2018: HNY

The relief of passing MiFID Day is palpable. After so long, it is hard to remember life before MiFID II was ‘just round the corner’. Now we have turned the corner and it is behind us. So, what is next? More MiFID II. Few firms will be able to say with conviction that all is done. For most, it will be mostly done, leaving room for improvement. With its carefully coded expressions of disdain for the EU’s drip-feed method of publishing requirements, the FCA has made plain its recognition that firms have not had adequate notice of many MiFID details to be able to comply on time. But firms would be wise to take note of the limitations of the regulator’s forbearance – terms and conditions apply.

Even as MiFID II remains the priority, attention must turn to the future. But which of the goodies on offer is to dominate? Will it be SMCR, so recently deferred by FCA in a passing comment about ‘mid to late 2019’? Might it be the measures under the Asset Management Market Study? Or will it be Brexit preparation?

 SMCR

As we have said recently, each step forward that FCA takes entails a step backwards in terms of implementation. The wise decision to defer implementation until 2019 has been greeted with a quiet welcome. The grandfathering, which surpasses most expectations, has put Statements of Responsibility back on the shelf. And the non-existent clarification of the impact of SMCR on the unfortunate Other Conduct Rules Staff has been largely ignored. The FCA has administered a sharp sedative where SMCR is concerned.

But is that how the industry should react? All this is going to be needed in due course. Firms now have the opportunity to approach SMCR at a measured pace, giving proper consideration to the substance of Statements and the contents and timing of training. The benefits that are due to emerge from the regime can be accessed well before the mandated date. Senior management can make a virtue of the ultimate necessity. De-prioritisation is unlikely to be the best response in most firms.

 Asset Management Market Study

The AMMS is an example of another area where FCA is showing an inclination for a less hurried approach than has often been witnessed in recent years. The common theme of AMMS and SMCR is the absence of the EU. Both being national measures, the regulator can largely set its own pace. It might not be entirely fanciful to suppose that FCA would be happy to show that, when freed from the apron strings, it is able to conduct policy changes in seemly style, providing reason for the industry, in considering where its future lies, to acknowledge official competence.

Although some of the most challenging items of AMMS have been held back for further review, especially the highly controversial matter of the all-in fee, most of the requirements consulted on last summer will be implemented. There is no real prospect that the obligation to recruit at least two Independent Directors to the Board of every Authorised Fund Manager will be abandoned. Those who drag their feet may find that the stock of directors is depleted, in quality if not in quantity.

 Brexit

With its Investment Management Strategy II, the government has dropped a modest hint about its UCITS plans. When we leave the EU, no UK domiciled fund will be recognised by the EU as a UCITS – such openness would run counter to EU philosophy. What, therefore, becomes of every UK UCITS from Brexit day? Subject to management action or regulatory intervention, existing investors will be wholly unaffected, wherever they might live. “Despite Brexit” there is no risk that those investors who live in an EU state will be deprived of their units, even if such unpatriotic investing shocks the neighbours. The key question relates to the funds’ marketing.

Here there are three distinct classes of market: the UK, the EU and the rest of the world. Most UK UCITS are intended primarily for domestic consumption. Here the regulator treats them, for marketing purposes, like all other authorised funds; they may be marketed to the general public.

Short of some amazing breakthrough in negotiations, which we discount, in the EU, UK UCITS will be treated as AIFs, as are all investment funds that are not EU-domiciled UCITS. The EU’s promise in AIFMD of passport access for non-EU entities has, of course, not been followed through, although national private placement structures have been restricted in anticipation, thus reinforcing the bloc’s protectionism. Anyway, AIFMD passports only guarantee access to professional investors, whereas UCITS are generally designed for retail consumption. Most private placement access has similar restrictions. So, broadly speaking, it is more than likely that the EU will be closed to UK UCITS.

What about everywhere else in the wider world where future growth lies? Despite a range of different regimes across the world, there can be no generic reason why a country that permits the marketing of EU UCITS will not also permit similar access to UK UCITS.

What then does HMT’s strategy statement mean by its sketchy and curiously drafted paragraph on UK UCITS? The wording suggests some form of industry-based UK UCITS kite-mark. But analysis of detailed wording in documents such as this is seldom instructive. There appear to be two main options: either the regulator will revert to pre-UCITS arrangements and authorise funds of various forms, including funds which happen to conform to UCITS standards or UK regulation will retain a UCITS category of authorised funds.

The first of these options provides great scope and flexibility as well as a relatively simple structure of fund regulation, so devised that only those deliberately flouting the requirements would breach the investment and borrowing scope. It ticks all the boxes of good regulation by minimising the restrictions, the complexity and the need for intervention. In short, it is precisely the internationally appealing regime that government and regulator wish to promote post-Brexit.

But there is a snag. The market has grown to recognise UCITS, even if the definition is broader than most believe. The brand is valuable, both here and in the rest of the world. So, a UK UCITS needs to reflect an EU UCITS if it is to be understood and accepted on equal terms. Will an industry kite-mark cut the mustard?

While kite-marks have their place, they can never compete with regulatory under-pinning, either in terms of enforcement or compensation. We appear, then, to be heading for the unusual phenomenon of industry pressure for regulation that is both restrictive and robustly enforced – that is the only way that the UK UCITS can command the global credibility so keenly sought.

Oliver Lodge                                                                                                 January 2018

OWL Regulatory Consulting is the adviser to the investment industry on matters of regulation.