In our previous Client Alert, Back to Work: The FCA's 2022-23 Priorities for Private Fund Managers, we mentioned the need for managers to consider the new consumer duty rules contained in PS22/9: A new Consumer Duty.
The first consumer duty deadline is the 31st October 2022, the date by which the U.K. Financial Conduct Authority (FCA) expects firms’ boards (or equivalent management body) to have agreed implementation plans “to meet the duty standards”.
For most private fund managers, who do not target or do not plan to target retail investors, the consumer duty should not give rise to regulatory obligations. Managers will, however, need to determine whether this is the case and, if the duty does apply or may apply in future, what they need to do to meet the duty standards.
Even if a manager concludes that the duty does not apply to its business, the manager will need to note this fact. In any event, as covered in our alert, the FCA expect managers to have reviewed their client categorisation processes to address any “consumer needs” linked, in turn, to the issue of whether investors have been properly classified, i.e. as non-retail investors.
FCA Authorised Firms and Retail Investors Only
The duty is captured in a new FCA Principle for Businesses 12 which states: “A firm must act to deliver good outcomes for retail customers.” From this, two points arise on application of the duty:
- The duty only applies to managers who are FCA authorised firms. The duty will not, therefore, apply to a non-U.K. manager who markets a private fund into the U.K. although any U.K. placement agent employed by the manager will have to consider the duty with knock-on contractual duties for the non-U.K. manager unless it is clear that it does not want the U.L. placement agent approaching U.K. investors to whom the duty applies.
- The duty applies to managers who provide services for a retail customer defined, in the context of an alternative investment fund as an investor in the fund or the beneficial owner of interests in the fund, that is not a professional client. The duty will not, therefore apply to professional investors in respect of whom the Alternative Investment Fund Managers Directive by default, limits the marketing of private funds.
A point of direct contact for the managers of private managers will be per se retail clients, who a manager cannot “opt-up” and treat as an elective professional client. This, in turn, highlights the role of the client categorisation processes, noted in our previous alert, and the FCA’s existing focus on these processes.
Likely retail client candidates include family offices, ultra-high-net worth individuals, and manager employees to whom the manager may be offering carried interest or other employee incentives.
What About Indirect Retail Investors?
The FCA rules state that, where a firm’s retail market business involves “operating in a distribution chain”, the duty will apply “only to the extent that the person is responsible in the course of that retail market business for determining or materially influencing retail customer outcomes”.
In keeping with its current approach, the FCA includes, within the term “distribution chain”, all firms, including manufacturers, involved in a service to an end-retail customer. This term is broad but the FCA’s guidance what it means to have a material influence over or determine is helpful: it excludes, a portfolio manager whose role is limited to managing assets under a mandate determined by a professional client that is entirely independent of the manager.
The FCA cites the example of a firm that manages part of the portfolio of a defined benefit pension scheme. By extension, this exclusion would likely apply to the manager of a fund included in a funds-of-funds managed by an institutional manager, noting also the FCA’s further example of the manager of a private fund into which a third party, without the manager’s involvement, via a retail fund-of-funds.
The FCA’s example also reflects the text of its rules which states that a manager be “responsible” for determining or materially influencing, rather than merely determining or materially influencing, retail customer outcomes. The place of another manager or fiduciary with clear responsibilities to end-retail investors in a fund will, therefore, be important in determining whether and to what extent the duty imposes regulatory obligations on a private manager who manages that fund.
If The Duty Applies, When Are The Relevant Deadlines?
If a manager concludes that the duty applies, the manager will need to move quickly to agree that plan, noting the 31st October deadline, above.
The FCA rules and guidance governing the duty, which the plan will need to address, only come into force for:
- New and existing investments open for sale on 31 July 2023 (the third deadline)
- Closed investments on 31 July 2024 (the fourth and final deadline).
A second deadline on 30 April 2023, will require manufacturers, which includes in-scope managers, to have conducted cross-cutting rule reviews, noted below, and shared information with distributors.
If The Duty Applies, What Does It Require?
For the purpose of designing a plan, managers should note the duty’s purpose, reflected in the FCA guidance, to require firms “to conduct their business to a standard which ensures an appropriate level of protection for retail customers”.
Three “cross-cutting rules” underpin the duty. These require firms to: (1) act in good faith towards retail customers; (2) avoid causing foreseeable harm to retail customers; and (3) enable and support retail customers to pursue their financial objectives.
The FCA also sets out four sets of “outcomes rules”, intended to help “define what is required by Principle 12”. These relate to: (1) products and services; (2) price and fair value; (3) consumer understanding; and, (4) consumer support.
While the FCA rules and guidance are compendious, with much being relevant more to those providing retail banking and investment products than managing private funds, examples of rules and guidance that managers should note include those governing:
- The review processes for the approval of funds and the ongoing monitoring of funds with measures to mitigate any harm to retail-customers that the manager identifies
- The monitoring of unregulated distributors, e.g. non-UK placement agents marketing a fund outside the UK to non-UK retail customers
- The application of price and value rules, including to closed books of business
How Does The Duty Fit With Existing Obligations?
The FCA notes in its guidance that the duty does not apply to activities to the extent that those activities are not included in an existing rule which sets out the scope of protections offered to retail customers. These include the FCA’s conduct of business and product governance rules. The duty, therefore, traverses familiar ground with the duty appearing, for the most part, to sharpen current obligations rather than create new obligations. A few points to note:
- Managers are already under special rules for retail customers in the context of marketing with a duty to prepare a key information document in accordance with the PRIIPs regulation noted in FUND 3.2 Investor information - FCA Handbook with managers having to comply with changes by 31 December 2022. (See FCA confirms PRIIPs regulations | FCA.)
- Managers also have current ongoing management duties in relation, for example, to liquidity management in compliance with the liquidity rules noted in FUND 3.6 Liquidity - FCA Handbook and general guidance in Liquidity management for investment firms: good practice that apply with respect to all investors, albeit that the FCA will likely scrutinise these more closely where there are retail investors in a private fund.
- More recently, as noted in our previous alert, the FCA will expect managers that offers investments to retail investors:
- To have a governance process that considers the application of relevant marketing restrictions to retail investors when communicating or approving financial promotions, especially to ensure compliance with COBS 4.12
- To have a governance process that ensures that target markets are clearly outlined for distribution channels to ensure a clear understanding of in scope investors; and
- To review new rules contained in PS22/10: Strengthening our financial promotion rules for high-risk investments and firms approving financial promotions, including changes to COBS 4.12. (The main risk warning rules come into force on 1st December 2022, with the remainder landing on 1st February 2023.)
If A Plan Is Required, What Should It Look Like?
The FCA rules and guidance, including the guidance set out in FG22/5 Final non-Handbook Guidance for firms on the Consumer Duty, amplify these requirements and, as applicable to a manager, who manages and markets a private fund, the plan would need to:
- Structure the plan by reference to the four outcomes, noting the cross-cutting rules
- Prioritise the steps in the plan by reference to each outcome, asking what would be the priorities for a private fund manager such as the manager, noting the FCA guidance on the reasonableness of the steps which a firm should take to give effect to the duty and the role of the nature of the product/service in question in determining these steps
- Undertake a gap-analysis identifying where the manager does not currently addresses the four outcomes, noting the FCA guidance that the duty does not apply to activities to the extent that those activities are not included in an existing rule which sets out the scope of protections offered to retail customers by, amongst other rules, those governing conduct of business and product governance
- Note possible outputs such as revised policies, agreements, marketing documents and communications, noting that these may not ultimately require revision
- Assign individual responsibility within the manager’s existing governance structure for implementation of the plan, including the identification of a SMF holder and/or their delegate and the role of existing bodies, such as risk committees, noting the FCA rule that Duty is reflected in a firm’s strategies, governance, leadership and people policies
- Identify staff, in sufficient numbers and with appropriate skills, to ensure implementation of the plan to meet the deadlines, noting any milestones ahead of the deadlines and staffing needs to meet these milestones
As with most FCA mandated process, in considering the scope of the plan and expected actions flowing from the plan, the nature, scale and complexity of the manager’s business will be relevant.
To discuss the contents of this alert, please contact the authors or your usual Goodwin contact.
Ajay PathakPartnerCo-Chair, London Office
Chris OrmondKnowledge Management Counsel