Private funds regulatory update

23 October 2019

The private funds regulatory update provides a practical overview of recent UK and EU financial services regulatory developments impacting private fund focused investment managers.

In this edition, we:

SMCR: less than two months to go

With less than two months to go until the application of the SMCR (which applies from 9 December 2019), there are a number of key steps that private fund managers should take to ensure that they are ready. In particular, it is important that firms:

  1. appropriately categorise their staff;
  2. allocate prescribed responsibilities and produce statements of responsibilities;
  3. complete any necessary FCA filings;
  4. provide training to staff; and
  5. update compliance documents and other relevant documents.

These actions are discussed in more detail below. For these purposes, we have assumed that most private fund managers will be “core firms” under the SMCR.

1. Categorisation of staff

The SMCR splits staff into three broad categories (Senior Managers, Certification Staff and Conduct Rules Staff). The categories of staff are ordered from those subject to the most significant regulatory requirements, Senior Managers, to those subject to the least, Conduct Rules Staff. The level of accompanying regulatory requirements is intended to be proportionate to the amount of harm the individuals could cause in their respective roles. As the regulatory requirements for each category of staff are different, it is important to categorise staff as a first step.

2. Prescribed Responsibilities and statements of responsibilities

Every Senior Manager is required to have a statement of responsibilities. This sets out the role and responsibilities of the Senior Manager. The Financial Conduct Authority (FCA) has explained that these statements should be brief and clear. The purpose of the document is to provide transparency regarding the areas of the firm for which each Senior Manager has responsibility.

It is important that statements of responsibilities are drafted accurately because every Senior Manager is subject to a “duty of responsibility”. This is the overarching responsibility of each Senior Manager for the area in respect of which they are responsible. The relevant Senior Manager could be held accountable for that breach if they did not take “reasonable steps” to prevent or stop the breach.

Prescribed Responsibilities are specific responsibilities set out by the FCA which must be allocated to a Senior Manager. There are six prescribed responsibilities applying to core firms. To the extent that a Senior Manager is allocated one or more of the Prescribed Responsibilities, this should be made clear in their statement of responsibilities.

3. FCA filings

With certain exceptions, firms are not required to apply for re-approval for individuals who are currently approved under the Approved Persons Regime.

If an individual is not currently approved, or is to carry out additional functions following the introduction of the SMCR, the firm will be required to submit a Form A in relation to the individual. This is likely to be of particular relevance in relation to the Chair function, as this was not a specified function under the Approved Persons Regime. Where a Form A is required, the individual’s statement of responsibilities should be filed alongside the form.

Additionally, where individuals currently carry out controlled functions under the Approved Persons Regime, but will not carry out corresponding Senior Management Functions under the SMCR, a Form C should be filed.

4. Training

Firms are required to have trained their Senior Managers and Certification Staff in relation to their responsibilities under the Conduct Rules by 9 December 2019. Firms will also be required to train Conduct Rules staff in relation to their obligations, but this does not need to be completed until 9 December 2020.

5. Updates to documentation

Firms will almost certainly need to make changes to their documentation to reflect the significant changes introduced by the SMCR, in particular, compliance manuals. Other documents which may require updating include the firm’s staff handbook and other policies allocating responsibilities or dealing with oversight within the firm.

Marketing initiatives in Switzerland and the EU

New regime for marketing funds in Switzerland

Private fund managers have become accustomed, in recent years, to having to appoint a Swiss representative and a Swiss paying agent in order to market their funds to Swiss investors.

From 1 January 2020, this requirement will – largely – be abolished. This means that private fund managers will no longer be required to appoint a Swiss representative or a Swiss paying agent in order to market to Swiss institutional and professional investors (including family offices with professional treasury operations). The requirement will continue to apply, though, for firms that want to market to high-net-worth individuals and to family offices that do not have professional treasury operations.

As the onboarding of a Swiss representative and Swiss paying agent typically takes at least four weeks and can cost around £15,000 per year, this change should result in a more streamlined and less costly marketing process for many firms.

There is, though, one small note of caution: the change is part of a wider reform of the Swiss regulatory landscape and there is some concern that, under the new framework, a private fund manager marketing a fund in Switzerland could be treated as conducting a “financial service” in Switzerland (and, as a result, being subject to Swiss registration requirements). Firms looking to fundraise in Switzerland in the New Year should therefore keep an eye out for the final rules in this particular area – they are expected to be published in November.

New EU pre-marketing rules

Slightly further down the line, firms looking to fundraise in 2021 or later will need to factor the new EU pre-marketing rules into their planning. Starting from August 2021, there will be a new standardised definition of pre-marketing across the EU, accompanied by new EU-wide rules regulating what firms can (and cannot) do as part of their pre-marketing activities.

The introduction of a single EU-wide interpretation of pre-marketing is positive and will avoid firms having to deal with the current patchwork of divergent views across the member states. However, we expect that many firms may, in practice, find the new rules to be quite limiting and to impose extra administrative burdens – for example, firms will be required to notify their home state regulator of their pre-marketing activities and ensure those activities are “adequately documented”. The new rules may also limit firms’ ability to rely on reverse solicitation in certain circumstances.

Some firms may also find that the new rules make it harder for them to pre-market: while the rules will oblige each member state to allow pre-marketing by full-scope EU AIFMs, member states will not be required to allow pre-marketing by either sub-threshold EU AIFMs or non-EU AIFMs (including, post-Brexit, UK AIFMs). Whether these firms will be able to pre-market at all in a given member state will therefore be a matter for that member state to decide. It is conceivable that some member states may take the view that only full-scope EU AIFMs should be allowed to pre-market, thereby effectively prohibiting sub-threshold EU AIFMs and non-EU AIFMs from pre-marketing.

A refresher on conflicts of interest

Nearly two years after the implementation of MiFID II, we see a number of firms reviewing their implementation of this significant piece of EU financial services legislation. A topic that regularly raises a number of questions is conflicts of interest. However, as AIFMD also contains conflicts of interest provisions, and this is a topic of investor focus, it is useful for all FCA authorised private fund managers to periodically re-consider this issue. We set out below a summary of the conflicts of interest provisions that commonly apply to private fund managers, depending on their precise business model.

MiFID conflicts of interest provisions

The MiFID conflicts of interest provisions are relevant to adviser/arranger firms, delegated portfolio managers and managers of separately managed accounts. Conflicts of interest was a key issue for the FCA during the implementation of MiFID II.

Private fund managers subject to the MiFID provisions are required to take appropriate steps to identify and to either manage or prevent conflicts of interest between: (i) the firm and its client(s) or (ii) one client and another. Firms must maintain a conflicts of interest policy which is appropriate to the size and organisation of the firm and the nature, scale and complexity of its business.

Firms must establish and maintain effective organisational and administrative arrangements with a view to taking all reasonable steps to prevent conflicts of interest from adversely affecting the interests of its clients.

In situations where the firm’s organisational or administrative arrangements are not sufficient to ensure, with reasonable confidence, that the risks of damage to client interests will not be prevented, the firm will clearly disclose to this client:

  • the general nature and/or sources of conflicts of interest; and
  • the steps taken to mitigate those risks before undertaking business on its behalf.

The content of any disclosure must be in sufficient detail, taking into account the nature of the client, to enable the client to take an informed decision with respect to the service in the context of which the conflict of interest arises.

As noted above, MiFID II required firms to change from taking “reasonable” steps to manage or prevent conflicts to taking “appropriate” steps. Arguably, the latter requires a high level of engagement by firms in identifying potential conflicts of interest. The FCA made clear that disclosure of conflicts of interest should be a last resort. In particular, the FCA states that “over reliance on disclosure without adequate consideration as to how conflicts may be appropriately managed is not permitted”.

AIFMD conflicts of interest provisions

The AIFMD conflicts of interest provisions vary depending on the AIFM’s assets under management.

A full-scope UK AIFM must take all reasonable steps to identify conflicts of interest that arise, in the course of managing AIFs, between:

  • the AIFM, including its managers, employees or any person directly or indirectly linked to the AIFM by control, and an AIF managed by the AIFM or the investors in that AIF;
  • an AIF or the investors in that AIF, and another AIF or the investors in that AIF;
  • an AIF or the investors in that AIF, and another client of the AIFM;
  • an AIF or the investors in that AIF, and a UCITS managed by the AIFM or the investors in that UCITS; and
  • two clients of the AIFM.

In addition, they must:

  • maintain and operate effective organisational and administrative arrangements, with a view to taking all reasonable steps designed to identify, prevent, manage and monitor conflicts of interest in order to prevent them from adversely affecting the interests of the AIFs and their investors;
  • segregate, within their own operating environment, tasks and responsibilities that may be regarded as incompatible with each other or that may potentially generate systematic conflicts of interest; and
  • assess whether their operating conditions may involve any other material conflicts of interest and disclose them to the AIF's investors.

If the organisational arrangements made by the AIFM to identify, prevent, manage and monitor conflicts of interest are not sufficient to ensure, with reasonable confidence, that risks of damage to investors' interests will be prevented, the AIFM must both:

  • clearly disclose the general nature or sources of conflicts of interest to the investors before undertaking business on their behalf; and
  • develop appropriate policies and procedures.

Please note that the conflicts of interest provisions apply in a modified form to small authorised UK AIFMs (i.e. those private fund managers whose assets under management do not meet the threshold to become full-scope UK AIFMs).

Firms subject to both the AIFMD and MIFID conflicts of interest provisions

Full-scope UK AIFMs that are also authorised to undertake certain MiFID activities (for example, firms that also provide delegated portfolio management services), will be subject to both the AIFMD and MiFID conflicts of interest regimes. Such firms are known as Collective Portfolio Management Investment (CPMI) firms. It is notable that the two conflict of interest regimes, and therefore standards, apply to CPMI firms. There are two potential options in this scenario:

  • UK AIFMs could apply the highest standard across both its AIFMD and MIFID business; or
  • firms could attempt to apply the different standards to each part of its business.

The approach which collective portfolio management investment firms should adopt will be determined by their particular business model.

EuVECA firms

On 22 May 2019, the European Commission’s proposed delegated regulation supplementing the EuVECA Regulation was published in the Official Journal of the EU (the Delegated Regulation). The Delegated Regulation clarifies the conflicts of interest rules governing EuVECA managers and what measures need to be taken by EuVECA managers to prevent, manage and monitor conflicts of interest. In particular, the Delegated Regulation includes provisions relating to:

  • the types of conflict of interest for the purposes of Article 9(2) of the EuVECA Regulation;
  • conflicts of interest policy requirements;
  • procedures and measures to prevent, manage and monitor conflicts of interest;
  • management of consequences of conflicts of interest;
  • strategies for the exercise of voting rights to prevent conflicts of interest; and
  • disclosure of conflicts of interest.

The Delegated Regulation applies from 11 December 2019 and, therefore, EuVECA managers will need to ensure that they are compliant with the Delegated Regulation by that date.

Timeline of key upcoming UK and EU regulatory developments impacting private fund managers

We have prepared a timeline which covers upcoming UK and EU regulatory developments to be aware of.