Investment Management Update

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

This issue includes:


Brexit developments

Brexit SIs

Financial crime


Multi-firm review into disclosure of costs by asset managers – FCA’s key findings

The Financial Conduct Authority (FCA) has published key findings from its multi-firm review on the effectiveness of overall cost disclosures and how asset managers, in their capacity as manufacturers of investments, calculate and disclose transaction costs. The review stemmed from the FCA’s Asset Management Market Study which found, among other things, weak price competition in the sector and this was partly a result of ineffective disclosure of costs and charges.

In its findings from the multi-firm review, the FCA highlights that while most asset managers calculate transaction costs in accordance with the relevant rules, there remain certain problems with the way in which costs are calculated and disclosed to the end investor. The FCA concludes that asset managers may be communicating with their customers in a manner that is unfair, unclear or misleading and as such, investors can be confused and misled as to how much they are being charged.

The review assessed costs and charges through two works streams and the key findings include:

  • Transaction costs work stream:
    • firms are incorrectly using the arrival price methodology, a PRIIPs requirement, when calculating transaction costs for primary issues;
    • the anti-dilution levy is being used incorrectly and there are instances where its use is artificially reducing transaction costs at the expense of customers who subscribe for or redeem a product; and
    • some UCITS products are reporting a transaction cost figure of zero as the transaction costs in underlying funds are being disclosed under "other ongoing costs" for UCITS products.
  • Effectiveness and consistency of cost disclosures work stream:
    • the impact of material portfolio transaction costs in UCITS is not reflected in the KIID;
    • marketing communications for UCITS can provide information in addition to that specifically required by the KIID, provided that the information does not contradict or diminish the information contained in the prospectus or KIID;
    • PRIIPs KIID disclosures are being contradicted in other communications such as factsheets and websites which show lower levels of costs and charges than the KIID;
    • even when all costs are disclosed, it is still confusing for investors as it becomes difficult to find and understand the costs when they are located in separate pages or documents on a firm’s website; and
    • some UCITS providers still refer to the annual management charge (AMC) despite being told by the FCA in 2014 that using the figure in such a way could be considered misleading.

In its findings, the FCA sets out examples of steps that asset managers should take to ensure compliance with the relevant requirements. The FCA notes that further action in this area could include more detailed investigations into specific firms, individuals or practices.

MiFID II costs and charges disclosures review: FCA’s findings

As part of its supervision work, the FCA has published its findings from the review of costs and charges disclosures of a sample of 50 firms authorised as MiFID investment firms in the retail investments sector. This is to understand if firms are complying with the new rules and the challenges they are finding in doing so.

The FCA notes that firms are aware of their obligations for disclosing costs and charges, but are interpreting the rules in a variety of ways. Firms were better at disclosing the costs of their own services than at disclosing relevant third-party costs and charges. The FCA found evidence that firms are not sharing their costs and charges with each other in order to meet their obligations to provide aggregated figures to clients.

In its findings, the FCA:

  • provides examples of good practice that demonstrate compliance with or, in some cases, go beyond the costs and charges disclosure requirements, i.e. using technological innovation;
  • outlines areas for improvement. Some examples include:
    • when illustrating the impact of percentage charges over the lifecycle of an example investment, firms should be using examples that reflect general customer experiences rather than selecting numbers that are easy to calculate;
    •  firms must ensure information in marketing is consistent with any separate information they give customers; and
    • if firms want to compare their own costs with those of competitors, they should consider if these costs are up-to-date and subject to the same disclosure rules.
  • gives information on the interaction between the disclosure requirements contained in the MiFID II Directive, PRIIPs Regulation and the UCITS Directive and how firms must comply with all the relevant requirements when disclosing costs and charges; and
  • sets out its expectations of firms going forward.

Investment consultancy and fiduciary management market investigation: FCA’s response to CMA report

The FCA has published a letter to the Competition Markets Authority (CMA) in relation to the CMA’s report on the market investigation into the supply and acquisition of investment consultancy services and fiduciary management services. In the letter, the FCA states that it fully supports the package of remedies and recommendations contained in the CMA’s report. It also outlines how it will respond to the recommendations that specifically affect the FCA.

Key takeaways include:

  • once the CMA introduces the remedies through a statutory order, the FCA will consult on introducing into its Handbook the relevant rules for firms offering fiduciary management services. It will also supervise compliance once the rules are in place;
  • the FCA will continue to support the CMA in preparing a notification to the European Commission on remedies that will be sitting alongside the existing obligations under MiFID; and
  • the FCA supports the recommendation to extend its perimeter to capture the full scope of investment consultancy services. This will enable the FCA to consider future market developments which may affect pension savers.

See our update of 27 February 2019 for the CMA’s consultation on the Investment Consultancy and Fiduciary Management Market Investigation Order 2019.

Outsourcing guidelines: EBA final report

The European Banking Authority (EBA) has published a final report on guidelines relating to outsourcing arrangements which supersedes the Committee of European Banking Supervisors’ 2006 guidelines. The purpose of the guidelines is to establish a more harmonised framework for all financial institutions within the scope of the EBA’s mandate. This includes credit institutions and investment firms subject to the Capital Requirements Directive, as well as payment and electronic money institutions. The guidelines aim to ensure that:

  • there is effective day-to-day management and oversight by senior management;
  • there are sound outsourcing policies and procedures in place; and
  • any risks associated with outsourcing critical functions are identified and mitigated.

The guidelines:

  • set out specific provisions for financial institutions’ governance frameworks with regard to their outsourcing arrangements and the related supervisory expectations and processes;
  • outlines which arrangements with third parties are to be considered as outsourcing; and
  • provides criteria for the identification of critical or important functions that have a strong impact on the financial institution’s risk profile or on its internal control framework.

Where critical and important functions are outsourced, stricter requirements apply to these outsourcing arrangements when compared to others. The guidelines will enter into force on 30 September 2019. The 2006 guidelines on outsourcing and the EBA’s recommendation on outsourcing to cloud service providers will be repealed at the same time. 

Impact of MiFID II investment research requirements on independent research providers: FCA speech

The FCA has published a speech by Andrew Bailey, FCA Chief Executive, outlining challenges and concerns relating to investment research requirements under the MiFID II package of measures. Mr Bailey commences the speech by highlighting some positive impacts of the MiFID II regime. He notes that there has there has been a shift by a vast majority of traditional asset managers to fund research from their own revenues instead of using their client’s funds. The price of written research is much lower than initial forecasts ahead of MiFID II and that new technology is changing not only the nature of research, but how this is supplied, monitored and valued by the buy-side.

In the speech, Mr Bailey highlights the following areas of concern:

  • scope of the MiFID inducements regime – the failure of the inducement requirements to differentiate between whether a research supplier is a broker, where a conflict of interest can arise, or an independent provider. The FCA will consider whether changes to trial periods like receiving free research for a period of three months may be beneficial to ensure they have the intended effect;
  • pricing – low pricing of research raises competition questions about the future of a sustainable and diverse research market in the interest of consumers. The FCA is keen to scrutinise and test low-cost ‘all you can eat’ packages. The FCA remains conscious that it does not necessarily have a full picture, and will continue to monitor developments through engagement with firms and trade bodies; and
  • other potential unintended consequences – ahead of MiFID II, there were concerns regarding the impact of the new rules on the research coverage of smaller companies and the liquidity of their shares in secondary markets. While the FCA had already taken some steps to ease this impact, since implementation the evidence does not seem to suggest the extent of the negative impact that some predicted. 

The FCA intends to provide feedback in the second quarter of 2019 on its supervisory work on how the rules are bedding in. Mr Bailey concluded the speech by stating that the unbundling of research remains one of the most debated aspects of MiFID II and that the FCA wants to see independent research providers continue to play a key role in this landscape. 

SM&CR Statements of Responsibilities and Responsibilities Maps for solo-regulated firms: FCA finalised guidance

The FCA has published finalised guidance (FG19/2) on the Statements of Responsibilities (SoRs) and Responsibilities Maps (RMs) for FCA firms under the Senior Managers and Certification Regime (SM&CR). The aim of the guidance is to give FCA solo-regulated firms practical assistance and information on preparing the SORs and RMs. The guidance:

  • sets out the purpose of SoRs and RMs and their role in demonstrating how a firm is managed and governed;
  • provides some questions for firms to ask themselves;
  • outlines examples of good practice (in green boxes) and poor practice (in burgundy boxes); and
  • is designed to be read alongside the Guide for FCA solo-regulated firms as well as applicable rules and guidance in the FCA Handbook.

The guidance should be applied in a risk-based and proportionate way. Firms should consider the size, nature and complexity of the firm when deciding whether a certain example of good or poor practice is appropriate to its business. See our update of 24 October 2018 for details in relation to the FCA's consultation on the guidance. 

New financial services directory: FCA policy statement

The FCA has published a policy statement (PS19/7) on introducing a new directory of financial services workers and amending the existing financial services register (FS Register). The proposed directory will: 

  • make information public on additional individuals carrying out specific roles in UK financial services (including certain roles that the FCA does not approve such as financial advisers, traders, portfolio managers and additional directors);
  • present information on these individuals and the Senior Managers the FCA continue to approve in a way that is more accessible and user friendly; and
  • enable users to find information on these individuals.

The existing FS Register will continue following the SM&CR but will contain fewer individuals. This is because only individuals for specified senior manager roles at FSMA firms will then be approved and appear on that register.

The policy statement summarises the feedback the FCA received to its consultation on introducing the directory (CP18/19) and summaries its response. The policy statement also sets out the final rules on establishing the directory. Whilst 99% of the respondents to the consultation were in favour of establishing a directory, many suggested ways in which the FCA could further improve its proposals. These changes are set out in Table 2 of the policy statement.

The dataset for the directory will begin on 9 December 2019 and firms will have 12 months from this date to upload information to the directory. The directory user interface will go live shortly after the information on directory persons has been uploaded.

Brexit developments

FCA’s policy statement on Brexit 

The FCA has published a policy statement (PS19/5) on Brexit following a series of consultation papers to ensure a functioning regulatory framework for financial services if the UK leaves the EU without a deal or an implementation period. The policy statement sets out the FCA’s response to the feedback on its proposals regarding:

  • amendments to the FCA Handbook to correct deficiencies created by Brexit; 
  • amendments to Binding Technical Standards (BTS) to correct deficiencies;
  • the establishment of a temporary permissions regime for European Economic Area (EEA) entities operating in the UK and a financial services contracts regime for those EEA entities seeking to service existing business, but not undertake new business, in the UK after Brexit;
  • establishment of regulatory regimes for credit rating agencies, trade repositories (TRs) and securitisation repositories;
  • EU Level 3 material;
  • guidance that sits outside the FCA’s Handbook (non-Handbook guidance); and 
  • forms.

Appendices 1 and 2 of the policy statement set out near-final Handbook and BTS instruments. The FCA will publish the final instruments on 28 March 2019 if the withdrawal agreement between the UK and the EU is not ratified.

Temporary transitional powers: FCA’s near-final draft transitional directions

The FCA has published two near-final draft transitional directions and an accompanying explanatory note. The purpose of the draft directions is to give effect to the use of the FCA’s temporary transitional power should the UK leave the EU without an implementation period. The directions provide time for regulated persons to adapt to the change in UK financial services regulation as a result of Brexit. Continuity is achieved by applying a "standstill" to enable firms to continue to comply with the pre-exit version of an obligation. In addition, the temporary permission firms are allowed substituted compliance for home state obligations.

  • FCA transitional direction, together with Annex A and Annex B – this transitional direction covers mainly conduct requirements and it builds on optionality as it is open for firms to comply with post-exit obligations. It also sets out the areas the direction will not apply; and 
  • FCA prudential transitional direction including Annex 1 – this direction covers onshored prudential requirements (such as capital requirements and bank recovery and resolution) that the FCA shares with the Bank of England and the Prudential Regulation Authority. It does not allow optionality, making it mandatory for firms to continue to comply with the effect of pre-exit requirements.

In a no-deal scenario, the FCA will make these directions final and they will take effect from exit day until midnight on 30 June 2020. After this date, all onshored changes will apply without modification.

Application of MiFID, MiFIR and BMR provisions in a no-deal Brexit: ESMA’s statement

ESMA has published a statement on the application of key provisions of MiFID, MiFIR and the Benchmarks Regulation provisions in the event of a no-deal Brexit. The statement considers the following in relation to MiFID II:

  • The MiFID II “C(6) carve out” – ESMA explains how a no-deal Brexit will impact the conditions that need to be satisfied in order to be eligible for the exemption set out in section C(6) of Annex 1 of MiFID II;
  • Trading obligation for derivatives – currently, ESMA does not have any evidence to suggest that market participants will not be able to continue meeting their obligations under the trading obligation for derivatives in a no-deal scenario and in the absence of an equivalence decision by the European Commission covering UK trading venues; 
  • ESMA opinions on post-trade transparency and position limits – ESMA has not yet assessed any UK trading venue against the criteria set out in the opinions, but will do so on the request of EU27 market participants. The need for assessment arises as trading venues established in the UK will, post-Brexit, will be considered as third country trading venues;
  • Post-trade transparency for OTC transactions between EU investment firms and UK counterparties – in the event of a no-deal, investment firms established in the UK will no longer be considered EU investment firms and will be categorised as counterparties established in a third country. To avoid this, EU investment firms are required to make public transactions concluded OTC with UK counterparties via an approved publication arrangement (APA) established in the EU27.

The statement also covers the ESMA’s register of administrators and third country benchmarks.

EU departure preparations for firms: FCA’s sectorial guidance

The FCA has updated its "Preparing your firm for Brexit" webpage by publishing a set of sectorial guidance to assist firms in finalising their preparations for Brexit. The guidance can be found on separate webpages and contains specific information for firms in different industry sectors. In particular, the guidance on participants in the wholesale markets operating in the UK provides information on outward passporting and the treatment of clients, access to financial market infrastructure, continuing to meet threshold conditions and onshoring EU directives. The webpage on retail investment firms in the UK outlines information in relation to servicing EEA customers in a no-deal scenario.

Brexit SIs

Money Market Funds (Amendment) (EU Exit) Regulations 2019 (SI 2019/394)

HM Treasury has published the Money Market Funds (Amendment) (EU Exit) Regulations 2019 (SI 2019/394), together with an explanatory memorandum. The SI, made on 26 February 2019, makes amendments to retained EU law in order to change the scope of the retained Money Market Funds Regulation to apply to MMFs established in the UK only. The Regulations will come into force on exit day, with the exception of amendments relating to the Technical Standards Regulations, which came into force on 27 February 2019. See our updates of 5 December 2018 and 30 January 2019 for more detail on the SI.

Brexit SI: Financial Services Contracts (Transitional and Saving Provision) (EU Exit) Regulations 2019 (SI 2019/405)

The Financial Services Contracts (Transitional and Saving Provision) (EU Exit) Regulations 2019 (SI 2019/405) has been made and is published alongside its explanatory memorandum. The SI will address deficiencies in retained EU law in relation to:

  • the EEA’s "financial services passport" which allows firms in EEA states to offer services in any other EEA state on the basis of their home state authorisation; and
  • non-UK central counterparties and TRs that provide certain services in the UK under the European Market Infrastructure Regulation.

The regulations came into force on 1 March 2019. See our update of 16 January 2019 for more detail on the SI.

Brexit SI: Packaged Retail and Insurance-based Investment Products (Amendment) (EU Exit) Regulations 2019 (SI 2019/403)

The Packaged Retail and Insurance-based Investment Products (Amendment) (EU Exit) Regulations 2019 (SI 2019/403) and an accompanying explanatory memorandum has been published by HM Treasury. The SI, made on 27 February 2019, makes amendments to the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulations 2017 and retained EU law in relation to PRIIPs. It also fixes any deficiencies to the legislation, to ensure that it continues to operate effectively in the UK on exit day. See our updates of 5 December 2018 and 16 January 2019 for a further discussion on the SI.

Amended draft Brexit SI: Financial Services (Miscellaneous) (Amendment) (EU Exit) (No 2) Regulations 2019 

HM Treasury has published an amended draft version of the Financial Services (Miscellaneous) (Amendment) (EU Exit) (No 2) Regulations 2019 and an accompanying explanatory memorandum. The purpose of the SI is to ensure a coherent and functioning financial services regulatory regime post-Brexit.

The SI makes amendments to other EU exit instruments and in particular:

  • corrects a minor drafting amendment in the Financial Conglomerates and Other Financial Groups (Amendment etc.) (EU Exit) Regulations 2019;
  • clarifies the scope of Article 5 of the Long-term Investment Funds (Amendment) (EU Exit) Regulations 2019;
  • removes references to redundant powers conferred on competent authorities in Commission Delegated Regulation (EU) 2015/61; and
  • ensures consistency between different amendments. The changes are designed to improve customer protection and increase consumer awareness where firms are in transitional regimes.

See our updates of 27 February 2019 and 13 February 2019 for details on the Financial Services (Miscellaneous) (Amendment) (EU Exit) Regulations 2019.

Financial crime

Money laundering and terrorist financing controls in higher risk jurisdictions: HM Treasury’s updated advisory note

HM Treasury has published an updated advisory note on money laundering and terrorist financing controls in higher risk jurisdictions. This is to reflect the Financial Action Task Force’s recent policy statements which identified jurisdictions with strategic deficiencies in their anti-money laundering and counter-terrorism financing regimes. HM Treasury advises firms to:

  • consider as high risk the Democratic People's Republic of Korea (DPRK) and apply counter measures and enhanced due diligence measures (EDD) in accordance with the risks;
  • consider Iran as high risk and apply EDD measures in accordance with the risk; and 
  • take appropriate actions to minimise the associated risks, which may include EDD measures in high-risk situations for the following jurisdictions: The Bahamas, Botswana, Cambodia, Ethiopia, Ghana, Pakistan, Serbia, Sri Lanka, Syria, Trinidad and Tobago, Tunisia and Yemen.

DPRK, Iran, Syria, Tunisia and Yemen are subject to sanctions measures which require firms to take additional measures.

Council of the EU objects to Delegated Regulation identifying high-risk third countries under MLD4

The Council of the EU has published a press release announcing that it has unanimously decided to reject the European Commission’s draft Delegated Regulation which identified 23 high-risk third countries in the area of money laundering and terrorist financing. The Council justified its decision on the grounds that it “cannot support the current proposal that was not established in a transparent and resilient process that actively incentivises affected countries to take decisive action while also respecting their right to be heard”. 

To achieve the full impact of the Delegated Regulation, in a related ‘I/A’ item note, the Council calls for an EU listing that meets high standards, thereby further strengthening anti-money laundering and combating terrorist financing. Due to the objection raised, the Delegated Regulation will not enter into force and the Commission will now have to propose a new draft list of third countries that will address the concerns. See our update of 27 February 2019 for details on the Delegated Regulation identifying high-risk third countries under MLD4.