Investment management update

On 3 August 2020, the Financial Conduct Authority (FCA) published a consultation paper on liquidity mismatch in authorised open-ended property funds. The consultation builds on the new rules for open-ended funds investing in inherently illiquid assets set out in the FCA policy statement published in September 2019. The FCA is seeking to reduce the potential for investor harm created by the liquidity mismatch between the redemption terms of a fund, and the liquidity of the underlying property investments within a fund.

The proposals will primarily affect:

• managers of open-ended UK authorised property funds, constituted as non-UCITS retail schemes (NURS);
• feeder funds and master funds investing in property, depositaries, distributors and providers that offer access to these funds; and
• funds predominantly investing in property (FPIP) (a new term as defined in proposed FCA Glossary in Annex A of the paper).

The FCA proposes that property funds operate a notice period before processing investor redemption requests and use the following dealing structure:

• each investor's redemption request is received and recorded, then processed at the end of a notice period. The FCA is consulting on a notice period of between 90 and 180 days;
• an investor will receive the value of their investment, based on the unit price of the fund at the first valuation point following the end of their notice period; and
• redemption requests (which can still be submitted as frequently as daily) will be irrevocable. Investors cannot place orders and withdraw them before the end of the notice period if market conditions change;

The FCA clarifies that fund managers will be expected to treat this as a significant change under the Collective Investment Schemes sourcebook (COLL) and notify investors before any change comes into effect. Fund managers will have to obtain FCA approval for any changes to a fund's instrument and prospectus. However, the FCA is not proposing specific transitional arrangements for the new rules.

See FCA speech: the role of investment managers in the post-Covid-19 recovery (below), for further information regarding the FCA’s discussion of a new framework for accessing capital such as the long term assets fund and our earlier passle.

The consultation closes to comments on 3 November 2020. The FCA is aiming to publish a policy statement in early 2021.

On 16 July 2020, HM Treasury published a consultation paper on updating the UK's prudential regime before the end of the Brexit transition period, focusing on the UK implementation of the CRD V Directive ((EU) 2019/878).

HM Treasury states that it will use secondary legislation to amend the UK legislation that implemented the CRD IV Directive (2013/36/EU) to reflect amendments to that Directive made by the CRD V Directive.

Key points to note in the consultation paper

• FCA regulated investment firms will be exempt from the scope of CRD V, given the planned introduction of the Investment Firms Prudential Regime (IFPR) by summer 2021. This is on the basis that requiring these firms to be operationally ready to comply with two different and consequential sets of regulations in less than a year would be unduly burdensome and disproportionate, and to no prudential benefit. As such, it intends to make the necessary legislative amendments to ensure that non-Prudential Regulatory Authority (PRA) investment firms do not have to comply with CRD V for the period until the IFPR applies.
• FCA regulated investment firms should continue to comply with the relevant current regulation until the IFPR is in place.
• HM Treasury does not intend to introduce new requirements to implement CRD V measures on gender neutrality in respect of remuneration policies and practices or disclosures concerning firms' gender pay gaps. It considers that the current reporting and enforcement framework in England, Scotland and Wales fulfils these requirements. As the Equality Act does not extend to Northern Ireland however, HM Treasury is considering further the application of the CRD V gender-neutrality measures in Northern Ireland.

The deadline for responses is 19 August 2020. The UK is required to transpose the CRD V Directive by 28 December 2020.

On 3 August 2020, the FCA published a consultation paper on its proposals for updating its Dual-regulated firms Remuneration Code to reflect the CRD V Directive ((EU) 2019/878).

The FCA intends to update the code to reflect the remuneration requirements introduced by CRD V and the PRA's proposals for implementing these requirements set out in its recent consultation paper.

The FCA will not apply the CRD V remuneration requirements to solo-regulated investment firms. These firms should continue to apply its existing remuneration regime until the new UK prudential regime for investment firms is in place. For more information on the new prudential regime, see our article ‘New prudential regime: time for investment managers to focus’.

The consultation paper covers:

• amendments to SYSC 19D and its guidance on proportionality for dual-regulated firms. The amendments reflect CRD V reforms relating to issues including the identification of material risk takers, proportionality, minimum deferral and clawback periods and listed firms being permitted to award variable remuneration in the form of share-linked instruments and equivalent non-cash instruments;
• the FCA proposal that firms apply the amended remuneration requirements from the next performance year that begins on or after 29 December 2020;
• splitting its existing FAQs on remuneration into two: one set of FAQs will apply to firms in the scope of the Dual-regulated firms Remuneration Code and the other set to firms in scope of the IFPRU Remuneration Code; and
• further amendments to its remuneration requirements for dual-regulated firms to ensure that they work effectively at the end of the Brexit transition period.

The deadline for responses is 30 September 2020. The FCA intends to publish a policy statement before the CRD V transposition deadline of 28 December 2020.

On 24 July 2020, the FCA published a new webpage explaining how it communicates with the firms it regulates. In particular, firms should note the FCA’s stated approach to portfolio communications.

The FCA supervises all firms as members of a portfolio of firms that share a common business model. For portfolio communications, the FCA will set out its view of the main risks of harm in a portfolio, the action it expects firms to take and what it will be doing to reduce the level of harm in that sector. Where firms’ activities span multiple regulated sectors, they will receive a letter for the main portfolio they operate in. However, firms should also review letters for other portfolios that may be relevant to their business and act on the expectations set out therein. The webpage lists and provides links to the portfolio letters the FCA has published to date. Going forward, whenever the FCA sends a portfolio letter, it will add it to the webpage.

The FCA will regularly review the portfolios and make changes to its approach where appropriate.

On 29 July 2020, the FCA published a consultation on draft guidance on the fair treatment of vulnerable consumers. The consultation forms the second stage of a two-stage consultation process; in July 2019, the FCA published the first stage consultation on the aims and content of the draft guidance.

The guidance is relevant to all firms involved in the supply of products and services to retail customers who are natural persons, even if they do not have a direct client relationship with the customers. The aim of the guidance is to ensure that vulnerable consumers experience outcomes as good as those for other consumers and receive consistently fair treatment across the sectors regulated by the FCA. The FCA wants to see firms being more proactive in anticipating the needs of vulnerable consumers, for example by considering vulnerability at all stages of the product and service design process.

The deadline for responses is 30 September 2020. The FCA intends to finalise the guidance later in 2020 or early in 2021.

On 22 July 2020, the FCA published a letter sent to firms' remuneration committee chairs. The letter sets out the FCA’s findings and observations from the 2019/20 remuneration round, and explains how it plans to assess firms' remuneration policies and practices throughout 2020/21. Although, the letter is directed at remuneration chairs, all senior managers should be mindful of the messages in the letter, including firms where a remuneration committee is not required.

The letter expresses the FCA’s concern that as a consequence of the Covid-19 pandemic, there is a risk that firms may deprioritise their focus on culture due to firms redirecting resources in response to the pandemic. It reminds firms and their leaders of the importance of continuing their focus on their organisational culture.

The FCA expects firms to make material progress towards tackling inequalities and creating an inclusive environment, including through the actions of the remuneration committee chair. Going forward, firms are expected to give due consideration to the following topics.

• Accountability: Firms are expected to ensure that remuneration policies and practices remain aligned with their long-term business plans. FCA supervisors will continue to assess how policies may have evolved in response to the Covid-19 pandemic. Firms will continue to be asked how they have satisfied themselves that their policies reinforce healthy cultures and promote the right behaviours. The FCA also expects firms to consider how its remuneration policies promote equality of opportunity and ensure that diversity and inclusion is embedded within the firm’s approach to rewarding individuals and avoiding unconscious bias.
• Ex-post risk adjustments: The FCA found in their review that some firms were slow in concluding investigations on major risk and performance issues and failed to demonstrate how they aligned levels of adjustment with what they knew about individuals' conduct. Remuneration committee chairs are expected to oversee how their firm makes consistent and timely judgements on the level of adjustments made.
• Diversity and inclusion: Firms should be aware of the risks that may have a negative impact on diverse and inclusive cultures. A positive difference can be made by firms proactively recognising particular issues that some people may face and aiming to take action where possible. This is the time for firms to push forward with their diversity agenda. Gender and Black, Asian and Minority Ethnic (BAME) pay gaps provide a quantitative window into inequalities. Firms are expected to consider the analysis from reports on this and use them to address inequalities.

The letter also confirms which supporting information should be provided alongside the Remuneration Policy Statement.

On 20 July 2020, HM Treasury published a consultation paper on proposed reforms to the regulatory framework for the approval of financial promotions under the Financial Services and Markets Act 2000 (FSMA). The proposals will affect unauthorised firms as well as authorised firms that approve financial promotions for unauthorised firms.

Under the proposals, the government will establish a regulatory “gateway” which authorised firms must pass through before they are able to approve the financial promotions of unauthorised firms. Firms wishing to approve financial promotions of unauthorised firms would first need to obtain the consent of FCA.

The deadline for responses to the consultation is 25 October 2020.

HM Treasury has published a policy statement on changes it intends to make to the FCA's process for cancelling firms' authorisation.

The statement explains that the current process for cancelling a firm’s authorisation is no longer sufficient to allow the FCA to quickly cancel a firm’s authorisation where the FCA suspects it is no longer carrying out an authorised activity and remove such firms from the Financial Services Register.

In light of this, the government intends to provide an additional process through which the FCA can cancel a firm’s authorisation. The FCA will be entitled to start the new process in a range of situations, including when a firm has failed to pay its fees or file returns.

The new proposed process will sit alongside the existing cancellation procedure. The FCA will be able to serve a first notice by letter (or by electronic means where agreed with the firm). If the firm does not respond within 28 days, including after a second notice is sent, the FCA will publish a notice on its website and on the FCA Register entry for that firm. After one month of the public notice, the FCA will cancel the firm's authorisation. At any stage of the procedure, until cancellation, the firm in question can notify the FCA in writing that it is carrying on a regulated activity. The FCA will then end the procedure and can remove any notice it has published.

The new process will apply only to FCA solo-regulated firms; dual regulated firms are not in scope of the proposals. The government has stated that it intends to take forward this measure when Parliamentary time allows.

On 22 July 2020, the European Commission adopted the following Delegated Regulations supplementing the Benchmarks Regulation ((EU) 2016/1011) (BMR) which set out the minimum requirements for benchmark administrators and contributors under BMR on sustainable finance issues.

• Delegated Regulation supplementing the BMR as regards the explanation in the benchmark statement of how environmental, social and governance factors are reflected in each benchmark. This Delegated Regulation sets out the explanation that should be included in the benchmark statement about how ESG factors are reflected in each benchmark or, where applicable, family of benchmarks provided and published.
• Delegated Regulation supplementing the BMR as regards minimum standards for EU climate transition benchmarks and EU Paris-aligned benchmarks. This Delegated Regulation sets out the minimum standards that EU climate transition and EU Paris-aligned benchmarks should meet in order to be labelled as such, and lays down the transparency requirements on the methodology for both benchmarks.
• Delegated Regulation supplementing the BMR as regards the minimum content of the explanation on how ESG factors are reflected in the benchmark methodology. This Delegated Regulation lays down the minimum content of the explanation of how the key elements of the benchmark methodology reflect ESG factors for each benchmark, with the exception of interest rate and foreign exchange benchmarks, as well as the standard format to be used. 

The next step will be for the Council of the EU and the European Parliament to consider the Delegated Regulations. If neither the Council nor the Parliament object to the Delegated Regulations, they will be published in the Official Journal of the EU (OJ).

The Delegated Regulations will enter into force and apply 20 days after publication in the OJ.

On 8 July 2020, the FCA published a speech by Christopher Woolard, FCA Interim Chief Executive, on the role of investment managers in the post-Covid-19 recovery.

Particular points of interest in Mr Woolard's speech include the FCA’s recognition of the:

• difficulty for open-ended property funds to maintain a promise of daily liquidity to investors when their assets are inherently illiquid. Mr Woolard stated that the FCA intends to consult later in summer 2020 on whether long-term investor interests would be better served by finding a way in which open-ended property funds could safely transition to a structure in which liquidity promises to investors are better aligned with the liquidity of fund assets. See above item, “FCA consultation on liquidity mismatch in authorised open-ended property funds” for further information;
• need for recapitalisation following the levels of lending provided as a result of the Covid-19 pandemic. To continue to support the vital work of recapitalisation, the FCA is seeking to understand whether there are some types of issuers that are unlikely to be served by public or private markets over the period of crisis into recovery. If there are, the FCA wants to know whether the current framework accommodates a wide range of issuers and those investors able to understand and bear the inherent risks involved; and
• need for less focus on tick box compliance and more on promoting outcomes that serve the public interest.

In discussing the issues regarding recapitalisation, Mr Woolard stated that the FCA wants to understand how the rules ought to be calibrated. In particular, the FCA raised the question about whether some elements of the framework inhibit rather than promote opportunities for issuers and investors. For instance, issuers whose securities are traded every day must, rightly, meet continuous disclosure requirements (to prevent market abuse and support investor confidence in traded prices). However, at the smaller end of the corporate spectrum, there are companies who do not have the scale to meet these requirements. The FCA welcomes a discussion on whether and how such companies could best access capital markets – for example, with periodic disclosures, perhaps with more periodic trading. Mr Woolard also considered if there might be a link between such less liquid securities and the Investment Association’s own work on the Long-Term Asset Fund. For more information on the Long-Term Asset Fund, see our Q&A ‘Patient capital: the retailisation of illiquid funds’.

The FCA is encouraging the investment management sector to work with it to ensure it creates a high-quality regulatory framework that supports a financial system fit for recovery and promotes outcomes that serve the public interest.

On 17 July 2020, the FCA published a consultation paper on extending the implementation deadlines for the certification regime and conduct rules for FCA solo-regulated firms. In our July edition, we reported that HM Treasury agreed to delay the deadline for solo-regulated firms to undertake the first assessment of the fitness and propriety of their certified persons under the Senior Managers and Certification Regime (SM&CR) from 9 December 2020 until 31 March 2021 in the light of the Covid-19 pandemic.

For solo-regulated firms that are not benchmark administrators, the FCA sets out proposals to extend the deadlines to 31 March 2021 for the following requirements:

• the date the conduct rules come into force, for staff who are not senior managers or certification staff;
• the date by which relevant employees (i.e. those who are not senior managers or certification staff) must have received training on the conduct rules;
• the deadline for submission of information about directory persons to the Financial Services Register; and
• references in the FCA rules to the deadline for assessing certified persons as fit and proper.

The FCA expects that the majority of firms will not need to use this extension. It encourages firms that are able to complete certification assessments, conduct rules training and directory persons reporting by 9 December 2020 to do so, provided that this does not affect the quality of their assessments or training.

The deadline for responses is 14 August 2020. 

On 31 July 2020, the FCA updated its statement on how firms should handle complaints during the Covid-19 pandemic. It builds on its original statement and subsequent updates published in May 2020 which we reported on in our May and June editions. 

As the pandemic continues, the updated statement clarifies:

• the FCA considers that firms have now had enough time to embed new ways of working. As such, a failure to comply with DISP 1.6, or other complaint handling requirements, should only arise in exceptional circumstances connected to the impact of Covid-19. Any firm that is facing difficulties in complying with DISP 1.6 should contact the FCA;
• the FCA continues to expect senior managers to be accountable for effectively overseeing how their firms handle complaints. Where firms are experiencing reduced complaint handling capacity as a result of Covid-19, they are expected to prioritise paying complainants promptly if they have been offered redress and accepted that offer (including compensation awarded by the Financial Ombudsman Service (FOS));
• firms should be mindful that the FCA expects them to co-operate with the FOS on any complaints that it is considering, and respond to requests for information in a timely fashion, as required by DISP 1.4.4R.

The FCA intends to review and update the statement again by the end of October 2020.

On 13 July 2020, the Bank of England (BoE) published a speech by BoE Governor, Andrew Bailey, on entering the LIBOR endgame.

Key points in Mr Bailey's speech

• Plans to transition from LIBOR to alternative reference rates need to be in place by end 2021.
• Despite the Covid-19 pandemic, work on transition in sterling markets has continued. There has been considerable progress in the both the UK and US since last year.
• Markets' efforts must now turn to much broader communication to ensure LIBOR end-users understand the weaknesses, why they need to move to alternatives and what the timeline is for the action they will need to take to prepare.
• From August 2020, the BoE will begin publication of a freely available compounded SONIA index to support use of the rate across a wide range of sterling products.
• In September 2020, the Working Group on Sterling Risk-Free Reference Rates will begin a further programme of public communications to help those with LIBOR-linked exposures navigate to more robust alternatives.
• From October 2020, UK banks should be offering alternatives to LIBOR. The BoE does not expect to see any further sterling LIBOR-linked lending after the end of March 2021. Regulated firms should expect their supervisors to monitor and discuss their progress with these milestones.
• A robust and trusted fallback for derivative contracts will shortly be introduced. The BoE is encouraging early sign-up to the protocol, but notes that it is not a substitute for continuing to move business onto near risk-free rates.
• The government announced last month its intention to legislate to provide the FCA with increased powers to deliver an orderly wind-down of critical benchmarks, such as LIBOR. The FCA will consult on what that action may look like and what the limitations of any solution may be.

Firms must take action now to ensure that they are transitioning from LIBOR to robust alternative rates and that they have concrete plans in place to deal with legacy exposures.

On 3 August 2020, the FCA published a speech given by the FCA Director of Markets and Wholesale Policy, Edwin Schooling Latter, noting the critical tasks ahead in the second half of 2020 relating to LIBOR transition and highlighting the limitations on its powers to manage the LIBOR transition.

Key takeaways from Mr Schooling Latter’s speech

• The four to six months ahead are arguably the most critical period in the transition away from LIBOR and the time to act is now. He confirms that the need to act on LIBOR transition has not been pushed back by the impact of Covid-19.
• ISDA is close to finalising the protocol and other documentation through which outstanding derivatives contracts that reference LIBOR can transform, more or less seamlessly, to work on the new risk-free rates (RFRs). Firms will need to sign the protocol within the four-month adherence period that ISDA will offer after the protocol is published this summer.
• The FCA welcomes the legislation put forward to give it additional powers to enhance its ability to manage the LIBOR end-game. However, Mr Schooling Latter stresses that these powers are not an alternative to transition. Firms still need to be ready for life without LIBOR. The FCA will only use its powers in respect of legacy transactions if doing so is necessary to protect consumers or market integrity.
• The existence of the powers does not mean that firms do not need the protocol. The FCA may not be comfortable using the powers unless there has been wide take up of the protocol – it does not view a synthetic LIBOR as a suitable foundation for derivatives markets.
• ISDA's protocol is necessary but insufficient. In the FCA's supervisory capacity, it will be expecting firms to be able to show that they have robust fallback documentation in place before LIBOR ceases or becomes unrepresentative. In addition, it expects firms to have completed transition for all new business, and have plans that make use of opportunities to reduce legacy LIBOR books before the end comes.

On 24 July 2020, the European Commission published a proposal for a regulation making targeted amendments to the Benchmarks Regulation ((EU) 2016/1011) (BMR) to address risks associated with the cessation of LIBOR in 2021.

The proposal is to provide a framework for a statutory replacement rate. This is to ensure that when a widely used benchmark is phased out, it does not cause economic disruption. A statutory replacement rate is a rate that the Commission can designate by law. Such a rate would take the place of LIBOR in all contracts and financial instruments that mature after 2021.

Under the proposals, the Commission would be able to designate a statutory replacement benchmark once it becomes clear that the cessation of LIBOR would result in significant disruption in the functioning of financial markets in the EU. The powers would be triggered as soon as the effective date for the cessation becomes clear. In doing so, the Commission will take into account the recommendations made by dedicated working groups on replacement rates. The powers of the Commission to designate a statutory successor for LIBOR would only apply to contracts concluded by supervised entities, such as investment firms or asset managers, as these contracts are governed by the BMR; contracts that do not involve supervised entities will not benefit from the statutory replacement rate.

The Commission is also proposing an adjustment to the BMR that will allow EU users to continue using currency benchmarks provided outside the EU, therefore allowing EU companies covering the risk of foreign currency fluctuations in their exporting and foreign investment activities.

On 7 July 2020, the FCA published an updated version of its webpage on UK firms considering how the end of the Brexit transition period may impact their business and customers.

Focusing in particular on outsourcing, the FCA advises firms to consider how their outsourcing and third-party relationships will be affected at the end of the transition period. Firms should also consider the associated operational risk to their business and the potential harm to consumers that may result from any change or disruption to the outsourced services provided.

The FCA expects firms to have a clear understanding of their dependencies on outsourcing or third-party service providers so they can assess whether they will be able to continue providing their services after the transition period. It sets out the following indicative list of questions that may help firms to decide how the end of the transition period might affect their outsourcing arrangements.

• Has the firm identified its key third-party service providers?
• Has the firm considered if these service providers will be materially affected by the end of the transition period?
• Has the firm and its third-party service providers discussed their respective plans for the end of the transition period, to ensure that the third-party service providers can continue to service the firm?
• Has the firm considered the potential demand for change management resources at critical service providers (arising from more than one client making increased demands on the service provider)?

Until the position on Brexit becomes clearer, UK firms are expected to continue to consider the implications of a range of scenarios, including that the UK and the European Union do not conclude a free trade agreement or make any equivalence determinations before the end of the transition period. For more information on approach to outsourcing dependencies, see our earlier passle ‘Brexit: are some senior managers suffering a false sense of security?’

On 7 July 2020, the European Commission published an updated version of its notice to stakeholders on the consequences of Brexit on the EU’s rules in the field of asset management. This update replaces the previous version published on 8 February 2018.

The notice has been updated to address the legal situation and practical implications that the end of the Brexit transition period on December 31 2020 will have on asset managers. After the Brexit transition period ends, the EU rules in the field of asset management will no longer apply to the UK. The changes will affect both UK-based asset managers who manage EU-based funds and EU-based managers managing UK-based assets.

Key takeaways from the updated notice

• UCITS management companies’, AIFMs and investors’ business adaptations and strategies will have to be ready for the situation where UK established entities cannot benefit from the third country passport regime laid down in Directive 2011/61/EU.
• UCITS management companies and AIFMs are advised to take appropriate action, such as obtaining an authorisation to manage non-EU AIFs (former UK UCITS or UK AIFs) and reviewing, when appropriate, the delegation of certain operational functions to providers established in the UK.
• By the end of the transition period:
  • AIFMs must disclose to investors any material change to the information that is required to be disclosed in accordance with Article 23 of Directive 2011/61/EU, which includes, but is not limited to, the legal implications of the contractual relationship entered into for the purpose of investment; and
  • UCITS management companies must keep up to date the essential elements of prospectus and a key investor information document. This includes information on Member States in which the management company is authorised, where the UCITS is managed or marketed cross-border.

On 20 July 2020, the House of Lords EU Services Sub-Committee published a letter it has sent to John Glen, Economic Secretary and City Minister, on the UK-EU negotiations in financial services and UK financial services after Brexit.

The letter follows Mr Glen’s appearance before the committee on 2 July 2020 during which he gave evidence on the UK-EU negotiations in financial services. The letter raises questions on some of the points considered during the discussion.

• UK-EU equivalence decisions: the committee asks whether the government's equivalence decisions for the EU should not be expected until autumn 2020 and whether these will only be published alongside the EU's equivalence decisions. It queries how this process will interact with the government's equivalence decisions for other third countries and its forthcoming guidance document on the UK's equivalence framework.
• Future UK-EU regulatory co-operation: the committee notes that the government has repeatedly called for a "structured dialogue" with the EU on financial services, as have both UK and EU industry groups. However, in a speech given in June 2020, Michel Barnier reaffirmed the EU’s position that there should be a "voluntary framework for dialogue" on financial services. The committee questions how, in Mr Glen's view, such a voluntary framework differs from the proposed structured dialogue and what limitations it would entail.
• The future regulatory framework for UK financial services: the committee notes that the government will soon be consulting on the second phase of its financial services future regulatory framework review. The committee requests clarification on how the government intends to engage with Parliament to ensure this issue is fully understood and does not result in insufficient parliamentary scrutiny in the UK's future regulatory framework. Specifically, it asks whether the consultation will outline specific proposals for enabling parliamentary oversight and consider models of accountability that exist in other jurisdictions.

The committee expects to receive a response to their questions in due course.