Structured products legal and regulatory bulletin: June 2020

• ESMA reminder of conduct of business obligations
• Developments regarding BMR ESG disclosure obligations
• Council adopts Taxonomy Regulation
• AFM publishes study on turbos
• FCA issues statement on the impact of COVID-19 in relation to the LIBOR transition timeline
• IBOR fallback rate adjustments update
• ISDA publishes results of second consultation on pre-cessation fallbacks
• ICMA issues COVID-19 guidance on its standard force majeure clause
• ICMA quarterly report for Q2 2020 focuses on impact of COVID-19

EU

ESMA reminder of conduct of business obligations

On 6 May 2020, the European Securities and Markets Authority (ESMA) published a statement (available here) in relation to firms’ MiFID II conduct of business obligations in the context of the COVID-19 pandemic.

ESMA stated that several National Competent Authorities (NCAs) have noticed an increase in trading and account opening by retail investors during the pandemic. EMSA highlighted that, in view of the intensified market volatility, such activities carry significant risks. ESMA’s view is that firms have “even greater duties” when providing investment services to investors, “especially when they are new or have limited investment knowledge or experience”, where they decide to invest during the current intensified market volatility. Such obligations include acting honestly, fairly and professionally in clients’ best interests and having adequate product governance arrangements in place. ESMA and NCAs will continue to monitor retail clients’ investment activities and firms’ compliance with conduct obligations.

Developments regarding BMR ESG disclosure obligations

Pursuant to the Benchmarks Regulation ((EU) 2016/1011), as amended by the Low Carbon Regulation ((EU) 2019/2089), benchmark administrators are required, with effect from 30 April 2020, to make available information on how benchmark methodologies reflect environmental, social and governance (ESG) factors. Minimum requirements in respect of such disclosure are to be set out in Delegated Regulations.

The Low Carbon Regulation also introduced a requirement to ensure that (also by 30 April 2020) benchmark statements include an explanation as to how ESG factors are reflected in the relevant benchmark (or, as applicable, that the benchmark does not pursue ESG objectives). Further information on these requirements is also to be set out in Delegated Regulations.

In addition, the Low Carbon Regulation introduced concepts of “EU Climate Transition Benchmarks” and “EU Paris-aligned Benchmarks”, providing for benchmarks to be labelled as such where they meet certain criteria, to be set out in Delegated Regulations.

In relation to these provisions, on 8 April 2020 the European Commission published three draft Delegated Regulations which cover the following:

• Details of minimum transparency requirements for benchmark administrators in relation to how benchmark methodologies reflect ESG factors. The text of the draft Delegated Regulation is available here.

• Details of minimum transparency requirements in relation to explanations to be included in benchmark statements in relation to ESG factors. The text of the draft Delegated Regulation is available here.

• Minimum standards for EU Climate Transition Benchmarks and EU Paris-aligned Benchmarks and associated transparency and methodology requirements. The text of the draft Delegated Regulation is available here.

Following completion of the related consultation period, the draft Delegated Regulations are now subject to a period of scrutiny and so not yet in force.

The fact that these Delegated Regulations are not yet in force has presented a challenge for benchmark administrators in terms of preparing to comply with the transparency obligations which started to apply on 30 April 2020. In view of this, on 29 April 2020 ESMA published a no action letter (available here) addressed to NCAs which states that, until the Delegated Regulations apply, NCAs should not prioritise supervisory or enforcement action in respect of the relevant transparency obligations.

Council adopts Taxonomy Regulation

The European Council announced on 15 April 2020 (available here) that it has adopted the Taxonomy Regulation (2018/0178(COD)). The Regulation is intended to create an EU-wide classification system (or taxonomy) which provides common language to identify environmentally sustainable activities. This was an integral part, and the first action point, in the European Commission’s Action Plan on Financing Sustainable Growth and the Regulation forms part of the package of related reforms introduced by the European Commission including the Disclosure Regulation ((EU) 2019/2088) and the Low Carbon Benchmark Regulation referred to above.

The Taxonomy Regulation mandates certain disclosure (both pre-contractual and periodic) in relation to environmental sustainability in respect of certain funds, pension products and other financial products including certain managed portfolios.

The Taxonomy Regulation will enter into force following adoption of the text of the Regulation by the EU Parliament and on the twentieth day following publication in the Official Journal. However, the effectiveness of the transparency requirements of the Regulation is not immediate and is subject to implementation of further Delegated Regulation.

Netherlands

AFM publishes study on turbos

On 3 March 2020, the Dutch Authority for the Financial Markets (the AFM) published its study on turbos (also referred to as sprinters or speeders) that are distributed to retail investors in the Netherlands. The study is available here (in English).

Both ESMA and the AFM have noted that there are similarities between contracts for differences (CFDs) and turbos and previously introduced restrictions on the marketing, distribution and sale of CFDs to retail investors. ESMA and the AFM are now monitoring the effects of retail investors trading turbos.

The study’s main conclusion is that turbos are generally traded with similar results as CFDs by retail investors. The key findings are that:

• the average return per investor was negative;
• higher leverage results in higher losses; and
• frequent trading leads to higher losses.

The AFM will decide on its follow-up approach regarding the risks involved in trading turbos in the second half of 2020.

UK

FCA issues statement on the impact of COVID-19 in relation to the LIBOR transition timeline

On 29 April 2020, the Financial Conduct Authority (FCA) issued a statement in relation to the timeline for firms’ LIBOR transition plans, which was further updated on 13 May 2020. The statement is available here.

The FCA stated that it remains the central assumption that firms cannot rely on LIBOR being published after the end of 2021. The FCA and the Bank of England have worked with members of the Working Group on Sterling Risk-Free Reference Rates and its sub-groups and task forces in considering the impact of COVID-19 on firms’ LIBOR transition plans. In light of the pandemic and recent developments, the Prudential Regulation Authority and FCA suspended transition data reporting at the end of Q1 for dual-regulated firms and cancelled some Q1 firm meetings. In light of subsequent developments, the PRA and FCA have decided to resume full supervisory engagement on LIBOR transition progress from 1 June 2020, including data reporting at the end of Q2.

ISDA and other trade associations

IBOR fallback rate adjustments update

To facilitate the effectiveness of fallback provisions and the transition of derivatives contracts referencing LIBORs / IBORs to alternative risk-free rates, on 23 April 2020, ISDA and Bloomberg Index Services Limited (BISL) published an IBOR Fallback Rate Adjustments Rule Book. The Rule Book set outs the methodology, rules and conventions that BISL will use to determine adjustments required to change LIBOR / IBOR rates to the relevant risk free rate, taking into account the inherent differences between the relevant rates. The Rule Book is available here.

In addition, ISDA published a tentative timetable regarding the implementation of fallback provisions. The timetable is available here.

Further, on 4 May 2020, ISDA published an updated version of its FAQs in respect of fallback rate adjustments. The FAQs are available here.

ISDA publishes results of second consultation on pre-cessation fallbacks

On 15 April 2020, ISDA announced the preliminary results of its consultation on the implementation of pre-cessation fallbacks for derivatives referencing LIBOR. The statement is available here. On 14 May 2020, ISDA published a summary of responses in relation to the consultation. The report is available here.

The consultation focused on the inclusion of a pre-cessation trigger in addition to the permanent cessation fallbacks in the amended 2006 ISDA Definitions for LIBOR and in a related protocol for applying the updated definitions to legacy trades. This is the second pre-cessation consultation conducted by ISDA; the first consultation in 2019 yielded mixed feedback. The initial results of the second consultation revealed that the majority of respondents prefer the inclusion of both pre-cessation and permanent cessation fallbacks in the amended 2006 ISDA Definitions for LIBOR. The respondents also showed a majority preference for ISDA to publish a protocol which features both pre-cessation and permanent cessation fallbacks.

In terms of next steps, ISDA plans to proceed on the basis that both pre-cessation fallbacks based on a ‘non-representativeness’ determination and permanent cessation fallbacks would apply to new and legacy derivatives referencing LIBOR that incorporate the amended 2006 ISDA Definitions. The updated definitions for other IBORs would continue to include permanent cessation fallbacks only. ISDA is aiming to publish the protocol and amendments to the 2006 Definitions in July 2020.

Once published, issuers and manufacturers of structured products may want to consider the extent to which the triggers and associated fallbacks are reflected in securities terms and conditions in order to maintain alignment with hedging arrangements.

ICMA issues COVID-19 guidance on its standard force majeure clause

On 27 March 2020, the International Capital Market Association (ICMA) published a note on the ICMA standard force majeure clause in the context of the COVID-19 pandemic. The note is available here.

The note offers guidance on the timing during which the clause may be triggered, historic use of the clause in practice and the application of the clause in the context of the COVID-19 pandemic. ICMA has determined not to make changes to the clause in the context of the pandemic.

Structured products issuers and manufacturers may consider reviewing force majeure provisions in programme documentation in view of the COVID-19 pandemic and the ICMA standard clause, and this guidance, is a helpful reference in that context.

ICMA quarterly report for Q2 2020 focuses on impact of COVID-19

On 6 April 2020, ICMA published its quarterly report for the second quarter of 2020. The report is available here. The report features various commentary on the impact of COVID-19, including in relation to Brexit and the various official responses to the market impact of the pandemic.

Other topics covered in the report include the post-Brexit transition period, sustainability and FinTech.