The future of UK asset management regulation — striking proposals for discussion

The FCA is seeking views on various ways the UK regulatory regime for asset managers could be bolstered, amended, and modernised. In part, this has been prompted by new post-Brexit powers for the FCA under the UK's Future Regulatory Framework (FRF) review. The FCA's Discussion Paper (DP 23/2) explores potential new requirements, streamlining some rules, and areas where technology could be used to modernise funds and improve consumers' experience and impact. It will use feedback to prioritise its work and plans to publish a feedback statement and potentially a consultation paper later in 2023.

The FCA states it does not “want to create unnecessary complexity for firms operating their businesses internationally”, will reform only where the benefits are clear, and rules should be “effective and proportionate”. However, the proposals point to potential new requirements that some may view as unnecessarily onerous and poorly timed given the significant volume of regulatory change already faced by asset managers, particularly in the face of Consumer Duty implementation and the incoming Sustainability Disclosure Requirements (SDR). Experience with the SDR consultation and the proposals in this paper indicate the outcome could be diverging rules between the UK and the EU.

In this article we summarise the topics covered and then provide our initial insights and views on the potential impacts.

The existing regulatory regime for asset managers (portfolio managers², fund managers³ and funds) is complex. Much of the regulation specific to the sector is derived from EU law (mainly the UCITS Directive, AIFMD and MiFID II). Under the post-Brexit FRF, the FCA will now need to review retained EU law and consider whether to reinstate rules or to make changes. 

Its key proposals relate to changing the approach to the following regimes:

• Fund managers and portfolio managers: Currently, similar activities and products are regulated differently. For example, only fund managers are subject to specific rules on liquidity and investment due diligence, and wealth managers do not need to comply with specific rules that apply to retail fund managers. The FCA therefore asks whether it should extend the rules to portfolio managers to create a common framework. 
• Retail funds: The FCA asks whether it should change the boundary of UCITS and considers three options: all authorised retail funds (UCITS and NURS) subject to a single set of rules; rebrand NURS as "UCITS plus" to capture more complex products; or create a new fund category of "basic funds" with restricted derivative use. 
• Managers of professional funds: The FCA considers whether the "full-scope" AIFM regime threshold should be increased, or whether to allow firms to use the "small-authorised" exemption if they meet non-size-related criteria (e.g. the strategies they manage). However, the FCA is concerned about aspects of the "small-registered" regime and may require some types of small-registered AIFMs to become authorised.

Rules for authorised fund managers (AFMs)

• Host AFMs: The FCA is concerned whether portfolio managers genuinely understand the role of AFMs and asks whether it should clarify its expectations by creating specific contractual requirements between the AFM and portfolio manager. It also considers clarifying the responsibilities of portfolio managers through new rules and guidance.
• Enhancing liquidity management: The FCA proposes to convert ESMA's stress testing guidelines into rules and remove ambiguity around whether stress testing must be performed. It also acknowledges the concerns of financial stability bodies and proposes to clarify its rules on certain liquidity management tools such as swing pricing. The FCA notes that reporting and/or public disclosure regarding UCITS funds' liquidity could be needed.
• Investment due diligence: The FCA notes weaknesses in this area and that investment in illiquid or complex securities can lead to consumer harm. It proposes making its expectations on due diligence clearer, potentially impacting portfolio managers.

Depositaries

The FCA states that depositaries have not always challenged fund managers in a way it would expect, and notes certain existing oversight functions may potentially be of limited benefit. It therefore proposes to clarify its expectations in a wide range of areas — for example around depositaries' resources and knowledge, and oversight of liquidity management and fund pricing. 

Improving fund rules

• UCITS eligible assets: The FCA is concerned about how firms are approaching the 10% unlisted rule, and that other criteria such as suitability, reliable valuation or liquidity characteristics are not considered by fund managers. It asks whether it should update or provide more guidance around rules in this area.
• Prudent spread of risk: The FCA notes the possibility of moving from prescriptive rules (e.g. the 5/10/40 rule) to principles-based requirements. Surprisingly, it asks whether it should remove or modify prescriptive requirements in this or other areas of the retail fund rules.

The FCA considers where the regulatory framework may need to be adapted to ensure technological change is supported and firms are not held back from innovating. It asks about changes that may be needed generally, as well as covering the following specific topics:

• Technology in fund operations: The FCA asks whether it should modernise the way fund units are bought and sold — for example, the Investment Association is proposing a "Direct2Fund" model that would allow investors to transact directly with the fund when buying and selling units, rather than relying on the AFM to do so.
• Tokenisation of fund units: The FCA is already looking at how existing rules around the creation/cancellation of units may need to be made more flexible to allow firms to operate a "digital register". The FCA asks for views on the benefits of tokenisation and the regulatory changes needed to enable it.
• Tokenisation of portfolio assets: The FCA asks if there are specific rules that could impact fund managers' ability to invest in tokenised assets where the underlying instrument is itself an eligible asset.
• Investment in cryptoassets: The FCA will not do more work in this area until the government has advanced its own thinking regarding the regulation of cryptoassets in the UK.

• Ongoing information needs of investors: The FCA considers how fund prospectuses could be modernised, and asks how their content and readability could be improved. The FCA notes that more frequent disclosures of holdings could be useful, and asks how the rules could be changed to enable firms to make better use of technology (e.g. implementing a machine-readable format). It also considers more radical ways of reformatting existing fund reports.
• Investor engagement: The FCA asks how rules for fund unitholder meetings could be reviewed to increase investor participation. Regarding shareholder voting and investor engagement, the FCA asks how the relationships between fund managers, intermediaries and investors could be better reflected in the rules (including to facilitate pass-through voting), and whether the FCA should do more on engagement in terms of regulatory intervention.

It is likely that the FCA, through the Financial Services & Markets Bill, will shortly have a secondary objective on international competitiveness and growth. Therefore, it is striking that the FCA does not appear to be using post-Brexit regulatory reform to make the UK market more competitive in any meaningful sense. In some cases, it is proposing more detailed and prescriptive rules in more areas, just as firms are working towards Consumer Duty implementation. We summarise the potential impacts below: 

The FCA will not be able to progress work in all the areas identified within the same timeframe, so it is seeking views on priorities by 22 May 2023. It plans to publish a feedback statement later in 2023, possibly alongside a consultation paper.