Summary: This briefing gives a short overview of, and some practical guidance about, three legal regulatory developments that are likely to impact those involved in investment funds in 2017. We also take a look at the AIFMD marketing state of play and possible options for UK AIFMs wanting to participate in the EEA market post-Brexit.
1. PRIIPs Regulation
The EU Regulation on Packaged Retail and Insurance-based Investment Products (PRIIPs) requires firms to prepare, publish and provide a Key Information Document (KID) in respect of each PRIIP they produce, before it is made available to a retail investor in the EEA. It aims to encourage efficient EU markets by helping investors better understand and compare key features, risks, rewards and costs of different PRIIPs. The PRIIPs Regulation will apply from 1 January 2018 (so is effectively aligned with MiFID II’s implementation). The application date was delayed from 31 December 2016, in part due to the European Parliament’s rejection of the Commission’s level 2 Regulatory Technical Standards (RTSs). The RTSs, currently being revised and expected in Q1 2017, will provide further clarity on the form and content of the KID.
Three practical points
- Identifying a PRIIP. The FCA acknowledged that identifying whether or not a particular product is a PRIIP is not always going to be straightforward, due to wide concepts such as ‘exposure to reference values’, so in some cases you will need to consider the specific product terms themselves. However, most alternative investment funds (both unregulated and regulated collective investment schemes such as those structured as a Non-UCITS Retail Scheme or a Qualified Investor Scheme) will be caught, as will investment trusts, structured investment products and derivatives. Pension products, corporate shares and bonds held directly and investment funds for institutional investors will not.
- Scope of retail investors. ‘Retail investors’ under PRIIPs include sophisticated investors and high net worth individuals as well as (following the implementation of MiFID II) many local and public authorities. Whilst some ‘retail’ investors can opt up to ‘professional’ investor status, this is only available where they meet onerous quantitative and qualitative tests. There has a been a degree of consternation in the industry about what this means in practice for firms that have local authorities (or local authority pension schemes) as existing clients; for instance, the Pensions and Lifetime Savings Association recently said that classifying local authority pension funds as per se retail for these purposes will compromise their ability to invest in professional investor funds, for instance infrastructure.
- Breadth of the Regulation. The PRIIPs Regulation applies to those who manufacture, sell or advise on PRIIPs. It will therefore affect placement agents, intermediaries and distributors (who will want to ensure that a KID is available from the relevant PRIIP manufacturer) as well as fund managers, investment managers and product providers. The FCA has provided guidance on how it envisages PRIIPs applying to firms based outside the EEA marketing products to UK investors.
Firms will also need to consider disclosures additional to those required in a PRIIPs KID, for instance the FCA’s high-level requirements such as ‘client’s best interest’ and ‘fair, clear and not misleading’ continue to apply. Existing MiFID rules are unaffected.
2.MiFID II Directive
MiFID II is an updated package of legislative measures to tackle the less regulated and more opaque areas of the financial system. It is due to be implemented by 3 January 2018. AIFMs that perform additional MiFID activities (i.e. under Article 6(4) of AIFMD), or form part of groups with MiFID investment firms which perform activities for the group and its funds, will fall within the scope of MiFID II. Those that do not are still likely to be affected, due to the consequential impact with their interactions with brokers, custodians and distributors (who are subject to MiFID II) and MiFID equivalent standards being applied in the industry, by the FCA or by way of a step-up in equivalent standards/best practice for AIFMs.
Three practical points
Whilst much of the detail of MiFID II has at last been settled, there is still a lot of uncertainty as to how many provisions will work in practice and what their impact will be upon the market. Areas that will be of particular concern to managers include:
- Commissions and unbundling. MiFID II represents a significant tightening of the rules around the use of investment research. Managers will need to consider what investment research products they currently receive and how they wish to ensure compliance with their new obligations. This may include either meeting the costs of purchasing research from the manager’s own account, or establishing research payment accounts.
- Product governance. Firms must put in place processes and procedures to ensure that all products that they produce and/or distribute meet the requirements under MiFID II. These requirements apply even where the products will be sold only to professional clients and also to a much broader range of products than just funds.
- Senior management responsibility. MiFID II imposes direct responsibility on the senior management of firms, in particular around signing-off on new products. It also imposes restrictions on the numbers of external posts that can be held which may be of particular relevance to private-equity style funds. It may also be necessary to strengthen the standing of the compliance team within the firm.
Click here to read our full briefing, which provides a detailed overview of MiFID II for investment managers.
3.MLD4 and amendments to the PSC regime
Transparency of beneficial ownership is becoming a familiar theme. The UK is seen as a leader in this field, having already established a new public register of persons with significant control (PSC) over UK private companies, limited liability partnerships and Societates Europaeae.
However, the Fourth Anti-Money Laundering Directive (MLD4) which member states must implement by 26 June 2017, goes further. It extends the requirements on the holding and disclosure of beneficial ownership information to apply to corporate and other legal entities and trusts, and also requires the information held centrally to be up to date. What this means for you is compliance with any amendments to the PSC regime in due course, including identifying which other entities in your business may also be subject to the revised regime. More detail is expected shortly following the outcome of various consultations.
Three practical points
- Broad range of entities caught. MLD4 applies to ‘corporate and other legal entities’ and therefore has a much broader scope that the PSC regime. Open-ended investment companies (OEICs), investment companies with variable capital (ICVCs), Scottish limited partnerships, unregistered companies and building and friendly societies are within scope and the technical parameters of the current PSC regime will need to be adapted to fit with each entity. HM Treasury has confirmed various entities that are not within scope, including English limited partnerships and unincorporated associations.
- Application to trusts. MLD4 provides that measures that apply to trusts will also apply to other types of legal arrangements having a structure or functions similar to trusts. HM Treasury notes that trusts administered in the UK and non-resident trusts with a UK source income will be captured. This would mean that, for instance, Jersey property unit trusts holding UK real estate would be in scope, but those used for feeder fund vehicles (where there is no UK source income) may not.
- Proposed extension to AIM and ISDX. Although companies with shares admitted to trading on the Main Market or AIM or otherwise subject to the Disclosure and Transparency Rules are exempt from the requirement to keep a PSC register, the UK government is considering extending the PSC regime to companies with shares admitted to trading on prescribed public markets such as AIM and ISDX. Views on this and potential transitional arrangements are currently being sought.
And finally, AIFMD and marketing in funds in Europe: taking stock
Despite two sets of ESMA advice (in July 2015 and July 2016) on the extension of the AIFMD passport to non-EEA AIFMs and AIFs, there has been no change in the status quo in terms of AIFMD marketing in Europe; which is that non-EEA AIFMs and EEA AIFMs of non-EEA AIFs can only access this market (absent genuine reverse solicitation) using national private placement regimes (PPRs). In the meantime, ESMA and the Commission are seeking to better facilitate cross-border distribution of funds in Europe. It is hoped that this project may address some of the various inconsistencies and practical difficulties common under both the AIFMD marketing mechanisms. However, changing the landscape may be easier said than done: for instance, contrary to ESMA’s views, BaFin, the German regulator, has stated that once third country passports are activated, it does not intend to run a dual system. This would mean that full and immediate compliance with AIFMD will be prerequisite for accessing the German market.
Whilst the industry waits to see whether or not the European legislators move to open up markets, UK AIFMs will be considering possible marketing options post-Brexit.
Three practical points
- UK AIFMs can no longer access the AIFMD passport. On the UK’s withdrawal from the EU (assuming no transitional arrangements or entry into the EEA instead of the EU), it is likely to become a ‘third country’ and UK AIFMs ‘third country firms’ (i.e. non-EEA AIFMs) which will be subject to the third country passport extension assessment. Pending access to the third country passport (and on the working assumption that this may be clouded by political issues at play and therefore a fully-equivalent regime will not be immediately available) UK AIFMs will have to market on a country-by-country basis using the PPRs.
- Possible use of MiFID II cross-border passport. When MiFID II comes into force in January 2018, third-country firms may gain the ability to provide services on a cross-border passported basis. However, this only applies to services for professional investors and is restricted only to certain specific circumstances (most crucially requiring the relevant third country firm to have received ‘equivalent’ status, and the third country firm to be authorised in the jurisdiction where its head office is established and have the relevant permissions, and co-operation agreements being in place).
- Delegate to UK firm. Another alternative option to consider is for the UK firm to act as the delegate portfolio manager of an EEA AIF with an EEA AIFM. AIFMD sets out the requirements and conditions of this delegation, including co-operation agreements being in place, and the UK firm complying with the AIFMD provisions on remuneration. The AIFM cannot delegate its portfolio management function to the extent it is reduced to a ‘letter box’ entity.
We have put together a table which illustrates how the AIFMD marketing regime currently applies, and summarises the conditions that apply when marketing under PPRs and also with a passport. It also includes the likely consequences for marketing by UK AIMFs on the UK’s withdrawal from the EU.
Please click the following link to see the full table: AIFMD table