The second quarter of 2018 saw certain regulatory developments of which private fund managers should be aware.
The purpose of this note is to outline three such developments:
1. Proposals by the UK Government to further reform UK Limited Partnership law, including proposals which would potentially impact migrated fund structures and subject UK limited partnerships to enhanced accounting and reporting requirements.
2. Progress made by EU lawmakers on the “Distribution Directive” and the definition of “pre-marketing” proposed.
3. Uncertainty around European credit institutions' treatment of private equity and venture capital investments arising from the draft guidelines (the “Guidelines”) on high risk exposures under Article 128(3) of the EU Capital Requirements Regulation (“CRR”) on which the European Banking Authority (“EBA”) is consulting.
UK Limited Partnership Reform
In April 2018, the Department for Business, Energy & Industrial Strategy (“BEIS”) launched a consultation on further reform of UK limited partnership (“UKLP”) law.
Readers may recall that UKLP law was amended in April 2017 to make way for the “Private Fund Limited Partnership” (“PFLP”) - an optional designation for UKLPs operated as private investment funds. However, as noted in a previous Client Memorandum on the subject at that time, BEIS had announced that it was investigating allegations that Scottish limited partnerships (“SLPs”) were being used for illicit purposes, and had issued a call for evidence to better understand how UKLPs were being used.
Whilst recognising that SLPs provided “a critical building block in UK private equity structures”, on review of the evidence provided, BEIS identified misuse of UKLPs, particularly SLPs (which had seemingly been used to facilitate money laundering). The BEIS consultation is issued in response to the call for evidence.
Whilst the reform proposals are not targeted at the fund management industry, fund managers using UKLPs in their structures will inevitably be affected. For the avoidance of doubt, the following proposed amendments will affect all UKLPs, whether or not they have been designated as PFLPs.
Perhaps the most significant proposal is the proposal to require UKLPs to maintain a connection to the UK following initial registration. In this regard, BEIS considers two alternative options:
- require a UKLP’s principal place of business to remain in the UK; or
- allow a UKLP’s principal place of business to move outside the UK, but with an additional requirement for UKLPs to maintain a service address in the UK.
The first of these two options, if implemented, would be a blow for the UK funds industry, since UKLPs may currently be migrated offshore following establishment, and sometimes are in order to take advantage of different tax and regulatory regimes. It is not clear to what extent the proposals would impact existing UKLPs that have already been migrated offshore.
The other potentially significant proposal for fund managers is the proposal to increase transparency and reporting requirements for UKLPs. Currently, UKLPs are subject to relatively lightweight transparency and reporting requirements. Following registration, UKLPs merely have an obligation to notify the registrar of specified changes (e.g. a change in the identity of its partners). In addition, SLPs have to register their persons with significant control, and provide an annual confirmation statement in relation thereto.
However, critically, unlike UK companies, UKLPs are not required to file accounts. In this context, BEIS is considering:
- extending the requirement to deliver a confirmation statement to all UKLPs, confirming that the information on the register remains correct; and
- more significantly, whether there is a case for all UKLPs to be required to prepare accounts and reports (in line with the requirements for private companies).
The latter proposal is likely to face significant resistance from the industry.
Other reforms being considered (of less significance from the fund management perspective) include:
- requiring all those seeking to register a UKLP to be registered with an anti-money laundering supervisory body; and
- providing the registrar with the power to strike a UKLP off the register in certain circumstances.
The consultation closes later this month, and BEIS states that it intends to legislate “as soon as Parliamentary time allows”. Those managers with UKLPs in their fund structures should monitor these developments closely.
In our Q1 European Regulatory Update for Funds, we reported that the European Commission had issued a legislative proposal to amend existing European laws (including, but not limited to, the EU Alternative Investment Fund Managers Directive) governing the cross-border marketing of funds within the EU (the “Distribution Directive”). We previously reported that, amongst other things, the Distribution Directive would introduce a harmonized concept of “pre-marketing” which, though theoretically welcome, was being drawn by the European Commission in narrow terms and, in certain jurisdictions, would further constrain the ability of fund managers to test investor appetite prior to obtaining the requisite marketing approvals.
The Distribution Directive has continued its journey through the European law making process and, in its compromise proposal, the Council of the European Union has proposed helpful amendments, which provide a more workable definition of “pre-marketing”.
Under the Council compromise proposal, it is possible to conduct pre-marketing in relation to a vehicle, which has been established but not yet approved for marketing. In addition, the Council compromise proposal would allow for managers to share draft constitutional and offering documents under the guise of pre-marketing. Circulation of subscription documents, or other information/documents enabling investors to commit to acquiring fund interests, would not be permitted.
The effect of these changes would effectively be to extend the UK’s current, pragmatic notion of premarketing across Europe, which would be welcome news for managers currently attempting to navigate divergent local interpretations.
There still remains room for interpretation – the Council compromise proposal provides that the draft prospectus or offering documents provided whilst pre-marketing must (amongst other things) not contain “all relevant information allowing investors to take an investment decision”. Views on where the tipping point lies would be commercial judgments, and may well vary.
On the whole this is undoubtedly a welcome development. It is however unlikely to be the end of the journey. The Council compromise proposal will now pass to the European Parliament for consideration.
EBA Guidelines on high risk exposures
In April 2018, the EBA launched a consultation on its Guidelines.
Under Article 128 of the CRR, institutions are required to assign a 150% risk weighting to exposures that are associated with particularly high risks. The legislation identifies four such types of exposures. These include “investments in private equity” and “investments in venture capital firms”.
Amongst other things, the Guidelines seek to clarify the meaning of “investments in private equity” and “investments in venture capital firms”. However, following the publication of the Guidelines, there remains confusion around whether the proposed definitions (and therefore Article 128) should apply to:
- direct exposures to unlisted equity; or
- other types of exposures to unlisted equity (including investments in private equity funds and lending to such funds).
In addition, it remains unclear from the definition of “investments in venture capital firms” whether the intention is to capture exposures to the house (as the words ostensibly suggest) or exposures to the underlying venture capital companies in which funds managed by the house invest.
The industry is unsurprisingly concerned by the resulting uncertainty and any impact it might have on the appetite of institutions to take on exposures relating to the private equity and venture capital sector. Industry lobbying is expected.