The FCA’s Quarterly Consultation Paper proposes changes to the COLL Sourcebook

What do the proposed changes deal with?

The changes proposed in CP19/27 cover:

• which counterparties can transact with an authorised fund manager (AFM) for an over-the-counter (OTC) derivative transaction;
• the requirement for the AFM of a Property Authorised Investment Fund (PAIF) to take reasonable steps to prevent a body corporate from beneficially holding more than 10% of the PAIF;
• requiring the operator of a scheme recognised under section 272 of the Financial Services and Markets Act (FSMA) to provide an annual certificate explaining whether the scheme’s ability to comply with the conditions of its recognition has changed and;
• minor amendments to COLL 6.6.12R and 8.5.4R on depositary safekeeping obligations.

What rule changes are being proposed?

(a) Eligible counterparties for OTC derivative transactions (COLL 5.2.23R)

The UCITS Directive requires the counterparty to an OTC derivative transaction to be prudentially regulated.

This is implemented in the UK by COLL 5.2.23R, which allows:

• banks regulated under the Capital Requirements Directive (CRD);
• MiFID investment firms and;
• certain non-EU banks

to be a counterparty to an OTC derivative contract with a UCITS.

(COLL 5.6.15R applies the same requirements to the AFM of a non-UCITS retail scheme (NURS) transacting in OTC derivatives.)

Although this works effectively for EU counterparties, the FCA feels that the rule unduly limits certain types of counterparties - particularly CCPs where the CCP itself (acting as agent for the clearing member) is the counterparty to the transaction, rather than the bank or investment firm that is the clearing member.

As it currently stands, the CCP could not be an eligible counterparty under COLL 5.2.23R. Nor does the rule fully reflect the change in market practice that the introduction of central clearing for several types of OTC derivative under EMIR has brought about.

The FCA is, then, proposing to amend COLL 5.2.23R to extend the range of entities that can be an approved counterparty. These would now include:

• any EU CCP authorised under EMIR;
• any non-EU CCP recognised under Article 25 of EMIR;
• CCPs from jurisdictions that have been assessed by the Financial Stability Board (FSB) as having implemented the G20 reforms on OTC derivatives as at June 2019.

(b) PAIFs (COLL 6.2.23R and COLL 8.5.12AR)

Regulations 69K and 69L of the Authorised Investment Fund (Tax) Regulations 2006 in effect prevent a body corporate from beneficially holding 10% or more of a PAIF to “ensure that the UK retains the ability to tax investors fairly on income from UK land and property.” This is reflected in COLL 6.2.23R and COLL 8.5.12AR.

A body corporate can, though, still have an indirect interest of more than 10% of a PAIF if it holds units in a feeder fund which invests in the PAIF. In this case, the feeder fund, rather than the body corporate, must be the beneficial owner of the interest in the PAIF.

COLL 6.2.23R and COLL 8.5.12AR require a PAIF’s AFM to “take reasonable steps to ensure that no body corporate holds more than 10% of the net asset value of that fund.” The FCA is proposing to align the text with the underlying tax regulations to clarify that a body corporate can have an indirect interest of more than 10% in a PAIF where it holds units in a feeder which holds units in the PAIF.

(c) Notifications by individually recognised schemes (COLL 9.3)

Being recognised under s.272 of the Financial Services and Markets Act (FSMA) allows a non-UK scheme to be marketed to the general public in the UK.

S.277A of FSMA enables the FCA to require operator of a s.272 scheme to provide information on a periodic basis showing that it continues to comply with UK regulatory requirements.

The FCA is proposing to add a direction to COLL 9.3, which will indicate what information must be provided and how often, so the FCA receives consistent and up-to-date information about funds recognised under s.272.

The fund operator will need to provide the FCA with an annual certificate explaining whether (and, if so, how) there has been any change in the scheme’s ability to comply with the conditions of its s.272 recognition.

The direction would:

• require the fund operator to set out the steps it has taken to inform itself of any changes to the relevant FCA rules (and consider these changes along with any made to the recognised scheme itself);
• specify when and how the certificate should be submitted. (The FCA does not intend to specify a form or template for this.)

Finally, new guidance at COLL 9.3.6G explains the circumstances in which it is unnecessary for the operator to submit a certificate where less than 12 months has passed since the last submission.

(d) Minor Amendments on safekeeping obligations of depositaries (COLL 6.6.12R and COLL 8.5.4R)

The FCA is proposing minor amendments to COLL 6.6.12R and 8.5.4R regarding the safekeeping obligations of depositaries.

The purpose of the change is to clarify how these rules interact with other EU legislation affecting depositaries of all UCITS schemes and of NURS and QIS managed by a full-scope AIFM.

The changes are not intended to either add to or alter the obligations of the depositary of an authorised fund.

What happens next?

The consultation period for CP19/27 closes on 1 November 2019. Following that, the FCA will review the responses it receives, finalise its decisions and make the appropriate changes to it Handbook in due course.