Each month, FactSet's Regulatory team offers a rundown of the most important developments in compliance and regulatory news. Read on to see which stories dominated the conversation last month.

International

Brexit Update

Over the last month, the UK and EU have published negotiating positions ahead of formal negotiations over a trade deal, which both sides hope will be achieved by the end of the Transition Period as agreed in the Withdrawal Agreement, which is set to expire on December 31, 2020.

The trade deal proposals are focused on goods rather than services. In the field of financial services, as expected, the EU has commenced negotiations by stating they want to maintain a "level playing field,"  ideally by way of "regulatory alignment." By contrast, the UK position is somewhat paradoxically, seeking "equivalence" from the EU, while maintaining its right to (and has stated its intention to) commence regulatory "divergence," as a function and manifestation of its sovereignty.

Nevertheless, during the transition period, the UK will continue to onshore existing EU laws and has also instituted transitional arrangements by way of a Temporary Permissions Regime (TPR) to facilitate non-UK EU firms’ access to the UK financial markets, subject to meeting certain conditions.

The EU is taking the reverse approach and compelling firms without an established presence on the Continent to set up operations there, which includes cash, personnel, and bricks and mortar to ensure continued access to EU markets.

Save for access to EU clearing and settlement infrastructure, which predominantly resides in the UK, the EU has suggested that equivalence for a regime that is by definition non-equivalent (in that it is "divergent") would not achieve its goal of securing a level playing field. Moreover, equivalence rulings apply on a regime by regime basis and are unilateral declarations made by the EU that can be withdrawn at any time. Consequently, at present, equivalence does not seem to be a viable mechanism through which to achieve some form of agreement over future arrangements in the sector.

While the political posturing and negotiations rumble on, the FCA has set up an Information for Firms webpage (last updated in February 2020), guidance for firms in anticipation of the end of the transition period, and a Brexit Microsite for firms, businesses, and the public setting out relevant arrangements that include details of the TPR. 

The FCA is also setting up a parallel regulatory system to that in the EU in anticipation of the end of the transitional period, which includes a mirror MiFID II framework that includes a UK transparency regime replete with FIRDS and FITRS datasets and a DVC mechanism, among other features; details of which continue to emerge and which the FCA communicates by way of updates to its Supervisory Statement on the Transparency Regime webpage—last updated in February 2020. Between now and the end of the transition period, the FCA has a lot of work to do as do the politicians if they are to secure a meaningful trade agreement and much can, and is expected, to change between now and then. Given the uncertainty, when matters finally crystallize, regulatory forbearance and transition periods rather than cliff edges are expected though not to be relied upon.

U.S.

SEC and DoJ Reach $3 Billion Settlement Over Misconduct Charges

In a Press Release on February 21, 2020, the U.S. Securities and Exchange Commission (SEC) announced that, together with the Department of Justice (DOJ), a $3 billion settlement had been reached with Wells Fargo & Co ("Wells") for fraudulent conduct spanning over a decade.

Specifically, Wells had promoted in official investor disclosures the success of its “cross-sell” strategy that ostensibly involved selling additional products to existing customers on a “needs” basis. In practice, the strategy was based on management pushing unrealistic sales targets that led to thousands of employees selling clients products they did not need and would not use and fraudulently opening millions of unauthorized accounts by (amongst other tactics) forging customer signatures and altering their contact information to prevent them from learning about the unauthorized accounts.

As set out in the DOJ’s Press Release, the settlement includes $500 million paid to the SEC (that will be redistributed to affected customers) for violation of Section 10(b) of the Securities Exchange Act 1934 and SEC Rule 10b-5; the settlement of civil claims brought in relation to the creation of false bank records under the 1989 Financial Institutions Reform, Recovery, and Enforcement Act; and a Deferred Prosecution Agreement in relation to ongoing criminal investigations into the creation of false bank records and identity theft.

Proposed Technical Amendments to Deliver Second Wave of Volcker Rollbacks

On January 30, 2020, it was announced by the Securities and Exchange Commission, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency,  and the Commodity Futures Trading Commission that they were launching a consultation on proposed revisions to rules that currently restrict banks investing in or sponsoring hedge funds or private equity funds ("covered funds").

These proposals  are part of the broader suite of Volcker Rule rollbacks that commenced with the liberalization of the Volcker Rule proprietary trading restrictions detailed in our October 2019 and November 2019 Regulatory Updates.

The current proposed modifications are designed to ease the compliance burden on banks by clarifying, simplifying, and streamlining the existing covered fund rules. In practice, they liberalize the restrictions by creating new exemptions, expanding existing exclusions, and modifying definitions or making technical amendments that have the effect of expanding exemptions or exclusions.

Specifically, the proposed modifications seek to expand several existing "exclusions" from the covered fund restrictions by modifying their definitions, including the "loan securitization" exclusion definition and the "foreign public funds" exclusion definition, together with some technical clarifications in relation to public welfare funds and small business investment companies exclusions (SBICs).

The proposals also seek to extend the application of certain exemptions under Federal Reserve Board Regulation W (which implements Section 23A of the Federal Reserve Act) to the Volcker Rule, thereby liberalizing the types of activity banking entities may undertake in relation to covered funds.

The proposals further seek to narrow the definition of "ownership interests" in covered funds through several technical modifications to the existing text, together with the introduction of a new "safe harbor" for investments in senior loan or debt interests.

Additionally, the proposals create a new "exemption" to the proprietary trading and covered fund prohibitions for non-U.S. funds offered and sold outside the U.S. ("qualifying foreign excluded funds") codifying existing regulatory relief. There are also proposals for new exclusions from the covered fund restrictions for investments in or sponsorship of "credit funds," "qualifying venture capital funds," "family wealth management vehicles" and "customer facilitation vehicles," each of which is carefully defined and subject to a host of limitations and conditions.

Finally, the proposals provide that a banking entity may make parallel direct investments alongside a covered fund. This is achieved by excluding such investments from ownership limitations under the rules, subject to meeting certain conditions.

Comments on the proposals will be accepted until April 1, 2020.

EU

ESMA Publishes Sustainable Finance Strategy

On February 6, 2020, ESMA announced the publication of a Sustainable Finance Strategy, which sets out how it intends to place sustainability at the core of its activities by embedding ESG factors into all aspects of its work.

The press release states that key priorities of the strategy include completing the transparency framework under the Disclosure Regulation, undertaking ESG risk analysis including through the use of climate-related stress tests, overseeing convergence of supervisory practices in relation to ESG factors with a particular focus on combatting greenwashing by ensuring consistent reporting of non-financial information and finally, undertaking an active role in the formulation of the EU taxonomy through its membership of the EU Platform on Sustainable Finance.

The press release further states that "to help deliver its strategy, ESMA set up a Coordination Network on Sustainability in 2019. The network is composed of experts from national competent authorities and ESMA staff. It will be supported by a consultative working group of stakeholders, which will be established in the coming months."

ESG at Forefront of EU 2020 Policy and Political Agenda

On January 29, 2020, the EU’s executive branch—the European Commission—published its 2020 Work Programme. The document states that the Commission’s lodestar will be the United Nations Sustainable Development Goals (SDGs). This approach will see ESG considerations factored into all of the EU’s policy areas. The Work Programme is based on the six broad ambitions set out in Commission President von der Leyen’s Political Guidelines, first and foremost of which is the European Green Deal. Other "ambitions" relevant to the financial services sector include "A stronger Europe in the World" and  "An Economy that Works for People," the former of which will capture Brexit negotiations, and the latter of which will include further work on the Anti-Money Laundering and Capital Markets Union Action Plans, among other measures.

Commission Launches Consultation on NFRD and Sustainable Finance

On February 20, 2020, the Commission announced it was launching a public consultation on a review of the Non-Financial Reporting Directive (NFRD), the principle focus of which is to modify the NFRD to enable increased sustainable investment in furtherance of the objectives of the Commission’s European Green Deal.

As set out in the Commission's European Green Deal Investment Plan, to meet the objectives of the Green Deal a substantial volumes of private sector investment will need to be channelled into sustainable initiatives. However, at present there is an ESG-shaped hole in corporate reporting requirements that needs to be plugged before investors can correctly identify and select sustainable investments whilst avoiding greenwashing.

To equip investors with this information and to inhibit greenwashing the Commission is seeking to enhance the ESG disclosures in the NFRD. The idea is that the data in these disclosures will be used by investment firms to identify whether a firm meets the criteria to qualify as a "sustainable investment" as set out in the proposed taxonomy regulation, the details of which will then be disclosed to investors pursuant to the Sustainability Disclosure Regulation (Regulation (EU) 2019/2088).  

As set out in a speech by Commission Vice President Valdis Dombrovskis to the IFRS Foundation Conference on February 19, 2020, recalibration of the NFRD is necessary to provide the back-end raw data from which to populate ESG disclosures and discern sustainable investments, with Dombrovskis further stating that, "In this context, the Commission will ask the European Financial Reporting Advisory Group—or EFRAG—to start preparatory work on non-financial reporting standards as quickly as possible."

Dombrovskis also stated in his speech that the Commission will explore the broader impact of climate change on accounting standards such as the financial impact of stranded assets in a public consultation for its next sustainable finance strategy.

Responses from the current consultation will feed into the Commission's impact assessment on the review of the Directive. The consultation will remain open until May 14, 2020.

Multiple MiFID II Reviews Underway by ESMA and the Commission

Following ESMA’s first formal MiFID II report (on the subject of market data and a consolidated tape for equities as summarized in our January 2020 update), ESMA has recently published several more documents on various aspects of the regime as part of its formal statutory review of the broader MiFID II regime (and more generally), as summarized below.

Third-Country Firms

As specified in the Investment Firms Regulation (EU) No 2019/2033 (IFR) and the Investment Firms Directive (EU) 2019/2034 (IFD), on January 31, 2020, ESMA announced it was consulting on draft technical standards under the new IFD/IFR MiFIR and MiFID II third-country firm regimes. These proposed technical standards specify the data and information to be disclosed by third-country firms registering with ESMA and the data to be disclosed by them in annual reporting to ESMA, which includes data on all transactions and orders.

ESMA is also consulting on MiFID II technical standards that specify requirements for the disclosure of information to National Competent Authorities (NCAs) by branches of third-country firms. The closing date for responses to the 196-page Consultation Paper (CP) is March 31, 2020.

Non-Equity Systematic Internalizers

On February 3, 2020, ESMA published a CP on Non-Equity Systematic Internalizers, providing substantive detailed analysis on this particular segment of the MiFIR transparency regime, concluding that modest technical changes to existing arrangements would simplify and make the regime more efficient. The consultation remains open until March 18, 2020.

The Equity Transparency Regime

On February 4, 2020, ESMA launched a consultation on the MiFIR equity transparency regime in the form of a CP containing a series of technical proposals for legislative amendments based on in-depth data and technical analysis. The objective of the proposals in the review is to simplify the existing reporting requirements while at the same time delivering improved overall transparency to the markets. The consultation and proposals cover multiple aspects of this segment of the MiFIR transparency regime including pre-trade transparency obligations and waivers, the double volume cap (DVC) mechanism, the share trading obligation, and systematic internalizers (SI) transparency provisions.

The analysis presented in the paper is particularly illuminating, revealing that no significant transition from OTC to on-venue trading has occurred since the regime commenced and that a large percentage of on-venue transactions are executed under pre-trade waivers, the use of which increases as the DVC mechanism is triggered.

Key proposals include restricting the use of or reducing the number of pre-trade waivers, simplifying and expanding the scale of the DVC regime, increasing the minimum SI quoting obligations subject to pre-trade transparency, a revised methodology for determining quoting sizes and/or an extension of the SI obligations to illiquid instruments, and clarification of the scope of the trading obligation, specifically in relation to third-country instruments.

The consultation will remain open until March 17, 2020, giving stakeholders just a handful of weeks to provide feedback on these important, complex, and lengthy proposals.

ESMA intends to submit its final equity transparency regime report to the Commission by July 2020.

Product Intervention

On February 3, 2020, ESMA published a Final Report on the functioning of the MiFIR Product Intervention rules, following a request from the Commission. In the Report, ESMA recommends addressing the risk of regulatory arbitrage arising between MiFID II investment firms who are in-scope for the measures and fund management companies, especially those with a "MiFID II top up", who are not. To overcome this, the Commission recommends extension of the product intervention powers to cover UCITS and Alternative Investment Fund managers. ESMA also recommends a mechanism to crystallize temporary measures into permanent ones and an extension of its temporary product intervention powers to 18 months.

Finally, the report recommends clarification on the application of product intervention measures in cross-border scenarios, particularly where Member State measures overlap or conflict.

Suitability

On February 5, 2020, ESMA announced it was commencing common supervisory action with NCAs on the application of MiFID II suitability rules across the EU during 2020. The authorities intend to focus on compliance with rules on assessments of suitability among other factors, analyzing in particular how the costs of investment products are taken into consideration by firms when recommending a product to a client.

Derivatives Clearing Obligation

On February 7, 2020, the European Securities and Markets Authority (ESMA) published and delivered a Final Report to the European Commission, as required under Regulation (EU) 2019/834 (EMIR Refit), on the alignment of the MiFIR derivatives trading obligation with the EMIR clearing obligation, following changes made by EMIR Refit to the  scope of counterparties subject to the clearing obligation. The report notes that the modifications made by EMIR Refit have led to a misalignment of counterparties in scope for the EMIR clearing obligation compared with those in-scope for the derivatives trading obligation under MiFIR.

In light of the close interconnection between the two obligations, ESMA has recommended that the MiFIR derivatives trading obligation should be modified to realign its scope of application with that of the re-calibrated EMIR clearing obligation. The European Commission now has until December 18, 2020, to deliver its report on the matter to the European Parliament and Council.

Other Measures

Finally, on February 17, 2020, the European Commission published a Consultation Paper on the broader MiFID II regulatory framework, seeking feedback on several disparate aspects of the regime including the development of an equities consolidated tape, investor protection measures such as product governance and best execution, research unbundling rules and the resultant diminished coverage of small- and medium-sized enterprises, various matters relating to commodities markets, and several other "non-priority" areas including organized and multilateral trading venues, foreign exchange markets, and the derivatives trading obligation. The consultation remains open until April 20, 2020.

Conclusions

ESMA is mandated to produce several further reports on various aspects of the broader MiFID II regime, which will be published over the coming months. Any changes to the regime the Commission is contemplating off the back of these and more generally will need to factor in the outcome of post-Brexit trade deal negotiations and consequently, the current flow of reports and consultations are not likely to lead to a substantive overhaul of MiFID II anytime soon. Nevertheless, the above measures clearly show that over the medium-term substantial change is coming.