Investment management update

On 14 December 2020, the FCA published its first consultation paper on the implementation of the Investment Firms Prudential Regime (IFPR) (CP20/24). The IFPR is the new prudential regime for UK investment firms conducting investment services capturing among others, BIPRU and IFPRU firms, as well as exempt-CAD firms. It is designed to be a tailored regime, which is specifically focused on the harm which may be caused by investment firms, replacing altogether the framework under the Capital Requirements Regulation which is deposit-taking focussed.   

CP20/24 is the first of a number of consultations on the IFPR, with two additional consultations currently planned in 2021. The second consultation paper will cover issues including liquidity, risk management and governance and remuneration requirements; and the third will cover consequential amendments to the FCA Handbook and any gaps or issues identified through the consultation process. The FCA will not publish final rules until the Financial Services Bill 2019-21 has passed through Parliament. The scope and impact of IFPR on CPMI firms will also be covered in the latter consultations.

See our Q&A on the new regime for further information.

The FCA has stated that its implementation approach for IFPR is to stagger the topics on which they consult. The intention is to consult earlier on the topics that the FCA considers firms will require the most time to prepare for.

The deadline for responses to CP20/24 is 5 February 2021.

In CP20/24, the FCA sets out its proposals for the following aspects of the IFPR.

• The categorisation of investment firms – the FCA is proposing that all the current definitions of FCA investment firms, such as BIPRU, IFPRU, exempt-CAD, will cease to exist. There will be a new category for MiFID firms called “MIFIDPRU investment firms” and a further sub-category for “small and non-interconnected” (SNI) investment firms called “SNI MIFIDPRU investment firms”.
• Prudential consolidation – the FCA’s proposals include introducing new rules for how requirements should be calculated on a consolidated basis as well as a group capital test for FCA investment firm groups that do not wish to be subject to prudential consolidation and meet certain specified conditions.
• Own funds and own funds requirements – the FCA’s proposals are:
  • that the own funds of FCA investment firms should be made up solely of common equity tier 1 capital, additional tier 1 capital and tier 2 capital;
  • to introduce a new permanent minimum requirement as one of the floors that a firm’s own funds must not fall below, and to increase the initial capital that is required for a firm to become authorised as an FCA investment firm;
  • to introduce a new approach to calculating capital requirements including the use of “K-factors”. This is a capital calculation based on the activities that an FCA investment firm undertakes; and
  • new monitoring requirements for general concentration risk.
• Reporting requirements – FCA investment firms will be required to assess and hold financial resources against the potential for harm that they present to markets and consumers.

The FCA intends to establish a new prudential sourcebook relating to the IFPR: the Prudential sourcebook for MiFID Investment Firms (MIFIDPRU). Appendix 1 to CP20/24 contains a draft version of the Handbook instrument relating to the establishment of the IFPR and the introduction of MIFIDPRU.

On 16 December 2020, the European Banking Authority (EBA) published a final report which sets out seven draft regulatory technical standards (RTS) relating to prudential requirements for investment firms under the Investment Firms Regulation (IFR) and the Investment Firms Directive (IFD). The EBA consulted on these proposals in June 2020.

The first draft RTS included in the final report relates to the authorisation of certain credit institutions and the remaining six relate to capital requirements for investment firms at solo level. Each of the RTS will come into force on the 20th day after its publication in the Official Journal of the EU.

In an accompanying press release, the EBA explains that the final draft RTS are part of the phase 1 mandates of the EBA's June 2020 roadmap for investment firms, and aim to ensure a proportionate implementation of the new prudential framework for investment firms under IFR/IFD (which is due to be applicable by mid-2021) taking into account the different activities, sizes and complexity of investments firms.

On 17 December 2020, the EBA published a consultation paper on draft guidelines on sound remuneration policies under the IFD. There will be a public hearing on the draft guidelines on 17 February 2021 and the consultation closes to responses on 17 March 2021. The EBA will then finalise the guidelines and expects to publish a final version before the end of June 2021.

The guidelines are addressed to competent authorities, and investment firms that do not meet all of the conditions for qualifying as SNI investment firms under the IFR. They will not apply directly in the UK which is implementing its own IFPRU regime as discussed above. However, it is likely that a significant degree of alignment will exist between the UK and EU regimes. The extent of any possible divergence between the two regimes is discussed in further detail in Chapter 9 of CP20/24.

On 17 December 2020, the EBA published a consultation paper on internal governance under the IFD, specifying the governance provisions that class 2 investment firms should comply with. The consultation closes on 17 March 2021. The EBA will hold a public hearing on the draft guidelines on 17 February 2021. The EBA expects that the guidelines will apply from 26 June 2021.

The guidelines are consistent with the guidelines on internal governance for credit institutions and with international standards. In particular, they are consistent with requirements that aim to foster a sound risk culture implemented by the management body to strengthen the management body's oversight of the firm's activities and to strengthen the risk management frameworks of investment firms.

To ensure that investment firms groups take a holistic approach to their risk management, the draft guidelines apply both at an individual and a consolidated level.

On 15 December 2020, the FCA updated its webpage on the notification and disclosure of net short positions, in response to the guidance published by HM Treasury announcing that it intends to lay a statutory instrument under the retained EU law version of the Short Selling Regulation (UK SSR) amending the initial notification threshold for the reporting of certain net short positions to the FCA.

The threshold is in relation to the issued share capital of a company that has shares admitted to trading on a UK trading venue (i.e. a UK regulated marketed and a UK multilateral trading facility) and it will change from 0.2% to 0.1%.

As such, since the end of the transition period on 31 December 2020, and until the statutory instrument comes into effect on 1 February 2021, the notification threshold for issued share capital of a company that has shares admitted to trading on a UK trading venue will be 0.2%. However, during this period, position holders will continue to be able to make notifications to the FCA at the lower 0.1% threshold if they wish to do so.

This follows ESMA’s decision, on 17 December 2020, to renew its March 2020 decision to temporarily amend the threshold for notifying net short positions to competent authorities under the EU law Short Selling Regulation from 0.2% of issued share capital to 0.1% in respect of shares admitted to trading on a regulated market.

On 6 January 2021, the Short Selling (Notification Thresholds) Regulations 2021 were published, together with an explanatory memorandum, giving effect to HM Treasury’s intention. The lower threshold takes effect from 1 February 2021, when the Regulations come into force, and will apply indefinitely.

On 8 January 2021, the FCA published an updated version of its webpage providing information for firms on Covid-19. The FCA has updated its section on market trading and reporting in the light of the extensive duration of working from home arrangements in response to the pandemic.

The FCA now expects firms to ensure that all relevant communications (including voice calls) are recorded when working outside the office, whereas it had previously accepted that it might on some occasions not be possible to record calls, and instructed firms to inform it if they were unable to meet its requirements.

The FCA previously accepted that firms may experience difficulties in submitting their regulatory data, in which case they should maintain appropriate records and submit the data as soon as possible. Firms are required to continue to take all steps to prevent market abuse risks and to submit regulatory data without undue delay.

The FCA advises any firms that have further concerns about their ability to meet their obligations due to the pandemic to contact it via their regular supervisory channels as soon as possible.

On 11 January 2021, the FCA published issue 66 of Market Watch, which sets out the FCA's expectations for firms on recording telephone conversations and electronic communications when alternative working arrangements are in place, including increased homeworking. It covers matters including the following.

• The FCA expects firms to continue to comply with the recording obligations in its Senior Management Arrangements, Systems and Controls sourcebook (SYSC 10A). Among other things, firms need to ensure that, if unmonitored or encrypted communication applications (such as WhatsApp) are used for in-scope activities on business devices, they are recorded and auditable.
• Firms to which the recording regime in SYSC 10A applies, must take reasonable steps to record telephone conversations and keep a copy of electronic communications of activities falling within scope of the recording rules.
• Firms are reminded that they must have effective, up-to-date recording policies and be able to demonstrate to the FCA, on request, that their policies, procedures and management oversight meet the recording rules. This includes policies and procedures adopted for home working arrangements. Policies should identify which telephone conversations and electronic communications are subject to recording requirements. They must also contain procedures to follow where breaches or gaps are identified. Where new or amended recording policies are needed, these should be clearly set out in writing, documented and signed off under appropriate governance arrangements.
• If new or amended policies are introduced, or new technologies used, the FCA expects firms to provide enhanced or refreshed training to staff covering the use of new technologies and conduct risks arising.

On 16 December 2020, ESMA published a final report on guidelines on stress test scenarios produced under Article 28 of the Regulation on money market funds (MMF Regulation). The guidelines will now be translated and will become applicable two months after the publication of the translations. The Annex to the report contains the text of the updated guidelines and the calibration of scenarios for 2020.

ESMA notes that, as a result of Covid-19 increasing risks for MMFs and the instruments in which they invest, and causing significant liquidity and redemption issues, applying 2019 scenarios in the current market environment generally leads to absolute levels of stress (with some scenarios being exceeded because of extreme market movements). The risk parameters have therefore been modified to reflect market developments.

MMFs and their managers are expected to measure the impact of the common reference stress scenarios specified in the guidelines. On the basis of the measurements, the reporting template referred to in Article 37 of the MMF Regulation should be completed and sent with quarterly reports to the relevant national competent authority. The new 2020 parameters will have to be used for the purpose of the first reporting period following the start of the application of the updated guidelines.

On 17 December 2020, ESMA published its final report containing guidelines under Article 25 of the Alternative Investment Fund Managers Directive (AIFMD). The guidelines will now be translated into the official EU languages and will apply two months after the publication of the translations.

Article 25 provides for national competent authorities (NCAs) to identify the extent to which the use of leverage in the alternative investment fund sector contributes to the build-up of systemic risk in the financial system, risks of disorderly markets, or risks to the long-term growth of the economy.

The guidelines provide NCAs with a set of indicators to consider when performing their risk assessment and a set of principles that they should take into account when calibrating and imposing leverage limits. They follow the two-step approach introduced by the International Organization of Securities Commissions (IOSCO) and translate this approach into the EU framework.

In the report, ESMA states that the guidelines are without prejudice to any further regulatory updates coming from IOSCO's work on leverage, the AIFMD review and any further calibration of the indicators that may be deemed appropriate in the future.

In response to Brexit and the end of the Brexit transition period, on 13 January 2021, ESMA published a statement reminding firms of the provisions in the MiFID II Directive on investments services to retail or professional clients by firms not established or situated in the EU. This guidance is relevant to UK firms which may be conducting limited business in the EEA, relying upon the argument that this business was subject to “reverse solicitation”.

Under Article 42 of MiFID II, where a retail client or professional client established or situated in the EU initiates, at its own exclusive initiative, the provision of an investment service or activity by a third-country firm, that third-country firm is not obliged to  establish a branch under Article 39 of MiFID II.

ESMA notes that, post-Brexit, some questionable practices by firms around reverse solicitation have emerged. It indicates that some firms appear to be trying to circumvent MiFID II requirements by including general clauses in their terms of business, or through the use of online pop-up "I agree" boxes, where clients state that any transaction is executed on the exclusive initiative of the client.

ESMA reminds firms of recital 111 of MiFID II, which provides guidance on what "own exclusive initiative of the client" means. It reminds firms that every communication means used, such as press releases, advertising on the internet or phone calls, should be considered in determining if the client, or potential client, has been subject to any solicitation, promotion or advertising in the EU on the firm's investment services or activities or on financial instruments.

On 18 January 2021, the FCA published a statement reminding firms to regularly review their regulatory permissions under Part 4A of the Financial Services and Markets Act 2000 (FSMA) to ensure that they are up-to-date and removed where they are not needed.

The FCA expects firms to notify it of material changes and apply to make any necessary changes to permissions in a timely way. It has the power to cancel a firm's Part 4A permission if it has not carried on a regulated activity for at least 12 months. The FCA also reminds firms that they must provide it with an annual attestation that the information held about it on the Financial Services Register is accurate.

Using new powers in the Financial Services Bill 2019-21, where the FCA believes that a firm is not carrying on a regulated activity, it will be able to serve notice on the firm, asking for a written response within 14 days. If the firm does not respond, the FCA will be able to publish a second, public notice, explaining it appears that the firm is not carrying on a regulated activity. It can then vary or cancel the firm's permissions after one month.

The FCA reminds firms that if a firm has a Part 4A permission, but has not carried on any regulated activities for 12 months or more and has no current plans to do so, it must apply for cancellation. If a firm has a Part 4A permission, and has not used and no longer needs some of the permissions, it must apply to remove the permissions it no longer needs by completing and submitting a variation of permission application.

We have considered the FCA’s statement in greater detail in our blog post.

On 18 January 2021, the FCA published a report on its consumer investments data review, covering the period between 1 January and 31 October 2020. This is the first FCA report on its consumer investments data review. The FCA intends to continue to publish an update report on consumer investments data on a half-yearly basis.

In the report, the FCA sets out details of the work it has undertaken during this period, including details of policy action, relating to the three strategic outcomes of its consumer investments strategy:

• stopping and disrupting firms and individuals causing harm. The FCA sets out data and other information on its work to prevent firms and individuals entering the perimeter, its regulatory oversight of the market and to act against firms and individuals that cause consumers harm;
• supporting and guiding consumers to investments that meet their needs. The FCA sets out data and other information on its work to stop scams through behaviour change campaigns and to provide direct consumer support through its consumer helpline; and
• firms addressing problems by dealing fairly with customer complaints and paying redress. The FCA sets out an analysis of consumer complaints and redress paid by firms.

On 16 December 2020, the Council of the EU published an “I” item note with an accompanying addendum setting out the final compromise text of the proposed Directive amending the MiFID II Directive as regards information requirements, product governance and position limits and the Capital Requirements Directive V and the CRD IV Directive as regards their application to investment firms, to help the recovery from the Covid-19 pandemic. In an accompanying press release, the Council states that it is possible that the amendments would be formally adopted in February 2021. These changes will include simplifying information requirements under MiFID II, for instance on costs and charges disclosures. Additionally, in order to facilitate securitisation, the existing EU framework for simple, transparent and standardised securitisations will be extended to cover synthetic securitisations.

The proposed Directive forms part of the EU's capital markets recovery package. Additional addenda to the Council's "I" item note also contain final compromise texts for the proposed regulations amending the Prospectus Regulation, the Securitisation Regulation and the Capital Requirements Regulation as further parts of that package.

On 18 December 2020, the FCA published an updated statement setting out its expectations to help firms using appointed representative arrangements apply the approved persons regime during the Covid-19 pandemic. 

The FCA explains that, as firms have adapted to the impact of the pandemic over the past few months, it expects that firms' application of the SMCR rules will return to normal.

• The FCA previously issued a modification by consent to the 12-week rule to support firms using temporary arrangements during the crisis. If temporary arrangements made as a result of the pandemic lasted longer than 12 weeks, firms could notify the FCA that they consented to an extension of the 12-week rule. While modification by consent is still available, a firm cannot consent to the modification after 30 April 2021 and all modifications consented to before then will come to an end on that date. This means that the maximum period of extension available to firms reduces closer to 30 April 2021.
• After 7 January 2021, firms will again be expected to notify the FCA of their temporary arrangements using Form D. However, the FCA does not expect firms to submit their Form D relating to changes made before 7 January 2021.

On 18 December 2020, the FCA published an updated statement on the impact of Covid-19 on the Senior Managers and Certification Regime (SMCR), setting out its expectations of solo-regulated firms.

The FCA explains that, as firms have adapted to the impact of the pandemic over the past few months, it expects that firms' application of the SMCR rules will return to normal. It was noted that:

• the relaxation of the requirement for a firm that needed to make temporary arrangements in direct response to the pandemic to submit updated Statements of Responsibilities (SoRs) ends on 7 January 2021. The FCA now expects firms to apply the notification requirements as normal and submit a Form J when significant changes are made to SoRs. However, it does not expect firms to submit updated SoRs relating to changes made before 7 January 2021; and
• while modification by consent to the 12-week rule for firms using temporary arrangements is still available, a firm cannot consent to the modification after 30 April 2021 and all modifications consented to before then will come to an end on that date. The end date means that the maximum period of extension available to firms reduces closer to 30 April 2021.

On 4 December 2020, ICE Benchmark Administration (IBA) published a consultation on its intention to cease publication of all tenors of EUR LIBOR, CHF LIBOR, JPY LIBOR and GBP LIBOR on 31 December 2021. The consultation closed for feedback at 5pm on 25 January 2021.

The consultation also requests feedback on IBA's intention to cease publication of USD LIBOR one week and two month rates on 31 December 2021 and overnight and one, three, six and 12 month rates on 30 June 2023.

IBA stresses that the consultation must not be taken to be an announcement that it will cease, or continue, the provision of any LIBOR settings after December 2021 or June 2023.

On 11 January 2021, the FCA published a press release highlighting the need for firms to complete the transition from sterling LIBOR by the end of 2021.

The UK regulators have set out clear expectations for regulated firms to remove their reliance on LIBOR in all new business, and in legacy contracts, where feasible. The primary way for market participants to have certainty over the economic terms of their contracts is to actively transition them away from LIBOR.

To support this, the Working Group on Sterling Risk-Free Reference Rates (RFRWG) has published an updated version of its priorities and roadmap for the final year of transition. The RFRWG's top priority is for markets and their users to be fully prepared for the end of sterling LIBOR by end-2021. In particular, it has recommended that:

• from the end of March 2021, sterling LIBOR is no longer used in any new lending or other cash products that mature after end-2021. Throughout the remainder of 2021, existing contracts linked to sterling LIBOR should be actively transitioned, where possible; and
• firms no longer initiate new linear derivatives linked to sterling LIBOR after the end of March 2021, other than for risk management of existing positions or where they mature before end-2021.

The FCA will expect transition plans to be executed in line with industry-recommended timelines across sterling and other LIBOR currencies. Senior managers with responsibility for LIBOR transition should expect close supervisory engagement on how they are ensuring their firm's progress relative to industry milestones.

On 24 December 2020, the government published the draft UK-EU trade and co-operation agreement setting out the future relationship with the EU that will follow the end of the Brexit transition period, together with related declarations, including a joint declaration on financial services regulatory co-operation.

Under the joint declaration on financial services regulatory co-operation, the UK and the EU have agreed to establish structured regulatory co-operation on financial services, with the aim of establishing a durable and stable relationship. The declaration states that the framework for regulatory co-operation will be codified in a memorandum of understanding (MoU), which the parties are to agree by March 2021. They will discuss how to move forward on both sides with equivalence determinations, without prejudice to each side's unilateral and autonomous decision-making process.

The agreement is implemented in the UK by the European Union (Future Relationship) Act 2020 which was passed by Parliament on 30 December 2020 and came into effect on 31 December 2020.

On 16 December 2020, the FCA published a new version of its supervisory statement on the operation of the transparency regime under the retained EU law version of the Markets in Financial Instruments Regulation (UK MiFIR) at the end of the transition period.

The areas covered by the statement include:

• the FCA's financial instruments reference database (FIRDS), the FCA's financial instruments transparency reference system (FITRS), the investment firms register, the trading venues register, and the systematic internalisers register;
• the concept of "traded on a trading venue";
• the double volume cap;
• transparency waivers and deferrals;
• equity transparency, bond transparency, derivatives and other non-equity instruments transparency; and
• trade reporting, tick sizes and commodity position limits.

On 22 December 2020, the FCA published the final versions of its temporary transitional power (TTP) directions and related guidance. The FCA published near-final versions of these documents on 1 October 2020 and 2 December 2020. The transitional directions and instruments will apply from the end of the Brexit transition period. The final documents include:

• the main FCA transitional directions and the temporary permission substituted compliance direction, which applies to FCA authorised firms and firms in the temporary permissions regime (TPR) or the supervised run-off (SRO) regime;
• the FCA prudential transitional direction, which contains the prudential standstill direction covering FCA prudential requirements;
• an explanatory note on the FCA's approach to the use of the transitional power; and
• the FCA transitional direction for the share trading obligation (STO) and the related explanatory note.

The FCA has also published the final instruments making amendments to the onshored binding technical standards (BTS) for which it is responsible. These relate to miscellaneous amendments and to consequential amendments to BTS supplementing the Capital Requirements Regulation and the CRD IV Directive that follow on from equivalent amendments made by the PRA.

On 31 December 2020, the FCA published a statement on the use of its TTP to modify the UK's derivatives trading obligation (DTO). The UK has onshored the MiFIR DTO under the EU Withdrawal Act 2020 (EUWA). The UK DTO applies to the same classes of derivatives as the EU DTO.

In the absence of a co-ordinated solution for mutual equivalence, the FCA is using its TTP to modify the application of the UK DTO. Under this modification, where firms subject to the UK DTO trade with, or on behalf of, EU clients that are subject to the EU DTO, they will be able to transact or execute those trades on EU venues provided:

• firms take reasonable steps to be satisfied the client does not have arrangements in place to execute the trade on a trading venue to which both the UK and EU have granted equivalence; and
• the EU venue has the necessary regulatory status to do business in the UK (including recognised overseas investment exchanges (ROEICs)), have been granted the relevant temporary permission, or are certain they benefit from the overseas person exclusion.

The modification applies to UK firms, EU firms using the UK's TPR, and branches of overseas firms in the UK. It does not apply to trades with non-EU clients, proprietary trading conducted, and trades between UK branches of EU firms. These trades remain subject to the UK DTO.

The FCA expects firms to be able to demonstrate they are taking all reasonable steps during Q1 2021 to ensure compliance with the UK DTO. The FCA stated that the use of the TTP will remain under review and it will consider by 31 March 2021 whether market or regulatory developments warrant a review of their approach.