Funds Legal Update

We take a look at highlights from the Financial Conduct Authority's (FCA) perimeter report 2020/21, which most notably identifies "significant shortcomings" in the appointed representative model and calls for change to the Financial Promotions Order. Separately, the regulator has set out its expectations on hybrid and remote working for firms.

In the environmental, social and governance (ESG) space, HM Treasury has published a policy paper on "Greening Finance: A Roadmap to Sustainable Investing", which sets out more detail on the government's plan to "green" the financial system and align it with the UK's net-zero commitment, including the new Sustainability Disclosure Requirements and UK Green Taxonomy. Across the Channel, the European authorities have published draft rules on taxonomy-related sustainability disclosures under the Sustainable Finance Disclosure Regulation, with an expected application date of 1 July 2022.

The FCA has now published final rules and guidance for the UK's Investment Funds Prudential Regime, with more final rules to come before the new regime comes into force on 1 January 2022.

Latest messages from the Financial Conduct Authority (FCA)

FCA perimeter report 2020/21

On 21 October 2021, the FCA announced the publication of its perimeter report 2020/21. Key areas of interest for the investment funds industry include:

Financial promotion regime: exemptions. The FCA is concerned that unauthorised persons are increasingly relying on the exemptions in the Financial Promotions Order for high-net worth and sophisticated investors to market high-risk investments. The FCA thinks significant changes are needed, in particular reforming the thresholds (for example, relating to investments in unlisted companies, and level of income/assets), and the ability for consumers to self-certify.

Appointed representatives (ARs). The FCA has identified "significant shortcomings" in how well principal firms understand and comply with their regulatory responsibilities for their ARs, creating potential for consumer harm like mis-selling and fraud. The regulator's work in this area includes:

• Targeted and proactive supervision of aspects of ARs’ interactions with consumers and principals’ oversight of their ARs, where the FCA thinks the use of ARs is a particular driver of harm
• Intensified scrutiny of all principals, and applicants which intend to appoint ARs, seeking permissions at the gateway – in a pilot of this tighter approach, 50% of firms intending to appoint ARs either withdrew their applications or the FCA refused them
• Consulting this year on specific proposals to amend the AR regime

Overseas Funds Regime. When marketing passports fell away post-Brexit, European Economic Area funds marketing in the UK were able to use the Temporary Marketing Permission Regime (TMPR), which allows them to be marketed in the UK on the same basis as before. The TMPR is due to end at the end of December 2025. The government plans to introduce a new equivalence regime, the Overseas Funds Regime (OFR), which will allow categories of non-UK collective investment schemes (CIS) approved by HM Treasury to be marketed by UK firms to UK investors.

HM Treasury will have to decide whether the protection for investors in an overseas fund is equivalent to the protection for investors in comparable UK-authorised CIS. 

The FCA will be consulting on amendments to the Handbook to implement the OFR nearer the time.

ESG data and ratings providers. The provision of ESG ratings remains an unregulated activity. Potential issues around ESG ratings include lack of transparency of methodologies and interpretability, which could mean the ratings are less useful to consumers, and significant costs for issuers of meeting data requests which vary between providers.

The FCA's June 2021 consultation paper (CP21/18) on climate-related disclosures looked at the potential role for regulation of ESG ratings providers. Next steps will be informed by relevant responses to the CP21/18 consultation.

Expectations on remote or hybrid working 

On 11 October 2021, the FCA published a new webpage on remote or hybrid working expectations for firms, which sets out a list of considerations for firms. 

In particular, a firm should be able to prove that the lack of a centralised location or remote working does not or is unlikely to affect its location in the UK or ability to meet and continue to meet the threshold conditions. It must not prevent the FCA receiving information, reduce the accuracy of the Financial Services Register, affect the ability of the firm to oversee its functions (including any outsourced functions), cause detriment to consumers, damage market integrity, increase the risk of financial crime or reduce competition. Firms must show satisfactory planning in relation to remote or hybrid working, and may be required to notify the FCA of any material changes to how they intend to operate.

Firms applying to be authorised should provide specific details in their applications on hybrid or remote working arrangements, as listed on the webpage.

ESG updates from the UK and EU: sustainability disclosures

UK government roadmap on greening finance and sustainable investing

On 18 October 2021, HM Treasury published a policy paper on "Greening Finance: A Roadmap to Sustainable Investing", which sets out the government's strategy to deliver phase 1 of the project, getting sustainability-related information to investors and consumers. The paper covers:

• New Sustainability Disclosure Requirements (SDR) that will require the financial services sector to disclose sustainability-related information. In particular, asset managers will need to disclose how they take sustainability into account, and creators of investment products will need to report on those products' sustainability impact and relevant risks. Figure B in the paper shows a snapshot of the SDR framework (see page 14).
• The UK Green Taxonomy, which will create a shared understanding as to which economic activities count as environmentally sustainable. Providers of investment funds will have to disclose what proportion of their activities are taxonomy-aligned.
• The role of the pensions and investment sectors as responsible stewards of capital – the industry should use the information generated by SDR to start moving capital to align with a net zero economy, and take ESG considerations into account in the context of investment decision-making, engagement with investee companies, and voting practices.
• Potential regulation of ESG ratings agencies (also flagged in the FCA's perimeter report).

  
In terms of next steps, a series of discussion papers will be published in November 2021, focusing on SDR disclosures, consumer-facing product-level SDR disclosures, and the sustainable investment labelling regime.

ESAs final report and draft RTS on taxonomy-related sustainability disclosures under SFDR

On 22 October 2021, the European Supervisory Authorities (ESAs) published a joint final report on draft regulatory technical standards (RTS) regarding the content and presentation of taxonomy-related disclosures for financial products caught by Article 8 and Article 9 of the Sustainable Finance Disclosure Regulation (SFDR).
  
The new RTS make changes to the existing draft RTS on the content, methodologies and presentation of disclosures under SFDR (finalised in February 2021), bringing in measures including:
  

• Sub-categories of SFDR Article 8 and 9 financial products
• Pre-contractual and periodic disclosures for financial products under Articles 5 and 6 of the Taxonomy Regulation, which (i) identify the environmental objective(s) to which the investment by the financial product contributes, and (ii) show how and to what extent the product’s investments are aligned with the EU taxonomy
• Amendments to the disclosure templates for SFDR Article 8 and 9 financial products to include the additional disclosures required under Articles 5 and 6 of the Taxonomy Regulation

The Commission confirmed in July 2021 that the SFDR RTS will be adopted in a single delegated act, expected to apply from 1 July 2022. Section 5 of the report contains a draft consolidated version of the SFDR RTS.

UK Investment Firms Prudential Regime update: final rules

On 22 October 2021, the FCA published a press release announcing the publication of final rules relating to its first two policy statements on the Investment Firms Prudential Regime (IFPR). These rules streamline and simplify prudential requirements for solo-regulated UK firms authorised under the Markets in Financial Instruments Directive (MiFID). It’s critical that investment firms prepare for the regime which comes into force soon.
The rules and guidance are as follows:

• Investment Firms Prudential Regime Instrument 2021 (FCA 2021/38). This Handbook instrument contains the text of the new Prudential sourcebook for MiFID Investment Firms (MIFIDPRU) and the MIFIDPRU Remuneration Code (contained in the Senior Management Arrangements, Systems and Controls sourcebook (SYSC) new chapter 19G).
• Investment Firms Prudential Regime (Consequential Amendments to other Prudential Sourcebooks) Instrument 2021 (FCA 2021/39). This Handbook instrument contains consequential changes to parts of the Handbook, including revocation of BIPRU (the Prudential sourcebook for Banks, Building Societies and Investment Firms) and most of IFPRU (the Prudential sourcebook for Investment Firms).
• Finalised Guidance: General guidance on the application of ex-post risk adjustment to variable remuneration (FG21/5). This guidance sets out the FCA’s expectations of how firms should comply with requirements in SYSC 19D and SYSC 19G on ex-post risk adjustment, including malus and clawback.

The instruments and finalised guidance come into force on 1 January 2022 (except a MIFIDPRU transitional provision on advance data collection that comes into force on 1 December 2021).

The FCA also published templates for firms' Remuneration Policy Statements and a material risk takers list.

The FCA intends to publish a third policy statement before the end of 2021, reflecting the outcome of its third consultation paper (CP21/26) published in August 2021.