HM Treasury Consultation: Reforming the Controllers Regime in part XII of FSMA 2000

The ‘controllers regime’ in Part XII of the Financial Services and Markets Act 2000 has long been criticised by the financial services industry as burdensome, costly and disproportionate. HM Treasury has published a consultation paper on reform of the controllers regime and is now inviting responses from the industry on the proposed changes.

Under the current regime, all persons (not just FSA authorised persons) must notify the FSA if:

• a step they are proposing to take would result in them acquiring control, or an additional kind of control, or increasing a relevant kind of control over a UK authorised person (section 178 FSMA);

• a step they are proposing to take would result in them ceasing to have control of a relevant kind, or reducing a relevant kind of control over a UK authorised person (section 190 FSMA); or

• they become aware that they have acquired control or an additional kind of control or increased or reduced or ceased to have control even without taking any such step.

Within three months of receiving such notification, the FSA must decide whether to approve the change in control, whether to attach conditions or whether to object. The person who acquires control must be fit and proper to do so and the interests of consumers must not be threatened by any change in control.

Section 179(2) sets out the cases in which control is considered to have been acquired, for example when 10% or more of the shares in a UK authorised person or its parent are held, or 10% of the voting power may be exercised.

Section 180 specifies that control is considered to be increased when the thresholds of 10%, 20%, 33% and 50% are surpassed or when a person becomes the parent undertaking of a UK authorised person. Section 181 specifies that control is reduced when the same thresholds are crossed downwards or when a person ceases to be a parent of a UK authorised person.

HM Treasury asked in February 2004 whether the FSMA controllers regime would merit further consideration. Six responses were received, from the Investment Management Association, the City of London Law Society, the Association of Private Client Investment Managers and Stockbrokers, the British Venture Capital Association, the Law Society Company Law Committee, and the Financial Services and Markets Legislation City Liaison Group. Issues identified included:

• the difficulty of managing time-critical takeover or investment decisions when the FSA has three months to approve or object to a proposed change of control;

• the enormous burden placed on fund managers in determining which firms they invest in are themselves controllers of authorised UK persons;

• the risk of depositaries, custodians and nominees inadvertently crossing thresholds when they only find out about clients’ investment decisions after the event;

• parent companies are required to aggregate the interests of their subsidiaries even if those subsidiaries have no beneficial interest in the shares or owe duties concerning the voting rights to independent third parties;

• where a company’s constitution contains pre-emption rights on transfer, every shareholder is regarded as being a controller even if they hold a minimal stake and would not otherwise be of any interest to the FSA

• venture capital funds set up as limited liability partnerships are required to notify the FSA of change of control issues affecting the limited partners even though the limited partners do not exercise voting power and are not involved in the running of the business.

i) A new simplified regime for ‘non-directive’ business sectors

The controllers regime implements requirements imposed by what HM Treasury calls in the consultation paper the ‘underlying EC directives’.

Certain business sectors are currently subject to the controllers regime when there is no requirement for them to be so in the underlying EC directives. These so-called non-directive business sectors include mortgage intermediaries, pre-paid funeral providers, occupational pension scheme firms, home reversion and home purchase plan providers and intermediaries, credit unions, some authorised professional firms, some commodity brokers and dealers, non-UCITS scheme operators, and some investment advisers, receivers and transmitters who do not hold client assets.

HM Treasury has already exercised its power to vary elements of the regime by implementing a single 20% notification threshold in relation to general insurance intermediaries. HM Treasury now proposes to extend this simplified regime to the non-directive business sectors listed above. The current partial exemption from the regime for authorised building societies would be replaced by the same sort of arrangement, while the complete exemption for friendly societies would be retained.

ii) Pre-notification rather than pre-approval for the lower thresholds

The underlying EC directives do not specifically require potential acquirers of control (or those increasing control) to secure pre-approval. They require pre-notification to the regulator, and allow for the regulator to prevent control being exercised when the regulator has objections.

HM Treasury proposes removing the need for explicit pre-approval at the 10% and 20% thresholds. Potential acquirers would pre-notify the FSA then proceed without having to wait for pre-approval. The potential acquirer has to assess for itself whether there are any grounds for objection from the FSA, as it bears the risk (and associated costs) that the FSA may object at a later stage and prevent control being exercised.

The current system of pre-approval would be retained at the 33% and 50% levels, although HM Treasury does invite responses on the possibility of having pre-notification across the board.

iii) Definition of controller

• Significant influence

The current definition of controller extends to cases where significant influence is held over the management of the parent undertaking of the authorised person, even if the parent undertaking is not actually able to control the authorised person. HM Treasury suggests specifying that the significant influence must relate to the authorised person. This would bring the definition into line with the underlying EC directives, including the EC Transparency Directive (which must be transposed into UK law by 20 January 2007).

• Voting power

The concept of being ‘entitled to exercise, or control the voting power’ would also be replaced with the simpler concept of ‘holding voting power’. The new definition of ‘voting power’ in the EC Transparency Directive captures cases where control over an authorised person is held both directly and indirectly. HM Treasury suggests that this new definition renders redundant the current concept of an ‘associate’ which has led to a disproportionately broad range of relationships being captured.

• Custodians, nominees, other bare trustees and voting by proxy

The new definition of controller would also reflect the relevant provisions of the EC Transparency Directive by exempting custodians and the ownership of shares held for the purpose of clearing and settling from the notification requirements of the controllers regime.

HM Treasury considers that it is unnecessary to include specific exemptions for nominees and other bare trustees in the light of the recent High Court case of Re Kilnoore (EWHC 1410, 2005), in which the court held that bare trustees and nominees are not to be regarded as being caught by provisions relating to those who exercise or control the exercise of voting power.

Voting by proxy is not intended to be caught by the regime either, but HM Treasury considers that the proposed changes to the wording of ‘holding voting power’ (at section 422 FSMA) should ensure that notifications are not needed in these circumstances, without requiring an explicit exemption.

iv) Unifying existing FSMA provisions

Sections 179 and 422 both contain overlapping provisions relating to when a person is considered to acquire control. HM Treasury proposes incorporating the provisions of section 422 by reference into section 179 so that there is a single definition of controller found within Part XII.

v) Trigger for notifying the FSA

HM Treasury suggests clarifying section 178 by changing the circumstances where the FSA must be notified from when a person ‘proposes to take a step’ to simply ‘proposes’ (to acquire, increase, reduce or cease to have control). The requirement to notify the FSA within fourteen days of becoming aware of the change of control should be changed to ‘first’ becoming aware of the change of control.

vi) Close links

Under paragraph 3 of Schedule 6 of FSMA, the FSA must be satisfied that if an authorised person has close links with another person, then those close links should not prevent the FSA’s effective supervision of the authorised person.

Industry has drawn comparisons between the controllers regime and the reporting requirements of the close links regime, and HM Treasury is inviting views on whether the close links regime should be simplified in line with the controllers regime.

Interested parties have until 14 June 2006 to respond to the consultation paper.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 19/04/2006.