An update from the Asset Management Sector Team - Issue No.3 ...
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
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)
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
Ian all the best in his career.
For further information and full biographies
on the team please follow the link below:
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.
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
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.
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
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
• 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
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
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:
Feedback Statement on DP05/4: Review of the Financial Services
Hedge Funds Discussion Paper Compensation Scheme DP06/1
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.
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.
The DP shows firms put into broad classes:
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
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.
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
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.
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:
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 email@example.com, 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)