## _cr16161

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---

### Executive summary and systemic challenge
- The size and interconnectedness of the U.K. investment management sector and equity markets pose a significant challenge to the U.K. authorities.
- Key statistics:
  - Total authorized investment fund assets under management (AUM) by U.K. fund managers: GBP 1,730 billion (end of 2014) — representing 95 percent of the U.K. GDP.
  - Fifty-two percent of these assets belonged to foreign domiciled funds.
  - In 2014, 11 U.K. based exchanges and MTFs held a 45 percent market share in all on-platform equity trading in Europe.
  - Eight U.K. based “dark” trading platforms held an 85 percent market share of European dark trading.
- Implications: potential inward and outward spillovers require effective domestic supervision, systemic risk monitoring, and international cooperation.

### FCA supervisory approach, organization, and resources
- High-level approach:
  - Sophisticated risk-based approach with a recently-launched new supervisory model.
  - Robust sector analysis supports prioritization; explicitly articulated risk appetites guide day-to-day supervisory choices.
  - Uses bottom-up sector risk analysis and a senior management top-down view; validated risks recorded on the Consolidated Risk Map (CRM).
- Organizational change:
  - Investment Management Department reorganized into teams responsible for (i) fixed portfolio firms; (ii) Pillar 2 supervision; and (iii) multi-firm supervision.
  - Investment management firms that are part of larger banking or insurance groups now supervised in the Investment Management Department.
- Resource indicators:
  - Permissions Department headcount: 69.8 FTE (end-2014), 77.0 FTE (end-2013), 73.3 FTE (end-June 2015).
  - FCA supervisory resource allocation (selected): total 58 FTE (2013/14), 59 FTE (2014/15), 58 FTE (2015/16 previous model).
  - Thirteen positions open (source note).
- Conduct classification:
  - Fixed portfolio firms: highest supervisory attention, dedicated supervisors (Pillar 1).
  - Flexible portfolio firms: supervised via thematic and market-based work (Pillar 3) and event-driven work (Pillar 2).
- Pillar 2 event supervision:
  - Centralized Event Supervision Department assesses events and prioritizes; possible actions include no action, mitigation, allocation to sector supervision, or referral to Enforcement.
  - Recommendation: ensure the Event Supervision Department is sufficiently resourced and has investment management expertise given the large flexible portfolio population.

### Fund management regulation — valuation, pricing, and errors
- Valuation framework:
  - UCITS and AIFMD-based valuation rules set national implementation details; fund managers responsible for NAV, subscription and redemption pricing, with procedures to ensure proper valuation.
  - UCITS valuation frequency:
    - UCITS Directive: at least two valuation points in a month at least two weeks apart.
    - FCA rules: valued at least as frequently as subscriptions and redemptions can take place.
    - Higher volatility funds and QIS: generally valued every business day.
  - Money Market Funds (MMFs):
    - Qualifying MMFs must be valued every business day at amortized cost basis.
    - Short term MMFs: valued every business day either at amortized cost or mark to market.
    - Regular MMFs: mark to market.
    - At time of FSAP, one U.K. MMF with AUM of GBP 2.2 billion aimed at maintaining a constant NAV.
    - FCA preference to await EU Money Market Funds Regulation negotiations; pending EU outcome, ensure any new constant NAV MMFs comply with IOSCO safeguards.
- Pricing timing and historic NAV:
  - FCA intended to remove historic NAV possibility; consultation closed December 7, 2015.
  - IOSCO Principle 9: purchase and redemption of CIS interests should not be at historic NAV (very limited exemptions).
  - Recommendation: FCA should proceed with plan to remove historic pricing from its rules.
- Pricing errors and reporting:
  - Fund manager must record incorrect pricing instances and report to depositary; depositary reports material breaches immediately to the FCA and makes a monthly return summarizing incorrect pricing instances.
  - FCA Handbook requires quarterly reporting, but practice has been monthly via voluntary arrangement; FCA consulted on formalizing monthly reporting.
  - Fund manager must reimburse affected unitholders and the fund except where depositary deems breach minimally significant.
  - Depositaries have submitted data since January 2015; January–May 2015: 3,163 breaches notified, including 864 pricing error breaches (47 material). FCA reviewed 47 material breaches, contacted firms about five pricing errors, required rectification in two instances; no enforcement action taken for these instances.

### Liquidity risk management and redemption tools
- UCITS liquidity requirements:
  - UCITS managers required to manage and measure fund risk on a continuous basis; risk management process must assess liquidity risk and employ appropriate liquidity risk management processes where relevant.
  - UCITS fund manager must employ liquidity stress tests to ensure compliance with redemption obligations; current requirement: stress tests in exceptional circumstances.
  - Recommendation: require UCITS managers to conduct liquidity stress tests under normal liquidity conditions as well (align with AIFMD and IOSCO Principle 14).
- AIFMD liquidity obligations:
  - Ensure investment strategy, liquidity profile and redemption policy are consistent.
  - Employ liquidity management systems and procedures; conduct stress tests under normal and exceptional conditions; disclose liquidity risk management and redemption arrangements to investors.
- Pricing and structural tools to mitigate first-mover advantage:
  - Available tools (subject to fund rules and prospectus): swing pricing, dilution levies, dilution adjustments, redemption in kind, dual prices.
  - Swing pricing and dilution levies pass costs to exiting investors; typically applied in periods of very high redemptions, market stress, or high transaction costs.
- Suspension, deferral and limited redemption arrangements:
  - UCITS may suspend redemptions only in exceptional cases in interest of unit holders; depositary agreement required; formal review at least every 28 days.
  - Deferral: where redemption requests exceed 10 percent (or other disclosed proportion) of fund value at a valuation point, deferral to next valuation point permitted for funds with daily valuation points.
  - AIFMD permits limited redemption arrangements for illiquid investments; NURS with immovable investments may have valuations and redemptions at least once every six months.

### Leverage: methods, reporting, and harmonization need
- UCITS:
  - Global exposure via commitment approach or VaR method.
  - Borrowing not taken into account when determining leverage; UCITS permitted to borrow up to 10 percent of NAV.
  - Derivative global exposure limited to 100 percent of portfolio net value.
- AIFMD:
  - Leverage defined broadly (including borrowing, leverage embedded in derivatives, SFTs).
  - AIFMs must set leverage limits for each AIF; no maximum limits set by AIFMD.
  - Leverage must be calculated using gross method and commitment method; overall leverage expressed as ratio of AIF exposure to NAV.
  - AIFMD reporting: leverage reported to competent authorities on a regular basis.
- Reporting gaps and harmonization:
  - UCITS reporting on leverage limited; FCA plans reporting template to capture UCITS’ gross long and short derivative positions and risk measures.
  - Identified gap: absence of an internationally agreed standard for determining investment fund leverage; market participants concerned about misleading leverage information.
  - Recommendation: FCA and U.K. authorities should develop a practical approach to measuring investment fund leverage and continue contributing to international harmonization efforts.

### Depositaries: functions, prudential requirements, independence, safekeeping, delegation, and liability
- Appointment and approval:
  - Depositary required for each UCITS and AIF; generally must have registered office or branch in the fund domicile country.
  - FCA must approve depositary of a U.K.-domiciled AIF.
- Prudential requirements:
  - U.K. prudential requirements for UCITS depositaries more stringent than UCITS IV Directive.
  - Example thresholds: U.K. bank subject to EUR 5 million capital requirement or investment firm subject to GBP 4 million capital requirement can be authorized to act as UCITS depositary.
  - U.K. requires higher capital for NURS and QIS depositaries: GBP 4 million (vs. EUR 730,000 standard MiFID requirement).
  - Depositary of private equity AIF and non-EEA AIF (AIFMD Article 36 ‘depositary light’) subject to minimum capital requirement of EUR 125,000 under U.K. rules.
- Independence safeguards:
  - AIFMD and UCITS V require separation and management of conflicts; U.K. framework imposes additional independence requirements for UCITS and authorized AIFs (not for unauthorized AIFs):
    - Directors in common, cross-shareholdings or contractual commitments between fund manager and depositary generally not permitted (FCA exemptions possible).
    - Limit for permitted cross-ownership is 15 percent.
- Safekeeping and segregation:
  - FCA client asset rules: restrictions on registering assets in the name of the depositary or nominee; records must distinguish each client’s safe custody assets; reconciliations and auditor confirmation required.
  - AIFMD: segregation and record-keeping for all AIF assets; financial instruments that cannot be physically delivered must be registered in segregated accounts in AIF or AIFM name.
- Delegation of custody:
  - FCA rules: subcustodian must be subject to regulation and supervision in its country; special rules for non-EEA countries and identification/separation of client assets.
  - AIFMD: delegation permitted only for safekeeping tasks; delegate must be prudentially regulated and audited; investor information and specific instructions required for deviations in non-EEA countries.
- Depositary liability:
  - U.K. requirements on depositary liability more detailed than UCITS IV; depositary remains liable for loss of financial instruments held in custody subject to limited external event defenses.
  - AIFMD permits contractual discharge of liability in case of delegation under certain conditions; UCITS V largely aligns with AIFMD but does not allow discharge of liability when safekeeping duties delegated.
  - HMT view (open consultation published October 23, 2015): existing U.K. legislation, FCA rules, and U.K. insolvency laws ensure custody assets are protected from creditor distribution upon insolvency of a U.K. depositary.

### Authorization framework, delegated management, and cross-border issues
- FCA authorization approach:
  - Applicant must be ready, willing and organized, capable of being effectively supervised.
  - Five threshold conditions: (i) offices located in the U.K.; (ii) capability of effective supervision by FCA; (iii) sufficient resources; (iv) fitness and properness; (v) suitable business model.
  - Statutory decision timelines (selected):
    - Full-scope or small registered AIFM: decision within three months from a complete application; six months from incomplete application for small registered AIFM.
    - Investment managers, UCITS fund managers, small authorized AIFMs: decision within six months from complete application; 12 months from incomplete application.
    - In practice, FCA applies FSMA 12 month deadline to incomplete applications for full-scope AIFM.
- Authorization volumes and trends (selected):
  - Table (selected years):
    - 2012/13 Received: Investment management firms 168; Total 175. Authorized: Investment management firms 154; Total 154. Withdrawn/refused: Investment management firms 21; Total 21.
    - 2013/14 Received: Investment management firms 68; Full scope AIFMs 56; Small authorized AIFMs 48; Small registered AIFMs and EuVECAs 56; Depositaries 9; Total 238. Authorized total 124. Withdrawn/refused total 22.
    - 2014/15 Received: Investment management firms 109; Full scope AIFMs 61; Small authorized AIFMs 39; Small registered AIFMs and EuVECAs 51; Depositaries 2; Total 300. Authorized total 341. Withdrawn/refused total 27.
  - 2012/13–2014/15: total 852 variation of permission applications by full scope and small authorized and registered AIFMs; 807 granted and 32 withdrawn or refused.
- Delegation and cross-border delegation:
  - UCITS and AIFMD impose delegation restrictions and duties to avoid “letter-box” entities; AIFMD has more detailed delegation rules including requirements for non-EEA delegates and subdelegation.
  - Common practice: U.K.-based investment managers manage assets under delegation from non-EEA AIFMs (e.g., U.S. domiciled AIFMs), posing supervisory challenges.
- Foreign fund managers and marketing:
  - Foreign managers can manage U.K. domiciled funds via UCITS and AIFMD passporting regimes and NPPR.
  - NPPR: non-EEA AIFMs managing U.K. AIFs or marketing AIFs in the U.K. are subject to their domestic requirements with the depositary of an authorized U.K. AIF required to be based in the U.K.
  - Cooperation arrangements required by AIFMD for systemic oversight and information exchange; FCA has established arrangements but effectiveness varies across jurisdictions.

### Data, transparency, AIFMD reporting, and analytical capability
- Data availability challenges:
  - Availability of data on investment funds—particularly AIFs—is a challenge.
  - AIFMD transparency reporting:
    - Quarterly reporting obligation since end-September 2014.
    - First annual reports submitted for end-December 2014: 1,203 AIFMs reported on 4,966 funds.
    - Small authorized and registered U.K. AIFMs and small non-EEA AIFMs marketing in the U.K.: subject only to annual reporting.
  - Data quality issues in initial reporting periods due to misinterpretation by firms and inexperience.
- FCA data initiatives and gaps:
  - Develop systems to identify misreporting; educate firms; provide proactive feedback to ESMA; develop automated charting and graphing for cross-period analysis.
  - FCA does not systematically collect regulatory data on UCITS risk profiles; relies on public databases given cross-border complexity.
  - Data gaps: FCA does not get information on non-EEA AIFMs managing AIFs not marketed in the U.K.; marketing-only information may be insufficient for systemic risk monitoring.
  - Recommendation: extend, if legally possible, scope of AIFMD transparency reporting to cover certain non-EEA AIFMs and enhance international exchange of information.
- Analytical tools:
  - Market data analysis tool conducts outlier analysis of approximately 3,000 authorized funds monthly.
  - Depositary voluntary reporting since January 2015 used to identify funds/firms with high or persistent breaches or falling risk ratings.
  - FCA working to develop capability for cross-sector comparisons by fund type (hedge fund, private equity, real estate, fund of funds, other) on counterparty credit, investment, leverage, and liquidity characteristics.

### Equity trading platforms: market structure, regulation, and supervision
- Market structure and market shares:
  - Equity trading occurs on RMs, MTFs, SIs and OTC (including BCNs).
  - BCN estimated European market share: about 1.8 percent; dark MTFs estimated at approximately 4.3 percent.
  - 11 U.K. exchanges and MTFs held a 45 percent market share of on-platform European equity trading in 2014; eight U.K. dark trading platforms held an 85 percent European dark trading market share.
- Legislative framework and MiFID II timing:
  - U.K. framework largely transposes MiFID; MiFID II transposition deadline originally July 3, 2016; European Commission proposed delaying application to January 3, 2018.
  - MiFID II expected to align regulatory treatment of various trading platforms (welcome).
- Recognition, authorization and supervision:
  - RIEs recognized under FSMA Recognition Requirements for Investment Exchanges and Clearing Houses Regulations 2001 (RRR); multidisciplinary FCA review at recognition stage.
  - MTF and BCN operators and SIs assessed as investment firms for threshold conditions.
  - BCNs can operate without being authorized trading system operators — identified deficiency to be addressed by MiFID II; pending MiFID II, FCA should ensure BCNs are sufficiently supervised given their trading system operator nature.
- Specific requirements and assessments for MTFs:
  - MTF operation requires MiFID permission; FCA reviews business model, operational and technological arrangements, surveillance, disaster recovery, and conducts onsite visits; typical MTF application can take up to 12 months.
  - Complex IT Controls Form reviewed by FCA IT operational risk experts.
- Supervision and thematic work:
  - Infrastructure & Trading Firms Department supervises RIEs and MTFs; Wholesale Banking Department captures SIs and BCNs under investment bank supervision.
  - Supervisory headcount for equity RIEs/ROIEs and MTFs: 13 FTEs.
  - Thematic reviews conducted (e.g., MTF rulebooks 2013–2015; pre-trade controls; dark pools review with findings intended Q2/2016).
- Transparency, waivers and trade reporting:
  - MiFID pre- and post-trade transparency apply to shares admitted to trading on an RM; SIs subject to limited pre-trade transparency.
  - FCA has granted all four MiFID waiver types to various RMs and MTFs; most dark pool MTFs operate under the reference price waiver.
  - FCA requires publication arrangements to be machine-readable and accessible for data consolidation; trade data monitors (TDMs) confirmed by FCA include BOAT Services Limited, Deutsche Boerse AG, London Stock Exchange plc, ICAP Securities & Derivatives Exchange, BATS Trading Limited.
  - MiFID II/MiFIR changes introduce Approved Publication Arrangements (APAs); TDMs will need authorization as APAs (no grandfathering).
- Market monitoring and resilience:
  - RIEs and MTFs required to have surveillance and market abuse detection systems; FCA analyzes operator notifications and suspicious transaction reports to identify gaps.
  - FPC and FCA monitoring of market-structure risks, algorithmic and high frequency trading, and episodes of high volatility (e.g., FPC September 2015 note on U.S. volatility episodes with sudden reductions in market depth).
  - Recommendation: FCA and FPC to continue monitoring and analyzing risks from equity market structure and functioning with consideration for asset valuation and financial stability implications.

### Systemic risk monitoring, BoE/FCA analytical work, and FPC conclusions
- BoE and FCA analytical work:
  - Collected liquidity management strategies and liquidation capacity data from 17 large asset managers and 143 funds, focusing on corporate bond holdings.
  - Data request included estimate of assets liquidatable under normal market conditions and use of liquidity tools (swing pricing, dilution levies, gates, payment in specie, suspension).
  - December 2015 FSR presented FPC review drawing on BoE/FCA information.
- FPC support and actions:
  - Supported BoE’s intention to incorporate investment fund activity into system-wide stress testing and to assess near-term market resilience to large-scale fund redemptions.
  - Supported further FCA work on investor awareness of liquidity risks, communication of good liquidity management practices, and assessment of leverage in funds.
  - FPC annual review of thirty types of activity outside core banking (July 2015) recommended no regulatory changes but detailed assessments of five activities including open-ended investment funds and hedge funds.
- Hedge fund focus:
  - FPC and FCA focus on hedge funds due to potential for high leverage, large exposures, complex instruments, and asset concentrations; concern over banks’ exposures to hedge funds via repo, margin loans, and derivatives.

### Main recommendations (Table 1 summary)
- Fund management:
  - Ensure that the FCA’s approach to authorizing fund managers and investment managers continues to take into account their specific risks — Medium.
  - Ensure that the FCA’s centralized event supervision function is sufficiently staffed or supported by investment management experts to effectively deal with relevant Pillar 2 events — Medium.
  - Ensure that the FCA’s own supervision of investment funds’ compliance with valuation requirements is sufficient — Medium.
  - Enhance liquidity risk management requirements for UCITS fund managers — Low.
  - Extend, if legally possible, the scope of the AIFMD transparency reporting to cover non-EEA managers and funds, where relevant for systemic risk monitoring, and strive for enhanced international exchange of information — High.
  - Develop a practical approach to measuring investment fund leverage and continue to contribute to international work to harmonize the leverage calculation method — Medium.
- Equity trading platforms:
  - Ensure that BCNs’ activities are sufficiently supervised and monitored — High.

*Source: UNITED KINGDOM — INTERNATIONAL MONETARY FUND (content unit _cr16161).*

### EXECUTIVE SUMMARY ___________________________________________________________________________ 5

### EXECUTIVE SUMMARY

### Overview and systemic challenge
- The size and interconnectedness of the U.K. investment management sector and equity markets pose a significant challenge to the U.K. authorities.
- Total authorized investment fund assets under management (AUM) by U.K. fund managers reached GBP 1,730 billion at the end of 2014, representing 95 percent of the U.K. GDP.
- Fifty-two percent of these assets belonged to foreign domiciled funds.
- In 2014, 11 U.K. based exchanges and MTFs held a 45 percent market share in all on-platform equity trading in Europe.
- The eight U.K. based “dark” (non-pre-transparent) trading platforms dominated European dark trading with an 85 percent market share.
- Many U.K. based brokers operate their own electronic crossing networks whose trades are reported as over-the-counter (OTC).
- These features create potential inward and outward spillovers requiring effective domestic supervision, systemic risk monitoring, and international cooperation.

### FCA supervisory approach and risks
- The Financial Conduct Authority (FCA) uses a sophisticated risk-based approach and has focused on developing a recently-launched new approach to supervision.
- Robust sector analysis supports the FCA’s prioritizations; explicitly articulated risk appetites guide day-to-day supervisory choices.
- The FCA has developed tools to identify trends and outliers in the markets.
- With current resources, the new approach appears to strike the right balance between firm-specific and market-based supervision.
- Potential risks:
  - Extent of use of this approach in authorizing new entrants.
  - Reacting to events in the large population of firms not subject to an ongoing cycle of proactive firm-specific supervision.
- Mitigants recommended:
  - Ensure the FCA’s approach to authorizing fund managers and investment managers continues to take into account their specific risks.
  - Ensure the FCA’s centralized event supervision function is sufficiently staffed or supported by investment management experts.

### Fund management regulation and supervision — findings
- The regulatory and supervisory approach for fund management is sound but would benefit from enhancements to prevent build-up of risks.
- U.K. funds are subject to detailed valuation requirements; depositaries are responsible for monitoring compliance and reporting pricing errors to the FCA.
- The FCA needs to ensure that its own supervision of investment funds’ compliance with valuation requirements is sufficient.
- The Financial Policy Committee (FPC) and the FCA are conducting timely work on liquidity risk management of corporate bond funds.
- The U.K. framework provides fund managers with a suite of tools to manage risk from large redemptions.
- Recommendation to complement existing measures: enhanced liquidity risk management requirements for managers of UCITS funds.

### Data, transparency, and leverage
- Availability of data on investment funds—in particular AIF—is a challenge.
- Authorities should extend, if legally possible, the scope of transparency reporting under the Alternative Investment Fund Managers Directive (AIFMD), and strive for enhanced international exchange of information to improve data availability.
- This is important to monitor potential systemic risk of foreign-domiciled AIFs and their managers with significant investments managed in the United Kingdom or with exposures to U.K. counterparties.
- Authorities’ ability to assess risks would be enhanced by adopting a globally harmonized calculation method for fund leverage.
- The U.K. authorities should continue to actively contribute to international work in this area.

### Equity trading platforms — findings and regulatory alignment
- Changes to European Union (EU) legislation are expected to align the regulatory treatment of various trading platforms, which would be welcome.
- Current regulatory framework applicable to regulated markets (RMs) and multilateral trading facilities (MTFs) is comprehensive and subject to robust supervision.
- Broker crossing networks (BCNs) currently operating in the U.K. are not regulated and supervised in an equal manner, despite conducting similar business.
- MiFID II is due to align requirements for various trading platforms; it is currently planned to enter into application one year later than originally planned.
- Pending application of the new requirements, the FCA should ensure that BCNs’ activities are sufficiently supervised and monitored, taking into account the nature of their business as trading system operators.

### Systemic risk monitoring and institutional roles
- The U.K. authorities are engaged in important work on identifying and monitoring potential systemic risk in fund management and equity trading platforms.
- The December 2015 Financial Stability Report (FSR) presented the FPC’s review of potential risks to U.K. financial stability arising from the activities of investment funds.
- The FPC is undertaking a detailed assessment of the investment activities of hedge funds.
- The FCA’s contribution includes input by sector experts and supervisors, whose expertise ranks highly in international comparison.
- The FCA’s role in systemic risk monitoring is backed by one of its three operational objectives: to protect and enhance the integrity of the U.K. financial system.

### Key statistics on U.K. funds and managers
- As of July 2015, out of 945 U.K. UCITS funds, only five were managed by non-U.K. managers; the rest were managed by 115 U.K. UCITS fund management companies.
- The AUM of U.K. domiciled UCITS funds as at end-September 2015 reached GBP 759 billion.
  - AUM of equity funds: GBP 464 billion.
  - AUM of fixed income funds: GBP 130 billion.
  - Money market funds (MMFs) AUM: GBP 6 billion.
- Alternative investment management:
  - More than 1,800 U.K. domiciled AIFs.
  - U.K. AIFMs total number exceeds 500.
  - U.K. AIFMs manage more than 2,200 non-U.K. AIFs, more than 60 percent of which are non-EEA AIFs.
  - According to Q2/2015 quarterly reporting, total net asset value (NAV) of assets managed by U.K. AIFMs was GBP 636 billion.
    - NAV of hedge funds: GBP 150 billion.
    - NAV of funds of funds: GBP 122 billion.
    - NAV of private equity funds: GBP 14 billion.
    - NAV of real estate funds: GBP 53 billion.
  - 484 foreign AIFMs reported they were marketing 611 AIFs with a total NAV of GBP 347 billion in the U.K.

### Main recommendations (from Table 1)
- Fund management
  - Ensure that the FCA’s approach to authorizing fund managers and investment managers continues to take into account their specific risks — Medium
  - Ensure that the FCA’s centralized event supervision function is sufficiently staffed or supported by investment management experts in order to be able to effectively deal with relevant Pillar 2 events — Medium
  - Ensure that the FCA’s own supervision of investment funds’ compliance with valuation requirements is sufficient — Medium
  - Enhance liquidity risk management requirements for UCITS fund managers — Low
  - Extend, if legally possible, the scope of the AIFMD transparency reporting to cover non-European Economic Area (EEA) managers and funds, where relevant for systemic risk monitoring, and strive for enhanced international exchange of information — High
  - Develop a practical approach to measuring investment fund leverage and continue to contribute to international work to harmonize the leverage calculation method — Medium
- Equity trading platforms
  - Ensure that BCNs’ activities are sufficiently supervised and monitored — High

*UNITED KINGDOM  INTERNATIONAL MONETARY FUND*

### 8.      AIFs are primarily intended for professional investors, and some AIFs are subject to

### _cr16161 - 8.      AIFs are primarily intended for professional investors, and some AIFs are subject to 

### Regulation: UK legislative and EU framework
- The United Kingdom legislative and regulatory framework for fund management is largely based on the relevant EU framework.
- Main U.K. legal instruments transposing EU legislation: Financial Services and Markets Act 2000 (FSMA), Open-Ended Investment Company Regulations 2001 (OEIC Regulations), Alternative Investment Fund Managers Regulations 2013 (AIFMD Regulations), and various FCA Handbook rules.
- Key EU Directives for fund management: UCITS Directive and AIFMD.
  - AIFMD had to be transposed by July 22, 2013; transitional period for existing AIFMs to seek authorization or registration ended a year later.
  - Recast UCITS Directive (UCITS V Directive) had to be transposed by March 18, 2016; UCITS IV Directive had been in place since 2011.
- The AIFMD focuses on managers (AIFMs) and includes a detailed framework for non-EEA AIFMs and non-EEA AIFs management and marketing in the EEA; that framework is not yet fully applicable and non-EEA AIFMs/AIFs are currently subject to National Private Placement Regimes (NPPRs) in some member states, including the U.K.
- Discussion below highlights areas most relevant for financial stability, identifies non-compliance with IOSCO Principles or Standards, and notes additional U.K. specific requirements where applicable.

### Fund categorization and marketing constraints
- As an EU member state, the United Kingdom classifies all U.K. investment funds as either UCITS funds or AIFs.
- UCITS funds require authorization; AIFMD applies to the manager (AIFM), though the U.K. regulatory framework requires some AIFs to be authorized.
- AIFs are primarily intended for professional investors.
- Financial promotion constraints in the United Kingdom prohibit promotion of Qualified Investor Schemes (QIS) and unauthorized AIFs to ordinary retail investors in the U.K., but do not impose restrictions on promotion to sophisticated investors and high net worth individuals.
- Non-UCITS Retail Schemes (NURS) can be promoted to ordinary retail investors, subject to specific FCA requirements. Listed closed-ended funds (investment trusts) can be acquired by retail investors.

### Valuation of assets — UCITS funds and NURS
- UCITS Directive: determination of valuation requirements is left to the member state; rules must be laid down in national law, fund rules, or instruments of incorporation.
- Management companies managing a UCITS domiciled in another EEA state must comply with that state’s valuation, accounting and pricing rules.
- Fund managers are responsible for calculating NAV and subscription/redemption prices and must have procedures ensuring proper and accurate valuation in accordance with fund rules and prospectus. Analogous requirements apply to AIFMs of NURS under the FCA Handbook.
- Required valuation frequency depends on type, redemption frequency and volatility:
  - UCITS Directive: a UCITS fund must have at least two valuation points in a month that are at least two weeks apart.
  - FCA rules require a UCITS fund to be valued at least as frequently as subscriptions and redemptions can take place.
  - Same requirements apply to NURS; certain NURS with limited redemption arrangements can be valued only every six months.
  - Higher volatility funds and QIS must generally be valued every business day.
- FCA Handbook guidance on fair value pricing:
  - Fair value pricing is expected when no reliable price exists or where the most recent price does not reflect the manager’s best estimate.
  - Fair value must consider fund type, securities, basis and reliability of alternative price, and manager’s valuation policy as disclosed in the prospectus.
- Accounts of UCITS funds, NURS, and QIS must comply with the Statement of Recommended Practice (SORP) issued by the Investment Association; SORP complies with U.K. Financial Reporting Standard 102 based on IFRS for SMEs — U.K. requirements appear to comply with IOSCO Principles 26 and 27.
- Money Market Funds (MMFs):
  - FCA Handbook: Qualifying MMFs must be valued every business day at amortized cost basis.
  - Short term MMFs must generally be valued every business day either at amortized cost or mark to market basis.
  - Regular money market funds must be valued on mark to market basis.
  - Additional requirements for MMFs valued on an amortized cost basis (e.g., weekly mark to market with tolerance thresholds and notification procedures).
  - At the time of the FSAP, there was only one U.K. MMF with AUM of GBP 2.2 billion that aims at maintaining a constant NAV.
  - The FCA has indicated preference to wait for outcome of EU Money Market Funds Regulation negotiations before making domestic policy amendments; pending EU outcome, FCA should ensure any new constant NAV MMFs comply with IOSCO Policy Recommendations safeguards and pay attention to extent of amortized cost valuation use by short-term MMFs.

### Valuation timing and pricing practices
- FCA Handbook had allowed both forward and historic NAV for determining subscription and redemption prices; FCA intended to remove historic NAV possibility.
  - Forward pricing already compulsory in certain cases: higher volatility funds where regular valuation points are more than one business day apart; at request of subscriber/redeemer; where manager believes current value would vary by more than two percent from last calculated price.
  - FCA consultation proposing deletion of historic NAV possibility closed on December 7, 2015.
  - IOSCO Principle 9 states purchase and redemption of CIS interests should not be made at historic NAV; permitted exemptions are very limited.
- Recommendation: FCA should proceed with plan to remove historic pricing from its rules.

### Valuation requirements for other AIFs (AIFMD-based)
- AIF assets must be valued and NAV per unit calculated at least once a year.
- For open-ended AIFs, valuation frequency must be appropriate to the assets and issuance/redemption frequency; financial instruments must be valued every time the NAV per unit is calculated; other assets at least once a year and whenever evidence shows last value is no longer fair or proper.
- For closed-ended AIFs, valuations and calculations must be carried out in case of an increase or decrease of the AIF’s capital.
- AIFMD implementing measures prescribe detailed requirements on valuation policies and procedures, use of models, and review of individual asset values.

### Who may conduct valuations and independence safeguards
- If the AIFM performs valuation, those responsible must be functionally independent from portfolio management; remuneration policy and other measures must mitigate conflicts.
- Any external valuer must be independent from the AIF, the AIFM, and any other person with close links to the AIF or AIFM.
- AIF’s depositary cannot be appointed as external valuer unless it has functionally and hierarchically separated depositary functions from external valuer tasks, and potential conflicts are identified, managed, monitored and disclosed to investors.
- External valuer is prohibited from delegating the valuation function.
- AIFM must notify the competent authority of appointment of external valuer.
- If valuation is not performed by an independent external valuer, competent authority may require verification by an external valuer or auditor; competent authority can require external valuer to verify independence of internal valuation.

### Role of depositaries and auditors
- Under UCITS Directive and AIFMD, depositary must ensure value of fund units is calculated in accordance with applicable national law and fund rules; AIFMD further requires depositary to ensure valuations are made in accordance with AIFM’s valuation procedures.
- FCA Handbook expands requirements: UCITS and NURS depositary must ensure manager has adopted appropriate procedures for correct unit price calculation and maintained sufficient records; depositary must confirm systems are satisfactory and periodically review valuation aspects.
- Fund auditors review valuation of fund assets as part of annual accounts review.
  - UCITS fund must appoint an independent auditor authorized by its EEA home state to audit annual accounts.
  - In the U.K., auditor's opinion must confirm annual accounts have been properly prepared in accordance with the SORP, the FCA Handbook and the fund rules.

### Treatment of pricing errors
- UCITS Directive and AIFMD include general references to treatment of pricing errors:
  - UCITS Directive: home state rules apply to errors in NAV calculation and related investor compensation.
  - AIFMD implementing measures require AIFM to ensure remedial procedures are in place for incorrect NAV calculation.
- FCA Handbook guidance:
  - Fund manager should record each instance of incorrect pricing and report it to the depositary with details of action taken to avoid repetition.
  - The depositary should report any material breaches immediately to the FCA and make a monthly return summarizing number of instances of incorrect pricing.
    - Note: FCA Handbook currently requires quarterly reporting, but in practice reporting takes place monthly based on a voluntary arrangement; FCA has consulted on changing its Handbook to formalize monthly reporting.
  - Fund manager must reimburse affected unitholders and the fund for instances of incorrect pricing, except where depositary deems breach of minimal significance. Depositary should ensure payments are accurately and promptly calculated and paid.

### Managing the redemption risk — Risk and liquidity management
- UCITS funds subject to investment limits and managers are required to manage and measure fund risk on a continuous basis.
- UCITS Directive sets detailed investment limits and requires a risk management process enabling monitoring and measurement of risk positions and their contribution to overall portfolio risk.
- UCITS Implementing Directive adds due diligence requirements for investment selection and requirements on risk management and measurement.
- Risk management policy must include procedures to assess exposure to liquidity risk.
- Competent authority must review risk management policy when authorizing the manager and on an ongoing basis; material changes must be notified.
- UCITS fund manager must adopt effective arrangements, processes and techniques to establish, implement and maintain a documented system of internal risk limits, including for liquidity risk where relevant.
- Manager must employ an appropriate liquidity risk management process to ensure each UCITS complies with redemption obligations and, where appropriate, conduct stress tests to assess UCITS liquidity risk under exceptional circumstances.
- Liquidity profile of UCITS must be appropriate to the disclosed redemption policy.

*Source: UNITED KINGDOM — INTERNATIONAL MONETARY FUND (excerpts from the referenced IMF country report section).*

### 24.      The above regulatory requirements on liquidity risk management are comprehensive,

### _cr16161 - 24.      The above regulatory requirements on liquidity risk management are comprehensive,

### Liquidity risk management: current requirements and recommended enhancements
- UCITS fund managers are required to conduct liquidity stress tests to assess liquidity risk only in exceptional circumstances.
- Principle 14 of the IOSCO Principles for Liquidity Risk Management for CIS requires that appropriate liquidity risk assessments should be carried out also for normal scenarios.
- Recommendation: Require UCITS fund managers to conduct liquidity stress tests also under normal liquidity conditions to align with AIFMD requirements and enhance robustness.
- The FCA is encouraged to seek enhancements to the liquidity risk management requirements for UCITS fund managers, either through changes to the UCITS Directive or through its own measures.
- FCA Handbook includes a requirement for prudent spread of a UCITS fund’s risk: investing in illiquid instruments is not prohibited, but the fund manager must ensure a prudent spread of risk, including liquidity risk.
- If it is not possible to provide a prudent spread of risk after meeting redemptions, the fund manager would be required to suspend or defer redemptions.

### AIFMD liquidity management and disclosure obligations
- AIFMD requires:
  - ensuring the investment strategy, liquidity profile and redemption policy of each AIF are consistent;
  - employing an appropriate liquidity management system and procedures to monitor AIF liquidity risk;
  - regularly conducting stress tests under normal and exceptional liquidity conditions;
  - disclosing to investors a description of the AIF’s liquidity risk management, including redemption rights in normal and exceptional circumstances and existing redemption arrangements;
  - identifying, managing and monitoring conflicts of interest between redeeming and remaining investors and between the AIFM’s incentive to invest in illiquid assets and its redemption policy.

### Pricing tools to mitigate first-mover advantage
- FCA rules enable the use of pricing tools subject to fund rules and prospectus; these tools pass costs to exiting investors rather than remaining investors.
- Examples of pricing tools:
  - Swing pricing: unit price determined by calculating the NAV before subscriptions and redemptions and then adjusting it by a pre-determined amount (the swing).
  - Dilution levies: a separate charge made to investors buying or selling fund units and paid into the fund to mitigate effects of dilution on remaining unitholders.
  - Dilution adjustments: unit price adjusted to reduce dilution in the scheme.
- Redemption in kind may be used in practice only for large (primarily institutional) redemptions.
- Note: Using dual prices is also possible. In practice swing pricing or dilution levies would be applied in the event of very high redemptions in a period of market stress or high transaction costs.

### Suspension and deferral of redemptions
- UCITS Directive: a UCITS fund may, in accordance with applicable national law and the fund rules, temporarily suspend redemption of its units only in exceptional cases where suspension is in the interest of unit holders.
- U.K. rules (also applying to NURS) require agreement of the depositary or may be required by the depositary for suspension.
- FCA Handbook specifies that difficulties in realizing fund assets or temporary shortfalls in liquidity may not, in isolation, be sufficient justification for suspension.
- Notification and review requirements:
  - The competent authority and investors must be informed about any suspension, as required in the UCITS Directive.
  - Suspension is only allowed as long as justified in the interest of unit holders, with a formal review at least every 28 days.
- Deferral rules:
  - A UCITS or NURS with at least one valuation point on each business day may permit deferral of redemptions at a valuation point to the next valuation point where the requested redemption exceeds 10 percent, or some other reasonable proportion disclosed in the prospectus, of the fund’s value.
  - No prior FCA approval is required and no maximum time period is set out.
  - For QIS and unauthorized AIFs, the AIFM can defer redemptions so long as it is provided for in the fund rules.
- The FSMA provides the FCA with the power to require suspension of redemptions based on the FCA’s general own initiative powers.

### Limited redemptions
- AIFMD permits limited redemption arrangements to manage liquidity risk of often illiquid investments.
- U.K. rules for NURS operating as a Fund of AIFs that invests substantially in immovables or has an objective to provide a specified level of return may provide for limited redemption arrangements:
  - Must provide for sales and redemptions at least once in every six months (instead of the normal twice monthly requirement for NURS).
- FCA Handbook guidance for QIS: maximum period between dealing days depends on reasonable expectations of target investor group and investment objectives and policy of the fund.
- For other AIFs, it is sufficient to provide information in the fund rules on any restrictions on the right to redeem units.

### Use of leverage: differences between UCITS and AIFMD
- UCITS:
  - Global exposure calculated using either the commitment approach or the Value-at-Risk (VaR) method.
  - Borrowing is not taken into account when determining leverage; UCITS funds are permitted to borrow only up to 10 percent of their NAV.
  - UCITS Directive limits global exposure from derivative instruments to 100 percent of the total net value of the UCITS portfolio.
- AIFMD:
  - Defines leverage as any method by which the AIFM increases the exposure of an AIF, including borrowing of cash or securities, leverage embedded in derivative positions or by any other means.
  - Requires AIFMs to set leverage limits for each AIF they manage but does not set maximum limits on leverage.
  - Leverage must be calculated using two methods: the gross method and the commitment method.
  - The overall leverage of an AIF is expressed as a ratio of the AIF exposure to its NAV.
- Box 2 — Leverage calculation methods (high-level points retained):
  - UCITS commitment approach: global exposure takes into account financial derivatives and SFTs that generate leverage; derivates = sum of equivalent positions in underlying assets after netting and hedging + SFT = market value of collateral received (including cash) when reinvested.
  - VaR usage conditions for UCITS: when complex strategies represent more than a negligible part of investment policy; more than a negligible exposure to exotic derivatives; or the commitment approach does not adequately capture market risk.
  - VaR specifics:
    - Relative VaR: VaR of the UCITS fund’s current portfolio compared to the VaR of an unleveraged reference portfolio. Portfolio VaR limit is twice the VaR of the unleveraged reference portfolio.
    - Absolute VaR: Risk limited to maximum of 20 percent of NAV; specific requirements on confidence interval, holding period and effective observation period of risk factors.
  - AIFMD commitment method: similar to UCITS commitment approach but includes all positions (not only derivative positions).
  - AIFMD gross method: requires summing absolute values of the assets of the AIF without netting and hedging; cash and cash equivalents are excluded.
  - AIFMD formulas (summary):
    - Commitment method components: Direct positions: accounting value + Derivatives: sum of market value of equivalent position after netting and hedging + SFT: market value of collateral received (including cash) when reinvested + Reuse of cash borrowing: the higher of the market value of the investment realized or the total amount of the cash borrowed.
    - Gross method: Direct positions: absolute value - Cash equivalents.

### Leverage reporting and need for harmonization
- AIFMD requires AIFs’ leverage to be reported to competent authorities on a regular basis.
- UCITS reporting on leverage is more limited:
  - UCITS fund managers must only report annually on types of derivative instruments used, underlying risks, quantitative limits and methods chosen to estimate risks associated with derivative transactions.
  - UCITS fund managers currently required to notify details of their derivative risk management process to the FCA at least annually.
  - FCA plans to introduce a reporting template to inform the FCA on, among others, a UCITS fund’s gross long and short derivative positions and details of the risk measures used (commitment approach or relative or absolute VaR).
  - FCA intends to use the reporting to focus supervisory work and monitor potential risks building in the sector.
- Identified gap: Absence of an internationally agreed standard for determining an investment fund’s leverage.
  - Market participants concerned about potentially misleading leverage information from current calculation methods.
  - Recommendation: The FCA and other U.K. authorities should develop a practical approach to measuring investment fund leverage and continue contributing to international work to harmonize leverage calculation method.

### Depositaries: appointment, prudential requirements, independence, and functions
- UCITS Directive and AIFMD require appointment of a depositary for each UCITS fund and AIF.
- General rule: a depositary must have its registered office or a branch in the same country where the fund is domiciled; non-EEA AIF’s depositary may be established in the AIFM home state.
- Competent authority of the UCITS home state must approve the depositary to act as depositary for a fund domiciled in that EEA state.
- FCA Handbook requires the FCA to approve the depositary of a U.K.-domiciled AIF.
- UCITS IV: when fund and manager in different EEA states, a detailed written agreement must regulate information flow; AIFMD and UCITS V require such a written contract independent of locations.
- Prudential requirements:
  - U.K. prudential requirements for UCITS depositaries are more stringent than UCITS IV Directive.
  - A U.K. bank subject to a EUR 5 million capital requirement or an investment firm subject to a GBP 4 million capital requirement can be authorized to act as a depositary of a UCITS fund.
  - UCITS V Directive eligibility requirements are more detailed; FCA plans to continue to apply stricter capital requirements than UCITS V.
  - U.K. requirements for NURS and QIS depositaries exceed AIFMD requirements: investment firm acting as NURS or QIS depositary must comply with GBP 4 million capital requirement instead of EUR 730,000 standard MiFID requirement.
  - Depositary of a private equity AIF and a non-EEA AIF (AIFMD Article 36 ‘depositary light’ regime) is subject to a minimum capital requirement of EUR 125,000 under U.K. rules.
- Depositary independence:
  - AIFMD and UCITS V include depositary independence requirements going beyond UCITS IV prohibition for management company to act as depositary.
  - They prohibit a depositary from carrying out activities with regard to a fund or its manager unless functionally and hierarchically separated and conflicts properly identified, managed, monitored and disclosed.
  - AIFMD specifically prohibits an AIF’s prime broker from acting as the AIF’s depositary unless prime brokerage and depositary functions are separated and conflicts properly managed and disclosed.
  - U.K. framework imposes additional depositary independence requirements not based on EU legislation, applying to UCITS funds and authorized AIFs (QIS and NURS) but not to unauthorized AIFs:
    - Directors in common, cross-shareholdings or contractual commitments between fund manager and depositary are generally not permitted (with FCA exemptions possible).
    - Limit for permitted cross-ownership is 15 percent.
    - For unauthorized AIFs, AIFM and depositary can be part of same corporate group or otherwise connected provided general AIFMD requirements are complied with.

### Safekeeping, segregation, and delegation of custody
- FCA Handbook client asset rules include safekeeping and segregation requirements for UCITS and NURS depositaries:
  - A depositary generally restricted from registering its own assets in the name of the client or any nominee in whose name a client’s safe custody asset is also registered.
  - Legal title to a safe custody asset may be registered in name of another party or the depositary if only option due to law or market practice of foreign jurisdiction and depositary has notified the client in writing.
  - Depositary’s records and accounts must distinguish each client’s safe custody assets from depositary’s own assets and those of other clients.
  - Accuracy checked through reconciliations; auditor must review reconciliation method and confirm in annual client assets report to FCA that depositary maintained adequate systems to comply with custody rules.
  - Detailed rules exist on treatment of shortfalls from record discrepancies.
  - Use of client assets in securities financing transactions or otherwise for account of depositary or account of another client requires client’s express prior consent.
- AIFMD requires segregation and safekeeping/record keeping for all AIF assets:
  - Financial instruments that can be held in custody but cannot be physically delivered to the depositary must be registered in a segregated financial instruments account opened in the name of the AIF or the AIFM acting on behalf of the AIF.
  - Up-to-date records must be kept of other assets.
- Delegation:
  - FCA Handbook includes specific requirements on delegation of custody by a UCITS or NURS depositary:
    - Subcustodian must be subject to regulation and supervision in a country that specifically regulates and supervises safekeeping of safe custody assets.
    - If not the case and the country is a non-EEA country, custody can be delegated only if nature of assets or services requires deposit with a third party in that non-EEA country.
    - Safe custody assets deposited with a subcustodian must be separately identifiable from assets belonging to depositary and subcustodian by differently titled accounts or equivalent measures.
  - AIFMD delegation rules permit delegating only safekeeping tasks:
    - Delegate providing subcustody must be subject to effective prudential regulation and an external periodic audit of financial instruments in custody.
    - Subject to informing investors and specific instructions from the AIF or AIFM, deviation allowed in non-EEA countries if local law requires custody tasks be provided by a local entity and none satisfies the above conditions.
    - Delegate must segregate assets of the depositary’s clients from its own assets and those of the depositary so they can be clearly identified as belonging to clients of a particular depositary.
    - Delegate must keep records and accounts necessary to distinguish assets of depositary’s AIF clients from its own assets, assets of its other clients, assets held by depositary for its own account, and assets held for clients of depositary which are not AIFs.
    - Delegate cannot make use of the assets unless it has received prior consent from the AIF or the AIFM and notified the depositary.

*Source: _cr16161 - 24.      The above regulatory requirements on liquidity risk management are comprehensive,*

### 45.      The above U.K. requirements comply with the segregation and safekeeping

### _cr16161 - 45.      The above U.K. requirements comply with the segregation and safekeeping

### Segregation and safekeeping
- The above U.K. requirements comply with the segregation and safekeeping requirements in IOSCO Principles and Standards.
- Given the lack of clarity on the interpretation of the segregation requirements under the AIFMD and the cross-border nature of the investment fund industry, the U.K. authorities should continue to contribute to EU-level discussions to develop a common approach.
- Differing interpretations would lead to operational challenges in custody arrangements and facilitate regulatory arbitrage.

### Depositary liability
- U.K. requirements on depositary liability are more detailed than the UCITS IV Directive requirements.
- Under UCITS IV Directive: a depositary is liable to the management company and the unit-holders for any loss suffered by them as a result of its unjustifiable failure to perform its obligations or its improper performance of them.
- U.K. rules further specify:
  - If a depositary retains the services of its own associate, the fund manager or that manager’s associate, the depositary’s liability remains unaffected.
  - In any other case, the depositary will not be held responsible for any act or omission of the delegate if it can show that:
    - it was reasonable for it to obtain assistance to perform the function;
    - the person retained was and remained competent to provide assistance in the performance of the function; and
    - it had taken reasonable care to ensure that the assistance was provided in a competent manner.
- AIFMD depositary liability requirements:
  - More explicit than UCITS IV but enable contractual discharge of liability in case of delegation.
  - Notwithstanding delegation, the depositary remains liable for any loss of financial instruments held in custody.
  - If a loss happens, the depositary will have to return to the AIF or AIFM a financial instrument identical to the type lost or the corresponding amount.
  - The depositary will not be liable if it can prove the loss arose as a result of an external event beyond its reasonable control, the consequences of which would have been unavoidable despite all reasonable efforts to the contrary.
  - Subject to the AIF’s agreement, the depositary can discharge itself of liability if it can prove a written contract between the depositary and the delegate expressly transfers the liability to the delegate and makes it possible to make a claim against the delegate.
- UCITS V Directive:
  - Largely aligns depositary liability requirements with those of the AIFMD.
  - Does not allow any discharge of liability (including for loss of assets) when safekeeping duties have been delegated to a third party.
  - Requires member states to ensure that, in the event of insolvency of the depositary or its delegate, the assets of the UCITS held in custody are unavailable for distribution among the creditors of the depositary or of the third party delegate.
  - HMT view (open consultation published on October 23, 2015): existing U.K. legislation, FCA rules, and U.K. insolvency laws ensure that custody assets are protected from creditor distribution upon the insolvency of a U.K. depositary.

### Authorization framework and processes
- FCA general authorization approach for fund management activities: applicant must be ready, willing, and organized to comply with FCA’s requirements and capable of being effectively supervised by the FCA.
- FCA five threshold conditions:
  - (i) offices located in the U.K.;
  - (ii) capability of being effectively supervised by the FCA;
  - (iii) sufficient resources;
  - (iv) fitness and properness; and
  - (v) a suitable business model.
- FCA must consider its competition objective and ensure no unjustified barriers to entry, expansion, or exit.
- FCA centralized authorization function: Permissions Department of the Supervision—Retail and Authorizations Division.
  - Headcount varied between 69.8 full-time employees (FTE) at the end of 2014 and 77.0 at the end of 2013.
  - The end-June 2015 headcount was 73.3 FTE.
  - Staff are in principle specialized by applicant type, but peaks (such as AIFM applications) required staff to work on non-specialized applications and use temporary staff.
  - Case officers for AIFM applications could change multiple times during the process; perception that staff sometimes had to focus on elements not key to AIFMs.
- Statutory deadlines under FSMA and AIFMD Regulations for authorization decisions:
  - FCA must make a decision within three months from receiving a complete application for authorization as a full-scope or small registered AIFM and within six months from receiving an incomplete application for authorization as a small registered AIFM.
  - For investment managers, UCITS fund managers and small authorized AIFMs: FCA is required to make a decision within six months from receiving a complete application and within 12 months from receiving an incomplete application.
  - Note: While no statutory deadline applies to incomplete applications for authorization as a full-scope AIFM, in practice the FCA applies the FSMA 12 month deadline.
- FCA publishes key performance indicators for retail and wholesale authorizations including volumes and distributions of applications (approved, withdrawn, refused).
- FCA risk-based processing:
  - Low risk applications: standard checks.
  - Medium and high risk applications: enhanced controls.
  - If satisfied applicant meets threshold conditions, case officer or secondary decision maker approves; otherwise Legal Team of Enforcement and Market Oversight Division (EMO) is engaged.
  - Refusal decisions are taken by the Regulatory Decisions Committee; applicants tend to withdraw if authorization within deadlines seems unlikely since refusals are made public.
- Authorization process largely document review; case officer may seek expert comments; no cross-departmental teams formed for applications; additional contacts with applicant when needed.
- Volume and peaks of applications pose significant challenges and likely to continue with MiFID II implementation.

### Managers (authorization requirements and practice)
- UCITS fund managers must be authorized; AIFMs must be either authorized or registered.
- A firm that manages a UCITS fund must be authorized as a UCITS management company; a firm that performs risk management or portfolio management for an AIF must be authorized or registered as an AIFM.
- AIFMD requires full authorization only for AIFMs managing AIFs above the AIFMD Article 3 AUM threshold; sub-threshold AIFMs required only to be registered.
- U.K. requirements go beyond AIFMD minima for some AIFMs: AIFMs of NURS and QIS must be authorized either as full-scope AIFMs (possibly through opt-in) or as small authorized AIFMs.
- Exemptions: AIFM of a non-EEA AIF not marketed in the EEA does not need to comply with depositary and annual reporting requirements of Articles 21 and 22 of the AIFMD.
  - If the AIF is marketed in the EEA, annual reporting applies but the AIFM is subject to the ‘depositary light’ regime under Article 36 of the AIFMD (appoint a depositary to carry out cash flow monitoring, safekeeping and certain monitoring tasks).
  - U.K. requires small authorized and registered AIFMs to comply with the safekeeping and segregation rules described above.
- Past practice: AIFM applications were reviewed more comprehensively than UCITS management company authorizations; UCITS reviews focused largely on generic threshold conditions, AIFM reviews paid closer attention to valuation, delegation, risk management, leverage and marketing.
- During FSAP, FCA enhanced UCITS fund manager authorization process to incorporate elements similar to AIFM applications: valuation, delegation, risk management (including liquidity risk management).
- Risk-based approach to authorizations poses challenges to ongoing supervision:
  - If firms categorized as low risk at authorization later fall under the flexible portfolio in supervision, risk of undetected risks accumulating increases.
  - This risk is more limited for UCITS fund managers since their applications typically subject to enhanced controls, while AIFMs’ applications are normally subject only to standard checks due to lower risk to FCA’s customer protection objective.
- Importance of continuing to adjust authorization process to sector-specific risks.

### Delegated management and cross-border delegation
- UCITS Directive: member states have discretion whether and subject to which conditions delegation of investment management is permitted.
  - Prevents delegating investment management to the depositary or to any other person with potential conflicts of interest.
  - Requires the delegate to be authorized for asset management, prudentially supervised and, if non-EEA, subject to cooperation between relevant authorities.
  - Delegation must not prevent effective supervision or the fund manager from giving further instructions or withdrawing the mandate.
  - Fund manager prohibited from delegating functions to the extent it becomes a letter box entity.
  - FCA Handbook includes additional requirements to ensure fund manager remains fully responsible despite outsourcing; fund manager obliged to inform the FCA of intention to delegate any function.
- AIFMD:
  - Similar requirements but significantly more detailed than UCITS Directive; FCA does not apply additional requirements.
  - AIFM must provide detailed description of entire delegation structure to competent authority.
  - Subject to home competent authority approval, an AIFM can delegate portfolio management or risk management to a person not authorized for asset management or subject to supervision (not permitted under UCITS Directive).
  - Subdelegation requires fund manager consent and notification to competent authority.
  - AIFMD prohibits delegation/subdelegation of portfolio management or risk management to a delegate of the depositary.
  - AIFM’s liability towards the AIF and its investors is not affected by delegation or sub-delegation.
  - AIFM must not delegate functions to the extent it becomes a ‘letter-box entity’.
  - Additional requirements on delegation to non-EEA persons: written agreement between relevant competent authorities covering access to information and documents, on-site inspections, and enforcement cooperation.
- Delegation arrangements are common and pose supervisory challenges, particularly cross-border delegation. This is relevant for the U.K. as an investment management hub.
  - Typical arrangements: U.K.-based investment manager manages hedge fund or private equity assets under delegation from a non-EEA AIFM (often domiciled in the United States); similar arrangements between fund managers in Ireland or Luxembourg and investment managers in the United Kingdom.

### Foreign fund managers
- Foreign fund managers can manage U.K. domiciled funds under UCITS Directive and AIFMD passporting regimes and under the NPPR.
- Under passporting, fund managers are subject to minimum harmonized requirements arising from EU Directives.
- Under U.K. NPPR regime, non-EEA AIFMs managing U.K. AIFs or marketing AIFs in the U.K. are subject to their domestic requirements with no additional requirements except that the depositary of an authorized U.K. AIF must be based in the United Kingdom.
  - (Further required cooperation arrangements for foreign funds are discussed in the section on foreign funds.)

### Funds (authorization of funds, timelines, and amendments)
- FCA follows same process for authorization of UCITS funds, NURS and QIS: case officers perform detailed review to verify compliance and ensure proposed fund appropriate for intended target investors.
  - FCA considers investment objective and policy but does not assess or endorse likelihood of achieving the aim.
  - Test: whether drafting of objective and policy is sufficiently representative of management, expectations created for investors, and whether investor has clear understanding of how fund will seek to deliver its stated aim.
- FCA fund authorization service standards and timelines:
  - Current one month authorization timeline for QIS and two month timeline for NURS (shorter than statutory deadline of six months).
  - UCITS fund authorization works within two month statutory timeline.
- FCA challenges applications when not satisfied with information or disclosures; applicants may amend documentation multiple times or withdraw application. Changes to fund operation or significant prospectus changes require FCA approval; notifications are risk assessed.
- Table 2: Number of New Firm Applications and Authorizations (selected figures)
  - 2012/13 Received: Investment management firms 168; Full scope AIFMs 0; Small authorized AIFMs 7; Small registered AIFMs and EuVECAs 0; Depositaries 0; Total 175.
  - 2012/13 Authorized: Investment management firms 154; Total 154.
  - 2012/13 Withdrawn/refused: Investment management firms 21; Total 21.
  - 2013/14 Received: Investment management firms 68; Full scope AIFMs 56; Small authorized AIFMs 48; Small registered AIFMs and EuVECAs 56; Depositaries 9; Total 238.
  - 2013/14 Authorized: Investment management firms 88; Full scope AIFMs 6; Small authorized AIFMs 15; Small registered AIFMs and EuVECAs 14; Depositaries 1; Total 124.
  - 2013/14 Withdrawn/refused: Investment management firms 19; Small authorized AIFMs 0; Small registered AIFMs and EuVECAs 3; Depositaries 6; Total 22.
  - 2014/15 Received: Investment management firms 109; Full scope AIFMs 61; Small authorized AIFMs 39; Small registered AIFMs and EuVECAs 51; Depositaries 2; Total 300.
  - 2014/15 Authorized: Investment management firms 90; Full scope AIFMs 68; Small authorized AIFMs 51; Small registered AIFMs and EuVECAs 123; Depositaries 9; Total 341.
  - 2014/15 Withdrawn/refused: Investment management firms 13; Full scope AIFMs 6; Small authorized AIFMs 6; Small registered AIFMs and EuVECAs 2; Total 27.
  - Note: These figures include both UCITS management companies and investment firms authorized under MiFID; includes transitional and business-as-usual cases.
  - Additional: In fiscal years 2012/13–2014/15 there were a total of 852 variation of permission applications submitted by full scope and small authorized and registered AIFMs; 807 variation of permission authorizations were granted and 32 withdrawn or refused.
- Table 3: Number of New Fund Applications and Authorizations and Amendments to Existing Funds (selected figures)
  - 2013: Number of new fund applications 53; Number of new fund authorizations 54; Number of amendments notified 1509; Number of amendments approved 956.
  - 2014: Number of new fund applications 65; Number of new fund authorizations 61; Number of amendments notified 1896; Number of amendments approved 1219.
  - Q1–Q2/2015: Number of new fund applications 35; Number of new fund authorizations 38; Number of amendments notified 588; Number of amendments approved 596.
  - Note: Not all notifications lead to the need to approve the change. All notifications have to be risk assessed.

*UNITED KINGDOM — INTERNATIONAL MONETARY FUND (content unit _cr16161)*

### 67.      The introduction of ELTIFs in the second half of 2015 is expected to increase the

### 67.      The introduction of ELTIFs in the second half of 2015 is expected to increase the 

### ELTIFs and foreign funds
- ELTIFs are an add-on to the AIFMD requiring each ELTIF to be authorized.
- ELTIFs will not be limited to the legal structures that have previously been subject to FCA authorization, and dealing with ELTIF applications may require the FCA to develop additional expertise in reviewing the new structures.
- Foreign UCITS funds and AIFs can be marketed to U.K. investors under certain conditions, with a distinction between funds marketed to retail investors and those marketed to professional investors.
- Funds that can be marketed to retail investors:
  - EEA UCITS funds passported under the UCITS Directive.
  - EEA or non-EEA AIFs individually recognized by the FCA as equivalent to NURS or QIS (Section 272 FSMA); such funds can become ‘recognized schemes’ and are not subject to the restrictions on the promotion of unauthorized funds to retail investors.
  - While passporting under the UCITS Directive is common, currently only 15 non-U.K. AIFs have been recognized for marketing to retail investors.
- Other AIFs can be marketed cross-border to professional investors only under:
  - AIFMD passporting regime: available to EEA AIFs managed by full scope EEA AIFMs.
  - U.K. NPPR: available to AIFs managed by non-EEA AIFMs and to non-EEA AIFs (and EEA feeder AIFs where the master fund is managed by a non-EEA AIFM or the master fund is a non-EEA AIF).
  - Reverse solicitation: available to non-EEA AIFMs marketing any AIFs at the initiative of the investor.
- Use of the NPPR is subject to sufficient cooperation arrangements.
  - The AIFMD requires cooperation arrangements in place for systemic risk oversight and efficient exchange of information in two cases relevant to the FCA:
    - Between the FCA and the supervisory authority of a non-EEA AIF in case a U.K. AIFM is marketing the non-EEA AIF.
    - Between the FCA and the supervisory authority of a non-EEA AIFM and, where different, the supervisory authority of an AIF, in case the non-EEA AIFM is marketing an EEA or non-EEA AIF in the U.K.
- The FCA has established the necessary cooperation arrangements, but in practice there is variation in effectiveness, with good cooperation with some jurisdictions. Cooperation is particularly important where the AIFM is located in a non-EEA country but has delegated investment management to a U.K. firm.

*UNITED KINGDOM 30 INTERNATIONAL MONETARY FUND (content continues)*

### Supervision — Organization and resources
- FCA’s investment management supervisory function currently lies in the Investment Management Department within the Supervision—Investment, Wholesale and Specialists Division.
- The Department was reorganized as a result of the FCA adopting its new supervisory approach. The new organization differs from the old one in two main aspects:
  - The old organization had three functions: firm supervision, fund supervision, and sector analysis. The new organization continues fund supervision and sector analysis, but firm supervision is organized on the basis of the new supervisory approach into three types of teams responsible for supervision of (i) fixed portfolio firms; (ii) Pillar 2 supervision; and (iii) multi-firm supervision.
  - Responsibility for investment management sector firms that are part of larger banking or insurance groups now lies in the Investment Management Department; previously they were supervised together with their parent bank or insurer in other FCA supervisory areas with the Department having a support role.
- The organizational change led to changes in responsibilities and staffing. Resource allocation across the three functions during the fiscal years 2013/14–2015/16 is set out in Table 4.

- Table 4. United Kingdom: FCA’s Supervisory Resource Allocation (as provided in source)
  - Sector supervision  Firm Supervision  Fund Authorization and Supervision  Total
  - 2013/14                                                8                                                44                                                6                                                58
  - 2014/15                                                8                                                41                                                10                                                59
  - 2015/16 (previous model)  8                                            36                                            14                                            58
  - 2015/16 (budget) 10 Fixed    Pillar    2    Multi-firm
  - 14               74
  - 1 
  - 11             1326
  - Source: FCA. 1 Thirteen positions are currently open.

### FCA’s supervisory approach (high level)
- The FCA aims at making forward-looking judgments about firms' business models, product strategy, and how they run their businesses, to identify and address problems before they cause harm and to ensure consumers get a better deal and markets are fair and orderly.
- Where the FCA has responsibilities for prudential supervision, its focus is on reducing the impact on customers and the integrity of the financial system of firms failing or being under financial strain. When consumer detriment occurs, the FCA aims at seeking redress robustly.
- The overarching objective of FCA firm supervision is to mitigate risks to the FCA’s statutory and operational objectives, with the consumer protection objective driving supervisory focus.
- The FCA applies a risk based approach combining bottom-up sector risk analysis with a senior management top-down view:
  - Sector risk analysis identifies and analyzes main risks, sets strategic aims, and allocates resources based on regulatory priorities.
  - Key prioritization criteria include the extent of detriment an unmitigated risk would cause and whether detriment would involve vulnerable consumers.
  - The risk identification, evaluation and validation process uses departmental approaches and quarterly risk challenge sessions; validated risks are recorded on the FCA’s Consolidated Risk Map (CRM).
  - The creation of a ‘house view’ for each sector is a cross-organizational effort; the first investment management ‘house view’ is expected to be completed by March 2016.
  - The Risk Framework Team verifies consistency of bottom-up processes with the FCA-wide risk framework.
- The CRM includes a record of asset management risks identified for mitigation since the FCA’s inception in 2013. There are 14 individual conduct risks that have already been mitigated, or are currently being mitigated. Examples of current asset management risks include systemic and conduct risks relating to shadow banking, AIFMD compliance and data quality.
- Peer Group Business Model and Strategy Analysis (PG-BMSA) is used for sector view and risk identification:
  - Two PG-BMSAs for asset management completed in 2013 and 2014 involving 21 firms.
  - A third PG-BMSA in process with 20 firms in scope.

### Conduct classification and supervision
- The FCA amended its conduct classification, replacing four conduct categories (C1–C4) with two categories:
  - Fixed portfolio firms: small population across retail and wholesale that require the highest level of supervisory attention; these firms have a dedicated team of supervisors and are subject to ongoing proactive supervision.
  - Flexible portfolio firms: supervised through thematic and market-based work, subject to programs of communication, engagement and education aligned to key sector risks; the large majority of firms in the Investment Management Department fall under this category.
- The conduct supervision model is built on three pillars:
  - Pillar 1: program of proactive, firm-specific supervision.
  - Pillar 2: event-driven, reactive supervision focused on crystallized or crystallizing risks in accordance with the FCA’s risk appetite.
  - Pillar 3: thematic approach focusing on emerging risks, new products and issues common to multiple firms.

### Pillar 1 — Fixed portfolio firm supervision
- Pillar 1 is used only for fixed portfolio firms; each has a dedicated portfolio supervisor.
- Pillar 1 tools include:
  - Proactive engagement.
  - Regular meetings between FCA supervisors and firm senior management and Board members.
  - Regular reviews of management information (e.g., Board and Executive Committee packs).
  - Annual strategy meetings between FCA senior management and firm executives.
  - Deep dive assessments as needed (a deep dive focuses on one of four risk groups: culture and governance; product design; sales and transaction processes; or post-sales/services and transaction handling).
  - Periodic firm evaluations (a firm evaluation summarizes the FCA’s supervisory view and results are communicated through a letter to the firm and a presentation to the firm’s Board).

### Pillar 2 — Event-driven and baseline monitoring
- Pillar 2 includes responding to events and baseline monitoring:
  - Responding to events: discretionary work based on intelligence or information on a crystallized or crystallizing event.
  - Baseline monitoring: reviewing regulatory data submitted by firms and dealing with mandatory supervisory work, such as notifications by firms.
- The centralized Event Supervision Department deals with events across most FCA supervisory areas; it has a case assessment team that assesses new information and risk scores and prioritizes events.
- Possible actions include closing the case with no action; risk based closing; mitigating the risk; allocating the case to a supervision sector department; or referring the case to Enforcement.
- A decision tree approach guides prioritization, referencing the risk appetites developed for relevant supervision functions. Each supervision function has qualitative and quantitative triggers to guide prioritization; triggers may differ between fixed and flexible portfolio firms and across sectors.
- Under the new supervisory model (in adoption during the FSAP):
  - The Event Supervision Department will have primary responsibility for all events relating to Investment Management Department’s flexible portfolio firms.
  - The Event Supervision Department is expected to transfer complex events and those that exceed the sectoral risk appetite to the relevant Pillar 2 team in the Investment Management Department.
- Recommendation (stated in source): The FCA should closely monitor the impact of the new supervisory approach on the effectiveness of its Pillar 2 supervision. With more firms subject only to Pillar 2 supervision and possibly Pillar 3, the FCA must continuously monitor that the Event Supervision Department is appropriately resourced to identify potentially complex events and risks. Monitoring already takes place, including detailed statistics on types and number of cases handled. Appropriate resourcing may require investment management expertise not only through consultation with the Investment Management Department but also within the Event Supervision Department.

### Pillar 3 — Thematic and market-based work
- Pillar 3 will primarily be used for flexible portfolio firms, but may apply to fixed portfolio firms where appropriate. It is driven by sector risk mapping, local risk prioritization, or directions issued by the FPC.
- Since 2012, the FCA has conducted thematic work in areas covered in the section on Regulation (selected themes and timing provided in source), including:
  - Absolute Return Funds — Investment funds — Q1/2012 — Published speech.
  - Host Authorized Corporate Directors — Delegation — Q1/2012 and Q1/2014 — Published speeches.
  - Outsourcing — Delegation — Q1/2013 — Thematic report.
  - Vulnerabilities to reversal in interest rates — Risk management — Q2/2013 — Report to the FPC.
  - Custody bank ancillary services — Custody — Q3/2013 — Published speech.
  - Trustees and Depositaries — Depositary — Q4/2013 — Bilateral feedback and industry association.
  - Corporate bond fund liquidity management — Liquidity risk management — Q1/2014 — Consumer factsheet.
  - Liquidity management in normal and stressed scenarios by funds offering daily or near daily liquidity — Liquidity risk management — Q4/2015 — Report to the FPC.
  - FCA good practice — Detailed assessment of hedge fund investment activities — Systemic risk — Ongoing — Report to the FPC.

### Product supervision
- Since April 2014, the FCA has conducted supervisory work on authorized funds, focusing on funds considered to present a risk to the FCA’s consumer protection objective.
- The FCA’s underlying assumption is that authorized funds operate in compliance with their rules and maintain appropriate liquidity and conduct standards until alerted by the firm or a third party (e.g., a depositary) or until potential non-compliance or outlier behavior is identified through analytical or thematic work.
- The team prioritizes work on the basis of a risk appetite based on the fund AUM, investor type, and potential or actual loss to consumers.

*UNITED KINGDOM — INTERNATIONAL MONETARY FUND*

### 91.      The work uses various analytical tools. A market data analysis tool conducts outlier analysis

### _cr16161 - 91.      The work uses various analytical tools. A market data analysis tool conducts outlier analysis

### Analytical tools and data utilization
- A market data analysis tool conducts outlier analysis of approximately 3,000 authorized funds on a monthly basis, enabling the FCA to identify funds that exhibit different risk characteristics or trends from peers.
- Depositaries have submitted certain data on authorized funds to the FCA since January 2015, which the FCA uses to identify funds or firms with high or persistent levels of breaches, or firms with low or falling risk ratings from depositaries.
- The FCA aims at using AIFMD transparency information to identify AIFs (with retail investors) that have different characteristics from peers.
- The team has conducted four thematic reviews since its establishment, including a recently completed review on depositary oversight of valuation and liquidity management of authorized funds conducting direct property investments.
- The team is undertaking a post-authorization review of investment funds to assess whether the funds meet investor expectations, and has worked on derivative reporting and disclosure and risk-targeted funds.
- The team reviews various fund reports and notifications, the majority addressed as part of Pillar 2 risk-based supervision.

### Prudential classification and supervision
- FCA prudential objective: minimize harm to consumers, wholesale market participants and market stability when firms experience financial stress or fail in a disorderly manner; allow failing firms to do so in an orderly manner regardless of size.
- FCA prudential categories for firms under sole supervision:
  - P1 firms: their failure would cause lasting and widespread financial and reputational damage to the firm’s customers, client assets and the marketplace beyond. They are subject to periodic capital and, if applicable, liquidity assessment every 24 months.
  - P2 firms: their disorderly failure would damage consumers and client assets but would be more easily dealt with than the failure of a P1 firm. They are subject to periodic capital and, if applicable, liquidity assessment, every 36 to 48 months.
  - P3 firms: their failure is unlikely to cause any significant detriment to consumers or market integrity. Supervision of P3 firms is currently only reactive, with the exception of Capital Requirements Directive (CRD) IV firms in the P3 population.
  - P4 firms: firms with special circumstances (such as administration) for which bespoke arrangements may be necessary.
- Baseline monitoring includes prudential returns and periodic SREP of the firm’s Internal Capital Adequacy Assessment Process (ICAAP).
- Note on SREP guidance: The European Banking Authority published SREP guidelines in December 2014 requiring reviews on all firms within the scope of CRD IV with a minimum frequency of every three years starting from January 1, 2016. The number of P3 legal entities caught by CRD IV is approximately 700.
- Historical SREPs carried out by prudential specialists since inception; prudential returns reviewed according to established risk appetite.
- Table 6 (summary): United Kingdom: Capital and Liquidity Reviews of Fund Managers and Investment Managers (Asset Managers including investment firms authorized for investment management)
  - Hedge Fund Managers / Total
    - 2013: 6 / 1 / 7
    - 2014: 9 / 2 / 14
    - 2015: 3 / 1 / 6
    - Total: 18 / 4 / 27
  - Source: FCA.

### Reporting: scope, quality, and challenges
- The FCA receives a significant range of reports relating to fund management and relies on publicly available databases for information on UCITS funds’ investments and risks.
- Fund managers required to submit certain regular reports through the FCA’s GABRIEL system, including periodic reports on financial resources.
- Risks and events reported on an ad hoc basis and addressed under Pillar 2 supervision.
- The FCA does not currently systematically collect and analyze regulatory data on the risk profiles of UCITS funds; relying on publicly available databases considered sufficiently workable given cross-border complexity and costs.
- Importance of effective cooperation arrangements between the FCA and foreign authorities to address customer protection, enforcement, and monitoring of systemic risk arising from fund management activities.
- Since January 2015, the FCA has received voluntary reporting from depositaries on relevant FCA Handbook breaches, including on material pricing errors:
  - In the period January 2015–May 2015 the FCA received notification of 3,163 breaches, including 864 pricing error breaches (of which 47 were material).
  - The FCA reviewed the 47 material breaches and contacted the relevant firms about five pricing errors and required them to rectify the situation in two instances to date.
  - No enforcement action has been taken (for these instances).
- AIFMD transparency reporting requirement:
  - Applicable to AIFMs (and AIFs) subject to the quarterly reporting obligation since end-September 2014.
  - The first annual reports were submitted for the end-December 2014 reporting period; 1,203 AIFMs reported then on 4,966 funds.
  - Small authorized and registered U.K. AIFMs and small non-EEA AIFMs marketing AIFs in the U.K. are subject only to the annual reporting obligation.
- Data quality and analytical capability:
  - Information received during the first two reporting periods was not of sufficient quality to complete the planned risk analysis, primarily due to undeveloped understanding and misinterpretation of reporting requirements by firms and lack of experience with the new regime.
  - The FCA has been able to continue developing its analytical framework, though data was still not of sufficient comprehensiveness and quality at the time of the missions.
  - Primary focus: develop capability to conduct cross-sector comparisons by fund type (hedge fund, private equity fund, real estate fund, fund of fund, other) on counterparty credit, investment, leverage, and liquidity characteristics.
- Initiatives to improve AIFMD transparency reporting data quality and analysis:
  - Develop systems to identify misreporting simply.
  - Educate firms through communications on common reporting errors.
  - Provide proactive feedback to ESMA.
  - Anecdotal evidence suggests the FCA is more advanced in dealing with AIFMD reporting challenges than many EEA peers.
  - Plan to develop automated charting and graphing functionality for each reporting period in a custom built data analysis tool to enhance cross-period analysis.
- Data gaps and international scope:
  - The FCA does not get information on non-EEA AIFMs managing AIFs that are not marketed in the United Kingdom.
  - Acquiring information only on AIFs marketed—including feeder funds—is not necessarily sufficient for supervisory and systemic risk monitoring.
  - Non-EEA AIFMs may be interconnected with the U.K. financial system (e.g., delegated portfolio management to a U.K. investment manager or no longer actively marketing in the U.K.).
  - Recommendation: U.K. authorities should extend, if legally possible, the scope of the AIFMD transparency reporting to cover certain non-EEA AIFMs and seek to enhance data availability through international cooperation and exchange of information.

### Use of supervisory and enforcement tools
- Identification and escalation:
  - Failures to comply with regulatory requirements are typically identified and considered by the relevant supervision division.
  - Where formal powers or enforcement expertise may assist, cases are discussed with EMO to agree an approach.
- Range of supervisory and enforcement measures:
  - Agree with the firm on required action, appoint a skilled person to obtain an independent view, prevent the firm from conducting particular activities, impose requirements on how activities are conducted, make the firm pay redress to customers, ban or restrict particular products or misleading financial promotions.
- Decision process:
  - Decision on appropriate tool made jointly by senior staff from EMO and the relevant supervision division using specific enforcement referral criteria.
  - Overarching question: whether an enforcement investigation would be likely to further the FCA’s aims and statutory objectives.
  - Enforcement referral criteria include strength of evidence, proportionality and impact of opening an investigation, purpose or goal to be served (deterring wrongdoers, changing industry behavior, protecting the industry), and other relevant factors.
  - Referral decisions recorded in a formal referral document; record maintained for reasons not to refer a significant case to enforcement.
- Investigation focus areas:
  - Supervisory focus areas guide investigation priorities; key themes for investment funds: protecting client assets, providing clear and not misleading communications to customers, maintaining adequate and effective front office systems and controls, and identifying and managing conflicts of interest.
  - Last three years: investigations have also focused on unlawful promotion and mis-selling of unauthorized AIFs (Unregulated Collective Investment Schemes—UCIS).
- Enforcement powers available:
  - Impose financial penalty, suspension, limitation, or public censure; issue a private warning; vary or cancel an authorized firm’s permission or impose requirements; prohibit individuals or withdraw approvals; obtain injunctions; obtain restitution and redress for customers; settlement possible at any stage subject to sufficient understanding of nature and gravity.
  - In relation to funds: close the fund, cease unit dealing, or replace the fund manager or depositary.
- Historical enforcement outcomes (selected):
  - Between July 1, 2012 and June 30, 2015 the FCA publicly disciplined eight firms performing regulated activities related to investment funds which included imposing fines of up to GBP 126 million.
  - During the same period, the FCA publicly disciplined firms and individuals in eleven UCIS related cases, which included imposing fines ranging from GBP 28,000 to GBP 350,000 as well as prohibitions, withdrawals of approvals and restrictions/suspensions.
  - It also issued one private warning in a UCIS related case.
  - Note: All fines and other sanctions set out in Final Notices published between July 1, 2012 and June 30, 2015. The information in the UCIS paragraph is based on keyword searches by the FCA across its case management systems and ‘Outcomes and Notices’ webpage using the terms ‘UCIS’ and ‘asset management.’ Threshold conditions cases not included.

### Systemic risk monitoring: FCA and FPC roles and findings
- FCA mandate:
  - The FCA’s integrity objective includes the financial system’s soundness, stability and resilience, and the orderly operation of financial markets.
  - The FCA is required to have regard to systemic issues which could adversely impact the stability of the U.K. financial system.
  - AIFMD places a requirement on the FCA to monitor the systemic risks of AIFs.
- FCA risk governance:
  - Operates a Three Lines of Defense model as part of its Risk Framework:
    - First line: day-to-day operations and risk owners (Investment Management Department is one first line).
    - Second line: Risk & Compliance Oversight Division provides organization-wide guidance and oversight.
    - Third line: Internal Audit Division provides independent assurance on risk framework, risk management, internal controls, and interaction effectiveness.
- FCA systemic risk focus:
  - Few regulated firms are likely systemically important in isolation; supervision focused more broadly on markets and sectors.
  - Main responsibility for investment management activities lies in department’s sector team with structured processes for analyzing investment management risks.
  - Primary focus on risks presented by hedge funds due to potential for high leverage, large exposures, complex and illiquid instruments, and asset concentrations.
  - Hedge fund supervision work has focused on potential systemic risk from market, liquidity and counterparty risks and on potential risks to market integrity.
  - Also undertaken market-based work on open-ended funds offering daily or near-daily liquidity while investing in less liquid assets.
  - Product- or activity-based approach considered important given the diversity of the fund management industry.
- FPC mandate and composition:
  - FPC responsible for monitoring and managing systemic risk in the United Kingdom; primary objective to identify, assess, monitor and take action to remove or reduce systemic risks to protect and enhance resilience of the U.K. financial system.
  - Secondary objective to support Government economic policy.
  - FPC membership: eleven members, including the Chief Executive of the FCA, five members from the BoE, four independent external experts and a non-voting member from HMT.
  - The FCA’s Financial Stability Team within the Strategy & Competition Division leads FCA engagement with the FPC.
- FPC output and findings (as reported in BoE FSRs):
  - June 2013 FSR: requested assessment of hedge funds’ vulnerability to sharp upward movements in long-term interest rates and credit spreads in a low interest rate environment.
  - June 2014 FSR: identified potential for increased liquidity risk in investment funds offering daily redemptions while investing in longer-dated assets that are only liquid if secondary markets function; noted increased investment in less liquid assets and growth in funds where investors expect quick access increase liquidity risk; retrenchment in market-making by banks and broker-dealers could exacerbate risk; rapid asset sales to meet redemptions might lead to impaired market liquidity affecting other participants.
  - June 2014 FSR on hedge funds: if market volatility leads to banks’ exposures to hedge funds becoming inadequately collateralized, the failure of a large hedge fund could lead to significant losses for banks; distressed hedge funds could withdraw from markets or sell assets rapidly, destabilizing liquidity and pricing; forced liquidations and market distortions amplified by leverage; large hedge funds with significant positions or exposures to counterparties (mainly banks) may be particular causes for concern.
  - BoE and FCA staff are working to develop better risk measures, including banks’ stressed exposures to hedge funds and the impact of hedge funds’ activities in certain markets.
  - July 2015 FSR: reported FPC annual review of thirty types of activity outside core banking; no changes to regulation recommended; FPC will undertake a detailed assessment of five activities over the coming year, including open-ended investment funds and hedge funds.
  - On hedge funds’ investment activities, BoE and FCA staffs continue to gather data; work notes hedge funds support secondary market liquidity and price discovery and are interconnected with banks via repo transactions, margin loans and derivative agreements.

*Italicized source attribution provided by the pipeline.*

### 113.      As part of its assessment of financial stability risks and regulation of open-ended

### _cr16161 - 113.      As part of its assessment of financial stability risks and regulation of open-ended

### Investment funds: BoE/FCA analytical work and FPC conclusions
- BoE and FCA gathered information from U.K. asset managers on liquidity management strategies in normal and stressed scenarios covering 17 large asset managers and 143 of their funds, focusing on those with large corporate bond holdings.
- Data collection included a comprehensive quantitative request (including an estimate of the amount of assets that could be liquidated under normal market conditions) and qualitative information on liquidity risk management processes and tools.
- Sampled information covered fund structures; investor redemption terms; liquidity risk management processes; and how sampled funds manage liquidity and redemptions, including availability and historical use of swing pricing, dilution levies, staggered/gated/deferred redemptions, payment in specie, and suspension of dealing.
- The December 2015 FSR presented the FPC’s review drawing on the BoE/FCA information.
- FPC supported:
  - BoE’s intention to incorporate investment fund activity into system-wide stress testing and to assess near-term market resilience to large-scale fund redemptions.
  - Further FCA work to assess investor awareness of liquidity risks, to communicate good liquidity management practices to the asset management industry, and to assess leverage in investment funds (including through international initiatives to address data gaps).
  - The recent Financial Stability Board statement encouraging appropriate use of stress testing by funds to assess their ability individually and collectively to meet redemptions under difficult market liquidity conditions.
- The FPC will reassess its position in light of these international initiatives.

### Equity trading platforms — Market structure
- Equity trading in the U.K. occurs on several platform types and OTC; systems based on multilateral, non-discretionary trading rules are either RMs or MTFs as regulated by MiFID.
- RMs are operated in the U.K. by RIEs that can also operate MTFs. There are also MiFID regulated systematic internalizers (SIs).
- OTC trading under MiFID I ranges from traditional voice-based OTC to multilateral internal matching systems operated by banks or investment firms (commonly referred to as BCNs).
- RMs and MTFs are subject to specific trading system regulation under MiFID I; SIs and BCNs must comply with standard investment firm requirements plus some additional pre-transparency obligations for SIs.
- BCNs:
  - Are permitted in the United Kingdom where investment firms execute transactions on behalf of clients by crossing client orders or by dealing on their own account against client orders.
  - Are multilateral systems that typically incorporate an element of discretion since orders are executed based on client instructions/permissions.
  - Lack complete public information on market share and trading functionalities; at European level BCN market share is estimated to be about 1.8 percent.
  - For comparison, estimated market share of dark MTFs is approximately 4.3 percent.
- MiFID I does not appear to prohibit an RM or MTF operator from acting as a riskless counterparty or liquidity provider in its own trading system; in practice no U.K. RIE is currently acting as a riskless counterparty or liquidity provider, but some MTF operators do.
- An SI is an investment firm that on an organized, frequent, and systematic basis deals on own account by executing client orders outside an RM or MTF (client orders executed against proprietary capital). There are only 11 SIs in the EEA, seven of which are based in the United Kingdom.
- A table of U.K.-domiciled equity trading systems (RIEs, MTFs, SIs and some BCNs) is provided in the source.

### Regulation — legislative framework and MiFID II timing
- U.K. legislative and regulatory framework for equity trading platform operators is largely based on the relevant EU framework. FSMA and various FCA Handbook rules transpose MiFID and add U.K.-specific requirements, particularly for RIEs.
- MiFID II was supposed to be transposed to member states’ national legislation by July 3, 2016. During the FSAP the European Commission proposed delaying entry into application of MiFID II and MiFIR until January 3, 2018.
- The discussion focuses on elements relevant for financial stability and highlights where U.K. requirements go beyond EU rules or where enhancements are recommended relative to IOSCO Principles or Standards.

### Financial resources
- MiFID does not include specific financial resources requirements for RM operators; U.K. framework gives the FCA discretion in setting requirements for each RIE.
- MiFID requires an RM to have sufficient financial resources to facilitate orderly functioning; U.K. rules require an RIE to have financial resources sufficient for the proper performance of its relevant functions.
- In July 2012 the FCA revised guidance on RIE financial resources to complement a “standard approach” with a risk based approach designed to ensure an RIE can implement an orderly wind-down after allowing for financial losses it might incur in stressed but plausible market conditions.
- This framework complies with the relevant requirements in Principle 33 of the IOSCO Principles.

### Market monitoring and surveillance
- MiFID requires RM and MTF operators to conduct market surveillance. RIEs must establish and maintain effective arrangements and procedures for regular monitoring of members’ compliance with rules and for identifying rule breaches, disorderly trading conditions, or conduct that may involve market abuse or financial crime.
- FCA must be informed without delay of such conduct or conditions. Similar requirements apply to MTF operators.
- Compliance with Principle 33 is ensured for RIEs and MTF operators.

### Member access and supervision
- Access to RMs and MTFs is subject to MiFID-derived criteria designed to protect orderly market functioning and investor interests.
- Members and participants must be fit and proper, have sufficient trading ability and competence, adequate organizational arrangements (where applicable), and sufficient resources for their role.
- U.K. rules require RIEs to notify the FCA on proposals to accept member firms that may pose particular risks (such as unauthorized firms or firms from new jurisdictions).
- FCA’s August 2013 guidance sets expectations for RIEs and MTF operators to have effective risk assessment procedures at onboarding, ongoing arrangements to assess members’ compliance, and monitoring/surveillance arrangements to detect rule breaches and market abuse. RIEs and MTF operators must be able to determine that members’ systems and controls can be reasonably expected to ensure compliance.

### Dealing with disorderly trading conditions
- MiFID requires RMs and MTFs to ensure fair and orderly trading and efficient execution of orders, including having transparent and non-discriminatory rules, soundly managed technical systems, and effective contingency arrangements for systems disruptions.
- Operators must comply immediately with any competent authority instruction to suspend or remove a financial instrument from trading and be able to do so themselves if an instrument no longer complies with their rules.

### Pre- and post-trade transparency
- MiFID pre- and post-trade transparency requirements apply to shares admitted to trading on an RM. Full pre-trade transparency obligations apply only to trading on RMs and MTFs; SIs are subject to limited pre-trade transparency requirements.
- Investment firms that do not operate an MTF or meet the SI definition are not required to follow any pre-trade transparency requirements. Post-trade transparency obligations apply to all trades in shares admitted to trading on an RM irrespective of where trades were made.
- For shares not admitted to trading on an RM there are no minimum EU-level transparency requirements, though the FCA expects MTF-traded shares to have equivalent pre- and post-trade transparency.
- MiFID allows the competent authority to waive pre-trade transparency in certain circumstances; the FCA has granted all four waiver types permitted under MiFID to various RMs and MTFs. One large U.K. RIE is allowed all waiver types except the reference price waiver; another RIE benefits from all four waiver types. Most dark pool MTFs operate under the reference price waiver.
- Before granting a new waiver, an EEA competent authority must ask ESMA’s opinion on the waiver’s compliance with the MiFID Implementing Regulation criteria. The FCA is conducting a thematic review on U.K. dark pools (MTFs and BCNs) to better understand waiver usage in practice.
- MiFID post-trade transparency requirements apply in the United Kingdom and the FCA has approved delayed publication of certain trade information to the extent permitted by MiFID (delayed publication applies to large risk trades (block trades) that fulfill Annex II, Table 4 of the MiFID Implementing Regulation).
- RIEs and MTF operators must notify the FCA when they plan to use the derogation (either during application for recognition/authorization or as part of ongoing supervision after a material change).
- Publication arrangements for pre- and post-trade information in shares admitted to trading on an RM must facilitate data consolidation and make information available to the public on a non-discriminatory commercial basis at a reasonable cost.
- The FCA imposed additional conditions: publication arrangements must be accessible by automated electronic means in a machine-readable way, utilize technology that facilitates consolidation and commercially viable usage, and be accompanied by instructions for access. The FCA provided further guidance on machine readability arrangements.
- FCA guidelines for firms intending to use trade publication arrangements include the concept of a trade data monitor (TDM), an arrangement confirmed by the FCA or an external auditor as enabling firms to meet FCA guidelines. Confirmed TDMs include BOAT Services Limited, Deutsche Boerse AG, London Stock Exchange plc, ICAP Securities & Derivatives Exchange, and BATS Trading Limited.
- The TDM scheme is voluntary; firms may publish post-trade data through non-TDM arrangements provided they comply with MiFID requirements. In practice, RIEs and MTF operators publish pre- and post-trade information both directly to customers and through data vendors or TDMs.
- IOSCO Principles and Standards have only very generic requirements on content and publication of pre- and post-trade transparency; current U.K. framework does not have material gaps in content. MiFID II changes are expected to enhance content and timeliness of pre- and post-trade transparency and improve consolidation of fragmented trading information.
- The FCA began considering implementation of new MiFIR pre- and post-trade transparency requirements and published a consultation paper on the new rules in December 2015.
- FCA plans to grandfather existing transparency waivers so long as they meet MiFID II requirements. For the double volume cap mechanism (under which negotiated trade and reference price waivers may be suspended on a per share basis following a breach of one or both caps), the FCA will need to adopt new processes.
- MiFID II introduces Approved Publication Arrangements (APAs) for firms publishing post-trade transparency information on behalf of investment firms; TDMs will have to be authorized to become APAs as there will be no grandfathering of existing approvals.

### SIs and BCNs
- SIs and BCN operators are generally subject only to MiFID investment firm requirements (except post-trade transparency and tailored SI pre-trade transparency obligations).
- MiFID investment firm requirements include the obligation to report suspicious transactions to the FCA and requirements to ensure compliance with fiduciary duties, order handling rules, best execution requirements, and other disclosure and due diligence obligations.
- FCA’s July 2014 report on best execution and payment for order flow addressed SIs’ best execution obligations and noted that executing a client order against a firm’s proprietary position where the firm decides how the order is executed, or executing by dealing as a riskless principal, will always be cases where best execution applies.
- The application of best execution requirements on SIs and BCN operators is a key distinction between them and RIEs and MTF operators, which are not subject to the best execution obligation.

*Source: _cr16161 - 113.      As part of its assessment of financial stability risks and regulation of open-ended (PDF content provided).*

### 134.      The recognition/authorization stage is important in the FCA’s approach to RIE and MTF

### _cr16161 - 134.      The recognition/authorization stage is important in the FCA’s approach to RIE and MTF

### Recognition and authorization: purpose and scope
- The recognition/authorization stage is used to ensure the FCA understands the nature of the risks posed by RIEs and MTFs to the FCA’s objectives at the point of entry, and that operators have taken sufficient action prior to authorization to mitigate any risks.  
- For RIEs:
  - An RIE has to be recognized by the FCA and must comply with the recognition requirements laid down in the FSMA Recognition Requirements for Investment Exchanges and Clearing Houses Regulations 2001 (RRR).
  - The RRR cover: financial resources; suitability; systems and controls; safeguards for investors; disclosure by issuers; promotion and maintenance of standards; rules and consultation; discipline; complaints; and default rules, thereby complying with IOSCO Principle 33.
  - The FCA’s multidisciplinary team reviews applications thoroughly and engages in meetings with applicants before recognition is granted.
- For MTF and BCN operators and SIs:
  - MTF and BCN operators and SIs are assessed as investment firms for compliance with the FCA’s threshold conditions.
  - The FCA assesses, on a risk basis, the applicant’s ability to monitor its system for market abuse and its business rules, governance, and risk management processes.
  - There have been no recent applications from firms planning to become an SI or operate a BCN; therefore, the FCA does not have an established process for such applications.
  - BCNs can be operated without being authorized as trading system operators—identified as a deficiency in the current regulatory framework to be addressed by MiFID II.
  - Pending MiFID II, the FCA should continue to ensure BCNs’ activities are sufficiently supervised and monitored, taking into account their nature as trading system operators.

### Specific requirements for MTF operators
- Operating an MTF requires an investment firm to have the relevant permission under MiFID, which requires specific competence.
- FCA assessment of MTF applications includes review of:
  - Proposed business model.
  - Operational and technological arrangements (including trading system).
  - Surveillance arrangements to ensure consistency with fair and orderly trading requirements.
- Where appropriate, applicants complete the Complex IT Controls Form, including IT risk management procedures; the form and platform are reviewed by FCA IT operational risk experts.
- The FCA considers disaster recovery/business continuity plans and conducts onsite visits to review the platform and market surveillance capabilities; key documents such as the MTF’s rulebook are reviewed.
- A typical MTF application can take up to 12 months to process.
- Collective review of an MTF application involves:
  - Wholesale Permissions Team (threshold conditions).
  - Financial Resources Team and Infrastructure & Trading Firms Team (ICAAP and capital adequacy).
  - Infrastructure & Trading Firms Team (compliance with FCA rules, corporate governance, independent directors).
  - Technology, Resilience and Outsourcing Team (IT Systems & Controls Form and technology risk).
  - Market Surveillance Team (surveillance and monitoring capabilities).
  - Trading and Post-Trade Policy Team (liaison to ensure compliance with EU and domestic legislation).

### Supervision: organization and resources
- Supervisory arrangements differ:
  - RIEs and MTFs are supervised by the FCA’s Infrastructure & Trading Firms Department in the Supervision—Investment, Wholesale & Specialists Division.
  - SIs and BCNs are captured within the FCA’s supervisory regime for investment banks in the Wholesale Banking Department.
  - Both Departments report to the same Director.
- Supervision headcount for equity RIEs/ROIEs and MTFs: 13 FTEs.

### FCA supervisory approach and classification
- The FCA’s supervisory approach to RIEs and MTFs aims to ensure comparable regulatory outcomes reflecting functional similarities while recognizing legal/regulatory differences; a different approach applies to BCNs and SIs.
- RIEs and MTF operators are subject to the FCA’s general conduct classification system (fixed or flexible portfolio).
- Classification considerations include:
  - Complexity of activities.
  - Market share.
  - Presence of systemically important member firms.
  - Integration of trading and clearing activities.
  - Role in the local primary market.
- The department uses a risk map outlining key potential risks posed by market infrastructure operators.
- Some MTF operators in the flexible portfolio are part of financial institutions classified as fixed portfolio firms and may be captured by firm supervision elements.
- Pillar 1 and Pillar 2 supervision approach mirrors fund management, with Pillar 2 event risk appetites tailored to RIEs and MTFs; Pillar 2 supervision is conducted in the Infrastructure & Trading Firms Department.
- Pillar 2 events can require review of order types, market structure, quality of market abuse referrals, admission criteria, and suspected breaches of financial resources requirements.

### Pillar 3 thematic work and supervisory findings
- The FCA conducted a comprehensive thematic review of MTF rulebooks in 2013-2015, resulting in a ‘Dear CEO letter’ and good practice guidance, including:
  - Rulebooks should be clearly labeled and publicly available on the MTF operator’s website.
  - Supporting documents (participation agreements, terms of business, product lists, user guides, fee schedules, technical specifications) should be publicly available and transparent.
- The FCA published findings from a thematic review of pre-trade controls covering:
  - Pre-trade controls.
  - Control setting amendment procedures.
  - On-going monitoring and incident surveillance.
- Ongoing thematic reviews at time of report:
  - A review covering a selection of U.K. dark pools (BCNs and dark MTFs) to assess whether functionality is accurately represented to users and how conflicts of interest are identified and managed; intention to publish findings in Q2/2016.
  - A comprehensive thematic review on information and data sources used by high frequency and highly automated trading strategies and their connectivity options; findings to inform supervisory work and policy considerations; not planned for publication since objective was not to assess compliance.

### Market monitoring and proactive reviews
- The EMO Market Monitoring Department assists Supervision in assessing arrangements to identify conduct that may involve market abuse; it had not transitioned to the new supervisory approach at the time of the report.
- Firms in the two highest risk categories (on a scale of three) for market abuse are subject to periodic proactive review every two or three years, including:
  - Desk-based work, information gathering, on-site visit with surveillance system demonstration.
  - Review of surveillance staff skills, record keeping, policies and procedures, and assessment of surveillance coverage and effectiveness.
- Lowest risk category firms are subject to an online questionnaire; on-site visits may follow if significant deficiencies are identified.
- The FCA analyzes all market abuse notifications from RIEs and MTF operators to identify trends and deficiencies; this analysis feeds into a holistic assessment of an operator’s market abuse detection capability.
- The FCA assesses escalation and investigation processes, tools, and data analysis methods; compares operator notifications with suspicious transaction reports and in-house surveillance to identify missed instances and provide education on system improvements.
- This approach is also applied to SIs, BCN operators, and other authorized firms arranging and executing transactions.

### Prudential supervision and capital requirements
- The FCA assesses prudential health of U.K. RIEs to ensure compliance with financial resources requirements.
- Frequency of RIE prudential reviews accounts for FCA’s risk appetite; all equity RIEs are subject to an annual prudential health review and are asked to provide stress and scenario testing plans considering systems and controls.
- Investment firms operating an MTF are subject to general investment firm capital requirements and related reporting obligations:
  - Required capital: EUR 730,000.
  - Financial resources reports must be submitted to the FCA on a regular basis.
  - An automated report is created if the investment firm’s financial resources fall below the required minimum.

### Rule approval, listing, and admission to trading
- The FCA reviews RIEs’ and MTFs’ rulebooks during recognition/authorization and, for RIEs and larger MTFs, on an ongoing basis.
- RIEs and MTF operators must notify the FCA of rule changes; at application stage, the FCA provides comments if rules are unclear or insufficient and requires assurances that applicants have clear and transparent rules.
- RIEs must have procedures to consult members and users on proposed material changes to rulebooks; supervisors consider consultation responses and provide no objection before changes take effect.
- Under the Pillar 1 approach for RIEs, the FCA routinely discusses proposed material rule changes; similar principles apply to larger MTFs—approach complies with IOSCO Principle 34.
- Listing is not the responsibility of RIEs in the U.K., but the FCA normally reviews RIEs’ admission to trading rules and those of Primary Market MTFs.
- Primary Market MTFs (e.g., LSE AIM) that admit instruments not admitted to trading on an RM are reviewed; investment firms operating Primary Market MTFs need a variation of permission to ensure sufficient disclosure requirements for issuers.

### Reporting and notifications
- RIEs and MTF operators are subject to standard periodic reporting and ad hoc reporting obligations; RIEs must notify the FCA of certain events—notifications are reviewed, logged, and followed up as necessary.
- RMs and MTFs must supply without delay to the FCA information on:
  - Significant breaches of their rules.
  - Disorderly trading conditions.
  - Conduct that may involve market abuse.
- Table 8: United Kingdom: RIE and MTF Notifications to the FCA
  - 2012
    - RIEs: 149
    - MTFs: 24
  - 2013
    - RIEs: 148
    - MTFs: 39
  - 2014
    - RIEs: 174
    - MTFs: 63

### Use of supervisory and enforcement tools
- The FCA often resolves matters through supervisory discussion rather than formal powers; no formal sanctions have been imposed on RIEs or MTF operators for regulatory breaches during the last three years covered by the report.
- Given the limited number of equity RIEs and MTF operators and close supervision, this absence of formal sanctions does not raise particular concerns about lack of effective enforcement.

### Systemic risk monitoring and FPC work
- The FPC has examined market-structure topics, focusing on technological developments such as increases in algorithmic and high frequency trading.
- The FPC September 2015 meeting record noted episodes of high volatility, particularly in U.S. markets, sharing characteristics of originating in largely electronic, often exchange-traded markets that experienced sudden reductions in market depth.
- The FPC noted automated trading and the use of passive and other pro-cyclical trading strategies might, in aggregate, amplify price moves; episodes have so far been short-lived and without systemic consequences, but disorderly conditions in one market could spill over to others.
- The BoE and FCA were undertaking additional analysis requested by the FPC to examine common causes of market volatility and whether past stabilizing factors could be relied upon, recognizing the possibility that future heightened volatility and reductions in market depth could have more widespread and persistent effects, including on the provision of credit to the real economy.
- Recommendation: The FCA and FPC are encouraged to continue to monitor and analyze potential risks arising from equity market structure and functioning, considering impacts on asset valuation and broader financial stability.

*Source: _cr16161 - 134.      The recognition/authorization stage is important in the FCA’s approach to RIE and MTF*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16161.pdf_