ACA Europe Digest provides clients with a brief overview of the major compliance developments facing investment managers, including issues we have reported on over the last few months, and a look ahead to what’s on the horizon. We appreciate understanding the relevant issues to your business from a regulatory compliance perspective can be a time-consuming exercise. However, ACA’s team continue to analyse regulatory developments and relevant legislation to assist you in staying current. We therefore hope you will find the material both informative and useful in your day-to-day operations and for planning future growth.
In this update...
The last few months have seen a heavy focus on MiFID II-related compliance. We make no apology therefore for steering you back, in this edition, towards topics that may have been partially overlooked. For MiFID II addicts, look further on!
The Packaged Retail and Insurance-Based Investment Products (“PRIIPs”) Regulation came into force on 1 January 2018 and applies to any type of fund “made available” to EU-based retail investors, regardless of where the fund itself is domiciled. Although the retail market is seldom targeted by most of our clients, it is worth noting that employees, family and friends would all be covered by PRIIPs rules (whatever the source of their interest).
For more information, see:
The EU’s PRIIP Regulation: What is it, and Why is it Relevant to Alternative Asset Managers?
EU Benchmarks Regulation
The EU Benchmarks Regulation also came into effect on 1 January 2018 and applies to all firms that administer, contribute to or use benchmarks. Investment managers will primarily fall into the “user” category where they use a benchmark to measure a fund’s performance, define the asset allocation of the portfolio, compute performance fee payable by the fund or evaluate an active manager’s performance.
Additionally, subject to certain provisions, a fund will be considered to use a benchmark where it enters into a derivative contract traded on a trading venue where the underlying is a benchmark. Managers should be ensuring that they have adequately considered their risk exposure to the regulation and that they have sought assurances from the administrators of the benchmarks they utilise. Firms are required to maintain credible contingency plans in the event of benchmarks failing, including switching to viable alternatives.
ESMA is in the process of developing a public register against which firms can check that benchmarks have been approved or whether approval should be sought. While the permanent public register is being developed, ESMA is publishing a daily register for firms to consult.
General Data Protection Regulation ("GDPR")
GDPR will apply in the UK from 25 May 2018 and brings significant implications for all firms that process data belonging to EU residents. The FCA have stressed that compliance with it is a board level responsibility and that firms must be able to evidence what steps they have taken to comply with both GDPR and FCA requirements. However, the FCA have recognised that discussions are still ongoing to ensure that specific details of the GDPR can be implemented in a manner consistent with existing regulation, and have stated that they are working closely with the Information Commissioner’s Office (“ICO”) and the industry to achieve this.
How ACA Aponix Can Help
ACA Aponix offers GDPR data processing reviews that include gap analyses, data inventories, risk assessments, policy creation/reviews, vendor due diligence and staff awareness training. Please contact email@example.com with any questions or for further information on how we can assist you with implementing GDPR requirements.
Post Implementation Concerns
Since go-live date on 3 January 2018, the European financial services world has kept spinning, albeit not without some significant issues. At least for now, the FCA is not focusing on pursuing enforcement against firms who can demonstrate that they have taken “sufficient steps” to meet these new obligations. Firms should nonetheless be mindful of areas where they are still having difficulties, or where regulatory uncertainty still persists. Below are summarised some of the key problem areas:
Trade/Transaction Reporting – Many firms have reported problems with submitting reports to the FCA since the new reporting obligations came into force in January. It appears that the problems fall into three main categories, although the below is not exhaustive of the difficulties faced:
- General ARM and APA issues, compounded by the FCA’s MDP struggling to handle reports;
- LEI based issues; and
- ISIN problems, such as multiple ISINs for the same instrument, or banks and SIs seeming generally unprepared to issue them.
The FCA is scheduling an industry roundtable on trade reporting in March, and we expect further guidance to follow. In the meantime, if a firm is aware that it is not meeting its reporting obligations, it should notify the FCA and be able to demonstrate that the firm is working with the right people in order to solve the issue.
Research – While firms were generally well prepared for the unbundling of investment research fees and have implemented an appropriate method for purchasing it, we are finding that there is still a fair amount of uncertainty around what constitutes research. This is particularly the case where the potential research is combined with other forms of interactions, such as a corporate access, roadshows, or sales or advisory chats. Firms are also still working out how to police the receipt of such materials, with approaches to logging interactions in particular varying between firms. The FCA is currently gathering feedback from firms on MiFID II implementation, including research and inducements, and seems likely to follow this up with formal thematic work later in the year.
Algorithmic Trading – In February, the FCA published a report on the supervision of Algorithmic Trading. The report focused on the following five key areas within algorithmic trading compliance in wholesale markets:
- Defining Algorithmic Trading
- Development and Testing Process
- Risk Controls
- Governance and Oversight
- Market Conduct
We encourage firms to examine whether they are subject to any related requirements under MiFID II, even if they do not class themselves as an algorithmic trading firm. This is particularly important as the FCA has reiterated that a number of MiFID II’s requirements for algorithmic trading firms also apply to firms that do not classify themselves under the algorithmic trading firm definition. Further follow-up work from the FCA is expected.
Product Governance - In February, ESMA published guidance on firms’ product governance obligations under MiFID II with the aim of providing more clarity and greater convergence in the implementation and application of the requirements. In particular it focuses on the identification of the target market by both manufacturers and distributors, target market assessments, and distribution strategy. The guidance also references illustrative examples which do not form part of the guidelines, but instead aim to enhance firms’ and competent authorities’ understanding of how the guidelines apply.
It is worth remembering that Product Governance can affect a wide variety of structures, not least 3rd country firms (e.g. US advisers) distributing their funds in the EU. Given the avalanche of requirements under MiFID II, it may be understandable that many firms have not so far focused their attention on product governance, but it remains central to its investor protection objectives.
AIFMD and the National Private Placement Regime: All Quiet on the Western Front?
The original AIFMD laid down two distinct but related timetables for the implementation and future review of the regime:
- A passporting regime for management services and marketing across the EEA, initially available to EU AIFMs and AIFs only, but to be extended to non-EU AIFMs and AIFs from as early as 2015, subject to equivalence determinations. The adjacent National Private Placement Regime (“NPPR”) was introduced, with the intention of switching off this route from as early as the end of 2018 (also subject to a process of review and determination by ESMA and the European Commission).
- A comprehensive review of the entire AIFMD regime to be initiated by the European Commission within four years of the original implementation date (i.e. by 22 July 2017).
Although the Commission issued a tender for a market study last April, there has been little sign of activity since, save for a recently announced survey carried out by a leading accountancy firm. Likewise, progress on the extension of the passporting regime appears moribund, with very little prospect of an end to NPPR which is, in any case, working satisfactorily in a handful of EU states.
Of course, a hard Brexit scenario from March 2019 could end this uneasy truce rather abruptly. UK AIFMs with significant investor bases in the rest of the EU have been showing increasing interest in EU-based structures, such as the Irish ICAVs and the Luxembourg RAIFs. Within the UK itself, an extension of the private placement regime (possibly under a different name) seems very likely.
Senior Managers & Certification Regime
In February, the FCA consulted on transitioning FCA firms and individuals to the Senior Managers & Certification Regime. A policy statement on this is expected to be published in summer 2018, with an implementation date likely to be mid-to-late 2019 for most investment managers.
One of the topics that the FCA received substantial feedback on after publishing its proposals for the SM&CR regime in July 2017 was the proposed changes to the Financial Services (“FS”) Register. Under the proposed changes, only the most senior individuals will be approved by the FCA and listed on the FS register. The FCA plans to consult on maintaining a central public record of approved and other important individuals in FCA regulated firms, such as non-executive directors, financial advisors, traders, and portfolio managers, in mid-2018.
Virtual currencies, particularly cryptocurrencies, remain a hot topic in 2018 for regulators, government, and the general public alike. With Bitcoin hitting record highs towards the end of 2017, and transactions in Bitcoin and other cryptocurrencies also increasing significantly, regulators and firms are beginning to consider how these currencies fall under current regulation and what systems and controls should be implemented. Regulators in the UK, Europe and USA are urging consumers to exercise caution and request information about potential risks before making any transaction involving virtual currencies.
Anti-Money Laundering ("AML")/Tax Evasion
A major concern for regulators and firms is the anonymity that many virtual currencies provide, which makes it difficult to ascertain beneficial ownership and perform appropriate due diligence. While work is underway to include specific provisions for cryptocurrencies in the next EU Money Laundering Directive, it remains important for firms to ensure that they continue to fulfil their legal and regulatory obligations in preventing their services from being used to facilitate money-laundering or other illegal activities.
Another area of particular concern to regulators is the protection of investors. This is due to the highly volatile and speculative nature of cryptocurrencies, the varying quality of information available to investors, which means investors could make ill-informed decisions or be defrauded, and the security and operational risks involved with such transactions. Additionally, virtual currencies and the exchanges they are traded are not regulated under EU law, and only some fall under US law, meaning that investors have less protection and fewer avenues for pursuing redress should malpractice occur.
SEC Chairman Jay Clayton’s statement from February 2018 addresses the SEC’s stance on virtual currencies and cites examples where action has been taken against individuals and firms who have offered or sold virtual currency in violation of the Securities Exchange Act. A main point to note is that the SEC is treating virtual currencies issued through an initial coin offering as securities, and thus subject to SEC regulation. However, the SEC is aware that this is an evolving area that may require its own specific legislation to mitigate its unique risks.
Personal Account Dealing
Firms especially are beginning to look at how they should apply their Personal Account Dealing Policy to virtual currency transactions, and what their reporting obligations would be. While some transactions may fall under the FX umbrella, it appears that many firms are taking a conservative approach and treating all transactions as reportable, particularly those firms that are subject to SEC regulation and so also need to consider the SEC’s approach. Another salient point for many firms to consider is the volatility of these virtual currencies and the opportunity for distraction of staff trading in them.
Brexit negotiations are still far from complete, and so its eventual impact on firms is still an uncertainty. However, the FCA continues to make it clear that all EU regulations and directives will remain in force until 29 March 2019, the current official date of the UK’s departure from the EU. Regulators in the UK and across the EU are increasingly looking to see that firms which operate in both the UK and the EU have, or are developing, a post-exit plan, with provisions in place for both a soft and a hard Brexit.
Of particular interest to asset managers will be the notice recently issued by the European Commission, which warns that, subject to any transitional arrangements, neither the UCITS nor AIFM Directives will apply to the UK post-Brexit. In a worst case scenario, this means that UK firms who manage and market funds in the EU may no longer be able to do so under their current structures.
FCA News in Brief
- The FCA has reiterated that firms who continue to charge for payment for order flow (“PFOF”) will be breaching MiFID II standards. PFOF will be a priority area of supervisory focus for the FCA going forward, so firms should ensure that they have taken all appropriate action to comply with requirements.
- The FCA has issued a Dear CEO letter regarding the quality of prudential regulatory reporting, in which it instructs CEOs of IFPRU and BIPRU firms to review and amend where necessary their regulatory reporting procedures. The FCA intends to conduct a sample review of firms’ returns from 1 October 2018.
- The European Commission has published legislative proposals that revise the prudential regime for investment firms and would classify firms into one of three categories. These proposals are under discussion by the Commission and the Council of the EU, with an 18 month implementation period envisaged.
SEC Examination Priorities The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) released their examination priorities on 7 February 2018. This year, OCIE has divided their priorities into five categories, although it notes that certain areas, such as developments in cryptocurrency, ICOs, and secondary market trading, will also be of particular interest. Additionally, while OCIE has not explicitly stated that it will focus on newly registered or never-before examined investment advisors, we are seeing an increase in the quantity of examinations for such firms and the rapidity with which newly registered firms are examined.
Questions regarding the SEC’s 2018 examination priorities may be directed to Andrew Petillon at or +44 (0)20 7042 0500.
The FCA’s business plan for 2018/2019 is due to be published in April. This will set out its activities and areas of priority for the coming year, including possible thematic reviews.
ACA is planning to conduct a survey amongst its clients on how various firms are tackling issues related to MiFID II, such as Inducements and Gifts and Hospitality. The results will be published in the next ACA digest.
Upcoming ACA Events
Performance Reporting Challenges for Investment Managers
Date: 11th April 2018
Time: 8.30 am -10.30 a.m.
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haysmacintyre and ACA Compliance explore VAT and MiFID II
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