An exploration of oversight responsibilities and how they affect asset management firms

At a glance: A number of differently configured arrangements at an asset management firm can create oversight requirements. One of which is delegation; a term that takes on a kaleidoscopic quality when it is considered in a business setting as well as a regulatory one. This blog seeks to demystify the language used to describe the activities firms are doing that require oversight. It puts forward the merits of taking a holistic and centralised view of oversight responsibilities in order to manage the full spectrum of its associated risks, regardless of the context that has triggered the need for oversight to take place.

Oversight Under The Microscope

Let's start by taking a look at what ‘oversight’ means. The Penguin English Dictionary's definition of oversight is supervision. The term has not been given an additional regulatory definition in the FCA's Glossary. Therefore, in this instance, the dictionary definition can be used a point of reference from which to explore the responsibilities that emerge when arrangements that require oversight are put in place at asset management firms.

If the cheese in the image above symbolises the 'prize' for achieving a robust and cohesive oversight model, what challenges do asset managers need to navigate to avoid triggering ‘traps’ and falling foul of regulations?

Asset managers are operating in a challenging economic climate where they are on a constant search for efficiencies in balancing taking care of their customers with the rising cost of doing business.

One way of potentially reducing costs is to delegate, outsource or set up bespoke arrangements with a third party (that are neither delegation nor outsourcing). This suite of practices is not new, but it is being revisited by firms as a way of reducing costs and making improvements to achieve operational efficiencies. This of course has implications on how those arrangements are overseen.

The key premise for these practices is that the asset management firm still retains ultimate responsibility for its regulated activities and all the activities involved in it operating as a business (even if the firm is not directly conducting them). Therefore, in order for firms to discharge their responsibilities they are required to oversee this ecosystem of arrangements and ensure that harm does not result from any failure on their part to adequately supervise their relationships with delegates, outsourced service providers or third parties.

So far, so simple right? Wrong.

A factor that contributes to complexity is the volume of choice when it comes to options for delegation, outsourcing and third-party arrangements resulting in the establishment of intricate chains of relationship agreements behind the 'frontage' of a regulated asset management firm. This is causing Regulators to direct more scrutiny towards firms and their oversight approaches. A current example of this can be seen in the FCA's finalised guidance for consumer duty which specifically highlights that if a firm chooses to outsource elements of its consumer support to a third party, the principal firm remains responsible for ensuring that the support provided meets consumer duty standards.

A Holistic Approach

Firms are finding that when they investigate their oversight responsibilities, they encounter challenges around the language to use when opening conversations on this topic within their business. This is because the oversight responsibilities are driven by arrangements with different names that are linked to different regulatory regimes e.g., delegation referenced in AIFMD/ UCITS¹, and outsourcing referenced in MiFID² (or fall outside of regulatory regimes altogether e.g., managerial delegation). However, by taking a step back and considering what regulatory regimes have in common and applying a more lateral approach it may be possible to land on what oversight activity is being undertaken rather than how that activity has been labelled in regulation. Focusing on the 'what' rather than the 'how' can allow firms to assess the entire population of their oversight resources from an efficiency perspective, helping them to align activities which share similarities and pool existing skillsets for oversight purposes.

Creating a Framework

Whilst taking a holistic approach may present advantages (e.g., reducing costs associated with multiple teams, streamlining data on oversight) listed below are some considerations that firms should bear in mind before starting to reconfigure or combine intricate oversight frameworks in order to make sure that they work as intended if they were to be amalgamated:

Knowledge and the root of the responsibility: it is necessary first to consider which relationships a firm has that require oversight and the regulated permission regime from which the responsibility for the activity being delegated is derived. For asset managers this could be one, two or potentially three different regimes (AIFMD, UCITS and MiFID). AIFMD and UCITS refer to delegation of functions and MiFID refers to outsourcing of operational functions. Both delegation and outsourcing require oversight. Consequently, before embarking on an oversight framework change programme, it is vital to begin by revisiting which requirements apply and to circle back regularly to ensure that shifts in one area aren't going to inadvertently affect a regulatory provision that's plugged in elsewhere.

Substance: Another key area on which a firm should spend time reflecting is whether it retains adequate substance, in terms of the number of resources and their level of skills, in the country in which it is regulated. This could be achieved by conducting a regular review to check whether the firm has appropriate resourcing and expertise to challenge the delegates, outsourced relationships and any third parties it oversees.

Consistency: Regulators expect firms to demonstrate an adequate level of oversight for any delegated/ outsourced arrangement that is considered critical whether the arrangement is internal (i.e., within the firm's group) or external.

Regularity: It is necessary to demonstrate that risk based and proportionate oversight of relationships involving delegation, outsourcing and third parties happens on an ongoing basis. Final review and sign off of due diligence and ongoing monitoring performed at the level of the entity delegating/outsourcing is also critical for ensuring compliance with regulatory expectations. A trend is emerging whereby firms are turning towards automated IT solutions to help them manage their oversight responsibilities. Digitisation allows firms to centralise and automate their ongoing oversight tasks and timelines, build a data repository, perform analysis, and produce reports on the various relationships they oversee.

EU Regulatory Change: The Review of AIFMD and UCITS

The above points should also be considered alongside the subtle regulatory shifts that are taking place in Europe on this topic which will be relevant to any decisions related to oversight arrangements a firm may go on to make.

On 20 July 2023, the Council of the EU announced that it had provisionally agreed a deal with the European Parliament on changes to the AIFMD and UCITS Directive (which both contain rules on delegation).

The European Council Report of February 2023 stated that one of the aims of the review is to create a "robust" delegation regime "through the removal of duplications and redundant requirements". Efforts are being made to align the AIFMD and UCITS legal frameworks and rules on delegation. This upcoming regulatory change has triggered renewed conversations on the topic of delegation arrangements and how they are being overseen by asset managers.

Due to Brexit, changes at a European level may no longer be directly applicable to UK asset managers. However, UK firms will be indirectly affected by the changes if they are the delegates of EU based Management Companies and AIFMs because they will be overseen by EU firms that are subject to the new requirements. Both UCITS and AIFMD were onshored at the end of the Brexit transition period so additional clarity on how the two regimes can work together more efficiently is likely to benefit UK asset managers reviewing delegation oversight frameworks and hopefully in turn drive simplicity and cost savings.

Furthermore, the FCA has consistently explored the theme of robustness and emphasised the need for firms to do more to strengthen their governance and oversight practices. This can be seen through the FCA's findings from its Asset Management Study, Review of Host Authorised Fund Management Firms, its work on outsourcing and operational resilience and the oversight requirements included in the new Consumer Duty regime. Therefore, despite the disruption caused by Brexit, EU and UK regulators are consistent in their goal to continually raise the thresholds firms need to meet prior to and whilst engaging in arrangements requiring oversight.

Additionally, it is worth mentioning that Brexit created a shift in the way the UK is perceived by Europe now that it is no longer a member state and directly subject to European Regulations. Consequently, EU asset management company groups which delegate/ outsource activities to a (third country) UK regulated entity are likely to issue requests to those firms asking them to provide more oversight assurances as the regulatory landscape begins to diverge.

Conclusion

In conclusion, taking a centralised view of all types of oversight responsibilities can give firms the best possible chance of comprehensively managing their risks and achieving a consistent level robustness in their oversight practices. This, in turn, can help drive both cost and operational efficiencies.

If you have stuck with me until the end, I'd like to know whether you think your firm has oversight figured out and can claim the "cheese"?

_____________________________________________________________

References

¹ AIFMD and UCITS were onshored to the UK at the end of the Brexit transition period.

² MiFID was onshored to the UK at the end of the Brexit transition period.