Welcome to the first Ropes & Gray European regulatory podcast for asset managers. These fortnightly podcasts and accompanying speaker notes are intended to provide an overview of updates relevant to GCs, CCOs and other compliance professionals to help you navigate both COVID-19 and other developments relevant to your business. The speakers on today's podcast are Eve Ellis, a partner in our asset management group specialising in fund regulation, and Rosemarie Paul, a partner in our litigation & enforcement group who specialises in regulatory enforcement matters.
COVID-19 updates
Information security
On 6 May, the FCA provided guidance on its expectations on information security. While alternative ways of working may be needed to enable business continuity, the FCA still expects firms to prioritise information security and ensure that adequate controls are in place to manage cyber threats and respond to major incidents. Firms should look to implement enhanced monitoring to protect end points, information and firm critical processes, including network connections and video conferencing software.
Firms need to proactively manage the increased risk during this unprecedented period. This includes:
- being vigilant to the potential increase in security breaches or cyber attacks
- ensuring that they continue to have appropriate governance and oversight arrangements
- reviewing the impact of coronavirus on their information and systems security defences, and taking action as needed
- ensuring that the general notification requirements are followed, and significant operational/cyber incidents are reported
Financial crime systems and controls
The FCA has also provided updated guidance on its expectations around financial crime systems and controls. While the FCA does recognise that the current climate may give rise to operational challenges in relation to financial crime systems and controls, firms should not seek to address operational issues by changing their risk appetite. For example, firms should not change or switch-off, current transaction monitoring triggers/thresholds, or sanctions screening systems, for the sole purpose of reducing the number of alerts generated to address operational issues.
However, the FCA does recognise that, while continuing to operate within the legislative framework for anti-money laundering and counter terrorist financing, firms may need to re-prioritise or reasonably delay some activities. These could include ongoing customer due diligence reviews, or reviews of transaction monitoring alerts.
The FCA would consider such delays reasonable as long as:
- the firm does so on a risk basis (for example, reviews for high risk customers should not be delayed unless absolutely necessary)
- there is a clear plan to return to the business as usual review process as soon as reasonably possible
The challenges of detecting terrorist financing remain, and firms must not weaken their controls to detect such high-risk activity.
Where a firm is collecting information from an existing customer, Regulation 31 of the Money Laundering Regulations (MLRs) requires the account to be closed where the information is not provided. However, in the current situation, the regulator expects firms to make reasonable efforts to collect this information or consider whether there are other ways of being reasonably satisfied with the customer's identity, before taking a decision to close the account.
Where firms need to amend their controls in response to the current circumstances, decisions should be clearly risk assessed, documented and go through appropriate governance.
The FCA expects firms to notify it of any material issues that
are impacting the effectiveness of their financial crime controls
or causing significant delays to remediation plans.
In addition to the above, the importance of mitigating financial
crime risk was also highlighted by the Financial Action Task Force
in a report which highlighted that COVID-19 has created financial
vulnerabilities and suggesting that regulators must reinforce
cooperation across borders and with the business sector to mitigate
such risk.
From a practical perspective, it would be sensible to remind staff of their obligations under the relevant financial crime legislation (including reporting suspicious activities) and also monitoring compliance with MLRs in this remote environment.
FCA delayed work plan and regulatory change
The FCA has updated its webpage regarding delayed work plans and regulatory change as a result of COVID-19. Those which are relevant to listeners include a consultation on operational resilience (delayed to October), a discussion paper on MIFID II and prudential rules (delayed until Q2 this year) and a call for evidence on market data (delayed to 1 October).
Dear CEO letter to banks and ESMA statement on treating customers fairly
The FCA says that it has received credible reports of certain banks using their lending relationship to exert pressure on corporate clients in order to obtain roles on equity mandates that they may not otherwise have been appointed to.
The FCA has said that it wants any practice of this kind to "cease immediately", warning that it could be a breach of its rules and principles including those in relation to integrity, market conduct, acting in the best interest of clients and management of conflicts. Firms and individuals should also consider the requirements of the Senior Managers and Certification Regime, including the conduct rules.
The FCA notes that firms need to meet the requirements of the Market Abuse Regulation (MAR) in relation to the identification, handling and disclosure of inside information received in connection with the renegotiation of a corporate client's existing facilities, which may include details of a potential equity capital markets transaction. Depending on the circumstances, sharing such information within a lending bank could be inconsistent with the bank's obligations under MAR.
The regulator is clear that it will take action if evidence is found to support the concerns identified. Firms that are active in both equity and lending markets are asked to review their systems and controls to satisfy themselves that they are appropriate for ensuring the proper treatment of clients, identification and mitigation of conflicts of interest, and the handling of inside information.
The FCA plans to contact senior managers at firms who have had both a lending relationship and equity role with any issuers who have recently raised significant equity capital. Firms will have to satisfy the FCA that they ensured clients were treated fairly and inside information was handled in accordance with the rules - otherwise it seems highly likely that enforcement action will follow.
On a similar note, ESMA released a statement in relation to treating retail investors fairly. This follows the fact that some regulators have noticed a significant increase in retail clients' trading activity during the crisis. ESMA has highlighted the risks to retail investors when trading under these unprecedented market circumstances.
ESMA's view is that in these turbulent times, firms have greater duties when providing services and it has reminded firms of their obligation to act in accordance with the best interests of their clients and other relevant conduct of business rules. For example, relating to product governance, information disclosure, suitability and appropriateness.
As with the FCA Dear CEO letter, which is not directly relevant for asset managers, the ESMA statement is less relevant for those who provide services to institutional investors. However, they illustrate the approach the FCA and ESMA will take if they think a firm is taking advantage of the COVID-19 crisis and isn't treating clients fairly. The Dear CEO letter also reminds all firms of the importance the FCA places on complying with the Market Abuse Regulations irrespective of the current situation.
Non-COVID-19 updates
Market abuse
The FCA recently published its suspicious transaction and order reports (STORS) figures for the year ending December 2019. They make for interesting reading.
The STOR regime requires market participants to identify and report suspicions of potential market abuse to the FCA and are an important source of intelligence for the FCA.
2019 saw an increase in the number of reports of potential market abuse from 812 in 2018 to 822 in 2019, with the majority in relation to equity markets.
The 2019 figures also show the number of commodity and fixed income STORs have continued to rise. The FCA believes that this reflects steps taken by firms to improve their detection capabilities and firms are encouraged to continue developing surveillance capabilities in this area. The FCA considers that the overall quality of STORs continues to improve every year.
There has also been increase in the number of market observations submitted. The FCA Market Observation form was launched in 2019 and intended to address the issue that firms often want to submit information about market activity they have observed which is not necessarily appropriate as a STOR. Market observations provide the FCA with valuable intelligence and it encourages their submission where a STOR is not appropriate.
Firms should continue to take all steps to prevent market abuse risks. The FCA will continue to monitor for market abuse and, if necessary, take action.
Brexit
At the end of April, the FCA published a statement on the proposed use of the temporary transitional power (TTP) following the end of the transitional period. The FCA has confirmed that after the transition period, they will apply the TTP on a broad basis and to the same areas previously communicated. The relief will be granted from the end of the transition period until 31 March 2022.
The TPP means that generally regulatory obligations will remain the same until 31 March 2022 and that, UK regulated firms will not need to complete preparations to implement changes in UK law arising from the end of the transition period by December 2020.
There are some specific areas where the FCA has said it will not grant transitional relief and of relevance for asset managers are rules in relation to transaction reporting, short selling, EMIR reporting, securitizations, benchmarking, BRRD and credit ratings. In these areas, the FCA expects firms and other regulated entities to take reasonable steps to comply with the changes to their regulatory obligations by the end of the transition period.
It's worth bearing in mind, the TPP is separate to the temporary permission regime, TPR, which applies to incoming EEA firms.
In addition, there was a speech by the FCA's Executive Director of International which highlighted that the FCA continues to prepare for the end of the Brexit transition period and they are working closely with the Treasury and the Bank of England to do whatever they can within its remit to prepare for a range of scenarios, and ensure as smooth a transition as possible. However, the FCA reiterate that firms should continue to consider what actions they need to take to be ready for the end of the transition period. As such, whilst Brexit is less visible given COVID-19, it is important Brexit planning still continues.
Contact us
For more information on the topics we discussed or other topics of interest, please visit our website at www.ropesgray.com. Also, if Eve or Rosemarie can help you navigate any of these areas, please do not hesitate to contact either of us. You can also subscribe to this series wherever you regularly listen to podcasts, including on Apple, Google and Spotify.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
