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05 December 2018

Investment Management Update

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

This issue includes:

General

Brexit

General

IT failures in the financial services sector:  Treasury Committee launches inquiry

HM Treasury’s Commons Select Committee has launched an inquiry into IT failures in the financial services sector. The purpose of the inquiry is to focus on the common causes of operational incidents in the financial services sector, the detriment caused to consumers as a result of such incidents and whether regulators have the relevant skills to adequately hold people to account for such incidents. Various financial institutions have written to the Committee outlining the disruption caused to customers as a result of IT failures within their organisations. The Committee calls for evidence on a number of topics listed on the inquiry webpage, including: 

  • the common causes of operational incidents in the financial services sector;
  • the ability of the regulators to ensure firms are adequately guarding against service disruptions;
  • the quality of technical documentation and the impact of outsourcing on operational resilience;
  • discussions on what should be considered an appropriate level of tolerance for operational disruptions; and
  • examples of best practice with respect to firms’ responses to and handling of operational incidents, including approaches to communicating with customers, identifying and addressing the causes of incidents, and handling customer complaints and compensation.

The deadline for submissions is 18 January 2019.

Executive remuneration: IA Principles of Remuneration

The Investment Association (IA) has published an updated version of its Principles of Remuneration. The updated Principles supersede the November 2017 version. The Principles set out investor expectations and best practice for how companies should pay their top executives. The following areas have been updated since the last edition to provide further clarity:

  • malus and clawback;
  • shareholding requirements and post-employment holding periods;
  • pensions;
  • restricted shares; and
  • leaver provisions.

Technology and cybersecurity: top priorities for the FCA

Following publication last month of the House of Commons Treasury Committee’s inquiry into IT failures and operational resilience in the financial sector, the Financial Conduct Authority (FCA) has published a report covering cyber and technology resilience. The report progresses on the joint Bank of England, Prudential Regulation Authority (PRA) and FCA Discussion Paper, published in July 2018 on building the UK financial sector’s operational resilience. The report gives the results of an FCA survey of 296 firms during 2017 and 2018 to assess their technology and cyber capabilities. The survey looked at key areas such as governance, delivery of change management, managing third party risks and effective cyber defences. In the report, the FCA identifies areas of strength and improvement across all sectors. Among others, these include:

  • the FCA’s expectation that firms should report major technology outages and cyber-attacks to the FCA as currently firms are under-reporting;
  • firms should have clear accountabilities in their governance structure for technology resilience;
  • there is a lack of Board understanding of cyber risks and the presentation of management information (MI) on these issues is not always clear or challenged; and
  • improvement is required in the areas of information sharing, detection of attacks and identifying key assets, services and people, including those provided by third parties.

The FCA encourages all firms to consider how the findings in the report apply to them. In particular, the FCA indicates that key areas of focus, such as third-party management and change management, will be considered in its supervisory plans for 2019. Alongside the report, the FCA also publishes an infographic to assist firms in knowing how to react to a cyber-attack. Firms need to tell the FCA as soon as they know of “material” cyber incidents which affect the firm. The infographic explores the steps firms can take to protect themselves, as well as points to consider when responding and recovering from an attack.

In a speech launching the report and infographic, Megan Butler, Executive Director of Supervision - Investment, Wholesale and Specialist at the FCA, stressed that senior managers need, at Board level, "enough knowledge, in-house capability and high quality MI to question the infallibility of their big (and small) ticket IT change programmes", but it is classic systems and controls failures which often let firms down.

FCA Mission: Approach to Authorisation and feedback statement

Following a December 2017 consultation on the document, the FCA has published “FCA Mission: Approach to Authorisation” with feedback to its consultation appearing at Annex 1 to the document. The paper addresses the following:

  • the legal basis for, and the purpose of, authorisation;
  • the difference between authorisation and registration;
  • how the FCA evaluates whether firms meet its threshold conditions for authorisation and whether individuals are “fit and proper”;
  • refusing and cancelling authorisation;
  • using authorisation to promote effective competition;
  • how and why the FCA revokes an authorisation;
  • helping firms respond effectively to regulatory change; and
  • improving the FCA’s approach and measuring the FCA’s performance.

Sanctions and Anti-Money Laundering Act 2018 (Commencement No.1) Regulations 2018

The Sanctions and Anti-Money Laundering Act 2018 (Commencement No.1) Regulations 2018 (SI 2018/1213) were made on 21 November 2018. These regulations bring into force the following provisions of the Sanctions and Anti-Money Laundering Act 2018 (SAMLA 2018):

  • sections 1 to 31;
  • sections 33 to 48;
  • sections 57 and 58;
  • schedule 1; and
  • paragraphs 1 to 7, and sub-paragraphs (1) to (3) of paragraph 8, of schedule 3 and section 59(4) so far as it relates to these provisions.

The SAMLA 2018 will enable the government to impose sanctions after the UK leaves the EU. Certain provisions of the SAMLA 2018 will be brought into force at a later date.

Global LEI System: LEI ROC consultation paper on fund relationships

The Legal Entity Identifier (LEI) Regulatory Oversight Committee (ROC) has published a second consultation paper on fund relationships in the Global LEI System (GLEIS). The consultation paper details proposals for a limited update to the way relationships affecting funds are recorded in the GLEIS. The objectives are to make sure that the implementation of relationship data is consistent throughout the GLEIS and to facilitate a standardised collection of fund relationship information at the global level. These objectives are being pursued by providing a definition for each fund relationship and better aligning the data structure with what is done for direct and ultimate accounting parent entities as defined in the LEI ROC report of March 2016.

The deadline for submitting responses to the consultation paper is 14 January 2019. Feedback will inform the final version of the policy framework that the ROC will approve for implementation by the Global LEI Foundation. Implementation is not expected before January 2020.

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Brexit

Draft political declaration on the framework for the future UK-EU relationship

The government has published the draft political declaration on the framework for the future UK-EU relationship. Financial services aspects include:

  • the UK and the EU's (the “Parties”) commitment to preserving financial stability, market integrity, investor and consumer protection and fair competition, while respecting regulatory autonomy and the ability to take equivalence decisions in their own interest;
  • the Parties will have equivalence frameworks in place and should begin assessments as soon as possible following the UK’s exit from the EU, with the aim to conclude any assessments before the end of June 2020;
  • the Parties agree that close and structured cooperation on regulatory and supervisory matters is in their mutual interest; and
  • this cooperation should be grounded in the economic partnership and based on the principles of regulatory autonomy, transparency and stability. It should include transparency and appropriate consultation in the process of adoption, suspension and withdrawal of equivalence decisions, information exchange and consultation on regulatory initiatives and other issues of mutual interest, at both political and technical levels.

Brexit changes to FCA Handbook and BTS: second FCA consultation

The FCA has published a second consultation paper (CP18/36) proposing changes to the FCA Handbook and to binding technical standards (BTS) to address deficiencies arising from Brexit. For information on the FCA’s first consultation paper (CP18/28), see our Update of 24 October 2018.

The second consultation paper:

  • discusses a range of cross-cutting issues which span the FCA Handbook and BTS and the FCA’s proposed approach to these. This includes further issues identified since the publication of the first consultation paper (Chapter 2);
  • explains the FCA Handbook proposals covered in the second consultation paper (except those related to the introduction of the temporary permissions regime (TPR) and the new credit rating and trade repository regimes) (Chapter 3);
  • sets out proposals relating to the TPR which were previously described but not consulted on in the first consultation paper (Chapter 4);
  • outlines changes which the FCA proposes to make to BTS (Chapter 5); 
  • summarises the FCA’s approach to forms and the guidance the FCA proposes to issue on this (Chapter 6);
  • outlines the transfer of supervision from the EU to the FCA with regards to credit rating agencies and trade repositories registered under the UK regime (Chapter 7); and
  • summarises the FCA’s proposed approach to non-Handbook guidance issued by the FCA and the guidance the FCA proposes to issue on this (Chapter 8).

The deadline for submitting comments to the FCA is 21 December 2018. The FCA intends to publish feedback and near final instruments in early 2019.

Legal uncertainties relating to draft Brexit SIs affecting funds and their managers: FMLC report

The Financial Markets Law Committee (FMLC) has published a report on the legal uncertainties arising from the changes proposed by the draft Alternative Investment Fund Managers (Amendment) (EU Exit) Regulations 2018 (the “AIFM SI”) and the Draft Collective Investment Schemes (Amendment etc.) (EU Exit) Regulations 2018 which affect investment funds and their managers. Please see our Update of 24 October 2018 for discussion of drafts of the SIs. The FMLC report addresses uncertainties relating to:

  • references to other legislation;
  • the temporary marketing provisions for funds in the AIFM SI;
  • temporary recognition of UCITS;
  • delegation of AIFM functions;
  • restriction on promotion of sub-funds; and
  • transfer of functions to HM Treasury and the SIs being too cumbersome a mechanism given the pace at which new market practices and products emerge.

The FMLC encourages the government to publish, where possible, guidance which might enable funds and managers to begin planning for the future.

EU withdrawal impact assessment: FCA reports to Treasury Committee

At the request of the House of Commons Treasury Committee, the FCA has published an EU withdrawal impact assessment, alongside a covering letter from Andrew Bailey, FCA Chair. The FCA's assessment covers the impact of Brexit in the following three areas:

  • the UK leaves the EU without an agreement, either on 29 March 2019 or after the implementation period on 31 December 2020. Among others, outstanding uncertainties include the extent of supervisory cooperation and how the separation of shared systems for market oversight will be managed;
  • the draft Withdrawal Agreement and the FCA and the government's input into shaping and influencing the evolution of financial services law. The FCA notes that the risks presented with an implementation period are preferable to the risks of a no-deal scenario; and
  • the outline of the political declaration on the framework for the future relationship between the EU and the UK. This includes commitments to preserving financial stability, market integrity, investor protection and fair competition, while respecting each parties' autonomy and ability to take equivalence decisions in their own interest.

In his covering letter, Mr Bailey notes that there is good reason to keep the duration of the implementation period to a minimum. This is because there remains uncertainty around the UK's role in the governance of the pipeline of EU legislation and rule-making during this period. Accordingly, Mr Bailey highlights that the FCA welcomes the commitment in the political declaration for both sides to undertake, during the implementation period, equivalence assessments where they are possible under the relevant legislation.

EU withdrawal scenarios and monetary and financial stability: BoE reports to Treasury Committee

Also at the request of the House of Commons Treasury Committee, the Bank of England (BoE) has published a report analysing how leaving the EU would affect its ability to deliver its objectives for monetary and financial stability. The report analyses the economic effects of the Withdrawal Agreement and the political declaration, as well as the consequences of leaving the EU without a deal.

Draft Brexit SI laid before Parliament: Alternative Investment Fund Managers (Amendment) (EU Exit) Regulations 2018

On 29 November 2018, a draft version of the Alternative Investment Fund Managers (Amendment) (EU Exit) Regulations 2018, as laid before Parliament, was published, accompanied by an explanatory memorandum. The regulations will come into force on exit day. See our Update of 24 October 2018 for discussion of an earlier draft of the SI. 

Draft Brexit SI explanatory note: Money Market Funds (Amendment) (EU Exit) Regulations 2018

The Treasury has published an explanatory note for the draft Money Market Funds (Amendment) (EU) Regulations 2018. The draft SI is in its developmental stages and will be published in due course. The purpose of the SI is to change the scope of the retained Money Market Funds (MMF) Regulation to apply to MMFs established in the UK only.

As MMF managers are currently regulated by the UCITS Directive and the Alternative Investment Fund Managers Directive, such fund managers will also be subject to changes made under separate SIs for those directives brought forward under the EU Withdrawal Act.

The MMF SI:

  • requires that the manager of an MMF is established in the UK, with the temporary exception of EEA MMFs currently marketed in the UK via a passport;
  • incorporates a transitional arrangement which enables all MMFs with a temporary marketing permission to be able to continue to be marketed for the duration of the temporary permissions regime;
  • transfers functions held by the European Commission to the Treasury; and
  • transfers functions held by the European Securities and Markets Authority (ESMA) to the FCA.

HM Treasury intends to lay the MMF SI before Parliament prior to exit day.

Draft Brexit SI: Long-term Investment Funds (Amendment) (EU Exit) Regulations 2018

HM Treasury has published a draft version of the Long-term Investment Funds (Amendment) (EU Exit) Regulations 2018, accompanied by an update to the explanatory note which also covers the Venture Capital Funds (Amendment) (EU Exit) Regulations 2018 and the Social Entrepreneurship Funds (Amendment) (EU Exit) Regulations 2018. We reported more fully on related developments in our Update of 7 November 2018.

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

HM Treasury has published a draft version of the Packaged Retail and Insurance-based Investment Products (Amendment) (EU Exit) Regulations 2019, accompanied by an explanatory note.  The purpose of the SI is to make amendments to the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulations 2017 (SI 2017/1127) (UK PRIIPs SI) and retained EU law in relation to PRIIPs and fix any deficiencies to the legislation, to ensure that is continues to operate effectively in the UK on exit day. The explanatory note indicates that the changes for firms resulting from this SI are expected to be minimal. The explanatory note states that the UK PRIIPs regime introduced by this SI will be operationally equivalent to the EU PRIIPs regime on exit day, so that firms manufacturing or advising on PRIIPs for sale to UK investors continue to be subject to the same obligations as they are currently.

Amendments in the draft SI include:

  • the introduction of a UK PRIIPs regime which will only apply to those firms (UK and third-country) that manufacture, advise on or sell PRIIPs to investors in the UK; and
  • retaining existing exemptions in the EU PRIIPs Regulation so that any products which are currently outside the scope of the EU PRIIPs Regulation will also be outside the scope of the UK PRIIPs regime.

HM Treasury intends to lay the SI before Parliament prior to exit day.

Draft Brexit SI explanatory note: Financial Services and Markets Act 2000 (Amendment) (EU Exit) Regulations 2019

The Treasury has published an explanatory note for the draft Financial Services and Markets Act 2000 (Amendment) (EU Exit) Regulations 2019. The SI is under development and will be published in due course. The purpose of the SI is to ensure that the financial services framework continues to operate effectively in a no-deal scenario; it is not intended to make substantive policy changes.

The SI, when made, will include provisions to:

  • amend definitions for regulated activities and entities used in the Financial Services and Markets Act 2000 (FSMA), the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 and the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001;
  • change the territorial scope of definitions from the EEA to the UK and definitions of third-country activities or entities to cover the EEA as well as non-EEA countries;
  • revoke references to passporting;
  • remove the section 59(8) and section 63E(7) exemptions relating to the approved persons regime and senior managers regime, subjecting EEA firms to the same framework as non-EEA firms;
  • amend provisions in Part 7 of FSMA relating to the transfers of insurance business from the EEA to the UK or from the UK to another EEA state;
  • introduce an onshoring provision for firms that are currently in the process of making Part 7 insurance transfers, whereby parties which have initiated a Part 7 insurance transfer prior to exit day will have up to two years from exit day to obtain a court order sanctioning the transfer;
  • amend provisions in Schedule 12 of FSMA relating to insurance business transfers involving Switzerland, with the intention of them being amended to facilitate a future agreement for Swiss firms between the UK and Switzerland; and
  • retain the requirements, including the control thresholds and notification bands for directive and non-directive firms, under Part 12 of FSMA (control over authorised persons).

HM Treasury plans to lay the SI before Parliament prior to exit day.

Draft Brexit SI explanatory note: E-Commerce Directive relating to financial services

HM Treasury has published an explanatory note on onshoring elements of the E-Commerce Directive (ECD) relating to financial services. Currently, under the ECD, EEA firms undertaking regulated financial services activities in the UK delivered solely over the internet are exempt from requiring UK authorisation. Post-Brexit, this exemption will cease to apply. Therefore, the following provisions relating to the exemption will be revoked:

  • article 72A of the Financial Services and Markets Act (Regulated Activity) Order 2001;
  • article 20B Financial Services and Markets Act 2000 (Financial Promotion) Order 2005; and
  • some elements of the Electronic Commerce Directive (Financial Services and Markets) Regulations 2002.

The SI will be laid before Parliament in due course and the FCA will make changes to its Handbook to account for the changes.

Draft Brexit SI explanatory note: Official Listing of Securities, Prospectus and Transparency (Amendment) (EU Exit) Regulations 2019

The Treasury has published a draft explanatory note for the draft Official Listing of Securities, Prospectus and Transparency (Amendment) (EU Exit) Regulations 2019. The purpose of the SI is to replicate, as far as possible, the current effects of the prospectus regime, the transparency rules and the listing rules that apply across the EU which stem from the Prospectus Directive (PD) and the Transparency Directive (TD). The Treasury notes that there are no policy deficiencies related to the Consolidated Admissions and Reporting Directive.

The explanatory note indicates that, in the event of a no-deal Brexit, the SI will:

  • require firms wishing to access UK capital markets for offers to the public or admissions to a regulated market to seek FCA approval of their prospectuses;
  • provide that prospectuses “passported” into the UK prior to exit day will be grandfathered for use in the UK until their validity expires; and
  • extend the existing exemptions for EEA public sector bodies to certain third-country public sector bodies and international bodies of which a state is a member.

For further commentary, see our recent Corporate Law Update.

The Treasury intends to lay the SI before Parliament in January 2019 and the FCA ultimately will update its Handbook and relevant BTS to reflect the changes introduced through this SI.

Draft Brexit SI: Market Abuse (Amendment) (EU Exit) Regulations 2018

HM Treasury has published a draft version of the Market Abuse (Amendment) (EU Exit) Regulations 2018, accompanied by an explanatory note. The purpose of the SI is to ensure that the retained EU law relating to market abuse, which stems from the Market Abuse Regulation (MAR), continues to operate effectively post-Brexit. The SI:

  • ensures that the scope of “UK MAR” captures conduct related to instruments admitted to trading or traded on both UK and EU trading venues;
  • retains the EU MAR’s notification requirements for issuers to report certain information to the relevant national competent authorities, including obligations to report manager transactions, any delay in publicly disclosing inside information and, on request, insider lists;
  • retains the EU MAR’s requirement that firms and venues located in the UK provide suspicious transaction and order reports to the FCA;
  • transfers the powers and functions of ESMA with regards to enforceability to the FCA; and
  • removes the unilateral obligation on UK supervisors to share information or cooperate with EU authorities.

HM Treasury intends to lay this instrument before Parliament prior to exit day.

Draft Brexit SI explanatory note: Benchmarks (Amendment) (EU Exit) Regulations 2018

HM Treasury has published an explanatory note for the draft Benchmarks (Amendment) (EU Exit) Regulations 2018. The SI will make amendments to retained EU law related to the EU Benchmarks Regulation (BMR) to ensure that it continues to operate effectively in the UK once the UK has left the EU.

The explanatory note details that the SI will:

  • ensure that UK-located benchmark administrators seeking authorisation or registration will continue to apply to the FCA;
  • clarify that the scope of the onshored Regulation (and thus of authorisation or registration by the FCA) is the UK, and not the whole of the EU;
  • ensure that EU-located administrators are subject to the onshored third-country regime, which requires third-country administrators or benchmarks to become approved through recognition or endorsement applications to the FCA to allow use of their benchmarks in the UK by supervised entities (unless and until an equivalence determination is made);
  • create a UK register for benchmarks which the FCA will maintain from exit day. Therefore, UK supervised entities may only use benchmarks which are on the UK register. However, the SI contains an additional transitional provision which temporarily migrates over to the UK register for a 24-month period any benchmarks or administrators which appear on the ESMA register at exit day as a result of a successful application outside of the UK. These third-country administrators or benchmarks must become approved by the FCA through equivalence, recognition or endorsement to enable their continued use within the UK beyond this 24-month period; and
  • enable the migration onto the UK register without further action: (a) administrators already authorised or registered in the UK by the FCA on exit day; and (b) third-country benchmarks and/or administrators that have been recognised by the FCA, or endorsed by UK administrators or supervised entities (with such endorsement authorised by the FCA) prior to exit day.

HM Treasury intends to lay this instrument before Parliament before the UK’s exit from the EU.

Brexit legislation: Financial Services (Implementation of Legislation) Bill 2017-19 introduced to Parliament

The Financial Services (Implementation of Legislation) Bill 2017-19 has been introduced to Parliament and an explanatory note has been published. In the event of a no-deal scenario, the government will not have a mechanism for the timely implementation of EU financial services legislation into domestic law. To address the legislative gap, in a no-deal scenario, this Bill will provide the government with the power to implement and make changes to “in-flight” EU financial services legislation for two years after the UK’s withdrawal from the EU. “In-flight” legislation is either adopted by the EU but is yet to apply, therefore not being captured in the EU Withdrawal Act 2018, or is currently under negotiation and may be adopted up to two years post-Brexit.

The Bill is due to have its second reading in the House of Lords on 4 December 2018 and will come into force the day it is passed.

In a Policy Note on the Bill, HM Treasury outlines the reasoning for choosing the “in-flight” legislation set out in the Bill. HM Treasury also highlights certain elements of proposed EU legislation that it may choose not to implement.

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