Global asset management quarterly - Europe

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

Introduction

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. 

Facts

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:

1. Whether the payment was payable under a legal obligation.
2. Whether the payment was capable of recurrence.
3. Whether the payment constituted income for the recipient.
4. Whether the payment represented “pure profit” for the recipient.

Decision

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.

Comment

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

Introduction

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:

• Regulation setting out a harmonised EU framework for facilitation of cross-border fund distribution (the Proposed Regulation); and
• Directive proposing certain amendments to the Alternative Investment Fund Managers Directive (AIFMD) and the UCITS IV Directive (the Proposed Directive).

Background

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.

Summary of key proposals

Proposed Regulation

• Alternative investment fund (AIF) and UCITS marketing communications must be identifiable as such, present the risks and rewards of purchasing units/shares of the relevant fund in an equally prominent manner and all information included must be fair, clear and not misleading. To the extent Member State national competent authorities (NCAs) have systems in place to verify compliance of marketing communications with national requirements, compliance cannot be a pre-condition to marketing and a decision must be made within 10 working days. NCAs must also apply and publish procedures ensuring transparent and non-discriminatory treatment regardless of the origin of the fund and report to the European Securities and Markets Authority (ESMA) on an annual basis in relation to the same.
• NCAs must publish online, and notify ESMA of, all applicable national laws, regulations and administrative provisions governing marketing rules for AIFs and UCITS in a language customary in the sphere of international finance. ESMA will publish and maintain on its website a dedicated central database of this information.
• Fees or charges levied by NCAs must be proportionate to supervisory tasks carried out and details (including, where possible, how the fees are calculated) must be maintained by those NCAs on a central database in a language customary in the sphere of international finance.
• ESMA, assisted by NCAs, will maintain a central database on all AIFMs, UCITS management companies, AIFs and UCITS, along with details of Member State marketing rules and applicable fees and charges.
• The EuVECA Regulation and the EuSEF Regulation will be amended to allow for pre-marketing.

Proposed Directive

• Both the UCITS IV Directive and the AIFMD will be amended to allow managers to de-notify the marketing of UCITS and AIFs if a maximum of 10 investors who hold up to 1% of assets under management have invested in the relevant UCITS or AIF in a Member State.
• The UCITS IV Directive will also be amended as follows:
  • Member States will be prohibited from requiring a local physical presence of facilities agents in other Member States where UCITS are marketed.
  • The notification procedure for changes to UCITS will be aligned with that of the AIFMD.
  • Provisions on marketing communications and transparency superseded by harmonising provisions in the Proposed Regulation will be deleted.
• The AIFMD will also be amended as follows:
  • A new Article 30a will be inserted to set out the conditions under which an EU AIFM can engage in pre-marketing activities in a Member State. In particular, an EU AIFM will be allowed to test an investment idea or strategy with professional investors, but will not be able to promote an established AIF without submitting a notification.
  • To ensure consistency of treatment, Member States that allow AIFMs to market units/shares of AIFs in their territories to retail investors are required to ensure that the AIFMs make facilities available for making subscriptions and payments or repurchasing or redeeming units. Electronic or distance communication will suffice in this respect.

Impact and challenges

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:

• the AIF must not yet be established; and
• no offering documents (even in draft form) can be distributed to potential investors.

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.

Timeline and next steps

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

Introduction

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:

• Policy Statement 18/8: Asset Management Market Study remedies and changes to the Handbook – Feedback and final rules to CP17/18 (PS18/8);
• Consultation Paper 18/9: Consultation on further remedies – Asset Management Market Study (CP18/9); and
• Occasional Paper 32 – Now you see it: drawing attention to charges in the asset management industry (OP32).

PS18/8

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

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:

• publish guidance reminding AFMs how they should express fund objectives and investment policies to make them more useful to investors. Firms should, when describing the objectives of their funds: (i) explain clearly what they are looking to achieve and how; (ii) explain the constraints that the fund’s portfolio construction may be under; and (iii) explain any non-financial objectives they have, for example the environmental or social objectives of an investment, and how they will measure and report progress against these objectives;
• make new rules so that AFMs must explain why they use benchmarks, or if they do not, how investors should assess the performance of the fund;
• require that, if an AFM uses benchmarks, the benchmarks must be referenced consistently across the fund’s documents and, wherever the AFM presents the fund’s past performance, benchmarks used as a constraint on portfolio construction or as a target must be presented alongside the past performance; and
• amend its performance fees rules to provide that performance fees must be calculated on performance net of other fees in all cases.

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.

Conclusion

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

Brexit

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.

Publication of revised AIF Rulebook and Central Bank of Ireland Q&A on AIFMD

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.

Publication on proposed amendments to the Central Bank of Ireland UCITS Regulations

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.

MiFID II

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 among the Top 3 financial centres in the EU and 21st globally

Author: Simon Lovegrove

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