Sustainable Finance Package

Finalisation of the regulatory framework on sustainable finance in sight

The EU has taken major steps over the past number of years to build a sustainable financial system. On this blog, we have repeatedly given updates on the EU Taxonomy Regulation, the Sustainable Finance Disclosure Regulation and the Benchmark Regulation that form the foundation of the EU’s work to increase transparency and provide tools for investors to identify sustainable investment opportunities. We are now steering toward a final regulatory framework on sustainable finance.

Sustainable Finance Package in a nutshell

On 21 April 2021, the European Commission has adopted a comprehensive package of measures (the Sustainable Finance Package) as part of its wider policy initiative on sustainable finance, which aims to re-orient capital flows towards more sustainable investments and enable the EU to reduce its carbon-footprint by at least 55% by 2030 and reach carbon neutrality by 2050.

The Sustainable Finance Package is comprised of:

  • Corporate Sustainability Reporting Directive (CSRD), which amends the existing reporting requirements under Directive 2014/95/E (Non-Financial Reporting Directive, NFRD) by expanding the scope of sustainability-related reporting requirements to more corporate entities;
  • Taxonomy Climate Delegated Act, which provides technical screening criteria under which an economic activity qualifies as environmentally sustainable, by contributing substantially to climate change mitigation or climate change adaptation while making no significant harm to any of the other environmental objectives;
  • Six Delegated Acts that amend requirements under UCITS, AIFMD, and MiFID II framework by incorporating new rules on consideration of sustainability risks, factors and preferences by investment managers and investment firms.

Corporate Sustainability Reporting Directive (CSRD)

With the aim to capture a wider group of companies and to bring sustainability reporting over time on a par to financial reporting, CSRD expands the scope of the existing NRFD, which currently applies only to companies with over 500 employees (even though national law in certain EU Member States stipulates lower thresholds).

The CSRD expands the scope of application of sustainability-related reporting requirements to all large undertakings (whether listed or not) that meet two of the following three criteria:

  • balance sheet total of EUR 20,000,000,
  • net turnover of EUR 40,000,000,
  • an average of 250 employees during the financial year.

In addition to large undertakings, the CSRD reporting requirements will apply to all companies listed on the EU regulated market as well, with the exception of listed micro companies.

To that end, the CSRD aims to capture nearly 50,000 companies in the EU in comparison to only 11,000 companies that are currently subject to reporting requirements under NFRD. This should provide financial institutions that are subject to Regulation (EU) 2020/2088 (Sustainable Finance Disclosure Regulation, SFDR) with more relevant sustainability-related data about prospective investee companies, based on which they will be able to fulfil disclosure requirements under the SFDR.

As a next step, the Commission will engage in discussions on the CSRD Proposal with the European Parliament and Council.

Taxonomy Climate Delegated Act

The Taxonomy Climate Delegated Act represents the first set of technical screening criteria that are intended to serve as a basis for the determination which economic activities can be deemed as environmentally sustainable under the Taxonomy Regulation. Developed based on the scientific advice of the Technical Expert Group (TEG), the Delegated Act provides technical screening criteria for determination whether an economic activity contributes significantly to either climate change mitigation or climate change adaption while making no significant harm to any other environmental objective under Article 9 of the Taxonomy Regulation.

Final Draft of the Delegated Act still needs to be officially adopted by the Commission, after which the European Parliament and the Council will have 4 months (which can be extended by additional 2 months) to officially adopt it.

Amending Delegated Acts

As part of the Sustainable Finance Package, the Commission has also published six long-awaited final versions of the draft amending delegated acts under MiFID II, UCITS and AIFMD framework with the aim of incorporating additional requirements on consideration of sustainability risks, factors and preferences by investment managers and investment firms.

The proposed changes introduced by delegated acts, which are expected to apply from October 2022, can be summarized as follows:

Product Governance: changes to MiFID II Delegated Directive (EU) 2017/593 put the obligation on manufacturers and distributors of financial instruments to take into consideration relevant sustainability factors and clients’ sustainability objectives in the process of product manufacturing and distribution.

Suitability assessment: changes to MiFID II Delegated Regulation (EU) 2017/565 require investment firms to take into account clients’ sustainability preferences in the course of suitability assessment. Given that requirements on suitability assessment apply only to firms providing investment advisory and portfolio management services, ESMA is separately considering (ESMA Consultation on appropriateness and execution only under MiFID II) whether the consideration of sustainability risks and factors shall be taken into account in the case of provision of other investment services for which requirements on appropriateness assessment apply.

Integration of sustainability risks and factors: amendments to MiFID II Delegated Regulation (EU) 2017/565, UCITS Delegated Directive 2010/43/EU and AIFMD Delegated Regulation (EU) 231/2013 impose new obligations on investment firms and asset managers, by requiring them to take into account sustainability risks and factors when complying with organisational requirements, including requirements on risk management and conflict of interest requirements.

Further, UCITS and AIF management companies that consider principal adverse impacts of their investment decisions on sustainability factors under SFDR (e.g. impact of an investment in a fossil fuel company on climate and environment), will be required to consider this when complying with due diligence requirements stipulated under UCITS and AIFMD framework.

The Sustainable Finance Package also includes similar changes to Delegated Acts under IDD, which affect insurance distributors.

Conclusion

The proposals published as part of the Sustainable Finance Package represent some of the last pieces in the puzzle of the EU regulatory framework on sustainable finance, which aims to support the EU on its way towards creation of a more sustainable economy. These latest efforts by the Commission provide some further clarity to corporate entities and financial institutions that have been facing with new regulatory challenges for quite some time now.  In the meantime, on 7 May 2021 the Commission has also published one additional Delegated Act under the Taxonomy Regulation, which outlines requirements on the content, methodology and presentation of key performance indicators (KPIs) that entities, which are subject to reporting requirements under Article 8 of the Taxonomy Regulation, need to comply with.

Nevertheless, there are some other important legislative proposals that still need to be published, like the final version of regulatory technical standards under the SFDR that is essential for compliance of financial institutions with disclosure requirements stipulated by this Regulation.  Those regulatory initiatives show that aiming at a sustainable financial market in Europe is more than a fancy trend but rather a new effort which needs to be taken seriously and is not to be underestimated. If you have any questions about the EU regulatory framework on sustainable finance and its impact on your business, please get in touch with us.

Final ESMA Guidelines on cloud outsourcing

At the end of December 2020, the European Securities and Markets Authority (ESMA) published its final report on its guidelines on outsourcing to cloud service providers (CSP). The purpose of the guidelines is to help firms identify, address and monitor the risks that may arise from their cloud outsourcing arrangements. Since the main risks associated with cloud outsourcing are similar across financial sectors, ESMA has considered the European Banking Authority (EBA) Guidelines on outsourcing arrangements, which have incorporated the EBA Recommendations on outsourcing to cloud services providers and the European Insurance and Occupational Pensions Authority (EIOPA) Guidelines on outsourcing to cloud service providers. This ensures consistency between the three sets of guidelines. The ESMA Guidelines on cloud outscoring apply to MiFID II firms such as investment firms and other financial services providers indirectly but they describe the market standard and set the supervisory framework for the National Competent Authorities (NCAs) in Europe such as the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin).

For the German jurisdiction, BaFin published guidance on outsourcing to cloud providers back in 2018. Please note that the amended MaRisk include outsourcing requirements for investment firms and other financial services providers and already reflect the EBA Guidelines on outsourcing, including cloud outsourcing. For more information on the MaRisk amendment, please see our previous Blogpost.

The guidelines in more detail

The following gives a brief overview of the main content of the ESMA cloud outsourcing guidelines.

  • Guideline 1: Governance, oversight and documentation

Firms should have a defined and up-to date cloud outsourcing strategy which should include, inter alia, a clear assignment of the responsibility for the documentation, management and control of cloud outsourcing arrangements, sufficient resources to ensure compliance with all legal requirements applicable to the firm’s outsourcing arrangements, a cloud outsourcing oversight function directly accountable to the management body and responsible for managing and overseeing the risk of cloud outsourcing arrangements, a (re)assessment of whether the cloud outsourcing arrangements concern critical or important functions as well as an updated register of information on all cloud outsourcing arrangements. For the outsourcing of critical or important functions, the ESMA guidelines include a detailed list of information which should be included in the register.

  • Guideline 2: Pre-outsourcing analysis and due diligence

ESMA provides information on what is required for the pre-outsourcing analysis (e.g. an assessment if the cloud outsourcing concerns a critical or important function). In the case of outsourcing of critical or important function, firms should conduct a comprehensive risk analysis and take into account benefits and costs of the cloud outsourcing and perform an evaluation of the suitability of the CSP.

  • Guideline 3: Key contractual elements

The guidelines provide a detailed list of what a written cloud outsourcing agreement should include in case of outsourcing of critical or important functions. Such agreements should include, inter alia, provisions regarding data protection, agreed service levels incident management, business continuity plans, termination rights and access and audit rights for the firm and its competent supervisory authority.

  • Guideline 4: Information security

Firms should set information security requirements in its internal policies and procedures and within the cloud outsourcing written agreement and monitor compliance with these requirements on an ongoing basis. In case of outsourcing of critical or important functions, additional requirements apply regarding information security organization, identity and access management, encryption and key management, operations and network security, application programming interfaces, business continuity and data location.

  • Guideline 5: Exit strategies

In case of outsourcing of critical or important functions, firms should develop and maintain exit strategies that ensure that the firm is able to exit the cloud outsourcing arrangement without undue disruption to its business activities and services to its client. Exit strategies should include comprehensive and documented exit plans, the identification of alternative solutions and provisions in the written outsourcing agreements that oblige the CSP to support orderly transfer of the outsourced function from the CSP to another CSP.

  • Guideline 6: Access and audit rights

Firms should ensure that the cloud outsourcing written agreement does not limit the firm´s and competent authority´s effective exercise of the access and audit rights on the CSP (see also Guideline 3). However, the Guideline also includes provisions aimed at reducing the organizational burden on the CSP and its clients when exercising access and audit rights: firm may use e.g. third-party certifications and external or internal audit reports made available by the CSP. However, in case of outsourcing of critical or important functions, the guidelines stipulate additional requirements that must be met in order to be able to rely on third party certifications or assessments.

  • Guideline 7: Sub-outsourcing

In case of sub-outsourcing, the firm should ensure that the CSP appropriately oversees the sub-outsourcer. In addition, ESMA provides information on the provisions that should be included in the written outsourcing agreement between the firm and the CSP in the case of sub-outsourcing critical or important function. This includes the remaining accountability of the CSP, a notification requirement for the CSP in case of any intended sub-outsourcing allowing the firm sufficient time to carry out a risk assessment of the proposed sub-outsourcer, the firm´s right to object to the intended sub-outsourcing and termination rights in case of such objection.

  • Guideline 8: Written notification to competent authorities

Firms should notify in writing its competent authority in a timely manner of planned cloud outsourcing arrangement that concern critical or important functions. The notification should include, inter alia, a description of the outsourced functions, a brief summary of the reasons why the outsourced function is considered critical or important and the individual or decision-making body in the firm that approved the cloud outsourcing arrangement.

What´s next?

In a next step, the guidelines will be translated in the official EU languages and published on the ESMA´s website. The publication of the translation will trigger a two-month period during which the national competent authorities must notify ESMA whether they comply or intend to comply with the guidelines (comply or explain mechanism). For the German jurisdiction, it is to be expected that BaFin will comply with the ESMA guidelines.

Brexit update on cross-border services: MiFID II requirements vs. reverse solicitation

The European Securities and Markets Authority (ESMA) has recently issued a public statement to remind firms of the MiFID II requirements on the provision of investment services to retail or professional clients by third-country firms. With the end of the UK transition period on December 2020, UK firms now qualify as third-country firms under the MiFID II regime. The third country status of the UK as of 2021 was explicitly confirmed by the German regulator BaFin in a recent publication.

Pursuant to MiFID II, EU Member States may require that a third-country firm intending to provide investment services to retail or to professional clients in its territory have to establish a branch in that Member State or may conduct business requiring a license on a cross-border basis, without having a presence in Germany (so-called notification procedure/EU Passport). However, according to MiFID II, where a retail or professional client established or situated in the EU initiates at its own exclusive initiative the provision of an investment service or activity by a third-country firm, the third country firm is not subject to the MiFID II requirement to establish a branch and to obtain a license (so-called reverse solicitation).

With the end of the UK transition period on December 2020, ESMA notes that some “questionable” practices by firms around reverse solicitation have emerged. For example, ESMA states that some firms appear to be trying to circumvent MiFID II requirements by including general clauses in their Terms of Business or by using online pop-up boxes whereby clients state that any transactions are executed in the exclusive initiative of the client.

With its public statement, ESMA aims to remind firms that pursuant to MiFID II, where a third-country firm solicits (potential) clients in the EU or promotes or advertises investment services in the EU, the investment service is not provided at the initiative of the client and, therefore, MiFID II requirements apply. Every communication means used (press release, advertising on internet, brochures, phone calls etc.) should be considered to determine if the client has been subject to any solicitation, promotion or advertising in the EU on the firm´s investment service or activities. Reverse solicitation only applies if the client actually initiates the provision of an investment service or activity, it does not apply if the investment firm “disguises” its own initiative as one of the client.

However, despite this seemingly rather strict approach of ESMA, reverse solicitation is generally still applicable if a (UK) third-country firm

  • only offers services at the sole initiative of the client,
  • (only) continues an already existing client relationship or
  • continues to inform its clients about its range of products within the scope of existing business relationships (which is often agreed upon in the client´s contract).

It is argued that, for example, in the case of an existing account or deposit or an existing loan agreement that a UK third country firm continues to provide to an EU client after Brexit, no direct marketing or solicitation of the client in the EU takes place. In this case, the third country firm would not have solicited the client.

In a nutshell: What UK firms should consider

The provision of investment services in the EU is subject to license requirements and can include the requirement to establish a branch or a subsidiary in the relevant EU member state. The provision of investment services without proper authorization exposes investment firms to administrative or criminal proceedings. Where a client established in the EU initiates at its own exclusive initiative the provision of an investment service by a third-country firm, such firm is not subject to the requirement to establish a branch or to obtain a license (reverse solicitation). Generally, reverse solicitation also applies when existing client relationships are continued (which have been legitimately established), as the investment firm would not solicit a client in this case.

ESMA update: Impact of Brexit on MiFID II/MiFIR and Benchmark Regulation

At the beginning of October 2020, the European Securities and Markets Authority (ESMA) has updated its previous statements from March and October 2019 on its approach to the application of key provisions of MiFID II/MiFIR and the Benchmark Regulation (BMR) in case of Brexit. As the EU-UK Withdrawal Agreement entered into force on February 2020 and the UK entered a transition period (during which EU law still applies in and to the UK) that will end on 31 December 2020, these statements needed to be revised.

This Blogpost highlights the updated ESMA approach on third-country trading venues regarding the post-trade transparency requirements (MIFID II/MiFIR) and the inclusion of third country UK benchmarks and administrators in the ESMA register of administrators and third country benchmarks (BMR).

MiFID II/MIFIR: Third-country trading venues and post-trade transparency The regulations of MiFID II/MiFIR provide for post-trade transparency requirements. EU investment firms which, for their own account or on behalf of clients, carry out transactions in certain financial instruments traded on a trading venue, are obliged to publish the volume, price and time of conclusion of the transaction. Such publication requirements serve the general transparency of the financial market. As ESMA has already stated in 2017, post-trade transparency obligations also apply where EU investment firms conduct transactions on a third country trading venue.

By the end of the transition period on 31 December 2020, UK trading venues will qualify as third country trading venues. Therefore, if an EU investment firm carries out transactions via a UK trading venue, it is, in general, subject to the MiFID II/MiFIR post-trade transparency obligations.

However, EU-investment firms would not be subject to the MiFID II/MiFIR post-trade transparency requirements if the relevant UK trading venue would already be subject to EU-comparable regulatory requirements itself. This would be the case if the trading venue would be subject to a licensing requirement and continuous monitoring and if a post-trade transparency regime would be provided for.

In June 2020, ESMA published a list of trading venues that meet these requirements. While the UK was a member of the EU and during the transition period, ESMA did not asses UK trading against those criteria. However, ESMA intends to perform such assessment of UK trading venues before the end of the transition period. Transactions executed by an EU investment firm on a UK trading venue that, after the ESMA assessment, would be included in the list, will not be subject to MiFID II/MiFIR post-trade transparency. In this case, sufficient transparency requirements would already be ensured by the comparable UK regime. However, any transactions conducted on UK trading venues not included in the ESMA list on EU-comparable trading venues will by the end of the transition period be subject to the MiFID II/MiFIR post-trade transparency rules.

BMR: ESMA register of administrators and third country benchmarks

Supervised EU-entities can only use a benchmark in the EU if it is provided by an EU administrator included in the ESMA register of administrators and third country benchmarks (ESMA Register) or by a third country administrator included in the ESMA Register. This is to ensure that all benchmarks used within the EU are subject to either the BMR Regulation or a comparable regulation.

So far, UK administrators qualified as EU administrators and have been included in the ESMA Register. After the Brexit transition period, UK administrators included in the ESMA register will be deleted as the BMR will by then no longer be applicable to UK administrators. UK administrators that were originally included in the ESMA Register as EU administrators, will after the Brexit transition period qualify as third country administrators. The BMR foresees different regimes for third country administrators to be included in the ESMA Register, being equivalence, recognition or endorsement.

“Equivalence” must be decided on by the European Commission. Such decision requires that the third country administrator is subject to a supervisory regime comparable to that of the BMR. So far, the European Commission has not yet issued any decision on the UK in this respect.  Until an equivalence decision is made by the European Commission, UK administrators therefore have (only) two options if they want their benchmarks eligible for being used in the EU: They/their benchmarks need to be recognized or need to be endorsed under the BMR.

Recognition of a third country administrator requires its compliance with essential provisions of the BMR. The endorsement of a third country benchmark by an administrator located in the EU is possible if the endorsing administrator has verified and is able to demonstrate on an on-going basis to its competent authority that the provision of the benchmark to be endorsed fulfils, on a mandatory or on a voluntary basis, requirements which are at least as stringent as the BMR requirements.

However, the BMR provides for a transitional period itself until 31 December 2021. A change of the ESMA Register would not have an effect on the ability of EU supervised entities to use the benchmarks provided by UK administrators. During the BMR 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 e.g. financial instruments. Therefore, EU supervised entities can until 31 December 2021 use third country UK benchmarks even if they are not included in the ESMA Register. In the absence of an equivalence decision by the European Commission, UK administrators will have until the end of the BMR transitional period to apply for a recognition or endorsement in the EU, in order for the benchmarks provided by these UK administrators to be included in the ESMA Register again.

Brexit, still great uncertainty

Currently, the whole Brexit situation is fraught with great uncertainty due to the faltering political negotiations. The updated ESMA Statement contributes to legal certainty in that it clearly sets out the legal consequences that will arise at the end of the transition period. This is valuable information and guidelines for all affected market participants, who must prepare themselves in time for the end of the transition period and take appropriate internal precautions.

ESMA updated AIFMD and UCITS Q&As

On June 4, 2019 ESMA published updates questions and answers on the application of the AIFM Directive (available here) and the UCITs Directive (available here). ESMA’s intention of publishing und regularly updating the Q&A documents ensures common supervisory approaches and practices in relation to both the AIFM Directive and the UCITS Directive and their implementing measures.

The latest update refers to the depositories and the possibilities to delegate the safekeeping of assets of the funds. ESMA clarifies that supporting tasks that are linked to depositary tasks such as administrative or technical functions performed as part of the depositary tasks could be entrusted to third parties where all of the following conditions are met:

  1. the execution of the tasks does not involve any discretionary judgement or interpretation by the third party in relation to the depositary functions;
  2. the execution of the tasks does not require specific expertise in regard to the depositary function; and
  3. the tasks are standardised and pre-defined.

Where depositaries entrust tasks to third parties and give them the ability to transfer assets belonging to AIFs or UCITS without requiring the intervention of the depositary, these arrangements are subject to the delegation requirements, in Germany subject to Para. 36 KAGB.

Another question relates to the supervision of branches of depositories. The AIFM Directive, the UCITS Directive, the CRD and the MiFID II do not grant any passporting rights for depositary activities in relation to safekeeping assets for AIFs or UCITS. Branches of depositories located in the home Member State of the AIF or UCITS that is not the home Member State of the depositary’s head office may also be subject to local authorisation in order to perform depositaries activities in relation to AIFs or UCITS. In this case, the competent authority for supervising the activities in relation to AIFs or UCITS is the one located in the Member State of the depository’s branch.

The guidance provided by ESMA in the Q&A documents for AIFs and UCITS regarding the depository function do not contain any surprising elements but further strengthen the harmonized interpretation and application of the AIFM and UCITS Directives in Europe.

Why equivalence is not the easy solution for Brexit

When reading the news, one cannot deny that a hard Brexit may well be looming. While we all hope that a political solution will be agreed upon in the end, it still makes sense to discuss legal possibilities that might soften the impact if no agreement can be reached.

When it comes to the UK’s loss of access to the European single market, the “equivalence solution” is almost automatically mentioned as a solution for the financial market. But what exactly does equivalence entail? And does it really represent a viable way for the UK and the EU in case of a hard Brexit? In this post we will provide an overview of the current equivalence regime within the European regulation.

In the event of a hard Brexit, the UK will lose access to the European single market overnight and will become a third country under European law. The solution for maintaining access to the European single market could be the so-called equivalence solution. This would allow companies established in third countries to gain access to the European single market, even if no bilateral agreement is concluded in time between the UK and the EU, which seems likely at the moment. The prerequisite is that the third country’s legal and supervisory standards would need to be recognised by the EU as equivalent to the European regulations. UK banking and financial services providers and fund managers would thus continue to have access to the European single market if the EU recognises the British legal and supervisory standard in the financial sector as equivalent to that of the EU. Since the UK currently applies EU regulations, this should at a first glance be a no-brainer.

However, the European legislator does not provide market access for third countries in all areas of banking and financial services easily through regulation. Specific third country rules are contained, for example, in:

  • the European Financial Markets Regulation (MiFIR);
  • the Second Financial Instruments Directive (MiFID II);
  • the Regulation on OTC derivatives, central counterparties and trade repositories (EMIR); and
  • the Directive on Alternative Investment Fund Managers (AIFMD).

In the Fourth Capital Requirements Directive (CRD IV), the Second Payment Services Directive (PSD II) and the UCITS Directive, the European legislator has not stipulated third country rules. In these contexts, access to the European single market through recognition of the equivalence of the supervisory regime is not currently possible. In the areas of the concerned financial services sectors (i.e. credit institutions, payment institutions and the management of UCITS), the UK would therefore be dependent on a bilateral agreement with the EU in any case in order to keep (or regain) access to the European single market.

In those areas where third country rules are provided for, the recognition procedure and the number of third countries recognised as equivalent differ.

For example, under EMIR, the following applies: If a Central Counterparty (CCP) established in a third country wishes to provide clearing services to clearing members or trading venues established in the EU, it may do so only if it has previously been recognised by the European Securities and Markets Authority (ESMA). For this purpose, the CCP must submit an application to ESMA. The latter may only recognise a CCP from a third country if the EU Commission has recognised the legal and supervisory mechanism of the third country as equivalent to that of the EU, and provided that the CCP is authorised in its home country and is subject to effective supervision and enforcement in that country. Moreover, it is required that ESMA has concluded a cooperation agreement with the local supervisory authorities which, for example, simplifies the exchange of information and the home country of the CCP must have an equivalent system for combating money laundering and terrorist financing. If these conditions are no longer met, ESMA may withdraw recognition from the CCP.

CCPs currently recognised by ESMA are located in Australia, Hong Kong, Japan, Singapore, South Africa, Canada, Mexico, Switzerland, South Korea, USA, UAE, India, Dubai International Financial Centre, Brazil and New Zealand.

The recognition procedure for trading venues under MiFIR is slightly different. It is not the trading venue for derivatives itself that can apply for equivalence. Rather, the EU may, at its own discretion and in cooperation with ESMA and the member states, issue a resolution recognising the legal and supervisory framework of a third country as equivalent to that of the EU. Before issuing a resolution, the member states must approve equivalence. The recognition of the equivalence of a third country in the area of MiFIR requires that: (i) the trading venues are admitted in their home country and are subject to effective and continuous supervision and enforcement; (ii) the trading venue has transparent admission rules; (iii) the issuers are subject to regular information obligations which guarantee a high level of investor protection and (iv) rules against market abuse in the form of insider dealing and market manipulation are in place.

So far, the EU has only recognised the USA as an equivalent third country under MiFIR. Under MiFID II, however, the EU has recognised four countries providing trading venues for other financial products (such as listed shares) as equivalent to EU venues: USA, Australia, Hong Kong and Switzerland (the recognition of Switzerland is limited to one year until 31 December 2018 but may be extended if there is sufficient progress on a common institutional framework).

This shows that even if the UK is recognised by the EU as a third country with equivalent regulatory standards, this is far from resolving all the difficulties.

On the one hand, the UK would actually have to maintain its current regulatory and supervisory standards and adapt to those of the EU in the future; a substantial deregulation is thus ruled out. A comparatively minor problem, on the other hand, is that the recognition of equivalence by the EU may well take some time. The UK’s supervisory standard currently corresponds to that of the EU, so if it were to be maintained after Brexit, there would at least be no legal grounds against swift recognition. However, much more serious for the UK, would be that as a third country they would no longer be able to influence the European legal and supervisory standards for lack of voting rights; they would be referred to the role of a “rule-taker”.

Therefore, it remains questionable whether recognition as an equivalent third country is really a good solution for the UK. The alternative would be one or more bilateral agreement(s) with a dispute settlement mechanism. In any event, the advantage of such an agreement would be that it would be negotiated by both sides and would not refer the UK to the passive role of an equivalent third country.

MiFID II: Fundraising in the EU for Non-EU Fund Managers

The revised Directive 2014/65/EU on markets in financial instruments (MiFID II) took effect throughout the EU on 3 January 2018. MiFID II and the corresponding Regulation (MiFIR) intend to enhance investor protection and improve the operations of financial markets, their efficiency, resilience and transparency. It aims to make European financial markets safer, thereby restoring investor confidence following the fallout from the financial crisis, and covers the majority of the financial services industry including banks, brokers, investors, asset managers and exchanges.

MiFID II generally does neither apply to fund managers nor to third country entities. In a recent Client Briefing my London colleagues explained why MiFID II may yet be an issue for third country fund managers.

If non-EU fund managers market and distribute their funds through intermediaries located within the EU some requirements introduced in MiFID II will indirectly also apply to the non-EU fund managers (non-EU AIFM). This is mainly due to the fact that the EU intermediary himself is subject to the regulation and needs to ensure compliance with MiFID II and the corresponding national implementations in the relevant EU Member States.

For example, when addressing the European market each non-EU fund manager in his role as manufacturer of the fund product will be required to define an intended target market for the interests in the fund distributed in the EU. Specifically, manufacturers of financial products are required to specify a target market of end clients/investors for whose needs, characteristics and objectives the product is intended, as well as a distribution strategy that is consistent with the identified target market. The manufacturers should then make available to any distributor information on the product, including the target market and distribution strategy. If the distributor is an EU investment firm acting as intermediary between the non-EU fund manager and investors located in the EU, the intermediary can only offer the interest in the fund to the defined end investors according to the manufacturer’s target market and distribution strategy.

Non-EU fund manager should also be aware that the implementation and enforcement of MiFID II rules may vary somewhat between the various EU member states.

You can download the full Client Briefing here