Investment Management Regulatory Update – Q2 2012
Developments this quarter
Welcome to the third edition of our Investment Management Regulatory Update which summarises the regulatory developments affecting the UK investment management sector.
In this edition we cover key international, European and UK regulatory developments including:
- Financial Services Authority (FSA) update
- FSA fees
- Financial Services Compensation Scheme (FSCS) levy
- FSA consultation on bribery and corruption
- Common Reporting (COREP)
- Retail Distribution Review (RDR)
- Markets in Financial Instruments Directive (MiFID)
- ESMA final report on short selling and credit default swaps
- ESMA launches European Markets Infrastructure Regulation (EMIR) consultation
- FSA feedback on Recovery and Resolution Plans (RRPs)
- CFTC and SEC final swap-related rules under Title VII Dodd-Frank Act
During the last three months, the FSA moved to an internal twin peaks regulatory model ahead of the legislative split, when the Financial Services Act is expected to take effect in the first quarter of next year. During this period there have been a number of speeches from the FSA indicating how the Financial Conduct Authority (FCA) will operate, these include:
- being more forward-looking in its assessment of potential problems. Looking at how the FCA/FSA can tackle issues before they start to go wrong and giving more focus on the analysis of business models;
- moving towards a model whereby they challenge firms about whether their business strategy delivers good outcomes for consumers;
- attempting to apply a particular focus to identifying and mitigating the underlying root causes of problems – not just patching up the symptoms;
- continuing to secure redress for consumers if failures do occur;
- taking meaningful action against firms that fail to meet the standards required by the regulator, through levels of fines that can act as a credible deterrent;
- where there are no signs of improvements in firms following the FSA/FCA’s actions, they will consider taking tougher action, including stopping firms taking on new business; and
- aiming to get a ‘fair deal’ for consumers by striking a balance between giving the consumer rights whilst allowing the industry to grow and innovate.
The FSA/FCA are also continuing to look at the cleanliness of the markets and taking an active line in the implementation of the over-the-counter (OTC) derivative reform agenda, especially with the implementation of the European Market Infrastructure Regulation (EMIR). However the message to the market is that industry needs to take responsibility for its own readiness.
A document is due to be issued in October 2012 to cover what firms can expect from the FCA on day one (currently 1 March/1 April 2013). Additionally, there will be a number of consultative papers released from September 2012 onwards; many dealing with practical/administrative matters, but the FSA will identify the importance of each.
Firms’ reference numbers will not be changing and the FSA Register will be amended to indicate whether a firm is registered with the Prudential Regulation Authority (PRA) or the FCA. The handbook for the FCA will look as it currently is on day one but there will be an ability to screen out PRA only regulations.
Firms supervised by the FCA will be grouped into four categories. Broadly global investment firms will fall into category C2 which will be subject to a two year assessment cycle. Other investment firms are likely to fall into categories C3 and C4, depending on risk profile and governance culture and controls, and will be subject to a four year assessment cycle involving elements of interviews and on-line assessment.
Consumer credit will not come under the FCA’s remit on day one but is being looked at for 2014/15.
The FSA has published a policy statement (PS12/11) containing details of regulatory fees and levies for 2012/13. Following an earlier consultation the FSA has reduced the total annual funding requirement that firms will have to pay by £18.6 million to £559.8 million. This reduction will be evenly allocated to all fee-payers except for those that only pay the minimum. The FSA has also increased the financial penalties discount, due to receipts from financial penalties being larger than estimated.
The annual funding requirement allocation to fund managers increased in 2012/13 and therefore fund managers can expect a little over 27% increase in fees for 2012/13, paying £8.66 per £million FUM compared to £6.80 in the current year.
In April 2011, the FSCS outlined the key components of the 2012/13 Annual Levy and provided an update on levy and compensation costs. Relevant points include;
- SD01 (fund managers) members will have no levy but will be responsible for £1.8m of the £24.5m management expenses;
- firms will receive their annual levy in July;
- total compensation costs have risen from £221m to £265m; and
- FSCS now assumes 70% of CF Arch Cru claims will be attributable to investments intermediation.
On 29 March, the FSA published its thematic review into anti-bribery and corruption (ABC) systems and controls in investment banks. As part of the review, which began in August 2011, the FSA assessed 15 firms including eight major investment banks and found that the majority of firms within the sample did not have sufficient ABC systems and controls. Common weaknesses identified included:
- inadequate ABC risk assessment in nearly half of the firms assessed;
- insufficient management information on ABC to enable senior management to have effective oversight;
- lack of ABC internal audits in all but two firms; and
- significant issues in firms’ dealings with third parties to obtain business.
As a result of the findings the FSA also launched a consultation on proposed amendments to the FSA’s regulatory guidance ‘Financial Crime: a guide for firms’. The consultation deadline closed on 29 April 2012. The proposed changes to the guidance include more examples of good and poor practice in chapters 2 and 6 of Part 1 as well a new Chapter 13 in Part 2 which will consolidate all examples of good and poor practice highlighted in the thematic review.
The COREP framework is designed to ensure EU-wide consistency of capital, risk and solvency information. In the UK, COREP will apply to all firms regulated under BIPRU. The FSA is expected to issue a consultation on COREP in August 2012 after the EBA finalises the rules. The first reporting under the new framework is expected to be for the period ending 31 March 2013 requiring reporting to the FSA by 13 May 2013 (where the reporting frequency is quarterly). The first set of semi-annual submissions are expected to be for the period ending June 2013.
COREP will replace the capital adequacy return (FSA003) as well as some of the risk returns (credit, market and operational). There are some FSA returns which will not be affected under COREP, for example the balance sheet, profit and loss and liquidity returns. The introduction of COREP will significantly increase the granularity of information provided to the FSA. This increased level of granularity will lead to a requirement for enhanced capabilities and solutions for data collection, consolidation and reporting for some firms, which in turn will require improved controls and governance. The impact on most investment managers is not expected to be significant due to the threshold and applicability of some of the new returns and the fact that many investment managers currently input information manually into GABRIEL (the FSA’s online regulatory reporting system for the collection, validation and storage of regulatory data). The reporting timelines, including frequency and submission dates are expected to change under COREP.
There is uncertainty around many aspects of implementation including format and the changes to number of forms. Industry bodies including the Investment Management Association are in the process of clarifying some of these with the FSA and more clarity is also expected when the FSA finalises its rules.
For further information about COREP, see Deloitte’s paper: COREP - Are you tuned in?
The RDR, which comes into effect on 31 December 2012, is a key part of the FSA’s consumer protection strategy, building on the work done around treating customers fairly (TCF) and focusing on “establishing a resilient, effective and attractive retail investment market that consumers can have confidence in and trust at a time when they need more help and advice than ever with their retirement and investment planning.” Final rules are in place for Describing and Disclosing Status (Independent or Restricted), Adviser Charging (banning payment by commission), Platforms and Professionalism (raising professional standards for advisers by implementing a minimum qualification and Continuous Professional Development requirements).
The majority of these recent developments refine and provide additional guidance to these above rules. However, the notable exception is the Platform Consultation Paper summarised below. The FSA published the sixth edition of the RDR newsletter in June and this brings together various elements of RDR.
Platform Consultation Paper (CP12/12)
The FSA has now published its long awaited consultation paper covering payments to platform service providers and cash rebates from providers to consumers. The paper, as largely anticipated, contains:
- a proposed ban on all payments from product providers to platforms;
- a proposed ban on all cash rebates to customer (unit rebates are however permitted);
- both these proposed bans could apply equally to advised and non-advised business; and
- both of these proposed bans could apply to SIPP operators, life companies offering life wrappers, discretionary fund managers and execution only brokers and ISA managers that currently fall outside of the definition of ‘platform service provider’. However, the FSA is minded not to extend the scope but is inviting views.
The overarching intention of these rules is to ensure that customers pay an explicit fee (which is clearly identifiable as such) for the use of the services of a platform provider.
Firms and industry bodies have until 27 September 2012 to submit a response. The FSA hopes to publish final rules in 2012 which will come into force on 31 December 2013.
Finalised guidance on Independent and Restricted Advice
In June 2012, the FSA published finalised guidance to help firms with implementation of their rules and guidance on Independent and Restricted Advice, by providing additional material on commonly asked questions. The paper provides greater clarity about the FSA’s expectations in relation to both Restricted and Independent Advice. For Independent Advice, the paper covers:
- FSA expectations of a relevant market;
- additional guidance on how a firm should consider the ‘comprehensive and fair analysis,’ and the ‘unbiased and unrestricted’ requirements;
- how firms should approach excluding product types from consideration; and
- additional help with reviewing product markets.
The finalised guidance also provides an additional avenue for an Independent firm to achieve Independent status via the use of an aggregate or team approach. Independent advice could potentially be developed where an advisor has consulted with other team members before delivering a personal recommendation. This is a departure from the previous guidance consultation and represents a softening of position from the regulator.
The paper also provides greater certainty about the FSA’s expectations with regards to use of panels, platforms, model portfolios, discretionary investment services and how firms should communicate their advice services to clients. For example, it highlights that it has seen evidence that automatically generated investment selections (e.g. from model portfolios or asset-allocation tools) are unsuitable for some individual customers.
Quarterly consultation paper
The FSA published final rules and guidance requiring platform operators and other nominee companies to provide fund information and voting rights to the beneficial owners of units in authorised funds in PS11/9. The aim of these proposals was to reduce the difference in treatment between the increasing number of consumers who hold fund units through nominees and those who invest in funds directly.
However, since that publication was released, the industry has highlighted a number of challenges to implementing the changes in line with the 31 December 2012 deadline. These queries have focused on operational aspects of the rules, including important issues such as the scope of application given differing business models across the potential population of intermediate unit holders. Consequently, the FSA is consulting on delaying the effective date of this rule by a year. This will align this change with those proposed new rules and guidance contained in PS12/12.
For further information, visit www.deloitte.co.uk/RDR.
MiFID II ECON vote delayed
The ECON (Economic and Monetary Affairs committee) vote on the Member of European Parliament (MEP) amendments to the MiFID II proposals has been delayed until September 2012. The ECON vote is a key milestone in order to allow trialogue discussions between the Council of Ministers, European Parliament and the European Commission to commence.
ESMA publishes guidelines on compliance function
European Securities and Markets Authority (ESMA) has published final guidelines on the compliance function in relation to MiFID. The purpose of the guidelines is to set out greater clarity in respect of existing requirements and cover the following:
- compliance risk assessments;
- monitoring programmes;
- compliance reporting; and
- advisory obligations.
National regulators will have two months following the publication of the official translations to confirm whether they intend to comply or explain why they are not complying with the guidelines. The guidelines then come into force 60 days after the end of this period.
ESMA publishes guidelines on suitability
ESMA has published final guidelines in respect of suitability under existing MiFID requirements. ESMA has identified a number of issues, such as the failure by firms to ask clients the right questions or to collect relevant information, which it is seeking to address through the publication of these guidelines. The guidelines include the following topics:
- information to clients about the suitability assessment;
- qualifications of employees;
- extent of information to be collected from clients and reliability of information; and
- record keeping.
ESMA call for evidence on transaction reporting
ESMA published a call for evidence on transaction reporting, which closed on 4 June 2012. The call for evidence sets out ESMA’s intentions on publishing guidelines to harmonise transaction reporting requirements across the European Economic Area (EEA). The call for evidence will be followed by a public consultation and a cost benefit analysis. However, the work on these guidelines will take into account the progress and contents of MiFID II.
On 19 April, ESMA published its final technical advice to the European Commission on possible Delegated Acts regarding the regulation on short selling and certain aspects of credit default swaps (‘Short Selling Regulation’ or ‘SSR’).
The report includes recommendations on the following:
- clarification around the circumstances under which a natural or legal person is considered to own a financial instrument for the purposes of the definition of short sale;
- the net position in shares or sovereign debt covering the concept of holding a position, the case when a person has a net short position and the method of calculation of such a position for fund management activities related to separate funds;
- the cases in which a credit default swap (CDS) transaction is considered to be hedging against a default risk or the risk of a decline of the value of the sovereign debt and the method of calculation of an uncovered position in a CDS; and
- the definition of the initial and incremental levels of the notification thresholds to apply for the reporting of net short positions in sovereign debt.
The SSR will come into effect on 1 November 2012.
On 25 June, ESMA launched a consultation on EMIR, the proposed regulation for OTC derivatives, central counterparty clearing houses and trade repositories. The paper contains the legal provisions for the regulation, consists of both draft Regulatory Technical Standards and draft Implementing Technical Standards and provides further detail as to how the initiative will work in practice, including:
- the framework for the application of the clearing obligation;
- details on the risk mitigation techniques applicable to OTC derivatives that are not centrally cleared;
- requirements regarding the application of exemptions for intra-group derivative transactions;
- clarity around which derivative contracts need to be reported to trade repositories; and
- details on the data that must be made available by trade repositories to relevant authorities.
The final draft standards are expected to be submitted to the European Commission for endorsement by 30 September 2012.
Following a Consultation in August 2011, the FSA published a feedback statement (FS12/1) on RRPs. FS12/1 sets out the approach being taken by the FSA, summarises the responses received to the consultation, reviews other UK and international initiatives that are relevant to recovery plans and resolution packs and sets out what the FSA expects firms to do while the final rules are being adjusted to take into consideration developments in the international arena. FS12/1 is relevant to all UK incorporated deposit-takers and significant UK investment firms with assets exceeding £15 billion.
The FSA has published draft ‘core’ rules. The publication of the final rules has been delayed in order to take into consideration international developments that are relevant to RRP, in particular the proposed EU Directive on recovery and resolution (published in June 2012 - view Deloitte’s briefing note summarising the changes).
The FSA has indicated that the submission of recovery plans and resolution packs will carry on as planned. Large firms involved in the pilot exercise will submit recovery and resolution packs by the end of June, as agreed with their supervisors. The FSA expects to publish the final rules no later than autumn 2012 and intends to consult at a later date on applying RRP rules to the UK branches of non-EEA firms without UK subsidiaries. More information on this including draft rules, information pack are available on the FSA’s website.
On 18 April, the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) approved final swap-related rules and guidance under Title VII of the Dodd-Frank Act. The rules define the following terms: ‘swap dealer’; ‘security-based swap dealer’; ‘major swap participant’; ‘major security-based swap participant’; and ‘eligible contract participant’. These definitions provide some further clarity to participants in the derivatives market regarding whether they will need to register with the CFTC or SEC as major swap participants or swap dealers and adhere to new requirements. While largely consistent with the proposed rules which were published in December 2010, there are some important differences, notably a relaxation of certain thresholds reducing those potentially caught within the definitions. On 18 May 2012, the CFTC also approved a final rule on swap data recordkeeping and reporting requirements for counterparties to swaps executed prior to passage of the Dodd-Frank Act and transition swaps.