FCA finds MiFID II research unbundling rules working well for investors
On 19 September, the FCA published multi-firm review findings indicating MiFID II research unbundling rules have improved asset managers’ accountability over costs, saving millions for investors. A key principle of the MiFID II unbundling reforms is to ensure that portfolio managers act as good agents in the best interests of their clients and that their investment decisions are not unduly influenced by third parties.
From 3 January 2018, asset managers were required to pay for research separately from execution services, and either charge clients transparently or pay for research themselves. Prior to MiFID II, research costs were often ‘bundled’ into opaque transaction fees borne by investors’ funds, with many firms not adequately controlling how much of their clients’ money was being used to pay for research.
The FCA’s review found that, following MiFID II, most asset managers have chosen to pay for research from their own revenues, instead of using their clients’ funds. Firms have also improved their accountability and scrutiny of both research and execution costs, including where firms have chosen to charge research costs to clients. This has resulted in investors in UK-managed equity portfolios saving around £70m in the first six months of 2018 across a sample of firms.
The review and analysis also found that:
- since the introduction of the reforms, budgets set by firms to spend on research have fallen on average by 20%-30%
- despite these budget reductions, most asset managers said they are still getting the research they need
- research coverage of small and medium enterprises (SMEs) listed in the UK has not seen a material reduction to date, and
- research pricing is still evolving, with wide price ranges being offered by brokers and independent providers.
Detailed findings in relation to asset managers’ approaches to valuing research, and the FCA’s expectations as to how certain activities, such as trade association events, research marketing and consensus forecasts, interact with the new rules can be found within the multi-firm review report. The FCA will continue to monitor both competition impacts and research coverage of SMEs following the MiFID II reforms by analysing market data and other reviews, such as the European Commission’s forthcoming study. The FCA also intends to carry out further work in this area in 12 to 24 months’ time to assess firms’ ongoing compliance with our rules.
Firms need to register for Connect to update their firm details
Firms need to register to the FCA online Connect platform. Firms need it to send the FCA their firm details – also known as a mandatory annual update. This will be a requirement from January 2020, so the FCA is recommending firms register now in preparation.
The FCA will be emailing, calling and writing to firms that are not currently Connect users to encourage them to sign up before the requirement comes into force from January 2020.
From January 2020, firms will be required to review and confirm the accuracy of firm details annually, in line with their Accounting Reference Date (ARD using Connect. Even if a firm’s details have not changed from the previous year, firms still need to log on to Connect and confirm that they are up to date.
Connect also allows firms to submit and keep track of applications and notifications, such as approved persons, appointed representatives and MiFID II notifications
PRA consults on supervisory statement on Solvency II prudent person principle
On 18 September 2019, the PRA published a consultation paper on a draft supervisory statement relating to the prudent person principle (PPP) under Solvency II (CP22/19).
The PRA requires firms within the scope of Solvency II to demonstrate that they comply with the Investments Part of the PRA Rulebook as regards investment risk. Chapters 2 to 5 of the Investments Part set out the PRA’s rules implementing the PPP, which derive from Article 132 of the Solvency II Directive (2009/138/EC).
In the draft supervisory statement, the PRA sets out its proposed expectations of firms relating to the PPP requirements. It focuses on specific areas where the PRA would expect firms to pay particular attention to comply with the PPP and identifies circumstances under which firms may be subject to greater supervisory scrutiny. It covers issues including:
- the development and maintenance of an investment strategy.
- the management of risks arising from investments and internal governance within the investment function.
- investment in assets not admitted to trading on a regulated market and intra-group loans and participations.
The PRA has produced the supervisory statement after observing inconsistencies in the way that different firms understand and apply the PPP. The supervisory statement is also intended to address the PRA’s concerns about issues arising from recent changes to the insurance sector, such as life insurers with annuity books increasing their exposures to assets not admitted to trading on a regulated market.
The deadline for responses is 18 December 2019. The PRA proposes that the expectations in the supervisory statement will apply from the date on which the final version of the statement is published.
EIOPA report on cyber risk challenges and opportunities
On 17 September 2019, EIOPA published a report on the challenges and opportunities for insurers arising from cyber risk. The report provides an overview of cyber risk as part of the risk profile of insurers from the operational risk perspective as well as the challenges and opportunities for the European cyber insurance market. It is based on the responses from 41 large (re)insurance groups across 12 European countries to an EIOPA questionnaire.
EIOPA found that the most common cyber incidents affecting insurers are phishing mail, malware infections, data exfiltration and denial of service attacks. The main consequences for insurers are business interruption and material costs for policyholders and third parties. It found that the industry is aware of potential cyber threats and has incorporated cyber risk explicitly in risk management frameworks. EIOPA raises concerns about non-affirmative cyber exposures – instances where cyber exposure is not explicitly included or excluded in an insurance policy. EIOPA suggests that the lack of quantitative approaches, explicit cyber exclusions and action plans to address non-affirmative cyber exposures indicates that insurers are not currently fully aware of the potential exposures to cyber risk.
EIOPA calls for:
- clear, comprehensive and common requirements on the governance of cybersecurity as part of operational resilience. These requirements should include a consistent set of definitions and terminology on cyber risks.
- further action to strengthen the resilience of the insurance sector against cyber vulnerabilities, including streamlining cyber incident reporting frameworks across the insurance and financial sector.
- measured, monitored and managed. EIOPA suggests that common and harmonised standards for cyber-risk measurement and reporting purposes could facilitate the understanding of cyber-risk underwriting and that a European-wide cyber incident reporting database, based on a common taxonomy, could be considered.
The report follows an EIOPA report on understanding cyber insurance published in August 2018 that concluded that the need for a deeper understanding of cyber risk was the core challenge for the European cyber insurance industry.
Independent Investigation of Interest Rate Hedging Products announced
John Swift QC has announced his full independent support team is now in place to conduct the investigation into the FSA’s (and subsequently the FCA’s) implementation and oversight of the Interest Rate Hedging Products (IRHP) Redress Scheme.
As part of the review the team will engage with interested parties in an organised and structured way in order to address the issues which are relevant to his investigation. Individuals or represented parties affected by the Scheme are invited to contact the Independent Review team by sending an email.
John Swift QC commented that the as part of the Review they will provide an assessment of the FSA/FCA’s actions relating to the redress exercise and set out the lessons, if any, that should be learned from the Review. A final report will be made publicly available as soon as is practically possible.
On 20 June 2019, the FCA announced the appointment of John Swift QC to carry out the review and published a detailed Terms of Reference setting out the scope and parameters of the review. The Review is not intended to be a route by which the redress scheme or individual cases can be re-opened; nor is it intended to assess the appropriateness and reasonableness of individual offers. Information relating to the independent investigation can be found on the Review of IRHP webpage, which will be updated regularly. This webpage also includes the protocol for the conduct of the investigation.
Update to June 2019 joint statement on opportunistic strategies in the credit derivatives market
On 24 June 2019, the Chairmen of the US Securities and Exchange Commission and the US Commodity Futures Trading Commission, along with the Chief Executive of the FCA, released a joint statement on opportunistic strategies in the credit derivatives markets. The joint statement outlined mutual concerns about the pursuit of these strategies and the adverse impact they may have on the integrity, confidence and reputation of the credit derivatives markets, as well as markets more generally.
These opportunistic strategies include, but are not limited to, what have been referred to as ‘manufactured credit events’ or ‘narrowly tailored credit events’. The International Swaps and Derivatives Association (ISDA) recently released a proposed protocol designed to address certain issues related to narrowly tailored credit events. This protocol contains two amendments to the 2014 ISDA Credit Derivatives Definitions. One relates to the Failure to Pay definition, and the other to the Outstanding Principal Balance definition.
The FCA stated that it expect firms to consider how the opportunistic strategies may impact their businesses and to take appropriate action to mitigate market, reputation and other risks arising from these types of strategies. With regard to the proposed ISDA protocol, firms should consider how adherence to the proposed ISDA protocol may help them mitigate these risks. Firms should also consider the risks to which they may be exposing themselves by trading with counter-parties who do not adhere to the proposed ISDA protocol.
The FCA commented that it looks forward to further industry efforts to improve the functioning of the credit derivative markets and welcomes continuing engagement with market participants.
Claire practises financial services law with a focus on regulatory issues, cryptocurrencies and tokens, trading and brokerage documentation and advising both existing and start-up funds and fund managers.
If you would like to discuss any of the points we raise, please contact me or one of our other lawyers.
Phone: 0207 585 1406