Structured products bulletin: Q1 2023

Introduction

Welcome to our first structured products bulletin of 2023, where we round up key legal and regulatory developments in the structured products space – today, we’re covering Q1 2023.

For those in the UK, we draw attention to the fast approaching deadlines for the Consumer Duty and summarise some of the FCA’s recent feedback, including on its amendment proposals – as a reminder, manufacturers should have completed all reviews of existing open products and services by 30 April 2023. Also from the FCA, we’ve seen a stern warning issued to benchmark administrators on ESG-related disclosures, highlighting the “poor” quality of what they’ve seen so far and reiterating the importance of fully implementing relevant ESG benchmark methodologies and disclosure requirements. The FCA itself has been under fire recently, facing ESG-related litigation for its approval of a prospectus by Ithaca Energy plc (an oil and gas company).

In the EU, this quarter (among other updates) we cover ESMA’s final report on its guidelines on the MiFID II product governance requirements and the Commission’s consultation on the third-country regime under the EU Benchmarks Regulation. We also cover the European green bonds regulation, following a provisional agreement being reached by the European Parliament and the Council.

We also summarise newly proposed US rules prohibiting “material conflicts of interest” in certain asset-backed transactions, noting that the wide construction of the proposed rule may have implications for non-US asset-backed transactions, including as UK and EU repackagings.

EU

MiFID II disclosures

ESMA and NCAs launch common supervisory action in relation to MiFID II disclosure rules

On 16 January 2023, ESMA announced the launch of a common supervisory action (CSA) with national competent authorities (NCAs) on the application of the disclosure rules under MiFID II.

The announcement explains that ESMA is launching the CSA to assess the application by investment firms and credit institutions of the MiFID II requirements on marketing communications across the EU, in light of the key role that marketing and advertisements can play in influencing consumers’ investment decisions. As part of the CSA, the NCAs will:

• review whether marketing communications (including advertisements) are fair, clear and non-misleading, particularly in the case of riskier and more complex investment products;
• review how firms select the target audience for the marketing communications, particularly in the case of riskier and more complex products; and
• collect information about possible ‘greenwashing practices’ seen in marketing communications and advertisements.

The CSA will be conducted over the course of 2023.

Costs and performance

EIOPA and ESMA publish costs and performance reports on retail investment products, insurance-based investments products and personal pension products

On 17 January 2023, the European Insurance and Occupational Pensions Authority (EIOPA) published its costs and past performance report, providing an overview of the past performance and costs of EU retail investment products (within EIOPA’s remit) for 2021. The report covers from 2017 to year end 2021 for past performance and 2021 for costs, and focuses on key findings and events which might impact consumers and their future net returns.

Similarly, on 30 January 2023, ESMA published its fifth annual report on costs and performance of EU retail investment products, covering UCITS, Retail AIFs and structured retail products (SRPs). The report provides an overview of key developments up to year end 2021, including detailed analysis on the effects of rising inflation on investment, UCITS following ESG strategies, the performance of retail AIFs and the performance and costs of SRPs, as based on PRIIPs KIDs.

Benchmark Regulation

European Commission consults on scope and third-country regime of EU Benchmarks Regulation

On 02 March 2023, the European Commission published a call for evidence (now closed, as of 29 March 2023) on the scope and third-country regime of the EU Benchmark Regulation ((EU) 2016/1011) (EU BMR). The call for evidence addresses the following two issues:

• Ensuring continued access to third-country benchmarks for EU businesses and investors: The EU BMR currently allows market participants to use third-country benchmarks until 31 December 2023. After that date, third-country benchmarks can only be used in the EU if they comply with rules comparable to the EU BMR. However, very few other major jurisdictions have regulated benchmarks as extensively as the EU and, as a result, very few third-country administrators have so far spent the necessary time and resources to obtain access to the EU market through recognition or endorsement. The result is that, from 1 January 2024, EU businesses and investors will be placed at a significant disadvantage compared to their non-EU competitors, with access to a less diverse and competitive set of benchmarks for use for hedging and investment. The call for evidence aims to explore changes allowing EU benchmark users to continue using certain third-country benchmarks, subject to certain supervisory protections.

• Promoting EU benchmark labels as an open standard under EU supervision: The labels for EU climate transition benchmarks and the EU Paris-aligned benchmarks come with a set of minimum requirements regarding benchmark methodology and disclosures. Currently, third-country administrators offering benchmarks in the EU under the transitional arrangements can use these labels without supervision of the labels’ specific rules. The call for evidence aims to explore changes ensuring that third-country administrators can continue to provide labelled benchmarks, subject to EU supervision of all label-related EU BMR provisions.

The feedback period ended on 29 March 2023. Feedback was provided by 24 market participants and is accessible via the Commission’s website. The Commission’s adoption of amendments is planned for the second quarter of 2023.

ESMA and the FCA agree new cooperation arrangements under the UK and EU BMR

On 25 January 2023, the FCA published the following two memoranda of understanding (MoUs) it has entered with ESMA, concerning cooperation and exchange of information arrangements in respect of the EU BMR and the retained EU law version of the EU BMR (UK BMR).

• An MoU concerning EU critical benchmarks, establishing a cooperation arrangement for the purposes of Article 30(4) of the UK BMR. This details a mechanism for the exchange of information between the FCA and ESMA in relation to (i) EU critical benchmarks and (ii) non-critical benchmarks provided by administrators of EU critical benchmarks supervised by ESMA.
• An MoU concerning the recognition of UK benchmark administrators in the EU. The MoU establishes co-operation arrangements between ESMA and the FCA and provides confirmations as regards certain supervisory conditions, each as required by Article 32(5) of the EU BMR. Those requirements must be met in order for ESMA to grant recognition to UK benchmark administrators subject to supervision in the UK.

Product governance

ESMA publishes final report on MiFID II product governance guidelines

On 27 March 2023, ESMA published its final report following a review of its guidelines on the product governance requirements introduced by the MiFID II. The guidelines, initially published in 2017, aim to support the MiFID II investor protection framework and ensure that firms are only manufacturing or distributing financial instruments and structured products when this is the best interests of their clients.

The report sets out that, while the existing guidelines remain relevant, recent regulatory and supervisory developments (including, notably, the Commission’s Capital Markets Recovery Package and subsequent MiFID II Amending Directive, the sustainability-related amendments to the MiFID II Delegated Directive, the recommendations on the product governance guidelines by ESMA’s Advisory Committee on Proportionality (ACP) and the findings of ESMA’s 2021 Common Supervisory Action on product governance) have prompted a review of the guidelines to ensure a common, uniform and consistent implementation of the MiFID II product governance requirements can continue to be realised.

The final report summarises responses to ESMA’s consultation on the draft guidelines published in July 2022, and explains how responses have been taken into account. Annex IV to the report summarises the feedback received and sets out ESMA’s proposed amendments to the guidelines following stakeholder feedback. The key areas raised by respondents in their feedback include consistency in terminology and processes used, granularity of the target market and complexity of the guidelines – noting a general need to avoid an excessive level of detail. The final guidelines are set out in Annex V of the final report.

As for next steps, the final guidelines will be translated into the official languages of the EU and published on ESMA’s website. They will apply two months after the date of publication.

Prospectus Regulation

ESMA updates its Q&As on the Prospectus Regulation

On 3 February 2023, ESMA published an updated version of its Q&As relating to the Prospectus Regulation.

The updated Q&A includes a new question and response, under the sub-section ‘‘Thresholds, calculations, exemptions and scope’. The new question is “May the purchase of securities via a joint account be considered as a purchase by one investor?”.

Settlements

TARGET2 replaced by new settlement system

On 20 March 2023, T2 replaced TARGET2 as the Eurosystem’s new real-time gross settlement system. Market participants should be aware of any operational or practical differences between the two systems and, from a legal documentation perspective, ensure that documentation referencing TARGET2 includes reference to its successors (or refers to T2 directly).

Green bonds

European Parliament and Council reach provisional agreement on the green bonds regulation

On 28 February 2023, it was announced that negotiators of the Council and the European Parliament had reached a provisional agreement on the regulation of environmentally sustainable bonds or, European green bonds (EuGB).

The proposal, initially published on 06 July 2021, provides for a European Green Bonds Standard (EUGBS) which companies can choose to comply with in order to be able to market bonds that can be considered as environmentally sustainable. Broadly, the proposal aims to regulate issuers of EuGB and establish a system of registration and supervision of entities acting as external reviewers of EuGB.

The provisional agreement is still to be confirmed and adopted by the Council and European Parliament before it is final.

UK

PRIIPs

UK PRIIPs

On 1 January 2023, the updated UK PRIIPs RTS became compulsory.

UK Consumer Duty

April deadline for manufacturers

As a reminder, FCA Guidance (see Para 12.11 PS/22-9) states that:

“Manufacturers should aim to complete all the reviews necessary to meet the four outcome rules for their existing open products and services by the end of April 2023, so that they can:

• share with distributors by the end of April 2023 the information necessary for them to meet their obligations under the Duty (eg in relation to the price and value, and products and service outcomes); and
• identify where changes need to be made to their existing open products and services to meet the Duty and implement these remedies by the end of July 2023.”

On 27 March, the FCA released a podcast (transcript available here) reminding manufacturers of the end of April implementation deadline where they should have completed all the reviews necessary to meet the four Consumer Duty outcomes rules for their existing open products and services and share the necessary information with distributors to enable them to meet their obligations under the Duty (eg in relation to the price and value, and products and service outcomes).

The FCA has also published various guidance throughout Q1 2023 on the Duty and its expectations in relation to firm’s implementation, including a number of podcasts, and updates to the Consumer Duty webpage. For further details, please see our Consumer Duty View available here.

FCA Feedback on December 2022 Quarterly Consultation Paper

On 2 December 2022, the FCA published its Quarterly Consultation Paper proposing certain clarificatory amendments to the Consumer Duty final rules. A number of the suggested amendments could have had significant impact on the scoping of products and business lines for Consumer Duty purposes.

On 31 March 2023, the FCA published its feedback and handbook notice – we note the following two points of interest:

• The FCA have introduced clarifications on the 'closed product' definition: under the current definition, a product cannot be classed as closed if it is still being distributed. However, the glossary term defines ‘distribute’ broadly. The FCA acknowledged that this could potentially be interpreted to mean that no product or service in which an account is still held, or an ongoing relationship exists, can be classed as closed. The FCA have removed the use of the defined ‘distribute’ term in the ‘closed product’ definition.
• The FCA have not introduced proposals on the application of the Consumer Duty to non-retail financial instruments: Proposals were included to amend the exemption so that it cannot be applied in respect of investment funds. This would mean that funds (AIFs or UCITS) that have a minimum £50,000 subscription amount but still have retail investors (eg high net worth investors) would not be able to rely on this exemption. There was a lot of lobbying on this point both through trade association responses and bilateral conversations with the FCA, and the proposals are not being introduced at this stage.

FCA Portfolio Letters

On 3 February 2023, the FCA published a series of sector-specific letters to portfolio firms, setting out their expectations for the implementation of the Consumer Duty and to give more sector-specific feedback on their findings from their review of firms’ implementation plans. This includes letters addressed to CEOs of consumer investments and retail finance providers.

Whilst these letters do not introduce any new requirements, they provide helpful information around the implementation of the Duty, including sector-specific examples of good (or less good) practices. This should be factored into firms final implementation projects and may be helpful for firms looking to determine what data and management information they need to collect under the Consumer Duty.

These expectations should be read in conjunction with the FCA’s multi-firm review published on 25 January which identifies examples of good practice, and areas where firms may need to improve their implementation approach to deliver the Duty’s standards on good consumer outcomes.

Final consultation on amendment to EMT led by cross-industry trade association Working Group

On 24 March 2023, the formal FinDatEx consultation regarding changes to the European MiFID template (EMT) to cater for Consumer Duty (Manufacturer to Distributor) closed, with any feedback being incorporated into the final version. EMT 4.1 is available for use and effectively final.

In summary, the draft includes 10 new optional fields required for products being distributed in the UK, which include ex-ante and ex-post transaction costs and fields providing information on UK value for money. The Working Group are particularly focussed on the feedback loop: that is, the flow of information between distributors and manufacturers, with vulnerable customers being an initial focus but not included as a specific field in the final template. Focus of the cross-industry trade association Working Group is now turning to the distributor to manufacturer feedback loop.

Financial services regulation

Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023

On 27 March 2023, HM Treasury published a draft of The Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) Order 2023 (Amendment Order), amending the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (2005/1529) (FPO), to bring certain cryptoassets into scope of the financial promotion restriction set out in section 21 of the Financial Services and Markets Act 2000 (FSMA).

Key points to note include:

• Qualifying cryptoassets have been added to the list of controlled investments.
• Qualifying cryptoassets are defined as “any cryptographically secured digital representation of value or contractual rights that (a) can be transferred, stored, or traded electronically, and (b) uses technology supporting the recording or storage of data (which may include distributed ledger technology).
• Certain controlled activities have been amended to incorporate qualifying cryptoassets, namely dealing in securities and contractually based investments, arranging deals in investments, managing investments and advising on investments.

The Amendment Order includes a four-month implementation period from when the draft statutory instrument comes into force. For further information, please refer to our March 2023 edition of Crypto View here.

ESG disclosures

FCA faces legal action over prospectus climate risk disclosure

On 16 February 2023, environmental charity ClientEarth said it had filed for judicial review of a decision by the FCA to approve the prospectus of UK oil and gas company Ithaca Energy plc. ClientEarth argues that the prospectus failed to adequately disclose climate risks relating to Ithaca’s significant interests in oil and gas fields in the North Sea, thereby failing to fulfil the requirements of the Prospectus Regulation.

ClientEarth is therefore alleging that the FCA has acted unlawfully in approving Ithaca’s listing documents and enabling their initial public offering. It will now be for the High Court to determine whether to grant permission to bring the claim.

FCA issues warning to benchmark administrators on ESG-related disclosures

On 20 March 2023, the FCA published a statement highlighting the “poor” quality of disclosures for ESG benchmarks, following completion of a preliminary review. The FCA have also sent a letter to administrators outlining the issues identified – these include:

• not enough detail on the ESG factors considered in benchmark methodologies;
• not ensuring that the underlying methodologies for ESG data and ratings products used in benchmarks are accessible, clearly presented and explained to users;
• not fully implementing ESG disclosure requirements; and
• benchmark administrators failing to implement their ESG benchmarks’ methodologies correctly.

The FCA stated that more work is to be done in this area to address potential failings, and that it expects firms to be able to explain their ESG strategies on request.

LIBOR transition

IBA to publish USD SOFR spread-adjusted ICE Swap Rate

On 10 March 2023, ICE Benchmark Administration (IBA) published a press release announcing its intention to launch USD SOFR Spread-Adjusted ICE Swap Rate, for use as a benchmark in financial contracts and financial instruments by licensees on 3 July 2023.

IBA has been publishing USD SOFR Spread-Adjusted ICE Swap Rate settings on an indicative, ‘Beta’ basis since October 2021, as part of an initial testing phase. Once published, USD SOFR Spread-Adjusted ICE Swap Rate settings are expected to be made available for the same tenors and published at the same time as the current USD LIBOR 1100 ICE Swap Rate settings.

US

SEC proposes prohibition on material conflicts of interest in certain ABS transactions

On 25 January 2023, the US Securities and Exchange Commission (SEC) announced its proposal for a new rule under the Securities Act 1973, to prohibit certain securitisation participants from engaging in transactions that would directly or indirectly involve or result in a “material conflict of interest” between the securitisation participant and an investor in an asset-backed security (ABS), subject to certain limited exceptions. The proposal is silent as to its jurisdictional scope and, therefore, potentially applies to transactions that lack a clear US nexus. The proposed wording of the prohibition is also constructed very broadly, so may affect non-US ABS, such as UK and EU repackaging transactions.

A transaction will be deemed to involve or result in a material conflict of interest between a securitisation participant and an investor in an ABS if it is a “conflicted transaction”. Under the proposed rule, this may include any of the following transactions, if a reasonable investor would consider them important to its investment decision:

• a short-sale of the relevant ABS;
• the purchase of a credit default swap or other credit derivative entitling the securitisation participant to payments on the occurrence of specified credit events in respect of the relevant ABS; or
• the purchase or sale of any financial instrument (other than the relevant ABS) or entry into a transaction, pursuant to which the securitisation participant would benefit from any actual, anticipated or potential (i) adverse performance of the underlying ABS portfolio, (ii) losses, monetary default or early amortisation on the relevant ABS or (iii) a decline in the market value of the relevant ABS.