The Alternative Investment Management Association

Alternative Investment Management Association Representing the global hedge fund industry

Principles-based approaches to training and competence

Patrick Thompson

Eukleia Training Ltd

Q4 2006


For almost 20 years those acting as investment advisers for UK authorised firms have had to pass tests on basic regulatory and technical knowledge.
These exams, such as the Securities & Investment Institute’s Certificate contain questions such as these:
(Answers are at the end of the article.)

1. A customer asks what exercise style LIFFE Euronext UK stock options have. Your reply would be:
A European
B American
C All American except FTSE 100
D American and European

2.Under which ONE of the following is market abuse a statutory offence?
A Banking Act 1987
B Companies Act 1985
C Criminal Justice Act 1993
D Financial Services and Markets Act 2000


Equipped with a pass in the examination, the individual is then able to practice as an investment adviser in areas as diverse as investment banking, wealth management or hedge fund sales. The fact-based and elementary nature of the exams has been a source of exasperation to students and this ‘Gradgrindian’ obsession with facts has given (or should have given) little comfort to firms that their employees have the understanding to do the right thing. They may leave the exam hall knowing that there is a maximum seven year prison sentence for insider dealing, but are they able to identify when they may have been made an insider?

The other frustration has been that the examinations have not been tailored to the needs of a particular sector, and consequently have been a very poor fit to the training needs of employees – a particular problem when dealing with the technical and regulatory issues confronted by hedge fund managers.

Changing requirements

After almost two decades, things are about to change. From the implementation date of MiFID, the FSA has stated that those dealing with wholesale/ professional customers will no longer be required to pass these ‘driving test’ examinations.

This recently announced FSA change was first aired in a 2005 FSA Consultation Paper (CP 05/10) and is part of a broader initiative by the FSA and the UK Government to reduce the regulatory burden, remove red tape and move the industry towards a more principles based approach. The FSA is keen to stress that this is not a “dumbing down” of the regime. The overarching requirements of the Training & Competence commitments (TC1), that require firms to ensure that their employees are competent, remain competent and have their competence assessed, will continue. The goal of the reform is to remove unnecessary prescription and usher in flexibility.

In the same CP, and much more controversially, the FSA also proposed to remove the requirement for investment advisers and investment managers dealing with wholesale customers to be “approved persons”. Hitherto, the idea of being personally approved by the regulator as ”fit and proper” and being individually vulnerable to FSA enforcement action was seen as a keystone of the UK regime. The FSA, however, argues that it is staff dealing with retail customers that pose the primary risk to the FSA’s statutory objective of protecting consumers, and it is therefore only these that will need to be approved. On the wholesale side it is the dual threats of market abuse and financial crime that loom largest, and against these risks the FSA already has an array of civil and criminal powers they can deploy against wrongdoers, whether they are approved or not.

The industry’s response to the training proposals within CP 05/10 has been interesting. Whilst most firms are happy to welcome the idea of a principles-based approach there is simultaneously an anxiety that the disappearance of prescription will leave uncertainty about how to demonstrate .competence. There is also anxiety about how the FSA will supervise firms in a principles-based world. While senior FSA staff are believed when they espouse their commitment to the ideal, there is greater scepticism about whether junior supervisors will have either the judgement or the confidence to step back and to allow firms to determine their own route to compliance.

The industry’s response to the suggested removal of approved person’s status has been much clearer. The industry has lobbied for a continuation of the regime which it argued has supported the efforts of compliance staff and senior management in getting ‘buy in’ to compliance. The FSA has held off making a final decision on this issue, citing a need for greater clarity on how the approved persons regime may be reconciled with the need for European harmonisation and MiFID.

The hedge fund industry’s response

What does this mean for the UK authorised hedge fund manager?

At the simplest level, the training and competence rule changes will do away with the need for compliance staff to force often senior and invariably highly qualified staff to sit what are seen as irrelevant exams. However this benefit needs to be offset by the need for some fresh and principles-based reflection about what constitutes competence, and how the required competencies are attained and assessed.

In other industry sectors, notably investment banking, there is beginning to be an examination of whether there is merit in developing a sectoral response to the challenge. The thinking here is partly defensive, in that in the absence of detailed FSA rules, firms can demonstrate compliance by being in step with industry best practice. Another driver is the time and cost efficiencies that may emerge from collaborating with other firms to commission and produce new training and assessment packages. A further benefit could be that if a new, industry driven training benchmark emerges, then satisfactory completion of this benchmark standard would facilitate easier determination of staff competence and assist in the speedy integration of lateral hires from other firms.

As to the content of any benchmark training programme it would seem from a risk-based perspective to focus on regulatory topics such as market abuse and to rely on, experience, university and post graduate qualifications, particularly CAIA and CFA to satisfy the technical elements of competence.

The changes in the FSA’s training and competence regime offer hedge fund managers an opportunity to replace ill-designed and inappropriate examinations with something more appropriate. It also provides the industry with an ideal opportunity to demonstrate once again its commitment to a genuinely principles-based adherence to regulatory and ethical standards.

Question1: C
Question 2: D

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