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Regulatory divergence since Brexit - the implications of the UK and EU's approach to fund regulation

With the UK and EU signaling their intent to diverge on matters of regulation, following Brexit, there are a number of key points that fund groups and asset managers with cross-border operations need to be aware of.

Our Regulations Manager Mikkel Bates spoke with The Summit for Asset Management (TSAM) and shared his thoughts on the changing regulatory environment.

The simplest way to look at this is that, if it was in place in the EU before 31 December 2020, when we reached the end of the Brexit transition period, then it was transcribed into UK law and applied here from 1 January this year.  So, in the fund world, that means that all the regulations and directives like MiFID II, PRIIPs, UCITS, AIFMD, the Benchmarks Regulation and so on that applied in the UK before 31 December still apply.

The big one missing from that list, as many will know by now, is the Sustainable Finance Disclosure Regulation, or SFDR.  Because that regulation was in train last year and had already been passed by the European Parliament at the end of 2019, a lot of fund groups and financial advisers in the UK started to incorporate it in their plans.  But because it wasn’t scheduled to come into force until March this year, after the end of the transition period, it was out of scope for the UK.

However, just recently, the Treasury published its Greening Finance: A Roadmap to Sustainable Investing and the FCA’s Discussion Paper DP21/4, Sustainability Disclosure Requirements (SDR) and investment labels, so a lot more flesh has been put on the bones of the earlier UK roadmap to TCFD-aligned disclosures.

Within that context, over the course of this year, the UK has started to move on and make changes to what was in place, where it was felt there was room for improvement or to make them more relevant to the UK market.

In terms of unwinding existing rules allowing cross-border activities, the FCA set up the Temporary Permissions Regime, allowing those EU firms who were doing business in the UK to sign up to do so for up to three years or until they are given their landing slot to apply for direct authorisation or then bow out gracefully.

The EU has been stricter, insisting that UK-based UCITS funds, which previously had passporting rights into EU countries, lost those rights and are now technically third country AIFs, even if the UK still ensures they apply the UCITS Directive in terms of investment and borrowing powers, because there is no equivalence between the UK and EU in financial services.

The Financial Services Act was passed in April and was pretty wide-ranging, making changes to the Market Abuse Regulation, the Benchmarks Regulation and the PRIIPs Regulation, as well as setting out the government’s stall on how it plans to make the UK more attractive to inward investment, and basically giving the Treasury and the FCA more control over matters for the UK.

Included in the changes to these regulations were things like the FCA having the power to arrange the orderly wind-down of critical benchmarks, such as LIBOR, and to extend the transition period for third country benchmarks by three years to the end of 2025.

On the Market Abuse side, the changes are largely around the practical application of the regulation and removing ambiguity.

And then, on PRIIPs, there are three specific changes.  One was about the clarification of what is in scope of the regulation, while the other two changes are really significant from an operational perspective – one which permitted the extension of the UCITS KIID exemption for up to five more years to the end of 2026 (or sooner if a suitable alternative is found that works for both PRIIPs and UCITS) and the other paving the way for changes to the much-criticised future performance scenarios.

We and many others felt – or at least hoped – that this would mean the inclusion of past performance. Particularly as the European regulators had said that they would like to have been able to include past performance on a PRIIPs KID, but were hamstrung by the Regulation, which of course no longer applies in the UK.

However, the consultation on the future of PRIIPs KIDs in the UK, proposed not including past performance, but instead replacing the performance scenarios with narrative explanations about the factors likely to affect performance in future.  This is an interesting proposal for two reasons: first, the trend has been to use more visual disclosures on the basis that consumers find them easier to understand than blocks of text, and second, filling a KID with free text makes it harder for consumers to compare different products, which is one of the aims of a KID.

The consultation closed at the end of September and it will be interesting to see how the final rules look, and equally important, when they come into effect, given the original plan was to go live in January 2022. However, the FCA has now delayed the publication of its Policy Statement until the first quarter of 2022.

It came as something of a surprise when it was announced quite late in 2020 that the European ESG regulations, the Sustainable Finance Disclosure Regulation or SFDR and the Taxonomy Regulation, would not apply in the UK, but it would have involved a positive decision to adopt them, given that they were not live by the end of the transition period.  So, instead, we now have two very different sets of rules in Europe and the UK.

So let’s look first at what the rules are in Europe.

Listed companies, banks and insurance companies with over 500 employees are required by the Non Financial Reporting Directive to report sustainability information and this directive introduced the concept of double materiality, whereby companies need to consider both the impact of sustainability issues on their business and also the impact of their business on the environment. The NFRD is in the process of being replaced by the Corporate Sustainability Reporting Directive, or CSRD, which widens the companies in scope to something like 50,000 across Europe.

Taxonomy Regulation

The Taxonomy Regulation, which starts to kick in on 1 January 2022, is a classification system that spells out whether activities across a whole range of industries are deemed to be sustainable in the context of six environmental objectives, starting with climate change mitigation and climate change adaptation.  The other four – on biodiversity, water, pollution prevention and a circular economy – will come in a year later.

Both the UK and the EU say they are well aware of the need to combat greenwashing, but are coming at it from opposite ends.


Alongside the Taxonomy Regulation is the SFDR, which sets out what funds and fund groups need to disclose, both pre-contractually and annually thereafter, depending on whether they promote ESG characteristics, have sustainability as an objective, or neither.  Ironically, this has become more of a classification system for funds, as it introduced the idea of Article 6, 8 and 9 funds.  While they are meant to be triggers for different levels of disclosure, they have become synonymous with what are otherwise known as brown, light green or dark green funds.  The SFDR came into effect in March this year, but the detailed templates won’t apply until next year.


Now, the UK has taken a different approach, preferring to align its reporting requirements with the principles set out by the Taskforce on Climate-related Financial Disclosure, or TCFD.  Asset managers, life insurers and pension providers need to disclose the metrics they are using to ensure they reach net zero by 2050 and how they are delivering against their targets.  As in Europe, reporting needs to be done at both company and fund level, with the largest groups caught from the start of 2022 and others following later. Further clarity on the differences between the approaches can be found in the Treasury’s Greening Finance: A Roadmap to Sustainable Investing and the FCA’s Discussion Paper DP21/4, Sustainability Disclosure Requirements (SDR) and investment labels.

So the key differences between the UK and EU approach to ESG are that the UK is focused, to start with, entirely on climate issues, ie the E, while the EU requires disclosures on E, S and G.  And the UK approach is much more principles-based, focusing o the outcome rather than the process, while the EU approach is quite rigid, setting out strict templates to be completed.