Capital Markets Newsletter - October 2024

Welcome to the latest edition of our compliance newsletter for capital markets firms, including wholesale buy and sell-side firms, wealth managers and corporate finance firms. We are now emerging from the traditionally quiet summer season for regulatory developments – extended this year by the UK General Election campaign. However, the remainder of 2024 will be interesting for at least a couple of reasons:

First, the series of regulatory initiatives known as the Edinburgh reforms that were already in play under the Conservative administration appear (thus far) to be unaffected by the change of regime in July. Talking of which, read our analysis of the political backdrop to regulatory reform in Financial regulation under Labour: 5 themes to watch, which was published just after the General Election result.

Second, this year’s other major political event: the US presidential election in November. Here the narrative has undergone a sizeable shift in the past couple of months. What was turning into a one-horse race has been transformed by the withdrawal of Joe Biden’s candidacy, and the consequent electrifying of the Democratic campaign under Kamala Harris. Whatever one thinks of the likely impact of a second Trump administration (both domestically and on global geopolitics), it is undeniable that he would look to reverse some the more intrusive regulatory reforms introduced under current SEC Chair, Gary Gensler. At the time of writing, the election result is too close to call.

Elsewhere in this edition, we look at one of the individual components of the Edinburgh reforms, research payment optionality; developments in Consumer Duty one year on from its introduction; the new criminal background check requirement for owners and controllers; updates in market abuse and whistleblowing; and a note on the relevance of the EU’s new AML regime. From the US, we look at two enforcement cases both of which (in different ways) are highly relevant to UK firms.

Recently, Consumer Duty has highlighted the importance of treating vulnerable customers fairly and appropriately, as it is woven throughout the Duty's framework. Currently, the FCA is conducting a review of how firms manage their vulnerable customers, with findings expected to be published later this year. In anticipation of the publication of the FCA’s findings, we thought it would be helpful to host a webinar for regulated firms to learn about what makes a vulnerable customer, and why the FCA is concerned about such customers. This webinar will also provide practical guidance firms can take on board on how to manage their regulatory expectations. Click below to register.

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UK to change tax treatment of carried interest?

First, a significant point of uncertainty affecting the private markets sector: the Labour party made a manifesto commitment in the run up to the General Election to reform the current tax treatment of carried interest. This refers to the share of profits realised from a private equity or venture capital funds’ investments that is paid to individual fund managers. The new administration immediately published a Call for Evidence on the Tax Treatment of Carried Interest , promising to engage extensively with interested parties in the coming weeks.

The Call for Evidence invites feedback on three main issues:

1. How can the tax treatment of carried interest most appropriately reflect its economic characteristics? The government notes that there are a range of circumstances in which carried interest is received, and that the characteristics of the reward will not be the same in all cases.
2. What are the different structures and market practices with respect to carried interest? The government is particularly interested to understand how these differences should be taken into account as part of its reforms.
3. Are there lessons that can be learned from approaches taken in other countries? While many other countries have specific regimes for the taxation of carried interest, their detail and conditions for access vary.

The consultation period closed on 30 August, and a further announcement is expected in Chancellor Reeves first Budget statement on 30 October.

FCA confirms new rules for payment optionality for investment research

The FCA has published its final rules on introducing a third option for investment managers to purchase research services through joint research and execution payments. These largely confirm the so-called “guardrails” for this new approach announced in CP24/7, itself a product of the Investment Research Review set up by the Treasury in March 2023. The new rules came into effect from 1 August .

It is important to note that the joint payment option currently only applies to MiFID investment firms, and not for AIFMs and UCITS Mancos. The Policy Statement notes that the FCA will consult on an equivalent option for these categories of firms later in 2024.

To read the full article click here.

The Consumer Duty one year on

The Consumer Duty, which came into force on 31 July 2023 and for closed products and services one year later, was always as much a holistic philosophy for firms in their treatment of retail customers, as it was a set of prescriptive rules and guidance.

Firms subject to the Duty were required to make their first Board Reports on the subject by the end of July and will have to continue doing so annually. Jennifer Cahill looked at some of the common mistakes firms make in this important aspect of their governance, some of which have been already identified by the FCA.

Identifying and supporting vulnerable customers is another key requirement of the Consumer Duty and again Jennifer Cahill has looked at ways in which firms should seek to do this.

In September, the FCA published examples of good and bad practice in Consumer Duty price and value outcomes following a review of firms’ fair value assessment frameworks.

FCA Review of retail conduct requirements

In a move that hints at some of the contradictions inherent in trying to reform the UK regulatory systems, the FCA launched a Review of retail conduct requirements following introduction of Consumer Duty in July. Just as the final phase of the Consumer Duty for closed products and services came into force, the FCA has launched a ‘Call for Input’ on simplifying its retail conduct rules and guidance.

The FCA states that it wants to address areas of complexity, duplication, confusion, or over-prescription, which create regulatory costs with limited or no consumer benefit. Although primarily focused on retail conduct rules, views are also invited on the wider regulatory regime in the UK. However, the FCA notes that it is still committed to a separate post-implementation review of the Consumer Duty, so comments and suggested changes to the Duty should not be made in the Call for Input.

Time will tell whether anything of substance comes out of this Review, but clearly the FCA wants to be seen to be in lockstep with the new UK Government’s emphasis on economic growth. However, some observers will see it as ironic that the FCA wishes to steer around criticism of the Consumer Duty in this Review, when this has been viewed by some as a primary example of unnecessary complexity and regulatory burden.

Criminal background checks on owners and controllers of FCA regulated firms

As is often the case, the FCA’s CP24/11: Quarterly Consultation No 44 contained a significant reform measure, namely criminal background checks on owners and controllers. This new requirement will apply both to new authorisations and change in control (“CIC”) applications. Applicants will have to confirm to the FCA that a DBS check has been undertaken within the past six months. Applicants from outside England and Wales will have to undertake an equivalent check in their own jurisdiction. If adopted, the new requirement will apply from January 2025.

Common problems with market abuse surveillance and how to address them

The FCA used Market Watch 79, the May edition of their regular newsletter on market abuse and transaction reporting, to highlight typical failures of market abuse surveillance arrangements caused by factors such as data and automated alert logic. It also provided new guidance derived from its recent peer review of banks’ testing of client front-running surveillance models. Read Martin Lovick’s summary of the latest in the FCA’s expectations in this critical area.

Whistleblowing Matters

The recent case involving Ashley Alder, Chair of the FCA, amply demonstrates that even regulators can make mistakes in the handling of whistleblowers. Even within cultures that are less hostile to the concept, it is sometimes hard to anticipate how senior individuals will react to being “called out”.

We view whistleblowing as a vital element of good governance and risk management for a regulated firm. It is crucial therefore for firms to review their suite of policies and procedures and keep them up to date so that they reflect the latest legislation and market developments.

This article, by Edward Vincent from our Payment Services team, concentrates on one element in particular, the whistleblowing policy, and sets out why it is especially important that it is kept up to date, and that staff and management are familiar with its key principles.

The EU’s new AML regime: what UK entities need to know

In June, the revised anti-money laundering (“AML”) regime was published in the EU Official Journal. This incorporates significant changes for financial services firms and other obligated entities and is of importance for UK-based entities with EU operations or those with plans to expand into the EU.

The legislation includes a new AML Regulation (with direct force across the EU) and a new AML Directive (commonly known as “AMLD6”), both of which come into force in July 2026. A new regulatory body, The Authority for Anti-Money Laundering and Countering the Financing of Terrorism (“AMLA”), will issue guidance, supervise AML/CFT across the EU, and support EU Financial Intelligence Units. Headquartered in Frankfurt, AMLA will start operations in the summer of 2025 and is expected to issue new guidance and Regulatory Technical Standards (RTS), next year and in 2026.

This article by Abou Bangoura, a Senior Consultant within our Payment Services team, runs through the new AML framework, summarising key changes are and how these will impact firms.

Two SEC enforcement cases with important implications

SEC fines firms $390 million for failures in monitoring off-channel communications

The SEC announced a series of fines (in addition to a further $78 million announced by the CFTC) against 26 firms for breaches of securities laws and recordkeeping requirements. Each firm was ordered to “cease and desist” from future violations of the relevant recordkeeping provisions and was censured. In large part, the violations relate to WhatsApp messages on personal devices.

In each case, the SEC found pervasive and longstanding use of unapproved communication methods, known as off-channel communications. The firms admitted that, during the relevant periods, their personnel sent and received off-channel communications that were records required to be maintained under the securities laws. The failure to maintain and preserve the required records deprived the SEC of these communications in its investigations. The failures involved personnel at multiple levels of authority, including supervisors and senior managers.

The fines demonstrate that the widespread use of WhatsApp messaging within the financial services sector is still highly problematic for firms who need to comply with record-keeping and recording requirements (not just in the US).

SEC charges adviser with violations of the Pay-to-Play rules and agrees $95,000 penalty

The SEC charged Obra Capital Management, LLC (“Obra Capital”) with violations of Rule 206(4)-5 under the Investment Advisers Act of 1940, otherwise known as the “Pay-to-Play Rule”. The case related to a $7k campaign contribution made by one individual to a government official with influence over hiring investment advisers for the Michigan Public Employees’ Retirement Fund. They had been an investor in the Obra Capital fund for several years prior to the hiring of the individual who made the contribution. Furthermore, the contribution was made several months prior to the individual becoming a “Covered Associate” (as defined by Pay-to-Play) of Obra Capital.

Because Obra Capital continued to provide investment advisory services to the Obra Fund in which the Michigan Pension Fund was an investor after hiring the individual, Obra Capital was deemed to have violated the Pay-to-Play Rule. Without admitting or denying the SEC's findings, Obra Capital consented to a cease-and-desist order and to a censure and agreed to pay a $95k penalty.

As well as being a timely reminder of Pay-to-Play rules ahead of the US elections, the case is notable in illustrating its look-back provisions - namely, that political contributions made by an individual prior to becoming a Covered Associate (within 2 years, reducing to 6 months if not involved in the solicitation of investors) fall within the prohibitions. Additionally, it also shows the SEC will pursue cases even where it was clear no influence had been exerted on the official in question.

Finally…

As regulatory consultants, Cosegic takes a lot of firms through the FCA authorisation process. Having successfully negotiated over this hurdle, a very common question from the client is “so what do we need to do now?”

Our Bitesize webinar: FCA compliance for investment managers: getting the basics right is an extended answer to that question. What should be the priorities from the regulated firm’s viewpoint and what steps can they take to minimise the chances of further scrutiny from the regulator? However, the webinar is not just for newly authorised firms: it is a checklist of minimum requirements applicable to all compliance programmes. Click on the link above to access the webinar recording.