that time will be taken to consider feedback and that there will be further engagement with industry.
See our Sidley Updates of May 2024 and March 2024 for further discussion of CP24/2.
FCA publishes Primary Market Bulletin 49
On 20 May 2024, the FCA published Primary Market Bulletin 49 (PMB 49) for primary market participants. While primarily focussed on issues relating to issuers, PMB 49 is of general relevance to market participants on UK capital markets. Key points include the following:
- Listing Rules (LRs) in relation to Long-Term Incentive Plans (LTIPs). The FCA reviewed compliance of disclosure obligations under the LRs in relation to LTIPs by a number of UK premium listed companies (Companies). The FCA found that (i) the Companies were largely compliant with the LRs, with low compliance with release of a shareholder circular only, and (ii) the Companies included both financial and non-financial metrics to assess LTIP performance.
- Global Depositary Receipts (GDRs). The FCA conducted a thematic review of GDRs to assess whether issuers of the underlying shares were compliant with their continuing obligations. The FCA found that most non-UK GDR issuers published more information in home jurisdictions than in the UK, presenting a risk of information gap for UK investors.
- Changes to ethnicity reporting categories. The FCA proposed to align the description of the Other Ethnic Group reporting category with the revised recommendations from the Office for National Statistics. An open Other box seeks to provide flexibility for self-identification by individuals.
8. UK — Diversity and Inclusion
Diversity and inclusion — FCA, PRA, and HM Treasury publish responses to the Treasury Select Committee’s Sexism in the City Report
In 2023, the Treasury Committee of the House of Commons (Treasury Committee) launched a Sexism in the City inquiry to determine what progress had been made since the Women in Finance inquiry, launched in 2017.
According to the Sexism in the City report (Report) of March 2024, “the answer appears to be not much.” While the Report acknowledged that there have been incremental improvements, such as the proportion of women holding senior roles, it noted that significant concerns persist.
On 14 May 2024, the FCA, the Prudential Regulation Authority (PRA), and HM Treasury published a response to the Report. Key points are set out below:
- FCA. The FCA stated that alongside the PRA, it is working through responses to its consultation paper on diversity and inclusion in the financial sector and will carefully consider what its role should be in light of the Treasury Committee and respondents’ views. Further, taking into account the Treasury Committee’s recommendations, the FCA is now prioritising its work on non-financial misconduct.
- PRA. In addition to the above, the PRA stated that it is considering feedback from industry roundtables and other engagement with stakeholders and will carefully consider the Treasury Committee’s recommendations. It further noted that it has committed to monitor the effects of the removal of the bonus cap on remuneration structures in PRA-authorised firms and that it would work with stakeholders to assess whether policy changes have affected gender pay gaps.
- HM Treasury. HM Treasury agreed that reporting alone would not reduce the gender pay gap and that employers need to take action but that it was too soon to make changes to the requirements. It noted that non-disclosure agreements would most likely be unenforceable to the extent they seek to prevent workers for reporting a crime, but does not commit to taking the Treasury Committee’s recommendation forward.
9. UK — MiFID II (Commodity Derivatives)
FCA publishes update on reforming the commodity derivatives framework
On 30 May 2024, the FCA published an update in relation to changes to the ancillary activities test (AAT) it had proposed in its Consultation Paper on reforming the commodity derivatives regulatory framework (CP23/27). For details on CP23/2, see our January 2024 Update.
The UK rules transposing Article 2(1)(j) of the EU Markets in Financial Instruments Directive (MiFID II) provide an exemption from authorisation to firms whose activities in commodity derivatives are ancillary to their commercial business. The AAT sets out the criteria which must be satisfied to benefit from the exemption.
In CP23/27, the FCA had proposed to replace the AAT with an approach based on qualitative criteria. The FCA notes that feedback from industry had expressed concern that such an approach would provide insufficient certainty to firms.
The FCA notes that HM Treasury has legislated to pause the commencement date of the provisions amending the AAT to allow time for the FCA and HM Treasury to consider and address these concerns. In the meantime, the AAT will continue to operate as it does currently.
UK Government publishes implementation update on UK Sustainability Disclosure Requirements
On 16 May 2024, the Government published an implementation update on its Sustainability Disclosure Requirements (SDR) framework (Update). The Update sets out a roadmap for the UK’s adoption of the various facets of the SDR.
Key points from the Update are summarised below:
- UK Sustainability Reporting Standards (UK SRS)
- UK SRS that are compliant with the International Sustainability Standards Board (ISSB) baseline standards are expected to be made available in Q1 2025. Following Government endorsement of the UK SRS (likely Q2 2025), the FCA intends to consult on UK SRS disclosure requirements for UK-listed companies (UK SRS Disclosures), with any such requirements for non-listed companies to be determined at a later stage.
- On 16 May 2024, the Government updated its webpage on the UK SRS and published the Framework and Terms of Reference for the Development of UK SRS, setting out the operation of the UK approach including the establishment of the Technical Advisory Committee and Policy Implementation Committee.
- Transition Plan Disclosures
- Separately to the Government’s development of its SRS, the transition plan disclosure framework, which is being developed by the Transition Plan Taskforce (TPT Disclosures), envisions certain overlaps with the UK SRS Disclosures.
- The FCA intends to consult on its expectations for the UK’s transition plan under the UK SRS with reference to the TPT Disclosures.
- UK Green Taxonomy
- The Government confirmed its plan to launch a consultation on the proposed UK Green Taxonomy during the course of this year.
- In summary, the Government remains committed to introducing voluntary taxonomy disclosures for at least two reporting years with mandatory taxonomy disclosures to be explored through consultation.
UK and Singapore strengthen collaboration in sustainable finance and FinTech
On 8 May 2024, HM Treasury and the Monetary Authority of Singapore issued a joint statement following the ninth UK-Singapore Financial Dialogue meeting held in Singapore (Dialogue).
Key agenda items arising from the Dialogue are summarised below:
- Sustainable finance. The UK and Singapore reaffirmed their commitment to the net-zero agenda by (i) progressing their respective transition planning initiatives, (ii) implementing ISSB baseline standards to sustainability-related disclosures, and (iii) furthering investment in Asia’s transition finance infrastructure through the 2023 UK-Singapore Strategic Partnership.
- Financial technology (FinTech) and innovation. The UK and Singapore agreed that international standards will be key to AI innovation and that tokenisation of assets and funds will be beneficial to the financial ecosystem. The UK also shared its current work on the “digital pound” and the regulatory framework for cryptoassets.
- NBFI risk. The UK and Singapore agreed on the importance of data-driven monitoring of risks in NBFIs by national authorities and to implement agreed NBFI policies on margining practices and leverage.
- Cross-border payment connectivity. The UK and Singapore remained committed to the G20 Roadmap to Enhancing Cross-Border Payments.
The tenth UK-Singapore Financial Dialogue is due to be held in the UK next year.
Tax Case: Court of Appeal decision in Hargreaves Property Holdings Ltd v HMRC: UK withholding tax and the meaning of “beneficial entitlement”
Payments of interest (other than short-term interest) that have a UK source are subject to UK withholding tax at the rate of 20% unless a relevant exemption applies.
UK domestic law provides for an exemption where the person “beneficially entitled” to the interest is a UK resident company — the so-called “UK-to-UK” exemption.
The UK-to-UK exemption may be used by credit funds that make loans to UK borrowers via a UK lending platform (which may be structured as a qualifying asset holding company (QAHC)), which would likely be funded with back-to-back or profit-participating loans to shelter UK taxable profits on the underlying interest income. In this context, it would be crucial that the UK lending platform is “beneficially entitled” to the relevant payments of interest in order for the UK-to-UK exemption to apply.
The recent Hargreaves case considered a number of different issues relevant to the application of UK withholding tax on interest payments.
One of the key aspects of the case (and the focus of this summary) relates to the meaning of “beneficial entitlement” for the purposes of the UK-to-UK exemption.
The case involved a UK resident company (UK Borrower) that was funded by way of interest-bearing loans from connected non-UK lenders. Following tax planning advice, these loans were subject to significant amendments and restructurings. The key fact emerging from those transactions for the purposes of the decision on the meaning of “beneficial entitlement” is that shortly before interest payments were due from UK Borrower on the loans, the non-UK lender entity that was entitled to receive the interest would assign the rights to the payments to a UK company (UK Assignee) for consideration equal to substantially all of the amount of interest so assigned. It was accepted that the purpose of these steps was to ensure that the interest payments from UK Borrower were not subject to UK withholding tax (relying on the UK-to-UK exemption) whilst ensuring that UK Borrower was still able to claim corporation tax deductions.
The taxpayer argued that the interest payments by UK Borrower to the UK Assignee were exempt from UK withholding tax under the UK-to-UK exemption on the basis that the UK Assignee was “beneficially entitled” to the interest.
The taxpayer’s case relied on its assertion that “beneficial entitlement” must be taken as having its ordinary and more limited English law meaning, such that a recipient would be beneficially entitled to interest as long as it does not receive the interest as a mere fiduciary for another person (e.g., where it is acting as a nominee or trustee for another person).
Prior to the superior Court of Appeal decision, the Upper Tribunal (UT) had previously held that the UK Assignee was not in fact “beneficially entitled” to the interest paid to it in this scenario. In reaching this decision, the UT had held that “beneficial entitlement” must be interpreted in light of the statutory context and purpose of the UK-to-UK exemption (going beyond the simple English law meaning advanced by the taxpayer). The accepted purpose of the statutory obligation to withhold tax from UK interest payments was (in the UT’s view) to ensure that UK tax is collected from the recipient of the interest easily, at source.
The UT went on to express the view that the UK-to-UK exemption exists (in that context) because where a UK company is in fact beneficially entitled to the interest, the UK tax due can instead be collected from the recipient of the interest and there is no need to withhold at source. Applying that view, the UT held that “beneficial entitlement” should therefore be limited to UK recipients of interest who are “substantively entitled to receive and enjoy the income.” The UT then went on to state that this more purposive interpretation of “beneficial entitlement” might exclude UK recipients “where the commercial and practical reality of the matter is that the interest […] is then paid on to an entity outside the UK” because in that situation there would be the same underlying concern that tax on the income will not in practice be able to be collected.
The UT further noted that “the lack of business purpose for the company’s involvement in receiving the interest is relevant in considering whether the company is beneficially entitled to the sum.” On the basis (in part) that the UK Assignee was obliged to pay away “very similar sums” to the assignor of the interest by way of contractual consideration for the assignment, the UT held that the UK Assignee was not in fact “beneficially entitled” to the interest in question.
The UT decision represented a significant extension of the previously well understood English law meaning of “beneficial entitlement” and received criticism from some quarters for the fact that in reaching its decision, the UT had failed to take account of a number of authoritative cases on the meaning of beneficial ownership and entitlement. Notwithstanding this criticism, the UT decision did lead to some concerns in the market that a UK recipient of interest might not be “beneficially entitled” to interest and able to benefit from the UK-to-UK exemption if there were circumstances in which the UK recipient could be obliged (legally or practically) to pay on all or a majority of the interest it received to another person.
This view, if correct, could give rise to some uncertainty for UK lending platforms and QAHCs funded with back-to-back debt or profit participating loans, which (one might think) was inconsistent with the significant efforts made by the UK tax authorities to introduce and develop usage of the relatively new QAHC regime to encourage asset managers to invest through the UK.
The Court of Appeal agreed with the UT that the concept of “beneficial entitlement” must be construed purposively, but it rejected the UT’s suggestion that the mere on-payment of “very similar sums” by a UK recipient of interest to an entity outside the UK could be sufficient to defeat beneficial entitlement (where beneficial entitlement can be otherwise established). Instead, the Court of Appeal held that “beneficial entitlement” must be construed (having regard to prior English case law) as referring to “an entitlement which carries at least some of the benefits of ownership.”
The question in the Hargreaves case was therefore whether the UK Assignee had, in fact, obtained any ownership benefit from its entitlement to the interest. Applying this test, the Court of Appeal did in fact reject the taxpayer’s appeal on the basis that there was insufficient evidence to establish that the UK Assignee had actually benefitted in any real sense from the interest it paid away (there being no evidence that the UK Assignee could have applied interest payments received from UK Borrower for any other purposes or that UK Assignee was in a position to actually benefit from any margin or profit or shoulder any risk in relation to the underlying loan(s) to UK Borrower).
That being the evidence in the case, the Court of Appeal concluded that the UK-to-UK exemption cannot (viewed purposively) have been intended to apply to a UK company whose only involvement in the arrangements was tax motivated and which had no other commercial purpose and was not exposed to any meaningful risk or reward with respect to the underlying interest income.
Although the Court of Appeal rejected the taxpayer’s appeal on the facts, the Court of Appeal’s decision is of more comfort to UK QAHC and similar credit fund structures than the prior UT decision because it is now clear that the mere fact that a recipient of interest pays away “very similar sums” to another entity will not in and of itself be sufficient to deny beneficial entitlement for the purposes of the UK-to-UK exemption provided that the recipient retains “any of the benefits” of the interest and there is otherwise evidence to substantiate the commercial purpose and role of the UK recipient of the interest (which should be the case in a typical QAHC structure).
The arguments made in this case at each stage do, however, serve as a reminder to taxpayers that it is important to ensure there is a clear commercial purpose underlying a UK recipient’s receipt of interest on a UK source loan and to think holistically about the inclusion and role of a QAHC or similar UK lending vehicle in a structure for UK borrowers.
ESMA publishes final guidelines on sustainability-related fund names
On 14 May 2024, ESMA published its Final Report on Guidelines on funds’ names using environmental, social, and governance (ESG)– or sustainability-related terms.
For further details on the implications of this for asset managers, see our Sidley Update Implications of Final ESMA Guidelines on Use of ESG- or Sustainability-Related Terms in Fund Names.
Commission publishes summary report of SFDR review consultation
On 3 May 2024, the Commission published a summary report (Report) of the stakeholder responses it received to its consultation on the EU SFDR (SFDR Consultation), for which the consultation window ran from 14 September to 15 December 2023. For details on the SFDR Consultation, see our Sidley Update Five Key Takeaways From the European Commission’s Consultation on the Sustainable Finance Disclosures Regulation.
Key points of the responses to the SFDR Consultation include the following:
- Widespread support for the broad objectives of the SFDR but divided opinions regarding the extent to which it has achieved these objectives during its first years of implementation. Respondents cited, for example, lack of legal clarity regarding key concepts, limited relevance of certain disclosure requirements, and issues linked to data availability.
- Consensus on the need to ensure consistency across the wider sustainable finance framework. Respondents identified problems with the interactions between the SFDR and the EU Taxonomy, the Corporate Sustainability Reporting Directive (CSRD), the sustainability rules under MiFID II, the Insurance Distribution Directive, and the EU Climate Benchmarks.
- Split views regarding the relevance of the SFDR entity-level disclosures. No consensus among respondents on the usefulness of the entity-level disclosures on remuneration policies and adverse sustainability impacts. Responses showed some support for the current disclosure requirements on sustainability risk policies. Many expressed concerns about a potential overlap between the transparency requirements on principal adverse impacts under the SFDR and the reporting obligations under the CSRD.
- Support for setting uniform disclosure requirements for all financial products offered in the EU as well as additional disclosures for products making sustainability claims. Most respondents supported harmonising requirements across all financial products, irrespective of sustainability claim.
- Strong support for a voluntary categorisation system regulated at the EU level.
- No clear preference for one of the two proposed approaches to a potential EU categorisation system. Respondents were divided on whether a potential EU categorisation system should be based on new criteria or on existing concepts under the SFDR (e.g., by converting the existing Article 8 and 9 concepts into formal product categories).
The Commission is considering the Report; however any reforms to the SFDR will be implemented by the post-election Commission and will likely be subject to further public consultation.
Council adopts the EU Corporate Sustainability Due Diligence Directive
On 24 May 2024, the Council of the EU (Council) announced it had formally adopted the EU Corporate Sustainability Due Diligence Directive (CS3D).
Following the Council’s approval, the legislative act has been adopted. This is the last step in the decision-making procedure.
CS3D will enter into force 20 days after publication in the Official Journal of the EU (Official Journal). EU Member States will then have two years to transpose CS3D into national law.
For further details on the finalised text of CS3D, see our Update Unprecedented ESG Due Diligence Obligations — EU Adopts Corporate Sustainability Due Diligence Directive.
ESMA issues statement on use of AI in provision of retail investment services
On 30 May 2024, ESMA issued a public statement (Statement) on the use of AI in the provision of retail investment services. While addressed to investment firms in the retail sector, much of ESMA’s commentary is equally relevant to firms in the wholesale financial sector.
ESMA notes that AI technologies offer a number of potential benefits to firms and clients and that various uses can be envisioned, including AI-powered chatbots assisting in customer service and support, AI analytics supporting investment advice/portfolio management, and uses in compliance, risk management, fraud detection, and operational efficiencies.
However, ESMA notes a number of potential risks, among them:
- algorithmic biases and data quality issues;
- opaque decision-making by a firm’s staff members;
- overreliance on AI by both firms and clients for decision-making; and
- privacy and security concerns linked to the collection, storage, and processing of the large amount of data needed by AI systems.
While there is a broader discourse on the development of a comprehensive EU legal framework for AI under the EU AI Act, ESMA highlights that investment firms using AI in the provision of retail investment services should review their use of AI through the lens of a number of existing MiFID II requirements, including:
- the client best interest rule and client disclosures;
- organisational requirements relating to governance, risk management, knowledge and competence, and staff training;
- conduct of business requirements (e.g., suitability considerations for portfolio managers, or consideration of AI system design and monitoring in in the context of the product governance rules); and
- record keeping — ESMA notes it expects firms to maintain comprehensive records on AI utilisation and any related clients’ complaints, for example.
ESMA encourages firms to engage with their regulators where appropriate and that it intends to keep monitoring developments in this area.
15. EU — MiFID II (Commodity Derivatives)
ESMA consults on commodity derivatives regime under MiFID review
On 23 May 2024, ESMA launched a public consultation on amending certain technical standards, in the context of the changes to the rules for commodity derivatives under the MiFID/ Markets in Financial Instruments Regulation (MiFIR) review, as mentioned in our March 2024 Update.
The consultation proposes amendments to:
- Commission Delegated Regulation (EU) 2022/1299: on regulatory technical standards (RTS) on position management controls by trading venues;
- Commission Implementing Regulation (EU) 2017/1093: on implementing technical standards (ITS) on position reporting; and
- Article 83 of Commission Delegated Regulation (EU) 2017/565: on the format of position reporting.
The consultation is seeking input on the proposed RTS and ITS. ESMA will consider all comments received by 23 August 2024 and will publish a final report towards the end of 2024.
ESMA launches two consultations on Level 2 measures under the MiFIR review
ESMA has launched two consultations in relation to Level 2 measures under the MiFIR review, which entered into force on 28 March 2024. An overview of each consultation is set out below.
Pre-and post-trade transparency
On 21 May 2024, ESMA launched a public consultation on the review and development of new and existing RTS. ESMA’s proposals aim to enhance the information available to stakeholders by improving, simplifying, and further harmonising transparency in capital markets.
The consultation is seeking input on RTS in relation to pre- and post-trade transparency requirements for non-equity instruments; the obligation to make pre- and post-trade data available on a reasonable commercial basis (RCB); and a review on the obligation to supply instrument reference data. An outline of the proposals is set out below:
- Amendments to RTS 2: proposed amendment in relation to non-equity transparency, including to the definition and characteristics of ‘central limit order books’, specific transparency fields, and the pre-trade waiver regime.
- New RTS on RCB: proposed introduction of an obligation to make pre- and post-trade data available on a RCB, and the conversion of ESMA’s guidelines on market data into legal obligations.
- Amendments to RTS 23: proposed introduction of an obligation to provide instrument reference data for transaction reporting and transparency and to align data with certain international standards and reporting frameworks.
ESMA will consider all comments received by 28 August 2024 and, after reviewing the feedback, will publish a final report and draft RTS to the Commission by Q4 2024.
Consolidated Tape Providers (CTPs)
On 23 May 2024, ESMA launched a public consultation on RTS related to CTPs, other data reporting service providers (DRSPs), and the assessment criteria for CTP selection.
In addition to feedback on the specification of the assessment criteria for the CTP selection procedure, the consultation is seeking input on draft RTS in relation to the following:
- Input and output data requirements of CTPs: prescribing data quality requirements for prospective CTPs and data contributors, including proposals relating to quality of transmission protocols; quality and substance of data; and data quality measures and enforcement standards.
- Revenue distribution scheme for the equity CTP: including specifications for weighting and methodology; specification of criteria under which the CTP can suspend the participation of a data contributor in the revenue redistribution scheme; and conditions to resume the application of the scheme.
- Synchronisation of business clocks: including specifications of the level of accuracy for the synchronisation of business clocks in accordance with international standards.
- Authorisation and organisational requirements for DSRPs: including information to be provided in an authorisation application for DSRPs; the proposition includes a new draft RTS and related ITS.
ESMA will consider all comments received by 28 August 2024 and, after reviewing the feedback, will publish a final report and submit final RTS to the Commission by the legislative deadline of 29 December 2024.
ESMA aims to publish a feedback statement on the specification of the assessment criteria for the CTP selection procedure, expected by Q4 2024.
EBA and ESMA launch discussion paper on investment firms’ prudential framework review
On 3 June 2024, the European Banking Authority (EBA) and ESMA issued a joint discussion paper (Discussion Paper) on the potential review of the prudential framework for EU investment firms under the EU Investment Firms Regulation (IFR) and Investment Firms Directive (IFD).
The Discussion Paper aims to gather feedback to inform the Commission’s Call for Advice of 1 February 2023 to the EBA and ESMA on IFR/IFD (CfA). It covers issues relating to the following aspects of IFR/IFD:
- categorisation of investment firms;
- conditions for classification as small and non-interconnected;
- the fixed overheads requirement and K-factors;
- risks not covered by existing K-factors;
- the implications of the adoption of the new EU Banking Package (CRR3 / CRD6);
- liquidity requirements;
- prudential consolidation; and
- remuneration and its governance.
The Discussion Paper also provides an overview of the interaction of IFD/IFR with requirements applicable to alternative investment fund managers and UCITS management companies providing MiFID services on an ancillary basis.
The deadline for submission of responses is 3 September 2024. A public hearing will take place via conference call on 20 June 2024.
Following the close of the consultation, the EBA and ESMA will prepare a joint report in response to the CfA.
18. EU — Market Abuse Regulation
ESMA issues statement of good practice on pre-close calls
On 29 May 2024, ESMA published a statement setting out good practices for issuers when engaging in pre-close calls.
Pre-close calls are communications between an issuer and analysts who generate research, forecasts, and recommendations related to the issuer’s financial instruments. These sessions occur just before the periods preceding an interim or year-end financial report, during which issuers avoid providing additional information or updates.
ESMA highlights that recent news in the media has suggested a connection between pre close calls and high share price volatility.
Accordingly, ESMA reminds issuers that inside information should only be disclosed in accordance with the EU Market Abuse Regulation. Consequently, issuers should share only non-inside information during pre-close calls.
ESMA also recommends good practices for issuers engaging in pre-close calls, including (i) assessing that information the issuer intends to disclose is not inside information, (ii) informing the public about the upcoming pre-close call on the issuer’s website, and (iii) making the material and documents used simultaneously available on the issuer’s website.
Parliament approves final text of EMIR 3
On 24 April 2024, the European Parliament approved the Council's final text of the regulation amending EMIR (EMIR 3).
EMIR 3 is expected to be published in the Official Journal in Q4 2024 and will enter into force 20 days after its publication.
For previous Sidley Updates tracking the development of EMIR 3, see our Updates of January 2024 and March 2024.
ESMA publishes Call for Evidence on UCITS Eligible Assets Directive review
On 7 May 2024, ESMA published a Call for Evidence (CfE) on the review of the UCITS Eligible Assets Directive (EAD) to collect stakeholder information in assessing the risks and benefits of UCITS being exposed to a broader range of asset classes.
The EAD specifies the classes of eligible assets in which a UCITS fund is permitted to invest. It is therefore relevant to European Economic Area (EEA) UCITS management companies as well as firms that manage UCITS funds on a delegated basis (including non-EEA sub-managers).
The CfE is launched in the context of the Commission’s request to ESMA to assess the implementation of the UCITS EAD in the EU and whether any divergences have arisen.
ESMA is therefore seeking input on questions including the extent to which UCITS have gained direct or indirect exposures to certain asset classes that may give rise to divergent interpretations as to eligibility as UCITS investments and/or risk for retail investors (e.g., structured/leveraged loans, catastrophe bonds, emission allowances, commodities, cryptoassets, and unlisted equities).
The CfE is open for three months, closing on 7 August 2024.
Council adopts final texts of new EU anti-money-laundering package
On 20 May 2024, the Council announced it had adopted the sixth Money Laundering Directive (MLD6), the AML/CFT Single Rulebook Regulation, and the Regulation establishing the Anti-Money Laundering Authority (AMLA) (AMLAR).
This is the final step of the adoption procedure. The texts will now be published in the Official Journal and enter into force.
The AML/CFT Single Rulebook Regulation will apply three years after its entry into force. EU Member States will have two years to transpose some parts of MLD6 and three years for others.
The AMLA will be based in Frankfurt and start operations in mid-2025.
For previous discussion on the EU's AML/CFT package, see our Updates of May 2020, January 2024, and February 2024.
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シニア・マネージング・アソシエイトellie.verran@sidley.com +44 20 7360 2049ロンドン*Only admitted to practice in New Zealand. Not admitted to practice in England and Wales.
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