UK and EU set out their stalls on equivalence and the future trade deal (or no deal…?)

On 26 February 2020, the UK Government published its approach to UK’s future relationship with the EU.

The sections on financial services in the UK’s approach document are set out below:

Chapter 16: Financial Services

  1. The Agreement should promote financial stability, market integrity, and investor and consumer protection for financial services, providing a predictable, transparent, and business-friendly environment for cross-border financial services business.
  1. The Agreement should include legally binding obligations on market access and fair competition, in line with recent CETA precedent.
  1. The Agreement should also build on recent precedent, such as the EU-Japan EPA and international best practice, by establishing regulatory cooperation arrangements that maintain trust and understanding between our autonomous systems of regulation as they evolve. This could include appropriate consultation and structured processes for the withdrawal of equivalence findings, to facilitate the enduring confidence which underpins trade in financial services.

Equivalence in Financial Services

  1. The UK and the EU have committed to carrying out unilateral equivalence assessments for financial services, distinct from the CFTA. The fact that the UK leaves the EU with the same rules provides a strong basis for concluding comprehensive equivalence assessments before the end of June 2020.

Unsurprisingly, these are brief and outcomes-focused in nature, reflecting the Government’s approach more generally and the desire for “autonomous systems of regulation” (as preserved under the EU-Japan Economic Partnership Agreement)  rather than close alignment. The comments on equivalence do serve as a reminder to the EU that the UK will nonetheless be starting from a position of close alignment, but as ever, there are no guarantees that this challenging deadline for completing assessments will be achieved.

On the same date, the European Commission has also published a speech delivered by Michel Barnier, the EU’s chief negotiator on its future relationship with the UK, addressing the potential for UK/EU co-operation post-Brexit. The tone of the speech is characteristically challenging of the UK’s perceived desire to preserve sovereignty and regulatory autonomy while maintaining access to EU markets. Mr. Barnier’s discussion of equivalence indicates the lack of appetite from the EU to develop a more extensive and durable form of equivalence for cross-border market access, as explained in the following extract:

[Equivalence in financial services]

“… The EU will have the possibility to grant equivalences. We will do so when it is in the interest of the EU; our financial stability; our investors and our consumers. But these equivalences will never be global nor permanent. Nor will they be subject to joint management with the UK. They are, and will remain, unilateral decisions.

I read in the Financial Times recently that London must retain its primacy as a hub for wholesale financial markets without becoming a rule-taker of European regulation. As a former Commissioner in charge of financial services, allow me to question that. Why should we accept that the profits stay in London while the EU carries the risks?

The UK may not want to be a rule-taker. But we do not want to be the risk-taker. When the next financial crisis strikes, who will foot the bill? I doubt the UK will foot it for the EU. That is why the EU must take the responsibility for its financial regulation, supervision and stability.”

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

ESMA publishes report on product intervention measures under MiFIR

The European Securities and Markets Authority (“ESMA”) has recently published final technical advice on the effects of product intervention measures under the Markets in Financial Instruments Regulation (“MiFIR”). ESMA makes recommendations in relation to the product intervention framework under MiFIR, including proposing extending the framework to alternative investment fund managers (“AIFMs“) and UCITS management companies. In addition, ESMA has said that it will be monitoring the markets in financial instruments linked to crypto assets as it is aware that some national competent authorities (“NCAs”) are consulting on potential product intervention measures concerning these products. If necessary, ESMA will consider exercising its intervention powers in this area.

When MiFIR was introduced in 2018, ESMA was given the power to temporarily prohibit or restrict the marketing, distribution or sale of certain financial instruments, financial instruments with certain specified features or a type of financial activity or practice. ESMA has since used this product intervention power in relation to binary options and contracts for difference (“CFDs“) due to detriment caused to retail investors. ESMA has been asked to report to the European Commission on, amongst other MiFID II/MiFIR topics, its experience of temporary intervention powers, including areas in which legislative changes might be appropriate in relation to the product intervention framework.

For more information on regulators’ product intervention powers across various jurisdictions, please see our global guide on Product Intervention Powers and Design and Distribution Obligations in Financial Services, available here.

ESMA’s technical advice

The main elements of ESMA’s technical advice are as follows:

  • Level playing field between MiFID firms and AIFMs/UCITS management companies: ESMA and NCAs currently cannot exercise MiFIR product intervention powers in relation to AIFMs and UCITS management companies despite these firms being able to carry out certain MiFID services/activities. ESMA recommends that the European Commission addresses the risk of arbitrage between MiFID firms and these fund management companies, and advises that NCAs and ESMA should have the powers to apply restrictions/prohibition directly to AIFMs and UCITS management companies.
  • Extending time validity of ESMA’s temporary product intervention powers: ESMA’s product intervention measures currently only last for a short-term period (3 months – although this period will be increased to 6 months from 1 January 2022) and reviews for extension is resource intensive and burdensome for both ESMA and the NCAs. Additionally, ESMA notes that there are divergences in product intervention measures taken by different NCAs, particularly where permanent national measures diverge from temporary ESMA ones. ESMA recommends consolidation of temporary measures into permanent ones by the European Commission, or alternatively extending ESMA’s powers to allow the introduction of temporary product intervention measures for 18 months.
  • Interaction of national product intervention measures: Article 42(1) MiFIR permits NCAs to take product interventions measures “in or from” their Member State, which ESMA suggests means that an NCA has the possibility to take measures that only apply in that Member State (and not from), and vice versa. Confusion also arises where Member States take overlapping product intervention measures. ESMA advises the Commission to clarify the application of product intervention measures to firms acting on a cross boarder basis and how those measures will be supervised and enforced.
  • ESMA opinion on proposed national product intervention measures: NCAs are required under Article 42(3) MiFIR to notify ESMA of proposed national product intervention measures, at least one month before the measure is intended to take effect, in order for ESMA to issue an opinion on the measure (Article 43(3) MiFIR). In ESMA’s view, this requirement is burdensome. ESMA advises the European Commission that NCAs should be exempt from seeking an opinion where their national measures are exactly the same as ESMA’s temporary measures, and that ESMA should have the option (not an obligation) to give an opinion in these circumstances.
  • Further clarification on Article 40(3) MiFIR: ESMA considers the wording in Article 40(3) MiFIR (“Where … competent authorities have taken a measure under Article 42, ESMA may take any … measures … without issuing the opinion provided for in Article 43”) to be unclear, and is of the view that the situation described is unlikely to occur in practice. ESMA asks the European Commission for further clarification of Article 40(3) MiFIR.

Future use of product intervention measures

ESMA is aware that some NCAs are consulting on potential product intervention measures concerning certain financial instruments linked to crypto assets. ESMA will continue to monitor markets and will exercise its coordination role in relation to measures proposed by NCAs. ESMA will consider taking product intervention measures if issues become apparent which cause significant concerns around investor protection or a threat to the orderly functioning and integrity of markets.

Next steps and Brexit

The European Commission will now present a report to the European Parliament and the Council on product intervention, and a decision will be taken on whether to adopt any of the measures set out by ESMA in this final report. If so, we may see an expansion of the scope of product intervention powers in the future.

Now that the UK has formally left the EU, the UK’s FCA is no longer a member of ESMA’s Board of Supervisors nor can it participate in any of ESMA’s other governance bodies. However, until the end of the transitional period on 31 December 2020, EU law (including MIFIR) will continue to apply to the UK as if it were a Member State, which means that ESMA will have product intervention powers over financial instruments and firms in the UK. Therefore any extension of these powers prior to the end of 2020 could have an effect in the UK. From 2020 onwards, it remains to be seen whether the UK will follow the EU’s approach in relation to product intervention.

 

Clive Cunningham

Clive Cunningham
Partner
+44 20 7466 2278

Patricia Horton

Patricia Horton
Professional Support Lawyer
+44 20 7466 2789

Katie McGrory

Katie McGrory
Associate
+44 20 7466 2669

FCA publishes Dear CEO letters to asset managers and alternative investment firms

The FCA this week published two template ‘Dear CEO’ letters, one to asset managers and one to alternative investment firms, highlighting the FCA’s views on the key risks posed to customers and markets, and setting out its supervision strategy for the coming months.

The FCA’s asset management portfolio comprises firms that predominantly directly manage mainstream investment vehicles, or advise on mainstream investments (excluding wealth managers and financial advisers), whilst its alternatives portfolio is comprised of firms that predominantly manage alternative investment vehicles (such as hedge funds or private equity funds) or alternative assets directly, or advise on those types of investments of investment vehicles.

The FCA’s key concern is that standards of governance in both sets of firms are below what it expects, and progress is needed in both sectors to protect the best interests of customers.

Next steps:

The ‘Dear CEO’ letters make it clear that the FCA will be very active in the asset management and alternatives sectors in the coming months, and firms should expect increasing scrutiny. It will be important for firms to look at the areas identified by the FCA and consider any changes they need to make.

Supervision strategy:

The FCA’s supervision strategy addresses the key issues in each sector, with specific priority areas set out below. Whilst the areas of focus are split between the two sectors, the FCA recognises that there will be overlap between the two.

Asset management:

The asset management supervision strategy will focus on the following key areas:

  • Liquidity management – Authorised Fund Managers (AFMs) are responsible for ensuring effective liquidity management in funds but the FCA warns that there can be a liquidity mismatch in open-ended funds between the terms at which investors can redeem and timescales needed to liquidate assets. The FCA expects firms to take necessary action following recent publications from the FCA and the Financial Policy Committee. This has been a continuing theme in light of the issues experienced by some real estate funds after Brexit and the collapse of the Woodford fund.
  • Firm’s governance – Following the extension of SMCR at the end of 2019, the FCA expects firms to have refreshed their approach to governance and taken the steps necessary to improve it in line with SMCR requirements. The FCA intends to carry out work in H1 2020 focussing on the implementation of SMCR across asset managers.
  • Asset Management Market Study (AMMS) remedies – The FCA published its AMMS Final Report in June 2017 and the consequential rule changes are now in force, including requirements around governing body structure and value assessment on funds. In H1 2020, the FCA plans to undertake work on how effectively firms have undertaken value assessments, with more work envisaged in the future given the breadth of the AMMS reforms.
  • Product governance – Following the introduction of new product governance requirements under MiFID II, the FCA has begun reviewing how effectively these requirements have been implemented by asset managers, and expects to complete this work in early 2020. In parallel, the FCA is also reviewing arrangements whereby funds are managed by ‘host’ Authorised Corporate Directors (ACDs) (AFMs that are not within the group structure of the delegate investment manager), as there are concerns that the ‘host’ ACD may not be undertaking their responsibilities effectively in some cases.
  • LIBOR transition – The FCA is currently gathering information from some asset management firms to enhance its understanding of business models, including their specific exposure to LIBOR risk, and intends to provide further communications on its expectations for LIBOR transition in due course.
  • Operational resilience – Operational resilience remains an area of focus for the FCA for financial services firms as a whole. In the asset management sector specifically, the FCA is conducting technology reviews and ad-hoc reviews of firms’ arrangements and expects to undertake further proactive work in this area. The FCA reminds firms of their obligations under Principle 11 to notify it of any material technology failures or cyber-attacks. For more information on operational resilience in the asset management sector, please see our blog post here.
  • EU withdrawal – With the UK’s exit from the EU approaching, the FCA expects firms to consider how the end of the implementation period will affect both the firm and its customers, and take action to be ready for 1 January 2021.

Alternative Investment Firms:

For alternative investment firms, the FCA’s supervisory priorities are as follows:

  • Investor exposure to inappropriate products or levels of investment risk – Significant levels of investment risk are inherent in alternative investments, so the FCA expects firms in this sector to carefully consider the suitability or appropriateness of these investments for their target investors. Where investors are allowed to ‘opt-up’ to elective professional client status, firms should robustly assess the client’s suitability to be opted-up. The FCA plans to review retail investor exposure to alternative investment products offered by alternatives firms, with a particular focus on firms being aware of who their clients are and acting in their clients’ best interests.
  • Client money and custody asset controls – As part of the retail investor exposure, the FCA also plans to assess whether firms which have client money or asset custody permissions are exercising them in accordance with the Client Assets Sourcebook (CASS) rules.
  • Market abuse – In the FCA’s view, market abuse control across the alternatives sector has “significant scope for improvement”. To that end, the FCA has recently conducted an assessment of the adequacy of market abuse controls in the sector and may invite firms to participate in a similar exercise in future. The FCA reminds firms that it may consider enforcement action for those firms which are found not to comply with Market Abuse Regulation (MAR).
  • Market integrity and disruption – With scope to take significant investment risk in managing their products (ie. credit risk and market risk), the FCA expects alternatives firms to operate robust risk management controls to avoid excessive risk-taking and effectively mitigate against potential harm or disruption to markets. The FCA may choose to undertake in-depth assessments of firms’ controls in future.
  • Anti-money laundering and anti-bribery and corruption – Alternatives firms face a risk of being used to facilitate fraud, money laundering, terrorist financing and bribery and corruption. The FCA intends to review firms’ systems and controls to mitigate this risk, with particular focus on the risks of money laundering and terrorist financing.
  • EU withdrawal – As above, the FCA expects firms to take steps to be prepared for the UK’s exit from the EU at the end of the implementation period on 1 January 2021.

 

Clive Cunningham

Clive Cunningham
Partner
+44 20 7466 2278

Nish Dissanayake

Nish Dissanayake
Partner
+44 20 7466 2365

Stephen Newby

Stephen Newby
Partner
+44 20 7466 2481

Tim West

Tim West
Partner
+44 20 7466 2309

Mark Staley

Mark Staley
Senior Associate
+44 20 7466 7621

Katie McGrory

Katie McGrory
Associate
+44 20 7466 2669

Herbert Smith Freehills leads ASIFMA member working group to formulate Best Practices for Effective Development of Fintech

The Asia Securities Industry & Financial Markets Association (ASIFMA) released on Friday afternoon its guide, Best Practices for Effective Development of Fintech. Its press release can be accessed here

The guide was developed by a member working group at ASIFMA led by Herbert Smith Freehills. The working group has agreed 10 best practices for policymakers and regulators in Asia Pacific to consider as they support the development of fintech in the financial services industry. The best practices acknowledge the delicate balance required between encouraging fintech innovation, and ensuring customer protection and market integrity. 

The best practices are released at a time of rapid development in fintech and increased involvement by financial regulators. Our e-bulletin regarding the best practices and the recent initiatives taken by regulators in the region to support fintech development can be accessed here.

If you would like to discuss the above further, please do not hesitate to contact Will HallattHannah Cassidy, Mark Robinson, Grace Chong, or your usual Herbert Smith Freehills contact.