In this edition we look at product governance and distribution policy, governance and compliance standards to do with auditing, the 'positive and negative indicators' that firms must heed when they obey the Senior Managers' and Certification Regime, the European Securities and Markets Authority's 19 areas for review in the AIFMD and UCITS directive, and of course compliance standards and Brexit.

Product governance and distribution policy

In early August the FCA started to consult interested parties about its idea of introducing notice periods for fund redemptions. Liquidity mismatches in open-ended property funds are the subject of the regulator's consultative paper, CP20/15. It can be hard for funds whose underlying investments consist of commercial property to provide daily liquidity, so liquidity management for many generally consists of maintaining large cash balances to manage redemptions and has, on recent occasions, led to the suspension of funds. The FCA proposes to introduce a 'prior notice' period of between 90 and 180 days of an intention to redeem. This, it hopes, ought to allow funds to sell assets by way of an orderly sales process and reduce the risk that the manager sells the fund’s highest-quality, most liquid assets to meet redemptions first.

The FCA proposes to introduce the concept of FPIPs, funds predominantly investing in property, i.e. non-UCITS (Undertakings for the Collective Investment in Transferable Securities) retail schemes that invest at least 50% of their assets in property and which do not operate redemption arrangements that reflect the typical time needed to sell these assets. The length of the notice period will be announced in a 'final' policy statement.

The FCA indicates there are 18 funds that might have to obey these rules that it is proposing to make, so the whole exercise is likely to be of limited effect. It does, however, concentrate quite rightly on perhaps the most illiquid of investment classes.

However, the potential liquidity mis-match in other funds and the systemic risk that this could create appears to be concerning the regulators. Buried in the Coronavirus (Covid-19) Information for Firms web-page, the FCA says that it has clubbed together with the Bank of England to undertake a survey that looks at the consistency between liquidity and redemption terms in terms of liquidity, pricing and redemption notice periods. Asset managers that volunteer to take part in this survey are being asked to respond to the questions as best they can by 30 September.

Governance and compliance standards

On 10 August, the FCA sent a letter to auditors about reporting, stating that it wanted auditors to disclose 'going concern' compliance risks. With this in mind, it published an open letter to senior partners and directors of audit firms, reminding external auditors of their statutory responsibility to give it 'certain' information that comes to their attention during the course of their work.

[Editor's note - It says: "In the current financial climate, it is vitally important that auditors are mindful of their reporting duties in relation to significant matters arising, for instance under SUP3 of the FCA handbook, sections 342(5) and 343(5) Financial Services and Markets Act 2000 and UK auditing standards."]

The FCA emphasises that this duty includes 'going concern' considerations as part of its attempts to strengthen capital adequacy standards through behavioural rather than prudential measures. The auditors' disclosure-related responsibilities are wider than only going concern matters, however.

Clients' assets and CASS

In a Dear CEO letter which it issued on 12 August the FCA encouraged firms that provide non-discretionary services to send money that they know is not going to be invested back to the clients that own it. This is because it observed an increase in client money balances between January and June. The relevant senior manager should consider whether his firm ought to hold client money balances which are unlikely to be reinvested, or whether it would be in the clients’ better interests for it to place these balances directly with their own current or savings account providers. This is on top of meeting existing CASS reporting requirements.

The SM&CR: positive and negative indicators

In a previous post last month we saw that the FCA had elected to extend the Senior Managers and Certification Regime's implementation deadline for employee certification to 31 March 2021. It has now refreshed its SM&CR (Senior Managers & Certification Regime) webpages. This update includes new statements about positive [behavioural] indicators that the FCA expects firms to prove to it that they are finding when assessing the fitness and propriety (F&P) of employees and applying conduct rules. In F&P assessments it expects firms to integrate their processes with their human resources (HR) departments, create panels to consider marginal cases, while acknowledging that some individuals may fail to qualify.

Firms are also expected to echo the FCA party line and tell their people that the new SM&CR and conduct rules are a “step change in regulatory expectations.” The recently created REP008 webpage (on the subject of solo-regulated firms having to send off reports to the FCA in line with the conduct rules) has been updated to tell firms what information to submit (if any) and what to include in the new return. REP008 is the new annual reporting requirement for solo-regulated firms that have to obey the SM&CR. It orders them to tell the FCA whether they have taken disciplinary action against people who are not senior managers for breaking its conduct rules. The relevant return will appear in GABRIEL and will need to be submitted within 2 months of the end of the reporting period, 1 September to 31 August each year, with submissions due by 31 October. Breaches of the conduct rules by people who perform senior management functions (SMFs) should not be included in REP008 as firms need to report these on Connect using the required forms.

Above all else, the FCA expectats SMFs to oversee the F&P process themselves and be involved in the provision of training on the subject of conduct. It is debatable whether the SM&CR is a “step change in regulatory expectations”; it is certain, however, that the regulator has introduced 1000+ rules which it claims to be based on principles and which firms have had to integrate into their business processes over nearly two-and-a-half years. These have now been kicked down the road by Covid-19 because the Treasury is intent on not over-burdening regulated firms. Nevertheless, firms should review the webpage to form their own opinions about the things that the regulator expects. For REP008, the 31 October falls on a weekend this year, so firms should submit the first REP008 by 2 November 2020. Firms should remember to file "nil" returns if no disciplinary actions for breaches of the conduct rules have occurred.

Governance and compliance standards

In a consultative paper, the FCA is proposing to extend financial crime reporting to investment managers. Every firm's Annual Financial Crime Report (REP-CRIM) provides the FCA with information about a range of things that gauge the money-laundering risks that it runs. In 2018, the Financial Action Task Force (FATF) asked the FCA to consider extending the application of REP-CRIM. The FCA noted its intention to bring this about in the UK’s Economic Crime Plan 2019 to 2022 and is now consulting interested parties about it. The proposals show the that the FCA intends to look more sharply at firms that are highly risky when it comes to financial crime, or smaller firms which lack the types of controls and processes that larger ones use. Firms may have to improve their systems and controls to meet regulatory expectations and collect the data. They could make a good start by updating their Financial Crime Risk Assessments and spotting any gaps in the controls or data they need to answer the questions in REP-CRIM accurately and completely.

ESMA pulls no punches

The European Securities and Markets Authority has written to the European Commission, setting out 19 areas for legislative review in the Alternative Investment Fund Managers (AIFMD) and UCITS directives. Delegation to non-EU entities (i.e. the UK) and hosted manager operating models appear to be in ESMA's range.

ESMA’s comments on delegation and substance are the most striking and could affect established operating models that make use of existing delegation rights in the organisational structure of an AIFM or where a “host” manager provides “white-labelling” services. Firms that use these models to provide services in the EU should follow the forthcoming debate closely.

Governance and compliance standards to do with Brexit

There has been a plethora of Bexit-related web-page updates in August on the Temporary Permissions Regime or TPR, including a notification that the FCA intends to reopen the TPR window for firms and fund managers as of 30 September to allow firms to submit further new notifications and/or amended notifications. EEA passporting firms are reminded that the financial services contracts regime (FSCR) will automatically apply to them regarding an orderly winding-down of their pre-existing contracts in the UK.

Firms that 'passport' funds and services and that wish to continue their activities in the UK after 31 December ought to have been making preparations for some time. For those that have not, however, there is still time to opt into the regime. This will allow them to continue providing services in the UK while they seek their own authorisation from the FCA.

Transaction reporting after Brexit

The unusually short length of the FCA's Market Watch 64 is a reminder to firms that the FCA has no intention of compromising its statutory objective of trying to bring integrity to the markets before the end of the "EU withdrawal transition period," as some call it. Firms that cannot comply with their obligations to report transactions after 31 December will be required to 'back-report' missing, incomplete or inaccurate transaction reports as soon as possible.  

The FCA's FIRDS (Financial Instruments Reference Data System) is available for testing with the FITRS (Financial Instrument Transparency System) opening on 5th October. The FCA is promising a smooth transition to the FCA FIRDS in January as the underlying mechanics of reporting and reporting logic remain largely unchanged.

Firms satisfy themselves that they can continue to report transactions after the end of the transitional period, which will entail testing their reporting processes with their designated Approved Reporting Mechanism (ARM). The transaction reporting rules are complex and firms are still submitting inaccurate files to the FCA that pass both ARM and FCA validations.

* Jonathan Wilson can be reached on +44 (0)20 3146 1869 or at jon@elliswilson.co.uk