Regulatory watch UK and EU update
A) UK latest
1. UK post-election catchup
“There will be no return to the single market, the customs union, or freedom of movement.” Labour Party Manifesto, 13 June 2024
One of the key pledges of the new UK Government is “to improve the UK’s trade and investment relationship with the European Union, by tearing down unnecessary barriers to trade”.
At last week’s NATO summit, the new UK Prime Minister confirmed his “reset” of EU relations, ahead of the European Political Community (EPC) conference, plus meetings with the Irish Taoiseach and French President.
Keir Starmer had previously stated he would “not want to diverge” from the EU, if he won the UK election.
He affirmed his intention to re-negotiate the EU–UK Trade and Cooperation Agreement (TCA), agreed in December 2020. This contains no equivalence decisions relating to financial services, meaning that UK firms have since lost their ability to ‘passport’ their financial products within the EU single market.
In contract with his predecessor, Mr Starmer had also expressed enthusiasm for a second UK referendum on EU membership. However, Starmer has lately ruled out UK rejoining the EU single market “…in his lifetime”.
2. The usual suspects
So, which options are now available to progress? Let’s reacquaint ourselves with the usual post-Brexit contenders:
- ‘Norway’ deal: Norway has been part of the European Economic Area (EEA) since 1992. This enables access to most of the EU single market, however, the ‘four freedoms’ (movement of labour, capital, goods and services) must be upheld, with all EU laws applied. Crucially, there is no formal participation in the legal decision-making process (i.e. “rule takers, not rule makers”). Despite media reports of widespread voter support, this type of deal seems a complete non-starter, given the latest UK government key pledges and statements.
- ‘Switzerland’ deal: Switzerland operates outside the EEA, as a member of the European Free Trade Association (EFTA). This is based on over 120 individual bilateral agreements, evolving since 1972. This enables access to some parts of the single market, plus free movement within the Schengen area. The EU are unlikely to seek replication of this very complex arrangement. In terms of financial services, while EEA-based firms can readily market their funds to Swiss clients, local firms are largely restricted from selling their products within the EEA.
- ‘Canada’ deal: the Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada entered into force on 21 September 2017, over ten years after original inception. ‘Financial services’ include asset management (i.e. collective investments, plus portfolios, cash and pension funds). EU-UCITS and AIF products are primarily sold to local investors on a private placement basis, using EU disclosures with a local ‘Canadian wrapper’; however, firms cannot register these for retail distribution.
3. Latest GovUK advice
Since the election, the Centre for European Reform thinktank wrote an open letter, with ten proposals on how the new Prime Minister can now encourage better relations with Europe.
Assuming sufficient good faith can be restored, one tip – “be ready to bargain with the EU” – prompts the UK pursue a ‘dynamic regulatory alignment’ in certain sectors, which would “delight businesses which hate having to deal with two sets of rules.”
Can the new UK government begin a new EU dialogue to better align financial services? Will they extinguish the previously ignited “bonfire of EU legislation”?
Where does this leave the UK Smarter Regulatory Framework (including a full review of local UCITS, AIFMD regimes this year, plus PRIIPs replacement before 2027)?
Finally, will there be any interim changes to the local Sustainability Disclosure regime, e.g. the H2-2025 legal placeholder for EU-UCITS?
Watch this space.
4. FCA: post-election updates awaited
“As you know much of asset management regulation is contained in assimilated EU law through an alphabet soup of UCITS, AIFMD and some parts of MIFID, where we are working through a process of repeal and replacement.” Ashley Alder (FCA Chair), 22 May 2024
On the same day the UK election was called, the chair of the Financial Conduct Authority declared their ‘ambitious agenda for UK asset management’ at a Bloomberg forum. Notable statements included:
- Smarter Regulatory Framework: aside from his colourful quote (above), the FCA chair did acknowledge that many in the industry prefer the UK “to remain broadly aligned with EU rules… especially for retail funds.” He re-affirmed the FCA’s plan to make local AIMFD regime rules “far more proportionate”; this follows his previous commitment of a 2024 FCA consultation, covering UK-AIFMD changes, plus a review of non-UCITS retail (NURS) fund rules.
- Retail Investments: the planned local revocation of PRIIPs was “certainly welcomed,” with the FCA “looking forward to consulting on a new regime that is proportionate and tailored to the market and products here in the UK, and which allows firms to design a more engaging consumer journey”.
- Sustainability Disclosure Requirements (SDR): the need for ‘international interoperability’ with other global ESG disclosure regimes was re-stated, in view of the previous UK Treasury’s intention to consult on extending SDR rules to EU products, within the long-term Overseas Fund Regime.
Although the FCA operates as an independent financial regulator, it remains accountable to both the UK Treasury and Parliament (i.e. now under new management, following the general election result). It remains to be seen if any of their ‘ambitious agenda’ will now be changed.
NB: The latest edition of the FCA’s Regulatory Initiatives Grid (now shared with the UK Treasury) was delayed ahead of the recent election. Members of the FCA Regulatory Initiatives Forum will consider when an update will follow, “later this year”.
5. Investment trust cost disclosure reforms “lost” amid UK election
Alongside many Conservative MPs, another casualty of the UK election was the attempt to legally resolve the long-running investment trust cost disclosure issues.
The private members ‘Alternative Investment Fund Designation Bill’ was drafted to exempt listed investment companies from “a series of regulatory requirements to disclose certain costs and charges to their clients, on the basis that such costs are already accounted for in those companies’ share price.”
However, despite successfully passing all readings within the House of Lords, this was effectively ‘lost’ as a result of the surprise election declaration. Thus, the Parliamentary effort to change these specific cost disclosure rules must now start again from scratch.
The chairman of the Association of Investment Companies (AIC) has now called on the new UK Government to “urgently fix” this issue, which they have actively pursued since 2018.
6. Reminder: Consumer Duty deadline
Firms within scope of the UK Consumer Duty must complete their first review of closed-end products (against all Duty aspects), before 31 July 2024.
The FCA recently updated their Consumer Duty information for firms, ahead of the next local deadlines. There is now additional information regarding the content and process of the first ‘Annual board reports’, required on the same date.
B) EU institutions latest
1. EP post-election results, EC next steps
“The relationship between the EU and the UK is rooted in our shared values and longstanding friendship. As allies and partners, it is in our common interest to continue working closely together.” Roberta Metsola (EP President), 5 July 2024
Since our last update, the European Parliament (EP) elections were also held.
The results were said to show a clear rightwards shift, with ‘Patriots for Europe’ and European Conservatives and Reformists blocs gaining seats, at the expense of liberal ‘Renew’ and progressive ‘Green’ alliances.
The centrist European People’s Party maintained their position as the largest EP group; this is led by the incumbent EU Commission (EC) President Ursula von der Leyen, who will this week try to secure a majority to continue in this role for another five years.
Once appointed, the remit of the new EU Commission will begin on 1 November 2024.
Ongoing, they will assume direct responsibility for the future direction of key initiatives, such as the Capital Markets Union (including Retail Investment Strategy), the Sustainable Finance Action Plan (including SFDR and Taxonomy regimes), the European Green Deal and EU Digital Strategy.
2. CoEU role in future UK trade discussions
“I look forward to working with you and your government in this new cycle for the UK.” Charles Michel (CoEU President), 5 July 2024
A reminder that alongside the new European Parliament and Commission, the Council of the EU (CoEU) plays a critical part in the functioning of the European Union legal process.
The CoEU comprises government ministers from each EU member state; along with the EP, they must formally approve any future changes to EU legislation (i.e. ‘Level 1’ or ‘Level 2’) before these can be enacted.
This includes any changes to current UK trading conditions, which will require majority approval.
The CoEU President will join the new UK Prime Minister at this week’s EPC conference.
NB: the CoEU’s General Affairs Council recently received a Franco-German working group report that proposed a ‘four-tier Europe’, that would offer the UK access to the single market as an ‘associate member’.
3. Status: Retail Investment Strategy
Last month, the CoEU ministers agreed their negotiating position on the Retail Investment Strategy.
Their formal statement points to changes they say are necessary to disputed future rules covering Inducements and Value for Money; they also shared marked-up legal texts, highlighting major revisions to cornerstone Directives (such as UCITS, AIFMD and MiFID II), along with the PRIIPs regulation.
This paves the way for future EP negotiations, in the effort to finalise the EC’s daunting legal proposals.
The EU ‘trilogue’ negotiations are expected to begin after the new Commission commence their term of office. Given the extent of complex legal updates, these are expected to last at least 12 months.
The legal application dates of each RIS legal texts remains a crucial item on the EU dialogue agenda.
NB: The original RIS legal package was unveiled by the outgoing EC over a year ago; the EU Parliament previously shared their amended ‘Omnibus’ Directive and PRIIPs Regulation texts in late April.
C) EU supervisory authority latest
1. ESMA propose CMU improvements
The Capital Markets Union (CMU) was originally announced by the EC back in 2015, with a long-term aim to create a single market for capital: i.e. “to get investments and savings flowing across the EU so that it can benefit consumers, investors and companies, regardless of where they are located”.
It is widely expected the next EU Commission will reveal their new CMU strategy next year (i.e. following the trend of high-profile 5-year Action Plans, adopted by their predecessors in 2015 and 2020).
Meanwhile, the European Securities and Markets Authority (ESMA) recently published a position paper ‘Building more effective and attractive capital markets in the EU’ . This was accompanied by a factsheet and press event.
In their CMU assessment, ESMA note “gradual progress made to improve efficiency, scale and resilience”. However, they conclude EU capital markets are presently:
- ‘Hampered’: “by an over reliance on the banking system”;
- ‘Underdeveloped’, with diminishing EU share of global equity market: 2009 (16%) 2023 (11%);
- ‘Fractured’: with EU asset management sector relatively un-scalable, compared to the United States.
Within the EU, there are 31,004 UCITS funds: averaging €400 million net assets. Within the US, there are 11,996 mutual funds/ETFs, averaging €2.7 billion net assets.
ESMA also point to “new geopolitical, environmental and societal challenges mean that a renewed momentum and greater commitment is needed to boost our capital markets“, including the support of “growth, innovation and competitiveness for the European economy”.
Hence, the need for ESMA’s twenty CMU recommendations, split across three groups (‘EU citizens’, ‘EU companies’ and ‘EU regulation and supervision’).
Eye-catching suggestions for the new EC to consider include:
- Create a voluntary ‘EU-label’ for “basic, non-complex” products: suitable for retail investors;
- Create a ‘simple’ advice category for basic investment products;
- Support digital solutions for retail investors (e.g. “safe and suitable investor tools”);
- Promote EU capital markets as a hub for green finance: “aid investor comprehension” via simplified ESG disclosures and use of sustainability product labels/categories;
- Modernise the EU financial services regulatory framework: EU co-legislators deploy Regulations instead of Directives, while considering “more principles-based legislation”;
- EC, ESMA to “streamline and tidy-up the single rulebook” in the next legislative cycle (including addressing inconsistencies and complexities across sectors).
2. ESMA update Q&As
You may have noticed that ESMA no longer publish updated ‘Level 3’ Q&A documents in relation to their directly administered regimes (e.g. UCITS, AIFMD, MiFID II, etc).
Instead, ESMA’s responses to queries raised can be viewed by direct interaction within their ‘Questions and Answers’ website. Recent ESMA Q&A updates include:
a) UCITS Directive:
- Performance Fees: Fund of Funds, Reference Indicators
- Derogation: newly authorized UCITS
b) AIFM Directive:
- Performance Fees: Fund of Funds, Reference Indicators
- Capital Requirements: Initial capital and additional own funds
- Cross-border distribution of funds: Notification upon establishment of a branch
NB: for now, the separate Level 3 Q&As from the joint European Supervisory Authorities (ESAs) seem to be updated and published as PDFs, as before (e.g. PRIIPs KIDs, SFDR/TR Level 2 disclosures).
3. ESMA consult on LMTs for AIFs, UCITS
In relation to ESMA’s current remit for AIFMD II / UCITS VI, we understand they will until 2025 before starting a dialogue on potential Supervisory Reporting and data collection improvements.
Meanwhile, they now seek input on other draft guidelines and technical standards, aiming to secure harmonised liquidity risk management within the funds sector:
a) Draft LMTs RTS: Within the draft Level 2 document, ESMA propose rules for nine types of specified liquidity management tools (LMTs), such as swing pricing. They cover specific LMT characteristics, calculation methodologies and activation mechanisms. The legal application date is yet to be confirmed.
b) Draft LMT Guidelines (UCITS, AIFs) : in this separate document, ESMA provides draft guidance on how managers should select and calibrate LMTs, considering respective investment strategy, liquidity profile and the redemption policy of the fund. They also propose appropriate disclosure to investors [p.30-33], within the fund documentation, rules or instruments of incorporation, prospectus and/or periodic reports, in relation to LMT selection, activation and calibration. This includes “sufficient pre-contractual information”. This is based on cited best practice from IOSCO and the Financial Stability Board.
Both consultations are open until 8 October. ESMA are mandated to deliver the final RTS and guidelines before 16 April 2025.
4. NCAs prepare for CBDF L2 deadline
Last time around, we reminded you of the pending 14 July 2024 legal application of standardised notifications for EU cross-border marketing and management of AIFs and UCITS. Since then:
a) Luxembourg: the CSSF has informed supervised firms of new notification templates, to be used from 14 July. Theses can be found within their new ‘European Passport’ AIFM and UCITS website sections.
The CSSF also revised their CBDF FAQ document, accordingly. Until further notice, local entities must send the respective notification forms and annexes via email, to the indicated addresses.
NB: At some stage, a dedicated eDesk module will be implemented for these CBDF notices.
b) Ireland: the CBI also updated their websites to include new CBDF notice templates, e.g.
- UCITS: ‘Outward marketing requirements’; ManCo Art20 notification letter;
- AIFMD: Passporting and pre-marketing.
Eire firms should submit the relevant notification forms and materials to the stated CBI email addresses.
5. CSSF mop-up
Aside from CBDF notices, the CSSF have been busy with other recent communiqués, including:
- PRIIPs: UCITS firms were reminded of the need to review the content of their key information documents this year, including referral to the local FAQ (which “encourages” firms to “annually update the PRIIPs KID for UCITS and to subsequently submit such document to the CSSF within 35 business days after 31 December of each year”).
- AIFMD reporting: it was formally confirmed that only the CSSF’s API (S3) channel or eDesk procedure are available for the ongoing transmission of local Annex IV reporting.
D) EU artificial intelligence latest
“A machine-based system that is designed to operate with varying levels of autonomy and that may exhibit adaptiveness after deployment, and that, for explicit or implicit objectives, infers, from the input it receives, how to generate outputs such as predictions, content, recommendations, or decisions that can influence physical or virtual Environments”. Definition of ‘AI system’ (AI Act), 12 July 2024
1. ‘AI act’ published in EUOJ
Last Friday, the Artificial Intelligence (AI) regulation was published in the EU official journal.
The legal application of the EU-AI act will now be phased in over the next three years:
- 2 Feb 2025: prohibitions on AI practices with identified ‘unacceptable’ level of risk;
- 2 Aug 2025: specific requirements on providers of general-purpose AI systems (GPAIs) will take effect (e.g. language-learning and foundation models);
- 2 Aug 2026: remaining obligations pertaining to Annex III (e.g. AI used in relation to financial services, insurance and critical infrastructure, as well as biometrics, education, employment);
- 2 Aug 2027: remaining obligations relating to ‘high-risk AI systems’ that were covered by previous legislation (e.g. medical devices, machinery, radio equipment).
2. EC begin ‘targeted’ AI consultation
The EC recently launched a targeted consultation on the use of AI in the financial sector.
They are now targeting feedback from all EU financial stakeholders; their consultation covers AI use cases, benefits, barriers, risks and stakeholder needs. It is spread across three parts:
Part 1 [p.5-10] contains thirty-two general questions of AI used in financial services;
Part 2 [p.11-18] contains one question, applied to specific use of AI within certain sectors. There are eight queries for asset managers within the scope of UCITS, AIFMD and MiFID regimes. Possible AI use cases range from risk and portfolio management, robo-advice, regulatory compliance, market abuse and customer service. This includes functions delegated to third parties.
Part 3 [p.19-22] contains ten questions in relation to the recently published EU-AI act.
The EC will “particularly welcome” views from companies that already provide or develop AI systems.
The consultation is open until 13 September 2024.
NB: The EC will also co-host a series of autumn workshops with the ESAs and local regulators to “give stakeholders the opportunity to present projects and exchange about the latest developments”. Registration is open until 26 July.
3. ESMA guidance for MiFID firms using AI
ESMA also provided initial guidance to firms using AI, when providing MiFID investment services to retail clients.
Their recent statement covers specific potential AI use cases by MiFID firms, including customer support, fraud detection, risk management, compliance and supporting the provision of investment advice and portfolio management. Although ESMA recognise that potential benefits are now available to firms and clients, they point to specific current AI technology risks, such as:
- ‘Algorithmic biases’ and other data quality issues;
- ‘Opaque decision-making’ by firms’ staff members;
- ‘Overreliance on AI for decision-making’ by both firms and clients;
- ‘Privacy and security concerns’: linked to the collection, storage, and processing of the large amount of data needed by AI systems.
When using AI, firms are now expected to comply with relevant MiFID II requirements, especially organisational aspects, conduct of business, and the regulatory obligation to act in the best interest of the client.
NB: ESMA acknowledge this statement as “initial guidance” and encourage firms “to seek further resources and engage with their supervisory authorities to navigate complex AI-related challenges effectively”.