Developments and market trends in Europe
Global | Publikation | February 2018
Authors: Richard Sheen and Simon Lovegrove
Having finally got to January and seen the implementation of key EU legislation – MiFID II, MiFIR, PRIIPs Regulation and the Benchmark Regulation – the roller coaster ride for asset managers shows no sign of slowing down. Whilst managers have been working hard to get their implementation projects over the line, further regulatory reform looms large on the horizon but perhaps the key agenda item in the board room remains Brexit particularly the discussions regarding a transitional period.
On the EU front 2018 promises to be an important year not least with work continuing on the European Commission’s proposals for a tailored prudential regime for investment firms. The industry response to the thinking behind the proposals, a clear demarcation between a prudential regime that is designed around banks and a more proportionate one aimed for the myriad of non-bank actors, is positive. In particular, many have welcomed the important step that the Commission has taken towards a closer alignment of the existing MiFID regime for discretionary portfolio managers and advisors with the standards of the UCITS/AIFMD frameworks.
In addition, Brussels has recently reminded us of the AIFMD review. In April last year the Commission took its first tentative steps on the AIFMD review by issuing a tender for a one-year market study. At the time the media reported that the tender document said that the Commission wanted to carry out an evidence-based study helping to identify to what extent the objectives of the AIFMD had been achieved, as well as its impact on AIFs, AIFMs and investors. But the market study was not expected to be completed until the middle of 2018, leading many commentators to correctly assume at the time that the Commission was delaying its review of the Directive. And then the trail went cold, until recently with a big four accountancy practice issuing on behalf of the Commission a survey which focuses on the functioning of the Directive.
On the UK front, the industry is awaiting the FCA’s final rules concerning the extension of the senior managers and certification regime. The starting point for all firms will be to work out what their classification is under the regime (core, enhanced or limited scope) and then allocate the appropriate senior management functions. Firms that are classified as ‘enhanced’ will need to prepare management responsibilities maps and have appropriate handover procedures. These firms will also be the only subset of firms joining the senior managers regime to which the ‘no gaps’ principle applies. This requires the firm to allocate responsibility for each business area, activity or management function. Notwithstanding this all firms within the senior managers regime will need to prepare individual statements of responsibilities for their senior managers. Following the banking experience of this regime, the allocation of responsibilities can be a difficult matter for a board where emotions often run high.
Algorithmic trading is also firmly in the sights of the UK regulators with both the PRA and the FCA issuing reports. The message from the FCA on this topic is fairly positive but like always the regulator has said that there is room for improvement particularly in delivering suitable market abuse training for staff that are involved in the development and implementation of algorithmic trading processes.
In terms of Brexit, the industry is currently holding its breath to see if the politicians can reach agreement on a transitional period. It is generally expected that if the politicians can agree on a transitional period it will be announced at the European Council summit in March. At present it's anyone’s guess. However, the Commission has told UK-based asset managers that they must prepare for all Brexit scenarios, including a hard Brexit. The Commission has recently issued Brexit related notices to stakeholders on a wide range of issues including one on asset management. In this notice asset managers are warned that “subject to any transitional arrangement that may be contained in a possible withdrawal agreement”, neither the UCITS or AIFMD Directives will apply to UK firms post Brexit. The notice continues, “this means that those UK entities will no longer be able to manage funds and market funds in the EU on the basis of their current authorisations”. Ignites Europe has said that the Commission’s notice is “one of Brussels’ toughest Brexit warnings to the asset management sector to date. Thomson Reuters said that it “brings home the particular implications Brexit has for the fund management industry”.
Finally some comments on fundraising activity over the last few months.
The FT ran an interesting article a couple of weeks ago, Private equity: flood of cash triggers buyout bubble fears. According to this article funds are raising more money than they can spend, fuelled by low interest rates on other asset classes. Buyout volumes are up 27 per cent year on year in 2017 and are expected to accelerate this year, propelled by the record $1.1tn of cash pledged by investors last year. But the FT article warns that despite this there are alarming signs that the boom in the private equity sector could turn to bust. The size of recent deals has surpassed those pre-crisis peaks and dependence on debt financing is nearing record levels. A decade ago, a string of buyout firms went out of business after a period of similarly frenzied activity.
This year the buy-side regulatory headlines have been dominated by the EU’s Markets in Financial Instruments Directive II (MiFID II), Brexit and the Financial Conduct Authority’s (FCA) asset management market study. As 2018 approaches, there is another significant regulatory development on the horizon that asset managers would be ill advised to ignore. This is the EU Benchmarks Regulation.
In 2012, as a result of scandals, the then CEO of the FCA, Martin Wheatley, was asked to conduct a review into the London Interbank Offered Rate (Libor). The resulting report, the ‘Wheatley Review’, recommended criminal sanctions for benchmark manipulation, and a program of reform, rather than replacement, for Libor (including its transfer to a new administrator, improvements in the methodology for calculating the benchmark, and that administration of and submission to Libor be made regulated activities under the Financial Services and Markets Act 2000).
Libor’s administrator and its 20 panel banks became regulated for benchmark activities on 1 April 2013. In April 2015 the list of regulated benchmarks in the UK was enlarged to include seven other major benchmarks – LBMA Gold Price, and LBMA Silver Price, the ICE Swap Rate, SONIA, RONIA, the WM/Reuters London 4pm Closing Spot Rate and the ICE Brent Index.
The administrators of these benchmarks are subject to FCA rules that require them to put in place appropriate governance arrangements (including the formation of an oversight committee) to have effective controls to ensure the integrity of input data and to keep adequate records. Benchmark submitters are subject to similar requirements to ensure that they manage any conflicts of interest and are subject to an annual audit. Both administrators and submitters need to have a named individual responsible for compliance with these rules.
While work was being undertaken in the UK, the International Organisation of Securities Commissions (IOSCO) developed global Principles for Financial Benchmarks, published in July 2013. These principles created a common cross-jurisdictional framework for good market practice and have been widely adopted as industry standards. They impress upon administrators the need for strong governance, robust benchmark design, transparent methodologies and clear accountability.
On 29 June 2016, Regulation (EU) 2016/1011 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds (the Benchmarks Regulation) was published in the Official Journal of the EU. It entered into force on 30 June 2016. The Benchmarks Regulation generally applies from 1 January 2018 subject to certain transitional provisions (see below). The Benchmarks Regulation, being directly applicable in Member States, will supersede the UK’s existing requirements.
Article 3(3) of the Benchmarks Regulation sets out the definition of “benchmark”. The definition does not hinge on what the benchmark references, but how it is used:
“’benchmark’ means any index by reference to which the amount payable under a financial instrument or a financial contract, or the value of a financial instrument, is determined, or an index that is used to measure the performance of an investment fund with the purpose of tracking the return of such index or of defining the asset allocation of a portfolio or of computing the performance fees.”
Article 3(1) of the Benchmarks Regulation defines an “index” as meaning any figure
A Commission Delegated Regulation sets out further guidance as to the meaning of “published or made available to the public” (Commission Delegated Regulation of 29 September 2017 supplementing Regulation (EU) 2016/1011 of the European Parliament and of the Council specifying technical elements of the definitions laid down in paragraph 1 of Article 3 of the Regulation).
Article 2 of the Benchmarks Regulation sets out certain exemptions to the definition of benchmark. Benchmarks provided by central banks or other authorities for public policy purposes are excluded. Also, benchmarks that reference a price of a single financial instrument (such as the price of a specific share) are not in scope1. Standard variable rates offered by credit institutions will not be considered benchmarks when used in mortgage or consumer credit contracts.
Applying the principle of proportionality, the Benchmarks Regulation classifies benchmarks as ‘critical’, ‘significant’ and ‘non-significant’, and the nature and degree of the requirements under it will be determined by these classifications. A benchmark is deemed to be either ‘critical’ or ‘significant’ where it satisfies the conditions set out in Articles 20(1) or 24(1) of the Benchmarks Regulation2. A ‘non-significant’ benchmark is one that meets the definition of ‘benchmark’ but does not satisfy the conditions to be either a critical or significant benchmark (Article 3(27) of the Benchmarks Regulation)3. The Benchmarks Regulation also contains requirements for different types of benchmark: regulated-data benchmarks (Article 17), interest rate benchmarks (Article 18) and commodity benchmarks (Article 19).
The primary impact of the Benchmarks Regulation will be on benchmark administrators, as it introduces a requirement for their prior-authorisation/registration (Article 34) and ongoing supervision (Articles 4 to 14 and 27 to 28). Where an administrator has been authorised its details shall be placed on a public register maintained by the European Securities and Markets Authority (ESMA) (Article 36 of the Benchmarks Regulation). ESMA will start publishing this register as from 1 January 2018. The ongoing requirements, like the IOSCO Principles, cover governance and accountability as well as the design and methodology of any benchmarks provided.
The Benchmarks Regulation also introduces a code of conduct for contributors of input data requiring the use of robust methodologies and sufficient and reliable data (Article 15 of the Benchmarks Regulation). It also sets out governance and control requirements for contributors (Article 16 of the Benchmarks Regulation).
The Benchmark Regulation also impacts users of benchmarks who are already 'supervised entities' (defined in Article 3(17) of the Benchmarks Regulation). This includes alternative investment fund managers (AIFMs), undertakings for collective investment in transferable securities (UCITS) management companies (and self-managed UCITS), MiFID II investment firms and credit institutions as defined by the Capital Requirements Regulation.
Supervised entities will need to consider carefully whether they ‘use’ a benchmark. Article 3(7) of the Benchmarks Regulation defines ‘use of a benchmark’ as:
Asset managers represent an important group of benchmark users, either in the case of passive managed funds and exchanged traded funds – where benchmarks are used as a target for index linked funds – or in the case of the evaluation of an active manager’s performance – where the fund performance is measured against a selected index or a set of indices. Asset managers as benchmark users are generally not involved in the production, calculation and contribution to data on which benchmarks are based4.
Where a fund uses a benchmark to measure its performance for the purpose of either tracking the return of the benchmark or defining the asset allocation of the portfolio or computing performance fees payable by it, such use will fall within the scope of the Benchmarks Regulation (Article 3(7)(e) of the Benchmarks Regulation)5.
Also, a fund will be considered to use a benchmark where it enters into a derivative contract (the underlying of which is a benchmark) which is traded on a trading venue unless the terms of that contract are set by:
The Benchmarks Regulation provides that:
The Benchmarks Regulation provides for the following mechanisms under which third country benchmarks may be used by supervised entities in the EU
In each of the above cases, the details of the third country administrators shall be placed on the public register maintained by ESMA.
Article 51 of the Benchmarks Regulation provides for certain transitional periods
Article 52 of the Benchmarks Regulation provides that for UCITS prospectuses approved prior to 1 January 2018, the underlying documents shall be updated on the first occasion or at the latest within 12 months after that date.
For some firms the introduction of the Benchmarks Regulation will not come as a huge shock where they have already been raising their standards under the IOSCO Principles. However, for other firms meeting the new requirements will be a challenging exercise.
Any supervised entity, including AIFMs and UCITS managers, should carefully consider their risk exposure to the Benchmarks Regulation. They should create an inventory of the benchmarks that they use, and seek assurances from the administrators of those benchmarks that they are aware of the Benchmarks Regulation and have plans in place to comply with it from 1 January 2018. This is particularly important where the benchmarks are provided by smaller administrators, particularly in third countries. Supervised entities should also be thinking about potential alternative benchmarks in case any benchmark they currently use becomes unavailable, and the creation of written contingency plans mentioned above. For UCITS funds, new prospectuses will need wording regarding compliance with the Benchmarks Regulation as will existing prospectuses that are updated.
The introduction of the PRIIPS regime on 1 January 2018 has been problematic to say the least, particularly for alternative investment funds which have their shares listed on the London Stock Exchange, with many managers, boards and commentators expressing strong concerns that the formulaic disclosure requirements risk forcing PRIIPs manufacturers to issue a document that risks being misleading to investors.
As a response to these criticisms, the FCA issued a statement on 24 January 2018 as follows:
"Where a PRIIPs manufacturer is concerned that performance scenarios in their KID are too optimistic, such that they may mislead investors, we are comfortable with them providing explanatory materials to put the calculation in context and to set out their concerns for investors to consider.
Where firms selling or advising on PRIIPs have concerns that the performance scenarios in a particular KID may mislead their clients, they should consider how to address this, for example by providing additional explanation as part of their communications with clients."
Manufacturers and advisers who have such concerns should be considering whether to provide such additional explanatory material. Particular areas of concern include disclosure of costs and expenses, performance scenarios and risk indicators.
In the absence of detailed guidance, it appears that the manner in which different PRIIPs manufacturers have calculated disclosure of costs and expenses is highly inconsistent. For example, whether or not to take account of transfer taxes, finance costs and performance fees. Estimates of portfolio transaction costs appear to vary widely between similar mandates.
In respect of the required disclosure of performance scenarios, the KID is not allowed to include historic returns. Instead, an illustration of the potential return under four performance scenarios (stress, unfavourable, moderate and favourable) are required to be included modelled over one, three and five years. However, these scenarios are inherently based on share price returns over the previous five years. At present, that means modelling them based on a particular market period that has seen strong market growth, narrowing discounts and falling volatility, which may possibly prove very different from the subsequent five year period. Funds that do not have sufficient share price data must create a model based on an appropriate market benchmark, which is not straight forward for asset classes like infrastructure and specialist real estate and may well be unreflective of likely share price performance or others in the peer group.
The methodology required to be followed for calculating a fund’s summary risk indicators (from 1 (very low) to 7 (very high)) requires traded funds to take account of the volatility of their share price. However, as some market commentators have pointed out, low historic volatility might be a reflection of a lack of liquidity rather than low risk and mean that certain funds are publishing a lower risk indicator that might be appropriate.
Author: Michael Newell
Following last November's budget, HM Treasury and HMRC have published a consultation document on taxing gains made by non-residents investing directly or indirectly in UK property.
Currently, non-resident investors disposing of their UK non-residential property are not subject to UK tax on their chargeable gains. Neither does the UK tax widely-held non-resident companies on disposals of interests in residential UK property held as an investment, nor seek to tax disposals of entities that derive their value predominantly from UK property held as an investment. The proposals therefore represent a significant change to the rules for taxing chargeable gains on UK property which have been in place for decades. As a result, real estate managers are analysing their existing UK real estate funds and holding structures to determine what steps may be required to mitigate the effects of the new regime.
With respect to non-residential property, only the gains attributable to changes in value from 1 April 2019 (for companies) or 6 April 2019 (for other persons) will be chargeable, which will be achieved by rebasing property values at April 2019. April 2019 will also be the rebasing point for widely held, non-resident companies on all disposals of interests in UK property and for all persons on all indirect interests.
As far as funds and holding entities are concerned, the new chargeable gains regime applies to "property rich” entities but will not apply to interests held by tax exempt entities or any entity in which a taxable investor has less than a 25% interest in the last five years before sale. Holdings are aggregated for this purpose and the ownership test is backward looking throughout the period rather than simply at the time of the disposal.
An entity will be considered “property rich” where, at the time of disposal, directly or indirectly, 75% or more of the value of the asset disposed derives from UK property. The test will be made on the gross asset value of the entity, so not including liabilities such as loan finance. The test will use the market value of the property at the time of disposal. For the purposes of establishing whether this 75% test is met all UK land held in the entity will be taken into account, i.e. both residential and non-residential property. Non-UK land will not count towards the 75%. The disposal may be directly of the interest in the property rich entity, or of a holding company or similar with a structure of entities beneath it which, taken together meet the property richness test. Where it is necessary to trace value, the government has stated that the rules will allow this to be done through layers of ownership, through entities, trusts or other arrangements to arrive at a just and reasonable attribution of value.
It may still be possible to rely on certain double tax treaties, particularly Luxembourg, which grant it taxing rights over the property holding entity to such other jurisdiction, so that such gains cannot also be taxed in the UK. However, the new legislation will contain an anti-forestalling rule, which will apply to certain arrangements entered into on or after the publication of the consultation document on 22 November 2017. The rule will counteract arrangements that seek to avoid this tax on non-residents by exploiting provisions in some tax treaties in a way that is contrary to the object and purpose of the new change to capital gains tax, which may particularly constrain the ability to rely on certain treaties such as Luxembourg’s. Details of the anti-forestalling measures are set out in a Technical Note published alongside the consultation.
The common use of Jersey property unit trusts (JPUTs) as holding entities or funds for UK real estate is particularly vulnerable to this legislation, since the JPUT has an unusual tax status in the UK being able to be transparent for income but opaque for chargeable gains. The application of the new rules to JPUTs is particularly uncertain.
Managers should certainly be reviewing existing holding structures to determine whether their tax treatment will change from March 2019. If so, it may be that it is still more attractive to sell the shares or units in the entity than to collapse it or try to restructure, although this will depend on the likely rebased value in March 2019 and the expected holding period and the tax status of the investors. We expect new funds and holding structures to make much use of the exemptions for tax exempt investors and taxable investors holding less than a 25% interest. However, existing funds structured as JPUTs seeking new capital face great uncertainty and we are likely to see some restructure during the course of this year.
The General Data Protection Regulation (GDPR) will apply with direct effect in all European Union (EU) Member States from 25 May 2018.
The UK Government has confirmed that Brexit is not expected to affect the commencement of the requirements of the GDPR in the UK. The first reading of the UK’s proposed Data Protection Bill (Bill) took place on 13th September 2017. Following its third reading in mid-January, the Bill was presented to the House of Commons on 18 January 2018. At the time of writing the date of the second reading in the House of Commons was still to be announced. The Bill is intended to replace the existing Data Protection Act 1998 and implement the GDPR into UK law, whilst exercising a number of permitted derogations from the GDPR.
Although it is unclear when the Bill will receive Royal Assent, it is clear that the UK is keen to ensure equivalence and adequacy with the GDPR post Brexit. Companies should therefore continue to plan for the implementation of GDPR standards in light of the impending Bill.
Territorial scope: The GDPR will apply to non-EU establishments where data about data subjects in the EU is processed in connection with “offering goods or services” to those European data subjects or “monitoring” their behavior. Non-EU entities that are subject to the GDPR will be required to designate a representative in an EU Member State (unless limited exceptions apply).
Fines: The fines under the GDPR are significantly higher than those which can be imposed under current law (up to £550,000 under current UK law). Under the GDPR, fines for breaches of certain important provisions can amount to up to €20 million or 4% of global annual turnover, whichever is the greater. Fines for breaches of other provisions can amount to up to €10m or 2% of global annual turnover, whichever is greater.
Data governance and accountability: The GDPR places onerous accountability obligations on organisations to demonstrate compliance with the GDPR. Some of the elements that must be demonstrated are explicit (whilst some are implied by the language of the GDPR). The net effect of the additional requirements is that all large organisations will need to implement a formal data protection programme to demonstrate data protection is taken seriously.
This will include having policies setting out how to comply coupled with training to bring those policies to life and taking steps to show that data protection compliance has been taken into consideration and the organisation has implemented appropriate compliance measures in relation to its data processing activities. Organisations will also be required to maintain a formal, written record of processing activities under its responsibility.
A data protection officer will also need to be appointed in certain circumstances. A data protection officer is responsible for monitoring compliance, advising the organisation on compliance with the GDPR and acting as the main point of contact in relation to data protection compliance.
Data processors: Data processors are organisations which process personal data for and on behalf of another organisation (the data controller). Under existing law, they have no statutory obligations or liability. The GDPR changes this – data processors will have direct obligations under the GDPR. These include requirements to implement technical and organisational security measures to protect personal data, an obligation to keep a register of data processing activities, direct obligations to comply with the rules relating to the transfer of personal data outside of the EU and restrictions on their ability to engage sub-processors obligations. Data processors can be liable for fines from data protection regulators and claims from individuals whom the personal data they process relates to (data subjects) where they breach their obligations under the GDPR.
Consent: The GDPR includes new limitations on the use of consent as a ground for processing personal data. This includes requirements that consent language is separate from other information and is unbundled. It also requires that it must be as easy to withdraw consent as to give it.
Fair processing notices: The information that is required to be given to data subjects is extended to include providing details of the grounds that are used to justify processing, the period for which the personal data will be retained, the mechanism of the export (see below) if the data exported outside the EU and the source of the data (if not the data subjects themselves).
The notice must highlight that consent may be withdrawn, the existence of the data subject rights (see below) and the right to lodge a complaint with the data protection regulator.
Data subject rights: The rights that data subjects have in respect of their personal data have been enhanced under the GDPR, including rights to have personal data transmitted to themselves or another data controller, to require the controller to erase personal data in some circumstances and to more information about a data controller's processing (export solution, storage limits) through a subject access request. Organisations must respond to requests from data subjects within a shorter time period than under current law.
Personal data breach: Under the GDPR, organisations must notify the data protection regulator within 72 hours of the breach and, in certain high risk circumstances, the individuals to whom the personal data relates without undue delay. Organisations must also maintain a personal data breach register.
Export of personal data: The shape of export restrictions remains similar as under current law in that personal data cannot be exported outside of the European Economic Area (EEA) unless the recipient non-EEA country has either been deemed by the European Commission (Commission) to offer adequate data protection safeguards or a valid export mechanism has been put in place (e.g. Commission approved model clauses or Binding Corporate Rules). Failure to comply with the export rules can attract the highest 4% of worldwide turnover fines.
Recent developments:
Guidelines on automated individual decision-making and profiling for the purposes of the GDPR
On 3 October 2017, the Article 29 Data Protection Working Party (Working Party) adopted guidelines on automated individual decision-making and profiling for the purposes of the GDPR. The GDPR introduces new provisions to address the risks arising from profiling and automated decision-making, notably, but not limited to, privacy. The purpose of the guidelines is to clarify those provisions.
Guidelines on personal data breach notification under the GDPR
On 3 October 2017, the Working Party adopted guidelines on personal data breach notification under the GDPR. The guidelines explain the mandatory breach notification and communication requirements of the GDPR and some of the steps controllers and processors can take to meet these new obligations. They also give examples of various types of breaches and who would need to be notified in different scenarios.
Guidelines on data protection impact assessment
On 4 October 2017, the Working Party adopted revised guidelines on data protection impact assessment and determining whether processing is “likely to result in a high risk” for the purposes of the GDPR. In order to ensure a consistent interpretation of the circumstances in which a data protection impact assessment is mandatory (Article 35(3)), the guidelines clarify this notion and provide criteria for the lists to be adopted by Data Protection Authorities under Article 35(4).
In a speech delivered in October 2017, the Central Bank confirmed that it strongly supported the work of the European Securities and Markets Authority (ESMA) at fostering consistency in the authorisation and supervision of entities, activities and functions proposing to relocate from the United Kingdom. Consistent with this position, in authorising applicants relocating from the UK, the Central Bank now looks for applicants to demonstrate compliance with the provisions of the ESMA Opinion of 13 July 2017 to support supervisory convergence in the area of investment management in the context of the United Kingdom withdrawing from the European Union.
The European Union (Markets In Financial Instruments) Regulations 2017 which were published in July of last year with the purpose of transposing Directive 2014/65/EU into Irish law have been revised by the publication of the European Union (Markets in Financial Instruments) (Amendment) Regulations 2017, with the majority of changes being very minor in nature.
In response to the European Supervisory Authorities joint statement in November 2017 in respect of the requirement under the margin regulatory technical standards to exchange variation Margin for physically settled FX forwards from 3 January 2018, the Central Bank issued a statement on 18 December 2017 confirming that it would apply its risk-based supervisory powers in the day-to-day enforcement of applicable legislation in a proportionate manner. Although not expressly stated, it may be inferred from the Central Bank’s statement that investment funds do not need to comply with the relevant requirement to exchange variation margin for physically-settled FX forwards. A copy of the Central Bank’s statement is available on the Central Bank’s website.
With effect from 1 December 2017, the Central Bank has introduced a new “authorisation” levy which will apply to every Irish domiciled investment fund that is authorised and every sub-fund that is approved by the Central Bank. This is a once-off levy which will be payable by the relevant fund within 28 days of the issue of the levy notice by the Central Bank. Details of the applicable rates, together with further information relating to the levy is available from the Central Bank’s webpage, which is accessible here.
In December 2017, a second edition of the Central Bank Investment Firms Regulations was signed into law and took effect from 3 January 2018. The revised Regulations are intended to consolidate all of the requirements applicable to certain investment firms, fund service providers and market operators and include changes related to MiFID II, and the Investor Money Regulations (IMR) have been incorporated, with certain matters relating to the client assets regime and the IMR which to date have been addressed in guidance have now been put on a legislative footing in the revised Regulations. The Central Bank has confirmed that they will issue guidance on Part 6 (relating to Client Asset Requirements) and Part 7 (Investor Money Requirements) but that pending the issue of such guidance, the current guidance will continue to apply.
It has also published a revised version of its Q&A on investment firms available on the Central Bank’s website.
The Central Bank issued a number of revised Q&A on Undertakings for Collective Investment in Transferable Securities (UCITS) and the Alternative Investment Fund Managers Directive (AIFMD), the most recent of which are the 28th edition of the Central Bank Q&A on AIFMD and the 22nd edition of the Central Bank Q&A on UCITS. The revised editions published in the period under review provide additional guidance on the prospectus disclosure requirements applicable to UCITS and alternative investment funds (AIFs) under the Benchmarks Regulation, set down regulatory considerations to be complied with by depositaries of UCITS and AIFs when acquiring Chinese shares through the Shanghai-Hong Kong Stock Connect and the Shenzen-Hong Kong Stock Connect and address the application of the Key Information Documents for Packaged Retail and Insurance - Based Investment Products (PRIIPs) Regulation to AIFs.
In late December 2017, the EU (Securities Financing Transactions) Regulations 2017 (the “Irish SFT Regulations”) were signed into Irish law. The purpose of these regulations is to give full effect to the SFT Regulation. The Irish SFT Regulations designate the Central Bank as the competent authority in Ireland for the purposes of the SFT Regulation and grant it with some far-reaching powers in order to monitor compliance with the provisions of the SFT Regulation and the Irish Regulations, including a right of access, inspection and questioning. The Irish SFT Regulations also grant the Central Bank with certain enforcement powers and sets down the administrative sanctions which it may impose for infringements of the SFT Regulation. They also impose obligations on in-scope firms to ensure that there are appropriate whistleblowing arrangements in place to allow employees to report actual or potential infringements of the SFT Regulation.
The EU PRIIPs Regulations (the “Irish PRIIPs Regulations”) were also signed into law in late December 2017. These Regulations, which are intended to give full effect to the PRIIPs Regulation, designate the Central Bank as the competent authority in Ireland for the purposes of the PRIIPs Regulation and set down the sanctions which may be imposed by the Central Bank for infringements of the PRIIPs Regulation. The Irish PRIIPs Regulations also require regulated financial service providers, including UCITS and AIFM and those regulated firms selling PRIIP to put in place whistleblowing arrangements to allow their employees to report actual or potential infringements of the PRIIPs Regulation.
Over the course of the past months, we have seen a strongly increasing interest for alternative investment funds (AIF) not being subject to a specific fund regime, a strongly increasing interest for reserved alternative investment funds (RAIF) and an ongoing interest for specialised investment funds (SIF). The main asset classes in these fund structures are typically private equity, venture capital, infrastructure, clean technology (and alike) real estate and debt. Furthermore there remains continuous demand for UCITS, especially in those having particular strategies or investing in more “exotic” markets.
Furthermore, additional asset managers, financial institutions and insurance companies are moving forward with their plans to relocate or re-domicile all or parts of their business (e.g. their foreign investment funds or management companies/AIFM) to Luxembourg. Despite the current political uncertainty over Brexit, the deadline implemented by Article 50 of the Treaty on European Union means that more and more market participants are having to take steps based on the best available knowledge.
As a consequence of investor demand and the uncertainties as to the implementation of a third-country AIFM passport as well as the limitation of reverse solicitation capacities, numerous re-domiciliation or next product domiciliation projects in Luxembourg involving both regulated and non-regulated funds have been realised and are under examination.
On the one side the possibility to transfer a foreign investment fund’s registered office to Luxembourg with the continuation of its legal personality is creating some strong interest for asset managers wishing to raise assets in the European Union. This process allows for a foreign fund to preserve its full corporate history, including track record and it is also worth noting that it is generally completely tax neutral.
On the other side Luxembourg offers with its broad range of legal structures (e.g. the special limited partnership) appropriate solutions for the next fund generation.
Parallel structures are also raising strong interest.
The possibility of re-domiciliation or shifting licensed business to Luxembourg may also be particularly relevant in the Brexit context for promoters wishing to keep the benefit of their funds’ passport and ensure it for their future products. This in particularly the case for asset managers. Recent months have seen more and more asset managers announce Luxembourg as the jurisdiction taking over these functions after Brexit. An increasing number of asset managers are also seriously considering possible localisation of their UCITS management companies or regulated AIFMs in Luxembourg and discussions with the Luxembourg regulator are increasing.
In addition during the past months more financial institutions and insurance companies have expressed their intention to either increase their business presence in their existing Luxembourg entities or establish newly formed entities to relocate business post Brexit.
The RAIF, the flexible investment vehicle which has been in existence for slightly more than 18 months (it has been implemented in July 2016), continues to create strong interest. Since implementation, 296 RAIF structures (official list at the companies register as at 3 Feb 2018) have been created in Luxembourg with a variety of different investment policies and for a number of different purposes (time-to-market, incubation, private wealth management etc.). The RAIF-product is not only fit for illiquid asset classes but, mainly due to the availability of variable capital structuring, also to liquid asset classes including strategies involving a high trading frequency.
It may be observed that investors, especially institutional investors, in Europe and around the globe, have now got used to the RAIF perhaps seeing it as an SIF alternative (and to a lower number a SICAR alternative), a Luxembourg investment fund meeting the highest standards of structural quality and flexibility, as they were used to in a “real” SIF (or “real” SICAR) but without an add-on regulation on the fund product itself.
Besides this, for illiquid asset classes there has been increasing demand for AIF’s structured as unregulated partnerships (SCS or SCSp). Promoters and investors appreciate the legal framework allowing (to the extent applicable requirements are met) for a choice of set ups which range from an AIF which is only managed by a registered AIFM (and, for instance, not requiring a depositary) to an AIF managed by an authorised AIFM. In both instances investments without the requirement of minimum diversification is allowed, to the extent it is intended.
Even though the RAIF and the unregulated AIF as described above are currently dominating the structural demand in the alternative asset classes, the SIF as the traditional regulated fund vehicle with its year-long market position and flexibility continues to preserve its importance within the range of available fund products. This particularly applies to strategies involving liquid asset classes and/or markets where certain investors are more comfortable or the legal framework is favouring/requiring regulated fund vehicles.
ALFI’s annual Real Estate Investment Fund Survey revealed that real estate assets held through Luxembourg fund vehicles (Real Estate Investment Fund, REIF) reached an all-time high of over €57.000 billion in more than 300 vehicles (not even taking into account fund of fund vehicles or debt fund vehicles related to real estate). Over more than a decade Luxembourg has positioned and increased its importance as the crossborder hub for REIFs and the strong activity on international real estate markets, for instance in Germany has, translated into a high demand for Luxembourg REIF structures.
The Luxembourg market sees a further strengthening of its position as the recognised on-shore hub for all kinds of private equity, venture capital, real estate, infrastructure etc. (and alike) fund structures. In particular professional and institutional investors from Europe and abroad trust the recognised stable and flexible Luxembourg market and its fund products, whether regulated or not. Notably, increasing investment in infrastructure and clean energy is being realised through Luxembourg fund vehicles which can be easily adapted.
Debt and credit funds are continuing their steady growth in Luxembourg thanks to the flexible legal and regulatory environment allowing them to implement all types of debt/credit strategies: mezzanine, distressed, including in particular origination, etc.
Luxembourg is strengthening its position as a key on-shore domicile for structuring debt funds: over 70 per cent of the top 30 debt fund managers worldwide are present in Luxembourg.
We see an increasing demand for a potential structuring of Luxembourg funds investing in the Cryptocurrency/Bitcoin sector. It is an interesting and challenging exercise to bring together on-shore market requirements and a dynamic and new asset class which functions very differently from the “traditional” alternative world. We are confident that the Luxembourg market will have a workable answer to this challenge.
On 16 January 2018, the Commission de Surveillance du Secteur Financier (CSSF) published a revised version of its Application Questionnaire which needs to be filed when seeking authorisation of an alternative investment fund manager.
The Application Questionnaire includes, inter alia, the following:
A draft bill of law has been introduced in Luxembourg on 6 December 2017 in order to implement the Fourth Anti-Money Laundering Directive (the AML Directive) into Luxembourg Law.
Further to this draft bill a register of beneficial owners (registre de bénéficiaires effectifs = REBECO) will be created. It is expected that the draft bill will be adopted around the end of Q1 2018.
Briefly, for every beneficial owner (BO) who directly or indirectly holds more than 25% in an entity the following information will need to be provided to the REBECO:
The information must be accurate, complete and up-to-date.
In practice, access to this information will be limited. The information contained in the REBECO will be made available electronically only to national competent public authorities, including but not limited to the prosecutor, the Commission de Surveillance du Secteur Financier (CSSF), the Commissariat aux Assurances (CAA) and tax administrations. Such electronic access is unrestricted.
Self-regulatory bodies (such as the Bar Council, Notary Chamber and the Institut des Réviseurs d’Entreprises) will also have limited electronic access to the REBECO. Such electronic access is only to be used within the strict context of their supervisory functions. Access is subject to the authorisation of the REBECO manager. Only partial information may be disclosed to these self-regulatory bodies.
Obliged entities (for instance credit institutions, professionals of the financial sector, insurance undertakings, UCITS management companies and AIFMs) will also have limited electronic access to the REBECO. Limited access will only be given where obliged entities are required to carry out client due diligence measures in relation to their clients.
Physical access may also be granted to any person or organisation that: (i) can demonstrate a legitimate interest in relation to anti-money laundering; (ii) is resident in Luxembourg; and (iii) has made an official written and duly justified request in this respect. Such access is subject to the prior approval of a formal commission created by the Minister of Justice.
Any subject entity may request a restriction of access to the REBECO where such access would expose the BO to a risk of fraud, kidnapping, blackmail, violence or intimidation, or where the BO is a minor or otherwise incapable.
Furthermore, criminal sanctions may be imposed on the self-regulatory bodies or on the obliged entities if they purposely access the REBECO outside the aforementioned circumstances.
On 25 October 2017, a draft bill of law adapting and completing Luxembourg law to the Regulation (EU) No 1286/2014 on key information documents (KIDs) on packaged retail and insurance-based investment products (PRIIPs) (the PRIIPs Regulation) and, inter alia, modifying the amended Luxembourg law of 17 December 2010 on undertaking for collective investment and the amended Luxembourg law of 7 December 2015 on the insurance sector, was lodged with the Luxembourg Parliament.
Regulation (EU) No. 1286/2014 on key information documents (KIDs) on packaged retail and insurance-based investment products (PRIIPs), which entered into force on 29 December 2014, applies since 1 January 2018.
From a legislative perspective, the draft bill of law specifies that the CSSF and the CAA will be the relevant competent authorities for the PRIIPs Regulation for, respectively, management/investment companies and insurance companies. They will have controlling powers as well as the power to impose fines. In addition to that, the draft bill of law states that the SICARs (Investment Company in Risk Capital) and investment funds other than UCITS are authorized to prepare a UCITS KIID provided they clearly state on the document that they are not subject to the UCITS Directive. In such cases, these entities and the persons who sell or provide advice on the units or shares of those funds or SICARs would benefit from the exemption contained in art. 32 of the PRIIPs Regulation and therefore, for the time being and until 31 December 2019 would not have to comply with the requirements of the PRIIPs Regulation.
A new draft bill N°7184 adapting and completing Luxembourg law to Regulation (EU) 2016/679 of 27 April 2016 on the protection of natural persons with regard to the processing of personal data and on the free movement of such data (GDPR) was lodged with the Luxembourg Parliament on 12 September 2017.
On 3 October 2017, the Article 29 Working Party adopted two new guidelines: the first one on data breach notification and another on automated individual decision-making and profiling.
The guidelines on data breach notification are a consequence of the requirement imposed by the GDPR to notify to the competent national supervisory authority (the CNPD in Luxembourg) any breach which is likely to result in a risk to the rights and freedoms of individuals and, in certain cases, to also notify the individuals whose personal data have been affected by the breach.
Such notification will be mandatory for controllers, but also for processors who will have to inform their controllers if there is a breach. Therefore, controllers and processors are encouraged in these guidelines to plan in advance and put in place processes to be able to detect and promptly contain a breach. Thus, these guidelines explain the steps controllers and processors can take to meet these new obligations.
Such a failure to report a breach should be taken seriously since it may lead to a sanction, including an administrative fine, the value of which can be up to EUR 10 million or up to 2 per cent of the worldwide annual turnover of the controlling entity.
As a consequence of advances in new technologies and the widespread availability of personal data on the internet, the Article 29 Working Party also decided to adopt guidelines on automated individual decision-making and profiling.
Automated individual decision-making and profiling are used in a large number of sectors, including in banking and finance, health, taxation, insurance, marketing and advertising.
The Article 29 Working Party recognises that there are two general benefits of these technologies: increased efficiencies and resource savings.
However, automated individual decision-making and profiling may also pose significant risks for individuals, which is the reason why the GDPR introduces new provisions to address these risks.
These guidelines clarify these new provisions and give good practice recommendations to the actors involved.
On 29 November 2017 the Luxembourg tax authorities issued a revised version of the Circular L.I.R. 104/2 (the Circular) depicting a favorable tax treatment for salaried Luxembourg tax payers (whether they are resident or non-resident) benefitting from stock option plans under the conditions contained therein. Download our tax newsletter to read the main amendments: Download newsletter
Author: Simon Lovegrove
A roundup of recent regulatory developments in the EU and UK. To receive daily updates on regulatory developments subscribe to our blog, Regulationtomorrow.com
| Title | Date | Comment |
| ESMA consults on potential CFD and binary options measures to protect retail investors | 18.01.2018 | The European Securities and Markets Authority (ESMA) publishes a call for evidence on potential product intervention measures relating to the provision of contracts for difference (CFDs), including rolling spot forex and binary options to retail investors. In relation to CFDs, ESMA is considering restricting the marketing, distribution or sale to retail clients of CFDs, including rolling spot forex. ESMA states that the option of applying the restrictions to professional clients is not under consideration due to the lack of evidence of harm to this type of client. The deadline for comments on the call for evidence was 5 February 2018. |
| Commission Delegated Regulations supplementing the Benchmarks Regulation published in OJ | 17.01.2018 | The following Commission Delegated Acts are published in the Official Journal of the EU (OJ):
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| Commission Roadmap – Delegated Act on MMF Regulation | 16.01.2018 | The European Commission (Commission) publishes a Roadmap on the Delegated Act on the Money Market Funds (MMF) Regulation, specifying quantitative and qualitative liquidity requirements applicable to assets received as part of a reverse repurchase agreement and on credit quality assessment. The deadline for feedback on the Roadmap was 12 February 2018. |
| ISDA updates Brexit FAQs | 10.01.2018 |
The International Swaps and Derivatives Association (ISDA) updates its publicly available FAQs on Brexit which covers the following key areas:
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| FCA Dear CEO letter to providers and distributers of CFDs | 09.01.2018 | The FCA publishes a Dear CEO letter to providers and distributers of CFD products. The Dear CEO letter summarises the findings of an FCA review of 19 firms that provide CFDs to intermediaries which in turn distribute this product to retail consumers on either an advisory or discretionary basis. Overall, the FCA observed that CFD providers and distributors may be failing to conduct their activities in accordance with the Principles for Businesses, the client’s best interests rule (COBS 2.1.1R) and the Senior Management Arrangements, Systems and Controls sourcebook. |
| AFME due diligence questionnaire to further standardise process for global custodians | 08.01.2018 | The Association for Financial Markets in Europe publishes a revised version of its Due Diligence Questionnaire (DDQ) which harmonises and simplifies the process of completing questionnaires for global custodians. |
| IOSCO statement on the use of financial benchmarks | 05.01.2018 | The International Organization of Securities Commissions (IOSCO) publishes a statement setting out matters for users of financial benchmarks to consider in selecting an appropriate benchmark and in contingency planning, particularly for scenarios in which a benchmark is no longer available. |
| FMLC paper on Brexit and impact of WTO rules on financial services | 22.12.2017 | The Financial Markets Law Committee publishes a paper on the potential impact of Brexit and World Trade Organisation (WTO) rules on financial services. The paper examines the future of the UK’s cross-border trade with the EU and the potential impact of the WTO rules. |
| Revised versions of JMLSG AML and CFT guidance | 21.12.2017 | The Joint Money Laundering Steering Group (JMLSG) publishes revised versions of its anti-money laundering (AML) and counter-terrorist financing (CTF) guidance. |
| FCA updates documents on reporting transparency information under AIFMD | 20.12.2017 |
The FCA publishes an updated version of its Q&A document on reporting transparency information to the FCA. The document provides information to alternative investment fund managers about:
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Commission adopts legislative proposals for revised EU prudential framework for investment firms |
20.12.2017 | The Commission publishes legislative proposals that revise the EU prudential regime for investment firms. Under the legislative proposals EU investment firms would be classified into one of three categories for prudential purposes:
The minimum capital requirement for class 2 investment firms would be set either as for class 3 investment firms, or according to a new ‘K-factor’ approach for measuring their risks, whichever is higher. The K-factors specifically target the services and business practices that are most likely to generate risks to the firm, to its customers and to counterparties. They set capital requirements according to the volume of each activity. Revised governance and remuneration requirements will also apply to class 2 and 3 investment firms. The provisions in MiFIR on assessing the equivalence of a third country’s regulatory framework are adjusted in light of the proposals. The legislative proposals are being discussed by the European Parliament and the Council of the EU. Once adopted, an implementation period of 18 months is envisaged before the new regime starts to apply. |
| FCA feedback statement on distributed ledger technology | 15.12.2017 | The FCA publishes Distributed ledger technology: Feedback statement on DP17/03. The FC14 states that nearly all respondents to its earlier Discussion Paper feel that these is generally no substancial barriers to adopting distributed ledger technology under existing FCA rules. |
| PFOF – priority area of FCA supervisory focus | 13.12.2017 | The FCA publishes a Dear CEO letter on payment for order flow (PFOF). In the Dear CEO letter, the FCA reiterates that firms that continue to charge PFOF will breach the new standards implemented in MiFID II, reminding firms that they must take action to ensure compliance and warn against any attempted models that seek to avoid these rules. |
| The Duty of Responsibility for FCA solo-regulated firms | 13.12.2017 | The FCA publishes Consultation Paper 17/42: The duty of responsibility for insurers and FCA solo-regulated firms (CP17/42). In CP17/42 the FCA consults on extending the duty of responsibility (that already applies to firms currently subject to the Senior Managers & Certification Regime (SM&CR)) to FCA solo-regulated firms and insurance and reinsurance firms. The deadline for comments on CP17/42 is 21 February 2018. |
| FCA consultation paper on transitioning FCA firms and individuals to the SM&CR | 13.12.2017 | The FCA publishes Consultation Paper 17/40: Individual Accountability: Transitioning FCA firms and individuals to the SM&CR (CP17/40). In CP17/40, the FCA consults on the operational aspects of extending the SM&CR to FCA solo-regulated firms, including how firms would transition from the approved persons regime to the SM&CR. The deadline for comments on CP17/40 is 21 February 2018. |
| FCA consultations on approach to consumers, competition and authorisation | 11.12.2017 | The FCA publishes the following documents that are linked to its Mission 2017:
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| Commission and UK Government report on phase 1 of the Brexit negotiations | 08.12.2017 | The Commission and the UK Government jointly publish a report on the progress of phase 1 of the Brexit negotiations. The Commission is satisfied that sufficient progress had been made to allow the negotiations to move onto phase 2 dealing with the EU/UK future trading relationship. |
| The UK’s Investment Management Strategy II | 06.12.2017 | The HM Treasury publishes the UK’s Investment Management Strategy II. The report sets out the Government’s long-term strategy, to be delivered in collaboration with the industry, to ensure that the UK remains a globally competitive location for asset management. |
| Commission adopts Delegated Regulation supplementing ELTIF Regulation | 04.12.2017 | The Commission adopts a Delegated Regulation supplementing the Regulation on European long-term investment funds. The Council of the EU and the European Parliament will now consider the Delegated Regulation. If neither objects, the Delegated Regulation enters into force on the twentieth day following that of its publication in the OJ. |
| GLEIF published Entity Legal Forms Code List | 30.11.2017 | The Global Legal Entity Identifier Foundation (GLEIF) publishes the ‘Entity Legal Forms Code List’. The list covers more than 1,600 entity legal forms across more than 50 jurisdictions. The GLEIF will publish updated versions of the list periodically. |
| IOSCO reports on fourth hedge fund survey | 23.11.2017 | IOSCO publishes its latest biannual Hedge Fund Survey report. Among other things, the report makes the following observations:
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| IOSCO final report on good practices for termination of investment funds | 23.11.2017 | IOSCO publishes a report setting out good practices on the voluntary termination of collective investment schemes and other fund structures such as commodity, real estate and hedge funds. |
| ESMA updates Q&As on MAR | 21.11.2017 |
ESMA publishes an updated version of its Q&As on the Market Abuse Regulation (MAR). ESMA added answers on the following questions:
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| ESMA final report on MMF Regulation | 17.11.2017 | ESMA publishes a final report containing its technical advice, draft implementing technical standards (ITS) and guidelines under the MMF Regulation. With respect to the ITS on the establishment of a reporting template and the timing of implementation of the corresponding data base, ESMA confirms that managers would need to send their first quarterly reports mentioned in Article 37 to national competent authorities (NCAs) in October / November 2019. |
| FCA speech on effective compliance with MAR | 14.11.2017 | The FCA publishes a speech given by Julia Hoggett (Director of Market Oversight, FCA). The speech is entitled ‘Effective compliance with MAR – a state of mind’. Among other things, the FCA notes that it expects firms to ensure that their systems are in constant evolution to meet the changing nature and needs of the businesses within which they operate. |
| Public consultation on institutional investors and asset managers’ duties regarding sustainability | 13.11.2017 | The Commission issues a consultation document seeking information on how asset managers and institutional investors could include environmental, social and governance factors when taking decisions. The deadline for comments on the consultation document was 22 January 2018. The Commission will adopt an Action Plan on sustainable finance in Q1 2018. |
| ESMA highlights ICO risks for investors and firms | 13.11.2017 | ESMA issues two statements on initial coin offerings (ICOs), one on the risks of ICOs for investors and one on the rules applicable to firms involved in ICOs. |
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Official Journal: Regulation amending EuVECA Regulation and EuSEF Regulation |
10.11.2017 | There is published in OJ, Regulation (EU) 2017/1991 of the European Parliament and of the Council of 25 October 2017 amending Regulation (EU) No 345/2013 on European venture capital funds and Regulation (EU) No 346/2013 on European social entrepreneurship funds. The Regulation applies from 1 March 2018. |
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FCA Market Watch issue 54 |
07.11.2017 | The FCA publishes Market Watch 54. In this issue of Market Watch, the FCA focusses on the MiFID II LEI. |
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FCA publishes Future Approach to Consumers |
06.11.2017 | The FCA publishes its ‘Approach to Consumers’ paper which explores its approach to regulating retail consumers. The paper sets out the FCA’s initial views on what good looks like for all retail consumers, and aims to clearly explain how the regulator will work to diagnose and remedy actual and potential harm, giving more certainty about its framework. |
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FSB considers financial stability implications of artificial intelligence and machine learning |
01.11.2017 | The Financial Stability Board (FSB) publishes a report that considers the financial stability implications of the growing use of artificial intelligence (AI) and machine learning in financial services. Overall, the FSB finds that AI and machine learning applications show substantial promise if their specific risks are properly managed. |
| MiFID II: EU issues guidance on obtaining brokerage and research services from non-EU brokers | 26.10.2017 |
The Commission issues FAQs in order to clarify how EU investment firms should interact when they seek out brokerage and research services from broker-dealers in non-EU countries. |
Further information can be found in Q4.2 of ESMA Questions and Answers on the Benchmarks Regulation.
On critical benchmarks see also Articles 21 to 23 (inclusive) of the Benchmarks Regulation. For significant benchmarks see also Article 25.
For the requirements concerning non-significant benchmarks see Article 26 of the Benchmarks Regulation.
See EFAMA response to the ESMA Discussion Paper on Benchmarks Regulation Public Comment.
See also recital 13 of the Benchmarks Regulation: Financial benchmarks are not only used in the issuance and manufacturing of financial instruments and contracts. The financial industry also relies on benchmarks for measuring the performance of investment funds for the purpose of return tracking or of determining the asset allocation of a portfolio or of computing the performance fees. A given benchmark can be used either directly as a reference for financial instruments and financial contacts or to measure the performance of investment funds, or indirectly within a combination of benchmarks. In the latter case, the setting and review of the weights to be assigned to various indices within a combination for the purpose of determining the pay-out or the value of a financial instrument or a financial contract or measuring the performance of an investment fund also amounts to use as such an activity does not involve discretion, in contrast to the activity of provision of benchmarks. The holding of financial instruments referencing a certain benchmark is not considered to be use of the benchmark.
See Q5.2 of ESMA Questions and Answers on the Benchmarks Regulation.
Publikation
n a long-running dispute, taking in no less than three arbitrations spanning 26 years cumulatively (involving allegations of state interference in the arbitral process), the Court has provided useful guidance on the ss.67 and 68 challenges, particularly in the context of investor-state claims.
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