Tim Steele offers US asset managers a guide to what EU funds regulation means to them. We hope you enjoy your stay.
The frenetic pace of regulatory change in Europe shows no sign of letting up. Three significant pieces of regulation have come into force in just the first five months of the year, with more to follow as regulators double down on their drive to enhance transparency, governance and investor protections.
For brevity, we’ll stick to the acronyms. The three regulations are: MiFID II, a set of far-reaching capital market reforms affecting fund firms, distributors, brokers and banks; the Priips regulation covers retail investments and insurance-backed products; while the GDPR sees the EU tackling data privacy across the business world.
Certainly, the industry is feeling the heat. In March, having interviewed more than 120 asset and wealth management chief executives, PwC flagged the increased level of regulation as one of the greatest threats for business, with 83% of the CEOs saying they were “somewhat or extremely concerned”. The PwC report – ‘Optimistic CEOs, buoyant growth, disruption ahead’ – specifically referenced MiFID II as the most prominent new regulation in Europe, one that is set to squeeze margins and fees due to greater pressure around transparency.
In February, Thomas Richter, chief executive of the German Investment Funds Industry Association (BVI), called for a halt to more industry regulations until existing rules have been scrutinised for their efficacy and clarity. “Instead of imposing more and more rules, we should be assessing how effective the existing regulations have been and eliminating contradictions and errors,” Richter said.
For US asset managers in particular, there are a range of challenges and considerations to address. Below we look at five of the key pieces of regulation currently on their radar.
This sees asset managers facing stricter reporting requirements for clients and regulators. The theme here is investor protection, market resilience and transparency. Seven years in the making and encompassing all asset classes, the revised Markets in Financial Instruments Directive has ushered in sweeping changes in 11 key areas, most notably new requirements around product governance, best execution, transaction and trade reporting, the use of electronic platforms and the unbundling of analyst research and trading costs.
For the US financial industry it is this unbundling stipulation that has caused the greatest consternation.
After heavy lobbying by the broker community, the Securities and Exchange Commission (SEC) agreed in October 2017 to grant temporary relief permitting broker-dealers to accept hard dollar payment for research from investment managers subject to MiFID II and who pay through a MiFID II-mandated research payment account (RPA). No date for a final reckoning on the issue has yet been announced.
Ratings agency Moody’s has warned that MiFID II will “accentuate every trend hitting the industry today”, including the drift towards lower-cost passive investment strategies, fiercer competition between firms, and consolidation. “MiFID II will put pressure on asset managers’ profits by lowering their effective fee rate and increasing their costs,” the ratings firm noted, though cost-saving initiatives, new investment solutions and consolidation are expected to offset some of the negative effects, Moody’s added.
General Data Protection Regulation (GDPR)
Given the flood of GDPR-related emails hitting inboxes in recent weeks, few will need reminding that the EU’s GDPR came into force on May 25. Introducing one set of data protection rules for all companies operating in the EU, wherever they are based, GDPR regulates the processing – in a professional or commercial capacity – of personal data relating to individuals in the EU by an individual, a company or an organisation.
GDPR introduces new requirements around consent, transparency, data portability and an individual’s “right to be forgotten”. Under the Directive, ‘processing’ includes the collection, recording and storing of an EU individual’s information; and the definition of personal data has been extended to cover identifiers such as IP addresses and cookies. Breaches can result in administrative fines of up to €20 million or 4% of total worldwide turnover of the preceding financial year, whichever is higher.
GDPR has extraterritorial effect. International law firm Simmons & Simmons has highlighted that it applies to a US investment adviser and its funds in three situations: where fund interests or management services are offered to EU investors; where advisers monitor the behaviour of individuals in the EU (for instance through the collection of data on underlying borrowers or large-scale data used for algorithmic strategies); and where an adviser is established in the EU via a branch office, an affiliate or a marketing presence.
Coming into effect on July 1, 2018, the Central Bank of Ireland (CBI) Consultation Paper 86 (CP86) is designed to “underpin the achievement of substantive control by fund management companies, acting on behalf of investment funds, over the activities of their delegates”.
CP86 includes six chapters of guidance and four new rules, and will apply to the boards of directors of investment companies, Ucits and alternative funds incorporated and authorised in Ireland.
It means that half of directors and ‘designated persons’ should be located in the European Economic Area. An initial requirement that designated persons should be employed by the same group of companies when not working from the same location has been dropped.
Another key change is the requirement that on request, companies must provide the CBI with records within prescribed timelines, and must have a record-retention and retrievability policy, reviewed annually.
As Deloitte Ireland has noted, CP86 is intended to provide the CBI with comfort that a fund management company is managing its regulatory obligations and that the company is effectively “supervisable” and within the sphere of influence of the bank. “The aim is not to introduce a whole series of additional regulatory compliance rules but to ensure high-quality compliance with existing regulatory obligations,” Deloitte notes. “However, the CBI [has] indicated that it does not expect the boards of fund management companies to simply ‘comply or explain’ their approach to the adoption of CP86, but rather to aim for full compliance with the guidance.”
Senior Managers and Certification Regime (SMCR)
SMCR is a UK measure that is intended to increase individual accountability within financial institutions, raise standards of governance and restore confidence in the financial services sector. It stems from a revision to the Approved Persons Regime that covered investment firms regulated by the UK’s two regulators – the Financial Conduct Authority (FCA) and the Prudential Regulation Authority.
SMCR, however, covers all FCA solo-regulated firms, as well as EEA and third-country branches (insurers excepted), ranging from the very smallest to some of the largest global firms.
In December 2017, the FCA confirmed that the extension of SMCR would now apply to insurers from late 2018 and to other financial companies, including asset managers, in mid to late 2019. Final rules are expected to be published this summer.
The Alternative Investment Management Association notes that US staff involved in a UK business may very well be captured by the new rules. This would include global business heads, such as the head of IT, or managers of a UK business located offshore. In addition, careful consideration will need to be given to the outsourcing of trading and other functions to US affiliates to avoid a blurring of accountability. Traders and other US-based staff may also be caught by the regime if they’re involved with the clients or business of a UK entity.
FCA data arguably points to the shape of things to come. Vetting interviews conducted by the regulator increased by 33% during 2017, hitting a five-year high of 187, and legal advisory business Cleveland & Co says the increase illustrates how the FCA is “setting the bar higher” for senior managers if they want to lead financial services firms.
As part of the EU’s wider drive to enhance transparency and investor protection in financial markets, January 1, 2018 saw the advent of the Packaged Retail and Insurance-based Investment Products (Priips) regulation, covering all investment products and contracts in which consumers invest money – directly or indirectly – in the capital markets, or where its repayment is otherwise linked to the performance of certain securities or reference values.
To help investors make an informed choice, Priips introduced a common standard for retail investment information in the shape of the Key Information Document (KID), setting out risks, reward profile and costs; this is to be provided prior to investment. Ucits will continue to use their own Ucits Key Investor Information Document until 2019.
Priips’ reception has been chilly at best. Philip Warland, senior adviser to the Investment Association and a former director of policy at Fidelity International, has described it as “by far the worst piece of financial regulation ever in Europe”. Graham Laybourn, partner responsible for compliance and legal at Baillie Gifford, has disputed that new disclosures under Priips meet the “clear, fair and not misleading test”.
The focus on past performance data in the KID has come in for particular criticism, and the FCA has subsequently agreed to the inclusion of “explanatory materials to put the [performance scenario] calculation in context’.
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