Financial Services Regulation and Compliance - Investment Firms July 2022

Domestic

Minister Donohoe signs into national law finalised EU prudential rules for investment firms

On 5 July 2022, the Minister for Finance, Paschal Donohoe, signed three statutory instruments (S.I. 302 of 2022, S.I. 303 of 2022 and S.I. 304 of 2022) to complete the transposition of Directive (EU) 2019/2034 (the Investment Firms Directive or IFD) and the implementation of Regulation (EU) 2019/2033 (the Investment Firms Regulation or IFR) into Irish law. IFD and IFR puts in place a new prudential framework for investment firms authorised under the Markets in Financial Instruments Directive. However, large investment firms will remain subject to the prudential requirements of the Capital Requirements Directive and Regulation while Article 62(6) of IFD requires Member States to impose an obligation on large systemic investment firms (Class 1 Firms) to apply for re-authorisation as credit institutions.

These regulations, which should be read along with S.I. 355 of 2021 and S.I. 356 of 2021, transpose Article 62(6) of IFD into national law by inserting a new authorisation process (Part IIA) into the Central Bank Act, 1971 (No. 24) enabling Class 1 Firms to apply for re-authorisation as credit institutions.

European Union (Markets in Financial Instruments) (Amendment) (No. 3) Regulations 2022 [S.I. No. 363 of 2022]

These regulations amend the European Union (Markets in Financial Instruments) Regulations 2017 (S.I. No.375 of 2017) to provide for the integration of sustainability factors into product governance obligations, as required by Commission Delegated Directive (EU) 2021/1269, amending Commission Delegated Directive (EU) 2017/593. These regulations were published on 15 July 2022.

European

EBA publishes final regulatory products to harmonise the supervisory review and evaluation process of investment firms

On 21 July 2022, the European Banking Authority (EBA) jointly with the European Securities and Markets Authority (ESMA), published the final guidelines on common procedures and methodologies for the supervisory review and evaluation process) for investment firms. The EBA published also the final draft regulatory technical standards on Pillar 2 add-ons for investment firms. Both regulatory products are based on the Investment Firms Directive and aim to harmonise the supervisory practices regarding the supervisory review and evaluation process of investment firms.

ESMA proposes key risk indicators for retail investors

On 20 July 2022, ESMA published an article on the development of key retail risk indicators (RRIs) for the EU single market. The proposed RRIs highlight risks around:

• inexperienced investors
• use of digital tools by younger investors
• spikes in overall trading during periods of market stress

This development of RRIs is based on the new mandate ESMA recently received in this regard. ESMA is building on existing consumer analysis and indicators from the trends, risks and vulnerabilities reports to propose a conceptual framework that: defines key terms; considers how to measure risks practically; and identifies sources of risk to consumers.

Within this framework, RRIs should aim to reflect market developments, especially the rise of online- or mobile-based retail trading.

ESMA will continue to refine and develop RRIs to enhance its risk monitoring in this area. The article sets out several possible extensions to the analysis, including broadening the coverage in terms of the products and markets covered, and enhancing the evidence base on investor characteristics.  

ESMA reviews clearing and derivatives trading obligations

On 11 July 2022, ESMA launched a consultation exploring the extension of the scope of both the clearing obligation (CO) and the derivatives trading obligation (DTO). The proposals contained in the consultation, based on the progress made with the benchmark transition in the interest rate derivative market, introduce additional classes to the scope of the CO and of the DTO. These changes complement the first set of changes developed also in the context of the benchmark transition.

ESMA’s proposal includes for:

• the CO
  • the introduction of the overnight indexed swap (OIS) class referencing TONA (JPY)
  • the expansion of the maturities in scope of the CO for the OIS class referencing SOFR (USD)
• for the DTO – the introduction of certain classes of OIS referencing €STR (EUR), which have shown a substantial increase in liquidity over the last months

In November 2021, ESMA published a first set of technical standards on the CO and DTO amending the respective scopes of these two obligations in view of the benchmark transition, which entered into force in May 2022.

ESMA presents the results of the 2021 common supervisory action (CSA) on MiFID II product governance requirements

On 8 July 2022, ESMA presented the results of the 2021 common supervisory action (CSA) on MiFID II product governance requirements. The 2021 CSA has shown that firms generally define a target market for the products they manufacture and/or distribute and that firms follow the list of five target market categories set out in the ESMA guidelines. However, in some cases the definition of a target market appears to be approached as a formalistic exercise as it is done at an insufficiently granular level and with the use of unclearly defined terms.

Furthermore, the definition of a target market does not always translate into a compatible distribution strategy that enables the product to reach the identified target market.

Finally, further areas of improvement have emerged with regard to the requirements:

• To perform a scenario analysis as required under Article 9(10) of the MiFID II Delegated Directive. For example, a lack of convergence has emerged on how firms perform such an analysis and it is sometimes unclear how these scenarios are actually used by firms for the product’s target market identification.

• To perform a charging structure analysis as required under Article 9(12) of the MiFID II Delegated Directive, a key investor protection requirement on which ESMA had already provided guidance to firms in the form of dedicated Q&As. For example, it emerged that manufacturers’ procedures insufficiently describe how a product’s cost structure is evaluated to ensure compatibility with the product’s target market.

• To review products. For example, it emerged that such reviews are not always performed frequently enough and with an adequate scope to verify if the financial instrument remains consistent with the needs, characteristics and objectives of the target market.

• To exchange information between manufacturers and distributors. For example, a significant number of firms provide reports to the product manufacturers only at the latter’s request and not on a proactive basis.

ESMA consults on rules for recognition under the Benchmarks Regulation

On 8 July 2022, the European Securities and Markets Authority the EU’s securities markets regulator, has launched a consultation on amendments to the regulatory technical standards (RTS) under the Benchmarks Regulation (BMR). The proposed amendments cover the form and content of an application for recognition.

Proposed amendments to the RTS

ESMA’s objective for this review is to align the information provided in a recognition application with the changes introduced to the BMR in the ESAs Review. It also aims to ensure that the application includes all relevant information to enable ESMA to assess whether the applicant has established all the necessary arrangements to fulfil the regulation’s requirements.

The proposed changes come from the:

• transfer of supervisory responsibilities over third country recognised administrators to ESMA as of January 2022
• need to request additional information or provide further specifications on some information already requested under the current RTS

ESMA issues a third statement on the implementation of LEI requirements for third-country issuers

On 12 July 2022, the European Securities and Markets Authority, the EU’s securities markets regulator, issues a third statement on the implementation of legal entity identifier (LEI) requirements for third-country issuers under the Securities Financing Transactions Regulation reporting regime.

ESMA acknowledges the potential reporting implementation issue with respect to securities financing transactions entered into by EU investors for securities of third-country issuers. In particular, in third-country jurisdictions LEIs are not widely mandated beyond dealers of derivatives, therefore a significant number of issuers still do not have an LEI.

ESMA explains classification of third-country counterparties in weekly position reports

On 12 July 2022, ESMA released an opinion on the classification of third-country counterparties. This clarifies how third-country financial entities should be classified in the weekly positions reports on commodity derivatives and emission allowances derivatives under MiFID II.

The opinion states that for the purpose of the weekly position reports, third-country financial entities should be classified as they would be classified if they were established in the EU. Its aim is to improve the quality and consistency of these reports.

Weekly position reports provide transparency to market participants on the number of position holders, and the size of their positions, in certain commodity derivatives and emission allowances derivatives, with a breakdown per category of counterparties. Those reports are published every week by trading venues, as well as in a centralised manner by ESMA.

This opinion is a follow-up to ESMA’s report on the EU carbon market published in March 2022. In the report, they identified an issue related to the inconsistent classification of third-country financial counterparties in the published weekly reports and committed to follow-up on the matter.

ESMA consults on cash penalty process for cleared transactions

On 11 July 2022, the European Securities and Markets Authority (ESMA), the EU’s securities markets regulator, launched a consultation on a possible amendment to the Central Securities Depositories Regulation (CSDR) cash penalty process for cleared transactions.

The consultation paper seeks stakeholder views on simplifying the process of collection and distribution of cash penalties for settlement fails relating to cleared transactions.

ESMA’s proposals would change the existing practice by allowing the central securities depositories (CSD) to collect and distribute all types of penalties, including those for settlement fails relating to cleared transactions. Currently, central counterparties are responsible for the collection and distribution of cash penalties for settlement fails on cleared transactions.

Report on sanctions and measures imposed under MiFID II in 2021

On the 19 July 2022, ESMA reported that they will be launching a common supervisory action (CSA) with national competent authorities (NCAs) on the application of MiFID II costs and charges disclosure rules across the EU. The CSA will be conducted during 2022.

This action will allow ESMA and the NCAs to assess the application by firms of the MiFID II requirements on costs and charges. The focus of the CSA will be on information provided to retail clients. NCAs, in particular, will review how firms ensure that these disclosures:

• are provided to clients in a timely manner
• are fair, clear and not misleading
• are based on accurate data reflecting all explicit and implicit costs and charges
• adequately disclose inducements

ESMA believes this initiative and the related sharing of practices across NCAs, will help ensure consistent implementation and application of EU rules and enhance the protection of investors in line with ESMA’s objectives.

The CSA contributes to fulfilling ESMA’s mandate on building a common supervisory culture among NCAs to promote sound, efficient, and consistent supervision throughout the EU. ESMA’s promotion of supervisory convergence is done in close cooperation with NCAs.

ESMA has published a series of Q&As on this subject, and these will serve as input to this CSA.

Sanctions imposed in response to the crisis in the Ukraine