The new SEC Private Fund Adviser rules are causing concern, with the primary focus on imminent disclosure requirements. So far the format is not defined, and there is reluctance to be an early adopter and therefore the first to put information out there. The rules will also require a huge amount of interaction with administrators who are not geared up for the change – all the reporting will have to come from the administrators and include expense reporting, AUM reporting, line by line breakdowns…

Lead time, resourcing and significant extra cost are all a worry. It is not apparent who will cover this, especially bearing in mind the comments in the rule about transparency of costs to funds. These are just the practical issues before the impact on the funds is even considered. It Is a Pandora’s box! Many are talking to US counsel about this on a regular basis. The disclosure requirement is set in stone and everyone will get there over time but it will be painful.

The fair treatment investment rules are a thorny area – many have always approached this in the spirit of the rule but it is accepted that the bigger investor gets better treatment, for example fee breaks. The rules around materially similar asset pools are not clear at all. If all a firm’s structures are materially similar does that mean all fees must be the same across them? Firms need a lot more guidance quickly and it is not forthcoming. The fact that the industry is suing the SEC (via the MFA) does not improve the flow of information from the regulator.

A takeaway is that while the industry may win a battle through the lawsuit, it will still probably lose the war. With the election in the US imminent, there is potential for this shift to be codified into federal legislation, which is a scary prospect for the private funds sector.

The extent to which expense disclosure is included in a prospectus may drive a line-by-line examination rather than using a generic approach to expenses (for example, directors’ travel has to be specific now). Adding to the complexity, there is no prescribed format. Many US firms are in fact collaborating and coordinating advice on this huge problem, which itself is without precedent.

Payment for research under MiFID II

There was a move to extend this through no action letters, but it never happened and so the ability to pay US broker-dealers for research under soft commission agreements expired in July. There has also been a bid to revert to old arrangements in the UK since Brexit. Banks want to re-bundle but voices in the roundtable suggested the regulator will try to make this very tough to revive by pointing to the obvious conflicts (best ex and IPO preference, for example).

The cost of execution and research have both gone down dramatically since soft commission funding of research was banned in Europe, but so has the quality of the research. The banks want to put quality research back out but want to be paid for it. Investors also want quality research but convincing the regulator might be the stumbling block here.

Before the regulation there was an avalanche of low-quality research that was being churned out by junior analysts and was rarely consumed. Most best ex committees concluded that the firms were now paying a lot less for research and that it was more meaningful. Fund managers have been discerning when they are faced with the reality that they have to pay for the research – they can pick the three they value rather than the 30 they took before the change.   

SFDR compliance and enforcement

Discussion touched on Article 8 funds and the move towards their use to encourage investment in ‘so-called’ green and ESG-related investment. This has proven hard to document consistently. The EU led on this and two new regimes have followed for the US and UK. The US has just focused on names and labels. But It is still such a volatile area.

Some firms were behind the move to Article 8 from Article 6 on the basis that this was what the investors wanted. The names were also an issue but now the Central Bank of Ireland is pushing back on this. Many firms are now retreating as they are struggling with the reporting requirements.

The Article 8 route is still popular but it has many potholes – there is a fundamental misunderstanding of what the regulations require and much of the drive is to satisfy investors as fast as possible. Some fund managers seem to think the fact that they choose their stocks using ESG principles is compliant. There is so much more that is required now – just being in the spirit of an Article 8 fund won’t fly.

ESG mandates mean that some fund managers are desperately trying to find investments just to access the funds put aside for ESG investment. The Nordics have been doing this well for some time but they are extremely strict. The investment restrictions are incredibly narrow and tight, and once the fund manager realizes that they cannot invest how they want, they usually back off and don’t want to get involved.

UK FCA review of value assessments

The review was released in August and attendees debated whether a non-UK fund passported into the UK has to do a full assessment of value (AOV). If a fund is using a UK administrator, it would want to see a full AOV. This is very relevant for Lux and Irish funds and the debate suggested that while they are technically out of scope, there was still a push to show how they provide value for money. The current tick-box document that asks if the fund provides value for money, and that it complies, has a valueless set of questions with no analysis or methodology on how the firm has come to those answers.

Participants found it hard to fathom what the FCA is going to expect from overseas fund managers – some distributors have requested an extensive value report that will be costly to create. Some overseas fund groups are holding back on committing to this and have done internal analysis on value assessment but have not released it formally yet. Vanguard and Blackrock have produced something to cover the seven prescriptive pillars but those in the discussion dismissed these as too fluffy, bordering on marketing releases. 

Some of the platforms are now taking funds off where no value assessment has been provided or placing an asterisk against those where no AOV has been provided. Others are doing their own analysis of whether a fund provides value for money, to compare a fund to another in this respect. It is a combination of product governance and consumer duty. Some firms might be using this as a convenient excuse to close funds that have reached a certain size and type of performance that makes it viable now to shut them down. ESMA says that the spirit of this is to identify outliers and many firms are looking for regulatory guidance on what fair value actually means.

The UK FCA went to five big firms (so as not to disturb the whole market) and estimated that they were making 31% margin and was then very clear in saying it does not want firms making that much. The FCA does not like a percentage fee basis – it is viewed as a rip-off. This might be more than an outlier hunt, perhaps regulators want to change the way firms charge completely. They are asking everyone to justify fees – and this must come from bottom up and does not include a percentage fee basis.

Operational resilience

One firm was approached recently by UK FCA as part of a thematic review on operational resilience. The regulator wanted an update on progress towards compliance during this transition period (by March ‘25) and the firm sent a set of questions. No response had yet come from the FCA and there is no news on how information will be communicated to the rest of the market.

Other firms were approached in a similar vein in Dec 2022. For now the FCA is wanting to see the self-assessment document and there is an interest in governance to see if boards are signing off the self-assessment and when.

How boards engage with big topics like this is of interest to the FCA, as well as Consumer Duty. One firm has a working group (it meets weekly and has a plan) and a roadmap that is quite robust, and was using a third party to complete a mapping exercise to bring sophistication. March 2025 will be here in no time and their analysis may yet reveal a vulnerability that needs focus and investment which would take time to implement.

There are some related topics and pieces of regulation but none of them are as overarching as operational resilience and there are different requirements in each investment region now (eg DORA for Lux for ‘25).

Recordkeeping and enforcement

The Ofgem enforcement of Morgan Stanley in the UK was interesting as it stemmed more from a breach of internal policies than the use of personal devices. This was a case of out-of-date policies not being adapted to a change in practice at the firm. Everyone agreed that this is an issue that is not going away and that it requires all to revise their recordkeeping policies to ensure they are clear and up-to-date.

Many are setting their own standards for now on this. People are using WhatsApp and it is hard to stop this, so some firms have adapted their policy to allow its use for logistical arrangements and contact. The division between business-purpose contact and administrative logistics is one that might be acceptable to regulators.

One firm had done a survey on use and purpose of social messaging and it was clear that Messenger, Telegram and WhatsApp are widely used, but usually on a social basis rather than for business. It is vital that everyone is trained on the need to shift any business communication to a business channel at the right moment.

Other firms had experienced trouble related to social media after starting to use LinkedIn (LI) for business purposes. The plan was that this would allow for distribution of thought leadership, official documents and other brand promotion, and that any business communication then had to be moved to a captured business channel.

In one instance an investor could only be contacted via LI and the individual wanted to send a marketing deck and contact information via the platform. It was viewed as an error and a breach that could be excused but it is evidence that people will use whatever means they can to communicate. Policies need to be in place to address a pretty wide range of risks.

Odey fallout

A reputable lawyer (Leonard Ng – a partner at Sidley) was talking about a case related to an IFA who had been convicted of offences with minors and he had argued that this should not affect him being able to do a good job as an IFA. The reason the FCA deemed him unsuitable to be an approved person was due to him telling lies on a form about the prosecution. But if he had not lied on the form, the FCA had suggested he could have carried on as an approved person as his role as an IFA did not involve him being in contact with minors.

The FCA has intimated that since the Odey scandal, it would never take that line again.

Firms are trying to be more open and helpful with regulatory references in this environment. Some adopt a policy where this approach is disclosed in any settlement agreement. This helps any firm that is taking on a previous employee where there have been conduct issues at the firm they worked at before.

The question arose as to what the regulator would expect of members of the management committee who were all sacked by Odey when they confronted him about his conduct. Is there an obligation to whistleblow? All concluded that governance can be particularly challenging in firms where the power is concentrated among one or a limited number of partners.