Investment management update

In this month’s update we cover the FSCS supplementary levy, the FCA’s LIBOR communications, its intervention on the marketing of speculative mini-bonds to retain investors, the FCA and Bank of England review of open-ended funds and FCA consultation on the SMR for benchmark administrators, among other items.



FSCS outlook: FSCS forecasts a £46m supplementary levy for the life distribution, pensions and investment intermediation class as well as a risk warning for the investment provision class

The Financial Services Compensation Scheme (FSCS) issued its latest edition of Outlook on 17 December 2019. The most pressing item was that the life distribution, pensions and investment intermediation class is at a high risk of a supplementary levy.

The FSCS has forecast £46m will be needed from the class (including the provider contribution). The FSCS has explained that it has seen an increase in expected compensation in this class of £44m (23%) compared to the levy forecast. The main area of claims, £162m of total costs of £237m, is in relation to pension advice. The FSCS has stated that it has experienced more complex and expensive claims in this area and this has increased the cost by £20m. It also expects to make 1,200 (58%) more decisions in relation to general investment activities against a variety of firms. The FSCS has stated that as it is likely to have to deal with claims from the recent failures of SVS Securities and Reyker Capital, there is an allowance for this increase and it will provide an update in the new year.

The Investment Provision class is also stated to be at medium risk of a supplementary levy. There is currently a forecast of a £14m deficit.

The FSCS has explained that this is a result of two costs:

  • the costs in association with Beaufort Securities, for negligent discretionary fund management that are greater in volume, but lower in average compensation value; and
  • expected costs to fund approximately 500 additional claims this year in respect of SIPP operators following the recent failures of Lifetime SIPP, Guardian and Berkeley Burke.

The FSCS is keeping this under review and will announce an update in the new year.

LIBOR transition: FCA presses firms to extend their SMCR arrangements to cover LIBOR risks

The Financial Conduct Authority (FCA) has published a webpage answering key questions on conduct risk arising from the transition from LIBOR to alternative reference rates. The FCA expects firms to have an appropriate strategy in place and take necessary action during LIBOR transition in order to ensure that customers are treated fairly.

Of particular interest were the references to the Senior Managers and Certification Regime (SMCR) and the governance and accountability of firms which are affected more widely. The FCA has stated that firms which are subject to the SMCR should identify the senior manager responsible for overseeing the transition away from LIBOR and that this responsibility should be detailed in that senior manager’s Statement of Responsibilities. This is a particularly significant development, given that the FCA have made clear that they will look to the Statements of Responsibilities of senior managers when establishing responsibility for any failures at FCA authorised and regulated firms.

Continuing with the theme of how the LIBOR transition and firm governance interact, the FCA made clear that firms are required to consider whether LIBOR-related risks are best addressed within existing conduct risk frameworks or whether a separate, dedicated program ought to be established in order to ensure that such risks are adequately dealt with. In any case, firms will be required to meet their obligations to act with due skill, care and diligence and to make and retain adequate records. As a result, firms should consider keeping appropriate records of management meetings or committees which deal with their approach to LIBOR transition in order to demonstrate that they have discharged their obligations.

Following the Q&As, the FCA published a speech by Edwin Schooling Latter, Director of Markets and Wholesale Policy at the FCA, in relation to next steps in the transition from LIBOR. Points of interest from the speech include:

  • the FCA raises concerns that prudential and conduct risks of continuing to rely on contracts that reference LIBOR beyond end-2021 are rising. It will no longer be credible for regulated firms to claim they did not know that LIBOR might not survive this date;
  • progress on transition from LIBOR in the loans and swaps markets is the key task for 2020. In sterling interest rate swap (IRS) markets, the FCA will encourage market makers to make Sterling Overnight Index Average rate (SONIA) the market convention from Q1 2020; and
  • the best way to avoid LIBOR-related risks is to move off LIBOR altogether, but for those not quite ready to make the move to SONIA or equivalents contractual fall backs offer a safety net.

FCA temporary intervention on the marketing of speculative mini-bonds to retail investors

The Financial Conduct Authority (FCA) has announced that it plans to use emergency powers to restrict the promotion of speculative mini-bonds to retail investors from 1 January 2020. In doing so, the FCA is electing to use special powers that it has only used twice before. This is a result of the pressure on the FCA to respond to the £236m collapse of London Capital & Finance, which sold mini-bonds to 11,600 retail investors.

The ban stems from the FCA’s recent findings of poor quality promotions for speculative illiquid securities targeting retail investors, particularly on online platforms. These promotions often contain limited explanations of risks and fees or costs involved, and may include misleading information suggesting these products are more secure or less risky than is the case.

The new temporary rules:

  • restrict the marketing of speculative illiquid securities to ensure they can only be promoted to individual retail investors who have been pre-categorised as either sophisticated or high net worth, and where the product has been initially assessed as likely to be suitable for them; and
  • mandate a specific risk warning and disclosures of any costs or payments to third parties that are deducted from the money raised by an issuer in a financial promotion for these products.

These restrictions are a severe measure, given that they will apply without any period of consultation. However, it is also only a temporary measure. They will last for 12 months while the FCA consults with the markets in order to create permanent rules.

The FCA states that the temporary rules will not apply to promotions approved by authorised firms before 1 January 2020, which can still be communicated by an unauthorised person on or after 1 January 2020. The FCA expects firms that have approved financial promotions for illiquid securities before the temporary rules apply to consider the recent guidance on financial promotions and, if necessary, withdraw their approval if they cannot satisfy themselves that a promotion is clear, fair and not misleading.

SMR for benchmark administrators: FCA consultation

The FCA has published a consultation paper (CP19/31) on extending the Senior Managers Regime (SMR) to benchmark administrators. The SMR will come into force on 7 December 2020 for firms that only administer benchmarks and do not undertake any other regulated activities.

The FCA proposes to:

  • not apply the Certification Regime to benchmark administrators;
  • categorise benchmark administrators under the SMR as "core" firms initially, with the option of subsequent waivers;
  • require benchmark administrators to allocate up to four senior manager functions, depending on their governance structure; and
  • require benchmark administrators to apply the Conduct Rules to almost all their employees.

The FCA additionally noted that, after 9 December 2019, the existing Approved Persons Regime (APR) no longer applied to firms authorised under the Financial Services and Markets Act 2000, and will only apply to appointed representatives. The consultation proposes some consequential changes to the FCA rules to make this clear.

Until the new rules come into force in December 2020, the APR will continue to apply in full to benchmark administrators, and the FCA will continue to process applications for controlled functions. The deadline for responding to the consultation is 28 February 2020.

Approving unauthorised persons’ financial promotions: FCA’s new webpage

The FCA has published a new webpage providing guidance on approving the financial promotions of unauthorised persons. The FCA explains that firms which approve financial promotions are already required to ensure that those promotions comply with the FCA rules (both in presentation and in substance). The guidance therefore outlines practical implications of the existing requirements, rather than setting out new standards. Significantly, the FCA refers firms to the Financial Services Authority’s (FSA, predecessor of the FCA), previously published guidance (FG15/4).

In particular, the FCA notes that it has concerns about the promotion of unlisted debt securities or "mini-bonds" (see above regarding FCA temporary intervention rules), although the broad principles outlined in the webpage are also likely to be relevant to approving financial promotions in other sectors. If firms intend to begin approving financial promotions of unauthorised persons, they should consider whether this is something that should be informed to the FCA in accordance with principle 11 (relations with regulators) of FCA’s Principles for Businesses.

By way of reminder, the FCA outlines the following guidance:

  • all financial promotions must be fair, clear and not misleading;
  • firms must ensure that a promotion complies with all applicable financial promotion rules;
  • when approving a financial promotion of, and for communication by, an unauthorised person, it is unlikely to be appropriate to accept at face value information provided by the unauthorised person. Firms should form their own view as to whether the promotion complies with the FCA’s financial promotion rules and consider the appropriateness of relying on information prepared by independent professional advisers on a case-by-case basis;
  • adequate records of the financial promotions approved must be maintained;
  • a firm’s systems and controls should ensure that it does not approve financial promotions which it lacks the competence to properly review and consider; and
  • firms should consider the FSA’s previously published guidance (FG15/4) when approving financial promotions for social media and digital communications.

FCA and Bank of England joint review of open-ended funds

The Bank of England’s (BoE) Financial Policy Committee (FPC) published its Financial Stability Report on 16 December setting out initial findings of a joint review by the FCA and the Bank of England on open-ended investment funds and the risks posed by their liquidity mismatch.

The report identified the following principles in order to prevent mismatch between the liquidity of a fund’s assets and its redemption terms.

  • Liquidity of funds’ assets should be assessed by reference to the price discount needed for a quick sale of a representative sample (or vertical slice) of those assets or the time period needed for a sale which avoids a material price discount. In the US, the Securities and Exchange Commission has recently adopted measures of liquidity based on this concept.
  • Redeeming investors should receive a price for their units in the fund that reflects the discount needed to sell the required portion of a fund’s assets in the specified redemption notice period, ensuring fair outcomes for redeeming and remaining investors.
  • Redemption notice periods should reflect the time needed to sell the required portion of a fund’s assets without discounts beyond those captured in the price received by redeeming investors.

The FCA will use the conclusions of the review, which will be released in 2020, to inform the development of the FCA’s rules for open-ended funds.

Strengthening operational resilience in the financial services sector: FCA, PRA and BoE consultations

The BOE, the Prudential Regulation Authority (PRA) and the FCA have published a shared policy summary and co-ordinated consultation papers (CP) on new requirements to strengthen operational resilience in the financial services sector.

The proposed policies will comprise new rules (for the FCA and PRA), principles, expectations and guidance, and will be implemented through the authorities’ respective supervisory areas. Not all firms would be subject to the formal policy proposals. Firms should refer to the following consultation documents for the proposed scope of the policies:

  • PRA CP29/19: Operational resilience: Impact tolerances for important business services;
  • PRA CP30/19: Outsourcing and third party risk management;
  • FCA CP19/32: Building operational resilience: impact tolerances for important business services and feedback to DP18/04. This CP affects banks, building societies, PRA designated investment firms, Solvency II firms, recognised investment enhanced scope SMCR firms and entities authorised or registered under the Payment Services Regulations 2017 and/or the Electronic Money Regulations 2011; and
  • individual consultation papers and draft supervisory statements (SS) issued by the BoE for central counterparties, and central securities depositories. The BoE will also publish a CP, a draft SS and a draft operational resilience chapter of the Code of Practice for recognised payment system operators and specified service providers.

Due to the different legislation and regulatory frameworks under which the PRA, the FCA and the BoE operate, the approach taken by each supervisory authority is not identical but their intended outcomes are aligned.

In particular, in CP19/32, the FCA proposes that firms and Financial Market Infrastructures (FMIs):

  • identify their important business services that if disrupted could cause harm to consumers on market integrity;
  • identify and document the people, processes, technology, facilities and information that support a firm’s important business services (i.e. mapping);
  • set impact tolerances for each important business service (i.e. thresholds for maximum tolerable disruption);
  • test their ability to remain within their impact tolerances through a range of severe but plausible disruption scenarios;
  • conduct “lessons learned” exercises to identify, prioritise and invest in their ability to respond and cover from disruptions as effectively as possible;
  • develop internal and external communications plans for when important business services are disrupted; and
  • create a self-assessment document.

The FCA states that the proposals are not intended to conflict with or supersede existing requirements to manage operational risk or business continuity planning, but rather aim to set new requirements that enhance operational resilience. The deadline for responding to the FCA consultation is 3 April 2020.

MAR and “cold-shouldering”: FCA Primary Market Bulletin

The FCA has published the 25th edition of its Primary Market Bulletin. The FCA reminds firms of their obligations around “cold-shouldering” under the FCA’s MAR 4.3.1R (meaning that no FCA-regulated entity can act for an individual or any transaction subject to The City Code on Takeovers and Mergers).

Following a ruling by the Panel on Takeovers and Mergers on “cold-shouldering”, firms are reminded that they should not deal with David Cunningham King, the Chairman of Rangers International Football Club PLC, for a period of four years from the date of the ruling (2 October 2019). The FCA also expects regulated firms to inform all approved persons at their firms that they should not deal with this individual or his principals on any such transactions. The FCA reiterates that a breach of MAR 4.3 may leave firm and any individuals involved open to enforcement action.

SMCR extended to solo-regulated firms: FCA press release and update webpage

The FCA has published a press release stating that as of 9 December 2019, the SMCR has been extended to around 47,000 solo-regulated firms. The SMCR also applies to branches of non-UK firms with permission to carry out regulated activities. The FCA states that the extension is a key step to creating a culture across financial services where individuals step forward and take accountability for their own actions and competence.

There is a 12 month transitional period for certain aspects of the regime.  By 9 December 2020, solo-regulated firms transitioning to the new regime will need to ensure:

  • all relevant staff are trained on the Conduct Rules and how they apply to their roles;
  • all staff in certified roles are fit and proper to perform that role and are issued with a certificate; and
  • they submit data to the FCA for the new directory of key people working in financial services.

To this effect, the FCA has published a suite of materials effective from 9 December 2019. Among other items, the following has been published:

The FCA has also updated its SMCR webpage to highlight a number of ongoing requirements, including:

  • senior management functions (SMFs) appeared on the FS register on 9 December 2019. Firms are encouraged to check the FS register to ensure they have the correct SMFs;
  • SMFs are not restricted to members of the governing body. The SMF3 executive director function extends beyond members of the governing body to include a person in accordance with whose directions or instructions the directors are accustomed to act; and
  • senior managers should ensure that any delegation is reasonable in itself, that the individuals to whom they have delegated are appropriate, for example with suitable skills, and they should retain an appropriate level of oversight.

FCA policy statement on investment platform transfers

The FCA has published a policy statement (PS) in relation to rules that aim to make it easier for consumers to transfer their assets from one platform to another which forms part of the package of remedies from the investment platforms market study (IPMS). The FCA states that the intention of the PS is to complement existing rules on transfers and re-registration.

The PS will be of interest to platform service providers; fund managers and their service providers; financial advisers and consumers of platform services and consumer organisations. The new rules will come into force on 31 July 2020.

The new rules will introduce requirements for platforms to:

  • offer consumers the choice to transfer units in investment funds that are common to both platforms via an “in-specie transfer” (this is a transfer where a customer’s investments are transferred directly from one platform to another, with the customer remaining invested throughout);
  • request a conversion of unit classes where this is necessary to enable an in-specie transfer to take place; and
  • ensure that consumers moving onto a new platform are given an option to convert to discounted units where these are available for them to invest in.