FCA consults on fund manager regime overhaul

Quite some time after HM Treasury proposed significant changes to alternative fund manager regulation, it has produced draft legislation to make the changes and the FCA is now consulting on a new, updated and more proportionate prudential supervisory regime for alternative investment fund managers. The change is long overdue, as the UK framework currently in place largely stems from EU requirements, some of which were never popular. Now they are outdated anyway, and the UK has the opportunity to create a clearer and more proportionate regime.

What's the plan?

Broadly, there will now be three tiers of AIFM, and a graduated, more flexible application of FCA Rules. It follows the Government and regulators' strategy of providing the right degree of consumer protection and market integrity, while recognising that there are firms that do not present high levels of risk and therefore can benefit from less onerous regulation than higher risk ones.

Alongside the fundamental changes, the FCA is also continuing its drive to cut administrative burdens where it can.

The FCA is proposing its changes alongside the HMT consultation that will make the necessary legislative changes to allow the FCA to make rules to set the size thresholds and categories of AIFM, as well as taking account of changes the draft legislation also includes about the scope of the regime. Consequently also, the FCA will need to include within its rules appropriate provisions from the AIFMD Level 2 regulation that had been onshored into UK law following Brexit and which will be repealed.

AIFs and permissions

An AIF will still be defined as a collective investment undertaking that raises capital from multiple investors with a view to investing it in accordance with a defined investment policy. However, the law will clarify that:

• The capital raising can happen in the past, present or future;
• A defined investment policy does not have to be explicit in writing, but can be implicit; and
• That any firm managing an AIF that needs to be authorised as an AIFM will need the "managing an AIF" permission.

What are the tiers?

The tiers, which the FCA will have power to set, have changed since consultation and are now a lot higher.

Smaller AIFMs will be those with less than £750m NAV, and medium AIFMs between £750m and £5bn. Firms with £5bn and over NAV will be large AIFMs. So the leverage based metric has gone but the FCA still expects firms that use high levels of leverage to manage their risks appropriately, and it will be collecting data to check that they are doing so.

When calculating the size of a firm it should include all CIS and non-CIS AIFs and any residual CIS that aren't AIFs or UCITs. And there will be a 6 month period in which firms that go over a threshold will need to become compliant with additional requirements that apply to the new band. Firms won't need a VOP to move to the new band, but must tell the FCA, and must also tell the FCA if they choose to comply with rules for a higher band than the one in which they fall. It won't be possible to tell from the Register which band a firm falls in.

Another hangover from the EU regime is the AFMD restriction on, in its terminology, full-scope AIFMs, who may not carry on any business other than managing AIFs and related ancillary services. Now that this distinction will be gone, the FCA has to decide whether to apply it to any of the new tiers of AIFM. Its preference is to remove the restriction completely, as it feels it has had limited impact anyway, and there would be obvious issues if it applied it only to medium and large firms. It thinks it can address any risks using its principles-based, outcomes-focussed approach, but is seeking views on this.

What about residual CIS operators?

For residual CIS operators (that is, firms who operate collective investment schemes that are neither AIFs nor UCITS), things could get complicated. If HMT makes the clarifications it is proposing, some current residual CISs may become AIFs, and if their operators do not already have AIF manager permission, they will need to apply for it.

The FCA's current view is that arrangements that will still be residual CISs are likely to be vehicles like carried interest vehicles, single investor or joint venture arrangements, many of which are likely essentially to be administrative vehicles with no ongoing investment management activity. That being so, the FCA would look to impose proportionate rules to as not to impose unduly onerous requirements in situations which pose little risk.

What's happening to the AIFM registration regime?

HMT proposes to keep the current registration regime only for venture capital and social enterprise funds. This means that all other small AIFMs that can currently be registered with the FCA will need (unless totally exempt) instead to become authorised and do so before the planned implementation date of 2028 (after which HMT will also review the registration requirement for the remaining registered entities).

One of the consequences of the AIFMD was to bring internally-managed closed ended investment companies within the authorisation (if big enough) or registration (if under set thresholds) regime. The plan now is that those currently within the registration threshold should be entirely exempt, which those above threshold or externally managed must be authorised as AIFMs. These will include investment trusts, REITs and VCTs that are listed in the UK. Again, though, the FCA wants to apply a tailored approach suitable for these types of vehicle.

What's happening to the NPPR?

HMT plans to keep the National Private Placement Regime that allows AIFs to be marketed in the UK, with a few changes, and the FCA regime will adapt accordingly.

How will the FCA rules change?

The FCA will create a new sourcebook, the Alternative Investment Funds Sourcebook to be known as ALTS. Separately it is consulting on fund reporting for asset managers and on remunderation for solo-regulated firms.

Within the proposed new rules, the FCA is taking the opportunity to:

• Review and update its expectations for firms of all sized on valuation;
• Remove some of the current complexity from the leverage regime;
• Create a more proportionate risk management framework better tailored to firms' activities;
• Make targeted changes to the liquidity framework, resulting in simplified rules for small firms;
• Keep the delegation model, but simplify it;
• Set a common baseline for annual reports to investors, but less overall prescription;
• Overhaul the disclosure framework and make the distinction between the professional and retail disclosure regimes clearer;
• Review how best to regulated closed ended entities (bearing in mind many smaller internally managed entities will now fall within exemptions, if the HMT proposals are implemented).

The depository requirements will remain largely unchanged.

What happens next?

Consultation closes mainly on 14 October, but the FCA would like comments on a few of its discussion chapters, including on what do to about the business restriction, earlier.

Once it has considered all responses, it will consult on draft rules, and also on changes to the regimes for authorised AIFs, and then finally publish its policy statement and rules when HMT publishes the final legislation in 2027. After that, it plans to bring the regime into force in 2028 but will consider whether it can introduce some measures earlier, if it would ease the burden on firms. But it is also interested in knowing how much time they would need to implement different rules.