Investment Management Update

In this issue: Investment Platforms Market Study - Terms of reference; ESMA opinion on supervisory convergence in investment management after Brexit; ESMA updated AIFMD and UCITS Q&A; IOSCO Advice on Managing Liquidity Risk; and European Commission Guidelines on the PRIIPS Key Information Document.

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17.07.2017 - Investment Platforms Market Study - Terms of reference

The FCA has published the Terms of Reference for its forthcoming Investment Platforms Market Study.  The study was trailed in the interim report of FCA’s Asset Management Market Study and confirmed in the final report published last month.

The study aims to look at how competition is working in this market.  In particular, the FCA will look at how platforms compete in practice and whether they use their bargaining power to get investors a good deal.  The FCA will also assess whether the relationships among platforms, advisers, asset managers and fund ratings providers work in the interests of investors.

FCA’s analysis will cover:

  • platforms and other firms that offer access to retail investment products through an online portal. This is likely to include financial advisers, wealth managers and other distributors;
  • retail investors who access retail investment products through an online portal;
  • intermediaries, including financial advisers and wealth managers who use intermediated platforms to access different retail investment providers on behalf of their clients;
  • product and wrapper providers who use platforms to distribute their products;
  • technology providers to whom platforms outsource services; and
  • fund ratings and data providers whose information platforms use and distribute.

The fundamental questions will be how do platforms and similar firms compete on the price and quality of the services and products they offer and the products over which they have influence; and do platforms and similar firms’ investment solutions offer investors value for money?

The key topics to be explored will be:

  • barriers to entry and expansion;
  • commercial relationships;
  • business models and platform profitability;
  • the impact of advisors; and
  • customer preferences and behaviour.

The FCA invites feedback on the proposed topics by 8 September 2017 and aims to publish an interim report by Summer 2018.

13.07.2017 - ESMA opinion on supervisory convergence in investment management after Brexit

The European Securities and Markets Authority (ESMA) has issued an opinion on EU supervisory convergence after Brexit, focusing on the investment management sector. The latest opinion builds on ESMA’s general industry-wide opinion that it issued in May.  As such, it represents a further regulatory intervention by ESMA with potential implications for UK firms looking to rely on delegation or outsourcing models post Brexit.

Given the likely increase in requests from UK financial market participants seeking to relocate to the 27 EU Member States that will remain post-Brexit (the EU27), ESMA believes it is important to avoid competition on regulatory and supervisory practices between these Member States. Its opinion therefore aims to ensure a consistent supervisory approach to investment management firms across the EU27.

ESMA states that it has based its opinion on the framework under the AIFMD and the UCITS Directive, rather than applying new or different standards or requirements. The opinion addresses the regulatory and supervisory arbitrage risks related to any relocation activities of UCITS management companies, self-managed investment companies and authorised AIFMs. In particular, the opinion provides principles on the following topics:

  • Authorisation: ESMA emphasises that national competent authorities (NCAs) should ensure that both they and the relocating firms seeking authorisation under the AIFMD or UCITS Directive comply fully with the authorisation requirements in those Directives. Furthermore, ESMA believes that NCAs in the EU27 should not give preferential or disadvantageous treatment to UK-based applicants over others.
  • Governance and internal control: ESMA explains how NCAs should ensure that relocating firms have effective governance structures and internal control mechanisms in place to comply with the AIFMD and the UCITS Directive. Although the Directives require firms to have a minimum of two senior managers in their governance structure, ESMA believes that NCAs should not apply this minimum standard for all firms. Instead, NCAs should adopt a proportionate approach according to the size, nature and complexity of a firm’s business activities. For example, a firm of significant size pursuing complex investment strategies should have more than two senior managers.

ESMA also highlights that NCAs should give special attention to firms engaged in “white-label” business. This is where a fund manager provides a platform to business partners by setting up funds at the initiative of the latter and typically delegating investment management functions to those initiators / business partners or by appointing them as investment advisers.

  • Delegation: ESMA sets out detailed principles on how NCAs should approach the assessment of a relocating firm’s delegation arrangements. One key point to note is that ESMA appears to extend  regulatory concepts developed under the AIFMD to firms seeking authorisation under the UCITS Directive.

ESMA also provides other guidance on relocating firms delegating to non-EU entities.

  • Effective supervision: ESMA states that NCAs should consider the extent to which the relocating firm’s planned operations in other jurisdictions might impact the NCA’s resources and ability to effectively supervise it.

ESMA has published this opinion alongside two other opinions (covering investment firms and secondary markets).

11.07.2017 - ESMA updated AIFMD and UCITS Q&A

ESMA has published updated Q&A documents on the application of AIFMD and UCITS.

The AIFMD Q&A includes the following three new questions and answers:

Q  In a situation where an AIF purchases a loan in the secondary market, how should the AIF measure its exposure in relation to that loan?

A  The notional value of the loan may overestimate the risk exposure. Therefore, the AIF should report the valuation of the loan, as it is reported in the calculation of its net asset value (NAV). During the life of the loan, the AIF should then measure the exposure in relation to that loan using the NAV valuation rules.

Q  How should AIFMs convert the total value of assets under management into Euro?

A  AIFMs should use the rounded values of the AIFs in the base currency. AIFMs should then divide these rounded values by the corresponding rate of one unit of the base currency in Euros.

Q  In which currency should the NAV of the AIF be reported?

A  AIFMs should report the NAV in the base currency of the AIF.
The UCITS Q&A includes the following two new questions and answers:

Q  Does the 40% limit set out in Article 52(2) of the UCITS Directive apply to index-tracking UCITS that are subject to Article 53 of the UCITS Directive?

A  No. The 40% limit set out in Article 52(2) does not apply to index-tracking UCITS that comply with the requirements set out in Article 53.

Q  Where a group link exists for the purpose of Article 24 of the Commission Delegated Regulation (EU) 2016/438 (UCITS V Level 2), does a person who served in the management body or supervisory body of an entity within the group or was otherwise employed by such an entity fulfil the independence requirement under Article 24(2) of the UCITS V Level 2 where the person has ceased any function within the entity?

A  A person who served in the management body or supervisory body of an entity or was otherwise employed by such an entity should be deemed to fulfil the independence requirement only after an appropriate cooling-off period following the termination of his / her relationship with the relevant entity. That period should start from the final payment of any outstanding remuneration due to them which entails a margin of discretion from the entity and is linked to their previous employment or other relationship with that entity. Non-discretionary outstanding payments from the entity to the person should not be taken into account for this purpose.

A  Without prejudice to any requirements established under the relevant national corporate governance rules or codes, the cooling-off period should be proportionate to the length of the employment or other relationship that the individual had with any of the companies within the group and to the type of functions performed within such company(ies).

06.07.2017 - IOSCO Advice on Managing Liquidity Risk

The International Organisation of Securities Commissions (IOSCO) has published Consultation Recommendations, a paper that outlines how to minimise the structural vulnerabilities that can arise from asset management activities. This paper is supplemented by a Consultation Report which focuses on practical solutions. The links to these papers is included below along with a brief summary.

Consultation Recommendations

The recommendations promote effective liquidity risk management for Collective Investment Schemes (CIS) in order to reduce the potential for financial stability risks as well as to protect investors and maintain ‘market integrity.’

The recommendations can be divided into two parts: additional guidance on existing recommendations from the 2013 Liquidity Report; and new recommendations.

The additional guidance section seems to focus around the design phase and planning of the CIS. Adding to recommendation three, IOSCO indicates that the choice to create an open-ended CIS is a significant decision that should prompt consideration of the impact this may have on decision making in the future. Recommendation four highlights the importance of appropriate dealing arrangements that are properly planned at the product design phase. Recommendation seven regards effective disclosure to investors of liquidity risk: again IOSCO asserts that the disclosures must be properly designed; taking into account the nature of the targeted assets. Overall, IOSCO calls for all newly-formed CISs to be the result of a considered design phase which includes careful planning.

The new recommendations address a broad range of topics: 1-7 again focus on the design process, advising changes such as: drawing up an effective liquidity risk management process that is compliant with the local jurisdiction; setting appropriate liquidity thresholds; determining a suitable dealing frequency; and having access to relevant information. Recommendations 8-15 give very general tips for day-to-day management such as: having ‘strong and effective governance’ and conducting ‘ongoing liquidity assessments.’ Recommendations 16-17 address contingency planning.

Consultation Report

The report advocates a ‘holistic’ approach when examining a fund’s management of liquidity. This means that the responsible entities are required to: have robust procedures during the design phase; continue to monitor liquidity levels; ensure that they have the ability to carry out any appropriate changes; and take into account the best interests of their investors.

The report also includes a range of practical instruments such as a table that lists jurisdictions and gives examples of the asset classes that are required to be offered through a closed-ended fund structure. In addition, the report provides an overview of a variety of the liquidity tools that can be employed, for example: anti-dilution levies; valuation according to bid; redemption gates; side pockets; and suspension of redemptions. The report also extensively demonstrates how swing pricing could be used as a solution. The final chapter of the report provides practical advice on stress-testing and how to tailor it to the CIS.

04.07.2017 - European Commission Guidelines on the PRIIPS Key Information Document

The European Commission has published guidelines on the application of Regulation (EU) No 1286/2014 (Regulation 1286/2014), seeking to facilitate compliance and smooth out potential interpretive divergences with regard to the Packaged Retail and Insurance-based Investment Products (PRIIPs) Key Information Document (KID).

The guidance focuses on frequent queries and provides the clarifications summarised below:

  • It is the responsibility of the manufacturers and persons advising on, or selling, retail investment and insurance products to ascertain whether the product must comply with the provisions of Regulation 1286/2014.
  • Where a PRIIP offers a range of options for investments, Article 6(3) of Regulation 1286/2014 only allows for derogation from the format of the single KID. It is essential that the KID produced for such ‘multi-option PRIIPS’, as set out in (b) of Article 10 and Article 14(1) of the Commission Delegated Regulation (EU) 2017/653 (Commission Delegated Regulation), complies with the rules for provision in Articles 13 and 14 of Regulation 1286/2014.
  • All insurance-based investment products are subject to the uniform requirements regarding the provision of the KID, regardless of whether the underlying investment options of those PRIIPS are themselves PRIIPS.
  • Under Article 4(4) of Regulation 1286/2014, an entity that makes changes to an existing PRIIP will be classed as a PRIIP manufacturer. Such changes are not limited to those listed in that provision.
  • Entities and persons advising on, or selling, PRIIPs made available from third countries must still provide a KID where the retail investor is within the territory of the Union.
  • Regulation 1286/2014 shall apply to PRIIPs made available to retail investors before 1 January 2018 that continue to be made available after that date. There is no transitional legal regime.
  • Alternative Investment Funds (AIFs) and UCITS required to produce the Key Investor Information Document (KIID) are exempt from Regulation 1286/2014 until 31 December 2019.
  • A KID must be translated into the language of each member state in which the PRIIP is distributed.
  • Civil liability may be incurred on the basis of the KID if it is misleading, inaccurate or inconsistent with the relevant parts of legally binding pre-contractual and contractual information or with the requirements set out in Regulation 1286/2014 and the Commission Delegated Regulation.
  • Regulation 1286/2014 does not distinguish between PRIIPs sold with or without advice to the retail investor. The PRIIP manufacturer must ensure that a KID is published on its website, even where the PRIIP is sold exclusively by persons other than the manufacturer. The persons advising on, or selling, PRIIPs must also provide that KID. 
  • A KID may only refer to information regarding a non-PRIIP product that is offered alongside a PRIIP in the ‘Other relevant information’ section.
  • The KID must not be adapted, including any adaptations to the titles and sequence of sections.
  • The KID must be concise and no longer than three A4-sized pages.
  • The KID must contain information about the competent authority of the PRIIP manufacturer, namely the competent authority of the Member State in which the PRIIP was established.
  • PRIIP manufacturers must revise and promptly redistribute the KID should a review find that changes are necessary. The required frequency for review of the KID depends on the nature of the PRIIP in question and whether the KID remains accurate. ‘On demand’ or ‘real time’ generation of the KID is allowed. 

The guidelines also set out four scenarios where a KID is not required:

  • where the acquisition of the product does not require payment by the retail investor, meaning that there is neither an initial payment or risk of future financial commitments;
  • where a PRIIP is only made available to investors outside the European Union;
  • where a PRIIP is no longer made available to retail investors as of 1 January 2018 and changes to the existing commitments are only subject to terms agreed before that date; and
  • where those terms allow exiting the PRIIP, but that PRIIP is no longer made available to other retail investors after 1 January 2018 .

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