The Alternative Investment Management Association

Alternative Investment Management Association Representing the global hedge fund industry

Regulation in 2014

Ashley Kovas, Head of Funds

Bovill Limited

Q1 2014

The changing regulatory regime

The regulatory regime for financial services firms has changed substantially over the last few years as governments worldwide have sought to make structural changes to mitigate the risk of future financial crises developing. In the UK, 2013 saw the splitting off from the Financial Services Authority of its prudential responsibilities for banking and insurance with the remainder of the old FSA forming the new Financial Conduct Authority (FCA).  The FCA has a single strategic objective – to ensure that the financial markets function well.  In addition, the FCA has operational objectives:

  • Consumer protection
  • Integrity
  • Competition

The FCA will be assessed and will assess itself on its success in meeting its objectives. The ‘Integrity’ objective implies greater emphasis on the behaviour of individuals as well as that of firms. The ‘Competition’ objective implies a focus on business models, price and profitability. The ‘Consumer protection’ objective is not new and was also an FSA objective. However, the objectives as a package could affect the way in which the FCA approaches consumer protection. For example, realisation that consumers do not necessarily behave in the self-serving manner expected by classical economic theory may affect the extent to which the FCA will be prepared to rely on disclosure as a regulatory tool – indeed we already know that this is how the FCA is thinking. In addition, the FCA is taking forward the FSA’s intrusive and interventionist approach, where supervisors will be making judgements on the judgements of firms’ senior management. Given this style of regulation, together with the regulatory changes expected to affect asset managers, hedge fund managers need to stay abreast of four key regulatory areas as 2014 develops.

  1. Focus on the individual

The FCA understands that the behaviour of firms is driven by the actions of individuals within the firm. This may seem obvious and indeed it is, but historically in the UK (and elsewhere) the approach of financial regulators has been directed at firm behaviour, with regulatory sanctions being aimed at the firm rather than the individual. The FSA was criticised significantly for not taking action against individuals in the wake of the financial crisis. The expectation of society is that individuals will be held to account and in the future we can expect that to happen. The new Financial Services (Banking Reform) Act 2013 makes it an offence for a senior manager to make decisions that lead to the failure of at least part of the firm’s business. Although these provisions are likely to be enforced most readily against banks and other substantial institutions, the wording of the provisions means they can, in theory, apply to any firm.

Notwithstanding the 2013 Act, the FCA has already begun asking firms to make “attestations” in certain circumstances. An attestation effectively requires an approved person of the institution to attest to the truth of a particular statement – in effect, to promise that his firm is in compliance with some aspect of the regulatory regime. Requiring such attestations must inevitably be linked to the possibility of future regulatory action if the firm is not compliant, so the personal risk for the person attesting is reasonably high. The difficulty for the person making the attestation is that, in large and complex institutions, it may not be possible for that person to be fully confident of the state of affairs, at least without relying on the work of others. This suggests that attention needs to be paid to the gathering of evidence within the firm to support any attestations made. It is also necessary to look at reporting lines to see whether the person making the attestation can rely on promises made by others in his firm.

Given the increasing focus on the individual, all approved persons in the firm should be made aware of the nature of their obligations as such, together with the consequences of failing to meet the required standard. It is particularly important that firms take appropriate steps to ensure that persons making attestations are fully aware of the liabilities that attach to them for doing so and that there is a proper system of support to ensure that attestations are truthful.

  1. Conduct risk

Traditionally, compliance monitoring has been about determining whether the firm has breached the regulatory rules. The financial crisis has shown that firms were not sufficiently forward-looking in assessing the risks that their businesses were facing in the markets. Merely reactive compliance monitoring is not enough because all it tells you is whether you breached the rules at some point in the past. Whilst this is important, what might happen in the future is equally so; the financial crisis might have been avoided or mitigated had firms been looking forward rather than backwards. Firms need to develop a methodology to assess the potential risks to their operations; where these relate to regulatory risks this amounts to conduct risk. Conduct risk is similar to operational risk, but goes wider in that crystallisation of the risk may be damaging fundamentally to consumers or the market more generally rather than or in addition to the firm. Operational risks on the other hand tend to be risks to the firm itself. 

Larger firms are already being quizzed on the nature of the risks they face, including conduct risks.  Given the FCA’s intention to challenge firms’ business models and strategies, firms must be in a position to show that risks have been identified and considered. If they do not, they may find themselves in an uncomfortable position with regulatory challenge delaying the implementation of strategy whilst the risk implications are sorted out. A robust system for the identification, measurement, mitigation and monitoring of conduct risk is needed, particularly for larger firms. This is of course additional to the usual risk management disciplines: Operational Risk, Market Risk and the like.

  1. EMIR

The European Market Infrastructure Regulation (EMIR) came into force on 16 August 2012 and the first EMIR reporting date was 12 February 2014. EMIR represents the EU’s implementation of the G20’s efforts, in response to the financial crisis, to address systemic risk associated with the derivatives market.

EMIR requires any derivative contract that is concluded, modified or terminated to be reported to a trade repository.  Reporting must be done by the close of the business day following the transaction. Trades outstanding on 16 August 2012 and which were still outstanding on 12 February 2014 had to be reported within 90 days of the reporting start date.  There is a three-year period during which relevant trades that have matured since 16 August 2012 will need to be reported.  EMIR captures both OTC and exchange-traded derivatives (though OTC contracts are only caught for the clearing requirements).

  1. AIFMD

The Alternative Investment Fund Managers Directive (AIFMD) is now in force, although transitional provisions apply until July 2014. Just before Christmas 2013, the Treasury announced that it was to abolish the original January 2014 deadline by which time managers were required to submit their Variation of Permission to the FCA. Instead it will suffice for a manager to submit the application for Variation by 22 July 2014. Managers will need to comply with the AIFMD regime from that date but may carry on managing AIFs unless the FCA later decides not to grant the Variation.

The FCA is likely to do some form of thematic work in H2 2014 or possibly early 2015 to look at compliance with the Directive. AIF Managers will have put in place a series of policies and procedures and the regulator will want to see that they are working in practice.  The Risk Management Policy is likely to be tested, as are those on Liquidity Management and Conflicts of Interest.  Although many firms are currently working to ensure they will have the necessary permissions to continue to manage AIFs after July 2014, prospective AIFMs also need to consider how they will comply with the Directive’s ongoing requirements, particularly those involving reporting to regulators.


So the to-do list for 2014 might include some thought about the following:

  • Do you understand the obligations of “approved person” status?  The expected standard of behaviour has probably not changed significantly, but the regulators are increasingly looking to discipline individuals where things go wrong.  Are your systems and governance arrangements in the right place to support employees, particularly senior employees?
  • If you are asked for an attestation by the FCA, will you have in place the necessary controls to make such an attestation in a way that minimises the risk to the person(s) attesting?
  • Have you considered the risks affecting your business, particularly your Conduct risks?  Is risk identification a part of your business strategy development process?
  • Are you ready for EMIR?  If not, what urgent steps are you taking?
  • Have you considered your position under AIFMD?  Getting your Variation of Permission application into the FCA by 22 July 2014 is important, but it is also important to make sure that you can actually comply with the Directive from that date.

Back to Listing

Main Menu

  1. Home
  2. About
    1. Our Core Objectives
    2. AIMA's Policy Principles
    3. Meet the team
    4. AIMA Council
    5. Global Network
    6. Sponsoring Partners
    7. Opportunities at AIMA
    8. AIMA’s 25th anniversary in 2015
  3. Join AIMA
    1. Benefits of Membership
    2. Membership Fees
    3. Application form
  4. Members
    1. AIMA DDQs
    2. AIMA Annual Reports
    3. AIMA Governance
    4. AIMA Logo
      1. Policy note
    5. AIMA Members' List
    6. AIMA Review of the Year
    7. Committees and Working Groups
    8. Weekly News
    9. Update Profile
  5. Investors
    1. AIMA Investor Services
    2. AIMA Members' List
    3. Investor Steering Committee
  6. Regulation
    1. Asset Management Regulation
      1. EU Asset Management Regulation
        1. AIFMD
        2. European Capital Markets Regulation
        3. MiFID / MiFIR
        4. UCITS
        5. European Venture Capital Directive
        6. Shareholder Rights Directive
        7. European Long Term Investment Fund Regulation
        8. Loan Origination Funds
        9. Capital Raising
        10. AIFMD-Related Events
      2. US Hedge Fund Adviser Regulations
        1. Registration and Reporting
        2. Incentive-Based Compensation
        3. JOBS Act
      3. Asia Pacific Asset Management regulation
      4. Other Jurisdictions’ Asset Management Regulation
      5. Private Placement Regime
        1. Canada
        2. Dubai
        3. Finland
        4. Germany
        5. Hong Kong
        6. Japan
        7. Saudi Arabia
        8. Sweden
        9. United Arab Emirates
      6. Systemically Important Financial Institutions ('SIFIs')
      7. Remuneration
        1. UK
        2. United States
        3. CRD IV and CRR
        4. AIFMD
        5. MiFID
      8. Shadow Banking
      9. Volcker Rule
      10. Other
      11. Systemic Risk Reporting
      12. Dealing Commission
      13. Corporate Governance
      14. Securitisation
    2. Markets Regulation
      1. Bank/Capital Regulation
        1. Capital Requirements Directive
        2. EU Bank Structural Reforms
      2. Capital Markets Union
      3. Derivatives/Clearing
        1. EMIR
        2. MiFID II / MiFIR - Derivatives
        3. MAD / MAR
        4. Dodd-Frank Act Title VII
        5. Hong Kong
        6. IOSCO
        7. Singapore
      4. High Frequency Trading
        1. EU automated trading
          1. ESMA Guidelines
          2. Germany
          3. MiFID II / MiFIR - HFT
        2. US automated trading
          1. SEC Regulation SCI
          2. CFTC Automated Trading
        3. IOSCO
        4. Flash Crash
      5. Insurance Regulation
        1. Solvency II
      6. Market Abuse
        1. MAD / MAR
        2. Indices as Benchmarks
      7. Position Limits
        1. MiFID II - Commodities
        2. CFTC Position Limits
      8. Resolution of Financial Institutions
        1. Europe
          1. EU Bank Recovery and Resolution Directive
          2. EU Non-Bank Recovery and Resolution
        2. CPSS-IOSCO
        3. Financial Stability Board
        4. UK
        5. USA
      9. Shadow Banking
        1. International Shadow Banking
        2. EU Shadow Banking
      10. Short Selling
        1. EU Short Selling Regulation
        2. Hong Kong Short Selling Regulation
        3. US Short Selling Regulation
        4. Securities Settlement
      11. Trading
        1. Dodd-Frank Act
        2. MiFID Portal
    3. Tax Affairs
      1. Automatic Exchange of Information (AEOI)
        1. FATCA
        2. EU - AEFI
        3. OECD - Global Standard on AEFI
      2. Australia - Investment Manager Regime (IMR)
      3. Base Erosion - Profit Shifting (BEPS)
      4. FAIFs and FINROFs
      5. FIN 48 and IAS 12
      6. Financial Transaction Tax (FTT)
      7. UK Investment Management Exemption (IME)
      8. UK Offshore Funds Regime
      9. Other
    4. AIMA's Policy Principles
    5. Search
    6. Resources
      1. Guidance Notes
      2. Jurisdictional Guides
      3. Noticeboard
        1. AEOI: FATCA and other regimes
        2. AIFMD
        3. Bank/Capital Regulation (including NSFR)
        4. BEPS
        5. CFTC Registration and Exemptions
        6. Corporate Governance
        7. Dealing Commission
        8. Derivatives
        9. FTT
        10. High Frequency Trading
        11. MiFID / MiFIR
        12. Other Hot Asset Management Topics
        13. Other Hot Markets Topics
        14. Other Hot Tax Topics
        15. Position Limits
        16. Trading
        17. UCITS
        18. UK Partnership Tax Review
        19. US State and Local Taxes
        20. Volcker Rule
      4. Hedge Fund Manager Training
      5. Quarterly Regulatory Update
      6. Webinar Programme
      7. Regulatory Compliance Association
        1. About the Regulatory Compliance Association
        2. RCA Curricula and initiatives for alternative investment firms
        3. Meet the regulators and Sr. Fellows
  7. Education
    1. Research
      1. AIMA Research
      2. Industry research
      3. Search research documents
    2. "The Case for Hedge Funds"
      1. Global Hedge Fund Industry Paper: The value of our industry
      2. The Value of the Hedge Fund Industry to Investors, Markets and the Broader Economy: Research commissioned by AIMA and KPMG
      3. The Evolution of an Industry: KPMG/AIMA Global Hedge Fund Survey
      4. Contributing to Communities: A global review of charitable and philanthropic activities by the hedge fund industry
      5. Beyond 60-40: The evolving role of hedge funds in institutional investor portfolios
      6. The Cost of Compliance: Global hedge fund survey by AIMA, MFA and KPMG
      7. Capital Markets and Economic Growth: Long-term trends and policy challenges
      8. Apples and Apples: How to better understand hedge fund performance
      9. The Extra Mile: Partnerships between hedge funds and investors
      10. Key articles by AIMA on the case for hedge funds
    3. AIMA Journal
      1. Recent issues
      2. Search AIMA Journal articles
      3. AIMA Journal Archive
    4. AIMA Guides to Sound Practices
    5. AIMA guides for institutional investors
    6. CAIA Association pages
      1. Fundamentals of Alternative Investments
    7. Regulatory Compliance Association pages
      1. About the Regulatory Compliance Association
      2. RCA Curricula and initiatives for alternative investment firms
      3. Meet the regulators and Sr. Fellows
    8. Certified Investment Fund Director programme
    9. Services to Start-up Managers
    10. Glossary
  8. Events
    1. AIMA Events
    2. AIMA webinars
    3. Industry events
  9. Media
    1. Press Releases & Statements
    2. AIMA's blog
    3. Media Coverage
      1. Articles by AIMA
        1. Archive
      2. AIMA in the news
      3. Video interviews
      4. Industry news
    4. Media Contact
    5. Press Materials

Sub Menu

  1. Education
    1. AIMA Journal
    2. Bibliography
    3. CAIA Designation
    4. Research
    5. Roadmap to Hedge Funds
    6. AIMA's Investor Steering Committee Paper
    7. Glossary
  2. Regulatory, Tax, Policy & Government Affairs
    1. AIMA Position Papers
    2. AIMA Responses
      1. Australian Tax Office
      2. Authority for the Financial Markets
      3. Committee of European Banking Supervisors
      4. Committee of European Securities Regulators
      5. Commodity Futures Trading Commission
      6. Dubai Financial Services Authority
      7. European Commission
      8. European Securities and Markets Authority
      9. Swiss Financial Market Supervisory Authority
      10. Financial Services Authority (UK)
      11. Financial Services and the Treasury Bureau
      12. Guernsey Financial Services Commission
      13. HM Revenue & Customs
      14. HM Treasury
      15. Independent Commission on Banking
      16. IOSCO
      17. Monetary Authority of Singapore
      18. Securities and Exchange Board of India
      19. Securities and Exchange Commission (USA)
      20. Securities and Futures Commission
      21. Singapore Exchange
      22. The Takeover Panel
      23. US House of Representatives / Senate
      24. Federal Deposit Insurance Corporation
      25. Financial Stability Oversight Council
      26. Financial Stability Board
      27. US Treasury
      28. Internal Revenue Service
      29. US Federal Reserve
      30. Financial Industry Regulatory Authority (FINRA)
      31. Council of European Union
      32. Hong Kong Exchanges and Clearing
      33. House of Lords
    3. AIMA Summaries
      1. CESR
      2. European Commission
      3. Financial Services Authority (UK)
      4. HM Revenue & Customs
      5. HM Treasury
      6. IOSCO
      7. Securities and Exchanges Commission
      8. FSOC
      9. CFTC
    4. Guidance Notes
    5. Jurisdictional Resource
    6. AIMA Noticeboard
      1. EU Directive on Alternative Investment Fund Managers
      2. FSA Remuneration Code
      3. Short Selling
      4. US Dodd-Frank Wall Street Reform and Consumer Protection Act
      5. UK Stewardship Code
      6. Securities Law Directive
      7. EU Directive on Alternative Investment Fund Managers - Level II
      8. EU Directive on Markets in Financial Instruments (MiFID)
      9. International Financial Centres
      10. Bribery Act
      11. Market Abuse Directive
      12. MF Global
      13. FATCA
      14. FTT
      15. Other Tax Issues
    7. AIMA Regulatory Update
  3. Sound Practices
    1. Due Diligence Questionnaires
    2. Guides to Sound Practices
  4. Start-Up Service Providers
  5. Useful Websites