Welcome to the April 2021 edition of our investment management update. This publication has been tailored to highlight topical news, cases and changes in the law impacting the investment management sector, including items that you might have missed.
Key things to keep an eye out for in this month's update include:
- regulators in the UK, the EU and globally are launching investigations into liquidity risk management in open-ended funds and separately into money market funds, with a view to reforms;
- a consultation on draft rules in respect of the disclosure of investment policies by investment firms under the EU’s Investment Firms Regulation; and
- several public statements by ESMA on the suspension of rules in response to Covid-19 and the application of rules after Brexit.
Global standard-setters launch investigation into fund liquidity risk management
On 5 March, the Financial Stability Board (FSB) and IOSCO announced that they are working on a joint analysis of the availability, use and impact of liquidity risk management tools in open-ended funds. The international organisations will consider the ability of funds to manage the stresses experienced during the pandemic-related market conditions in 2020.
The FSB, which is an umbrella group comprising many central banks, has an interest in the systemic risks emerging from asset managers and funds since their 2017 recommendations on the subject. The FSB and IOSCO joint analysis follows several public comments by central bankers, including from the ECB and the Bank of England, about liquidity mismatches in money market funds and in open-ended funds more generally.
IOSCO has also launched a review of its 2018 principles of liquidity risk management and has published a survey to collate feedback. The survey is designed to collect feedback from fund managers about their adoption of the 2018 recommendations and to better understand their experiences of the March 2020 market turmoil. The survey closes for feedback on 16 April 2021.
FCA scrutinises firms’ product governance
The FCA has published the results of its review into UK asset managers’ implementation of the MiFID II product governance rules. The FCA found that some asset managers are failing to comply with the requirements in respect of their retail investors.
Specifically, the FCA found that some disclosures to investors could be misleading and that some asset managers are exercising insufficient due diligence and foresight in the distribution of their products. It will come as no surprise to asset managers that the difficulties of obtaining end-client data from distributors especially for nominee accounts is also noted by the FCA. The FCA insists that asset managers need to do more to challenge (and document their challenge) of distributors and not allow commercial sensitivities to take precedence when they struggle to obtain data from distributors.
The FCA states that it expects to undertake further work in this area, which could include opening investigations where it identifies breaches in rules.
European Commission consults on supervisory convergence and single rulebook
On 12 March 2020, the European Commission published a consultation paper on supervisory convergence and the single rulebook.
The Commission notes that there has been considerable progress on both supervisory convergence and the single rulebook since the three European Supervisory Authorities (ESAs) (that is, the EBA, ESMA and EIOPA) were created in 2011. However, both require continued and appropriately targeted efforts to make further progress. In this context, the Commission's Capital Markets Union (CMU) Action Plan, published in September 2020, requires it to work towards an enhanced single rulebook, take stock of what has been achieved in supervisory convergence in the fourth quarter of 2021, and consider proposing measures for stronger supervisory co-ordination or direct supervision by the ESAs.
The aim of the consultation paper is to take stock of what has been achieved so far, in particular as regards supervisory practices among national competent authorities (NCAs), supervisory convergence and how the EU single rulebook works in practice. The Commission is also seeking targeted views on certain aspects related to its 2019 review of the ESAs, including the amendment of existing tools, conferred new tasks and governance changes. Among other things, the Commission is asking for views on:
- whether technical standards, guidelines and recommendations developed by the ESAs have contributed sufficiently to further harmonise the single rulebook;
- whether the process for developing draft technical standards is effective and efficient;
- areas where maximum harmonisation, or a higher degree of harmonisation, is desirable;
- areas where national rules going beyond the minimum requirements of a Directive (that is, gold plating) are particularly detrimental to the single market; and
- whether certain EU legislative acts (that is, level 1 acts), should become more detailed and contain a higher degree of harmonisation, and where these legislative frameworks are currently contained in Directives, whether all or part would benefit from being directly applicable in member states.
Comments can be made on the consultation paper until 21 May 2021.
The findings from the consultation exercise will feed into the Commission's preparation of the report required by the CMU Action Plan, and will also cover the review required under the ESAs' founding Regulations.
FCA speech on why diversity and inclusion are regulatory issues
On 17 March 2021, the FCA published a speech by Nikhil Rathi, FCA Chief Executive, on why diversity and inclusion are regulatory issues.
Points of interest in Mr Rathi's speech
- Evidence shows there is a strong business case for diversity. The current lack of diversity at the top raises questions about firms' ability to understand the different communities they serve, and their different needs. Mr Rathi would question whether firms can adequately respond to the needs of these consumers if they do not have the diversity of background and experience required to overcome biases and blind spots.
- Improving diversity and inclusion is both a matter of fairness and a crucial way to strengthen consumer outcomes. As a public body, the FCA is subject to the Public Sector Equality Duty with responsibilities as an employer and as a regulator. It is working with the PRA to formalise its regulatory approach to diversity and inclusion under that duty, and its objectives, with a view to making its expectations clear.
- Mr Rathi would like to see the FCA's "five conduct questions" expanded to all firms and a sixth question added: is your management team diverse enough to provide adequate challenge and do you create the right environment in which people of all backgrounds can speak up? This is much broader than representation as it concerns a firm's culture in relation to diversity and inclusion. Do people feel comfortable in the work environment such that they can demonstrate, share and bring to bear their diversity of experience and background?
- In the years ahead, if the FCA does not see improvements in diversity at senior levels and better answers, it will assess how to best use its powers. Over the next year, in work led by Georgina Philippou (who was FCA Chief Operating Officer until recently), the FCA will be considering this. Supervisory tools are available, such as whether the diversity of management teams, and the inclusivity of the management culture they create, could be part of the FCA's consideration of senior manager applications. The FCA and market participants also need to "look hard" at the way capital markets work.
- Aside of the social good, diversity reduces conduct risk and those firms that fail to reflect society run the risk of poorly serving diverse communities. This is the point at which diversity and inclusion become regulatory issues.
ESAs consult on draft rules for ESG fund disclosures under the Taxonomy Regulation
The European Supervisory Authorities (ESAs) are currently consulting on the proposed regulatory technical standards (RTS) on the content and presentation of disclosures required under the Taxonomy Regulation. The Taxonomy Regulation amends the Sustainable Finance Disclosure Regulation (SFDR) to impose additional disclosure requirements, in particular for certain types of Article 8 and 9 products with an environmental focus, and introduces regulatory definitions for a range of environmental objectives, including climate change mitigation, pollution prevention and control, and the transition to a circular economy.
The ESAs have agreed to amend the soon to be finalised SFDR RTS. The aim is to have the RTS function as a “single rulebook” for sustainability disclosures at level 2 for both SFDR and the Taxonomy Regulation.
The consultation closes on 12 May 2021. The ESAs expect to publish a final report including the final draft RTS in late June or early July. The tight timeline is due to the requirement for the ESAs to finalise the RTS for products with climate-related objectives by 1 June 2021 (while the RTS for products with other environmental objectives are not due until 1 June 2022). It also suggests that the ESAs do not expect to make substantial revisions to the draft RTS in response to feedback received during the consultation period.
The application of the RTS is expected to follow the effective date of the Level 1 requirements in the Taxonomy Regulation: 1 January 2022 in relation to climate-related objectives; 1 January 2023 for all other environmental objectives.
Trial dates listed for two insider dealing criminal prosecutions brought by FCA
On 18 March 2021, the FCA published a statement providing an update on the trial dates in two insider dealing criminal prosecutions.
The statement advises that:
- at a plea and trial preparation hearing at Southwark Crown Court on 11 March 2021, a date was set for the trial of two individuals who are being prosecuted by the FCA for insider dealing contrary to section 52(1) of the Criminal Justice Act 1993 (CJA 1993). One of the individuals has also been charged with improperly disclosing inside information, or encouraging another, while being an insider, to engage in dealing, contrary to section 52(2) of the CJA 1993. The case was listed for trial on 4 April 2022 and neither defendant was arraigned. The next hearing in the case will be for case management on 10 September 2021; and
- at a plea and trial preparation hearing at Southwark Crown Court on 16 March 2021, a date was set for the trial of two individuals charged with six offences of insider dealing contrary to section 52(1) of the CJA 1993, and three offences of fraud by false representation contrary to section 1 of the Fraud Act 2006. The case was listed for trial for eight weeks, commencing on 4 April 2022. Arraignment will take place at a further hearing on 28 June 2021. Both defendants were granted unconditional bail.
The FCA cannot provide any further comment or information on either case at this time.
FCA launches whistleblowing campaign
On 24 March 2021, the FCA published a press release announcing the launch of a campaign to encourage individuals to report wrongdoing.
The campaign, which the FCA refers to as "In confidence, with confidence", encourages individuals working in financial services to report potential wrongdoing to the FCA, and reminds them of the confidentiality processes in place.
As part of the campaign, the FCA has published materials for firms to share with employees and is using its events to highlight the campaign. It has also produced a digital toolkit for industry bodies, consumer groups and whistleblowing groups to encourage individuals to have confidence to step forward.
The FCA's website has been updated to provide more information for potential whistleblowers and the Whistleblowing team are developing a confidential webform, increasing the ways in which whistleblowers can make disclosures to them.
A new whistleblowing webpage sets out information on:
- when someone should speak to the FCA;
- how the FCA protects whistleblowers' identities. Individuals can choose to remain anonymous (as many do). If someone does share any information about themselves, the FCA will keep this safe. This includes not confirming the existence of a whistleblower when making enquiries, unless legally obliged to do so; and
- what the FCA will do with a whistleblower's information. Every report the FCA receives is reviewed and the FCA will protect individual whistleblowers' identities. Whistleblowers that report to the FCA will have a dedicated case manager. They can meet with the FCA to discuss their concerns and can receive optional regular updates throughout the investigation.
The FCA has invested in increased resourcing to support whistleblower interaction. As part of its aim to provide a smoother internal process, it has introduced a mandatory e-learning module for all staff, to help identify potential whistleblowers and make sure any intelligence received by the FCA is dealt with correctly and that identities are protected.
The FCA also reminds firms that its whistleblowing rules require firms to have effective arrangements in place for employees to raise concerns, and to guarantee these concerns are handled appropriately and confidentially. In particular, there is a requirement for firms to appoint a whistleblowers' champion to ensure there is senior management oversight over the integrity, independence and effectiveness of the firm's arrangements.
FCA feedback statement on open finance
On 26 March 2021, the FCA published a feedback statement on open finance (FS21/7).
The FCA sees open finance as an opportunity to build on the concept of open banking and allow consumers and SMEs to access and share their data with third party providers (TPPs). It involves extending open banking-like data sharing and third-party access to a wider range of financial sectors and products. The feedback statement summarises the responses received by the FCA to its December 2019 call for input on open finance, setting out comments received on the issues of maximising the potential of open banking, open finance and the FCA's draft principles for open finance.
The FCA concludes that open finance could potentially offer significant benefits to consumers and competition and help tackle some long-standing harms. However, it would also create or increase risks and raise new questions of data ethics that should be considered from the start as part of any system design. It considers that appropriate regulation is essential to managing those risks and also that a legislative framework is needed for open finance to develop fully. The implementation of open finance should be proportionate, phased and ideally driven by consideration of credible consumer propositions and use-cases.
The FCA's proposed next steps include:
- working with the Department for Business, Energy and Industrial Strategy (BEIS) and HM Treasury on the feasibility, timing and design of any secondary legislation relating to open finance;
- encouraging firms, TPPs and their representatives to work together on common standards that could support open finance;
- supporting the government in assessing the legislative and regulatory framework that would be needed to support open finance; and
- working with the Competition and Markets Authority (CMA) and HM Treasury on the implementation entity for open finance. The CMA launched a consultation on 5 March 2021 on the future governance of open banking.
ESMA concludes Common Supervisory Assessment on UCITS’ liquidity risk management
In September 2019, ESMA undertook a stress test of around 6,000 UCITS bond funds and found up to 40% experienced difficulties under severe but plausible market shocks. Consequently, ESMA asked national regulators to undertake a review of liquidity risk management in their local UCITS funds using a common methodology. ESMA has now published the results of the Common Supervisory Assessment.
Generally, the findings are positive. There were low reported instances of funds that would struggle to meet redemption requests under stressed market conditions. Most funds were reported to be adequately complying with liquidity risk management (LRM) regulations.
However, ESMA has identified several desired improvements. ESMA recommends that managers should review their LRM programmes against several recommendations to identify areas in which supervisors might challenge the manager; in addition, to ensuring their compliance with the UCITS and local regulations.
Bank of England/FCA publish report on liquidity risk management in open-ended funds
On 26 March 2021, the Bank of England and FCA published a joint report concluding a review into vulnerabilities due to liquidity mismatches in open-ended funds that began in July 2019. The authorities launched a survey in August 2020 that looked at 272 open-ended UK funds that invest in less liquid assets. The reporting period for the survey covered the market stress during the pandemic between Q4 2019 and Q2 2020.
The report found that:
- funds have a range of liquidity management tools available, which tend to be set for families of funds rather than fund-specific. These are used in stress periods although swing pricing is used predominantly and was intensified during the pandemic;
- there is a large variation in funds’ thresholds for swing pricing and these thresholds have been adapted through the pandemic;
- funds also typically hold liquidity buffers in the form of cash or liquid assets (most commonly, units in MMF and government bonds);
- some funds adapted their liquidity risk management processes during the pandemic and others have launched reviews; and
- managers of corporate bond funds may be overestimating the liquidity of their funds’ holdings. Managers considered almost most assets to be highly liquid in all market conditions and to have high valuation certainty, although the report argues that market conditions during the period suggested otherwise.
Following these conclusions, the Bank of England’s Financial Policy Committee will outline a method of liquidity classification and a more consistent approach to swing pricing in its July report. The authorities will also pursue its approach via the international standard-setters, FSB and IOSCO, which are jointly and separately considering fund liquidity risk management at a global level.
EBA consultation on draft RTS for the disclosure of investment policies by investment firms
On 31 March 2021, the EBA published a consultation paper on draft regulatory technical standards (RTS) on the disclosure of the investment policy by investment firms under the Investment Firms Regulation.
The obligation only applies to Class 2 firms that have total assets of at least €100m. The draft RTS provide for comparable disclosures that should help investors to understand the influence that investment companies have over the companies that they invest in.
The consultation and draft RTS:
- put forward templates and tables for the disclosure of information on the investment firm's voting behaviour, explanation of the votes, and the ratio of approved proposal, with the objective to show if the investment firm is an active shareholder that generally uses its voting rights, and how it uses them;
- include information on the use of proxy advisory firms that should help address uncertainties about potential conflicts of interest; and
- include information on investment firms' voting guidelines, including, when relevant, a breakdown of geographical zone, economic sector or topic of the resolution being voted.
The consultation closes on 1 July 2021.
Markets and Trading
FCA annual transparency calculations for equity and equity-like instruments for 2021/22
On 9 March 2021, the FCA published a press release announcing that it has made available its annual transparency calculations for UK equity and equity-like financial instruments that will apply from 1 April 2021.
As well as including the liquidity assessment, the calculations, which are available through the FCA's Financial Instrument Transparency Reference System (FCA FITRS), include the determination of the:
- most relevant market in terms of liquidity (MRM);
- average daily turnover (ADT) relevant for the determination of the pre-trade and post-trade large in scale (LIS) thresholds;
- average value of the transactions (AVT) and the related standard market size (SMS); and
- average daily number of transactions (ADNTE) on the most relevant market in terms of liquidity relevant for the determination of the tick-size regime.
The FCA explains that it is publishing the SMS of equity instruments for the purposes of the pre-trade transparency regime for systematic internalisers (SIs). This differs from the approach set out in the statement of policy on the FCA's power to suspend the use of pre-trade transparency waivers for a trading venue under the double volume cap (DVC) mechanism. This is because the FCA now has the capability to publish calculations.
The FCA has assessed that there are 497 liquid shares, and 341 liquid equity-like instruments (such as exchange traded funds (ETFs)), depositary receipts and certificates other than shares.
The FCA expects market participants to monitor the release of the transparency calculations for equity and equity-like instruments daily, to obtain the calculations for newly traded instruments.
The FCA is required to publish the data under the retained EU law version of the Markets in Financial Instruments Regulation (600/2014) (UK MiFIR).
PRA and FCA consult on amending BTS on margin requirements for non-centrally cleared derivatives under UK EMIR
On 9 March 2021, the PRA and FCA published a joint consultation paper on margin requirements for non-centrally cleared derivatives, amending the binding technical standards (BTS) in the UK onshored version of Commission Delegated Regulation (EU) 2016/2251 (PRA CP6/21, FCA CP21/7).
In the consultation paper, the regulators set out proposals to establish or extend exemptions for some products subject to bilateral margining requirements, as well as proposals to align implementation phases and thresholds of the initial margin (IM) requirements to the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO) standards. In particular, the proposed amendments would:
- change the implementation dates and thresholds for the phase-in of IM requirements;
- require the exchange of variation margin (VM) for physically settled foreign exchange (FX) forwards and swaps to specified counterparties only; and
- extend the temporary exemption for single-stock equity options and index options until 4 January 2024.
Drafts of the technical standards instruments that would make the proposed changes, the PRA. Standards Instrument: The Technical Standards (Bilateral Margining) Instrument 2021, and the FCA Standards Instrument: The Technical Standards (Bilateral Margining) Instrument 2021, are set out in an Annex to the consultation paper.
Since the EU BTS were finalised in 2016, the European Supervisory Authorities (ESAs) have proposed several amendments to address emerging issues. However, formal adoption has lagged and remains outstanding. This delay has left a gap between the adopted regulation and practice. The regulators have been operating in practice on the basis of the pending but unadopted amended BTS. The proposals set out in the consultation paper aim to maintain current market practice and give firms legal clarity on these margin requirements.
The regulators plan to use their making and amendment powers under Article 11(15) of UK EMIR (648/2012) and Section 138P of the Financial Services and Markets Act 2000 (FSMA).
Comments can be made on the proposals until 19 May 2021. After considering any responses, the regulators will submit the updated BTS to HM Treasury for approval. Assuming HM Treasury provides approval, the regulators will make and publish the BTS for their respective firms. The changes to the BTS will be effective on publication of the final technical standards instruments, which is planned for 1 July 2021.
European Commission consults on Delegated Regulation supplementing EMIR on FRANDT commercial terms for clearing services for OTC derivatives
On 11 March 2021, the European Commission published for consultation a draft Delegated Regulation (Ares(2021)1739053) supplementing EMIR (648/2012) by specifying the conditions under which the commercial terms for clearing services for OTC derivatives are to be considered to be fair, reasonable, non-discriminatory and transparent (FRANDT). The draft Delegated Regulation and accompanying draft Annex are accessible via a dedicated webpage.
The EMIR Refit Regulation ((EU) 2019/834) amended EMIR to introduce an obligation on clearing service providers to provide those services under FRANDT commercial terms. The requirement to apply FRANDT terms will apply from 18 June 2021.
Under Article 82 of EMIR, the Commission is empowered to adopt a delegated act specifying the conditions under which commercial terms for clearing services of clearing service providers are to be deemed FRANDT, based on the following:
- fairness and transparency requirements regarding fees, prices, discount policies and other general contractual terms and conditions regarding the price list, without prejudice to the confidentiality of contractual arrangements with individual counterparties;
- factors that constitute reasonable commercial terms to ensure unbiased and rational contractual arrangements;
- requirements that facilitate clearing services on a fair and non-discriminatory basis, having regard to related costs and risks, so that any differences in prices charged are proportionate to costs, risks and benefits; and
- risk control criteria for the clearing member or client related to the clearing services offered.
Article 2 of the draft Delegated Regulation states that the commercial terms for clearing services provided by clearing service providers will be considered to be FRANDT where they meet the requirements laid down in the Annex to the draft Delegated Regulation.
The draft Delegated Regulation takes into account ESMA's technical advice following a public consultation process. In addition, the Commission has received feedback from the Expert Group of the European Securities Committee (EGESC), and information has been provided to it directly. Stakeholders' views are briefly summarised in the introductory wording to the draft Delegated Regulation.
The consultation on the draft Delegated Regulation closes to responses on 7 April 2021. The Commission will take into account the consultation responses received when it finalises the draft Delegated Regulation.
FCA speech on future regulation of UK wholesale financial markets
On 16 March 2021, the FCA published a speech by Edwin Schooling Latter, Director of Markets and Wholesale Policy, about regulation of the UK's wholesale financial markets.
Topics the speech focuses on
- Whether the UK will diverge from the EU reporting regime under the Regulation on reporting and transparency of securities financing transactions ((EU) 2015/2365) (SFTR), with Mr Schooling Latter stating it's prudent to allow the regime to mature and that divergence could add complications and costs. However, one change the FCA is open to considering is whether to remove commodities lending transactions from scope. The FCA is also assessing evidence on the relative benefits of single versus double-sided reporting.
- How the FCA will soon consult on changes to MiFID II rules, with those changes being described as similar but "not absolutely identical" to the European amendments to the MiFID II regime to assist economic recovery from the Covid-19 pandemic.
- The FCA considerations about how to implement on a UK-only basis various elements of the MiFID transparency regime. On dark trading, the FCA's initial approach is not to have automated caps in the absence of evidence that the levels of dark trading it has seen harm price formation or execution outcomes for investors, and given there is no need to preserve the alignment of cap application in the absence of the EU accepting the equivalence of the UK share trading regime. In relation to threshold calculation and application, the FCA is considering how to both simplify the rules and increase flexibility to create options for alignments across different jurisdictions.
- What the FCA is considering following HM Treasury publishing Lord Hill's report on the UK listing regime. Mr Schooling Latter sees real efficiency gains in better aligning prospectus documentation requirements with the type of transaction being undertaken.
ESMA statement on supervisory approach to MiFID II position limits for commodity derivatives
On 19 March 2021, ESMA published a statement relating to its supervisory approach to position limits for commodity derivatives under the MiFID II Directive.
ESMA notes that the Directive amending the MiFID II Directive to help the EU's economic recovery from the Covid-19 pandemic will substantially reduce the scope of commodity derivatives that are subject to position limits. These provisions will start to apply early in 2022.
Given the delay in the application of the relaxation of these rules, ESMA states that it sees merit in already having in place a more favourable environment for the development of non-significant commodity derivatives that will no longer be subject to position limits in early 2022.
Although it cannot disapply EU law, ESMA believes that it is necessary to take into account the upcoming rule changes, as well as the impact of position limits on the development of new and less liquid commodity derivatives, the role of liquidity providers in developing those derivatives and the competitive environment in which EU commodity derivatives markets operate. It therefore expects national competent authorities (NCAs) to not prioritise their supervisory actions towards:
- entities holding positions in commodity derivatives, other than agricultural commodity derivatives, with a net open interest below 300,000 lots; and
- positions that are objectively measurable as resulting from transactions entered into to fulfil obligations to provide liquidity on a trading venue as referred to in point (c) of the fourth subparagraph of Article 2(4) of MiFID II.
European Commission adopts Delegated Regulation supplementing EMIR and SFTR on fees charged to trade repositories in 2021
On 24 March 2021, the European Commission adopted a Delegated Regulation (C(2021) 1874 final) amending Delegated Regulations (EU) 1003/2013 and (EU) 2019/360 as regards the annual supervisory fees charged by ESMA to trade repositories (TRs) for 2021.
Delegated Regulations (EU) 1003/2013 and (EU) 2019/360 set out the methodology for the fees paid to ESMA by TRs for the purposes of Article 72(3) of EMIR and Article 11(2) of the Regulation on reporting and transparency of securities financing transactions (SFTR) respectively.
The amendments to these Regulations reflect the effect of two UK TRs transferring part of their services and activities to the EU to be able to continue providing services and activities to counterparties established in the EU. As the new EU TRs effectively started their activity in the EU in January 2021, their level of activity in 2020 was almost non-existent and consequently their annual supervisory fee for 2021 would be negligible, although their activities are likely to be significant.
The Delegated Regulation changes the reference period for the calculation of the applicable turnover of trade repositories from 2020 to January to June 2021. This will have the effect of ensuring that the annual supervisory fees for 2021 for these TRs will be calculated on the basis of their applicable turnover during the first half of 2021.
The next step is for the Council of the EU and the European Parliament to consider the draft Delegated Regulation. If neither the Council nor the Parliament object, it will be published in the Official Journal of the European Union (OJ) and will enter into force the day after its publication.
EC considers extending pension scheme arrangements clearing exemption
EMIR, as amended by EMIR Refit, provides that certain pension scheme arrangements are temporarily exempt from the clearing obligation until 18 June 2021 in respect of OTC derivative transactions that are objectively measurable as reducing investment risks that directly relate to the financial solvency of the pension scheme arrangement.
The European Commission is consulting on a proposal to extend the temporary exemption by one year to 18 June 2022. It has also published a draft delegated regulation and requested feedback by 13 April 2021.
This follows the European Commission’s report in September 2020 which concluded that the key remaining challenge for pension scheme arrangements is the need to post variation margin in cash in case of market stress (when they may be required by CCPs to post significant amounts of variation margin). Similarly, ESMA’s report in December 2020 concluded that solutions to mitigate the challenges faced by pension schemes need to be further developed, or might need to be accompanied by some regulatory changes in certain cases, and noted that an extension of the exemption by one year is needed.
ESMA allows decision on reporting net short positions to expire
On 15 March 2021, ESMA published a press release announcing it has decided not to renew its decision to require holders of net short positions in shares traded on an EU regulated market to notify the relevant national competent authority (NCA) if the position reaches, exceeds or falls below 0.1% of the issued share capital.
The measure has applied since 16 March 2020 and was last renewed in December 2020. The decision expires on 19 March 2021. Therefore, the last reporting where the lower threshold of 0.1% applies will relate to 19 March 2021 and must be reported to NCAs by 15.30 on 22 March 2021.
From 20 March 2021, positions holders will need to send notifications only if they reach or exceed the 0.2% threshold again, while any outstanding net short position between 0.1% and 0.2% will not have to be reported.
The decision is expiring because ESMA's view is that the current situation in financial markets no longer resembles the emergency situation required by the Short Selling Regulation (236/2012) (SSR) to maintain the measure. The overall level of net short positions is decreasing across the EU, reducing the risk that selling pressures could initiate or exacerbate potential negative developments connected with the Covid-19 pandemic.
ESMA also notes that the EFTA Surveillance Authority, in co-operation with ESMA, has published a corresponding press release stating it is allowing temporary requirements to expire.
ESMA states it will, in co-ordination with NCAs, continue to monitor developments in financial markets as a result of the Covid-19 pandemic, and is prepared to use its powers to ensure the orderly functioning of markets, financial stability, and investor protection.
FCA list of business interruption insurance policies
On 12 March 2021, the FCA published a list of business interruption (BI) insurance policies capable of responding to the Covid-19 pandemic following the test case.
The FCA set out its intention to send an information request to insurers for updated details of all non-damage BI policies that are, in principle, capable of responding to the Covid-19 pandemic in a January 2021 Dear CEO letter.
The list is in the form submitted to the FCA and records each insurer's view of the application of the test case to the relevant policy. Each insurer has included:
- all relevant non-damage BI policies that it indicated in its July 2020 submissions were affected by the test case; and
- any relevant non-damage BI policy that it previously did not include in the July submissions, or had assessed as not affected, that it now deems to be affected by the outcome of the test case.
The policies listed cover over 200,000 policyholders and may be subject to further update. Inclusion in this list does not mean that the outcome on any particular claim for the policy wordings will be affected. Each policy wording and policyholder's circumstances will need to be considered on a case-by-case basis. Where a policy is not included on this list, this may be for a number of reasons, including but not limited to the policy wording being of a type not tested in the test case (for example, containing an exhaustive list of diseases only or where the policy contains a relevant exclusion clause which was not tested). The list also does not include policy wordings that only held by fewer than five policyholders.
FCA extends flexibility over 10% depreciation notifications and RTS 27 reports
On 19 March 2021, the FCA published a statement announcing a further extension to a temporary Covid-19 measure applying supervisory flexibility over 10% depreciation notifications. The temporary measure will be extended until the end of 2021 while the FCA consults on changes to the notification requirement. It intends to consult on the changes in spring 2021. The requirements apply to firms that provide portfolio management services or hold retail client accounts that include positions in leveraged financial instruments or contingent liability transactions.
The FCA informed firms in September 2020 that it would apply supervisory flexibility over 10% depreciation notifications until the end of March 2021.
The FCA also announces that it is establishing temporary measures relating to RTS 27 reports on execution quality. Commission Delegated Regulation (EU) 2017/575 contains regulatory technical standards (RTS) specifying the content, format and periodicity of the data to be published by execution venues relating to the quality of execution of transactions. The FCA refers to these RTS as RTS 27.
It explains that since the next set of RTS 27 reports will be based on pre-Brexit data, the information they contain is likely to be of limited use for market participants and may even be misleading. In addition, it is currently preparing a consultation on the RTS 27 reporting obligation, with a view to abolishing it, due to doubts about the value of these reports compared with the burden of producing them. On this basis, the FCA states that it will not take action against firms who do not produce RTS 27 reports for the rest of 2021. It expects to have finalised its policy consideration of the future of these reports by the end of 2021.
ECB advises on best practices for FMIs in business continuity plans during pandemic
On 19 March 2021, the European Central Bank (ECB) published a paper on best practices applied by financial market infrastructures (FMIs) in their business continuity plans during the Covid-19 pandemic.
The ECB explains that since its outbreak, the Eurosystem has been collecting information on the preparedness of payment systems, payment schemes and their critical service providers for dealing with the pandemic. It has also been monitoring FMIs' responses and resilience in terms of withstanding this shock. Based on its observations, the Eurosystem has compiled a set of key market practices for pandemic crisis planning.
The ECB divides its paper into the two sections.
- Managing a pandemic. In this section, the ECB notes that the main aim for an FMI during a pandemic is to maintain its safe and efficient operations in its interplay with its participants, its providers, interlinked systems, and other relevant stakeholders. It stresses that while a pandemic may lead an operator to refocus its resources on core and critical activities, security must not be lowered. This is particularly important as targeted threats of fraud or cyberattacks may increase during crisis events to exploit vulnerabilities. The ECB discusses the mobilisation of a dedicated pandemic management team, developing and implementing a pandemic management plan, and key considerations it has observed in FMIs' responses to the pandemic.
- Pandemic response process. The ECB sets out a table highlighting appropriate recovery measures that were adopted by some FMIs at different stages of the pandemic.
FCA updated statement on non-damage business interruption settlements and deductions
On 24 March 2021, the FCA published an updated statement on non-damage business interruption settlements and deductions made for government support to set out the FCA's expectations of firms.
The statement relates to the FCA's business interruption insurance test case.
The FCA expects firms to take the following into account when assessing whether it is appropriate to make deductions from business interruption insurance claim payouts:
- the exact type and nature of the government support;
- how the policyholder used this support; and
- the type of policy and its precise terms, including any set methodology for calculating the value of a claim set out under the relevant section of the policy.
In addition, the FCA expects firms to reflect the above matters appropriately in their communications with policyholders when making settlement offers and reaching settlement on relevant business interruption claims.
The FCA also refers to its September 2020 Dear CEO letter. Among other things, the letter confirmed the FCA's expectation that firms explicitly consider the treatment of the various forms of government support at board level and appropriately document their consideration and conclusions.
In September 2020, in discussions between the Association of British Insurers (ABI) and the Economic Secretary to HM Treasury, the ABI confirmed that a number of insurers have agreed not to deduct certain grants (as set out in the statement) from Covid-19 claim payments. The FCA states that even if an insurer's policy is with a different insurer to those listed in the statement, its views about the appropriateness of deducting small business grants still apply.
Taking the above into account, the FCA will consider how firms treat their policyholders as part of its usual supervisory activities. It may intervene and take further actions where firms do not appear to be meeting its expectations and treating their customers fairly on these points.
EU amended legislation on securitisation to support the economic recovery
On 6 April 2021, the EU published legislation in the EU’s Official Journal that amends the Securitisation Regulation, which provides for a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation to help the economic recovery from Covid-19.
In addition, the EU published legislation that amends the Capital Requirements Regulation for the same purpose of adjusting the securitisation framework to support the post-pandemic economic recovery.
The reforms effectively:
- provide synthetic on-balance sheet securitisations with access to the simple, transparent and standardised (STS) framework, which was previously only available to “true sale” securitisations;
- remove regulatory obstacles to the securitisation of non-performing loans;
- lower capital requirements for the senior tranche of synthetic on-balance sheet securitisations; and
- provide for a specific capital treatment of securitisation of non-performing loans.
ESMA public statement on the temporary suspension of the obligation to publish RTS 27 reports
On 31 March 2021, ESMA has made a public statement on the temporary suspension of the obligation on execution venues to publish best execution reports. The obligation occurs under MiFID II RTS 27, which prescribes the content, the format and the periodicity of the data to be published by execution venues relating to the quality of execution of transactions.
The obligation was suspended as part of the package of reforms to MiFID II in response to Covid-19 and with the aim of supporting the economic recovery from the pandemic. This set of reforms (termed the “quick fix”) is expected to be the first part of the MiFID II Review. Further and more extensive reforms to the legislation are likely to be proposed later this year.
ESMA notes that there is confusion among some market participants as to the application date of the suspension. ESMA clarifies that the legislative intention of the reforms was to suspend best execution reports for two years after the Amending Directive enters into force.
FMLC and EFMLG letter on LIBOR transition
On 22 March 2021, the Financial Markets Law Committee (FMLC) and the European Financial Markets Lawyers Group (EFMLG) published a joint letter (dated 19 March 2021) to Katharine Braddick, HM Treasury Director of General Financial Services, on LIBOR transition.
Given the problems of divergence and overlap that arise from the legislative approaches adopted by authorities in the UK, EU and US, the letter observes that market transactions could become subject to conflicting legal or regulatory requirements. It also stresses that international co-ordination around the exercise of any powers to adapt benchmark methodology or the terms of financial transactions is essential to avoid significant market confusion.
The letter sets out areas of potential conflict and overlap that may arise owing to the differences in the legislative approaches.
- LIBOR could be theoretically extant under English law as a screen rate, but "in cessation" as a methodology or as a measure of London interbank unsecured lending rates and therefore replaceable by the statutory replacement rate under the proposed EU regime.
- A major concern is the potential disparity of fallback rates (or synthetic methodologies), which may be identified in different jurisdictions.
- The new powers that will be granted under the UK legislative initiative allow the FCA to direct a change in LIBOR methodology. Although this solution is positive per se, there is a contingent risk that it could also provide a platform for litigation or result in the frustration of contracts in agreements that are subject to US or EU law. This is unless there is some form of equivalence mechanism or other similar process to endorse legislative solutions implemented by UK authorities.
- There is also a risk that similar situations might be treated differently under the various legislative systems.
In addition, the letter refers to the letter sent by the Global Financial Markets Association (GFMA) recommending the establishment of a "tough legacy" cross-border collaboration working group to help facilitate policy alignment wherever possible of regulatory and legislative solutions. Members of both the FMLC and the EFMLG express their support for the establishment of such an international initiative.
European Commission consults on designating replacement rate for CHF LIBOR
On 23 March 2021, the European Commission published a consultation paper to assess the suitability of designating a statutory replacement rate for certain settings of Swiss Franc (CHF) LIBOR.
It is relevant to products such as savings accounts, mortgages and loans, including consumer credit agreements and small business loans, that were concluded before the EU Benchmarks Regulation (EU BMR) applied (that is, 1 January 2018), and that are governed by the laws of one of the EU member states.
The FCA announced, on 5 March 2021, the cessation of CHF, GBP, JPY and EUR LIBOR rates at the end of 2021. It has no plans to require the administrator of LIBOR to continue publishing any of the CHF LIBOR settings on a non-representative, synthetic basis for a further period after this date.
The Commission has received submissions from market participants active in the banking sector in several member states, including Poland and Austria, according to which CHF LIBOR plays an important role in their financial markets. The submitters point out that the cessation of CHF LIBOR, in particular the three-month setting, without designation of a contractual replacement rate would have impacts on financial stability in their respective consumer markets.
The submissions also state that the current stock of mortgage credit agreements to consumers and loans to small businesses denominated in CHF LIBOR amounts to several billion EUR, with most of the existing stock maturing after the end of 2021. The submitters further state that practically none of their existing contracts expiring after 31 December 2021 referencing CHF LIBOR contain contractual fall-back arrangements, as most of the mortgage credit agreements were concluded before 1 January 2018. For the purpose of the consultation, the legacy stock in CHF LIBOR only includes contracts entered into before 1 January 2018 and expiring after 31 December 2021.
Among other things, stakeholders propose that the Commission statutory designation follows the recommendation of the Swiss National Working Group on Swiss Franc Reference Rates for replacing CHF LIBOR in mortgages.
Comments can be made on the consultation until 18 May 2021.
BoE responds to Treasury Committee inquiry into future of UK's financial services post-Brexit
On 23 March 2021, the House of Commons Treasury Committee published the Bank of England's (BoE) written response to the committee's inquiry into the future of financial services in the UK after Brexit.
The response takes into account the BoE's financial stability objective and the PRA's primary objectives of safety and soundness and insurance policyholder protection. Strong standards are therefore at the centre of the response.
Points of interest
- Leaving the EU gives the UK an opportunity to tailor its approach to financial services policy and regulation. The policy should consider how regulation can facilitate innovation, so that the UK can seize opportunities from new areas of growth and productive investment in financial services as they emerge, especially as such features are also supportive of long-term resilience. This could include digitisation of the economy and FinTech.
- Regulation should promote competition (for example, by ensuring that standards are proportionate to firms' business models).
- "Safe openness" to firms from other jurisdictions who are seeking to access the UK market, based on international collaboration and standards, will be a key element in the UK's future success. This approach ensures that the BoE can support openness, while mitigating the risks through regulatory assessments of deference, regulatory and supervisory co-operation, and a commitment to common international standards.
- The BoE agrees with the government that there are significant benefits from a model where the technical details of regulatory standards are set by expert, independent regulators. Such a model puts a particular weight on the regulators acting in a transparent and accountable way. Parliament will have a vital ongoing role in any future framework as it is the body that holds the regulators to account for achieving their objectives. The BoE is committed to helping Parliament fulfil this role.
FCA statement on use of TTP to modify UK's derivatives trading obligation: March 2021
On 24 March 2021, the FCA published a statement on the use of its temporary transitional power (TTP) to modify the UK's derivatives trading obligation (DTO).
The FCA previously published a statement, in December 2020, in which it said that it would keep its use of the TTP under review and consider, by 31 March 2021, whether market or regulatory developments warrant a review of its approach.
The FCA has not observed market or regulatory developments in Q1 2021 that justify a change in its approach. Therefore, it will continue to use the TTP to modify the application of the DTO as previously set out.
The FCA will continue to monitor market and regulatory developments and review its approach if necessary. If it does see a case for a change, it will provide sufficient notice to market participants so that any changes can be implemented smoothly.
As specified in the December statement, the FCA expects firms and other regulated persons to be able to demonstrate compliance with the UK DTO.
ESMA updates statement on impact of Brexit on BMR
On 24 March 2021, ESMA published an updated statement (dated 9 March 2021) (ESMA80-187-881) on the application of key provisions in the Benchmarks Regulation (EU BMR) in the light of Brexit.
The update specifies the EU's regulatory approach towards UK-based third-country benchmarks as well as UK endorsed and recognised benchmarks.
Following the end of the Brexit transition period, UK-based administrators that were initially included in the ESMA register of administrators and third-country benchmarks were deleted as the BMR no longer applies to UK-based benchmark administrators. They now qualify as third-country administrators.
However, due to the fact that the BMR transitional period, as defined in Article 51(5)4 of the EU BMR, has been extended to 31 December 2023, the change in the ESMA register does not yet have an effect on the ability of EU supervised entities to use the benchmarks provided by any third-country administrators, including UK ones. This means that, during the BMR transitional period, third-country benchmarks can still be used by supervised entities in the EU if the benchmark is already used in the EU as a reference for financial instruments, financial contracts, or for measuring the performance of an investment fund. Therefore, until 31 December 2023, EU supervised entities can use third-country UK-based benchmarks even if they are not included in the ESMA register.
In the absence of an equivalence decision by the European Commission, UK-based administrators have until the end of the extended BMR transitional period to apply for recognition or endorsement in the EU for the benchmarks provided by UK-based administrators to be included in the ESMA register again.
The extended BMR transitional period also applies to UK-recognised or endorsed third-country benchmarks.
ESMA public statement on the application of the Transparency Directive to UK issuers with shares traded in the EU after Brexit
On 31 March 2021, ESMA issued a public statement concerning the application of the transparency requirements under Article 4 of the Transparency Directive by UK issuers with securities admitted to trading in the EU following Brexit.
The primary aim of ESMA’s statement is to ensure a common supervisory approach by the EU’s national competent authorities in respect of the application of accountancy frameworks used by UK issuers.
The statement highlights that, from 1 January 2021, UK issuers may use the International Financial Reporting Standards (IFRS), as endorsed by the EU, or as issued by the International Accounting Standards Board (IASB), amongst other accounting standards, when complying with the Transparency Directive for consolidated financial statements and individual financial statements of single entities.