Background

The FCA have contacted firms where they hold a Financial Services Compensation Scheme (“FSCS”) “exemption record” which currently exempts them from paying scheme levies raised to cover the cost of compensating investors, due redress from firms that are insolvent and unable to pay.

Firms contacted have one or more of the following regulated activities; managing investments, managing an AIF, and establishing, operating or winding up a collective investment scheme. These activities belong to the FSCS Investment Provision funding class SD01 and all firms that are not exempt are required to report income from these activities.

FCA Rule COMP 12A.3, which came into effect in April 2018 requires firms to assess, firstly, if they are undertaking “Protected Investment Business” under COMP 5.5.3R. Only if the firm concludes it is undertaking “Protected Investment Business” does it need to then assess “Eligible Income” derived from the underlying investors in the collective investment schemes they manage.

Protected Investment Business

Non-UK Funds
Most hedge funds are domiciled outside the UK in jurisdictions such as the Cayman Islands. We believe that under COMP 5.5.3R (1)(b) funds domiciled outside the UK are not Protected Investment Businesses so will continue to be able to claim an FSCS exemption.

UK limited partnerships
Most Private Equity funds are unauthorized UK funds structured as limited partnerships or “limited partnership collective investment schemes” under the FSMA. Firms had understood from the FCA consultation that only managers of authorized funds (e.g. authorized unit trusts or OEICs) were affected by the proposed rule changes. The BVCA engaged urgently with the FCA to clarify the position for managers of unauthorized UK limited partnerships and as a result the FCA have confirmed to the BVCA that managers of “limited partnership collective investment schemes” will continue to be able to claim an FSCS exemption for this year. The FCA have promised “to consider this position further in due course and would be keen to discuss it further with BVCA and its members”.

Eligible Claimants
If the firm concludes it is undertaking “Protected Investment Business”, the rule change requires it to “look through” the funds to the underlying investors to assess if any of the investors in their funds are “Eligible claimants” as set out in COMP 4.2. There are twenty separate categories of “Persons not eligible to claim” under COMP 4.2.2R including Authorized Firms; Overseas Financial Services Institutions; Local Authorities and Large Companies. For example “A Large Company is a body corporate which does not qualify as a small company under section 247 of the Companies Act 1985, or section 382 of the Companies Act 2006 as applicable”. All Private Individual Investors are “Eligible Claimants”, even high net worth investors.

Firms required to report eligible income
Firms that undertake “Protected Investment Business” and manage funds that have one or more investors that are “Eligible Claimants” should confirm that the exemption is no longer appropriate. The firm will need to report “Eligible Income” for FSCS funding class SD01 for its year-end 2017, which will require calculating the portion of the management fee that is attributable to managing the assets of “Eligible Claimants”. If it is not possible in the time frame to make the calculation of “Eligible Income”, the firm is required to report all income as “Eligible Income”. The firm will then be required to make a contribution to the annual levy raised by the scheme based on the level of its “Eligible Income”.

Responding to FCA
The firm needs to respond to the FCA email no later than Friday 15 June 2018, quoting ‘FSCS Exemption’ in the subject line together with your FCA firm number. This is a strict deadline, with invoices for the levy being issued in July.

For more information or assistance please contact the Augentius Compliance Team.