UK/EU Investment Management Update (September 2024)
2. UK — Appointed Representatives
4. UK — Senior Manager Assessment
7. UK — Artificial Intelligence
11. EU — (ESG) ESMA Guidelines
FCA sets out temporary measures for firms on “naming and marketing” sustainability rules
On 9 September 2024, the FCA announced temporary measures to provide firms with additional flexibility to comply with the “naming and marketing” rules under the UK SDR and investment labels regime. The SDR aims to (among other things) protect investors by helping them make more informed decisions when investing. For a discussion of the SDR, please see our Update Final Rules on UK Sustainability Disclosure Requirements and Investment Labels — Key Takeaways for Asset Managers.
While the FCA’s anti-greenwashing rule took effect from 31 May 2024, and managers of UK-based investment funds have been able to use investment labels on their products since 31 July 2024, the “naming and marketing” and disclosure rules are set to come into force from 2 December 2024.
Nonetheless, following engagement with industry and trade bodies, the FCA has concluded that some firms require more time to meet the standards of the SDR and prepare the necessary disclosures for FCA approval.
Accordingly, the FCA is offering limited temporary flexibility, until 5 p.m. on 2 April 2025, for firms to comply with the “naming and marketing” rules (i.e., ESG 4.3.2R to ESG 4.3.8R of the ESG sourcebook) in exceptional circumstances where a firm:
- has submitted a completed application for approval of amended disclosures in line with ESG 5.3.2R for that fund by 5 p.m. on 1 October 2024; and
- is using one or more of the terms “sustainable,” “sustainability,” or “impact” (or a variation of those terms) in the name of that fund and is intending either to use a label or to change the name of that fund.
The FCA emphasises that firms should comply with the rules without requiring this flexibility where possible and expects firms to comply as soon as they can, without waiting until 2 April 2025. Firms must also continue to comply with all other relevant rules, including the anti-greenwashing rule.
The FCA will continue to maintain firm engagement, pre-application meetings, and support for firms. For fund mergers, wind-ups, and terminations before 2 December 2024, the FCA will take a supportive, proportionate, and outcomes-based approach, with firms encouraged to contact their supervisor or usual supervisory contact to discuss on a case-by-case basis.
2. UK — Appointed Representatives
FCA review finds oversight of ARs improving but more work needed
On 6 September 2024, the FCA published the findings of its review of how principal firms are meeting the enhanced AR rules introduced in December 2022. The review, which involved a telephone survey with 251 principal firms and in-depth assessments of documentation from 23 firms, identified good practices and areas for improvement in the effective monitoring of ARs.
Examples of good practice from principal firms included maintaining a strong understanding of ARs’ business models and using a broad range of checks and information to oversee and monitor ARs’ activities. However, the review also revealed that some firms were taking a tick-box approach to compliance, with firms relying on basic information such as website checks and AR self-declarations to demonstrate effective oversight.
Other key findings from the review include:
- One in five principal firms had not carried out a required self-assessment or annual review of their ARs.
- Over half of principal firms regularly reviewed their AR agreements, but less than a third checked consumer-facing materials such as websites and leaflets.
- A third of principal firms were not using data or management information to monitor whether ARs were acting within the scope of AR agreements.
- Most principal firms had not changed their AR onboarding or termination procedures since the introduction of the enhanced rules in December 2022.
The FCA has followed up directly with firms in the review and will take swift action where it sees principal firms not meeting its standards.
FCA issues public censure to H2O AM LLP for serious failings in its management of funds
On 2 August 2024, the FCA issued a Final Notice imposing a public censure on H2O AM LLP (H2O LLP) for serious breaches of regulatory requirements in its management of certain funds.
Between April 2015 and November 2019 (the Relevant Period), H2O LLP, acting as the authorised fund manager (AFM) for several funds, made a series of investments through the funds it managed into 24 entities controlled or introduced by German financier Lars Windhorst (the Investments). The estimated value of the Investments as of August 2020 totalled €1.643 billion.
The FCA found that H2O LLP failed to:
- conduct its business with due skill, care, and diligence (Principle 2) and ensure a high level of diligence in the selection of scheme property;
- take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems (Principle 3); and
- deal with the FCA in an open and cooperative manner (Principle 11).
In particular, H2O LLP failed to conduct adequate due diligence on the Investments, both initially and on an ongoing basis. It also lacked appropriate policies, procedures, systems, and controls regarding investment decision-making, and its Risk and Compliance functions failed to provide adequate oversight and challenge.
Additionally, H2O LLP provided false and misleading information to the FCA on multiple occasions regarding the level of due diligence it had conducted on the Investments and failed to disclose the close relationship between H2O LLP’s CEO and Windhorst.
As part of the resolution, the H2O Group has voluntarily secured €250 million to be paid to current unitholders in the Side-pocketed Funds that hold the Investments. The H2O Group has also waived its rights to fees and investments totalling €320 million for the benefit of these unitholders. In addition, H2O LLP has agreed to voluntarily cancel its UK regulatory permissions by 31 December 2024.
4. UK — Senior Manager Assessment
Saranac Partners Limited vs The Financial Conduct Authority [2024] UKUT 00254 (TCC): fitness and propriety
On 27 August 2024, the Upper Tribunal (Tax and Chancery Chamber) upheld a decision by the FCA to refuse approval for Thomas Kalaris (a former CEO of the wealth management division of a major UK bank) to perform senior management functions (SMF) for Saranac Partners Limited (Saranac), an FCA-authorised wealth management firm that he co-founded.
The FCA decision notice, issued on 17 November 2022, stated that the FCA was not satisfied that Kalaris was fit and proper to perform the Chief Executive (SMF1) and Executive Director (SMF3) functions for Saranac. The FCA’s decision was based on its view that Kalaris had failed to be candid and truthful in his responses during two previous interviews with the FCA, in 2013 and 2014.
The 2013 interview related to Kalaris’ involvement in a 2008 capital raising by his former employer and an associated advisory services agreement entered into with a sovereign wealth fund. The 2014 interview concerned Kalaris’ knowledge of the existence of a cultural audit report prepared by a consulting firm in 2012.
The Tribunal concurred with the FCA on both issues, finding that Kalaris had not been candid in his answers and in some cases dishonest.
This decision underscores the significant weight the FCA places on the honesty and integrity of persons wishing to perform controlled functions, and demonstrates that past behaviour, even if historic, carries substantial importance in assessing an individual’s fitness and propriety for regulated roles in the financial services industry.
IG Index Ltd v Tchenguiz [2024] EWHC 1880 (Comm): client re-categorisation and contractual enforceability
On 31 July 2024, the High Court handed down judgment in the case of IG Index Ltd v Tchenguiz.
IG Index Ltd (IG) (a spread betting firm) sought to recover £6,549,430.34 (plus interest) from its former client, Robert Tchenguiz, relating to losses incurred on the closing out of his spread betting account in March 2020. Tchenguiz had used the account to take substantial spread betting positions on the share price of FirstGroup Plc.
Tchenguiz denied liability for the sums claimed. He contended that his exposure to payments arose because IG re-categorised him as an Elective Professional Client (EPC). Had he remained a retail client, he would not have faced such exposure (this is because retail clients benefit from negative balance protection and, as such, cannot be liable for more than the funds in their account).
Tchenguiz argued that his client re-categorisation was not valid because IG failed to ensure that he met the qualitative and quantitative tests for EPC status under Chapter 3 of the FCA’s Conduct of Business Sourcebook (COBS). On that basis, he should have remained categorised as a retail client and should have enjoyed the negative balance protection afforded to retail clients. The court rejected Tchenguiz’s case, finding as set out below.
- IG’s approach to the qualitative test, using Tchenguiz’s Markets in Financial Instruments Directive appropriateness score, was reasonable and gave IG the necessary assurance of his competence to trade spread bets as EPC.
- A 2012 court judgment relied upon by IG showed Tchenguiz had the requisite professional experience through his directorship of a company that made investment decisions on contracts for difference and other derivatives for a family trust for the purposes of the quantitative test.
- IG gave Tchenguiz clear warnings about the loss of negative balance protection before he was re-categorised as an EPC.
The court further held that even if IG had breached the re-categorisation rules, this would not have provided Tchenguiz with a complete defence to IG’s claim. Under Sections 138D(2) and 138E(2) of the UK Financial Services and Markets Act 2000, contravention of the COBS re-categorisation rules is actionable only as a claim for damages, not as a matter of contractual enforceability. The spread bet contracts, made on EPC terms, therefore remained valid and enforceable. To avoid liability, Tchenguiz would have needed to bring a damages counterclaim and establish causation of loss.
The case demonstrates the limits of COBS client categorisation rules as a shield to contractual liabilities faced by professional clients. It also shows that courts will carefully scrutinise whether firms have taken “all reasonable steps” to ensure clients satisfied the qualitative and quantitative tests under COBS. As such, firms should ensure that robust processes are followed when opting up clients from retail to elective professional client status to avoid similar challenges.
FCA speech on Consumer Duty: 1 year on
On 31 July 2024, Sheldon Mills, Executive Director of Consumers and Competition at the FCA, delivered a speech on implementation of the Consumer Duty (the Duty) at the FCA’s Consumer Duty: 1 year on event.
Key points from the speech are summarised below.
- Impact of the Duty. The Duty is already having a tangible impact on consumer outcomes, with firms (for example) making significant changes to their business models to simplify and unbundle their charging structures and developing new data and metrics to better understand their customers, including tracking customers who fall outside of their target markets.
- Supervisory approach to the Duty. The FCA has been, and will continue to be, proportionate in its approach to supervising the Duty and will work with firms to get the Duty right in response to practices it observes.
- Planned supervisory activities. The FCA will publish a forward work program in the coming weeks focusing on (i) addressing harm or potential harm to retail customers, (ii) understanding how firms are embedding the Duty and emerging issues, and (iii) sharing good practices and expectations.
7. UK — Artificial Intelligence
FCA launches Digital Regulation Cooperation Forum (DRCF) AI and Digital Hub
On 27 August 2024, the FCA announced the launch of the DRCF AI and Digital Hub, an informal advice service to support innovators with cross-regulatory queries. The service, set up by the UK Information Commissioner’s Office, Competition Markets Authority, Office of Communications, and FCA, aims to help bring innovations to market responsibly, faster, and with greater confidence. The Hub will run until March 2025.
FCA provides updates on consolidated tape (CT) for bonds and equities
On 13 August 2024, the FCA provided an update on its ongoing work to establish separate CTs for bonds and equities (shares and exchange-traded funds).
The FCA reiterates its view that the market for bond data is distinct from that for equities, and the two need distinct assessments of the potential role of a CT provider (CTP), its characteristics, and the appropriate business model for the CT.
Bond CT
The FCA has been developing a framework for a bond CT over the past year. The FCA’s initial proposals were outlined in its July 2023 consultation (CP23/15), followed by a policy statement and a follow-up consultation in December 2023 (CP23/33), which largely confirmed the proposals consulted on in CP23/15. For an overview of CP23/33, please see our January 2024 Update.
The FCA is now working with DotEcon Ltd to finalise the design of the tender process to appoint a bond CTP. The tender is expected to commence before the end of 2024. Interested parties are encouraged to contact the FCA by 13 September 2024 to participate in the tender process.
Equities CT
As regards the equities CT, the FCA notes that there is no consensus among market participants on whether, and how much, pre-trade data (information about bids and offers) should be included in an equities CT.
Accordingly, the FCA has appointed Europe Economics to undertake an independent study on the potential impact of including pre-trade data in a UK equities CT. The study aims to provide a robust evidence base to inform the FCA’s policy proposals on use cases for pre-trade data, the CT’s ability to support them, and any potential unintended consequences for UK markets.
The FCA expects to update stakeholders on the study’s progress by the end of 2024, with findings likely to influence its policy direction for the UK equities CT.
European Commission publishes draft FAQs on sustainability reporting
On 7 August 2024, the European Commission published a draft FAQs clarifying certain aspects of the CSRD. Among other things, the FAQs clarify the following:
- Scope and exemptions. UCITS and Alternative Investment Funds (AIFs) are exempt from CSRD reporting under Articles 19a and 29a of the EU Accounting Directive, even where they are subject to the EU Accounting Directive for accounting purposes. However, managers of these funds do need to provide sustainability information where they meet the CSRD scope requirements (i.e., if they are an undertaking type listed in Annex I or II of the EU Accounting Directive and meet the relevant company size criteria).
- Value chain information. The FAQs provide guidance on how the concept of “reasonable effort” in the European Sustainability Reporting Standards (ESRS) should be applied when reporting value chain information. In short, the level of effort required will depend on the specific circumstances of each undertaking. While firms are expected to make more frequent use of estimates in the initial years of application of the reporting requirements, the use of estimates should become less common over time as firms and participants in their value chains improve their ability to share sustainability information. In all cases, firms are expected to consider whether the use of estimates is likely to affect the quality of the reported information.
- Third-country undertakings. If a third-country undertaking is subject to Article 40a of the EU Accounting Directive, its EU subsidiary or branch must publish and make accessible a sustainability report on behalf of the third-country parent undertaking. However, the responsibility to prepare the sustainability report does not specifically lie with the EU subsidiary or branch. Consequently, the third-country parent can prepare the report, which the EU subsidiary or branch will then publish and make accessible, either by filing it in an EU business register or by posting it on its website. Alternatively, the EU subsidiary or branch has the option to prepare, publish, and make accessible the report on behalf of the third-country parent undertaking.
- Third-country issuers. Third-country issuers with transferable securities admitted to trading on EU regulated markets (except micro-undertakings) are required to report sustainability information at individual and/or consolidated level per Articles 19a or 29a of the EU Accounting Directive and must include sustainability information in the management report that forms part of their annual financial report, per Article 4(5) of the EU Transparency Directive.
For our in-depth analysis of the CSRD and its implications for in-scope companies, please refer to our Sidley Update EU Adopts First Set of European Sustainability Reporting Standards — Critical Considerations for Companies in Scope of CSRD.
European Supervisory Authorities (ESAs) publish additional Q&As on SFDR
On 25 July 2024, the ESAs published additional Q&As on the application of the SFDR. The new Q&As cover several key topics, including:
- Website disclosures. A registered Alternative Investment Fund Manager (AIFM) offering financial products under Article 8 or 9 of the SFDR must comply with the disclosure requirements of Article 10 of the SFDR. This includes ensuring that all relevant information is available on a website; the website may be the AIFM’s own website or the website of its group. If the AIFM does not have a website, it must establish one to meet these requirements. The information must be easily accessible to investors, it must be kept up to date, and any changes should be clearly explained.
- Sustainable investment. Sustainable investments pursuant to Article 2(17) SFDR can be made by investing in another financial product (e.g., a Undertakings for Collective Investments in Transferable Securities (UCITS)). In such cases, financial market participants should look through to the underlying investments to ensure they qualify as sustainable investments and to accurately assess the proportion.
- Principal Adverse Impact (PAI) calculation. For PAI indicator 4 in Table 1, Annex I (exposure to companies active in the fossil-fuel sector) of the SFDR Delegated Regulation, the calculation should be performed on a pass/fail basis. Therefore, a company should be considered to be active in the fossil-fuel sector as soon as it derives any revenues from exploration or other activities related to fossil fuels.
- Emissions scopes. Where a financial market participant (e.g., a UCITS management company) is aggregating the adverse impact of its financial products or its financial products invested in other financial products (e.g., fund of funds), there should be a look-through approach to the investee companies causing the greenhouse gas (GHG) emissions. In other words, the PAI indicator 1 (GHG emissions) should be calculated from the underlying investee companies, irrespective of whether the investment in them is direct or indirect (e.g., through a fund).
11. EU — (ESG) ESMA Guidelines
ESMA publishes translations of its guidelines on use of ESG or sustainability-related terms
On 21 August 2024, ESMA published translations of its guidelines on the use of ESG-related terms in fund names (the Guidelines) in all official EU languages. The Guidelines aim to protect investors from unsubstantiated or exaggerated sustainability claims in fund names and to provide asset managers with clear and measurable criteria for assessing their ability to use ESG or sustainability-related terms in fund names.
The Guidelines will come into effect on 21 November 2024, three months after publication of translations into all official languages of the EU. Funds existing before 21 November 2024 will have a six-month transitional period, while funds established on or after 21 November 2024 are expected to apply the Guidelines from their inception.
For our analysis of the Guidelines and how it will affect asset managers, please see our Sidley Update Implications of Final ESMA Guidelines on Use of ESG- or Sustainability-Related Terms in Fund Names.
ESMA publishes opinion on application of MiCA to multifunction crypto-asset intermediaries (MCIs)
On 31 July 2024, ESMA published an opinion on the application of MiCA to cryptoasset trading platforms, particularly MCIs (the ESMA Opinion). MCIs are firms or groups that combine a broad range of cryptoasset services, products, and functions typically centred around the operation of a trading platform.
The ESMA Opinion aims to clarify how certain MiCA obligations should be applied to prevent regulatory arbitrage and ensure a level playing field between EU and third-country trading platforms. To that end, ESMA provides guidance on the following matters.
- Reverse solicitation. ESMA reiterates that while EU clients are permitted to receive cryptoasset services at their own exclusive initiatives from non-EU firms, the availability of the reverse solicitation exemption should be construed narrowly. It should not be assumed, nor exploited, to circumvent MiCA. As such, when assessing authorisation applications, national competent authorities (NCAs) should ensure they do not provide legal cover for third-country firms aiming to solicit EU clients through establishing an authorised EU affiliate. While MiCA does not prohibit cryptoasset service providers from routing, executing, or hedging orders on non-EU execution venues, NCAs should ensure that an applicant’s proposed group arrangements do not result in the indirect solicitation of EU clients and/or provision of services in the EU by unauthorised persons in breach of MiCA.
Although a case-by-case assessment is required, NCAs may regard the systematic routing of client orders to a group execution venue located outside of the EU (be it a trading platform or another broker, within the EU entity’s group) as likely indication of unlawful solicitation of EU clients and consequently the provision of cryptoasset services by a third-country firm in the EU. - Best execution. EU brokers executing orders on third-country venues must comply with MiCA’s best execution requirements. NCAs should scrutinise brokers that are part of a group that includes execution venues to ensure they have procedures to execute orders with the best possible results for clients. Relying on a single execution venue is unlikely to consistently deliver best execution.
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