International Funds Legal Update | 19 March 2024

The start of spring brings an update from the Financial Conduct Authority (FCA), following up on two previous "Dear CEO" letters, setting forth their supervisory priorities for the next year. Meanwhile, in the European Union, the updated Markets in Financial Instruments Directive (MiFID II) and Markets in Financial Instruments Regulation (MiFIR) have been amended, and the penultimate step towards Alternative Investment Fund Managers Directive (AIFMD) II has been taken.

The UK regulator hones in on asset managers' governance

The FCA has sent alternative asset managers a "Dear CEO" letter explaining what its supervisory focus will be over the next year. As usual, each firm's CEO will need to discuss the letter with their board and executive committee, consider how it applies to their firm and take action where necessary.

Generally, firms have experienced challenges in raising and maintaining assets due to heightened uncertainty and market shocks in 2023. This has raised concern over whether asset managers have sufficient compliance resources to deal with the "high volume of significant business and regulatory change to be delivered in 2024".

To address this concern, rather than focusing on the minutia firms need to deal with, the regulator's overall approach will be to review the effectiveness of:

• Asset managers' governance arrangements in assigning senior accountability for the risks
• Oversight by governance bodies.
• Ensuring appropriate management information about the identified risks support good decision making.

Valuations of private assets

The FCA has prioritised reviewing valuation practices for private assets and will be conducting a multi-firm review examining this. In line with this approach, they will assess firms' effectiveness of the governance, oversight and management information relating to valuations.

FCA's other areas of focus

• Setting and testing higher standards, including the price and value of products and services provided to unit-linked funds in the light of the consumer duty, as well as operational resilience.
• Reducing and preventing serious harm, including on market integrity and disruption.
• Supporting innovation, such as fund and asset tokenisation.
• Promoting competition and positive change, including the government's post-Brexit Smarter Regulatory Framework with a focus on MiFID II, AIFMD and Undertakings for the Collective Investment in Transferable Securities (UCITS), as well as modernising the funds authorisation process and enabling cross-border operation.

Consumer Duty next steps

The FCA has taken stock of the Consumer Duty implementation and published helpful information, including the results of the second survey of firms carried out in November 2023 and a summary of two Ipsos surveys of 1,864 firms.

The FCA has welcomed improvements to deliver better outcomes for firms' retail customers since the duty came into force in July 2023. However, some firms are lagging behind. Where asset managers experience problems with implementing the Consumer Duty for closed products, the FCA expects to hear from them sooner rather than later.

The regulator has reminded firms of the four consumer outcomes required by the duty and set out examples of good practice and highlights areas for improvement.

Firms need to:

• Ensure that the focus on good customer outcomes is understood at all levels, and in their strategies, leadership and people policies.
• Not wait for the FCA to intervene if they identify an issue, but proactively tackle it themselves.
• Identify where particular groups of customers receive poorer outcomes than other customers and take action to address this.
• Share relevant information with each other, when in the same distribution chain to quickly address issues to prevent consumer harm and deliver good outcomes.
• Show that their products offer fair value to customers.
• Consider the consumer duty and its requirements when approving financial promotions.

The findings may be useful for asset managers when considering what changes they need to make to meet the 31 July 2024 implementation deadline for closed products and services.

Sheldon Mills, executive director of the FCA, has identified the following require attention:

• Gaps in monitoring data. Firms must be able to evidence that they are delivering good outcomes for consumers and address any gaps in customer data.
• Fair value in closed products. Firms must assess, and be able to demonstrate, that their closed products provide fair value to customers. They should be confident that they do not exploit consumers' lack of knowledge or behavioural biases. Mr Mills emphasises that the FCA will not judge firms with the benefit of hindsight.
• Keeping customer connection. Firms must take action relating to less engaged and "gone away" customers, including the support offered and how they assess whether these customers understand the products they hold.
• Vested rights. Firms must ensure that the design of their products and services deliver good consumer outcomes over the long haul, even where the firm has vested rights.

The European Union updates AIFMD, UCITS Directive, MiFID II and MiFIR

The Council of the EU have adopted the proposed directive amending both the AIFMD and the UCITS Directive, jointly known as "AIFMD II". This relates to delegation arrangements, liquidity risk management, supervisory reporting, provision of depositary and custody services, and loan origination by alternative investment funds. For more information about the substance of these change please see our second international funds legal update from February 2024.

We expect the AIFMD II to be published soon. The amendments will enter into force 20 days after its publication in the Official Journal of the European Union, and Member States will have 24 months after this to adopt and publish the laws, regulations and administrative provisions necessary for transposition.

The expected amendments to Markets in Financial Instruments Directive 2014 (MiFID II) and the Markets in Financial Instruments Regulation (MiFIR) have been published in the European Union's Official journal. These changes mainly improve access to market data and trade transparency.

Key amendments are:

• Establishing EU-level "consolidated tapes" that bring together market data provided by platforms on which financial instruments are traded in the EU, and which will aim to publish the information as close as possible to real time.
• Imposing a general ban on "payment for order flow", which means that, broadly speaking, the practice whereby brokers receive payments for forwarding client orders to certain trading platforms must be phased out by 30 June 2026.
• Introducing new rules on commodity derivatives.

The amending legislation will enter into force 28 March 2024. The MiFIR amending regulation will then apply immediately in all member states. Member states will have until 29 September 2025 to bring into force the laws, regulations and administrative provisions necessary to comply with the amending directive.