BCLP's 2020 funds update

In this briefing we set out an overview of some of the main developments and upcoming changes that we think will be of impact to fund managers, fund investors and to the funds sector as a whole.

The FCA takes a tough stance on key risks of harm posed by (i) asset managers; and (ii) alternative investment firms - as set out in its 20 January 2020 Dear CEO letters

These letters provide a regulatory barometer for managers on the issues where the FCA believes progress is required.  In particular, the Dear CEO letters should be seen by the asset management and alternative investment sectors as an indication of the areas of their business where the FCA will be focusing its attention and of where managers should be ready to engage with the FCA when requested. We would not expect any of the areas to cause surprise to the affected communities as they are all topics that the FCA has been looking at in the past year.  As a result, they should already form part of a firm's compliance workstreams - for instance, liquidity management; effective governance and implementation of SMCR; Libor transition; Brexit; retail investor exposure to alternative investment products and market abuse, integrity and disruption.

Although not expressed, these letters can be viewed in the context of three events: the high-profile collapse of Neil Woodford's investment empire, the liquidity difficulties experienced by many property funds following the Brexit vote in 2016, and the more recent real estate fund gatings in December 2019. The FCA has been heavily criticised from many quarters for its lack of foresight and oversight on each of these occasions. This stock-taking exercise is here to remind fund managers of their own duties but also provides an important insight into FCA priorities.

Liquidity management in open-ended funds investing in illiquid assets

Liquidity management in funds remains a hot topic in 2020. The FCA's rules and guidance in its September 2019 Policy Statement include a new fund classification, "Funds investing in illiquid assets (FIIA)", new rules on suspension, on liquidity management, risk warnings and other disclosures. Although not in force until 30 September 2020, the FCA is encouraging authorised fund managers (AFMs) and depositaries to consider adopting some of the measures earlier (eg increased disclosure and improved liquidity management) where it would be in customers' interests and the changes do not conflict with existing rules. The Bank of England and the FCA are still exploring this area: the December 2019 Financial Stability Report sets out an initial blueprint which would impact liquidity management and monitoring, redemption and fund pricing and mechanics.

As well as the liquidity management, stress testing and related risk and disclosure requirements that a firm may be subject to (whether by virtue of being an AFM, alternative investment fund manager (AIFM) or investment firm), they must also be on top of the impact of other initiatives and best practices at both the pre and post fund launch stages. For example, they should look to Iosco's recommendations on fund liquidity and Esma's guidance on liquidity stress testing in alternative investment funds (AIFs) and Ucits.

Discontinuation of Libor - asset managers need to increase preparations for the disappearance of Libor at the end of 2021 and to transition out of Libor instruments

In January the FCA and PRA issued a joint letter to senior managers responsible for implementing Libor transition plans, emphasising their intention "that sterling Libor will cease to exist after the end of 2021." Both entities support a Working Group on Sterling Risk Free Reference Rates, which has set a number of targets for the key transition year of 2020, including a further shift from Libor to Sonia in derivative markets, ceasing issuance of sterling Libor-based cash products maturing beyond 2021 by end-Q3 2020 and significantly reducing the stock of Libor referencing contracts by Q1 2021. Additional FCA and PRA supervision of firms will aim to assess whether enough progress has been made by mid-2020, or whether additional supervisory measures should be implemented. Firms will need to continue to consider legacy contracts that are already in existence and are expected to continue beyond 2021, any amendments or alternative solutions (ie to convert the contract to reference an alternative risk-free rate), any consents that may be needed and the potential for any mismatch with any hedging contract.

AIFMD - removing barriers to cross-border distribution of investment funds

Of particular interest in the legislative package which applies from August 2021 are the new rules on "pre-marketing", which mean that managers will be able to have initial discussions with prospective investors in common across the EU and test the market before documents are finalised, and without having had to fully commit to a particular regulatory marketing strategy. Although the provisions apply to EU AIFMs only, a reference to the harmonised rules not disadvantaging EU AIFMs over non-EU AIFMs may mean that local regulators (national competent authorities or NCAs) apply this new approach across the board.

EU AIFMs can carry out "pre-marketing" activities in relation to AIFs pre-launch, or for established AIFs that are not yet notified for marketing in the member state where the investor is domiciled or has its registered office. To qualify, pre-marketing must not amount to an offer or placement (no subscription documents can be available, whether draft or final form) and for funds pre-launch, only draft fund and offering documents can be in circulation. In practice, this means marketing teaser documents and draft offering and fund documents can be used at this early stage, provided it is clear that they are subject to change and do not constitute an offer or invitation to subscribe. New operational compliance rules apply (eg notification requirements).

This legislative package also contain provisions relating to reverse solicitation, marketing communications, retail investors, ceasing marketing and fees and charges that can be levied by NCAs. A couple of additional points of note:

• The AIFM will be deemed to  be "marketing" (and therefore, for an EU AIFM, need to have a marketing passport) where an EU professional investor subscribes to an AIF within 18 months of starting to pre-market, where that AIF was referred to or established as a result of such pre-marketing. This rules out reliance on reverse solicitation (where an investor approaches the manager on its own initiative and therefore the manager has not engaged in marketing) in these circumstances.
• Following de-registration of an AIFM to market in a member state, that AIFM cannot engage in "pre-marketing" for a 3 year period, in relation either to the EU AIF(s) referred to in the notification or in respect of similar investment strategies or ideas. Although this reduces compliance costs and reporting, it may curtail an AIFM's future ability to pre-market a similar investment strategy in that jurisdiction.

In addition, from 1 April 2020 depositaries will be subject to new obligations regarding clear identification and traceability of assets belonging to a particular AIF, including a requirement for asset segregation at the delegate level where a depositary has delegated the safe-keeping functions.

Chris Ormond, Kate Binedell and Matthew Baker, are lawyers at BCLP