Cross-border business is again receiving regulatory attention, both across the looming EU-UK border and within the EU. The extent of delegation in the asset management and funds sector continues to be a feature of regulatory debates. It is now joined by the need for regulators to respond to the greater use of digital channels, by investors to transact and by firms to communicate with clients and fund investors. A thread running through these discussions is which supervisor is responsible for what in cross-border scenarios, whether within the EU or with third countries.
Firms should factor these debates into their thinking when considering which markets they wish to continue to operate in or enter, and how; whether they intend to have regulated entities in each of their core markets or operate across borders; and to what extent they intend to delegate functions to other entities.
Questions for CEOs
In the current challenging operational conditions, how do we keep abreast of regulatory developments and consider the potential impacts for our business?
Are we fully prepared for the loss of passports or the ending of national provisions?
Have we reviewed what “substance” we have in each jurisdiction and whether it is sufficient to meet supervisory expectations?
How are we adapting our business to accommodate and take advantage of the increased use of digital channels?
Have we reviewed our governance arrangements, systems and controls in a digital context to protect our business and deliver value to our clients and fund investors?
The new EU-UK border
At the time of writing, the future EU-UK trade arrangements remain uncertain, in both timing and substance, but both sides have repeatedly stated that the Transition Period will conclude at the end of 2020. The likelihood of financial services (especially for retail markets) being included in the future trade agreement was always low, but now seems at zero. The critical questions, therefore, are whether equivalence judgements will be confirmed in time (both by the EU and by the UK) and what national arrangements might be put in place to smooth the impact of the ending of the Transition Period.
At the beginning of November, the UK Chancellor announced a series of equivalence decisions by the UK about the EU framework. These decisions are important to ensure continuing operation of the capital markets and are therefore important for the asset and fund management sector.
The UK's Temporary Permissions Regime will allow registered EU asset managers, EU fund managers and EU funds to continue to operate or be marketed in the UK for three years. Thereafter, EU UCITS and EU AIFs wishing to market into the UK will be dependent on the UK's national private placement regime (NPPR) for professional investors or will need to register each fund with the FCA if they wish to market more widely. The UK NPPR i for professional investors is relatively open, but the registration process for third-country funds requires each fund to be considered on a case-by-case basis. The proposed Offshore Funds Regime in the UK will ease this process. Funds from countries whose fund regimes are judged by the FCA to be equivalent will be able register with the FCA via a much simplified process. It is not yet certain what additional requirements will be imposed for third-country funds marketed to UK retail investors.
On the other hand, UK asset managers, fund managers and funds will lose the EU passports. It is for individual member states to decide whether they will allow portfolio management services to be provided to retail clients in their jurisdiction by UK asset/wealth managers. UK funds will need to use NPPRs, which are generally limited to placements with professional clients and do not exist, or are of narrow scope, in some member states.
A few member states have put in place national temporary arrangements to smooth the ending of the Transition Period (including ensuring the validity of certain types of financial services contracts for a short period), but these arrangements are of more limited scope and duration than the UK's provisions.
Divergence and equivalence
Until recently, it was a commonly-held view in some parts of the industry that UK regulation would remain closely aligned with EU regulation, at least in the short to medium term, but continue, as now, to impose additional requirements in relation to the retail markets. That view is changing. The UK's approach to new incoming requirements and to the review of existing rules is already showing signs of divergence. For example, the FCA will not implement the EU Sustainable Finance Disclosures Regulation, but its approach to revised capital requirements for asset managers is set to be closely aligned with the Investment Firms Directive and Regulation.
This begs the question how long any equivalence judgements by the EU of the UK will last. There is, therefore, a concern over the ongoing provision of portfolio management services by UK asset managers to EU funds and EU professional clients.
Looking forward, some member states are suggesting that the EU's current use of equivalence (whereby it depends on the rules of and supervision by a third-country regulator) should be replaced by a requirement for third-country firms to register in the EU and to comply with EU rules. Firms should monitor closely this and other regulatory debates impacting cross-border business.
Delegation and substance
Both EU and UK firms should also factor into their thinking the ongoing debate on delegation and substance, which has been raised again in the European Commission's consultation on the AIFMD review.
We noted in the June 2020 edition that the Commission's long-awaited report was short and did not indicate a full re-opening of the Level 1 directive. Since then, ESMA's report to the Commission raised many additional issues, including the need to clarify aspects of the delegation provisions and to extend them to UCITS management companies. It also says there is a need to harmonise the supervision of cross-border entities. This report led the Commission to include in its consultation six questions relating to delegation. Industry has until 29 January 2021 to respond.
It is clear that EU entities will need to have increased in-house skills and more experienced staff than may previously have been permitted. Most policymakers recognise, though, that the delegation of portfolio management, both within the EU and to third countries, can provide EU investors with the best knowledge and skills from around the globe. Indeed, Steven Maijoor, ESMA Chair made this point clearly in his remarks at EFAMA's annual conference in November. He said that there was no wish to change the current model, only to clarify it and mitigate the risk of over-concentration.
The Commission is expected soon to publish the Digital Services Act and Digital Markets Act. Meanwhile, it has published a staff working document (PDF 4.1 MB) on its evaluation of the Distance Marketing of Consumer Financial Services Directive (DMD). The evaluation acknowledges that the objectives of the DMD were in line with the expected needs of consumers and financial services providers when it was introduced and some objectives remain relevant. However:
- Developments in new selling practices, especially in the context of digitalisation, and consumer behaviour trends reveal that some consumer needs, including understanding of online pre-contractual information, are not addressed properly in the DMD.
- The objective of single market consolidation has been achieved to a limited extent, but consumers and providers still face barriers in providing or accessing cross-border financial services.
- The subsequent adoption of product-specific and horizontal legislation has reduced the relevance of the DMD in some markets.
- The enforcement landscape varies across member states, which points to the need to step up enforcement activity.
The results of the evaluation will inform the Commission's review of the Directive, which has been postponed to Q4 2021.
Finally, ESMA is consulting (PDF 383 KB) on guidelines on marketing communications under the regulation that was intended to facilitate cross-border distribution of all forms of investment funds. Key points are that the communication must be identifiable as marketing material, describe in an equally prominent manner the risks and rewards of investing in funds, and contain information that is fair, clear and not misleading. The deadline for comments is 8 February 2021 and the final guidelines will be published by August 2021.