EU/UK Regulatory roundup

There was published in the Official Journal of the EU (OJ) the following legislative acts:

• Directive (EU) 2019/1160 amending the UCITS Directive and the Alternative Investment Fund Managers Directive with regard to the cross-border distribution of collective investment undertakings.
• Regulation (EU) 2019/1156 on facilitating cross-border distribution of collective investment undertakings and amending the European Venture Capital Funds Regulation, the European Social Entrepreneurship Funds Regulation, and the Regulation on key information documents for packaged retail and insurance-based investment products.

The Directive and Regulation entered into force on August 1, 2019. The Regulation will apply from August 1, 2019, with the exception of Articles 4(1) to (5), Articles 5(1) and (2), Article 15 and Article 16, which will apply from August 2, 2021. Member States are required to apply measures implementing the Directive from August 2, 2021.

ESMA consults on draft guidelines on performance fees in UCITS

The European Securities and Markets Authority (ESMA) issued a public consultation on draft guidelines on performance fees under the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive.

ESMA’s draft guidelines propose common criteria to promote supervisory convergence in the following areas:

• General principles on performance fee calculation methods
• Consistency between the performance fee model and the fund’s investment objectives, strategy and policy
• Frequency for the performance fee crystallization and payment
• The circumstances where a performance fee should be payable
• Disclosure of the performance fee model

The deadline for responding to the consultation was October 31, 2019.

The International Organization of Securities Commissions (IOSCO) published a statement explaining why its 2018 Liquidity Risk Management Recommendations (LRM) provide a comprehensive framework for regulators to deal with liquidity risks in investment funds.

The statement followed media coverage of liquidity problems that affected some investment funds and the comments made by the UK Financial Policy Committee (FPC) in the Bank of England’s Financial Stability Report which discussed potential mismatches between the liquidity of fund assets and redemption terms offered by funds to their investors. In particular the FPC stated that: “This is a global issue. For that reason, the FPC supported the Financial Stability Board’s 2017 recommendation that funds’ assets and investment strategies should be consistent with their redemption terms. However, subsequent work by IOSCO did not prescribe how this should be achieved.”

IOSCO concluded its statement by commenting that the 2018 LRM Recommendations are directed at preventing liquidity and redemption mismatches from arising in the first place, rather than just mitigating problems as they crystallize. It also adds that they deal with attendant benefits and risks when open-ended investment funds may exceptionally look to use other liquidity management tools in the face of untoward redemption pressures, including the need to treat investors fairly and to consider any broader market implications. They also allow domestic regulators to apply the recommendations in a prescriptive manner to manage specific or idiosyncratic liquidity risks.

The FCA published Policy Statement 19/22: Guidance on cryptoassets – feedback and final guidance to CP19/3 (PS19/22). In PS19/22 the FCA responded to the feedback it received to Consultation Paper 19/3: Guidance on cryptoassets (CP19/3) and set out final guidance.

In PS19/22 the FCA reported that the majority of respondents to CP19/3 were receptive to its proposals. The FCA therefore decided to proceed on the basis on which it consulted. The final guidance remains largely the same as the version consulted on. However, the FCA made amendments in a few areas, for example it amended the wording in the guidance to provide further clarity on tokens commonly referred to as ‘stablecoins’. The FCA also made minor drafting changes throughout the guidance, particularly to provide more clarity where tokens might be e-money.

The FCA expects market participants to take the final guidance into consideration and will use it as a basis on which the regulator can proactively engage with any cryptoassets firms to check whether they are carrying on regulated activities.

The FCA published a letter (dated August 6, 2019) from Andrew Bailey, FCA Chief Executive, in response to Lord Myners’ written question asking if the Government has ever formally reviewed the case for the UK establishing its own requirements for liquidity standards for UCITS at higher levels than specified in EU Directives or whether the UK is bound by EU rules and cannot introduce higher standards.

Mr Bailey explained that the UCITS Directive is generally minimum harmonizing and therefore it would be possible to tighten the liquidity standards for UCITS schemes established in the UK. However, Mr Bailey also pointed out two significant drawbacks to this course of action:

• The FCA is not permitted by EU law to unilaterally extend measures to UCITS established in the EEA (as opposed to the UK) and marketed in the UK under EU passporting rights so tightening the liquidity standards for UK funds would not be sufficient in protecting UK investors from harm.
• The UCITS Directive sets an overall objective that funds should be liquid, but the legislation contains detailed rules that may be, in some areas, not sufficient to ensure liquidity. Mr Bailey used the example of the suspension of the LF Woodford Equity Income Fund to demonstrate that exchange listing and liquidity are not synonymous and that listing does not mean trading will occur. He added that there is a potential conflict between the detailed rules and overall requirement for liquidity which may need clarifying.

Mr Bailey stated that in his view there was merit in considering the new SEC approach in the US which creates a purposive test of liquid status and supports this with requirements around governance, systems and controls, etc. The purposive test requires fund managers to allocate assets to liquidity buckets based on the estimated time it would take to sell the asset.

ESMA published its final guidance regarding liquidity stress testing of investment funds – applicable to AIFs and UCITS. The report follows an earlier consultation in February 2019 on draft guidelines and contains an overview of the feedback received and explains how ESMA took this into account.

The guidelines will be translated into the official EU languages, the publication of which will trigger a two-month period where Member State competent authorities must notify ESMA whether they comply or intend to comply with the guidelines. The guidelines apply from September 30, 2020.

ESMA has developed a framework to be used for stress simulations for the investment fund sector. ESMA encourages national authorities to use the method as described in the accompanying report. The report contains a case study where the method has been applied to 6,000 UCITS bond funds.

ESMA intends to use this stress simulation framework to assist in its regular risk monitoring to identify and assess risks that may impact the funds industry.

The FCA updated its webpage on the national private placement regime (NPPR). The FCA reported that on September 9, 2019, it would make changes to the submission of notifications by AIFMs marketing AIFs under Regulations 57, 58, 59 of the Alternative Investment Fund Managers Regulations 2013 (as amended). AIFMs marketing funds under Regulations 58, 59 and, for UK AIFMs only, Regulation 57, will return to submitting notifications via Connect. Full scope EEA AIFMs marketing AIFs under Regulation 57 will be required to submit notifications using new forms.

The FCA published a webpage setting out its key findings and next steps in relation to its review of firms’ governance practices covering the value provided by unit-linked funds. These funds can be described as funds whose performance determines the benefits due to holders of unit-linked insurance contracts.

The FCA found that insurance firms’ fund governance for unit-linked funds often does not include considerations that it believes are likely to be important in assessing whether unit-linked funds provide good value for their investors.

In terms of next steps, the FCA will assess the findings from its review alongside the continuing work on non-workplace pensions, the governance of unit-linked mirror funds and the effectiveness and scope of independent governance committees. It will then decide whether further remedies are necessary.

The FCA published Policy Statement 19/24: Illiquid assets and open-ended funds and feedback to Consultation Paper 18/27 (PS19/24).

In October 2018, the FCA consulted on changes intended to reduce the risk of poor outcomes to retail investors in open-ended funds, specifically non-UCITS retail schemes (NURSs), that invest in illiquid assets. In PS19/24, the FCA summarised the feedback it received to the consultation, its response to the feedback and set out its final rules.

The FCA stated that its final rules in PS19/24 reflected that it does not want to prohibit open-ended funds from investing in illiquid or less liquid assets where investors understand and are willing to accept the liquidity risk this can involve.

The FCA reported that following feedback to its consultation it will not proceed with two of its proposals:

• The requirement for a manager of a FIIA to add an ‘identifier’ to the name of the fund. However, fund managers are reminded that fund names should be carefully chosen so they do not mislead, as set out in COLL 6.9.
• Guidance relating to limiting the accumulation of large cash buffers within NURSs and UCITS funds. Under the new rules, where authorized fund managers managing NURSs choose not to manage the liquidity mismatch directly, for example by adapting the redemption arrangements to be more similar to the liquidity of the underlying assets, the fund will have to be classified as a FIIA and become subject to the additional requirements this brings.

In terms of the new rules, these are in summary:

• NURSs holding property and other immovables to suspend dealing when there is material uncertainty about the valuation of at least 20% of the scheme property. However, an authorized fund manager will be allowed to continue to deal where they have agreed with the fund’s depositary that to do so is in the best interests of investors.
• Managers of funds investing in illiquid assets to produce contingency plans for dealing with liquidity risks. Depositaries are also given a specific duty to oversee the processes used to manage the liquidity of the fund.
• Further guidance is provided which is intended to clarify both the circumstances in which it may be appropriate to suspend dealing and the process for arriving at a fair and reasonable value for an immovable asset, where it needs to be sold quickly to ensure that the fund can continue to meet redemption requests as they fall due.
• Additional disclosure in a fund’s prospectus of the details of their liquidity risk management strategies plus a standard risk warning in financial promotions to retail clients for such funds (this applies to all firms communicating a financial promotion, not just the fund manager).

The new rules and guidance will enter into force on September 30, 2020. This will allow firms to use scheduled annual reviews of fund documentation to make the necessary changes.

IOSCO published two update reports on its peer reviews of the regulation of MMFs and of the implementation of incentive alignment recommendations for securitization.

• A MMF report covered three topics: valuation, liquidity management and MMFs that offer a stable net asset value. IOSCO found that most jurisdictions have implemented the fair value approach for the valuation of MMF portfolios, but progress in liquidity management is less advanced and less even.
• A securitization report covered two topics: incentive alignment arrangements and disclosure requirements. IOSCO observed that, overall, progress remains mixed across participating jurisdictions in implementing the recommendations for incentive alignment for securitization.

The FCA published Consultation Paper 19/29: Recovery of costs of supervising cryptoasset businesses under the anti-money laundering regulations – fees proposals (CP19/29). From January 10, 2020, the FCA will become the anti-money laundering and counter terrorist financing (AML/CTF) supervisor for cryptoassets businesses. In CP19/29 the FCA sets out its proposals for recovering the costs of the new role.

The deadline for comments on the proposed registration fee was November 11, 2019. The deadline for comments on periodic fees based on income is December 10, 2019.

The FCA will consider the responses to the consultation and intends to publish feedback on registration fees in December 2019, and on periodic fees in April 2020. 

The Council of the EU published the texts it adopted at first
reading for the:

• The Regulation on disclosures relating to sustainable investments and sustainability risks in the financial services sector (the Disclosure Regulation).
• The Regulation amending the Benchmarks Regulation as regards EU Climate Transition Benchmarks, EU Paris-aligned Benchmarks and sustainability-related disclosures for benchmarks (the Low Carbon Benchmarks Regulation).

The Disclosure Regulation will enter into force on the 20th day following its publication in the OJ of the EU and will apply from 15 months following that date. The Low Carbon Benchmarks Regulation will enter into force on the day after publication in the OJ.

The FCA published the following revised directions for:

• EEA firms with passports and Treaty firms
• EEA collective investment schemes
• EEA alternative investment funds
• Authorized payment institutions and EEA registered account information service providers
• E-money institutions

The directions amend the previous versions in the FCA Handbook and extend the notification period for firms wanting to enter the temporary permissions regime to January 30, 2020

The FCA published a letter sent by the head of its Asset Management Department, Nick Miller, to the Chairs of AFMs in relation to good practices for effective liquidity management.

Specifically, the letter asked chairs to:

• Consider their regulatory obligations on portfolio composition, asset eligibility and liquidity management, as outlined in the Collective Investment Schemes sourcebook.
• Review their liquidity management arrangements against the 2016 FCA good practice paper and improve them where necessary, to ensure that they comply with the applicable requirements for liquidity management and valuation under FCA rules and directly applicable European regulation. Furthermore, it asked them to review the IOSCO 2018 liquidity recommendations and consider to what extent their own arrangements mirror these.

The FCA also asked chairs to carry out their reviews “as soon as practicable” so that they and their fellow AFM board members are confident that their practices are appropriate.