news european views - Citibank · European News & Views ... the FSA Business Plan, which focuses on how the FSA intends to manage ... SKF, Volvo (the largest employer in

News from:

Sweden• Citi launches new Fiduciary

Services business

International• Suspensions of CIS redemptions

Europe• Update on European regulation

United Kingdom • New regulatory structure

• FSA Risk Outlooks

• FSA Business Plan

• Revised Remuneration Code

Ireland• Fitness and probity standards

Luxembourg• Infrastructure funds

news & viewseuropean

second edition 2011

2 | European News & Views | Second Edition 2011

Contributors

Europe

Amanda J Hale

Head of UK Fiduciary Technical

[email protected]

Tel: +44 (0) 20 7508 0178

Ireland

Ian McCarthy

Senior Fiduciary Monitoring Officer

[email protected]

Tel: +353 1 622 1012

Luxembourg

Jean-Christian Six

Partner

Allen & Overy Luxembourg

[email protected]

Tel: +352 444 455 710

United Kingdom

Amanda J Hale

Head of UK Fiduciary Technical

[email protected]

Tel: +44 (0) 20 7508 0178

Selina Staines

Fiduciary Technical Analyst, UK

[email protected]

Tel: +44 (0) 20 7500 9741

Charlotte Hill

Financial Services Partner

[email protected]

Tel: +44 (0) 20 7809 2169

European News & Views | Second Edition 2011 | (i)

Contents

Introduction

By David Morrison 01

Sweden

Land of the Midnight Sun 02

International

Principles on suspensions of redemptions in Collective Investment Schemes 06

Europe

Positional update on European regulation 10

United Kingdom

A new approach to financial regulation: building a stronger system 14

Retail Conduct Risk Outlook and Prudential Risk Outlook arise out of Financial

Services Authority (FSA) restructure 16

The FSA Business Plan 2011/2012 22

Casting the net wider: the FSA’s revised Remuneration Code and its impact on asset managers 25

Ireland

The Central Bank of Ireland raises the bar in fitness and probity standards 28

Luxembourg

Luxembourg regulated infrastructure funds 31

Glossary 36

(ii) | European News & Views | Second Edition 2011

European News & Views | Second Edition 2011 | 1

Introduction

Hello and welcome! We are very

pleased to present our latest edition

of European News & Views, one that

provides you with the same incisive

commentary you know and trust on

the regulatory developments that are

shaping the fiduciary landscape across

EMEA, but with a renewed voice.

We begin our journey in “The Land

of the Midnight Sun” in honour

of our newly launched Fiduciary

Services business in Stockholm. With

a very skilled labour force, extensive

welfare benefits, first-rate internal

and external communications,

high-tech capitalism and an advanced

distribution system, Sweden certainly

offers an attractive standard of

living. It is a favourable place to

do business, as Swedish retail and

institutional investors, who have an

appetite for risk and who enjoy an

equities culture, will no doubt attest

to. Stockholm is sure to add a new

dimension to our strong fiduciary

coverage across EMEA.

From Stockholm, we move on to

open-ended collective investment

schemes and IOSCO’s published

consultation report on suspensions

of redemptions. With an overview

of IOSCO’s principles applicable to

the suspensions process — from how

to avoid a suspension through to

situations where suspension becomes

necessary — we ask if IOSCO’s

standards can be seen as minimum

best practice in the absence of

regulatory guidance.

On regulatory guidance in general,

we survey the profusion of regulation

that has hit the UK financial services

space. Supervisory reforms, “too-

big-to-fail” rules, market-wide

consultations, investment and retail

directives — including a helpful

timeline of the key initiatives

affecting the asset management

industry across Europe

“A New Approach to Financial

Regulation” takes a look at how the

UK government is working towards

sustainable growth in a programme of

reform driven by international efforts

and progression within the EU.

With the coming restructuring of

the FSA, we turn to the authority’s

decision to publish a Prudential Risk

Outlook and a Retail Conduct Risk

Outlook, examining how the former

aims to yield an understanding of the

overall macroeconomic and financial

trends in the UK financial system and

how the latter aims to increase risk

awareness and lead the authority’s

supervisory focus.

The FSA’s move to a new

organisational structure will be a

milestone event. So we give pause to

the FSA Business Plan, which focuses

on how the FSA intends to manage

the transition, touching on high-level

aims, work programme and priorities,

and other deliverables that will be of

interest to stakeholders.

Remaining with our UK focus,

Charlotte Hill, Partner, Stephenson

Harwood, gives us a welcome

rundown of the impact of the

FSA’s Remuneration Code on asset

managers, giving us an appreciation

of which firms and employees are

likely to be affected, what the key

issues are, how firms will be expected

to apply the Code, supervision

and enforcement, and steps to

implementation.

We include an article on how “Ireland

Raises the Bar in Fitness and Probity

Standards”, following the Central

Bank of Ireland’s recent consultation

paper on amendments to the Fit and

Proper Regime, which will come into

effect on 1 September 2011.

Finally, Jean-Christian Six, Partner,

Allen & Overy Luxembourg,

presents his interesting article on

regulated infrastructure funds,

placing Luxembourg as the likely

domicile of choice in Europe for the

establishment of such funds, which

are already seen by many institutional

investors as attractive for their

portfolio-enhancing qualities.

We hope you enjoy this edition of

European News & Views, and we very

much welcome your comments and

suggestions on anything of interest to

you in these engaging articles.

David MorrisonDirector and Head of Fiduciary Services, EMEA


Land of the Midnight Sun

The royal Swedish capital of Stockholm,

frequently referred to as one of the

world’s most beautiful cities, was built

over eight centuries and constitutes the

most populated area in Scandinavia.

Its strategic location on 14 islands on

the south-central east coast of Sweden

at the mouth of Lake Mälaren, by

the Stockholm archipelago, has been

historically important. It is home to

the national Swedish government, the

Riksdag (parliament) and the official

residence of the Swedish monarch and

prime minister. Stockholm is Sweden’s

financial centre. Major Swedish banks,

such as Swedbank, Handelsbanken and

Skandinaviska Enskilda Banken, are

headquartered in Stockholm, as are the

major insurance companies Skandia and

Trygg-Hansa. Stockholm is also home

to Sweden’s foremost stock exchange,

the Stockholm Stock Exchange

(Stockholmsbörsen). Additionally, about

45% of Swedish companies with more

than 200 employees are headquartered

in Stockholm.1

Goteborg (otherwise known as

Gothenburg), Sweden’s second largest

city, is a city of commerce, culture and

entertainment, one influenced by its

proximity to the sea. Its port has come

to be the largest harbour in Scandinavia.

Apart from trade, the second pillar

of Gothenburg has traditionally been

manufacturing. Major companies

operating plants in the area include

SKF, Volvo (the largest employer in

Gothenburg) and Ericsson.

Banking and finance are also important

trades, as are the event and tourist

industries.2

Malmö, which is Sweden’s third largest

city, is traditionally an old shipbuilding

and industrial centre. The city has

undergone a metamorphosis in recent

years since its economic integration with

Denmark, which was brought about by the

construction of the Oresund Bridge. The

bridge connects Sweden and Denmark

and is the longest road and rail bridge in

Europe. Almost 10% of the population of

Malmö works in Copenhagen, Denmark, as

a result. Malmö has built an international

reputation for being a creative,

progressive and environmentally aware

city, and has received international awards

such as Eco City and Fair Trade City.

Some other interesting facts about

Sweden are:

• Sweden is one of the largest countries

in Europe.3

• The Nobel Prizes were founded by the

Swedish inventor and entrepreneur

Alfred Nobel, who also invented

dynamite in 1866.4

• Swedish inventions include the

pacemaker, the ball bearing, the

safety match, the adjustable wrench,

the working zipper and the Tetra Pak

carton.5

• With Ericsson headquartered in

Stockholm, Sweden is a global

leader in mobile telecommunications

technology.

• Sweden has one of the highest

standards of living worldwide.

This is closely linked to trade

— many multinational companies

have their roots in Sweden, among

them, Volvo, AstraZeneca, ABB, IKEA,

Ericsson, Electrolux, H&M and Absolut.

Cutting-edge companies such as

Skype and Spotify were also founded

in Sweden.6

• Sweden is also the Land of the

Midnight Sun.7 In the summer, the

regions north of the Arctic Circle

enjoy between one and two months of

sunlight, which is a very long period

of constant daylight. In winter, the

Northern Lights can be seen, caused

by electrically charged particles being

thrust into the earth’s magnetic field at

great speed, propelled by solar winds.8

A short history of Sweden 10

Fourteen thousand years ago, Sweden

was covered by a thick ice cap. As the

ice cap melted, humankind began to

inhabit the area. Its first known dwelling

place, found in the south of the country,

dates from around 12,000 BCE.

Sweden

The Innovation Union Scorecard says “Sweden is the most innovative country in the EU.” 9

Sweden is separated in the west from Norway by the Scandinavian Mountains and shares the Gulf of Bothnia to the north

of the Baltic Sea with Finland. The southern part of the country is chiefly agricultural, forests covering an increasing

percentage of the land the further north you go. With its intense green countryside, impenetrable forests, little red

cottages atop remote islands and famously clear blue waters, Sweden’s pastoral beauty is distinctive.


Sweden

In its earliest history, the Swedish

population lived by hunting and fishing.

However, during the early Iron Age the

population of Sweden became settled

and agriculture came to form the basis

of the economy and society.

It was not until the 1890s that industry

began to grow. Between 1900 and 1930,

Sweden transformed into one

of Europe’s leading industrial nations.

In 1995, Sweden became a member

of the European Union (EU). Sweden has

held the EU presidency on two occasions:

from 1 January to 30 June 2001 and from

30 June to 31 December 2009.

As you may be aware, it was under

the Swedish EU presidency that

technical discussions started around the

first Alternative Investment

Fund Managers Directive (AIFMD),

and the first official publication of

the AIFMD compromise text.12

Sweden’s economy

The World Economic Forum 2010

competitiveness index ranks Sweden as

the second most competitive economy

behind Switzerland, and the long-run

prospects for growth remain favourable.13

Looking forward to 2015, the Economist

Intelligence Unit Limited (EIU) has

reported some of the following

expectations for the Swedish economy: 14

• An increase in competition and the

sale of state holdings in enterprise.

The government will also try to

increase incentives to work but will

not introduce any radical reforms of

the labour market.

• With public debt and the general

government deficit low, there is an

urgent need for fiscal tightening. The

EIU has forecast that the balance will

improve from an estimated deficit of

1.5% of GDP in 2010 to a surplus of

1.8% by 2015.

• Monetary policy is expected to be

gradually tightened with the benchmark

repo rate rising to under 4% by the

latter part of the forecast period.

• From an estimated 5.3% in 2010,

growth is expected to slow on a

quarterly basis in 2011 (although

annual growth will be strong, owing

to carryover effects in 2010). This

will be followed by a pick-up to around

2.4% in 2012-15.

“Aided by peace and neutrality for the whole of the 20th century, Sweden has achieved an enviable standard of living under a mixed system of high-tech capitalism and extensive welfare benefits. It has a modern distribution system, excellent internal and external communications, and a skilled labour force.” 11


• Inflation (EU harmonised measure)

is expected to rise from an average

of 1.9% in 2009 and 2010 to over

2% throughout 2011-15, owing

to continued growth, falling

unemployment and upward

pressure on wages.

Importantly, the EIU has reported that

Swedish banks are well prepared for

Basel III as they are well capitalised

by international standards and

currently able to fund their operations

themselves through the financial

markets. So, even under the new

regulatory framework proposed by

the Basel Committee on Banking

Supervision (Basel III), Swedish

banks have already begun the process

of raising capital levels to meet the

new regulations.

A focus on mutual funds

The “Cerulli Quantitative Update:

Global Markets 2010” on Sweden

reported that Swedish investors, in

general, have an appetite for risk

and enjoy an equity culture. This

is demonstrated by the fact that

equity funds had positive net inflows

throughout 2009, despite the fact that

the Swedish equity market, in line with

global markets, was not fruitful for

investors at the start of that year.

Equity funds continue to dominate

in Sweden and are back at the levels

seen before the crash in 2008,

when falling markets took the equity

exposure to low levels. The bar graph

below shows that the Swedish remain

dedicated equity investors and are

not afraid to take on risk in their

investment portfolios, as seen by the

level of interest in emerging market

equity funds. 15

Top players in the mutual funds space

There were only two foreign players

among the top ten mutual fund

managers in Sweden in 2009; both

had close ties to the local market. One

was Norway’s Storebrand; the other,

Old Mutual, which owns Skandia, the

Swedish insurer.

When provided with the opportunity,

Swedish retail and institutional

investors have been open to investing

in foreign fund groups, as seen on

platforms such as Nordnet and Avanza.

At the time of the Cerulli Associates

report, distribution was dominated by

banks and unit-linked platforms. 16

The below table provides a list of the

largest Swedish asset managers.

Market regulation

Companies who operate business

in the Swedish financial sector

are authorised and supervised by

the Swedish Financial Supervisory

Authority, Finansinspektionen (FI).

The main rules applicable to

the Swedish securities markets

are defined by the Financial

Markets Act (2007:528) (Lag om

Vardepappersmarknaden [LVM]), and

the Financial Trading Act (1991:980)

(Lag om handel med finansiella

instrument [LHFI]). In addition to the

LVM and the LHFI, there are a number

of Acts that cover reporting duties,

insider rules, takeover rules and

money-laundering regulations. 17

The LVM came into force in 2007 and

through its adoption Sweden became

compliant with the Markets in Financial

Instruments Directive (MiFID). The LVM

contains fundamental rules for the

organisation of a securities business,

such as capital requirements and

portfolio risk diversification rules.

The LVM also sets out requirements for

obtaining a licence to conduct securities

business. Any company planning to offer

services on the securities market in

Sweden needs to obtain a licence from

the FI. The application procedures are

described in the LVM. 18

Sweden

Rank Manager

2009

AUM (SEK bn)

Market Share (%)

1 Swedbank AB 443.4 34.6

2 SEB 146.1 11.4

3 Svenska Handelsbanken 125.6 9.8

4 Nordea AB 94.7 7.4

5 Sjunde AP-fondens 92.6 7.2

6 Lansforsakringsbolagen 65.8 5.1

7 AMF Pension 52.4 4.1

8 Storebrand SPAR A/S 47.9 3.7

9 Old Mutual 43.9 3.4

10 Hagstromer & Qviberg AB 25.6 2.0

Others 143.7 11.2

Mutual fund total 1,281.7 100.0

70%

60%

50%

40%

30%

20%

10%

0%2005

Balanced Bond Equity Money Market Others

2006 2007 2008 2009


At present, there are two securities

exchanges in Sweden, the OMX Nordic

Exchange Stockholm (OMX) and the

Nordic Growth Market. The OMX is the

largest securities exchange in the Baltic

region and offers trade in shares, money-

market instruments and derivatives. 19

Investment funds specifically are

captured by the Swedish Investment

Funds Act (SFS 2004:46) (SIFA). It

covers, among other things:

• Authorisation obligations

• Capital requirements

• Branch and cross-border operations

• Depositaries

• Management of investment funds

• Fund rules

• Report and accounts requirements, etc.

Depositary bank activities

Pursuant to SIFA, each investment

fund shall have a depositary

(Förvaringsinstitut). SIFA defines the

Förvaringsinstitut as a bank or other

credit institution that holds assets in

custody in an investment fund and

administers deposits into, and payments

from, the fund. The Förvaringsinstitut

shall maintain its registered office in

Sweden or, where the Förvaringsinstitut

is a branch established in Sweden, in

another state within the European

Economic Area (EEA).

The duties of the Förvaringsinstitut,

according to SIFA, chapter 3, are

outlined below:

• Implement decisions of the

management company provided that

they do not violate the provisions of

SIFA or the fund rules.

• Take receipt and hold in custody the

property of the fund.

• Ensure the sale and redemption

of the fund’s units is conducted in

accordance with the provisions of

SIFA and the fund rules.

• Ensure the value of the fund’s units

is calculated in accordance with the

provisions of SIFA and the fund rules.

• Ensure the assets of the fund are

transferred to the depositary

without delay.

• Ensure the assets of the fund are

used in accordance with provisions

of SIFA and the fund rules.

Additional guidance regarding depositary

responsibilities is provided by the FI

through complementary ordinances,

regulations and the fund market

handbook (Investeringsfonder — en

vägledning), for example, in its Guidelines

on Depositary Bank Outsourcing. 20

Conclusion

This article provides just the hint of

a flavour of the country. You might

say “the tip of the iceberg”. Which

is rather fitting given the nature of

certain parts of the country’s climate.

By many accounts, though, Sweden

is not only known to be a favourable

country in which to live but a favourable

place in which to conduct business. (Just

a few of the headlines that captivate this

ethos are featured in this article.)

So, why the interest in Sweden specifically?

As you will have seen from the

introduction of this edition of European

News & Views, due to client demand,

Citi has just launched a new Swedish

fiduciary business in Stockholm.

This new addition to Citi’s fiduciary

product will further provide clients

with significant coverage across the

EMEA region, ensuring high-quality,

consistent and single-point access to

Citi’s award-winning fiduciary team.

If you have any questions regarding

the launch of our new branch in

Stockholm, please do not hesitate to

contact us.

1 www.stockholmbusinessregion.se/en/, accessed on 1 April 2011.

2 www.ne.se/g%C3%B6teborg/999778 (Swedish National Encyclopaedia), accessed on 1 April 2011.

3 www.sweden.se/eng/Home/Lifestyle/Facts/Sweden-in-brief/, accessed on 1 April 2011.

4 www.nobelprize.org/alfred_nobel/biographical/articles/life-work/index.html, accessed on 30 March 2011.

5 www.sweden.se/eng/Home/Education/Research/Facts/Innovation/, accessed on 1 April 2011.

6 www.sweden.se/eng/Home/Society/Facts/This-is-Sweden/, accessed on 1 April 2011.

7 www.sweden.se/eng/Home/Work/Life_in_Sweden/Climate_nature/Seasons/, accessed on 1 April 2011.

8 www.sweden.se/upload/Sweden_se/english/slides/Flash/Sweden_Swedes_20_Speakers_notes.pdf, accessed on 1 April 2011.

9 “Innovation Union Scorecard: Sweden is the Most Innovative Country in the EU,” 3 February 2011, www.investsweden.se, accessed on 1 April 2011.

10 www.sweden.se/eng/Home/Lifestyle/Facts/History-of-Sweden/, accessed on 1 April 2011.

11 ”Sweden: Economy Overview”, Ina Dimireva, 14 November 2009, www.eubusiness.com/europe/sweden, accessed on 1 April 2011.

12 Issued on 12 October 2009. All AIFMD compromise proposals are available on the Council’s website (www.consilium.europa.eu) by performing a search under the applicable interinstitutional file reference, 2009/0064(COD).

13 www.weforum.org/issues/global-competitiveness (World Economic Forum Global Competitiveness Report), accessed on 1 April 2011.

14 Economist Intelligence Unit Limited Country Report on Sweden, March 2011.

15 Cerulli Quantitative Update: Global Markets 2010, Sweden.

16 Exhibit 1 Largest 10 Swedish Mutual Fund Managers, 2007-2009 (sources: Lipper FMI, Cerulli Associates).

17 www.iflr1000.com/LegislationGuide/132/Securities-market-regulation-an-overview.html, accessed on 1 April 2011.

18 www.iflr1000.com/pdfs/Directories/1/Sweden_2009.pdf, 1 April 2011.

19 www.nasdaqomx.com/listingcenter/nordicmarket/rulesand regulations/, accessed on 1 April 2011.

20 Förvaringsinstitut och delegering — en vägledning.

Sweden


Risks and consequences

IOSCO considers some of the risks

and consequences deriving from the

suspension of redemption rights in an

investment fund in terms of:

• The direct impact on the investor:

if the risks inherent to investing

into a fund are not adequately

disclosed to investors, retail

or institutional, redemption

suspensions could cause serious

consequences to financial

markets. Suspensions carried out

in unsatisfactory conditions may

lead to the unequal treatment of

investors, for example, should some

investors in the fund be made aware

of the planned suspension, before

it becomes effective.

• Confidence and reputation:

suspending redemptions in a

sizeable investment fund may have

consequences that go far beyond its

investors, and may eventually lead

to wider macroeconomic or market-

wide implications. As the decision

to suspend subscription rights has

an adverse impact on investors’

confidence, it is possible that a

poor information/disclosure policy

eventually has a wider effect on the

financial industry and a general loss

of investors trust. Additionally, the

reputation of the fund manager/

promoter may be seriously

impacted and could generate issues

in the long term, particularly after

the suspension limitations have

been lifted.

• Market impact: the recognition

of a suspension in one or more

investment funds could lead to

investors performing withdrawals

in other investment funds. These

actions may cause liquidity issues

in the funds concerned, and they

may be forced to sell their assets.

Under particular market or sector

conditions, a forced sale may add

pressure to an already stressed

market and lead to further declines

in prices, possibly ending in a

vicious-circle scenario.

• The impact on counterparties:

an investment fund with liquidity

issues due to significant or

extraordinary withdrawals may

find itself in difficulties in meeting

other payment obligations (e.g.

margin calls). Liquidity problems

due to large redemptions may also

have an impact on funds’ market

counterparties.

IOSCO principles

IOSCO’s guidelines include principles

applicable to the “suspensions

process” in a chronological order,

from how to avoid a suspension

through to situations where

suspension becomes the only option.

A. Management of liquidity risk

Principle 1: “The responsible entity

should ensure that the degree of

liquidity of the open-ended CIS it

manages allows it in general to

meet redemption obligations and

other liabilities.”

Principles on Suspensions of Redemptions in Collective Investment Schemes

The redemption of units is a fundamental right of investors in open-ended collective investment schemes (CISs). It is on

the basis of this right that the technical committee of the International Organisation of Securities Commissions (IOSCO)

has published a consultation report on principles on suspensions of redemptions in CISs. IOSCO’s guidelines are issued on

a consultation basis and are open for comments until 30 May 2011. 1

International


International

An open-ended fund should be

managed in a way that allows it to

meet redemption obligations and

other liabilities. This can be achieved

either by holding very liquid assets as

a fixed percentage (often determined

by laws or regulations) or by using a

principle-based approach.

IOSCO considers that although

the borrowing of cash can be used

to facilitate redemption requests,

“the routine use of borrowing is

not an appropriate way to manage

the CIS liquidity risk.” Besides

the consideration of redemption

obligations, the liquidity of the CIS

must be appropriate to deal with other

liabilities or payment commitments

that may, for example, result from

margin calls or collateral requirements

for derivatives positions.

Principle 2: “Before and during any

investment, the responsible entity

should consider the liquidity of the

types of instruments and assets

and its consistency with the overall

liquidity profile of the open-ended

CIS. For this purpose, the responsible

entity should establish, implement

and maintain an appropriate liquidity

management policy and process.”

In considering this principle, and

to meet redemption obligations

and liabilities, the responsible

entity should establish, implement

and maintain an appropriate

and proportionate liquidity risk

management policy and process.

B. Ex-ante disclosures to investors

Investors should be made aware

of the risk of the suspension of

redemptions, prior to their investment

in an open-ended CIS. Therefore, as

a minimum, the fund’s constitutional

documents and/or prospectus should

clearly disclose that redemptions

may be suspended in exceptional

circumstances. However, IOSCO

considers it unpractical to define the

term “exceptional circumstances” and

considers that examples of what might

constitute “exceptional circumstances”

should be provided instead.

C. Criteria and reasons for

the suspension

Principle 3: “Suspensions of

redemptions by the responsible entity

may be justified only in exceptional

circumstances provided such

suspension is in the best interest of

all unitholders within the CIS or if the

suspension is required by law.”

According to the consultation report,

the decision to suspend is a two-

step approach. The first relates to

exceptional circumstances.

Exceptional circumstances are generally

temporary situations, occur rarely and

should be such that a fair and robust

valuation, and orderly sale, of the fund’s

assets are not possible. Besides valuation,

suspensions might also be justified if

it is not possible to sell assets other

than at fire sale prices in order to meet

redemption requests. The consultation

report provides possible reasons for the

suspension of redemptions, but does

not provide a non-exhaustive list. Such

examples may include:

• Market failures, exchange closures:

markets may be affected by

unexpected events that impact

the functioning of exchanges or

the regular course of transactions.

Unexpected events can also be

related to political, economic, military,

monetary or other emergencies.

“An open-ended fund should be managed in a way that allows it to meet redemption obligations and other liabilities. This can be achieved either by holding very liquid assets as a fixed percentage (often determined by laws or regulations) or by using a principle-based approach.”


• Operational issues: unpredictable

operational problems and technical

failures can temporarily hamper

transactions, or affect the valuation

of the assets — this includes

operational issues affecting a fund’s

service providers.

• Liquidity issues: a suspension

arising as a result of poor liquidity

management in a fund is not

acceptable, in IOSCO’s view.

Therefore, suspensions as a result

of lack of liquidity should be the

last resort in cases where, despite

appropriate liquidity management

processes, the fund has to face

unforeseeable liquidity issues.

• Poor management: it may be

reasonable to suspend redemptions

when facing operational or iquidity

issues, if caused by poor management

rather than by unpredictable

circumstances, if this is in the interest

of investors. In such cases, IOSCO

considers the competent regulatory

authorities should take measures

against those responsible for poor

management practices.

The second relates to the best

interests of investors, as the fair and

equal treatment of incoming, ongoing

and outgoing investors must be a

consideration.

D. Decision to suspend

Principle 4: “The responsible entity

should have the operational capability

to suspend redemptions in an orderly

and efficient manner.”

Principle 5: “The decision by the

responsible entity to suspend

redemptions, in particular the reasons

for the suspension and the planned

actions, should be appropriately:

a) documented; b) communicated

to competent authorities and other

relevant parties; c) communicated

to unitholders.”

Principle 6: “During the suspension

of the redemptions, the responsible

entity should generally not accept

new subscriptions. Subscriptions

cannot be accepted if reliable,

meaningful and robust valuation of

the assets is not possible.”

Principle 7: “The suspension

should be regularly reviewed by the

responsible entity. The responsible

entity should take all necessary steps

in order to resume normal operations

as soon as possible, having regard to

the best interest of unitholders.”

Principle 8: “The responsible

entity should keep the competent

authority and unitholders informed

throughout the period of the

suspension. The decision to resume

normal operations should also be

communicated immediately.”

In terms of implementing processes

in advance, the decision to suspend

redemptions should be enforced in

an orderly and efficient manner.

This implies that the parties

responsible for the relevant operational

tasks should have the capabilities to

perform their roles. Processes and

procedures should exist to react

immediately in cases of circumstances

requiring dealing suspensions. Such

processes and procedures should

include interactions and communication

channels and notification procedures

with relevant third parties (e.g.

depositary, intermediaries, distributors

and regulatory authorities). Detailed

communication plans should exist,

devising the most effective

communication strategy targeting

investors, including processes

for dealing with investor queries

or complaints.

Should the case be that a suspension

is required, or is being considered,

the entities responsible for taking

the decision to suspend should make

sure all relevant parties (depositary,

external legal counsel and regulatory

authority) have been engaged and

notified as required (approval may be

required in some jurisdictions). Any

alternative course of action should

be considered and discounted, and

the suspension should be temporary

and consistent with disclosures made

to investors.

The decision to suspend redemptions

should be appropriately documented,

communicated to the regulatory

authorities and to other relevant

parties, and communicated to

concerned unitholders. When a

suspension event actually arises,

the responsible entity should

thoroughly analyse the situation

that might even require involvement

from external legal counsel.

A suspension of redemptions

should also imply a suspension

of subscriptions. However, IOSCO

considers that there may be cases

where, if a reliable NAV can still

be calculated, subscriptions could

be accepted. But any prospective

investor should be clearly informed

about the redemptions suspension in

a clear and comprehensive manner

and be given the chance to cancel the

subscription order.

The decision to suspend redemptions

should be formally reviewed on an

ongoing basis during the suspension

period. The acceptable length of

the suspension depends on the

circumstances and particular reasons

for the suspension and on applicable

laws and regulations. Under no

circumstances should the suspension

of redemptions remain in force for

a prolonged period. All alternatives

should be investigated to allow

investors access to their money,

including liquidation and/or the

establishment of side pockets.

Regular updates should be provided

to all concerned parties, during the

International


suspension period. Any decision to

resume normal operations should be

communicated immediately to the

competent regulatory authority and

to unitholders.

E. Alternative measures

IOSCO identifies three examples

of alternative measures to the

suspension of redemptions, applicable

in extraordinary circumstances.

• Gating mechanism: by using a

gate, the entity responsible for the

management of the open-ended

fund limits the redemption amounts

to a specific proportion, on any one

redemption day. All redemption

orders are (if applicable)

proportionally reduced to ensure

equal treatment of investors. When

such safeguards are introduced,

these should be clearly disclosed in

the prospectus or other constitutive

documents of the fund, and

maximum transparency should be

applied at all times. It should be

noted that only some regulatory

regimes of certain jurisdictions

allow for gates. You should refer

to the full consultation report for

further details.

• Side pockets: a side pocket is

created when specific assets in a

fund’s portfolio are ring-fenced and

segregated from the rest of the

fund’s portfolio. A side pocket is

usually not actively managed, and

the assets it contains are liquidated

by seeking the best timing and

market opportunities. Again, note

should be taken of the fact that

only some jurisdictions

allow the creation of side pockets.

Refer to the full consultation report

for further details.

• Discount: a few jurisdictions allow

for a discount to be applied on

the redemption price determined

on the basis of the NAV in the

case of stressed markets or an

unusual and significant number of

redemptions. This methodology

requires maximum care to address

transparency and discretion issues.

A discount should be applied only

if the reasons for its application

are properly disclosed in the

prospectus, and should be applied

consistently to all redemptions

completed on the same day.

Conclusions

IOSCO standards are highly regarded

by regulatory authorities in general.

They are also often referred to by the

European Commission in its legislative

proposals. Although they do not have

any binding force, they should always

be regarded as minimum best practice

in the absence of clear or specific

regulatory guidance.

International

1 Consultation Report on Principles on Suspensions of Redemptions in Collective Investment Schemes, CR01/11, March 2011.

“The decision to suspend redemptions should be appropriately documented, communicated to the regulatory authorities and to other relevant parties, and communicated to concerned unitholders. When a suspension event actually arises, the responsible entity should thoroughly analyse the situation that might even require involvement from external legal counsel.”


Europe

Positional update on European regulation

In response to the financial crisis and

the threat of economic instability, an

abundance of regulation has hit the

UK financial services industry. This

is something that we have discussed

in other articles in this edition of

European News & Views. And we

have seen how this has been driven

at international and European levels,

with the EU in particular continuing

to develop its agenda for regulatory

reform. But not all initiatives for reform

have been driven by the financial crisis.

In fact, there are a number of reviews

of existing EU legislation taking

place. The following table provides a

snapshot of the current position of key

initiatives currently affecting the asset

management industry across Europe.

If you would like further information

on anything listed below, please

contact [email protected].

Supervisory structure

EU Financial Supervisory Reform

Macro: New European Systemic Risk Board (ESRB)

• Regulations have been published in the European Commission’s Official Journal.

Micro: New European Supervisory Authorities (ESAs)

• Regulations have been published in the European Commission’s Official Journal.

• Chairpersons and executive directors have been confirmed.

• Stakeholder groups have been established for the European Banking Authority (EBA) and European Insurance and Occupational Pensions Authority (EIOPA).

• European Securities and Markets Authority (ESMA) stakeholder group formation currently in progress.

• The ESAs became operational from 1 January 2011.

UK Financial Supervisory Reform

Macro: Financial Policy Committee (FPC) to be established in Bank of England

• HM Treasury issued a consultation paper on 17 February 2011.

• The consultation closed on 14 April 2011.

• The government is expected to publish a white paper, including a draft bill for pre-legislative scrutiny, in spring 2011.

• The FSA split into four main business units in April 2011.

• Government legislation is expected to be introduced before summer 2011.

• Final bill to receive royal assent in summer 2012.


Europe

Markets

European Markets Infrastructure Regulation (EMIR)

European Commission proposal for a regulation on the European Parliament and of the Council on OTC derivatives, central counterparties and trade repositories

• The proposed regulation was published on 15 September 2010.

• The EU Parliament and EU Council are currently negotiating on the text and final agreement is expected in July 2011.

• Subject to negotiation, regulations will come into force 20 days after publication in the European Commission’s Official Journal.

EU Securities Law

Securities Law Directive (SLD)

• The European Commission published a consultation paper (set of principles) on 5 November 2010.

• The consultation closed on 1 January 2011.

• Responses to the European Commission’s consultation were published on 3 March 2011.

• The European Commission is expected to issue a legislative proposal in Q2 2011.

EU Central Securities Depositaries

European Commission consultation on Central Securities Depositories (CSDs) and on the harmonisation of certain aspects of securities settlement in the European Union

• The European Commission published a consultation paper 13 January 2011.

• The consultation closed on 1 March 2011.

• Responses to the European Commission’s consultation were published on 9 March 2011.

• The European Commission is expected to issue a legislative proposal in June 2011.

“Too big to fail”

UK Investment Bank Resolution Regime

Special Administration Regime (SAR)

• The Investment Bank Special Administration Regulations 2011 and The Investment Bank (Amendment of Definition) Order 2011 was published and entered into force on 8 February 2011.

• HM Treasury is expected to introduce insolvency rules to accompany Regulations in 2011.

• The FSA is expected to consult early in 2011 on proposals to ensure firms prepare their own managed recovery and resolution plan policy.

EU Investor Compensation

Investor Compensation Schemes Directive (ICSD)

• The European Commission issued a proposal for an amending Directive on 12 July 2010.

• The EU Parliament’s Economic and Monetary Affairs Committee (ECON) approved a report on the Commission’s proposal on 13 April 2011.

• The EU Parliament and EU Council are currently negotiating on the text and final agreement is expected in June 2011.

• Member States are expected to transpose the legislation into final rules in 2012.


Europe

Investment management and retail market

EU AIFMD

Alternative Investment Fund Managers Directive (AIFMD)

• The Directive was formally adopted by the EU Parliament on 11 November 2010.

• The EU Council is expected to formally adopt the text and publish it in the European Commission’s Official Journal in June 2011.

• Regulations will come into force 20 days after publication in the European Commission’s Official Journal.

• ESMA published a Discussion Paper setting out its proposed implementing measures on 15 April 2011.

• Comments on the Discussion Paper are due by 16 May 2011.

• ESMA is expected to consult on its technical advice in early summer 2011 and report to the European Commission by 16 November 2011.

• The European Commission is expected to issue Level 2 implementing legislation in early 2012.

• ESMA is then expected to issue draft binding technical standards for the Commission’s approval.

• Member States will be expected to transpose the legislation into national law by mid-2013.

EU UCITS IV

Recast Undertakings for Collective Investment in Transferable Securities Directive (UCITS IV)

• The European Parliament and EU Council approved a reform of the UCITS Directive on 13 July 2009.

• The European Commission adopted Level 2 implementing acts on 1 July 2010.

• UCITS IV is to be transposed into national law by 1 July 2011.

EU UCITS V

Consultation on legislative changes to the UCITS depositary function and to the UCITS managers remuneration (UCITS V)

• The European Commission published a consultation paper on 14 December 2010.

• The consultation closed on 31 January 2011.

• The European Commission published a feedback statement on the responses received on 17 February 2011.

• The European Commission is expected to publish legislative proposals and an impact assessment in July 2011.

EU PRIPs Regime

Packaged Retail Investment Products (PRIPs)

• The European Commission published a consultation paper on legislative proposals for PRIPs, which closed on 31 January 2011.

• The European Commission published responses to its consultation on 8 March 2011.

• The European Commission is expected to publish its legislative proposals for disclosure rules in Q2 2011 and its distribution rules in Q4 2011.

UK Client Assets

FSA Policy Statement (PS10/16) and Client Assets Sourcebook (Enhancements) Instrument

• The FSA issued its Policy Statement (PS10/16) on 20 October 2010.

• The FSA Client Assets Sourcebook (Enhancements) Instrument 2010 was also issued on 20 October 2010.

• The rules come into force throughout 2011. The Client Assets Rules took effect from 1 March 2011 (with some transitional relief until October 2011, where appropriate).


Europe

Others

EU Corporate Governance

EU Commission Green Paper: Corporate Governance in Financial Institutions and Remuneration Policies published in June 2010 on the review of corporate governance in financial institutions

• The European Commission published a Green Paper on 2 June 2010.

• The consultation closed on 1 September 2010.

• The European Commission published a Feedback Statement on 12 November 2010.

• The European Commission is expected to publish legislative proposals in June 2011.

EU Commission Green Paper: The EU Corporate Governance Framework

• The European Commission published a Green Paper on 5 April 2011.

• The consultation closes on 22 July 2011.

• The European Commission is expected to issue a Feedback Statement in Q4 2011.

• The European Commission will then decide whether legislative proposals are required.

UK Retail Distribution

Retail Distribution Review (RDR)

• The FSA has issued a number of Policy Statements as follows:

» PS10/6 — Disclosure and Remuneration (March 2010). » PS11/01 — Raising Professional Standards of Advisers (January 2011). » PS10/10 — Group Personal Pensions (June 2010). » PS10/13 — Pure Protection Products (September 2010).

• The FSA also issued a consultation paper — CP10/29: Platforms — delivering the RDR and other issues for platforms and nominee-related services, which closed on 17 February 2011.

• On 25 November 2010, the Treasury Select Committee (TSC) launched an inquiry into whether the RDR would achieve its stated objectives. The closing date for submissions was 17 January 2011.

• TSC Oral hearings were held on 9 March 2011, at which Hector Sants confirmed the RDR rules were final, although the FSA will constantly monitor the impact of the new regulatory framework.

• The FSA published its Business Plan 2011/2012 on 22 March 2011, which indicated that it would undertake the following in 2011/2012:

» Set out the final rules on platforms. » Publish the final list of accredited bodies. » Consult on data requirements. » Publish a paper setting out a framework for simplified advice services.

Investment management and retail market (continued)


A new approach to financial regulation: building a stronger system

Supported by the Bank of England

(the Bank) and the Financial Services

Authority (FSA), the government

has played a leading role in the

international programme of reform

that is being taken forward by the

Financial Stability Board (FSB),

the International Monetary Fund

(IMF) and the Basel Committee on

Banking Supervision, and within

the European Union.

The government has also established

the Independent Banking Commission

(IBC), chaired by Sir John Vickers,

to consider the structure of the UK

banking market.

Reforms focus on three key

institutional changes:

• A new Financial Policy Committee

(FPC) to be established within

the Bank, with responsibility for

“macro-prudential” regulation, or

regulation of stability and resilience

of the financial system as a whole.

• The “micro-prudential” regulation

of financial institutions that

manage significant risks on their

balance sheets will be carried out

by an operationally independent

subsidiary of the Bank, the Prudential

Regulation Authority (PRA). 2

• The responsibility for conduct

of business regulation will be

transferred to a new specialist

regulator responsible for conduct

issues across the entire spectrum of

financial services. The government

has now finalised the name of this

body, which has had the working

title “Consumer Protection and

Markets Authority” (CPMA), as the

Financial Conduct Authority (FCA).

Under this framework, the Treasury,

the Bank and the FSA will be

collectively responsible for financial

stability. The diagram opposite

depicts the roles of the bodies within

the new regulatory architecture. 3

The government has made it clear

that there will be a fundamental

change in the way that the new

regulatory authorities carry out

their functions. The intention is to

deliver a more judgment-led, focused

and effective regulation of the

financial sector. The reforms

will be implemented through

primary legislation amending the

Financial Services and Markets

Act 2000 (FSMA).

Since the Treasury consultation was

published, a press release issued

on the UK Parliament’s website

(entitled, “Committee Launches

Inquiry into the Accountability of

the Bank of England”) discusses the

fact that on the 3 February 2011, the

Treasury Committee reported on the

government’s proposals for financial

regulation. It commended the Bank’s

engagement with Parliament over the

Monetary Policy Committee. As the

government’s proposals will extend the

responsibilities of the Bank to include

monitoring financial stability and taking

action against threats to that stability,

the Treasury Committee is launching an

inquiry into the Bank to give the issue

the attention it deserves.

Some of the key questions will be

to determine:

• What kind of decisions should be

made by each body within the Bank.

• To whom the Bank should be

accountable.

• What resources the Bank will need

to carry out its functions.

An article in FTfm, dated 7 March

2011, talks about the Treasury’s

proposals: 4

“Keen observers (aka the anoraks)

will be familiar with the government’s

determination to drop the legislative

obligation, previously binding on

the regulators, always to consider

the impact of their actions on the

competiveness of the industry . . .

It is interesting, then, to see the

cultivation of competition emerge

as a key statement in the objectives

of the unborn FCA.”

The article also goes on to uncover a

second surprise from the consultation:

United Kingdom

In February 2011, HM Treasury (the Treasury) consulted on a new approach to financial regulation. The consultation paper

was entitled “Building a Stronger System”. 1 In it, the government asserts its commitment to restoring the UK economy to

sustainable, long-term growth, and to recognising the crucial role of the financial sector.

“Under this framework, the Treasury, the Bank and the FSA will be collectively responsible for financial stability.”


United Kingdom

“Lurking among the UK aspirations for

the European Supervisory Authorities

is a call for them to consider, more

clearly than European institutions

have hitherto, the need for ‘reforms

. . . supporting EU competiveness in

global financial markets’.”

The article makes the argument

that this is unreasonable when “it is

no longer deemed appropriate for

domestic consumption”.

Next steps

The next steps will be for the

government to publish a white

paper in the spring of 2011 including

a draft bill for Parliamentary pre-

legislative scrutiny (PLS).

The FSA is on track to make the

transition to the new regulatory

structure at the end 2012. In April

2011, the FSA announced that

it had undertaken an internal

reorganisation, splitting itself into

four main business units.

The Supervision and Risk units were

replaced by a Prudential Business Unit

(PBU) and a Conduct Business Unit

(CBU), and two new units (the Direct

Reports Business Unit and Operations

Business Unit) were also created.

Work is also underway to complete a

more detailed design of the operating

models for the PRA and the FCA.

So, the FSA and the Bank will

continue to work closely together as

the reform programme progresses.

1 “A New Approach to Financial Regulation: Building a Stronger System”, presented to Parliament by the Financial Secretary to the Treasury by Command of her Majesty (Cm 8012: February 2011).

2 Here “micro-prudential” means “firm-specific”.

3 This has been taken directly from Cm 8012.

4 “Gaps in UK’s New Approach to Regulation” by Oliver Lodge (a director of Owl Regulatory Consulting), Financial Times, FTfm, 7 March 2011.

Protecting and enhancing the stability of the financial

system of the United Kingdom, aiming to work with other

relevant bodies including the Treasury, the PRA and the

FCA. The Bank’s Special Resolution Unit is responsible for

resolving failing banks using the special resolution regime.

Financial Policy Committee (FPC)

Contributing to the Bank’s objective to protect and enhance

financial stability, through identifying and taking action to

remove or reduce systematic risks, with a view to protecting

and enhancing the resilience of the UK financial system.

Financial Conduct Authority (FCA)

Enhancing confidence in the UK financial system by

facilitating efficiency and choice in services, securing an

appropriate degree of consumer protection and protecting

and enhancing the integrity of the UK financial system.

FPC powers of recommendation and

direction to address systematic risk.

Systematic infrastructure

Central counterparties, settlement

systems and payment systems.

Investment firms and exchanges, and

other financial services providers

Including IFAs, investment exchanges,

insurance brokers and fund managers.

Prudentially significant firms

Deposit takers, insurance, some

investment firms.

Prudential

regulation

Prudential

regulation

Prudential and

conduct regulation

Conduct

regulation

BANK OF ENGLAND

Subsidiary

Prudential Regulation Authority (PRA)

Enhancing financial stability by promoting the

safety and soundness of PRA authorised persons,

including minimising the impact of their failure.


Retail Conduct Risk Outlook and Prudential Risk Outlook arise out of Financial Services Authority (FSA) restructure

In response to the recent financial crisis

and the threat to economic stability,

a plethora of new regulation — set to

continue over the coming months — has

hit the financial services industry.

Against this backdrop, the FSA is

concerned that firms’ assessment and

reaction to the challenges brought on

by new initiatives and regulatory change

could create additional risks to the

detriment of consumers.

In March 2010, the FSA launched its

enhanced Consumer Protection Strategy,

which included a commitment to the

earlier identification of retail conduct

risks. The other initiatives included:

• A more intensive supervision of the

conduct of large retail firms.

• An increased focus on product

intervention, which is further detailed

in the FSA’s Product Intervention

Discussion Paper (published in

January 2011) and covered in our

January Regulatory Update.

• A greater use of enforcement and

other regulatory tools for dealing

with poor conduct.

The FSA’s RCRO 2011

As the FSA aims to see fewer risks

resulting in consumer detriment

across the industry, the RCRO,

published on 28 February 2011,

presents the FSA’s view of current,

emerging and potential risks

arising from firms’ conduct in their

relationship with consumers. It aims

to increase risk awareness and inform

the FSA’s supervisory focus.

The RCRO is divided into two

main sections, “Chapter A — The

Environment” and “Chapter B — The

United Kingdom

This year the FSA has decided to publish two documents (rather than its historical Financial Risk Outlook): the

Prudential Risk Outlook (PRO) and the Retail Conduct Risk Outlook (RCRO). These better fit the coming restructuring

of the FSA into the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) and reflect the

FSA’s focus on prudential and conduct issues.1 Together, they will help inform how the FSA sets its priorities and deploys

its resources over the next twelve months.2


United Kingdom

Risks”. The key points of relevance to

asset managers from each of these

sections are detailed below.

Chapter A — The Environment

Consumers and financial services firms

face an uncertain macroeconomic

environment. Many households remain

vulnerable to further macroeconomic

shocks, such as higher unemployment

or interest rates. This section discusses

the key macroeconomic trends that are

of most relevance to consumers.

Asset management and the economy

Crucial to the demand for financial

services is how consumers choose to

allocate their income. Interestingly,

the rate of saving has increased

significantly since before the financial

crisis. In addition, following a period of

disinvestment in financial assets in 2007

and 2008, investment into equity and

pension funds started to increase. In

fact, the UK asset management sector

experienced a record year for retail

investment in 2009 with net retail sales

of GBP25.8 billion. This strong trend

continued in 2010, when net retail sales

showed an inflow of approximately

GBP24 billion.

The RCRO analysis suggests that, due to

the low-interest-rate environment, the

search for yield and capital protection

has driven consumers’ investment

decisions. This is reflected by the

growth of investment in bond funds,

absolute return funds, passive funds

and exchange-traded funds. This trend

is expected to continue for some time.

However, the FSA is concerned that, as

a result, consumers may be attracted to

the higher returns offered by higher risk

products without fully understanding

the impact.

For example, asset managers are

continuing to develop more complex

investment strategies and promoting

these funds to retail investors. Absolute

return funds are one such example.

While they may all use the same sector

name, they use a wide range of often

complex investment strategies across

multiple asset classes. Consumers may

have difficulty in distinguishing between

these different products or in assessing

the level of risk that is being taken to

achieve returns.

There has also been a long-term trend

towards growth in funds being managed

passively (passive funds), which has

recently manifested in the growth of

exchange-traded funds (ETFs). This,

coupled with the changes to adviser

remuneration as a result of the Retail

Distribution Review (RDR), may lead to

advisers increasingly recommending

passive funds. The FSA raises its

concern that consumers may not

understand the difference between

product types in terms of investment

strategy, tax status and risk.

Regulatory background and outlook

This section summarises some of

the main regulatory initiatives that

are currently affecting the asset

management industry.

Retail Distribution Review (RDR)

The rules for implementing the RDR will

come into effect at the end of 2012. The

proposals aim to ensure that:

• Consumers are offered a transparent

and fair charging system for the

advice they receive.

• Consumers are clear about the

service they receive.

• Consumers receive advice from

highly respected professionals.

• Advisory firms become more stable

and better able to meet their

liabilities.

The new rules will apply to any individual

advising on products and services

regardless of the type of firm for which

they work. Therefore, advisers within

banks, asset managers, life insurers, sole

traders, partnerships, stockbrokers, IFAs

or financial advice firms will be subject

to the same regulatory environment.

The RDR introduces minimum

qualification requirements for advisers.

Therefore, it is important for firms to

ensure that their plans for achieving

these qualification requirements are

well under way.

Packaged Retail Investment

Products (PRIPs)

A new EU regime for PRIPs, which

is expected to have complementary

elements to the RDR, is likely to be

implemented in 2012 or 2013. The aim of

the regime is to harmonise the standards

of consumer protection applicable to

substitutable retail products sold by

different sectors of the financial services

industry, including fund managers. The

FSA is working with the Commission in

developing these proposals.

UCITS IV

The new UCITS IV rules, which come

into force from 1 July 2011, except

for the transitional rules for the KIID,

make a number of technical changes

to the current UCITS regulations. Of

particular relevance to consumers is the

replacement of simplified prospectuses

with a key investor information document

(KIID), including a new synthetic risk

and reward indicator. This means that

firms will need to present information

about UCITS funds to consumers in a

different format. The FSA suggests that

there is a possibility that consumers may

be discouraged from buying products

that are classified as higher risk, even

where they might best meet their needs.

Consequently, firms may need to improve

the quality of their marketing and sales

advice to explain the risks and benefits of

their products and invest in systems and

controls to ensure that their KIIDs meet

the requirements of the directive.

Prudential measures with possible

effects on conduct

Prudential measures can affect the

behaviour of firms in a way that

may indirectly affect consumers.

For example, the Basel III framework,

published on 16 December 2010 by the


EU Commission, set out the following

micro-prudential and macro-prudential

reforms for internationally active banks:

• Higher and better quality capital.

• Better risk coverage.

• The introduction of a leverage ratio

as a backdrop to the risk-based

requirement.

• Measures to promote the build-up

of capital that can be drawn down in

periods of stress.

• The introduction of global liquidity

standards.

This culminated in a Policy Statement

(PS) from the FSA (PS09/16) in October

2009. The PS develops an enhanced

prudential framework for firms and

aims to improve their ability to monitor

their liquidity risk and reduce the risk of

failure. This should enhance consumer

protection and, in turn, help to build

greater confidence in the financial

system as a whole. (We cover the

Prudential Risk Outlook [PRO] later in

this article, which provides further detail

on macroeconomic and financial trends.)

Chapter B – The Risks

This section of the RCRO describes the

retail conduct risks that the FSA believes

require particular attention by firms

and in terms of supervisory focus. The

identified risks have been considered

under three categories:

1. Current issues: risks that have

already crystallised, with poor

firm conduct already resulting in

customer detriment.

2. Emerging risks: risks where the

FSA already has evidence of

poor conduct in firms but little

or no evidence yet of widespread

consumer detriment, although the

FSA believes the issue could grow.

3. Potential concerns: risks that may

emerge in the future, given the

possible impact of environmental

factors and firm behaviour.

The following are of particular relevance

to asset managers.

Current issues

The sale and marketing of structured

investment products

The interest in structured investment

products remains high in the current

environment. However, consumers

investing in these products are

exposed to a number of risks, such as

counterparty risk, inflation risk and

market risk. The varying features of

these products can be difficult for

consumers to understand. Therefore,

the quality of the design, marketing and

distribution of structured investments

is of paramount importance. The FSA

suggests that firms should ensure that

they are promoted in a way that is fair,

clear and not misleading, and that they

meet the needs, circumstances and

objectives of each individual investor.

Emerging risks

The increasing popularity of complex

investment products

ETFs — In addition to the risks outlined

earlier, many of the funds underlying

ETFs listed in London are domiciled in

other jurisdictions, usually Luxembourg

and Ireland. Consequently, those ETFs

are primarily supervised and covered

by the relevant investor protection

and compensation schemes of their

country of domicile, which may differ

from the protections offered in the UK.

Therefore, there is a risk that retail

investors may not always be aware of

these differences where they exist.

The FSA has heightened their

supervisory vigilance in this area

and will intervene where they

believe the sale of complex ETFs

or other exchange-traded products

is contributing to poor consumer

outcomes.

Pensions — With the long-term trend

of declining defined benefit pension

schemes, consumers are becoming

increasingly dependent on annuity

income and other private investment

to fund their retirement. In its 2010

Financial Risk Outlook, the FSA

reported that the financial crisis had

materially impacted the value of

investments held by consumers close

to retirement. The FSA is concerned

that such consumers will be vulnerable

to those products that offer potentially

greater returns but that are not suited

to individual circumstances or are

higher risk than appreciated or desired.

Therefore, ensuring that consumers

understand the level of risk, capital

protection, costs and likely impact on

investment return is essential.

Unauthorised Collective Investment

Schemes (UCIS) — The FSA is becoming

increasingly concerned over the sale of

UCIS to consumers. The risks associated

with such funds are not always easy

for advisers and consumers to

understand. In addition, the governance

arrangements and financial structure

of the schemes may themselves cause

risks for investors. For example, many

UCIS may not be subject to investment

and borrowing restrictions, which aim to

ensure a prudent spread of risk and, as

a result, are generally considered to be

higher risk.

Transition to the implementation of

the RDR — The FSA is concerned firms

making changes to their business

models may seek to maximise their

recurring revenue stream before the

RDR is implemented. This could be

by: attempting to acquire a larger

market share, which could result

in unnecessary churn in the retail

investment market and excessive

costs for consumers; building up their

book to increase the attractiveness

of the firm, particularly should they

be planning to leave the market and

sell their business; or increasing the

amount of trail commission on their

United Kingdom


books. As a consequence, the FSA

has heightened their supervisory

vigilance in this area and will continue

to intervene where it believes high

commission levels may be contributing

to poor consumer outcomes.

Platforms — In the third quarter

of 2010, platforms administered

approximately GBP135 billion in IFA

assets. In addition, approximately

50% of all new retail fund investment

business was placed through platforms.

While platforms can bring benefits to

consumers, they also bring a number of

risks. In March 2010, the FSA published

the findings of its thematic review, which

assessed the quality of advice when

recommending investments held on

platforms. The key risks identified were:

• Poor quality of advice in relation to

investments.

• A lack of review of oversight and risk

management procedures.

• Inadequate management of conflicts

of interest.

• Poor standards of disclosure of

information on charges and

ongoing services.

In November 2010, the FSA published a

consultation paper on platforms (CP10/29)

to ensure that platform services would be

fully aligned with the standards required

by the RDR after January 2013. The main

proposals included:

• Preventing product providers from

making payments that advisers

could use to disguise the charge the

customer is paying for advice.

• Ensuring platforms allow their

customers to transfer their

investments elsewhere without

having to cash them in first.

• Requiring platforms to be upfront

about the income they receive from

fund managers or product providers.

• Ensuring that customers who invest

in funds through platforms are

provided with information about

the fund from fund managers and

maintain their voting rights.

The FSA plans to continue monitoring

developments in this market and will

consider whether further regulatory

action is required. The FSA suggests

that firms should ensure that they

only place investments on a platform

where it is considered to be in the

best interests of clients and should

ensure that the oversight and risk

management arrangements of

their business are fit for purpose,

particularly when making changes to

their business model.

Firms’ reward policies and practices

— The FSA is concerned that, in the

current environment in particular,

firms may consider using their reward

policies to achieve specific strategic

targets, which could influence staff

behaviour and pose risks to the

delivery of fair consumer outcomes or

to the effectiveness of controls that

would otherwise mitigate these risks.

As a result, the FSA expects firms

to ensure that they comply with the

revised Remuneration Code. This seeks

to ensure that remuneration policies,

practices and procedures for firms are

consistent with, and promote, effective

risk management and include measures

to avoid conflicts of interest.3

Potential concerns

Business model changes

following the RDR

As already discussed, the RDR may

require asset management firms

to alter their business models — for

example, by changing their charging

structures or launching new share

classes to support the rules on

charging. The way in which funds

are distributed will also undoubtedly

change — for example, some financial

advice firms and advisers are planning

to leave the market because of

the RDR (the FSA estimates that

adviser numbers will reduce by 11%).

Therefore, product providers will have

to identify new strategies to get their

products to market. Some of these

changes may lead to new areas of risk

for consumers.

Next steps

With the RDR on the horizon, business

model change will inevitably require

firms to adopt new processes and the

FSA has outlined that it will be vital for

firms to ensure that their systems and

controls, including the competence

of employees, keep pace with these

changes. The FSA plans to work with

the industry to ensure these risks

are minimised.

Firms should ensure that any

marketing material and sales advice

clearly explains the risks and benefits

of each product and is clear, fair

and not misleading. In particular,

firms should ensure that their KIIDs

meet the requirements of the

UCITS IV Directive.

UCITS IV contains a number of new

rules regarding risk management. By

ensuring that they have a robust risk

United Kingdom

“In the third quarter of 2010, platforms administered approximately GBP135 billion in IFA assets. In addition, approximately 50% of all new retail fund investment business was placed through platforms.”


management framework and process

in place, firms can make great steps

in mitigating many of the risks

outlined in this article.

As always, disclosure and transparency

underpin the strategic objectives of

the FSA to ensure that consumers

are protected. Compliance with the

remuneration standards is just one way

in which firms can achieve this goal.

The FSA’s PRO 2011

The FSA’s PRO provides an

understanding of the overall

macroeconomic and financial trends

in the UK financial system. The FSA

states that regulated firms will need

to take account of that context when

assessing and managing their risks.

This year’s PRO describes still

important risks to financial stability,

but highlights, in particular, the

following:

• Further progress needs to be made

in the deleveraging required to

create a less vulnerable financial

system.

• Further progress needs to be made

towards improving global capital and

liquidity standards and the need to

understand the possible transfer of

risk and migrations to other parts of

the financial system.

• Vulnerable euro-area countries,

commercial real estate and the

potential for rapid property price

inflation in emerging markets

are all important areas of future

credit risk.

• Risks created by a sustained period

of low interest rates, which could

crystallise as and when interest

rates return to more normal levels.

The PRO also sets out macroeconomic

parameters that the FSA will be

using in its supervisory stress tests

of major banks.

Section A: The Macroeconomic Context

This part of the PRO covers

macroeconomic contexts and provides

three scenarios of possible economic

behaviors. These include:

• Weak global and, in particular,

European growth leading to slower

UK growth.

• Rapid global growth leading to

higher inflation and rising

interest rates.

• Two-track global growth with

developed economies lagging behind

emerging markets and the UK facing

both slow growth and rising inflation

and interest rates.

Key messages for firms are provided,

which include statements to the

effect that demand for credit in the

UK is likely to grow more slowly than

nominal GDP for a number of years as

households and parts of the corporate

sector, such as commercial real estate

(CRE) companies, reduce indebtedness

relative to their income. Until

deleveraging is achieved, continuing

high levels of indebtedness in parts of

the household and corporate sectors

will leave the UK economy vulnerable

to economic shocks.

Section B: The UK Financial Sector

Included in this section are banks’

profitability, balance sheet, asset mix

and capital, along with liquidity and

funding in the banking system, risk

transfer between banks, insurance

companies and the “shadow banking

system”, and issues affecting the

insurance sector.

In relation to the transition to

Basel III, the FSA states that it is

planning to keep in place an interim

capital framework until the global

Basel III capital requirements —

agreed by the Basel Committee on

Banking Supervision (BCBS) in 2010

— take effect.

Those capital requirements comprise

the following elements:

• An increase in the minimum

common equity capital ratio to 4.5%

of risk-weighted assets to be phased

in between 2013 and 2015.

• The position of individual banks will

vary relative to this aggregate view.

• The 7% benchmark does not take

account of a potential add-on for

systemically important banks.

• The BCBS is currently undertaking

a fundamental review of the trading

book, targeted for completion by

the end of 2011, which may lead to

higher capital requirements

for banks.

Another potential regulatory

development that may have

implications for medium-term

funding markets is that of “bail-in”

bonds. We have been following

these developments as part of our

UK monthly regulatory updates

with interest. This is where senior

United Kingdom

“As international regulators seek to raise capital standards, limit maturity transformation and control risk taking in the banking sector, the question arises as to how, and to what extent, other parts of the financial system will take on those risks.”


unsecured debt would be made

“bail-in-able” (that is, capable of being

rapidly written down or converted

to equity in order to recapitalise a

potentially failing bank).

The proposals made by the European

Commission, and being discussed

by the Financial Stability Board, are

intended to expose shareholders,

subordinated debt investors and

potentially senior debt investors in

all banks to risk of loss if banks fail,

respecting the creditor hierarchy.

As international regulators seek to

raise capital standards, limit maturity

transformation and control risk taking

in the banking sector, the question

arises as to how, and to what extent,

other parts of the financial system

will take on those risks. Because of

this, the PRO looks at links between

banks and insurers, shadow banking

institutions and hedge funds.

For example, UK insurance companies

are significant investors in the

debt and capital instruments of UK

and overseas banks, and potential

contagion between the banking sector

and the insurance sector needs to

be considered.

Another potential place for risk-taking

activities formerly undertaken by

banks is hedge funds. Hedge funds

may have the potential to pose

systemic risks if they are individually

very large or as a group have similar

leveraged positions, which could

create the risk of a downward, self-

reinforcing spiral of falling liquidity

and asset prices.

Section C: Credit Risks

This section discusses five broad

areas of credit risk to UK firms. These

include euro-area country risks, credit

risks on UK household lending, credit

risk on commercial property lending

in the UK, credit risks on property

lending in the United States and credit

risks in emerging markets.

Section D: The Low Interest-Rate

Environment

Here the FSA’s key messages to firms

contain a recommendation for firms

to prepare for a range of interest-rate

scenarios within their stress-testing

of banking and trading books and in

assessing the vulnerability of their

customers to rising interest rates

within their credit assessments.

Next steps

The FSA expects all financial

institutions to focus strongly on the

specific risks to which their business

mix exposes them.

The FSA plans to incorporate the

findings of both the RCRO and PRO in

its 2011/2012 Business Plan, which will

outline how its supervisory and policy-

making resources will be deployed

over the next twelve months.

1 See “A New Approach to Financial Regulation: Building a Stronger System” in this edition of European News & Views.

2 More detail on those priorities and the resulting resource requirements are included in our article on the FSA’s Business Plan in this edition of European News & Views.

3 See “Casting the Net Wider: The FSA’s Revised Remuneration Code and its Impact on Asset Managers” in this edition of European News & Views.

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The FSA Business Plan 2011/2012

As moving to the new organisational

structure will be a major challenge

for the FSA, the Plan is devoted to

explaining how the FSA will manage

the transition. The FSA estimates that

it will cost between GBP15 million to

GBP25 million to create the FCA and

between GBP75 million to GBP150

million to create the PRA.

Alongside this transition, the FSA

also needs to be able to deliver

against their statutory objectives so

the Plan also explains how this will

be accomplished. At a high level, this

will be achieved by:

• The need to maintain focus on key

issues of financial stability through

prudential supervision.

• Completing the global and regulatory

reform agenda, such as Basel III, and

the resolution of remaining issues

relating to Solvency II.

• Developing a new regulatory

approach to retail customer

protection by changing its approach

and identifying potential customer

detriment before it happens and

intervening to prevent it.

• Maintaining and building on existing

FSA strengths in the areas of markets

regulation and enforcement.

The Plan also sets out the FSA’s

work programme and priorities

for 2011/12.

In his overview at the beginning of

the Plan, FSA Chief Executive Hector

Sants talks about the importance of

recognising the implications of the

changes occurring in the European

Union (EU) regulatory landscape. By

this, he is referring to the creation

of the new European Supervisory

Authorities (ESAs). These ESAs will be

the key policy-making forums in the EU,

leaving the FSA and its successor bodies

primarily acting in the roles of policy

influencers and national supervisors.

The FSA has been able to secure

senior representation in all three

ESAs through appointments to the

Management Boards of both the

European and Securities Markets

Authority (ESMA) and the European

Insurance and Occupational Pensions

Authority (EIOPA) and the vice-chair of

the European Banking Authority (EBA).

The Plan is further organised into

seven sections covering the following.

Delivering regulatory reform in the UK

As already mentioned, last year the

government announced plans to

change the structure of regulation in

the UK. The FSA will be responsible

for transitioning to the new regulatory

structure, but in designing it, it is, and

will, be working closely with both the

Treasury and the Bank of England.

The FSA will be moving to a new

management structure in April 2011

to more accurately reflect the future

structure. However, the FSA will remain

as a unitary entity until formal cutover

to the new structure, which is expected

to be at the end of 2012 or early in 2013.

Delivering financial stability

The FSA’s principal contribution will be

to deliver financial stability by ensuring

that firms are well supervised and

that any emerging threats and risks to

financial stability are acted upon. The

FSA’s Financial Stability Strategy was

published in October 2010 and outlines

the FSA’s thinking in greater detail.

In the future regulatory structure,

financial stability oversight of

As explained in our earlier article, “A New Approach to Financial Regulation: Building a Stronger System”, last year the government

announced plans for fundamental changes to the structure of financial regulation in the UK. This year’s FSA Business Plan (the

Plan) has been shaped by those intended changes and takes account of the findings of the FSA’s Retail Conduct Risk Outlook

(RCRO) and Prudential Risk Outlook (PRO), both of which are covered in more detail in this edition of European News & Views.


United Kingdom

the system as a whole will be the

responsibility of the Financial Policy

Committee (FPC) within the Bank of

England. The Treasury has announced

that from 2011, an interim FPC will be

in operation, with the FSA represented

by FSA Chairman Adair Turner and

FSA Chief Executive Hector Sants.

See the table below for some of the key

initiatives to be taken forward in 2011/12.

Delivering market confidence

The aim is for the FSA to deliver

efficient, clean, orderly and fair markets

that remain attractive and sustainable

both in the UK and internationally. The

creation of ESMA means that rules for

the wholesale markets area are almost

entirely developed by this body. So, a

key priority for the FSA will be to work

at influencing ESMA to ensure its policy

initiatives are aligned with our market

confidence goals.

Three key pieces of work that the FSA

will be working on with ESMA include:

1. The reform of the over-the-counter

(OTC) derivatives market with

the aim of reducing systemic risk:

here the primary objective is to

reduce systemic counterparty risk

management and ensure greater

transparency of OTC markets for

regulators and the public. In 2011/12,

the FSA will have a wide-ranging

commodities agenda.

2. The forthcoming Markets in

Financial Instruments Directive

(MiFID) review: which is to review

the impact of MiFID to make sure

it remains appropriate for current

and future market developments,

which in 2011/12 will mean the FSA

working with the Treasury and

ESMA to influence the final form of

EU proposals to amend MiFID; and

3. The regulation of commodity

derivatives markets: to combat

market manipulation and control or

limit price movements.

Delivering consumer confidence

The FSA’s new consumer protection

strategy, launched in 2010, now seeks to

actively anticipate consumer detriment

and stop it before it occurs. The FSA is

exploring exactly how it can intervene

earlier in the product cycle before risks

develop. The FSA Discussion Paper

DP11/1: Product Intervention, published in

January 2011, discussed this in detail. We

have provided details of the contents of

DP11/1 within our new monthly regulatory

update Bite-sized, so please contact

the UK Fiduciary Technical Team if you

would like to discuss the content of this

DP in further detail.

Another key element of the FSA’s

consumer protection strategy is the

Stress testing

The FSA will continue to refine and improve its approach, which will include an

FSA test based on its own macro-prudential scenario (published annually in the

FSA Prudential Risk Outlook). The FSA will also require firms to conduct more

rigorous stress tests themselves.

Corporate governance

The FSA remain committed to improving standards across the financial

services industry. For example, the September 2010 Policy Statement on

Effective Corporate Governance (PS10/15) introduced new requirements on risk

governance and controls that will become effective in May 2011.

Remuneration

The revised European Code came into effect on 1 January 2011. So, during the

year, the FSA will ensure it is being rigorously applied. Requirements for firms’

remuneration policies and practices are likely to be included in other forthcoming

European Directives, including Solvency II, the Alternative Investment Funds

Managers Directive (AIFMD) and UCITS V.


Retail Distribution Review (RDR), which is

designed to establish a resilient, effective

and attractive retail investment market

in which consumers can have confidence

and trust. The FSA appreciates that the

RDR involves significant change to the

market and plans to publish the rest

of its rules in 2011/12 after carefully

considering the feedback it has received

from the industry. In particular, the FSA

acknowledges industry concerns around

simplified advice and the importance of

ensuring there is a credible simplified

advice service.

Delivering protection against

financial crime

The FSA plans to reduce the extent

to which the industry can be used for

financial crime. Where firms fail to put

in place the right safeguards, the FSA

will take tough enforcement action to

provide a credible deterrent for others.

To support its supervisory work, the

FSA will publish “Financial Crime: A

Guide for Firms”, in 2011, aimed at

regulated firms. This will be a high-

level guide that contains illustrative

case studies and examples of industry

good and bad practice. In May 2011,

the FSA also plans to publish two new

thematic reports: one on high-risk

customers, and one on businesses in

the context of anti-money laundering.

Delivering the FSA operational platform

This section of the Plan covers

the quality and capability of FSA

staff along with IT systems and the

effectiveness of the FSA’s project

delivery. Major programmes for 2011/12

focus on improving systems that

support the FSA’s market surveillance

operations and supervisory analysis.

The 2011/2012 budget

This section explains the FSA’s budget

and funding needs under three headings:

1. Ongoing regulatory activity (ORA)

2. Capital expenditure

3. Annual funding requirement (AFR)

Appendix 4 of the Plan includes a

table that lists the principal European

legislation that the FSA will be working to

influence during 2011/12. Those of most

relevance are detailed in the table below.

Next steps

To ensure that they meet the demands

of the FSA over the coming twelve

months, managers are advised to

ensure that their product design and

governance processes are robust and

adequately documented. In addition,

they should ensure that they have a

suitable and robust risk management

framework in place by 1 July 2011.

And, in relation to the RDR, managers

should be able to deliver the intended

principle changes with regard to the

adviser remuneration commission

structure and ensure that training and

qualification requirements are met.

United Kingdom

EU Legislation Action Detail

Investor Compensation Schemes

DirectiveNegotiation of revised legislation

Negotiations expected to be completed

in 2011

Packaged Retail Investment Products Negotiation of new legislation Draft legislation expected mid-2011

UCITS V Directive Negotiation of new legislation Draft legislation expected Q2 2011

Alternative Investment Fund Managers

DirectiveNegotiation of implementing measures Negotiations continue through 2011

EU Commission Green Paper on

Corporate Governance in Financial

Institutions and Remuneration Policies

Input into ongoing Commission work

on this topic, which could result in

new legislation

Q1 2011 through 2012

European Market Infrastructure

RegulationNegotiation of new legislation

Negotiations expected to be completed

in 2011

Markets in Financial Instruments

DirectiveCommission Review Draft legislation expected mid-2011

Securities Law Directive Negotiation of new legislation Draft legislation expected in 2011

Central Securities Depositories

LegislationNegotiation of new legislation Draft legislation expected in 2011

The above EU legislation has been covered as part of our regulatory publications, so please contact us should you require further details.

“Managers are advised to ensure that they have a suitable and robust risk management framework in place by 1 July 2011.”


United Kingdom

Casting the net wider: the FSA’s revised Remuneration Code and its impact on asset managers

Last year, the FSA consulted on proposals

to amend the Remuneration Code and

published the final rules in a Policy

Statement in December. These changes

to the Remuneration Code incorporate:

• The requirements relating to

remuneration in the Financial

Services Act 2010.

• The amendments to CRD3.

• Adjustments to the Remuneration Code.

• A recommendation of the Walker

Review of corporate governance in

UK banks and financial institutions.

Which firms are affected?

The scope of the Revised Code is much

wider than the old Remuneration Code,

which only applied to a limited number

of large firms, including banks, building

societies and broker-dealers.

Following the revision, it now applies to

firms to which the BIPRU Sourcebook

of the FSA Handbook applies. This

includes all banks, building societies

and investment firms covered by the

Capital Adequacy Directive (CAD).

Investment firms that fall within the

CAD comprise a significant number of

asset managers, most hedge funds and

all UCITS investment firms. However,

investment firms that are exempt

from the CAD are not caught. In total,

the Revised Code now applies to over

2,500 FSA-authorised firms.

It also covers some corporate finance

firms, venture capital firms, firms

providing financial advice, brokers

and a number of multilateral trading

facilities. In addition, some third-

country firms operating in the UK,

which would be in the scope of the CAD

if they were UK-domestic firms, are also

caught. However, firms whose home

state is within the EEA and that have

A new Remuneration Code (Revised Code), which revises the current Remuneration Code, came into force on 1 January

2011. The Revised Code has major implications for all firms to which the Capital Requirements Directive (CRD3) applies

— and not just for those larger firms to which the previous Remuneration Code applied. This includes a large number of

asset managers and UCITS investment firms.


branches in the UK are not covered by

the Revised Code, as they are subject

to the rules that implement the CRD3 in

their home state.

The Revised Code applies to:

• Remuneration awarded, whether

pursuant to a contract or otherwise,

on or after 1 January 2011.

• Remuneration due on the basis of

contracts concluded before 1 January

2011, which is awarded or paid on or

after 1 January 2011.

• Remuneration awarded prior to

1 January 2011, but not yet paid,

for services provided in 2010.

Which employees are affected?

The Revised Code applies to the

following persons, defined in the

Revised Code as “Code Staff”:

• Senior management, i.e. all those

performing SIFs and controlled

functions.

• Risk takers, whose professional

activities have a material impact

on the firm’s risk profile.

• Any other employee receiving total

remuneration that takes them into

the same remuneration bracket as

senior management and risk takers.

The Revised Code also makes it clear that

the pay of those in risk and compliance

departments, as well as those in HR and

legal, should not be substantively linked

to the performance of the business.

Remuneration awarded by a firm

headquartered outside the UK (not

subject to the Revised Code) to an

individual on secondment to a major

firm within the UK would be subject to

the Revised Code.

The Revised Code and

Remuneration Principles

The Revised Code has 12 Remuneration

Principles. The general overarching

requirement of the Revised Code is

that remuneration policies must be

consistent with and promote effective risk

management. This means that firms must

avoid remuneration structures that will

encourage employees to take excessive

risks in order to maximise bonuses. There

is a further general requirement, retained

from the current Remuneration Code

as guidance, that procedures for setting

remuneration within a firm should be

clear and documented.

What are the key issues?

Under Remuneration Principle 4,

which covers governance, firms of a

significant size and complexity must

establish remuneration committees,

whose chair and members are non-

executive directors. Other smaller

firms should have suitable structures in

place to monitor remuneration and, in

addition, remuneration policies must be

reviewed at least annually.

Principle 5 states that remuneration

for employees in risk and compliance

functions must be determined

independently from the business areas

they oversee and should be based

on achieving the objectives of those

functions. Those in risk and compliance

functions shall also have input into

setting remuneration policies in other

areas where appropriate.

Principle 6, on remuneration and capital,

requires all firms covered by the Revised

Code to ensure that their total variable

remuneration should not limit their

ability to strengthen their capital bases.

Principle 8 provides that firms must

take into account current and future

risks when determining variable

remuneration.

Principle 12 deals with the structure

of remuneration awards and covers a

number of key issues. These include:

• The proportion of remuneration

to be provided in shares: at least

50% of variable remuneration

should be provided in shares or

equivalent instruments.

• Deferral: at least 40% of variable

pay should be deferred, rising to

60% where variable pay is more than

GBP500,000. The deferral should

be for no less than three years,

with amounts vesting pro rata over

the period. Amounts that have not

vested may be reduced in the event

of employee misbehaviour or error/

material downturn.

• Guaranteed bonuses and severance:

tighter constraints on guaranteed

new hire and retention bonuses.

Severance pay should not reward

poor risk behaviour or business

performance.

These specific issues only apply to

individuals at firms that have:

• A total remuneration of more than

GBP500,000.

• Variable remuneration (i.e. bonuses

and long-term incentives) of 33% or

more of that total remuneration.

How will firms be expected to

apply the Revised Code?

When a firm applies the new total

remuneration policies for Code

Staff, it must comply with the new

rules “in a way and to an extent that

is appropriate to its size, internal

organisation and the nature, scope and

complexity of its activities”. The FSA

calls this approach proportionality.

All firms caught by the Revised Code

are divided into four proportionality

“Tiers”. This approach allows for a

minimum set of the new rules to be

applied to all firms, whereas other rules

may be applied or disapplied depending

on which of the four Tiers a firm fits

into. In deciding into which Tier a firm

should fall, the FSA takes into account

the nature of the firm and its internal

organisation, size and complexity.

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Broadly, Tiers 1 and 2 contain credit

institutions and broker-dealers who

engage in significant proprietary trading

and investment banking activities. Tier

3 consists mainly of small banks and

building societies and firms that take

short-term risks with their balance

sheets. Tier 4 contains firms that

generate income from agency business

and do not put their balance sheets at

risk. This includes all limited licence and

limited activity firms.

The FSA has also stated that it will

apply a proportionate approach to

firms within each Tier, so as to avoid

major differences between applying the

Revised Code to firms at the

lower end of one Tier and the higher

end of the next.

Firms in Tiers 3 and 4 are not

expected to apply rules that the

guidance provided by the Committee

of European Banking Supervisors

(CEBS) in December 2010 recommends

may be disapplied. These include

the requirement to have a UK-based

remuneration committee, deferral

and the proportion of variable

remuneration to be paid in shares.

At the end of last year, the FSA also

published a separate Policy Statement

clarifying its remuneration disclosure

requirements.

Supervision and enforcement

The FSA now incorporates reviews of

firms’ remuneration policies into its

existing supervisory framework. It uses

the ARROW framework to implement

the Revised Code in a risk-based way.

Firms must submit a minimum level of

data each year, including a declaration,

in the form of a “Remuneration

Policy Statement”, that the firm’s

remuneration policies are compliant

with the Code. Firms must also provide

information on Code Staff.

The Financial Services Act 2010

provides the FSA with express powers

to deal with breaches of the Revised

Code, in particular:

• The authority to rule as void

contractual provisions that breach

the Revised Code.

• To recover the payments made or

property transferred under such a

void provision.

These express powers only apply

to individuals at firms who have

a total remuneration of more

than GBP500,000, and variable

remuneration of 33% or more of that

total remuneration.

Implementation and steps

to be taken

All firms were required to have in place

procedures and appropriate governance

arrangements by the start of 2011,

although they had until the end of

January in which to rectify any shortfalls.

However, the FSA does appreciate that

other measures will take time to be put

in place. Firms outside Tier 1 should

be able to demonstrate that they have

considered the impact of future risks

and uncertainties on their bonus pools

and that these shall be considered when

determining future bonus pools. However,

prescribed remuneration structures,

such as minimum levels of deferral and

performance adjustment, do not need to

be in place for firms newly caught by the

Revised Code until 1 July 2011.

If they have not already done so, firms

should immediately take steps to:

• Update their remuneration policies,

structures and practices in line with

the provisions of the Revised Code,

including setting minimum levels of

deferral and performance adjustment.

• Consider and implement the necessary

changes to their corporate governance

structures as soon as possible.

• Prepare a list of Code Staff and notify

these individuals of the implications

of the Revised Code.

For those larger firms to which the old

Remuneration Code already applied,

the FSA expected all appropriate

policies, procedures and performance

measurement tools to be in place

by 1 January 2011. Indeed, the FSA

was quick to announce its intention

to review these larger firms’ plans

for their 2010 remuneration awards

against the Revised Code.

Charlotte Hill

Partner

Stephenson Harwood

United Kingdom

“The general overarching requirement of the Revised Code is that remuneration policies must be consistent with and promote effective risk management. This means that firms must avoid remuneration structures that will encourage employees to take excessive risks in order to maximise bonuses.”


Ireland

The Central Bank of Ireland raises the bar in fitness and probity standards

The purpose of the consultation is

twofold: the designation of certain

positions in regulated financial

services providers as either Pre-

Approved Control Functions (PCF)

or Control Functions (CF), and

the determination of the standards

of fitness and probity, which must

be met to ensure compliance with

the Regulations.

A PCF is essentially a job function

requiring Central Bank pre-approval

before the position can be assumed.

A CF does not require pre-approval,

but individuals in CF positions can be

removed from their respective roles

if they are not deemed by the Central

Bank to be meeting the fitness and

probity standards. The term “fitness”

focuses on the competence and

capability of the individual; “probity”

refers to an individual’s ethical

makeup. We will elaborate further

on the exact meaning of these terms

throughout the course of this article

while summarising some of

the more pertinent points outlined

in the consultation paper.

Background

In the wake of the financial crisis, the

analyses performed by the Central Bank

highlighted the following two areas in

which shortcomings were evident:

1. Weak or absent corporate

governance.

2. Board members and senior

management members who were

complacent, lacked knowledge and

expertise, and/or did not understand

the risks associated with their

business and the wider economy.

The Central Bank has begun to

address these shortcomings in the

following ways:

1. The introduction of a

comprehensive corporate

governance regime for banks and

insurance companies.

2. The development of appropriate

corporate governance regimes for

other sectors of the financial services

industry, such as the draft of the

corporate governance code for the

investment fund industry (mentioned

in the first edition of European News

& Views earlier this year).

3. Additional statutory powers have

been granted that enable the

Central Bank to apply an enhanced

fitness and probity regime to

individuals across all regulated

financial services providers. These

powers were granted under the Act

in October of last year.

The Regulations will apply to all

regulated financial services providers

except credit unions. Some examples

of the types of entities that will fall

within the remit of this new fitness

and probity regime are trustees/

custodians, UCITS and Non-UCITS

self-managed investment companies,

MiFID/Investment Intermediaries

Act investment firms, insurance

undertakings, credit institutions and

fund administrators.

PCFs and CFs

Under the proposed Regulations, the

Central Bank may now designate a

function in a regulated institution

(with the exception of credit unions)

as a PCF or a CF. One of the primary

On 23 March 2011, the Central Bank of Ireland (the Central Bank) released a consultation paper on amendments to the

Fit and Proper Regime (the Regulations) as per the Central Bank Reform Act 2010 (the Act). Given the relatively tight

implementation deadline of 1 September 2011, we have decided to focus on this topic.1


Ireland

differences between the classifications

is that individuals designated as PCFs

must be deemed/approved as fit and

proper before they can take up their

positions, whereas for CFs, while prior

approval of appointments will not be

required, can be removed from their

positions if they are not deemed to

meet the requisite standards of fitness

and probity.

The Act is quite prescriptive in setting

out the relevant criteria applying to

positions that may constitute PCFs and

CFs. In the case of regulated financial

service providers established in the

state for example, positions such as

head of finance, head of compliance,

head of internal audit and head of risk

are just some of those designated as

PCFs. PCFs would generally tend to

be those individuals involved in the

management of a particular provider.

On the other hand, specific examples

are not given for CFs other than to

outline that they relate to functions

such as the provision of advice to

consumers, the “giving of assistance”,

compliance monitoring and any

function that would enable a person

to exert significant influence on the

conduct of the affairs of an entity.

Although CFs do not require the prior

approval of the Central Bank, firms are

still required to carry out appropriate

due diligence prior to appointing

individuals to CF positions. As part

of the consultation, the Central Bank

has invited submissions on the most

appropriate guidance to firms in

relation to the level of due diligence

that should be carried out prior to

appointing individuals to CF positions.

Interestingly, the Central Bank may

even change its classification and

prescribe a CF as a PCF if the person

performing the function reports

directly to a director, company

secretary or chief executive, although

the concept of proportionality will

apply here in terms of the size or

complexity of the regulated financial

services provider. The Central Bank

can also determine that a function is

a PCF if:

1. The person performs a

management function.

2. The function is not prescribed in

the regulations as a PCF.

3. There are no other PCFs in the

particular provider.

Fitness vs probity

As stated earlier, the aim of these

Regulations is to apply enhanced

fitness and probity standards to

individuals in regulated financial

services providers. However, what

do the terms “fitness” and “probity”

actually mean? Thankfully these are

outlined in detail in the Consultation

Paper. The term “fitness” focuses on

the competence and capability of the

individual. An individual is required

to have the competence necessary to

perform the CF or the PCF for which

he or she is proposed. This can be

demonstrated by the qualifications and

experience of the individual, but the

Central Bank has specified that it may

also require individuals to demonstrate

capabilities such as the ability to

understand internal governance

and risk management concepts and

the overall business model of the

entity. Competency requirements are

expected to vary as they will depend

on the exact nature of the role along

with the size and activity of the entity

within which it is proposed.

To meet the requirements of

“probity” people in PCF and CF

roles must be honest, diligent and

independent-minded; should act in

an ethical manner with both integrity

and fairness; and should be able to

ensure they act without any conflict

of interest. Probity is really a matter

of character, and the Central Bank

believes this can be demonstrated

to a certain extent, although not

exclusively, by a person’s past

“Under the proposed Regulations, the Central Bank may now designate a function in a regulated institution (with the exception of credit unions) as a PCF or a CF.”


behaviour. However, the Central Bank

acknowledges that Probity is too broad

a concept to be specifically defined

using examples. Unlike Fitness, it is

expected that the same standards of

probity will apply, irrespective of the

size and activity of the entity involved.

Financial soundness

Although not reflected in the name of

this new regime, a third area that the

Central Bank will focus on is that of

financial soundness. This is relevant as

the Central Bank deems that this can

have an impact on or reflect upon a

person’s competence or probity.

Financial soundness is regarded as

encompassing two areas: personal

bankruptcy and association with the

bankruptcy of a company. It has been

clarified as having nothing to do

with an individual’s personal wealth.

Where an individual has experienced

problems with his or her financial

affairs or where perhaps his or her

actions have had a negative financial

impact on others, the Central Bank has

stated that the person’s competence,

honesty and integrity could be

called into question and may as a

result require the instigation of an

investigation into any questionable

events in the person’s past. The same

approach would equally apply where

a person has had any dealings with an

entity that became insolvent.

Transitional arrangements

This new regime will come into effect

on 1 September 2011. Individuals

designated as PCFs and CFs at that

date will continue in those positions.

However, firms are not permitted to

allow an individual to carry out a CF

unless the firm is satisfied that the

person meets these new fitness and

probity standards and the person

has agreed to abide by them. The

PCF requirement to apply for the

Central Bank’s pre-approval will

apply to all new applicants after the

commencement of the Regulations on

1 September, while people in existing

functions prescribed as PCFs by the

Regulations are not required to seek

the Central Bank’s written approval to

continue in such roles or functions,

though they will fall within the Central

Bank’s powers concerning CFs. A

person filling a PCF role temporarily

will not be held responsible for the

performance of that role provided

there is an agreement in writing with

the Central Bank in advance of such

person assuming that role.

Firms will also be required to submit

lists of the individuals in PCF roles

(at the date on which the Regulations

come into effect) to the Central Bank

by 31 December 2011. The boards of

these firms will need to sign-off that

the people in these lists meet the

fitness and probity standards issued

under section 50 of the Act.

The closing date for submissions in

response to the Consultation Paper

was Friday 20 May.

Conclusion

The proposed changes place the

burden of compliance on the actual

regulated financial services providers

themselves as much as on the Central

Bank. It should also be noted that the

Central Bank’s Minimum Competency

Requirements of June 2006, where

relevant to an individual in a particular

PCF or CF role, will also continue to

apply after the new regime comes into

effect on 1 September.

Ireland

“The proposed changes place the burden of compliance on the actual regulated financial services providers themselves as much as on the Central Bank.”

1 Consultation Paper 51: The Fit and Proper Regime in Part 3 of the Central Bank Reform Act 2010, published by the Central Bank of Ireland on 23 March 2011.


Luxembourg

Luxembourg regulated infrastructure funds

Against this backdrop, it is widely

expected that the number of

vehicles, regulated or not, that will

be established in the years to come

to invest in infrastructure will grow

significantly. Luxembourg non-

regulated vehicles such as SOPARFIs

(sociétés de participation financières)

have been widely used by institutional

investors to structure investments,

including in infrastructure assets, for

quite some time now.

Since 2004, we have also seen

more and more infrastructure funds

being established in Luxembourg as

investment companies in risk capital

(sociétés d’investment en capital à

risque or SICARs) or (since 2007)

specialised investment funds (SIFs).

Although this structure is sometimes

outshined by the SICAR and SIF

regimes, which are more widely used,

there is a third regime available in

Luxembourg that is appropriate for

the structuring of infrastructure

funds: the funds subject to Part

II of the Act of 17 December 2010

on undertakings for collective

investment (Part II Funds).

Luxembourg is uniquely placed to

emerge as the domicile of choice

in Europe for the establishment of

infrastructure funds. As the second-

largest worldwide domicile for funds

As an asset class for private investors, infrastructure has a huge growth potential. There is an increasing need around

the world for better infrastructure in all sectors, including transport, utilities, communications, energy and social

infrastructure. At the same time, public expenditure is being strained because of the crisis. Governments are turning to

the private sector to compensate for the deficit of public investments in infrastructure. So, private investors are more

and more frequently being offered the opportunity to invest in infrastructure. These investments are seen by many

institutional investors as an attractive way to diversify their portfolio because of their low correlation with other asset

classes and high potential returns, among other things.

“It is widely expected that the number of vehicles, regulated or not, that will be established in the years to come to invest in infrastructure will grow significantly.”


Luxembourg

after the US, Luxembourg offers real

advantages compared with other

jurisdictions. It is a highly stable

(politically, financially and tax-wise)

EU Member State with sound public

finance; it is well recognised; it has

a broad-based range of service

providers; it is multilingual; it already

has in excess of EUR2.1 trillion

domiciled in fund assets and a strong

reputation, including in the field of

alternative assets.

The purpose of this article is to

outline some of the main features

of the three regulated vehicles

available in Luxembourg for

structuring an infrastructure fund

(SIFs, SICARs and Part II Funds) and

to mention some elements likely to

be relevant for the initiator of an

infrastructure fund when choosing

between these three vehicles.

Main common features of SIFs

and SICARs

The SIF or the SICAR will generally

appear as the most appropriate

Luxembourg vehicles for the set-up

of a regulated infrastructure fund.

At international level, over time, both

vehicles have gained an enviable

reputation for the structuring of

infrastructure funds.

SIFs and SICARs share many

common features:

• They benefit from very flexible

corporate rules. There are no legal

constraints on the rules applying

to the issue and redemption of

shares of SIFs or SICARs (including

those applying to the issue price),

which are to be determined in

their constitutive documents.

They are not subject to specific

restrictions in terms of payment

of dividends (except for basic

minimum requirements in terms

of net assets). Also, they may be

established with variable capital

(in which case the share capital is

automatically increased or reduced

upon the issue of new shares or the

redemption of existing shares).

• They may be structured as

umbrella vehicles with multiple

compartments, each compartment

corresponding to a distinct part of

the assets and liabilities of the SIF

or SICAR. Each compartment of the

umbrella SIF or SICAR can display

specific features. Within the same

umbrella, it is possible, for instance,

to combine open-ended and closed-

ended compartments, fully funded

compartments and compartments

with a drawdown capital structure,

compartments with different fee

or carried-interest structures,

compartments reserved for one

or several investors or categories

of investors, etc.

• They are subject to the supervision

of the Luxembourg supervisory

authority (Commission de

Surveillance du Secteur Financier,

or the CSSF).

• They are reserved for subscription

by well informed investors. This

concept is broadly defined and

covers institutional investors and

any other investor committing to

invest at least EUR125,000 in the SIF

or SICAR and confirming in writing

that it accepts to be considered as a

well informed investor.

The structure of infrastructure funds

are generally based on the typical

model of private equity funds. They

are generally set up with a fixed term

(typically longer than for private

equity funds), where investors commit

to subscribe a certain amount to the

fund, which can be called upon each

time there is a need to finance an

investment. Also, the management

is generally remunerated through

the combination of a management

fee and a carried interest. Both the

SIF and the SICAR regimes provide

very wide flexibility for initiators of

infrastructure (and private equity)

funds to tailor their funds to their

own needs.

The FCP structure: not available

for SICARs

There is one structuring option that

is available to SIFs and not to SICARs:

the FCP structure. While SICARs may

only be established as companies,

SIFs may also be established under

contractual form as fonds communs

de placement (FCPs). An FCP may

be compared to a unit trust under

English law and must be managed

by a management company (société

de gestion) that must be established

in Luxembourg. Most Luxembourg

infrastructure funds are established

as companies. Several corporate

forms are available under the SIF

“The structure of infrastructure funds are generally based on the typical model of private equity funds. They are generally set up with a fixed term where investors commit to subscribe a certain amount to the fund, which can be called upon each time there is a need to finance an investment.”


Luxembourg

and the SICAR regimes. The one

which is the most frequently used for

funds of this type is the corporate

partnership limited by shares (société

en commandite par actions) where

the management of the fund belongs

to the general partner.

Key drivers for the choice between

a SIF and a SICAR

Tax

The choice between a SICAR and

a SIF for the structuring of an

infrastructure fund will sometimes

be driven by tax considerations. Both

the SICAR and the SIF benefit from an

attractive tax regime, but these two

regimes are fundamentally different.

The SICAR is in principle subject to

the ordinary Luxembourg taxation

regime,1 which in principle enables

it to benefit from double taxation

treaties and EU tax directives.2

However, income generated by

securities (including capital gains on

the disposal of these securities) held

by a SICAR is exempt from taxation.

This generally enables SICARs to

avoid any material taxation. SIFs are

tax-exempt vehicles, except for a

0.01% annual subscription tax levied

on their net assets. They do not

have access to most double-taxation

treaties and to EU tax directives.3

The choice of the most appropriate

vehicle from a tax standpoint has to

be assessed on a case-by-case basis,

depending, among other things, on

the specific tax situation of targeted

investors and the localisation of

proposed investments.

Tax optimisation aside, the choice

between a SIF and a SICAR for the

set-up of an infrastructure fund will

generally depend on the expected

level of diversification of its portfolio

and the type of investments targeted.

Portfolio diversification

The SIF structure is only available

if the infrastructure fund complies

with certain basic risk diversification

requirements. SIFs must have as

their objective the building-up of

a diversified portfolio of assets.

According to a circular issued by

the CSSF, a SIF (or a compartment

thereof) may not invest more than

30% of its gross assets into one

and the same investment. This

maximum concentration ratio must

be met at the end of a portfolio

building phase that may not last

more than four years. The initiator

of an infrastructure fund, which may

not comply with this 30% maximum

concentration ratio, must opt for the

SICAR structure.4

However, the AIFM Directive 5 could

open the door to a potential

relaxation of the 30% maximum

concentration ratio for SIFs.

Compliance with the risk

diversification principle is not a

constitutive element of an alternative

investment fund under the AIFM

Directive.6 This does not seem to be

an oversight. Rather, it seems that the

European lawmaker’s intention was to

cover all types of investment funds, 7

whether or not they had a diversified

portfolio. Therefore, it does not seem

completely unreasonable to expect

that, in the context of the

implementation of the AIFM Directive,

the risk diversification limit applicable

to SIFs could be somewhat relaxed.

By contrast, SICARs are not subject

to any risk diversification obligations.

The SICAR is currently the sole

“The SICAR is currently the sole Luxembourg investment vehicle in which it is possible to combine a multiple compartment structure with the absence of risk diversification. This makes possible, for instance, the structuring of à la carte investment programmes.”


Luxembourg investment vehicle in

which it is possible to combine a

multiple compartment structure with

the absence of risk diversification.

This makes possible, for instance, the

structuring of à la carte investment

programmes, whereby investors

can decide on a case-by-case basis

whether or not to participate in

certain investments by isolating

those into a separate compartment.

Type of investments: the risk

capital criterion

The type of investments

contemplated is also relevant in the

choice of the appropriate structure.

While SIFs may invest in virtually any

asset class, SICARs may exclusively

be used for investing in risk capital.

The Act of 15 June 2004 on the

SICAR does not include a detailed

definition of the concept of risk

capital. Back in 2006, the CSSF

published an administrative circular

providing further guidance

on what constitutes “risk capital”

in its eyes.

According to this circular,

the concept of risk capital is

characterised by the coexistence

of two key elements: the existence

of “high risk” associated with the

relevant assets and the intention to

“develop” the target entity/assets.8

The reference to the concept of high

risk may appear at first sight to be

incompatible with infrastructure

investments, which generally have a

reputation for guaranteeing stable

cash flows. But this has been put

into question by recent research.

A study published by the European

Investment Bank did not find

evidence supporting the hypothesis

that infrastructure investments

offer more stable cash flows than

other investments.9

Several SICARs have as their

objective to invest in infrastructure.

In practice, the eligibility of the

strategy of an infrastructure fund to

be established as a SICAR is analysed

on a case-by-case basis by the CSSF.

This assessment takes into account

the way the fund is structured and its

exit strategy and investment horizon,

among other factors. In principle, it is

also necessary to demonstrate that

the SICAR will effectively have as its

investment strategy to develop the

target company(ies) or underlying

projects. This assessment must be

made on a case-by-case basis as

infrastructure investments do not

constitute a homogeneous asset

class and infrastructure assets have

a different risk profile depending on

the type of investment (greenfield or

brownfield) 10 and on the relevant

sector (energy, transport, etc).

The necessity for the CSSF to

check the eligibility of the proposed

investment strategy of a SICAR in

light of the risk capital criterion

makes the approval process less

straightforward for a SICAR than for

a SIF. No similar verifications have

to be made for SIFs that are not

subject to any restrictions in terms

of eligible assets. This is the reason

why SIFs may be launched without

the prior approval of the CSSF,

something which is not permitted

for SICARs.

Part II Funds

In contrast, Part II Funds are not

subject to any restrictions in terms

of investor eligibility. SIFs and

SICARs are reserved for investment

by well informed investors. Although

this restriction is not an obstacle to

a technical listing, it precludes the

development of an active secondary

market. Therefore, the SIF and

SICAR are not appropriate vehicles

for the set-up of funds applying

for a listing with a view to developing

an active trading of their shares

on the market.

Luxembourg

“The optimal choice among these three structures will depend on a series of factors, including the type of investors targeted, the level of diversification of the fund’s portfolio and whether it is intended to develop an active trading of the fund’s shares through a listing.”


Luxembourg

1 It is also possible to set up a SICAR as a limited partnership (société en commandite simple), which is fiscally transparent.

2 Council Directive 2003/49/EC of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States, as amended and Council Directive 90/435/EEC of 23 July 1990 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States, as amended.

3 It is possible to set up a SIF as an FCP, which is fiscally transparent, or a SICAV, which is fiscally opaque.

4 CSSF circular 07/309 dated 3 August 2007 on risk-spreading in the context of specialised investment funds (SIFs).

5 Draft directive on alternative investment fund managers.

6 If adopted under the form approved by the European Parliament in November 2010.

7 Excluding UCITS and other exempted investment vehicles.

8 Circular 06/241 of 5 April 2006, p. 1.

9 F Bitsch, A Buchner, C Kaserer, “Risk, Return and Cash Flow Characteristics of Infrastructure Fund Investments”, EIB Papers, Vol. 15, n°1, 2010, pp. 129, 130. See also G Inderst, “Infrastructure as an Asset Class”, EIB Papers, Vol. 15, n°1, 2010, p. 99.

10 Brownfield investments refer to investments in assets already operational and generate cash flows. By contrast, greenfield investments refer to the financing of projects involving the construction of a new infrastructure asset. For a description of the different risk profiles of brownfield vs. greenfield investments, please refer to B Weber and H W Alfen, Infrastructure as an Asset Class, Wiley, 2010, p. 17., and PFG, Investing in Infrastructure Funds, September 2007, p. 8.

11 2010 Preqin Global Infrastructure Report, p. 43.

Certain infrastructure funds

enter into this category. Most

infrastructure funds are established,

based on the model of private equity

funds, with a fixed term and a capital

drawdown structure.

However, other infrastructure funds

are set up as evergreen structures,

without capital call mechanisms.

These funds turn to the capital

market through a listing in order to

collect capital. For these funds, the

development of an active secondary

market is an absolute must as they

are at the same time closed-ended

and set up for an unlimited period

of time. The only liquidity they

offer to their investors is through

the listing. According to Preqin,

the number of listed infrastructure

funds have increased globally ten to

forty-eight, including five that were

launched in 2010. 11

In Luxembourg, an infrastructure

fund seeking to develop an active

secondary market through a listing

of its shares must be established as

a Part II Fund. Part II Funds being

authorised to distribute their shares

to retail investors are subject to

certain rules, which aim to ensure

a higher level of investor protection

than that imposed under the SIF

and SICAR regimes. For instance,

Part II Funds are subject to more

prescriptive investment limits than

SIFs. In principle, they may not invest

more than 20% of their assets into

one and the same target.

Conclusion

Luxembourg offers a range of

three regulated vehicles that are

appropriate for the structuring of

infrastructure funds.

The optimal choice among these

three structures will depend on a

series of factors, including the type

of investors targeted, the level of

diversification of the fund’s portfolio

and whether it is intended to develop

an active trading of the fund’s shares

through a listing.

Whatever the infrastructure’s

specific needs and requirements,

it is very likely that the initiator

of such a fund will find, among

the array of Luxembourg vehicles

available, a suitable structure.

Jean-Christian Six

Partner

Allen & Overy

Luxembourg


Glossary

AFR Annual Funding Requirement

AIFMD Alternative Investment Fund Managers Directive

ARROW Advanced Risk-Responsive Operating FrameWork

BCBS Basel Committee on Banking Supervision

BIPRU UK Prudential Sourcebook for Banks, Building Societies and Investment Firms

CBU UK Conduct Business Unit

CEBS Committee of European Banking Supervisors

CF Control Functions

CIS Collective Investment Scheme

CRD Capital Requirements Directive

CRE Commercial Real Estate

CSD Credit Default Swap

CSSF Commission de Surveillance du Secteur Financier

EBA European Banking Authority

ECON EU Parliament’s Economic and Monetary Affairs Committee

EEA European Economic Area

EEC European Economic Community

EIOPA European Insurance and Occupational Pensions Authority

EIU European Intelligence Unit

EMEA Europe, the Middle East and Africa

ESA European Supervisory Authorities

ESMA European Securities and Markets Authority

ESRB European Systemic Risk Board

ETF Exchange-traded fund

EU European Union

FCA UK Financial Conduct Authority

FCP Fonds Communs de Placement

FI Finansinspektionen — Swedish financial supervisory authority

FPC Financial Policy Committee

FSA UK Financial Services Authority

FSB Financial Stability Board

FSMA UK Financial Services and Markets Act 2000

FTfm Financial Times Fund Management


GDP Gross domestic product

HR Human resources

IBC Independent Banking Commission

ICSD Investor Compensation Scheme Directive

IFA Independent Financial Adviser

IMF International Monetary Fund

IOSCO International Organisation of Securities Commissions

KIID Key Investor Information Document

LHFI Lag om Handel med Finansiella Instrument — Swedish Financial Trading Act

LVM Lag om Vardepappersmarknaden — Swedish Financial Markets Act

NAV Net asset value

MiFID Markets in Financial Instruments Directive

ORA Ongoing Regulatory Activity

OTC Over-the-counter (derivatives)

PBU UK Prudential Business Unit

PCF Pre-Approved Control Functions

PRA UK Prudential Regulation Authority

PRIPs Packaged Retail Investment Products

PRO Prudential Risk Outlook

RCRO Retail Conduct Risk Outlook

RDR Retail Distribution Review

SAR Special Administration Regime

SICAR Sociétés d’Investment en Capital à Risque

SIF Significant Influence Function

SIFs Specialised Investment Funds

SIFA Swedish Investment Funds Association

SLD Securities Law Directive

SOPARFI Sociétés de Participation Financière

TSC UK Treasury Select Committee

UCIs Undertakings for Collective Investment (Part II Funds)

UCIS Unauthorised Collective Investment Scheme

UCITS Undertakings for Collective Investment in Transferable Securities


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future content or if you would like to write an article in the next edition, please do not hesitate to contact either Amanda

Hale or Selina Staines at: [email protected].

Europe

David Morrison

Director and Head of Fiduciary

Services, EMEA

[email protected]

Tel: +44 (0) 20 7500 8021

Ireland

Robert Hennessy

Head of Fiduciary Services, Ireland

[email protected]

Tel: +353 1 622 6112

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Head of Trustee Client Management

and Fiduciary Monitoring

[email protected]

Tel: + 353 1 622 1015

Jersey

Ann-Marie Roddie

Fiduciary Manager

[email protected]

Tel: +44 (0) 1534 608 201

Luxembourg

Patrick Watelet

Head of Fiduciary Services,

Luxembourg

[email protected]

Tel: +352 451 414 231

Francis Pedrini

Fiduciary Relationship Manager

[email protected]

Tel: +352 451 414 228

Davide Tassi


[email protected]

Tel: +352 451 414 630

Ulrich Witt


[email protected]

Tel: +352 451 414 520

United Kingdom

Therese Lundi

Fiduciary Business and Relationship

Manager

[email protected]

Tel: +44 (0) 131 524 2825

Iain Lyall

Head of Relationship Management

[email protected]

Tel: +44 (0) 20 7500 8356

Francine Bailey

Senior Fiduciary Relationship Manager

[email protected]

Tel: +44 (0) 20 7500 8580

Andrew Newson

Senior Fiduciary Relationship Manager

[email protected]

Tel: +44 (0) 20 7500 8410


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