Authors Imogen Garner, Jay Modrall
Application of the AIFMD passport to non-EU AIFMs: regulatory change is on the horizon
On January 19, 2016, the European Commission published its response to the European Securities and Markets Authority’s (ESMA’s) July 2015 opinion and advice on the application of the Alternative Investment Fund Managers Directive (AIFMD) passport to non-EU funds and alternative investment fund managers (AIFMs).
By ESMA’s own admission in a recent press release, the road to clarity over the application of the passporting rights in Article 32 of the AIFMD to non-EU funds and AIFMs has been hindered by some Member States’ delay in implementing the Directive. That being said, the Commission’s response to ESMA’s opinion and advice on the application of the passport brings us a little closer to understanding what the future may hold for EU capital-raising by non-EU funds and AIFMs from a number of jurisdictions.
Following assessment of six jurisdictions – Guernsey, Hong Kong, Jersey, Switzerland, Singapore and the USA – ESMA concluded in July 2015 that there were no obstacles to the extension of the passport to Guernsey and Jersey, and that incoming legislation in Switzerland would eradicate any concerns ESMA had about the extension of the passport to Swiss AIFMs. However, ESMA could not yet provide any recommendation in respect of Hong Kong, Singapore and USA AIFMs, primarily because of concerns relating to competition, regulatory issues and a general lack of evidence to determine whether such extension would be suitable.
In a subsequent speech, ESMA’s Chair, Steven Maijoor, stated that ESMA had begun to assess extending the passport to another six non-EU jurisdictions: Australia, Canada, Japan, the Cayman Islands, the Isle of Man and Bermuda. As with the first group of jurisdictions, ESMA proposes to assess the merits of each jurisdiction individually. This approach has not been without controversy, as a number of commentators have argued that the Level 1 text of the AIFMD provides no basis for this country-by-country approach and has subsequently created a timing problem for the Commission, which is obligated to implement delegated legislation within three months of the receipt of positive ESMA guidance.
However, the Commission has now provided a degree of certainty as to how this issue will progress over the course of the year, issuing the following instructions to ESMA:
- the Commission agrees with ESMA’s approach of taking a country-by-country approach to assessing whether the passport should be amended, thus validating ESMA’s proposed approach to the second group of jurisdictions it will assess;
- ESMA has been invited to complete its assessment of Hong Kong, Singapore and the USA, as well as the six new third country jurisdictions by June 30 2016;
- ESMA is invited to provide to the Commission a detailed assessment of the supervisory authorities in each of the third country jurisdictions it is currently assessing, with particular focus on the track records of those authorities in delivering effective enforcement; and
- as a means of assessing the potential market disruption and competition effects of extending the EU passport to non-EU jurisdictions, the Commission has invited ESMA to prepare a preliminary assessment of the expected inflow of funds into the EU from relevant third countries. Further, once the AIFMD has been fully transposed in all Member States and a greater level of certainty is available regarding how the AIFMD framework will function in practice, the expectation is that ESMA will produce a further opinion detailing the functioning of the passport and the current national private placement regimes (NPPRs) for consideration by the Commission.
The Commission has also confirmed that it will take no further action with respect to extending the passport to Guernsey, Jersey and Switzerland until it receives ESMA’s final view on the remaining nine non-EU jurisdictions that it is assessing.
Therefore, we expect that by the end of Q3 2016, we should have more of a defined view from ESMA as to which of the 12 non-EU jurisdictions will benefit from the AIFMD passport. At that stage, assuming ESMA has completed its work on building supervisory frameworks with those non-EU jurisdictions, it may be the case that we have seen the first step toward the anticipated end for NPPRs in the European Economic Area by 2018.
Cross-jurisdictional AIFMD guides 2016
Author Imogen Garner
There are two methods which allow the managing and marketing of alternative investment funds (AIFs) in the EU by alternative investment fund managers (AIFMs). The first method is a marketing “passport” which has been introduced by the Alternative Investment Fund Managers Directive (AIFMD) to allow AIFs to be marketed to professional investors across the EU subject to certain conditions being met. The second method allows AIFs to be marketed in a specific member state in accordance with that member state’s private placement regime, subject to certain conditions being met.
In March 2015 we published two guides concerning the AIFMD. Both guides covered 15 EU jurisdictions – Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden and the UK.
The first guide considered whether the AIFMD marketing passport is working in practice and is a useful tool for managers as it illustrates the significant differences across jurisdictions.
The second guide looked at the requirements that non-EEA managers face when marketing non-EEA alternative investment funds to professional EEA investors. The guide revealed a number of discrepancies across Member States and will help managers navigate the requirements.
Given the positive feedback that both guides received we are in the process of updating them and they will be published shortly.
Should you wish to receive a copy of the updated guides please contact Imogen Garner.
MAR and asset managers: 5 essential to-do’s
Author Conor Foley
It’s a brave new world in conduct regulation and it begins on July 3, 2016. This marks the date of application of (most of) the Market Abuse Regulation (MAR). This legislation was originally proposed by the European Commission in October 2011 and in advance of revelations regarding the manipulation of interest rate and commodity benchmarks. The legislation is drafted to complement the recast Markets in Financial Instruments Directive (MiFID II) and the new Markets in Financial Instruments Regulation (MiFIR). The legislation is intended to bring about “a more uniform and stronger framework in order to preserve market integrity” and “provide more legal certainty and less regulatory complexity for market participants”.
Whether MAR provides more legal certainty and less regulatory complexity for asset managers is debatable. What is certain is that the legislation is both more detailed and prescriptive than the current regime under the Market Abuse Directive. What is also certain is that the legislation sets a lower hurdle for Member State national competent authorities to prove breaches and enforce administrative penalties against market participants generally.
So, what do asset managers need to concern themselves with in the legislation? I suggest five essential “to do’s”:
01 | Managing inside information
MAR broadens the definition of “inside information” and introduces a new market soundings regime. Asset managers will need to review and adapt internal procedures for identifying prospective inside information, sequestering any inside information identified, disclosing inside information for financial instruments for which they may be deemed an “issuer” and managing information received in the course of market soundings.
02 | Algorithmic trading and market manipulation
MAR also broadens the definition of “market manipulation”, with some sweeping requirements on orders, consequent effects on trading systems and order books. These requirements are aimed squarely at persons engaged in algorithmic trading as defined in MiFID II. While application of MiFID II has now been delayed until 2018, there is no corresponding delay in application of the market manipulation prohibition and asset managers using even relatively simple algorithms will need systems and supervision arrangements to monitor order traffic and trading conditions at the trading venue.
03 | Detecting and reporting suspicious orders and transactions
Article 16(2) MAR expands the application of the requirement to detect and report suspicious orders and transactions to persons “executing transactions”, which the Commission, European Securities and Markets Authority (ESMA) and the UK Financial Conduct Authority (FCA) consider to be just about every market participant. Asset managers will need “appropriate” arrangements to surveil trading (in most cases automated systems), procedures to identify and assess suspicious orders and transactions, file suspicious order and transaction reports (STORs) and record submitted STORs and so-called “near misses”.
04 | Investment research
MAR requirements on investment recommendations are not new but the draft implementing legislation for Article 20 MAR is inordinately prescriptive. Asset managers will (likely) need to have policies governing the format, content, disclosure of conflicts relating to, and dissemination of investment recommendations or extracts thereof.
05 | Whistleblowing
Buried away in Article 32(3) MAR is the requirement for “employers who carry out activities that are regulated by financial services regulation” to have internal procedures for employees to report infringements of the legislation. There is no express or obvious limitation to this requirement and no detail as to procedures required in the draft UK statutory instrument. In the absence of further guidance and none is expected imminently, asset managers will need whistleblowing policies meeting current FCA requirements.
Quite when asset managers can expect the Commission to adopt the draft regulatory technical standards for MAR is anybody’s guess and some ESMA guidelines on the legislation will not be adopted before application. However, asset managers are obligated to comply with the above and (most) other requirements in the legislation ahead of July 3, 2016.
EU / UK regulatory roundup
Author Simon Lovegrove
Asset managers see regulatory change as the biggest risk for their businesses over the coming months. It has been reported in the press that there has been a massive increase in costs that the asset management industry has had to bear in terms of dealing with extra regulation. For example, the cost of implementing the AIFMD was quoted at $6 billion and MiFID II has been quoted at half a billion dollars. The rise of regulation has sparked concerns about the extra demands on compliance and risk management with asset managers allocating significant resources to these areas.
Keeping track of what is going on in the regulatory world is proving to be a challenge. We have a blog, Regulationtomorrow.com, that tracks global regulatory developments and subscription is free. The following highlight some of the key EU regulatory developments that have recently been reported in the asset management sector.
HFSB releases the results of its first cyber attack simulation (January 21, 2016)
The Hedge Fund Standards Board (HFSB) is a standard setting body for the hedge fund industry. Recently, it held its first table top cyber attack simulation for hedge fund managers in London. Insights into cyber security arising from the simulation were:
- confusion over responsibilities can prevent an effective response. Cyber security should not be considered as only an IT issue given the legal, compliance, investor relations and reputational issues involved;
- some cyber attacks may exceed internal response capabilities and managers need to be prepared to quickly access external legal and IT expertise; and
- the preparation of a cyber security incident response plan is important as it identifies responsibilities, external resources and speeds decisions in the event of an actual incident.
The cyber attack simulation roundtable followed the HFSB’s publication of a memo on cyber security that can be found in the HFSB toolbox published in September 2015.
ESMA publishes letter from the Commission on AIFMD passport (January 19, 2016)
The European Securities and Markets Authority (ESMA) published a letter that it received from the European Commission in respect of its advice on the application of the Alternative Investment Fund Managers Directive (AIFMD) passport to non-EU alternative investment fund managers (non-EU AIFMs) and alternative investment funds (AIFs), and ESMA’s opinion on the functioning of the passport for EU AIFMs and on the national private placement regimes (NPPRs).
The Commission’s letter made the following points:
- as regards the advice on granting the AIFMD passport to managers and funds established in third countries, the Commission takes the view that the country-by-country approach adopted by ESMA is correct. The nature of the test set out in article 67 of the AIFMD may result in different outcomes depending on the regulatory and supervisory framework of the third countries in which non-EU AIFMs and funds are established;
- by 30 June 2016 ESMA is invited to complete its assessment of the following countries: the USA, Hong Kong, Singapore, Japan, Canada, Isle of Man, Cayman Islands, Bermuda and Australia; and
- the Commission agrees that ESMA should produce another opinion on the functioning of the EU passport and NPPRs once the AIFMD has been fully transposed in all Member States and there is more experience on the functioning of the framework. An updated opinion would be helpful for the planned review of the AIFMD that should start in 2017.
Investment Association guidance on paperless renunciation or transfers of units in authorised CIS (January 6, 2016)
The Investment Association (IA) has published industry guidance on the paperless renunciation or transfers of units in authorised collective investment schemes (CIS). The guidance provides a non-exhaustive statement of the measures that operators of a UK authorised CIS may adopt to comply with the requirements of Rule 4.4.13(3)(b) of the FCA’s Collective Investment Schemes sourcebook (COLL), and paragraph 4C of Schedule 4 to the Open Ended Investment Companies Regulations 2001. The guidance is directed solely at authorised fund managers for the purpose of assisting them in determining the steps they should take to satisfy the “reasonable steps” requirement. The guidance in relation to renunciation of title is applicable both when dealing as principal or as agent on behalf of the fund.
FCA MiFID II implementation roundtable minutes (January 6, 2016)
The FCA has published the minutes of its latest MiFID II implementation roundtable held on January 6, 2016. In particular the minutes note:
- the FCA said it expected that there will be a greater clarity on a possible delay to the date of application for the whole of MiFID II in the course of January;
- it is unclear at this stage whether any legislative proposal from the European Commission will include substantive changes to the Level 1 text as well as changes to dates. It is not known whether ESMA’s suggestion of a change to the application of pre-trade transparency to package transactions will be picked up; and
- there is still no clarity on whether the Commission will propose a delay to the transposition deadline, which is currently July 3, 2016, as well as the date of application.
EBA final guidelines on sound remuneration policies (December 23, 2016)
The European Banking Authority has published its final guidelines on sound remuneration policies under Articles 74(3) and 75(2) of the CRD IV Directive and disclosures under Article 450 of the Capital Requirements Regulation (CRR). The guidelines set out the requirements for remuneration policies, group application and proportionality, along with criteria for the allocation of remuneration as fixed and variable and details on the disclosures required under the CRR.
The guidelines will apply from January 1, 2017 (rather than from January 1, 2016, as originally proposed). The guidelines on remuneration policies and practices published by the Committee of European Banking Supervisors (CEBS), the EBA’s predecessor, in December 2010 were repealed on December 31, 2016.
The EBA also published an opinion on the application of the principle of proportionality to the CRD IV Directive remuneration provisions, based on responses to its March 2015 draft guidelines.
FCA issues first MiFID II consultation (December 16, 2016)
The FCA has published its first consultation paper on the implementation of the Markets in Financial Instruments Directive II (Consultation Paper 15/43: Markets in Financial Instruments Directive II implementation – Consultation Paper I (CP15/43)).
In CP15/43 the FCA consults on issues concerning the regulation of secondary trading of financial instruments. It covers:
- trading venues: (i) regulated markets (RMs) – issues around new obligations relating to algorithmic and high frequency trading, direct electronic access, tick sizes, business continuity and systems and controls. The FCA proposes to make changes to the Recognised Investment Exchanges sourcebook (REC); (ii) multilateral trading facilities (MTFs) – changes to the requirements for MTFs. The FCA proposes changes to chapter 5 of the Market Conduct sourcebook (MAR 5); and (iii) organised trading facilities (OTFs) – the FCA is proposing to introduce a new MAR 5A that will cover issues around the requirements for this new category of trading venue;
- systematic internalisers: whilst much of the changes to the systematic internaliser regime is being introduced by MiFID the FCA proposes amendments to MAR 6;
- transparency: the expansion of transparency requirements to equity like and non-equity markets, including the approach to pre-trade transparency waivers and post-trade transparency deferrals. The FCA is proposing changes to certain sections of the Handbook including REC, MAR 5 and the new MAR 5A;
- market data: the introduction of the new Data Reporting Services Providers (DRSP) category of firms and their responsibilities, and transaction reporting. The FCA is seeking views on proposals within a new chapter of the Handbook, MAR 9 on DRSPs, and whether it should apply MiFID II’s transaction reporting obligations to managers of collective investment undertakings and pension funds;
- algorithmic and high frequency trading requirements: the controls for MTFs and OTFs in MAR 5 and 5A, and those for trading firms in the new MAR 7A. The FCA’s proposals cover, among other things, business continuity, systems and controls, financial crime and market abuse, direct electronic access and tick sizes;
- passporting and UK branches of non-European Economic Area (EEA) firms: the FCA addresses the technical changes it feels are necessary to make the correct references to the new MiFID II provisions and highlights the harmonised forms required for passporting notifications. The proposed changes predominantly apply to the Supervision manual (SUP). The FCA also makes a proposal to ensure that UK branches of non-EEA firms are subject to the same rules as investment firms when undertaking investment services and activities;
- principles for businesses: the FCA takes account of the extension in MiFID II of some conduct of business obligations and proposes extending the application of some of the principles, to include firms that conduct business with clients categorised as Eligible Counterparties; and
- the Perimeter Guidance manual: MiFID II introduces some changes to the scope of investment services and activities and financial instruments, requiring the FCA to make proposals to revise parts of PERG 13.
The deadline for comments on CP15/43 is March 8, 2016.
The FCA stated that it will consult on the other MiFID II changes that it needs to make to its Handbook, including the conduct issues covered in its earlier discussion paper, in the first half of 2016. The FCA understands that the PRA will also consult in 2016 on the changes it needs to make to its Rulebook.
FCA application form for ELTIFs (December 2, 2015)
The FCA has published Form ELTIF, an application form for the authorisation of a UK European long-term investment fund (ELTIF) and/or approval to manage a UK ELTIF.
The FCA notes that this form may be used:
- by a UK alternative investment fund manager (AIFM) or an EEA AIFM to apply for the authorisation of a UK ELTIF;
- by a UK AIFM or an EEA AIFM to apply for approval to manage a new UK ELTIF; or
- by a UK AIFM or an EEA AIFM to apply for approval to manage a UK ELTIF that has previously been authorised.
ESMA publishes consolidated UCITS Q&A (February 1, 2016)
ESMA has published a new Q&A document on the application of the UCITS Directive (as amended). Section I of the Q&A includes new questions on additional documents that funds need to provide in order to satisfy the remuneration and depositary requirements of UCITS V. The Q&A also repeals and replaces previously issued Q&A documents in relation to UCITS.
FCA Policy Statement on UCITS V Directive (December 2, 2016)
The FCA has published Policy Statement 16/2: Implementation of the UCITS V Directive (PS16/2).
In PS16/2 the FCA sets out Handbook changes affecting managers and depositaries of UCITS and alternative investment funds (AIFs). These changes mainly relate to final rules and guidance for implementing UCITS V. The FCA also provides its response to feedback on Part I of Consultation Paper 15/27: UCITS V implementation and other changes to the Handbook affecting investment funds (CP15/27).
Some of the changes the FCA consulted on in Part I of CP15/27 affect managers of non-UCITS retail schemes (NURs). In PS16/2 the FCA sets out final rules for managers of NURS. It also outlines some final guidance for depositaries of AIFs, which it consulted on in its March 2015 quarterly consultation.
Key points in PS16/2 include:
- in chapter 2 the FCA summarises the feedback received on the proposed remuneration code and disclosure requirements for UCITS managers. In response to comments from respondents the FCA has made some changes to the guidance on payments in non-cash instruments. The FCA also clarifies whether consequential changes to the prospectus and scheme documents, following the implementation of UCITS V, require approval from the regulator;
- the FCA notes that some respondents objected to extending to managers of NURS certain UCITS V disclosure requirements, in particular the disclosure of the list of the depositary’s delegates and sub-delegates in the prospectus. The FCA has taken this feedback into account, so that managers of NURS will not now be required to disclose in the prospectus the list of the depositary’s delegates and sub-delegates. However, it is maintaining some of the disclosure requirements for NURS where they are consistent with the AIFMD; and
- in chapter 3 the FCA responds to feedback on its proposed rules for the appointment, operational duties and responsibilities of UCITS depositaries. In particular, the regulator clarifies its position with regard to the level of infrastructure that non-bank depositaries must have in place when delegating the safekeeping function to a third party. The regulator also clarifies that UCITS depositaries would be able to delegate the performance of administrative and technical tasks to a third party. The FCA has also changed the proposed CASS rules to clarify which of the CASS 6.6 requirements will remain applicable to depositaries of UCITS until the Level 2 Regulation comes into force.
The FCA notes that it is still unclear when the final text for the Level 2 Regulation will be published in the Official Journal of the EU and when it will become applicable. The draft text allows for a six month transitional period which starts when the Regulation comes into force. The FCA therefore expects that firms will not be subject to the Regulation’s requirements until Q3 2016 at the earliest which means that there is a mismatch between the time when the UCITS V requirements come into force on March 18, 2016 and when the detailed provisions supplementing some of the requirements will become applicable to firms. The FCA states that during this period it will expect firms to make efforts to comply with the UCITS V requirements as of March 18, 2016 (unless a relevant transitional provision applies) even if the detailed requirements under the Level 2 Regulation are not yet applicable.
The FCA also adds that the ESMA is expected to finalise its UCITS V remuneration guidelines in Q1 2016. Once these have been published, it will consider whether any further guidance on applying its UCITS Remuneration Code principles is required. If so, the FCA will consult on further guidance.
The rules and guidance in PS16/2 will come into force on March 18, 2016. The Handbook changes affecting managers and depositaries of AIFs will also take effect on this date. However, there are certain transitional provisions applying to some of the final requirements which run for up to two years, starting from March 18, 2016.