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Q2 2013 Investment Management Regulatory Update

Developments this quarter

Welcome to the seventh edition of our Investment Management Regulatory Update which summarises the key regulatory developments affecting the UK investment management sector.

In this edition we cover key international, European and UK developments including:

Financial Conduct Authority speeches 

Following the transition from the Financial Services Authority (FSA) to the Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA), key individuals from the FCA have made a number of speeches this quarter setting out the FCA agenda and approach to supervision.

Clive Adamson speech – The importance of culture in driving behaviours of firms and how the FCA will assess this
On 19 April, Clive Adamson, FCA Director of Supervision, gave a speech on the importance of culture in driving behaviours of firms and how the FCA will assess this. He defined culture as being “like DNA. It shapes judgements, ethics and behaviours displayed at those key moments, big or small, that matter to the performance and reputation of firms and the services that they provide to customers and clients”.

In outlining the drivers of culture, Mr Adamson said that the CEO and senior management should set the tone from the top and personally demonstrate their values through their actions. The FCA holds the view that everyone at the firm is responsible for ensuring the right customer outcomes. He went on to say that firms must translate this tone into business practices and behaviours. Performance management, employee development and reward programmes should be aligned with promoting fair customer outcomes.

Firms can expect culture to be a continuing area of focus for the FCA, one where their thinking will “continue to evolve”. The FCA will draw conclusions about firms’ culture through “joining the dots”, rather than assessing culture directly. For example, it will look at how firms respond to regulatory issues, how firms run their product approval processes, how decisions are made or escalated, the behaviour of firms on certain markets, customer experiences, and remuneration structures. The FCA will also look at how boards engage with those issues, for example, whether they probe high return products or business lines and whether they understand cross-selling strategies, how fast growth is obtained and whether products are being sold to the consumers and markets they are designed for.

Martin Wheatley speech - Regulation as a spur to growth
On 5 June, Martin Wheatley, FCA CEO, gave a speech to the Investment Management Association at the Mansion House about regulation as a spur to growth.  He stated that good regulation should “act as a catalyst for economic progress, rather than a brake” and outlined the 3 Cs’ – cooperation, competition and client focus – which specifically relate to investment management firms

  • Cooperation – the FCA will work alongside all participants, including the Government and asset managers, and be easier to access and engage with. It will also seek to be more transparent and collaborative about what it is doing and what it might mean for asset managers.
  • Competition – the FCA will only use its powers to support its main objective of making markets work well. Mr Wheatley cited two examples that the FCA might consider relating to competition: the effectiveness of disclosure; and whether the criteria consumers use to choose products or managers create the right incentives for suppliers in the market.
  • Client focus – while recognising that the “the overwhelming majority of asset managers in this country operate to the very highest levels of integrity and client focus”, he stressed that client focus is an area that the FCA “will be looking towards in the years to come”.

David Lawton speech – Investor relations in an increasingly regulated and international world
On 18 June, David Lawton, Director of Markets at the FCA, gave a speech on investor relations in an increasingly regulated and international world to the Investor Relations Society’s Annual Conference. The speech covered key issues that Mr Lawton feels represent a step change for firms.

The FCA’s objectives and approach:

  • The approach is governed by a single strategic objective: ‘making relevant markets work well’.
  • The FCA will be taking a more holistic approach to consumer protection and conduct issues, focusing on both retail and wholesale clients.
  • The FCA will be examining the combined input of systemically important firms and how they impact the integrity of UK financial services. This will tie into the FCA’s continuing work in maintaining the Listing Regime and keeping it fit for purpose, with final proposals for amendments due to be set out this summer.
  • The regulator is planning on reviewing corporate access for investors with the aim of promoting active and engaged investors.

Observations on the international landscape:

  • There is a significant amount of cross-jurisdictional regulation which may not be easy for firms to implement but does have the advantage of offering uniformity across regions.
  • An aligned and coordinated approach is required from regulators to avoid obstacles to market access, unnecessary costs and unnecessarily preventing economic activity.

Mr Lawton concluded his speech by surmising that the firms who are most successful in coping with this new global regulatory environment will be those who make the effort to have a constructive dialogue and engage early with regulators both domestically and internationally.

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AIFMD update 

There have been a number of key developments in the last quarter in relation to the implementation of the Alternative Investment Fund Managers Directive (AIFMD). To keep advised of further developments and for further detail and analysis of the AIFMD Level 2 implementing measures, visit our AIFMD publications page at

Draft AIFM Regulations, AIFMD Q&As and HM Treasury response to consultation on transposing AIFMD
The UK Government has been laying the groundwork this quarter in the run up to the AIFM Regulations coming into force on 22 July 2013.

On 1 May, HM Treasury published a set of questions and answers relating to the UK’s transposition of AIFMD. The Q&As cover a range of technical issues including the transitional arrangements under the AIFMD, marketing issues and the definition of an alternative investment fund manager (AIFM).

On 13 May, HM Treasury also published its response to its January 2013 and March 2013 consultations on transposing the AIFMD. The responses clarify the approach the Government will take in implementing the AIFMD.

On 12 June, the UK Government published the Draft Alternative Investment Fund Managers Regulations 2013 with an explanatory memorandum. The Regulations transpose the majority of the provisions contained in the AIFMD by making amendments to the Financial Services and Markets Act 2000 (FSMA) and other relevant legislation. The Government are due to review the Regulations and will then publish a report setting out their conclusions by 22 July 2013.

ESMA Consultation paper – Guidelines on reporting obligations under Article 3 and Article 24 of the AIFMD
On 24 May, the European Securities and Markets Authority (ESMA) published a consultation paper on guidelines on AIFMD reporting obligations under Articles 3 and 24 of the AIFMD. ESMA is seeking to standardise the format of information AIFMs send to their home state regulator in relation to the portfolio of the alternative investment funds (AIFs) they manage or market in the EU.

These draft guidelines, set out in Annex III, provide clarification on the information that AIFMs should report to their home state regulator, the timing of such reporting and the procedures to be followed when AIFMs move from one reporting obligation to another. The consultation closed on 1 July 2013 and the responses can be read here.

ESMA final report: guidelines on key concepts of the AIFM Directive
On 24 May, ESMA published a final report containing guidelines on key concepts of AIFMD. The guidelines apply to AIFMs and national regulators and aim to clarify the concepts used in the AIF definition. The guidelines will now be translated into the official languages of the EU, and the final texts will be published on the ESMA website. The guidelines will become applicable two months after the publication of the translations.

FCA Policy Statement PS13/5 - Implementation of the AIFMD
On 28 June, the FCA published its policy statement (PS13/5) on the implementation of the AIFMD. PS13/5 summarises the FCA's response to feedback received about the FSA's November 2012 (CP12/32) and March 2013 (CP13/9) consultation papers on implementation of the AIFMD.

PS13/5 covers issues relating to the scope of the AIFMD, operating requirements and prudential rules for AIFMs, consumer redress, depositaries, marketing and remuneration.

Appendix 1 to PS13/5 contains a copy of the AIFMD Instrument 2013 (FCA 2013/51), made by the FCA Board on 27 June 2013. These Handbook provisions come into force on 22 July 2013, except for some transitional provisions that come into force on 22 July 2014.

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MiFID update 

Council of the EU publishes proposed general approach for MiFID II
On 19 June, the Council of the EU (the Council) published its proposed general approach to the draft recast of the Markets in Financial Instruments Directive and Regulation (MiFID/MiFIR). The news comes 20 months after the European Commission published its proposals in October 2011 and the European Parliament (EP) agreed its position in October 2012.  Despite the Council agreeing its general approach there are a number of areas which differ from the proposals set out by the Commission and EP.

  • OTF and trading obligation for derivatives – both the Council and EP support the introduction of an Organised Trading Facility (OTF), a new type of multilateral trading venue aimed at bringing more over the counter (OTC) products onto regulated markets, but they hold conflicting views on whether the scope of OTFs should include equity markets.
  • Algorithmic and high frequency trading (HFT) – the text proposes that firms engaging in HFT should be authorised and therefore subject to certain requirements and supervision. It is proposed that firms and markets using algorithmic and HFT should have appropriate controls such as circuit breakers.
  • Pre-trade and post-trade transparency – for non-equity markets, both the EP and the Council support capturing bonds within the pre- and post-trade transparency regime but their proposals currently differ on derivatives.
  • Access to clearing/market infrastructure – the EP seeks to exclude exchange listed derivatives from the requirement for non-discriminatory access to trading venues and CCPs (which under the Commission proposals would apply for all types of financial instruments).  In contrast, the Council seeks to broaden safeguards, favouring exemptions for smaller trading venues and phase-in for new CCPs.
  • Third country regime – whilst the EP supports the introduction of the equivalence test to create a more harmonised framework for third country firms’ access to the EU market, the Council is against introducing ‘equivalence’, which would also mean no passporting.
  • Third-party inducements – the Council supports the Commission’s proposal to ban firms from receiving third party inducements when providing independent advice and portfolio management. However, the EP has instead opted for increased disclosure.
  • Appropriateness regime – the Council again broadly supports the Commission’s proposal to limit the range of products which can be sold without an appropriateness test, in particular by classifying structured UCITS as complex. In contrast, the EP favours the status quo, that all UCITS (including structured UCITS) should be excluded from the appropriateness regime.

Work towards a final text will take place through the trialogue negotiations, which will commence after the summer recess. The requirements set out in the final text are unlikely to come into force until two years after publication in the Official Journal.

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Capital Requirements Directive 

Almost two years have passed since the publication of the European Commission’s proposals for the Capital Requirements Directive IV (CRD IV) package, which will implement the internationally agreed standards on capital and liquidity – Basel III – in the EU. The legislative process came to an end on 27 June with the publication of the CRD IV package in the Official Journal of the European Union

European Council adopts new capital requirements for banks and investment firms
On 20 June, the Economic and Financial Affairs (ECOFIN) Council of the EU announced that it had adopted the CRD IV package following approval by the European Parliament in April 2013.  The CRD IV Regulation and Directive were published in the Official Journal of the European Union on 27 June and it was confirmed that the CRD IV package will take effect from 1 January 2014. The new framework will amend and replace the existing capital requirements directives by setting out two new legislative instruments: a regulation establishing prudential requirements that institutions need to respect, and a directive governing access to deposit-taking activities.

The new legislation will aim to strengthen capital requirements by requiring banks and investment firms  to hold common equity tier 1 capital of 4.5% of risk weighted assets, introduce a mandatory capital conservation buffer of 2.5% and a discretionary institution-specific countercyclical buffer of up to 2.5%. It will also introduce a framework for new regulatory requirements on liquidity and leverage with the introduction of a 30 day minimum liquidity coverage ratio, Net Stable Funding Ratio and a leverage ratio as well as additional capital surcharges for systemically important institutions.

CRD IV/CRR - consultation papers (draft technical standards/implementing measures)
The CRD IV package contains specific mandates for the European Banking Authority (EBA) to develop Binding Technical Standards (BTS), guidelines and recommendations which will form part of the Single Rulebook. The EBA will need to draft many of these rules during the course of 2013 and 2014. The EBA has already published several consultation papers which can be found on the EBA website and more EBA consultation papers will be published over the coming months.

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RDR update 

Consultation Paper (CP13/4) - Distribution of retail investments: referrals to Discretionary Investment Managers (DIM) and adviser complaints reporting
On 4 July, the FCA published a consultation paper in response to questions received on how to apply the Retail Distribution Review (RDR) rules to referral payment from DIMs. This consultation paper proposes:

  • that referral payments for pre-RDR referrals can continue (payments to advisers for new business post-RDR are already banned). However, payments for post-RDR top-ups resulting from the adviser recommending that the client should pay more money into the investments held with the DIM will be banned; and
  • a ban on referral payments where an adviser firm does not provide personal recommendations to particular clients, but provides other services to them.

Comments must be sent to the FCA by 4 October 2013.

For further information, visit

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Other European highlights 

Principles for the Valuation of Collective Investment Schemes
On 3 May, the International Organization of Securities Commissions (IOSCO) published its final report on principles for the valuation of Collective Investment Schemes (CIS).

The Principles are intended to be a basis against which both the industry and regulators can assess the quality of regulation and industry practices concerning CIS valuation. IOSCO acknowledges that implementation of the principles may vary from jurisdiction to jurisdiction, depending on local conditions and circumstances. The Principles are as follows:

  • the Responsible Entity should establish comprehensive, documented policies and procedures to govern the valuation of assets held or employed by a CIS;
  • the policies and procedures should identify the methodologies that will be used for valuing each type of asset held or employed by the CIS;
  • the valuation policies and procedures should seek to address conflicts of interest;
  • the assets held or employed by the CIS should be consistently valued according to the policies and procedures;
  • the Responsible Entity should have policies and procedures in place that seek to detect, prevent and correct pricing errors. Pricing errors that result in material harm to CIS investors should be addressed promptly, and investors fully compensated;
  • the Responsible Entity should provide for the periodic review of the valuation policies and procedures to seek to ensure their continued appropriateness and effective implementation. A third party should review the CIS valuation process at least annually;
  • the Responsible Entity should conduct initial and periodic due diligence on third parties that are appointed to perform valuation services;
  • the Responsible Entity should seek to ensure that arrangements in place for the valuation of the assets in the CIS's portfolio are disclosed appropriately to investors in the CIS offering documents or otherwise made transparent to investors;
  • the purchase and redemption of CIS interests generally should not be effected at historic NAV;
  • a CIS’s portfolio should be valued on any day that CIS units are purchased or redeemed; and
  • a CIS’s NAV should be available to investors at no fee.

ESMA publishes guidelines on remuneration policies and practices for firms providing investment services
On 11 June, ESMA published its final report and guidelines on remuneration policies and practices. The purpose of the guidelines is to ensure consistent implementation of MiFID conflicts of interest and conduct of business requirements as they relate to remuneration.

Governance and design of remuneration policies and practices:

  • Remuneration policies and practices should be aligned with effective conflicts of interest management duties and conduct of business risk management obligations.
  • Policies and practices should also be designed in a way that does not lead employees to favour their own, or the firm’s interests above those of clients. Where firms link remuneration directly to the sale of specific financial products, it is unlikely that they will be able to demonstrate compliance with MiFID conduct of business and conflicts of interest requirements.
  • The ratio between fixed and variable components of the remuneration should be appropriate and take into account the best interests of clients.
  • The design of remuneration policies should be challenged and approved by senior management.
  • Remuneration policies should be formally documented, but not overly complex and should be reviewed periodically.

Controlling the risks that remuneration policies and practices create:

  • Adequate controls for compliance with policies should be designed to ensure the intended outcomes are delivered and these should be implemented throughout the firm.
  • The compliance function should be involved in the design of remuneration policies and practices at an early stage.
  • Senior management should be fully engaged with and supportive of the remuneration policies and practices to ensure that individuals effectively comply with conflicts of interest and conduct of business requirements.
  • ESMA’s guidelines include examples of both good and bad practice for firms to consider.

Principles for the Regulation of Exchange Traded Funds
On 24 June, IOSCO published a final report setting out nine principles for the regulation of exchange-traded funds (ETFs), which aim to address the specific features and risks of ETFs. These principles have been established following extensive consultation between regulators and the industry.

The first section of the report describes principles around ETF classification, intended to aid differentiation of ETFs from other similar products. It also sets out principles around disclosure and calls for the disclosure of fees and expenses as well as risk disclosure (relevant to ETFs which use complex strategies using leverage). The second section describes principles around structuring of ETFs, including the management of potential inherent conflicts of interest and of counterparty risks arising from their replication methods.

Council of the European Union sets out its position on transparency rules for investment products
On 26 June, the Permanent Representatives Committee set out, on behalf of the Council, its position on a draft regulation aimed at improving market transparency for retail investors. The proposal forms part of a legislative package dedicated to strengthening consumer trust in financial markets. The text covers packaged retail investment products (PRIPs), specifically investment funds, structured deposits and life insurance policies with an investment element.

The draft regulation requires key information documents to be drawn up for PRIPs, laying down uniform rules on the format and content of such documents and on their provision to retail investors. The Council called on the presidency to start negotiations with the European Parliament with the aim of adopting the regulation at first reading.

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Q2 2013 FSA enforcement summary 

There were 17 final notices published by the new FCA in the quarter ending 31 June 2013. Seven of these were against individuals, including individual breaches of the Threshold Conditions as well as Principle 1 (integrity).

In relation to action against firms, suitability failings and inaccurate KYC information were recurring themes.  One high profile organisation was fined over £3 million for a number of deficiencies in these areas, including:

  • client files often did not record, or keep up to date, important client suitability information such as a client’s objectives, capacity for loss, and investment experience;
  • information concerned with on-going account management, such as client communications and the rationale for both investment selections and client risk profiles, was sometimes incomplete or inaccurate, or not retained on the appropriate system;
  • suitability reports (when required) failed adequately to contain a statement of the client’s demands and needs, explain why the investment was suitable to meet those needs or indicate any disadvantages of the investment; and
  • failure to ensure that communications were sent to clients confirming suitability.

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