Regulatory Outlook | Investment Funds | January 2021

Current issues

Securing a sustainable and competitive UK asset management sector after Brexit

The chancellor, in a statement delivered on 9 November 2020, set out proposals to bolster the dynamism, openness and competitiveness of the UK’s financial services post-Brexit, including:

• TCFD disclosures: The government proposes to make disclosures that are in line with the Task Force on Climate-related Financial Disclosures (TCFD) fully mandatory. Pursuant to the government’s interim report and roadmap, the aim is to apply these disclosures to UK-authorised asset managers in two phases - asset managers with assets under management in excess of £50Bn from 2022 and other managers from 2023 with a possible exclusion for ‘very small firms’ subject to consultation.
• Green taxonomy: The UK plans to implement a green taxonomy – a common framework for determining which activities can be defined as environmentally sustainable. The UK taxonomy will adopt the scientific metrics in the EU Taxonomy Regulation as its basis and a UK Green Technical Advisory Group will be established to review these metrics to

ensure they are right for the UK market. The UK also intends to join the International Platform on Sustainable Finance to support and benefit from the development of common international standards on taxonomies.

Sustainable Finance Disclosure Regulation

On 30 October 2020, the European Commission confirmed that the Level 1 obligations set out in the Sustainable Finance Disclosure Regulation (SFDR) will take effect from 10 March 2021 so financial market participants and financial advisers within scope will need to comply with its high level and principle based requirements from that time.

Publication of the accompanying Regulatory Technical Standards (RTS) has, however, been delayed. At a speech delivered on 19 November 2020, the European Securities and Markets Authority stated that it hoped to be able to communicate ‘shortly’ on the exact date of the application of the RTS and on what the supervisory expectations would be in the interim period. We can also expect a final report by the European Supervisory Authorities on the RTS and disclosure templates by the end of January 2021 (with the expectation that the RTS will start to apply at the end of this year).

The UK has not on-shored the SFDR. Nevertheless, certain provisions (which are currently unclear, but likely to be limited to the SFDR product-level requirements) may still apply to non-EU Alternative Investment Funds Managers (AIFMs) (which will include UK AIFMs as of 1 January 2021), which have registered one or more funds for marketing in the EU, under the national private placement regimes in the Alternative Investment Funds Managers Directive (AIFMD).

Both the Alternative Investment Management Association and the Investment Association have published Q&As on the SFDR, which provide valuable insight into the current industry views on the various ‘grey areas’ of the SFDR.

ESMA highlights priority areas for improving AIFMD

In August 2020, ESMA published a letter it sent to the European Commission highlighting improvements that could be made under the Commission’s review of the AIFMD. ESMA’s letter brings regulatory substance and the issue of delegation to the forefront, and addresses a number of issues that are crucial to the asset management industry.

In a speech delivered at the AIMA Global Policy & Regulatory Forum on 19 November 2020, ESMA noted that the AIFMD requires that the delegation of investment management functions shall “not exceed by a substantial margin” the functions retained by the authorised fund manager. It will be up to the Commission to inform the industry, when it releases its proposed amendments to AIFMD later this year, how “substantial margin” should be interpreted.

Global asset managers should familiarise themselves with the proposals when they become available.

Improving the PRIIPs regime for the UK

The Financial Services Bill 2019-21 is currently progressing through Parliament.

In the long term, the UK government intends to undertake a wholesale review of the disclosure regime for UK retail investors, but in the meantime, the bill makes targeted amendments to the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation (as transposed into UK law). The changes are intended to avoid consumer harm and provide the appropriate certainty to industry, by:

• Addressing significant uncertainty among industry as to the precise scope of PRIIPs, without changing the definition of a PRIIP.
• Removing the obligation for PRIIPs manufacturers to produce performance scenarios, the methodology for which has been criticised for producing misleading predictions.
• Providing UCITS (Undertakings for the Collective Investment in Transferable Securities) retail schemes with an extended transitional period to comply with the Regulation, up to a maximum of five years.

Cooperation and exchange of information with EU regulators

On 4 January 2021, the FCA published a statement confirming that the various Memoranda of Understanding (MoUs) agreed with ESMA and EU regulators covering cooperation and exchange of information came into effect at the end of the transition period.

This included a multilateral MoU with EU and EEA National Competent Authorities covering supervisory cooperation, enforcement and information exchange. Among other things, this MoU allows fund manager outsourcing and delegation to continue to be carried out by UK-based entities on behalf of counterparties based in the EEA, in addition to private placement under Article 42 AIFMD.

New guidelines on funds’ marketing communications

On 9 November 2020, ESMA issued a consultation paper concerning guidelines on marketing communications under Regulation 2019/1156 on facilitating cross-border distribution of collective investment undertakings. The regulation, which comes into force on 2 August 2021, will amend the AIFMD by introducing new rules relating to the marketing of Alternative Investment Funds (AIFs) in the EEA.

Only fund managers are subject to the guidelines. As proposed, the guidelines would apply to all communications for UCITS funds and AIFs, including European venture capital, social entrepreneurship and long-term investment funds as well as money market funds that have a marketing purpose.

The deadline for comments on the draft Guidelines is 8 February 2021 with final guidelines expected by 2 August 2021.

Find out about these changes and the new rules on marketing and pre-marketing alternative funds in Europe due to come into effect on 2 August 2021 in our technical guide here.

FCA focuses on purpose and governance in the asset management sector

On 21 September 2020, the Financial Conduct Authority (FCA) published a speech by Marc Teasdale, Director of Wholesale Supervision, emphasising the importance of culture and the role of purpose and governance in the asset management sector.

Asset management firms should assess their business model, governance structures (including processes for managing conflicts of interest) and diversity and inclusion, to ensure their culture is producing beneficial outcomes for consumers and markets.

Firms should explain clearly to staff and customers about the value their basic business proposition provides, and assess the extent to which it delivers that value in practice. Where there is mismatch, the FCA expects firms to take action to improve the proposition they are offering to customers.

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 will be 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.

In Focus: Regulation after Brexit

What do UK businesses trading in the EU need to do now that the Brexit transition period has ended?

The options available to UK AIFMs who wish to continue to market into the EU, and were previously relying on passporting rights to do so, will be driven by a number of factors. These include: their existing structure (and whether they have an EU presence already), the make-up of their investor base (do EU investors constitute a large percentage of the fund’s capital?) and where those investors are located (are they concentrated in a small number of EU Member States?). In addition, some investors under local laws may have a problem investing in non-EU managed structures, and so managers will need to conduct their impact analysis on an investor by investor level.

Some AIFM managers and advisers are using an existing entity to market without using the AIFMD national private placement regime or are using host solutions. Some have set up funds in EU Member States – Luxembourg and Ireland being the popular choices – whilst others are using principal or parallel vehicles to invest alongside UK or non-EU vehicles.

The approach taken by EU regulators to certain issues arising from Brexit (such as delegation, substance, the use of secondments or third party host solutions) is likely to develop

over time and may vary from Member State to Member State. Whether UK fund managers can afford to ‘wait for the dust to settle’ will in large part depend on where they are in their fundraising cycle.

UK firms and funds that were previously relying on the passport for marketing or management of funds in the EU and who intend to continue to operate cross-border with the EU should engage with local EEA regulators and lawyers. It is important that UK fund managers stay abreast of any announcements from the EU regulators as their approach to the various issues outlined above evolves.

What do non-UK businesses trading in the UK need to do now that the transition period has ended?

EEA AIFs that notified the FCA to enter the Temporary Marketing Permissions Regime (TMPR) prior to the end of the transition period will be able to be marketed in the UK for a temporary period on the same basis as they were before exit.

Fund managers will be issued with a ‘landing slot’ by the FCA, during which period they will be required to apply for UK authorisation/recognition. It is expected that the TMPR will operate for three years, with the last landing slots allocated in early 2021.

Which incoming EU laws should UK businesses be aware of, and is the UK likely to implement similar rules?

New rules relating to the marketing of AIFs in the EEA are coming into force in Europe on 2 August 2021 and proposals for an ‘AIFMD II’ are expected from the European Commission in Q1/Q2 2021. Fund managers aiming to raise capital from professional or retail investors in the EU from summer 2021 onwards should be aware of these changes and their potential impact on cross-border marketing activities.

The majority of the new marketing rules do not apply to non-EU AIFMs marketing funds in Europe under the AIFMD private placement regime. Accordingly, managers from the US and the UK may continue to approach European investors in accordance with the existing private placement rules – or else rely on ‘reverse solicitation’.

In the context of the European Commission’s review of AIFMD, it seems likely that some of the new marketing rules will then be applied to non-EU AIFMs who market their funds into the EU under the AIFMD private placement regime.

In addition, the substantive provisions of the SFDR will start to apply from 10 March 2021. Whilst the UK has not on-shored the SRDR, certain provisions (which are currently unclear, but are likely to be limited to the SFDR product-level requirements) may still apply to UK AIFMs which have registered one or more funds for marketing in the EU, under the national private placement regimes.

The FCA has confirmed that it is working closely with the UK government and other regulators to consider how the UK might implement the SFDR in the future.

Are there any other areas where the UK regime might start to diverge from that of the EU? If so, what should businesses do to ensure they are prepared?

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 is seeking to make certain improvements to the Regulation (as transposed into UK law) through the amendments set out in the Financial Services Bill 2019-21 (see above). It also intends to conduct a wholesale review of the regime in the longer term. While EU trade bodies have called upon the European Commission to review the regime as it applies in the EU for fear that the UK could obtain a competitive advantage, at the time of writing the Commission has not committed to this. Accordingly, this is one area where we may, at least in the short term, see some divergence.

Dates for the diary

January 2021

Final report expected from the ESAs on the RTS and disclosure templates under SFDR.

Q1/Q2 2021

European Commission due to consult on AIFMD following its report on the application and scope of the legislation.

19 January 2021

European Commission consultation on review of the Regulation on European long-term investment funds ((EU) 2015/760) closes to feedback.

29 January 2021

The European Commission’s consultation on the AIFMD review closes to comments.

8 February 2021

ESMA’s consultation on guidelines for marketing communications under the Cross-Border Distribution Regulation (CBDR) closes to comments.

10 March 2021

The substantive provisions in the Sustainable Finance Disclosure Regulation start to apply.

2 August 2021

New rules on the marketing of AIFs in the EEA under the CBDR and the Cross-Border Distribution Directive start to apply.

2 August 2021

Deadline for ESMA to develop marketing guidelines under this new framework.

2 August 2021

The European Commission is required to report on reverse solicitation under the framework.

For more on what the EU-UK TCA means, across 17 areas of regulation, and what else is on the regulatory agenda, see our full Regulatory Outlook.