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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Good to see the Investment Association talking publicly (FT 27th July) about developing a new improved version of UCITS for funds domiciled in the UK. We at OWL have been promoting the concept for many months and hope to see such a regime in place as early as possible after the transition period ends. And we have made the point before that such a regime can and should run in parallel with a continuing UK UCITS regime, which has such strong global brand-recognition

Posted in: Brexit, EU, FCA, UCITS
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