UK/EU Investment Management Update (November 2022)

1. UK — FCA
2. UK — ESG
3. UK — CMA
4. UK — SFTR
5. UK — MiFIR
6. UK — Overseas Funds Regime
7. EU — Securitisation Regulation
8. EU — CSDR
9. EU — SRD II
10. EU — ESG

1. UK — FCA

FCA fines Sigma Broking £500,000 for transaction reporting and market abuse failures

The FCA has fined Sigma Broking Limited (Sigma) £531,600 for transaction reporting and market abuse failures as well as imposing fines totalling over £200,000 on three of its current and former directors. Two of Sigma’s directors have also been prohibited from holding significant management functions in FCA-regulated firms.

In its Final Notice of 4 October 2022, the FCA noted that between December 2014 and August 2016, Sigma either did not report, or failed to report accurately, 56,000 contracts for difference (CFD) transactions to the FCA. The inaccurate reports were due to Sigma reporting only the first leg of CFD trades executed for clients on a “matched principal” basis and failing to report the second client-side transaction.

The FCA also found that Sigma had failed to identify 97 suspicious transactions or orders that it should have reported to the FCA in accordance with its obligations under the EU Market Abuse Regulation.

The FCA attributed many of these issues to inadequate governance and oversight from Sigma’s board of directors, resulting in Sigma being found to have breached its obligation under Principle 3 to take reasonable care to organise and control its affairs responsibly and effectively with adequate risk management systems.

Amongst the governance failings were a failure to hold board meetings with sufficient regularity or to provide the board with adequate management information to enable it to oversee the CFD desk’s business effectively. Sigma was also found to have failed to establish and adequately resource an effective compliance function.

As a result, the FCA issued prohibitions against two of Sigma’s directors, preventing them from holding significant management functions in FCA-regulated firms. They have also been fined £67,900 and £69,600, respectively. A third director has been fined £83,600.

This comes among a number of signs that the FCA is focussed on transaction reporting by firms, including observations made in its recent Market Watch 70, as noted in our October 2022 Update.

FCA publishes update on its authorisation timelines

The FCA published on 10 October 2022 an update on its operating service metrics for authorisation timelines.

The FCA notes that it has shown improvement in meeting its timelines for various types of application over 2021–22. In particular, the FCA notes that during this period it was near target on its statutory timelines for applications for authorisation, variation of permission and changes in control, and money laundering registrations.

Where timelines were not met, this is noted as attributable to increased scrutiny applied at the gateway, incomplete or poor-quality applications (particularly in the context of money laundering registrations, and applications from payments, electronic money, and cryptoasset businesses) and increased volumes of applications (e.g., due to a spike in Approved Person applications following the expansion of the Senior Managers and Certification Regime).

On change of control applications specifically, the FCA notes a roughly 40% decrease in time to allocate cases.

House of Lords committee chairs question FCA on oversight of LDI funds

On 14 October 2022, the chairs of the House of Lords Industry and Regulators Committee and Economic Affairs Committee wrote to the FCA requesting information on its oversight of liability-driven investment (LDI) funds and their managers. This comes in the context of the Bank of England (BoE) emergency £65bn bond-buying programme to stabilise rising gilt yields.

The letter highlighted that the committees’ recent exchanges with the BoE and the Pensions Regulator regarding their monitoring of the risk of use of derivatives by defined-benefit pension schemes highlighted the FCA’s role in this space as the regulator of pension investment managers.

In addition, the committee chairs asked the FCA to outline what steps it has taken in recent years to minimise the risk to consumers with defined-benefit pensions from the firms it regulates, including LDI funds, in light of its consumer protection objective.

In its response of 20 October 2022, the FCA highlighted the contact it has had since March this year with the largest LDI fund managers and during the time of the BoE’s intervention, as well as its collaboration with other regulators in the context of cross-border fund structures.

The FCA notes that one area of focus for the future, in addition to financial resilience, is likely to be operational resilience – whether funds and their managers have the systems in place to adjust to rapidly changing market conditions.

2. UK — ESG

FCA launches consultation on Sustainability Disclosure Requirements (SDR) and investment labels

The FCA launched on 25 October 2022 its consultation on SDR and investment labels.

In its consultation paper, the FCA sets out its proposal to introduce:

• sustainable investment labels, across three categories underpinned by objective criteria — sustainable focus, sustainable improver, and sustainable impact;
• restrictions on how certain sustainability-related terms (such as “ESG,” “green,” or “sustainable”) can be used in product names and marketing as well as a more general anti-greenwashing rule for all regulated firms;
• consumer-facing disclosures relating to the key sustainability features of an investment product;
• more detailed disclosures for institutional investors or retail investors that want more information; and
• requirements on product distributors to ensure that the labels and disclosures are accessible and clear to consumers.

The consultation is open until 25 January 2023. The FCA intends to publish final rules by the end of the first half of 2023.

We will shortly be publishing a more detailed update on the consultation.

3. UK — CMA

The UK Competition and Markets Authority (CMA) has stated that it is continuing to investigate suspected anti-competitive arrangements in the financial services sector under the Competition Act 1998 and will provide a further update by spring 2023.

The CMA launched the investigation in November 2018 in relation to suspected infringements of Chapter I of the Competition Act 1998 (CA98) and/or Article 101 of the Treaty on the Functioning of the European Union. Following the end of the Brexit transition period, the CMA continued its investigation in respect of the suspected CA98 infringement.

While the CMA and the FCA have concurrent competition law enforcement in the sector, it was agreed that the CMA would exercise those functions for this investigation.

The CMA continues to state that no assumption should be made at this point that competition law has been infringed and that it has not reached a view as to whether there is sufficient evidence of a competition law infringement or to issue a statement of objections to any of the parties under investigation.

4. UK — SFTR

FCA extends forbearance on reporting of third-country issuer legal entity identifiers (LEIs) under SFTR

The FCA provided an update on 7 October 2022 noting its intention not to prioritise supervisory action in relation to the reporting of LEIs of third-country issuers under the UK SFTR. This follows a period of forbearance for such reporting in view of the large number of third-country issuers without an LEI (its analysis of SFTR data shows that 29% of loaned-security transaction records relating to securities issued in a third country were reported without an issuer LEI).

The FCA asks that counterparties to securities financing transactions report an LEI for third-country issuers where available and continue to engage with such issuers to encourage them to acquire an LEI where one is not.

The FCA notes that it will provide at least six months’ notice to industry of any change in its position on third-country issuer LEIs.

5. UK — MiFIR

Two-year extension of FCA temporary transitional power (TTP) in relation to share trading obligation (STO) and derivative trading obligation (DTO)

The expiry date of the FCA’s TTP in relation to the STO and DTO under the UK Markets in Financial Instruments Regulation (MiFIR) is due to be extended from two to four years following the end of the Brexit transition period.

The FCA’s TTP Directions on the STO and DTO were due to expire on 31 December 2020 but will be extended by a further two years under the Financial Services (Miscellaneous Amendments) (EU Exit) Regulations 2022 when these come into force on 15 November 2022.

As the STO and DTO TTP Directions do not specify an end date, they will remain in effect until 31 December 2024 unless the FCA varies or revokes them earlier.

Note that the UK government is proposing to remove the STO and make certain reforms to the DTO under the Financial Services and Markets Bill 2022–23, which is making its way through the parliamentary process. For details, please see our August 2022 Update.

6. UK — Overseas Funds Regime (OFR)

HM Treasury commences equivalence assessment of EU and EEA under OFR

The UK government has commenced its equivalence assessment of the EU and EEA under the OFR, as noted in an update to HM Treasury’s webpage on the OFR.

The OFR provides a framework for non-UK funds to be recognised, allowing them to be marketed to retail investors in the UK. It is expected to be used in particular by the large number of EEA Undertakings for the Collective Investment in Transferable Securities (UCITS) funds currently marketing in the UK via the Temporary Marketing Permissions Regime (TMPR) once the TMPR expires. It is intended to supersede the existing recognition regime under Section 272 of the Financial Services and Markets Act 2000 in relation to funds eligible to use the OFR.

The legislative framework for the OFR is in place but is yet to be operationalised, including by way of assessing overseas regulatory frameworks as equivalent to that of the UK.

7. EU — Securitisation Regulation

European Commission considering amendments to EUSR that would affect non-EU fund managers

The European Commission (Commission) published its report on the functioning of the EUSR on 10 October 2022. Two elements of the report will be of particular significance to asset managers.

Non-EU alternative investment fund managers (AIFMs) marketing alternattive investment funds (AIFs) into / managing AIFs in the EU

The first is the Commission’s comments on the legal uncertainty surrounding the application of the EUSR to non-EU AIFMs that market funds into, or manage funds in, the EU. This uncertainty was acknowledged by the European Supervisory Authorities (ESAs) in their Joint Committee report of 17 May 2021. The Commission considers that the EUSR legislators intended to include such non-EU AIFMs in the definition of “institutional investor” under the EUSR, as treating them as outside scope would undermine the investor protection aims of the EUSR.

The effect of being an “institutional investor” under the EUSR it that one must comply with certain due diligence requirements prior to holding a securitisation position including, inter alia, verifying that the originator, sponsor, or original lender retains on an ongoing basis a material net economic interest in the securitisation of not less than 5%. This restricts the ability of such investors to hold positions in securitisations that have not been designed with the EUSR in mind.

The Commission also notes in its report that the EUSR should only apply to non-EU AIFMs in relation to funds that they market into, or manage in, the EU, but not to any management and marketing activities that have no link to the EU.

The Commission notes that it will consider amending the definition of “institutional investor” to clarify this in a “future proposal to amend” the EUSR. However, given the Commission’s overall assessment that subject to fine-tuning on certain aspects, the EUSR is fit for purpose, there is no current proposal for the EUSR to be amended in this regard. As such, it is uncertain whether, and if so, when the EUSR will be amended to address the Commission’s comments.

The position the Commission has taken on the above issue contrasts with that taken by HM Treasury in the UK in relation to the UK Securitisation Regulation (UKSR). As noted in its Call for Evidence Response in December 2021, HM Treasury intends to clarify that non-UK AIFMs that manage or market funds in the UK will not be subject to the investor due diligence requirements, given the extraterritorial problems regarding supervision and enforcement as well as the potential to disincentivise firms from seeking investors in the UK.

Non-EU securitisations

The second key point is the Commission’s comments on whether the obligation of an institutional investor to verify that information has been made available in accordance with Article 7 EUSR applies when investing in a non-EU securitisation (i.e., where the sponsor, originator, and issuer are all outside the EU). To date, there has been uncertainty on this point.

The Commission states that it would be contrary to the legislative intent of the EUSR to differentiate between information requirements depending on whether the securitisation is issued by EU or non-EU entities. As such, it considers that non-EU securitisations were intended to be in scope of Article 7 reporting requirements.

The impact of applying this view would be that EU institutional investors would be prohibited from investing in non-EU securitisations unless they prepare asset-level and investor reports in the form of the templates prescribed for purposes of Article 7 EUSR.

Please see the separate Sidley Update on this Article 7 issue, published on or about the date of this Update.

When applied together with the Commission’s proposals on non-EU AIFMs above, the effect would be that non-EU fund managers marketing into the EU would be prohibited from investing in non-EU securitisations that do not comply with Article 7 EUSR reporting requirements.

Similarly to the above-mentioned proposal, it is unclear whether / when the EUSR will be amended to reflect this comment as well as whether EU Member State regulators may begin to align their approach with the Commission’s views in the interim.

8. EU — CSDR

European Parliament’s draft report on CSDR Refit proposes removal of mandatory buy-in regime

On 11 October 2022, the European Parliament Committee on Economic and Monetary Affairs (ECON) published its draft report on the Commission’s proposal for a regulation amending the CSDR (Regulation (EU) No 909/2014), referred to as CSDR Refit.

The report suggests a number of modifications to the CSDR Refit proposal. Of particular interests to asset managers, ECON proposes to discard the CSDR mandatory buy-in regime (MBI) in its entirety. It considers this a significant interference in the execution of securities transactions and the functioning of securities markets, posing significant risks for market liquidity and financial stability and the EU’s global competitiveness.

In connection with the removal of the MBI regime, the report proposes reintroducing into the EU Short Selling Regulation the central counterparty buy-in provisions against uncovered short selling that already existed prior to CSDR as well as making certain enhancements to the CSDR penalties regime.

This contrasts with the position under the CSDR Refit proposal adopted by the Commission on 16 March 2022, which had introduced a “two-step approach” whereby MBIs could become applicable if and when the penalties regime alone does not improve rates of settlement failure in the EU.

Pending these changes, the application of the MBI regime was delayed by Regulatory Technical Standards (RTS) that came into effect on 2 November 2022. Please also see our June 2022 Update for further background on the delayed application of the MBI.

9. EU — Revised Shareholder Rights Directive

European Securities and Markets Authority (ESMA) publishes Call for Evidence on Revised Shareholder Rights Directive (SRD II)

On 11 October 2022, ESMA published a Call for Evidence on the implementation of the revised EU Shareholders Rights Directive (SRD II).

The purpose is to gather information on how market participants perceive the appropriateness of the scope and the effectiveness of the SRD II provisions on the identification of shareholders, transmission of information, and facilitation of the exercise of shareholder rights as well as on the transparency of proxy advisers.

The Call for Evidence includes a number of specific questions for investors in shares of EU listed companies, including asset managers. These focus on views regarding the remaining obstacles to the effective exercise of their rights and the extent up to which shareholder engagement is achievable under the SRD II framework.

Responses to the Call for Evidence are requested by 28 November 2022. ESMA intends to consider the feedback when preparing its input for the SRD II review it is due to provide to the Commission by July 2023.

10. EU — ESG

EU Platform for Sustainable Finance (the Platform) publishes two reports on the Taxonomy Regulation (TR)

On 11 October 2022, the Platform published two reports relating to the TR;

• a final report on the application of minimum safeguards for the purposes of Articles 3 and 18 of the TR (the MS Report), and
• a report setting out recommendations on data and usability as part of taxonomy reporting (the Data Report).

The MS Report identifies, through analysis of the various standards referenced in Article 18 of the TR (i.e., the Organisation for Economic Co-operation and Development (OECD) guidelines for Multinational Enterprises, United Nations Guiding Principles on Business and Human Rights, the eight International Labour Organisation conventions on fundamental principles and rights at work, and the international bill of human rights), four core topics for which compliance with minimum safeguards should be defined. These are:

• human rights, including workers’ rights;
• bribery/corruption;
• taxation; and
• fair competition.

The MS Report notes that the Platform’s advice should be finalised once certain other regulatory frameworks are finalised and experience on practical implementation and court rulings is accumulated, in particular those relating to human rights due diligence (under the upcoming Corporate Sustainability Due Diligence Directive, or CS3D) and corporate sustainability reporting (under Corporate Sustainability Reporting Directive, or CSRD). For further information, please see our previous updates on CSRD and CS3D.

The Data Report makes a range of recommendations, relating to the following key themes:

• proposed changes to Level 1 or 2 legal guidance on taxonomy reporting, to both support the 2024 review period and consider key usability challenges with the current proposals around sustainable finance disclosures;
• recommendations for supplementary guidance from the Commission to user groups;
• recommendations for supervisory guidance from the ESAs to user groups;
• proposed recommendations on policy consistency across the sustainable finance framework; and
• proposed recommendations on taxonomy usability.

The reports will now be analysed by the Commission, but they do not bind the Commission to take any particular action on the matter.