Legal Shorts 23.11.19 including conduct risk during LIBOR transition

Conduct risk during LIBOR transition

On 19 November 2019, the FCA published a new page on conduct risk arising from LIBOR which is expected to cease after end-2021, when the voluntary agreement of panel banks to continue to submit to LIBOR ends. Firms need to find suitable alternatives to LIBOR. The market-led Risk Free Rate Working Group (RFR Working Group recommends the Sterling Overnight Index Average rate (SONIA) as the preferred risk-free rate (RFR) to replace Sterling LIBOR. The FCA and the Bank of England (BOE) support transition to SONIA and alternative rates.

LIBOR is used as the interest rate benchmark to price or value a wide range of financial products, including but not limited to mortgages, commercial and personal loans, bonds, securitisations and derivatives. Many firms are affected, including investment banks, asset and wealth managers, insurers, retail banks, building societies and mortgage lenders and other intermediaries such as advisors and brokers.

For many firms, LIBOR transition will involve many steps including, but not limited to, the following:

  • developing and offering new products linked to RFRs and other, appropriately robust alternative rates;
  • assessing and reducing their own and clients’ exposure to legacy LIBOR contracts by amending or replacing existing contracts to either include robust fall back provisions and or replace LIBOR with RFRs or an alternative rate;
  • for firms investing on clients’ behalf, avoiding/managing risks relating to LIBOR discontinuation by either: • investing in RFR-linked instruments; or
  • engaging issuers of LIBOR-referencing securities, and derivative and loan counterparties, to convert LIBOR-linked instruments and products to alternative reference rates, eg through consent solicitation processes or buy-backs for bonds and or compression or other conversion exercises for derivatives.

Even where a firm does not itself provide or distribute products linked to LIBOR, it may have links to LIBOR in its systems, or in its contractual relationships with other firms. While the following questions focus on conduct, firms also need to consider operational, financial resilience and business model risks posed by LIBOR transition.

The FCA states that firms will need to consider how to meet these obligations in the context of LIBOR transition. This may include, for example, keeping appropriate records of management meetings or committees that demonstrate they have acted with due skill, care and diligence in their overall approach to LIBOR transition and when making decisions impacting customers.

For many, LIBOR transition will impact their overall business strategy and front-office client engagement, rather than being a narrow legal and compliance risk. Potential impact and risk therefore needs to be considered and addressed in an appropriately coordinated way across a firm.

FCA fines Henderson for fund failings

The FCA has fined Henderson Investment Funds Limited (HIFL) £1,867,900 for failing to treat fairly more than 4,500 retail investors in two of its funds, the Henderson Japan Enhanced Equity Fund and the Henderson North American Enhanced Equity Fund (the Japan and North American Funds). This was in contravention of Principle 6 of the FCA’s Principles for Business.

In November 2011, HIFL’s investment manager, Henderson Global Investors Limited (HGIL), decided to reduce the level of active management of its Japan and North American Funds. The subsequent treatment of retail investors in these funds was substantially different from its treatment of the institutional investors in the same funds. HGIL informed nearly all of the institutional investors who were affected by this change and offered to manage these two funds for those investors without charge. However, HGIL did not communicate the change in investment strategy to any of the retail customers either by amending the funds’ prospectus or otherwise. As a consequence, for nearly five years HGIL charged these investors the same level of fees as it had before the decision was made without providing the same level of active management.

HIFL charged investors £1,784,465.32 more than if they had invested in a passive fund. HIFL has now disclosed the matter to all affected customers and compensated them for the additional costs they incurred. The situation revealed serious weaknesses in HIFL’s systems and controls in relation to the management, oversight and governance of an area of its business which included the Japan and North American Funds. This was in contravention of Principle 3 of the FCA’s Principles for Business. These weaknesses resulted in the issue not being identified and resolved for a considerable amount of time. 4,713 direct retail investors, 75 intermediary companies with underlying non-retail investors and two institutional investors in the Japan and North American Funds were affected by HGIL’s decision not to reduce their level of fees.

HIFL agreed to resolve this matter and qualified for a 30% (stage 1) discount under the FCA’s executive settlement procedures. Were it not for this discount, the FCA would have imposed a financial penalty of £2,668,547.40.

Investment Association publishes final report on responsible investment framework

On 18 November 2019, the Investment Association (IA) published a final report on its responsible investment framework. The investment management industry has come together to agree a common language and clear product categorisation for responsible investment approaches to help savers better access and compare funds with a focus on environmental or social outcomes. Currently a variety of terms and phrases are used in different ways, which could leave customers confused or unable to find the investment opportunities to match their diverse responsible investment goals.

The industry-wide definitions, published by the IA, aim to provide clarity and consistency for savers, and are based on consultation with over 40 investment management firms, representing £5 trillion of assets. Investment managers are encouraged to adopt the framework and definitions, which reflect the wide range of responsible investment approaches, including commonly-used terms such as: ESG integration, stewardship, impact investing, exclusions and sustainability focus.

As part of the IA’s aim to help savers navigate the sustainable and responsible investment fund market, the trade body is continuing to explore the creation of a UK retail product label. More than 8 out 10 firms (85%) which responded to the industry consultation support a fund-level label. Providing clarity to investors was the single most cited reason for establishing a label, with firms also keen to highlight the UK’s role as a global leader within sustainability and responsible investment.

From the start of next year IA members will also be asked to identify which funds should be classified as having responsible investment characteristics to help bring further clarity to this market. The IA will publish statistics on funds with responsible investment characteristics later in 2020.

You can access the report here: https://www.theia.org/sites/default/files/2019-11/20191118-iaresponsibleinvestmentframework.pdf

General insurance distribution chain: Finalised guidance for insurance product manufacturers and distributors

On 19 November 2019, the FCA published its finalised guidance on its expectations of insurance product manufacturers and distributors. During 2017 and 2018, the FCA conducted diagnostic work on general insurance distribution chains. This found a number of harms to customers from failures in product design, oversight and distribution. The finalised guidance provides clarity to firms about the FCA’s expectations, in particular on the design and distribution of insurance products and the requirement to act in accordance with the customer’s best interests. The guidance applies to all firms conducting general insurance and protection business – both insurers and intermediaries, including:

  • retail banks
  • mortgage intermediaries
  • independent financial advisors; and
  • others who distribute general insurance and protection products alongside their primary business.

In the guidance, the FCA includes:

  • a clarification on the scope of the guidance and how the guidance on value links to existing Handbook rules;
  • an explanation that value includes a range of factors, including price and quality, which are the focus of the guidance; and
  • an amendment to the guidance for manufacturers on their oversight of distribution arrangements.

The guidance is part of a wider FCA focus on product value. It is aimed at addressing customer detriment specific to distribution chains, and states that the FCA expects firms to consider product value to the end customer when applying the underlying rules relating to all sales types. The FCA expects manufacturers to consider product value to their end customer regardless of the type of distribution strategy they use.

Claire Cummings

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
Email: claire.cummings@cummingsfisher.com

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