1. Brexit (29 March 2019): Where are we now?
Can you hear the Brexit clock a-ticking? Two years on from the Referendum and I assumed a transition agreement would be signed and that the future landscape and direction for asset managers would be firmly in place. I was wrong. Unless there is a signed Brexit transition agreement or magical Brexit unicorn dividend, the UK on 29 March 2019 will be crashing out of the EU – embarking on a fantastic voyage of discovery, unfettered by pesky EU red tape, where greatness awaits. The reality, of course, for financial services is that the FCA has confirmed that leaving the EU will not mean the UK stops following EU rules, but will continue to be a rule taker from the EU. However, let’s not use facts or reality, as these concepts have rarely touched the Brexit debate.
A recent survey from TheCityUK finds that the UK manages £8.1tn in assets under management, 37% (a record £2.6tn) of which are managed for overseas clients. Anjalika Bardalai, chief economist and head of research at TheCityUK, confirmed the UK fund sector is a world leader at managing overseas assets but Brexit could put that at risk. She is quoted in the FT saying that half of these overseas client assets come from EEA countries, “with the rest predominantly from the US and Asia”.
MiFID II: post 1 January 2018 trends
Inducements and research
Under the Markets in Financial Instruments Directive II (MiFID II), research is allowed not to be treated as an inducement provided that it is paid for:
- directly by the firm from its own resources; or
- via a separate research payment account, funded by specific research charges to the client.
The FCA intends to extend these requirements to Undertakings for Collective Investment in Transferable Securities (UCITS) management companies and Alternative Investment Fund Managers (AIFMs) (non-MIFID business).
So, what has this meant on the ground since 1 January 2018, or rather 1 April 2018 when the extension for the implementation of this rule ran out?
Most large asset managers have added the costs of research to their profit and loss reports, which means now much less research is being approved. This has put pressure on research houses’ margins and business models. Larger asset managers and banks have been able to absorb these new pressures, but a consultant quoted in the FT has said: “Tier 2 players are struggling to monetise their research offerings”. The result is there is increasingly less research available, but given that under MiFID II, client interactions are more closely tracked, it’s easier for analysts to track how much their research is worth. Estimates are that investment research numbers are likely to halve, with the result that a ‘star analyst’ culture is emerging. The FT quotes a banking executive who confirms: “If you’re the tenth-ranked analyst, you’re seeing a rapid deterioration in your levels of client engagement.” So MiFID II for the average analyst will be a testing time, and could prove fatal, but for star analysts their services will be sought out and their research valued and paid for. This is analogous to Darwin’s theory of the survival of the fittest, with some researchers finding their futures more akin to that of the Dodo once man landed on their islands. Flightless birds don’t do well when they need to fly. Tier 2 analysts know these things.
3. General Data Protection Regulation: post 25 May 2018
Although the deadline for GDPR has been and gone, this continues to be a big deal for asset managers. With a maximum fine for a breach of GDPR controls being equivalent to 4% of global revenue, failure to have robust controls around processing and control of personal data has serious consequences and is an ongoing requirement.
The Information Commissioner (IC) has acknowledged that firms should be actively implementing GDPR and will stamp on those firms who ignore the requirements (Brexit has no impact on GDPR implementation for the UK). This invariably involves completion of GDPR risk assessments across business units, identifying and addressing gaps, as well as updating data protection procedures with GDPR requirements, including staff training and other processes. Don’t underestimate the time and resources this has and will continue to take. The IC has confirmed GDPR compliance should be viewed as an evolutionary process for the organisation, recognising the need for firms to identify and address emerging privacy and security risks going forwards.
Several important areas for asset managers hold and process personal information, including:
- Investors
- Marketing
- Staff
- Data protection officers
- Contracts
- Privacy notices
- Data subject access requests
- Monitoring/audit
- Policies and procedures
- Training of staff.
4. FCA sets out next steps to improve competition in the UK’s asset management sector
The FCA is introducing requirements on asset managers to not only provide investors with more information (ie, improving transparency of key information for investors) but is now requiring firms to carry out actions to ensure investors get value for money (which will impact on profit margins as well as the control environment). A case in point is PS18/8, which relates to UK authorised fund managers in respect of their management of authorised funds (eg, authorised open-ended collective investment schemes, and will be of interest to delegated portfolio managers, the depositories of authorised funds and financial advisors). Simmons & Simmons produced a handy summary table which confirms from 5 April 2018 the circumstances when it can mandatorily transfer client investments to a lower fee charging unit class. This is part of an obligation to carry out assessments on whether payments out of a fund are “justified in context of the overall value delivered to unitholders”, which is an ongoing obligation.
This more hands-on approach to FCA guidance in the asset management sector comes at a time of pressures on fund performance, reduced fees, active versus passive fee restructuring and Brexit, so may well make entry into the asset management sector harder for the smaller player, which might not necessarily increase competition. This more aggressive approach to regulatory oversight in the sector may be part of a trend, so it is worth monitoring this area.
The attached table also includes additional governance; SMCR; value for money; and box profits requirements which come into effect in the coming months and shows a more prescriptive style to FCA guidance that some asset managers will have issues with.
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Final report and CP17/18
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Policy statement
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Timing
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Governance
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Proposed requirements at AFM level included:
- AFMs must appoint at least two independent directors to the board, and
- independent directors must make up at least 25% of the AFM board.
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The proposals were implemented with some minor changes:
- independent directors must make up at least 25% of the AFM board
- if an AFM board has fewer than eight members, it must appoint at least two independent directors to the board
- independent directors can serve for a maximum term of ten years, and
- introduce specific criteria for determining a director’s independence.
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By 30 September 2019
(18-month implementation)
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SMCR
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Proposed introduction of a new prescribed responsibility through SMCR:
“Responsibility for an AFM’s value for money assessments, independent director representation and acting in investors’ best interests” (PR7)
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The FCA has adopted the new prescribed responsibility without change.
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At same time as the SMCR extension
(mid to late 2019)
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Value for money
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Proposed a new ‘value for money rule’, which would require AFMs to assess whether investors had received value for money on an ongoing basis and which would need to be documented formally on an annual basis (as part of each fund’s annual report or through a separate dedicated report).
Such an assessment should consider (at least) economies of scale, fees and charges, and quality of services.
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The FCA has redrafted its proposed rules to clarify that fund charges should be assessed in the context of the overall value delivered, rather than using the term “value for money”.
The FCA has clarified that:
- the assessment criteria will include fund performance (based on reasonably expected future performance as well as past performance), and
- the assessment can be made over a time appropriate to the fund’s investment objective, policy and strategy.
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By 30 September 2019
(18-month implementation)
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Box profits
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Proposed new rules:
- AFMs must pass risk-free box profits back to the fund, and
- the AFM’s approach to box management must be disclosed in the fund prospectus.
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The FCA has implemented its proposed rules with minor changes to allow flexibility for the allocation of risk-free box profits (to the fund or to the investors).
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By 1 April 2019
(12 months implementation)
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Switching share classes
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Proposed certain modifications to the FCA’s Finalised Guidance: Changing customers to post-RDR unit classes (FG14/4) to clarify that when dealing with unresponsive unitholders the circumstances in which the AFM can undertake a mandatory conversion.
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Final guidance introduced which requires:
- one-off notification to investors which does not require a response
- a minimum of 60 days before a mandatory conversion, and
- AFMs should consider whether mandatory conversions are in investors’ best interests.
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05 April 2018
(immediate effect)
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5. Senior Managers and Certification Regime – reminder
The FCA/Treasury are yet to confirm when the SMCR comes into effect (the policy statement affirming final guidance has yet to be communicated) for asset managers and insurers. It was supposed to be late 2018, but it will very likely slip, due to MiFID II implementation / Brexit, to mid-2019.
Just be aware that there will be a delayed transition process for smaller and medium sized asset managers a year after it comes into effect. It’s worth double checking the FCA guidance as you may be surprised. For example, I heard that a member of a private compliance group was discussing SMCR requirements and was surprised to discover his firm came under the ‘Enhanced SMCR firm’ category and would have to implement the extensive requirements for day one of implementation. Given the SMCR has onerous requirements it’s better to be safe than sorry confirm how your firm is classified under the SMCR as it may impact on whether you have an enjoyable summer break.
Views expressed in this article are those of the author alone and do not necessarily represent the views of the CISI.