Structured products bulletin: Q3 2022

EU

CSDR

EU institutions suggest removing the CSDR mandatory buy-in regime

On 26 September 2022, the European Central Bank published its opinion on the European Commission’s proposed amendments to CSDR. A separate report on the same topic was published on 13 October 2022 by the Rapporteur to the European Parliament’s Committee on Economic and Monetary Affairs. Both the opinion and report consider the mandatory buy-in regime in CSDR to be “a significant interference in the execution of securities transactions and the functioning of securities markets” and suggest it should be removed.

The opinion and report cover a range of other areas in relation to the CSDR amendments.

ESMA updates its Q&As on the implementation of CSDR

On 3 August 2022, ESMA published updated Q&As on the implementation of CSDR, including in relation to calculation of cash penalties and bilateral cancellation of settlement instructions already matched by a trading venue.

PRIIPs

Changes to FinDatEx PRIIPs template following FCA amendment

On 4 August 2022, Financial Data Exchange Templates updated its European PRIIPs Template (EPT V2.1). The update made a series of changes dealing with the FCA’s amendments to the PRIIPs regime in March 2022 relating to additional information now required in the UK, including, but not limited to:

• transaction costs methodology;
• KID publication date and website address;
• investment objective portfolio; and
• UK performance information and performance fees.

The template follows prior public consultation.

MiFID II

ESMA publishes statement advising firms to consider inflation risk for investor protection

On 27 September 2022, ESMA published a statement to investment firms in relation to inflation and inflation risk. The statement seeks to remind MiFID firms of the relevant requirements under MiFID II relating to raising their clients’ awareness of this risk in manufacturing and distributing investment products and providing investment services.

The statement reminds firms that inflation and associated risks may be relevant in the context of:

• the MiFID II requirement that “all information, including marketing communications, addressed by the investment firm to clients or potential clients shall be fair, clear and not misleading”;
• the suitability assessment; and
• product governance processes.

UK

Appointed representatives regime

FCA publishes policy statement on final changes to the appointed representatives regime

On 3 August 2022, the FCA published its new policy statement regarding improvements to the Appointed Representatives regime.

The Appointed Representatives (AR) regime applies to a firm or a person who carries on a regulated activity under the responsibility of an authorised financial services firm. The regime seeks to ensure that principal firms maintain adequate oversight and implement effective systems and controls for overseeing the activities ARs undertake, as well as ensuring consumers of financial services which ARs undertake are not exposed to additional risk or otherwise disadvantaged in their direct dealings with authorised firms.

The rules will help prevent consumers being mis-sold or mis-led by ARs. In order to prevent misconduct, firms must now ensure that there is appropriate oversight of ARs and ensure adequate systems and controls are in place to monitor their actions. Future AR appointments must now be notified to the FCA 30 calendar days prior to taking effect.

We are aware that a number of structured products plan managers will make use of ARs as part of their approach to licensing.

Financial promotion rules

FCA tightens financial promotion rules relating to high-risk investments

On 1 August 2022, the FCA published a policy statement setting out tighter rules in relation to the promotion of high-risk products. Restrictions on mass marketing to retail investors relating to Restricted Mass Market Investments, such as Non-Readily Realisable Securities, have been implemented as a result, together with a blanket ban on mass marketing of Non-Mass Market Investments, such as Speculative Illiquid Securities.

After concerns were raised over consumers investing in high-risk products that do not match their risk appetite, firms that issue and approve advertisements must now have sufficient expertise and conduct stringent checks to ensure investors and products are appropriately matched. Further, referral bonuses and other similar incentives are now banned in relation to these products and risk warnings must be more prominent.

The UKSPA recently reached out to the FCA to challenge one of its website pages entitled “Understanding High Risk Investments” where structured products were used a key bullet point example of a high risk investment, which seemed at odds with recent publication PS22/10 on financial promotions rules for high-risk investments. The FCA reminded UKSPA that firms need to consider whether FCA marketing restrictions apply to particular investments on a case-by-case basis and the fact that a particular security is not subject to a restriction on promotion does not of itself mean that the product is not ‘high-risk’ and that firms need to be mindful of the need to communicate with clients in a way that is fair, clear and not misleading and that makes fair and prominent reference to relevant risks. That said, and without commenting on the level of risk of any particular structured product, or of structured products generally, the FCA agreed to remove the reference to structured products from this webpage in the interests of providing clarity and simplicity to the inexperienced self-directed investors they target.

UK Consumer Duty

FCA publishes final guidance and Policy Statement in relation to Consumer Duty

On 27 July 2022, the FCA published its final guidance in relation to UK Consumer Duty, with an extended phased timeline for implementation of (i) 31 July 2023 for all in scope new and existing products and services open to sale or renewal; or (ii) 31 July 2024 for closed products and services. Boards have until 31 October 2022 to agree their implementation roadmaps.

While the FCA retained their approach to a number of items, changes to the previous consultation paper include, amongst others:

• additional factors are now included in the value assessment, such as accrued costs and/or benefits and whether there are any products that have been priced significantly lower for a similar or better benefit than the product in question;
• consumer support - firms should consider whether they need to build positive friction points into their processes to mitigate the risk of harm and give customers sufficient opportunity to understand and assess their options. Firms need to consider friction points carefully as inappropriate friction points (or “sludge”) can amount to an unreasonable barrier;
• consumer understanding - the concept of the “average” customer has been amended in the rules and replaced throughout with “retail customers in the target market”, removing uncertainty about diverse needs within a customer group; and
• in-scope activities – there are changes to the scope of retail market business to exclude primarily wholesale instruments. This includes removing the term “non-complex financial instrument” and reducing the threshold for non-retail financial instruments to £50,000.

FCA publishes new information clarifying FAQs as implementation deadline approaches

On 5 October 2022, the FCA published further information for firms relating to queries on parts of the Consumer Duty received from firms of note for the wider market. Clarifications to the Duty include:

• October implementation plans – firms do not have to have scoped all work required to implement the Duty by the October deadline, but firms will be expected to have set out how they will do so in order to ensure timely implementation;
• Consumer Duty Board champions – FCA guidance has stated that this champion should be an independent Non-Executive Director (where possible) to support the Chair and CEO in implementing the Duty. The FCA has clarified this is not a prescribed responsibility under SMCR, and that the designated champion may also be the Chair. Firms are encouraged to apply judgment and set up the role in a manner effective to their organisation; and
• definition of closed products – closed products are those that are no longer marketed or distributed to retail customers or open to renewal. Where existing customers can continue to make payments under the existing product terms this would still be considered closed, as long as the product or service is not open to new customers.

LIBOR

LIBOR transition

FCA announces decision on cessation of 1- and 6-month synthetic sterling LIBOR at end-March 2023

On 29 September 2022, the FCA announced that it does not plan to use its powers to compel ICE Benchmark Administration, the administrator of LIBOR, to continue publishing 1- and 6-month synthetic sterling LIBOR beyond the end of March 2023. As a result, 1- and 6-month synthetic sterling LIBOR will permanently cease immediately after final publication on 31 March 2023.

The announcement follows the FCA’s related consultation. In that consultation, the FCA also asked for views on when 3-month synthetic sterling LIBOR could cease in an orderly fashion. The FCA’s announcement states that it is considering responses on that question but that there was support for continuing the 3-month synthetic sterling LIBOR setting for a limited period beyond end-March 2023.

The consultation also sought information on exposures to US dollar LIBOR and information to help the FCA assess whether to compel IBA to produce US dollar LIBOR using a synthetic methodology for a limited period. The FCA is also assessing that feedback and plans to respond later in the autumn.

IBA opens consultation on cessation of USD LIBOR ICE Swap Rate

On 30 August 2022, ICE Benchmark Administration (IBA) published its consultation on the potential cessation of publication of USD LIBOR ICE Swap Rate benchmark settings.

The consultation is not an announcement that IBA will cease or continue publication after this date. A feedback statement will be published in due course.

ESG

ESMA consultation on revised MiFID II product governance guidelines

As we previously reported, on 8 July 2022 ESMA published a consultation paper which includes certain proposals to update the MiFID II product governance guidelines. This includes the following proposals:

• 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 publishes final MiFID II suitability requirements

On 23 September 2022, ESMA published its final guidelines on aspects of the MiFID II suitability requirements.

The report builds on the 2018 guidelines and has been reviewed to include the amendments in the MiFID II Delegated Regulation, namely advising clients and collecting information from them in relation to their sustainability preferences, assessment of these preferences and organisational requirements within firms to train staff and keep appropriate records of consumers’ preferences.

The guidelines also take into account the examples of good and poor practice raised in ESMA’s 2020 Common Supervisory Action.

ESG Ratings

European Commission releases responses to consultation on ESG ratings and factors

On 4 August 2022, the European Commission released its summary report outlining the responses received to its consultation on ESG ratings and factors.

In summary, the report found the following:

• almost all respondents consider that intervention in the ESG market is necessary, as it does not currently “function well”;
• around three-quarters of respondents reported using ESG ratings to opine on companies and products that impact on society or the environment;
• a large majority support legislative intervention and consider that ESG rating providers should be subject to regulatory supervision, such as authorisation or registration, to offer services within the EU; and
• the respondent pool was evenly split in considering whether the ratings market was competitive or non-competitive.

The report will likely influence further initiatives in the ESG ratings market, which may affect how sustainable structured products are rated and the ability of ratings providers to operate.

Sustainability disclosure

FCA consults on sustainability disclosure requirements and investment labels

On 4 July 2022, the FCA published updates to its website as a result of its prior discussion paper relating to sustainability disclosure requirements and investment labels.

The FCA intends to consult on the proposed policies during autumn 2022 to take into account other international policy decisions and to ensure stakeholders have time to consider and respond accordingly.

Currently, we assume that this will relate more to funds than to debt instruments; however, following this further consultation period there may be developments in policy applicable in the structured products market.