Welcome to the 2020 edition of In Principle. With the United Kingdom (UK) leaving the European Union (EU) on 31 January 2020, and moving into a transition period which will last until 31 December 2020, Brexit of course looms large over this publication. During the transition period, most people – including authorised firms – are unlikely to feel the practical effect of Brexit; what comes after, however, depends on the outcome of bilateral trade talks which will be taking place throughout the year. Before the end of the transition period, however, there are many other pressing issues that firms will have to prepare for. For example, both the UK and EU financial services regulators have shown particular interest in enhancing firms' attitudes towards environmental, social and governance issues, and as the global interest in climate change continues to accelerate, the trend towards requiring additional disclosures in relevant areas is set to continue throughout 2020. In the UK, the Financial Conduct Authority concluded a number of significant enforcement cases, and we expect this to continue in 2020. After its rollout to all UK-authorised firms in December 2019, this year will see the Senior Managers and Certification Regime come into full force and effect, with individuals taking on greater personal liability, and firms assuming a greater responsibility for assessing their employees' fitness and propriety. With proposals to amend the EU market abuse regime, new securities financing transaction reporting requirements, and changes to the Benchmarks Regulation, to preview just a few, here are ten things authorised firms need to know in 2020.
1. Sustainability and Asset Management
Environmental, social and governance matters have emerged as a key policy focus in the financial services sector. The EU has adopted ambitious plans in relation to climate change and sustainability, and different national requirements applicable to certain types of institutional investors have been enacted in a number of EU member states. The UK itself has enacted its own rules partly in response to its international commitments, and partly as a matter of domestic priority. Investment managers will need to pay close attention to this new landscape that includes new obligations, including disclosure requirements, and greater scrutiny both from regulators and investors.
2. Market Abuse
Market abuse continues to be an area of very significant interest for the Financial Conduct Authority (FCA), and of growing interest across the rest of the EU. Recent action taken by the regulator – including 91 enforcement investigations, custodial sentences and a fine for a person discharging managerial responsibility – serves as a reminder that the FCA expects firms and individuals alike to take their obligations under the EU Market Abuse Regulation (MAR) seriously and that it is prepared to enforce against them where there are instances of non-compliance. In late 2019, The European Securities and Markets Authority (ESMA) concluded a consultation about proposed significant
amendments to MAR which could potentially lead to substantial changes in both scope and, to an extent, have consequences to firms in practice. ESMA is expected to issue a report following the consultation to the EU Commission in H1 2020.
There has been much speculation regarding the ultimate practical outcome of the 2016 Brexit vote, and the fundamental uncertainty of the political negotiations domestically and with the EU has seen the UK's Constitution tested and scrutinised more thoroughly than at any time since the 17th century. Now Boris Johnson commands a majority in the House of Commons, the first stage of Brexit is clear: on 31 January 2020, the UK will leave the EU with a transition period. What will happen before the next potential cliff-edge on 31 December 2020, however, remains unclear. We recap the key issues for investment managers considering whether they are prepared for Brexit.
4. Senior Managers and Certification Regime
On 9 December 2019, the Senior Managers and Certification Regime (SMCR) was extended to the remainder of the financial services sector. Firms have a year after the commencement of the new regime to assess the fitness and propriety of all members of certified staff and, if found suitable, issue them with a certificate setting out the affairs of the firm with which that individual will be involved. In requiring them to do so, the FCA has passed this burden, and potential liability, onto firms themselves. Firms will also be required to scrutinise employees' behaviour and misconduct away from their professional environment. While this represents a broadening of scope of issues covered by the fit and proper assessment, this is a consistent direction of travel for both the FCA and other regulated professions in the UK.
5. Enforcement Trends
The FCA continues to be active in commencing enforcement cases, albeit with still only one successful action brought under the SMCR. With the extension of this regime to the remainder of the financial services industry, one would expect this number to increase in the not too distant future. In the last year, the number of open investigations has increased across the board and the quantum of fines levied has increased when compared with last year's statistics. Particular areas of focus continue to include retail conduct, insider dealing, financial crime and culture and governance. The 2018/2019 Annual Report does, however, indicate a slight change in direction, with increased focus expected to fall upon operational resilience, cryptoassets and data security. In a small piece of good news for firms, the FCA has noted that the average time taken to conclude an investigation has fallen year-on-year.
6. Data Protection and Cybersecurity
A number of enforcement cases under the General Data Protection Regulation (GDPR) during 2019 have illustrated the importance of careful GDPR compliance, including by entities which are not physically established within the EU but which are nevertheless caught by the scope of the GDPR as a result of their EU activities. Enforcement – and significant fines for breach of the GDPR – is expected to be a continued theme in 2020. The European Commission is due to report on the GDPR in 2020 which may result in amended rules and updated guidance in due course. Brexit may present issues where EU and/or UK-based "EU representatives" are used. In light of the expanding scope of nonEU regulatory regimes addressing data protection (in the Cayman Islands and California, for example), firms operating internationally will need to take care to ensure compliance in all relevant jurisdictions in which they operate, reflecting the development of the relevant rules and guidance.
7. EMIR and SFTR
2019 saw an overhaul of the European Market Infrastructure Regulation (EMIR) under the so-called "EMIR Refit", with significant impacts on asset managers in particular reflecting amendments to rules on counterparty classification and the scope of the clearing obligation. In 2020, a number of further changes (including with regard to the initial margin exchange requirement) are expected to take effect. The changes will also extend current exemptions under EMIR and implement latest internationallyagreed standards.
2020 will also see the obligation to report securities financing transactions commence under the EU Securities Financing Transactions Regulation (SFTR). The reporting obligations will represent an additional and not insignificant compliance burden on EU investment managers, and will directly affect non EU managers that manager EU funds, and may indirectly affect non-EU investment managers with EU clients depending on the scope of their contractual obligations. In-scope firms should take active steps to establish reporting systems and contractual arrangements (including delegated reporting arrangements, as applicable) to cater for the new requirements. Brexit is unlikely to affect the shape of the SFTR in the UK, other than insofar as reporting will be required to both UK and EU trade repositories, rather than EU trade repositories only.
New rules were adopted in 2019 relating to the crossborder distribution of investment funds, and these will enter into effect in mid-2021. The rules introduce a harmonised definition of "pre-marketing" across the EU, which will have an impact on, among other things, the availability of reverse solicitation and the promotional materials used. The rules are not expressed to apply to non-EU managers, although a number of EU member states may apply them to non-EU managers in due course to ensure a level playing field with EU managers. Post-Brexit, the rules in the UK-domesticated version of the Alternative Investment Fund Managers Directive (AIFMD) are expected to be largely consistent with the current scope of the reforms, at least in the short term.
9. EU Benchmarks Regulation/LIBOR
Providing some relief for industry, the end of 2019 saw the extension of the transitional period under the EU Benchmarks Regulation, under which benchmarks that are not yet authorised by ESMA may continue to be used until the end of 2021. These had been due to expire at the end of 2019.
The London Inter-bank Offered Rate (LIBOR) is expected to cease to exist from the end of 2021, so preparations to cater for its cessation will continue throughout 2020. Industry solutions are expected to emerge in 2020 to assist with the transition to alternative risk-free rates as fallbacks in securities documentation. Appropriate alternative risk-free rates will also need to begin to be used for internal operational processes, including front office calculations, models and risk systems.
10. Key Cases and Enforcement Round-Up
The FCA issued 265 Final Notices (243 against firms and individuals trading as firms, and two against individuals) and secured 288 outcomes (276 regulatory/ civil and 12 criminal) using its enforcement powers during 2018/2019. While the number of financial penalties imposed remained the same as last year – 16 in both cases – the quantum increased significantly. A large number of the actions brought by the regulator related to the failure of firms to (a) treat customers fairly, (b) organise and control affairs responsibly and effectively, and (c) deal with regulators in an open and cooperative manner. A number of these cases are discussed in more detail in Section 10 below.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.