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As part of our sector-focused series, we have spoken with our in-house PSLs to outline the key legal trends to watch in Financial Services as 2019 draws to a close.

This article focuses on sustainable finance, LIBOR and the new prudential regime.

1.  A growing focus on sustainable finance

On 22 September 2019, 13 years after the launch of the United Nations (UN)-supported (), the UN Environment Programme Finance Initiative’s (UNEP FI) () were launched.  

The PRB aim to strategically align banks with the UN Sustainable Development Goals (SDGs) and the UN Paris Agreement on Climate Change and - like the PRI - contain mandatory reporting requirements for signatories. 

Both the PRI and the PRB have a significant number of signatories globally and it is likely that further banks, asset owners, investment managers and service providers will sign up to these principles.

In addition to the global, voluntary PRB and PRI - and a wide range of industry best practice guidance for different asset classes - there are proposals for EU regulations (and amendments to delegated acts under the recast Markets in Financial Instruments Directive 2014/65/EU (MiFID II) and the Insurance Distribution Directive (EU) 2016/97) on:

• Taxonomy  -  a unified classification system on what can be considered an environmentally sustainable economic activity, which (amongst other things) is intended to reduce the risk for ‘greenwashing,’ ie where the ‘green’ label is potentially mis-used in order to tap into increased investor demand for sustainable and green investments

   

• ESG integration - disclosure obligations on how pension schemes, asset managers, institutional investors, insurance distributors and investment advisors integrate environment, social and governance (ESG) factors into their risk management processes, investment decisions and advisory processes, including suitability tests

   

• Benchmarks - new categories of benchmarks, comprising low-carbon and positive carbon impact benchmarks, intended to provide investors with better information about the ‘carbon footprint’ of their investments

Further reading:

For further information about these EU regulatory developments, see the European Commission’s and and our .

2.  LIBOR transition – the pressure builds

On 30 September 2019, Bank Overground published an reminding the market to prepare to transition from the London interbank offered rate (LIBOR) to alternative, more robust benchmarks such as overnight risk-free rates (RFRs) by end-2021, when it is expected that LIBOR will be discontinued.

The article noted that despite progress in establishing RFRs, many new contracts maturing beyond 2021 continue to reference LIBOR. In particular, LIBOR-linked lending continues to dominate in loan markets, and many new long-dated derivative contracts continue to reference LIBOR.

In a given in June 2019, the Bank of England (BoE)’s executive director for markets, Andrew Hauser, called the transition from LIBOR ‘as complex a task as any the financial sector has faced over the past decade, involving a global network of market participants and public authorities, and touching most systems, products and markets in some way’.

There are significant regulatory barriers, as outlined in to the European Commission, the Basel Committee on Banking Supervision, the Prudential Regulation Authority and the FCA which BoE’s working group on sterling RFRs (RFR WG) published on 23 October 2019. The issues highlighted by the RFR WG include:

• the possibility that contractual amendments related to the transition will bring ‘legacy’ contracts within the margin and clearing requirements of the European Market Infrastructure Regulation (EU) 648/2012 (EMIR)
• firms will have to report a change in their contracts from LIBOR to the new SONIA RFR en masse, which might create an artificial impression that there is sufficient liquidity in SONIA swaps to meet the threshold for the trading obligation under the Markets in Financial Instruments Regulation (EU) 600/2014 (MiFIR)
• internal model standards under the Capital Requirements Regulation (EU) 575/2013 (CRR) and other prudential regulations were not designed to accommodate a wholesale (probably phased) shift from existing to alternative interest rate benchmarks across a wide variety of products and currencies. The transition to RFRs will require firms to have sufficient data to build or re-calibrate internal models, and in the absence of such data a period of forbearance is necessary during which firms are permitted use current benchmarks as proxies and, where possible, backfill or extrapolate to help mitigate against unnecessary regulatory capital requirements

Further reading:

For updates on the transition to RFRs, see .

3.  A new prudential regime for investment firms

In April 2019, the European Parliament and the Council of the EU reached political agreement on a revised version of the European Commission’s 2017 proposal to overhaul the prudential regime for investment firms in the EU.  

The intention is to create a framework that is more proportionate and risk-sensitive. Under the new regime, most investment firms will be subject to new, simpler prudential rules, while large, systemic firms that carry out bank-like activities and pose similar risks as banks will be regulated and supervised like banks.

The new regime will take the form of a new , which will include amendments to CRR and MiFIR, and a new , which will include amendments to the Capital Requirements Directive 2013/36/EU (CRD IV) and MiFID II. Other changes include:

• tighter equivalence rules for third-country firms, which will now be subject to a detailed assessment by the European Commission and enhanced monitoring by the European Securities and Markets Authority (ESMA) before they can provide services of systemic importance within the EU—this could have a significant impact on the ability of UK firms to access EU markets post-Brexit
• new transparency requirements for investment firms about their investments and their voting behaviour during shareholder meetings
• extending the “tick size regime” under MiFID II so that it will apply to systematic internalisers (SIs) in order to level the playing field between SIs and trading venues

The Council is expected to adopt the final texts shortly. The new legislation will enter into force 20 days after publication in the Official Journal of the EU and will take effect in 2021. Given the magnitude of changes, however, investment firms should familiarise themselves with the changes and start preparing now.

Further reading:

For more information, see our Practice Notes: and