Funds Legal Update | 22 April 2020

Covid-19 is challenging investment funds operationally and as a result of increased market volatility. With the growing number of property fund suspensions, manager/investor relationships are being put under strain.

In this edition, we take a brief look at the UK government's new financial package to support UK businesses driving innovation and development, how the FCA is assisting investment firms in a very practical way and the pitfalls to avoid when communicating with clients during this uncertain time. Covid-19 aside, ESMA has also been busy – with new guidance issued on performance fees and two ongoing consultations.

Financial support announced for the UK economy's most dynamic sectors

On 20 April 2020, the UK Government announced a £1.25 billion government support package for UK businesses driving innovation and development through the coronavirus outbreak. The package includes a new £500 million loan scheme for high-growth firms, called the Future Fund, and £750 million of targeted support for small and medium sized businesses focusing on research and development. Key points to note include the following:

The £500 million Future Fund

• The scheme will be launched by the UK Government and the British Business Bank (acting in partnership) in May 2020.
• To be eligible, a business must be an unlisted UK registered company that has previously raised at least £250,000 in equity investment from third party investors in the last five years.
• The government is committing an initial £250 million in funding towards the scheme, with private investors at least matching the Government's commitment.
• The loans will automatically convert into equity on the company’s next qualifying funding round, or at the end of the loan if they are not repaid.
• The scheme will initially be open until the end of September.

The £750 million targeted support for the most R&D intensive small and medium size firms

• The first payments will be made by mid-May.
• The funds will be available through Innovate UK’s grants and loan scheme.
• Innovate UK, the national innovation agency, will accelerate up to £200 million of grant and loan payments for its 2,500 existing Innovate UK customers, on an opt-in basis.
• An extra £550 million will also be made available to increase support for existing customers and £175,000 will be offered to around 1,200 firms not currently in receipt of Innovate UK funding.

These schemes build upon the government's other financial support packages available to UK businesses, including the Coronavirus Business Interruption Loan Scheme and the (recently expanded) Coronavirus Large Business Interruption Loan Scheme. See here for details.

Find out what these measures mean for private equity and venture capital investors – and the businesses they back - in our latest Insights (here and here) on the Coronavirus Large Business Interruption Scheme and the Future Fund.

Expectations of funds amidst the Covid-19 crisis

Investment firms are facing significant operational challenges as a result of Covid-19. The travel restrictions have made it particularly difficult for firms engage a large number of internal and external parties, obtain "wet ink" signatures and hold their general meetings in the traditional way. To assist firms, the Financial Conduct Authority (FCA) has announced that:

1. firms may have an extra two months to publish their annual reports and an extra month to publish their half-yearly reports. However, this relief currently applies only to UK UCITS schemes and non-UCITS retail schemes;
2. firms may hold their general meetings in a virtual format; and
3. the regulator is willing to accept electronic signatures on applications to authorise funds or approve changes to funds.

The European Securities and Markets Authority (ESMA) has also issued a statement urging European regulators to adopt a risk-based approach and not prioritise supervisory actions against fund managers if they are struggling to meet regulatory deadlines as a result of Covid-19. Where fund managers reasonably anticipate that publication of their annual reports and half-yearly reports will be delayed, they are expected to notify their regulator promptly and inform investors as soon as practicable of the delay, the reasons for such a delay and to the extent possible the estimated publication date. A complete list of EMSA's responses to the COVID-19 pandemic can be found on its new web page.

Property fund suspensions create tension

On 8 March 2020, the FCA published a statement confirming that where there is currently material uncertainty over the value of commercial real estate (meaning a fair and reasonable valuation cannot be established), a temporary suspension of the fund by its manager is likely to be in the best interests of fund investors in the circumstances.

Last month Aviva, one of the UK’s largest pension providers, made the decision to prevent customers from cashing in property funds because of uncertainty over the value of the assets, citing coronavirus-induced market turmoil. According to this FT Article, at least 10 daily traded property funds, managing more than £12.9bn in assets, have been suspended after the economic fallout from Covid-19 cast doubt over the value of their underlying properties (including shopping centres, office buildings, pubs and warehouses). By the time investors are permitted to withdraw from their funds once assets start being sold again, the value of at least some of the funds is expected to have deteriorated. In the meantime, managers are justifying the continued payment of their management fees on the basis that the market disruption has led to an increase in the resources required to manage their fund portfolios.

Fund managers have a duty to act in the best interests of all investors. They must consider how to ensure the on-going fair treatment of all investors in their funds in the context of the current market conditions. Where fund managers have chosen to temporarily suspend dealings in funds, they will need to consider when to resume dealings in the interest of investors and in doing so, ensure that they are following carefully the FCA's rules and guidance.

Supervisory flexibility over depreciation notifications

A number of firms providing portfolio management services or holding retail client accounts that include leveraged investments have raised concerns over their obligation to inform investors where the value of their portfolio or leveraged position falls by 10% or more compared with its value in their last periodic statement, and for each subsequent 10% fall in value. Due to current market volatility, this presents a significant operational burden and could adversely impact consumers.

The FCA has therefore confirmed that until 1 October 2020, it will not take enforcement action against a firm that:

• has issued at least one notification to a retail clients within a current reporting period, indicating their portfolio has decreased in value by at least 10%;
• subsequently provides general updates through its website, other public channels (such as social media) and/or generic, non-personalised client communications; or
• chooses to cease providing 10% depreciation reports for any professional clients.

Keeping customers informed in times of market volatility – pitfalls to avoid

Many customers are naturally concerned about falls in the value of their investments at this time, and are seeking information and support from financial services firms. They might ask to surrender their investment or switch to less volatile funds. Or they might ask the firm for advice on whether to take these, or other, steps. However, by trying to provide customers with information to make better informed decisions, firms risk unwittingly straying into giving personal recommendations (i.e. providing regulated investment advice). To avoid this, the FCA has set out its views on the actions that firms can take to assist customers which, in its view, don’t amount to the provision of a personal recommendation.

ESMA guidance on performance fees in UCITS and certain AIFs

On 3 April 2020, ESMA published final guidance on performance fees in investment funds – applicable to Undertakings for Collective Investments in Transferable Securities (UCITS) and some types of open-ended alternative investment funds (AIFs) marketed to retail investors. The guidelines are intended to harmonise the way fund managers charge performance fees to retail investors, as well as the circumstances in which performance fees can be paid.

Certain provisions in the guidelines will require managers to review and adjust their performance fee models. Prospectuses and Key Information Documents (KIDs) will also need to be reviewed and amended in order to implement the transparency requirements introduced under the new rules. In particular, fund managers will need to be mindful of the obligation to produce a KID in circumstances where retail investors in the fund are unable to opt-up to 'professional client' status.

The guidelines will be translated into the official EU languages and subsequently published on ESMA's website and will become applicable two months after the publication of the translations:

• Managers of any new funds created after the date of application of the guidelines with a performance fee, or any funds existing before the date of application that introduce a performance fee for the first time after that date, should comply with these guidelines immediately in respect of those funds.
• Managers of funds with a performance fee existing before the date of application of these guidelines should apply these guidelines in respect of those funds by the beginning of the financial year following 6 months from the application date of the guidelines.

Standardised information to facilitate cross-border funds distribution

On 31 March 2020, ESMA launched a consultation paper on the standard forms, templates, and procedures that Member State national competent authorities should use to publish information on their websites to facilitate cross-border distribution of funds.

In particular, the standard information should cover:

• National laws, regulations and administrative provisions governing marketing requirements for AIFs and UCITS and the summaries thereof; and
• Regulatory fees and charges they levy for carrying out their duties in relation to the cross-border activities of fund managers.

ESMA will consider the feedback it receives to this consultation by 30 June 2020 with a view to finalising the implementing technical standards for submission to the European Commission by 2 February 2021.

Guidance to address leverage risk under the AIFMD

On 27 March 2020, ESMA issued a public consultation on draft guidelines to address leverage risks in the alternative investment fund sector. The aim of the guidelines is to impose greater consistency on how national competent authorities (a) assess the systemic risk of the use of leverage and (b) set limits on the amount of leverage an AIF can employ. Accordingly, the outcome of the consultation could have a significant impact on Alternative Investment Fund Managers. ESMA will consider the feedback it receives to the public consultation by 1 September 2020 with a view to finalising the guidelines for publication.

Ninety-six percent of Limited Partners prefer emerging fund managers

The BVCA recently published the results of its survey on emerging managers, asking investors how they define what an emerging manager is and the attractions and challenges of investing. Almost all of the respondents said that emerging managers have advantages over established ones – they are hungrier to out-perform, more likely to form strategic relationships with investors, and more often focussed on unique investment strategies. However, the lack of track record remains the number one challenge for investors when assessing emerging managers. Whilst the survey was conducted before the Covid-19 pandemic, its findings will make for interesting reading as the investment funds industry navigates and emerges from these challenging times, and will be useful to LPs and GPs alike.