AIFMD divergence An Interesting FCA asset Management Discussion

On 20 February 2023, the FCA published a discussion paper on Updating and improving the UK regime for asset management. The Discussion Paper sets out high level ideas about how to improve asset management regulation with a more modern regime to better meet the needs of UK markets and consumers.

The FCA focuses on the following topics:

• Simplifying and standardising rules for asset managers (both retail and wholesale);
• Updating areas where the rules could work better, including in the depositary space; and
• How technology (including tokenisation) could drive better outcomes including in disclosure.

Rather than summarise the paper up front we have decided to set out the things that we do not think work well in the current regime, focussing on predominately wholesale funds. This discussion paper presents an opportunity to rethink a regime that has become "UCITS light" rather than a thoughtful interpretation of how to deal with funds raised by and for sophisticated and institutional investors.

We think it is a shame the FCA has indicated that it does not plan to significantly change the rules derived from AIFMD. The "upgrade" from the pre-AIFMD regime largely covered by the collective investment scheme concept has provided limited benefit to wholesale investors, presents minimal data collection that is sufficiently granular and timely for regulators, and has created inconsistencies and difficulties in interpretation that can slow fund raises and deployment of capital, especially in a time when the UK is seeking to unlock capital and be seen as an investment management hub for the world.

Ashurst Wishlist – top 10 things

1. Where different directives have slightly different standards without any meaningful difference there should be standardisation – for instance the same best execution test applies across the board and its made clear when best execution does not apply.
2. A more sensible approach to who can invest in AIFs should be taken.
3. Remove "retail" rules from wholesale AIFs – as examples: remove the Article 23 and ongoing disclosures that have not provided any investor protection, the requirement to wait a month before launching new funds or making material changes; and the requirement to apply for marketing permissions.
4. Proportionality in the rules should not just apply to wholesale versus retail funds but to asset classes – closed-ended private equity and infrastructure funds pose significantly less risk to the system than hedge funds or even some UCITS funds. Likewise funds subject to significant other rules, such as investment trusts, should not be required to comply with two (often duplicative but not always consistent) sets of rules.
5. Reporting needs a fundamental rethink – Annex IV reporting is done so long after events that it provides little helpful information about the risks the FCA is concerned about. Particularly for liquid funds.
6. Ignore the direction of travel in the EU under the proposed AIFMD 2, the recent cross border fund distribution rules that don't provide any additional meaningful investor protection or regulatory oversight.
7. Lift the threshold for small AIFMs, which has remained the same since AIFMD was implemented and come up with a more sensible definition of fund level leverage.
8. Exempt fund managers from complying with certain rules where the vehicle is "house" money such as employee co-invest and carried interest vehicles. Where staff are committing their own money they should not be required to disclose information to themselves as if it was third party money.
9. If rethinking disclosure some acknowledgement that the various rules over the years have at best not worked and at worst caused more confusion (yes, we're looking at you PRIIPS KID) – new disclosure rules are relatively easy and cheap (for the regulator at least) to implement but it is unclear that they do anything. In the wholesale fund space Article 23 disclosures consist of information that was already largely disclosed to sophisticated and institutional investors or was not relevant and the additional disclosure is pointless.
10. Abolish the portfolio company notification and anti-asset stripping rules that have benefited no one apart from the lawyers who make some of the worst drafted EU law work.

Simplifying and standardising

As most readers will be aware the UK asset management regime is largely driven by three pieces of European legislation:

• UCITS – rules for retail fund managers;
• AIFMD – rules for wholesale fund managers; and
• MiFID II – rules that affect delegated portfolio managers, distributors and other parties that asset managers interact with such as brokers.

The FCA has noted that the rules in this space could be clearer and more coherent using the examples of conflicts. We think that this would be helpful. Given the uplifts to AIFMD, UCITS and MiFID have happened at different times asset managers can find two similar products are subject to slightly different rules, creating unnecessary complexity. Someone looking for disclosure rules and who a fund can be marketed to might need to look at rules that derive from COBS 3.5, COBS 4.12, the Promotion of Collective Investment Schemes Order, FUND or COLL sourcebook, PRIIPS, SFTR. That is before any consumer duty and ESG issues are considered. Consolidation of these rules would be helpful.
The FCA also suggests a possibly that it works with Treasury to amend the threshold at which AIFMs must apply the full-scope rules. This figure has remained the same since AIFMD came into effect

Improving current rules

In addition to simplifying and standardising, the FCA has identified a number of areas where it thinks current rules don't work. Most of the focus here is in the retail space. However, there are a few issues for wholesale asset managers.

In particular the FCA considers that it might make expectations on investment due diligence clearer for all asset managers. It is unclear how this would work . Ultimately sometimes asset managers make poor decisions but is not clear that in most cases this is due to a lack of regulatory oversight on due diligence. It also risks situations where investments fail (and they do, even with appropriate due diligence) that the FCA with the benefit of hindsight looks at this as poor due diligence.

In addition the FCA has suggested clearer rules for depositaries.

Technology

The FCA sees technology as a driver of better consumer outcomes. This includes interaction with clients as well as back-office functions such as transaction settlement and fund accounting.

The FCA is also willing to consider new rules with respect to fund tokenisation and also the acquisition of tokenised assets at the level of the fund.

Where does this lead

Since UCITS I in 1985 (followed by ISD, MiFID, AIFMD, MiFID II and various UCITS reforms) the European and UK regimes – like many other national regimes - slowly converged, as to be expected as part of the single market. Since Brexit, there has been a gradual divergence in rules predominately due to the EU adopting legislation that the UK has not (for instance cross border fund distribution rules and new rules on ESG). If the UK gradually moves away from the EU rules and does not adopt future EU reform (e.g. AIFMD 2), we will have slow divergence.

Many of the rules, particularly in AIFMD are cumbersome and have little to no benefit, as demonstrated by our list above. The benefit whilst in the EU was the ability to use the marketing passport. A more radical rethink of some of the rules, when the loss of passport has already occurred would make the UK asset management industry stronger, particularly in the wholesale space.