Investment Firms

New prudential regime for investment firms

Directive (EU) 2019/2034, the Investment Firms Directive (IFD) and Regulation (EU) 2019/2033, the Investment Firms Regulation (IFR), came into effect on 26 June 2021.  The IFR/IFD classify investment firms according to their business model and size, the latter of which is benchmarked on various threshold, which is based on the same principles as the Capital Requirements Directive (CRD).

A number of delegated acts are issued by the European Commission on a continuous basis to assist the industry in reporting and understanding of several requirements included in this new prudential regime.

The Malta Financial Services Authority (MFSA) has also issued a number of Circulars on this new regime. The European Banking Authority (EBA) has also issued clarifications, way back in July 2021, on the implementation of the IFR/IFD.

MiFID II "Quick Fix"

Following the changes brought about by COVID 19, the European Commission have issued an update to the Markets in Financial Instruments Directive II (MiFID II) through the EU Directive 2021/338. This updated Directive does not drastically change MiFID II but provides several amendments to facilitate some of the administration burdens investment firms had to go through due to COVID 19.  overhaul Implementation date for these changes is 28 February 2022.

The local Conduct of Business Rulebook has been revised on 16 November 2021 to include the new requirements stemming out of the update to MiFID II.

Below are some of the major updates brought about by this update:

• Default communication medium has been changed to electronic rather than paper-based however currently clients still have the option to choose for paper-based medium;
• Non-provision of cost and charges disclosures to professional clients and eligible counterparties when providing any service other than investment advice and discretionary portfolio management;
• When distant communication method is opted for, the investment firm has a time window to provide cost and charges information;
• Unless opted for by the client, there is no requirement to provide ex-post reporting and cost benefit analysis in relation to switching to professional clients;
• Changes to requirements in relation to product governance requirements. These include exemptions from the obligation to perform product governance requirements in relation to bonds having a make-whole clause and are not linked with any embedded derivatives as well as when the investment services are being marketed and distributed to just eligible counterparties. New requirements around product governance have been introduced around product design, target market and distribution strategy;
• Requirement to make available best execution reports on an annual basis has been suspended until 28 February 2023;
• Obligation on the European Commission to issue a new delegated regulation replacing the Commission Delegated Regulation (EU) 2017/592 (Regulatory Technical Standard (RTS) 20);
• Changes to position limits; and
• Possibility to bundle research costs by investment firms when paying out for research to third parties.

Clarifications through the updated Q&As, opinions and guidelines by the European Securities and Markets Authority were also provided.

Delegated MiFID II Acts on sustainability

Since 2021, MiFID firms had to make changes to comply with requirements stemming out of the Sustainable Finance Disclosure Directive (SFDR) and the introduction of the Taxonomy Regulation, which both have a direct impact on MiFID licence holders. To be able to support the sustainability requirements under SFDR and the Taxonomy, new legislative measures have come into force since mid-2021 which will  further leave an impact to main financial services industry players, namely fund and asset managers, including the providers of UCITS, AIF’s and MiFID investment firms, as well as (re)insurance undertakings.

From a sustainability point of view, MiFID II is supplemented with the below:

• Commission Delegated Regulation (EU) 2021/1253 of 21 April 2021 amending Delegated Regulation (EU) 2017/565 as regards the integration of sustainability factors, risks and preferences into certain organisational requirements and operating conditions for investment firms has been issued on the EU Official Journal on the 02 of August 2021 with effective date set for August 2022; and
• Commission Delegated Regulation(EU) 2021/1269 of 21 April 2021 amending Delegated Directive (EU) 2017/593 as regards the integration of sustainability factors into the product governance obligations has been issued on the EU Official Journal on the 02 of August 2021 with effective date set for November 2022.

In line with the Commission Delegated Regulation (EU) 2021/1253, as from August 2022, MiFID firms will need to integrate sustainability factors, risks and preferences (as defined in the SFDR), including:  

• Sustainability risks are to be taken into account in general organizational requirements including policies, processes, controls, resources, record-keeping and internal reporting.  These are also to be considered in risk management policies, procedures, and risk tolerances, and where appropriate, set the level of risk tolerated by the firm.  The firm would need to comply with such requirement by taking into account the nature, scale and complexity of the business and the nature and range of investment services and activities undertaken in the course of that business;
• Identification of conflicts of interest, which may have a detriment to the investor, should also consider potential damage to an investor’s sustainability preferences; and
• When the investment firm is providing investment advice to its clients, sustainability factors are to be included in the suitability assessment when recommending financial instruments to the client. This means that during the suitability assessment, sustainability preferences of the client should also be included in the suitability report. 

In line with the Commission Delegated Regulation (EU) 2021/1269, as from November 2022, MiFID firms manufacturing financial instruments must consider sustainability factors in product governance, approval, and oversight. This includes:

• Consideration of sustainability-related objectives in analysing potential target markets, and consistency of the financial instrument objectives with the target market. This consistency should be reviewed on a regular basis;
• Sustainability factors presented transparently so distributors can consider the sustainability related objectives of their clients or potential clients; and
• Product governance arrangements to ensure products and services are compatible with clients’ needs must include their sustainability related objectives and this should be reviewed on a regular basis.

Proposals for further changes to MiFID II and MiFIR

As part of the Capital Markets Union (CMU) package, proposals to change MiFID II and the Markets in Financial Instruments Regulation (MiFIR) have been issued. The key priority areas driving these proposed changes are to: (i) further enhance investor protection through improving transparency and market data availability; (ii) facilitate investors’ accessibility to investments by improving the level playing field between execution venues; and (iii) assist in increasing robustness to the EU market infrastructure by remaining competitive internationally.

Following a review of both MiFID II and MiFIR, it was argued that updates are to be carried out on the regulatory regime to address the issue of trade execution risk and illiquidity. Both issues result from a lack of correct and timely information on prices and available trading volumes for traded securities, as well as the risk that insufficient transparency affects the share trading landscape and the competitiveness of the EU as a financial hub.

From a MiFIR perspective, the main changes proposed in these enhancements include the following:

• Equity transparency through the streamline of the complex interplay between transparency waivers and the double volume cap;
• Non-equities transparency through the removal of size specific to instrument (SSTI) waivers while also shortening and harmonisation of the post-trade deferral periods;
• An overhaul to the consolidated tape providers (CTP) regime, in particular it amends the consolidated tape (CT) provisions to facilitate the emergence of one CTP for each asset class (shares, ETFs, bonds and derivatives);
• Obligations for multilateral trading systems to operate as regulated markets by shifting obligations to MiFIR;
• Obligation on ESMA to develop RTS to specify the content, format and terminology of the pre- and post-trade data that trading venues and systematic internalizers (SI) are required to publish on a reasonable commercial basis;
• Share trade obligations (STO) to be restricted to European Economic Area (EEA) International Securities Identification Number (ISIN) shares; and
• Amends to the technical reporting and reference data for harmonisation with the European Markets Infrastructure Regulation (EMIR) and the Securities Financing Transactions Regulation (SFTR).

On the other hand, the main proposed changes to MiFID II are the following:

• The licensing requirement for investors only dealing on own account on a trading venue through a direct electronic access (DEA) is removed;
• Member States to implement requirements for trading values to put arrangements in place to meet data quality standards included under MiFIR; and
• Regulatory Technical Standard (RTS) 27 on best execution has been removed.

The Proposals provide a 12-month transposition timeframe (from the issuing date) within which to transpose the legislation into national law.

You may access the proposed updated MiFID II and MiFIR by accessing the provided links. Furthermore, the Commission has also published the following related documents:

• A factsheet on the consolidated tape proposals; and
• An impact assessment for the MiFIR legislative proposals, together with a summary of that impact assessment.

Investment Funds Regime

Proposals to changes to the AIFM Directive and UCITS Directive

Apart to the proposed changes to MiFID/MiFIR as part of the CMU, the European Commission is also proposing update to the Alternative Investment Fund Manager Directive (AIFMD).

On November 25, 2021, the European Commission issued its proposed updated AIFMD, which proposed Regulation shall amend Directives 2011/61/EU and 2009/65/EC as regards delegation arrangements, liquidity risk management, supervisory reporting, provision of depositary and custody services and loan origination by alternative investment funds, as well as its Annex.

The European Commission has also suggested that the changes brought about in the AIFMD will also be reflected in the Undertakings for Collective Investment in Transferable Securities Directive (UCITS Directive) to harmonise both legislations.

The main changes to the AIFMD relate to the below areas:

• Delegated activities: (i) extending this also to ancillary activities; (ii) notifications to be sent to ESMA by National Competent Authorities (NCAs) on an annual basis where the AIFM is delegating more risk, than it retains, to third country providers; and (iii) peer reviews on delegation activities to third countries to be carried out by ESMA every 2 years. These delegation changes will also be applied to the UCITS regime;
• Loan origination requirements for AIFMs involved in lending: (i) requirement to implement policies and procedures for lending; and (ii) introduction of new capping whereby loans granted to Financial Institutions (FIs) must not exceed 20% of the Alternative Investment Funds’ (AIF) capital and AIFs have to close-ended in cases where the notional value of the loan exceeds 60% the fund’s net asset value (NAV);
• Marketing: Marketing requirements under Articles 36 and 42 will be updated to refer to the EU list of non-cooperative tax jurisdictions (replacing the previous Financial Action Task Force (FATF) list of Non-Cooperative Countries and Territories); and
• Liquidity management tools: (i) open-ended AIFs has to at least opt for one liquidity management tool included in Annex V of the proposed regulation, these being: (a) suspension of redemptions and subscriptions, (b) redemption gates; (c) notice periods; (d) redemption fees; (e) swing pricing; (f) anti-dilution levy; (g) redemptions in kind; and (h) side pockets; (ii) NCAs given the authority to request AIFs to change by activating/deactivating certain liquidity management tools; and (iii) requirement on the AIFM to inform the NCA of any activation/deactivation of the liquidity management tools.

The Proposal provides a 24-months transposition timeframe (from the issuing date) within which to transpose the legislation into national law.

PRIIPS Regulation and UCITS Directive

Regulation (EU) 1286/2014 on key information documents for packaged retail and insurance-based investment products (PRIIPs) has introduced the key information document (KID). This document is considered as a pre-contractual product disclosure document and is given to investors during the financial advice stage and/or prior to commitment.

The PRIIPs regulation had imposed an exemption period to UCITS products manufacturers and distributors in preparing the KID (under the PRIIPS Regulation) and only had to prepare and provide to retail investors when selling or advising a UCITS products, the key investor information document (KIID) as provide for in the UCITS Directive. This exemption was initially set till 31 December 2021, however this transitionary period has been further extended by the European Commission by another year, till 31 December 2022. This has been provided in Regulation (EU) 2021/2259 amending Regulation (EU) No 1286/2014 as regards the extension of the transitional arrangement for management companies, investment companies and persons advising on, or selling, units of UCITS and non-UCITS

In order to cater for these updates, Directive (EU) 2021/2261 amending Directive 2009/65/EC (the UCITS Directive) as regards the use of key information documents by management companies of UCITS, has been issued, which provides a number of quick fixes to the UCITS Directive. This update will remove any duplication of requirements for the preparation of the pre-contractual disclosure documentation (KID/KIID). Transposition by the EU Member States shall be completed by end of June 2022.  This quick fix to the UCITS Directive shall have an effective date as of 1 January 2023.

Cross-border distribution of funds framework

The cross-border distribution of funds framework is dominated by two sets of legislations:

• Updates to the AIFMD and UCITS Directive, through the Directive (EU) 2019/1160 with regard to cross-border distribution of collective investment undertakings; and
• The introduction of Regulation (EU) 2019/1156 on facilitating cross-border distribution of collective investment undertakings (CBDF).

Effective date for the above legislations is the 2 February 2022.The main intention of this framework is to remove unnecessary barriers for fund distribution in the EU as well as stimulate the competitive environment in the EU.

The main elements of this new framework are the following:

• Pre-Marketing Regime: This is a new concept which has been introduced under this framework, whereby full scope AIFMS (this does not apply to de minimis AIFMs or UCITS Managers) are allowed to provide information (in the form of communication and information, be it direct and/or indirect) to professional investors, in order to test the investors’ appetite in an AIF. This AIF may be licenced but not yet notified for marketing under the AIFMD in that jurisdiction, or otherwise is still not yet licence. This pre-marketing regime needs to be notified to the home member regulator and the draft offering documentation and other marketing materials used would need to include relevant disclosures outlining that the AIF is still under the pre-marketing regime. Under this regime, there is some limitations under the reverse solicitation; and

• Marketing Communications: this framework also creates a level playing field for marketing communications used by for both AIFs and UCITS by the fund managers. It provides a standardised approach to communication used. This standardised approach would not be introduced under the AIFMD and the UCITS Directive however it gives the power to regulators to require pre-notification of any marketing material distributed to retail investors (Retail AIFs / UCITS).

Sustainable Finance

SFDR and the Taxonomy Regulation

Some of the provisions of Regulation (EU) 2020/852 on the establishment of a framework to facilitate sustainable investment, also referred to as the Taxonomy Regulation, has come into effect since January 1, 2022. Amongst other things, the Taxonomy Regulation defines activities being referred to as sustainable activities and sets out disclosure requirements on the product offering in the areas of environmental, social and corporate governance (ESG) sphere to investors, allowing the investors to compare and contrast products.

These ESG disclosures refer to Articles 8 and 9 of the Sustainable Finance Disclosure Regulation (SFDR) (Regulation (EU) 2019/2088). Pre-contractual disclosures were introduced by the SFDR, which Level 1 pre-contractual disclosures came into effect on 10 March 2021. The deadline for the Level 2 disclosure requirements has been extended till January 2023 by the European Commission. These Level 2 reporting obligations require firms to report on 18 mandatory principle adverse impacts statements (PAIS) as well as other voluntary areas which go as far as the risks to a products’ valuation due to environmental impacts. 

Apart from these disclosures, the Taxonomy Regulation lays down several reporting requirements, for financial market participants and financial advisers. The MFSA has recently issued a Circular on the Publication of the Taxonomy Regulation Article 8 Disclosures Delegated Act. 

NFRD and CSRD proposal

Non-financial reporting helps investors, civil society organisations, consumers, policy makers and other stakeholders to evaluate the non-financial performance of large companies and encourages these companies to develop a responsible approach to business.

Directive 2014/95/EU – also called the Non-Financial Reporting Directive (NFRD) – lays down the rules on disclosure of non-financial and diversity information by certain large companies. This directive amends the Accounting Directive 2013/34/EU.

On 21 April 2021, the Commission adopted a proposal for a Corporate Sustainability Reporting Directive (CSRD), which would amend the existing reporting requirements of the NFRD. The CSRD proposal:

• Extends the scope to all large companies and all companies listed on regulated markets (except listed micro-enterprises);
• Requires the audit (assurance) of reported information;
• Introduces more detailed reporting requirements, and a requirement to report according to mandatory EU sustainability reporting standards; and
• Requires companies to digitally ‘tag’ the reported information, so it is machine readable and feeds into the European single access point envisaged in the capital markets union action plan.

Further information on this proposed directive was also provided in the MFSA’s Circular on Sustainable Finance. While there is no confirmed effective date for the CSRD, it is expected that implementation date should be in 2023.