The fund industry is at an inflection point. Whether it’s the demand for investment to help the world economy rebound from Covid, the drive to achieve better social and environmental conditions or the contentious issues surrounding trade and exports, fund managers are in focus. In this update, we try to make sense of the big changes that private funds face, in addition to our usual bulletins on the latest relevant developments.

The Brexit effect

Brexit took effect at the start of the year with the EU and the UK achieving the Trade and Cooperation Agreement before the 31 December deadline. The economic effects of the agreement are beginning to be felt, particularly in respect of customs arrangements, and this has put immediate pressure on some portfolio companies. Nonetheless many are relieved that the acrimony that would have resulted from no agreement has been avoided.

The Prime Minister acknowledged that the deal “probably does not go as far as we would like” on financial services, although the parties did announce their intention to agree a Memorandum of Understanding (MoU) on financial services by the end of March (which, at the time of writing, is yet to be published). Hopes have been pinned on the MoU to detail equivalence agreements that might facilitate UK firms’ access to the single market and vice versa. This seems increasingly unlikely. It appears that the MoU will outline the institutional arrangements for future discussions about regulation, based on the EU/US Financial Services Forum. This model does not compel the parties to reach agreement. The smart money, then, is that equivalence will not be agreed soon or on any wide-spread basis. The EU’s Commissioner for Financial Services, Mairead McGuinness, recently said as much, stating that the absence of cliff-edge risks means that the EU can take its time on equivalence to “get it right”. Given that, even if granted, equivalence can be withdrawn by the EU with little notice, many firms have restructured their businesses to continue to operate under the current circumstances, which is effectively “no deal” for financial services. Equivalence agreements will be welcomed but as time goes on, their value will be a diminishing return.

If true, this would make regulatory divergence more likely over time. The UK is already floating ideas about dropping parts of MiFID II. We recently published a report entitled “Big Bang 2.0” that details the UK’s options for divergence, the benefits and costs. Managers might be interested in the possibility that the UK might adopt a dual regime for AIFs, like the Channel Island’s approach, scaling back undesirable rules such as the AIFMD’s remuneration requirements for some firms. The UK is also exploring the possibilities of trade deals with other countries. Some, such as the pan-Asian CPTPP, have financial services chapters. Trade-offs will be involved.

Restricting delegation: another try?

Meanwhile the EU is considering another attempt at restricting the ability of managers to delegate portfolio management outside of the EU. ESMA initially recommended quantitative limits on the amount of business that can be delegated, but the rhetoric has softened lately. Natasha Cazenove, newly announced as ESMA’s Executive Director-designate, addressed a Politico conference. She suggested that the European Commission (EC) should ban name-plate entities, investigate suspect business models and tightening the UCITS and AIFMD rules to align with ESMA’s tougher supervisory guidelines. These are all laudable aims, although there was no mention of quantitative limits being imposed. However, at the political level, discussions about changes to delegation got underway this month. Perhaps regulators will try to moderate some of the stronger and more damaging proposals, although the trend continues towards more “substance” required within the EU. We will know more when the EC is expected to announce its intentions for the AIFMD Review around the middle of this year.

More EU marketing rules

Managers are facing the introduction of new rules for the cross-border marketing of AIFs and UCITS in the EU from August. There are several problems resulting from the current uncertainty in these rules. We present a deep dive into the issues in this update.

The Investment Firms Prudential Regime

The Investment Firm Prudential Regime (IFPR) will overhaul the prudential regime that applies to investment firms when it comes into effect on its planned date of 1 January 2022. We also look at the effect which the proposed rules set out in the FCA’s most recent consultation paper, CP20/24 (CP1) could have on private fund managers in this update.

The onward march of ESG rules

The first phase of the new ESG rules for fund managers and advisers, the Sustainable Finance Disclosure Regulation (SFDR), took effect for funds from 10 March. The regulation poses tricky issues, such as how to classify funds and whether and how the rules apply to non-EU managers. You might find it helpful to refer to our Q&A which sets out our views on some of the key interpretation questions raised most frequently by our clients.

The SFDR has also raised questions about how managers obtain the ESG data that they need to comply with the regulations and to meet their investors’ requirements. The next wave of ESG regulations will focus on investee company disclosures and on the quality of ESG ratings and scores. Investors in private markets will wish to know whether private and unlisted companies will be mandated to make ESG disclosures or whether only large publicly listed companies will be subject to the requirements. In addition, regulators will be scrutinising ESG fund labels. These labels typically help retail investors gain certainty about what they are investing in (like the environmental labels on white goods to help non-experts know that they are buying a “green” product). Although if regulators are serious about tackling green-washing, private funds might also be in the regulators’ crosshairs.

For more on our thoughts relating to ESG, visit our hubpage.

Increasing retail access

Finally, some good news: the drive to “retailisation” is underway. The aim is to get retail investors into illiquid assets, providing more funds for infrastructure, small businesses and to support the economy’s emergence from the pandemic. Policymakers are targeting the large amounts of capital sitting in DC pension schemes and mass affluent investors. The UK’s Chancellor, Rishi Sunak, has made it his aim to launch the first Long Term Asset Fund by the end of this year and the EU is looking at improvements to make the ELTIF more attractive. The lure of growing AuM and achieving greater yield for a wider pool of investors will be appealing to managers, provided that the regulations can prevent a Woodford-type situation happening again. In the longer term, the weakening boundary between retail and private funds could shake up the industry’s structure.