MiFID3 View - April 2022

Below is our April edition of MiFID3 View. In case you have missed our earlier MiFID3 View publications you can find them here. As always your feedback is appreciated and we hope that you find this helpful.

Russian Sanctions – EU and UK commentary

Over these past months, the devastating situation in the Ukraine has been at the foremost of everyone’s minds. It continues to be hard to predict how it will unfold and our thoughts are with all those who continue to suffer.

As you are probably aware in response to the crisis most of the key EU local regulators (and the UK regulator) have now issued public sector-specific commentary in some form, with the exception of Spain. We are also aware that some regulators have been having additional direct discussions with certain firms. On 14 March, ESMA released a communication highlighting its work co-ordinating a response to the crisis and also updated its guidance and annex on third-country trading venues to state that, in the context of the EU sanctions on Russia, trading venues established in Russia will be considered inactive from 14 March until further notice. We are likely to see further instructive communications from EU and UK regulators as the crisis continues and we have set up a dedicated Simmons & Simmons webpage to keep on top of regulatory communications in this area which we hope you find useful to navigate these developments as they happen.

UK 'Quick Fix' changes to inducement and reporting requirements – in force

We continue to be busy advising a number of clients on the UK MiFID ‘Quick Fix’ changes and in particular what updates or notifications they need to be making to their terms of business and clients. For a quick recap, the UK ‘Quick Fix’ made a number of de-regulatory changes to the conduct of business rules in the UK. The changes were made by HM Treasury’s Markets in Financial Instruments (Capital Markets) (Amendment) Regulations 2021, which amended the UK onshored version of Commission Delegated Regulation (EU) 2017/565 and the FCA Policy Statement PS21/20, which amended MiFID requirements in the FCA COBS rules.

The rule changes apply to any authorised firm which is directly subject to MiFID conduct of business rules in the UK. Certain changes came into force in Q2 2021, including reduced client-reporting requirements, and the removal of the “Top 5” reports under the best execution rules. See our MiFID3 View - July edition for a summary of those changes.

More recently (and particularly relevant to UK firms authorised to provide investment management services) new changes the UK inducements rules came into force last month. These cover an important expansion in the list of acceptable minor non-monetary benefits, which an investment manager can receive for free or on a bundled basis to include research on certain SMEs, FICC research, and research from independent research providers.

Our Simmons & Simmons briefing note ‘UK changes to conduct of business rules Practical Impact for Investment Managers’ sets out detail on the scope and what firms caught by these changes should be doing for compliance. It is worth noting that the changes to the inducement rules do not immediately apply to AIFMs and UCITS Mancos when acting as fund managers. However, the changes immediately apply to such firms when acting as investment managers under MiFID top-up permissions. To rectify this gap (as we understand this was a drafting oversight) the FCA has proposed in CP22/4 to amend the research and inducement rules to cover fund management activities. The consultation was open until mid-April, and we’d expect the rules to be finalised shortly after, likely during Q2 2022.

If not already done so, all firms should be checking that they have addressed these reforms and in particular review their contractual terms with clients to determine any update or notification requirements. We would be happy to assist so please reach out to our dedicated Simmons & Simmons MiFID3 Team if you have any questions.

UK Ancillary Exemption – Market Size data gap

As you may recall, late last year the European Commission made a number of changes to the EU ancillary exemption calculations and notification requirements which included the removal of the ‘market share test’ – also known as the ‘overall market test’ under Article 2 of the RTS 20. This led to a lot of confusion amongst UK commodity firms that rely on the EU data to make use of the exemption and in the absence of the FCA producing any data. In what has been a welcome clarification, last month the FCA confirmed that commodity firms can rely on Article 72J of the RAO which enables firms seeking to rely on the UK ancillary activities exemption to carry on their business without obtaining authorisation if there is no data from a regulator to enable them to perform the ‘market share test’. The FCA in CP22/4 is consulting on clarifying this position and so we should expect to see formal rules shortly after the consultation closes this month.

UK HM Treasury Response to Wholesale Market Review

At the beginning of last month, HM Treasury published its response to the July 2021 consultation on the Wholesale Markets Review proposing a package of reforms to create a simpler and less prescriptive regime, whilst promoting growth, innovation and global competition. The vision for the future of the UK market is also being progressed in other reforms currently underway with the Future Regulatory Framework (FRF), Prospectus Regime Review and UK Listings Review which aim to encourage fund raising and promote retail investment and equity crowdfunding. Key highlights from the HM Treasury response include:

• The systematic internaliser (SI) regime will be simplified, and unnecessary regulatory burdens removed (e.g., the SI definition will be clarified, and the reporting regime simplified).
• Removal of restrictions on firms' ability to execute transactions to ensure that market participants can get the best outcomes for investors.
• Reconfiguration of the transparency regime for fixed income and derivatives markets so that only appropriate instruments are subject to enhanced transparency requirements, removing unnecessary burdens on firms.
• Reduction of the scope of the commodities position limits regime and delegation to trading venues to ensure market activity is not unnecessarily restricted, while ensuring that markets function efficiently.
• Ensure the FCA can help support the provision of a consolidated tape, which will better enable participants to identify the best available pricing for instruments.

The paper sets out how HM Treasury and the FCA plan to take forward the various proposals. HM Treasury intends to deliver the most important changes as a priority, whilst others will be delivered as part of the implementation of the outcomes of the FRF Review. Where changes can be made to the parts of the regime that are already set out in regulatory rules and guidance, the FCA has committed to progress these in line with its normal processes. Indeed, in a speech delivered on 3 March, the FCA noted that it plans to consult in the second quarter of 2022 on the detail of some of these changes where rules are set out in technical standards and are not dependent on changes to legislation.

In terms of where we may expect to see changes first, at a recent industry conference Simmons & Simmons attended, a representative from HM Treasury indicated that areas of priority include: repealing the double volume cap and the share trading obligation, recalibration of the transparency regime for derivatives and bonds, removal of current burdens on SI’s, and enhanced FCA powers to develop a consolidated tape.

So whilst we await the exact details of the reforms, what we do know is that change is very much underway and both the HM Treasury and FCA have indicated a commitment to an outcomes focussed approach and a willingness to diverge from the EU.

Sustainability preferences and ESMA guidelines

The deadline of 2 August is fast approaching for when firms will be need to comply with the changes made in August 2021 to the MiFID2 Delegated Regulation and integrate sustainability factors, risks and preferences into their organisational requirements and operating conditions. For more information on these changes, please see our Simmons & Simmons webpage here. In order to support these changes ESMA launched a consultation on changes to its Guidelines on certain aspects of the MiFID2 suitability requirements.

ESMA’s proposed changes have raised a number of concerns within industry around the practical aspects of the guidance and how it is to fit with current suitability assessment. In particular, many in industry have noted that ESMA’s proposed method of gathering sustainability information is overly cumbersome and unrealistic given there will unlikely be the products to meet a client’s sustainability preferences (at least initially) which would overall lead to a poor customer experience. These concerns were noted at the recent ESMA open hearing where a number of further issues for clarification were raised. Key questions included:

• Under the proposed guidelines, if a firm cannot match a client’s sustainability preferences it will not be able to recommend a product until the client has amended its sustainability preferences. However, ESMA states that amending the sustainability preferences should not be standard practice which industry notes is unrealistic in at least the early years.
• How aligned does a particular product have to be with the sustainability preferences of the client? Can a firm limit the granularity of the questions to ensure a broader range of products?
• How should firms deal with the definition of “sustainable investment” which is arguably open to a relatively broad interpretation?
• How should firms balance a client’s sustainability preferences with other suitability factors such as financial objectives, risk profile etc ?

It is hoped that ESMA’s final guidelines - expected to be published Q3 2022 - will address many of these open questions. In the meantime, firms should be continuing with their compliance and preparation arrangements for the August 2022 deadline.

Suitability assessments - ESMA responds to Commission consultation

In a further development on suitability, ESMA has published a letter to the European Commission setting out its response to the February 2022, “Targeted Consultation on Options to Enhance the Suitability and Appropriateness Assessments”, where the European Commission proposed changes to:

• modify the current MIFID/IDD suitability and appropriateness tests with the view to no longer differentiate among the various investment services offered to retail investors”; and
• replace the current “’per product’ approach with a new element, a personalised asset allocation strategy.”

ESMA’s letter gives a useful insight into the supervisory authority’s views on the European Commission’s proposals and although not binding, ESMA would expect its views to carry some weight as the work in this area progresses. As such, the letter marks a helpful marker as to ESMA’s overall approach on the topic. ESMA’s letter notes that whilst it fully supports the Commission’s aims it does raise a number of concerns, which it hopes will be addressed as the work progresses. See our Simmons & Simmons briefing note ‘Suitability assessments - ESMA responds to Commission consultation’ for further detail.

ESMA Final Report on Guidelines on certain aspects of the MiFID2 remuneration requirements published

ESMA has now published its final Guidelines on MiFID2 Remuneration requirements to replace the existing guidelines which were last published in 2013. The guidelines have been reorganised and divided in the following sections: (i) design of remuneration policies and practices; (ii) governance; (iii) controlling risks that remuneration policies and practices create. The revised guidelines are set out in Annex V and in Annex IV ESMA helpfully sets out a correlation table between the new guidelines and the 2013 version. These will now be translated in the official EU language and published on ESMA's website. The publication of the translations in all official EU languages will trigger a two-month period during which NCAs must notify ESMA whether they comply or intend to comply with the Guidelines. Six months following publication in all EU languages the Guidelines will apply.

ESMA Final Reports RTS 1 & RTS 2- First round of reforms

ESMA has now published its long-awaited first round of proposed changes to RTS 1 (equity transparency) & RTS 2 (non-equity transparency) in two final reports. Given the ongoing negotiations being conducted under the EU Commissions wider MiFIR Review, ESMA has confirmed that it has decided to carry out its review of RTS 1 and RTS 2 in two steps:

• These final reports include a first series of proposed amendments to address issues that have received broad support from stakeholders and/or are considered important in the context of establishing a consolidated tape provider (CTP); and
• A second, and broader, review will be carried out following the MiFIR Review which will focus on the necessary changes to RTS 1 and 2 in consequence of the MiFIR Review and also including the analysis of proposals included ESMA’s consultation paper published in July 2021 but not covered in these final reports.

Some key takeaways from the two Final Reports include:

• RTS 1 revisions to (i) Large in scale (LIS) thresholds for ETFs, (ii) the legal provisions relating to non-price forming transactions, (iii) the list of trading systems and of the pre-trade transparency requirements attached to those.
• technical amendments to RTS 1 which relate to (i) the time of publication of transactions executed outside trading hours, (i) the date of application of ESMA transparency calculations and (iii) the calculation of the standard Market Sizes (SMS) (iv) changes to the reporting field.
• Proposed amendments to the main text of RTS2 including the list of trading systems, non-price forming transactions (Article 13) and the application dates of the transparency calculations (Article 13).
• Some limited proposals for amending RTS 2 with respect to commodity derivatives noting that the majority of the proposals on commodity derivatives will only be finalised in a future review of RTS 2.

Both reports have been submitted officially to the European Commission who will have three months to decide whether to endorse the proposed amendments to the RTS.

Commodity Position Limits

After considerable delay the European Commission has finally adopted Delegated Regulation and Annex with regards to RTS for the application of position limits to commodity derivatives and procedures for applying for exemption from position limits. The adopted text is intended to effect the changes to the position limits regime which were implemented by the EU MiFID ‘Quick Fix’. The now published Delegated Regulation repeals Commission Delegated Regulation (RTS 21) making a number of changes to the regime and:

• Contains the method for calculating the size of the net position of a person.
• Sets out a procedure for the risk-reducing exemption for financial entities that are part of a predominantly commercial group and a procedure for applying the liquidity provision exemption.
• Builds on the RTS 21 list of non-financial entities, with a positive list of legal or natural persons defined as financial entities.

The Council of the EU and the European Parliament will now scrutinise the Delegated Regulation. If neither object, it will enter into force 20 days after its publication in the Official Journal.

ESMA has published the official translations of its guidelines on aspects of the appropriateness and execution-only requirements

You will recall in our last MiFID3 View, we discussed ESMA’s final report on its Guidelines on certain aspects of the MiFID2 appropriateness and execution-only requirements. The Guidelines address several key aspects of the appropriateness process, including the information to be provided to clients regarding the objective of the appropriateness assessment, the arrangements required to comprehend clients and products, the matching of clients with appropriate products and the effectiveness of warnings. Additionally, other related requirements are clarified, such as the execution-only exemption and record-keeping and controls. ESMA has now published the official translations on a webpage, including the English language version, of its revised guidelines which will apply from 12 October 2022. If not already done so in-scope firms should be reviewing an updating their arrangements for compliance.

Italy consultation on changes to costs, suitability and reporting closes

CONSOB concluded in March a consultation on proposed amendments to Regulation No. 20307 of 2020 (Intermediaries Regulation) as part of its implementation of the EU’s MiFID2 Quick Fix reforms. The proposals include changes to:

• Disclosures of costs and fees relating to financial instruments and investment services;
• Suitability assessments for portfolio managers and investment advisors;
• Rules on reporting requirements;
• Rules applicable to dealings with eligible counterparties.

There is no indication yet that any of the proposals gold-plate the MiFID2 EU ‘Quick Fix’ standard, however we await the publication of the final draft.

As always if you have any questions on the above developments then please do not hesitate to reach out to our dedicated MiFID3 Team.