COVID-19 | The UK supervisory and regulatory response for investment managers

This blog was updated on 02 April to reflect additional announcements from the FCA.

This blog provides a round-up of the key regulatory initiatives and measures that the FCA and ESMA have taken on the investment management sector in response to COVID-19; it also identifies areas where supervisory scrutiny is likely to intensify in response to the crisis and identifies some areas where we think the regulators may contemplate further action as the crisis unfolds:

Fund liquidity - Certain funds are facing increasing difficulty in meeting investor redemptions. The funds facing the greatest challenges are those which are open-ended and offer daily liquidity but have inherently illiquid underlying assets (e.g. property, unquoted and smaller companies etc.) and have seen steep falls in market prices of their underlying assets. Such large market falls may mean these funds face heightened redemption related risks. Regulators were already focused on fund liquidity prior to the COVID-19 outbreak, and given these new risks the management of liquidity has become still more important for the sector, including by firms updating and revising their liquidity modelling and monitoring. The FCA has stated that it expects firms to manage their liquidity and financial resilience and has urged firms to report to it immediately if they consider they will face difficulties in these areas.

We expect that in the event of any possible fund suspension, the FCA will increasingly ask firms to provide comprehensive information to the fund depositaries, as it is they who must agree with the authorised fund manager should a fund require suspension (COLL 7.2). In addition, we expect that the FCA will step up its scrutiny of fund liquidity positions, particularly in relation to margin calls or from abnormal levels of failed trades.

Property fund gating – A number of property funds have gated their funds due to the material uncertainty around the value of their illiquid assets. This is in compliance with new FCA liquidity rules (PS 19/24) which are due to come into effect in September 2020, but on which firms are choosing to act now. The FCA put out a statement saying that if the funds cannot be valued fairly, suspensions are likely be in the best interests of investors.

Contingency plans - Firms have been rapidly adapting their operations and business continuity planning to cope with what in many cases have been unanticipated developments. The regulatory focus now will be on the effectiveness and sustainability of measures so far taken; whether unforeseen consequences are arising and, if so, how these are being met; and how business continuity plans are being further adapted in relation to possible scenarios that may emerge over the coming months.

Offsite working - The FCA has said that it has no objection to UK firms making use of backup sites or having staff working from home provided that firms are still able to meet regulatory standards. Particular challenges for firms in current circumstances include the ability to enter orders and transactions promptly into the relevant systems, using recorded lines when trading and with staff having access to sufficient compliance support.

Recording calls - While firms are expected to continue to make all efforts to record calls, the FCA accepts that there may be some circumstances where this is not possible. In such circumstances firms have been asked to notify the FCA that they are unable to meet these requirements. This will be relevant not only with respect to monitoring trading related calls, but also in relation to customer call centres or any other forms of direct customer telephone communication. The FCA expects firms to consider what steps they could take to mitigate outstanding risks if they are unable to comply with their obligations to record voice communications. This could include enhanced monitoring, or retrospective review once the situation has been resolved.

ESMA has noted that due to COVID-19, “some scenarios may emerge where, notwithstanding steps taken by the firm, the recording of relevant conversations may not be practicable.” ESMA said that firms should consider what alternative steps they could take to mitigate the risks related to the lack of recording. It has suggested that this could include the use of written minutes or notes of telephone conversations when providing services to clients, subject to prior information being provided to the client of the impossibility to record the call and that written minutes or notes of the call will be taken instead.

Market abuse - The FCA has emphasised its expectation that firms continue to comply with their Market Abuse obligations and to take all steps to prevent market abuse risks. This could include firms undertaking, inter alia, enhanced monitoring, or retrospective reviews. Where issuers have relevant significant information concerning the impact of COVID-19 on their fundamentals, prospects or financial situation, ESMA and the FCA expects them to make the appropriate disclosures as soon as possible in accordance with their transparency obligations under the Market Abuse Regulation.

Regulatory and transaction reporting - Firms may experience difficulties in submitting their regulatory data, in which case the FCA has said that it expects them to maintain appropriate records during this period and to submit the data as soon as possible. We recommend that if firms anticipate any problems in this regard, they should alert the FCA as soon as possible.

Financial disclosure – The FCA has announced temporary reporting relief for listed companies in respect of their corporate reporting obligations. This relief means that listed companies will have an additional two months in which to publish their audited financial statements. Currently, under the Transparency Directive, companies have 4 months from their financial year-end in which to publish audited financial statements, which means that companies will now have a total of six months in which to publish their statements.

ESMA has stated that issuers should provide transparency to the market on the actual and potential impacts of COVID-19 to the extent possible based on both a qualitative and quantitative assessment on their business activities, financial situation and economic performance. This can be done in their 2019 year-end financial report if these have not yet been finalised or otherwise in their financial reporting disclosures.

Short selling - There is no FCA ban on short selling so far, but some European countries have introduced bans, which the FCA has followed in respect of shares for which those European NCAs are responsible for. The FCA has said that the loss of the benefits of short selling "would need to be carefully balanced before determining that any intervention to prevent short selling was appropriate." The FCA is taking the view that banning short selling could reduce market liquidity and prevent firms from hedging their positions, and so reduce the effective functioning of markets.

ESMA has lowered the reporting threshold for short positions. It is now temporarily requiring the holders of net short positions in shares traded on an EU regulated market to notify the relevant NCA if the position reaches or exceeds 0.1% of the issued share capital. This precautionary measure, intended to protect financial stability and investors, does not apply to shares admitted to trading on a regulated market where the principal venue for the trading of the shares is located in a third country, market making or stabilisation activities.

Treating customers flexibly and fairly – The FCA has emphasised that it expects firms to provide strong support and services to customers during this period and that they must be clear and transparent in their communications.

It is encouraging firms to make use of any flexibility within its rules to support consumers, bearing in mind customers’ individual circumstances, and says that it welcomes firms taking initiatives that go beyond usual business practices. We recommend firms notify the FCA of any such initiatives to allow it to “consider the impacts and offer support as appropriate”. The regulator is likely to look harshly on any evidence of firms seeking to exploit the crisis for financial gain at the expense of their customers, a subject that is attracting rising political attention.

In the meantime, firms are still expected to deal with complaints promptly, within the usual 8-week deadline. Where the pandemic prevents this, the FCA has said that firms should contact it and write to the customer explaining why the deadline has not been met.

Best execution - Firms are expected to continue to meet Best Execution obligations, however the FCA has said that it will not take enforcement action where a firm:

• Does not publish RTS 27 by 1 April 2020, provided it is published no later than 30 June 2020.
• Does not publish RTS 28 and Article 65 (6) reports, provided they are published by 30 June 2020.

10% depreciation notifications - Where clients’ portfolios have seen a drop in value in excess of 10% firms have a regulatory obligation to inform them of this. However, given the ongoing market volatility the FCA has relaxed this requirement. The FCA has said that firms only need to notify clients once, rather than of repeated drops, provided they make available more general market updates on their websites or through social media and other public channels.

Anti-Money Laundering – While the FCA recognises that restrictions on non-essential travel have affected firms’ abilities to use traditional methods to verify customers’ identities, it has emphasised that firms must continue to comply with their AML obligations. However, the FCA notes that firms can be flexible and that the MLRs and Joint Money Laundering Steering Group’s existing guidance already provides for client identity verifications to be carried out remotely via a variety of different methods.

Regulatory Prioritisation

Both the PRA and FCA have taken steps to delay certain supervisory activities and deadlines in order to relieve pressure on firms and supervisors alike.  So far as the investment management sector is concerned, the following pieces of regulatory work have been delayed:

• The joint FCA and Bank of England survey into open ended funds has been postponed. The planned survey covering c.300 funds has been delayed until further notice, with a subsequent impact on the FCA consultation that would have followed.

The following FCA Consultation Papers and Calls for Input have had their deadlines for responses extended until 1st October 2020:

• CP 20/4 Quarterly Consultation No 27
• CP 19/32 Building operational resilience: Impact tolerances for important business services
• CP 20/3 Proposals to enhance climate-related disclosures by listed issuers and clarification of existing disclosure obligations
• CP 20/5 Consultation paper on ETF listing: Premium to Standard Listing
• Open Finance
• Accessing and using wholesale data