Over the last few weeks, there have been several key developments with potential implications for funds and fund managers. These include, in particular:
- a discussion paper on UCITS share classes, guidelines on UCITS remuneration and an opinion on loan origination by investment funds issued by the European Securities and Markets Authority (“ESMA”);
- Regulatory Technical Standards (“RTS”) on the contents of the Key information document (“KID”) required under Regulation 1286/2014 on Key Information Documents for Packaged Retail and Insurance-based Investment Products (the “PRIIPs Regulation”), published by the Joint Committee of the European Supervisory Authorities (“ESAs”); and
- a Delegated Regulation on UCITS depositaries’ obligations, which has been published in the European Union’s Official Journal (“OJ”).
UCITS Share Classes
On 6 April 2016 ESMA published a discussion paper with a view to developing an EU wide framework for UCITS share classes (available here).
Although the UCITS Directive recognises the possibility for UCITS to offer different share classes to different investors, it does not prescribe whether, and to what extent, share classes of a given UCITS can differ from one another: there are diverging national practices in this regard.
The discussion paper sets out high-level principles regarding share classes which are further detailed, where necessary, by a set of operational principles. The overall purpose of the discussion paper is to elicit stakeholders’ views on whether and how share classes can actually work under these high-level principles. It follows an earlier ESMA discussion paper on UCITS share classes which was published in December 2014.
The high-level principles on which ESMA is seeking feedback are the following:
Common investment objective: share classes of the same fund should have a common investment objective reflected by a common pool of assets. Currency risk hedging at the level of the share class, for exmaple, is compatible with this objective as it helps ensure that, in so far as possible, each investor participates in the same performance of the common pool of assets irrespective of the currency through which that investor obtains exposure to the fund. UCITS managers seeking to offer different investment objectives to investors should set up different funds or compartments.
Non-contagion: UCITS management companies should implement appropriate procedures to minimise the risk that features that are specific to one share class could have a potentially adverse impact on other share classes of the same fund. If a UCITS management company uses a specific derivative overlay for hedging purposes at share class level, it should ensure that the overlay is scaled and managed appropriately. The discussion paper outlines a number of operational principles which constitute a minimum standard for share classes with a derivative overlay. According to ESMA, the derivative overlay should be implemented according to a detailed, pre-defined and transparent hedging strategy.
Pre-determination: prior to setting up a fund, all features of the fund’s share classes should be determined to ensure that a potential investor has a full overview of the rights and/or features attributed to his or her investment. In share classes with hedging arrangements, this predetermination should also apply to the kinds of risk which are to be hedged out systematically. If the share class is created after the authorisation of the fund in which the share class is included, the new share class should not affect the features and characteristics of the fund for the investors already invested in other classes of the fund. A share class offering any form of discretion to the UCITS management company with regard to hedging mechanisms is incompatible with the predetermination principle.
Transparency: the existence and nature of all the fund’s share classes must be disclosed to all the fund’s investors, whether they are participants in the share class or not. New and existing investors should be informed about the creation and existence of share classes with derivative overlays in a timely fashion, including updates in periodic reports. A fund with share classes should observe the following operational principles, at a minimum:
- the fund prospectus should provide information about existing share classes as part of the details of the share types and main characteristics;
- the management company should provide a list of share classes with a contagion risk in the form of readily available information which is kept current; and
- stress tests results should be regularly made available to national competent authorities.
ESMA is seeking detailed feedback on whether and how share classes can actually work under the principles outlined in the discussion paper, by 6 June 2016. It expects to take further steps on UCITS share classes by the end of 2016.
ESMA’s long awaited guidelines on sound remuneration policies under the UCITS Directive and AIFMD (“Remuneration Guidelines”) were published on 31 March 2016 (here).
By way of background, Directive 2014/91 amends the UCITS Directive (as amended, the “UCITS Directive”), including by imposing remuneration requirements on UCITS Managers similar to those imposed on alternative investment fund managers (“AIFMs”) under the Alternative Investment Funds Directive (“AIFMD”). It also mandates ESMA to issue guidelines concerning the application of those requirements.
The Remuneration Guidelines seek to provide clarity on the requirements applicable to management companies when establishing and applying a remuneration policy for key staff. While the remuneration requirements set out in the UCITS Directive apply since 18 March 2016, following the entry into force of the European Union (Undertakings for Collective Investment in Transferable Securities) (Amendment) Regulations 2016, the Remuneration Guidelines themselves will only apply from 1 January 2017. Significantly, the guidance on the rules on variable remuneration will first apply for the calculation of payments relating to new awards of variable remuneration to key staff for the first full performance period after 1 January 2017.
Although the UCITS Directive explicitly subjects the remuneration requirements to proportionality, the Remuneration Guidelines do not deal with this issue, reflecting the approach adopted by the European Banking Authority (“EBA”) in its Guidelines on Sound Remuneration Policies under the CRD IV Directive 2013/36 (“CRD IV Guidelines”), issued on 21 December 2015.
In its earlier consultation on the draft CRD IV Guidelines, the EBA controversially proposed limiting the scope of the proportionality principle to prevent the neutralisation of the requirements on the pay-out process (see our related briefing here). While ultimately the EBA did not adopt this proposal it did issue an opinion addressed to the European Commission, European Parliament and Council (the “EU Legislators”) seeking legislative amendments to, among other things, exclude certain institutions and staff from the full scope of the CRD IV remuneration requirements.
ESMA’s decision not to address proportionality in the Remuneration Guidelines takes into consideration the fact that the UCITS Directive explicitly requires ESMA and the EBA to ensure consistency in the remuneration requirements applicable to different financial sectors. ESMA has however written a letter to the EU Legislators outlining its stance on proportionality and calling for further clarity and cross-sectoral alignment. It has not amended the guidance set out in the AIFMD remuneration guidelines, and AIFM’s should continue to comply with that guidance.
Loan Origination by Investment Funds
On 11 April 2016 ESMA published its opinion, Key principles for a European Framework on loan origination by funds, which sets out its views on the necessary elements for a common European framework for loan origination by investment funds (available here).
ESMA’s opinion deals with the authorisation of loan-originating funds and their managers, eligible investors, organisational requirements and leverage. It does not cover alternative investment funds (“AIFs”) that are subject to the EuVECA1, EuSEF2 or ELTIF3 Regulations. Nor does it deal with credit provided by investment funds by way of loan participation or loan restructuring. Moreover, the opinion focuses exclusively on circumstances where an investment fund provides credit while acting as a sole or a primary lender.
Several issues mentioned in the opinion are of particular interest from an Irish perspective in light of the Central Bank of Ireland’s rules on loan origination by investment funds which are set out in the AIF Rulebook.
In particular, in the opinion, ESMA advocates a detailed operational and conduct framework for loan origination funds which overlaps substantially with that set out in the AIF Rulebook. As is the case under the AIF Rulebook, loan origination funds should be prohibited from lending to individuals, financial institutions, collective investment schemes, its manager and other related parties. Consistent with the AIF Rulebook’s stress-testing requirements, loan origination funds should be required to conduct regular stress tests and report the results of those tests to the board of the fund manager on a quarterly basis.
However, in its opinion ESMA:
- does not express a view as to whether loan origination funds should be restricted from conducting other types of investment activity but considers this to be an issue for consultation – under the AIF Rulebook, loan origination funds are prohibited from conducting non-loan related investment activity;
- recognises the need to set a limit on leverage, but does not express a view as
- to what this limit should be – under the AIF Rulebook, the gross assets of loan-originating AIF must not exceed 200% of the AIF’s Net Asset Value (NAV);
- while acknowledging the need to assess possible mitigants to address systemic risk, does not mention ‘skin in the game’ requirements;
- raises the possibility of allowing retail investors to invest in loan-originating funds, subject to the application of suitable protections, similar to those set out in the ELTIF Regulation; and
- recognises the advantages of mandatory diversification requirements but observes that those advantages need to be balanced with the potential for loan origination funds to benefit specialised industrial sectors with limited access to financing through credit institutions.
Loan origination by investment funds is a key way of promoting non-banking lending in the EU, one of the central goals of the European Commission’s Capital Markets Union. As part of its CMU Action Plan, the European Commission plan to consult on the framework for loan originating funds in the second quarter of 2016. The opinion is intended to feed into that consultation.
Draft PRIIPs RTS
On 7 April 2016 the ESAs finalised the proposal for regulatory technical standards on key information documents for PRIIPs (available here).
Under the PRIIPs Regulation, manufacturers of PRIIPs targeted at retail investors, such as fund managers, insurance companies, credit institutions and investment firms, must produce a KID. Although that Regulation sets out a number of features of the KID, it leaves details of the information to be included and its presentation to RTS. The draft RTS set out these details, which include:
- a common mandatory 3-page template for the KID, covering the texts and layouts to be used;
- a summary risk indicator (“SRI”) of seven classes for the risk and reward section of the KID;
- a methodology to assign each PRIIP to one of the seven classes contained in the SRI, and for the inclusion of additional warnings and narrative explanations for certain PRIIPs;
- details on performance scenarios and a format for their presentation, including possible performance for different time periods and at least three scenarios;
- costs presentation, including the figures that must be calculated and the format to be used for these ie in both cash and percentage terms;
- specific layouts and contents for the KID for products offering multiple options that cannot effectively be covered in three pages;
- rules on revision and republication of the KID, to be done at least each year; and
- rules on providing the KID sufficiently early for a retail investor to be able to take its contents into account when making an investment decision.
The ESAs have submitted the new rules to the European Commission for endorsement and they will come into force on 31 December 2016.
Delegated Regulation 2016/438
supplementing the UCITS Directive with regard to obligations of depositories was published in the OJ on 24 March 2016 (available here).
The Delegated Regulation contains detailed provisions about the obligations and rights of depositaries including regarding: details of the written contract; depository functions, due diligence duties, segregation obligation and insolvency protection; loss of financial instruments and liability discharge; and independence requirements (see our earlier briefing on the draft Delegated Regulation here). It will apply from 13 October 2016.