Investment management update
- Regulatory Initiatives Grid: regulatory developments tracker
- European Commission: new Delegated Regulation amending list of high-risk third countries under MLD4
- FSCS 2020/21 levy
- JMLSG consultation of proposed new annex to be added to AML and CTF guidance
- High Court: FCA consent must be obtained before appointing administrators of a regulated company
- FCA speech: national and international response to Covid-19 and Brexit
- Updates to the FCA’s webpage on information for firms during Covid-19
- FCA webpage: financial crime systems and controls during Covid-19
- Updated FCA statement: firm handling of complaints during Covid-19
- FCA statement: how firms should handle post and paper documents
- FCA modification by consent – extending the “12 week rule” for Senior Manager cover
- FCA webpage: allowing individuals to carry over CPD because of Covid-19
- FCA Market Watch issue 63
- ESRB actions to address the Covid-19 impact on the financial system
- ESRB recommendation: liquidity risks in investment funds
- ESMA statement: firms’ MiFID II conduct of business obligations in the context of retail investor activity
On 7 May, the Financial Services Regulatory Initiatives Forum (FSRIF) launched the “Regulatory Initiatives Grid”, a new initiative to help the financial services industry and other stakeholders to understand and plan for the timing of the initiatives that may have a significant operational impact on them.
The FSRIF is comprised of the Bank of England, Prudential Regulation Authority (PRA), Financial Conduct Authority (FCA), the Payment Systems Regulator and the Competition and Markets Authority, with HM Treasury attending as an observer member. The grid lays out the planned timetable for major initiatives – including the transition from LIBOR and the introduction of financial services legislation to prepare for the end of the EU withdrawal transition period.
The grid will run as an initial 12-month pilot and will be published at least twice a year. It includes initiatives and milestones on both a cross-sector basis, such as climate change, technological innovation, and operational resilience, as well as for specific sectors. The following initiatives were identified as impacting the investment management sector.
- MiFID II product governance assessments/review of MiFID II implementation – review of MiFID implementation to assess how asset managers oversee the design of their products, identify their target market and monitor their products and distribution activities, in compliance with MiFID II’s product governance requirements. Key milestones are yet to be announced.
- Overseas funds regime (OFR) – the introduction of new equivalence regimes for retail investment funds and money market funds. To be implemented in the upcoming Financial Services Bill.
- Survey into open ended funds – this has been paused until further notice.
- Review of the UK funds regime, covering direct and indirect tax, as well as relevant areas of regulation – the consultation on tax treatment of asset-holding companies closes 19 August 2020.
- Investment firms prudential regime – the introduction of a new prudential regime for investment firms, currently regulated under rules made for banks and building societies. This is to be included in the upcoming Financial Services Bill.
Under the Fourth Money Laundering Directive, the European Commission (EC) is empowered to adopt delegated acts to identify high-risk third countries. Firms are then required to apply enhanced customer due diligence where business relationships or transactions involve designated high risk third countries.
On 7 May, the EC adopted a Delegated Regulation that amends the list of high-risk third countries. In a related press release, the EC explains that this update is necessary as its list of high-risk third countries has not reflected the latest Financial Action Task Force (FATF) lists since October 2018.
- The following countries have been added to the list: the Bahamas, Barbados, Botswana, Cambodia, Ghana, Jamaica, Mauritius, Mongolia, Myanmar/Burma, Nicaragua, Panama and Zimbabwe.
- The following countries have been removed from the list: Bosnia-Herzegovina, Ethiopia, Guyana, Lao People’s Democratic Republic, Sri Lanka and Tunisia.
The new list will become effective from 1 October 2020. The EC has provided a later application date for this Article as a result of the Covid-19 pandemic. We also remind firms that in accordance with HM Treasury’s Advisory Notice, firms should already consider the FATF lists as well as the EC list.
On 21 May, the Financial Services Compensation Scheme (FSCS) published a press release announcing its final levy for 2020/21.
The FSCS will levy firms £649m, which includes management expenses of £74.7m. This figure is £14m more than the indicative levy that the FSCS forecast in its plan and budget for 2020/21 (which was published in January 2020).
Of particular note is the investment provision class which remains at the limit of £200m (compared to £133m set out in the 2019/20 FSCS final levy and £52m in the 2018/19 FSCS outlook). This is notwithstanding that the forecasted compensation costs for 2020/21 have reduced by £7m due to a change in the timing and cost of recent SIPP operator failures, as well as other failures expected to happen in the future.
The Joint Money Laundering Steering Group (JMLSG) has published for consultation the proposed text of a new annex to be added to Part I Chapter 5 of its anti-money laundering (AML) and counterterrorist financing (CTF) guidance. The proposed new annex contains guidance on pooled client accounts. The deadline for responses to the proposed text of the new annex is 10 June 2020.
In Gregory and others v ARG (Mansfield) Ltd  EWHC 1133 (Ch) (7 May 2020), the High Court held that the requirement for regulated companies to obtain FCA consent to the appointment of administrators is not satisfied when obtained retrospectively. As such, in order to comply with the Financial Services and Markets Act 2000, the FCA’s consent must be obtained prior to appointing administrators of a regulated company.
On 6 May, the FCA published a speech by Nausicaa Delfas, FCA Executive Director of International, on the FCA's response to Covid-19 and Brexit.
FCA response to the Covid-19 outbreak
For firms and markets, Ms Delfas explained that the FCA’s focus has been to keep markets open and orderly, which has meant easing operational pressures on firms where appropriate. However, the speech notes that, while the FCA has been flexible, firms need to continue to treat their customers fairly and to operate with integrity. For example, the FCA is clear that the Senior Managers and Certification Regime obligations continue to apply.
The FCA has been engaging closely with partners in the US and Europe to coordinate responses to Covid-19. The focus of the international response has involved offering supervisory flexibility where appropriate, delaying some scheduled rule changes which would have placed additional operational burden on firms at this extraordinary time, as well as re-prioritising non-essential supervisory work.
Emerging trends in international financial regulation
Ms Delfas noted that firms' operational resilience has come under a new focus. Given the UK's large global markets and the outsourcing arrangements of many UK firms with significant operations in other countries, it is particularly important for the FCA and the UK in general to identify and address any increased vulnerability to disruption from unexpected events.
Ms Delfas commented on certain Brexit-related risks that need multilateral or reciprocal action by both the UK and the EU, which the UK cannot address alone.
In respect of issues that cannot be resolved through equivalence (including provision of retail financial services by UK firms to EU customers), Ms Delfas noted that, while the FCA has put in place transitional regimes for EEA firms, the situation for UK firms in the EU is not the same. Their continued operations after the end of the transition period will depend on the regulatory regimes of individual EU member states. Although many of these member states had put in place temporary transitional regimes in the event of a no-deal exit, the majority of these have now lapsed.
Firms should continue to consider what actions they need to take to prepare for the end of the transition period. The FCA will continue to engage closely with firms, trade and consumer bodies in preparation for the end of the transition period over the course of this year.
The FCA has updated its webpage “Coronavirus (Covid-19): Information for firms” to provide further information regarding its expectations for (i) information security and (ii) financial systems and controls.
The FCA notes that as more firms enable their employees to work from home, online systems are becoming increasingly "mission critical" and cyber criminals are exploiting the situation for their own gain.
The FCA recognises that alternative ways of working may be needed to enable business continuity. However, it expects firms to prioritise information security and ensure that adequate controls are in place to manage cyber threats and respond to major incidents. Firms should look to implement enhanced monitoring to protect end points, information and firm-critical processes, including network connections and video conferencing software. The FCA expects firms to proactively manage the increased risk during this unprecedented period. This includes firms:
- being vigilant to the potential increase in security breaches or cyber-attacks;
- ensuring that they continue to have appropriate governance and oversight arrangements in place;
- reviewing the Covid-19 impact on their information and systems security defences, and taking action as needed; and
- ensuring that the general notification requirements are followed, and significant operational and cyber incidents are reported.
The FCA advises firms to check the National Cyber Security Centre for advice on how to keep their organisations secure.
Financial systems and controls
The FCA reminds firms that, in the current climate, it is important for firms to maintain effective systems and controls to prevent money laundering and terrorist financing. The FCA draws firms’ attention to its dedicated webpage (which we discuss below) setting out its expectations on systems and controls for combatting and preventing financial crime.
On 6 May, the FCA published a new webpage on its expectations of how firms should apply their systems and controls to combat and prevent financial crime during the Covid-19 crisis.
Similar to the FCA’s comments on cybercrime (noted above), the FCA notes that criminals are taking advantage of the Covid-19 pandemic to carry out fraud and exploitation scams through a variety of methods. The FCA reminds firms that it is important that they remain vigilant to new types of fraud and amend their control environment where necessary to respond to new threats. This should include the timely reporting of suspicious activity reports of any new threats.
The FCA has made it clear that firms should not address operational issues by changing their risk appetite. For example, the FCA states that firms should not change or switch-off current transaction monitoring triggers or thresholds, or sanctions screening systems, for the sole purpose of reducing the number of alerts generated to address operational issues.
However, helpfully, the FCA recognises that, while continuing to operate within the legislative framework for AML and CTF, firms may need to re-prioritise or reasonably delay some activities. These could include ongoing customer due diligence reviews, or reviews of transaction monitoring alerts. The FCA would consider such delays reasonable as long as:
- the firm does so on a risk basis (e.g. reviews for high risk customers should not be delayed unless absolutely necessary); and
- there is a clear plan to return to the business as usual review process as soon as reasonably possible.
Where firms need to amend their controls in response to Covid-19, the FCA states that decisions should be clearly risk assessed, documented and go through appropriate governance. It expects firms to notify it of any material issues that impact on the effectiveness of a firm’s financial crime controls or cause significant delays to remediation plans.
In our May edition, we reported that the FCA issued a helpful statement for firms on complaints handling. On 7 May, the FCA updated this statement to include information on the Financial Ombudsman Service’s (FOS) general approach to determining complaints. The FCA states that the challenges faced by firms during this period, and what counted as good industry practice at the time, will form part of the FOS’s assessment of any complaints.
On 13 May, the FCA published a statement on how firms should handle post and paper documents. The FCA continues to expect firms to comply with the requirements for post and paper-based processes (both incoming and outgoing). However, it recognises that, in the current circumstances, some firms may not be able to fully comply with them. Where this is the case, firms must notify the FCA as soon as possible and do the following.
- Try to ensure that customers are not disadvantaged because of delays, and make particular efforts to contact customers who do not use online services. In particular, vulnerable customers must be protected and firms should send communications in a timely manner.
- Demonstrate any steps taken to mitigate the impact of non-compliance with postal and paper processes and return to full compliance as soon as it is practical.
- Provide general updates on how they will treat incoming and outgoing post and cheques through their website and other public channels (e.g. social media). These communications should update customers on market conditions, explain how customers can check their financial statements (which may arrive late) and invite customers to contact the firm if they wish.
- Use other methods to conduct a suitability assessment, such as phone calls and relevant due diligence checks online, because face-to-face assessments are not currently possible. Firms should then send out the assessment without delay, whether online or by post.
- Ask customers who have sent instructions or cheques that have not been processed to contact the firm urgently by telephone or electronic means. Where a customer has made a payment by cheque that has not been processed, the FCA expects firms to consider, on a case-by-case basis, the potential harm caused by not being able to cash the cheque. Firms should ensure, where possible, customers receive the services or cover required (e.g. retrospective cover). Where the uncashed cheque represents client money under the Client Assets sourcebook (CASS) regime and the firm provides the service or cover without cashing the cheque, firms must consider whether proceeding in this way might breach CASS and expose other clients to the risk of a client money shortfall.
The FCA will review the arrangements described in the statement as the pandemic develops. However, firms should revert to complying with regulatory requirements as soon as reasonably practicable and not wait for a further FCA statement.
The FCA has published a modification by consent, which has modified SUP 10C.3.12R (the “12-week rule”) by extending the maximum period firms can arrange cover for a Senior Manager without being approved from 12 weeks to 36 weeks, in a consecutive 12-month period. The FCA is also allowing firms to allocate an absent Senior Manager's prescribed responsibilities to the individual covering the role, by modifying SYSC 24.2.1.
This modification is intended to accommodate firms that are managing their governance arrangements in a period of uncertainty and aims to provide flexibility to firms at this time. The FCA explains that firms can use the modification by consent if, for example, a Senior Manager is absent because of Covid-19 or recruitment to replace a Senior Manager is delayed due to the pandemic.
Firms wanting to take up the modification by consent should submit an application into the FCA's Connect system. The modification by consent will take effect from the date a firm applies for it and will end on 30 April 2021.
The FCA has published a new webpage that explains that individuals can defer uncompleted continuing professional development (CPD) hours to the next CPD year as a result of Covid-19.
The FCA expects firms to demonstrate that relevant individuals remain competent to carry out their work and notes that effective and consistent CPD is an essential part of this. In particular, it expects that most individuals will be able to continue completing CPD whilst on furlough or working from home, e.g. through e-learning, and notes that firms, accredited bodies and professional qualifications providers are helping individuals by providing this material. The FCA also expects firms to support furloughed staff with materials to complete their CPD.
Nevertheless, the FCA recognises that there could be exceptional circumstances where individuals may struggle to complete the required minimum CPD hours. Impacted firms may be those with retail investment advisers and those carrying on insurance distribution activities. The FCA has therefore decided to temporarily allow firms to let individuals carry over any uncompleted CPD hours to the next CPD year, in exceptional circumstances. This applies to CPD years ending before 1 April 2021. However, the FCA expects individuals to stay up to date with its Covid-19 regulatory developments which could count towards CPD if relevant.
Individuals carrying over CPD hours must complete the carried-over hours within the next CPD period on top of the hours already required. When a firm has decided to carry over uncompleted CPD hours in accordance with its guidance, the FCA will treat the firm as having complied with the requirements for the current CPD period.
The FCA states that the following circumstances can count as exceptional:
- when individuals during the current pandemic are needed to carry out extra duties to manage risks or to provide support to consumers and businesses, have caring responsibilities, and have difficulties accessing CPD material, for example, due to technical difficulties or unavailable material; and/or
- where it is not realistic to expect the individual to also fulfil the CPD requirements.
The FCA requires firms to consider certain factors, including the individual's role and responsibilities, their knowledge and skill development and their individual circumstances during the current situation. Firms should also record their decision and the reasons for it, but do not need to report this to the FCA.
On 27 May 2020, the FCA published issue 63 of Market Watch, its newsletter on market conduct and transaction reporting issues.
In this issue, the FCA recognises the uncertainty created by the Covid-19 pandemic and operational challenges arising from the public policy on social distancing. However, it states that it expects all market participants, including issuers, advisors and anyone handling inside information to continue to act in a manner that supports the integrity and orderly functioning of financial markets.
- The FCA reminds firms that any persons handling inside information should ensure that it is only disclosed where disclosure is necessary in the normal exercise of employment, a profession or duties.
- The FCA encourages the meeting of transparency and short position covering requirements under the Short Selling Regulation (SSR) for market participants, to support the effective functioning of the market.
- The FCA states that the SSR restricts uncovered short sales in shares to prevent “naked” short selling, which could harm market integrity and disrupt settlement. To meet their obligations under the SSR, investors must ensure that they only enter into a short sale of a share where they have borrowed the share, entered into an agreement to borrow the share or have an arrangement with a third party who confirms that the share has been located.
- The FCA will continue to monitor short selling activity as part of its market monitoring.
- The FCA reminds firms of the importance of undertaking risk assessments to identify market abuse risks that firms could be exposed to and what controls are necessary to mitigate them. It notes that reviewing and updating risk assessments in response to Covid-19 could enable firms to modify their surveillance systems to ensure they remain adequately and appropriately calibrated to detect any new or heightened market abuse risks that they have recognised.
On 14 May 2020, the European Systemic Risk Board (ESRB) published a press release announcing that its General Board discussed a first set of actions to address the impact of the Covid-19 outbreak on the financial system from a macro-prudential perspective. The actions are in five priority areas.
- Implications for the financial system of guarantee schemes and other fiscal measures to protect the real economy – the ESRB has sent a letter to the Economic and Financial Affairs Council about the work it has begun on identifying financial stability implications of the guarantee schemes and fiscal measures that have been introduced to tackle the emergency situation.
- Market illiquidity and implications for asset managers and insurers – the ESRB has adopted a recommendation to ESMA, which we outline below, and published a statement about the importance of investment funds using liquidity management tools.
- Impact of large-scale downgrades of corporate bonds on markets and entities across the financial system – the ESRB has published an issues note that discusses liquidity in the corporate bond and commercial paper markets, the procyclical impact of downgrades and implications for asset managers and insurers. In addition, it has decided to coordinate a top-down analysis to assess the impact of a common scenario of large-scale downgrades across all parts of the financial sector.
- System wide restrains on dividend payments, share buybacks and other pay-outs – the general board supports measures taken by ESRB member countries and EU institutions to encourage banks and insurers in the EU to limit voluntary pay-outs.
- Liquidity risks arising from margin calls – the Covid-19 pandemic and recent oil market disruptions have caused a sharp drop in asset prices and increased volatility, resulting in significant margin calls across centrally cleared and non-centrally cleared OTC derivative markets. The ESRB general board is discussing the possible adverse liquidity impact on both bank and non-bank entities.
On 14 May, the ESRB published a recommendation on liquidity risks in investment funds.
The ESRB states that, in light of the economic shock caused by the Covid-19 pandemic and associated containment measures, its general board has decided to focus on five priority areas (as discussed above). One of these areas relates to financial market liquidity and implications for asset managers and insurers (as regards unit-linked products).
The ESRB notes that the sharp fall in asset prices observed at the onset of the Covid-19 pandemic was accompanied by significant redemptions from certain investment funds and a significant deterioration in financial market liquidity. While market conditions have subsequently stabilised, it has identified two segments of the investment funds sector as particularly high-priority areas for enhanced scrutiny from a financial stability perspective.
In this context, the ESRB's recommendation is for ESMA to:
- co-ordinate with the national competent authorities to undertake a focused piece of supervisory work with investment funds that have significant exposures to corporate debt and real estate assets to assess the preparedness of these two segments to potential future adverse shocks, including any potential resumption of significant redemptions or an increase in valuation uncertainty; and
- report to the ESRB on its analysis and on the conclusions reached regarding the preparedness of the relevant investment funds.
ESMA is required to communicate the actions taken in response to the recommendation to the European Parliament, the Council of the EU, the European Commission and the ESRB by 31 October 2020.
Alongside its recommendation, the ESRB has also published a statement, emphasising the importance of the availability and timely use of liquidity management tools by investment funds with exposures to less liquid assets, as a key element of prudent liquidity risk management.
Separately, ESMA has published a statement expressing its support for the ESRB’s recommendation and statement.
ESMA has published a statement reminding firms about their conduct of business obligations under the MiFID II Directive in the context of increasing retail investor activity during the Covid-19 pandemic.
ESMA states that several national competent authorities have noticed a significant increase in the number of investment accounts opened by retail clients and a surge in trading by retail clients. It is therefore drawing firms’ and clients’ attention to the risks of trading in these highly uncertain market conditions and to remind investment firms of their conduct of business obligations. ESMA believes that firms have even greater duties when providing investment services to investors who decide to invest during these times of intensified market volatility.
It reminds firms of their obligation to act honestly, fairly and professionally in accordance with the best interests of their clients and to comply with all relevant MiFID II conduct of business and related organisational requirements. In particular, ESMA highlights firms' obligations in respect of product governance, information disclosure, suitability and appropriateness.
ESMA says that it and national competent authorities will continue to monitor retail clients' involvement in the financial markets and firms' compliance with their conduct of business obligations and related organisational requirements under MiFID II.
On 13 May, the FCA updated its statement on the impact of Covid-19 on the timeline for firms’ LIBOR transition plans.
The updated statement explains that, due to the Covid-19 pandemic, the PRA and FCA suspended transition data reporting at the end of Q1 for dual regulated firms, and cancelled some Q1 firm meetings. In light of the developments since, including the Financial Policy Committee statement on LIBOR published on 7 May 2020, the PRA and FCA have decided to resume full supervisory engagement with these firms on their LIBOR transition progress from 1 June 2020, including data reporting at the end of Q2.
In our April update, we reported that HM Treasury published a consultation paper on an OFR to replace the existing UCITS passporting regime. The consultation paper set out the government's proposal for a new process to allow overseas investment funds to be marketed and sold to UK investors. On 11 May 2020 the Financial Markets Law Committee (FMLC) published its response to HM Treasury’s consultation on an OFR.
The FMLC notes that, whilst HM Treasury’s consultation paper sets out, in broad strokes, its future approach to non-UK funds, much of the specificity around the criteria, timing and process of the equivalence assessments remains unknown. The FMLC, in its response, highlights the following uncertainties.
- Timing and overlap – the compressed timeline within which the existing temporary marketing permissions regime (TPMR) will cease and the proposed OFR needs to be established results in uncertainty around timing. It is not clear whether the regimes will overlap, or when "umbrella" funds will need to start using the proposed OFR and cease using the TMPR. There should be greater clarity on this and how the proposed equivalence regime will be updated over time as the UK minimum standards evolve.
- Equivalence criteria – equivalence determinations made under the proposed OFR will be "outcomes-based". This means that HM Treasury will consider whether a third country's regulatory regime provides a level of protection that is broadly comparable to that which applies to UK-authorised funds. However, the FMLC notes that it is unclear which specific areas of a third country's regime will be examined by the “outcomes-based equivalence” assessment. Further, the FMLC states that HM Treasury envisages limiting equivalence decisions to particular types of funds. Greater clarity is needed as to which types of vehicles are eligible, and whether certain fund types (such as a UCITS) will be treated as the broad equivalence standard or whether the FCA will promote certain fund types.
- Equivalence withdrawal and timing – the proposed OFR gives HM Treasury the power to modify or withdraw equivalence decisions. The FMLC states that more specific timeframes and a clear and transparent process for the modification and withdrawal of equivalence decisions would provide legal certainty and operational continuity.
- Reporting – the FMLC states that it is important that there is clarity as to the nature of the reporting requirements and the types of changes to the fund that may impact eligibility.
- Financial promotion – operators of funds marketing into the UK under the proposed OFR will not be deemed authorised persons and will have to rely on a UK authorised person to make or approve their financial promotions, unless the financial promotion falls within the scope of an exemption. Limited exemptions are available for retail funds which means, in practice, operators of third-country funds will only be able to market funds through UK authorised partners or affiliates. To avoid this result, the FMLC suggest that the equivalence regime could require OFR-recognised operators to meet the UK financial promotion standards that apply to UK authorised persons.