The FSA’s latest Quarterly Consultation Paper in CP12/27: October 2012 contained a number of proposals in relation to COLL. Responses to the consultation are due by 5 November.

Taking the proposals in no particular order, as their impact for managers will depend very much on the type of funds in your range:

  1. Calculation of the preliminary charge

Many managers will be aware that the FSA recently raised some concerns about the way that preliminary charges are described as being taken in some funds’ prospectuses.

This highlighted the fact that there is no single consistent approach being taken across the industry, with some firms expressing the preliminary charge as a percentage of the price of units or shares and others as a percentage of an investor’s total investment. The issue also drew attention to the fact that the way that parts of COLL described the preliminary charge as being calculated was inconsistent with the relevant requirements for the KIID.

In response, the FSA is consulting on its proposal to change the language in COLL 6.7.7R(2)(a) to bring the COLL Sourcebook in line with the KIID Regulations, so that going forward preliminary charges will be expressed as a percentage of an investor’s total investment. In practice this means that, in order to be consistent with the KIID methodology, the preliminary charge stated in the prospectus will be the percentage deducted from an investor’s total investment. We note, however, that the FSA’s proposed amendment does not specify that the preliminary charge must be a deduction.

The ability to express the preliminary charge as a fixed amount is to be retained. The FSA is also proposing to make consequential amendments to the table in COLL 4.2.5R which sets out required contents of a prospectus.

  1. Disclosures to clarify certain descriptions in fund objectives or names

The FSA has for some time been concerned that fund names, investment objectives and fund literature that incorporate descriptions such as ‘absolute return’ or ‘total return’ imply a degree of capital protection, irrespective of whether such guarantee exists. The Retail Conduct Risk Outlook 2012 cited this as one of the reasons why absolute return funds posed a potential retail risk.

The FSA therefore intends amending COLL 4.2.5R(3) in respect of such funds, requiring them to incorporate additional disclosures into the fund objectives set out in prospectuses. The additional disclosures will inform investors that there may be a risk to their capital, provide information on the anticipated timescale for a positive return and advise that there is no guarantee of such return.

The FSA clearly believes that existing disclosures and warnings have not been sufficiently prominent, and this prescribed inclusion will mean they are brought more effectively to the attention of investors.

The proposed amendment will have a transitional provision, giving affected fund managers up to six months to change their existing funds’ prospectuses. It is expected that this change would be made alongside any other changes that are made in that period.  

  1. Income allocations when converting between unit classes

Due to the implementation of RDR, the FSA is, like everyone in the industry, anticipating a far greater volume of conversions between shares or units of one class in a fund to shares or units of another class in the same fund. A conversion is distinguished from a switch, a switch being between shares in one class in a fund to shares in a class of a different fund. A switch triggers a capital gains tax event while a conversion does not.

COLL 6.8.3R(3A)(c)(v) details the “income equalisation” method which ensures that income earned by shareholders in a fund is not adversely affected by deals in shares, by allowing transfers between capital and income accounts.

However, COLL does not currently make clear that income equalisation may be used on a conversion to protect income earned.  Following a lot of work by industry participants on the practicalities of class conversions, the FSA proposes, therefore, to state explicitly that income equalisation can be applied on a conversion. This will be by way of amendment to COLL 6.8.3R(3A)(c)(v) and the FSA Glossary definition of income equalisation. HMRC have also been consulted on this proposal, which will supersede the modification by consent to the rule that is currently available.

  1. Netting of issue and cancellation of units

Another feature of the consultation paper is the introduction of changes to COLL to permit aggregation of buy and sell orders across different classes of a fund on a dealing day, even where there are different charges for those classes. With the introduction of unbundled offerings and a proliferation of new classes as part of RDR, the FSA proposal removes the most obvious impediment to netting across classes given that there will typically be differences in charging structures across classes.

The changes in COLL around netting should have the potential to bring additional operational efficiencies and cost savings to the dealing process by avoiding the unnecessary issue or cancellation of units in one class where there is a counterbalancing issue or cancellation of units in another class on the same day.

As the FSA’s concern has always been that netting across classes with different charging structures can pose a risk of pricing errors, it is proposing some specific provisions to address that risk. As before, the depositary’s consent is required for netting (and we envisage that often being a standing instruction) and it will have a specific duty of ongoing monitoring of the arrangements as part of its wider duties in relation to the dealing process.  The manager will be required to satisfy itself that the arrangements do not cause detriment to any unitholder, and managers will need to have systems and controls in place to protect against the risk of pricing and valuation errors arising from such netting.  

  1. Disclosure requirements for PAIFs

There is currently an anomaly in requirements of COLL that mean a PAIF may technically consist only of a single fund or an umbrella made up of funds that are also PAIFs. By removing the requirement in the COLL rule relating to the contents of an instrument constituting a scheme which states that a PAIF needs a statement that it is such (COLL 3.2.6R), an umbrella NURS may include both sub-funds that are PAIFs and sub-funds that are not PAIFs. The rule is replaced by additional requirements for the contents of a PAIF’s Prospectus, to disclose its status and the status of any sub-funds.  A similar change should we think be made to the equivalent requirements for a QIS PAIF in COLL 8.

  1. Requirement for recognised schemes to provide annual and half-yearly reports free of charge

Lastly, a minor change. Under COLL 9.4.2R investors can obtain the latest prospectus and, where applicable, EEA KIID(s) free of charge, but they may in some cases be charged for obtaining annual and half-yearly reports. UCITS IV stipulates that the latest published annual and half-yearly reports must be made available to investors free of charge. Consequently, investors in a section 264 recognised scheme may currently obtain the latest published annual and half-yearly reports at no cost but investors in a section 270 and 272 recognised schemes may be charged.

In order to bring the treatment of investors in a section 270 or 272 recognised scheme in line with that of investors in a section 264 recognised scheme, COLL 9.4.2R(1) will be amended such that investors in all recognised schemes will be able to obtain annual and half-yearly reports free of charge.