Proposed asset managers regime must strike difficult balance

The FCA’s landmark paper on the future of asset management regulation raises the possibility of streamlining the regulatory structure in the UK. Decoupling from the EU-imposed directives, in theory, removes the duplication and inconsistency caused by UCITS, AIFMD and MiFID. But re-writing the rules may not necessarily result in simplification. And smoothing the distinction between retail and institutional investors could create unnecessary hurdles for some funds while failing to better protect consumers.

At the end of February, the FCA published DP23/2 Updating and improving the UK regime for asset management. Defining asset management as fund management and portfolio management, the paper covers possible future architecture for asset management regulations, areas where the FCA wants to improve regulation and encourage technological innovations.

Aligning the regulatory structure

Much of asset management regulation comes from three pieces of EU legislation, UCITS and AIFMD (fund managers) and MiFID (portfolio managers). The FCA notes that, because the law making for UCITS AIFMD and MiFID was done over different times and was independent of each other, there is a lot of duplication. This is particularly the case in the rules for conduct or organisational requirements such as conflicts of interest, leading to identical or broadly similar activities being regulated to a slightly different standard.

However, there are other differences that are more material:  investment due diligence and liquidity management requirements, which do not apply to portfolio management firms; more stringent rules on best execution, which do not apply to AIFMD firms; financial stability considerations that are not applicable to UCITS firms but are to other fund management activity and differences between the regimes for managing a UCITS and a NURS despite them both being retail focused products.

The FCA has suggested that, subject to costs and prioritisation, it could create a common framework that would set standards for all types of asset manager (UCITS, AIFMD and MiFID), leading to significantly simpler regulation of the sector.

The FCA also looks at the regimes for retail and professional funds. For retail funds, possible changes include moving the boundary between the UCITS and NURS regimes, whilst for professional funds, the FCA may consider changes to the definition of small authorised and potentially removing the small registered AIFM regime entirely.

Areas where the FCA wants to improve regulation include clarifying the responsibilities of host authorised fund managers, enhancing liquidity management (including clarifying the rules around dilution levies and swing pricing), setting out regulatory expectations around investment due diligence, clarifying rules for depositaries and possible changes to the fund rules on eligible assets and prudent spread of risk (maybe replacing the 5/10/40 rule). Some of these initiatives are regulatory improvements that the FCA will want to make as part of its post-Woodford agenda and so are not really for discussion.  Protecting the unwary retail investor is a clear imperative for FCA. How to do that whilst promoting the UK as a competitive and dynamic hub for institutions wishing to invest in increasingly arcane financial instruments is the juggling act FCA must master.

Embracing technology for consumer outcomes

Under the two chapters on technology, the Discussion Paper looks at how technology could be a driver of better consumer outcomes; how it might build a new model for fund operations; how it could allow tokenisation of both fund units and portfolio assets, and how technology might improve investor engagement through digitalisation of fund prospectuses and managers’ periodic reporting. The Investment Association’s 2022 paper ‘Investing for the Future: Three Potential Paths for a Tech-Powered UK Fund Industry’ will drive much of the discussions around technology driven innovation.

Crypto assets remain out of scope until the Government has decided whether there is a case for bringing the activity of portfolio management of cryptoassets into the regulatory perimeter.

The wider regulatory evolution

The FCA is asking questions now because they want feedback as they start to think about what the Future Regulatory Framework will look like for the asset management sector when, under the provisions of the Financial Services and Markets Bill, the FCA will be responsible for retained EU laws that apply to UK based financial services firms. It covers more detailed regulatory issues outside the scope of the Treasury’s ‘Building a smarter financial services framework for the UK review’, which was published in December last year.

Whilst this Discussion Paper is a stand-alone document, it fits into the FCA’s wider agenda for asset management, which includes Consumer Duty, its Consumer investments strategy, its aim to reform the advice model (CP22/24) and a new post PRIIPs disclosure regime (DP22/6), as well as areas raised in its recent portfolio letters, including assessments of value, product governance, ESG, liquidity management, operational resilience, financial resilience, conflicts of interest and market abuse controls.

The regulator has opened a three-month window for input to the Discussion Paper, a reflection of the scale and complexity of the suggested changes and the intended – and potentially unintended – consequences on the industry. In parallel, as we see more detail of the Edinburgh reforms unfurl, balancing swathes of regulatory change with making the UK an attractive place to do business will not get any easier.

The FCA is asking for comments by 22 May.

How we can help

If you would like to share your views on any elements of the Discussion Paper, we would be happy to listen and review responses you might be considering providing to FCA.

We can also help you assess the impact of the FCA’s asset and alternative asset management portfolio letters. If you are concerned about any aspects of them, and wish us to come and give you a compliance health check, please get in touch. Alternatively, if you are participating in one of the FCA’s firm reviews, and would like help in preparing for it, we can help.