On 20 February 2023, the FCA published a discussion paper, DP23/2: Updating and improving the UK regime for asset management (the Discussion Paper). This is an important contribution to the Future Regulatory Framework Review, established by the UK Government back in 2019, to rethink the UK’s new position outside the EU. The FCA’s stated intention is to initiate a debate about modernising the regulatory regime for funds and asset managers. It wants to “improve outcomes for UK markets and consumers and to support the UK’s position as a world-leading centre for asset management”.
The Discussion Paper comes hard on the heels of the Edinburgh Reforms in December, a broader set of initiatives across the whole of financial services, and a Dear CEO Letter to Asset Managers in February which set out the FCA’s immediate supervisory priorities for the sector.
The FCA stresses in the Discussion Paper that it will not propose change for change’s sake and is particularly concerned about creating complexity for firms operating in several international jurisdictions. It also wants to ensure that reforms meet certain key tests:
That they better meet the needs of investors, both retail and professional, as well as domestic and international;
That they facilitate technological innovation and smart use of data; and
That they are effective and proportionate, simplifying where possible.
Improving the structure of the regime
Chapter 3 of the Discussion Pater looks at ways to make the structure of the regulatory framework for asset managers clearer and more coherent. The three main topics are:
Fund manager types including portfolio managers: Across the sector, there are inconsistent sets of rules applying to authorised funds, the managers of authorised and unauthorised funds, and to portfolio managers making investment decisions on behalf of funds and other clients. One example is of conflicts of interest with subtly different standards (appropriate, sufficient etc) depending on whether you are managing a UCITS, an alternative investment fund or a segregated portfolio. Creating a single rulebook for asset managers may be too ambitious, the FCA acknowledges, but it does see merit in a consolidation of rules within a common framework, but with different treatment for certain exceptions.
The regime for retail funds: the current regime for authorised retail funds consists of both UCITS funds and NURS (Non-UCITS Retail Schemes). Within each category there now exists a wide range of funds across degrees of risk and complexity, but this creates difficulties for retail investors who want to access them without advice. Possible solutions include removing the distinction between UCITS and NURS, rebranding NURS as “UCITS plus”, and/or creating a category of “basic” funds subject to restrictions on liquidity of assets, use of derivatives and degree of diversification.
The regime for managers of professional funds: perhaps the most eye-catching potential reform is to change the size threshold for small UK AIFMs (currently €500 million for unleveraged, closed-ended funds, or €100 million for all others) – with small AIFMs being subject to less prescriptive requirements. Even an uplift in the thresholds to reflect inflation over the past decade would be substantial. A bigger increase, perhaps accompanied by other exemptions based on types of strategy or clients, will potentially bring sizeable benefits to smaller managers navigating the route to economic viability.
Areas of focus
The three remaining chapters of the Discussion Paper set out individual areas for possible improvement which are, for the most part, independent of the structural changes discussed in Chapter 3. Details around these proposed individual areas for improvement are set out as below.
Improving outcomes for retail and professional investors:
Rules for authorised fund managers (“AFM”): whether the responsibilities of portfolio managers using the AFM model need to be spelt out more clearly, including minimum contractual requirements between AFM and portfolio manager.
Improving the management of liquidity: whether ESMA’s Liquidity stress testing guidelines should be incorporated into the FCA Handbook; making clearer the rules around dilution adjustments (swing-pricing): and potential new requirements on public disclosure of fund liquidity.
Investment due diligence: whether expectations around investment due diligence (including credit assessment) need to be made clearer.
Rules for depositaries: clarifying and rethinking the role of depositaries in providing oversight to protect investors’ interests, with more detailed specification of their duties in some areas.
Improving fund rules for eligible assets and diversification: updating and rethinking the rules on eligible assets for UCITS; whether the more detailed and prescriptive rules on the prudent spread of risk should be removed or modified.
The role of technology and innovation:
Driving better consumer outcomes: identifying opportunities for technological change in the funds industry, and to think strategically about longer-term trends.
Fund operations: whether to consult on the “Direct2Fund” model proposed by the Investment Association as an alternative to the current role of the AFM in buying and selling units on behalf of the fund.
Fund tokenisation: investigating the introduction of tokenised units in authorised funds, including what regulatory changes would be required.
Tokenised portfolio assets: similarly, whether funds should be permitted to invest in tokenised assets, where the underlying instrument is an eligible asset.
Investing in cryptoassets: in addition, whether the scope of eligible assets should be broadened to include unregulated tokens, such as stablecoins and other forms of cryptocurrency.
Improving investor engagement through technology
Fund prospectus: how the existing rules on fund prospectuses can be changed to improve content and readability and hence improve investor engagement.
Managers’ reports and accounts and ongoing investor information needs: what changes could be made to make better use of technology and improve the disclosure of ongoing information.
Investor engagement, including unitholder meetings: whether to change the rules for unitholder meetings to improve attendance and participation. Also, how changes to the rules for authorised funds could foster closer relationships between fund managers, intermediaries and investors.
The FCA invites comments from interested parties by 22 May 2023. These can be sent to the Asset Management and Funds Policy Team, email: [email protected].
Considering the ambition and breadth of the FCA’s stated objectives in launching this discussion, we find the issues raised and solutions signalled simply don’t meet them. Apart from changing the size threshold for smaller managers, there is not much to get the alternatives sector excited. Has the FCA missed the opportunity for a much more radical streamlining of the FCA Handbook, which would create a regime that is tailored and proportionate to specific sectors of the asset management industry? Answers on a postcard…
We may yet see reforms coming out of the wider reviews initiated in Edinburgh, such as the Senior Managers and Certification Regime (“SM&CR”) with the possibility of a streamlined application process for Senior Managers and let’s not forget the Short Selling Regime with the potential of higher thresholds for reporting. We would also urge a review of other reporting obligations on asset managers – for example, transaction reporting and Annex IV – which might not survive re-worked cost/benefit analysis.
But, mindful perhaps of the time limitations of the political cycle, together with the sheer volume of work being teed up by the Edinburgh Reforms, the FCA has signalled a set of piecemeal changes which may individually be helpful, but which will not fundamentally boost the competitive position of UK managers relative to other centres.
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