01 November 2011

FSA's Nicoll: Update on EU fund management regulatory developments

"You have had to deal with a difficult operating environment over the last few years while at the same time keeping at least one eye fixed on the regulatory developments emerging from Brussels and elsewhere. The AIFMD, the over-the-counter (OTC) derivative reforms under the European Market Infrastructure Regulation, the requirements for short selling transparency, and the remuneration code emanating from the revision to the Capital Requirements Directive (CRD) do, I am sure, feel like a lot of regulatory interference. 

AIFMD

Although this Directive was originally adopted by the Commission over two-and-a-half years ago, there are still a number of important details yet to be finalised. One of the most important remaining aspects is the detailed rules (the so-called ‘implementing measures’) on which ESMA have been working since the beginning of this year.

ESMA is due to deliver its ‘advice’ to the European Commission by 16 November on how these implementing measures should look. As many of you will be aware, ESMA consulted on its draft advice over the summer. There were, not entirely surprisingly, a lot of responses, totalling well over 150. We have spent time with ESMA reviewing these responses and considering the themes that have been emerging in making amendments to ESMA’s advice.

It is important to remember here that ESMA has to make a balanced judgement between different options, sometimes in circumstances where half the industry thinks one thing and half the industry another. In some cases, regulation is developed in a highly-charged political environment, at EU level: the preoccupations of 27 different governments, regulators, industry and consumer representatives are never going to coincide all the time.

Depositary

Turning firstly to the issue of depositaries, and particularly the liability of depositaries in the event of the loss of certain assets. This is the issue that above all others has received the greatest degree of commentary and scrutiny over the last couple of years. The liability of a depositary for a loss under the Directive depends on a number of factors. These include the underlying cause of the loss and the reasonable efforts the depositary could have taken to prevent it.

Many respondents to ESMA’s consultation focused on setting out those events that would result in a loss but for which the depositary could not have reasonably prevented. Others suggested that the so-called ‘duty of care’ of the depositary should be based on the due diligence standards under the Directive.

In this regard, ESMA has worked on defining what it has referred to as ‘acts or omissions’ by the depositary. The purpose of this is to seek to provide further advice to the European Commission on this issue. The focus over the coming months, will need to be on how these so called ‘acts or omissions’ apply in cases of insolvency and fraud.

Leverage

Another issue of considerable debate that ESMA has been dealing with is the definition of leverage. Whilst the concept of leverage ratios and backstops is familiar in the banking context, in the fund management arena this has not to date been an area subject either to definition or to regulation. One of the most difficult aspects of this work for ESMA is the need to develop an approach or combination of approaches that satisfy two distinct objectives.

MiFID II

Having been published a couple of weeks ago, MiFID II can probably now claim the title of the ‘new kid on the block’ from the AIFMD. If you will allow me to move ‘off market’ for a moment, it is worth noting that MiFID II will deal not only with market issues, but also the way that we regulate conduct of business standards.

This will include matters that we have been tackling in the UK through our Retail Distribution Review (or ‘RDR’) – such as investment adviser independence, and the risk of commission-biased advice. We are pleased to note the similarities between the MiFID II legislative proposals and some of our RDR requirements. And, importantly, we believe that our RDR rules are compatible with the MiFID proposals. So, while the MiFID II proposals explicitly provide for a ban on commission when firms describe their advice as ‘independent’, the draft Directive does not prohibit regulators from going further. In the UK we will already have banned commissions set by product providers – for advisers of all types – when MiFID II comes into force.

The concerns that led us to develop the RDR remain valid in the UK, and may also be shared by some other regulators in respect of their national markets. Given this, it may yet prove that other Member States are also interested in restricting inducements for all firms that give advice, while remaining in conformity with MiFID II.

Also in the conduct sphere, it is pleasing to see that the proposals also cover issues around product intervention: we, and a number of our fellow EU regulators, have been focusing on this over recent months. We look forward to some interesting discussions on these issues.

Regulatory reform

I want to turn briefly to the subject of regulatory reform – a subject which I think it is almost impossible for an FSA speaker to omit from their remarks at the moment. Regulatory reform provides an opportunity to take a fresh look at how ‘wholesale conduct issues’ are addressed. One of the key issues for the FCA will be to make sure it tailors its approach appropriately to different parts of the market. What is right for pure ‘retail’ markets is not appropriate for entirely ‘wholesale’ ones – another way of putting it, as Hector Sants did earlier in the year, is that a distinction can and needs to be made between ‘investor protection’ and ‘consumer protection’. The complexity, in particular, arises where, for example, products that start off in the wholesale market can and do find themselves in the retail market – recent developments in the UCITS market are a case in point.

Getting this right will be a key challenge for the FCA, which needs wide debate since it underpins the success of London both as an international marketplace and as a mechanism for providing retail investors with access to a variety of financial products. I would encourage you to participate in that debate, and the range of other debates that need to take place as we develop and establish the new regulatory environment.

Conclusion

So, by way of conclusion, regardless of whether you are bullish or bearish about some of the regulatory changes afoot at either a domestic or European level, as we go through the next period I believe it is important that together we have a constructive engagement and aim to build a stronger relationship. I would encourage you all to be a part of that."

Full speech

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