In a nutshell:

Yesterday, the FCA dropped yet another discussion paper (DP 23/2, the DP); this one announcing that the FCA has turned its mind to further changes that might be needed to the regime governing the UK's 2,600 asset managers. The context here is the forthcoming change in the UK's regulatory framework and the FCA's expanded remit that will flow from this and the eventual shift of firm-facing requirements from statute to regulatory rulebooks.

The DP does not provide any detailed recommendations for discussion, but flags at a high level possible directions of travel across a broad range of areas. It seeks input from a range of industry participants through a series of open-ended questions, noting "This feedback will help us decide what we should prioritise".

The FCA says it "will only reform the regulation of the sector where there are clear benefits from doing so" and commits to full public consultation on changes it takes forward. Further, it will seek to ensure that any changes:

  • better meet the needs of investors, both domestic and international, retail and professional;
  • enable technological development, innovation and 'better' use of data;
  • are consistent with standards and rules promulgated outside the UK's domestic environment; and
  • are effective, proportionate and represent simplification and standardisation where possible.

The FCA's focus in the DP is on conduct and the operation of managers. The DP does not, it says, directly focus on point-of-sale disclosure, prudential matters, 'cross cutting issues', money market funds, regulatory reporting or 'FCA processes'.

In a bit more detail:

We summarise below a few of the areas of possible change mentioned in the DP, some of which would represent a substantial change in the funds and asset management landscape.

Establishing a common framework for conduct rules across different asset management activities

The FCA recognises that asset managers often wear different hats: managers of authorised funds; managers of unauthorised funds; portfolio managers in relation to funds; and portfolio managers of other clients.

The rules governing conduct in these capacities derive from different sources (for example, MiFID for the portfolio managers and the AIFMD and / or UCITS for the fund managers). The FCA recognises that although there is significant convergence in the conduct rules in these different areas, there are often differences and that "sometimes the differences in the rules are mainly technical detail but seeking to achieve the same outcomes". It gives the example of the myriad of rules governing conflicts of interest.

The FCA also notes that there are differences of substance in how asset managers are regulated depending on the service they are providing. For example, the AIFMD rules on best execution have not been updated to match those flowing from MiFID II (unlike the UCITS rules, which were updated). The FCA also notes that rules around investment due diligence and liquidity management are absent in the portfolio management framework, despite featuring in the rulebooks on fund management.

It seems to us that some rationalisation and standardisation would make sense, but that this would need to be done selectively and carefully. Eliminating some of the purely 'technical' differences would make sense, but simply levelling up the portfolio management rules to meet those applicable to fund managers could have unintended consequences. The role of the manager of a fund, and the context in which that relationship plays out, is quite different to that of a portfolio manager for segregated clients – consequently, not all differences in the regime lend themselves to rationalisation.

Requiring portfolio managers to consider financial stability risks

Using the recent drama in liability driven investments (LDI) as context, the FCA considers whether there should be specific rules requiring portfolio managers, like their fund manager counterparts, to consider the risks they pose to financial stability. This could potentially include the manner in which they interact with unregulated service providers (again, using LDI as a backdrop, the FCA intimates that more could be done to govern how portfolio managers interact with investment consultants). We would point out here that the perceived issues in the LDI context were not confined to portfolio managers of segregated accounts. Indeed, some might argue that the perceived issues were more acute in the context of pooled funds i.e. the rules on considering financial stability risks were not the difference maker.

Treating the portfolio management of multiple individual retail portfolios as akin to fund management

The FCA identifies that some retail clients have their portfolios externally managed, possibly on a standardised basis with little scope for customisation. It says "developments in technology mean that it may be almost as efficient for an asset manager to manage multiple individual portfolios as to manage a fund". The FCA suggests that services such as this, where firms run multiple individual portfolios, may allow them to avoid the rules that apply to fund managers and that there is therefore a risk of harm. It has not been explicit in identifying the services in relation to which it is concerned, or what has sparked this concern. The FCA is considering driving consistency in the rules for individual portfolio management of this sort and fund management on the basis that "this type of service may be very similar in economic terms to the management of a fund". It is unclear what fund rules they have in mind to plug the perceived investor protection gap. Clearly not all of them will be appropriate.

Collapsing or reconfiguring the NURS-UCITS distinction

The FCA considers that "there might be benefits in having a regime, or a sub-category of the retail funds regime, that helps retail investors navigate it more effectively".

One approach being considered by the FCA is to remove the boundary dividing NURS from UCITS. In effect, this would mean that all authorised funds that could be widely distributed to deep retail would be subject to a single set of rules. At present, although both NURS and UCITS can be distributed widely to deep retail, they represent two distinct products distinguishable mainly by reference to the differences in the assets in which they are permitted to invest.

Another approach considered would be to "rebrand the NURS regime as UCITS plus". Mainstream retail products would be UCITS and more complex retail products would be 'UCITS plus'. It would need to be considered which existing NURS would fall under the UCITS regime and which would fall under the 'UCITS plus' regime, and if any changes would need to be made to those existing products.

The FCA also contemplates introducing a 'basic funds' category; funds that might, for example, be limited to investing in large liquid stocks and be restricted in the use of derivatives. This idea is not elaborated on in the DP in any detail but it appears that it may be a category of fund distinct from other retail funds as a means of helping retail investors distinguish the more complex end of the UCITS and NURS spectrum from the simpler end.

The FCA recognises the difficulties in reconfiguring the regime in any of these ways and seems sensitive to the impact it could have on markets and the conditioning of retail risk appetites (i.e. that some of these changes may inadvertently funnel investor flows into the simplest of products). It also recognises the dilutive impact the changes may have on the UCITS brand, which is an internationally recognised one.

It is unclear how these changes will speak to the conduct rules that would apply to the asset managers managing such products – will these be UCITS or AIFs? This may be moot if the conduct regimes are sufficiently rationalised.

Plugging gaps in the host AFM model

The FCA identifies that there have been issues in how host authorised fund manager (AFM) models have worked recently, noting that in their supervisory experience of host AFMs "they sometimes fall below appropriate standards". That said, it does not seem minded to diminish or eliminate such platforms; it sees the fundamental benefit in them. It notes, perhaps a little cryptically, that some of their concerns have "come about because of misunderstandings by some portfolio managers about the role of the AFM", and that solutions might be focused on ensuring that portfolio managers play a more central role where appropriate in this context. One option contemplated is to issue rules on the contractual provisions that should be in place between the AFM and portfolio managers to ensure this. Another option posited is that it be left to trade bodies to issue standards that might serve as a "guide for host AFMs". The FCA will also consider rules clarifying their expectations on portfolio managers in these host AFM scenarios (without, it makes clear, diluting the responsibilities of the AFM). One thing the FCA will need to note in this regard is that many portfolio manager 'users' of host AFM services are overseas portfolio managers.

More liquidity stress testing and (public) disclosure on liquidity

The FCA states that it plans to convert ESMAs guidelines on liquidity stress testing into FCA rules and guidance. It is also considering modifying the COLL rules (specifically, COLL 6.12.11R(2)) such that more managers will perform stress tests.

Further, the FCA notes that the conduct rules applicable to portfolio managers (in contrast to fund managers) do not have detailed rules on liquidity. It is considering levelling the rules up in this regard.

Finally, the FCA is contemplating enhanced reporting on liquidity to the FCA so that the data it gets on UCITS matches the reporting it gets for AIFs. Moreover, it is considering if there are benefits in public disclosure relating to the liquidity of investments. There is a complexity that underpins liquidity management and planning in a portfolio, especially in more complex portfolios, such that careful thought would need to be given to a public disclosure regime as to underlying liquidity. It is unclear what investors would be expected to do with such information in relation to funds; and we can see possible risks in relation to financial stability flowing from this unless such a disclosure regime is carefully managed.

Requiring investment due diligence to be performed in more situations

The FCA is contemplating setting out explicit regulatory expectations in relation to investment due diligence (over and above that which might be implied by existing conduct rules). Very little colour is given on what this might look like and what it is aiming to achieve that existing conduct rules do not already achieve. The main gap identified is in relation to portfolio management services as there are specific due diligence rules in the context of the management of AIFs, which are not replicated in the rules on portfolio management.

More clarity around use of anti-dilution mechanisms

The COLL rules contain provisions around use of anti-dilution mechanisms in an authorised fund context. Fund managers often use these when there are large net inflows into or outflows from a fund, as the costs associated with this in the underlying portfolio can reduce / dilute the value of the fund for existing shareholders. The FCA has observed firms using the existing rules in different ways and possibly in ways that can impact on the fairness of redemptions in a fund (e.g. by increasing the risk of first mover advantage). This can then, it says, have systemic impacts. The FCA therefore is considering clarifying its expectations about what factors a fund manager must consider when calculating a dilution adjustment.

More flexibility around eligible asset rules for funds, including on spread of risk

The FCA sees value in creating flexibility for managers dealing with circumstances outside their control to avoid, for example, forced selling. It appreciates however this may not be entirely compatible with a central pillar of the UCITS brand – the confidence with which retail investors might invest in these products. The FCA asks the open question of whether it should update or provide guidance on the eligible asset rules.

It has been suggested to the FCA that it removes hard quantitative spread limits in fund portfolios and that a more principles-based regime that allows for greater investment flexibility is substituted. The argument is that hard limits are overly constraining and also lead to inadvertent breaches that take time to deal with. Interestingly, the FCA does say that it is currently contemplating this, although it not "currently minded to remove quantitative restrictions". It asks about the loosening of specific restrictions.

It seems to us that the answers to the questions that the FCA poses in this regard tie closely into where it lands on its conceptualisation of retail funds in the future and the blurring of distinctions between NURS and UCITS and the introduction of a 'basic fund' label, for example.

Modernising fund operations

The FCA is considering "the role of technology in supporting better outcomes from authorised funds", specifically in relation to fund operations. In the FCA's view, these better outcomes include:

  • customers having a better understanding of how their investment is performing and whether it is meeting their needs;
  • customers being more engaged in the way their investment is run, with an improved ability to ask questions, express views and hold the fund manager to account; and
  • increases in efficiency that improve the customer proposition for the same costs, or enable fees to be reduced.

The FCA indicates that its policy objective is to "amend our fund rules to support technological changes that could modernise fund propositions". The FCA recognises that although regulation does not dictate exactly how technology might be used in fund operations, it is sometimes prescriptive about processes, which may deter firms from finding better solutions.

The FCA has been engaging with the Investment Association's (IA) working group to identify and analyse several different regulatory issues in introducing the 'Direct2Fund' direct dealing model which the IA proposed in March last year. Currently, units in authorised funds may only be bought and sold by the AFM on behalf of the fund and its investors. The Direct2Fund model would facilitate investors transacting directly with the relevant fund and remove the AFM as a counterpart to the investor deal. The IA has identified a few specific areas where the currently regulatory regime would need to be modified to accommodate such a dealing model. The FCA asks whether it should work towards consulting on rules to implement this model.

Fund tokenisation

Fund tokenisation is the ability to issue a fund's rights of participation (units or shares) to investors as digital tokens, usually by means of a distributed ledger. The FCA recognises that fund tokenisation could lead to "greater efficiency with resulting cost savings, and faster transactions, as well as eliminating potential administrative errors", and that existing rules are not flexible enough to allow firms to operate a digital register.

The FCA is already working on potential rule changes in this area, and asks for views on the benefits of fund tokenisation, what regulatory changes are required to make this happen and how much of a priority this is for market participants. The FCA considers that it is likely to be large intermediate unitholders – either institutions or retail platform providers – who may have most initial interest in this technology. In due course it envisages that at least some private retail investors would be able "to hold units directly this way", "once the technology has been properly trialled in the wholesale market".

Tokenisation of portfolio assets

In addition, the FCA also considers the possibility of tokenised portfolio assets, whereby funds could hold tokens representing underlying assets rather than holding such assets directly. Importantly, the FCA limits this discussion to cases where the underlying asset represented by a token is itself a permitted investment. The FCA's discussion of this topic is very brief, and it is not entirely clear on the mechanics of how some of this would operate – in particular, the relationship between asset ownership and the tokens is unclear and could require further consideration. However, there is a clear recognition of the improved liquidity and efficiencies which may result from the tokenisation of real estate and other real assets, such as infrastructure projects.

The FCA recognises that any rule changes in this area are dependent on cross-cutting regulatory issues such as the role of custodians and the FCA's regulatory perimeter. However, the FCA notes the potential benefit of such regulatory change specifically for managers of fund structures such as LTAFs (which require a careful balancing of investor liquidity demands against portfolios comprising a majority of illiquid assets). Where such funds are holding real estate or other real assets, holding and trading tokens representing these assets (or fractional entitlements thereof) may enable the fund to manage liquidity on an ongoing basis more efficiently than would otherwise be possible without sacrificing an illiquidity premium.

Ongoing information needs of investors

The FCA focusses in the DP on the fund prospectus and periodic reporting contained in managers' reports and accounts.

In relation to fund prospectuses, the FCA states that "prospectuses are generally written in legal, technical language, often including generic elements". Although there is an overarching obligation to include "any other material information which investors would reasonably require", the FCA suggests that current rules relating to the content of prospectuses do not reflect all of the disclosure elements which may be important to investors. In response to this, the FCA is considering a number of proposals, including: (i) reviewing and aligning prospectus content requirements to international best practice; (ii) giving sufficient prominence to elements which it is important for investors to understand; (iii) allowing incorporation by reference; (iv) making the prospectus more modular and accessible and requiring it to be stored on a central repository; (v) renaming the term 'prospectus' to make it easier for investors to understand; and (vi) requiring firms to use tagging, data, or other forms of machine-readable content so as to make prospectuses more useful to intermediaries comparing funds.

On managers' reports, the FCA states that the existing rules were drafted with paper-based investor communications in mind and may no longer be suited to new means of disseminating information. The FCA is considering a number of proposals to provide investors with more timely and well-presented information including: (i) using presentation techniques such as layering to make sure the essential elements are presented clearly and concisely, while allowing investors to access details if they wished; (ii) publishing reports in a machine-readable format, so they can be repackaged in a user-friendly way by aggregators of information and compared with other products; and (iii) requiring reports to be prominent and easily accessible on the managers' website or stored on a central repository. Finally, the FCA also asks for views on 'more radical' approaches to periodic reporting, referring specifically to the Financial Reporting Council's consultation paper from 2021, which suggested ways of modernising periodic reporting.

Improving investor engagement through technology

The FCA recognises that some existing regulatory requirements assume that investors are the registered unitholders in funds and interact directly with fund managers. These rules are therefore no longer fit for purpose as they do not recognise the crucial role played by intermediate unitholders such as platform service providers and wealth managers.

The FCA is considering making a number of changes in this regard, which it recognises may be better implemented as examples of best practice rather than being mandated by regulation. Some proposals include: (i) allowing virtual or hybrid meetings as a permanent arrangement (rather than the temporary forbearance measure during the Covid pandemic); (ii) enabling the use of technology to improve attendance and participation at investor meetings; (iii) providing greater visibility to fund managers as to the profile of the underlying investors in their funds; and (iv) enabling investors to exercise greater influence over issues such as a fund's strategy, its approach to ESG considerations, or its stewardship policy for engaging with the companies in which the fund invests.


The DP sets out a wide-ranging and ambitious scope for possible change in the regulation of fund and asset management in the UK. It is an important recognition that certain areas of the regime cannot stand still, particularly as technology has driven substantial change in the asset management industry in recent years and will continue to do so.

The FCA recognises that whilst a consolidation of the rules could significantly simplify regulation of the sector, it could also cause significant one-off costs and disruption for many firms and may also take significant policy-making time and resource. The FCA notes it may therefore not be appropriate for them to prioritise this work over other, more immediate, issuers affecting consumers and markets and any substantive changes to the rules may be introduced, following public consultation, with a lengthy timeline for implementation.

The FCA says that alongside the DP, they plan to "engage with a wide range of stakeholders in forums and roundtables as well as individual meetings". Responses to the DP are requested by 22 May 2023. The FCA will consider feedback and publish a feedback statement later in 2023.

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