18 January 2022

Latest Regulatory Update

1. EU Sustainable Finance developments

a) SFDR: level 1 disclosure now requires Taxonomy alignment

The climate delegated act (DA) of the EU taxonomy regulation (TR) is now applicable.

The technical screening criteria for many economic activities (i.e. to determine their contribution to climate change mitigation and adaptation environmental objectives) started to apply from 1 January 2022. Meanwhile, “principles-based” sustainable finance disclosure regulation (SFDR) information must now conform with respective TR transparency obligations (articles 5, 6, 7); this will directly impact pre-contractual prospectus content, alongside annual reporting currently in production.

b) EU taxonomy: member state, expert disquiet escalates

A reminder that current EU taxonomy screening criteria does not include natural gas and nuclear energy sectors. On New Year’s Day, the European Commission launched a surprise (quick) consultation on draft proposals for the placement of both within the EU Taxonomy as transitional activities (i.e. those able to contribute, under certain conditions, to the “green” decarbonisation of the economy).

Although the latest draft DA is strongly supported by France and Poland, it also prompted a negative reaction from five key EU member states (Germany, Luxembourg, Portugal, Denmark and Austria), including threats of an “anti-nuclear lawsuit” against the EU.

The EC has now extended the consultation deadline until 21 January, following claims that the Platform on Sustainable Finance (PSF) were given no prior notification (and less than two weeks response time) to submit feedback alongside the Member States Expert Group on Sustainable Finance. Meanwhile, the EC plans to adopt the finalised DA by end-January (with proposals unpublished and no public consultation planned at this stage).

c) EU-ESG: market reaction to latest Taxonomy proposals

FT Ignites: German fund industry reject proposals, set to continue avoidance of nuclear energy
Investment & Pensions Europe: Dutch pensions industry “resistance”, gas power station forecasts
Institutional Investors Group on Climate Change (IIGCC): EU parliament should exclude gas from TR
CNBC: investors now face widespread “confusion” and further risk of greenwashing

d) FinDatEx verify ESG template availability

Although the legal application of the SFDR level 2 RTS has been deferred until 1 January 2023, there are additional DAs that will apply SFDR sustainability risk criteria and factors to firms operating within the scope of their UCITS, AIFMD and MiFID II regimes, starting from 1 August 2022.

One prominent legal firm has recently warned that asset managers are only now “waking up” to the full impact of SFDR, particularly the revised MiFID II “sustainability preference”, where financial advisors are required to formally extend the current suitability assessment process to incorporate the ESG preferences of their clients.

Meanwhile, in direct relation to SFDR and MiFID II, FinDatEx clarified the intended availability of:

The initial European ESG Template (EET) v1.0
The updated version of their European MiFID Template (EMT) v4.0

Ahead of their expected consultation (February-March): FinDatEx currently intend to enable product manufacturers commence their supply of both completed templates before 1 June 2022.

NB: EET and EMT templates remain a key component of the Kneip product catalogue.

e) Other local ESG updates

Germany: BaFin surprise local firms by applying new ESG rules ahead of legal transposition
Luxembourg: Luxflag predict “lots more art.8 funds” to appear this year
Ireland: CBI thematic review of SFDR will “flush out” greenwashing fund firms.

2. UK Sustainable Finance latest

a) FCA climate disclosure regime now in place for larger firms

As mentioned last time, the Financial Conduct Authority (FCA) have now applied the rules of their Climate-Related Disclosures policy statement for local asset managers, life assurers and pension providers, framed on recommendations from the Task Force on Climate-related Financial Disclosures [TCFD] advisory body.

b) FCA-SDR regime: latest industry feedback

The FCA’s recent discussion paper (DP) outlining a separate Sustainability Disclosure Requirements (SDR) and investment labels framework has attracted notable responses from local trade organisations.

Firstly, the UK Investment Association (IA) published a 37 page response to the FCA’s SDR paper.

While the IA “particularly welcome” the FCA goal “to align where possible” with the EU-SFDR, critical feedback items in their executive summary include:

A warning of “many unknowns” within a “rapidly-evolving environment”, including “highly fluid” key definitions and the incomplete nature of some key process elements “… notably the UK taxonomy”
Key aspects of the proposed 5-stage labelling system (i.e. based on a “spectrum of capital” concept, including use of ‘transition’, ‘alignment’ and ‘responsible’ terms) may initially act as an “undue constraint” while becoming “outmoded in the longer term”.
The risk of FCA proposals currently “too complex and difficult for consumers to understand”
The “two-fold critical challenges” related to the specification of data requirements, e.
How to achieve the “right balance between prescription [i.e. rules] and principles”
How to regulate in a context “where many data points are either yet to be fully defined” or “data is yet to be available.”

In conclusion, the IA cite the DP feedback period as “too short, given the importance and complexity of the issues”, and recommend the FCA seek “a clearer consensus” on the “many issues” outlined in their document, before the UK-SDR framework progresses to the consultation paper stage (scheduled Q2-2022).

In their DP response, the UK Sustainable Investment and Finance Association (UKSIF) recommend the FCA explore a single, harmonised set of sustainability disclosures for all client groups, ensure consistency with EEA-SFDR (i.e. “while avoiding some of the flaws”) and maintain the credibility of the UK’s system “that signals global ambition”. They also suggest the FCA “may wish to reconsider entirely” their proposed ‘responsible’ fund category (as this term is now used less frequently and may prove ambiguous).

Separately, the Association of Investment Companies (AIC) propose that demanding standards should be set for funds that either call themselves “sustainable” or make ESG claims. Their press statement also urges the FCA to apply their SDR regime to all retail investment products that fall under the PRIIPs and UCITS regimes, including investment companies.

c) UK associations announce CET template

The IA has also announced the development of a Carbon Emissions Template (CET) in a joint effort with the Pensions and Lifetime Savings Association (PLSA) and Association of British Insurers (ABI).

The CET is a standard template and data specification designed primarily to assist:

non-FCA pension scheme Trustees meet their UK Climate Change Governance & Reporting Regulations obligations, as detailed in the Statutory Guidance for trustees of occupational schemes issued by the UK Department of Work & Pensions (DWP) in June 2021.
FCA-regulated asset managers and insurers fulfil their TCFD obligations under the new ESG Sourcebook (i.e. per December FCA policy statement: Annex B, pages 17-25).

The joint working group has provided 2 x separate templates in relation to pooled funds and segregated mandates. The CET is intended to provide data used by pension schemes in relation to Y/E 31 December 2021.

3. UCITS regimes: EU work-in-progress, UK key clarification

Later this month, EU member states will meet to discuss the EC proposed amendments to the current UCITS regime (framed by some as “UCITS VI”), released alongside recommendations for a revised Alternative Investment Fund Managers Directive (“AIFMD II”).

In the shorter-term, a reminder that all Key investor information documents (KIIDs) currently under revision in accordance to financial year-end deadlines are expected to conform with ESMA’s performance fee guidelines (applicable since Jan 2021, since adopted by all NCAs for UCITs products).

Over in the UK: in a recent update, the FCA now state that for the duration of their 5 year exemption from the UK-PRIIPS regime, UCITS funds offered to UK retail investors “can continue to supply either a PRIIPs key information document [KID] or a UCITS key investor information document [KIID].” See also next item.

4. PRIIPS regimes: EU public hearing, UK policy statement pending

The European Supervisory Authorities (ESAs) have scheduled an online public hearing to discuss the development of their draft technical advice to the EC as part of the PRIIPs regulation level 1 review.

The ESAs will present feedback provided during the recent call for evidence, covering topics such as the general use of the PRIIPS KID, the operation of the comprehension alert and the ongoing use of digital media.

The hearing will take place on Friday 11 February (09:30-16:30 CET) with the deadline for registrations set one week earlier. A draft agenda will be made available in advance.

In the meantime, formal alignment of the ESA’s level 2 revised KID RTS application date (with the UCITS / PRIIPS “quick-fixes” recently published in the EU official journal) is expected to take place shortly.

Across the channel, the re-scheduled UK-PRIIPS regime policy statement announced within the most recent FCA regulatory initiatives grid is now expected later this quarter, including a finalised UK-KID template, application rules and implementation timeline. Presumably, this will also specify which editions of the PRIIPS KID (i.e. UK or EEA) will be readily accepted from (otherwise exempt) UCITS funds in due course.

5. AIFMD II: feedback on EC adopted act continues

The proposed EC amendments to the current level 1 AIFM directive regime remain open for feedback until 11 March 2022.

Meanwhile, following recent prominent reportage of diplomatic tensions between France and the UK, fresh concerns have now been raised about the possibility of “stricter” investment manager delegation rules (that may transpire from the EU council and parliament) during the months ahead.

6. EU-Cross-Border Distribution of Funds (CBDF) regime latest

Shortly before Christmas, the EC updated their transposition status of the Cross-border distribution of investment funds directive (CBDF/D). In summary, only fifteen (56%) of EU member states have fully achieved full transposition status, with eight yet to communicate any required measures. Accordingly, the EC confirm that infringement procedures are now pending against 18 countries, including Austria, Belgium, Italy, the Netherlands, Portugal, Spain and Sweden.

In relation to the regulation part of the CBDF package, ESMA has also recently published a compliance table summarising the adoption of their Cross-Border Marketing Guidelines by the national competent authorities (NCAs) across the EEA. At this stage, there are nine NCAs (including the Luxembourg CSSF) yet to finalise their compliance ahead of the 2 February 2022 application.

7. FinTech catch-up

Finally, for now, some recent updates in relation to financial technology / digital innovation.

a)ESMA: announce call for evidence for blockchain pilot

Included in our previous synopsis of the EU Digital Finance Strategy was an overview of the EC’s proposed Distributed Ledger Technology Market Infrastructure regulation (DLTR).

This is essentially an ‘experimental’ pilot legal framework for the practical application of DLT in post-trade services, including extended multilateral trading facilities (MTFs) operated by MiFID II licensed firms.

Following recent endorsement by the EU Parliament and Council, ESMA have launched a DLT pilot call for evidence, seeking feedback on updates to the current Markets in Financial instruments regulation (MiFIR) specifications for pre / post-trade transparency and required data reporting.

In their pilot, ESMA introduce 3 x categories of DLT market infrastructures (DLT-MI) that will provide trading and settlement facilities. It was previously agreed that only certain exchange-traded financial instruments can be admitted to the DLT market, subject to value thresholds:

Bonds: EUR 1 billion
UCITS: 500 million
Shares: EUR 500 million

ESMA also state that the total market value of DLT transferable securities recorded by a DLT-MI may not exceed EUR 9 billion (at which point the DLT operator has to “implement a pre-defined transition strategy”).

Stakeholders are now invited to provide comments by 4 March 2022. The pilot has already secured prominent backing (including from the BVI in Germany) and is likely to start from Q1-2023.

b) EU Council reaches agreement on MICA, DORA

The EU Council also recently adopted a position on two other proposed regulations within the Digital finance package covering ‘Markets in Crypto Assets’ (MiCA) and a ‘Digital Operational Resilience Act’ (DORA).

MiCA: will create a legal crypto-assets market framework, to “support innovation and draw on the potential of crypto-assets”, while “preserving financial stability and protecting investors”.
DORA: will establish a separate digital operational resilience legal regime, where “all firms ensure they can withstand all types of ICT-related disruptions and threats”.

The Council and European Parliament will now enter negotiations; once provisional political agreement is reached, both institutions will formally adopt both MiCA and DORA regulations, currently expected to become effective between 2023 and 2025.

c) CSSF: AIFs may invest (and depositaries can “hold”) virtual assets

Lastly, in the latest version of their Virtual Assets FAQ, the CSSF clarifies that local AIFs may invest directly (and indirectly) in virtual assets on condition that units are marketed only to professional investors. Elsewhere, they also confirm that a Luxembourg depositary can now be mandated by AIFs investing in virtual assets, provided the CSSF are pre-notified and the depository has adequate organisational arrangements and an appropriate safekeeping operational model (i.e. to manage the specific risks associated).