Structured products bulletin: Q2 2022

Welcome to our new-look structured products bulletin, where we take a look each quarter at the key legal and regulatory developments in the structured products space.

For those in the UK, the most significant development in Q2 2022 – and arguably since Brexit, in fact – was the introduction of the Financial Services and Markets Bill. The Bill will create a framework to repeal all retained EU laws relating to financial services (including the Prospectus Regulation, following HM Treasury’s previous review) and enable the UK regulators to replace them with new UK-specific rules. From a structured products perspective the more substantive developments will come at a later stage, when the UK regulators consult on and pass the replacement rules themselves. The successor to the prospectus regime is rumoured to be the first in line for reform following the Bill’s assent. So plenty to look out for in the future.

Elsewhere we’ve seen a good deal of activity in retail and consumer-focused regulation, as outlined further below in the bulletin. The EU are seeking to strengthen the protection afforded to consumers without dampening their participation in the capital markets – a difficult but familiar tightrope for regulators. The FCA’s latest statements on the FCA’s new Consumer Duty is not referenced below (as it was published in Q3) but our in-depth summary is accessible here.

The FCA’s consultation paper on winding down synthetic LIBOR and USD LIBOR rounds-off the most notable developments for Q2 2022. We expect the consultation will prompt market participants to re-engage with their transition planning, after a brief hiatus since the transition deadlines for several key LIBOR rates passed at the end of 2021.

The full bulletin is set out below.

EU

CSDR

ESMA publishes final report postponing the CSDR mandatory buy-in regime

On 2 June 2022, ESMA published a final report on amending the RTS on settlement discipline to postpone the CSDR mandatory buy-in regime for a period of three years. The draft RTS will now be sent to the European Commission for endorsement in the form of a Commission Delegated Regulation, following which the Commission Delegated Regulation will then be subject to the non-objection of the European Parliament and of the Council.

By way of background, the CSDR settlement discipline regime has applied since 1 February 2022. However, market participants have voiced significant concerns about the mandatory buy-in regime due, in particular, to an absence of clarity on some open questions necessary for implementation of the buy-in requirements.

EU BMR

ESMA updates Q&As on EU BMR

On 1 April 2022 and on 23 June 2022 ESMA issued updates to its Q&A on the EU BMR.

The updates modify the Q&A relating to ESG factors reflected in benchmark statements and methodologies and the meaning of the term “readily available” data in relation to contribution of input data.

European Commission publishes consultation on EU BMR use of third-country benchmarks

On 20 May 2022, the European Commission published a consultation on rules governing the use of third-country benchmarks under the EU BMR. The consultation will inform the European Commission’s proposal to review those rules, to be published in Q4 2022.

By way of background, a transitional period currently applies in respect of the use of benchmarks provided by third country (i.e. non-EU) administrators which runs until the end of December 2023. During the transitional period, third country benchmarks can still be used by supervised entities in the EU if the benchmark is already used in the EU as a reference for financial instruments, financial contracts, or for measuring the performance of an investment fund. Following expiry of the transitional period, third country benchmarks will need to be either deemed equivalent, recognised or endorsed for use in the EU.

MiFID/investor protection

ESMA response to European Commission consultation on enhancing retail investor suitability and appropriateness assessments

On 19 April 2022, ESMA published a response to the European Commission’s consultation on the enhancement of assessments of retail investors’ suitability and appropriateness assessments.

By way of background, in its February 2022 consultation, “Targeted Consultation on Options to Enhance the Suitability and Appropriateness Assessments” the Commission stated that its suggested approach might:

• “Modify the current MIFID II/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.”

In the response, ESMA states that it is supportive of taking a holistic view of investor protection but also raises a number of points of concern, including:

• Whether a standardised retail investor assessment regime with no differentiation between investment services is effective to serve the needs of different types of retail investors in different contexts; and
• The significant impact on the current model for providing services and need for related guidance.

ESMA makes recommendations to improve retail investor protection

On 29 April 2022, ESMA published advice for the European Commission in relation to aspects of retail investor protection. ESMA’s recommendations seek to maintain a high level of investor protection whilst ensuring that retail investors benefit from digitalisation opportunities. They include:

• Ensuring machine readability of disclosure documents to enable the public to have access to searchable databases;
• Preventing information overload through limiting the definition of vital information;
• Developing standard formats for information on costs, charges and disclosures and aligning the disclosures under MiFID and the PRIIPs KID; and
• Taking action against aggressive and misleading marketing communications, especially on social media.

European Commission calls for evidence on retail investment legislative package

On 3 May 2022, the European Commission published a call for evidence to assist in the development of a package of measures intended to enhance participation of retail investors in capital markets based on a perception that consumers do not currently benefit sufficiently from capital markets.

The call for evidence indicates various measures which could be explored to address the issue including further improvement of disclosure regimes and efforts to enhance financial literacy.

ESMA consultation on revised MiFID II product governance guidelines

On 8 July 2022, ESMA published a consultation paper which includes certain proposals to update the MiFID II product governance guidelines. The proposals include:

• If the product is linked to sustainability-related objectives, ensuring these are specified;
• Specific to complex products, such as certain OTC derivatives or structured products, defining the target market at the level of the individual product, as opposed to using a clustering approach;
• Ensuring a compatible distribution strategy is determined; and
• Ensuring there is a periodic review of products in line with the proportionality principle.

ESMA will be holding an Open Hearing on this consultation on 14 September 2022, with the deadline for responses to the consultation being 7 October 2022.

PRIIPs

ESA’s publish technical advice on European Commission’s review of the PRIIPs Regulation, recommending significant changes

On 2 May 2022, the European Supervisory Authorities (ESAs) published technical advice on the European Commission’s review of the EU PRIIPs Regulation.

The ESAs encouraged the European Commission to consider wide-ranging changes to the PRIIPS framework, with the aim of increasing the ease with which consumers can compare different products. Some of the ESAs’ key proposals include the increased use of digital disclosure, clarifying the scope of the regulation and, in relation to key information documents (KIDs), allowing flexibility on the information to be provided in the performance section and introducing a new section focussed on sustainability objectives.

ESAs suggest improvements to the What is this product? section of PRIIPs KIDs

On 10 May 2022, the ESAs published recommendations to improve the “What is this product?” section of the PRIIPs KIDs.

The ESAs noted that current descriptions lead to a lack of clarity, which impacts the ability of retail investors to understand products’ key features. The statement includes various recommendations aimed at improving comprehensibility including:

• Presenting information, including the class of product, in clear and understandable language that is not too generic;
• Avoiding technical jargon and terminology to ensure retail investors to whom the product is targeted can understand; and
• Including clear, precise and direct descriptions of key information, including the risk of capital loss, the feature of early termination, and the underlying assets.

UK

UK Financial Services and Markets Bill

Financial Services and Markets Bill introduced to the House of Commons

On 20 July 2022, the Financial Services and Markets Bill was introduced to the House of Commons. From a capital markets perspective, the most significant provisions are those which:

• Revoke all retained EU law that relates to financial services (including the Prospectus Regulation, the PRIIPs Regulation, MiFIR and EMIR). The revocations will take effect when HM Treasury makes further regulations, after replacement rules have been drafted and consulted on;
• Grant greater rule-making powers to the UK regulators, which will be used to produce the abovementioned replacement rules. The replacement rules will likely form part of regulators’ existing rulebooks; and
• Amend certain specific legislation, either permanently or for the transitional period between the Bill passing into law and the revocation of the relevant retained EU law. One example of the latter is the proposed amendments to UK MiFIR.

The Bill will undergo several rounds of further readings as part of the parliamentary approval process, during which the Bill will likely be subject to numerous amendment proposals. The overall timeline to pass the Bill into law is not yet clear, save to say that the ‘second reading’ of the Bill is due to take place on 7 September 2022.

UK Consumer Duty

FCA publishes an update on implementation of guidance on fair treatment of vulnerable customers

On 16 June 2022, the FCA published an update on the progress market participants have made towards implementing its guidance on the fair treatment of vulnerable customers. Although the FCA highlights that it has seen good examples of flexible customer service and increased training of staff, improvement could be made in relation to the following areas:

• Monitoring and evaluation to support governance processes, particularly in relation to the production of management information, capturing data on consumers’ needs and monitoring the effectiveness of staff training;
• Considering the needs of consumers when developing products and services; and
• Increased engagement of senior leaders in overseeing and providing direction to the relevant firms.

Firms marketing products to retail investors who are natural persons and have characteristics of vulnerability should consider the guidance.

LIBOR

LIBOR transition

LIBOR transition Fallbacks for contracts linked to USD LIBOR ICE Swap Rates

On 8 June 2022 the Alternative Reference Rates Committee (ARRC) released recommendations for contracts linked to USD LIBOR ICE Swap Rates and on 15 June 2022 ISDA released the June 2022 Benchmark Module to the ISDA 2021 Fallbacks Protocol, which covers USD LIBOR swap rates.

ICE Swap Rates (alternatively referred to as constant maturity swap (CMS) rates) represent mid-market fixed rates for fixed/floating interest rate swaps for a set of tenors at a specified time of the day. They are often used as reference rates for structured products and these publications set out the basis on which derivatives and other contracts which reference USD LIBOR ICE swap rates can be transitioned to refer to the relevant USD SOFR ICE swap rate.

Minutes of a conference of the Working Group on Euro Risk-Free Rates published with comments on designation of statutory replacement rates for GBP and JPY LIBOR

ESMA has published the minutes of a conference of the Working Group on Euro Risk-Free Rates held on 17 June 2022.

The minutes include, amongst other things, an update from the European Commission on the possible designation of statutory replacement rates for GBP LIBOR and JPY LIBOR; the minutes show that the European Commission will not make an urgent designation at this stage but will keep monitoring market developments, recalling that every decision by the Commission regarding the designation of a statutory replacement rate will have to be subject to a public consultation.

FCA publishes consultation paper on winding down synthetic sterling LIBOR, and USD LIBOR

On 30 June 2022, the FCA published a consultation paper seeking opinions on:

• The progress of the transition away from one, three and six-month sterling LIBOR settings, including views on whether the requirement to continue publication of one and six-month LIBOR settings should be extended to the end of March 2023 as opposed to the end of December 2022, and when it will be possible for the 3-month sterling LIBOR setting to cease in an orderly fashion; and
• The size and nature of remaining exposures of market participants to USD LIBOR, and any challenges that may be faced from the publication of USD LIBOR settings on a synthetic basis.

The consultation closes on 24 August 2022.

ARRC playbook for transition of cash products

On 11 July 2022 the ARRC published its LIBOR Legacy Playbook. This is intended as a guide to support the transition of cash products which reference USD LIBOR.

ISDA/ICMA and other trade associations

ICMA updates its Primary Market Handbook

On 22 June 2022, ICMA published amendments to its standard language appendices in its Primary Market Handbook. A small number of introductory paragraphs and endnotes were updated to reflect recent FCA guidance to the UK PRIIPs Regulation. No changes have been made to the standard language itself.

ICMA updates its green, social and sustainability bond principles

On 30 June 2022, ICMA published new documentation and other resources in relation to its green, social and sustainability bond principles. This includes new definitions for green securitisation, an updated version of its Guidance Handbook Q&As, updated key performance indicators for sustainability-linked bonds and new resources for climate transition finance. The new definitions may be of interest to manufacturers considering the parameters of the Green Bond Principles in relation to certain asset backed structures.

ESG

Developments re EU Green Bonds Regulation

On 13 April 2022, the Council of the EU confirmed that it had agreed its position on the European Commission’s proposed Green Bonds Regulation, which will create uniform requirements for issuers of bonds that use the designation “European Green Bond” or “EuGB”, and establishes a registration system and supervisory framework for external reviewers of European green bonds.

On 16 May 2022, the European Parliament adopted their negotiation position on the regulation and introduced various changes to the Commission’s proposal, broadening its scope to regulate the entire green bond market, rather than only establishing the European Green Bond label, stating that they want to achieve a “gold standard in the international bond market”.

The position proposes changes to the draft text, including extending the scope of the regulation to impose mandatory requirements to bonds marketed as environmentally sustainable and sustainability-linked bonds (i.e. not just those carrying the European Green Bond label).

Trilogue discussions to finalise the regulation are ongoing.

ICMA publishes updated analysis on the EU’s proposed Green Bond Regulation

On 22 June 2022, ICMA published analysis on the proposed Green Bond Regulation. ICMA highlighted that although it supports the development of a voluntary standard, proposals to extend the scope of the regulation may hinder the success of the European Green Bond label due to the additional impracticalities and increase of the legal liability on issuers.

FCA publishes feedback statement on ESG integration in UK capital markets

On 29 June 2022, the FCA published a feedback statement on its consultation paper on integrating ESG factors into the UK capital markets. The statement focuses on issues relating to ESG-labelled debt instruments (including oversight of verifiers and second party opinion (SPO) providers) and ESG data and rating providers.

Further to this, the FCA published guidance for issuers of ESG-labelled debt instruments. In summary, the FCA:

• Encourages issuers of ESG-labelled ‘use of proceeds’ debt instruments to apply industry standards, such as ICMA’s green, social and sustainability bond principles;
• Reminds issuers, advisors and other market participants of their existing obligation to ensure that any advertisement is not inaccurate or misleading, and is consistent with the information contained in the prospectus; and
• Encourages issuers and their advisors to consider verifiers’ and assurance providers’ expertise and professional standards, and to engage with second party opinion providers and verifiers who adhere to appropriate standards.