Treating EU customers fairly

While we have been known to suggest that the EU does not always act as it should, in some areas, whether right or wrong, it has at least the merit of consistency. One such area is its approach to determining where a financial service is being carried out. Take the example of the investment manager sitting in his office in the City (lovely old concept, for those that can still remember it) looking after the investments of his favourite Italian client, who is sitting comfortably somewhere near Milan. We would say, rather obviously, that the investment manager was managing investments in the United Kingdom. That is where he is, that is where his regulator is, that is where the Compensation Scheme is based, that is where his counterparties know him to be and that is where complainants will find him. But ask the EU exactly the same question and they will tell you that he is managing investments in Italy. They have produced the same answer for years and they will go on doing so, quite consistently. 

For all those years this difference of view has not really mattered very much. Indeed, within the Single Market, the EU would prefer you not to know where you are – everything should be the same and everyone should work together, which does have a vestige of truth, at least when it comes down to standardised regulation. Moreover, we, in this country, have not troubled to challenge this quaint EU belief because we have always been able to live with it by routinely applying for directive-based passports which we didn’t really believe we needed, except for the purpose of keeping the peace with difficult European regulators. But now reality is breaking through and we have to confront the issues arising from years of wading in fudge.

While it would be nice to think that the EU was taking its position entirely from a dutiful desire to protect its consumers, that is really quite hard to believe. As with its reluctance to recognise equivalence in others, the EU motivation is the prevalent, predictable protectionism that pervades its practice – the self-same driver that leads it to go to extraordinary lengths to stifle reverse solicitation. The time may eventually come, and Brexit may be the catalyst, when EU consumers show their resentment at obstacles created by their politicians to prevent them from buying goods and services from wherever they choose.

Meanwhile there are decisions to take. While this country has worked hard to ensure that UK consumers can continue to receive financial services from EU entities, surprisingly enough no equivalent arrangements have been made by the EU or even by most EU countries. They, like us, could have established a temporary permissions regime, but no. In order to try to unnerve UK providers, cajoling them into relocation, they prefer to run the risk of disrupting the services delivered reliably for many years to their own consumers. And they will of course seek to place the blame on the providers and the UK authorities. 

So why might it be that FCA is so coy on this question? They, like the rest of us, are well aware of the game that is being played. But they have no intention of playing into EU hands and have hinted strongly that acting in the best interests of consumers matters at least as much as observing the irrational restriction of foreign governments and regulators. After all, providing services to EU residents does not, either this year or next, become a breach of UK law or regulation, so FCA will have no role in terminating that business. So, for those who have not already jumped, the prospect of no deal poses a significant question over how to manage the situation. We believe that the key is transparency. This is a combination of a blame-game and a tussle for hearts and minds. Consumers need to understand who is doing what and why. A pre-emptive move by providers will be seen by consumers as the simple exercise of their own initiative; the provider will be blamed. But if it is crystal clear that the provider is moving only after a direct and credible threat from EU based authorities, and if evidence of that anti-competitive behaviour is all around, the penny will drop. Is there a risk that firms will be penalised? Yes, some. But does that risk outweigh the prospect that this battle might yet be won, whether in substance or in PR terms – probably not

Posted in: Brexit, ESMA, EU, FCA, MiFID, Miscellaneous, UCITS
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ESMA’s Cunning Plan

Those who have whiled away a covid summer afternoon enjoying ESMA’s note to the European Commission on improvements to AIFMD  ( esma_letter_on_aifmd_review ), will have formed the vaguest suspicion that despite its noises about Wirecard, it is really Woodford that is still on ESMA’s mind. The fact that the highest profile Woodford funds were UCITS need not deflect that thought – ESMA’s No 1 complaint is the extent of pointless differences between the two directives. It was Sybil Fawlty who was identified as the master of statements of the bleeding obvious and there are signs that ESMA may have become confused between the hotel sketch and the investment fund disaster.

There is a sense emerging from its note, that ESMA has been looking forward to this opportunity. In between the told-you-so remarks and the statements of the BO, there are the wonderfully unoriginal bids for more regulation and more Europe. They have wisely abandoned their attempt to dress up their naked protectionism as investor protection – remarks about the appalling prospect of business being done with London and other haunts of ill repute abound.

As is so often the case, the main attraction is Delegation. What else could be said on this subject that has not already been dismissed? Nothing new, it seems, but quite a lot that can be re-heated. It is after all a subject where Woodford can help. So, we have observations, after a passing reference to possible benefits, that delegation

  • “may also increase operational and supervisory risks”
  • “may raise questions as to whether AIFs and UCITS can still be effectively managed by the licensed AIFM or UCITS management companies”

This is not revealing stuff – except perhaps to the extent that it suggests that either ESMA’s understanding is worryingly superficial or that it has decided to recite points that it believes will best chime with Commission fixations. There is in this treatise something approaching a real failure to grasp how, in the context of regulation, delegation is supposed to work. There is no recognition that almost any delegation, whether in the context of investment funds or any other area, involves the prospect that an activity is carried out by a party that is not itself subject to at least some applicable regulations. There is no reflection on how that is usually dealt with. There is no proper emphasis on the retention of responsibility when delegation is effected and that delegators are required to execute due diligence, apply clear duties and carry out sufficient monitoring to ensure that all relevant regulatory obligations are fulfilled and that consumers suffer no disadvantage from the delegation. If it was that they thought that to make such obvious points would be to trespass on Sybil Fawlty territory, there is no sign that that has stopped them elsewhere.

What tempts one to think that ESMA’s professed concerns are not substantive, but merely uttered for effect, is the careful incision of references to the horrors of the non-EU delegate. Consider

  • “In the case of delegation to non-EU delegates, the regulatory arbitrage and investor protection concerns may be further increased since the non-EU delegate will not be directly subject to the AIFMD or UCITS frameworks.”

Most would say that the stated impact was far from peculiar to the circumstances of delegation to non-EU parties, but rather that the majority of EU funds have a portfolio manager that is a MiFID firm. In fact delegation to a firm that isdirectly subject to AIFMD or UCITS would be so peculiar that it would raise questions as to how such an arrangement was in the interests of investors. So it is either time to be troubled at ESMA’s ignorance or suspicious that it is playing politics to the audience.

You will of course be unable to guess what remedies ESMA proposes. Perhaps a sample or two will provide a clue.

  • “To avoid regulatory arbitrage and protect EU investors, legislative amendments should ensure that the management of AIFs and UCITS is subject to the regulatory standards set out in the AIFMD and UCITS frameworks, irrespective of the regulatory license or location of the delegate.”
  • “the Commission may in particular wish to reconsider and/or complement the qualitative criteria set in Article 82(1)(d) with clear quantitative criteria or provide a list of core or critical functions that must always be performed internally and may not be delegated to third parties.”

So ESMA is at the same time calling for action and studiedly vague about what should and should not be a permitted delegation. They don’t expressly call for a ban on delegating portfolio management, inside or outside the EU, but there is more than a hint that protectionism is what really matters. Some say that this would be very damaging to the UK investment management industry. Others note that it is EU funds that will be hobbled by absurd restrictions – and the UK is safely outside. Perhaps the reference to protecting EU investors is tacit recognition that there may soon be no others.

It is said that the intention of the SNP is to alienate the English in order to get them to support Scottish independence. If there were to be any truth in that, the strategy would be logical and seemingly pretty effective. What it may not sufficiently take into account is the longer-term impact of being on bad terms with your most important trading partner.

And so you may have wondered whether a similar strategy is at work here, with ESMA and others falling prey in our wicked web. There can be no doubt that the EU aspires to wrest financial services business from the UK, but there is certainly doubt over whether their tactics will damage business in this country more than it does on the Continent.

Posted in: AIFMD, Brexit, ESMA, EU, MiFID, UCITS
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Property Funds on Notice

Deferred gratification is always said to be the best. So, it is good of FCA to propose it. Except that that should say ‘impose it’, particularly if you hold units in authorised property funds. The Woodford legacy just keeps on giving.


On the astonishment scale, Consultation Paper 20/15 gets a low score. No crystal balls needed to have predicted the thrust and even quite a bit of the detail of this one. But there are one or two oddities, nevertheless. This must be the first time that FCA has identified the need to consult while most of its subject matter is disabled through suspension. It almost feels like waiting until he is unconscious before you punch him, but perhaps not quite. It is, though, as FCA admits, concern that these proposals could cause a mass exodus and a disorderly market. Not exactly the best advertisement for a measure designed to protect those very people.


Keen observers of the art will have noted FCA’s uncharacteristic uncertainty. Usually we are treated to clear opinions and usually FCA knows its own mind, not least because it will have spent many months talking to affected groups and carefully discounting much of what they hear as just more of they-would-say-that-wouldn’t-they. But this time it is different. FCA positively implores interested parties to find a better way. That too fails to inspires confidence in the proposals, but it is an offer. And who said that regulatory consultation was just a question of going through the motions?


For those who have not read the story, it’s pretty simple. As of ‘as soon as possible in 2021’, the happy unitholders of property funds will be locked in (again), this time by the imposition of a redemption notice period. Luckily, they are well used to lock-ins, so it will be difficult for many to know whether the gratification deferral is one for which they should thank the manager or the regulator. Anyway, the gist is that investors will not get their money back when they ask for it – they will have to wait for three months, six months or somewhere in between, either fixed by the manager or fixed by the regulator. When FCA makes up its mind, that is. And the notice the investor gave to start the process is irrevocable – the whole point is that the manager must know whether he needs to raise liquidity or not.


But of course, it is not as easy as that. The funds are suspended, or might be just when your ticket is called, so, when you thought you were going to get your money, you might not (but suspension risk should by then have been reduced). And the amount? Well that depends too. It will be what it will be when the day comes that you can have it back. If all that makes you feel like starting the process now, that is just what FCA was worried about. In fact, whatever they may say about suspension lasting no longer than absolutely necessary, there is a distinct sensation that the current suspension would do well to last until all this has come into force. Either that or watch out for exciting times, probably just in time for Christmas.


You might also be puzzled that this looks a bit like a second bite at the cherry. Only last autumn FCA published its rules for funds investing in inherently illiquid assets. Surely that covered property funds. Well, yes, but the new regime, when in force, will supersede, for property funds, the FIIA regime. Although the FIIA rules come into force first (next month), almost all of them are going to apply to property funds anyway, so the new rules will merely add the notice period requirement at the appointed time in 2021. Why is the notice period not applied to other FIIAs as well? We have to assume that it is more difficult to generalise about what is appropriate for an FIIA than it is for a property fund and therefore judgement calls must be left to the manager.


In case that leaves the hornets as yet unstirred, consider the grandfathering. Certain funds (those with limited redemption, dealing no more than once a month) in existence before the rules come into force next year, won’t be caught as ‘funds predominantly investing in property’ and will therefore escape the new obligations. But any that move into that exempt territory after that date will be hit by these new rules. So the grandfathered funds have an indefinite advantage, which FCA justifies, saying that they have ‘typically’ not suffered the same history of suspension. Time will tell whether this advantage becomes a valuable investor magnet. This distortion of competition is rationalised in FCA’s Compatibility Statement, but none of the argument explains why pre-existing funds, still open to new investors, should be treated differently from new ones.



For those who believe that the obvious means of dealing with the issue is to establish a secondary market in the units, the FCA has a token paragraph. Guarded as its words may be, the FCA actually concludes that it welcomes thoughts on what would be needed to enable a secondary market to operate safely for retail investors. And why not?


Oddly though, there is no sign of de minimis redemptions being exempt from the notice period. There may be problems associated with bulk registration of unitholders, but to ignore the possibility altogether seems surprising. To allow a unitholder to redeem £1000 of units per quarter would seem pretty manageable and might deal with the hard cases.


So, will they or won’t they? There can be little doubt that these plans, or something remarkably like them, will be in force in six months’ time. Roll on the secondary market.


Posted in: Competition, FCA
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