Funds Legal Update
Published on 14th Feb 2022
Welcome to our latest Funds Legal Update.
We look at recent developments in the UK of interest to the investment funds sector, from the government's "levelling up" white paper and the Financial Conduct Authority's (FCA) consultation on strengthening financial promotion rules for high-risk investments, including many types of investment fund, to the latest FCA guidance on appointing money-laundering reporting officers (MLROs) and heads of compliance.
Turning to Europe, the European Commission is proposing to include the Cayman Islands on the EU list of high-risk countries from an anti-money laundering (AML) and counter-terrorist financing (CTF) perspective, which could potentially create issues for third-country managers down the line. In the environmental, social and governance (ESG) space, the European Commission has confirmed the EU taxonomy framework will cover gas and nuclear energy, meaning they will be included as activities that contribute to environmental objectives under the EU Taxonomy Regulation. This proposal has proved controversial in many quarters.
Government unveils 'levelling up' plan
On 2 February 2022, the government published its white paper on "Levelling Up the United Kingdom". The paper discusses "unlocking institutional investment" and, in particular, flags proposed changes impacting local government pension schemes, which have total investments of over £330 billion with only a small amount currently allocated to local projects. The government intends to work with local government pension funds to publish plans for increasing local investment, including setting an "ambition" of up to 5% of assets being invested in projects which support local areas.
The government is generally aiming to remove obstacles and costs to making long-term illiquid investments accessible for more investors; for example, as we mentioned back in our December 2021 issue, consulting on changes to the regulatory charge cap for defined contribution pension schemes to ensure savers can benefit from access to potentially higher-return investments. The Department for Work and Pensions consultation on this closed in January 2022, and a response is due in the coming months.
FCA consultation paper on strengthening financial promotion rules for high-risk investments and firms approving financial promotions
On 19 January 2022, the FCA published a consultation paper (CP22/2) on strengthening its financial promotion rules for high-risk investments and firms approving financial promotions. Comments can be made until 23 March 2022.
The proposals primarily relate to financial promotions of high-risk investments, and this category includes interests in unregulated collective investment schemes. The category will also cover qualifying cryptoassets once they are brought within scope of the financial promotions regime (further to HM Treasury's recent consultation response). The FCA will consult on potential changes to the distribution rules for long-term asset funds later in 2022.
The proposals cover the following areas:
- classification of high-risk investments;
- the consumer journey for high-risk investments;
- strengthening the role of firms approving and communicating financial promotions; and
- applying the financial promotion rules to qualifying cryptoassets.
The FCA intends to finalise the rules this summer, with firms being given three months from publication of the final rules to comply with the new requirements for the consumer journey and section 21 approvers. The cryptoasset promotion requirements will apply from the date qualifying cryptoassets are brought into the scope of the financial promotion regime.
New FCA webpage on competency of heads of compliance and MLRO applicants
On 28 February 2022, the FCA published a webpage aimed at helping firms decide if a candidate for head of compliance or MLRO is competent and capable of taking on the role effectively. The guidance covers factors including the following:
- Training: Before applying for FCA approval, most successful applicants will have completed training courses that are recent, up to date, relevant to the business they work in, and sufficiently detailed/in depth for the role.
- Experience: Applicants do not need to have had head of compliance and MLRO positions before; they may have had more junior compliance roles, for example, compliance manager or deputy MLRO. Previously holding the same/similar approved positions is a good indication someone may be suitable, but the person will not be approved automatically.
- External compliance support: Firms may get compliance support from outside advisors (for example, lawyers or compliance consultants) to help with applications and/or the ongoing running of their compliance function. However, firms tend not to be successful where external support is their only compliance resource. Third-party support is unlikely to mitigate any concern regarding the competency of a firm's head of compliance or MLRO candidate.
- Time commitment: Smaller firms may put forward an individual who will perform the role part-time, and the FCA has accepted this in some cases. However, the time commitment to the role must be proportionate and sufficient. Applicants who plan to spend only a few hours a week on the role or who are not senior leaders within the business tend to be unsuccessful. If the proposed head of compliance or MLRO has another role within the firm or externally, the FCA will look at whether there are any conflicts of interest.
Even if an applicant thinks they have enough experience or training, the FCA may still ask for an interview and consider the applicant's response to questions asked during the application process.
EU proposes to include Cayman Islands on list of high-risk countries for AML purposes
On 7 January 2022, the European Commission adopted a Delegated Regulation that amends the list of high-risk third countries with strategic AML and CTF deficiencies produced under the EU Fourth Money Laundering Directive (MLD4). One of the proposed changes is adding the Cayman Islands to the list, as well as removing Mauritius.
By way of background, last year the Financial Action Task Force (FATF), the international AML watchdog, added the Cayman Islands to its list of jurisdictions under increased monitoring, often called the "grey list" (February 2021). It is important to note this is not the same as the list of high-risk jurisdictions known as the "black list".
In terms of AIFMD marketing, the Commission's proposals around the Cayman Islands have no impact at present. However, if proposals for "AIFMD II" are implemented in their current form in future, and the Cayman Islands is still on the EU AML list at the time, this would restrict managers from marketing Cayman funds via national private placement regimes.
Unlike FATF, the EU currently has only one AML list. However, reforms to the EU AML framework are also afoot, including the creation of two separate EU AML lists modelled on the FATF lists – this could further change the picture.
Commission approves rules including gas and nuclear activities in the EU Taxonomy framework
On 2 February 2022, the Commission reached political agreement and approved in principle a Complementary Climate Delegated Act setting out the conditions for including nuclear and natural gas energy activities in the list of economic activities under the EU Taxonomy Regulation. The conditions include:
- that they contribute to the transition to climate neutrality;
- for nuclear power, that it meets relevant safety requirements; and
- for natural gas, that it contributes to the transition from coal to renewables.
The Act also amends rules supplementing Article 8 of the EU Taxonomy Regulation to require large listed non-financial and financial companies to disclose the proportion of their activities linked to gas and nuclear energy.
If the European Parliament and the Council of the EU do not exercise their veto right, the Act will apply from 1 January 2023.
This follows an earlier press release about this development, which remains controversial. For example, the EU Platform on Sustainable Finance published a response (24 January 2022) which recommended not considering activities relating to new and existing nuclear energy facilities aligned with the Taxonomy Regulation, on the grounds they do not fulfil the "do no significant harm" principle.