Investment management update
Key things to keep an eye out for in this month's update
- The FCA has published its long-awaited consultation on the Long Term Asset Fund. Macfarlanes is actively engaged in the industry responses and will send our own feedback to the FCA, which we expect to share with you next month.
- The FCA has also proposed a new Consumer Duty that has attracted attention within the industry. Less obvious, but worth noting, is an FCA notice on the Individual Accountability/Senior Managers Regime.
- To understand the EU’s future policy direction, see details of a new strategy for retail investors and a speech on financial integration and financial stability.
- While Covid-specific measures are winding up, LIBOR cessation is coming to fruition and we have a slew of related developments in this month’s report.
On 6 May 2021, the FCA updated its webpage on outsourcing and operational resilience to clarify its expectations regarding firms' obligations to review their legacy outsourcing arrangements for the purposes of complying with the EBA's guidelines on outsourcing.
The EBA's guidelines require firms to review their existing critical or important outsourcing arrangements entered into before 30 September 2019 (which was the date the guidelines entered into force) to ensure they are compliant with the guidelines. Where firms have not finalised this review by 31 December 2021, the guidelines require them to inform their competent authority of that fact, including the measures planned to complete the review or the possible exit strategy.
The FCA has updated its webpage to confirm that, while it expects firms to continue to comply with the guidelines following the UK's departure from the EU, it does not expect them to report to it on their progress towards meeting the 31 December 2021 timeline in the guidelines regarding their legacy outsourcing arrangements. It states that:
- firms should aim to review any outstanding critical or important outsourcing arrangement at the first appropriate contract renewal following the first renewal date of each existing outsourcing arrangement or revision point; and
- where critical or important outsourcing arrangements have not been finalised by 31 March 2022, firms should inform it.
On 7 May 2021, the FCA published a consultation paper on a new authorised fund regime for investing in long-term assets (CP21/12). The new Long Term Asset Fund will permit DC pension schemes and some retail investors to access private assets such as private equity and debt, infrastructure and real estate.
Please see our blog post for a summary of the consultation and the regulators’ next steps.
On 11 May 2021, the FCA updated its webpage on the latest news relating to Gabriel, its previous platform for gathering regulatory data from firms.
The FCA has confirmed that Gabriel has now been fully replaced by RegData, a new platform for gathering regulatory data that is intended to be faster, easier to use and built with flexible technology.
On 14 May 2021, the FCA published a consultation paper (CP21/13) on a new consumer duty, which will set a higher level of consumer protection in retail financial markets for firms to adhere to.
The consumer duty would require firms to:
- ask themselves what outcomes consumers should be able to expect from their products and services;
- act to enable rather than hinder these outcomes; and
- assess the effectiveness of firms' actions.
In essence, the FCA wants to see firms putting themselves in their customers' shoes. For many firms, this would require a significant shift in culture and behaviour, where they consistently focus on consumer outcomes, and put customers in a position where they can act and make decisions in their interests.
The proposals in CP21/13:
- apply to firms in relation to their regulated activities;
- relate to products and services sold to retail clients. This includes all clients other than professional clients (such as large corporate entities and government bodies) and eligible counterparties. Therefore, in most cases, where the FCA regulates the provision of financial services to SMEs, the proposals would apply; and
- extend to firms that are involved in the manufacture or supply of products and services to retail clients, even if they do not have a direct relationship with the end customer (referred to as retail markets).
On 28 May 2021, the FCA published Handbook Notice 88, which sets out changes to the FCA Handbook made by the FCA Board on 27 May 2021.
The Handbook Notice reflects changes made by the Individual Accountability (Miscellaneous Amendments) Instrument 2021 (2021/18), which comes into force on 2 June 2021.
The instrument makes changes to the Handbook to reflect the FCA's expectations for firms to notify it of when an approved person at an appointed representative firm, or a senior manager, takes temporary leave for longer than 12 weeks (long-term leave). The changes include adding an additional field to Form D (Changes to personal information/application details and conduct breaches/disciplinary action related to conduct) to enable firms to notify the FCA that the relevant individual is taking leave or returning from that leave.
The FCA consulted on the proposals in CP20/23, which was published in December 2020. Feedback is provided in chapter 3 of the Handbook Notice. Given the feedback received predominantly supported the proposals, the FCA is including additional Handbook guidance and proceeding in line with its proposals.
On 7 May 2021, the European Commission published for consultation a draft Delegated Regulation supplementing Article 8 of the Taxonomy Regulation ((EU) 2020/852) by specifying the content and presentation of information to be disclosed by undertakings subject to Articles 19a or 29a of the Non-Financial Reporting Directive (2014/95/EU) (NFRD) concerning environmentally sustainable economic activities and the methodology to comply with that disclosure obligation (Ares(2021)3080956).
Article 8 of the Taxonomy Regulation requires large corporates to include in their non-financial statements information on how and to what extent their activities are associated with environmentally sustainable economic activities. The draft Delegated Regulation:
- specifies the content and presentation of information to be disclosed by non-financial undertakings, asset managers, credit institutions, investment firms, and insurance and reinsurance undertakings; and
- sets out common rules relating to key performance indicators (KPIs).
A Commission webpage states the consultation closes on 2 June 2021. A set of FAQs explain Commission adoption is planned by the end of June 2021 and the Delegated Regulation should apply from 1 January 2022.
On 11 May 2021, the European Commission published a consultation paper on a retail investment strategy for the EU.
The aim of the consultation is to gather views and evidence to help the Commission develop its policies to improve the EU's existing retail investor protection framework. In particular, the Commission is seeking views on:
- the limited comparability of similar investment products that are regulated by different legislation and are therefore subject to different disclosure requirements, which prevents individual investors from making informed investment choices. For example, currently, requirements are set out in legislation including the MiFID II Directive (2014/65/EU), the Insurance Distribution Directive ((EU) 2016/97) (IDD), the PRIIPs Regulation (1286/2014) and the UCITS Directive (2009/65/EC);
- how to ensure access to fair advice in the light of current inducement practices;
- how to address the fact that many citizens lack sufficient financial literacy to make good decisions about personal finances;
- the impact of the increased digitalisation of financial services; and
- sustainable investing.
Other issues covered by the consultation include reviewing the framework for investor categorisation, suitability and appropriateness assessments, consumer redress and views on the PRIIPs Regulation. How to address the complexity of products targeted at retail investors, and ESMA's and EIOPA's product intervention powers to temporarily address perceived harm from certain high-risk products are also considered.
Comments can be made on the consultation paper until 3 August 2021. The Commission intends to adopt a Retail Investment Strategy in early 2022.
On 26 May 2021, ESMA published the letter (ESMA22-328-603) it has sent to the European Commission setting out its response to the Commission's targeted consultation on the functioning of the European Supervisory Authorities (ESAs).
The response reflects the views of ESMA's board of supervisors on certain existing issues and limitations that could be addressed in the ESMA Regulation and other relevant EU financial services legislation. These views are based on ESMA's experience over recent years, as well as its more limited experience with the use of the new tools it acquired following the last review of the ESAs that concluded in 2019.
The annex to the letter sets out ESMA's general recommendations, which it believes merit further consideration by the Commission in the context of the consultation. These recommendations focus on:
- reinforcing ESMA's approach to supervisory convergence;
- considering the merits of EU-level direct supervision
- building ESMA's data capabilities;
- ensuring the single rulebook remains fit for purpose; and
- alleviating funding issues.
ESMA's aim in putting forward these recommendations is to support the objectives of the Capital Markets Union and further promote and facilitate supervisory convergence across member states.
On 27 May 2021, the European Commission published a speech by Mairead McGuinness, European Commissioner for Financial Services, Financial Stability, and Capital Markets Union (CMU), in which she considers European financial integration and stability.
Ms McGuinness was speaking at the annual joint Commission and European Central Bank (ECB) conference 2021.
Points of interest in her speech
- Three main risks to financial stability remain: disruptive repricing of assets, the sustainability of debt and possible stress in the banking sector. The Commission's 2020 financial stability and integration report did not account for the Covid-19 pandemic, which became the defining economic event of the year. Given this, it is vital to be aware of the need to prepare for unexpected events and build up a stronger financial system that is resilient to shocks.
- The massive relocation of capital in the wake of Covid-19 creates new relationships between market participants. It is important to avoid these new linkages creating undue risks to financial stability.
- Converging supervision and co-ordination of national supervisors is vital. The Commission has now concluded its targeted consultation on supervisory convergence and the single rulebook. It received over 100 responses and is assessing them.
- Although there are risks to financial stability as a result of Covid-19, it can also work as a catalyst. The big disruption in normal business and working methods due to lockdowns forced financial services providers to use technology. Covid-19 has also shown that sustainability is not sufficiently integrated in EU economies, but the recovery presents an opportunity to support sustainable finance. These green and digital transitions affect all market participants: banks, asset managers, insurers, regulators and retail investors.
- Digitalisation will need to be carefully considered in the Commission's retail investment strategy, on which it is currently consulting. Technological changes may pose challenges to retail investors and the existing investor protection rules may no longer be fit for purpose. A framework is therefore required to take advantage of digitalisation while addressing potential emerging risks.
- The Commission will shortly be presenting its renewed sustainable finance strategy. This strategy will aim to ensure that climate and environmental risks become mainstream in the financial system, which is essential for a stable system that is resilient to the impacts of climate change.
On 10 May 2021, the FCA updated its statement on the operation of the MiFID markets regime webpage announcing that it has made available its annual transparency calculations for UK non-equity instruments that will apply from 1 June 2021.
The FCA has also published updated data relating to:
- large in scale (LIS) and size specific to the instrument (SSTI) thresholds for all bond types (except exchange traded commodities (ETCs) and exchange traded notes (ETNs); and
- liquidity assessment and the LIS and SSTI thresholds for the liquid classes of non-equity instruments other than bonds.
These results cover the 2021 annual bonds threshold assessment, the May 2021 quarterly bonds liquidity determination and the 2021 annual derivatives threshold and liquidity assessment. The calculations are available through the FCA's Financial Instrument Transparency Reference System (FCA FITRS).
On 20 May 2021, the Bank of England (BoE) published a consultation paper setting out its proposal to modify the scope of contracts that are subject to the derivatives clearing obligation under the retained EU law version of EMIR (648/2012) (known as UK EMIR) to reflect the ongoing reforms to interest rate benchmarks.
The classes of OTC derivatives contracts that are mandated to be cleared in the UK comprise certain standardised interest rate derivative and credit default swap (CDS) contracts. Given the anticipated changes in market activity resulting from interest rate benchmark reform, the BoE intends to remove contracts that reference benchmarks being discontinued and replace them with overnight index swaps (OIS), with the same range of maturities, that reference the replacement near risk-free reference rate (RFR) benchmarks selected for each currency.
The BoE's proposed changes are limited to those relating to benchmarks currently within the scope of the clearing obligation that are being discontinued by January 2022. Specifically, the BoE proposes to remove contracts referencing:
- EONIA – these will be replaced with contracts referencing €STR;
- GBP LIBOR – these will be replaced with contracts referencing SONIA; and
- JPY LIBOR.
As the publication of the most widely used USD settings will cease in June 2023, the BoE's proposals do not relate to the transition from USD LIBOR at this time. The dates on which each of the modifications to the clearing obligation come into force will coincide with key dates associated with the broader RFR transition.
The BoE's proposals will result in changes to the onshored version of Commission Delegated Regulation (EU) 2015/2205 supplementing EMIR with regard to regulatory technical standards (RTS) on the clearing obligation (that is, Binding Technical Standards (BTS) 2015/2205). The appendix to the consultation contains a draft version of the Technical Standards (Clearing Obligation) Instrument 2021, which amends BTS 2015/2205.
The consultation closes to responses on 14 July 2021. Having considered any responses, and subject to approval by HM Treasury, the BoE intends to make and publish the final version of the technical standards instrument in autumn 2021.
On 26 May 2021, ESMA published a consultation paper (ESMA70-156-4067) on draft technical standards for commodity derivatives.
The consultation paper seeks stakeholders' views on the regulatory technical standards (RTS) that ESMA is required to develop under the MiFID II Amending Directive ((EU) 2021/338) and forms part of the post-Covid-19 MiFID II recovery package.
The MiFID II Amending Directive introduces significant changes to the MiFID II commodity framework, including to the position limit regime. ESMA's proposals relating to the application of position limits to commodity derivatives focus on:
- developing procedures for financial entities undertaking hedging activities and for liquidity providers to apply for an exemption from position limits; and
- suggesting other technical adjustments to improve the application of the position limit regime in practice.
In addition, the consultation paper also contains ESMA's proposals for technical standards on position management controls.
Comments can be made until 23 July 2021. ESMA intends to finalise the draft technical standards and submit a final report to the European Commission for endorsement by November 2021.
On 26 May 2021, ESMA published a consultation paper (ESMA33-9-412) on guidelines on disclosure requirements for initial reviews and preliminary ratings under the CRA Regulation (1060/2009).
The CRA Regulation (CRAR) includes a number of provisions that are designed to provide greater clarity to market participants as to whether entities or debt instruments have been subject to an initial review or a preliminary rating by CRAs before receiving a credit rating. The aim of these provisions is to mitigate against the effects of ratings shopping.
ESMA has engaged with CRAs over a number of years to assess current market practices around initial reviews and preliminary ratings with the aim of identifying possible inconsistencies in CRAs' practices and defining necessary steps to address these inconsistencies.
In Annex I to the consultation, ESMA sets out a draft version of guidelines for CRAs to address inconsistencies in the interpretation of the relevant provisions and, by extension, reduce (to the extent possible under the existing CRA Regulation provisions) the risks posed by rating shopping.
In particular, and as ESMA explains in the consultation, the draft guidelines aim to clarify ESMA's views on the following:
- how the term "initial review and preliminary rating" should be understood for the purposes of the CRA Regulation's public disclosure requirements;
- the content and timing of CRAs' public disclosures for interactions that meet the standard of "initial review and preliminary rating"; and
- the steps to ensure these public disclosures are more accessible for investors and the market.
The consultation closes to responses on 4 August 2021. ESMA is seeking feedback from debt issuers and users of credit ratings, as well as CRAs.
On 26 May 2021, ESMA published its final report (dated 20 May 2020) (ESMA74-362-1986) on guidelines on calculating positions by trade repositories (TRs) under the Securities Financing Transactions Regulation ((EU) 2015/2365) (SFTR).
The purpose of the guidelines is to ensure that a uniform methodology is used under EMIR (648/2012) and the SFTR, while taking into account the specificities of securities financing transactions (SFT) reporting. In particular, the guidelines clarify how to comply with:
- Article 12(2) of the SFTR, which requires TRs to collect and maintain details of SFTs;
- Article 80(4) of EMIR, as referred to in 5(2) of SFTR, which sets out a general requirement for TRs to calculate positions; and
- Article 5 of RTS on data aggregation, which specifically requires TRs to calculate positions in SFTs in a harmonised and consistent manner. High-quality position data is necessary for the assessment of systemic risks to financial stability by the relevant authorities.
The guidelines will apply from 31 January 2022.
On 27 May 2021, the European Commission published for consultation a draft Delegated Regulation supplementing the MiFID II Directive (2014/65/EU) by specifying the criteria for establishing when an activity can be considered to be ancillary to the main business at group level. The draft Delegated Regulation can be addressed through a Commission webpage.
Article 2(1)(j) of the MiFID II Directive exempts a person from the regulated activities of dealing on own account and providing investment services in relation to commodity derivatives provided that those activities are ancillary to that person's (or its group's) main business, and the main business is not the provision of investment services.
The Commission has power under Article 2(4) of the MiFID II Directive to adopt regulatory technical standards (RTS) specifying the criteria for establishing when an activity is to be considered ancillary to the main business of a group.
Directive (EU) 2021/338, which amends the MiFID II Directive to help the EU's economic recovery from the Covid-19 pandemic (the Amending Directive or "Quick Fix" Directive), revisited the ancillary activity exemption and empowered the Commission to adopt a delegated regulation to replace Delegated Regulation 2017/592 (RTS 20).
Proposed changes to the ancillary activity exemption are the deletion of the overall market size test in Article 2 of RTS 20 and the introduction of the new de-minimis threshold test. The amended text does not change the established calculation methodology of the trading test and capital employed test in RTS 20. The only change to these two tests is the level of the corresponding threshold as set out in the Amending Directive.
The consultation closes on 24 June 2021.
On 11 May 2021, the FCA updated its webpage on changes to regulatory reporting during the Covid-19 pandemic.
The FCA explained in February 2021 that firms could apply for a two-month extension to the deadline for submissions for FIN-A (annual report and accounts) due up to and including 31 July 2021.
The FCA has removed the February 2021 entry from the webpage and has replaced it with a May entry, which makes it clear that for this return only, firms will have an "automatic" two-month extension to the deadline for submissions up to and including 31 July 2021.
The FCA still advises that this flexibility is intended to cover the situation where the impacts of Covid-19 have made it impractical to finalise audited financial statements. If firms are able to submit FIN-A on time, then they should do so. In any event, firms should submit FIN-A as soon as they are reasonably able to, and no later than 30 September 2021.
On 13 May 2021, the FCA announced that, with effect from 1 May 2021, its statement on firms' handling of complaints during the Covid-19 pandemic was no longer in force.
On 11 May 2021, the BoE published a speech by Andrew Bailey, BoE Governor, on life after LIBOR, in which he focuses on the important role benchmarks play in the financial system and why financial firms and borrowers would do well to choose the most robust alternative reference rates that meet their use case.
Key points made by Mr Bailey
- Substituting LIBOR for credit sensitive rates that do not address all of LIBOR's fundamental weaknesses, risks much of the good progress made. Such rates present a range of longer-term risks: in particular, their ability to maintain representativeness through periods of stress remains a challenge to which the BoE has not seen adequate answers.
- Firms regulated by the PRA who may be guilty of "lazy" behaviors in unnecessarily sustaining LIBOR-linked contracts can expect to hear from their supervisors.
- Safety nets (such as the proposed synthetic LIBOR) are temporary solutions, and active transition ahead of LIBOR cessation remains important. Mr Bailey points out that the ISDA IBOR fallbacks protocol remains open for entities that have not yet adhered and it is critical that equally robust fallback arrangements are adopted in cash products too. Supervisory engagement will continue after the end of 2021 to ensure regulated firms continue to move those exposures onto robust alternatives where that is possible.
- While forward-looking term rates can support transition, a broad-based transition to the most robust overnight rates will support a stronger, more transparent, financial system and ultimately benefit all market participants.
- The alternatives to the selected risk-free rates must address all of the weaknesses of LIBOR (that is, the lack of underlying transactions on which to base the rate, use of expert judgement to supplement the dates where actual transactions are not available, and the impact of the underlying liquidity dynamics of the markets being referenced) and not just the likelihood of the application of judgement. Mr Bailey explains that it is not yet clear to what extent alternative credit sensitive benchmarks have truly addressed those weaknesses. However, in the UK there is a clear consensus that credit sensitive rates are not required or wanted as part of sterling LIBOR transition.
On 7 May 2021, ICE Benchmark Administration (IBA) published a consultation on its intention to cease the publication of GBP LIBOR ICE Swap Rate settings for all tenors immediately after publication on 31 December 2021.
IBA has published GBP ICE Swap Rate settings based on SONIA for the same tenors as GBP LIBOR settings, since December 2020, to allow market participants to start using SONIA, rather than LIBOR, for sterling interest rate swaps before the end of 2021.
IBA has stressed that the consultation is not an announcement that it will either cease or continue the publication of GBP LIBOR ICE Swap Rate after December 2021.
Feedback is requested on the consultation by Friday, 4 June 2021. IBA expects to consult on the potential cessation of USD LIBOR ICE Swap Rate in due course.
On 11 May 2021, the Working Group on Euro Risk-Free Rates published recommendations on EURIBOR fallbacks, covering events that could trigger fallbacks in EURIBOR-linked contracts and the rates that could be used if a fallback is triggered.
The recommendations include an €STR-based EURIBOR fallback rate for specific use cases, including corporate lending, debt securities, securitisations and trade finance and recommendations for a spread adjustment to be added to the fallback rate.
The working group published two consultations on fallback trigger events and €STR-based EURIBOR fallback rates in November 2020, with the feedback on the consultations taken into account in the recommendations.
There is currently no plan to discontinue EURIBOR but the working group considers that the development of more robust fallback language addresses the risk of a potential permanent discontinuation, enhances legal certainty and is in line with the EU Benchmarks Regulation.
On 13 May 2021, the FCA and the Bank of England (BoE) published a joint statement announcing that they support and encourage liquidity providers in the sterling exchange traded derivatives market to switch the default traded instrument to SONIA instead of LIBOR from 17 June 2021.
This follows the recommendation by the Working Group on Sterling Risk-Free Reference Rates to cease initiation of new sterling LIBOR exchange traded derivatives expiring after 2021 by end-Q2 2021, other than for risk management of existing positions, which the FCA and PRA both support.
A survey conducted by the FCA of a broad set of participants in the exchange traded derivatives markets, including liquidity providers, bank dealers, buy-side firms and exchanges, identified strong support for the switch.
All participants in the sterling exchange traded derivatives market are now encouraged to take the necessary steps to prepare for and implement the changes to standard trading conventions on 17 June 2021 and assist the transition to SONIA. Before then, the FCA and BoE will engage with market participants to determine whether market conditions allow the switch to proceed smoothly.
On 19 May 2021, the Working Group on Sterling Risk-Free Reference Rates (Working Group) published a statement recommending the use of overnight SONIA compounded in arrear as the successor rate to replace GBP LIBOR for fallbacks in bond documentation.
The recommendation follows feedback received by the Working Group on its consultation in February 2021.
The statement recommends that it should be left to the issuer to decide on the conventions to be used to accompany the recommended successor rate.
On 20 May 2021, the FCA published a consultation paper (CP21/15) on its proposed use of its new powers under the retained EU law version of the Benchmarks Regulation ((EU) 2016/1011) (UK BMR), as amended by the Financial Services Act 2021 (FS Act 2021), in relation to the use of critical benchmarks that are being wound down, such as LIBOR.
The two powers on which the FCA is consulting in CP21/15 are:
- legacy use power (under new Article 23C(2) of the UK BMR). This power enables the FCA to permit some or all "legacy" use of a critical benchmark that has been designated as an "Article 23A benchmark" because it has become permanently unrepresentative of the market it is intended to measure; and
- new use restriction power (under new Article 21A of the UK BMR). This power gives the FCA the ability to prohibit some or all new use of a critical benchmark when it has been notified by its administrator that it will cease to be provided.
The FCA may only exercise these powers where it considers it would advance either or both of its consumer protection and integrity statutory objectives.
In CP21/15, the FCA sets out the factors it proposes to consider when making decisions to exercise these two new powers. It points out that not every factor will always be relevant and therefore they might not all be considered or applied in every case. In addition, the list of factors is not exhaustive. The prevailing circumstances at the time the FCA takes a decision may make it desirable or appropriate to take account of some of the factors, or to take account of additional or alternative factors, or both.
LIBOR is currently the only critical benchmark in the UK. The FCA has therefore drawn on its engagement with market participants in the context of LIBOR transition to help inform its proposed policy approach in this area. In relation to the legacy use power, this includes the Working Group on Sterling Risk Free Reference Rates’ (RFRWG) paper on the identification of tough legacy issues. However, the legacy use power could be used in relation to any critical benchmark designated as an Article 23A benchmark, and the new use restriction power could be applied to any ceasing critical benchmark. For this reason, the FCA has sought to identify all relevant factors that might apply more broadly.