Ireland and UK – Latest Regulatory Update

1. ESMA announces common supervisory action on valuation of UCITS and open-ended AIFs

On the 20th of January 2022, the European Securities and Markets Authority (ESMA) confirmed that it launched the common supervisory action (CSA) to be conducted in 2022.

The CSA is to be focused on valuation of UCITS and open-ended AIFs and to assess compliance of UCITS and AIF management companies with valuation related provisions in the UCITS and AIFMD regulations. It will focus on the valuation of less liquid assets. ESMA confirmed that this will include unlisted equities, unrated bonds, corporate debt, real estate, high yield bonds, emerging markets, listed equities which are not actively traded and bank loans.

2. ESMA Guidelines on Marketing Communications

The Central Bank of Ireland (CBI) expects management companies to comply with the ESMA Guidelines on Marketing Communication (Guidelines) entered into force on the 2nd of February 2022. Management companies need to ensure that all marketing communications regarding a fund under management comply with such Guidelines.
The risks and rewards need to be disclosed according to the Guidelines, meaning that the marketing communications need to be fair, clear and not misleading. All information on costs, past performance or expected future performance and sustainability-related aspects of the communications also need to comply with such Guidelines.

3. Update on plans to include gas and nuclear energy within EU Taxonomy Framework

The EU Taxonomy Regulation includes the requirements the companies need to comply with in order to achieve an economic activity considered environmentally sustainable. This regulation is supplemental by delegated acts which identify the specific technical criteria that need to be in place in order to achieve such goal.

The EU Taxonomy Climate Delegated Act entered into force on the 1st of January 2022 and includes the technical criteria to be in place for an economic activity to comply with the climate change mitigation or adaptation.

On the 2nd of February 2022, the European Commission has confirmed the publication of the EU Taxonomy Climate Complementary Delegated Act which was approved to include the technical screening criteria in order for an economic activity involving gas or nuclear energy to be considered environmentally sustainable. The European Commission also published a FAQ in which states this initiative is in place until better alternatives based on renewable or low-carbon technologies are sufficiently developed.

If the European Parliament and the Council of Europe have no objections to raise this legislation will apply from the 1st of January 2023.

4. Central Bank Securities Markets Risk Outlook Report 2022 – Action for Management Companies

On the 8th of February 2022, the CBI published its second Securities Markets Risk Outlook Report (Report) to confirm the key conduct risks for 2022 and what companies should do to identify, mitigate and manage these risks.

The Report focus on the key conduct risks which are relevant to the fund management companies, the funds they manage and actions to be taken to manage such risks. The CBI confirmed the risks will be related to the Sustainable Finance Disclosure Regulation (SFDR) implementation, fund liquidity and leverage, board oversight, governance structures and due diligence, conflict of interests, financial innovation and cyber security.

The report also provides the details of the supervisory priorities of the CBI for 2022 which will focus on the CSA on UCITS costs and fees and revision of the Probability Risk and Impact System (PRISM) impact rating model for funds and related supervisory expectations.

5. ESMA publishes its opinion on the review of the MMFR

On the 14th of February 2022, the ESMA published its final report (Final Report) on its opinion for the review of the Money Markets Fund Regulation (MMFR). EMAS’ recommendations include the following:

1. a decoupling of regulatory thresholds from suspensions, gates, redemption fees to limit liquidity stress for Low Volatility Net Asset Value (LVNAV) and Constant Net Asset Value (CNAV) funds;
2. Remove the possibility to use amortised costs and stable NAV pricing for LVNAVs;
3. Imposing an obligation on the EU Money Market Funds (MMFs) to have at least one liquidity management tool (LMT) available to them and activation of these liquidity management tools by the manager of the MMF;
4. Amendments of the daily liquidity asset ratios (DLAs) and weekly liquidity asset ratios (WLAs) applicable to VNAV and LVNAV MMFs as well as amending the pool of eligible assets (including public debt assets) which can be used to satisfy the liquidity ratios;
5. Inclusion and reinforcement of the possibility to temporarily use liquidity buffers in times of stress;
6. Enhancement of MMF reporting requirements;
7. Enhancement of the MMF stress testing framework;
8. Clarifications around the requirements applicable to external (sponsor) support; and
9. New disclosure requirements on ratings of MMFs.

6. EU sanctions relating to Ukraine

On the 23rd of February 2022, the European Council approved a package of restrictive measures to reflect the new EU sanctions in response to the Russian Federation’s decision to send troops to Ukraine. All EU Member States must comply with EU Council Regulations (Regulations) regarding these sanctions. The measures include:

a) restrictions on individuals and entities associated with the situation in Ukraine;
b) restrictions on trade between the affected regions and the EU; and
c) restrictions on Russian state entities, including its central bank, from accessing EU capital markets.

6.1 Implication for the Irish financial service providers

The Regulations have direct effect in Ireland and must be complied with by all Irish natural and legal persons. Irish financial services providers must comply with the new sanctions and in order to do so they will need to conduct ongoing monitoring of transactions and customers and investors.

The EU Council Regulations have direct effect in Ireland and must be complied with by all Irish natural and legal persons in the same way as domestic Irish legislation. Irish financial service providers should ensure that they are compliant with these new financial sanctions. Compliance will necessitate conducting ongoing monitoring of transactions and customers or investors.

There is a legal obligation on financial service providers to freeze the assets or funds of a sanctioned person or entity and to not transfer any funds or to not make funds or economic resources of any kind available, directly or indirectly, to a sanctioned person.

The CBI must be notified of all relevant information if a financial sanction breach or suspected financial sanction breach was identified. This is a sanctions “hit”. If there is a sanction “hit” on an entity or individual, the financial service provider must immediately freeze the account of the individual or entity and immediately stop the transaction. The financial service provider is obliged to immediately report it to the CBI.

The CBI also issued a Frequently Asked Questions (FAQ) for Credit and Financial Institutions available to assist services providers with any information regarding the sanctions. The CBI has also publish its updates regarding the Russian sanction.

7. ESAs publish revised supervisory statement on the application of the SFDR

The European Supervisory Authorities (ESAs) published an updated supervisory statement (Statement) on the application of the SFDR regarding the postponed of the entry into force of the related Level 2 measures (Level 2 Measures) until the 1st of January 2023. It also gives further guidance in relation to the disclosure of explicit quantification of the taxonomy alignment of financial products under Article 5 and 6 of the Taxonomy Regulation until the finalised Level 2 Measures enter into force on the 1st of January 2023 (Interim Period) and the use of estimates in calculating such taxonomy alignment.

7.1 Entity-level principal adverse impact reporting

The Statement confirms that for the entities that are required to comply with the entity-level disclosures of principal adverse impacts (PAI) according to Article 4 of the Sustainable Finance Disclosures Regulation (SFDR), the PAI disclosure needs to be updated to comply with the finalised Level 2 Measures from the 1st of January 2023. However, the first information relating to a reference period needs to be disclosed in the PAI published by the 30th of June 2023 covering the period from the 1st of January to 31st of December 2022.

7.2 Annual report

The annual report published falling within the scope of Article 8 or 9 of the SFDR in 2022 needs to comply with Article 11 and can use the draft Level 2 Measures as a reference.

7.3 Taxonomy-related disclosures

Any fund falling within the disclosure obligations of Article 5 and 6 of the Taxonomy Regulation needs to include explicit quantification of the extent to which the product can be considered taxonomy-aligned using a numeric disclosure as a percentage.

7.4 Use of estimates in Taxonomy-alignment calculations

The Statement indicated that estimates should not be used to calculate the taxonomy-alignment of in-scope financial products. If the information is not available from public disclosures by investee companies, financial market participants may rely on equivalent information on taxonomy alignment obtained directly from the investees companies or from third parties.

1. FCA’s Temporary Transitional Power (TTP) to end on 31 March 2022

On 31 March 2022, the FCA’s Temporary Transitional Power (TPP) ended on and now all financial services firms and other regulated entities must now ensure that they are in full compliance with all UK on-shored EU legislation.

The on-shored regulatory obligations have applied since the end of the transition period (31 December 2020), which followed the UK’s departure from the EU.
The TTP granted temporary relief from the requirement for full compliance in the areas where it was applied, meaning that firms could continue to comply with their pre-existing requirements, but were expected to use the TTP period to prepare for full compliance with the on-shored UK regime.

2. FCA publishes its final policy on PRIIPs KID in the UK

On 25 March 2022, the UK Financial Conduct Authority (“FCA”) set out its final policy position on the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation in order to address the areas of the regulation the most harm to consumers. Following the FCA’s initial consultation (CP21/23) on the PRIIPs Regulatory Standards, which sought to develop draft Regulatory Technical Standards on the content and presentation of the key investor document (“KIDs”) for PRIIPs at a European level, and having received industry wide feedback on the topic, the FCA sought to address key area of concerns, which were:

• The introduction of rules to clarify the scope of the PRIIPs Regulation for corporate bonds, making it clearer that certain common features of these instruments do not make them into a PRIIP;
• The introduction of interpretative guidance to clarify what it means for a PRIIP to be “made available” to retail investors; and
• The amendment of the PRIIPs Regulatory Technical Standards to:
  • replace the requirements and methodologies for presentation of performance scenarios in the KID with a requirement for narrative information on performance to be provided;
  • address the potential for some PRIIPs to be assigned an inappropriately low summary risk indicator in the KID; and
  • address concerns about certain applications of the “slippage” methodology when calculating transaction costs.

A transition period which will end on 31 December 2022, by which date firms must apply the new requirements.

3. FCA warning to all regulated firms with exposure to crypto assets

On 24 March 2022, the FCA published a statement regarding the existing obligations that all FCA regulated firms have when interacting with or exposed to cryptoassets. The statement referenced some key risk parameters to be considered:

• Customer Clarity: the FCA highlights that regulated firms are fully responsible for identifying and managing risks relating to cryptoassets and must ensure that consumers understand the extent of business that is regulated and clearly distinguish those elements which are unregulated.
• Financial Crime: the FCA reminds all regulated firms which carry out cryptoasset activity in the UK have had to comply with the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, and therefore must ensure they have sufficient due diligence and money laundering controls in place to manage the risks posed by their customer. This sections further adds that regulated firms should assess the risks posed by a customer whose wealth or funds derive from the sale of cryptoassets, or other cryptoasset related activities, using the same criteria that would be applied to other sources of wealth or funds.
• Prudential Considerations: the FCA reminds firms subject to the FCA’s new investment firm prudential regime, that each have its own obligations to assess and mitigate the potential for harm to clients, to the markets in which the firm operates and to itself, that could arise from all of their business.
• Custody Considerations: the FCA’s Client Assets Sourcebook (CASS) sets out rules for firms to follow when holding regulated assets in custody. Where cryptoassets are specified investments, firms carrying out regulated activities involving custody of these assets are likely to be subject to the CASS regime.

4. FCA to consult on the use of Side Pockets

On 16 March 2022, the FCA announced the start of a consultation process on allowing UK authorised retail funds to make ‘exceptional’ use of side pockets which comes in light of “significant practical challenges” in disposing of Russian and Belarussian assets given current suspensions and extensive global sanctions.

In a result of the recent sanctions, the FCA acknowledges that such assets have become difficult to sell and/or hard to value, and recognizes that the use of a side pocket would give authorised fund managers (AFMs) the option to separate these from the fund’s other main investments.

In permitting the use of side-pockets, the FCA notes that this may allow:

• new investors to enter the fund without getting exposure to Russian assets
• existing investors to redeem the rest of their investment, while illiquid Russian assets remain in the separate side pocket (and in many cases marked to zero), while retaining rights to any eventual value
• some funds to end their current suspension of dealing.

From the FCA’s statement, it is clear already that its proposals:

• shall be aimed at ensuring that any side pockets introduced (and the date on which they take effect) treat existing, redeeming and subscribing investors fairly.
• to allow an AFM to use a side pocket where it considers this to be in the best interests of the fund.
• intended to avoid speculative new investment into affected funds at the expense of existing investors.
• limit in scope to assets that are illiquid because of the Russia/Ukraine war. The precise scope remains to be determined as part of the consultation process.

The FCA’ statement reminds AFMs that it is their duty to ensure fair and accurate valuation of assets with subscriptions and redemptions taking place at a fair price.

5. FCA consult on “high risk” investments

On 19 January 2022, the FCA published consultation paper CP22/2 (“Consultation”) in which it proposes various changes to strengthen financial promotion rules for high-risk investments, including cyptoassets. The proposals relate to “high-risk investments”, assets and products that are subject to restrictions under the FCA’s marketing rules.
The Consultation would affect (i) authorised firms which approve financial promotions for unauthorised persons (section 21 approvers), whether for high-risk investments or otherwise, (ii) authorised firms which communicate financial promotions relating to investment business (iii) issuers of non-mainstream pooled investments, speculative illiquid securities and non-readily realisable securities investment-based crowdfunding platforms and other intermediaries distributing investments to consumers (iv) firms operating in the cryptoasset market, (v) trade bodies for the investment-based crowdfunding, (vi) peer to peer and crypto-asset sectors, (vii) financial advisers, (vii) asset managers with experience of managing illiquid, long-term assets and (viii) potential investors in long-term asset funds (in scope firms).

The Consultation proposes amendments to:

• the FCA’s classification of high-risk investments, in order for consumers to understand what restrictions may apply to a particular product;
• the consumer journey into high-risk investments by strengthening risk warnings, banning inducements to invest, introducing positive frictions, improving client categorisation and stronger appropriateness tests.;
• strengthen the role of firms approving and communicating financial promotion and that they have the relevant expertise in the promotions they approve and the overall quality of financial promotions in the market is high; and
• apply restricted mass market investment rules to qualifying cryptoassets.

The FCA aims to publish a policy statement and final handbook rules in summer 2022. It will give in scope firms three months from publishing final rules to comply with the new requirements.