General counsel’s in-tray: regulatory developments in the asset management sector

The big issues facing the asset management sector continue to be the assimilation of regulatory change, the adoption of new and developing technologies and the considerable economic pressures on asset managers which in many cases are driving industry consolidation. If you add into the mix the uncertainties around the shape of any Brexit deal asset managers are having to deal with a range of inter-connecting challenges.

Here are some of the key UK and EU regulatory challenges for asset managers.

The UK’s Asset Management Market Study (AMMS) is gathering pace. The FCA has now published a policy statement (PS18/8), setting out feedback on its earlier consultation, and final rules implementing some of the remedies identified in the AMMS on April 5, 2018. It has also published a new consultation paper (CP18/9) on further remedies under the AMMS, which is open to comments until July 5, 2018.

Key points in the policy statement

The FCA has redrafted its final rules concerning the assessment by an authorised fund manager of “value for money” for investors. The regulator has clarified that fund charges should be assessed in the context of the overall value delivered, rather than using the term “value for money”. Authorised fund managers (AFMs) will have to publish an annual statement within four months of the relevant accounting period describing their value for money assessment. AFMs are not expected to disclose information which is commercially sensitive or anticompetitive but they must comply with the FCA requirement that communications are fair, clear and not misleading. The FCA has decided to extend the implementation period for the value for money requirement from 12 to 18 months (September 30, 2019).

The FCA has also published final rules requiring an AFM to appoint a minimum of two independent directors and for them to comprise at least 25 per cent of the total board membership. The FCA has set out detailed rules on who will be classified as independent. Independent directors can sit on more than one AFM within a group. However, time served will be calculated on a group basis. An independent director can serve a term of up to five years (renewed once to a maximum of ten years) within one group, starting from the time of the first appointment. The new requirements come into effect from September 30, 2019.

The FCA has updated its guidance making it easier for fund investors to be moved (converted) to cheaper but otherwise identical classes of the same fund. The recast guidance removes the need for the AFM to get individual consent from each investor before converting them. The recast guidance now recommends AFMs make a simple, one-off notification to investors, which does not require a response, a minimum of 60 days before a mandatory conversion. The recast of Final Guidance 14/4, now known as Final Guidance 18/3, is now effective.

Some AFMs, especially those offering dual-priced funds, may operate a “manager’s box” which is a mechanism whereby an AFM, using its own capital, stands between the fund and those investors who are entering or leaving the fund, rather than the investors transacting directly with the fund. Whilst acknowledging that the use of a manager’s box can be compatible with acting in the best interests of investors there is a concern that AFMs might be profiting from it unfairly. There is no explicit rule in the FCA’s Collective Investment Schemes sourcebook (COLL) that allows profits to be made from box management, although the language in COLL 6.2.9G implies that the manager could keep risk-free box profits. The FCA has now published final rules to require the AFM not to retain risk-free box profits and to allocate them in a way that is fair to unitholders, while removing the obligation to pay them to the fund. The new rules come into effect on April 1, 2019. Detailed commentary on risk-free box profits rules and guidance can be found in Annex II of PS18/8.

The FCA has asked questions about whether it should continue to allow the payment of trail commission. The FCA reported in PS18/8 that it is still considering the issue and has no immediate plans to bring forward proposals for policy change.

Key points in the consultation paper

To deliver improved fund disclosures the FCA proposes to: (1) publish guidance reminding AFMs how they should express fund objectives and investment policies to make them more useful to investors. Firms should, when describing the objectives of their funds: (i) explain clearly what they are looking to achieve and how; (ii) explain the constraints that the fund’s portfolio construction may be under; and (iii) explain any non-financial objectives they have, for example the environmental or social objectives of an investment, and how they will measure and report progress against these objectives; (2) make new rules so that AFMs must explain why they use benchmarks, or if they do not, how investors should assess the performance of the fund; (3) require that, if an AFM uses benchmarks, the benchmarks must be referenced consistently across the fund’s documents and, wherever the AFM presents the fund’s past performance, benchmarks used as a constraint on portfolio construction or as a target must be presented alongside the past performance; and (4) amend its performance fees rules to provide that performance fees must be calculated on performance net of other fees in all cases. The deadline for responding to CP18/9 is July 5, 2018.

The FCA consultation does not cover the all-in fee and the possible standardisation of disclosure of fees and charges. On the latter, the FCA has published an Occasional Paper (OP32), which considers the impact of different ways of presenting information on investors’ decision making and understanding. OP32 does not put forward any specific policy proposals but is designed to encourage debate and inform the FCA’s next steps.

As part of the AMMS the FCA will be introducing a new prescribed responsibility that would make clear that a senior manager, usually the chair of the board of an AFM, must take reasonable steps to ensure that the firm complies with its obligation to carry out the assessment of value, the duty to recruit independent directors, and the duty to act in the best interests of fund investors. The FCA expects the prescribed responsiblity to come into effect at the same time as the rules extending the Senior Managers and Certification regime (SM&CR) which is expected to be in mid to late 2019.

There is also the general extension of the SM&CR to consider. The final rules are expected to be published this summer and will come into effect mid to late 2019. The extended SM&CR will apply to all authorised businesses. For all businesses except insurers, the exact rules that apply will depend on which of the following three categories a business falls into: limited scope firm, core firm, and enhanced firm. The FCA expects only 1 per cent of firms to be classified as enhanced, with most falling into the core firm category. Limited scope firms will be sole traders and consumer credit firms.

The position of General Counsel as regards the SM&CR has been a hot topic since its introduction to banks. At the press conference of the launch of the FCA Business Plan 2018-19 Andrew Bailey (FCA CEO) said that the regulator would be doing work on this topic but given Brexit such work would probably happen next year.

In May 2018 the FCA updated its web page on automated investment services, reminding firms that provide such services that they need to consider Finalised Guidance 17/8: streamlined advice.

Last July the FCA issued terms of reference for an investment platforms market study. The study looks at both investment platforms and firms that provide similar services by allowing investors or their advisers to access retail investment platforms through an online portal. In a recent speech Andrew Bailey said that an interim report on the market study would be published this summer.

An money market fund (MMF) is a type of investment fund that allows investors exposure to short-term debt such as money market instruments issued by banks, governments and companies. The MMF Regulation generally applies from July 21, 2018.

The MMF Regulation: (1) defines what an MMF is; (2) contains details about the investment policies of an MMF, restricted activities, and diversification rules; (3) sets out the requirement for a manager of an MMF to establish, implement and apply an internal credit quality assessment procedure; (4) requires risk management rules to be followed; and (5) contains detailed transparency rules.

In the UK, the Money Market Funds Regulations 2018 (SI 2018/698) have been published. They enable the FCA to authorise MMFs and enforce the provisions of the EU MMF Regulation when it comes into force on July 21, 2018. Separately, the FCA has published two consultations relating to the EU MMF Regulation (CP18/4 and CP18/14). The FCA policy statement is due shortly.

Article 69 of the Alternative Investment Fund Managers Directive (AIFMD) required the European Commission to start a review of the application and the scope of the AIFMD by July 22, 2017. In particular, the review must include a general survey of the functioning of the AIFMD’s rules and the experience acquired in applying them. However, the review has been significantly delayed. On behalf of the Commission, KPMG issued a survey on the functioning of the AIFMD a couple of months ago which is now closed (May 30, 2018). A Commission report is expected in Q4 2018.

Essentially the Omnibus proposals are designed to create a harmonised EU framework for the facilitation of cross-border fund distribution. The proposals themselves consist of a draft Regulation setting out a harmonised EU framework for facilitation of cross-border fund distribution and a draft Directive amending the AIFMD and UCITS Directive.

The Bulgarian Presidency of the Council of the EU has already held several working group discussions on the proposals but the Presidency is unlikely to reach a general approach before the end of its term. The file will be taken on by the new Austrian Presidency in July and a general approach is expected in September/October 2018. The European Parliament has yet to begin its review of the proposals and a rapporteur has not yet been appointed. That said, a draft report is expected from the European Parliament by October/November 2018. Based on these expectations, trilogues could begin in Q4 2018 with agreement in Q1/Q2 2019. This aligns with the current intention for the proposals to be adopted before the May 2019 European Parliament elections.

Currently, investment firms that are authorised under MiFID II are subject to prudential requirements set out in the Capital Requirements Regulation (CRR) and the Capital Requirements Directive IV (CRD IV). Last December the Commission published legislative proposals establishing a new prudential framework for these firms. Essentially, systemically important investment firms will continue to be subject to the CRR and CRD IV and all other investment firms will be subject to a new prudential framework where so-called “K-factors” will be used to classify them. The legislative proposals are currently undergoing trilogues.

Last year the European Securities and Markets Authority (ESMA) published four opinions on Brexit, one general opinion and three sector specific opinions that included one on investment management. This latter opinion caused some concern in the asset management industry in the sense that the underlying message was that ESMA seemed to be requiring EU27 regulators to be tough on proposed relocations and, in particular, any proposals to delegate functions back to the UK. Before Christmas ESMA’s chair, Steven Maijoor, sought to reassure the industry by giving a speech in which he confirmed that the opinion is in line with the requirements of the AIFMD and the UCITS Directive and, importantly, does not call into question the delegation model but rather guide EU27 regulators into making consistent decisions on delegation structures. Arguably the rules on delegation have not become stricter as the ESMA opinions can’t change the law, but the policing of how the rules are applied seems to have increased.