1. UK —  Enforcement Action
Ofgem fines Morgan Stanley under REMIT rules
On 23 August 2023, the UK’s energy regulator, Ofgem, fined Morgan Stanley & Co. International Plc (MSIP) £5.41 million for breaching the UK Electricity and Gas (Market Integrity and Transparency) (Enforcement etc.) Regulations 2013 (the REMIT Enforcement Regulations).
REMIT is the UK version of Regulation (EU) No 1227/2011 on wholesale energy market integrity and transparency. REMIT requires that in-scope market participants record and retain their electronic communications.
Ofgem found that MSIP breached Regulation 8 of the REMIT Enforcement Regulations because it failed to take reasonable steps to prevent the making, sending, or receiving of relevant communications, in this case  instant messages, that it could not ensure were recorded and retained, and by failing to take reasonable steps to ensure that such communications were recorded and retained.
This fine is the first of its kind in the UK since REMIT was retained in UK law following Brexit. Asset managers that come under the scope of REMIT (e.g., asset managers that are REMIT market participants) should review their obligations under REMIT, particularly given the willingness of Ofgem to impose penalties for non-compliance.
More broadly, this enforcement action signals the continued scrutiny by regulatory authorities in the UK and elsewhere over the use of unmonitored communications. For a discussion of the FCA’s previous warning on the use of  and similar apps, see our Sidley Update UK FCA Expectations on Call Recording in a Remote Working Environment — Market Watch 66.
2. UK — Securitisation Regulations 2023
FCA consults on rules relating to securitisation On 7 August 2023, the FCA published CP23/17 (CP). The CP primarily addresses the areas for policy change that were identified in HM Treasury’s 2021 review. Many of the proposed changes in the CP are described as clarificatory. As such, the proposed rules are not expected to differ significantly from the current requirements under the UK SR.
The CP should be read alongside the near-final draft statutory instrument (Draft SI) of the UK Securitisation Regulations 2023 (UK SR) published by HM Treasury in July 2023 (see our August 2023 Update for further information on the Draft SI). The Draft SI contains rules on so-called “firm-facing requirements,” including due diligence, risk-retention, and transparency requirements.
A new sourcebook in the FCA Handbook will house the rules, which will apply to FCA-authorised firms, as well as unauthorised entities that act as originators, sponsors, original lenders, or securitisation special purpose entities. The Prudential Regulation Authority (PRA) is also consulting on the firm-facing requirements to be included in its rulebook. Those rules would apply only to PRA-authorised firms.
Asset managers should specifically note that the Draft SI amends the “institutional investor” definition related to alternative investment fund managers (AIFMs), such that the requirements apply only to UK-authorised AIFMs. Accordingly, non-UK AIFMs will be excluded from the scope of the rules.
As a result, the following provisions are only relevant to UK-authorised AIFMs:
- Due diligence of risk retention. Under the proposed rules, institutional investors would still be required to verify that sponsors and originators are retaining a 5% net economic interest in the securitisation.
- Due diligence of information disclosures. The FCA is proposing to adopt a more “principles-based” list of information that all institutional investors must obtain. The current regime requires investors in UK securitisations to obtain fully compliant transparency reports in the format prescribed by the UK SR, whilst investors in non-UK securitisations are required to obtain information that is “substantially the same.” Under the new regime, the rules will not create a distinction based on the location of the originator or sponsor.
- Delegation of due diligence. The proposed rules clarify that where an institutional investor delegates its due diligence obligations to another institutional investor, the responsibility to fulfil the obligation will pass to the managing party (i.e., enforcement action for failure to fulfil the obligation will not be taken against the delegating party). The exception to this rule is where an institutional investor delegates its due diligence obligation to an occupational pension scheme (OPS), in which case, the responsibility remains with the delegating party. See our August 2023 Update for further information on delegation of due diligence to or from an OPS.
Once enacted, the Draft SI will grant the FCA a new power to make due diligence rules for small registered UK AIFMs, which would not otherwise be caught under the definition of “institutional investor.” The CP indicates that the proposed rules will cover small registered UK AIFMs in the same way as for other institutional investors.
Sell-side parties should also note the proposals relating to risk retention and transparency reporting in the CP. The respective core requirements are broadly the same as they are in the UK SR. However, the FCA intends to publish a second consultation in 2024, which will consider potential changes to the reporting framework for securitisations. In anticipation of this second consultation, the CP has initiated a discussion on the meaning of “private” and “public” securitisations. The discussion is intended to help the FCA to evaluate whether these terms adequately serve their purpose in the context of transparency requirements.
The FCA consultation closes on 30 October 2023, with implementation of the new rules expected to take place in Q2 2024.
3. UK — FCA Updates
Update on FCA’s wholesale data market study On 31 August 2023, the FCA published an update report for its wholesale data market study. The study was launched in March 2023 to investigate potential competition problems in the following three markets: (i) benchmarks; (ii) credit ratings data; and (iii) market data vendor services.
The FCA stated that it is continuing to identify harm in these markets and potential ways to address them, where appropriate. At this stage, the FCA considers that it is likely best placed to address any harm and proposes not to refer any of the three markets to the Competition and Markets Authority, although it has invited views on this proposed stance.
In the update report, the FCA highlighted the following emerging themes and issues that it has been seeing in its study so far:
- Benchmarks. The FCA has noted that the market for benchmarks is concentrated. This can enable benchmark administrators to impose commercial practices that result in high costs for users and weaken competitive pressures through complex, non-standard and non-transparent licensing terms, such as termination requirements.
- Credit ratings data. The FCA has found that users have limited choice in credit ratings data services, particularly in the case of larger firms that face regulatory and end- investor requirements, as such firms have to license data from all of the key market players. As a result, the FCA has observed that credit rating agency data affiliates are able to price discriminate in ways that can limit competition. This has caused many respondents in the FCA’s survey to flag a perceived lack of transparency on how prices are set for credit ratings data.
- Market data vendor services. The FCA has observed that most of the buyers in this market are sophisticated users that are able to review licences regularly. Nevertheless, the FCA has observed that the largest vendors hold market power from switching costs. As a result, the majority of the respondents in the FCA’s study have reported that they have little to no bargaining power when negotiating with such vendors.
The FCA confirmed that it plans to develop its analysis of the information it has collected and intends to publish its final report by 1 March 2024.
The wholesale data market study forms part of the FCA’s wider work on wholesale data and the wholesale market review that the FCA is conducting in collaboration with HM Treasury. See our August 2023 Update for further information on the FCA’s consultation for stablishing a consolidated tape for bonds in the UK.
FCA review of Authorised Fund Managers’ (AFMs) value assessments On 10 August 2023, the FCA published its review of the processes that Authorised Fund Managers (AFMs) use for assessments of values (AoVs) in respect of the fees and charges that are set for the funds that they operate. Under the Collective Investment Schemes sourcebook (COLL), AFMs must carry out AoVs at least annually and report them publicly.
An AFM is defined in the FCA Handbook to mean an authorised corporate director, an authorised contractual scheme manager, or an authorised unit trust manager. These are concepts that are applicable to authorised UK funds (primarily UK Undertakings for the Collective Investment of Transferable Securities, or UCITS) rather than alternative investment funds. However, AIFMs may wish to also consider the implications of the FCA’s review for their business generally.
In the review, the FCA reported that AFMs have improved their understanding of the COLL rules and their AoV processes since the publication of its last review in June 2021 (see our July 2021 Update for a summary of the previous review).
In particular, the FCA found that firms had a better understanding for the need to justify fees, especially where poor value was identified. While some firms took remedial action by reducing fund fees, the FCA observed that some firms cited erroneous operational or regulatory barriers to reducing fees.
More broadly, the FCA also highlighted its expectation for fund management:
- Firms should substantiate any claims they make to support their assumptions and assessments with sufficient evidence.
- The tension between a firm’s interest in the profitability of its fund and assessing the fund’s value for money for investors may influence decision making and outcomes in respect of AoVs. Accordingly, the FCA cautioned AFM boards to ensure that they are aware of such conflicts and to manage them accordingly.
- Firms that fail to make reasonable decisions to deliver good outcomes will likely fall short of the standards expected to comply with the FCA’s rules.
- The AFM board and Senior Management Function (SMF) holders of a fund remain accountable for overseeing the fund in the best interests of fund investors.
- Firms should ensure that their practice and delivery of fair value for products and services is consistent with the expectations arising from the Consumer Duty that recently came into force (see our August 2023 Update).
FCA introduces multi-factor authentication
On 28 July 2023, the FCA announced that it had introduced multi-factor authentication when logging into certain FCA systems. A one-time passcode from an authenticator app, text message, or automated phone call will be required for access to:
- Reg Data;
- Online Invoicing (Fees Portal);
- Shared Intelligence Service (SIS); and
- Electronic Submission System (ESS).
Firms that engage third parties to access these systems (such as compliance consultants) will need to ensure that such parties have been registered as firm users before such parties can turn on multi-factor authentication.
4. UK — Markets in Financial Instruments Regulation (MiFIR)
FSMA 2023’s amendments to UK MiFIR come into force On 29 August 2023, certain provisions of the Financial Services and Markets Act 2023 (FSMA 2023) came into force that addressed Markets in Financial Instruments Directive (MiFID) transitional modifications relating to financial instruments, derivatives, securitisation, and critical third parties.
As noted in our August 2023 Update, FSMA 2023 paves the way for the UK government’s gradual repeal of on-shored EU financial services regulations such as UK MiFIR, MiFID-derived instruments, and related technical standards over several years.
FSMA 2023 temporarily modifies UK MiFIR and the Financial Services and Markets Act 2000 (Markets in Financial Instruments) Regulations 2017 (the MiFIR Regulations) until the retained EU-derived regulations are eventually permanently modified or replaced with a UK legislative alternative.
The key temporary modifications that have now come into force, effective from 29 August 2023, include:
- Share Trading Obligation (STO) — revoked (Article 23 UK MiFIR). Accordingly, UK investment firms are no longer required to ensure that shares admitted to trading in the UK are traded on a UK-regulated or EU-regulated market, multilateral trading facility, systematic internaliser, or equivalent third-country venue. Such shares may be traded over-the-counter or on any UK or overseas venue of the firm’s choice.
- Realigning Derivatives Trading Obligation (DTO) and Derivatives Clearing Obligation (DCO) — amended. The European Market Infrastructure Regulation (EMIR) REFIT’s exemption of minor financial counterparties from the DCO resulted in a misalignment between the scope of the DCO under UK EMIR and the DTO under UK MiFIR. This has now been amended so that the counterparty scope for both types of obligations are now consistent.
- Systematic Internaliser (SI) Midpoint Execution — revoked (Article 17a UK MiFIR). The UK government found that limiting SIs to executing “large in scale” orders at the midpoint did not safeguard price formation quality and could hinder SIs from securing the best execution for clients. Consequently, the Act removes restrictions on midpoint crossing for trades under Article 17a of MiFIR.
- Double Volume Cap (DVC) Mechanism — revoked (Article 5 UK MiFIR). The DVC had restricted the reference price waiver and negotiated waiver as part of MiFID II’s pre-trade equity transparency requirements.
5. UK — ESG
UK government intending to endorse ISSB Standards for UK Sustainability Disclosure Standards
On 2 August 2023, the UK Government Department for Business and Trade (DBT) published high-level guidance on its proposed framework for the UK Sustainability Disclosure Standards (UK SDS).
In the guidance, the DBT reiterates the UK government’s intention to base the UK SDS on the International Sustainability Standards Board’s (ISSB) sustainability standards (ISSB Standards) and that divergence from the standards will occur only “if absolutely necessary for UK specific matters.”
For more information on the launch of the ISSB Standards, please see our July 2023 Update.
The DBT is considering whether to endorse the ISSB Standards and aims to make a decision by July 2024.
To assist with the endorsement process, the UK government has created two committees:
- the UK Sustainability Disclosure Technical Advisory Committee (TAC), which will assess the ISSB Standards on a technical basis and provide independent recommendations on endorsement to the UK government; and
- the UK Sustainability Disclosure Policy and Implementation Committee, whose work will include an analysis of the interactions between the ISSB Standards and existing UK legislation and regulation.
Following endorsement, it is expected that the UK government will legislate for the application of the UK SDS to UK-registered companies and limited liability partnerships, and the FCA will propose new rules for listed companies.
The FCA noted in Primary Market Bulletin 45 (published on 10 August 2023) that it plans to consult on disclosure rules referencing the ISSB Standards for listed companies in the first half of 2024, “with a view to bring new requirements into force for accounting periods beginning on or after 1 January 2025.”
In addition, on 18 July 2023, the Financial Reporting Council (FRC) published a Call for Evidence (CfE) on the proposed endorsement of the ISSB Standards. As the FRC is Secretariat to the TAC, the responses to the CfE will be used to assess the ISSB Standards on a technical basis.
In particular, the CfE seeks views on whether the application of the ISSB Standards in the UK SDS will result in disclosures that are “understandable, relevant, reliable and comparable for investors” and also seeks feedback on technical feasibility, timelines alongside financial reporting, and proportionality of costs to benefits. The deadline for responses to the CfE is 11 October 2023.
GTAG publishes on the development of a UK Green Taxonomy
On 1 September 2023, the Green Technical Advisory Group (GTAG) published two technical advice papers to HM Treasury on the development of a UK Green Taxonomy. GTAG is responsible for providing non-binding advice to the UK government on market and regulatory considerations for developing and implementing the UK’s Green Taxonomy.
GTAG’s first paper makes a number of key recommendations and considerations that include, among others:
- Prioritise delivering an effective tool rather than an extended taxonomy. As the development of the Green Taxonomy has already been delayed (the UK government had initially intended for the Green Taxonomy to be made into regulation by 1 January 2023 before announcing its delay), the GTAG stresses that the focus should be on getting the Green Taxonomy implemented. In particular, the GTAG recommends that the UK government should, “in the first instance,” prioritise delivering a UK taxonomy that clearly defines “green” economic activities and is viewed as a “credible, robust usable tool” for the market. GTAG cautioned against the complexity of developing and requiring reporting against an extended taxonomy at this early stage.
- Taxonomy reviews. It is expected that UK government will review the Green Taxonomy under a three-yearly review process.
- Taxonomy reporting. GTAG advises that taxonomy reporting should apply to companies subject to the UK’s mandatory Taskforce on Climate-Related Financial Disclosures (TCFD) reporting regime as both frameworks will be integrated under the UK’s forthcoming Sustainability Disclosure Requirements (SDR). Timing-wise, GTAG advises that: non-financial companies should report on taxonomy eligibility in year 1; reports on taxonomy eligibility by financial institutions and taxonomy alignment by non-financial services companies should follow in year 2; and taxonomy alignment by financial institutions should follow in year 3. For a discussion on the FCA’s prior Consultation Paper on SDR, please see our Sidley Update Financial Conduct Authority Consultation on UK Sustainability Disclosure Requirements — Five Key Takeaways for Asset Managers (November 2022).
- International interoperability. GTAG notes that there seems to be “limited benefit from major divergence” from the EU Taxonomy and that the EU Taxonomy is a good fit for the UK’s emissions profile, which suggests that the Green Taxonomy may be developed in a consistent manner with the EU Taxonomy. GTAG notes that there are some potential gaps in the existing EU Taxonomy sectors, such as agriculture not being covered at all. However, GTAG notes that the UK government can address such gaps in its own Green Taxonomy. More generally, GTAG advises the UK government to monitor the international landscape of taxonomies so that it can benefit from its follower status by learning from best practice and any implementation issues.
- Diverge from the EU Taxonomy’s Key Performance Indicator (KPI) reporting: Currently, the EU Taxonomy KPIs require in-scope corporates to report on their taxonomy-related CapEx, OpEx, and turnover. GTAG advises that the EU’s approach should be reassessed. Specifically, GTAG advises that mandatory KPI reporting should be limited to CapEx and turnover only. GTAG suggests that OpEx reporting should be optional without requiring a materiality assessment to reduce burden on companies. In addition, GTAG recommends addressing challenges observed with the EU Taxonomy’s DPIs when developing the UK equivalents, to improve their usability and comparability. GTAG also published a separate second paper that provides further advice on KPIs.
The UK government expects to consult on the UK Green Taxonomy in autumn 2023. This is expected to include nuclear energy (subject to consultation) and may also include certain transitional activities.
6. EU — Shareholders Rights Directive (SRD2)
ESMA and EBA publish joint report on SRD2 implementation On 27 July 2023, the European Securities and Markets Authority (ESMA) and the European Banking Authority (EBA) published a joint report assessing the implementation of the revised Shareholders Rights Directive (SRD2). The report, informed by a Call for Evidence conducted between October and November 2022, offers comprehensive suggestions for enhancing the directive’s efficiency, recommendations for proxy advisors, and proposals concerning the investment chain.
For proxy advisors, ESMA and EBA suggest:
- Refining the “proxy advisor” definition;
- Contemplating the establishment of baseline standards for proxy advisors’ codes of conduct;
- Enhancing disclosure regulations for potential conflicts of interest among proxy advisors; and
- Implementing a fundamental registration process for EU proxy advisors, encompassing code of conduct adherence information.
The Call for Evidence feedback also indicates a rising significance of ESG-related matters in proxy advisory services, notably the examination of ESG-associated risks and climate-linked investment risks. These subjects are also increasingly prominent in meeting agendas and voting recommendations.
Concerning the investment chain, the report further suggests to:
- Establish a uniform definition for “shareholder” throughout the EU.
- Offer more explicit guidelines on which securities are encompassed by the directive.
- Enhance the alignment of SRD’s stipulations on shareholder identification, information transmission, and facilitation of shareholders’ rights exercise with other EU regulations.
- Standardise the documentation needed for exercising voting rights.
- Standardise the terminology related to non-discrimination, proportionality, and cost transparency.
Call for Evidence respondents emphasised the necessity to simplify shareholder engagement and voting in investee firms as much as feasible, also from a corporate sustainability standpoint. These recommendations will contribute to the upcoming European Commission’s evaluation of the SRD2 implementation and a potential directive review.
7. EU — ESG
ESMA publishes updated sustainable finance timeline
On 3 August 2023, ESMA published an updated version of its sustainable finance timeline, which sets outs key dates regarding the implementation of sustainable finance legislation in the EU.
The timeline covers updates and key milestones in relation to SFDR, Taxonomy Regulation, and EU Corporate Sustainability Reporting Directive (CSRD) as well as MiFID and Insurance Distribution Directive (IDD), and UCITS and IDD. The timeline runs until 1 January 2028, when the CSRD will apply to third-country companies and listed small- and medium-size enterprises and small financial institutions.
ESMA comments on sustainability information, greenwashing
On 16 August 2023, ESMA Chair Verena Ross commented on several key EU regulatory topics in an interview published in the Supervisory Newsletter of the European Central Bank.
Clarity of sustainability information
Ross commented that EU regulators “need to make financial information concerning sustainability comprehensible and comparable for investors” and improve “the practicality of the current EU framework.” Noting that incorporating ESG considerations into the disclosure framework of financial products “inevitably entails a certain level of complexity,” Ross acknowledged that EU regulators should work together to make the EU reporting framework more streamlined.
Investment firms should therefore note that sustainable finance and investor transparency remains a key priority for EU regulators. While it is unlikely that the current EU framework will be dramatically changed, it is likely that efforts to streamline inconsistencies across various regulatory requirements will be an area for ongoing review.
In the interview, Ross highlighted ESMA’s continued focus on greenwashing in the financial sector. She noted that the common understanding of greenwashing, as stated in the progress report published by the three European supervisory authorities (ESAs) on 1 June 2023, “should serve as a shared reference point for market participants and regulators.”
As a reminder, the common understanding proposes that greenwashing is:
a practice where sustainability-related statements, declarations, actions, or communications do not clearly and fairly reflect the underlying sustainability profile of an entity, a financial product, or financial services. This practice may be misleading to consumers, investors, or other market participants.
The interview highlighted that the ESAs agree on the need for a mature regulatory framework for sustainable finance and will look to provide relevant guidance where rules are unclear.
Investment firms should note that Ross also reiterated the other key findings from the progress report, including that greenwashing can happen intentionally and unintentionally and can arise in products inside and outside the EU.
For an overview of the ESAs’ progress report on greenwashing, please see our June 2023 Update.
Climate risk stress testing
Ross confirmed that ESMA will introduce climate risk as a factor in its EU-wide stress testing exercise for 2023. The results, including against climate risk indicators, will be published in 2024.
In addition, the Commission has asked ESMA and other EU regulators to conduct a one-off “major” climate risk test, which is designed to assess whether the EU’s financial sector as a whole is sufficiently resilient to handle climate risk and how far climate-risk-related shocks could place significant stress on the financial system as a whole by 2030.
ESMA intends to run sectoral modelling, with a focus on investment funds, and aims to report to the Commission on the results at the beginning of 2025.
8. EU — Cryptoasset Regulation
ESMA comments on cryptoasset regulation
In the speech by Verena Ross mentioned above, Ross also commented on the status of cryptoasset regulation in the EU. Despite the adoption of the Markets in Crypto-Assets Regulation (MiCA), which includes introducing minimum standards for the authorisation and governance of cryptoasset firms, Ross nevertheless noted that “there will be no such thing as a safe crypto-asset” and that “MiCA does not provide the same protection as for traditional financial products.”
For more information on MiCA, please see our Sidley Update How Will the EU Markets in Crypto-Assets Regulation Affect Crypto and Other Financial Services Firms?
9. EU — European Systemic Risk Board
ESRB publishes policy options regarding investment funds with exposures to corporate debt and real estate On 4 September 2023, the European Systemic Risk Board (ESRB) published an issues paper containing policy options to prevent systemic risks arising from investment funds that invest in assets that are either inherently illiquid or might become illiquid during times of stress.
In particular, the note focused on investment funds with large exposures to corporate debt and real estate and described ways in which the EU regulatory framework for investment funds could be enhanced to further prevent and mitigate systemic risks arising from such funds (the Alternative Investment Fund Managers Directive (AIFMD) and the UCITS Directive are currently being revised in the EU legislative process; see our July 2022 Update and our Sidley Update EU AIFMD II — Implications of the Commission Proposal).
In particular, the ESRB noted the following policy suggestions directed at such investment funds and the corresponding timeframes for their work:
- Adapt existing policy tools. The resilience of such investment funds could be further improved by adapting existing policy tools in the regulatory framework. These include closer alignment between fund redemption terms and investment strategy, the use of anti-dilution liquidity management tools (LMTs), and better preparedness for cash needs stemming from margin and/or collateral calls in derivative and repo transactions.
- The ESRB intends to focus on this area first in the coming years. It aims to inform the transposition of the revised AIFMD and UCITS Directive into national law by providing national supervisory guidelines and to inform the development of the relevant Level 2 and Level 3 EU acts for the revised directives.
- Develop new tools. The ESRB considers that new policy tools could also be developed to increase resilience, such as a liquidity bucketing approach and the development of an ex-ante policy instrument aimed at mitigating the buildup of liquidity risk. The ESRB intends to continue its work in this area over the medium term, which would inform any potential future reviews of the AIFMD and the UCITS Directive. Such reviews are expected to take place 60 months after the revised framework for the AIFMD and UCITS Directive enters into force.
The ESRB’s conclusions in the issues note are also expected to inform the ongoing Financial Stability Board (FSB) consultation on policies to address vulnerabilities from liquidity mismatch in open-ended funds.