Recent FCA changes catching out private equity firms

Highlighting the hazards and guiding safe passage

Private equity firms in the UK face the risk of eye-watering Financial Services Compensation Scheme (FSCS) levies if they complete their FCA fee data returns incorrectly. This risk, which has been catching out some newly authorised managers, follows changes to FCA Handbook rules that came into effect in April 2018.

These changes have made certain investors in collective investment schemes FSCS eligible for the first time, meaning FCA-regulated firms need to consider carefully whether they engage in protected investment business with eligible claimants through any collective investment schemes or funds managed. If so, these firms should include income attributed to FSCS-eligible investors in their annual FCA fee return.

If income attributed to FSCS investors is not calculated then authorised firms need to include all fee income in their return, which dramatically increases their FCA fees because the FSCS proportion of fee is directly proportional to the level of eligible income. Firms also need to ensure they do not mistakenly report all their income as eligible income, which will lead to the same level of FSCS fees as above. 

FCA Rule COMP 12A.3 outlines when the FSCS can provide compensation to investors in a collective investment scheme if those investors (eligible claimants) have suffered a loss due to default of an operator, investment manager or depositary. Firms should therefore revisit their exemptions claimed from the FSCS to ensure they still apply, especially where the FSCS levy amount has increased.

Review is equally crucial whether the firm is managing investments directly or as a delegated investment manager (for example, of a fund operated by an authorised fund manager).

Questions to consider:

  • Does the firm undertake protected investment business as defined in FCA Rule COMP 5.5?

FCA Rule COMP 5.5 defines “protected investment business” as designated investment business covered by the compensation scheme. It is understood that fund vehicles domiciled outside of the UK will be out of scope of COMP 5.5, meaning that firms managing an offshore fund and not undertaking any other designated investment business will be exempt from the FSCS levy.

  • Are the underlying investors eligible claimants as per FCA Rule COMP 4.2?

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 are eligible claimants. FCA Rule COMP 4.2 provides a definition of eligible claimants and a list of 20 separate categories of “persons not eligible to claim”. This includes authorised firms, overseas financial services institutions, local authorities and large companies. Notably, all private individual investors are considered eligible claimants; even high-net-worth investors.

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