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General introduction to the regulatory framework
i The Financial Services and Markets Act 2000
The main framework for the regulation of asset management activities in the UK is contained in the Financial Services and Markets Act 2000 (FSMA) and various instruments introduced under the powers contained in the FSMA.
Regulated activities
The FSMA regulates the provision of financial services, including investment services, in the UK through the concept of regulated activities that may only be carried out by persons who hold appropriate authorisations or are otherwise able to take advantage of a specific exemption from the usual authorisation requirement. Regulated activities are specified activities set out in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (Regulated Activities Order) that are carried on by way of business in connection with certain specified investments also listed in the Regulated Activities Order. Specified investments include a wide range of financial products including shares, bonds, government securities, deposits, units in collective investment schemes (CISs) and contracts of insurance. The list of specified activities includes:
- dealing in investments as principal or agent;
- arranging deals in investments;
- managing investments;
- establishing, operating or winding up a CIS;
- managing an alternative investment fund (AIF);
- managing an undertaking for collective investment in transferable securities (UCITS) (see Section III.i); and
- advising on investments.
Many investment managers and certain investment fund vehicles in the UK will require FCA authorisation as they are likely to be carrying out regulated activities, such as advising clients on investments, managing investments or dealing in investments as an agent on their clients' behalf. It is a criminal offence, potentially punishable by up to two years in prison and a fine, for any person who is not authorised or exempt to carry out any regulated activity in the UK.
Financial promotion
The FSMA contains a basic prohibition on any person who is not appropriately authorised, acting in the course of business, from communicating an invitation or inducement to engage in investment activity. Investment activity for these purposes includes entering or offering to enter into an agreement, the making or performance of which by either party would be a regulated activity. However, this prohibition will not apply where an appropriately authorised person has approved the content of the proposed communication or if an exemption to the basic prohibition applies.
CISs
The concept of a CIS is a central part of the system of regulation of asset management vehicles in the UK. These are widely defined in the FSMA to include:
any arrangements with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements . . . to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income.
Participants in a CIS must not have day-to-day control over the management of the property. In addition, the relevant arrangements must involve the pooling of participants' contributions and the profits or income out of which payments are to be made to such participants, or the property must be managed as a whole by, or on behalf of, the operator of the scheme, or both. The potentially wide definition of a CIS included in the FSMA is narrowed by the Financial Services and Markets Act 2000 (Collective Investment Schemes) Order 2001 (Collective Investment Schemes Order), which excludes, among other arrangements, all bodies corporate (other than open-ended investment companies (OEICs) and limited liability partnerships), contracts of insurance, and occupational and personal pension schemes. A CIS need not have any particular legal form and, subject to the exemptions outlined above, the concept attaches to a wide range of legal vehicles and contractual arrangements.
If an arrangement is classified as a CIS, a number of important regulatory consequences follow. Units (i.e., rights or interests) in a CIS are a specified investment, and establishing, operating or winding up a CIS are specified activities under the FSMA that require FCA authorisation. The restrictions on financial promotion summarised above will also become relevant. Furthermore, Section 238 FSMA prohibits authorised persons from promoting or marketing unregulated CISs, such as unauthorised unit trusts (UUTs) and hedge funds, except in certain circ*mstances (e.g., where the promotion is made only to investment professionals). The promotion of unregulated CISs, together with certain close substitutes called non-mainstream pooled investments, is prohibited to the majority of retail investors.
ii FCA
The FCA is the conduct-of-business regulator for all authorised firms. It is also responsible for the prudential regulation of all firms not authorised by the Prudential Regulation Authority (PRA). PRA-authorised firms (being, broadly speaking, banks, insurance companies and certain systemically important investment firms) are dual-regulated by the PRA for prudential matters and the FCA in respect of conduct of business. Most investment managers and investment vehicles requiring authorisation are regulated solely by the FCA; however, those deemed to be of significant importance to the UK's wider financial system fall within the ambit of the PRA's supervision.
The FSMA confers a wide range of regulatory functions and powers on the FCA. The FCA's statutory objectives include:
- ensuring that relevant markets function well;
- protecting and enhancing the integrity of the UK financial system;
- promoting effective competition in the markets for regulated financial services in the interests of consumers; and
- securing an appropriate degree of protection for consumers.
Under the FSMA, the FCA has extensive rule and code-making powers; it is permitted to issue such rules that it considers necessary or expedient for the purpose of advancing one or more of its statutory objectives. The rules and guidance applicable to FCA-authorised firms are consolidated in the FCA Handbook, which includes high-level standards, conduct-of-business requirements, regulatory guides and specific specialist sourcebooks applicable to a wide range of asset management vehicles and arrangements. The content of the FCA Handbook is heavily influenced by EU legislation; for instance, the Markets in Financial Instruments Directive (MiFID), which sets out various organisational and conduct-of-business requirements that apply to authorised investment firms. The FCA substantially updated the FCA Handbook to reflect the MiFID II regime, which came into force in January 2018.
The FCA makes use of a number of supervisory tools in its oversight of the asset management industry, including thematic reviews and market studies, which involve investigations into key current or emerging risks relating to a specific issue or product. Notably, the FCA recently published the final report on its wide-ranging asset management market study in June 2017. The key findings of that study focused on price competition in a number of areas of the asset management industry, fund performance, how asset managers communicate their objectives to clients, and the role of investment consultants and other intermediaries in the asset management sector (see further details in Section V.vi, below).
In March 2017, the FCA published the final report on its Financial Advice Market Review (FAMR). The latter was launched jointly by HM Treasury and the FCA in August 2015 to explore the ways in which the government, industry and regulators could stimulate the development of a market that delivers affordable and accessible financial advice and guidance. The final report set out a series of recommendations intended to tackle barriers to consumers accessing advice and guidance. Those recommendations fall into three key areas: the affordability and accessibility of advice, liabilities of investment advisers and redress. As part of the implementation of those measures, the report recommended that the FCA and HM Treasury should work together to develop an appropriate baseline and indicators to monitor the development of the advisory market. The FCA published its baseline report in June 2017. It launched a call for input asking for feedback on its proposed approach to reviewing the outcomes of the FAMR in May 2019, with the publication of the review findings currently expected in autumn 2020.
Another key area of interest for the FCA over the past few years has been potential conflicts of interest between asset management firms and their clients, particularly in relation to the clarity of fund charges, inducements given or received by investment firms, and the way in which commissions charged to customers were spent. Prior to the implementation of MiFID II, the FCA had reformed its rules on the use of dealing commission to make clear that commissions should only be spent on the actual costs of executing customer orders, goods and services related to the execution of trades, or goods and services related to the provision of research. Under the new MiFID II inducements regime however, many asset managers are now prevented from charging clients for research on a bundled basis, and must either pay for the research directly from their own balance sheets or charge the costs back to clients via a special research payment account. The FCA has reviewed how asset managers are implementing these rules and how firms are pricing research and corporate access services. The review concluded that while most asset managers calculated transaction costs in accordance with the new rules, there are problems with the way some asset managers are calculating transaction costs and how they disclose them. Further, the FCA has been expanding its interest in innovation, big data, technology and competition. The FCA has set fintech as one of its cross-sector priorities, particularly noting that it is driving change in markets and encouraging innovations. The FCA has launched programmes to enable the development of fintech, for example, by providing assistance to firms using innovation to improve consumer outcomes through its Innovate programme. Firms can test the commercial and regulatory viability of their innovative concepts before investing in them in the FCA's regulatory 'sandbox'. In the context of asset management specifically, the FCA launched its Advice Unit to provide regulatory feedback to firms developing automated models to deliver lower-cost advice and guidance to consumers, and on 21 May 2018 published guidance in relation to automated investment services, and specifically its approach to the supervision of automated or 'robo' advice. In a review of the impact and effectiveness of its innovation programme, published in April 2019, the FCA noted that asset management was one of the sectors from which it had received comparatively low numbers of applications for the regulatory sandbox, despite proactive attempts to engage with the sector.
The FCA issued its first decision under competition law in February 2019, penalising three asset managers found to have shared strategic information in relation to initial public offerings and one placing. The FCA issued fines of £306,300 and £108,600 (one of the asset managers was given immunity under the competition leniency programme), and it was widely regarded as the start of a crackdown on information sharing in equity capital markets transactions. The FCA also recently published a package of measures to improve competition in the investment platforms market. The measures include provisions designed to allow consumers to switch platforms and remain in the same fund without having to sell their investments, together with restrictions on exit fees.
