Funds Legal Update | 26 August 2020
Published on 4th Sep 2020
As far as the investment funds industry is concerned, August has been far from the usual summer lull.
The European Securities and Markets Authority's (ESMA) letter to the European Commission on its review of the Alternative Investment Funds Managers Directive (AIFMD) raises a number of important issues for asset managers, in particular around delegation and "substantive presence". It is attracting a lot of attention and industry bodies are already calling for members to provide their views. We will probably have to wait until next year to get clarity from the Commission on what an "AIFMD II" might look like, by which time the UK may well have mapped out its own framework for UK asset managers.
As it alluded to earlier this summer, the Financial Conduct Authority (FCA) has sharpened its focus on liquidity management. With proposals to introduce a notice period prior to redemption for certain UK open-ended property funds, and a joint review with the Bank of England into liquidity mismatch, we can certainly expect to see changes in this area.
The UK fintech sector attracted £4.1 billion in venture capital last year. With this level of activity in the sector, venture capital fund managers and investors will be looking with interest to the outcome of the Fintech Strategic Review when it is published at the start of 2021.
Finally, as we edge closer to the end of the transition period, the FCA has confirmed the reopening of the temporary permissions regime notification window at the end of this month – and ESMA has made further calls on firms to finalise their preparations. The often criticised PRIIPs (packaged retail investment and insurance-based products) legislation also continues to make the headlines as the UK announces plans to change the rules from next year – prompting EU funds trade bodies to demand legislative changes to protect European asset managers.
ESMA recommends improvements to the AIFMD
The European Securities and Markets Authority (ESMA) recently published a letter it has sent to the European Commission on 18 August 2020, highlighting the areas where it considers improvements could be made under the Commission's review of the Alternative Investment Funds Managers Directive (AIFMD).
The various recommendations focus on 19 areas including harmonising the AIFMD and UCITS (undertakings for the collective investment in transferable securities) regimes, delegation and substance, liquidity management tools, leverage, the AIFMD reporting regime and data use, and the harmonisation of supervision of cross-border entities.
The Alternative Investment Management Association has since published a helpful summary table, accessible by its members, which lists some of ESMA's key recommendations and with their own comment.
The Commission is expected to publish a proposal for the AIFMD review towards the end of this year and beginning of next year, and ESMA’s views are likely to carry considerable weight. But what about Brexit? After the end of the transition period on 31 December 2020, the UK is not bound to implement any changes to AIFMD. It is not known at this stage whether the UK government will propose any changes, although it may take into consideration changes made to AIFMD adopted by the EU which are of benefit to UK managers.
Tackling liquidity mismatch in open-ended funds
On 3 August 2020, the FCA launched a consultation on rules to improve open-ended property fund structures by introducing a notice period prior to redemption. The new rules will be directly relevant to UK authorised property funds that are non-UCITS (undertakings for the collective investment in transferable securities) retail schemes.
The requirement for such notice period (the FCA proposes between 90 to 180 days) is to address the potential for investor harm, which arises because the terms for dealing in units of some property funds are not aligned with the time that it takes to buy or sell the buildings that the funds invest in.
The consultation closes on 3 November 2020 and the FCA aims to publish a policy statement and final handbook rules as soon as possible in 2021.
If the new rules come into force authorised fund managers of property funds will need to adjust their fund documentation, including each fund's constituting instrument, prospectus and Key Investor Information Document. It will also be important to explain the changes to existing and potential investors, before they come into effect.
Investment intermediaries such as wealth managers and firms with staff that advise on retail investment products, such as financial advisers, banks and building societies and investment managers, will need to review whether a notice period changes their current product or advice, where they use authorised property funds. Wealth managers with model portfolios may need to review their product offerings and alter their asset allocation process.
Separately, on 26 August 2020, the FCA announced that it has launched a joint survey with the Bank of England to review liquidity mismatch in open-ended funds – with specific focus on measures of liquidity, pricing, and redemption notice period. The review will consider how a framework around these principles could be designed.
The survey is a voluntary exercise and the data will provide an important element for the joint review. Asset managers included in the survey are being asked to respond to the questions on a best-effort basis by 30 September 2020.
European Fund Classification adapted to reflect new investment themes
The European Fund and Asset Management Association (EFAMA) has published the second edition of the brochure "The European Fund Classification – EFC Categories" to adapt the classification criteria to recent market evolutions. The European Fund Classification (EFC) is a pan-European classification system of investment funds, which is maintained by a task force of EFAMA.
The idea behind this is that the provision of a clear and transparent classification of funds should promote cross-border distribution of funds and better protect investors. The EFC will help European investors and their advisors compare funds from different jurisdictions and make sound investment decisions. EFAMA strongly encourages the adoption of the EFC by fund managers and distributors to contribute to a more integrated and competitive European fund market.
It is interesting to note the introduction of "investment themes" in the classification of equity funds. Twelve specific investment themes have been identified as particularly relevant in today's market: natural resources, infrastructure, climate, agriculture, water, biotechnology, medtech, clean energy, digitalisation, nutrition, global trends and high dividend.
Former Worldpay boss to lead review of UK's £7bn fintech sector
First announced in the 2020 Budget, the independent Fintech Strategic Review will establish priority areas for industry, policy makers, and regulators to explore in order to support the ongoing success of the UK fintech sector.
Part of the review recommendations will be made for diversifying the UK investment landscape and addressing the challenges to attracting growth funding. Five workstreams will provide recommendations on: skills and talent, investment, national connectivity, policy, and international attractiveness. The review will be independent and is expected to report back to HM Treasury at the start of next year.
Venture capital fund managers and investors may be particularly interested to follow this review, given that last year the UK fintech sector attracted £4.1 billion in venture capital.
ESMA urges market participants to finalise Brexit preparations and implement suitable contingency plans
The European Securities and Markets Authority (ESMA) has issued a statement urging market participants to finalise their preparations and implement suitable contingency plans in advance of the end of the transition period. ESMA stated on 17 July 2020 that all entities "should also have provided appropriate information to their clients on any resulting consequences".
The regulator also refers to its previous Brexit statements from 2017, in particular its general opinion (to support supervisory convergence in the context of Brexit issued) and its sector-specific opinions (to investment firms, investment management and secondary markets), stating that these remain relevant and should be followed while firms finalise their preparations and contingency plans.
ESMA confirmed in its statement – as has the FCA – that the memoranda of understanding (MoUs), which it and other EU national competent authorities (NCAs) agreed on 1 February 2019 with the FCA to cover in the event of the UK leaving the EU without a withdrawal agreement, remain relevant to ensure continued good regulatory cooperation and the exchange of information at the end of the transition period, despite the withdrawal agreement's ratification.
The MoUs cover the substance of the regulatory cooperation agreements needed to permit delegation to the UK under UCITS (Undertakings for the Collective Investment in Transferable Securities) Directive and the Alternative Investment Funds Marketing Directive (AIFMD), and outsourcing under the Markets in Financial Instruments Directive. In fact, the multilateral MoU with the EU and NCAs will allow fund manager outsourcing and delegation to continue to be carried out by UK based entities on behalf of counterparties based in the European Economic Area.
Real estate firms may be interested to note that the Association of Real Estate Fund's recently published update on this area.
EU funds trade body urges Brussels to exempt funds from PRIIPs, in fear of falling behind UK post-Brexit
As reported by the Financial Times, EFAMA has warned that European asset managers could be disadvantaged by the performance forecast regulations relating to packaged retail investment and insurance-based products known as PRIIPs when the UK diverges from EU rules on 31 December 2020.
In line with the PRIIPs Regulation (which has applied since 1 January 2018), standardised "key information" documents, or KIDs, must be provided to retail investors in relation to any PRIIP, detailing risks, performance projections, costs and other information. The PRIIPs Regulation has faced intense criticism due to its requirement that providers publish future performance projections in different market conditions, which, if overly optimistic, could mislead consumers.
The UK government has recently issued a policy statement detailing its plans to change the PRIIPs rules for the UK from next year, to allow for UK funds to disregard the PRIIPs rules while the Treasury reviews the disclosure framework. However, Brussels has made no such promise after disagreements between regulators and lawmakers on the issue, leading to EFAMA to call for a full legislative review of the PRIIPs Regulation.
FCA updates webpage on temporary permissions regime, which is to re-open on 30 September
The temporary permissions regime (TPR) exists to enable relevant firms and funds which passport into the UK to continue operating in the UK when the passporting regime falls away at the end of the transition period.
The FCA announced in July 2020 that it would re-open the notifications window for the TPR on 30 September 2020, to allow firms and fund managers that have not yet notified to do so before the end of the transition period on 31 December 2020. The updated FCA webpage also confirms that there will be an opportunity for fund managers to update their previously submitted notifications, if necessary.
The FCA has also updated its webpage on the TPR, creating a number of sub-webpages on the following topics: