UK/EU Investment Management Update (June 2021)

Contents:

1. New EU Cross-Border Distribution of Funds Directive and Regulation
2. EU Short Selling Regulation
3. EU ESG
4. EU Investment Firm Regulation (IFR)
5. EU Market Abuse
6. EU MiFID II
7. EU Securitisation Regulation (SECR)
8. EU Cloud Service Providers Guidelines
9. UK PRIIPs Regulation
10. Brexit
11. UK FCA Compliance Matters
12. UK Regulatory Initiatives Grid
13. UK Long-Term Asset Funds (LTAFs)
14. LIBOR Transition
15. Cryptoassets

1. New EU Cross-Border Distribution of Funds Directive and Regulation

New AIFMD rules on pre-marketing and possible impact on non-EU managers

Starting 2 August 2021, a new framework relating to the cross-border distribution of investment funds in the EU is required to be implemented in EU Member States. Among other things, the new rules amend the existing EU Alternative Investment Fund Managers Directive (AIFMD) to harmonise the ability of EU alternative investment fund managers (AIFMs) to distribute their funds (AIFs) across the EU, including by introducing a new regime for “pre-marketing,” which in turn has implications for “reverse solicitation.”

Please see our Sidley Update EU AIFMD — New Rules on the Cross-Border Distribution of Funds (published on 8 June 2021) for the implications of the new EU cross-border distribution of collective investment funds regime for non-EU managers.

ESMA publishes final report and guidelines for funds’ marketing communications

On 27 May 2021, the European Securities and Markets Authority (ESMA) published its final report on guidelines for funds’ marketing communications under the CBDF Regulation (the Guidelines).

The Guidelines apply broadly to EU AIFMs and Undertakings Collective Investment in Transferable Securities (UCITS) management companies, which are conducting marketing communication with investors or potential investors in UCITS or AIFs. It is unclear at this stage whether non-EU AIFMs conducting marketing communication with EU-based investors would be required to comply with the Guidelines.

The Guidelines set prescriptive content and formatting requirements for a notably extensive range of marketing communications, including:

• all messages advertising for a UCITS or AIF, regardless of medium (i.e., including printed documents as well as video presentations, live presentations, and radio messages);
• messages on any social media platform; and
• communications by a third party and used by a UCITS management company or AIFM for marketing purposes.

The Guidelines require, among other things, that all marketing communications be identifiable as such and contain fair, clear, and not misleading information, regardless of the target investors. The information presented in the marketing communication should also be consistent with information contained in the legal and regulatory documents of the promoted fund, including in the case of AIFs, the Article 23 AIFMD pre-investment disclosures, and the AIF’s annual reports.

The Guidelines will apply six months after publication on ESMA’s website in all EU official languages and will be enforced by EU national competent authorities.

2. EU Short Selling Regulation

ESMA recommends lowering the reporting threshold for net short positions to 0.1% on a permanent basis

On 20 May 2021, ESMA published an opinion recommending that the reporting threshold for net short positions in shares under Article 5 of the EU Short Selling Regulation (EU SSR) should be lowered from 0.2% (the threshold specified in the EU SSR) to 0.1% permanently.

In March 2020, ESMA reduced the net short position reporting threshold for shares admitted to trading on a regulated market from 0.2% to 0.1% temporarily in response to the COVID-19 pandemic. The 0.1% threshold applied from 16 March 2020 to 19 March 2021, as noted in our April 2021 Update; from 19 March 2021 the threshold reverted to and has been held at 0.2%.

ESMA considers that the evidence gathered since the lower threshold was introduced provided a substantial amount of additional and essential information to EU national competent authorities, allowing for better market oversight. ESMA recommends a return to this position in light of the uncertainty of the current financial market conditions.

Due to the urgency of the situation, ESMA has decided not to publicly consult on this change, recommending that the European Commission adopt the proposal as soon as possible.

Note that since 1 February 2021, the reporting threshold for net short positions in in-scope shares under the UK Short Selling Regulation has been 0.1%.

ESMA publishes updated net short position notification thresholds for sovereign issuers

On 8 June 2021, ESMA published an updated table of reporting thresholds for net short position in sovereign debt.

ESMA is required to publish, under the EU SSR, a list of the thresholds applicable to the sovereign issuers for the purpose of the notification to competent authorities of significant net short position in sovereign debt.

3. EU ESG

European Commission consults on draft delegated regulation for sustainability disclosures under EU Taxonomy Regulation

On 7 May 2021, the European Commission published a consultation on a draft delegated regulation (the Delegated Regulation) that supplements the disclosure obligations contained in Article 8 Taxonomy Regulation, specifying the content, methodology, and presentation of information that certain large financial and non-financial undertakings must disclose concerning their environmentally sustainable economic activities.

Article 8(1) Taxonomy Regulation requires financial or non-financial undertaking in scope of the Non-Financial Reporting Directive (NFRD) to publicly disclose information on how and to what extent their activities are associated with environmentally sustainable economic activities.

Undertakings that are in scope of the NFRD are, broadly, EU listed entities, EU asset managers, credit institutions, insurance undertakings, and entities designated as such by an EU Member State that have more than 500 employees. As noted in our May 2021 Update, the Commission has adopted a proposal to extend the scope of the NFRD to all large companies and all companies listed on the EU regulated markets.

Consultation on the Delegated Regulation closed on 2 June 2021, and Commission adoption is expected by the end of June. The Delegated Regulation will apply fully from 1 January 2023, with only certain elements and qualitative reporting expected to come into effect 1 January 2022.

The Delegated Regulation will be of interest to EU and non-EU investment managers who are “financial market participants” under the Sustainable Finance Disclosure Regulation (SFDR), given certain of those managers may need to collect data from such large entities for purposes of complying with their own disclosure obligations under the SFDR.

ESMA EU investment fund climate-related financial risk assessment

On 8 June 2021, ESMA published its first Trends, Risks and Vulnerabilities (TRV) Report of 2021.

ESMA continues to identify very high risks throughout its remit. In this report, it highlights the significant rebound of the EU equity markets and the valuation of debt indices, which it notes reached pre-crisis levels across all segments and contrasts with the weak economic fundamentals.

ESMA sees this ongoing decoupling as the main risk for EU financial markets, as well as volatility in the prices of non-regulated cryptoassets, which it notes implies significant risks for investors.

Of particular note, the report includes ESMA’s first assessment of EU investment funds’ exposure to climate-sensitive economic sectors. ESMA notes that whereas a number of efforts have been made to conduct climate-related financial risk assessments of the European banking and insurance sectors, there has been little similar analysis of the European investment fund.

Using a data set of €10.7 trillion of European investment fund portfolio holdings from 23,352 EU-domiciled investment funds, ESMA found the following:

• EU investment funds are more exposed to climate-sensitive economic sectors than banks, insurers, and pension funds.
• EU funds whose portfolios are tilted towards more polluting assets (brown funds) distribute their portfolio over a larger number of companies than funds with cleaner portfolios (green funds).
• However, this apparent diversification hides a concentration risk: Brown funds are more closely connected with each other (have more similar portfolios) than green fund portfolios, which tend to ‘herd’ less (have less similar portfolios to those of other green funds). Hence, widespread climate-related financial shocks are likely to disproportionately affect brown funds.
• A preliminary climate risk scenario exercise suggests most brown funds’ losses range from about 9% to 18% of affected assets, in contrast to green funds’ losses, which usually range from 3% to 8%.
• Accordingly, ESMA’s assessment notes that if climate-related financial risks affect brown firms more than green firms, and many EU fund portfolios overweight brown firms, then this indicates that climate-related shocks will affect more EU funds.

The TRV report includes additional detailed analyses of market risk in the securities markets, infrastructures and services, sustainable finance, and financial innovation as well as a report on the market for ESG ratings, including types of ratings, key providers, and issues pertaining to a lack of common definitions and of comparability.

4. EU Investment Firm Regulation (IFR)

EBA and ESMA publish provisional list of instruments and funds for the smallest investment firms under the EU IFR

On 31 May 2021, ESMA and the European Banking Authority (EBA) published a provisional list of additional instruments and funds that EU competent authorities may allow to use as own funds for small and non-interconnected investment firms (SNI firms) and non-SNI firms that are not legal persons or joint stock companies.

The EBA, together with ESMA, is required under Article 9(4) of the IFR to establish, maintain, and publish a list of all the forms of instruments or funds in each EU Member State that qualify as own funds for SNI firms and non-SNI firms that are not legal persons or joint stock companies.

The list is provisional and intended to provide guidance to investment firms and competent authorities ahead of the application of the IFR requirements, as of 26 June 2021. Please see our Sidley Update New EU Investment Firm Prudential Regime for further information on the regime.

Note that the UK will be introducing its own Investment Firm Prudential Regime (IFPR). For more information about the IFPR, please see our Sidley Update UK Investment Firm Prudential Regime – FCA’s Second Consultation – Implications for Investment Managers.

5. EU Market Abuse

French AMF fines a German company and its CEO for manipulating the price of a sovereign bond futures contract

On 28 May 2021, the Autorité des marchés financiers (AMF) fined Global Derivative Trading GmbH (GDT) and its CEO, Thorsten Wagner, €1.2 million for manipulating the price of a French sovereign bond futures contract.

Between 1 July and 13 October 2015, GDT issued orders on Eurex for futures contracts with French fungible Treasury bonds as the underlying asset (FOAT).

The AMF found that GDT had placed orders that gave misleading signals as to the supply of, demand for, and price of the FOAT through issuing passive orders for significant and atypical quantities of contracts, which created strong pressure on one side of the order book at the three best limits, in turn creating doubt as to the reality of supply and demand, before the mass cancellation of these orders.

In assessing the fine, the AMF considered the seriousness of the breaches, the amount of profit made, estimated at almost €340,000, and the prejudice for other market participants who suffered from the unfair trading conditions on the FOAT.

6. EU MiFID II

ESMA publishes final report on draft guidelines on market data obligations

On 1 June 2021, ESMA published its final report containing finalised guidelines on the EU MiFIR market data obligations.

The final report follows ESMA’s consultation paper of 6 November 2020 (which we covered in our December 2020 Update) on draft guidelines pertaining to the requirement to publish market data on a reasonable commercial basis and make market data available free of charge 15 minutes after publication under EU MiFIR.

The guidelines will apply to (among others) EU trading venues, approved publication arrangements, and systematic internalisers (together, Market Data Providers).

Whilst investment managers will not be directly subject to the guidelines, the guidelines may eventually have a positive effect on how managers in general consume data from EU market data providers and on greater transparency in relation to data costs.

To that end, the guidelines require Market Data Providers to (among other things):

• market data on the basis of cost;
• provide market data on a non-discriminatory basis; and
• inform customers that the purchase of market data is available separately from additional services (‘data unbundling’).

The guidelines will apply from 1 January 2022.

ESMA publishes new Q&A on costs and charges

On 28 May 2021, ESMA published an updated version of its Q&As on MiFID II and MiFIR investor protection and intermediaries topics. It includes an additional question on when a firm providing both investment advice and reception and transmission / execution services to a client relating to the same transaction(s) should provide ex-ante information on costs and charges.

ESMA confirms the requirement to inform the client about all costs and charges in good time before the provision of investment advice applies irrespective of whether the client is subsequently provided with an RTO or execution service relating to the same transaction(s).

However, ex-ante cost and charges information disclosed to the client when the investment advice is provided would not need to be provided a second time in the context of the subsequent RTO or execution service provided that:

• both services relate to the same transaction(s) and are provided within a reasonably short time period; and
• the ex-ante cost and charges information is still accurate and complete at the time of the provision of the RTO or execution service.

7. EU Securitisation Regulation (SECR)

ESAs publish joint report on the implementation and functioning of the SECR

On 17 May 2021, the ESAs published a joint committee report (the Report) containing its analysis of the implementation and functioning of the SECR. This follows the ESAs’ recent joint opinion (the Opinion), which drew attention to the uncertainties around whether non-EU AIFMs fell within the “institutional investor” definition under the SECR and were therefore subject to due diligence requirements (for further details on the Opinion, please see our April 2021 Update).

The Report echoes the Opinion in relation to the imprecision of the “institutional investor” definition and recommends that the Commission amend the SECR or provide interpretative guidance as proposed in the Opinion; the Report does not propose any amendments beyond those recommended in the Opinion.

8. EU Cloud Service Providers Guidelines

ESMA publishes final guidelines on outsourcing to cloud service providers

On 10 May 2021, ESMA published final guidelines on outsourcing to cloud service providers (the CSP Guidelines). The CSP Guidelines apply to a broad range of financial institutions, including AIFMs and related depositaries, UCITS management companies and related depositaries, and MiFID investment firms.

The CSP Guidelines are silent on whether non-EU AIFMs marketing AIFs in the EU are caught, though references are made to various provisions in the AIFMD and the related delegated regulation that apply only to EU AIFMs and not also to non-EU AIFMs.

The CSP Guidelines set out:

• the governance, documentation, oversight, and monitoring mechanisms that firms should have in place;
• the assessment and due diligence that should be undertaken prior to outsourcing;
• the minimum elements that outsourcing and sub-outsourcing agreements should include;
• the exit strategies and the access and audit rights that should to be catered for;
• the notification to competent authorities; and
• the supervision by competent authorities.

The CSP Guidelines apply from 31 July 2021 to all cloud outsourcings arrangements entered into, renewed, or amended on or after this date. In relation to existing cloud outsourcing arrangements, in-scope firms are required to ensure that such existing arrangements take into account the CSP Guidelines by 31 December 2022.

9. UK PRIIPs Regulation

HM Treasury announces extension of PRIIPs exemption for UCITS funds

On 1 June 2021, HM Treasury announced that the current exemption for UCITS funds from the requirements of the UK Packaged Retail Investment and Insurance-Based Products (UK PRIIPs) Regulation will be extended by five years to 31 December 2026.

UCITs funds are currently exempt from the requirements of the UK PRIIPs Regulations. As such, UCITS funds are not currently required to produce a UK PRIIPS Key Information Document (KID). Instead they must produce a UCITS Key Investor Information Document (KIID), as per the requirements of the EU UCITS Directive as transposed in the UK. This exemption expires on 31 December 2021. This announcement is designed to provide certainty for industry and investors regarding the disclosures UCITS funds providers will have to make to retail investors beyond 2021.

HM Treasury further notes that changes to the UK PRIIPs Regulation may be made, or a successor regulation may be introduced sooner than 2026, in which case consideration would be given to a smooth transition to the new regime for all retail investment product providers, including those marketing UCITS funds.

10. Brexit

FCA publishes speech on the UK regulatory landscape post-Brexit

On 6 May 2021, the Financial Conduct Authority (FCA) published a speech by CEO Nikhil Rathi discussing regulation and competition in UK markets and how the FCA will use the UK’s increased flexibility post-Brexit. The following points were considered:

• Regulation and competition in UK markets. While the FCA will apply the same rules, standards, and threshold conditions to international firms seeking authorisation as they would to domestic firms, international firms pose more risk to consumers, clients, and markets and can therefore expect proportionately closer scrutiny and higher expectations. As such, international firms require structural arrangements enabling the FCA to supervise them effectively, and the FCA expects firms seeking authorisation to have an active place of business in the UK. Where EU firms access UK markets via the Temporary Permissions Regime (TPR), the FCA will carry out a rigorous review of all firms seeking to enter the UK authorisation gateway. The FCA reminds firms that where they have seen misconduct, they have taken action to remove firms from the TPR to avoid harm to UK markets or consumers.
• Using the FCA’s increased flexibility. The FCA recognises the increased flexibility available to the UK following exit from the EU and will use its autonomy to regulate for the benefit of UK financial markets and consumers. The FCA recognises that divergence will affect potential EU equivalence, though the FCA will not pursue equivalence at the cost of failing to improve UK markets and references the recently announced proposed changes to the MiFID rules on research and best execution reporting as an example of such improvements (for further details on this consultation, please see our May 2021 Update).
• Global regulatory issues. Other key areas of focus in international regulation include ESG and the sustainability agenda, and dealing with financial crime.

11. UK FCA Compliance Matters

FCA publishes Market Watch issue 67

On 28 May 2021, the FCA published Issue 67 of Market Watch, its newsletter on market conduct and transaction reporting issues.

The FCA explains that it uses the order book records of key UK equity trading venues to identify suspected market manipulation. The FCA assesses the controls of all trading venues and firms to ensure that they have effective surveillance arrangements and report suspicious activity as required, and may make information requests for orderbook data to support enquiries.

Such surveillance has led to identifying potential manipulative trading, which is then investigated further: In recent cases, non-enforcement outcomes were reached in relation to the impact on the market of the trading of an algorithmic trading firm, and enforcement outcomes were successfully pursued for market abuse against Adrian Horn, as noted in our March 2021 Update.

FCA announces that previous data collection platform has now been replaced

On 5 May 2021, the FCA announced that its previous data collection platform, Gabriel, had been replaced by its new platform, RegData.

While the new platform is intended to look similar to Gabriel, and there will be no change to the way firms currently provide data to the FCA, the FCA notes that RegData is faster, more accessible, and can be more easily maintained and upgraded.

12. UK Regulatory Initiatives Grid

On 7 May 2021, the UK Financial Services Regulatory Initiatives Forum (the Forum, which includes the FCA) issued the latest version of the Regulatory Initiatives Grid (the Grid) setting out key UK financial services regulatory initiatives over a 24-month horizon (see the FCA’s statement here). This is a useful reference document to check the anticipated timeframe for reforms in particular areas, including investment management, anti-money-laundering, market abuse, LIBOR transition, and cryptoassets.

As noted in our June 2020 Update, the Grid will be published twice a year. The Grid was first published in May 2020 and focused on the delays and cancellations to initiatives taken in view of the COVID-19 pandemic. As started with the September 2020 edition, the most recent version continues with a more typical focus on upcoming initiatives.

The Grid expects the UK IFPR to be introduced by 1 January 2022, with FCA rules and necessary secondary legislation in place before then. Please see our Sidley Update UK Investment Firm Prudential Regime – FCA’s Second Consultation – Implications for Investment Managers (referred in item 4 above).

13. UK Long-Term Asset Funds (LTAFs)

FCA publishes consultation on LTAFs

On 7 May 2021, the FCA published a consultation paper on a new UK authorised fund regime for investing in long-term assets. Noting that UK investors typically invest in illiquid assets through closed-ended structures, the FCA proposes to create a new category of fund called LTAFs, which will be open-ended and invest in long-term, illiquid assets such as venture capital, private equity, private debt, real estate, and infrastructure.

The FCA proposes that LTAFs will be AIFs with the following features:

• The management of LTAFs will be restricted to full-scope UK AIFMs that meet additional requirements. In particular, the FCA will expect such AIFMs to demonstrate that they have sufficient relevant expertise to manage LTAFs.
• LTAFs will have wide investment flexibility, including the ability to invest in certain loans and collective investment schemes; the FCA does not plan to set any specific diversification requirements beyond an overarching requirement that LTAFs have a prudent spread of risk. LTAFs may borrow up to 30% of net assets.
• The FCA will expect that more than 50% of the value of the LTAF to be invested in unlisted securities or other long-term assets (or collective investment schemes investing in such assets).
• Distribution of LTAFs will initially be restricted to professional investors and sophisticated retail investors, though the FCA is considering making LTAFs available to a wider investor base.

The consultation closes on 25 June 2021. The FCA intends to publish a final policy statement and final handbook rules later this year.

14. LIBOR Transition

FCA and Bank of England publish statement encouraging switch to SONIA

On 13 May 2021, the FCA and Bank of England published a statement encouraging market users and liquidity providers in the sterling exchange-traded derivatives market to switch the default-traded instrument from LIBOR to the sterling overnight index average (SONIA) from 17 June 2021.

This forms part of the effort to meet the Working Group on Sterling Risk-Free Reference Rates’ recommendation to cease the initiation of new GBP LIBOR exchange-traded derivatives expiring after 2021 by the end of Q2, 2021.

FCA consults on new powers to support orderly wind-down of critical benchmarks

On 20 May 2021, the FCA published a consultation paper on its proposed use of two new powers under the UK Benchmarks Regulation (BMR) relating to the wind-down of LIBOR, which will be introduced by the Financial Services Act 2021.

The first power enables the FCA to designate a benchmark as permanently unrepresentative of the market it is intended to measure. This results in an automatic prohibition on the use of the benchmark by UK supervised entities, though the FCA may permit some or all legacy use to continue.

In issuing such a permission, the FCA will have regard for whether the legacy contracts contain adequate provisions to deal with a prohibition and are of such scale and nature that they could have consumer protection and market integrity implications. This is particularly relevant should the FCA require continued publication of LIBOR on a “synthetic” basis in order to assist with some LIBOR contracts that are especially difficult to amend (the FCA will soon consult on using powers under the BMR to implement a “synthetic LIBOR” rate for some sterling and yen LIBOR settings). As synthetic LIBOR will be prima facie permanently unrepresentative, it will be automatically prohibited.

The second power enables the FCA to restrict the new use of a ceasing critical benchmark. Similarly, the FCA shall consider the impact on their consumer protection and integrity objectives and shall restrict the use of relevant benchmarks only where these objectives are promoted.

The FCA will finalise its policies in light of feedback on the consultation. The FCA aims to consult in Q3 2021 on its proposed decisions on precisely what legacy use to allow for any synthetic sterling and yen LIBOR rates and how it may restrict new use of LIBOR rates (including U.S. dollar LIBOR), coming to a final decision as soon as practicable in Q4.

15. Cryptoassets

Temporary Registration Regime extended for cryptoasset businesses

On 3 June 2021, the FCA announced an extension to the end date of the Temporary Registrations Regime (TRR) for cryptoasset businesses from 9 July 2021 to 31 March 2022.

The TRR allows existing cryptoasset firms that applied for registration before 16 December 2020, and whose applications are still being assessed, to continue trading.

The FCA notes that the extension will allow cryptoasset firms to continue trading while the FCA carries on its robust assessment of applicants’ compliance with the requirements of the UK Money Laundering Regulations.

Law Commission launches call for evidence on digital assets

On 30 April 2021, the Law Commission published a call for evidence (the Call for Evidence), seeking views on the ways digital assets are being used by market participants and on the potential consequences of making digital assets “possessable.”

The Call for Evidence forms part of the Law Commission’s overarching digital assets project, which involves making recommendations for reform to ensure that English law is capable of accommodating transactions involving digital assets (like cryptoassets).

The Call for Evidence seeks evidence on views on various issues, including possession and transferability of digital assets and use of security over digital assets.

The Call for Evidence closes on 30 July 2021, and the responses will inform the Law Commission’s proposals for reform, which it will put forward in its consultation paper on digital assets.