Investment management update

On 13 August 2020, the Financial Conduct Authority (FCA) published a new webpage on Conduct Rules reporting for solo-regulated firms under the Senior Managers and Certification Regime (SM&CR).

Under the SM&CR, FCA solo-regulated firms must report annually to the FCA as to whether any disciplinary action has been taken against individuals who are not Senior Managers for breaches of the Conduct Rules. This report is the REP008 and it should be completed and submitted using Gabriel.

If there has been a breach of the Conduct Rules, firms need to provide information in the REP008 including details about the:

• individual who has committed the breach;
• Conduct Rules that have been breached; and
• disciplinary action taken (where disciplinary action means issuing a formal written warning, suspension or dismissal of a person, or reduction or recovery of remuneration (clawback)).

Firms must submit the REP008 annually even if there have not been any Conduct Rule breaches resulting in disciplinary action. The FCA makes clear that firms that do not submit the REP008 by the reporting deadline will be charged a late return fee of £250.

The FCA has also updated its webpage for solo-regulated firms to provide information on good and bad practice (referred to as positive and negative indicators) relating to training staff on the Conduct Rules and carrying out fitness and propriety assessments.

Firms should demonstrate that they are making regular, thorough and consistent assessments of the fitness and propriety of their Senior Managers and Certification Staff. Good practice includes (amongst other things):

• ensuring that managers are adequately trained in the firm's approach to fitness and propriety and understand what is expected of them;
• having a detailed fitness and propriety process which is integrated into existing HR processes and competence assessments which demonstrate that thought has been given to each role; and
• having appropriate criteria and a robust process for identifying Certification Staff on an ongoing basis.

When training staff on the Conduct Rules, the FCA expects firms to, among other things, have interactive training that uses realistic scenarios and which is reinforced regularly. This interactive training should be built into on-boarding processes. The effectiveness of Conduct Rules training should also be assessed, and line managers should be involved in training delivery.

The European Securities and Markets Authority (ESMA) has published a letter dated 18 August 2020 which it has sent to the European Commission, highlighting the areas where ESMA considers improvements could be made to the Alternative Investment Fund Managers Directive (2011/61/EU) (AIFMD).

The letter proposes a number of changes to be made as part of the European Commission’s upcoming review of the AIFMD, as well as part of any future review of the Undertakings for the Collective Investment in Transferable Securities (UCITS) Directive.

In the letter, ESMA notes that it has had significant exchanges with national competent authorities on their practical experience in supervising firms in accordance with the AIFMD's provisions. In doing so, ESMA has noticed many areas of the framework that could be improved. In addition, the recent stresses related to Covid-19 have drawn attention to some areas that could be further improved.

Annex I to the letter sets out the key areas in the legislative framework where ESMA proposes that amendments are made.

Particular points of interest

• Harmonisation of AIFMD and UCITS regimes – ESMA states that, in some cases, the newer AIFMD provisions are more granular or specific compared to UCITS Directive requirements, although there might not be any objective justification for such differences. ESMA notes that the European Commission should consider aligning the frameworks where appropriate as applying different requirements to management companies which manage both UCITS and AIFs creates additional burdens for the firms concerned and divergences in supervisory/regulatory outcomes.
• Harmonised reporting for UCITS – ESMA suggests that, after improvements to AIFMD Annex IV reporting have been made, harmonised UCITS reporting should generally be aligned with those requirements while allowing for tailoring to the characteristics of UCITS funds. To the extent possible, the reporting should try to exploit the synergies with existing surveys both at EU and national level, and avoid duplications or unnecessary burdens for the supervised entities.
• Delegation and substance – ESMA sees merit in providing additional legislative clarifications in the AIFMD and UCITS frameworks with respect to delegation and substance requirements. For more information, see our Passle blog post “AIFMD review: ESMA goes after delegation structures”.
• Leverage – AIFMD has two measures of leverage calculation, the gross notional exposure method and the commitment method. Both are used for reporting purposes. In December 2019, IOSCO issued recommendations for a two-step approach for a framework assessing leverage in investment funds. ESMA believes the IOSCO recommendations give rise to a need to amend the current reporting of the gross method calculation in Article 7 of the Commission Delegated Regulation (EU) No 231/2013, to ensure alignment with the IOSCO framework.
• Harmonisation of supervision of cross-border entities – ESMA suggests there is a still a lack of clarity in what the precise responsibilities of home and host supervisors are in some cross-border marketing, management and delegation cases. Clarification of the supervisory responsibilities regarding the supervision of cross-border activities of UCITS and AIFs, their managers and their delegates would reduce uncertainty regarding cross-border activities.
• Semi-professional investors – currently, there is no definition of “semi-professional” investor in AIFMD. ESMA has already called for greater convergence in the definition of “professional investor” and it sees merit in clarifying the definition of “professional investors” under AIFMD. ESMA is of the view that any possible introduction of any new categories of investors under the AIFMD (such as “semi-professional” investors) should be accompanied by appropriate investor protection rules and that passporting activities should be allowed only in relation to the marketing to professional investors.
• Proportionality principle for remuneration requirements – in 2016, ESMA wrote to the European Commission requesting clarification of the application of the proportionality principle in both AIFMD and the UCITS Directive. This clarification would be to make clear that the proportionality principle applies to the full set of remuneration requirements in letters (a) to (r) of paragraph 1 of Annex II of the AIFMD (and Article 14b(1)(a) to (r) of the UCITS Directive).

In addition, Annex II to the letter sets out more specifically ESMA's proposed changes to the AIFMD in relation to the reporting regime and data use.

ESMA encourages the Commission to support the areas identified in the letter to improve the effectiveness and soundness of the AIFMD.

On 20 August 2020, the FCA published its regulation round-up newsletter for August 2020, which, amongst other things, comments on firms' approach to disclosure to consumers during the Covid-19 pandemic.

The FCA notes that, during the Covid-19 crisis, consumers have been expected to make difficult financial decisions, many of which carry longer term consequences. The FCA has been monitoring and evaluating disclosure by firms, in order to understand whether they are providing consumers with enough support with their decisions.

The FCA states that it is impressed with how firms have approached disclosure during the crisis. It hopes firms will build on what they have achieved and continue to design innovative disclosures that facilitate consumer understanding.

The FCA also asks firms (including investment managers) to respond to its call for input (CFI) on open finance which closes on 1 October. The CFI explores the opportunities and risks from open finance, what is needed to ensure that it develops in the best interests of consumers, and what the FCA’s role should be.

On 14 August 2020, the Prudential Regulatory Authority (PRA) published a new webpage on the fourth meeting (held in July 2020) of the Climate Financial Risk Forum (CFRF), which it hosts jointly with the FCA. The CFRF was established by the PRA and FCA in 2019, with the aim of sharing best practice between regulators and industry to advance responses to the financial risks from climate change.

Key points

• The CFRF discussed how to publicise and promote use of its June 2020 guide by the financial services industry. For information on the guide, see our July update.
• For the second year of the CFRF, the existing working groups (on risk management, scenario analysis, disclosure and innovation) will undertake thematic pieces of work on metrics, data and methodologies. They will also focus on building the guide by progressing and refining the recommendations, in particular, highlighting how firms can effectively implement the approaches set out in the guide.
• The next CFRF meeting will take place in Q4 2020, where workplans and approaches will be agreed. Also at that meeting, possible next steps to support COP26 (the international climate summit being hosted by the UK in November 2021) will be discussed.

On 12 August 2020, the FCA published a Dear CEO letter addressed to firms who provide non-discretionary investment services relating to the increase in levels of client money held by firms. Note that the FCA clarifies that this letter does not apply to client money balances held within a tax efficient wrapper or under a collateral arrangement for margined transactions.

The FCA states that a number of firms have reported an increase in client money balances (in some cases a significant increase) in their reporting from January to June 2020. The increase may have been caused by clients rebalancing their portfolios to mitigate volatility during the Covid-19 pandemic.

The FCA advises that each in-scope firm’s relevant Senior Manager should consider whether the firm needs to hold client money balances that are unlikely to be reinvested, or whether it would be in its clients' better interests to place those balances directly with their own current or savings account providers.  

The FCA considers it good practice at this time for firms to communicate with clients about increased client money balances to determine whether these should be returned to them or whether the firm should hold on to them to facilitate further investment in the short term. If it is in clients' better interests during this period, the FCA expects firms to return client money balances if those balances are unlikely to be reinvested in the short term. The FCA will continue to review client money balances and follow up with firms that report significantly increased balances.

The FCA has published a speech given by Mark Steward, Executive Director of Enforcement and Market Oversight, on capital market regulation in light of the Covid-19 pandemic.

Key points to note from the speech

• The speech notes that the FCA’s core mission is to ensure markets work well, and that this happens when investors have confidence that the market rules and standards are effective.
• The speech refers to the FCA’s recent public censure against Redcentric PLC as a good example of how regulation operates to correct the market in circumstances where false or misleading information has distorted it. In particular, Mr Steward explains how Redcentric PLC’s response, which included taking remedial steps in respect of its governance, were factors in the decision to announce the FCA’s public censure rather than fine the company.
• Last year, the FCA ingested close to 10 billion transaction reports and over 150 million order reports every day into its market data processor. This gives the FCA visibility over trading in the market, meaning instances of false or misleading information distorting the market are more readily identified.
• In response to the Covid-19 pandemic, the FCA has introduced many temporary measures to address the difficulties faced by capital markets during Covid-19. This has included additional time for listed companies to file audited financial statements, additional time for interim accounts to be filed and a series of measures for companies raising new capital.
• The FCA continues to monitor actively these measures to ensure markets continue to work well.

On 26 August 2020, the FCA updated its “Coronavirus (Covid-19): Information for firms” webpage to announce that it has launched a joint survey with the Bank of England (BoE) to review liquidity mismatch in open-ended funds. This joint survey is a continuation from the initial data collection exercise announced in Q1 2020 by the FPC, but which was postponed in March due to Covid-19.

In Q4 2019, the Financial Policy Committee (FPC) judged that the mismatch between redemption terms and the liquidity of some funds' assets could become a systemic risk. The FPC’s view was that there should be greater consistency between these, with specific focus on three principles:

• measures of liquidity;
• pricing; and
• redemption notice period.

The review will consider how a framework around the above principles could be designed.

The survey is a voluntary exercise. Asset managers included in the survey are being asked to respond to the questions on a best-effort basis by 30 September 2020.

See also our August update where we discussed the FCA’s consultation on liquidity mismatch in open-ended funds.

On 28 August 2020, the FCA updated its webpage on changes to regulatory reporting during the Covid-19 pandemic.

The FCA has allowed an extension to complaints data returns. It will allow flexibility in relation to the 31 August 2020 deadline for the publication of the complaints data summary (as required under DISP 1.10A.1R of the FCA Handbook).

Firms may apply a two-month extension to this deadline, meaning that summary data for complaints reports submitted to the FCA covering reporting periods ending between 1 January and 30 June 2020 must be published by firms no later than 31 October 2020.

The FCA has published a consultation paper (CP20/17) on extending its annual financial crime reporting obligation (referred to as "REP-CRIM").

The annual financial crime reporting obligation shows the FCA the potential money laundering risk faced by a firm, based on its regulated activities and the nature of its customers. Currently, firms are subject to the REP-CRIM reporting obligation based on their firm type. Certain firms are subject to the REP-CRIM reporting obligation irrespective of their revenue (e.g. banks, building societies and mortgage lenders), whilst others are subject depending on their activity type and whether the firm has total annual revenue of £5m or over (for example, AIFMs).

The FCA proposes to extend its requirements to include firms which are within the scope of the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 and that:

• hold client money or assets (i.e. subject to CASS 5, 6 or 7 of the FCA Handbook), or
• carry on regulated activities that it considers potentially pose a higher money laundering risk.

This extension will, in effect, extend the REP-CRIM reporting obligation to all UCITS management companies, AIFMs and discretionary investment managers.

In the consultation paper, the FCA reminds all firms, irrespective of whether they are required to provide REP-CRIM information, to continue to assess their systems and controls, including through assessments against relevant financial crime publications, to identify and manage money laundering risks. Firms should also be able to evidence the steps they have taken to manage that risk.

The consultation closes to comments on 23 November 2020. Subject to feedback, the FCA is aiming to publish a policy statement in early 2021.

On 20 August 2020, the FCA updated and restructured its webpage on the temporary permissions regime (TPR). The TPR is designed to enable relevant firms and funds which passport into the UK to continue operating in the UK when the passporting regime falls away at the end of the Brexit transition period.

The FCA has updated its advice on the operation of the TPR, echoing its July 2020 announcement that the notification window for both inbound firms and funds will reopen on 30 September 2020. This will allow firms and fund managers that have not yet notified the FCA to do so before the end of the transition period. Firms and fund managers that have already submitted a notification can update this with the FCA if new products have since been launched.

Based on information that was previously provided, the FCA has usefully also created a number of webpages covering the following TPR-related topics:

• which firms and investment funds can use the TPR;
• the rules which will apply to firms and fund operators in the TPR;
• the notification process for firms (including information on withdrawing a TPR notification);
• considerations for firms leaving the TPR;
• the notification process for funds;
• TPR fees that your firm or investment fund will need to pay; and
• the financial services contracts regime.

The BoE has also published a webpage on the TPR, summarising its approach to the TPR and highlighting the key requirements for UK branches of firms.

On 27 August 2020, the FCA published Market Watch 64, its newsletter on market conduct and transaction reporting issues. In this edition, the FCA provides information to help MiFID II firms prepare for the end of the Brexit transition period on 31 December 2020.

The FCA reminds firms that the temporary transitional power (which allows firms time to adapt to new requirements that apply as a result of Brexit) does not apply to the transaction reporting rules. Firms and Approved Reporting Mechanisms (ARMs) must therefore ensure that they comply with the changes to their regulatory obligations by the end of the transition period.

Crucially, firms that are unable to comply fully with the transaction reporting regime immediately following the end of the transition period will need to be able to back-report missing, incomplete or inaccurate transaction reports as soon as possible.

The FCA also confirms that, as part of the development of a post-exit MiFID regime, industry testing for the FCA's Financial Instruments Transparency System (FCA FITRS) will open on 5 October 2020. The FCA's Financial Instruments Reference Data System (FCA FIRDS) is still available for testing. The FCA has dedicated webpages on both the FCA FITRS and FCA FIRDS.