Investment Management Update
This issue includes:
- Asset management market study: FCA policy statement on further remedies
- Securitisation Regulation: ICMA guide to investor due diligence requirements
- PRIIPs KID: ESAs final report and supervisory statement on performance scenarios
- SM&CR: FCA video of banking leaders’ experiences
- Certification Regime regulatory references: BSB guidance consultation
- MiFIR data reporting: ESMA updates Q&As
- Global Financial Innovation Network: FCA update
- FSCS management expenses levy limit 2019/20: FCA and PRA joint consultation paper
- Timings for technical standards under Investment Firms Regulation and Directive: EBA letter
- Cooperation and exchange of information: FCA agrees MoUs with ESMA and EU regulators to enable delegation models post-Brexit
- Supervision of non-EU branches of EU firms providing investment services and activities: ESMA MiFID II supervisory briefing
- Brexit and expectations of firms: FCA statement on use of its temporary transitional power
- Use of UK data in ESMA databases and performance of MiFID II calculations following a no-deal Brexit: ESMA statement
- Financial sanctions: HM Treasury and OFSI’s Post-EU Exit Guide
- Draft Brexit SI laid before Parliament: Financial Services (Distance Marketing) (Amendment and Savings Provision) (EU Exit) Regulations 2019
- Draft Brexit SI laid before Parliament: Financial Services and Markets Act (Amendment) (EU Exit) Regulations 2019
- Draft Brexit SI laid before Parliament: Gibraltar (Miscellaneous Amendments) (EU Exit) Regulations
- Draft Brexit SI laid before Parliament: Financial Regulators' Powers (Technical Standards etc.) and Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2019
- Draft SI published: Financial Services (Miscellaneous) (Amendment) (EU Exit) Regulations 2019
- Liquidity stress testing of UCITS and AIFs: ESMA consults on draft guidelines
- EuVECA Regulation: European Commission adopts conflicts of interest Delegated Regulation
- EuSEF Regulation: European Commission adopts conflicts of interest Delegated Regulation
- Cross-border distribution of collective investment funds: political agreement reached on Regulation and Directive
- Shareholder engagement: FCA consultation paper
- Stewardship Code: FRC consultation
- Building a framework for effective stewardship: FCA and FRC discussion paper
- Sustainable finance in emerging markets and the role of securities regulators: IOSCO consultation paper
The Financial Conduct Authority (FCA) has published a policy statement (PS19/4) setting out the latest rules and guidance, stemming from the 2017 asset management market study, on measures to improve information available to investors. Key areas covered within the policy statement include fund objectives, benchmarks and past performance. The FCA aims to address the concern that current fund disclosures are unclear, therefore making it difficult for investors to make effective investment decisions.
The FCA sets out how fund managers should describe fund objectives and investment policies to make them more useful to investors. Specifically, the non-handbook guidance (contained in annex 2 of the policy statement) explains how firms might comply with existing requirements on fund objectives. Guidance provides that fund managers should include a description of the investment strategy in key information documents (KIDs) and that consumer friendly language should be used. Financial and non-financial objectives should be set out clearly. While the FCA agrees that achievement of non-financial objectives may be difficult to quantify, it expects, nonetheless, that a clear explanation should be provided of how fund managers will measure whether non-financial objectives are being met.
The FCA seeks to prevent selective disclosure of benchmarks within fund documentation. The latest rules represent significant reform for the use of benchmarks. Fund managers are now required to explain why and how their funds use particular benchmarks. Alternatively, if they do not use a benchmark, managers should explain how investors can assess the performance of the fund.
The FCA proposes three benchmark categories for funds using benchmarks:
- “constraint”, applicable where a manager constrains how they construct a fund’s portfolio;
- “target”, applicable where a target is used for fund performance; or
- “comparator”, applicable where the benchmark is used as a method for investors to compare the fund’s performance.
Regardless of the type of benchmark used, benchmarks should be referred to consistently throughout all fund documentation.
Past performance should be presented against each benchmark using a constraint or a target. Equally, for funds with more than one such benchmark, the FCA expects past performance to be shown against all benchmarks used. Where a fund manager uses comparator benchmarks, there is no requirement to show past performance against it.
The FCA also clarifies that where a performance fee is specified in the prospectus; it must be calculated based on the scheme’s performance after the deduction of all other fees.
The FCA will publish a brief update on its assessment of whether fund disclosures have become progressively clear, consistent and meaningful after 12 and 24 months. The Investment Association will also publish its guidance on fund communication in February 2019 as part of its work with the fund objectives working group.
Fund managers are expected to take guidance on fund objectives into consideration when reviewing fund documentation from the date of publication. The new handbook rules and guidance covered in the "benchmarks" section come into force on 7 May 2019 for new funds and on 7 August 2019 for existing funds. Rules on performance fees come into force on 7 August 2019.
The International Capital Market Association’s (ICMA) Asset Management and Investors Council has published a guide on due diligence (DD) requirements for investing in a securitisation position. The guide gives an introduction to the Securitisation Regulation regime and provides potential investors with some practical guidance as to what DD information should be obtained and where this information can be sourced.
See also Richard Fletcher’s recent blog on the uncertainty around the disclosure requirements.
The Joint Committee of the European Supervisory Authorities (ESAs) has published a final report following a joint consultation paper (CP) suggesting targeted amendments to the Delegated Regulation on the PRIIPs KID. The overall feedback provided to the CP indicated that stakeholders did not support the proposed amendments. In light of this feedback, the implications of a possible decision by the European co-legislators to defer the application of the KID by certain types of investment funds beyond 2020 and the timing of a review of PRIIPs, the ESAs have decided that it is not appropriate to propose substantive amendments to the PRIIPs Delegated Regulation at this time.
Instead, the ESAs have initiated work to input into a review of PRIIPs Delegated Regulation during 2019 and will launch a consultation on draft regulatory technical standards. The feedback received from the public consultation will be used to inform the upcoming work. In addition, the ESAs are of the view that an immediate supervisory response is needed in relation to performance scenarios.
The final report:
- sets out the background to the CP;
- describes the political developments since the publication of the CP;
- summarises the feedback received in response to the CP and the ESAs’ response to this feedback at this stage, including the issuance of a Supervisory Statement on performance scenarios which includes a recommendation that PRIIP manufacturers provide a warning in the KID to ensure that retail investors are fully aware of the limitations of the figures provided in the performance scenarios; and
- explains the intended next steps regarding the work to review the PRIIPs Delegated Regulation this year.
The FCA has published a video in which banking leaders from four financial services firms, Virgin Money, HSBC, State Street and J.P. Morgan, share their experiences of adopting the Senior Managers and Certification Regime (SM&CR). The individuals talk about how the SM&CR has helped improve the culture and governance in their organisations and give advice to firms which will adopt the SM&CR in 2019.
The Banking Standards Board (BSB) has published a consultation paper and draft guidance on implementing the Certification Regime’s regulatory references requirements under the SM&CR. While the draft guidance will be of primary interest to members of the BSB, the BSB states that it hopes the wider sector will find it relevant and practical and that they will use or refer to it in developing their own processes, policies and procedures. The deadline for consultation responses is 20 March 2019.
The European Securities and Markets Authority (ESMA) has published an updated version of its Q&As on data reporting under the Markets and Financial Instruments Regulation (MiFIR). Four new Q&As are included to provide further clarification on the requirements for submission of reference data under MiFIR. In addition, ESMA has amended an existing Q&A to clarify the use of trading venue transaction identification code when reporting transactions on complex trades.
The FCA has published a webpage giving an update on the Global Financial Innovation Network (GFIN) which was formally launched in January 2019 by an international group of financial regulators and related organisations, including the FCA. The GFIN is a network of 29 organisations committed to supporting financial innovation in the interests of consumers. It seeks to provide a more efficient way for innovative firms to interact with regulators and includes a pilot for firms wishing to test innovative products, services or business models across more than one jurisdiction. The FCA has also published the finalised terms of reference for the governance and membership of the group.
The GFIN has opened a one month application period for a pilot phase of cross-border testing. Interested firms should submit applications to relevant participating regulators, which includes the FCA, by 28 February 2019. The FCA states that it expects the pilots, for applications it accepts, to run from the second quarter of this year. Pilot tests will run for a six month period, unless regulators agree to extend them.
The FCA and the Prudential Regulation Authority (PRA) have published a joint consultation paper on the management expenses levy limit (MELL) for 2019/20 for the Financial Services Compensation Scheme (FSCS). Under the Financial Services and Markets Act 2000, the FCA and PRA must set an annual limit for the total management expenses which the FSCS can levy on financial services firms. The proposed MELL for 2019/20 is £79.6m and consists of FSCA management expenses of £74.6m and an unlevied contingency reserve of £5m. This is an increase of 2.4% from the 2018/19 MELL of £77.7m.
The deadline for submitting comments on the proposed MELL is 28 February 2019. Following consideration of responses, the FCA and the PRA will publish final rules so the new fees are in place for the start of the FSCS’s financial year on 1 April 2019.
The European Banking Authority (EBA) has published a letter to the Council of the EU, European Parliament and the European Commission requesting revised deadlines in the draft Investment Firms Regulation (IFR) and the Investment Firms Directive (IFD) for the submission of draft technical standards. The IFR and IFD will, for most investment firms, replace their prudential requirements under CRD IV. While the EBA states that it is fully committed to accomplishing its tasks within the current legal deadlines, it is concerned that the compressed timeline risks compromising quality. The EBA recommends reviewing the deadlines for mandates into three different groups with submission dates of respectively 12, 18 and 24 months after the entry into force of the IFR and IFD. The annex to the letter lists the mandates under IFD and IFR, the current deadlines and EBA’s recommended deadlines.
The FCA has published a press release announcing that is has agreed Memoranda of Understanding (MoUs) with ESMA and EU regulators. The text of the MoUs has not been published yet, however, the FCA states that the MoUs will support cross border supervision of firms and allow the FCA to share information with its EU counterparts. These regulatory cooperation agreements are a prerequisite to allow EU fund managers (including AIFMs and UCITS managers) to delegate portfolio management services to a third party in another country outside the EU.
Following Brexit, the UK will become a third country. This means that EU fund managers can only delegate portfolio management to UK entities if these cooperation agreements are in place. This will be good news to many firms whose Brexit planning involves delegation to a UK entity following either a hard Brexit or soft Brexit on terms under which the UK loses its existing financial services passport rights (as it would under the Government's current proposals).
ESMA has published a MiFID II supervisory briefing the aim of which is to help EU competent authorities with their judgements relating to the authorisation and supervision of investment firms and credit institutions which intend to establish (or have established) a branch in a non-EU jurisdiction. This supervisory briefing builds on ESMA’s Opinion in July 2017 issued in the context of Brexit, in which ESMA urged EU competent authorities should carefully monitor the risk of letter-box entities. ESMA states that, while these issues were initially identified in the context of the UK withdrawal from the EU, they appear relevant beyond Brexit and it is thereby important to address them in a convergent manner as regards to all third countries. In the briefing, ESMA also intends to provide market participants with indications of compliant implementation of the MiFID II provisions and the recommendations expressed in the ESMA Opinion on investment firms. The briefing is structured around the following three elements:
- supervisory expectations in relation to the authorisation of investment firms;
- ongoing supervisory activity of non-EU branches (including reporting and collection of information); and
- supervisory activity and coordination with non-EU Competent Authorities (non-EU CAs).
The FCA has published a statement on how it would use its temporary transitional power in the event the UK leaves the EU without an agreement. The temporary transitional power would give the FCA the ability to delay or phase in changes to regulatory requirements made under the EU (Withdrawal) Act 2018 for a maximum of two years from exit. The FCA notes that, given the complexity and magnitude of the Brexit-related changes and in the event that the UK leaves the EU without an implementation period, it will not take a strict liability approach and does not intend to take enforcement action against firms and other regulated entities for not meeting the requirements immediately. However, this will only be the case if firms can demonstrate that they have taken reasonable steps to prepare to meet the new obligations by exit day.
However, the FCA also sets out the areas where it would not be appropriate to provide a phase-in and consequently expects firms and other regulated persons to start preparing now to comply with these post-exit obligations. This applies to:
- firms subject to the MiFID II transaction reporting regime and connected persons (for example, approved reporting mechanisms);
- firms subject to reporting obligations under European Market Infrastructure Regulations;
- EEA issuers that have securities traded or admitted to trading on UK markets;
- investment firms subject to the Bank Recovery and Resolution Directive and that have liabilities governed by the law of an EEA State;
- EEA firms intending to use the market-making exemption under the Short Selling Regulation;
- firms intending to use credit ratings issued or endorsed by FCA-registered credit ratings agencies after exit day; and
- UK originators, sponsors, or securitisation special purpose entities of securitisations that they wish to be considered simple, transparent, and standardised under the Securitisation Regulation.
The FCA will publish more information on how firms should comply with post-exit rules before exit day and is coordinating its approach closely with the Bank of England and the PRA.
ESMA has published a public statement on the use of UK data in ESMA databases and performance of MiFID II calculations in the case of a no-deal Brexit. On a no-deal Brexit, the FCA will stop sending data to ESMA and will cease having access to ESMA’s IT applications and databases. Among other things, ESMA outlines the following:
- the FCA will cease to be the relevant competent authority for any EU-traded instruments;
- post-Brexit, trading venues and systematic internalisers (SIs) established in the UK will no longer be subject to the obligation to submit reference data and reference data submitted by UK trading venues and SIs to FIRDS will be terminated;
- ESMA will freeze the quarterly calculations for the SIs determination for equity instruments and bonds, the quarterly determination of the liquidity status of bonds and the monthly DVC publications for a period of two months after Brexit due to concerns about the temporary disruption of the ESMA IT applications and databases;
- due to remaining data quality issues, ESMA will also not publish the SI-calculations for non-equity instruments other than bonds until at the latest 2020; and
- UK-related data received until 29 March 2019 in all other ESMA IT systems and registers will, depending on the systems and registers in question, be either removed or will remain in ESMA systems and be flagged as "inactive"/"no longer valid" with a termination date on 29 March 2019.
In a subsequent statement, the FCA states that, by the end of February 2019, it expects to set out its approach to using temporary powers to operate MiFID II in the UK. The FCA’s approach will provide continuity in the operation of the transparency regime in the UK.
HM Treasury and the Office of Financial Sanctions Implementation (OFSI) have published guidance on financial sanctions which apply when the UK leaves the EU. The guidance outlines an overview of financial sanctions, which persons are subject to sanctions, the financial sanctions restrictions, ownership and control, the obligations to report to the OFSI, exceptions and licensing, compliance and enforcement and challenging designations. The guidance does not currently apply and will become operational only when the SIs under the Sanctions and Anti-Money Laundering Act 2018 transfer existing EU sanctions into UK law; this will be in the event of a no-deal exit.
The draft version of the Financial Services (Distance Marketing) (Amendment and Savings Provision) (EU Exit) Regulations 2019 and a supplementing explanatory memorandum, as laid before Parliament have been published. The purpose of the draft statutory instrument (SI) is to make amendments to the Financial Services (Distance Marketing) Regulations 2004 to ensure that those Regulations continue to operate effectively in the UK post Brexit. See our update of 19 December 2018 for more detail on the SI.
The draft version of the Financial Services and Markets Act (Amendment) (EU Exit) Regulations 2019 and its accompanying explanatory memorandum, as laid before Parliament, has been published. The draft SI makes a number of amendments to the Financial Services and Markets Act 2000 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. See our update of 5 December 2018 for more detail on the SI.
The draft version of the Gibraltar (Miscellaneous Amendments) (EU Exit) Regulations 2019 and a supplementing explanatory memorandum, as laid before Parliament, has been published. The draft SI ensures that, after Brexit, financial services firms incorporated and headquartered in Gibraltar will be able to continue to conduct certain financial services activities in the UK as they do now. For example, this includes maintaining, among other UK-Gibraltar financial services arrangements:
- existing provisions for home state responsibility in cross-border insolvency proceedings;
- existing treatments for policyholder and depositor protections; and
- a payments regime governing euro transactions between the UK and Gibraltar.
Part 2 of, and Schedules 1 and 2 to, the Regulations make a number of Gibraltar-related modifications and amendments to UK financial services legislation in the context of Brexit. Part 3 of the Regulations saves the effect of certain financial services legislation in relation to Gibraltar-based firms and activities. Regulations 2, 3, 4, 5, 11 and Schedules 1 and 2 to the Regulations come into force on exit day. The other provisions in the Regulations come into force immediately before exit day. See our updates of 30 January 2019 and 16 January 2019 for a discussion on the Financial Services (Gibraltar) (Amendment) (EU Exit Regulations 2019).
The draft version of the Financial Regulators' Powers (Technical Standards etc.) and Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2019, together with an explanatory memorandum, as laid before Parliament, has been published. This SI amends the Schedule to the 2018 Regulations to add binding technical standards (BTS) that have come into force since they were laid. This has the effect of giving the UK regulators the necessary powers to address any failure of those BTS to operate effectively after exit. The SI will come into force on the day after it is made.
HM Treasury has published a draft version of the Financial Services (Miscellaneous) (Amendment) (EU Exit) Regulations 2019, together with an explanatory memorandum. The purpose of the SI is to ensure a coherent and functioning financial services regulatory regime post-Brexit. The SI:
- addresses deficiencies in UK domestic law and retained EU law arising from the UK’s withdrawal from the EU, in line with the approach taken in other financial services EU exit instruments under the EU (Withdrawal) Act 2018 (EUWA);
- revokes a number of pieces of retained EU law and UK domestic law, which it would be inappropriate to keep on the statute book after exit as they deal with cross-border activity within the EU and the functioning of EU institutions; and
- makes amendments to a number of financial services EU exit SIs, correcting errors identified in legislation after it was made and making amendments to ensure consistency between EU exit instruments.
The SI will enter into force on exit day, with the exception of amendments to SIs made under EUWA, which will come into force immediately before exit day.
ESMA has published a consultation paper on guidelines for liquidity stress testing in UCITS and AIFs. The draft guidelines for fund managers aim to promote convergence in the way national competent authorities supervise funds liquidity stress testing across the EU. The consultation sets out 14 principles based criteria for managers’ liquidity stress tests to follow when executing liquidity stress tests on their funds.
The draft principles require stress tests to:
- be tailored towards the individual fund;
- reflect the most applicable risks to a fund;
- be sufficiently extreme or unfavourable (yet plausible);
- sufficiently model how a manager is likely to act in times of stressed market conditions; and
- be embedded into the fund’s overall risk management framework.
Managers of investment funds in the EU need to regularly test the resilience of their funds for different types of market risks, including for liquidity risk – the risk that assets cannot be sold quickly enough to meet investors’ redemption requests.
The deadline for submitting responses to the consultation paper is 1 April 2019. ESMA will consider the feedback it receives to this consultation early in the second quarter of 2019 and expects to publish a final report by the summer of 2019.
The European Commission has adopted a Delegated Regulation supplementing the European Venture Capital Funds (EuVECA) Regulation with regards to conflicts of interest (COI). Among other things, the Delegated Regulation:
- provides a list of types of COI in the context of qualifying venture capital funds (VECAs);
- sets out the obligation on the part of the managers of qualifying VECAs to establish, implement and maintain an effective COI policy;
- outlines the steps to be taken as part of the procedures and measures preventing and COI; and
- specifies the minimum steps which an organisation should take in cases where the organisational or administrative arrangements are not sufficient to prevent the risks of damage to the interests of the qualifying VECA or its investors.
The Delegation Regulation will enter into force 20 days after its publication in the Official Journal of the EU (OJ) and will apply six months after its entry into force. The European Parliament and the Council of the EU will now consider the Delegation Regulation.
The European Commission has adopted a Delegated Regulation supplementing the European Social Entrepreneurship Funds (EuSEF) with regards to COI, social impact measurement and information to investors. Among other things, the Delegated Regulation:
- provides a list of types of COI in the context of qualifying SEFs;
- sets out the requirements pertaining to the strategies for the exercise of voting rights to prevent COI;
- specifies the requirements, the format and certain conditions pertaining to the disclosure of COI; and
- outlines the content of certain information to be provided to investors.
The Delegation Regulation will enter into force 20 days after its publication in the OJ and will apply six months after its entry into force. The European Parliament and the Council of the EU will now consider the Delegation Regulation.
The Council of EU has published a press release announcing that the European Parliament and the Council of EU have reached a political agreement on the proposed Regulation and Directive aimed at removing existing regulatory barriers to the cross-distribution of investment funds and making it less costly. The political agreement will now be submitted for endorsement by EU ambassadors. Parliament and Council will be called on to adopt the proposed regulation and directive at first reading.
The European Commission has adopted a Delegated Regulation supplementing the Fourth Money Laundering Directive (MLD4) with regard to regulatory technical standards (RTS) for the minimum action and the type of additional measures credit and financial institutions must take to mitigate money laundering (ML) and terrorist financing (TF) risk in certain third countries. The RTS will apply where credit or financial institutions are exposed as a result of their operations in a third-country, in circumstances where the third country’s law prevent the application of MLD4-compliant group-wide policies and procedures.
If no objection is raised by the Council of the EU and the European Parliament, the Delegated Regulation will enter into force 20 days after it is published in the OJ and will apply three months after it has entered into force.
The FCA has published a consultation paper (CP19/7) on proposals to implement parts of the revised Shareholder Rights Directive (SRD II) which apply to FCA regulated financial services firms and issuers in respect of related party transactions. SRD II aims to promote effective stewardship and long-term investment decision-making. The FCA plans to take a copy-out approach to transposing the SRD II requirements for life insurers and asset managers. Broadly, it proposes to introduce rules for:
- asset managers and certain life insurers to make disclosures relating to their shareholder engagement policies;
- life insurers to: (a) make disclosures about their arrangements with asset managers; and (b) publicly disclose how the main elements of their equity investment strategy are consistent with the profile and duration of their liabilities, long-term liabilities and how these elements of their strategy contribute to the medium to long term performance of their assets;
- asset managers to make disclosures relating to their arrangements with asset owners and how their investment strategies are consistent with the medium and long-term performance of the assets of the asset owner or fund; and
- UK companies with shares admitted on a regulated market to disclose and seek board approval for related party transactions
The implementation of SRD II through the FCA’s proposed new rules for asset owners and managers sets an important baseline in a continuum of measures to drive effective stewardship. The revised Stewardship Code aims to encourage higher standards beyond this baseline (see below "Stewardship Code: FRC consultation"). The FCA consultation closes on 27 March 2019. The intention is for the final rules, when made, to take effect on 10 June 2019.
The Financial Reporting Council (FRC) has published a consultation paper on changes to its Stewardship Code. The FRC states that the purpose of the changes is to set out more rigorous reporting requirements and to focus on how stewardship activities deliver outcomes against objectives. See our Corporate Law Update of 8 February 2019 for further details. The FRC asks for comments by 29 March 2019.
The FCA and FRC have published a joint discussion paper (DP19/1) on the importance of effective stewardship. In the paper, they examine what effective stewardship should look like, what the minimum expectations should be for financial services firms that invest for clients and beneficiaries, the standards the UK should aspire to and how these could be achieved. This paper is of particular relevance to asset management firms and life insurers and is considered in greater detail in our Corporate Law Update of 8 February 2019. Comments on the discussion paper should be submitted by 30 April 2019.
The Growth and Emerging Markets Committee of the International Organisation of Securities Commissions (IOSCO) has published a consultation paper proposing a set of recommendations to assist growth and emerging markets regulators in their efforts with regard to sustainable finance.
The recommendations include:
- issuers and other regulated entities should integrate material environmental, social and governance (ESG) specific issues in the overall risk appetite and governance of these entities;
- regulators should require disclosure on material ESG-specific risks (including transition risks) and opportunities in relation to governance, strategy and risk management of an issuer or collective investment schemes;
- where additional ESG-specific reporting is needed, regulators should aim to ensure adequate data quality for ESG-specific reporting;
- sustainable instruments should be clearly defined and should refer to the categories of eligible projects and assets that the funds raised through their issuance can be used for;
- funds raised through sustainable instruments should be used for projects and activities falling under one or a combination of the broad ESG categories;
- regulators should establish requirements for the offerings of sustainable instruments, establish ongoing disclosure requirements regarding the use of the funds raised and provide for measures to prevent, detect and sanction the misuse of funds raised;
- issuers should consider the use of external reviews;
- institutional investors should incorporate ESG-specific issues into their investment analysis, strategies and overall governance; and
- regulators should analyse the gaps in capacity and expertise with regard to ESG-related issues consider targeted capacity building to address these gaps.
The deadline for submitting responses to the consultation is 1 April 2019.