UK/EU Investment Management Update (August 2024)

1. UK — General Election

2. UK — FCA

3. UK — EMIR

4. UK — MiFID II

5. UK — Cryptoassets

6. UK —Tax

7. EU — ESG

8. EU — AIFMD/UCITS

9. EU — MiFID II

10. EU — Market Abuse

11. EU — Artificial Intelligence

12. EU — AML

13. EU — DORA

14. EU — Cryptoassets

1. UK — General Election

Labour Party’s post-election plan for financial services

On 4 July 2024, the United Kingdom held a General Election to elect 650 members of Parliament to the House of Commons, the lower house of the Parliament of the United Kingdom. The opposition Labour Party defeated the governing Conservative Party with a landslide victory of 412 seats, ending 14 years of Conservative government.

The Labour Party had published its plan for financial services in its election manifesto. In terms of what the asset management sector can expect from the new government, the Labour Party outlined a number of policy priorities that may be particularly relevant:

• enhancing the international competitiveness of the UK’s financial services sector by pursuing a more joined-up and innovation-centred approach to regulation and supervision, streamlining the regulatory rulebook in line with the Consumer Duty, strengthening our international engagement in financial services, and building a more collaborative relationship with the EU
• leading the world in sustainable finance by making the UK a global hub for green finance activity, delivering a world-leading green finance regulatory framework, and partnering with the financial services sector to support the decarbonisation of our homes
• embracing innovation and fintech as the future of financial services by becoming a global standard-setter for the use of artificial intelligence in financial services, delivering the next phase of Open Banking, defining a roadmap for Open Finance, embracing securities tokenisation and a central bank digital currency, and establishing a regulatory sandbox for financial products to reach underserved communities

Whilst the Labour Party (now the Government) has already begun to implement a number of policy initiatives in line with these priorities, the overall direction of travel for the UK’s regulatory environment is not yet fully clear. Whilst a core theme of the policy priorities is the streamlining and simplification of existing rules, it is not clear exactly how this will be balanced with the Government’s commitment to providing clarity to financial services firms and maintaining the UK’s reputation for high-quality regulatory standards.

2. UK — FCA

FCA publishes final rules on payment optionality for investment research

On 26 July 2024, the Financial Conduct Authority (FCA) published its Policy Statement on Payment Optionality for Investment Research (PS24/9). The Policy Statement summarises the feedback received from the FCA's consultation in April 2024 (CP24/7), as discussed in our May 2024 Update. The FCA is proceeding with the introduction of an additional payment option for investment research.

For our analysis of the Policy Statement and how it will affect asset managers, please see our Sidley Update Implications of Final UK FCA Rules on Payment for Investment Research.

FCA invites input on review of Retail Conduct Rules

On 29 July 2024, the FCA published a Call for Input on stakeholder views on whether, where, and how the FCA can refine its retail conduct rules, by removing detailed rules in favour of reliance on the Consumer Duty.

The goal of the Call for Input is to help the FCA to understand how different types of firms may be affected by changes to its rulemaking approach. The FCA noted that reducing complexity of the FCA’s rulebook could lower costs for firms, encourage innovation, and help support the risk appetite needed to support growth, ultimately boosting international competitiveness and the economy.

While the FCA is primarily focused on our retail conduct rules and guidance, it also welcomes views on its wider rules and guidance. The issues being consulted on in the Call for Input include

• which detailed rules or guidance could be simplified to rely on high-level rules or have interactions with other rules that could be clarified
• how any steps to simplify the FCA’s rules and guidance affect its statutory objectives
• the appropriate balance between high-level and more detailed rules
• the potential benefits and costs of simplifying the rules

Launching the Call for Input, Nikhil Rathi, chief executive of the FCA, said,

The Consumer Duty marked a major shift for firms and consumers by setting higher and clearer standards of consumer protection and requiring firms to put their customers’ needs first.

We now want to seize the opportunity of the Duty and the move to a clear outcomes-based approach to streamline our rulebook, lowering costs for businesses and supporting the competitiveness and growth of the economy.

The call for input is open for responses from stakeholders until 31 October 2024.

FCA publishes final rules and guidance on the OFR

On 17 July 2024, the FCA published a Policy Statement (PS24/7) on the final rules and guidance necessary to implement of the overseas funds regime (OFR).

In the Policy Statement, the FCA provides feedback to its December 2023 Consultation Paper (CP23/26) and sets out the final rules and guidance necessary to implement the OFR, which will allow investment funds domiciled overseas to be offered to UK retail investors.

Unlike the temporary marketing permissions regime (TMPR), under the OFR, funds will need to apply the FCA and be assessed for recognition. To maintain a proportionate approach, the regime relies in part on the overall equivalence determination of overseas regimes made by the government while gathering and assessing information it needs to meet its obligation to protect UK investors.

Notably, in light of the feedback received to the Consultation Paper, the FCA has made changes to the final rules, including:

• removing the proposed 30-day period between notifying the FCA of changes to OFR funds and when those changes could take effect in the UK
• providing further explanation and clarification as to which categories of changes should be notified
• including guidance relating to additional information in disclosures for fund prospectus and point of sale information
• clarifying which UK fund prospectus requirements apply to OFR funds

The relevant amendments to the FCA Handbook implementing this change came into force on 31 July 2024. The OFR gateway is expected to open later in 2024 for European Economic Area (EEA) UCITS (except for money market funds). Operators with funds currently in the TMPR should check the FCA website published in May 2024 for details of when they can apply for OFR recognition of those funds.

FCA introduces new UK Listing Rules (UKLR) and consults on public offer framework

On 11 July 2024, the FCA published a Policy Statement (PS24/6), setting out the final rules for a new simplified UK listing regime, which entered into force on 29 July 2024.

Notably, the new UKLR removes the previous “premium” and “standard” listing segments and replaces these with a single commercial companies category. The reforms seek, where possible, to remove disincentives for prospective issuers to choose a UK listing, as well as removing frictions to growth once listed, while continuing to place emphasis on disclosure and putting information in the hands of investors to inform their investment decisions.

These changes to the UKLR are the most significant reforms to the UK’s listing regime in over 30 years as the UK seeks to reinvigorate its capital markets against a fall in the number of companies listed on the UK stock exchange.

As the next step in the reform of the UK’s listings and public offer framework, on 26 July 2024 the FCA published consultation papers on new regimes for (i) public offers and admissions to trading (CP24/12) and (ii) regulating public offer platforms (CP24/13). These new regimes reform the UK Prospectus Regulation and support the new regulated activity of operating a public platform, respectively.

Under the proposals set out in the consultations, companies will still be required to publish a prospectus when first admitting securities to public markets. However, a prospectus would not be required when a company raises further capital except in limited circumstances.

Together with other existing disclosure obligations, these proposals will make sure investors get the information they need while significantly reducing the costs associated with further capital raises for companies.

In relation to the new activity of operating a public offer platform, these platforms will offer an alternative route for companies to raise capital outside public markets including from retail investors. The introduction of the platforms should promote scale-up capital raising for smaller companies while ensuring that investors get the right disclosures on the key terms and risks of an investment.

FCA proposes criminal background checks for controllers of authorised firms

On 9 July 2024, the FCA published its 44th quarterly Consultation Paper (CP24/11).

In the Consultation Paper, the FCA sets out proposed changes to the FCA Handbook relating to matters including the introduction of criminal background checks on owners and controllers at the FCA’s Authorisation Gateway.

The FCA’s proposals will apply to the following persons (Controllers):

• potential controllers submitting a change-in-control (CIC) notice under Part XII of Financial Services and Markets Act 2000 (FSMA)
• controllers of firms applying to become authorised persons under FSMA (new firm authorisations) (both Markets in Financial Instruments Directive (MiFID) and non-MiFID)
• individuals with a qualifying holding in a payment institution or e-money institution
• beneficial owners of Annex 1 financial institutions and cryptoasset businesses registered under regulation 54(1A) of the Money Laundering Regulations (MLRs)
• persons submitting a CIC notice in accordance with the MLRs, Payment Services Regulations 2017, and the Electronic Money Regulations 2011
• controllers submitting an application or notification made to the Prudential Regulatory Authority where the FCA is required to provide its consent or consultation (excluding appointed representatives)

The proposals introduce Disclosure and Barring Service (DBS) checks for Controllers by asking applicants or notice givers to confirm to the FCA that a DBS check for the Controllers has been undertaken within the past six months when submitting the relevant application or CIC notification. In addition to this confirmation, the FCA may request a copy of the DBS certificate when deemed necessary. This will be determined by the FCA on a case-by-case basis.

The proposed amendments are set out in draft instruments in the appendices to the Consultation Paper. The deadline for comments on the proposals is 12 August 2024.

FCA publishes 2024/2025 regulatory fees and levies

On 3 July 2024, the FCA published a Policy Statement (PS24/5) setting out the final 2024/2025 regulatory fee rates for the FCA and levy rates for the Financial Ombudsman Service and certain government departments.

PS24/5 relates to CP24/6 on the proposed fee and levy rates, for which the consultation window closed on 14 May 2024, and applies from July 2024 to all current FCA fee-payers and any pending FCA-authorised or registered businesses.

Key takeaways from the Policy Statement are as follows:

• increased minimum flat rate and application fees
• staged increases for A-block and consumer credit minimum fees
• distribution of exceptional project costs between fee-blocks

The FCA had told the firms it oversees that its regulatory costs for 2024/25 would increase by 10.7%, to £755 million, with firms expected to shoulder the burden of these increased costs through increased fees.

The Policy Statement notes that several UK financial services trade bodies had voiced concerns in relation to the final fees and levies during the consultation process. Industry respondents argued that the increased fees do not reflect the rate of inflation and come at a time when firms are already facing difficult market conditions.

3. UK — EMIR

FCA publishes final UK EMIR reporting Q&As

On 12 July 2024, the FCA published the final UK European Market Infrastructure Regulation (UK EMIR) reporting Q&As on its webpage, following close of the second consultation on 12 June 2024.

In light of the general support from respondents, the FCA maintained the overall approach and proposed guidance consulted on for the majority of the questions and added only clarificatory amendments, mindful of the approaching go-live date of 30 September 2024 for the amended UK EMIR reporting requirements.

The FCA highlighted the following three Q&As where they diverged from their previously stated approach:

• Q&A 6.7. Derivatives resulting from clearing are no longer required to be reported with the original execution timestamp, given that such derivatives receive their own unique transaction identifier and associated execution timestamp.
  
• Q&A 6.8. New derivatives resulting from post-trade risk reduction (PTRR) events are no longer required to retain the venue of execution of the preceding trades, given that such derivatives are treated as new trades.
  
• Q&A 10.7. The Option Premium Amount field (Table 2, Item 141) is to be populated with “0” when reporting at position level to provide meaningful data.

Additionally, on 26 July 2024, the FCA published a further Q&A (10.9) in relation to spread bets, clarifying that spread bets can be reported at position level, similar to how contracts for difference can be reported under the new requirements.

4. UK — MiFID II

FCA consults on derivatives trading obligation

On 26 July 2024, the FCA published a Consultation Paper (CP24/14) on the derivatives trading obligation (DTO) and PTRR services under the UK version of the Markets in Financial Instruments Directive (MiFID II), as part of its broader Wholesale Markets Review. The FCA is seeking input on the following changes:

• List of derivatives subject to the DTO. Modifying the scope of the DTO register to bring in scope certain secured overnight financing rate overnight index swaps instruments. The FCA states that this will increase transparency in the over-the-counter derivatives market in the UK and support the FCA’s G20 commitment.
• PTRR services. The FCA proposes to maintain the existing exemptions for trades conducted as part of portfolio compression, but it is looking to expand the exemptions to trade conducted as part of portfolio rebalancing and basis risk optimisation, which are widely used risk reduction services. The FCA sets out the characteristics that risk reduction services would need to satisfy for trades used to conduct them to be eligible for exemption and proposes to require providers of PTRR services to comply with disclosure and notification obligations.

Additionally, the FCA was granted temporary transitional powers to modify the application of the DTO following the UK’s exit from the EU; these powers expire on 31 December 2024. The Consultation Paper sets out how the FCA intends to use the powers to suspend or modify the DTO, given to it under the Financial Services and Markets Act 2023.

The deadline for comments on the consultation is 30 September 2024. The FCA will then consider the responses and finalise the draft rules, guidance, technical standards, and policy statement. It will publish its direction on the modification of the DTO in Q4 2024.

5. UK — Cryptoassets

FCA takes first enforcement action against a firm enabling cryptoasset trading

On 23 July 2024, the FCA published a Final Notice imposing a financial penalty of £3,503,546 on CB Payments Ltd (CBPL) for repeatedly breaching a requirement that prevented the firm from offering services to high-risk customers. CBPL agreed to resolve the matter and qualified for a 30% discount under the FCA’s executive settlement procedures; the financial penalty would otherwise have been £5,003,646.

CBPL is a UK subsidiary of Coinbase, which operates a cryptoasset trading platform that is globally accessible. CPBL is not currently registered to undertake cryptoasset activities in the UK and does not undertake cryptoasset transactions for customers but acts as a gateway for customers to trade cryptoassets via other entities within the Coinbase group.

In October 2020, following extensive engagement with the FCA regarding significant concerns about CBPL’s financial crime control network, CBPL entered into a voluntary requirement (VREQ) with the FCA. The VREQ prevented CBPL from taking on new high-risk customers whilst it addressed issues with its framework.

The FCA stated in its Final Notice that despite the restrictions imposed by the VREQ, between 31 October 2020 and 1 October 2023, CBPL onboarded and provided e-money services to 13,416 separate high-risk customers, and approximately 31% of these customers deposited approximately US$ 24,900,000. This money was then used to make withdrawals and, thereafter, execute multiple cryptoasset transactions via other entities in the Coinbase group, using the same funds. This totalled approximately US$ 226,000,000.

The FCA stated that CBPL’s lack of due skill, care, and diligence in the design, testing, implementation, and monitoring of the controls put in place to ensure that the VREQ was effective led to the breaches. This also included failure to consider the ways in which customers might be onboarded during the design of the controls. The FCA notes CBPL’s repeated and material breaches went undiscovered for almost two years as a result of inadequacies in the initial monitoring of the compliance with the VREQ.

The action was taken under the Electronic Money Regulations 2011, and it is the first time the FCA has taken enforcement action using these powers. The FCA further stated that the money laundering risks associated with crypto are obvious and need to be taken seriously.

6. UK — Tax

HM Treasury Call for Evidence on UK Tax Treatment of Carried Interest

On 29 July 2024, acting on its pre-election pledges, the new Government issued a Call for Evidence on the UK tax treatment of carried interest. The Call for Evidence states that the Labour Government intends to take “decisive action” to correct a current tax treatment that “does not appropriately reflect the economic characteristics of carried interest and the level of risk assumed by fund managers in receipt of it.” This position was well trailed before the recent General Election, and it seems inevitable that there will be significant change in this area.

The Call for Evidence is not a formal consultation on any firm proposals from the Government: No specific policy is being trailed, and there is no legislation or other technical material to review at this stage. The Call for Evidence is, instead, an invitation to submit market data and representations to HM Treasury to inform the design of the new rules. HM Treasury is inviting written submissions as well as making itself available for meetings with interested parties. The timeline is very short, with written submissions and meetings strongly encouraged before 30 August (whilst Parliament is in summer recess).

Currently, returns derived by individual fund managers that fall within the UK statutory definition of “carried interest” (broadly, reflecting economic participation or reward linked to the performance of underlying investments) can be taxed in the UK as capital gains at a special rate of 28%, as compared with employment or professional income tax and social security rates of up to 47%. The existing rules are not simple, but in principle it is possible to achieve capital gains treatment for carried interest regardless of any actual co-investment made by individual fund managers into the underlying fund(s). It is worth noting that the current regime is the product of significant legislation introduced in the last decade — the Government is not focused on an area one could describe as “under-legislated,” and it seems reasonable to suggest that (despite the Call for Evidence) the policymakers have some tangible outcomes in mind as they turn to reform in this area.

More specifically, the Labour Party (as both the opposition, and now Government) had expressed the view in recent months that carried interest should be taxed as “performance-related pay” (i.e., as employment or professional income). More recent pronouncements in the run-up to the General Election hinted that some element of capital gains treatment might be retained where individual fund managers are also making significant co-investment and putting their own capital at risk. The current Call for Evidence does not make any explicit suggestions as to how carried interest should be taxed in the future, but an outcome along these lines is clearly in contemplation and respondents to the Call for Evidence will no doubt be making their submissions with these likely parameters in mind.

The Call for Evidence focuses on three substantive questions:

1. How can the tax treatment of carried interest most appropriately reflect its economic characteristics?
2. What are the different structures and market practices with respect to carried interest?
3. Are there lessons that can be learned from approaches taken in other countries?

We expect that a number of fund managers, industry bodies, and advisers will be looking to submit market data to support their preferred outcomes (within the range of likely possibilities). In our view, responses to the call for evidence are likely to be most productive where they either

(i) help HM Treasury gain a better understanding of the different circumstances in which carried interest is awarded to both senior and junior staff (potentially, with a view to delineating between scenarios in which carried interest is a “bonus” and scenarios in which the relevant individuals’ core economics (and professional standing) with the fund manager are truly aligned with fund performance) or

(ii) identify jurisdictions outside the UK that are realistic competitors as world-class locations for asset management and that have adopted a regime for the taxation of carried interest that may be workable in the context of the tangible outcomes previously alluded to by the incoming Government.

Tax Case: Court of Appeal decision in HMRC v HFFX LLP: Miscellaneous Income

On 19 July 2024, the Court of Appeal handed down judgement in the case of HMRC v HFFX LLP (HFFX). In HFFX, individual fund managers became members of a UK LLP that entitled them to share in the profits of the underlying fund in respect of which they provided investment management services. The UK LLP also had a corporate member and, pursuant to a deferred remuneration arrangement put in place following a restructuring, fund profits that would otherwise have been allocated to the individual fund managers were instead allocated to the corporate member. The corporate member paid UK corporation tax on the profits allocated to it and then ultimately re-contributed the net (after-tax) profits back to the UK LLP as “special capital.” The corporate member then exercised its discretion to re-allocate that special capital (on the recommendation of the UK LLP’s managing member) to the individual fund managers who withdrew those amounts. It was argued by the taxpayer that the “special capital” amounts re-allocated to, and withdrawn by, the individual fund managers were not taxable. The desired effect of the deferred remuneration arrangements was that these amounts were ultimately taxed at corporation tax rates rather than higher income tax rates.

HMRC argued that the re-allocated special capital amounts were subject to tax in the hands of the individual fund managers as “miscellaneous income.” The miscellaneous income tax charge is a sweep-up provision that seeks to tax “income from any source that is not charged to income tax under or as a result of any other provision.” -One of the conditions in order for the miscellaneous income tax charge to apply — and the focus of the Court of Appeal decision — is that the income must arise from an identifiable “source” and there must be a sufficient connection between that source and the recipient of the income.

The taxpayer argued that this condition required the individual fund managers to have a legal right to receive the relevant income and that no such legal right existed as the corporate member had an unfettered discretion to re-allocate the special capital. The Court of Appeal held that although a pure gift or voluntary act would not be sufficient to establish the requisite “source,” a legal right to receive the income was not required. The corporate member’s decision to exercise its discretion in favour of the individual fund managers together with the corporate member’s implied duty to exercise its discretion rationally and in good faith and the individual fund managers’ rights under the limited partnership agreement (which provided the legal context for the exercise of discretion) were sufficient in the Court of Appeal’s view to create the requisite “source.”

HMRC had further sought to argue (unsuccessfully) in both the First Tier Tribunal and Upper Tribunal that the profit allocated to the corporate member should in fact be treated as having been allocated to the individual fund managers under the UK’s partnership profit allocation rules. However, HMRC ultimately accepted that the recent Court of Appeal decision in BlueCrest determined this issue against them (and so while they had permission to appeal they did not make any submissions to the court on this point).

This case will be of reduced relevance to fund managers following the introduction of the salaried member rules and mixed member partnership rules in 2014 that (if they had been in force at the relevant time) HMRC would likely have relied on in this case. Nevertheless, this decision (together with the recent Court of Appeal decision in BlueCrest) is a clear message to fund managers that these types of deferred remuneration planning arrangements are not effective and that the miscellaneous income tax charge is broad enough to counteract this type of tax planning.

7. EU — ESG

CSDDD enters into force

On 25 July 2024, the EU Corporate Sustainability Due Diligence Directive (CSDDD) entered into force. EU Member States are required to transpose CSDDD into national law and communicate the relevant texts to the Commission by 26 July 2026.

For further details on the implications of the CSDDD on asset managers and other firms, see the following Sidley Updates: June 2024 Update and Unprecedented ESG Due Diligence Obligations – EU Adopts Corporate Sustainability Due Diligence Directive.

ESMA sets out its long-term vision of the functioning of the Sustainable Finance Regulatory Framework

On 24 July 2024, the European Securities and Markets Authority (ESMA) published an opinion (the Opinion) on the Sustainable Finance Regulatory Framework (Framework), setting out possible long-term improvements. The Opinion is the last component of ESMA’s reply to the Commission’s request for input related to greenwashing, alongside its Final Report on Greenwashing (discussed in our July 2024 Update).

ESMA acknowledges that the Framework in the EU is already well developed and includes safeguards against greenwashing. It notes that a key driver in putting together proposals has been addressing complexity and further simplifying the Framework. ESMA’s suggestions foresee the simplification of definitions and their harmonisation across the Framework in order to ensure consistency, as well as tailoring disclosures to cater to investors’ needs and capabilities and to incorporate signalling tools in the Framework to facilitate retail investors in their investment choices.

Key recommendations for the Commission’s consideration:

• EU Taxonomy. The EU Taxonomy should become the sole, common reference point for the assessment of sustainability; it should be embedded in all sustainable finance legislation; and be completed for all activities that can substantially contribute to environmental sustainability, including with a social taxonomy. Notably, ESMA recommends that the definition of “sustainable investments” under the Sustainable Finance Disclosure Regulation should be phased out.
  
• Effectively support the transition to a sustainable economy. A definition of transition investments should be incorporated into the Framework to provide legal clarity and support the creation of transition-related products. In addition, further work on the disclosures related to transition plans is required, to ensure credibility and consistency.
  
• Adapted transparency requirements. All financial products should disclose some minimum standards of sustainability information, covering environmental and social characteristics. A subset of the sustainability disclosures containing “vital” information should be provided to retail investors, akin to the current Key Information Document requirements under the Packaged Retail and Insurance-based Investment Products Regulation.
  
• Product categorisation system. A product categorisation system should be established, catering to sustainability and transition investments, based on a set of clear eligibility criteria and binding transparency obligations.
  
• ESG data quality. ESG data products should be brought into the regulatory perimeter; the consistency of ESG metrics should continue to be improved upon; and the reliability of estimates should be ensured.
  
• Conduct of sustainable investment value chain (SIVC) actors. The responsibility of all market actors for conducting their own due diligence and making the materiality assessment should be well defined and commensurate to their role and responsibilities in the SIVC.
  
• Consumer and industry testing. Consumer and industry testing should be carried out before implementing policy solutions to ensure their feasibility and appropriateness for retail investors.

ESMA publishes Final Report on GLESI and Public Statement on the first application of ESRS

On 5 July 2024, ESMA published a Final Report on the Guidelines on Enforcement of Sustainability Information (GLESI) and a Public Statement on the first application of the European Sustainability Reporting Standards (ESRS).

The EU Corporate Sustainability Reporting Directive (CSRD) expanded the scope of companies subject to sustainability information reporting, while issuers within the scope of the EU Transparency Directive were already subject to such reporting. Thus, the GLESI have been developed to promote convergence on National Competent Authorities’ (NCAs’) supervisory practices on sustainability reporting under both Directives. The GLESI Final Report summarises the public responses received to the Consultation Paper on draft GLESI and contains the final GLESI.

NCAs must notify ESMA whether they comply or intend to comply with the GLESI within two months of its pending publication in all official EU languages on ESMA’s website.

The ESRS Public Statement relays ESMA’s support to guide the first group of listed issuers set to publish their first ESRS-compliant sustainability statements in 2025 under the CSRD. In particular, ESMA considers the following aspects important in the preparation of the sustainability statements:

• establishing governance arrangements and internal controls that can promote high-quality sustainability reporting
• properly designing and conducting the double materiality assessment and being transparent about it
• being transparent about the use of transitional reliefs
• preparing a clearly structured and digitisation-ready sustainability statement
• creating connectivity between financial and sustainability information

ESMA is set to publish further recommendations relating to the sustainability statements of listed companies in its annual European Common Enforcement Priorities Statement in Q4 2024.

The GLESI and the ESRS Public Statement align with two of ESMA’s 20-recommendation Position Paper on building more effective and attractive capital markets in the EU published on 22 May 2024, namely (i) promoting EU capital markets as a hub for green finance and (ii) improving supervisory consistency amongst EU national authorities.

8. EU — AIFMD/UCITS

ESMA consults on LMTs for funds under AIFMD/UCITS

On 8 July 2024, ESMA published consultation papers seeking input on draft regulatory technical standards (RTS) (RTS CP) and guidelines (Guidelines CP) for Liquidity Management Tools (LMTs) under the Alternative Investment Fund Managers Directive (AIFMD) and Undertakings for Collective Investment in Transferable Securities Directive (UCITS) – both directives aim to mitigate potential financial stability risks and promote harmonisation of liquidity risk management in the investment funds sector.

The key takeaways:

• RTS CP. The amended AIFMD and UCITS Directive provide that alternative investment fund managers and UCITS shall select at least two appropriate LMTs from those listed in the amended directive. These include the following: redemption gates; extension of notice periods; redemption fees; swing pricing; dual pricing; anti-dilution levy; redemptions in kind; and side pockets. The RTS CP sets out the defining characteristics of each of these LMTs, such as calculation methodologies and activation mechanisms, and invites comments from stakeholders on the details of these characteristics.
  
• Guidelines CP. The Guidelines CP recognises that the primary responsibility for liquidity risk management remains with UCITS and alternative investment fund managers. As with the RTS CP, the Guidelines CP goes through each LMT in turn, setting out guidelines on the selection and calibration of the LMTs, and also covers general and governance principles. Additionally, it sets out indications as to the circumstances in which side pockets can be activated and allow adequate time for adaption before they apply, in particular for existing UCITS and open-ended alternative investment funds.

The consultation period for each CP closes on 8 October 2024. By 16 April 2025, ESMA will submit draft RTS to the Commission and publish a final report containing its guidelines, which will be translated into the official languages of the EU and formally published on ESMA’s website within two months of the date of publication of the guidelines.

9. EU — MiFID II

ESMA consults on firms’ order execution policies under MiFID II

On 16 July 2024, ESMA published a consultation paper on draft RTS specifying the criteria for establishing and assessing the effectiveness of investment firms’ order execution policies. ESMA has developed the proposals in light of the mandate set out in MiFID II and from the policy perspective that order execution policies should effectively contribute to enhancing the execution quality for all retail and professional clients, through requirements aiming at fostering an effective establishment and assessment of the order execution policy.

ESMA is seeking input on the following:

• the establishment of an investment firm’s order execution policy, including the classification of financial instruments in which firms execute client orders and the initial selection of venues for the order execution policy
• the investment firm’s procedures to monitor and regularly assess the effectiveness of its order execution arrangements and order execution policy
• the investment firm’s execution of client orders through own account dealing
• how an investment firm deals with client instructions

The deadline for comments on the consultation is 16 October 2024. ESMA will then consider the feedback received, prepare a report, and submit the draft RTS to the Commission for endorsement by 29 December 2024.

ESMA consults on MiFIR review

On 10 July 2024, ESMA published its third consultation package on the Level 2 measures mandated by the Commission under the Markets in Financial Instruments Regulation (MiFIR) review (CP3). CP3 focusses on the following:

• amendments to the Level 2 provisions specifying the requirements on liquidity determination and equity transparency, covering technical advice to the Commission and the amendments to the RTS on equity transparency
• a new implementing technical standard (ITS) for the content and format of the notification of investment firms acting as systematic internalisers to NCAs
• amendments to the RTS specifying simplifications to the volume cap mechanism
• amendments to the RTS specifying organisational requirements for trading venues in order to integrate the new empowerment on circuit breakers and reflecting the changes stemming from DORA
• a new RTS on input/output data for equity consolidated tape providers
• amendments to the RTS on flags for post-trade transparency for the transparency requirements for non-equity instruments, notably bonds

Given the breadth of CP3, ESMA has given two deadlines for stakeholders to provide comments — 15 September 2024 for the proposals on equity transparency and the flags on post-trade transparency for non-equity instruments, 15 October 2024 for the remaining sections. ESMA will then consider the feedback received and will prepare a report for the submission of the final draft RTS and ITS to the Commission, prior to publication in the Official Journal of the EU.

10. EU — Market Abuse

ESMA publishes second report on STORs

On 17 July 2024, ESMA published a Report on suspicious transaction and order reports (STORs), focusing on data gathered from 2023.

Under Article 16 of EU MAR, any person professionally arranging or executing transactions must establish and maintain effective arrangements, systems and procedures to detect and report suspicious orders and transactions in relation to insider dealing and market manipulation. The UK Market Abuse Regulation contains the same provision.

STORs are a key information tool in market abuse investigations. The aim of the report is to provide the market with a clear overview of the use of STORs in different jurisdictions across the EU and how this has evolved over time.

ESMA received survey responses from all 30 EEA NCAs. Key statistics highlighted in the Report:

• 7,491 total notifications were received in 2023, consisting of 6,530 STORs and 961 other notifications. The number of STORs received is 12% higher than the number of STORs received in 2022.
• The majority of notifications in 2023 originated from investment firms (77%), followed by other parties (13%), regulated markets (7%), and multilateral/organised trading facilities (3%).
• In terms of the type of financial instrument that notifications received in 2023 related to, 85% concerned shares, 7% concerned bonds, 5% concerned derivatives, and 3% concerned combinations thereof or other instruments. This is consistent with data in previous years.
• The 2023 data shows that the majority (51%) of notifications covered cases of alleged insider trading, while market manipulation accounted for a slightly lower share (47%), followed by cases involving other violations (around 2%) and cases making reference to both insider trading and market manipulation (around 1%). This represents a small change compared to previous years where, in most cases, reports were sent for cases of alleged market manipulation (52% across the past four years).

The Report follows ESMA’s first STOR report, published in July 2023, which focused mainly on 2021 and 2022 data. In this context, ESMA noted that the figures are largely consistent, and no major changes can be detected when compared with the previous years. The number of notifications received from NCAs has only slightly increased, and other indicators also point towards very similar results.

As highlighted in the previous report, comparison between the figures from the past few years and those of years before 2019 is of limited use, given the magnitude of STORs received by the UK FCA until 2018. On an aggregate basis, the UK accounted respectively for 50% and 43% of the total number of the STORs received in 2017 and 2018. Accordingly, the sharp decrease is mainly due to the impact of Brexit. To that effect, ESMA also included, where possible, statistics both with and without the UK in order to provide a comprehensive view.

The FCA had also independently published the number of STORs received on its webpage in February 2024, although no accompanying report and analysis is provided.

11. EU — Artificial Intelligence

AI Act enters into force

On 12 July 2024, the EU AI Act was published in the Official Journal of the EU. The AI Act entered into force on 1 August 2024 and will apply in phases, with staggered transition periods of six to thirty-six months, with the earliest provisions applying from 2 February 2025.

The AI Act will govern the overall development and use of AI in the EU, which is expected to enter into force in July 2024 (for further information, see our Sidley Update Top 10 Questions on the EU AI Act).

12. EU — AML

BNP Paribas fined by Luxembourg regulator over money laundering failings

On 8 July 2024, Luxembourg’s Financial Sector Supervisory Commission (CSSF) announced that it had imposed an administrative fine amounting to €3 million on BNP Paribas S.A. (BNP Paribas) for severe breaches of its anti-money laundering (AML) and countering the financing of terrorism (CFT) obligations. The fine was issued on 8 May 2024 and follows an inspection between May and November 2021, which covered AML/CFT and internal governance frameworks in relation to a limited number of files belonging to a group of related clients. It is one of the largest ever issued by the CSSF; in 2020, CSSF fined Banque Internationale à Luxembourg for similar issues.

CSSF stated that BNP Paribas had several deficiencies, including related to the following:

• Due diligence. The implementation of enhanced due diligence of the source of funds and source of wealth of high-risk clients and ongoing due diligence was deficient, which meant BNP Paribas failed to identify unusual or suspicious transactions when these transactions were not in line with the expected transactions on the accounts.
  
• Lack of vigilance. BNP Paribas’ lack of vigilance with regard to a group of related clients, of which certain clients were subject to adverse press articles, which prevented it from informing, of its own initiative, the Cellule de Renseignement Financier of suspicious activities.
  
• Internal organisation. BNP Paribas’ internal organisation regarding the validation and/or maintaining of business relationships with a limited number of files belonging to high-risk clients did not allow sufficient involvement of people responsible for AML/CFT matters.

The CSSF noted that BNP Paribas fully co-operated throughout the investigation and reacted by putting in place a general action plan and initiated corrective measures during and after the inspection to remedy the breaches found.

13. EU — DORA

ESAs publish joint final report on the draft technical standards on subcontracting under DORA

On 26 July 2024, the European Supervisory Authorities (ESAs) published a final report on draft RTS specifying how to determine and assess the conditions for subcontracting information and communication technology services that support critical or important functions under the Digital Operational Resilience Act (DORA). The RTS finalise the publication of the ESAs’ second batch of regulatory products under DORA, and aim to enhance the digital operational resilience of the EU financial sector by strengthening the financial entities’ ICT risk management over the use of subcontracting.

The draft RTS sets out

• requirements and conditions for financial entities when the use of subcontracted ICT services supporting critical or important functions or material parts by ICT third-party service providers is permitted
• requirements for financial entities to assess the risks associated with subcontracting during the precontractual phase, including the due diligence process
• requirements regarding the implementation, monitoring, and management of contractual arrangements regarding the subcontracting conditions for the use of ICT services supporting critical or important functions or material parts thereof, ensuring that financial entities are able to monitor the entire ICT subcontracting chain

In terms of next steps, the ESAs will submit the draft RTS to the Commission for adoption.

ESAs publish second set of DORA policy products

On 17 July 2024, the ESAs, consisting of the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority, and ESMA, published the second set of policy products under DORA, following the close of the public consultation on 4 March 2024.

The package, aimed at enhancing the EU financial sector's digital operational resilience, consists of

• final draft RTS and ITS on the content, format, templates, and timelines for reporting major ICT-related incidents and significant cyberthreats
• final draft RTS on the harmonisation of conditions enabling the conduct of the oversight activities
• final-draft RTS specifying the criteria for determining the composition of the joint examination team
• final-draft RTS on threat-led penetration testing
• guidelines on the estimation of aggregated costs/losses caused by major ICT-related incidents
• guidelines on oversight cooperation

The ESAs’ Boards of Supervisors have adopted the two guidelines. The Commission is reviewing the four final-draft RTS submitted by the ESAs for adoption. The ESAs will be publishing and submitting the final-draft RTS on subcontracting in due course.

ESAs establish EU systemic cyberincident coordination framework

On 17 July 2024, the ESAs announced the establishment of the EU System Cyber Incident Coordination Framework (EU-SCICF) in the context of DORA.

The context behind the establishment of the EU-SCICF is the European Systemic Risk Board (ESRB) recommendation that the ESAs expand the function of DORA and move to develop a pan-European systemic cyberincident coordination framework, following the identification of shortfalls in crisis management frameworks for the European financial sector to remain equipped for significant cross-border ICT-related incidents.

The EU-SCICF is designed to facilitate a coordinated response by the EU financial sector to cyberincidents that threaten cybersecurity. As policy products under DORA continue to be developed pending its applicability in 2025, the EU-SCICF serves to strengthen the coordination between the relevant EU bodies and NCAs as well as with other key international institutions.

The ESAs plan to implement the EU-SCICF by establishing

• the EU-SCICF Secretariat, supporting the functioning of the framework
• the EU-SCICF Forum, working on testing and maturing the functioning
• the EU-SCICF Crisis Coordination, facilitating during a crisis the coordination of actions by participating authorities

Further development of the EU-SCICF is subject to the availability of the resources and discretion of the Commission.

14. EU — Cryptoassets

ESAs consult on guidelines under MiCAR

On 12 July 2024, the ESAs published a consultation paper on guidelines (Guidelines) establishing templates for explanations and legal opinions regarding the classification of cryptoassets, along with a standardised test to foster a common approach to classification. The draft Guidelines aim to support market participants and supervisors in adopting a convergent approach to the classification of cryptoassets and set out the following:

• Templates. The draft guidelines provide templates for the purpose of establishing the content and form requirements of the explanation accompanying the cryptoasset white paper for cryptoassets that are not asset-referenced tokens (ARTs) or electronic money tokens (EMTs); and templates establishing the content and form of the legal opinion explaining the classification of the cryptoasset.
  
• Standardised test. A standardised test for the classification of cryptoassets, recognising that MiCAR applies to cryptoassets that are not
  • unique and non-fungible with other cryptoassets
  • in scope of relevant sectoral measures by virtue of their qualification as financial instruments, deposits, insurance and pensions products, and other relevant financial products
  • issued by excluded persons

Additionally, the Guidelines note that NCAs should comply with the Guidelines by incorporating them into their practices as appropriate, for example by amending the legal framework or their supervisory processes, including where guidelines are directed primarily at financial market participants and financial institutions.

The Guidelines are expected to apply two months after publication of the final version of the Guidelines in all EU official languages on the ESA’s websites. The deadline for comments on the consultation paper is 12 October 2024, and the ESAs will hold a virtual public hearing on the consultation paper on 23 September 2024.

EBA publishes statement on the application of MiCAR to ARTs and EMTs

On 5 July 2024, the EBA published a statement (Statement) on the application of MiCAR to issuers of ARTs and EMTs, alongside a document containing supervisory priorities across the EU for issuers of ARTs and EMTs in 2024/2025 (Supervisory Priorities). Both documents aim to promote the timely and consistent application of MiCAR, which has applied since 30 June 2024. The EBA expects any person who intends to commence either ART or EMT activities to ensure prompt and full compliance from this date. Additionally, it reminds persons who are issuing, or intend to issue, to the public, to offer to the public, or to seek admission to trading ARTs and EMT of the new requirements under MiCAR and draws attention to technical standards and guidelines available on its website.

Key takeaways from the Statement:

• Transitional arrangements. Issuers who have issued ARTs in accordance with applicable law prior to 30 June 2024 may continue to do so in accordance with the transitional arrangements set out in Article 143(4) and (5) MiCAR. No similar arrangement applies for EMTs.
  
• Consumers. The EBA highlights factors consumers should have regard to when deciding whether to acquire ARTs or EMTs and reminds consumers of the risks of acquiring ARTs or EMTs that have not been issued in accordance with MiCAR.
  
• Stakeholders. All stakeholders providing services related to cryptoassets should, as soon as possible, set up procedures to assess compliance with MiCAR of ARTs and EMTs for which they offer related services from carrying out services that constitute offering to the public, seeking admission to trading, or placing non-compliant ARTs or EMTs.
  
• NCAs. The EBA expects NCAs that become aware that a person has commenced or plans to commence ART or EMT activities to bring to that person’s attention (on a best-efforts basis) (i) MiCAR’s requirements; (ii) the EBA’s guidelines and technical standards; and (iii) other applicable regulatory measures, including in the areas of AML/CFT and operational resilience. The EBA observes that cryptoassets are inherently “borderless”, and thus close cooperation between competent authorities, the EBA, and the other ESAs is expected to ensure that MiCAR is enforced in a consistent, timely, and effective manner to ART/EMT activities.

The Supervisory Priorities identify key issues for NCAs and the ESAs to focus their supervisory efforts on, including (i) internal governance and risk management; (ii) financial resilience (including, where applicable, own funds requirements and reserve of assets); (iii) technology risk management; and (iv) financial crime risk management. A high level of holder protection and financial stability remain as over-arching objectives to consider for all priority areas. The EBA intends to review the priorities on annually, based on a regular risk assessment integrating market developments, supervisory experience, and regulatory changes.

ESMA publishes second final report under MiCAR

On 3 July 2024, ESMA published the second final report under MiCAR (Final Report) covering six RTS and two ITS that aim to provide more transparency for retail investors and clarity for providers on the technical aspects of disclosure and record-keeping requirements. ESMA published the final report on the first set of RTS and ITS under MiCAR in March 2024.

The draft technical standards detailed in the Final Report include the following:

• RTS: content, methodologies, and presentation of sustainability indicators on adverse impacts on the climate and the environment
  
• RTS: continuity and regularity in the performance of cryptoasset services
  
• RTS: offering pre- and post-trade data for cryptoasset service provider (CASP) trading platforms
  
• 2 RTS: record-keeping obligations for CASPs, covering record-keeping for all CASPs and order book records for CASPs operating a trading platform
  
• RTS and ITS: machine readability of white papers and the register of white papers, covering standard forms, formats, and templates of white papers; and the data necessary for classification of white papers
  
• ITS: technical means for appropriate public disclosure of inside information

ESMA consulted on the above RTS and ITS in October 2023, and the draft technical standards will be submitted to the European Commission (Commission) for adoption. The Commission will decide whether to adopt the technical standards within three months.