Eva Dauberton
News Editor
FCA releases guidance on AIFM hosting
The Financial Conduct Authority (FCA) has released a new webpage on alternative investment fund manager (AIFM) hosting. This page provides information and guidance for AIFMs who use the host model to manage alternative investment funds (AIFs). Specifically, the FCA shares findings from a review conducted last year and offers guidance for firms operating under this model.
Some context
Under the host model, AIFMs can hire staff on secondment from a third party to help manage the AIF. These seconded staff members handle regulated tasks like portfolio management and administrative duties related to customer interactions. In some cases, the AIFM may act as the principal firm, and the seconded individuals could come from one of its appointed representatives (ARs).
During a review in 2023, the FCA assessed firms using the host AIFM model to determine their understanding and compliance with regulatory responsibilities. As a result, the FCA identified potential harm that could arise from this model. This includes insufficient oversight of seconded staff, inadequate involvement in investor due diligence, inaccuracies in capital adequacy calculations, and misleading claims made by third parties who second staff to an AIFM.
What are the key takeaways?
The FCA provides guidance against each potential harm identified during the review, specifically, oversight of secondees and potential conflicts of interest, investor due diligence and capital adequacy.
The FCA also mentioned that it has taken steps against individual firms where harm was identified and will continue to monitor secondment arrangements in the AIFM sector closely.
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ESMA publishes MiCA final reports and consultation
The European Securities and Markets Authority (ESMA) has published two final reports covering its first package of regulatory technical standards (RTS) and implementing technical standards (ITS) for the Markets in Crypto-Assets Regulation (MiCA). Additionally, ESMA has issued a consultation paper on its third set of draft technical standards under MiCA.
Some context
MiCA came into effect in June 2023 and consists of numerous Level 2 and Level 3 measures that must be developed before the new regime is implemented.
Throughout the implementation phase of MiCA, ESMA, in close collaboration with EBA, EIOPA, and the ECB, has released consultations on various technical standards. These standards were to be published in three packages sequentially.
The first package, published in July 2023, covers notification from selected entities to NCAs, application for authorisation for crypto asset service providers (CASPs), complaint handling procedures, conflicts of interest, and intended acquisition information requirements.
The second package, published in October 2023, includes sustainability indicators, business continuity requirements, trade transparency data and order book record-keeping, record-keeping requirements, classification and templates, and the format of crypto-asset white papers, as well as the public disclosure of inside information.
Part of the third package, published in January 2024, focuses on guidelines for the conditions and criteria for the qualification of crypto assets as financial instruments.
What are the proposals in the consultation?
This consultation is the second part of the third package. It includes all remaining mandates and contains four sets of proposed rules and guidelines:
- Detection and reporting of suspected market abuse in crypto assets (RTS).
- Policies and procedures, including the rights of clients, for crypto-asset transfer services (Guidelines).
- Suitability requirements for certain crypto-asset services and format of the periodic statement for portfolio management (Guidelines).
- ICT operational resilience for certain entities under MiCA (Guidelines).
What are the contents of the final reports?
The final reports result from the first consultation package.
The first report covers draft technical standards relating to:
- Information required for authorisation as a CASP (RTS and ITS).
- Notification by certain financial entities to provide crypto-asset services (RTS and ITS).
- Complaints handling by CASPs (RTS).
- Information required for the assessment of intended acquisition of a qualifying holding in a CASP (RTS).
The second report includes draft technical standards relating to:
- Information to be exchanged between competent authorities (RTS).
- Relevant standard forms, templates and procedures for the exchange of information between competent authorities (ITS).
- Forms for information exchange between competent authorities and ESMA/EBA (ITS).
- Cooperation template with third countries (RTS).
What's next?
Consultation: The consultation deadline is 25 June 2024. ESMA will publish a final report based on the feedback received and submit the draft RTS to the Commission by 30 December 2024.
Final reports: ESMA has submitted the Final Reports to the European Commission (EC). If requested by the EC, ESMA will provide further advice and technical guidance in this area.
A final report on conflicts of interest for crypto-asset service providers will be published later. This will allow the European Banking Authority (EBA) to complete its consultation process and ensure close cooperation and alignment with ESMA.
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US imposes sanctions on Russian entities and individuals in financial and technology sectors
The US Department of the Treasury’s Office of Foreign Assets Control (OFAC) has imposed sanctions on thirteen entities and two individuals operating in Russia’s financial services and technology sectors. These entities are involved in developing or providing virtual assets services that allow the circumvention of US sanctions. Five entities have also been designated due to their ownership or control by individuals previously sanctioned by OFAC.
What happened?
The designated companies have either built or operated blockchain-based services or facilitated virtual currency payments in the Russian financial sector. This has enabled them to potentially evade sanctions. These designations are an extension of OFAC’s previous action on 23 February 2024, which aimed to target companies supporting Russia’s core financial infrastructure and limit its access to the international financial system in its conflict with Ukraine.
What’s next?
As a result of this action, all property and interests in property belonging to the designated persons, whether in the US or under the control of US individuals, are blocked and must be reported to OFAC. Additionally, any entities that are owned, directly or indirectly, individually or collectively, by 50 % or more by blocked persons will also be subject to the same restrictions. Foreign financial institutions engaging in significant transactions or providing services related to Russia’s military-industrial base are also at risk of being sanctioned by OFAC.
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EIOPA issues survey on taxonomy implementation starting dates
The European Insurance and Occupational Pensions Authority (EIOPA) has issued a survey on taxonomy implementation starting dates.
Some context
In February 2023, EIPOA introduced a more automated and efficient way to produce taxonomies, which reduces the likelihood of errors and mitigates the impact of business and technical changes. In addition, in May 2023, EBA and EIOPA jointly revised the taxonomy architecture to implement improvements to the data point modelling through the DPM Refit.
Considering this, EIOPA has launched the survey to gather technical insights on the potential challenges stakeholders may encounter if the taxonomy starting date is set for either the fourth quarter or the first of January of the following year.
What’s next?
The deadline to respond to the survey is 14 June 2024
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OCC Michael Hsu: fairness can drive compliance
In a speech at the Consumer Bankers Association event, Acting Comptroller of the Currency Michael Hsu spoke about compliance and fairness in the banking sector, and in particular, how “banks can improve the effectiveness of their compliance risk management programs by developing a strong internal sense of fairness”.
Noting the challenge of remaining compliant in times of change and uncertainty, Hsu said that deploying more resources and using technology can help, but anticipating where risk may emerge and having a strong sense of fairness is also important.
This is not a new concept and Hsu credited others with linking safety and soundness, fairness and compliance. He went on to outline a number of factors affecting the current climate, such as:
- Growth in product offerings.
- Digitalisation of banking and reliance on third-party non-financial providers.
- Greater attention on wealth inequality.
These, and other factors, mean that “successfully balancing innovation and growth with safety, soundness, and fairness is getting harder. Consumer banking and compliance are more inextricably linked now than ever. This presents a challenge—and an opportunity—for banks and how they approach compliance risk management".
Turning to an example of how compliance and fairness are linked, Hsu cited bank overdrafts and how those banks that adopted a fairer approach to overdraft fees early had been able to strengthen their retail deposit franchises. Looking at new product development, he added that: “as with overdrafts, having a clear sense of where this fairness line is prior to the development and launch of such a product can help a bank avoid compliance risk issues down the road, when the product has grown and consumer harms are more apparent”.
Hsu also addressed the concepts of disparate treatment (when a bank’s policies treat customers differently because of race, sex, ethnicity and so on) and disparate impact (when a bank’s “neutral” policies or practices nevertheless result in disadvantaging certain customers) and how banks need to address both. Artificial intelligence (AI) and machine learning (ML) are tools increasingly being used by the banking sector, but Hsu warned of the “biases in training data and in supervised and reinforcement learning” that can exist when using such technologies.
The traditional view of compliance with laws and regulations helping achieve fairness means that if banks comply, fairness should follow. Hsu’s speech suggests inverting this “encouraging banks to use fairness as an input to help guide their compliance risk management programs...[to] improve their ability to anticipate and adapt to emerging compliance risk issues.”
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APRA chair discusses new system-wide stress test
In a speech at the Australian Financial Review’s Banking Summit, Australian Prudential Regulation Authority (APRA) chair John Lonsdale addressed the work being done to ensure the safety of the financial system.
A year on from the turmoil of March 2023, and with a number of current challenges including high inflation and geopolitical uncertainty, banks need to remain vigilant. Lonsdale noted the importance of the annual authorised deposit-taking institution (ADI) stress test in aiding this process but added that the interconnectedness of the modern financial system would mean that a crisis in banking would highly likely affect other sectors and vice versa. Lonsdale said this is why APRA is planning a broader financial system stress test.
Turning back to the 2023 ADI stress test, Lonsdale outlined the scenario and the results, noting that “of the 11 large banks chosen to undertake the stress test, all had sufficient capital to withstand the severe downturn and support an economic recovery.”
Lonsdale explained that the APRA has subsequently written to all the banks involved to detail the areas where they could do better including governance, modelling and data, and stress test scenarios.
For the 2024 ADI test, operational resilience and the heavy dependence of banks on non-financial third parties are the focus. Lonsdale noted that:
“APRA released prudential standard CPS 230 Operational Risk Management last July to ensure banks, insurers and superannuation trustees could better manage operational risks and respond to business disruptions. It doesn’t make a bank responsible for a telecommunications or electricity outage. But it does mean we expect these types of scenarios to have been identified against defined critical operations and plans put in place to respond so that impacts on business continuity and customers are minimised.”
As far as the broader financial system stress test is concerned, Lonsdale noted this will occur in 2025 with the goal being “to sharpen APRA’s response to systemic risks by deepening our understanding of the transmission mechanisms of shocks across the financial system”.
He added that during 2024 APRA will engage with stakeholders to plan the test, not only firms but also global regulators who have carried out similar exercises including the Bank of England.
In concluding, Lonsdale again reiterated the increasing interconnectedness of the global financial system with its potential exposure to non-financial third parties, adding that the purpose of the new system-wide test is to “contribute to greater understanding of these linkages and how they could spill over or amplify a potential future shock.”
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