Developments and market trends in Europe
Global | Publication | May 2018
Author: Richard Sheen
The big issues facing the asset management sector continue to be the assimilation of regulatory change, the adoption of new and developing technologies and the considerable economic pressures on asset managers which in many cases are driving industry consolidation. If you add into the mix the uncertainties around the shape of any Brexit deal – with the European Commission stating in early April that managers need to take into account “all possible outcomes” of the Brexit negotiations and not necessarily place reliance on a 21 month transitional period - managers are having to deal with a range of inter-connecting challenges.
Regarding Brexit, one of the main continuing concerns for UK managers relates to the risks of changes to the delegation rules enabling MIFID investment firms, alternative investment fund managers and UCITS management firms to delegate to a UK based investment manager. ESMA has recently sought to clarify the position on post Brexit delegation by stating that it is in no-ones interest to allow the creation of letterbox entities emphasising that both the UCITS Directive and the AIFMD explicitly require there to be enough substance in the entity established in the home Member State.
The way in which the above will be interpreted going forward will be critical as will the extent to which managers feel they need to re-balance their operations away from the UK. Anecdotally, a recent press report suggested that recruitment by UK asset managers has fallen since the Brexit vote, while recruitment efforts have increased in Luxembourg and Paris.
On a different note, the EU’s new Money Market Funds Regulation will come into effect for new funds in July (although existing funds will have until next January to comply) – with constant net asset value funds likely to be modified to become limited-volatility net asset value funds. There is a suggestion that money market fund managers are having to invest considerable resource into adapting their fund models or considering the economic viability of such structures going forward.
In the UK the FCA has published its Policy Statement in response to concerns previously identified in its earlier asset management market study. At the core of the FCA’s policy is that investment managers should be accountable to their investors on how they deliver value with fund charges to be assessed in the context of overall value delivered. Other proposals include the ability to switch investors into better performing funds without their consent and the requirement for managers to appoint independent investors to their board as part of an overall objective of strengthening governance. Simon Lovegrove summarises the Policy Statement and the FCA’s new Consultation Paper later in this edition.
Like many other businesses, asset managers are busy finalising their compliance with the General Data Protection Regulation which comes in towards the end of May this year. Asset managers are required to assess how and where personal data is being processed and ensure that all the service providers they are working with are compliant. Managers may have to seek consents from clients and others to process data and will also have to implement systems to recover from cyber-attacks.
In terms of corporate activity in the sector, there have been a number of recent mergers and acquisitions evidencing the trend towards market consolidation and the desire of managers to broaden their product offering and/or distribution channels. Reportedly Natixis Investment Managers is in talks to sell its fund distribution platform to competitor MFEX and Intesa Sanpaolo is in talks with more than one global manager over a potential partnership. In January, Franklin Templeton Investments agreed to buy $10bn UK fund manager, Edinburgh Partners and in April it was announced that US firm, Federated Investors Inc., had agreed to buy a majority interest in Hermes Fund Managers Ltd. from BT Pension Scheme for £246 million. We have also seen Old Mutual Wealth announce its intention to IPO in June of this year, whilst one of the leading providers of fund, corporate and private client services, JTC PLC, listed on London Main Market in March affording CBPE Capital an exit of its investment in the business.
Private fundraising activity has continued into 2018, 2017 having been a record year with the global private equity industry raising $453 billion, albeit that there were a quarter fewer new private equity funds launched than in 2016, with fundraising boosted by the “mega buyout funds”.
There have been a trickle of new listed investment company IPOs in 2018 including Augmentum Fintech plc which raised £94m to invest in a portfolio of UK and European financial services technology businessesand Ballie Gifford US Growth Trust plc which raised £173 million. A number of other new funds have announced their intention to float including Odyssean Investment Trust and Fundamentum Supported Housing REIT. Real estate remains a relatively sought after assets class along with other income producing alternatives. We have seen a number of recent closed-ended funds seeking to structure as UK resident investment trusts once again which is an interesting development.
Authors: Dominic Stuttaford and Greg Branagan
In the case of Hargreaves Lansdown Asset Management Limited v The Commissioners for Her Majesty’s Revenue & Customs [2018] UKFTT 127 (TC), the UK’s First Tier Tax Tribunal (FTT) has held that certain “loyalty bonuses” paid by Hargreaves Lansdown (HL) to investors using its investment platforms did not fall within the definition of “annual payments” and so were not subject to 20 per cent withholding tax in the UK.
As an operator of a large investment platform, HL was able to negotiate lower annual management charges (AMCs) with the underlying product providers. The lower AMCs took the form of a rebate of part of the amounts paid as AMCs. In relation to rebates received pre-April 2014, HL paid some of the rebated amounts back to investors as a “loyalty bonus” and kept the remainder as a commission payment for their services. However, rebates received from 1 April 2014, were required to be repaid in full to the investors as a result in changes to the regulatory rules on payments of commission. HMRC contended that these “loyalty bonuses” were in fact “annual payments” which were then subject to 20 per cent withholding tax.
In examining the payments of the “loyalty bonuses”, the FTT had regard to the following common law tests to determine whether payments would be “annual payments” for the purposes of UK withholding tax:
The FTT ultimately held that while the first three tests were all satisfied, the receipt of the “loyalty bonuses” by the investors did not represent “pure profit” because the payments were in fact a reduction of the investors’ net costs. As a result, the payments of “loyalty bonuses” did not fall within the definition of “annual payments” and so would not be subject to 20 per cent withholding tax.
While this is a decision of the FTT which is likely to be appealed by HMRC (as it is contrary to their stated policy), the outcome of this case is of particular interest to life insurance companies, operators of digital investment platforms and other similar investment entities which receive or pass on rebates from underlying product providers.
A key point to note in relation to the judgment is that the FTT held that when determining whether an item of income is “pure profit”, it is necessary for the decision to be made by reference to how the payment is viewed from the recipient’s perspective. However, it is not clear how this would work in practice as the determination of whether a payment is an “annual payment” subject to withholding tax will ultimately be the responsibility of the payer. In the context of transactions between unrelated third parties, the payer may not be able to accurately make this determination, which could leave the tax treatment of the payments open to challenge from HMRC.
Authors: Iona Wright and Imogen Garner
On 12 March 2018, the European Commission adopted legislative proposals on the cross-border distribution of collective investment funds as part of its work to establish a Capital Markets Union (CMU). They target existing regulatory barriers with a view to reducing the cost of cross-border fund distribution and supporting a more integrated Single Market, resulting in increased competition within the EU. This would, in turn, help to give investors more choice and better value for money.
The proposals apply to alternative investment fund managers (AIFMs), undertakings for collective investment in transferable securities (UCITS) management companies and managers of funds falling within scope of the European Venture Capital Funds Regulation (EuVECA Regulation) and the European Social Entrepreneurship Funds Regulation (EuSEF Regulation) and include a:
The legislative proposals were scheduled in the Commission Work Programme 2018 and should be viewed in the broader context of the September 2015 CMU Action Plan and the June 2017 CMU mid-term review, which aim to establish a genuine internal capital market by addressing fragmentation in the capital markets, removing regulatory barriers to the financing of the economy and increasing the supply of capital to businesses. These barriers were identified in response to the 2015 green paper on the CMU, the 2016 call for evidence on the EU regulatory framework for financial services and the 2016 public consultation on barriers to the cross-border distribution of investment funds.
Proposed Regulation
Proposed Directive
The proposed ban on requiring mandatory local physical presence has been welcomed by the industry since it is costly and, in light of the use of digital technology, unnecessary, to have on-the-ground facilities agents. There is also support to extend the ban to all third-party entities, such as paying agents, to help further the removal of barriers to cross-border distribution.
There are considerable national divergences in the treatment of pre-marketing under the AIFMD, but, in those Member States where it is permitted, it has become heavily relied on by AIFMs in order to test investor appetite. The proposals state that, in order for an EU AIFM to be pre-marketing a fund:
For a number of Member States, including the UK, this would significantly bring forward the point at which EU AIFMs would be deemed to be “marketing” under the AIFMD and would mean marketing notifications need to be made at a much earlier stage. Managers operating in private, non-listed markets will also likely struggle with the requirement not to circulate draft documents, especially given that in some Member States, such as the UK, “marketing” is currently considered to occur at the moment when documents are in materially final form, regardless of whether or not the AIF is established. Although ESMA is of the view that these proposals will help smaller market players, the reality is that defining pre-marketing in this manner will likely benefit larger, more established asset managers that have more certainty about getting their products sold. Frontloading the costs of marketing registration and AIFMD compliance may also stifle the market for new and innovative products somewhat, with managers less willing to put aside budget for products whose chances of success are unknown. Note, also, that the proposed conditions are expressed as only applying to EU AIFMs. It is unclear whether this therefore imposes a restriction on pre-marketing by non-EU or sub-threshold AIFMs.
The proposed harmonisation of transparency requirements has been received, although there are some questions around the process for keeping the ESMA central database and NCA portals up-to-date, which will be addressed in draft implementing technical standards. It is also unclear how the proportionality of fees and charges levied by NCAs will be measured and enforced.
The European Parliament and the Council of the EU will now consider the proposals, which are intended to be adopted before the May 2019 European Parliament elections.
The Commission is also inviting feedback on its proposals, with the deadline for responses being the latter of 7 May 2018 or 8 weeks after the proposals are made available in all EU languages.
Authors: Simon Lovegrove, Mike Newell and Imogen Garner
On 5 April 2018, the FCA published its latest documents in response to the concerns the regulator previously identified in its asset management market study.
The documents, which together contain over 150 pages, comprise:
PS18/8 follows Consultation Paper 17/18: Consultation on implementing asset management market study remedies and changes to Handbook (CP17/18) and sets out feedback and final rules and guidance.
Who is in scope of the new rules?
The new requirements in PS18/8 only apply to authorised fund managers (AFMs). AFMs include managers/operators of open-ended FCA-authorised funds (including ICVCs, Property Authorised Investment Funds, Co-Ownership Authorised Contractual Schemes and authorised unit trusts) which take the form of UCITS, NURSs and QISs. AIFMs of unregulated vehicles and other portfolio managers are not within scope irrespective of who those structures are targeted at.
Governance - Value for money
In CP17/18 the FCA consulted on proposals to strengthen and clarify an AFMs duty to act in the best interests of fund investors. Specifically, the FCA said that they must assess the value for money (VfM) of each fund against a non-exhaustive list of prescribed elements, conclude that each fund offers good VfM or take corrective action if it does not, and explain the assessment annually in a report made available to the public.
In PS18/8 the FCA reports that stakeholders agreed that value is at the heart of the asset management proposition but there were concerns over the regulator’s drafting. The FCA states that it has considered the feedback to CP17/18 carefully and still believes that the core of its policy is correct – that agents should be accountable to their underlying beneficiaries on how they deliver value. However, the FCA accepts that its draft rules could be seen as too focused on AFMs’ costs rather than the full value proposition of funds, which was not its intention. The FCA has therefore redrafted its final rules to clarify that fund charges should be assessed in the context of the overall value delivered, rather than using the term ‘value for money’. AFMs will have to publish an annual statement within 4 months of the relevant accounting period describing their value for money assessment. AFMs are not expected to disclose information which is commercially sensitive or anticompetitive but they must comply with the FCA requirement that communications are fair, clear and not misleading. The FCA has also decided to extend the implementation period for the value for money requirement from 12 to 18 months (30 September 2019).
Governance - Independent directors
In CP17/18 the FCA proposed rules requiring AFMs to appoint independent directors to their board. The FCA proposed that AFMs appoint a minimum of two independent directors and for them to comprise at least 25% of the total board membership. The FCA thinks that the introduction of independent members to AFM boards will lead to better outcomes for investors, so it has made final rules introducing this requirement as consulted on.
Which directors are considered to be independent will be an important question. The FCA rules set out detailed requirements on this issue and it is noteworthy that there is no obligation for the AFM’s chair to be independent (this is a decision left to the AFM itself). A director is unlikely to be independent where there is a monetary link with the AFM group, or where he/she has a close relative in a senior position in the AFM or a firm in its group. Significantly, independent directors can sit on more than one AFM within a group. However, time served will be calculated on a group basis. An independent director can serve a term of up to five years (renewed once to a maximum of ten years) within one group, starting from the time of the first appointment. The FCA has also clarified that a director, having already started to serve on the board of one AFM within a group, is not prevented from serving on another board within the same group, as long as the overall time limits are not breached.
The new requirements come into effect from 30 September 2019.
Governance - Senior managers’ regime
In CP17/18 the FCA consulted on a new prescribed responsibility that would make clear that a senior manager, usually the chair of the board of an AFM, must take reasonable steps to ensure that the firm complies with its obligation to carry out the assessment of value, the duty to recruit independent directors, and the duty to act in the best interests of fund investors.
The FCA reports that after considering the feedback it has decided to introduce the prescribed responsibility for AFMs as part of the extension of the senior managers’ and certification regime (SM&CR). The FCA intends to publish the final rules on the extended SM&CR during the summer. The FCA expects the prescribed rule to come into effect at the same time as the rules extending the SM&CR which is expected to be in mid to late 2019.
Conversion
In CP17/18 the FCA consulted on changes to its guidance to make it easier for fund investors to be moved (converted) to cheaper but otherwise identical classes of the same fund. The FCA has now published final recast guidance which removes the need for the AFM to get individual consent from each investor before converting them. The recast guidance now recommends AFMs make a simple, one-off notification to investors, which does not require a response, a minimum of 60 days before a mandatory conversion. The recast of Final Guidance 14/4, now known as Final Guidance 18/3, is effective from the date of publication of PS18/8.
Trail commission
In CP17/18 the FCA asked questions for discussion about whether it should continue to allow the payment of trail commission. The FCA reports that it is still considering the issue and has no immediate plans to bring forward proposals for policy change.
Box profits
The FCA found that the managers of some dual-priced authorised funds were making a risk-free profit when dealing as principal in the units of their funds. In CP17/18 the FCA proposed that these profits should be repaid to the fund, for the benefit of investors. The FCA has proceeded with its proposal while making some technical changes to the rules and guidance. It is also allowing some flexibility in how risk-free profits should be allocated fairly and in the interests of investors. The rules on box profits will come into effect on 1 April 2019.
Extending the governance proposals to other investment products
In PS18/8 the FCA reports that views were mixed as regards extending the governance proposals for the authorised funds market to other investment products and investment trusts. The FCA has planned diagnostic work into with-profits and unit-linked products that will improve its view of any harm that exists in these markets. The FCA expects to reach a view on whether further intervention is required in the first half of 2019. The FCA is also keeping the possibility of further changes to investment trust governance arrangements under review, but is not planning any immediate action. Consistent with its earlier consultation, the FCA is not bringing forward proposals on extending the governance proposals to pensions at this time.
CP18/9 is the FCA’s second consultation paper proposing changes following the regulator’s asset management market study. As before the proposals in CP18/9 apply to UK AFMs.
CP18/9 proposes measures to improve the quality, comparability and robustness of information available to investors. They seek to address the regulator’s concern that fund objectives are not as clear or specific as they could or should be. The FCA is also consulting on proposals to ensure that benchmarks are used appropriately. The FCA proposes that if a fund has benchmarks, their use must be explained and referenced consistently in consumer facing documents. This includes a proposal to ensure that benchmarks are shown appropriately and consistently against fund past performance.
To deliver improved fund disclosures the FCA proposes to:
The deadline for responding to CP18/9 is 5 July 2018.
CP18/9 does not cover the all-in fee and the possible standardisation of disclosure of fees and charges. On the latter, the FCA has published an Occasional Paper (OP32), which considers the impact of different ways of presenting information on investors’ decision making and understanding. OP32 does not put forward any specific policy proposals but is designed to encourage debate and inform the FCA’s next steps.
Some aspects of PS18/8 have generated concerns in the industry, including how the delivery of overall value to investors will be benchmarked. A key challenge for the industry will now be to try to establish consistent ways of delivering compliance with these new requirements and to avoid a plethora of different approaches being taken. The possibility of extension of the rules to cover listed investment companies and insurance products has been ruled out for now but still remains a possibility for the future. Certainly ensuring that the new requirements to act in the best interests of investors and consider that overall value is being delivered are now prescribed responsibilities for senior management should give the new rules proper “bite”.
The requirement for managers to appoint independent directors is also considered relatively onerous, presents logistical issues in sourcing suitable persons and there is no dispensation for smaller firms. Managers will need to carefully review the composition of their boards and assess the independence of their existing non-executive directors. It’s helpful that managers have an 18 month timescale in which to become compliant, but even so this may be difficult to achieve given the challenges.
Another key change which has provoked discussion is the proposal to enable investors to be switched to better performing funds without the requirement to obtain investor approval. Whilst this undoubtedly reduces the administrative burden, issues such as the onus of responsibility on managers to consider making these changes (together with possible legal complexities) needs to be fully assessed. The proposals on box profits are generally considered to be uncontentious as many managers have already stopped such practices.
CP18/9 is also initially focused on AFMs and areas on which the asset management market study highlighted difficulties in comparing retail funds, particularly funds having seemingly very similar investment objectives and the manner in which historical performance data and performance fee data is disclosed, but again the FCA is considering the possible extension of the rules to insurers and listed investment companies. Given the extension of KIIDs across such products, it seems somewhat anomalous that investment objective and benchmarking disclosure would not be aligned. At this stage the FCA appear not to wish to change the rules on prospectus disclosure but rather to ensure consistent but helpful disclosure in KIIDs and other marketing literature.
Author: Donnacha O’Connor from Dillon Eustace
In March, the Central Bank of Ireland issued a communication relating to the Brexit Opinions in which it confirmed that it had concluded its review of its authorisation and supervisory processes in light of the principles set down in the Brexit Opinions. While it noted that some “procedural enhancements” would be made to its application forms and internal procedures relating to the authorisation and supervision of investment firms, it has not deemed it necessary to make any significant overhauls to its existing authorisation and supervisory regime in light of the Brexit Opinions.
The Central Bank has published a revised AIF Rulebook together with the twenty-ninth edition of the Central Bank Q&A on AIFMD. As a result of the changes introduced under the revised AIF Rulebook, Irish domiciled loan originating Qualifying Investor Alternative Investment Funds may now invest in a broad range of debit/credit instruments as part of their core investment strategies whereas previously such funds could only invest in debt/credit instruments where the issuer was from the corporate group of a borrower to a loan originated by the Irish fund or if the investment was part of the treasury management or hedging operations of the relevant fund. The revised Central Bank Q&A on AIFMD has been amended as a consequence of these amendments to the AIF Rulebook.
In April, the Central Bank published a consultation paper seeking feedback on proposed amendments to the Central Bank UCITS regulations. Amongst other items, the consultation paper proposes converting the Central Bank’s guidance on performance fee calculation methodology into regulation. In addition, the Central Bank proposes introducing a new requirement whereby a performance fee may not crystallise, nor be paid, more frequently than annually. This represents a significant change from its existing regime, under which it has previously permitted performance fees which crystallised and were paid as frequently as quarterly. The Central Bank has said that this is in order to align its practices with IOSCO Good Practice for Fees & Expenses of Collective Investment Schemes.
It is also proposed that the draft regulation will incorporate the Central Bank’s guidance on hedging at share class level which implements ESMA's Opinion on UCITS Share Classes published in January 2017 as well as proposing new rules relating to notification of suspension of redemptions to the Central Bank. Separately, the draft legislation confirms that structured UCITS may charge an annual management fee based on the initial offer price of the relevant share class subject to certain conditions being met.
A Bill has just been published which intends to introduce some complementary measures following on from the transposition of MiFID II into Irish law in August, 2017. The Bill mostly deals with penalties for contraventions of certain provisions of the Irish MiFID Regulations. These include (but are not limited to) failure to notify of proposed acquisition of the MiFID firm, failure to comply with record keeping requirements under its organisational rules, failure to comply with obligation to act honestly, fairly, professionally and in the best interests of clients, breach of best execution rules/order handling rules and breach of client asset/client monies rules.
The remainder of the provisions of the bill make technical amendments to the Credit Reporting Act 2013 and to the Financial Services and Pensions Ombudsman Act 2017.
Author: Manfred Dietrich, Partner Norton Rose Fulbright Luxembourg
Luxembourg once again ranks as one of the top 3 financial centres in the EU and 21st globally, according to the latest edition of the Global Financial Centres Index 23, published on 26 March 2018. This index confirms once more the successful past year, where top-ranked international institutions chose to set up all or part of their activities and benefit from the specialization that exists within the Luxembourg financial sector.
Major international financial institutions are serving the EU Single Market out of Luxembourg. Luxembourg is moreover the largest investment fund centre in Europe, second to the United States globally, and hosts more than 139 banks from over 28 countries.
The financial centre is also committed to leading the drive towards digital financial services and playing a pioneering role in sustainable finance. In fact, Luxembourg was recently ranked as the second most important green financial centre, according to the first edition of the Global Green Finance Index (GGFI) published on 14 March 2018. Finally, the insurance sector in Luxembourg has experienced significant growth, with over 10 new global insurers setting up in the Grand Duchy.
According to Luxembourg Fund Association (Alfi) Luxembourg domiciled funds have attracted €418bn in new assets, representing an increase of 11.18% in 2017 compared to the previous year. Net sales tripled in 2017 compared to 2016, going from €99.6bn to €308.4bn. Overall, the assets under management (AuM) of Luxembourg domiciled funds has increased by a trillion over the scope of three years, from €3trn in September 2014 to 4trn as of September 2017.
Over the course of the past months, we have seen an ongoing strongly increasing interest for alternative investment funds (AIF) not being subject to a specific fund regime which included an ongoing strongly increasing interest for reserved alternative investment funds (RAIF). In turn also the interest for specialised investment funds (SIF) persists but not in a leading position for newly established structures. The main asset classes in these fund structures are typically private equity, venture capital, infrastructure, clean technology (and alike) real estate and debt. More liquid (and listed) asset classes are invested through RAIF and SIF, where the role of the latter is also stronger.
Furthermore UCITS, in particular those having particular strategies or investing in more “exotic” markets as well as structured UCITS, see continuous demand.
The discussion of or the arrival of additional asset managers, financial institutions and insurance companies regarding relocation or re-domiciliation of all or parts of their business (e.g. their foreign investment funds or management companies/AIFM) to Luxembourg is an with an increasing intensity. Having become slightly more concrete (at least in immediate timing) the preparation in the context of Brexit is running and requiring more and more market participants to arrange for or even determine the measures to be taken in order to be well prepared, to the best of currently available knowledge.
As stated in previous quarters, as a consequence of investor demand and the uncertainties as to the implementation of a third-country AIFM-passport as well as the limitation of reverse solicitation capacities, numerous re-domiciliation or next product domiciliation projects in Luxembourg involving both regulated and non-regulated funds have been realised and are under examination.
On the one side the possibility to transfer a foreign investment fund’s registered office to Luxembourg with the continuation of its legal personality is creating some strong interest for asset managers wishing to raise assets in the European Union. This process allows for a foreign fund to preserve its full corporate history, including track record and it is also worth noting that it is generally completely tax neutral.
On the other side Luxembourg offers with its broad range of legal structures (e.g. the special limited partnership = SCSp or SLP) appropriate solutions for the next fund generation.
Parallel structures are also raising strong interest
This possibility of re-domiciliation or shifting licensed business to Luxembourg may also be particularly relevant in the context of Brexit for promoters wishing to keep the benefit of the passport for their funds and ensure it for their future products. The past months saw again asset managers announcing Luxembourg taking over these functions after a Brexit. A steadily increasing number of asset managers is seriously considering possible localisation of their UCITS management companies or regulated AIFM in Luxembourg and discussions with the Luxembourg regulator are increasingly seen. In addition thereto also during the past months a further number of financial institutions and insurance companies have expressed their intention to either increase their existing business presence in the existing Luxembourg entities or to establish newly formed entities to relocate business in the context of Brexit.
The system of service providing as permitted under EU regulation which is practised within a group of companies or by third party service providers is an important part of the Luxemburg market (combined with the legal environment, regulation and market practice) in the overall context.
According to Luxembourg Investment Fund Association (Alfi) UCITS remain the most popular investment vehicle: More than 70% of investments in Luxembourg investment funds constituted new money in UCITS.
The Commission de Surveillance du Secteur Financier’s (CSSF’s) updated its UCITS FAQ and issued the CSSF press release 18/02 dated January 5th 2018 relating to the deletion of section 1.4 of the UCITS FAQ.
This means that UCITS subject to the Law of December 20th 2010 on undertakings for collective investment in transferable securities, as amended and which have invested in other UCIs following the policy laid down in CSSF’s UCITS FAQ section 1.4, meaning in certain Non-UCITS ETFs which have been considered eligible for investment, are required to divest these UCIs as soon as possible taking into account the best interests of the investors. Mere compliance controls or written confirmation of the ETF in question or of the manager –as it was the case in the previous understanding are not sufficient anymore.
The CSSF has contacted by March 31st 2018 the investment fund managers which have invested in such UCIs to check the compliance with the new eligibility requirements. New investments in such UCIs are no longer allowed.
The RAIF, the flexible investment vehicle which is not even existing for two years (it has been implemented in July 2016), pursues its route with a strongly increasing interest. Since implementation, 355 RAIF structures (official list at the companies register as at 17 April 2018) have been created in Luxembourg with a variety of different investment policies and for a number of purposes (time-to-market, incubation, private wealth management etc.). The RAIF-product does not only fit for illiquid asset classes but, mainly due to the availability of variable capital structuring, also to liquid asset classes including strategies involving a high trading frequency.
It may be observed that investors, especially institutional investors, in Europe and around the globe, got used to the product and have included the RAIF as the SIF looking alike (and to a lower number SICAR looking alike) Luxembourg investment fund/vehicle meeting the highest standards of structural quality and flexibility, as they were used to in a “real” SIF (or “real” SICAR) but without an add-on regulation on the fund/investment product itself.
Besides this, for illiquid asset classes AIF’s structured as unregulated partnerships (SCS or SCSp) see as well a strongly increasing demand. Promoters and investors appreciate the legal framework allowing (to the extent requirements met) for the choice from the set-up as AIF only managed by a registered AIFM (and, for instance, not requiring a depositary) to the set-up as AIF managed by an authorised AIFM, both, for instance allowing for investments without the requirement of minimum diversification, to the extent this is intended.
Even though the RAIF and the unregulated AIF as described here-above are currently dominating the structural demand in the alternative asset classes, the SIF as the traditional regulated fund vehicle with its long year market position and flexibility continuous to preserve its role in the range of available fund products. This applies certainly more for strategies involving liquid asset classes and/or markets where certain investors are more comfortable or the legal framework is favouring/requiring regulated fund vehicles .
Alfi’s annual Real Estate Investment Fund Survey revealed that real estate assets held through Luxembourg fund vehicles (Real Estate Investment Fund=REIF) reached an all-time high of over 57.000 billion in more than 300 vehicles (not even taking into account fund of fund vehicles or debt fund vehicles related to real estate). Over more than a decade Luxembourg has positioned and increased its importance as the on-shore hub for cross-border hub for REIFs and the strong activity on international real estate markets, for instance in Germany, translated into a more than corresponding demand for Luxembourg REIF structures.
Luxembourg market sees a further strengthening of its position as the recognised on-shore hub for all kind of private equity, venture capital, real estate, infrastructure etc. (and alike) fund structures. In particular professional and institutional investors from Europe and abroad trust the recognised stable and flexible Luxembourg market and its fund products, whether regulated itself or not. Especially an increasing investment in infrastructure and clean energy is realised through the easily adapted Luxembourg fund vehicles.
Debt and credit funds are also continuing their steady growth in Luxembourg thanks to the flexible legal and regulatory environment allowing them to implement all types of debt/credit strategies: mezzanine, distressed, including in particular origination, etc.
Luxembourg is strengthening its position as a key on-shore domicile for structuring debt funds: over 70 per cent of the top 30 debt fund managers worldwide are present in Luxembourg.
We see an increasing demand for a potential structuring of Luxembourg funds investing in the Cryptocurrency/Bitcoin - or the virtual currencies-sector in general. It is an interesting and challenging exercise to contribute to bring together on-shore market requirements and a dynamic and new asset class, functioning however very different than the “traditional” alternative world.
In this context it needs, however, to be mentioned that after the European Securities and Markets Authority (ESMA) Statements to firms and investors on 13 November 2017 in regard to ICO’s and several warnings on consumers on virtual currencies by the European Bank Authority (EBA), the CSSF sent out a warning on 14 March 2018, expressing their concerns on ICOs. They point out that ICOs are a form of fundraising by way of public offering in view of financing the launch of virtual currencies and are highly speculative investments.
ICO’s often involve the publication of a “White Paper” which looks like a prospectus of public offering and therefore often gives investors the impression that it is under a specific regulation, which is not the case. It warns about various major risks, e.g. no Luxembourg or European regulation, no protection to investors, loss of capital, theft of tokens, lack of liquidity of tokens, volatility, money laundering and fraud, lack of transparency and price manipulation.
It also includes a prohibition to investment funds subject to CSSF supervision where investors are not professional investors to invest in virtual currencies. On the other side this clarifies also that there is an understanding of the professional investors sector where, especially in unregulated funds, e.g . AIF without fund regime and RAIF, such investments are not excluded.
Furthermore the CSSF informed that it is about to extend its analysis on the assessment to determine if ICOs are not circumventing the rules of the law of 10 July 2005 on prospectuses of securities, as amended, or the law of 5 April 1993 on the financial sector. ICOs and investments in virtual currencies by Luxembourg investment funds is a challenging item to be carefully followed in the future.
Since 5th March 2018 undertakings for collective investment governed by Part II of the UCI Law ("Part II Funds") which are (i) managed by an authorized AIFM or by a non-EU AIFM and (ii) whose issuing documents explicitly do not allow the marketing of their shares to retail investors on Luxembourg territory, as an exception from the UCI Law, the AIFM Law depositary regime (so called “lighter depositary regime”) shall apply rather than the UCITS depositary regime.
As a reminder and in a nutshell, Part II funds have been part of a dual system: The UCITS depositary regime and the AIFMD depositary regime. They two regimes differ in that the AIFM Law depositary regime permits (i) contractually agreed transfer of liability from the depositary to a sub-depositary (including a broker acting as sub-depositary) and (ii) extended possibilities for hypothecation. As a result of this legislation, Part II Funds managed by a (only) registered AIFM were subject to the stricter UCITS depositary regime, even if they were only distributed to professional investors. This led to a stricter regime on the depositary in question compared to other AIF solely distributed to professional investors which was not intended by law. This has been changed now with the implementation of an exception in the Law of 17 December 2010 on undertakings for collective investment, as amended (UCITS/UCI Law). This amendment is clearly improving the legal framework for Part II Funds, in practice especially relevant for Part II Funds which pursue an investment strategy that implies the involvement of a prime broker or similar which also acts as sub-depositaryas the depositary liability is now aligned with the one of other AIF solely marketed to professional investors.
We would like to remind that on 16 January 2018, the CSSF published a revised version of the Application Questionnaire to be filed for gathering the authorisation of an alternative investment fund manager.
The Application Questionnaire includes, inter alia, the following:
Ownership and qualifying holdings: The repeal of CSSF Circular 09/392 has been taken into account by the CSSF and it has been replaced by CSSF Circular 17/669 adopting the joint guidelines of ESMA, EBA, and the European Insurance and Occupational Pensions Authority (EIOPA) on the prudential assessment of acquisitions and increases of qualifying holdings in the financial sector.
For self-managed AIFM and for existing Chapter 15 management companies applying for the AIFM license , the amount of the own funds must be at least equal to (a) 300,000 EUR plus 0.02% of assets under management above 250 million EUR or (b) a quarter of the previous year’s general expenses, whichever is higher.
Further to the fourth Anti-Money Laundering Directive dated 20 May 2015 (the AML Directive) a draft bill of law has been introduced in Luxembourg on 6 December 2017 in order to implement the AML Directive into Luxembourg Law. Further to this draft bill a register of beneficial owners (registre de bénéficiaires effectifs = REBECO) shall be created. It was expected that the bill would be adopted around the end of the first quarter 2018, but due to the fact that there still is an internal debate going on in regard to the scope of the REBECO, there is a delay.It is supposed, as a general rule, to enter into force the first day of the month following its vote.
Briefly summarised, the draft bill of law stipulates that for every ultimate beneficial owner (UBO) holding directly or indirectly more than 25% in an entity (the so called “Registered Entity”) the following information will need to be provided to the REBECO:
The information must always remain accurate, complete and up-to-date. In line with such objective, the Registered Entities covered by the law must also themselves maintain a register of their UBO’s.
Registered Entities or their proxies must request the relevant information to be registered. The information shall be requested within one month at the latest following the event which makes it necessary (must be given before entering into a business relationship). It is foreseen by the law that even the notary, as drafter of the deed of incorporation or any amending act of the Registered Entity can also request the info to be added in the REBECO. The REBECO will be managed by an economic interest grouping (but separate database from the Trade and Companies register) of the Luxembourg Register of Commerce and Companies (RCS) ( the –so called – “Administrator”) under the authority of the Minister of Justice. The Minister of Justice will act as data controller within the meaning of the amended Act of 2 August 2002 on the protection of persons with regard to treatment of personal data.
The Administrator is responsible for the recording of the data in the REBECO upon request and on behalf of the Registered Entity. The entities concerned must request the recording of the relevant information within 6 months from the entry into force of the law. The application for registration shall be made on the Administrator’s website. The exact procedures will be laid down in grand-ducal decree (which is not yet available).
Access to the information stored in the register is in principle limited to self-regulatory bodies (such as the Luxembourg Bar, Notary Chamber or the order of accountants) and obliged entities as defined in the AML Law (such as for instance credit institutions, insurance undertakings UCITS management companies and Alternative Investment Fund Managers). The access is limited to partial information and not to the supporting documents. The electronic access of self-regulatory bodies is only to be used within the strict context of their supervisory functions whereas the electronic access of obliged entities may be used only where obliged entities are required to carry out client due diligence measures in relation to their clients.
Access to the REBECO without any restriction will be made available electronically only to national competent public authorities, including but not limited to the prosecutor, the Commission de Surveillance du Secteur Financier (CSSF), the Commissariat aux Assurances (CAA) and tax administration.
Furthermore a limited access to the REBECO will be granted to any person or organisation that (i) can demonstrate a legitimate interest, (ii) is resident in Luxembourg and (iii) has made an official written and reasoned request in this respect. Such access is subject to the prior approval of a formal commission to be created by the Minister of Justice. At this stage it remains to be seen what will be considered as “legitimate interest” by the authorities. In any case the access does not include the very personal information, such as day and place of birth or address.
In case a “legitimate interest” is recognized and an access is granted the commission (then created by the the Minister of Justice) will inform not only the applicant but also the concerned entity.
Another limitation of access is to be seen in the fact that any subject entity may request a restriction of access to the REBECO, in case of “exceptional circumstances”, to limit the access to its UBO information to public authorities only, where access would expose the UBO to the risk of fraud, kidnapping, blackmail, violence or intimidation, or where the beneficial owner is a minor or otherwise incapable.
As a final remark, please note that criminal sanctions up to EUR 1.250.000 may be imposed on the self-regulatory bodies or on the obliged entities if they purposely access the REBECO outside the aforementioned circumstances.
On 25 October 2017, a draft bill of law adapting and completing Luxembourg law to the Regulation (EU) No 1286/2014 on key information documents (KIDs) on packaged retail and insurance-based investment products (PRIIPs) (the PRIIPs Regulation) and, inter alia, modifying the amended Luxembourg law of 17 December 2010 on undertaking for collective investment and the amended Luxembourg law of 7 December 2015 on the insurance sector, has been lodged with the Luxembourg parliament .
The Regulation (EU) No 1286/2014 on key information documents (KIDs) on packaged retail and insurance-based investment products (PRIIPs), which entered into force on 29 December 2014, applies since 1 January 2018.
From a legislative perspective, the draft bill of law mentioned here-above specifies that the CSSF and the Commissariat aux assurances (CAA) respectively for management/investment companies and insurance companies will be the Authorities in charge of the supervision of the compliance with the PRIIPs Regulation. They will have controlling powers as well as the possibility to impose fines. In addition to that, the said draft bill of law states that the SICARs (Investment Company in Risk Capital) and investment funds other than UCITS are authorized to prepare a UCITS KIID document provided that they clearly state on the document that they are not subject to Directive 2009/65/EC. In such a case the management companies, the investment companies and the persons who sell or provide advice on the units or shares of those investment funds or SICARs would benefit from the exemption of art. 32 of the Regulation (UE) 1286/2014 and therefore, for the time being and until 31 December 2019 would not have to comply with the requirements of the PRIIPs Regulation.
On 18 August and 20 November 2017, the Joint Committee of ESAs (comprising EBA, ESMA and EIOPA) published updated versions of its questions and answers document in relation to the PRIIPs Delegated Regulation, which includes new questions and answers on market risk assessment (Annex II, Part 1), methodology for assessing credit risk (Annex II, Part 2), summary risk indicator (SRI) (Annex III), performance scenarios (Annex IV), derivatives, multi-option products (MOPs) and presentation of costs (Annex VII).
In October 2017, EFAMA and Insurance Europe endorsed new versions of the EU PRIIPs Template (EPT) and Comfort EU PRIIPs Template (CEPT), which are both immediately applicable and replace the previously available version approved in July 2017.
The law, coming into force on 25 May 2018 provides for the enhancement of both legal and practical security for individual, economic operators and public authorities. This new law (bill N°7184) adapts and completes Luxembourg law to Regulation (EU) 2016/679 of 27 April 2016 on the protection of individuals with respect to the treatment of persons with disabilities, personal data and the free movement of such data (GDPR).
The guidelines on data breach notification are a consequence of the requirement imposed by the GDPR to notify to the competent national supervisory authority (the CNPD in Luxembourg) any breach which is likely to result in a risk to the rights and freedoms of individuals and, in certain cases, to notify also the individuals whose personal data have been affected by the breach.
Such notification will be mandatory for controllers as well as their subcontractors established on Luxembourg territory, but also for processors who will have to inform their controllers if there is a breach. Therefore the addressed parties are encouraged in these guidelines to plan in advance and put in place processes to be able to detect promptly a breach. Despite its timely entry into force, there are still some questions with regard to its scope - In the area of fund management in particular, it is difficult to distinguish between controller on one hand and processor on the other. The differentiation is important for the question of who is subject to which obligations set out in the law. With regard to the fund industry, it is yet not entirely clear who is considered being the fund controller(the Fund, the AIFM or both?) Therefore we hope it will be clarified by the Luxembourg authorities in the future.
Nevertheless it is to be expected that there will be no gold-plating in regard to the application of the Luxembourg GDPR Law.
The companies operating in the fund industry are currently adapting their GDPR relevant agreements in order to comply with GDPR. This applies in particular to the (former or to be signed) “data processing agreements” with the processors in order to meet the requirements of the law.
I t needs to be pointed out that the sanctions contained in the GDPR of a failure to report a breach should be taken seriously since it may lead to a sanction, including an administrative fine, the value of which can be up to EUR 10 million or up to 2% of the worldwide annual turnover of the controlling entity.
The EU-Commission has issued legislative proposals on cross-border distribution of investment fundsin order to reduce barriers and increase the volume of cross border distribution of funds. The aim is to reduce the cost for fund managers of going cross-border, to support a more integrated single market for investment funds and to support more cross-border marketing of investment funds.
One proposal has the form of a directive modifying the UCITS and AIFM Directives and the second one a regulation on facilitation of cross-border distribution of funds that also amends the EuSEF/EuVECA regulations.
The proposed changes relate mainly to:
It will need to be followed-up in which form these proposals will come into force after the respective discussions. The consequences on the market will depend on the final form.
Author: Simon Lovegrove
A round up of recent regulatory developments in the EU and UK. To receive daily or weekly updates on regulatory developments subscribe to our blog, regulationtomorrow.com
| Title | Date | Comment |
| CMA paper on investment consultants’ market investigation – trustee engagement | 16.04.18 | The Competition and Markets Authority (CMA) issued a consultative working paper as part of its investment consultants’ market investigation. The working paper set out the CMA’s initial analysis of trustee engagement with investment consultancy and fiduciary management. The deadline for comments on the consultative working paper was 26 April 2018. |
| ECON report on draft Directive on the prudential supervision of investment firms | 11.04.18 | The European Parliament’s Committee on Economic and Monetary Affairs (ECON) published a draft report on the proposed Directive on the prudential supervision of investment firms. The report contains a draft European Parliament legislative resolution which sets out suggested amendments to the draft Directive. The Rapportuer for the draft Directive, Markus Ferber MEP, broadly supports the proposed legislation but believes that a number of changes are necessary including to the own funds requirements, capital and liquidity requirements, K-factors, third country equivalence and requirements on reporting, governance and remuneration. |
| ESMA seeks clarification of MiFID II ancillary activity test | 10.04.18 | The European Securities and Markets Authority (ESMA) published a letter it had sent to the European Commission asking it to provide further guidance on how the ancillary activity criteria set out in Article 2(4) of MiFID II, and further specified in RTS 20, are to be interpreted and implemented, and more specifically at which level the ancillary tests should be performed. |
| MMF Delegated Regulation on investment requirements | 10.04.18 | The European Commission adopted a Delegated Regulation on simple, transparent and standardised securitisations and asset-backed commercial papers, requirements for assets received as part of reverse repurchase agreements and credit quality assessment methodologies under the Regulation on money market funds. The Council of the EU and the European Parliament will consider the Delegated Regulation. If neither of them objects, it will enter into force twenty days after it is published in the Official Journal of the EU (OJ). It will apply from 21 July 2018, with the exception of Article 1 which will apply from 1 January 2019. |
| ECON report on equivalence | 04.04.18 | ECON published a draft report on relationships between the EU and third countries concerning financial services regulation and supervision. The draft report contains a motion for a European Parliament resolution which amongst other things argues that the EU’s process for granting equivalence lacks certainty and sufficient transparency. It also calls for the European Parliament to scrutinise equivalence decisions in the area of financial services including that the institution should be consulted before any equivalence decision is withdrawn. The draft report will be reviewed in further ECON meetings. It is expected to be voted on by all MEPs in September 2018. |
| AIMA paper on Brexit and alternative asset managers | 09.04.18 | The Alternative Investment Management Association (AIMA) published a paper on Brexit and alternative asset managers. The goal of the paper is to offer a bottom-up assessment of what will need to be addressed during the transition period – regardless of whether there is an agreement on mutual recognition – looking individually at the cross-border provisions in EU legislation that AIMA members use when providing services to clients and investors across the EEA. |
| PRA and FCA Business Plans 2018/19 | 09.04.18 | The PRA and the FCA published their Business Plans for 2018/19. Work on Brexit is a key feature in both plans. |
| FCA statement on cryptocurrency derivatives | 06.04.18 | The FCA published a statement on the requirement for firms offering cryptocurrency derivatives. In the statement the FCA reminded firms that cryptocurrencies are not currently regulated provided they are not part of other regulated products or services. The FCA stated that cryptocurrency derivatives are, however, capable of being financial instruments under MiFID II although the FCA does not consider cryptocurrencies to be currencies or commodities for regulatory purposes under MiFID II. |
| FCA sets out next steps to improve competition in the UK’s asset management industry | 05.04.18 | The FCA published its latest documents in response to the concerns it previously identified in its asset management market study. The documents comprise: (i) Policy Statement 18/8: Asset Management Market Study remedies and changes to the Handbook – Feedback and final rules to CP17/18; (ii) Consultation Paper 18/9: Consultation on further remedies – Asset Management Market Study; and (iii) Occasional Paper 32 – Now you see it: drawing attention to charges in the asset management industry. |
| ESMA proposes simplifications to prospectuses format and content | 04.04.18 | ESMA published a final report containing technical advice under the Prospectus Regulation. The technical advice covers: (i) format and content of a prospectus; (ii) the EU growth prospectus; (iii) scrutiny and approval of a prospectus. The final report has been delivered to the European Commission. Subject to endorsement by the European Commission, the technical advice will form the basis for the delegated acts to be adopted by the European Commission by 21 January 2019. |
| PRA update on Brexit | 28.03.18 | Following the European Council meeting in late March the Bank of England (BoE) published a news release providing an update on the regulatory approach to preparations for EU withdrawal. The BoE welcomed the agreement between the UK and the EU27 that there should be an implementation period until the end of 2020 as part of the UK’s Withdrawal Agreement with the EU. The BoE stated that it considers it reasonable for firms currently carrying on regulated activities in the UK by means of passporting rights to plan that they will be able to continue undertaking these activities during the implementation period in much the same way as now. The BoE stated that firms may plan on the assumption that UK authorisation or recognition will only be needed by the end of the implementation period. The BoE stated that in the context of their future preparations for the UK’s withdrawal from the EU, EEA banks and insurers may (if they are not conducting material retail business) apply for authorisation to operate as a branch in the UK. The BoE noted that the UK Government has committed to bring forward legislation, if necessary, to create a temporary permissions regime to allow firms to continue their activities in the UK for a limited period after withdrawal. It added that in the unlikely event the Withdrawal Agreement is not ratified, this regime provides confidence that a back-stop will be available. The BoE published Policy Statement 3/18: International banks: the PRA’s approach to branch authorisation and supervision (PS3/18). In PS3/18 the PRA provided feedback on responses to ‘Consultation Paper 29/17: International banks: the PRA’s approach to branch authorisation and supervision’. |
| FCA statement on Brexit | 28.03.18 | The FCA published a statement on the EU withdrawal following the March European Council. The FCA welcomed the agreement reached on the terms of the implementation period that will apply following the UK’s withdrawal from the EU. The statement covered the temporary permissions regime for firms and funds passporting into the UK. The FCA stated: “Subject to HM Government’s legislation setting up the regime, our expectation is that firms and funds that will be solo-regulated by the FCA will need to notify us of their desire to benefit from the regime. Notification will not require submission of an application for authorisation. We will set out further details on these proposals later in the year.” The FCA stated that the implementation period would permit firms and funds to continue to benefit from passporting between the UK and EEA until the end of December 2020. UK firms and funds passporting into the EEA should discuss with their relevant EU regulator the implications of a implementation period for their contingency planning. The FCA also published a speech by its Chief Executive, Andrew Bailey. In his speech Mr Bailey explained why an implementation period is important and what needs to be done to make the best use of that time. |
| FCA proposes guidance on financial crime systems and controls: insider dealing and market manipulation | 27.03.18 | The FCA issued Guidance Consultation 18/1: Proposed guidance on financial crime systems and controls: insider dealing and market manipulation (GC18/1). The FCA proposes to update the financial crime guide for firms (the Guide) with an additional chapter on insider dealing and market manipulation. The new chapter will outline the FCA’s observations of good and bad market practice around the requirement to detect, report and counter the risk of financial crime, as it relates to insider dealing and market manipulation. Therefore the proposed guidance will be of interest to firms who are subject to the financial crime rules in SYSC 6.1.1R and who arrange or execute transactions in financial markets. The FCA also proposes minor amendments to other parts of the Guide to reflect recent regulatory changes and ensure the Guide remains up-to-date. The deadline for comments on GC18/1 is 28 June 2018. |
| ESMA temporary product intervention measures applied to retail CFD and binary option products | 27.03.18 | ESMA agreed measures on the provision of contracts for differences (CFDs) and binary options to retail investors in the EU. The agreed measures included:
The FCA also issued a statement supporting ESMA’s measures. |
| RTS to ELTIF Regulation published in OJ | 23.03.18 | There was published in the OJ, Commission Delegated Regulation (EU) 2018/480 of 4 December 2017 supplementing Regulation (EU) 2015/760 of the European Parliament and of the Council with regard to regulatory technical standards on financial derivative instruments solely serving hedging purposes, sufficient length of the life of the European long-term investment funds, assessment criteria for the market for potential buyers and valuation of the assets to be divested, and the types and characteristics of the facilities available to retail investors. The Delegated Regulation entered into force on the twentieth day following its publication in the OJ. |
| Translations of guidelines on stress test scenarios under Art. 28 MMF Regulation | 21.03.18 | ESMA published the official translations of its guidelines on stress test scenarios under Article 28 of the Regulation on money markets funds. Member State national competent authorities must notify ESMA whether they comply or intend to comply with the guidelines within two months of the date of publication. |
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On 24 October 2024, the Court of Justice of the European Union (CJEU) confirmed that the European Commission’s (the EC) 2009 decision, which imposed a (then record) €1.06 billion fine on Intel, was flawed as far as it found that loyalty rebates granted by Intel had anti-competitive effects.
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