Investment management update - 19 December 2018

A round-up of recent legal and regulatory developments of interest to the investment management sector.

This issue includes:

General

• Why the buy-side should buy into the FX Global Code: BoE speech
• PRIIPS Regulation: ESMA's SMSG calls on European Commission to start mandatory review
• FCA quarterly consultation paper: industry codes and firm details reporting
• Distance Marketing Directive: European Commission launches review
• GC100 and Investor Group updates directors' remuneration reporting guidance
• Investment consultancy market investigation: CMA final report
• SM&CR: FCA statement on the Client Dealing Function
• Sustainable finance taxonomy: European Commission's technical expert group consultation

Funds

• Investment in patient capital: FCA proposals
• UK limited partnership law reform: Government response to consultation

Brexit

• Updated draft Brexit SI and explanatory memorandum: Collective Investment Scheme (Amendment etc.) (EU Exit) Regulations 2019
• Draft Brexit SI: Official Listing of Securities, Prospectus and Transparency (Amendment etc.) (EU Exit) Regulations 2019
• Draft Brexit SI: Financial Services (Distance Marketing) (Amendment and Savings Provision) (EU Exit) Regulations 2019
• Updates to FCA webpage "Preparing your firm for Brexit"

Financial Crime

• FCA findings on multi-firm cyber review
• FCA finalised guidance on financial crime systems and controls: insider dealing and market manipulation

General

Why the buy-side should buy into the FX Global Code: BoE speech

The Bank of England (BoE) has published a speech given by Andrew Hauser, Executive Director, Markets at the Bank of England. Mr Hauser highlights the rapid increase in the number of firms committing to follow the FX Global Code, from 100 firms in April 2018 to 605 last month. However, he reports that the take up from the buy-side is slower, only 11 of the largest 30 asset managers have signed up. Therefore, in his speech, Mr Hauser encourages asset managers to commit to the Code, aiming to identify the perceived obstacles to managers and how they may be addressed.

Among other things, Mr Hauser emphasises that:

• proportionality in the application of the Code is a key principle and the steps taken to comply with it should reflect the size and complexity of the relevant FX market activities;
• the Code is a living document which can be strengthened or clarified where necessary - an area of interest to the buy-side recently updated in the Code includes clarifying that trading should not take place if it uses information from a client's trade request during the last look window. Signing up to the Code will give the buy-side a stronger voice in the development of the Code and the FX market as a whole;
• becoming a signatory to the Code gives a clear signal to the sell-side about the standard of services the buy-side expects for itself and its customers;
• the mark of quality signified by committing to the Code could give a buy-side firm a competitive edge; and
• as the Code has been submitted to the Financial Conduct Authority (FCA) for formal recognition, compliance with it will help to demonstrate that senior managers are observing proper standards of market conduct. Mr Hauser highlights how this will become increasingly important under the senior managers regime (SMR) which applies to the buy-side from 9 December 2019.

The FX Global Code was first launched in 2017 setting out 55 principles of good practice in the FX market. Committing to the Code by firms is voluntary. However, the reference by Mr Hauser to compliance with the Code as evidencing a market norm in the context of the SMR can only weigh in favour of firms signing up to it.

PRIIPS Regulation: ESMA's SMSG calls on European Commission to start mandatory review

The European Securities and Markets Authority (ESMA) has published the response of its Securities and Markets Stakeholder Group (SMSG) to the Joint Committee of the European Supervisory Authorities' (ESAs) consultation on amendments to the Commission Delegated Regulation on key information documents (KID) for packaged retail and insurance-based investment products (PRIIPs) (the PRIIPs KIDs Delegation Regulation). The ESA's consultation was published in November 2018.

The SMSG makes a number of comments. It highlights the failings of the current design of the PRIIPs KID and urges the ESAs to address these. The SMSG appreciates the ESA's efforts to amend the Delegation Regulation but stresses that this rushed consultation and any consequential amendments cannot replace the need for the European Commission to begin its mandatory review of the level one PRIIPs Regulation.

The SMSG considers that the current exemption of UCITS funds and certain AIFs from PRIIPs should be extended until the review of the PRIIPs Regulation has been fully completed and its conclusion implemented.

FCA quarterly consultation paper: industry codes and firm details reporting

The FCA has published Quarterly Consultation No. 23 (CP18/39). Among other things, the FCA consults on:

• a proposal to recognise the FX Global Code (August 2018) and the UK Money Markets Code (April 2017), both of which the FCA consider to meet its recognition criteria; and
• a number of changes to the FCA's "Firm Details" reporting form in its Supervision manual (SUP), SUP 16.10, and in annexes to SUP 15 and 16, to ensure compliance and increase accuracy of firm details reporting. The FCA is concerned that currently it holds inaccurate and incomplete firm details for a large number of firms, which indicates high levels of non-compliance with FCA rules. Proposed changes include strengthening the current requirement for firms to carry out an annual "accuracy check", by requiring firms whose firm details are accurate to give an annual confirmation of "no change" to the FCA.

The consultation period closes on 6 February 2019.

Distance Marketing Directive: European Commission launches review

The European Commission has published an evolution and fitness check roadmap relating to evaluating the Distance Marketing of Financial Services Directive (DMD). The DMD aims to protect consumers when they sign a contract with a retail financial services provider in another EU country. It ensures the free movement of financial services in the single market by harmonising consumer protection rules governing this area.

The evolution and fitness check roadmap will:

• review the original objectives of the DMD to assess whether it is still fit for purpose, in light of the development of product-specific legislation and the evolution of digitalisation and the commercial practices used online by providers;
• conduct, alongside a qualitative analysis, a quantitative assessment of its actual costs and benefits including impacts on business, consumers and authorities; and
• gather evidence, in particular, on the following aspects: scope of services covered, information disclosure, right of withdrawal, unsolicited services and communications, regulatory choices by member states and the interplay with product-specific legislation in the field of retail financial services, the e-commerce framework and horizontal consumer protection rules.

Comments on the roadmap can be made until the 4 January 2019. The Commission aims to conclude the evaluation during 2019.

GC100 and Investor Group updates directors' remuneration reporting guidance

The GC100 and the Investor Group (the Group) have published a revised version of their directors' remuneration reporting guidance 2018. The guidance is designed to assist companies and their investors in the interpretation of the directors' remuneration reporting regulations. The Group updated the guidance in response to amendments to these regulations.

Investment consultancy market investigation: CMA final report

The Competition & Markets Authority (CMA) has published the final report on its market investigation into investment consultancy and fiduciary management services following a reference from the FCA in September 2017 at the conclusion of the FCA's Asset Management Market Study.

The CMA found competition problems within both the investment consultancy market and, to a greater degree it says, the fiduciary management market. It concludes that:

• some pension trustees will choose their existing investment consultant to be their fiduciary manager even if a better deal may be available elsewhere, with only a third of pension trustees asking fiduciary managers to compete for their business through a tender;
• investment consultants offering fiduciary management services have an advantage when it comes to gaining business from existing clients as they are able to steer customers towards their own service;
• many pension trustees do not have sufficient information on the fees or quality of investment consultancy and fiduciary management to be able to judge if they are receiving good value from their existing provider or if they could do better elsewhere; and
• these features reduce pension trustees' ability to effectively compare all their options and reduce providers' incentives to compete. The CMA considers that this could lead to a worse deal for pension trustees and the people whose pensions they manage.

The CMA recommends the following steps are taken:

• pension trustees wishing to delegate investment decisions for more than 20 per cent of their scheme assets to a fiduciary manager must run a competitive tender with at least three firms. If a trustee has already appointed a fiduciary manager without a tender, it must put the service out to tender within five years after the first appointment of a fiduciary management services provider;
• fiduciary management firms must provide potential clients with clear information on their fees and use a standard approach to show how they have performed for other clients so that pension trustees have the information they need to compare different providers;
• The Pensions Regulator (TPR) produces new guidance to help trustees with these services; and
• the UK Government broadens the regulatory scope of both the FCA and TPR to ensure greater oversight of this sector in the future.

The CMA will consult on these requirements in early 2019 with a view to implementation later in the year.

SM&CR: FCA statement on the Client Dealing Function

The FCA has published an update relating to the Client Dealing Function under the Senior Managers and Certification Regime (SM&CR). The FCA indicates that there is some uncertainty among firms on whether certain administrative functions would be in scope of the Client Dealing Function in the Certification Regime.

In response to feedback, the FCA states that its intention is to consult on clarifying the scope of the function and make final rules before December 2019, ahead of commencement for solo-regulated firms. In the meantime, the FCA gives some guidance on its webpage on the scope of the Client Dealing Function indicating that this information will be relevant to solo-regulated firms' preparations for the Certification Regime.

Sustainable finance taxonomy: European Commission's technical expert group consultation

The European Commission has published a webpage on a call for feedback from its technical expert group (TEG) on sustainable finance. The call for feedback is in relation to an EU classification system - the so-called taxonomy - to determine whether an economic activity is environmentally sustainable. It will be established under the Taxonomy Regulation and is a key step in establishing a framework to facilitate sustainable finance. The TEG has also identified areas where additional technical expertise is needed. The Commission will therefore host several workshops with the purpose of gathering this expertise and interested parties can register through its webpage to attend these workshops.

The consultation period closes on 22 February 2019 and the TEG intends to publish the final report of recommendations on the taxonomy in June 2019.

Funds

Investment in patient capital: FCA proposals

The FCA has published a consultation paper on proposed changes to the permitted links rules in its Conduct of Business sourcebook (COBS), COBS 21.3. The proposals would:

• broaden the categories of permitted links underlying unit-linked policies, with the aim of facilitating increased investment by retail investors in "patient capital", that is, longer-term, more illiquid investments such as infrastructure projects; and
• for firms that meet certain investor protection conditions, introduce a new aggregate limit of 50 per cent for illiquid assets. This new aggregate limit would replace the existing limits for individual categories of permitted links, with the aim of introducing greater flexibility in the choice of illiquid assets.

The FCA simultaneously published a discussion paper exploring how UK authorised funds can be used to invest in patient capital. In its discussion paper, the FCA asks for industry views on whether the current limits on investment in patient capital for authorised funds are appropriate or whether the existing rules act as inappropriate barriers to patient capital investment in the UK. The FCA also asks whether there is demand for a new type of UK authorised retail fund which can invest all its capital directly into patient capital assets.

These FCA papers, announced in the October 2018 Budget statement, form part of a wider push across Government to increase and facilitate investment in a range of illiquid investments intended to deliver longer-term returns. Responses to both papers can be submitted until 28 February 2019.

UK limited partnership law reform: Government response to consultation

In a response to its consultation on reforming the law of limited partnerships, the Government has announced its intention to make four key changes to UK limited partnership law:

• Only firms that are registered with an anti-money laundering (AML) supervisory authority (including law firms and FCA authorised firms, for example) will be able to submit applications to register new UK limited partnerships (UK LPs). These firms (so-called "presenters") will need to provide evidence of their AML registration as part of the application process.
• Every UK LP will be required to maintain a "UK link" by complying with one of the following three requirements:
  • retaining its principal place of business in the UK;
  • demonstrating that it is continuing some legitimate business activity at an address in the UK; or
  • demonstrating that it continues to engage the services of an agent that is registered with a UK AML supervisory body and which has agreed to provide its address as a service address for the UK LP.
• UK LPs will be required to file an annual confirmation statement at Companies House, confirming that all details previously filed remain correct. Further, each UK LP will be required to file, both on registration and on an ongoing basis, the following additional information: (i) contact information for all its limited and general partners; (ii) the date of birth and nationality of all limited and general partners that are natural persons; and (iii) a SIC (standard industrial classification) code, identifying the nature of the LP's business.
• Companies House will be given power to strike off LPs that have dissolved or which Companies House concludes are not carrying on business or in operation. The exact process to achieve this is still to be designed.

The announcement sets out the Government's intentions in broad strokes; the details will come when the draft legislation is published. The Government says this will happen "when Parliamentary time allows" - which may well not be for a while, given the current state of play on Brexit.

The details will be key, particularly as regards the additional information filing requirements. There is no mention in the announcement as to whether private fund limited partnerships (known as PFLPs) will be exempted from these requirements. PFLPs were themselves only introduced last year, and one of their key selling points was a more streamlined filing regime, with less information required to be filed at Companies House. If these new requirements are extended to PFLPs, it would certainly make the UK a less attractive jurisdiction in which to establish private investment funds structured as limited partnerships: many global investors would be reluctant to have their contact details and (if natural persons) dates of birth and nationalities filed at Companies House (something which is not required in any other "fund" jurisdiction). Hopefully the draft legislation will make it clear that PFLPs will be exempted from these requirements.

The remaining changes should be seen as broadly positive for the fund management industry. Although there will be some increased administrative burdens, these should be relatively minor; and there will be relief at the flexibility offered to UK LPs to satisfy the "UK link" requirement (there had been significant concern that the government might force all UK LPs to maintain a permanent UK principal place of business), as well as the confirmation that UK LPs will not be required to prepare and publish statutory accounts.

Brexit

Updated draft Brexit SI and explanatory memorandum: Collective Investment Scheme (Amendment etc.) (EU Exit) Regulations 2019

HM Treasury has published updated versions of the draft Collective Investment Scheme (Amendment etc.) (EU Exit) Regulations 2019 and its accompanying explanatory note. For discussion on the earlier draft of the statutory instrument (SI), see our update of 23 October 2018. The purpose of the SI is to make amendments to retained EU law related to the UCITS Directive for investment funds and their managers to ensure it continues to operate effectively after Brexit. The Treasury intends to lay the SI before Parliament prior to exit day.

Draft Brexit SI: Official Listing of Securities, Prospectus and Transparency (Amendment etc.) (EU Exit) Regulations 2019

HM Treasury has published a draft version of the Listing of Securities, Prospectus and Transparency (Amendment etc.) (EU Exit) Regulations 2019. The purpose of the SI is to replicate, as far as possible, the current effects of the prospectus regime, the transparency rules and the listing rules which stem from the Prospectus Directive and the Transparency Directive. We reported more fully on related developments in our update of 5 December 2018.

Draft Brexit SI: Financial Services (Distance Marketing) (Amendment and Savings Provision) (EU Exit) Regulations 2019

The Treasury has published a draft version of the Financial Services (Distance Marketing) (Amendment and Savings Provision) (EU Exit) Regulations 2019, accompanied by an explanatory note. The purpose of the SI is to make amendments to the Financial Services (Distance Marketing) Regulations 2004 to ensure that the regulations continue to operate effectively in the UK post Brexit.

The SI:

• removes references to EU and EEA bodies, territories and instruments; and
• replaces references to the European Consumer Credit Information form with references to the Pre-Contract Credit Information (Overdrafts) Form.

HM Treasury intends to lay this SI before Parliament prior to exit day. The FCA will update its Handbook to ensure consistency with the amendments introduced through this SI. For discussion of the FCA consultations on Handbook changes proposed to date see our updates of 5 December 2018 and 24 October 2018.

Updates to FCA webpage "Preparing your firm for Brexit"

The FCA has published a press release flagging up what it has recently updated on its webpage "Preparing your firm for Brexit".

Updates include:

• contract continuity - firms doing business in the EEA under the passport are reminded to consider how they will continue to provide services to customers with existing contracts after Brexit;
• execution of firms' contingency plans - firms should continue to take into account their clients' best interests when executing their plans;
• data sharing - the FCA reminds firms of the importance in considering whether they are transferring personal data between the UK and the EEA and whether any contingency plans may be necessary for this; and
• customer communications - firms are reminded of the importance of considering what communications to customers will be necessary to explain how Brexit might affect them.

Financial crime

FCA findings on multi-firm cyber review

The FCA has published its key findings from a multi-firm review of cybersecurity in the asset management and wholesale banking sectors during 2017 and 2018. The FCA outlines how Boards and Management Committees understand and manage the cyber risks their firms face and how effective second line functions are in overseeing the identification and management of cyber risks. The FCA is concerned that Boards and Management Committees have limited knowledge on the cyber risks facing their organisations despite the overall growing regulatory focus on cyber security in the financial services sector. This is further weakened by the second line of defence's inadequate technical cyber-expertise and the limited ability to challenge the first line of defence on such issues.

In particular, the FCA highlights that, in some of the firms reviewed, there was limited evidence of firms actively trying to "connect the dots" between cyber and conduct risk, which may occur through cyber channels like market abuse and financial crime. Firms are encouraged to consider how they could incorporate cybersecurity risks into their approach to conduct risk. This involves moving away from seeing cyber as an IT issue to viewing it as an organisation-wide priority. The FCA notes that there is also a risk where a firm relies on group-level arrangements and slips away from addressing any gaps when trying to align the firm's specific risks.

In its findings, the FCA did observe some firms adopting an effective approach with regards to third-party vendor risk management which involved the firm identifying and engaging with stakeholders across the business for each supplier. This model, which is different to a purely centralised vendor management function, appears to have effective oversight and resilience benefits.

The FCA concludes by giving example questions that Board and Management Committee members should be asking themselves about their business and cyber-related matters.

FCA finalised guidance on financial crime systems and controls: insider dealing and market manipulation

Following feedback received from its guidance consultation, FG18/5, the FCA has published "Finalised Guidance on financial crime systems and controls: insider dealing and market manipulation" (FG18/5). The purpose of the guide is to consolidate the FCA's guidance on financial crime and aims to enhance firms' understanding of the FCA's expectations of systems and controls in this area. The guidance is of interest to firms that are subject to the financial crime rules in the FCA's Senior Management Arrangements, Systems and Controls sourcebook (SYSC), SYSC 6.1.1R, and those which also arrange or execute transactions in financial markets.

GC18/1 replaces guidance previously contained in "Financial crime: a guide for firms" with two new modules of non-Handbook guidance:

• Financial Crime Guide (FCG): A firm's guide to countering financial crime risks - this includes an additional chapter on insider dealing and market manipulation; and
• Financial Crime Thematic Reviews (FCTR).

FCG and FCTR came into effect on 13 December 2018.

The next Investment Management Update will be on 16 January 2019.

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