UK/EU Investment Management Update (March 2022)

1. Europe — War in Ukraine

2. UK — FCA change in control processing delays

3. UK — Wholesale Markets Review

4. UK — Market Abuse

5. UK — Cryptoassets

6. EU — AIFMD and UCITS Directive

7. EU — ESMA Report on Trends, Risks, and Vulnerabilities (TRV)

8. EU — ESG

1. Europe — War in Ukraine 

FCA

Following the publication of the initial tranche of Russia-related sanctions by the UK government, the FCA published a statement (last updated on 24 February 2022) setting out its expectations for firms. In particular, firms should have established financial crime systems and controls to counter the risk that they might be used to further financial crime, which includes compliance with financial sanctions obligations (as detailed further in Chapter 7 of the FCA Financial Crime Guide).

Firms should screen against the UK Sanctions List to meet these new sanctions measures and screen against the Office of Financial Sanctions Implementation (OFSI) list of asset freeze targets for financial sanctions obligations. Firms are legally obliged to report to OFSI (at the earliest opportunity) if:

• they know or suspect that a breach of financial sanctions has occurred;
• a person a firm is dealing with directly or indirectly is a designated person;
• a firm holds any frozen assets;
• knowledge or suspicion of the above arise while conducting the firm’s business.

Firms should also notify the FCA.

London Stock Exchange suspends trading in 27 firms with strong links to Russia

On 3 March 2022, the London Stock Exchange issued a Market Notice to announce that it had suspended trading in the global depositary receipts (GDRs) and American depositary receipts (ADRs) of 27 companies with links to Russia, including the energy and banking firms Gazprom and Sberbank.

Russia Central Bank Bans Short Selling

On 24 February 2022, the Bank of Russia issued an instruction to Russian brokers to suspend short sales in exchange and over-the-counter markets until further notice.

2. UK — FCA change in control processing delays

On 18 February 2022, the FCA updated its website to highlight further the processing delays being experienced by firms that have submitted change in control applications.

In our December 2021 Update we noted that the FCA had discussed such delays in its responses to unanswered questions from its annual public meeting.

In its 18 February update, the FCA confirms that delays are extending to approximately two months between submission of a complete notification and allocation to a case officer.

The FCA states that it is recruiting additional case officers and making improvements as part of its broader “Transformation programme” to reduce the time taken to allocate and determine cases.

Notwithstanding the delays, the FCA reminds prospective controllers that it is a criminal offence to proceed with a transaction before a decision has been made. Transaction timelines must therefore be adjusted to take account of these delays.

3. UK — Wholesale Markets Review

On 1 March 2022, HM Treasury (HMT) published its response to the Wholesale Markets Review consultation, setting out its feedback on a wide range of topics. See our July 2021 Update, in which we set out an overview of the Wholesale Markets Review consultation document.

The publication of HMT’s response follows an announcement in November 2021 by the Economic Secretary to the Treasury, John Glen MP, that the UK government intends to:

• abolish the UK Markets in Financial Instruments Directive (MiFID) II share trading obligation;
• amend the scope of the transparency regime for fixed income and derivatives markets; and
• remove the double volume cap (DVC), which limits the amount of trading that happens under the reference price and negotiated price waivers to pre-trade transparency.

In its consultation response, HMT identifies a number of policy proposals that will be taken forward; however, while various measures that have been identified as priorities will be addressed in legislation “when parliamentary time allows,” including the removal of the DVC. Other measures, such as the requirement for algorithmic trading firms to enter into market making agreements with trading venues, will be subject to review by the FCA following the UK government’s Future Regulatory Framework review.

By way of an overview, HMT’s response identifies the following areas that should be amended (or be subject to further consideration):

• Trading venues
  • clarification of the regulatory perimeter for firms operating multilateral trading facilities (MTFs);
  • ability for organised trading facilities (OTFs) to execute transactions in equities when dealing in large packages;
  • ability for investment firms to operate a systematic internaliser (SI) and OTF within the same legal entity (subject to further consideration);
  • development of a new venue/segment for micro, small and medium-size enterprises (subject to stakeholder engagement to determine whether to proceed);
  • provision of FCA guidance on market outages;
• SIs
  • introduction of a qualitative rather than quantitative test to identify firms that must become SIs;
  • changes to the reporting regime for SIs (although, notably, the Treasury did not express support for the popular ‘super reporter’ model);
  • SIs permitted to cross at the midpoint;
  • changes to the minimum quote sizes for SIs;
• Equity markets
  • removal of the double volume cap;
  • delegation of the pre-trade transparency waivers regime to the FCA;
  • removal of the share trading obligation;
  • removal of the requirement for algorithmic firms to enter into market making agreements with trading venues;
  • allowing trading venues to follow the tick size applicable to the primary market of a share, even when that market is overseas;
  • allowing trading venues to establish tick sizes for new shares until sufficiently robust data is available;
  • delegation of the tick size regime to trading venues (further consideration needed);
• Fixed income and derivatives markets
  • realignment of the scope of the derivatives trading obligation (DTO) and European Market Infrastructure Regulation (EMIR) clearing obligation (CO);
  • exemption for post-trade risk reduction (PTRR) services from the DTO;
  • exemption for PTRR services from the CO;
  • granting power to the FCA to amend the scope of the DTO in certain circumstances;
  • delegation of the pre- and post-trade transparency regime for fixed income and derivatives markets to the FCA;
• Commodity derivatives
  • amendment to the definition of a commodity derivative (further consideration required);
  • removal of economically equivalent over-the-counter contracts from the scope of the position limits regime;
  • revocation of the requirement for position limits to be applied to all exchange-traded contracts;
  • transfer of the power to set position limit controls from the FCA to trading venues;
  • amendments to the position reporting regime (case for change not conclusive and so changes not being considered);
  • amendments to the ancillary activities test;
• Market data
  • giving of power to the FCA to make requirements for consolidated tape providers with the aim of facilitating the emergence of one or more consolidated tapes;
• Reporting
  • amendments to investor protection reports (further stakeholder engagement required); and
  • amendments to product identifiers (case for change not conclusive).

4. UK — Market Abuse

Former CFO and finance director guilty of misleading investors in case brought by the FCA, former CEO found not guilty

On 11 February 2022, the FCA published a press release stating that Timothy Coleman, former chief financial officer, and Estelle Croft, former finance director of an IT service provider and AIM-listed company, Redcentric Plc, had been found guilty of misleading investors in a case brought by the FCA. The third defendant, the company’s former CEO, was acquitted on all counts.

As a result of false statements made by the defendants, the price of Redcentric shares was artificially inflated, causing estimated losses to investors of approximately £43 million. The FCA publicly censured Redcentric on 26 June 2020 in proceedings in which the company agreed to pay compensation to affected investors.

Croft has already been sentenced to three years imprisonment and ordered to pay £120,346.70 following confiscation proceedings.

On 3 March 2022, the FCA published a further press release, stating that Coleman had been sentenced to five and a half years imprisonment and disqualified from being a director for 10 years, having been found guilty of two offences of making false and misleading statements to the market and three offences of false accounting.

5. UK — Crypto-assets

Gidiplus Limited v The Financial Conduct Authority [2022] UKUT 000433 (TCC)

On 16 February 2022, the Upper Tribunal published a decision in suspension proceedings connected to an appeal brought by Gidiplus against an FCA Decision Notice refusing permission to register Gidiplus as a crypto-asset exchange under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs). The Decision Notice had been given because the FCA considered that Gidiplus had not met the conditions for registration as a crypto-asset exchange provider contained in the MLRs.

Gidiplus is a UK-based business that operates crypto-asset automated teller machines (CATMs) that allow customers to feed in currency (in the form of banknotes) to be converted into crypto-currencies (in particular, bitcoin). Prior to the receipt of the FCA’s Decision Notice, Gidiplus was able to continue operating its CATM business under the FCA’s Temporary Registration Regime for pre-existing crypto-asset exchange providers that were active prior to January 2020.

Pending its appeal against the FCA’s Decision Notice, Gidiplus applied for a direction that the effect of the Decision Notice be suspended.

In its decision on the suspension application, the Upper Tribunal refused to grant Gidiplus’ application, noting the “serious concerns identified in the Decision Notice and the lack of evidence as to how Gidiplus would undertake its business in a broadly compliant fashion pending determination of its appeal.”

The substantive appeal remains to be determined, but in the meantime, Gidiplus will not be able to carry out CATM services.

The case serves to highlight the continuing difficulties that many firms are facing in their attempts to meet the FCA’s requirements for registration as crypto-asset businesses under the MLRs. It is clear that the FCA will closely scrutinise firms’ anti-money-laundering systems and controls and the fitness and propriety of the persons running the relevant business as part of any crypto-asset application under the MLRs.

FCA — Action to tackle harm in the consumer investments market

On 3 March 2022, the FCA published a press release detailing its plan to take assertive action to tackle harm in the consumer investments market.

The FCA notes that between April and September 2021, the FCA received 16,400 enquires about possible scams, up nearly a third from the same period in 2020. The top types of scams being reported to the FCA included crypto-asset, boiler room, and recovery room scams.

During this period the FCA opened over 300 cases relating to possible crypto-asset businesses not registered with the FCA (which may include scams) and currently has 50 live investigations into unauthorised businesses.

6. EU — AIFMD and UCITS Directive

ESMA publishes information from NCAs on AIF and UCITS marketing

On 4 February 2022, as required under the Cross-Border Distribution of Funds (CBDF) Regulation, ESMA published on its website the hyperlinks to the websites of national competent authorities (NCAs) where information on the applicable national laws, regulations, and administrative provisions governing marketing requirements for AIFs and UCITS is published.

ESMA’s publication also includes summaries of the information published by the NCAs, including (for certain jurisdictions) information on the requirements for non-EU alternative investment fund managers (AIFMs) to market AIFs.

ESMA finalises rules on standardised information to facilitate cross-border distribution of funds

On 1 February 2022, ESMA published a final report on implementing technical standards (ITS) under the CBDF Regulation. The draft ITS set out requirements relating to the publication of information by NCAs on their websites (including in relation to fees and charges levied on AIFMs and UCITS management companies), the notification of information by NCAs to ESMA and ESMA's publication of information on its website (necessary for the creation of the central database on cross-border marketing of AIFs and UCITS).

ESMA has submitted the draft ITS to the European Commission for endorsement. The European Commission shall take a decision on whether to adopt the ITS within three months. The Commission may extend that period by one month.

ESMA publishes fourth annual AIF statistical report

On 3 February 2022, ESMA published its fourth annual statistical report on the AIF sector.

Among other observations, ESMA notes that following the withdrawal of the UK from the EU, the size of the European Economic Area (EEA) hedge fund sector has declined to only €89 billion, down from €354 billion in 2019 when the UK was still a member of the EU. Nonetheless, the overall EEA AIF sector has increased by 8% in 2020 to €5.9 trillion in net assets from €5.5 trillion in 2019.

ESMA identifies the main risk to sector as a mismatch between the potential liquidity of the assets and the redemption timeframe offered to investors. It indicates that AIFs with a liquidity deficit would face challenges if large redemptions were to occur. This is particularly the case for real estate funds and funds of funds.

ESMA will continue to report annually on its analysis.

7. EU — ESMA Report on Trends, Risks, and Vulnerabilities (TRV)

On 15 February 2022, ESMA published its TRV Report for the first half of 2022.

ESMA’s TRV reports are published periodically as part of ESMA’s attempts to identify and assess, at an early stage, TRV at a micro prudential level, across borders and across sectors. The TRV reports are wide-ranging and cover a broad range of financial-services-related topics. We addressed ESMA’s TRV Report for H2 2021 in our September 2021 Update.

For the asset management sector, the latest TRV report highlights that investment fund markets continued to grow, particularly with inflows into equity funds but that risks remained elevated, including liquidity risk and credit risk, and higher inflation expectations raise concerns in relation to duration risk.

ESMA notes that growth in ESG markets remained steady and ESG fund assets increased by 9% in the second half of 2021, while ESG bond markets grew by 19%, but concerns over possible green asset overvaluation remained.

The TRV designated environmental risk as a distinct risk category in the risk dashboard for the first time (shown as an elevated risk, which is increasing versus the previous quarter), and new risk indicators on climate-related disclosures, firms’ reputational risk, and EU carbon markets were included in the statistical annex to the TRV. See above regarding ESMA’s TRV Risk Analysis on Monitoring environmental risks in EU financial markets.

8. EU — ESG

ESMA to consult on the review of MiFID II suitability guidelines

On 27 January 2022, ESMA published a consultation paper in respect of proposed updates to its guidelines on certain aspects of the MiFID II suitability requirements.

The requirement to assess the suitability of an investment under Article 25(2) of the MiFID II Directive applies to the provision of investment advice (whether independent or not) and portfolio management. Articles 54 and 55 of the MiFID Org Regulation (Commission Delegated Regulation (EU) 2017/565) further elaborate on this requirement.

From August 2022, as a result of amendments to the MiFID Org Regulation, EU investment firms providing investment advice or portfolio management will be required to obtain information on and consider their clients’ “sustainability preferences.” Clients will be able to express a preference in relation to financial instruments that:

• pursue a minimum proportion of sustainable investments in economic activities that qualify as environmentally sustainable under the EU Taxonomy Regulation;
• pursue a minimum proportion of sustainable investments as defined in SFDR; and
• consider principal adverse effects on sustainability factors, where elements demonstrating that consideration are determined by the client.

As well as the above, EU investment firms will be required to integrate sustainability factors and sustainability risks into certain organisational requirements and operating conditions for investment firms under the MiFID Org Reg.

ESMA has therefore built on its existing 2018 suitability guidelines to expand some of the existing guidelines to consider these changes.

Although neither the revised obligations in the MiFID Org Reg, nor the updated suitability requirements will apply to UK firms (or firms in any other non-EU jurisdiction), the requirement to obtain and consider client sustainability preferences is likely to influence the capital allocation decisions of EU portfolio managers and the advice given by EU investment advisers, and could therefore have an indirect effect on asset managers that have marketed their products into the EU, which are therefore subject to the EU Sustainable Finance Disclosure Regulation (SFDR) (see our August 2021 Sidley Update for more information on the SFDR).

The consultation closes on 27 April 2022. ESMA will consider the feedback it receives to the consultation in Q2 2022 and expects to publish a final report in Q3 2022.

ESMA launches Call for Evidence on ESG Ratings

On 3 February 2022, ESMA published a Call for Evidence on market characteristics for ESG rating providers. The call for evidence is addressed to ESG rating providers, users of ESG ratings (including asset managers), and entities covered by ESG rating providers (including public and private issuers and sovereign issuers) and is structured with a separate questionnaire for each type of addressee.

ESMA is seeking to develop an idea of the size, structure, resourcing, revenues, and product offerings of the different ESG rating providers operating in the EU.

Asset managers are directed to Questionnaire B, which requests information on the ESG ratings and ESG data products contracted for by the user, including in relation to the characteristic use of ESG ratings and data products, contractual characteristics of the ratings and products subscribed for, and general views on ESG ratings in financial markets.

For the purpose of the call for evidence, ESMA adopts the following definitions of “ESG data products” and “ESG ratings.”

• “ESG data products” refers to the broad spectrum of data products marketed as providing either a specific E, S, or G focus or a holistic ESG focus on an entity, financial instrument, product, or company’s ESG profile or characteristics or exposure to ESG, climatic or environmental risks, or impact on society and the environment, whether or not they are explicitly labelled as “ESG data products.”
• “ESG ratings” refers to the broad spectrum of ratings products marketed as providing an opinion regarding an entity, a financial instrument, or a product, a company’s ESG profile or characteristics or exposure to ESG, climatic, or environmental risks, or impact on society and the environment that are issued using a defined ranking system of rating categories, whether or not these are explicitly labelled as “ESG ratings.”

The call for evidence will complement a separate consultation by the Commission that will seek stakeholder views on the use of ESG ratings by market participants and the functioning and dynamics of the market.

Stakeholders are invited to submit their responses by 11 March 2022 for ESMA’s consideration.

ESMA publishes new Sustainable Finance Roadmap

On 11 February 2022, ESMA published its Sustainable Finance Roadmap 2022-2024, which will allow for a coordinated approach to ESMA’s delivery on the variety of sustainable finance tasks across several areas over the next three years.

The Roadmap identifies three priorities for this period, namely tackling greenwashing and promoting transparency; building NCAs’ and ESMA’s capacity on sustainable finance by developing new skills to enable regulators to understand and address the supervisory implications of new regulation and of novel market practices relating to sustainable finance; and monitoring, assessing and analysing ESG markets and risks through specific activities including climate scenario analysis for investment funds, central counterparty stress testing and the establishment of common methodologies for climate-related risk analysis.

The Roadmap includes a list of actions over the period 2022-24, including a number of actions in the investment management context.

ESMA will review the incoming SFDR regulatory technical standards during 2022 to clarify the indicators principal adverse impacts relating to climate, environment, social and employee matters, respect for human rights, anti-corruption, and anti-bribery matters.

ESMA will also contribute to the Commission’s work on minimum sustainability criteria for SFDR Article 8 products during 2022. This action point will be of particular interest and importance for any investment managers that have (or are intending to) market an AIF in the EU that has (or will be) sold on the basis of its contribution to environmental or social characteristics. Since the SFDR came into force in March 2021, concerns have been expressed as to the high number of funds marketed in the EU under Article 8 of the SFDR, with the implication that certain funds that only weakly promote environmental or social characteristics are potentially misleading investors.

Commission proposal for Directive on corporate sustainability due diligence

Following an open public consultation that ran from October 2020 to February 2021, on 23 February 2022, the European Commission adopted a proposal for a Directive on corporate sustainability due diligence. The proposal aims to enhance sustainable and responsible corporate behaviour throughout global value chains, through requirements relating to corporate due diligence, directors’ duties, and directors’ remuneration, which are intended to be complementary elements.

The proposed Directive would represent a new set of requirements intended to complement the existing EU Non-Financial Reporting Directive and the proposed Corporate Sustainability Reporting Directive by adding a substantive corporate duty to perform due diligence to identify, prevent, mitigate, and account for external harm resulting from adverse human rights and environmental impacts in the company’s own operations, its subsidiaries, and the value chain and (for certain companies) to prepare a Paris-aligned business transition plan.

Whereas a number of member states have introduced national rules, the Commission has identified a need for improvement to sustainability due diligence in corporate value chains. The proposed Directive would oblige all EU companies above a certain size (500 employees, €150 million worldwide turnover) (Group 1) and companies in high-impact sectors (subject to a lower size threshold of 250 employees and €40 million worldwide turnover) (Group 2) to diligence the potential negative effects of their value chains.

Companies will be required to identify and, where necessary, prevent, end, or mitigate adverse impacts of their activities on human rights, such as child labour and exploitation of workers, and on the environment, for example, pollution and biodiversity loss. Companies must implement comprehensive mitigation processes for adverse human rights and environmental impacts in their value chains, integrate sustainability into corporate governance and management systems, and frame business decisions in terms of human rights, climate and environmental impact, and in terms of the company’s resilience in the longer term.

Directors of in-scope companies will be subject to a duty to set up and oversee implementation of the company’s due diligence framework and to integrate it into the corporate strategy. In addition, when fulfilling their duty to act in the best interest of the company, directors must take into account the human rights, climate change, and environmental consequences of their decisions.

In addition, Group 1 companies will be obliged to have a plan to ensure that their business strategy is compatible with limiting global warming to 1.5 °C in line with the Paris Agreement. Where directors’ variable remuneration is linked to the contribution of a director to the company’s business strategy and long-term interests and sustainability, companies should have regard to the fulfilment of the Paris-aligned business transition strategy when setting variable remuneration.

The proposed Directive would also have extraterritorial effect as it would apply to non-EU companies active in the EU with turnover threshold aligned with Group 1 and 2, generated in the EU.

National administrative authorities appointed by EU member states would be responsible for supervising compliance with the new regime and would be empowered to impose fines in case of non-compliance. Victims will also be given legal standing to take action for damages that could have been avoided with appropriate due diligence measures.

To the extent that they fall within the Group 1 or Group 2 thresholds, the proposed Directive specifically applies to regulated financial institutions, including banks, insurance companies, and asset managers (and their funds). For such firms providing loan, credit, or other financial services, the meaning of “value chain” with respect to the provision of such services should be limited to the activities of the clients receiving such services, and the subsidiaries thereof whose activities are linked to the contract in question.

Nonetheless, as many alternative asset management firms fall well below the 500-employee threshold for Group 1 firms, it is unlikely that the proposed Directive would have a significant impact on the alternative asset management sector; however, firms should continue to be aware of developments in this area as it is possible that the relevant scoping provisions could be amended.

The Commission’s proposal will be presented to the European Parliament and the Council for approval. Once approved, member states will have two years to transpose the Directive into national law.

ESMA TRV Risk Analysis — monitoring environmental risks in EU financial markets

As part of its TRV report for the first half of 2022 (see further below), on 15 February 2022, ESMA published a risk analysis regarding the monitoring of environmental risks in EU financial markets.

The article seeks to depict how environmental risks can be expected to affect EU securities markets and their participants and seeks to provide a comprehensive framework through which climate risks can be monitored in the context of EU securities markets.

ESMA notes that “the growing interest in and shift to sustainable investing confirms a public urge to consider wider ESG factors in investment decision-making,” and “the increasing visibility of climate change impacts” means that accounting for climate risk in ESMA’s monitoring and analysis is “imperative.”

EU Platform published revised proposal for a social taxonomy

On 28 February 2022, the Platform on Sustainable Finance (the Platform) published a final report on a proposal for an EU social taxonomy. The Platform’s recommendations are a proof of concept that is not binding on the Commission, meaning that any social taxonomy proposed by the Commission could differ significantly.

Following feedback to an earlier consultation, the structure of the Platform’s proposed social taxonomy more closely aligns with the existing EU taxonomy for environmentally sustainable economic activities. In line with environmental taxonomy, the Platform proposes that the social taxonomy should adopt the following common framework:

• the development of social objectives;
• types of substantial contributions;
• ‘do no significant harm’ criteria (DNSH); and
• minimum safeguards.

The Platform suggests three objectives for a social taxonomy (each with its own sub-objectives): decent work; adequate living standards and wellbeing for end users; and inclusive and sustainable communities and societies. Under the Platform’s suggested framework, an economic activity would not need to make a substantial contribution to all sub-objectives included in an objective to qualify as sustainable.

The Platform further recommends that activities detrimental to the environment should be excluded from social taxonomy, in another bid to push for alignment.

The Platform will publish a follow-up report to clarify measurement metrics, particularly in connection with minimum safeguards, substantial contribution, and DNSH criteria.