MiFID II: ESMA guidance on compliance function requirements

Background

ESMA published, on 5 June 2020, new final guidelines on certain aspects of the compliance function requirements under the recast Markets in Financial Instruments Directive (MiFID II)[1].

The new guidelines replace those issued in 2012, and have been updated in accordance with MiFID II requirements – specifically article 16(2) of MiFID II and article 22 of the MiFID II Delegated Regulation[2].

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Megan Butler on the FCA’s response to Covid-19 and expectations for 2020

On 4 June 2020, Megan Butler, Executive Director of Supervision – Investment, Wholesale and Specialists at the FCA, delivered a speech on the FCA’s response to Covid-19 and expectations for 2020.

Addressing a virtual audience at PIMFA’s Virtual Festival, Ms Butler explored the FCA’s priorities and longer-term expectations, in particular for the wealth management and advice industry. Continue reading

FCA to carry out a survey of firms’ financial resilience

The FCA has announced that it will be surveying the financial resilience of around 13,000 firms from across 15 sectors. Between the 4 and 8 June 2020, firms will be sent a short survey by email to complete. In her speech at the PIMFA Virtual Festival, Megan Butler,  Executive Director of Supervision – Investment, Wholesale and Specialists, advised that firms will be given seven days to respond to the survey. The survey is intended to help the FCA better understand the effects that the Covid-19 pandemic is having on the finances of the firms it regulates and better guide its supervisory actions.

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COVID-19: Temporary bans on short selling in the EU come to an end

Those national regulators in the EU which had put in place temporary restrictions on any short selling of securities admitted to trading on regulated markets in their jurisdictions have all confirmed that the prohibitions will not be extended. However, firms should be aware that ESMA’s temporary lower net short reporting threshold will remain in force until 16 June.

National regulators – end of temporary bans on short selling

The regulators in France, Belgium, Spain, Austria and Greece have confirmed that the bans on short selling will not be extended and will expire at 11.59 pm on 18 May. The Italian regulator has also confirmed it will end the prohibition one month earlier than its original 18 June deadline at 11.59pm 18 May (in line with the other jurisdictions).

The below summary table sets out the details of each jurisdiction’s prohibition.

Jurisdiction Latest national regulator public statement Date prohibition imposed Prohibition imposed until
France AMF 18 March 18 May
Belgium FSMA 17 March 18 May
Spain CNMV 17 March 18 May
Austria FMA 18 March 18 May
Greece HCMC 17 March 18 May
Italy CONSOB 18 March 18 May

ESMA – Lower net short reporting threshold still in place

While local regulators now plan to lift the bans on short selling, ESMA has confirmed that its decision to lower the threshold at which persons who hold net short positions in companies whose shares are admitted to trading on an EU regulated market must report to national regulators to 0.1% of the issued share capital (down from 0.2%) will remain in place until 16 June.

More information about the measures put in place can be found at our previous blogpost available here.

Clive Cunningham
Clive Cunningham
Partner, London
+44 20 7466 2278
Nick May
Nick May
Partner, London
+44 20 7466 2617
Mark Staley
Mark Staley
Senior Associate, London
+44 20 7466 7621
Emma Reid
Emma Reid
Associate, London
+44 20 7466 2633

The month ahead in financial services regulatory developments…

In this blog post, we round-up forthcoming developments in the UK and at EU and International levels in financial services regulation which are expected for May 2020.

In response to COVID-19, many regulators have announced delays to planned activities and/or have revised response deadlines for open consultations. It is possible that further such announcements may be forthcoming. This note reflects the circumstances as at 1 May 2020.

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FCA publishes its Business Plan for 2020/21

On 7 April 2020, the FCA released its Business Plan for 2020/21. The FCA had planned to focus on the areas identified in its Sector Views published on 18 February 2020 (see our blog post here), but recognises that its work will be fundamentally reshaped by the impact of COVID-19.

Aware that the current circumstances create the need for it to both respond to change and initiate it, the FCA outlined plans for transforming fundamentally the way the FCA works and regulates, with a view to becoming a more efficient and effective regulator.

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ESMA proposes changes to MiFID II inducements and costs and charges disclosure regimes

On 1 April 2019 the European Securities and Markets Authority (ESMA) published its final report to the European Commission (EC) setting out its technical advice on the impact of the inducements and costs and charges disclosure requirements under MiFID II (Directive 2014/65/EU).

ESMA expresses some concerns over the efficacy of the current inducements disclosure regime and proposes some changes designed to improve clients’ understanding of inducements. ESMA considers but rejects certain more fundamental changes, including the introduction of a more general inducements ban and the creation of a new sub-category of sophisticated retail clients.

ESMA finds that the costs and charges disclosure regime generally works well and helps investors make informed investment decisions, but recommends that certain requirements should be scaled back for eligible counterparties and professional clients.

Disclosure requirements for inducements under Article 24(9) MiFID II:

Overall, ESMA finds that the impact of the MiFID II inducement disclosure rules has not been as positive as expected and has not facilitated the development of independent investment advice (with clients remaining reluctant to pay separately for such advice).

In terms of specific changes proposed, ESMA recommends that the EC take the following steps to improve client understanding of inducements:

  • clarify that the ex-ante and ex-post disclosures (where applicable) should always be made on an ISIN-by-ISIN basis;
  • introduce the obligation to include a simple, consistent explanation of the meaning of “inducements” (for instance, third-party payments) in all inducements disclosures; and
  • strengthen the MiFID II requirements around quality enhancing services by requiring firms to notify clients of the specific services the firm could be benefitting from (but reject the introduction of a closed list of quality enhancing services without further market impact assessment).

Other key areas considered by ESMA in the report are as follows:

  • A complete ban on inducements for all MiFID investment services was considered but not recommended at present. Instead, ESMA recommends that the EC assesses the potential impact of a ban and possible mitigating measures, including by consideration of more extensive inducements bans introduced in the UK and the Netherlands.
  • It is not appropriate for a new category of clients (“sophisticated retail clients”) to be created for the purposes of the inducements regime.
  • Placing agent fees or underwriting fees should only be disclosed where the firm also, respectively, provides an investment service to the investor buying the financial instruments it is placing, or sells the financial instruments issued to investors in addition to underwriting.
  • For level playing field reasons, the disclosure requirements should be extended beyond MiFID financial instruments to capture comparable investment products (in particular certain insurance products).
  • Further analysis of potential measures to tackle investor protection issues arising in bank-led closed-distribution models is recommended.

Costs and charges disclosure requirements under Article 24(4) MiFID II:

On costs and charges, ESMA is of the view that the disclosure regime generally works well, and helps investors make informed investment decisions. The main change recommended by ESMA is the reduction of mandatory disclosures for eligible counterparties and professional clients, as follows:

  • Eligible counterparties should be allowed to opt out of the entire costs and charges disclosure regime, and the obligation to provide the illustration of the impact of costs on return should never apply.
  • Professional clients should be given flexibility to opt out of the costs and charges regime entirely for investment services other than portfolio management and investment advice.
  • For retail clients or professional clients receiving portfolio management and investment advice services, the existing regime should continue to apply (subject to recommended clarifications).
  • ESMA once again rejects the creation of a sub-category of retail clients for “sophisticated retail clients”, as described above.

With regard to the current regime, ESMA believes this has proven effective so should remain in place, subject to certain recommended amendments:

  • Certain ESMA Q&As should be incorporated into the MiFID II Delegated Regulation (2017/565/EU) to foster convergence across member states.
  • Ex-post disclosures should show both total costs and costs on an ISIN-by-ISIN basis (but with more optionality for portfolio management clients). Implicit costs should be included.
  • Firms should monitor and track clients’ portfolios on a day-to-day basis so that they can show actual costs incurred by a client in ex-post disclosures as accurately as possible.
  • For telephone transactions requested by the client, where not possible to provide the ex-ante costs disclosure before the completion of transactions, disclosures may be provided immediately afterwards.
  • As with the inducements rules, the costs and charges disclosure regime should be harmonised across MiFID instruments and other substitutable products (e.g. insurance).
  • Electronic communications should become the default “durable medium” for communicating with clients (rather than requiring consent to electronic disclosure). Personalised client consent to best execution and conflicts of interest policies should also be abolished provided that they are freely available on the firm’s website.

Potential impact on firms:

The implementation of the changes recommended by ESMA will require legislative action by the EC. No indicative timetable is given and under current circumstances this could take some time to implement. The EC may also reject or diverge from the technical advice in various respects, or commission further review. It is also unclear whether and in what respects these recommendations or any subsequent legislative revisions at EC level may be taken forward by the UK.

Nevertheless, investment firms should be aware of this technical advice, as the changes recommended could, if taken forward, impact the ways in which firms communicate with and apply the rules to their client base, and the information they are required to gather and provide to clients, both for MiFID instruments and other comparable investment products. The advice also gives some indicators of ESMA’s expectations on points such as ISIN-level inducement disclosures and disclosure of implicit costs.

Firms should also be aware of ESMA’s rejection of a more flexible regime for sophisticated retail clients that cannot be opted up to professional status, and alive to the possibility that certain key areas remain under consideration, including the possibility of a more extensive inducements ban.

 

Clive Cunningham
Clive Cunningham
Partner, London
+44 20 7466 2278
Katherine Dillon
Katherine Dillon
Of Counsel, London
+44 20 7466 2522
Patricia Horton
Patricia Horton
Professional Support Lawyer, London
+44 20 7466 2789
Katie McGrory
Katie McGrory
Associate, London
+44 20 7466 2669

COVID-19: Governance: FCA and PRA publish statements on their expectations for regulated firms under SMCR (UK)

[This post was last updated on 11 May 2020 to reflect the latest FCA publication on SMCR for solo-regulated firms]

The PRA and FCA have published two statements setting out their expectations on UK-regulated firms under the Senior Managers and Certification Regime (SMCR).

A joint statement from the PRA and FCA has been published for dual-regulated firms (the Joint Statement), while the FCA have separately published a statement for solo-regulated firms (the FCA Statement).

There are also some differences in expectations as between solo and dual-regulated firms to be aware of, which we highlight below in Key expectations.

Next steps

In line with the expectations set out in the statements, firms should:

  • Ensure responsibility for the response to COVID-19 disruption is clearly allocated to an appropriate Senior Manager(s) (SM).
  • Document internally all decisions relating to interim re-allocation of Senior Management Functions (SMFs) and Prescribed Responsibilities (PRs) as a result of temporary absences during this period. Firms should be prepared to share these internal documents with the regulators on request.
  • Communicate material temporary changes to the appropriate regulator promptly (this may not need to be by way of usual SMCR notification forms).
  • Keep contingency plans under review to ensure they remain up-to-date.
  • Take reasonable steps to complete any annual certifications that are due to expire while restrictions are in place.

Key expectations

Allocating responsibility for COVID-19 response

  • Firms are not required to allocate a single SM to be responsible for response to the disruption caused by COVID-19. No “one size fits all” approach is being mandated (with the exception of requiring the responsibility of identifying key workers to be allocated to SMF1 (Chief Executive Officer) – see the FCA and PRA statements for more information).
  • In the Joint Statement, the PRA also recommends that dual-regulated firms consider how they respond to unexpected changes to contingency plans, given the possibility of SMs becoming temporarily absent. Solo-regulated firms should consider doing the same.

Temporary arrangements for SMFs and PRs

SMFs

  • Where an SM is unexpectedly absent due to illness (or other COVID-19 related circumstances) firms may choose to allocate SMFs to existing SMs. In addition, under the existing ‘12-week rule’, firms may permit an unapproved individual to perform an SMF role where such arrangements are temporary.
  • For solo-regulated firms, the FCA has issued a Modification by Consent to the 12-week rule to support firms using temporary arrangements for up to up to 36 weeks. This extended period is not currently available for dual-regulated firms (although this position remains under review).

PRs

  • The FCA and PRA expect PRs (for both solo and dual-regulated firms) to be allocated to existing approved SMs wherever possible. Where this is not possible (for example due to other SM absences), the PR can be allocated to an unapproved individual performing an SMF’s role on an interim basis.
  • All temporary changes to SMFs or PRs throughout this period should be clearly documented on internal records, including in Statements of Responsibilities (SoRs) and Responsibilities Maps (where appropriate). These records will need to be available to the FCA and/or PRA on request.

Furloughing staff

  • Both statements confirm that furloughed SMs will retain their approved status during their temporary absence and will not need to seek re-approval.
  • Certain ‘required’ functions (such as Compliance Oversight and MLRO) and/or ‘mandatory’ functions (such as the CEO, CFO and Chair of the Governing Body for CRR and SII firms) should only be furloughed “as a last resort”. Firms must arrange cover for those SMFs during the individual’s absence.
  • Firms have greater flexibility in furloughing SMs whose function are not mandatory. However, in the Joint Statement, dual regulated firms are cautioned to think carefully about the implications of furloughing non-mandatory SMFs (such as SMFs responsible for business continuity). Solo-regulated firms should also consider the implications of furloughing key senior staff.

Notification requirements during this period

All firms

  • All firms should update the FCA (and, where relevant, the PRA) by email or by telephone where:
    • unapproved individuals are acting as SMFs under the ‘12-week rule’; and/or
    • SMs have been furloughed.

Firms are not required to submit Forms C, D or J in connection with these temporary absences.

Solo-regulated firms

  • Solo-regulated firms will not be required to submit an updated SoR for approved SMs if a temporary change is made to their responsibilities. However, solo-regulated firms will still need to notify the FCA of the detail of any changes (by email or by telephone) that would normally be included in updated SoRs.

Dual-regulated firms

  • Dual-regulated firms are still required to update and submit SoRs if there are significant changesas soon as reasonably practical”. It is acknowledged in that this may take longer than usual due to current operational challenges.

No change to the obligation to certify staff as fit and proper

  • Dual-regulated firms should take reasonable steps to complete annual certifications due to expire during this period. What might constitute reasonable steps may be altered given the current situation, and certification policies and procedures may need to be adapted.
  • While not specifically addressed in the FCA Statement, in the absence of any new regulatory guidance, the FCA’s expectation appears to be that solo-regulated firms should also take reasonable steps to continue with annual certifications during this period.

Our blog post on the PRA and FCA’s guidance on key workers in financial services is available here, and our general briefing on COVID-19 – Key Issues for Employers is available here.

 

Clive Cunningham
Clive Cunningham
Partner, London
+44 20 7466 2278
Mark Staley
Mark Staley
Senior Associate, London
+44 20 7466 7621
Patricia Horton
Patricia Horton
Professional Support Lawyer, London
+44 20 7466 2789
Emma Reid
Emma Reid
Associate, London
+44 20 7466 2633

COVID-19: Pressure Points: FCA issues ‘Dear CEO’ letter with update to retail firms (UK)

The Financial Conduct Authority (FCA) has issued a ‘Dear CEO’ letter (the letter) with an update on key issues in light of COVID-19 to firms providing services to retail investors. In addition to the measures it has taken with the Bank of England (BoE) and HM Treasury (HMT), the FCA has considered many requests for forbearance and regulatory adaptations from firms and trade associations, some of which are discussed further below. The FCA has implemented a “significant package of reprioritisation and deprioritisaion of regulatory work” to allow firms to concentrate on their COVID-19 response efforts and protecting their consumers and has indicated that it will continue to update its approach in response the crisis.

The FCA will generally look favourably on forbearance requests for changes which support firms and consumers (some of which it will have the power to make immediately; others which may require co-ordination between the FCA and other UK Government or European agencies), and will only consider requests where there is a genuine need to help consumers or which, for example, would support the FCA’s response to the crisis.

Next steps for firms:

  • In light of the impact of COVID-19 on firms’ operational resilience, the FCA re-emphasised its expectations for firms to focus strongly on supporting and serving consumers and small businesses during this time. The FCA also expects firms to be actively managing their own financial resources/resilience (and in particular liquidity), with firms notifying the FCA immediately if they expect to face financial difficulties.
  • Where firms are re-directing resources due to reduced levels of staff, they should have regard to the FCA’s strong focus on consumer protection. Firms should consider documenting how these decisions are made, with the aim of allocating resources to achieve consumers protection as far as possible during this time.
  • Firms should keep up-to-date with developments by regularly checking the FCA’s website to ensure they are aware of the regulations and rules which continue to apply to them. Firms should also remain vigilant of scams which are increasingly prevalent during the COVID-19 crisis; both the FCA and National Crime Agency have released warnings on rising fraud levels and firms have a responsibility to ensure that consumers are protected.
  • Firms may also wish to consider making use of dialogue between trade associations and the FCA where appropriate to raise prevalent operational challenges with the FCA.

Key areas of focus:

In addition to the above, the FCA sets out in the letter its approach to a number of key issues to help firms manage their response to the crisis:

  • Financial resilience – The FCA has already published guidance on financial resilience and prudential issues. Importantly, the FCA has clarified that government loans cannot be used to meet capital adequacy requirements as they do not meet the definition of capital. Firms therefore need to ensure that they have other appropriate funding available to meet their capital adequacy requirements, if necessary.
  • Flexibility for client identity verification – Whilst firms must continue to comply with their obligations under the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) to verify clients’ identities, they can be flexible with how they achieve this. The MLRs and Joint Money Laundering Steering Group guidance already provide that client identity verification can be carried out remotely, and outline appropriate safeguards and checks which firms can implement to assist with verification – some examples are given by the FCA. Firms can also consider seeking additional verifications once restrictions on movement are lifted.
  • Flexibility over best execution reports – The FCA and the European Securities and Markets Authority (ESMA) have both published clarification for firms on best execution obligations in the current climate (the ESMA public statement is available here). The FCA expects firms to continue to meet their best execution obligations, including on client order handling, taking into account current market conditions when determining the relative importance of execution factors. Firms may wish to consider using different types or orders to execute client orders and manage risk during market volatility.

Following ESMA’s guidance, the FCA will not take enforcement action where a firm:

    • does not publish its RTS 27 report by 1 April 2020, provided it is published no later than 30 June 2020; or
    • does not publish RTS 28 and Article 65(6) reports, provided they are published by 30 June 2020.
  • Flexibility over 10% depreciation notifications – Firms will not be required to inform investors in every instance where the value of their portfolio or leveraged position falls by 10% or more in value. Instead, until 1 October 2020, the FCA has confirmed that it will not take enforcement action provided that a firm:
    • has issued at least one notification to retail clients within a current reporting period notifying them that their portfolio has decreased in value by at least 10%; and
    • subsequently provides general market updates online, through other public channels, and/or generic, non-personalised client communications; or
    • chooses to cease providing 10% depreciation reports for any professional clients.

In what is currently a highly volatile market, firms may wish to think about adopting this new approach which could ease the impact of repeated communications on consumers and the operational burden on themselves, or using email or phone calls to notify clients as opposed to written notifications.

  • Pause on implementation of measures – The FCA’s policy statement on pension transfer advice has been delayed until Spring 2020 and follow-up work on assessing the suitability of retirement income advice has been paused. Rules on investment pathways and platform switching provisions have already been made; these have been referred to the FCA Board for further consideration. Ongoing work with firms providing defined benefit transfer advice will continue.

 

Clive Cunningham
Clive Cunningham
Partner, London
+44 20 7466 2278
Susannah Cogman
Susannah Cogman
Partner, London
+44 20 7466 2580
Mark Staley
Mark Staley
Senior Associate, London
+44 20 7466 7621
Katie McGrory
Katie McGrory
Associate, London
+44 20 7466 2669
Patricia Horton
Patricia Horton
Professional Support Lawyer, London
+44 20 7466 2789
Cat Dankos
Cat Dankos
Regulatory Consultant, London
+44 20 7466 7494