More UK/EU regulatory developments
1. UK updates
a) UK Future Regulatory Framework (FRF) outcome awaited
The UK government’s Future Regulatory Framework (FRF) review has now ended; in the Summary of Responses, they re-state their intention to achieve an enhanced UK funds regime, including:
- a new tax regime for qualifying asset holding companies (QAHCs)
- the activation of the Long-Term Asset Fund (LTAF) structure (to rival the relaunched EU-ELTIF)
Elsewhere, a finalised post-Brexit blueprint for the entire UK financial services legal framework (previously labelled “Big Bang 2”) is now pending.
The Financial Times recently joined in speculation that Solvency II is about to be “reformed”.
They also report the newly appointed UK minister of Brexit opportunities has been tasked by the Prime Minister “to come up with 1,000 EU rules to scrap”; if verified, his previous comments on MiFID II may prove significant in due course.
Meanwhile, the Investment Association (IA) have responded to the UK-FRF consultation; they reportedly propose the Financial Conduct Authority (FCA) assume “sweeping new powers and responsibilities” to “overturn” EU financial regulation deemed “ineffective and costly”. This follows on from the IA’s recent suggestion to the EU-PRIIPS call for evidence that the key information document (KID) should be “replaced by smarter, digitally-adapted disclosure”.
More to follow.
b) TheIA : UK delegation “critical” to European AIFMD success
The European Commission (EC) have been reminded of the “key” UK importance to the evolving AIFMD regime. Writing last week in Funds Europe, the IA chief executive praised the AIFMD framework as “a global success story with over 32,000 AIFs in operation”, including over EUR 7.1 trillion invested in EU-based funds. Despite renewed EU/UK tensions widely reported elsewhere, the IA restated their belief that the ability for EU-based firms to delegate investment management functions to the UK is “critical” for the continued success of the entire market.
As the EC proceeds with their level 1 review, theIA warn that if the EU Parliament and Council introduce new restrictive AIFM delegation rules that will impact UK firms, they risk “undermining one of the key features that has made its fund industry so successful”.
c) Carbon Emissions Template (CET) launched
The IA also recently announced that the new Carbon Emissions Template (CET) is now “endorsed and launched”. As mentioned previously, this new template is the result of collaboration between the IA, the Association of British Insurers (ABI) and the Pensions and Lifetime Savings Association (PLSA); their aim is to create a standardised data set to help firms’ pension scheme clients meet their TCFD reporting obligations.
d) FT Ignites clarify: TPR v TMPR
FT Ignites recently clarified their use of post-Brexit UK legal regimes in an article last month.
They now highlight the distinction between:
- Temporary Permissions Regime (TPR): “set up to allow EEA-based firms to continue carrying out regulated activities, such as investment advice, while they seek full UK authorisation”
- Temporary Marketing Permissions Regime (TMPR): separately set up “to allow EEA-based funds to continue to be passported into the UK”.
It is also emphasised that “EEA-based firms need permissions under both the TPR and TMPR if they wish to passport EEA-based funds into the UK using non-UK-based staff”.
Separately, another reminder that the 15-month Temporary Transitional Power (TTP) transition period (for EEA firms to prepare for their full UK regime compliance) will shortly end on 31 March 2022.
2. Other EU updates
a) ESMA: “high risk of significant market corrections”
The high productivity rate of the European Securities and Markets Authority (ESMA) continues.
In addition to their notable PRIIPS and ESG-related activities, they have published the latest Trends, Risks and Vulnerabilities (TRV) report.
ESMA’s press announcement flagged the current “high risks to investors of further – possibly significant –market corrections” while “markets remain nervous and geopolitical tensions are rising”.
Inside the report, ESMA maintain their summary assessment of “very high market and liquidity risks; high credit, contagion and operational risks; and elevated environmental risks”.
There is also specific concern about a “possible overvaluation of green assets” following the 2021 “investor rush” into “sustainable investment vehicles that were chasing too few assets”.
b) ESMA: Liquidity mismatch the ‘main risk’ for AIF sector
ESMA also recently published their latest annual AIF statistical report. While estimating the entire EEA-AIF market at almost EUR 6 trillion (an annual increase of 8%), ESMA state the EU hedge fund sector has “plummeted” to EUR 89 billion (a 75% reduction) post-Brexit. They remain concerned about the “main risk” of “mismatch between the potential liquidity of the assets and the redemption timeframe offered to investors”. This includes open-ended fund of funds investing in UCITS.
A reminder that last May, ESMA’s package of revised AIFMD risk guidance included:
- Their opinion that EEA-NCAs should collect additional AIFMD information where required to enable systemic risk to be monitored more effectively
- AIFMD Q&A updates to clarify the importance of 3 x Annex IV reporting fields: NET DV01, NET CS01, New Equity Delta (i.e., AIF market risk profile section)
- New NCA guidelines for firms managing leveraged AIFs which include a quarterly assessment of leverage-related systemic risk (i.e., based on supervisory reporting content supplied by AIFM/AIFs).
With all NCAs now intent to apply ESMA’s guidelines, a quarterly leverage-related systemic risk assessment (i.e. including regulators’ scrutiny of Q1-2022 Annex IV reporting information filed by AIFMs) is expected to commence during Q2-2022.
Further information on our AIFMD reporting solution is available on the Kneip website.
c) ESMA: propose “major” Money Market Funds reforms
Last week, ESMA issued their latest opinion, this time covering the Money Market Funds regulation (MMFR). Active in the EU/UK since January 2019, this regime is also currently under review by the EC (alongside AIFMD / UCITS, MiFID II and PRIIPS).
ESMA have advised the EC to proceed with their recommendations:
- major regime reforms to “improve MMF resilience”, with referral to both general liquidity issues and specific “threshold effects” for constant net asset value (CNAV) and low volatility net asset value (LVNAV) fund types.
- complementary / crisis preparedness reforms, including enhanced MMF reporting requirements and new disclosures required for MMF ratings.
Some of ESMA’s latest MMFR measures appear contrary to industry opinion received during their 2021 consultation process. Proposed changes to the LVNAV structure have been singled out for criticism in latest media coverage, including Fitch Ratings forecast these could “disrupt the industry”.
ESMA also highlighted the need for improvements to the current MMFR stress testing framework; they have now refined their Guidelines for MMF managers ahead of further review later this year to reflect specific market interdependency between different risk factors (i.e. liquidity, credit, redemptions and interest / FX rate spreads). They will publish another consultation paper on this subject by Q2 2022.
d) ESMA: launch review of MiFID II costs and charges
Earlier this month, ESMA launched a common supervisory action (CSA) focusing on the application of MiFID II costs and charges disclosure rules by the EU national competent authorities (NCAs).
This latest CSA will run for remainder of 2022; during this time, the supervisory authorities will scrutinise the effectiveness of MiFID firms’ disclosures to retail clients; these are expected to be timely, understandable and based on accurate data (i.e., reflecting all explicit and implicit costs and charges).
NB: the disparity of costs between MiFID II and PRIIPS regimes has been recognised in the funds industry for many years; the content remains of key European MiFID template (EMT) importance, with Kneip (again) ideally placed to track interim convergence efforts.
On the Kneip website, you can find out more about how we can support both your MiFID II and PRIIPs disclosure requirements.
e) ESMA: NCAs should “clamp-down” on UK firms using MiFID tied agents
ESMA also recently published a supervisory briefing to ensure uniform supervision of firms using tied agents within the EU, following their post-Brexit monitoring of MiFID firms’ behaviour.
Tied agency is now apparently a “popular” option for UK asset managers who lost their MiFID license last year; they “typically” set up a company based in a EEA member state and lease their license to a local MiFID firm, who proceed to promote investment, provide advice and administer client orders on behalf of the UK entity.
ESMA now formally recognise “potential circumvention” of the regime rules and re-iterate their expectation that “MiFID tied agents have sufficient substance in the EU” and “do not mainly rely on resources based outside of the EU in the provision of activities on behalf of the appointing firm”.
3. FinTech latest
Digitalisation is bringing profound changes across the economy, and the financial sector is no exception. It creates new linkages and dependencies, as incumbent firms partner with technology companies, and social media affects the way potential investors receive and spread information.
Verena Ross, ESMA Chair (9 February 2022)
a) ESMA: ‘keeping on track in an evolving digital world’
In her keynote speech at the latest Annual Fintech and Regulation conference, the Executive Director of ESMA covers many fast-developing areas of the new financial digital marketplace, highlighting latest opportunities alongside risks (e.g. crypto-assets and “Finfluencers”) not currently addressed by the EU regulatory framework.
b) ESAs: respond to EC Digital Finance call for advice
In February last year, the EC requested their European Supervisory Authorities (ESAs) to supply technical advice on Digital Finance. The ESAs have now published their extensive response, highlighting risks related to fragmented value chains, digital platforms, bundling of various financial services and risks of groups combining different activities.
In summary, the ESA now recommend “rapid action” from the EC, with a long list of proposals to enable a “holistic approach to the regulation and supervision of the financial services value chain” and “strengthened consumer protection in a digital context”. One key recommendation is for the EC to “update current disclosure requirements in EU law to make them fit for the digital age to allow consumers to make informed decisions about products and services”: this makes specific referral to current PRIIPS and MiFID II regimes.
The ESA report will be incorporated into the EC retail investment strategy (which will legally amend the current legal framework) expected before end-June 2022.
c) CBI: ‘highly unlikely’ to approve UCITS exposure to crypto
Finally for now, the Central Bank of Ireland (CBI) recently issued their latest annual Markets Risk Outlook report. Published in the “backdrop of continued uncertainty”, the CBI address eight areas of risk including Sustainable Finance, Financial Innovation, Data and Cyber Security.
One notable position states the CBI are “highly unlikely to approve a UCITS or a retail investor AIF proposing any exposure (either direct or indirect) to crypto-assets”, given the inherent risk facing unqualified retail investors. However, digital / crypto related assets are currently deemed “suitable” for wholesale (institutional) and professional investors.
Elsewhere, the CBI have restated their interim expectations for fund manager compliance with the SFDR / TR disclosure obligations (i.e. as highlighted in their climate change and sustainability letter issued during COP26).