Q4 2012 Investment Management Regulatory Update

Financial Services Act 2012 In December, following Royal Assent, the Financial Services Act 2012 was published and will now come into force on 1 April 2013. The Act:

abolishes the Financial Services Authority (FSA) and creates a new regulatory architecture consisting of the Financial Policy Committee, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA); gives the Bank of England responsibility for protecting and strengthening financial stability, bringing together macro and micro prudential regulation; and empowers authorities to look beyond 'tick-box' compliance while fostering a regulatory culture of judgement, expertise and proactive supervision. The Government will bring forward secondary legislation in 2013 in advance of the launch of the new regulatory authorities.

FSA's 'Dear CEO' letters to asset management firms FSA 'Dear CEO' letter: Conflicts of interest between asset managers and their customers On 9 November, the FSA published a 'Dear CEO' letter setting out the findings of its thematic review carried out between June 2011 and February 2012 on asset management firms' arrangements for managing conflicts of interest. The review highlighted the better practices observed in identifying and managing conflicts of interest, along with the key issues of concern which were observed.

A summary of key findings stated that a firm's culture is central in identifying potential conflicts of interest, with better practices including:

the consideration of whether new activities are likely to create new conflicts, whilst carrying out periodic reviews of operations to look for existing unidentified conflicts; better designed control frameworks for managing conflicts of interest which are the result of a synergy of efforts between both business line management and second line teams such as Legal or Compliance; and the monitoring and management of conflicts, which involves both the Business and Compliance, with boards receiving adequate management information and UK boards having committees dedicated to conflicts of interest. The thematic review also identified a number of issues in relation to:

The purchase of research and trade execution services on behalf of customers - only a few firms exercised the same control over payments for research and trade execution services on behalf of customers, as they would if the payment were being made from the firm's own resources. Further, firms did not regularly review whether services were eligible to be paid for using customers' commission. Managing gifts and entertainment - many firms set their gift and entertainment policies in line with market practices without any further considerations, and not taking the necessary steps to consider whether the value and frequency of gifts and entertainment were likely to give rise to conflicts. Ensuring that customers have equal access to all suitable investment opportunities - one firm delayed the allocation of trades for several hours, allowing fund managers to favour some customers over others. It was also demonstrated that not all cross trading was in the interest of both customers involved, with failure to document reasons for cross trading in some instances. Personal account dealing - it concluded most firms had satisfactory arrangements for managing conflicts of interest arising from employees' personal account dealing but the application to staff was inconsistent. Most firms also had clear arrangements for handling errors, but some were too reliant on contractual limitation to avoid reporting the cost of errors to customers. A number of section 166 skilled person reviews have been commissioned following the thematic review and enforcement action is being considered where more serious issues have been identified. Where an asset management firm has been directly contacted by the FSA, the board must consider the review and each firm's CEO must complete and return the required 'attestation' by 28 February 2013. All asset management firms must conduct an assessment of their conflicts management framework and may be required to submit an attestation to the FSA at a later stage. The FSA communicated that a second round of thematic visits on conflicts is being planned. The FSA has said that the attestations received will influence their selection of firms for the second round of visits.

FSA 'Dear CEO' letter: Review of outsourcing arrangements

On 11 December 2012, the FSA wrote a 'Dear CEO' letter to the CEOs of asset management firms regarding its review of outsourcing arrangements within the asset management sector.

Noting that the asset management industry outsources a growing number of activities to providers that are often part of complex international banking groups, the FSA expressed concern that UK asset managers would not be able to perform critical or important regulated activities in the event that an outsource provider faced financial difficulties or severe operational disruption. The FSA was concerned that those asset managers would not be able to function effectively and that this could lead to customer detriment. In particular, the FSA noted that some firms appear to rely on their outsource service providers being part of a large financial institution which would be rescued using public funds; this is inconsistent with the FSA's policy in relation to allowing organisations to fail and is not sufficiently prudent.

The FSA noted that it was "not confident that across the industry, effective recovery and resolution plans are in place for the asset management sector as a whole", stating that it was the responsibility of firms' Boards to ensure appropriate contingency plans were in place that would enable the firm to carry out regulated activity if a service provider fails.

The FSA asked that asset management firms review their current contingency plans, taking into account the observations in the letter. There is a general concern in the industry and from the regulator that there are not any credible plans to mitigate failure of administrators and there is a lack of clarity as to how best to approach this issue. The FSA has invited feedback on how it can achieve its aim of ensuring effective recovery and resolution plans are in place in the asset management industry and intends to host an industry event in early 2013 in order to facilitate an exchange of views.

FSA consultation papers and speeches FSA CP12/26: Regulatory reform - the PRA and FCA regimes for Approved Persons

On 3 October, the FSA published a consultation paper (CP12/26) prepared in consultation with the Bank of England seeking views and comments on the proposed amendments to the existing regulatory rules and guidance relating to approved persons following the introduction of the Financial Service Bill. The consultation also looks at the wider objective in creating two new rulebooks which will come in to effect when the FCA and the PRA acquire their legal powers.

The FSA has communicated that all investment management firms will be single-regulated by the FCA. Where a firm is single-regulated, the FCA will be responsible for all existing CFs which are currently specified by the FSA (excluding the actuarial controlled functions, CF12-12B which will apply only to dual regulated firms). However, where a firm is dual regulated it is proposed that the current list of controlled functions be split between the FCA and PRA, in order to avoid unnecessary duplication and to reduce any...