Investment management update: Summer 2022 roundup

This month’s edition includes the following updates:

• several FCA updates over the summer, including the final rules for the new financial promotions regime, fund side pockets and the Consumer Duty, a consultation on the Long Term Asset Fund, and an overview of the FCA’s approach to supervising alternative investments;
• the UK Government introduced the Financial Services & Markets Bill, and policymakers have begun work on regulating critical third parties; and
• in the EU, there have been developments in relation to sustainable finance, including greenwashing, the creation of an ESG Benchmarks regime, and the MiFID II ESG reforms took effect.

UK

• On 24 August 2022, the FCA announced the launch of its diversity, equity, and inclusion (DEI) innovation spotlight. The initiative encourages firms to develop products in the DEI space. Firms with business models that aim to address financial inclusion of people who may struggle to access financial services can apply to the FCA via the regulatory sandbox (which allows firms to test their products with real consumers) and via innovation pathways (for firms that are pre-product testing phase but wish to better understand the FCA’s regulatory framework).
• On 23 August 2022, the FCA announced that it will establish a new expert committee to advise the FCA Board on its ESG responsibilities, including oversight of ESG issues as a regulator and in its own operations, emerging ESG topics, and the development of the FCA’s ESG Strategy. The FCA does not expect to appoint representatives from FCA regulated firms. The committee’s first meeting will be in Q4 2022. The announcement comes while the Government proposes to give the UK’s regulators a new secondary objective to help the country achieve its net zero targets.
• On 12 August 2022, the FCA updated its webpage on considerations for firms leaving the temporary permissions regime (TPR) to confirm that all firms expecting to apply for full authorisation in the UK should have received a formal direction confirming their landing slot. On a separate webpage, the FCA has stated that a firm that misses its landing slot or otherwise fails to apply by 31 December 2022 will have failed to meet its expectations.
• On 9 August 2022, the FCA published a portfolio letter on its alternatives supervision strategy. The FCA’s alternatives portfolio is comprised of FCA authorised firms that predominantly manage alternative investment vehicles or manage and advise alternative assets directly. The FCA’s priorities include putting investors’ interests first, the fair promotion of crypto-currencies, management of conflicts of interest, ESG responsibilities, and diversity and inclusion considerations.
• On 2 August 2022, the FCA and the Financial Reporting Council (FRC) published their reviews of the implementation of mandatory Taskforce for Financial Disclosures (TCFD) reporting in the UK. The reports note that premium listed companies made significant progress in making climate-related disclosures in their financial reporting. Since 2021, premium listed companies have been required to “comply or explain” in respect of the TCFD’s four pillars (governance, strategy, risk management, and metrics and targets). The FCA’s next steps are the UK’s adoption of global ISSB reporting standards and consolidating TCFD disclosures with the ISSB’s broader environmental reporting.
• On 1 August 2022, the FCA published its Policy Statement and final handbook rules on its reforms to the financial promotions regime. The reforms are significant and seek to clarify and strengthen the requirements on the promotion of high-risk investments to retail investors. The reforms will introduce a three-part classification system for investments marketed to retail investors. The requirements relating to risk warnings will take effect on 31 December 2022. All other rules take effect on 1 February 2023.
• On 1 August 2022, the FCA published a consultation on amendments to the Long-Term Asset Fund (LTAF) The reforms seek to broaden access to the LTAF by permitting a broader array of retail investors to invest in the fund under specified conditions, including reclassifying the LTAF under the new financial promotions regime (see the item above). Currently the LTAF is only accessible to professional, self-certified sophisticated and certified high-net worth investors. The consultation will close on 10 October 2022. The FCA intends to publish a policy statement and final rules early in 2023.
• On 27 July 2022, the FCA published its Policy Statement, final handbook rules, and supporting guidance on its new Consumer Duty. The Duty aims to improve standards of customer service across financial services in respect of retail consumers. The Duty will take effect for new and future products and services from 31 July 2023 – an additional three months on the FCA’s initial proposal of implementation by 31 April 2023. However, the FCA has set an aggressive series of deadlines for firms to prepare for the implementation date, beginning with the expectation for a firm’s board or management committee to sign off the firm’s implementation plans by 31 October 2022. Existing and closed products will have until 31 July 2024 to comply with the rules. Our article contains more information.
• On 21 July 2022, the PRA and the Bank of England jointly published a discussion paper, “Operational resilience: critical third parties to the financial sector”. The paper considers how regulation can address firms’ and financial market infrastructures’ (FMIs) increasing reliance on third parties, such as cloud providers and other technology services, to support their operations. The consultation follows an HM Treasury policy statement on 8 July 2022, and the inclusion of provisions in the Financial Services and Markets Bill (see the item immediately below) that will enable the Government to designate third parties as “critical” and to be subject to the financial regulation and supervision. The discussion paper closes for feedback on 23 December 2022. Subject to the progress of the Financial Services and Markets Bill, the PRA expects to consult on their proposed rules and guidance in 2023.
• The Government introduced the Financial Services and Markets Bill to Parliament on 21 July 2022 before Parliament went into recess for the summer. The legislation is important because it will revoke on-shored EU financial services legislation from the statute books, and it will give the FCA and PRA the authority to rewrite those rules in their own Handbooks or to scrap regulations. The Bill will also amend the Financial Services and Markets Act 2000 (FSMA) to establish a new post-Brexit regulatory structure in the UK. Finally, the Bill amends existing regulations such as Solvency II and introductions new regulations in some areas such as in respect of critical third parties. The Bill is likely to receive Royal Assent no sooner than next year. Our article summarises the context of the legislation.
• On 18 July 2022, the High Court ruled that the Government has failed to provide sufficient detail on its strategy to achieve net zero carbon emissions by 2050. The Climate Change Act 2019 requires the Government to provide five-year carbon budgets to achieve its goal. However, Friends of the Earth, Client Earth and the Good Law Project successfully argued that the Government’s Net Zero Strategy of October 2021 did not provide details about actions. The Department for Business, Enterprise and Innovation must publish a new report by March 2023. On 19 July, the Department for Transport published its “Jet Zero Strategy” on achieving net zero aviation by 2050.
• On 15 July 2022, the (interim) Pensions Minister Guy Opperman launched a new taskforce to support the integration of social factors into pension scheme investments. He said that “climate change should not be trustees’ sole consideration”. The aim is to help schemes identify reliable data and resources to assess and manage social risks and opportunities, and to develop common approaches.
• On 11 July 2022, the FCA’s final rules took effect on the use of side pockets by funds with Russian, Ukrainian, and Belarussian assets affected by the war. The rules permit funds to exercise this option, subject to agreement with the FCA’s Funds Authorisation Team. Our article contains more information.

EU

• On 19 August 2022, ESMA published its response to the European Commission’s consultation on the regulatory regime for benchmark administrators outside the EU. As part of its response (which mainly concerns non-ESG matters), ESMA called for the creation of an EU ESG benchmark label to combat greenwashing. ESMA is concerned that there is too much variance in the quality of ESG labels, partly due to the absence of a clear labelling system. ESMA suggested that an EU ESG benchmark label should be consistent with the EU Sustainable Finance Disclosure Regulation and Taxonomy Regulation. It is not yet clear whether the rules might entail a minimum level of Taxonomy alignment, which might prove difficult to attain for some indices that focus on transitional investments.
• On 18 August 2022, the European Commission requested that the European Supervisory Authorities (ESAs) provide feedback on the risks of greenwashing and the tools that the regulators have at their disposal to address those risks. The ESAs have been asked to provide views on the definition of greenwashing, examples of the practice, and how it relates to existing regulations. The request also asks about data and monitoring, and supervisory and enforcement tools to deal with firms operating in or providing services into the EU. The ESAs’ first progress report is due by 15 August 2023 and their final report by 15 August 2024. The European Commission’s call for input comes amid concerns of potential greenwashing among some Article 8 funds which, according to Morningstar data, experienced net outflows in Q2 2022 compared with net inflows for Article 9 funds. Morningstar also estimates that around a quarter of Article 8 funds might not adequately meet the regulatory standard.
• On 4 August 2022, Luxembourg published regulations to implement the EU’s reforms on incorporating sustainability considerations into ESG product governance requirements (under MiFID II). The rules require product “manufacturers” (such as asset managers) to identify sustainability factors that are relevant to their product’s target market and ensure consistency between their product and the identified sustainability factors. Product “distributors” must monitor consistency between the manufacturer’s intended target market and sustainability factors, and consumers to which they sell or recommend the product. On 2 August 2022 (the date on which the rules took effect), the CSSF published a press release, noting that ESMA is still due to publish related guidelines, but that the published regulations give enough information for firms to comply immediately.
• The EU has reportedly shelved indefinitely plans for the creation of a Social Taxonomy, a classification of economic activities that significantly contribute to EU-defined social objectives. Their concern is that political divisions that occurred over the inclusion of nuclear power and natural gas in the EU’s Environmental Taxonomy could be replicated in its social equivalent. There are also concerns about the difficulty of defining and measuring social factors. The European Commission is yet to publish a report on the Social Taxonomy that was due by the end of 2021. Deliberations were scheduled to finish by the end of the European Commission’s current term before 2025, which now seems unlikely.
• On 28 July 2022, the European Supervisory Authorities (ESAs) published a report on the extent of voluntary disclosures of principal adverse impacts (PAIs) under the Sustainable Finance Disclosure Regulation (SFDR). The ESAs found significant variance across Member States and felt unable to discern clear trends in voluntary compliance due to the differences in the types of firms involved. However, the report does consider best practices in disclosure and lessons learned from the first year of the SFDR.
• The ECB and European Systemic Risk Board (ESRB) jointly published a report on the systemic financial risks posed by climate change. The report considers climate transition and physical-related risks and considers several amplifiers of risk across the financial system and non-financial economy. The report also considers the potential macro-prudential response that the EU could adopt.
• On 15 July 2022, the EU’s Taxonomy Regulation delegated regulation on the inclusion of nuclear and natural gas was published in the EU’s Official Journal and therefore became law.
• On 13 July 2022, ESMA published its response to the ISSB’s consultation on its draft global reporting standards (IFRS 1 that sets general requirements for the disclosure of sustainability-related financial information, and IFRS 2 that covers climate-related disclosures). The response is important because there have been concerns in the market (and from HMT and the FCA in the UK) that the EU might diverge from global ESG reporting standards. ESMA strongly supports the ISSB’s work and encourages further collaboration between the ISSB, the European Financial Reporting Advisory Group (EFRAG) and the Global Reporting Initiative (GRI). ESMA’s response outlines three areas for further collaboration.
• On 8 July 2022, ESMA published a consultation on updates to its product governance guidelines under MiFID II. The updated guidelines include provision for the “clustering approach” (grouped products) for the target market assessment, the relation between the target market and investors’ sustainability preferences, and situations in which the distributor believes that a more complex product can be sold on an execution-only basis. The consultation will close on 7 October 2022 and ESMA expects to publish a final report in Q1 2023. Looking further ahead, the EU is considering replacing suitability and appropriateness assessments with a new distribution regime. Our recent article provides an overview of the proposed reforms and their significant implications.

International

• On 27 July 2022, IOSCO’s board welcomed the strong engagement from industry, policymakers, and other stakeholders on the ISSB’s global reporting standard. IOSCO (the umbrella group for the world’s securities regulators) expects to endorse the ISSB’s standard as the global baseline for sustainability reporting, when the ISSB completes the standard later this year.