Latest regulatory update

1. UK developments

a) GovUK: financial services “overhaul” pending

Despite recent political developments in London, it is widely reported that the UK Government intend to publish their landmark Financial Services and Markets Bill, next week.  Bloomberg sources say this will see the “most important revamp of regulations for the local financial services industry for several decades”.

At this stage, the extent of the anticipated EU financial regulation “bonfire” (post-Brexit) remains unclear.

b) PRIIPS: FCA re-state mandatory UCITS-KIID for EEA firms

Last night, the Financial Conduct Authority (FCA) refreshed the temporary permissions regime (TPR) website.  They re-state that EEA UCITS must continue to supply a UCITS-KIID to UK investors until (at least) 31 Dec 2025.   This means EEA UCITS firms remain obliged to provide two pre-contractual disclosure documents from 1 Jan 2023 (i.e. UCITS-KIID, EU-PRIIPS KID) for the same product marketed in the EU and UK.

The FCA also recently made some ‘minor’ amendments to the UK-PRIIPS KID technical specification.  The anti-dilution benefit rule now accurately states this should only be taken in account “to the extent that the benefit does not take the total transaction costs below zero”.

c) AIFMD: FCA flag RegData XML upload issue

We previously mentioned the 3-month extended deadline for the first set of UK-AIFMD reporting (Q2-2022) announced by the FCA.  Firms now have until 31 October to file their updated version of the Annex IV supervisory reporting (including revised templates).

On 1 July, the FCA reported an issue on their RegData notice board [i.e. AIF002 duplication XML upload].

NB: Kneip are able to file within the original due date of 1 August 2022 and are unaffected by this case (which currently remains open).

d) UK Sustainable Finance latest

Last week, the FCA updated their Sustainable Disclosure Regime (SDR) website to formally confirm postponement of their draft SDR policy statement:

“We had aimed to consult in Q2 of 2022. We are now planning on consulting in the autumn, to allow us to take account of other international policy initiatives and ensure stakeholders have time to consider these issues.”

There remains no sign of the UK Taxonomy (ESG classification system), scheduled to appear last quarter.

The Green Taxonomy Advisory Group (GTAG) was appointed in 2021 as independent expert advisors on the development and implementation of a UK Taxonomy, including respective technical screening criteria (“TSC”) on specific “sustainable” economic activities.

In a recent interview with RI Europe, the GTAG chair suggested that the UK Taxonomy may be “slowed” to ensure the UK “gets it right first time”.  Ingrid Holmes cited the “UK benefitting from not being the first mover in taxonomy creation”, with likely “potential divergence” areas from the EU.  However, she conceded that the UK taxonomy was “ultimately political”, referring to apparent differences of opinion between GTAG and the UK Government over the inclusion of gas and nuclear industries.

e) FCA: publish UCITS side pocket policy statement (06/07)

ESMA’s recent public statement outlined necessary fund manager actions to mitigate the impact of Eastern Europe developments. The FCA have now published a detailed policy statement defining a local side pockets framework that applies to authorised fund managers (AFMs), following the Russian invasion of Ukraine.

The FCA clarify that UCITS KIIDs are not required for the new side pocket classes, while investment objectives and policies are not deemed fundamental changes (i.e. requiring prior approval at unitholder meetings).

f) FCA: Customer Duty rules imminent

This FCA will shortly publish another policy statement, confirming the rules of a new Consumer Duty regime.

The previous 243-page FCA consultation paper fleshed out what they had described as “a paradigm shift in our expectations of firms in retail markets.”  One notable component is the Assessment of Value (AoV) obligation extended to all firms manufacturing and distributing retail products.  AFMs also face having to supplement current AoV disclosure statements with a formal identification of appropriate distribution channels for the target market of their products.

The new UK fund Consumer Duty rules are set to apply from 30 April 2023.

g) IA: publish Investment Fund 3.0 proposals

Kneip are a member of the UK Investment Association (IA), whose latest ‘Investments for the future’ report attracted notable media attention.  At the centre of their evolving Investment Fund 3.0 vision lie “three potential paths for a tech-powered UK fund industry”, which may include:

• “Hyper customisation… where individual preferences shape portfolios”
• “Regulated routes” for “native digital asset exposure”
• UCITS / domestic funds with “well-diversified portfolios”: now eligible for cryptoassets

The IA now predict the UK funds industry “is about to undergo an exciting next stage of development”.

 2. EU latest: ESG disclosure

 a) SFDR/TR status

Today, the European Commission’s delegated Climate Act was published in the EU Official Journal, to apply from 1 January 2023.

This followed the European Parliament (EP) vote on 6 July 2022 not to block the inclusion of gas and nuclear energy as ‘transitional’ activities in the Taxonomy regulation (TR).

By default, the European Council (EUCO) had also adopted the EC’s legal text (i.e. with insufficient Member States objecting).  However, it has emerged that Austria and Luxembourg plan to file a lawsuit at the European Court of Justice, citing “greenwashing” of the EU Taxonomy itself.

Separately, the EP and EUCO now have until 6 October to formally endorse the existing draft SFDR/TR RTS scheduled to apply from 1 January. The European Supervisory Authorities (ESAs) have been mandated by the EC to update their RTS in relation to the complex Principal Adverse Impact (PAI) indicators.

ESMA are also scheduled to conduct two separate SFDR/PAI consultations this year (during Q3 and Q4).

b) TISA: issue EET Best Practice guide

The Investing and Saving Alliance (TISA) is a UK-based trade organisation of over 240 member firms representing all sectors of the financial services industry, including Clearstream.

Kneip are also a founding member and partner of TISA’s Universal Reporting Network (TURN) solution.

TISA recently published their Best Practice Guide to assist financial market participants faced with completing their initial European ESG Template (EET). It is designed to specify the data required for each section in the first phase of the EET from an operational perspective during the current first phase of the EET deployment.

A reminder that a full population of all mandatory EET data items will be required from 1 January 2023.

c) Sustainability rules pending: UCITS, AIFMD

SFDR-related sustainability rules for UCITS and AIFMD entities come into effect on 1 August 2022.

New obligations for both regimes include the integration of ‘sustainability risks’ into the fund management process, alongside formal consideration of ‘sustainability factors’ and any relevant PAIs, as part of the investment due diligence.  

It is reported that firms are “struggling” ahead of this imminent deadline, given the current shortage of qualified senior sustainability risk managers and “dearth of ESG knowledge among directors”.

d) Sustainability rules pending: MiFID II

More SFDR-related deadlines loom ahead for MiFID II firms (in two phases).

Firstly, investment firms are obliged to apply ‘sustainability factors, risks and preferences’ into their organisations and operations from 2 August 2022. Unfortunately, ESMA’s draft Guidelines – which include an updated suitability assessment (to reflect client sustainability preferences) – have yet to be finalised and published.

Secondly, manufacturers and distributors are also obliged to further apply ‘sustainability factors’ to their product governance duties from 22 November 2022.  One key impact area is the target market identification, currently embodied in the European MiFID template (EMT).

Last week, ESMA began another consultation on their latest draft MiFID II product governance guidelines.

Open for comment until 7 October, proposed sustainability-related amendments include:

• A new “clustering approach” for target market identification: based on a group of comparable products (instead of each individual product)
• Sustainability-related objectives can be excluded from any ‘negative’ Target Market assessment.

NB: ESMA expects to publish these final guidelines in Q1-2023 (i.e. after most MiFID II and SFDR/TR deadlines have passed).

e) ESMA: analyse ESG ratings data providers

ESMA have also published the results of their call for evidence analysing information on ESG rating providers.

59 ESG ratings providers are identified as currently ‘active’ in “an immature but growing” EU market.

ESMA note “a small number of very large non-EU headquartered providers”, with 65% of respondents not subject to any EU financial regulatory regime.

The most popular data providers mentioned are MSCI, Morningstar/Sustainalytics, Institutional Shareholder Services (ISS) and Moody’s/VE.  However, the majority of financial market participants (22%) currently use ESG data supplied from other (smaller) providers.

3. EU latest: misc.

a) Delayed: EC retail investment strategy: delayed until 2023

Speaking at the latest EIOPA conference, the EU Commissioner for financial services revealed that the EC’s Retail Investment Strategy (RIS) will be delayed until early 2023.  This wide-ranging EU initiative had recently generated the ESA’s 150-page review of the PRIIPS framework, together with ESMA’s detailed technical advice on MiFID II retail investor protection.

b) EUCO: ESAP should be delayed

Last November, the EC published a legal proposal on their European Single Access Point (ESAP) initiative.

Originally planned for launch before 2024, the ESAP is meant to provide “a single access point for public financial and sustainability-related information about EU companies and EU investment products”.

It is also seen as a potential solution to the current shortage of ESG data.

However, the Council of EU ministers has recently agreed to seek a delayed, gradual phase-in of the ESAP platform between 2026 and 2030.

4. Market trends and commentary

a) EET “data holes” risk firms “screened out” by distributors

“The EET should be widely adopted, as it provides a clear articulation of ESG disclosures, product categorisation, entity-level disclosures and links to suitability preferences in one place. “

It was reported yesterday that unless fund firms have their European ESG template adequately populated before the August MiFID II deadline, they risk having their sustainable products “screened out” by distributors.

A notable advisory firm stated their expectation that asset managers currently producing an EMT must also make available a fully-aligned EET template (within the time remaining), to avoid any sales impact.

Likewise, a boutique platform predicted the EET will be used as a “screen by fund selectors, in the same way as art. 8 and art. 9 products under SFDR”.

b) SFDR fund downgrades “likely” before 2023

ESMA stated in their recent SFDR/TR clarifications that products with a sustainable investment objective “…should only make sustainable investments”.  This has reportedly prompted certain asset managers to conduct “feasibility assessments” of products currently categorised as ‘dark-green’ (per SFDR, article 9).

One industry insider declares that “many” SFDR art.9 fund portfolios currently contain between 20-30% of non-sustainable investments.  Another anonymous source points to one large asset manager forced to “rethink” their current ‘dark-green’ products after realising the rules “are not as flexible as we thought they were”.

Accordingly, fund lawyers now predict “likely downgrades” of products to ‘light-green’ (per SFDR, article 8), ahead of 1 January 2023.

c) MiFID II sustainability rules require product development “rethink”

There are mixed initial reactions to ESMA’s draft MiFID II product governance rules (set to apply in November).

One legal firm concludes the new sustainability-related target market rules will force manufacturers “back to the start of the product construction process.”  However, the necessary “fundamental changes to the sales and design processes” may risk a “disconnection” between asset managers and investors.

Another investment advisor also warns of unresolved sustainability “disconnects” between the regulators, manufacturers and their investors.