In this Sidley Update, we cover on the UK side the latest Market Watch newsletter published by the UK Financial Conduct Authority (FCA) focussing on transaction reporting issues, proposed amendments to the FCA Handbook, and updates on the London Interbank Offered Rate (LIBOR). On the EU side, we cover the latest on the EU Investment Firms Regulation (EU IFR), the EU Markets in Financial Instruments Directive II (MiFID II), the EU Market Abuse Regulation (MAR) and Environmental, Social and Governance (ESG) matters.
1. UK – Market Conduct and Transaction Reporting
FCA publishes newsletter on market conduct and transaction reporting issues
On 3 October 2022, the FCA published its Market Watch 70 on market conduct and transaction reporting issues.
In this edition, the FCA outlined a number of observations on the transaction reporting and instrument reference data regimes, which will be of interest to investment firms, credit institutions, trading venues, systematic internalisers, and approved reporting mechanisms. The FCA’s observations specifically relevant to investment managers include the following:
- Transaction reporting. Many firms are not conducting sufficient checks on their data (this would be done by firms accessing the FCA Market Data Processor (MDP) Entity Portal to make a transaction reporting data extract request). Reconciliations should not be limited to certain fields or to data samples that do not adequately reflect the trading scenarios and asset classes traded by a firm. Also, when firms submit errors and omissions reports to the FCA (if they do so at all), some include limited details and unhelpful references to proprietary reporting systems or processes in breach notifications; best practice includes the provision of examples to show how a field was misreported and how this will be corrected.
- National identifiers. In Market Watch 59 and 62, the FCA had highlighted that first-priority national identifiers must be used wherever available to identify natural persons in transaction reports. Despite the FCA’s warnings, the FCA continues to see firms failing to conduct sufficient due diligence when onboarding clients to obtain these identifiers. Best practices include:
– ensuring that transactions are not executed for clients until an identifier has been subject to internal review and validation;
– reviewing identifiers received to ensure that no duplicates exist within a database of clients; and
– requiring explanations from clients that do not provide a first-priority identifier.
- Principal firms (for appointed representatives). When a transaction is executed by an appointed representative who provides the investment service of reception and transmission for a principal firm that is subject to transaction reporting obligations, the principal firm should be identified in the applicable fields of its transaction report. The appointed representative should not be identified. Also, principal firms are responsible for ensuring that their transaction reports are not only complete and accurate but also able to implement an adequate systems and controls framework.
- Other transaction reporting issues. Firms are misusing the “INTC” reporting convention, for example when failing to report both the market side and client side of a transaction. Also, the venue (Field 36, RTS 22) should be populated “XOFF” by investment firms who are in a chain and who do not access a venue directly. Finally, for transactions executed in financial instruments that are not admitted to trading or traded on a trading venue (e.g., contracts for differences (CFDs)), the instrument’s full name reported should contain a clear description of the financial instrument traded (e.g., “Vodafone CFD”).
2. UK – FCA Handbook Proposed Amendments
FCA Consultation Paper on proposed amendments to the FCA Handbook
On 2 September 2022, the FCA published a Consultation Paper (CP22/17) on proposed miscellaneous amendments to the FCA Handbook. The proposed changes to the FCA Handbook that are relevant to investment managers include the following.
- Chapter 2 of CP22/17 – changes to the Glossary of definitions, the Decision Procedure and Penalties manual (DEPP), the Collective Investment Schemes sourcebook (COLL) and the Enforcement Guide (EG) to reflect amendments made to the individually recognised overseas collective investment schemes regime under Section 272 of the Financial Services and Markets Act 2000 (FSMA), together with other minor changes to COLL to reflect the UK’s withdrawal from the EU. These proposed changes will be of interest to the operators of overseas collective investment schemes currently recognised, or potentially interested in obtaining recognition, under Section 272 of FSMA as well as UK firms involved in the promotion of those schemes and UK consumers who are, or who may become, investors in those schemes. The consultation for this chapter is open for responses until 10 October 2022.
- Chapter 5 of CP22/17 – changes to clarify the definition of a “significant SYSC firm” in the FCA Handbook in line with the FCA’s statement on 16 August 2022 (discussed in greater detail in our September 2022 Update). The consultation for this chapter closed on 26 September 2022.
3. UK – LIBOR
FCA announces cessation of one- and six-month synthetic sterling LIBOR at end-March 2023
In a statement published to its website on 29 September 2022, the FCA announced its decision that following a consultation in June 2022, publication of one- and six-month synthetic sterling LIBOR will permanently cease on 31 March 2023 and urged market participants to ensure that they are prepared for such permanent cessation. This statement follows the FCA’s statement in August 2022 (as discussed in our September 2022 Update).
As regards the cessation of the three-month synthetic sterling LIBOR, the FCA stated that it is still considering responses on this question. There was support for continuing the three-month synthetic sterling LIBOR setting for a limited period beyond end-March 2023. The FCA warned that those market participants who still have contracts referencing three-month synthetic sterling LIBOR should be preparing for its cessation in due course.
4. EU – MiFID II
ESMA publishes updated Q&A on MiFID/MiFIR market structure
On 23 September 2022, ESMA published updated Q&A in respect of market structure topics under MiFID/MiFIR.
This update adds a new Q&A (35) on direct electronic access and algorithmic trading as follows.
“Question 35 [Last update: 23/09/2022] *New*
Can trading venues set specific trading hours which are applicable only to a sub-set of financial instruments (or to a specific financial instrument)?
Yes, a trading venue may set instrument-level trading hours for a specific sub-set of financial instruments (or for a specific financial instrument), provided that such specific trading hours (and the instruments to which they apply) are made public and communicated by the venue to market participants.
As an example, trading venues may set specific trading hours based on the trading hours of the underlying market (where applicable) to facilitate liquidity provisions by market makers.”
5. EU – Market Abuse Regulation (MAR)
ESMA publishes updated MAR Q&A
On 20 September 2022, ESMA published updated Q&A on MAR. This update adds two new Q&A (11) on financial guidance and disclosure of inside information and (12) on market analysts’ expectations and the identification of inside information as follows.
“Q5.11 Should the issuer generally consider the first financial guidance for a given financial year to be inside information in the context of MAR, bearing in mind that such financial guidance forms part of the financial reports prepared under the Transparency Directive and national legislation, which do not require or even anticipate premature disclosure?
A5.11 In principle, the financial expectations to be published by the issuer in certain jurisdictions (i.e. financial guidance), must follow the schedule established under the Transparency Directive (TD) and the corresponding national legislation, just like the yearly and half-yearly reports under the TD.
However, a piece of inside information under Article 7 of MAR can be identified while preparing the financial guidance, the half-yearly or the yearly reports. In that case, that piece of inside information has to be immediately published unless delayed disclosure under Article 17 of MAR takes place, irrespective of the date of publication of the financial guidance, the half-yearly or the yearly report as determined by the relevant national legislation.
Q5.12 Is the issuer permitted to take into consideration market analysts’ expectations (consensus), when considering whether an event or items in a financial report or the first financial guidance for a given financial year may constitute inside information?
A5.12 All available information has to be considered by the issuers to determine whether a piece of information may constitute inside information in accordance with Article 7 of MAR. This also includes the consensus of market analysts’ expectations.
In particular, ESMA understands that the consensus of market analysts’ expectations may impact the market expectation (also known as investor sentiment) and would be part of the investment decision, which is described in Article 7(4) of MAR.
As a side note, ESMA reminds that delayed disclosure of inside information is likely to mislead the public “where the inside information is in contrast with the market’s expectations, where such expectations are based on signals that the issuer has previously sent to the market, such as interviews, roadshows or any other type of communication organised by the issuer or with its approval” (Guideline 2.c of MAR Guidelines on delay in the disclosure of inside information and interactions with prudential supervision).”
6. EU – Investment Firms Regulation (IFR)
RTS on fixed overheads requirements under the IFR
On 25 September 2022, Commission Delegated Regulation (EU) 2022/1455 of 11 April 2022, supplementing the Investment Firms Regulation (Regulation (EU) 2019/2033) by setting out the regulatory technical standards (RTS) for own funds requirement for investment firms based on fixed overheads came into force (having been published in the Official Journal of the European Union 20 days earlier).
The RTS, as set out in the Delegated Regulation, specify:
- the elements to be deducted by investment firms from their total expenses used for the calculation of the fixed overheads requirement;
- the additional elements to be deducted from the total expenses by commodity and emission allowance dealers; and
- the conditions for determining whether material change has occurred in the activity of an investment firm for the purposes of Article 13(2) of the EU IFR.
7. EU – ESG
Final ESMA Guidelines on the new MiFID II Suitability Requirements
On 23 September 2022, the European Securities and Markets Authority (ESMA) published its final guidelines on the new MiFID II suitability requirements (i.e., the new sustainability preference requirements), which came into effect on 2 August 2022 for EU (but not UK) MiFID firms (as discussed in our September 2022 Update). The new sustainability preference requirements aim to increase investor protection under the MiFID framework and apply to the provision of any type of investment advice, whether independent or not, and to portfolio management.
The final guidelines build on the 2018 ESMA guidelines and address the responses to the consultation published by ESMA on 27 January 2022 on its proposed draft guidelines on the new sustainability preference requirements (discussed in our September 2022 Update). The final guidelines aim to rid competent authorities and firms of the uncertainty created by the fact that the new sustainability preference requirements came into effect on 2 August 2022 without finalised guidance on the changes that firms will need to make to their suitability assessments to comply.
The key final guidelines can be summarised as follows:
- Information to clients on the sustainability preferences – Firms will need to help clients understand the concept of sustainability preferences and explain the difference between products with and without sustainability features in a clear manner and avoiding technical language.
- Collection of information from clients on sustainability preferences – Firms will need to collect information from clients on their preferences in relation to the different types of sustainable investment products and to what extent they want to invest in these products.
- Assessment of sustainability preferences – Once firms have identified a range of suitable products for individual clients, in accordance with the criteria of knowledge and experience, financial situation, and other investment objectives, firms shall identify the product(s) that fulfil the clients’ sustainability preferences.
- Organisational requirements – Firms will need to give staff appropriate training on sustainability topics and keep appropriate records of the sustainability preferences of clients (if any) and of any updates to these preferences.
The final guidelines will be translated in all EU official languages and will apply six months after the date of their publication on ESMA’s website in all EU official languages. The 2018 ESMA guidelines will cease to apply on the same date.
As already mentioned in our September 2022 Update, although UK (and other non-EU) firms are not in scope of these new requirements, it is likely that there will be a knock-on effect on firms whose products are invested by EU asset managers, or which are distributed via EU financial advisers, because such firms will require information as to the sustainability characteristics of non-EU firms’ products.
ESAs final draft RTS regarding exposure to investments in fossil gas and nuclear energy activities under the SFDR
On 30 September 2022, the three European Supervisory Authorities (ESAs) delivered to the European Commission their Final Report with draft RTS regarding the disclosure of financial products’ exposure to investments in fossil gas and nuclear energy activities under the EU Sustainable Finance Disclosure Regulation (SFDR).
In the amending final draft RTS, the ESAs propose to add specific disclosures to provide transparency about investments in taxonomy-aligned gas and nuclear economic activities.
Specifically, the disclosures:
- add a “yes/no” question in the financial product templates of the SFDR Delegated Regulation to identify whether the financial product intends to invest in such activities; if the answer was yes, a graphical representation of the proportion of investments in such activities would be required; and
- implement minor technical revisions to the Delegated Regulation to correct inconsistencies observed after its publication.
The ESAs consider the existing disclosures in the SFDR Delegated Regulation sufficient for fossil gas or nuclear energy investments by financial products that are not covered by the EU Taxonomy.
BaFin publishes Q&A on the SFDR
On 5 September 2022, the German Federal Financial Supervisory Authority (BaFin) published Q&A on the interpretation of the EU SFDR. The Q&A seeks to answer, amongst others, questions that arose from the European Commission’s Q&A documents published in July 2021 and May 2022 (see our June 2022 Update and, especially, our Update ‘European Commission Q&A on SFDR – Five Key Takeaways for Investment Managers for a detailed analysis of the European Commission’s Q&A in May 2022). At this time, the Q&A is available only in the German language.
The Q&A covers:
- the scope of the SFDR in relation to independent financial brokers domiciled in Germany;
- the interpretation of the term “promotion;”
- the assessment of taxonomy-alignment for investments underlying a financial product; and
- disclosures for legacy financial products.
The Q&A will inform BaFin’s administrative practice in relation to both German and foreign funds marketed in Germany unless and until they are overruled by guidance from the European Commission or the Joint Committee of the ESAs.
BaFin will be updating its Q&A on a regular basis.
The Swedish Financial Supervisory Authority concludes that disclosures of Article 9 SFDR funds are unclear
On 9 September 2022, the Swedish Financial Supervisory Authority (SFSA) announced that it had analysed the prospectuses of 30 funds registered in Sweden falling under Article 9 of the SFDR and had concluded that the disclosures of several of those funds were unclear and/or not specific enough on:
- what is considered to be a sustainable investment;
- which environmental or social objectives a fund contributes to;
- how sustainability risks are taken into account in the investment decision-making process; and
- the likely effects of sustainability risks on returns.
SFSA’s Head of Sustainable Finance, Johanna Fager Wettergren, warned that “managers need to be better at providing clear and comparable information for those who want to invest in sustainable funds” and encouraged the industry “to increase its collaboration in order to make joint assessments and use common terminology in order to make it easier for consumers to understand and compare sustainable financial products.”
The SFSA’s report in Swedish can be found here. An English translation of the report will be available in due course.