Happy New Decade

At the beginning will be Brexit. At the end will be Brexit. And in between it will mainly be Brexit. I hope that those remarks relate to 2020, not to the whole decade, but I am probably wrong. There will be no escape from the great escape.

But where I really hope we are wrong is in expecting the worst. Certainly Brexit will present many challenges, but the Brexit optimists among us, including the new government, view this as a new opportunity. We have lived without passports before and we will have to do so again. We will focus much more on the world’s fastest growing economies and we will fight protectionism wherever we find it. More and more and more of this anon.

Swiftly moving on, or perhaps back, it is tempting to think of SMCR as so last year. However, as we know, the ever considerate FCA has staggered implementation, ensuring that there is still some SMCR to enjoy in 2020. Certification and Conduct Rules training spring to mind as aspects to follow on, but, and in many ways more importantly, proper embedding of the senior managers in their new circumstances is also a must for this year. Has each one got a copy of the DEPP guidance pinned to his desktop? Are they ready to answer the question of how they, as an SMF manager, have taken “such steps as a person in their position could reasonably be expected to take to avoid the contravention of a relevant requirement by the firm occurring (or continuing)” ? If the FCA come to visit, they are likely, on that occasion, to express their views in plain English.

And talking last decade, the Asset Management Market Study may now feel like ancient history, but in truth its key aspects, Assessments of Value and Independent Directors, are bound to be making the headlines in 2020. At some point in the year, every authorised fund will have to be assessed and publicly reported, with invaluable and prescribed input from the Independent Directors. Will we see rigour accompanied by a degree of self-flagellation or will there be whitewash on every webpage? Better the former – the latter will not avoid the flagellation; it will merely transfer its administration to the FCA. And first in line for the cane will be the Independent Directors.

The bizarre introduction of the requirements of SRD II, published only days before implementation, will not preclude a more robust approach in 2020. Even those who managed to publish a substantive engagement policy before the Christmas party will, this year, be facing the need for their first annual disclosure. How did you vote in those non-routine corporate ballots? We must be told, as must the press and the activists, unless, of course, the firm is ready to explain its non-compliance. Many would say that there were more and better reasons to maintain confidentiality than to comply with rules that FCA admitted it would not have applied had it had any discretion in the matter.

In an apparently genuine coincidence with other developments, FCA produced, last year, new rules for the treatment of funds investing in inherently illiquid assets – these to be implemented in the quiet calm of autumn 2020. Affected authorised fund managers, as well as other firms making mention of FIIAs, will be notifying the happy holders and those encouraged to contemplate taking the plunge, of their fund’s new-found status and what their manager’s smart new liquidity risk management strategy looks like. Even depositaries will be dragged from the shadows to strut their stuff in assessing liquidity profiles, overseeing liquidity management systems and notifying the FCA of anything that FCA would reasonably view as significant. Few depositaries enjoy the lime-light, but guest appearances may become more frequent.

Audience participation is invariably tiresome, but there may be some scope for dedicated spectators this year as well. Take the role of FCA CEO. Or rather, don’t. The most poisoned of all chalices may be up for grabs this year, but our recommendation is leave it for someone else. Don’t be tempted by the money. Don’t be tempted by the glamour. And don’t expect that taking the job will lead you to the Governorship a few years later. Keep this one firmly in the spectator category and see who falls for it.

Clearly we should also expect to see some sparks from the sweeping up of the Woodford car-crash. While a great deal has been said about this sorry saga, there is also much that we do not know. The challenge facing the regulator is to be seen to do the right thing while avoiding the easy trap of judging with the benefit of hindsight. Pressure from Parliament will be piled on and more than a few in the industry would have no regrets were some of the players to be humiliated further, but the regulator is quite experienced at not pleasing the crowds and will need to keep a very steady nerve as it publishes its conclusions. Whether this will be the end of the career of some hapless interim FCA CEO or just a  hospital pass for the new girl on the block remains to be seen.

Final thought for the year: prepare to hear further about the acquisition of research. After its blithe note about its alleged review last autumn, the FCA has held in reserve a number of points that it will want to make. While it struggles under the yoke of the EU, it must work with the clumsy drafting of its own intentions as distorted by the EU27 and unheard-of numbers of translators. Once freedom of speech is restored to the FCA, we should expect  its views to be clarified in all its favourite areas, of which this is firmly one. It may concede that the original drafting was so poor as to be unactionable, but it will, by then, have a little list of those who need to try harder. So, for 2020, it may be no names, no pack-drill. Nothing like having something up the sleeve for 2021.

With all the fun of the year, we are here to help.


Posted in: Assessment of Value, Asset Management Market Study, Brexit, EU, FCA, MiFID, Senior Managers Regime, UCITS
Tagged in: , , , , , , , , , , , , , , , , , ,

Stressing the Directors

As we may have mentioned before, the FCA is a trifle concerned about the liquidity of investment funds. Some would say that the threat to the career of its Chief Executive was good reason for the organisation to focus the minds of its many employees, and even of those beyond its Stratford bunker, on this important matter. So it is that FCA has issued to all Authorised Fund Managers a call to arms. And true to expectations, clearly embedded in the regulator’s missive (Effective Liquidity Management) is an early message to Independent Directors. Their honeymoon, only begun in October, is officially over.

The other reason why is also not hard to see. While any measures, relating to the Woodford implosion, taken against firms might be expected to be the message, enforcement action takes time, running the risk that there is another car crash before the previous one is swept up. UCITS managers must be alerted to short-comings unearthed in the course of the dig taking place at the ruins of the Woodford fund. Those who thought that all this was covered just a month ago in the Policy Statement on illiquidity in open-ended funds need to stay with the plot. That was dealing with NURSs; now it is time to tackle UCITS.

The letter’s main point is the obvious one: that the responsibility for compliance with the fund regulations lies with the Authorised Fund Manager, the FCA-regulated firm that is the focal point of the fund’s constitution. Whomever they may have selected to work the magic for them on the investment portfolio, they, the AFM, are absolved of none of their responsibilities. And the Independent Directors sitting on the AFM Board would do well to remember that fact. Pleas for a review of liquidity management arrangements are peppered across the not-very-long letter, but none is more pointed than the last, saying “Please review your firm’s practices as soon as practicable to ensure you and your fellow AFM Board members are comfortable they are appropriate.” If the practices aren’t, the Board members may shortly not be either.

As if to reinforce the point repeatedly made by Andrew Bailey, the notion that regulation should be pitched at a higher level with less how-to-do-it instruction is brought to life in the letter’s emphasis on the need to ensure that the liquidity of an investment, whatever its listing, does not compromise the AFM’s ability to redeem units in the fund. Don’t lose sight of the big picture while you enjoy the exceptions, the qualifications and the encouraging guidance. But remember also that this is a coin of two sides: why commit yourselves to daily unit dealing if the fund’s strategy is longer-term investment? Attracting investors with hard-to-keep promises may end in tears all round.

For the assistance of those inclined to question what it is that FCA is really looking for, stress testing is twice stressed. Many AFMs will not have participated in this, hitherto, minority sport. The challenge is to know how far to go and what to do with the results. Bearing in mind the key phrase of assessing the impact of ‘extreme but plausible’ scenarios provides some guidance on the former. And as for the results, they should tell you at what stage you will need to ring the alarm bell, triggering your crisis management plan, but preferably the one that precedes suspension.

The letter is sent to chairmen, the warning is addressed to the whole Board.

Originally published by Thomson Reuters © Thomson Reuters

OWL Regulatory Consulting is the adviser to the investment industry on matters of regulation.

OWL Regulatory Consulting

Posted in: Asset Management Market Study, EU, FCA, UCITS
Tagged in: , , , , , , , , , ,

Singularis v Daiwa: Supreme Court Judgment A case with “far-reaching implications” (FT) Oliver Lodge as Expert Witness

Despite limited press attention, the Supreme Court judgment delivered in late October in the case of Singularis v Daiwa should be of considerable interest and concern to regulated financial services firms in this country. The case began three years earlier in the Chancery Division of the High Court and, in February 2017, Mrs Justice Rose delivered a judgment, which was subsequently upheld in both the Court of Appeal and the Supreme Court.

The case amounted to a suit against Daiwa, a UK domiciled and regulated subsidiary of the Japanese bank, by the liquidators of Singularis for $200 million. Oliver Lodge was appointed by Daiwa as an expert witness. The judgment awarded some $150 million to Singularis’ liquidators. Before its insolvency, Singularis, a Cayman-domiciled company, had been a client of Daiwa. When that client relationship came to an end, the sole shareholder of the company instructed Daiwa to make payments of some $200 million to two other companies under his control. These instructions were held by the court to be an attempt to defraud the creditors of Singularis. There are a number of aspects of the judgment which have considerable general significance.

Among the completely unsurprising findings was the key conclusion that the firm’s record keeping was inadequate. Such a finding must be the most common of any in the context of financial services judgments, whether from the courts or the regulator. In this case, it could be that the firm would have been fully indemnified through the disclaimers in its terms of business had it retained a reliable record of presenting them to its client. The absence of such records led the judge to disregard completely all disclaimers. The message is obvious.

Equally obvious was the point about the need for experience and expertise. The firm was held to have invited a member of its staff who was not accustomed to managing major transactions to manage a series of major transactions. The consequence of his inexperience in this area was that the firm proceeded to make large payments on the instructions of the client’s director, who has been held to have acted fraudulently. The firm was unable to explain how it was that this member of its staff was put in that position. Mrs Justice Rose commented that “it was remarkable that when [the firm’s chief executive of the time] was asked at the close of his cross-examination who he thought should have been in charge of checking whether the payment was a proper one, his answer was confused and confusing.”

The judge also took the view that although senior management exchanged a wealth of emails between themselves, stressing how great care, extreme caution and so forth needed to be exercised in handling any requests for payment from the client, no one explained to those processing the transactions what they needed to do. In short, management was not managing.

Other aspects of the judgment were a great deal less obvious.

Although the fraud was held to have been committed by the dominant director and sole shareholder of the client, the firm was held liable for the loss essentially because it had failed to prevent the fraud. The judge took the view that denial of the claim against Daiwa would have a material impact on the growing reliance on banks and other financial institutions to play an important part in reducing and uncovering financial crime and money laundering. She pointed out that both expert witnesses had described how these matters had been the subject of substantial policy focus by the regulator for a number of years. She then concluded “if, however, a regulated entity can escape from the consequences of failing to identify and prevent financial crime by casting on the customer the illegal conduct of its mandated employee, that policy will be undermined.”

This is not a comfortable conclusion. The regulator requires that “A firm must establish, implement and maintain adequate policies and procedures sufficient … for countering the risk that the firm might be used to further financial crime(SYSC 6.1.1R). Clearly, such an obligation falls short of a requirement to prevent financial crime, particularly where it is perpetrated by an authorised signatory against his own company.

It is also remarkable to note that the culpability of the client was held to amount to a mere 25% contributory negligence. In awarding to the client damages of 75% of the value of the misappropriated money, the judge rejected the proposition that the client company had itself acted fraudulently. She ruled that the knowledge and actions of the individual who she concluded had committed the fraud could not be attributed to the company itself, despite being the sole shareholder, the Chairman, the Treasurer and the authorised signatory, because there were six other directors on the board, albeit that, as she commented, they “do not appear to have performed any kind of supervisory function even when the fortunes of the [group] started to decline” and had not troubled themselves to hold a Board meeting for two years. Still more to the point, the client company had not seen fit to put in place any discernible controls to reduce the risk of fraud.

So, how should firms react? I take as read the need for proper records, adequate expertise and effective management. Of much greater concern is the conclusion that a client can expect to recover losses from a firm which fails to prevent a fraud perpetrated by the client’s signatory, while the client itself neglects to put in place even rudimentary systems and controls to counter that very risk.

Two observations are worth making.

First, if firms are to bear so much responsibility, they will need to instruct their clients in basic business management. This needs to ensure that the client adopts and maintains effective anti-fraud measures, especially in relation to dealings between the client and the firm. It might even be necessary to go so far as introducing a process by which clients produce a certificate from their auditors confirming the adequacy of their anti-fraud procedures. While that may be a pretty unpalatable proposition, the extent of the liability emerging indicates the need for a radical review of prevailing standards.

Secondly, it should be noted that this judgment has been unanimously upheld by both the Court of Appeal and the Supreme Court. This is the new reality in financial services in this country.



Posted in: CASS, FCA
Tagged in: , , , , , , , , , , , , , , ,