Legal Shorts 09.08.19 including FCA letter on tightening UK liquidity standards for UCITS

FCA letter on tightening UK liquidity standards for UCITS

On 7 August 2019, the FCA published a letter from Andrew Bailey, FCA Chief Executive, to Lord Myners on the possibility of the UK establishing its own requirements for liquidity standards for UCITS at a higher standard than those specified in the UCITS Directive. Mr Bailey states that, as the UCITS Directive is generally minimum harmonising, it would be possible for the UK to tighten liquidity standards for UCITS schemes established in the UK. However, he believes there are two significant drawbacks:

  • Tightening liquidity standards for UK funds would not be sufficient to protect UK investors from harm because the FCA is not permitted, under EU law, to extend unilaterally these measures to UCITS established in other EEA member states and marketed in the UK under EU passporting rights.
  • The UCITS Directive sets an overall objective that funds should be liquid, but the detailed rules underlying this may not be sufficient to ensure liquidity. Mr Bailey comments, in the light of the suspension of the LF Woodford Equity Income Fund (WEIF), that exchange listing does not necessarily lead to liquidity as trading may not occur. He suggests that the interaction between the overall requirement for liquidity and the more detailed rules may need clarification.

Mr Bailey believes that there is merit in considering the purposive test of liquid status introduced by the US Securities and Exchange Commission (SEC). This requires fund managers to allocate assets to liquidity buckets based on the estimated time it would take to sell the asset. This should ensure an overall picture of the liquidity of the fund’s assets and does not rely on assumptions, such as linking liquidity to listing status. The Financial Policy Committee (FPC) announced in July 2019 that the FCA would work with the Bank of England (BoE) to consider how funds’ redemption terms might be better aligned with the liquidity of their assets in order to minimise financial stability risks without compromising the supply of productive finance.

New FCA webpage providing more information on SM&CR categorisation for FCA solo-regulated firms

On 31 July 2019, the FCA published a new webpage providing more information on categorisation under the senior managers and certification regime (SM&CR) for solo-regulated firms.

The webpage summarises how firms can change their SM&CR category (by “opting-up” or “opting down”), and the process for reviewing a firm’s SM&CR categorisation.

The FCA explains that there are six thresholds that will result in a firm being classified as an enhanced firm. Four of these thresholds are based on GABRIEL. The webpage includes a table setting out these thresholds and indicating on which specific GABRIEL reports this information is based. A firm that considers it has been categorised incorrectly is advised to contact the FCA.

House of Commons Treasury Committee report on the work of the FCA and the perimeter of regulation

On 2 August 2019, the House of Commons Treasury Committee published its thirty-fifth report of session 2017-19 on the work of the FCA and the perimeter of regulation. The report contains recommendations to HM Treasury on the remit and powers of the FCA and follows the FCA’s June 2019 perimeter report for 2018/19. The committee notes that the perimeter of regulation appears to be confusing for consumers and that some firms may “deliberately game the perimeter” to undertake regulatory arbitrage. Therefore, the report recommends that where regulated financial institutions undertake unregulated activity, there should be clear and explicit warnings provided, with potential consequences clearly explained.

The report also recommends that the FCA be given the formal power and necessary remit to be able to formally recommend to HM Treasury changes to the perimeter of regulation, where that would enhance its ability to meet its objectives, in particular to prevent consumer harm. HM Treasury would then be obliged to consider the recommendation promptly and publicly.

In terms of warnings on financial products, the report states that the FCA should be given the remit (by way of primary legislation) to highlight risks faced by financial services consumers, including where an activity is beyond the perimeter of regulation.

It also suggests the FCA should have greater information gathering powers to stop it being reactive. The Financial Policy Committee (FPC) has the power to recommend that HM Treasury order additional information from unregulated entities to help meet its objectives. At the very least, this should be replicated for the FCA, with the FCA potentially being able to determine what data it can gather.

FCA review of banking SM&CR

On 5 August 2019, the FCA published its findings, on a webpage, following a review into the embedding of the senior managers and certification regime (SM&CR) for deposit-taking firms and dual-regulated investment firms (collectively referred to as the banking sector), which came into force in March 2016.

Overall, the FCA found that the industry has made a concerted effort to implement the regime. Points of interest include the following:

  • Senior manager accountability. The SM&CR does not seek to redefine the roles of non-executive directors (NEDs) and it does not expect NEDs to act more like executive directors. With regard to the meaning of “reasonable steps” under the duty of responsibility, there is guidance in the Decision Procedure and Penalties manual (DEPP). It is not possible for the FCA to provide an exhaustive list that would cover every situation and it does not believe that this would be helpful.
  • Most firms could not demonstrate the effectiveness of their certification assessment approach, use of subjective judgement or how they ensure consistency across all certified staff.
  • Conduct rules. Many firms were often unable to explain what a conduct breach looked like in the context of their business. The FCA explains that the conduct rules are a critical foundation for firms’ culture and the conduct of individuals. It is essential that staff understand the rules and how they apply to them. Firms must provide suitable training to staff.
  • Impact on culture. Firms told the FCA that the SM&CR is having an impact on the mindset of senior managers. Also, it is enabling firms to improve their controls environment, which firms expect to lead to improved behaviours.
  • For most firms, the implementation of the SM&CR did not lead to significant unintended consequences. Where it did, this was specific to a firms’ particular business.

The findings will also be of interest to FCA solo-regulated firms, for which the SM&CR comes into force on 9 December 2019, and insurers.

The FCA notes that this is not a full post-implementation review and it does not propose to make any policy changes based on it. However, in the light of its findings, it will increase its supervisory focus on the conduct rules.

ESMA’s temporary product restriction on marketing, distributing and selling CFDs to retail clients expires

On 31 July 2019, ESMA published a press release announcing that it will not renew the temporary restriction on the marketing, distribution or sale of contracts for differences (CFDs) to retail clients in the EU.

As a result, the measures in ESMA Decision (EU) 2019/679 automatically expired on 31 July 2019. (For more information on the Decision, see Legal update, ESMA temporary restriction on CFDs applicable from 1 May 2019 published in OJ).

ESMA has taken this decision as most national competent authorities (NCAs) have taken permanent national product intervention measures relating to CFDs that are at least as stringent as ESMA’s temporary measures. However, it will continue to monitor activities relating to CFDs, and other related speculative products, to determine whether any other EU-wide measures may be needed.

The Decision was made under Article 40 of the Markets in Financial Instruments Regulation (600/2014) (MiFIR), which gives ESMA the power to introduce temporary intervention measures on a three-monthly basis. Before the end of the three months, ESMA must review the measures and consider whether they should be extended for a further three months.

FCA Market Watch issue 60

On 1 August 2019, the FCA published issue 60 of Market Watch, its newsletter on market conduct and transaction reporting issues. In issue 60, the FCA shares its concerns and findings about control of access to inside information. This follows the conviction of a former compliance officer in the London branch of a major investment bank. The individual was found guilty of five counts of insider dealing under section 52(2)(b) of the Criminal Justice Act 1993. The FCA notes that Article 10(1) of the Market Abuse Regulation (596/2014) (MAR) also concerns unlawful disclosure.

In a recent speech, the FCA highlighted the importance of firms being able to identify conduct risks to ensure they have effective market abuse controls in place. This sits within questions 1 and 3 of the FCA’s “5 Conduct Questions”. The FCA explains that, when investigating suspected insider dealing, it is crucial to establish who had access to inside information at particular points in time. Recently, the FCA reviewed the systems and controls used by a sample of investment banks, legal advisers and other consultancies to manage access to inside information. Issue 60 sets out some of its key findings.

The FCA views a firm’s inability to respond to a regulatory request with accurate records of who had access to inside information, as an indication of underlying weaknesses in systems, procedures and policies. Firms that cannot respond appropriately to FCA requests may be subject to further regulatory scrutiny. The FCA expects firms to take reasonable steps to ensure the risks of handling inside information are identified and appropriately mitigated. The recent conviction of the former compliance officer is an example of the risks of non-deal team staff being granted access to inside information not being identified and appropriately mitigated, leading to criminal activity.

In addition, the FCA highlights in issue 60 its recent thematic review of money laundering risks in capital markets (TR19/4). It notes that the report contains an annex of typologies, demonstrating how money might be laundered through the capital markets. The FCA expects firms to consider their approaches to identifying and assessing money laundering risk in light of the report and annex.

ISDA® publishes statement on supplemental benchmark fallbacks consultation

On 30 July 2019, ISDA® published a statement of the preliminary results of its supplemental consultation on spread and term adjustments for benchmark fallbacks in derivatives contracts referencing certain interbank offered rates (IBORs), including USD LIBOR, CDOR and HIBOR (see Legal update, ISDA® consults on benchmark fallbacks).

The statement announces that, based on the majority of responses received, ISDA expects to proceed with developing benchmark fallbacks for use in its standard definitions based on a risk-free rate adjusted by the following:

• For the spread adjustment, the historical mean/median approach.
• For the term adjustment, the compounded setting in arrears rate.

This approach is consistent with the results from a similar previous consultation relating to GBP LIBOR, CHF LIBOR, JPY LIBOR, TIBOR, Euroyen TIBOR and BBSW conducted in 2018.