The Asset Management Market Study: Further remedies

The Financial Conduct Authority (FCA) has published its response to its consultation on further remedies (as proposed in CP18/9) in connection with the asset management market study (AMMS) in Policy Statement (PS19/4). The remedies are relevant to authorised fund managers in the United Kingdom who manage authorised open-ended collective investment schemes (Authorised Funds). In this briefing Grania Baird and Kya Fear consider the remedies and implications for managers of Authorised Funds including relevant industry guidance.

What does the Policy Statement cover?

The Policy Statement sets out the FCA’s final position in respect of remedies it had proposed in order to improve the information available to investors in relation to the objectives and policies of Authorised Funds and to improve transparency in relation to the use of benchmarks. The remedies included in the Policy Statement closely follow the FCA’s original proposals as set out in the consultation published in April last year (CP 18/9), with only minor changes made.

The remedies involve:

• non-Handbook guidance in respect of the description of fund objectives and investment policies;
• new rules in the FCA’s Collective Investment Schemes Sourcebook (COLL) and Conduct of Business Sourcebook (COBS) concerning benchmarks; and
• a new rule in COLL relating to disclosure of performance fees.

What is the impact on fund objectives and investment policies (objectives)?

The AMMS found that Authorised Fund objectives are not always as clear and helpful to consumers as they could be. The FCA expects firms to use consumer friendly language when describing objectives.

In relation to improving the clarity and usefulness of Authorised Fund objectives, the FCA has decided to continue with its original approach of publishing non-Handbook guidance (which is included at Appendix 2 to the Policy Statement) to set out the FCA’s expectations in this area rather than amending or making new rules in COLL (which it felt were adequate).

The new guidance covers four main areas, as follows:

Language requirements

There is a reminder that it is a regulatory requirement that the UCITS KIID and the PRIIPs KID be written in language that is clear, succinct and comprehensible (avoiding the use of jargon and technical terms). In addition, the guidance notes that although there is no explicit requirement as to the style of language used, the information must be consistent with the information in the prospectus but it does not have to be identical.

Description of factors that are not covered in the prospectus investment objectives and policy section

The guidance provides that managers of Authorised Funds should consider whether to provide information in the relevant sections of the KIID and KID which goes beyond that set out in the prospectus.

The KIID section on objectives and policy must include information on the broad categories of investments used and the approach to these investments.

The FCA considers that it would generally be necessary for an adequate description of the objectives and investment policy in key information documents to include relevant elements of the investment strategy, including disclosing features of the investment strategy that are a fundamental feature of how an Authorised Fund or product is managed. The guidance contains some non-exhaustive examples:

• if the manager’s strategy is to avoid investing in a particular area which the investment strategy permits investment in, and / or is to make specific use of one of the investment powers, this should be made clear; and

• if the manager’s strategy is to focus on investments with certain characteristics or if the manager’s strategy is to be flexible about which opportunities they consider best, depending for example on their view of the market cycle, then this should be made clear.

Reference to a benchmark

FCA’s guidance reminds managers that they should consider whether in practice their investment approach implies a reference to a benchmark. The FCA has confirmed its view that where a fund is in practice constrained in how far its holdings can deviate from the weightings of a benchmark, that this implies a reference to a benchmark for the purposes of the KII Regulation.

The guidance also highlights that even if there is no explicit restriction there may be practical or internal restrictions within the firm which limit how far an Authorised Fund can differ from the composition of a benchmark. Firms are reminded that they need to assess whether restrictions mean that in practice the Authorised Fund is managed by reference to a benchmark. Examples in the guidance of restrictions to consider in this context include:

• risk management processes causing an Authorised Fund to be monitored and controlled relative to a benchmark;
• individuals managing the Authorised Fund being remunerated based on the Authorised Fund’s performance relative to a benchmark; or
• portfolio management systems restricting transactions using hard or soft limits relative to a benchmark.

Non-financial objectives

The FCA expects that where Authorised Funds have non-financial objectives (such as environmental or social objectives), they are set out in the prospectus and key information documents in a way that is fair, clear and not misleading.

Further, managers should clarify how they will measure whether those objectives are being met, and provide ongoing information to investors in that regard.

What is good practice when communicating fund objectives and policies with clients?

Firms which manage Authorised Funds will have experienced the greater scrutiny which the FCA has been paying to the objectives and policies of new Authorised Funds and sub funds in recent applications. In our experience, terms which are open to interpretation or which are potentially ambiguous or confusing, are likely to be challenged by the FCA. For example, terms such as sustainable, regular, moderate, and attractive mean different things to different investors and should be avoided unless fully explained. In addition firms should try to avoid using technical jargon.

In the Policy Statement the FCA said it did not intend to publish examples of good and bad practice or publish a glossary of consumer-friendly terms at this stage. The onus therefore remains on the managers to assess whether investors can reasonably understand the Authorised Fund’s objectives.

Helpfully as agreed with the FCA, the Investment Association (IA) has worked with consumer representatives and carried out consumer testing to promote the use of consistent terminology by managers in respect of Authorised Funds. This has resulted in the Fund Communication Guidance document recently published by the IA.

The IA’s Fund Communication Guidance is split into two parts. Part one examines key regulatory disclosures and provides the IA’s interpretation of the relevant legislative provisions. Part two discusses findings from consumer testing with examples of words and phrases some retail customers may have difficulty understanding, including:

• List I - a list of terms that retail customers find confusing (the list is quite lengthy and includes terms such as “growth” “liquidity”, “platform”) but which can be understood when shown alongside short, simple explanations; and
• List II - a list of terms that retail customers struggle with (the list is not as lengthy as List I but includes terms such “asset allocation” and “hedging”) and where a description might work better than the term itself.

The IA’s Fund Communication Guidance makes it clear that the terms in the Lists are not intended to be a comprehensive list of terms which customers do not understand, and that firm’s may consider some terms should be on the first list rather than the second. However the Lists are a useful reference point for firms considering Authorised Fund objectives and should help the review process rather than being a prescribed approach to use.

We understand that the IA’s Fund Communication Guidance document will be kept under review and will be amended in due course following further IA led consumer testing.

What are the new rules concerning benchmarks?

Prospectus disclosures

The FCA rules (COLL 4.2.2R) will require a manager:

• using comparator, target, and / or constraining benchmarks, to state this in the Authorised Fund’s prospectus, and provide sufficient information so that investors understand the choice and use of such benchmarks; and
• to provide information concerning the historical performance of an Authorised Fund, comparing its historical performance against each target benchmark and constraining benchmark.

The FCA rules (COLL 4.2.2R) will also require a manager that is not using comparator, target and / or constraining benchmarks in relation to an Authorised Fund, to state in the prospectus that it does not use benchmarks and instead explain how investors can assess the performance of the Authorised Fund. The FCA states in the Policy Statement that the use of benchmarks in assessing performance is not mandatory, however in practice this requirement may prove challenging for managers, with the result that they may end up using a benchmark when they previously had not.

Investor communications

The FCA rules (COBS 4.5) will require a manager to provide in its communications with retail clients:

• a short explanation, in terms consistent with the prospectus, of the choice of every target, comparator or constraining benchmark used in relation to an Authorised Fund;
• where no benchmark is used in the prospectus, a statement to that effect with a short explanation of how an investor can assess the performance of the Authorised Fund;
• if past performance is indicated in the communication, to include in the communication the past performance record of the target or constraining benchmark(s) referred to in the prospectus (and no other indices unless they are referred to in the prospectus);
• if a communication includes information comparing past performance against one or more comparator benchmark(s), to include a comparison against the same comparator benchmark(s), and not include a comparison against any other(s) for a period of at least twelve months (save that this will not apply when a comparator benchmark is used in a communication exclusively in the course of a personal visit or call, or is made in response to a specific request by a client).

What are the new rules concerning performance fees?

The FCA rules (COLL 6.7.6AR) will require any performance fee specified in a prospectus to be calculated on the basis of the fund’s performance after deduction of all other payments out of the fund’s property.

When do the remedies take effect / come into force?

The FCA’s guidance on disclosing fund objectives and investment policies was effective as of 4 February 2019, and managers should be referring to this now.

In respect of the changes to the FCA rules concerning benchmarks these take effect as follows:

• for new Authorised Funds on 7 May 2019; and
• for existing Authorised Funds on 7 August 2019. As a result managers currently reviewing their prospectuses and / or key information documents, may find it helpful to make necessary changes ahead of that date.

The new rule in COLL concerning the performance fee disclosure will also come into force on 7 August 2019. Again, managers currently reviewing their prospectuses may find it helpful to make the change ahead of that date.

If you require further information about anything covered in this briefing note, please contact Grania Baird or Kya Fear, or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, April 2019