Funds Legal Update | 10 February 2021

It is only a matter of weeks until the first set of disclosure obligations kick in under the Sustainable Finance Disclosure Regulation (SFDR), and the funds industry is gearing up to ensure their websites and offering memoranda are all compliant on 10 March 2021. The revised draft Regulatory Technical Standards recently published provide some more certainty over the level of detail that is required, and have been improved in certain respects following the initial industry pushback. Nevertheless there remain some key "grey areas" which the European Commission needs to clarify.

As the UK moves forward in its new relationship with the EU and seeks to rebuild from the Covid-19 pandemic, HM Treasury is seeking industry views on ways to make the UK a more attractive location to set up, manage and administer funds. Focussing both on the regulation and taxation of investment funds, it promises to be a key opportunity to make improvements to the UK funds regime.

Surely prompted by the UK's transition outside of the European Economic Area, the European Securities and Markets Authority (ESMA) has issued a stark warning to non-EU firms not to circumvent their regulatory obligations through the use of reverse solicitation. This is the latest in a series of events which signal that a tightening of the rules around the concept of reverse solicitation may be on the horizon.

Finally, take the opportunity to register for our virtual panel and networking event on 4 March 2021 - Opportunities for investors to accelerate the green industrial revolution and the road to net zero. Details on how to register are below.

Revised Regulatory Technical Standards published – but SFDR 'grey areas' remain

Next month, EU alternative investment fund managers (AIFMs) – and potentially UK AIFMs who market their funds into Europe under the AIFMD National Private Placement Regimes – will be required to comply with the first set of disclosure obligations under the SFDR.

As from 10 March 2021, asset managers who fall within scope of the SFDR will need ensure they include appropriate sustainability disclosures in their pre-contractual information (for example, the fund prospectus) and on their websites. However, despite the fast approaching deadline, there remain fundamental question marks over the scope of the Regulation, in particular whether it will apply to UK (and other non-EU) AIFMs at all.

The publication of the revised Regulatory Technical Standards (RTS) on 4 February 2021 at least plugs a gap in terms of the detail on the content, methodologies and presentation of the information that needs to be disclosed. The good news is that the European Supervisory Authorities have simplified some aspects of the templates, bearing in mind the policy objective of achieving comprehensive and comparable disclosures, and the industry's strong desire to reduce the cost and burden of compliance. The proposed application date for the RTS is 1 January 2022.

Meanwhile, asset managers wait with baited breath for a response from the Commission to the ESAs' letter (7 January 2021) seeking urgent clarification on the following five 'priority areas':

1. The application of SFDR to non-EU AIFMs and registered AIFMs.
2. Application of the 500-employee threshold for principal adverse impact reporting on parent undertakings of a large group.
3. The meaning of "promotion" in the context of products promoting environmental or social characteristics.
4. The application of Article 9 of the SFDR.
5. The application of SFDR product rules to portfolios and dedicated funds.

Environmental, social and governance (ESG) waters have been further muddied by moves from certain European regulators to implement their own ESG requirements for funds, in some cases going beyond what is required under the SFDR. In a recent press release from the AMF (Autorité des Marchés Financiers), the French regulator seeks to clarify how its ESG requirements interact with the SFDR in respect of green products being sold to French investors. While the AMF indicates that amendments to bring its own rules in line with the EU position are in the offing, managers are who market into France should stay abreast of these developments.

Until the funds industry receives clarity on the issues that are outstanding, there will inevitably be a degree of asset managers needing to "learn by doing", which will necessarily evolve over time to meet the regulators' high expectations.

Osborne Clarke Panel and Networking Event: Opportunities for investors to accelerate the green industrial revolution and the road to net zero – 4 March – 16:00

Join us for what promises to be a lively virtual panel and networking event in collaboration with the Clean Growth Fund (CGF). The government’s legislated ambition to reduce carbon emissions to net-zero levels by 2050 represents one of the country’s biggest challenges, as well as opportunities. View full details on our website here.

The focus of this session will be on the opportunities for investors on the road to net zero; we’ll look to cover topics such as the exciting areas for potential investment, funding strategies, scalable innovation, recognisable risks and mitigation measures.

The panel event will be chaired by Head of Decarbonisation, James Watson and we are delighted to be joined by Beverley Gower-Jones, Managing Partner at CGF, James Bevan, Chief Investment Officer at CCLA, Mark Taylor, Deputy Director Energy Innovation at the Department for Business, Energy and Industrial Strategy, and Sir Roger Gifford, Chair of the Green Finance Institute.

You can register for the event here.

What will make the UK a more attractive location for funds?

On 26 January 2021, HM Treasury published their Review of the UK funds regime: a call for input, seeking views on how to improve the UK funds regime.

The intention is to identify options which will make the UK an attractive location to set up, manage and administer funds, and to better meet investors’ needs for a wider range of more efficient investments. This includes reforms to the UK regulatory and tax regime. HM Treasury thinks that managers of UK funds will have a greater opportunity to distribute funds globally if the attractiveness of the UK funds regime is enhanced.

The Call for Input also looks at opportunities for wider reform, including how to attract AIFs targeting international markets to set up in the UK, and encourage fund administration firms to locate their activities outside London and the South East.

Perceived as being complex with unnecessary barriers, the review identifies Real Estate Investment Trusts (REIT) (a key element of the UK's asset management industry) as a segment of the market deserving of overhaul. The paper highlights four possible changes to the REIT regime:

1. Removing the potentially "burdensome" interest cover test, which can see some large REITs pay a charge based on their financing-to-cost ratio in addition to being subject to the corporate interest restriction.
2. Amending the rule deciding how profits or loss on a disposal are treated if a REIT sells an asset it looked to hold on to within three years of completing significant development work.
3. Changing the rule that means REITs must hold at least three properties, based on a suggestion that single-property REITs may make the UK regime be "more attractive to investors".
4. Changing the rules that currently see UK-based REITs holding overseas properties having to pay tax in the overseas jurisdiction as well as the tax withheld in the UK to pay income to investors.

The deadline for responses is 20 April 2021 and HM Treasury is will look to prioritise those reforms which will have the greatest impact and those which can be implemented swiftly.

While the UK Funds Regime Working Group report has set out recommendations to establish a Long-Term Asset Fund for the UK, on 3 February 2021, ESMA published a letter it has sent to the European Commission, highlighting where improvements could be made to the Regulation on European long-term investment funds (ELTIFs) ((EU) 2015/760). It comments that bringing ELTIFs more in line with the needs of investors, both retail and professional, would make it a more attractive investment vehicle.

Reverse solicitation continues to feel the squeeze

The concept of reverse solicitation (used as a means of offering or placing a fund with investors outside of the scope of AIFMD) has come under a great deal of heat in recent months. Since the European Securities and Markets Authority's (ESMA) letter back in August 2020 urging the Commission to clarify the definition and rules for reverse solicitation as part of the AIFMD review, the concept has continued to attract regulatory scrutiny.

Most recently, on 13 January 2021, ESMA published a statement reminding firms of the requirements under the Markets in Financial Instruments Directive (MiFID) II (2014/65/EU) concerning the provision of investments services to retail or professional clients by non-EU firms. According to ESMA, some "questionable practices" by firms around reverse solicitation have emerged, with some firms seeking to circumvent MiFID II requirements by including general clauses in their terms of business (or through the use of online pop-up "I agree" boxes), where clients state that any transaction is executed on the exclusive initiative of the client.

Among other things, ESMA reminds firms of recital 111 of MiFID II, which provides guidance on what "own exclusive initiative of the client" means. In addition, it reminds firms that every communication means used, such as press releases, advertising on the internet or phone calls, should be considered in determining if the client has been subject to any solicitation, promotion or advertising in the EU on the firm's investment services or activities or on financial instruments.

A breach of the MiFID II requirements has two serious implications:

1. The provision of investment services in the EU without proper authorisation in accordance with the EU and the national law applicable in Member States exposes service providers to the risk of administrative or criminal proceedings, for the application of relevant sanctions.
2. When using the services of investment service providers which are not properly authorised in accordance with EU and Member States' law, investors may lose protections granted to them under EU relevant rules, including coverage under the investor compensation schemes.

It is unclear whether the Commission will seek to tighten the rules on reverse solicitation as part of the AIFMD review process, in any event we can expect to see a report from the Commission on reverse solicitation by 2 August 2021 as part of the new framework for the cross-border distribution of investment funds which comes into effect on that date.

Nevertheless, as many UK investment firms and funds look to firm-up their long term plans in the post-Brexit world, it is a timely reminder that they are being watched closely by the European authorities and that local EU regulators will take appropriate action against firms where necessary.

2021 marks the beginning of the end of DAC6 in the UK

On 31 December 2020, HMRC announced that reporting under the EU directive known as "DAC6" would only be required for arrangements that meet hallmarks under Category D. Category D broadly deals with undermining reporting obligations and obscuring beneficial ownership and shares substantial common ground with the Mandatory Disclosure Rules developed by the Organisation for Economic Co-operation and Development (OECD). Reporting requirements under Hallmarks A, B, C and E have been repealed.

Given the DAC6 reporting requirements were particularly onerous, this has been welcome news for many “intermediaries” (including law firms, accountants and tax advisors) who fell within the scope of the EU directive.

In the coming year, the UK government is expected to consult on and implement the OECD’s Mandatory Disclosure Rules as soon as practicable, to replace DAC6 and transition from European to international rules.

For more information, see our Insight here.