EU UK Regulatory Roundup

On 8 March 2021, the Financial Conduct Authority (FCA) published a speech by its Executive Director of Enforcement and Market Oversight, Mark Steward, at the Expert Forum: Market Abuse 2021.

Key points include:

Volumes and STORs

• There was an overall increase in transactions and transaction reports by 34% in 2020.
• Whilst total volumes for the year were lower than previous years, suspicious transaction and order reports (STORs) have returned to the expected levels across all asset classes.
• Surveillance and investigation work over the last couple of years has reduced trading by certain actors whose trading prompted high numbers of STORs.
• The quality of the STORs being received have remained high.
• The market infrastructure has stood up to significant surges in trading volumes, especially during the initial lockdown period.
• There has been an increase in proactive market monitoring during the year.

Market Monitoring, Short Positions etc

• The FCA’s approach to short selling, which requires all short positions above 0.1% to be reported to it, and all positions over 0.5% to be disclosed publicly on a daily basis, gives the FCA and the market a very high degree of transparency over short selling positions.
• There is a risk that new retail investors may become subject to misleading online marketing.
• New initiatives have been introduced, including, a new approach to short selling reporting which enables short positions to be reported on the FCA’s Electronic Submission System (ESS) and a new measure for market cleanliness.
• There was an increase in retail trading accounts in the UK during 2020, although a considerable number of opened accounts have not been used. There are concerns that new retail investors may become subject to misleading online marketing.

Cleanliness

• The Potentially Anomalous Trading Ratio (PATR) introduced in September 2020, focusing on underlying trading behaviour around specified price sensitive announcements and assessing whether behaviour can be deemed anomalous, produced a figure of 6.7% anomalous trades for 2019 across around 958 price sensitive announcements, which is very close to the Abnormal Trading Volume (ATV) metric result for the same period.

On 8 March 2021, the European Commission (Commission) issued a roadmap seeking views on how central securities depositories (CSDs) are working.

In particular, the Commission is seeking views on:

• How CSDs are able to operate in different countries across the EU.
• How requests to use their services are handled.
• Whether there are other substantive barriers to competition in this sector that need to be addressed.

The Commission 2021 Work Programme and the 2020 Capital Markets Union (CMU) Action Plan announced that the Commission will consider amending existing rules to simplify the Central Securities Depositories Regulation (CSDR) and contribute to the development of a more integrated post-trading landscape in the EU (CSDR REFIT). CSDR REFIT will build on the conclusions of a Commission report to be published in the first half of 2021. That report is required under Article 75 of the CSDR and will also cover the requirement to conduct a comprehensive assessment of the potential supervision of third-country CSDs by the European Securities and Markets Authority (ESMA) as required by Article 81(2c) of Regulation (EU) No 1095/2010. The impact assessment underpinning the roadmap will be prepared in parallel with the evaluation of the CSDR.

On 9 March 2021, the FCA published the annual transparency calculations for UK equity and equity-like financial instruments which take effect on 1 April 2021.

The calculations include the:

• Liquidity assessment.
• Determination of the most relevant market in terms of liquidity (MRM).
• Determination of the average daily turnover (ADT) relevant for the determination of the pre-trade and post-trade large in scale (LIS) thresholds.
• Determination of the average value of the transactions (AVT) and the related the standard market size (SMS).
• Determination of the 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 states that the published calculations reflect the approach set out in its December Supervisory Statement where the regulator said that until further notice it would regard the shares of EU issuers who have not sought admission to trading in the UK as illiquid and subject to the pre-trade and post-trade LIS thresholds associated with having ADT of under 50,000. However, the FCA adds that where there are discrepancies in the published results, the approach outlined in paragraph 27 of the Supervisory Statement should prevail.

The FCA also states that the annual calculations do not change what it said about tick sizes in paragraphs 54 and 55 of the Supervisory Statement. For EU shares, trading venues and systematic internalisers (SIs) can use the ADNTE figure published by the European Securities and Markets Authority to determine the tick size where it is larger than the published ADNTE.

The FCA has also published the SMS of equity instruments for the purposes of the pre-trade transparency regime for SIs. This differs from the approach set out in an earlier Statement of Policy because the FCA has the capability to publish calculations.

On 5 March 2021, the FCA issued a Feedback Statement regarding the exercise of its powers under Article 23D of the onshored Benchmarks Regulation (BMR).

Article 23D of the BMR grants the FCA the ability, in certain circumstances, to impose certain requirements on the administrator of a critical benchmark designated under Article 23A. Article 23F(1)(d) of the BMR requires the FCA to prepare and publish a Statement of Policy on how it will exercise its powers under Article 23D.

In November 2020, the FCA published a consultation setting out its proposed policy approach in respect of applying the Article 23D requirements to a benchmark that has been designated as an Article 23A benchmark. The Feedback Statement now published summarizes the feedback the FCA received to the consultation and its response. The FCA has also published its Statement of Policy for Article 23D, fulfilling the requirement at Article 23F(1)(d).

The FCA is confirming in the Statement of Policy that it will include consideration of the factors that it outlined in its earlier consultation. In addition, after reviewing the responses, it has expanded some of the considerations that underpin the factors that were proposed.

On 4 March 2021, the FCA published a revised version of its Statement of Policy regarding suspending the use of pre-trade transparency waivers for a trading venue for the purposes of the Double Volume Cap (DVC) under Article 5(3B) of the onshored.

Markets in Financial Instruments Regulation (UK MiFIR). The DVC limits the level of dark trading to a certain proportion of total trading in an equity.

UK MiFIR gives the FCA the power to make and renew suspensions of waivers under the DVC without undertaking and publishing the calculations of whether trading has exceeded the 4 and 8 per cent thresholds. Under this power, the FCA may suspend the use of a waiver for a period of up to six months and may renew a suspension where it feels that the circumstances which led it to impose the suspension of a waiver continue to exist.

In December, the FCA announced that it would not automatically apply the DVC to UK equities and it is now extending this to all equities.

The Statement of Policy explains that the FCA may exercise the power to suspend pre-trade transparency waivers to ensure that its use does not unduly harm price formation if it considers it necessary to advance its integrity objective under section 1D of the Financial Services and Markets Act 2000 (FSMA). In deciding whether that test has been met the FCA:

1. must take into account –

• its consumer protection objective and competition objective under sections 1C and 1E of FSMA;
• the thresholds applying under Article 5 of MiFIR as it has effect in the EU; and
• the most recent information published by the European Securities and Markets Authority under Article 5(4), 5(5) and 5(6) of MiFIR before the end of the Brexit transition period.

1. the FCA may also take into account –

• any relevant information produced under Article 3 of UK MiFIR, or under equivalent pre-trading transparency requirements in other jurisdictions, about the use of the waiver in the United Kingdom, or under equivalent waiver arrangements in any other country, in relation to the financial instrument; and
• any relevant information available in relation to trading volumes in the financial instrument concerned, whether in the United Kingdom or in any other country.

• In the revised Statement of Policy the FCA states that it is willing to use its temporary powers flexibly and amend its approach to the DVC if another jurisdiction makes an equivalence decision in respect of the UK.

prospectuses as well as to ensure the common, uniform and consistent application of the disclosure requirements set out in Commission Delegated Regulation (EU) 2019/980 of 14 March 2019.

Among other things ESMA recommends that issuers involve financial reporting experts in order to ensure that the financial information in prospectuses satisfies the requirements set out in the guidelines, as well as the general obligation in Article 6(1) of the Prospectus Regulation to ensure that the prospectus contains the information necessary for investors to make an informed assessment of the assets and liabilities, profits and losses, financial position, and prospects of the issuer and of any guarantor. Likewise, Member State competent authorities should ensure that their supervisors are familiar with the contents of the guidelines and that expertise in financial reporting is available to deal with issues that arise when applying the guidelines.

On 5 March 2021, the FCA confirmed that all LIBOR settings will either cease to be provided by any administrator or no longer be representative:

• Immediately after 31 December 2021, in the case of all sterling, euro, Swiss franc and Japanese yen settings, and the 1-week and 2-month US dollar settings.
• Immediately after 30 June 2023, in the case of the remaining US dollar settings.

The end-June 2023 deadline for the cessation of US dollar LIBOR follows the ICE Benchmark Administration (IBA) consultation last December.

The FCA acknowledges that this announcement will engage certain contractual triggers for the calculation and future application of fallbacks that are activated by pre-cessation or cessation announcements made by the FCA in contracts.

On 1 March 2021, ESMA published the results of the annual transparency calculations for equity and equity-like instruments, which will apply from 1 April 2021.

The calculations made available include the:

• Liquidity assessment as per Articles 1 to 5 of Commission Delegated Regulation 2017/567.
• Determination of the most relevant market in terms of liquidity as per Article 4 of Commission Delegated Regulation 2017/587.
• Determination of the average daily turnover relevant for the determination of the pre-trade and post-trade large in scale thresholds.
• Determination of the average value of the transactions and the related standard market size.
• Determination of the average daily number of transactions on the most relevant market in terms of liquidity relevant for the determination of the tick-size regime.

The transparency requirements based on the results of the annual transparency calculations published from 1 March 2021 for equity and equity-like instruments will apply from 1 April 2021 until 31 March 2022. From 1 April 2022 the next annual transparency calculations for equity and equity-like instruments, to be published by 1 March 2022, will become applicable.

On 1 March 2021, ESMA published its final report on advice under Article 8 of the Taxonomy Regulation, which covers the information to be provided by non-financial undertakings and asset managers to comply with their disclosure obligations under the Non-Financial Reporting Directive (NFRD).

According to Article 8(1) of the Taxonomy Regulation, undertakings required to publish non-financial information pursuant to Articles 19a and 29a of the Accounting Directive have to include information on how and to what extent their activities are associated with economic activities that qualify as environmentally sustainable under the Taxonomy Regulation. For this purpose, Article 8(2) of the Taxonomy Regulation requires non-financial undertakings subject to the NFRD to provide disclosure of three key performance indicators (KPIs): turnover (turnover KPI), capital expenditure (CapEx KPI) and operating expenditure (OpEx KPI) related to environmentally sustainable activities. The Taxonomy Regulation, however, does not specify any KPIs for financial undertakings (including asset managers) which are subject to the disclosure requirements for non-financial information in the Accounting Directive. Article 8(4) of the Taxonomy Regulation requires the Commission to adopt a delegated act to supplement Article 8(1) and (2) by specifying the content and presentation of the information to be disclosed pursuant to those paragraphs, including the methodology to be used in order to comply with them, taking into account the specificities of both financial and non-financial undertakings and the technical screening criteria established pursuant to the Taxonomy Regulation. The Commission is required to adopt the delegated act by 1 June 2021.

ESMA’s advice on the KPIs that will be disclosed by non-financial undertakings provides the definitions that entities should use for the calculation of the three metrics namely the turnover KPI, the CapEx KPI and the OpEx KPI. The advice also sets out the content of the information that should accompany these disclosures and the level of granularity that should be provided to comply with these reporting obligations. ESMA has mainly focussed on activities that are 

covered by the EU Taxonomy (activities that are ‘eligible’ to qualify as environmentally sustainable for the formulation of its proposals on non-financial undertakings). On asset managers, ESMA proposes the KPI that asset managers should disclose along with a number of methodological considerations relating to the calculation of this metric. ESMA proposes the use of standardised tables for the Article 8 disclosures by non-financial undertakings and asset managers and recommends a transitional application of the Level 2 provisions.

The final report will be delivered to the Commission.

On 26 February 2021, the FCA issued the results of a review of product governance in a sample of 8 asset management firms. The review examined how these firms, as product providers, take MiFID II’s product governance rules into account, particularly the interests of the end clients, throughout the product lifecycle.

The review found that some asset managers are not undertaking activities in line with MiFID II’s product governance regime (PROD).

Key findings include:

• Of the firms in the review, only 1 manufacturer appeared to have considered the ‘negative target market’ concept, but it could not identify the specific group of consumers that would be a ‘negative target market’ for its UCITS and non-UCITS retail scheme products. PROD asks asset managers to identify the potential target market for each financial instrument and specify the type of clients the product is compatible with, or not (a negative target market). Firms should also determine whether the risk/reward profile is consistent with the target market as outlined in PROD 3.2.10R. The FCA expects asset managers to carry out these activities to enable them to comply with the customer best interest rules (COBS 2.1.1R or COBS 2.1.4R and PRIN 6).
• All firms in the sample had a framework for managing conflicts of interest, but not all appeared to be effective. Simply having a framework in place is not enough; the ultimate outcomes are fundamental. Failing to undertake these activities may damage the interests of a client and also risks breaching rules in SYSC 10 and PRIN 8 (conflicts of interest).
• While all manufacturers could provide evidence of some scenario and stress testing, their approaches varied. To protect investors, PROD asks certain firms to carry out scenario analysis to assess the risk of poor outcomes to consumers and the circumstances in which they may occur. This includes assessing resilience in volatile market conditions and scenarios that may affect how an individual product performs (outlined in PROD 3.2.13R). Stress tests should cover adverse market conditions, including the firm’s own financial strength, asset-specific stresses and any risks from a highly concentrated consumer base. The FCA expects firms to consider such activities in order to comply with other rules, such as BIPRU 12.4.1R, COLL 6.12 or FUND 3.7.
• There are areas where firms need to improve their costs and charges disclosures. Some cost information shown in marketing documents did not match the information shown in regulatory documents such as the UCITS Key Investor Information Document. Most of the firms the FCA assessed also appeared to leave out certain charges, particularly portfolio transaction costs, from their cost disclosures. The FCA expects manufacturers to disclose costs and charges in a way that is clear, fair and not misleading and that complies with relevant regulatory requirements.
• The quality of due diligence over distributors was variable. Some firms assessed a distributor’s arrangements more robustly than others. Due diligence means asset managers can establish whether their chosen distributors are fit for purpose in client on boarding and if a distributor’s intended product recipient matches the product’s target market.
• All asset managers faced challenges in getting end-client data from distributors – even when they specifically asked for this information. Some asked for feedback through meetings rather than with detailed questionnaires. A recurrent theme was that asset managers feel unable to influence distributors because of the commercial sensitivity of the data request. It appears to the FCA that commercial agreements and sensitivities between asset manager/product provider and distributor may be taking precedence as asset managers are reluctant to insist on end-client data trends from their distributors. The FCA feels that asset managers could do more to challenge their distributors for this information – and document that challenge – to work towards a more collaborative relationship that allows asset managers to meet their obligations to act in clients’ best interests.
• The systems and procedures for monitoring data internally varied, as did how firms use management information (MI). The FCA published ‘Treating customers fairly – guide to management information’ in 2015. It remains relevant in giving examples of good and poor practice and helping firms develop MI.
• Nearly all firms carried out a formal product assessment or review every year. However, different firms showed varying levels of oversight and challenge across these governance channels. Key areas the FCA focused on were the second line of defence and product governance committees, the obligations of the authorised fund manager board, how firms approached record keeping and training on product governance.
• Most asset managers had poor record keeping. This may have been due to a lack of formal process in product design and oversight. The inability to evidence robust challenge and oversight should raise concern for those individuals accountable for this activity (the focus of the new Senior Management and Certification Regime) as it leaves firms and those accountable unable to evidence challenge and oversight, potentially in breach of SYSC 9.1.1R.

The FCA states that it’s likely it will undertake further work in this area. Part of this may be to consider whether it needs to make further changes to its product governance rules and guidance for both asset managers/manufacturers and distributors. The regulator will also consider whether these changes will better address the key sources of harm throughout the product lifecycle.

The FCA expects firms to ensure their activities prioritise good customer outcomes and that they comply with the relevant regulatory rules and requirements. Where the FCA identifies potential breaches of its rules, it will consider whether it needs to take action, which may include opening investigations or other appropriate measures.

On 25 February 2021, ESMA published a joint supervisory statement designed to mitigate the risk of divergent application of the Regulation on sustainability related disclosures in the financial sector (SFDR) from 10 March 2021 to the application date of the regulatory technical standards (RTS) on the content, methodologies and presentation of sustainability-related disclosures.

The joint statement provides that for the sake of applying the provisions of the SFDR without the RTS during the interim period, Member State national competent authorities are encouraged to refer financial market participants and financial advisers to the requirements set out in the draft RTS of the final report that the European Supervisory Authorities (ESAs) submitted to the Commission on 4 February 2021. The draft RTS can be used as a reference for the purposes of applying the provisions of Articles 2a, 4, 8, 9 and 10 of the SFDR in the interim period.

The joint statement adds that it is important to note that the draft RTS still have to be adopted by the Commission and that the European Parliament or the Council may object to the draft RTS within a period of three months from the date of notification of the RTS adopted by the Commission. Therefore, the final RTS may be different to the draft RTS in the ESAs’ final report. Nevertheless, the ESAs recommend that Member State national competent authorities encourage financial market participants and financial advisers to use the interim period from 10 March 2021 until 1 January 2022 to prepare for the application of the final RTS.

On 25 February 2021, the Prudential Regulation Authority (PRA) issued a statement on its website regarding an error it has identified in the Remuneration Part of the PRA Rulebook. The error relates to the ‘higher paid material risk taker’ definition in Rule 1.3 in the Remuneration Part of the PRA Rulebook.

The ‘higher paid material risk taker’ definition currently sets the requirement that an individual would be treated as a ‘higher paid material risk taker’ when their:

1. annual variable remuneration exceeds 33% of their total remuneration; and
2. total remuneration exceeds £500,000.

The PRA has identified that this is an error. An individual should instead be treated as a ‘higher paid material risk taker’ where either condition (a) or (b) is satisfied. This is in line with the PRA’s position outlined in Consultation Paper 12/20 Capital Requirements Directive V (CRD V) and Policy Statement 26/20 Capital Requirements Directive V (CRD V).

As the error in the rule has been identified, the PRA intends to consult on amending the rule at the earliest opportunity. In the meantime, it expects firms to treat individuals as ‘higher paid material risk takers’ where either condition (a) or (b) has been satisfied.

On 23 February 2021, the Commission published the speech that Commissioner McGuinness gave at the European Parliamentary Financial Services Forum Winter Conference, ‘What vision for Europe?’

Key points in the speech include:

• Some Member States are expected to see economic output returning to pre-pandemic levels by the end of this year, while the recovery will take longer and be more difficult in other Member States.
• The recovery should focus on green and digital transition. Structural initiatives such as the CMU and measures on non-performing loans can lead the way to further enable financial markets to support the economic recovery.
• This year, the Commission will look at the review of MiFID II. The Commission’s objective is to put forward a legislative proposal at the end this year. In particular:

• The Commission is aware of the potentially declining volume of trading in shares executed on transparent regulated exchanges, while volumes on generally more opaque alternative venues seem to have grown to unanticipated levels, such as trading through banks’ internal books.
• The Commission will assess whether different execution venues operate on a level playing field and, whether transparency requirements need to be strengthened.
• The review will also be an opportunity to have a fresh look at trading data and its quality. It will allow the Commission to put in place the right conditions for a consolidated tape, as envisaged in the CMU Action Plan.
• In parallel, the Commission wants to focus on retail investment and investor protection more broadly to ensure that retail investors seize the investment potential of the internal market. Many EU instruments, including the MiFID framework, address their situation. The Commission believes that there may be merit in looking at the investor’s journey in a horizontal way, from the very beginning until the very end of the investment process.

The European Green Deal will be vital for the EU’s economic recovery. Later this year the Commission will present a Renewed Sustainable Finance Strategy. It will also review the non-financial reporting directive, and present an EU Green Bond Standard.

The EU and the UK committed in the Joint Declaration to establish a framework for regulatory cooperation in financial services by March 2021. Once the Commission agrees with the UK on the working arrangements for the future relationship, the Commission will turn to resuming its unilateral equivalence assessments, using the same criteria as for all third countries, including anti-money laundering (AML) and tax cooperation.

On 3 February 2021, ESMA published a letter it had sent to the Commission concerning the review of the European Long Term Investment Funds (ELTIF) Regulation. In the letter ESMA highlights some areas of the ELTIF Regulation where improvements could be made. ESMA has issued the letter in light of the impending review of the ELTIF Regulation, and as a response to an earlier letter which it received from the Commission on the functioning of the ELTIF framework. The letter is also intended to meet the request for input from ESMA as per Article 37 of the ELTIF Regulation.

In terms of areas of the ELTIF Regulation where amendments could be made ESMA highlights the following:

• Eligible assets and investments.
• Authorisation process.
• Conflicts of interests.
• Portfolio composition and diversification.
• Disposal of ELITF assets.
• Prospectus and cost disclosure.
• Local physical presence.
• Specific requirements concerning retail investors.
• Other residual areas – professional investors, investment incentives (including tax treatment) and eligibility criteria for investors and consistency with the EuVECA and EuSEF Regulations

When discussing possible changes to eligible assets and investments ESMA suggests, among other things, clarifying the definition of “real asset” (Article 2(6) of the ELTIF Regulation). In particular, ESMA states that the nature of real estate referred to in this article could be clarified. ESMA also states that the definition of a “long term investment project that contributes to the Union objective of smart, sustainable and inclusive growth” could be clarified in relation to sustainable growth by reference to contribution to environmentally sustainable economic activities in accordance with Regulation (EU) 2020/852 (Taxonomy Regulation).

Following consultation, the Commission is expected to submit to the European Parliament and Council a report assessing the functioning of ELTIFs in the context of the Capital Markets Union project and suggesting a review of the ELTIF Regulation.

On 1 February 2021, ESMA published a final report on implementing technical standards (ITS) under the Regulation on cross-border distribution of funds. The final report follows a consultation paper that ESMA published in March 2020 on the proposed draft ITS relating to the publications to be made by Member State national competent authorities on their websites. However, the consultation paper did not cover draft ITS on the communication of information by Member State national competent authorities  to ESMA, nor draft ITS relating to the central database on the cross-border marketing of alternative investment funds and UCITS and on the related notification portal. This was on the basis that the content of the ITS related to the bilateral relationship between the Member State national competent authorities and ESMA. However, the final report includes these draft ITS.

The draft ITS relating to publications to be made by Member State national competent authorities largely reflect those that were consulted on, focussing on the information to be published by such authorities’ websites regarding the national rules governing marketing requirements for funds, and the regulatory fees and charges levied in relation to fund managers’ cross-border activities.

The draft ITS set out in the final report have been submitted to the Commission for endorsement. From the date of submission, the Commission shall take a decision on whether to adopt the draft ITS within three months. The Commission may extend that period by one month.