UK/EU Investment Management Update (October 2024)

1. UK — Enforcement / Financial Crime

2. UK — Securitisation Regulation

3. UK — Sanctions

4. UK — Retail Funds

5. UK — Tax

6. EU — Securitisation

7. EU — NBFI

8. EU — ESG

9. EU — MiFID

1. UK — Enforcement / Financial Crime

FCA publishes 2023/24 enforcement data

On 5 September 2024, the FCA released its Annual Report and Accounts 2023/24, which includes enforcement data for the same period.

The FCA has reported current enforcement operations by reference to its “strategic priorities”: (i) reducing and preventing financial crime; (ii) strengthening wholesale markets; and (iii) protecting consumers. Among these priorities, financial crime stands out, constituting 83 of the 188 operations open at year end (31 March 2024).

Additionally, since the 2022/23 report, the number of threshold condition cases opened has increased from 1,206 to 4,194, indicating a focus on firms meeting the minimum standards for authorisation. This increase is largely attributable to the following:

• Use It or Lose It (UIOLI) – since May 2021, the FCA has been carrying out an initiative to cancel firms’ inactive or outdated permissions on the Financial Services Register. From 2022/23 to 2023/24, the number of UIOLI cases opened has more than quadrupled, demonstrating that this is a continuing priority.
• Regulatory Returns – firms’ submission of regulatory returns has been another clear focus for the FCA. Cases opened in this area increased from 232 in 2022/23 to 1,056 in 2023/24.
• Firm Details Attestations – FCA-regulated firms are required to complete an annual Firm Details Attestation in order to keep firm details up to date. The number of Firm Details Attestation cases opened in 2023/24 increased from 203 to 996.

FCA begins criminal proceedings against two individuals for insider dealing

On 3 October 2024, the FCA announced that it had commenced criminal proceedings against two men for conspiracy to deal in stocks while having inside information between 2016 and 2020.

Matthew and Nikolas West are jointly charged with conspiracy to deal in four stocks while having inside information. Matthew West has been charged with insider dealing in relation to two stocks. He has been charged with disclosing to and encouraging Nikolas West to deal in two stocks, while Nikolas West has been charged with dealing in the same two stocks based on that insider information.

The alleged offending resulted in a profit of around £110,000 for the two men.

As the offences are alleged to predate 1 November 2021, the insider dealing here is punishable by a fine and/or up to seven years’ imprisonment. Had the offence occurred on or after 1 November 2021, the maximum sentence would be ten years’ imprisonment.

A Crown Court trial will take place on 31 October 2024.

FCA enforcement action upheld on appeal

On 2 October 2024, the Court of Appeal upheld an appeal by the FCA with regards to an enforcement action against BlueCrest Capital Management (UK) LLP (BlueCrest). The Court of Appeal decision can be read in full here.

In December 2021, the FCA had published a Decision Notice against BlueCrest, imposing: (i) a fine of £40,806,700 for conflicts of interest failings; and (ii) a requirement on the firm to pay redress to clients (of an estimated US$700 million).

BlueCrest then referred its case to the Upper Tribunal, which had:

• ruled that the FCA did not have the power to impose a redress requirement; and
• decided that it was unable to consider certain new allegations and issues the FCA had sought to introduce into the tribunal proceedings in response to arguments BlueCrest had put forward as part of its defence.

Subsequently, the FCA appealed against the Upper Tribunal’s decision, and its appeal has now been upheld by the Court of Appeal. The FCA’s press release on this case notes that this has important wider implications both for the FCA’s ability to secure redress for consumers and its ability to conduct litigation before the Upper Tribunal effectively.

Starling Bank fined £29 million for financial crime failings

On 27 September 2024, the FCA published a Final Notice to Starling Bank Limited (Starling) issuing a fine of £29 million for failings in Starling’s financial sanctions screening and repeated breaches of a requirement not to open accounts for high-risk customers. Although the case relates to challenger bank, the systems and controls considerations are equally relevant to asset managers.

In this instance, regulatory intervention began in 2021, when the FCA notified Starling of serious concerns over its anti-money laundering (AML) and sanctions screening processes. Starling had agreed with the FCA to pause new accounts for “high-risk customers” but, in contravention of that requirement, opened accounts for almost 50,000 such customers between September 2021 and November 2023.

Additionally, it transpired in 2023 that the sanctions screening system used by Starling screened new and existing customers against only part of the consolidated list maintained by the Office of Financial Sanctions Implementation (OFSI).

Starling cooperated with the FCA and has both rectified these breaches with new AML and sanctions frameworks and enhanced its general compliance resources. For this reason, the proposed fine of £41 million was reduced to £29 million.

Notably, this case took only 14 months from opening to achieving an outcome (by contrast, the average for cases closed in 2023/24 was 42 months).

FCA speech on outcomes-based approach to financial crime

On 5 September 2024, FCA Executive Director Sarah Pritchard delivered a speech at the International Financial Crime Summit in London. The speech details various aspects of the FCA’s financial crime strategy, noting that financial crime is a key commitment in its three-year strategy for 2022-2025.

The speech highlights various instances of the FCA’s targeted approach to financial crime enforcement. For instance, it notes that:

• in last financial year, 21 individuals were charged with financial crime offences (the highest number of charges the FCA has achieved in any single year);
• in 2023, the FCA secured three times as many freezing orders as in 2022; and
• in August 2024, the FCA issued a £15 million fine against an accounting firm for failing to alert it to suspected fraudulent activity.

The FCA is also focusing on preventative measures, particularly by upholding high standards at the authorisations gateway. Notably, in the last financial year, 36% of “Annex 1” firms (that is, firms seeking to register with the FCA for AML purposes only) withdrew their applications or had applications rejected.

2. UK — Securitisation Regulation

Revocation of assimilated law relating to UK securitisation regime

On 2 September 2024, the Financial Services and Markets Act 2023 (Commencement No 7) Regulations 2024 were published. These regulations formally revoke the assimilated law (previously known as “retained EU law”) relating to the UK securitisation regime.

This paves the way for entry into force of the UK Securitisation Regulations 2024 (UKSR) on 1 November 2024. Please see our Sidley Updates of March 2024 and May 2024 for further detail on the UKSR and the incoming UK securitisation regime.

3. UK — Sanctions

OFSI commences annual review of frozen assets

On 11 September 2024, OFSI issued a financial sanctions notice commencing its annual review of frozen assets (the Notice).

By 11 November 2024, persons who “hold or control funds economic resources belonging to, owned, held, or controlled by a designated person” must submit an annual frozen assets report, as should persons who have previously reported frozen assets. OFSI’s current list of “designated persons” can be found here.

The frozen assets report must include details of all funds or economic resources frozen in the UK. It must also include overseas funds or economic resources subject to a UK asset freeze. Guidance on what should be included in the frozen assets report — particularly, the types of assets — can be found in the annex to the Notice.

Reports must be completed in a designated template available on the HM Treasury website and submitted by email to OFSI by 11 November 2024.

4. UK — Retail Funds

FCA publishes guidance on Overseas Funds Regime applications

On 11 September 2024, the FCA published guidance for firms on making applications under the Overseas Funds Regime (OFR). The OFR allows overseas collective investment schemes to be marketed to retail investors in the UK, provided they are domiciled in jurisdictions deemed to be “equivalent.” This includes the European Economic Area, under an equivalence determination made earlier this year.

The guidance provides a practical, user-friendly overview of how to work through the FCA Connect System and a list of information required to complete the relevant forms.

In terms of timing, the FCA has up to two months to make a decision provided the application is deemed “complete”. However, the guidance also sets out that, in the majority of applications, the FCA will aim to reach its decision much sooner than this.

In the final section of the guidance, the FCA outlines its approach to recognition. For instance, it is entitled to revoke recognition where it identifies a risk to UK investors in the fund. Additionally, it notes that certain fund features may lead to refusal, such as inappropriate fund names, investments in high-risk assets (such as cryptocurrencies), or liquidity issues.

Upcoming reform to UK retail disclosure requirements

On 19 September 2024, the UK Government and the FCA announced the upcoming reform of the UK retail disclosure requirements.

The existing retail disclosure framework derives from the EU Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation. However, under the upcoming reform, the PRIIPs regime will be replaced in UK law with a new Consumer Composite Investments (CCI) framework. The FCA will issue a consultation on the proposed rules this autumn, and HM Treasury will lay down legislation empowering the FCA to begin the reform process.

In connection with this upcoming reform, the FCA has issued a forbearance statement stating that as of 19 September 2024, the FCA will no longer take supervisory or enforcement actions to enforce PRIIPs Regulation requirements against certain investment funds. To benefit from this interim measure, a fund must be close-ended and trading on a UK regulated market or multilateral trading facility. The measure will last until the CCI framework comes into force.

The new regime is expected to be in place in H1 2025, subject to Parliamentary approval and the FCA consultation process.

FCA consults on widening access to LTAFs

On 6 September 2024, the FCA published its Quarterly Consultation No. 45 (CP24/18). The consultation proposes widening access to long-term asset funds (LTAFs) by amending the rules for non-UCITS retail schemes (NURSs).

LTAFs, which were first introduced in 2021, are authorised open-ended funds that allow UK retail investors to access long-term illiquid assets. The FCA expanded the range of retail investors and pension schemes eligible to invest in LTAFs in 2023. However, in its consultation, the FCA cites recent feedback indicating that its current rules do not sufficiently support the development of the LTAF market.

Currently, NURSs can invest only in LTAFs that do not invest more than 15% of their portfolio in collective investment schemes (CIS). The FCA is proposing removing this 15% limit, given that LTAFs often invest through vehicles that meet the CIS definition. It considers that this will help to unlock retail investment in LTAFs.

The consultation closes on 11 October 2024.

5. UK — Tax

Millican v HMRC: FTT decision on the scope of the “carried interest” capital gains tax regime

Since 2015, the UK has operated a special capital gains tax regime for “carried interest.” This regime broadly provides for an increased rate of tax at 28% (as opposed to the usual 20% on gains) and also prevents individual carry holders benefiting from “base cost shift” (as was possible before) through the application of UK partnership tax rules. A recent case in the FTT has considered a number of interesting points around the scope of this special carried interest regime.

The case involved a joint venture vehicle established as a UK Limited Liability Partnership (the JV Vehicle) whose principal activity was to acquire, hold, and manage an indirect interest in the MOTO group of companies. The members of the JV Vehicle were Greycoat EPIC Capital LLP (GEC LLP) and a number of third-party funds related to one another (the Cheyne Funds). The Appellant, Nicholas Millican, was a member of GEC LLP.

On the face of the documents, GEC LLP and the Cheyne Funds were jointly responsible (in their capacity as members of the JV Vehicle) for the day-to-day management of the JV Vehicle. In addition, GEC LLP undertook to provide certain “advisory services” to the Cheyne Funds in return for a fee payable entirely by the Cheyne Funds. Following the disposal of its indirect interest in the MOTO group, the JV Vehicle distributed proceeds to GEC LLP and the Cheyne Funds. The tax dispute was around whether the Appellant’s share of the amounts distributed to GEC LLP should be subject to UK tax under the special carried interest regime.

For that regime to apply, it had to be established that:

1. the Appellant performed “investment management services”;
2. those services were performed under arrangements involving at least one partnership — it was common ground that this was the case;
3. those services were performed, directly or indirectly, “in respect of an investment scheme” — although it was common ground that the JV Vehicle was not an “investment scheme” for this purpose, the UK tax authority argued that those services were provided “in respect of” the Cheyne Funds and that the Cheyne Funds were “investment schemes”; and
4. an amount of “carried interest” arose to the Appellant under those arrangements — the parties agreed that the amounts derived by the Appellant otherwise (subject to the points above) answered the description of “carried interest” for this purpose.

This summary focuses on the decisions of the FTT as to (i) the meaning of “investment management services” and (ii) when services should be treated as being performed “in respect of” an investment scheme. It is worth noting that the FTT’s decisions on these aspects of the case are also relevant to the UK’s disguised investment management fund rules.

It is notable that (as set out in point 3 above) it was common ground between the parties at the FTT hearing that the JV Vehicle was not an “investment scheme”. It is, however, not clear why the UK tax authority agreed to this position — the FTT’s judgment strongly suggests that had they sought to argue that the JV Vehicle was an “investment scheme”, they might well have been successful on that point, and as a result the outcome of the case would have gone the other way.

“Investment management services”

“Investment management services” is defined in the legislation to include four specific categories of activity. The FTT rejected the Appellant’s argument that this definition is exhaustive, instead finding that services that do not fall within one of those four categories can nonetheless satisfy the definition for the purposes of the carried interest legislation if they would naturally be regarded as investment management services within the general meaning of that term. This is, in our view, a helpful but not surprising clarification of the law.

The Appellant further argued that although he played a significant role in the day-to-day management of the JV Vehicle, those management duties were carried out in his capacity as an indirect member of the JV Vehicle and that activities of a partner in managing its own partnership cannot constitute a “service” (of, e.g., investment management) to the partnership or to anyone else. The FTT disagreed, concluding that the nature of the activities performed rather than the capacity in which those activities are performed is what is important. Here again, we consider this to be an unsurprising clarification of the law.

Finally, the Appellant sought to draw a distinction between services that involve investment management and those that merely constitute investment advice. He argued that the “advisory services” GEC LLP was required to provide to the Cheyne Funds (and that were performed by the Appellant) in exchange for a fee were merely advisory in nature. This argument also failed on the basis that one of these “advisory services” (serving on the boards of companies owned by the JV Vehicle) clearly went beyond the mere provision of “advice” and fell to be recognized as an investment management service within the general meaning of that term. It is worth noting, however, that the FTT did appear to agree that for the carried interest tax regime to apply, the activities do need to involve investment management rather than merely advice. It does not seem likely that this distinction would be significant for most asset managers in practice, but this decision does leave some scope for purely advisory roles at the periphery of the asset management function to fall outside the UK’s carried interest tax regime.

“In respect of”

The UK tax authority argued that the services GEC LLP was required to provide to the Cheyne Funds must have been provided “in respect of” the Cheyne Funds on the basis that they were clearly contractually provided to, and paid for by, the Cheyne Funds. In addition, the UK tax authority argued that the activities carried out by the Appellant in the course of the day-to-day management of the JV Vehicle should also be treated as being performed “in respect of” the Cheyne Funds on the basis that the Cheyne Funds benefitted from those services (by virtue of its membership in the JV Vehicle).

The FTT rejected those arguments in their entirety. The decision underlines that the question of which person investment management services are performed “in respect of” is to be determined by identifying the person to whom those services relate. The contractual counterparty to those services and (if different) the person paying for those services are not the relevant person. Similarly, the decision asserts that the mere fact that a person benefits from services is not sufficient to find that those services are provided “in respect of” that person (with particular regard to the example of a parent company that will inevitably always benefit (indirectly) from services provided to its subsidiaries but is nonetheless not the person in respect of which those services are provided).

Conclusion

On this basis, the Appellant taxpayer prevailed in the case, and the relevant sale proceeds were not to be treated as subject to the UK’s carried interest tax regime. It is apparent from this element of the FTT’s decision in particular that the UK tax authority could have won the case had it only argued successfully that the JV Vehicle itself was an “investment scheme”. As a result, it does not seem likely that this decision of the FTT provides authority for any specific planning opportunities; the decision is more interesting for the technical points around the UK carried interest tax regime that it discusses.

We note that the UK’s carried interest tax regime is expected to see material changes as part of the forthcoming UK Budget on 30 October 2024. We will provide further updates on that topic in next month’s edition.

6. EU — Securitisation

ESMA chair Verena Ross speaks on securitisation and operational resilience

On 23 September 2024, ESMA chair Verena Ross delivered a speech at the Eighth Annual European Compliance and Legal Conference of AFME. The speech discusses work done in the EU to develop its capital markets regulatory framework, particularly with regards to the securitisation framework and operational resilience.

On the securitisation framework, the speech highlights the need to revive the securitisation market in the EU. It acknowledges that due to post-2009 securitisation reforms and the changes in behaviour of investors and originators, investors still perceive securitisations as a complex product with extensive due diligence requirements, while originators have access to cheaper alternative sources of funding.

As such, the three European Supervisory Authorities are working with the European Commission to develop proposals to improve the functioning of the securitisation regulatory framework. These proposals include:

• providing greater clarity and predictability around, for instance, the jurisdictional scope of application of the EU Securitisation Regulation
• introducing proportionality to the due diligence requirements; the speech acknowledges that currently, smaller market participants might not be able to enter the securitisation market due to lack of necessary infrastructure, so ESMA is looking to publicly consult on this topic in coming weeks
• introducing proportionality within the transparency framework under Article 7 of the EU Securitisation Regulation; this would reduce burdensome disclosure requirements that, the speech acknowledges, are often not sufficiently tailored to the diverse needs of investors and supervisors across different types of securitisations

In the short term, ESMA is preparing a feedback statement based on the consultation paper published in December 2023 on the Securitisation Disclosure Templates. This feedback statement will have a clear focus on introducing proportionality, particularly concerning the disclosure requirements for private securitisations.

7. EU — Non-Bank Financial Institutions

European Central Bank blog on hedge fund activity and market functioning

On 23 September 2024, an article was published on the European Central Bank blog entitled “Hedge funds: good or bad for marketing functioning?” While the blog does not necessarily represent the views of the European Central Bank or Eurosystem, it contains insights on the effects of increased hedge fund trading activity in euro-area government bond and repo markets.

Firstly, the article acknowledges that hedge funds play an increasing role in bond market trading. For instance, data from one leading electronic platform for bond trading show that hedge fund activity represented 56% of volumes in the secondary market in 2023, up from 26% in 2018.

An analysis of hedge fund activity in euro-area repo markets leads the authors to state there is little evidence that an increased market presence of hedge funds could structurally contribute to amplified volatility dynamics. However, they note that questions remain about the persistence and the reliability of hedge funds’ presence in this market segment, particularly under conditions of market stress.

The blog illustrates the continued focus within the EU on non-banks and their effect on market functioning, particularly in relation to the bond markets.

8. EU — Environmental, Social, and Governance

Infringement proceedings commenced against EU Member States for CSRD transposition failures

On 26 September 2024, the European Commission decided to open infringement procedures in relation to seventeen Member States for failing to notify their national measures transposing fully the amendments to Accounting Directive (Directive 2013/34/EU), the Transparency Directive (Directive 2004/109/EC), and the Audit Directive (Directive 2014/56/EU), as required by the CSRD (Directive (EU) 2022/2464).

The CSRD introduces new rules on sustainability reporting. It requires large companies and listed companies (excluding micro-undertakings) to disclose information on the social and environmental risks they face and on how their activities affect people and the environment. This helps investors and other stakeholders to evaluate the sustainability performance of companies. The new sustainability reporting rules apply from financial years beginning on or after 1 January 2024. In the absence of transposition of these new rules it will not be possible to achieve the necessary level of harmonisation of sustainability reporting in the EU, and investors will not be in a position to take into account the sustainability performance of companies when making investment decisions.

The European Commission has opened infringement proceedings against the following Member States: Belgium, Czechia, Germany, Estonia, Greece, Spain, Cyprus, Latvia, Luxembourg, Malta, the Netherlands, Austria, Poland, Portugal, Romania, Slovenia, and Finland.

The seventeen Member States concerned have not yet communicated full transposition into national law of the provisions of the CSRD. The transposition deadline expired on 6 July 2024. The Commission is therefore sending letters of formal notice to the concerned Member States, which now have two months to respond and complete their transposition. In the absence of a satisfactory response, the Commission may decide to issue a reasoned opinion.

9. EU — MiFID

ESMA announces next steps for selection of Consolidated Tape Providers

On 30 September 2024, ESMA published next steps for the selection of Consolidated Tape Providers (CTP) for bonds and for shares and exchange-traded funds (ETFs).

For bonds, ESMA will launch the selection procedure for the CTP on Friday, 3 January 2025. It then intends to adopt a reasoned decision on the selected applicant within six months of the launch, that is, by early July 2025.

For shares and ETFs, ESMA will launch the selection procedure for the CTP in June 2025 with the objective to adopt a reasoned decision on the selected applicant by the end of 2025.

This follows a recent consultation paper on draft technical standards related to the CTPs and on the specifications of the assessment criteria for the CTP selection procedure (for further details on this, see our Sidley Update of June 2024).