The FCA has tabled a discussion paper to promote debate on what regulatory change would be most helpful to develop the UK’s asset management industry.

While the regulatory regime in place for the asset management industry is EU-derived, the FCA points out it is also “widely trusted and respected”. The regulator also emphasizes the global nature of the asset management industry and the close integration of UK firms with “wider asset management groups serving clients worldwide”. 

Regulatory objective

The paper sets out the effective interaction with other jurisdictions as a key regulatory objective for this sector and also explicitly indicates that the FCA wants “to ensure that the UK remains an attractive domicile for internationally active asset managers”. Consistency with international standards and rules in other jurisdictions will remain a key consideration so that “firms can continue to operate efficiently on a global basis”.

Given the recognition of the international context, a “bonfire” of regulations in this area is therefore extremely unlikely, with any future changes focusing on reducing complexity and regulatory friction, encouraging innovation and ensuring that the regulations meet the needs of all investors – both foreign and domestic. As political bluster around regulation persists it is reassuring to see the FCA taking a pragmatic stance while also very clearly acknowledging that the UK asset management sector’s success is dependent on it remaining an attractive, stable and safe place to invest.

As political bluster around regulation persists it is reassuring to see the FCA taking a pragmatic stance while also very clearly acknowledging that the UK asset management sector’s success is dependent on it remaining an attractive, stable and safe place to invest.

The FCA does point out that standing completely still in terms of the current UK asset management regulatory regime is not an option because of the sometimes unsatisfactory state of the inherited rules, continuing innovation in technology and the FCA’s focus on good consumer outcomes, all factors militating for some modest changes to the rules.

Because the rules applying to the sector stem from a variety of EU directives, the FCA believes that their technical consistency can be improved by introducing a common framework. The regulator is very keen, in particular, to eliminate any gaps in the rules. Areas that are explicitly identified as potentially benefiting from more consistency and better clarity are:

• conflict of interest;
• conduct;
• financial stability;
• retail portfolio management; and
• differences between UCITS and AIF management rules.

The FCA believes that there may be room for improvement in connection with the UCITS and NURS fund regimes. Options mooted include:

• Removing the boundary between the two regimes altogether;
• Rebranding NURS (non-UCITS retail schemes) as UCITS (undertaking for collective investment in transferable securities) plus; or
• Creating a ‘basic funds’ category.

Changes to the regulatory regime for authorized UK AIFMs are unlikely, but the FCA would like to explore amending the rules to permit a larger number of firms to use the less prescriptive small UK AIFMs regime. This potential change is in response to the growth experienced in the market, with a larger number of firms needing to comply with the more onerous regime. Irrespective of whether such changes to the UK AIFM rules are made, the FCA is considering introducing more specific rules for smaller authorized AIFMs in order to continue to protect financial stability and market integrity.

Rules targeted for improvement

The FCA would like to enhance the rules and guidance applying to portfolio managers and their host authorized fund managers (AFMs) either by creating specific contractual requirements between the parties or making the responsibilities of portfolio managers clearer.

The paper also highlights liquidity management and investment due diligence in the AFM context as areas of inconsistency and weakness that are both ripe for improvement.

Fund depositaries in the UK will likely be expected to play a more active part in intervening and challenging fund managers in the future. The paper highlights some key areas where clearer rules are expected in to facilitate this more hands-on monitoring role:

• systems and controls;
• resources, knowledge, skills and experience;
• actions following breach identification;
• escalation path;
• liquidity management oversight;
• pricing and dealing oversight.

Essentially the FCA sees depositaries as an important part of the check and controls ecosystem for asset management, one that has been underutilised in the past.

The regulator is particularly concerned about the 10% rule, which permits investment of 10% of a UCITS fund portfolio into assets that do not meet the eligible markets criteria.

Feedback from industry is also being sought on the suitability of the eligible market rules, particularly because of “significant changes in what constitutes a market” since the rules have been written. The regulator is particularly concerned about the 10% rule, which permits investment of 10% of a UCITS fund portfolio into assets that do not meet the eligible markets criteria. The paper points out that this does not permit managers to invest in any type of asset because all other eligible asset criteria must be met for this tranche of the portfolio. In other words the 10% rule does not constitute a carte blanche to invest in things that are risky, illiquid or just a ‘punt’.

In contrast to the regulatory concern about the potentially lax approach to the 10% rule, the prudent spread of risk rule has come under criticism as being too prescriptive and feedback is sought on whether a principles-based approach or the removing or loosening of specific restrictions connected to this is desirable.

Technology

Regulatory changes in response to changes in technology being mooted include the potential introduction of a new dealing model, which would permit investors to buy and sell units directly from the fund as well as potentially amending regulations to permit firms to operate a digital register. This latter concept, known as fund tokenization, would attempt to deploy distributed ledger technology to record unit ownership. Advocates suggest that this could improve efficiency, eliminate errors and result in faster transactions and cost savings. By asking about the priority of this project the FCA appears to be seeking information from industry about how close to becoming operational this new model might be. Presumably a response from industry indicating that tokenisation projects are already under way will prompt swifter regulatory action in this area.

Any stakeholders expecting regulatory clarity for crypto assets will be sorely disappointed, however. The DP simply points out that stablecoins and other forms of cryptocurrency are “not currently permitted investments” and that “it is not currently possible for authorised funds to hold them”. It then defers to the Government consultation on cryptoassets, stating that no further regulatory work would be appropriate in connection with these until “the Government has advanced its thinking on this matter”.

Reporting and investor engagement

The final section of the discussion paper focuses on investor needs and is all about information dissemination and reporting. This section is closely connected to the requirements of the new Consumer Duty as well as the future disclosure network that is also being consulted on by the FCA at the moment.

The FCA is unhappy with the prospectus – beginning with the name itself, which, according to the paper “is rather opaque and unhelpful” and might “deter some investors from accessing the document”. More importantly this document, according to the FCA, “is not fulfilling its primary function of providing in-depth information to fund investors”. Suggested ways forward include, in addition to renaming and redesigning the document, a more modular structure and prescriptive content tagging as well as centralised storage.

The number of options being presented seems to suggest that the FCA’s thinking in this area is not advanced and there is an opportunity for stakeholders to shape the future state of the prospectus in the UK, including potential simplification, which might result in cost and efficiency savings for firms.

Options for change

Changes are probably even more distant in connection with managers’ reports and accounts. While the FCA points out that these are “unengaging documents” created under rules that took into account the costly and burdensome need to publish on paper, which is no longer necessarily relevant, it is careful to note that investors’ lack of interest in these does not denote “a market failure” and suggests that it is possible that “the needs of many investors are already being met”. Here again the number of potential options for changing the rules is wide-ranging and include rule enhancements, introducing machine-readable formatting (similar to or perhaps even in some way aligned with the XBRL framework for financial reporting), centralised storage, or a complete overhaul of the structure of these documents.

The paper concludes by looking at the potential of technology improving investor engagement and “ensuring a fair balance between the interests of the investor and the fund manager.” Specifically the FCA is seeking advice on how to better maximise investor participation in unitholder meetings and improve interactions between investor and asset managers more broadly.

Two common threads are apparent in the report – one is the focus on responding to changes in and leveraging technology in areas as wide-ranging as dealing and reporting, the other is the focus on ensuring better outcomes for investors. Both could be viewed as an attempt to ensure not only that the UK regulatory regime in this area is fit for purpose, but that it also remains attractive to investors.

Responses on the Discussion Paper are needed by May 22, 2023.