EU and UK regulator commentary regarding Ukraine / Russia

Since the crisis began, we have continued to see communications from the key local and EU regarding the impact of the Ukrainian crisis on the financial services sector, particularly in the areas of sanctions compliance, liquidity management and cybersecurity.

Most of the key local regulators have now publicly issued sector-specific communications in some form.  We are also aware that some regulators continue to have direct discussions with certain firms. At EU-level, we have seen sector-specific commentary issued as to how firms are expected to operate under the current crisis.

As the crisis has continued, we have more recently seen publications commenting on the ongoing impact on the financial markets. September saw ESMA publish its Second TRV Report of 2022, which discusses how the Russian war on Ukraine against a backdrop of already-increasing inflation has profoundly impacted the risk environment of EU financial markets. In October ESMA published its Enforcement Priorities for 2023 which sets out the areas where ESMA, together with national enforcers, will pay particular attention when monitoring and assessing the application of the relevant reporting requirements - this includes firms' reporting requirements on the financial impact of the Ukraine/Russia crisis. Most recently ESMA’s First Trends, Risks and Vulnerabilities Report of 2023 (published February 2023) discusses how the Ukraine crisis, against a backdrop of already-increasing inflation, has profoundly impacted the risk environment of EU financial markets. Read more here.

Our Overview Table shows a snapshot of the latest position at EU and local level.

Key themes

The key themes of these EU-level and local level communications can, broadly, continue to be split into the following:

1. Sanctions - Strict compliance with sanctions is expected and obligations on firms to stop subscriptions, suspend redemptions and asset freeze where in scope of the sanctions. On the other hand, unnecessary de-risking should be avoided. In September we also saw commentary (e.g. from the Dutch AFM regulator) noting the risks for firms outsourcing their sanctions screening processes.

2. Robust board, senior management and internal control functions - Strong board and senior management oversight is required over the impact of sanctions across groups, and strong internal control functions are required to ensure ongoing sanction compliance.

3. Valuation & liquidity management - In particular the obligations on asset management firms to monitor likely volatile valuations and liquidity risk and to use liquidity management tools.

4. Cybersecurity - In particular the obligations on firms to be extra vigilant to cybersecurity incidents and be in a position to recover quickly if a cyberattack does occur.

5. Inside information and financial reporting - In particular the obligations on issuers to comply with their transparency obligations under the Market Abuse Regulation and financial reporting obligations, in relation to the impact of the crisis on their business. The importance of this is highlighted in ESMA's October 2022 Enforcement Priorities for 2023 which sets out the areas where ESMA, together with national enforcers, will pay particular attention when monitoring and assessing the application of the relevant reporting requirements - this includes firms' reporting requirements on the financial impact of the Ukraine/Russia crisis.

6. Other - This includes commentary on broader issues like business continuity, regulator engagement and operational matters.

There still remains a variation in:

• topics covered by these communications

• the levels of instruction and guidance provided by local regulators

• whether the communications are all publicly available or a mixture of direct-to-firm and publicly available

Below we have summarised some of the key sector-specific details coming out of EU-level commentary.

Investment Management Sector

On 16 May, the European Securities and Markets Authority (ESMA) published a statement to fund managers of AIFs, UCITS, EuVECAs and EuSEFs discussing expectations on liquidity management and valuations, including:

• Fair Value assessment: Managers with exposures to assets facing liquidity issues need to assess if a fair value can be determined and adapt valuations without undue delay. A consistent approach to valuation should be followed in line with policies/procedures and EU/national law. Managers should not apply a "one-size-fits-all" approach where assets facing liquidity issues are by default written down to zero without consideration given to the specifics of each individual asset.

• Suspension of subscriptions/redemptions: In cases where fair value can no longer be determined, or subscription/redemption at current market price is not in the best interest of investors, consideration should be given to temporarily suspending subscriptions/redemptions as an immediate measure.

• Other measures: Managers may consider whether other measures in some cases are preferable from an investor protection perspective e.g. total write off of the relevant assets, the liquidation of the fund or the segregation of the assets that have become illiquid or non-tradable. The solution to be chosen will depend on a case-by-case assessment taking into account, inter alia, the possible value that could be recovered, the amount of affected assets and their weight in the total portfolio, the cost of each measure and the tools available according to EU and national law.

• Side Pockets: A central question that is discussed is whether fund managers can use side pockets or similar arrangements to segregate assets that have become illiquid or non-tradable. ESMA supports the European Systemic Risk Board (ESRB) recommendations that the use of side pockets has advantages, but also notes the risks of using side pockets. That said, in the context of the Russian invasion of Ukraine, and in light of the material valuation issues referred to above, ESMA states that side pockets may in some cases be preferable from an investor protection perspective compared to a temporary suspension. In summary:

  • AIFMs, EuVECA and EuSEF managers: side pockets are envisaged under AIFMD, where in the best interests of investors; and similar considerations apply to EuVECA and EuSEF managers (although ESMA notes that this should be less relevant in practice given the closed-ended nature of these funds)

  • UCITS managers: whilst the UCITS framework does not make any reference to side pockets, side pockets could be permissible for UCITS for the purpose of managing the impact of the Russian invasion of Ukraine

  • Exceptional circumstances: the use of side pockets, including for UCITS, is subject to ongoing discussions in the context of the AIFMD/UCITS review. Therefore, the clarifications provided in ESMA's statement are provided in the context of the exceptional circumstances arising due to the impact of the Russian invasion of Ukraine (and are without prejudice to any potential future legislative amendments adopted by the EU legislators)

  • Manager responsibility: it remains the responsibility of the fund manager to perform a comprehensive analysis to ascertain, whether and which of the permissible side pocket arrangements could be implemented in the relevant case and under what circumstances and conditions, carefully weighing the advantages and disadvantages for all investors wishing to subscribe, redeem or remain invested in the fund.

Indeed, in relation to side pockets, we have seen the Irish CBI and UK FCA publish rules enabling the use of side pockets in certain circumstances.

Financial Institutions Sector

On 26 April, the European Central Bank (ECB) published FAQs addressed to financial institutions, on the following key areas:

• Strong board, senior management and internal functions: Firms should have strong oversight from the board and senior management on the impact of the sanctions regimes for the whole group. Firms should also have strong internal control functions - e.g. a proactive compliance department to monitor developments under the different sanctions regimes and assess their impact on the firm, as well as risk management arrangements for the approval of transactions and engagement with clients

• Cyber Security: The ECB notes that whilst there has, to date, been no material disruption from cyberattacks, the threat remains and financial institutions must protect against such attacks, as well as be in a position to recover quickly if a cyberattack does occur

• Contact with firms: The ECB is in close discussions with financial institutions most affected by the sanctions

• Queries on sanctions: The ECB confirms that the European Banking Authority (EBA) is helping the European Commission to collect and filter queries from firms about sanctions - queries can be sent by firms to eba.sanctions.qa@eba.europa.eu

• Co-operation with national regulators: The ECB is in constant contact with national regulators in the EU (as well as the Bank of England and the US Federal Reserve System) to monitor the impact on supervised banks

The European Banking Authority (EBA) also issued a statement on 27 April, which in summary covers:

• Refugee access to EU financial system and protection: This sets out how firms and their supervisors can provide access to Ukraine refugees to the EU's financial system. It also expects firms to be vigilant of refugee abuse by criminals - e.g. by being alert to any indicators suggesting that refugee customers are being exploited. Examples include recurring payments for wages at unreasonably low amounts and unusual patterns of money transfers

• Sanctions avoidance: Firms should pay particular attention to apparent attempts by customers to obfuscate relationships with sanctioned persons and those who are at risk of being sanctioned, or to conceal the ultimate beneficial owner - e.g. sudden changes in the customer's ownership or control structure

• Unwarranted de-risking: Firms should ensure that compliance with the EU's sanctions regime does not lead to unwarranted de-risking - i.e. the financial exclusion of legitimate and potentially vulnerable customers (including customers with links to Russia or Belarus that are legally resident in the EU).

Wider Financial Services Sector

Prospectus approvals: There continues to be a strong EU expectation on firms to comply with ongoing sanction requirements. This has most recently manifested in the context of prospectus approvals. On 7 July ESMA published a statement informing market participants that the European Commission has confirmed that infringements of EU sanctions can constitute sufficient legal basis for national regulators to refuse the approval of a prospectus. Against this backdrop, issuers submitting a prospectus to national regulators should note that they may receive questions and/or requests for additional documentation from those regulators concerning the areas and parties identified by EU sanctions. These questions or requests for additional information may occur when the prospectus is first submitted or at any time during the scrutiny and approval process.

This follows-on from ESMA's 14 March broader communication to the financial services sector which covered, amongst other things:

• Investment management: ESMA has reinforced its co-ordination role and is organising frequent exchanges with local EU regulators to analyse market developments and supervisory risks (with a focus on liquidity issues and the use of liquidity management tools).

• Cyber Security: ESMA is facilitating the collection and sharing of information and experiences among local EU regulators regarding cyber incidents

• *Sanctions: *Financial market participants should ensure that they comply with the EU sanctions and monitor further restrictions - and the European Commission will provide clarity and answer queries on the scope and implementation of these sanctions (e.g. recent clarity has been provided on prospectus approvals - see above)

• CCPs: ESMA is monitoring central counterparty related volatility and margin developments in the energy and commodities markets

• CRAs: ESMA is engaging with credit ratings agencies (CRAs) to ensure transparency around rating and the impact of sanctions on CRA's operations

• Benchmarks: ESMA is engaging with benchmarks administrators to verify the impact of market developments and sanctions on benchmarks

• Secondary markets: ESMA is assisting local regulators with the consistent implementation of sanctions by market operators (including suspension of trading in instruments by venues)

• CSDs: ESMA is monitoring the impact of sanctions on central securities depositories (CSDs) and consolidating data on settlement fail levels as an indicator of market developments.

• Inside information: Issuers should disclose as soon as possible any inside information concerning the impact of the crisis on their fundamentals, prospects and financial situation in line with the Market Abuse Regulation (unless the delayed disclosure conditions are met)

• Financial reporting: Issuers should provide transparency to the extent possible on a qualitative and quantitative basis of the impact of the crisis in their 2021 year-end reports (if not yet finalised) and in the annual shareholders' meeting or otherwise in their interim financial reporting disclosures.

What's next?

Whilst there continues to be some divergence in the content of these communications across jurisdictions and the EU, many firms will be reading these cumulatively - and what is clear from the EU communications (and peppered throughout the local regulator, and UK, communications that have been issued so far) is that there remains a broad expectation on firms to:

• monitor sanction developments, and comply with the sanctions in full and in a timely manner - including having robust management and internal control functions to ensure continued compliance with sanctions

• closely monitor unnecessary de-risking in an attempt to comply with sanction requirements

• closely monitor and effectively manage valuations and liquidity

• make full use of liquidity management tools

• closely monitor cybersecurity risks and have business continuity plans in place

• comply with market abuse reporting obligations and financial reporting obligations

• keep engagement lines with their local regulator open (and to notify the regulator of specific issues, where applicable)

We expect further commentary and guidance to continue to be published at EU and local level. We will keep you updated accordingly.