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Monthly Update

Putting an End to Greenwashing


Just as regulators – in the aftermath of the 2008 crisis – clamped down on product misselling – whereby exotic funds and dicey financial instruments were inappropriately marketed to retail investors – the US SEC (Securities and Exchange Commission) is now looking to make an example of managers who they believe are guilty of “greenwashing”. This refers to misleading investors by overstating a focus on ESG (environmental, social, governance) factors, or sustainability impacts.

This nefarious practice has been allowed to proliferate due to the lack of joined-up regulation on ESG, the sheer volume of competing industry standards, and significant differences of opinion around the meaning and measurement of “ESG”.

So what is the SEC proposing?

The SEC is recommending that funds and advisers provide more specific disclosures about their ESG strategies in prospectuses, annual reports and adviser brochures.  In the case of managers who say they are looking to make an environmental impact, they will be required to disclose the greenhouse gas emissions associated with their underlying portfolio investments.

The SEC continues that funds claiming to achieve a specific ESG impact could be required to describe the impacts in question and provide a summary outlining their progress in terms of meeting their ESG targets.

Other rules are also being tightened up. Existing SEC requirements stipulate that if a fund’s name implies it is investing in a particular industry, geography or investment types, then at least 80% of its portfolio must be made up of those assets. The SEC is now extending this to include ESG. This follows mounting concerns that a minority of managers are giving their funds ESG names or labels, but are running strategies which do not correlate.

Elsewhere, funds that use proxy voting could be required by the SEC to disclose information regarding their voting of proxies on particular ESG-related voting matters and information concerning their ESG engagement meetings.

The SEC’s uncompromising stance on ESG comes not long after it fined the investment advisory arm of BNY Mellon $1.5 million following misstatements and omissions about its ESG approach to managing funds. The SEC said claims made by BNY Mellon Investment Advisor that it had embedded ESG quality reviews into all of its funds turned out not to be the case.

Given that the SEC has repeatedly warned the industry that it would target greenwashing, the fine should not come as a surprise. As such, managers are bracing themselves for further ESG scrutiny – and potential sanctions – from the SEC.

The US’ approach towards ESG is largely being welcomed by the funds’ industry, who have been asking for greater clarity on the issue for a long time.

If investors are unable to benchmark managers on ESG – or believe they are being mis-sold products masquerading as ESG funds – then the appetite for ESG investing will inevitably flounder. Therefore, it is essential regulators take a tough line on greenwashing if confidence in the ESG market is to be retained.

It is very probable that other regulators will follow the US’ lead as they look to root out greenwashing.

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Monthly Update

The Need for Oversight in Crypto Markets

As volatile asset classes go, few exceed the violent and gyrating price swings seen in crypto-currencies. Even so, the events of the last month have resulted in serious questions being asked of crypto-currencies, with some calling for greater regulation of the asset class.

A small chorus of institutional investors – dominated mainly by family offices, high net worth individuals,  smaller hedge funds, and specialist crypto-fund managers –  have built up exposures to crypto-currencies and StableCoins, a type of crypto-currency designed to have a stable price which is pegged to a fiat currency or another tangible asset.

However,  many – including a number of IIMI members –  have chosen to avoid crypto-currencies altogether. Their reasons for avoiding crypto are well-documented. Crypto-currencies are unregulated; have been used extensively to facilitate illegal activities such as money laundering and terrorist financing, while some experts question the basic macro fundamentals and valuations behind the asset class. 

Nonetheless, two events in May are likely to trigger even more regulatory scrutiny of crypto-assets.

Not-so StableCoins

The first involves StableCoins.  StableCoins act as a medium of exchange between the traditional financial world and the crypto-universe, meaning that their values are pegged to conventional assets (e.g. USD, Euro, etc.) so as to avoid some of the volatility which is endemic in crypto-currencies like Bitcoin.

That one of the largest StableCoins – Tether – broke its one on one peg with the USD is likely to invite regulatory intervention. A number of regulators have repeatedly warned that StableCoins – despite the comforting name – could suffer serious losses or become illiquid during stressful market events.

This is partly because of concerns about the nature of the reserve assets underpinning StableCoins amid fears that some StableCoin issuers have provided only limited details about their underlying holdings and how they are managed. In the case of the latter, Tether, for instance, has said this is strictly proprietary information.   

However, a recent article in the Financial Times notes that half of Tether’s $80 billion of reserve assets comprise of US Treasuries, while corporate debt accounts for 25% of its holdings. Nonetheless, a lot of this corporate debt – according to reports – has been issued by Chinese companies.

This is not the first time that Tether’s reserve assets have been challenged by the authorities. In October 2021,  Tether was fined $41 million by the  Commodity Futures Trading Commission for making misleading statements and omissions about its reserves.

While the $180 billion StableCoin market is not systemically important per se,  it has grown exponentially in the last two years and its price movements could one day have a wider market impact than what they do today. As such, the volatility witnessed earlier in the month could usher in further oversight of StableCoins and their holdings.

The crypto-custody model faces tough Questions

The second incident to tarnish the crypto-asset market follows an SEC (Securities and Exchange) regulatory filing made by Coinbase, a publicly listed crypto-custodian which is widely considered to be the dominant provider in this growing space.

Coinbase’s filing warned that custodied crypto-assets “could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors.” Although Coinbase’s CEO and analysts were quick to point out the company had significant liquidity, the statement has raised eyebrows in institutional circles.

Given that Coinbase is one of the most sophisticated providers in its field, the revelations prompted intense debate about the operating models of the countless other –  and arguably less cutting edge-   crypto-custodians in the market. 

While some traditional bank custodians are looking to develop solutions supporting digital asset trading, incumbent providers have made it clear that firmer regulation is needed in the crypto-custody market.

Crypto will face a regulatory reckoning

The latest turmoil afflicting crypto markets will likely result in sweeping regulations being introduced across these asset classes beyond what is being lined up already.

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Monthly Update

Another “Dear CEO” Letter Shakes up the Industry

“Dear CEO” letters issued by the UK’s Financial Conduct Authority (FCA) rarely make for enjoyable reading – as the asset management industry can surely attest –  having been on the receiving end of several brusque missives over the last few years. In late March 2022, it became the turn of the custody and fund services sector to face the FCA’s opprobrium in one of the regulator’s latest communique. The FCA outlined four principal challenges facing fund servicers – all of which could have serious downstream consequences for asset managers and asset owner clients.

Cyber controls in need of improvement

Chief among the FCA’s priorities were operational resilience and cyber-security, which the regulator identified as being areas of weakness at some firms. “The levels of interconnectedness between systems, lack of internal knowledge on how the systems operate, and ineffective oversight of third party or intra-group service providers can all threaten resilience. These are areas where you can expect questioning on how risks have been mitigated,” according to the FCA’s letter. 

The FCA reiterates that asset servicers hold sensitive investor data, stressing this information should be safeguarded by robust security measures. The FCA also highlights that asset servicers, where controls have been found wanting, are currently being subjected to heightened technology reviews.

Protection of Client Assets and Money

Although the FCA notes that providers have invested heavily into facilitating CASS (Client Assets Sourcebook) compliance, it says there are deficiencies at firms in terms of their change management; dependency on legacy or end of life IT infrastructure; and high levels of manual processing.

“We think that challenges with CASS compliance often have their root causes in poor governance and oversight, under-investment in systems, and a failure to fully consider CASS impacts when managing change. We have seen cases where the root causes also include a lack of adequate CASS knowledge,” says the FCA.

Depositary oversight requires remediation

Entrusted with overseeing asset managers’ operations (i.e. cash flow monitoring, compliance with investment mandates, service provider oversight etc.), depositaries are a vital investor protection tool. Despite these critical responsibilities, the FCA criticised depositaries for having inadequate oversight processes in place and failing to properly challenge fund managers when needed.

“This can lead to potential harm to unitholders and investors. We also have concerns about the robustness of controls used to oversee fund liquidity, and investment and borrowing limits. We have seen examples of a lack of holistic judgements in these areas, including – for example –  a narrow interpretation of the applicable COLL rule requiring a ‘prudent spread of risk’ and the lack of policies or procedures related to it,” adds the letter.

Be wary of speculative and illiquid investments

Although the FCA said it was not presently aware of any fund services providers manufacturing or promoting speculative or illiquid products (i.e. mini-bonds), the regulator warns “firms in this sector may contract with and provide services to the issuers or promoters of these products, such as trustee, safekeeping and administrative services. In some cases, FCA regulated custody and fund services firms may inadvertently provide increased legitimacy to the marketing of unregulated products. Promoters of these products may exploit the FCA badge of a regulated entity from which it is procuring services, to create false confidence surrounding a product, marketing claims or consumer protections,” it says.  

The FCA warns there have been instances of providers displaying “a disregard for consumer outcomes in their activities and inadequate due diligence on parties with which they have contracted”, adding it will take action against organisations when serious misconduct is suspected.

Why fund managers should care

Although this “Dear CEO” letter does not apply to fund managers directly but rather to their asset servicers, the industry should take note of its contents. Engaging with poor quality providers (i.e. a depositary who does not flag problems or an administrator with lax cyber hygiene policies) can have adverse consequences for fund managers together with their investors.  In addition, boutiques – including IIMI members – should be wary of being locked into asset servicer relationships– where higher service costs do not necessarily reflect a reinvestment in systems and security processes.

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Monthly Update

Fund managers brace themselves for Russian fall-out

Despite the glaring warning signs and litany of pessimistic Western intelligence reports, the Russian invasion of Ukraine caught a number of institutional investors by surprise. According to data from the Moscow Exchange (MOEX), foreign investors are currently sitting on circa $86 billion of Russian equities, $20 billion of Russia’s USD debt and  $41 billion of Rouble denominated sovereign bonds. [1] 

A number of institutional investors – including pension schemes and sovereign wealth funds across the US, UK, Canada, Norway and Australia – are coming under massive political and regulatory pressure to divest their Russian holdings. Several Russian-focused funds have already suspended investor redemptions. Given the extent of the sanctions being imposed on Russia –  offloading these problem assets will be incredibly tough. Capital losses are also expected to be substantial owing to the precipitous fall in market prices, doubling of Russian interest rates and collapse of the Rouble’s value.

So what is exactly happening? The exclusion of certain Russian banks from the SWIFT financial messaging network at the end of February had already made it extremely complicated for foreign institutions to exit their Russian investments. In short, this measure effectively rendered it almost impossible for firms to remit any sales proceeds from Russia. Not only are foreign investors at enormous risk of breaching sanctions rules if they do sell their Russian assets, but few – if any counterparties – will want to buy or sell Russian securities because of the political environment, market risk and potential scope for incurring harsh penalties should they violate sanctions.

Compounding matters further is that foreign institutions are banned by the Russian government from selling locally listed securities on MOEX while trading of Russian companies abroad has been suspended. According to the FT-  Nasdaq, Deutsche Borse and the London Stock Exchange (LSE) are among some of the major stock exchanges to have introduced share trading bans on listed Russian securities.[2] In addition, the LSE has ceased trading of global depository receipts of several Russian-based companies including Rosneft, Sberbank, Gazprom, En+ and LuKoil.  Elsewhere, MSCI and FTSE Russell have both excluded Russian securities from their respective EM (emerging markets) indices – a decision that will further heap pressure on the country’s embattled equity market.

At a financial market infrastructure level, CSDs (central securities depositories) have also made it significantly harder for foreign institutions to trade in the Russian market. Euroclear confirmed it would suspend its link with the Russian Bank, VTB, which until now has acted as the main outlet for trades in Russian securities for both Euroclear and Clearstream. Clearstream also stated that the Rouble was no longer an eligible settlement currency inside or outside of Russia, while Euroclear stopped settling Rouble denominated trades transacted outside of Russia on March 3. [3] Asset servicing has also been impacted with income distributions accrued from Russian securities now suspended until further notice. It is unclear what would happen if a Russian security undertook a corporate event but it should be assumed overseas investors impacted by the embargo would have to allow it to lapse.

With there being no end in sight to this crisis, it is highly probable that foreign institutions’ holdings of Russian assets are likely to be trapped for the foreseeable future. Local providers in Russia – such as custodians – can certainly provide information to clients, –  but other services will likely be restricted.


[1] Financial Times (March 1, 2022) Investors struggle to trade Russian assets as sanctions hit market plumbing

[2] Financial Times (March 1, 2022) Investors struggle to trade Russian assets as sanctions hit market plumbing

[3] Reuters (February 28, 2022) Europe carves out Russian securities from financial markets

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Monthly Update

Market data faces a regulatory reckoning

The cost of market data being supplied by benchmarks and indices to asset managers – together with the complexity of the contracts binding investment firms to these providers – is an issue that IIMI (Independent Investment Management Initiative) has repeatedly raised with regulators  – most notably the UK’s Financial Conduct Authority (FCA). In a missive released in January, the FCA confirmed that it will launch two studies investigating how easily market participants can access wholesale data. 

According to the FCA, this comes amid mounting concerns that there is limited competition in the markets for benchmarks and indices, credit ratings and trading data, which in turn is leading to higher costs for fund managers and their end investors. The FCA said the first study – which will start in the Summer – will review concerns that contracts for benchmarks and indices are excessively complex – in what is precluding investment firms from switching to cheaper, better alternatives. At the end of the year, the FCA continued it would launch a follow-up study examining whether high charges for access to credit rating data is creating added costs for investors and hindering new market entrants.

The FCA said it will be gathering input about competition in the market for wholesale trading data, namely information about what financial instruments are being traded; how much people are prepared to pay for them, and the prices at which transactions are executed. A lot of this information is supplied by trading venues – principally stock exchanges – where the transactions take place. Nonetheless, there is disquiet about the absence of proper competition in this corner of the market, in what some say is resulting in asset managers facing higher costs. Others point out these costs might even have an impact on the nature and type of assets that investment managers buy and sell.

One IIMI manager adds that the lack of clarity over display and non-display data contracts with wholesale data providers and exchanges is still a live issue. This is because many managers are being challenged on how they use security/index data in their trading activities. Some firms have been informed by providers that these activities are not covered by their existing contracts or are being forced to sign new contracts to cover data use for something they did not need to pay for previously.

Experts say this FCA review could pit stock exchanges  – where proceeds from data distribution and sales are becoming an increasingly important component of their revenues – against asset managers, who are frustrated about the rising data charges – especially at a time when margin pressures elsewhere continue to grow. A number of investment firms are spending more than ever on operations – including data –  despite facing fee compression and heightened regulations. In response, many managers are looking to net meaningful cost savings, something which could be facilitated through greater competition in the benchmarking world.

As the UK increasingly strives to attract more foreign investment into the country post-Brexit, greater competition in terms of how market data is supplied could be one of the ways in which this is achieved. 

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Monthly Update

Regulations to Watch 2022

The regulatory tsunami shows no sign of relenting anytime soon.  The Independent Investment Management Initiative(IIMI) looks at some of the regulations, which could affect its members in 2022.

  1. ESG – no let up yet

The introduction of new ESG rules in both the EU and UK will have an impact on some IIMI members’ operations. Although the EU has delayed the SFDR’s (Sustainable Finance Disclosure Regulation’s) Level 2 obligations until January 2023, managers should be thinking about their next steps in terms of compliance. Under the Level 2 rules, asset managers will need to report on 18 compulsory PAIS (Principle Adverse Impacts) in addition to a number of voluntary disclosures covering sustainability. Elsewhere, the UK is adopting its own provisions around ESG having published its “Roadmap to Sustainable Investing” report at the tail-end of last year. The UK’s report outlined plans to subject asset managers to ESG disclosure requirements and pledged to establish a taxonomy  – with the latter likely to have some overlap with the EU’s benchmark. Nonetheless, it is clear that different countries will impose their own ESG rules in what is likely to fuel further arbitrage and cause confusion.

  • Phase six of UMR (uncleared margining rules) takes effect

Having introduced phases one through to five of EMIR’s (European Market Infrastructure Regulation) initial margining rules for uncleared OTC derivatives, Phase 6 will be felt by a much greater number of buy-side firms including UCITS and AIFMs. Firstly, the final phase will apply to financial institutions with an AANA (average aggregate notional amount) in excess of €8 billion. According to ISDA (International Swaps and Derivatives Association), around 775 firms will be affected by Phase 6, which is more than double that of Phase 5, and will most likely include a number of boutique asset managers. Affected managers must ensure they have processes in place to facilitate the posting of initial margin.

  • CSDR – settlement efficiency is now paramount

Although EU regulators have confirmed that mandatory buy-in requirements under the CSDR (Central Securities Depositories Regulation) have been postponed (potentially by several years), cash penalties for settlement fails will apply from February 2022. Most asset managers have historically presumed that it is their custodians or brokers who are primarily responsible for ensuring trades settle on a timely basis. Not anymore. Under CSDR, CSDs (central securities depositories) will be entrusted with imposing fines for settlement fails on brokers and custodians, who unless they are themselves at fault – will offload these costs to underlying clients responsible for the fails, namely asset managers. As such, managers need to augment their settlement processes if they are to avoid CSDR cash penalties.

  • AIFMD – not the overhaul many expected

Many of the proposed amendments by the EC to AIFMD have been welcomed by the industry. It was widely feared that non-EU asset managers would find their access to EU investors heavily restricted were AIFMD’s delegation requirements to be tightened up, but this has not happened. Instead, the delegation rules remain largely unchanged much to the industry’s relief. It is true the National Private Placement Regime (NPPR) rules have been toughened up but only marginally so. Right now, non-EU AIFMs and AIFs using NPPR cannot be based in countries designated by the Financial Action Task Force as being a non-cooperative country or territory. The EC has since said that third country AIFs cannot market into the EU if they are based in a country on the EU’s list of non -cooperative jurisdictions for tax purposes and AML.  While this will not apply to high-profile financial hubs like the UK or US, it could impact some offshore centres – with the Cayman Islands having been on such a list as recently as 2020. In a worst-case scenario, restrictions could be imposed on managers running offshore funds in certain domiciles.

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AIFMD – amendments now under discussion

A month ago, the European Commission (EC) announced far-reaching proposals designed to curtail non-EU banks – including those based in the UK and Switzerland – from cross-selling their services into the Single Market. With an EC review of the AIFMD (Alternative Investment Fund Managers Directive) also looming, a number of UK asset managers were bracing themselves for the worst, namely the imposition of new limits further impeding their ability to access EU investors.  In November, the EC finally published its proposed amendments to AIFMD – which are more measured than what many had anticipated.

Let’s begin with the good news. Despite a lot of noise emanating from certain member states about banning the practice entirely – delegation is likely to continue albeit subject to a few additional requirements. The EC has said that delegation by AIFMs and UCITs of portfolio management and risk management to third countries will not change, but managers must have substance in the EU. In effect, the EC has stated that AIFMs and UCITS need to employ at least two full-time EU residents so as to prevent the emergence of letterbox entities. A number of law firms have stressed that this provision is not especially burdensome and simply codifies existing rules.

However, “whilst there is no requirement for an AIFM to retain more risk or portfolio management than is delegated, there are more onerous reporting requirements where this is the case. The proposal is that competent authorities notify the European Securities and Markets Authority (ESMA) on an annual basis of delegation arrangements where more risk or portfolio management is delegated to third-country entities than is retained,” according to an article by law firm Dechert. ESMA will also assess how member states are applying the delegation rules and will conduct regular peer reviews to ensure letterbox entities are not being created and regulatory arbitrage is avoided.

Revisions to the AIFMD’s National Private Placement Regime (NPPR) – while not laborious or prohibitive – could potentially pose problems for some alternative asset managers –  if political circumstances were to dramatically change. Right now, non-EU AIFMs and non-EU AIFs looking to leverage NPPRs cannot be based in a jurisdiction designated as being a “non-cooperative country or territory” by the Financial Action Task Force (FATF). Moving forward, the EC is now widening the goals posts and proposing that third country AIFs cannot be distributed into the EU if they are operating out of a market that is on the EU’s list of non-cooperative jurisdictions for tax purposes and AML (anti-money laundering) – i.e. a high-risk third country.

While this clause is unlikely to affect non-EU AIFMs in leading financial centres such as the UK, US, Hong Kong, Singapore or Switzerland, offshore fund hubs (i.e. the British Virgin Islands, Cayman Islands, Jersey, Guernsey) could find themselves under scrutiny. Although none of these offshore centres are currently deemed high risk by the EU from an AML or tax perspective, the Cayman Islands was on the EU Tax List between February 2020 and October 2020.  If one (or more) of these offshore centres were to be added to an EU AML or Tax List, then it could prevent managers with funds domiciled in those jurisdictions from marketing into the EU. 

The EC’s proposed revisions are not ground-breaking nor are they likely to disrupt IIMI members’ operations. Barring a few added requirements here and there, the EC’s amendments will come as a relief to  IIMI  members who had previously assumed that much tougher rules would be introduced.

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Monthly Update

Managing Cloud Risk

A few years ago, regulators – including the UK’s Financial Conduct Authority [FCA] scrutinised asset managers’ outsourcing arrangements, highlighting repeatedly that improvements were necessitated – especially around their contingency plans for a service provider failure. Although asset managers have since implemented more robust systems and backup procedures to properly insulate themselves against the failure of a critical third-party, concerns are mounting that the industry is missing some glaring risks-namely around cloud service providers [CSPs].

CSPs are used by a wide array of financial institutions – including banks and asset managers. To their proponents, CSPs are an effective way for asset managers to reduce their IT costs, realise economies of scale and increase operational resilience – the latter being a massive selling point in a post-COVID-19 world. At a time when margins are shrinking, CSPs can provide efficiencies at asset managers enabling firms to redeploy more internal resources to revenue-generating and client-facing activities. While CSPs confer many benefits for fund managers, they are not without risks, something which regulators such as  ESMA[European Securities and Markets Authority]are becoming more attuned to.

So what are the main issues around CSPs? Research shows that three providers – Amazon World Service, Google and Microsoft – control 60% of the CSP market suggesting very high levels of concentration risk. An outage or failure at one or more of these CSPs could pose huge operational and technological challenges for their underlying clients. ESMA warns “migrating to the cloud….can also raise challenges at the firm level in terms of governance, data protection and information security. Operational risks are also relevant as they result from inadequacies or failures of internal processes, people, and systems, or from external events, and they may impact financial institutions in different ways. For instance, data losses could happen due to failures, deletion or disasters that occur at CSPs, or when CSPs outsource some of their functions to third parties, or ‘fourth parties’. Cyber risk is also important to consider, as massive amounts of data are stored in cloud ecosystems. ‘Vendor lock-in’ is also relevant when financial institutions rely strongly on the services of one CSP,” reads ESMA’s report.

While COVID-19 has reinforced the importance of technology, it has also simultaneously illustrated how vulnerable the financial services industry is too disruptive events of all stripes – including technology outages. The European Commission, in particular, has started to pay more attention to digital resiliency, namely IT risk management, incident reporting and IT third party risk with the publication of DORA [the Proposal for a Regulation on digital operational resilience for the financial sector]. This is something asset managers will need to be cognisant of. It is not just regulators who are examining asset managers’ CSP and third party IT arrangements, but so too are institutional investors. It is vital asset managers can demonstrate they have an excellent understanding of IT and CSP risk.

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Divergences start to show on Brexit

In the run-up to Brexit last year, many within the industry lobbied the UK government extensively arguing for a bonfire of EU regulations –  as they applied to financial services. While a sweeping away of EU rules never materialised, the UK has gradually been diverging away from the EU on some regulations.

Take ESG [environment, social, governance] as an example. Although the EU introduced its Sustainable Finance Disclosure Regulation [SFDR] and is in the process of developing a Taxonomy to provide investors with a benchmark outlining what economic activities are sustainable, the UK is unlikely to onshore either of these provisions. Instead, the UK is demanding asset managers running at least £5 billion produce ESG disclosures which are based on the Financial Stability Board’s [FSB] Task Force for Climate-related Financial Disclosures [TCFD]. Some lawyers have argued the UK’s approach is incredibly sensible, pointing out the TCFD is a global, pre-existing standard, in contrast to the EU’s Taxonomy, which is being manufactured from scratch. This means more global institutions are likely to have adopted the TCFD standard, unlike the EU’s taxonomy, which is expected to be far more euro-centric.  However, the dual regulatory approach does risk creating challenges for investment firms with operations straddling both the UK and EU.

The Central Securities Depositories Regulation [CSDR] is another piece of regulation on which the UK has deviated from the EU. Although many investment firms assume CSDR is applicable to post-trade providers only, the rules will be felt widely, including within asset management. Under the CSDR’s Settlement Discipline Regime [SDR], counterparties to failed trades will be subject to cash penalties and mandatory buy-ins. While the industry begrudgingly accepts that the threat of cash penalties will help drive up settlement discipline, mandatory buy-ins could prove destabilising, by creating added costs and undermining liquidity. The European Securities and Markets Authority [ESMA] has recognised this and is advising the European Commission to delay the phase-in of mandatory buy-ins beyond their current implementation date of February 2022. Some industry associations have warned the EU that CSDR’s buy-in rules could have catastrophic implications during periods of extreme volatility, highlighting that systemic events might have occurred [especially in the bond markets] had the rules been in place during March/April 2020. While there is speculation the EU could make buy-ins voluntary, the UK already confirmed that the SDR will not apply in the domestic market, in a move that has been largely welcomed by the industry. Nonetheless, UK managers will still need to comply with SDR for any European transactions which are settled by EU-based central securities depositories.

Beyond ESG and settlement discipline, the UK is also making tweaks to other EU rules. It recently acknowledged that non-financial counterparties [NFCs] do not need to report under the Securities Financing Transaction Regulation [SFTR]. Similarly, it is believed that the UK’s Financial Conduct Authority [FCA] could ease some of the research rules and best execution obligations imposed under the Markets in Financial Instruments Directive II (MiFID II). Proposals have emerged suggesting the UK could exempt SMEs with a market cap of less than £200m together with FICC [fixed income, currencies, commodities] research from MIFID II unbundling requirements. Elsewhere, MiFID II  share trading obligations and double volume caps have also been shelved by the UK regulators. These revisions to EU regulations are receiving a positive response from the industry.

Although the UK is shifting away from a handful of EU rules, the differences are not massive and certainly do not represent a race to the bottom. Instead, the UK appears to be taking a proportionate and sensible approach to post-Brexit rulemaking, at least for now.

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The UK pursues a home-grown ESG regime

Investor appetite for ESG (environment, social, governance)-focussed and sustainable funds is reaching new heights, fuelled by the sector’s perceived performance benefits; regulatory intervention; and growing fears about stranded asset risk. According to Morningstar data, ESG funds accumulated $139.2 billion in net inflows during the second quarter of 2021, bringing total AuM (assets under management) to $2.3 trillion. [1] Amid the asset class’ strong growth, regulators – particularly in the UK- are keen to ensure standards remain high – following growing concerns about potential greenwashing.

Improving clarity around ESG funds

In a letter to AFMs – published in July 2021 – the UK’s Financial Conduct Authority [FCA] noted that it had seen a notable increase in ESG/sustainable funds applying for authorisation, before adding that a number of these applications “have been poorly drafted and have fallen below our [FCA] expectations.” In its letter, the FCA continued that many of the ESG claims in these applications do not bear scrutiny, and stressed they should have been addressed during the fund product design process. Among some of the more egregious examples of product mis-labelling cited by the FCA included a proposed passive fund with an ESG-related name which was looking to track an index that was not ESG-focused. In another case,the FCA criticised  a sustainable investment fund  for having two high carbon emitting energy companies in its portfolio holdings without “providing obvious context or rationale behind it – e.g. a stewardship approach that supports companies moving towards an orderly transaction to net zero.” Such behaviour risks undermining consumer confidence in ESG funds.

In response, the FCA has outlined a set of guiding principles on the design, delivery and disclosure of ESG and sustainable funds. These requirements are entirely sensible and proportionate, and have not elicited criticism from the Independent Investment Management Initiative [IIMI]. For example, the FCA urges that references to ESG in a fund’s name, financial promotions or any other documentation should reflect the materiality of ESG/sustainability considerations to the objectives and/or investment policy and strategy of the fund. For example, the FCA highlights managers should not use terms such as ‘ESG’, ‘ethical’ or ‘green’ in their fund name unless they are directly adopting such strategies. The second principle states that the resources used by a firm to pursue its ESG objectives be appropriate, and the manner in which an investment strategy is implemented be consistent with its disclosed objectives. And finally, the third principle advises that pre-contractual and ongoing periodic disclosure by sustainable investment funds be available to consumers and must contain information to help them make investment decisions. The latter requirement will be vital in ensuring trust among retail clients.

Enhancing ESG reporting in the UK

Having announced in November 2020 that it would introduce climate-related disclosure obligations for asset managers, life insurers and pension providers, the FCA has since published a consultation – CP21/17 – outlining its requirements. Under the FCA’s proposals, in-scope investment firms [i.e. UK AIFMs; UK UCITS] will need to produce disclosures which are based on the Financial Stability Board’s [FSB] recommendations  in the Task Force on Climate-related Financial Disclosures [TCFD]. The FCA has said the new reporting requirements will take effect from January 1, 2022 for the largest investment managers, namely firms with more than £50 billion.  As of January 1, 2023, the rules will apply to all other fund managers running at least £5 billion in AuM. Although the proposals only cover UK managers, an article by international law firm Sidley Austin warns that non-UK managers could also be indirectly impacted. “The FCA’s proposals could result in in-scope UK asset managers and asset owners requesting that a non-UK asset manager provide certain product-level information – in order to discharge the in-scope UK asset managers’/asset owners’ own disclosure obligations,” it continues.[2]

In terms of the specific reporting obligations, the FCA has told managers to report information at both an entity and product/portfolio level. In the case of entity level disclosures, “these would be made with reference to activities over the previous 12 months using the most up to date information available. We {FCA] are proposing to give firms the flexibility to select the 12-month reporting period for their first entity level TCFD report provided that the period begins no earlier than January 1, 2022 and that the first disclosures are published on their website by June 30, 2023.”[3] On product and portfolio level disclosures, the FCA said “firms required to make public disclosures would be required to publish them on their websites by June 30 of each calendar year. These disclosures would be made using the most up-to-date data available at the time of reporting. The data must be calculated within the 12 month reporting period covered by the TCFD entity report. Firms would be required to publish disclosures on their website by June 30. This includes [or cross-reference to] the website disclosures in the appropriate client communication which follows most closely after the reporting deadline. In the case of on demand disclosures to institutional clients, firms must provide the requested information from July 1, 2023.” Although it is clear the UK needs to demonstrate its ESG credentials – particularly following Brexit – there are concerns among managers about the risk of duplication of ESG regulations.

ESG reporting could pose challenges

In isolation, the UK’s climate reporting regime appears sensible, not least because it adopts a widely used international standard [TCFD] as its template. Nonetheless, the UK’s approach does create its own problems, especially for firms who are also caught out by the EU’s SFDR (Sustainable Finance Disclosure Regulation). With more regulators across the globe now contemplating their own bespoke ESG reporting regimes (i.e. the US and certain APAC markets), there is a risk that the entire process could become increasingly complicated and costly. This comes at a time when boutique investment managers are already grappling with rising regulatory costs and operational overheads – the latter a direct consequence of the pandemic. While the IIMI fully supports a comprehensive and meaningful ESG reporting regime, it has growing concerns that too many regulators are introducing their own rules in silos leading to duplication and arbitrage. Moreover, the multitude of different reporting templates and approaches that are likely to emerge is going to be confusing for investors, particularly retail.  In order to mitigate this risk, it is vital  regulators engage and collaborate with each other when developing their ESG reporting regimes , so that there is a degree of standardisation and consistency.  


[1] Reuters (July 27, 2021) Global sustainable fund assets hit record $2.3 trillion in Q2, says Morningstar

[2] Sidley Austin

[3] FCA