An update from the Asset Management Sector Team - Issue No.3 ...

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An update from the Asset Management Sector Team - Issue No.3 ...

  1. 1. A s s e t M a n a g e m e n t N ew s l e t t e r An update from the Asset Management Sector Team Issue No.3 – April 2006 Welcome to the third edition of the FSA’s Asset Management newsletter. Update on Asset Management We are well aware that 2006 is likely to prove a Sector Team challenging one for the asset management sector from a regulatory perspective. We highlight some The Asset Management Sector team of our upcoming publications which will outline welcomed four new team members in these challenges below: January of this year. Second Quarter of 2006 Bruce Robson (Manager) • Feedback statement to the Consultation Paper Bruce joins the team from the Retail Firms (CP) on retail investment implications of Division of the FSA where he oversaw a softing and bundling reforms number of asset management firms. He • CP on Systems and Controls (SYSC) previously had 14 years of experience at a major financial services group in a variety • DP on Best Execution of roles. Second Half of 2006 Christine Brentani (Associate) • CP on Integrated Regulatory Reporting Christine joins the team from the Wholesale • CP covering Markets in Financial Instruments Institutional Policy section of the FSA. She Directive (MiFID) markets provisions, previously worked at a number of financial authorisation and permissions, enforcement and cooperation institutions and has written a book entitled ‘Portfolio Management in Practice’. • CP on Conduct Of Business COB, covering MiFID, simplification and relevant non-scope Stéphane Blais (Associate) issues Stéphane joins from the risk assessment • CP on financial promotion, including MiFID area of the FSA. He previously worked as a and results of wider review. consultant and director of a trading forum. In this edition, we examine our recently published feedback statements to DP05/3 & DP05/4 and our William Bell (Associate) CP on the implementing the Capital Requirements William joins from the risk assessment Directive (CRD). We also provide some detail on area of the FSA. He previously worked the DP on the Financial Services Compensation Scheme (FSCS) Funding Review for a press agency. Dan Waters remains in the role of Sector Owing to the full complement of policy review in Leader & Jennifer Hayward remains as this issue, we do not include our regular FAQs section. We would like to remind readers however Associate on the team. that we are keen to receive your suggestions for Ian Lumb has left the FSA to work in the items in forthcoming issues at industry. I hope you will join us in wishing asset.management@fsa.gov.uk Ian all the best in his career. For further information and full biographies on the team please follow the link below: http://www.fsa.gov.uk/Pages/About/Teams/ Dan Waters Asset/How/index.shtml Asset Management Sector Leader Save the date Our third Annual Asset Management Conference will be held on 21 September 2006 at the Queen Elizabeth II Conference Centre. We will provide further details of content and speakers in due course. This is not FSA guidance.
  2. 2. Markets in Financial Instruments Discussion Paper in Q2 2006 that will explore the challenges presented by new MiFID requirements Directive (MiFID) update relating to best execution. This paper will examine practical issues around execution policies and The Commission’s draft proposals for the MiFID arrangements and how firms will monitor and level 2 implementing measures were published in review those policies and arrangements. Among February. Formal adoption of the level 2 package is other things, the paper will discuss whether there now unlikely before July at the earliest. Over the could be different options for fulfilment of these coming months, the text will be considered by the obligations in different sectors of the market. European Securities Committee and the European Parliament, so may therefore be subject to further change. But its publication provides us with a Pre and post-trade transparency – Wider reference case for developing our consultation Market Impact for Asset Managers as Users proposals, according to the programme we set of the Markets out recently in our Business Plan. The asset management industry has been closely We shall shortly be publishing a Joint monitoring the new transparency regime. We Implementation Plan with the Treasury, which understand the industry’s position is, essentially, will explain our approach to and timetable for that greater transparency is a good thing where it implementation of the MiFID requirements. enhances price discovery, but it is important that The overall MiFID implementation timeline fund managers can continue to access the dealer remains as follows: market in the knowledge that the dealer will be able to effect transactions on-exchange or off- • Member States must have introduced exchange, in the client’s best interests, and with implementing legislation, rules and/or guidance no reduction of liquidity in the market. We as necessary by 31 January 2007. understand the industry’s concern that if MIFID • 1 November 2007 is the date from which facilitates more competing venues for equity MiFID will apply to firms. trading, then any obstacles to the efficient consolidation of trading data need to be removed. MiFID will touch on numerous aspects of asset managers’ businesses. Below are examples of Private Equity/ Venture Capital three areas where changes will be occurring. Negotiations on these and many other aspects of Most private equity and venture capital firms MiFID are still taking place. We are aware that will fall outside the scope of MiFID due to the several issues are of concern to industry and firms exemption for CIS managers. However, for are keen for us to provide early sight of our example, inclusion of investment advice as a core thinking on implementation. We are considering investment service may bring certain private equity how we might best respond to that request. Please / venture capital firms who act as advisors to funds check the following link regularly for any or persons within its scope. Those firms that do communications updates on MiFID: – fall under MiFID will also be subject to prudential http://www.fsa.gov.uk/Pages/About/What/ requirements set out in the recast Capital International/EU/ fsap/mifid/index.shtml. Adequacy Directive (recast CAD part of CRD). Best Execution Capital Requirements Directive (‘CRD’) MiFID extends best execution to a wider set of considerations than just best price – firms are required to take all reasonable steps to obtain ‘the CP06/3 – Strengthening Capital best possible result’ for clients, taking into account Standards 2 CP price, cost, speed, likelihood of execution and settlement, size, nature or any other consideration On 28 February we published our second CP relevant to the execution of the order. We on implementing CRD in the UK proposed a similar idea in CP154 in October (http://www.fsa.gov.uk/pages/Library/Policy/CP/ 2002. And we are planning to publish a 2006/06_03.shtml). It sets out our latest policy Page N 2 This is not FSA guidance.
  3. 3. proposals and comes with a full set of draft rules launched in 2003. This review involved wide and guidance for the GENPRU and BIPRU consultation – including 250 interviews with users modules of the FSA Handbook. The consultation and discussions with a cross-section of firms and will close on 30 April 2006 and we intend to industry bodies. We set up the ARROW Project produce a Feedback Statement in July 2006. By in 2004 to design and implement solutions. October, we plan to finalise the Handbook rules The changes we are implementing are designed to and guidance in time for the CRD coming into make the FSA a more effective and efficient risk- force on 1 January 2007. (Chapter 2 examines based regulator. These involve a major overhaul of how the CRD will apply to investment firms our risk framework to allow better comparison of which are covered by the Directive). risks in different areas and thus enhance our For asset managers that are BIPRU firms, CRD is resource allocation. We are building a new risk going to represent a very important legislative model that will allow supervisors to reflect more change because it will introduce a new prudential accurately their views of risk and make our risk regime for them. In short, UCITS Firms, as management more effective by improving opposed to UCITS Investment Firms, will not be knowledge-sharing. It also aims to be subject to BIPRU; as with effect from 1 January comprehensive, for example by fully integrating 2007 they will instead be subject to the new the range of issues presented to firms under the UPRU, effectively the current Chapter 7 of IPRU banner of Treating Customers Fairly. (INV). On the other hand, UCITS Investment The design of the next generation ARROW is Firms, that is those scheme managers carrying on virtually complete and we are currently completing core investment services as permitted by Article 5 our piloting of the new risk model, processes and (3) of the UCITS Directive will be subject to IT with most of the changes being rolled out from BIPRU and therefore the recast CAD. Likewise, the beginning of Q2 2006. asset managers that are not UCITS management companies will be subject to BIPRU if they conduct core investment services under the ISD/MiFID Feedback statement on DP05/3: outside the terms of the existing exemptions. Wider Range Retail Investment In addition, to provide further assistance to Products: Consumer Protection in a investment firms, we have published on our Rapidly Changing World website draft guidance in ‘question and answer’ format on the scope of the Markets in Financial Following our consideration of the feedback Instruments (MiFID) and the re-cast CAD received regarding last year’s Discussion Paper we (http://www.fsa.gov.uk/pubs/international/draft_ have decided to consult in 2007 on widening the guidance.pdf). range of funds that can be marketed to retail investors to include new authorised funds of ARROW & the FSA’s risk-based approach to unregulated schemes including funds of hedge regulation funds. This would enable retail investors, who are already gaining access to products with hedge-fund In maintaining our policy of risk-based regulation, investment characteristics through a variety of we have started to roll out changes to our other sturctures, to invest in products that would ARROW framework. We use the Advanced Risk- be subject to our regime for authorised collective Responsive Operating FrameWork (ARROW) to investment schemes. operate our risk-based regulation. This approach We identified three risks in DP05/3. covers all of our risks, whether they are global, firm-specific or thematic. • Retail consumers do not understand (and regulated firms do not adequately manage) the We decided to build on the existing ARROW significantly changed risks presented by UCITS following a review of user experience over the III products. past few years and the substantial increase in the number of smaller firms for which we have • Consumers might be confused by different regulatory responsibility. forms and distribution channels of products The ARROW review formed part of a wider FSA of different nature, resulting in mis-buying internal Business Improvement Programme or mis-selling. This is not FSA guidance. Page N 3
  4. 4. • Some consumers might not get sufficient access administrator and the fund auditor in the to investment products because of the different Integrated Regulatory Returns (IRR) that firms will regulatory requirements. send to us (a Consultation Paper on the IRR is due in the second quarter of this year). We now propose three means of dealing with There are also a further two specific areas which these risks. will be the subject of supervisory focus. These are: • We propose to reinforce our existing consumer Asset Valuations: hedge fund managers may be information and awareness work, stressing the exposed to conflicts of interest as their increasing need for consumers to invest remuneration is very dependent on investment proportionately in investment products. performance. This may create an incentive to overstate the valuations it provides to • We intend to look at the question of product administrators for complex illiquid instruments, provider responsibility, which we have who may not be able to challenge them. Thematic already flagged in our work on Treating supervision visits are currently being carried out Customers Fairly. in this area and the findings will be made public in the third quarter of this year. We have also • We propose to extend the range of ‘Non- sponsored an IOSCO project on valuing complex UCITS Retail Schemes’ (NURSs) to include and illiquid assets in hedge funds which we refer to funds of unregulated schemes, subject to in more detail later on page five of the newsletter. appropriate safeguards. NURSs are readily marketable to retail consumers in the UK. Side Letters: the failure by hedge fund managers to disclose that side letters have been granted The new funds would be subject to structural and to certain clients may result in some investors operational safeguards, including the requirement receiving more information and preferential to have an independent depositary. In addition, the treatment to other investors in the same share fund of hedge funds managers will not be able to class. As a minimum standard we would expect invest into all hedge funds – there will be liquidity managers to ensure that all investors are informed criteria, for example, in respect of the underlying when a side letter is granted and any conflicts that funds. This should enhance investor protection may arise are adequately managed. while allowing increased investor choice. We discuss the above issues in full in our Feedback You can download the full text of the paper at the Statement to the aforementioned DP. You can view address below: the statement at: http://www.fsa.gov.uk/pubs/discussion/fs06_03.pdf http://www.fsa.gov.uk/pubs/discussion/fs06_02.pdf Feedback Statement on DP05/4: Review of the Financial Services Hedge Funds Discussion Paper Compensation Scheme DP06/1 released We have published a Discussion Paper on the We have published our Feedback Statement to the review of the current funding arrangements of the above Discussion Paper regarding hedge funds. We Financial Services Compensation Scheme. This continue to view hedge funds as a vital segment of review was announced in May 2005 and was the financial services industry. In particular they undertaken because of concerns that the funding play a fundamental role in the efficient reallocation arrangements should be stable and robust enough of capital and risk, and remain an important source to ensure that the Scheme would be able to deliver of liquidity and innovation in today’s markets. compensation to consumers in a wide range of Following our consultation process we have drawn scenarios. Concerns had also been expressed in the several conclusions from the feedback received. industry about the burden of levies upon some groups, their volatility and the logic of current To increase our understanding of the activities of cost-allocation arrangements. We published the those asset managers using hedge fund techniques, DP with a report from Oxera, the economic we propose to include additional questions to consultancy that was commissioned by the FSA identify the firm’s prime broker, third party to provide independent analysis on this issue. Page N 4 This is not FSA guidance.
  5. 5. The DP makes several key assumptions: there will At the same time, its administration would be be no subsidy or financial support from outside relatively straightforward and its spread would the industry; the primary legislation will not mitigate the impact of compensation bills on change; the ceiling on awards to individual individual firms. claimants will not rise; the funding of the Scheme’s The discussion period ends on 21 June 2006 and general running costs will not change; and there we will publish a Consultation Paper later in 2006, are no foreseeable reasons to consider that EU with new rules being drafted in early 2007. The new regulation may pre-empt the outcome of this arrangements are likely to come into effect by 1 review. We drew up a number of key design October 2007. For the full text of both the DP and principles to formulate and assess alternative the Oxera Report, please go to the following link: arrangements for funding the Scheme. http://www.fsa.gov.uk/pages/Library/Communication The DP shows firms put into broad classes: /PR/2006/023.shtml 1. general insurance 2. securities, mutual funds and derivatives European Commission appoints 3. life and pensions experts to investment fund groups 4. mortgages The European Commission has appointed the 5. deposits members of two expert groups: the Expert Group on Market Efficiency will provide a These categories would replace the current sub- hands-on commercial and technical perspective schemes and contribution groups system in place on a range of issues relating to the functioning at the moment. The category which most asset of the single market framework for retail management firms would fall into would be investment funds (UCITS) and the Expert number 2. This would be broadly listed as firms Group on Alternative Investment Funds will with the following regulated activities: analyse the current organisation of alternative investments business. 1. dealing in equities/bonds/derivatives The groups will meet on several occasions until 2. fund management June 2006, when they will produce reports on 3. discretionary portfolio management their findings, which will also be discussed with regulatory bodies and other stakeholders. These 4. corporate finance reports and the reactions to them will feed into the 5. mutual fund provision Commission’s White Paper on investment funds and related impact assessment work, scheduled 6. mutual fund intermediation for publication in October 2006. 7. spreadbetting. The list of nominating associations and experts We put forward four options in the DP: can be found at: Option A: The broad classes would stand alone http://europa.eu.int/comm/internal_market/securities with no cross-subsidy between each class. /ucits/index_en.htm#experts Option B: The broad classes would have a general pool above which would be activated in the event IOSCO and Hedge Fund Valuations of any class facing catastrophic costs. The International Organisation of Securities Option C: Includes sub-classes within the broad Commissions (IOSCO) is currently working with classes. Each sub-class would meet the first tranche recognised industry experts to develop a set of of liabilities falling to it. Each class would then principles representing good practice for valuations meet its own class liabilities, net of first tranches. by hedge funds and their counterparties. The Option D: A widening net with sub-classes, classes industry group is chaired by and includes experts and a general pool. from hedge fund managers, fund of funds managers, prime brokers, auditors, administrators and pricing Option B is our preferred option since it gives the service providers. Scheme a broad financial base and a deep pocket. This is not FSA guidance. Page N 5
  6. 6. Hedge funds operate with economic and financial HMT and CIS leverage. Much of that financial leverage is provided via the repo market to hedge funds, from a bank’s HM Revenues & Customs has published on its prime brokerage desk. Performance figures influence website a collection of information in respect of the decisions of potential and current investors on the tax treatment of different types of collective whether to increase, decrease or leave their exposure investment schemes (including authorised to a hedge fund at its current level. Robust, impartial schemes) and of the taxation of the investors and transparent valuation policies and processes are into those schemes. There is also a guide for the key to delivering equitable treatment amongst industry practitioners. generations of investors. http://www.hmrc.gov.uk/collective/index.htm In pursing one of our key objectives in promoting efficient, orderly and fair markets we are becoming Memorandum of Understanding with SEC actively involved in the valuation issue. We are undertaking a thematic review of the accuracy of We have signed a Memorandum of Understanding valuations sent by hedge fund managers to their (MoU) with the United States’ Securities and administrators, and assessing the systems and Exchange Commission (SEC) to strengthen controls that managers have in this area. The cooperation in oversight and supervision of global project is reviewing the frequency and basis of firms. The arrangement will support the exchange valuations, the separation of duties between fund of supervisory information when undertaking managers and those providing and checking the consolidated supervision of major UK and US prices and the reliance that can be placed on third firms. For the full text of the agreement please party pricing specialists. refer to our website at the link below: Dan Waters recently spoke on this issue to members http://www.fsa.gov.uk/pubs/mou/fsa_sec.pdf of the National Association of Pension Funds and you can find the speech on our website at: http://www.fsa.gov.uk/pages/Library/Communication /Speeches/2006/0316_dw.shtml We hope that you have found this newsletter instructive and useful. We would like to hear from you about what you would like to see in future editions. For instance, we are considering including the FAQ section as a standard item, but would be keen to know which issues are key for readers. Similarly, if we have not covered a subject you would like further information on, please let us know. Please note that the contents of this update do not represent general guidance. Please send your comments and suggestions to asset.management@fsa.gov.uk, including the word ‘Newsletter’ in the subject line. Closing the Book on CIS The FSA is calling for all authorised fund managers currently managing authorised funds to start finalising their plans for switching from the CIS rulebook to the COLL rulebook. The CIS rulebook will be revoked on 12 February 2007. Closing the book on CIS (http://www.fsa.gov.uk/pages/Library/Policy/Handbook/cis.shtml)

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