Asset management quarterly - Europe

Developments and market trends in Europe


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,, 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.


UK market trends

Author Richard Sheen

Looking back at 2015, the key area where investors focused their interest was on those alternative investment funds producing income. On UK public markets a significant proportion of the £3.8 billion raised across 23 IPOs came from direct lending and peer to peer (P2P) strategies, although appetite seemed to dissipate a little towards the end of the year.

More of the same? The significant recent market declines and volatility, Brexit and global macro-economic concerns will not be helpful to investment managers eyeing potential new fundraisings – however, looking ahead to 2016, it seems unlikely that investor demand for income will wain anytime soon. Raising money for P2P lending has now become difficult with disappointing results in 2015 for the first movers in this space which may hinder any new players who are keen to add a permanent capital lending vehicle to their stable. We are aware of several of these vehicles at various stages in the market at the moment – let’s hope that Funding Circle did not clear out all of the remaining appetite for this space in Q4 last year.

If not more direct / P2P lending, then there are still plenty of credit managers still looking actively to establish new income producing funds in this area with an array of different strategies. However, raising new funds remains difficult. It seems to us that one of the key concerns for potential investors in new funds, which by their nature lack any trading history, is the discount at which their shares may very quickly trade. Investors are acutely aware that listing a fund is not in itself a ticket to liquidity. We have seen numerous mechanisms (share buybacks, continuation votes, tenders, redemptions etc.) implemented with varying degrees of success to seek to address the discount issue. For all the discount protection mechanisms employed by a fund, they mean very little unless the fund is performing well, which is of course the best discount protection mechanism. For savvy investors and funds of funds there is of course the opportunity to purchase shares from cash-poor or over-exposed investors being forced to sell at significantly discounted rates.

On the private side, there still appears to be demand for infrastructure and real estate funds, however for infrastructure in particular there is a perception that quality assets may be harder to come by. The same rings true for listed infrastructure and real estate too, and here, given the potential for cash-drag, blind pool fundraisings remain difficult. Private equity is active at the moment, although private equity fundraisings stalled in 2015 – down from the levels seen in 2014, and the more mature European and North American markets’ aggregate share of money raised fell. It seems that for the big names, fundraisings remain oversubscribed. It’s the first time funds finding is very difficult, where achieving critical mass is a little more hit and miss. In contrast to the now perhaps constrained listed direct lending markets, fundraising for private debt looks to remain active far into 2016. There is still substantial demand from borrowers, although we do see renewed interest from more traditional sources of finance with some banks re-entering the market in competition with debt funds for the most attractive opportunities.

The next big thing? As a number of banks continue to look to reduce their overall exposure levels as they work through the implications of Basel III, but retain the benefit of loan arrangement and syndication fees, we’ll be on the lookout for banks seeking to sell off large portfolios of loans to newly established self-managed alternative investment funds. The key point for investors will be ensuring the quality of the assets and that those assets are fairly priced. As an aside, we are seeing interest in the launch of new exchange traded funds.

To state the obvious, one thing remains clear for the year ahead: markets are tough for new funds trying to get off the ground. A further £6 billion was raised by existing investment companies last year, so perhaps established funds coming back for secondary fundraisings will have the best luck.

The regulatory assault on the asset management sector continues apace, although the possible modification of RDR and the prospective AIFMD passporting developments may be welcome news. How the FCA’s market study into competition in the UK asset management industry (discussed below) plays out, will be something to keep a keen eye on. Finally, the relatively steady stream of M&A deals for asset managers does not appear to be abating with the announcement of a number of recent deals and speculation as to further consolidation in the space.

The UK FCA asset management market study – what does it really mean?

Authors Imogen Garner, Peter Scott

In November 2015, the UK (FCA) published the Terms of Reference for its current asset management market study. This is the latest in a series of market studies launched by the FCA using its new competition powers which it obtained in April 2015. The FCA’s stated aim is to understand whether competition is working effectively to enable investors to get value for money when purchasing asset management services.

The FCA will gather information to assist its understanding of the competition dynamics of the market, through roundtables with industry, bilateral meetings and a number of information requests to market participants.

Although the market study will look at the sector primarily through a competition lens, it is clear that the FCA will be interested to understand how wider principles of financial services regulation, such as conflicts of interest, are managed by various participants and segments of the market.

The regulator wants to understand how well both retail and wholesale customers are served. The FCA’s early signal that it will consider the impact of the role of investment consultants on competition amongst institutional asset managers has been picked up by a number of commentators as a potentially important indication as to likely remedies arising out of the study.

The FCA will consider the impact of current costs and charging structures, and whether they act as a barrier to competition.

The FCA will consider the market through the ‘access, assess, act’ framework of behaviour, which it has utilised in other market studies including the call for inputs into competition in the mortgage market. From the regulator’s perspective, transparency of fees and charges is critical to enabling customers to access and assess products and services. The FCA has indicated that it will look in detail at the impact of current costs and charging structures, and whether they act as a barrier to competition. Industry and commentators have lost no time in placing this market study within the context of a longer running debate in the sector regarding fees and charges. The departure of Daniel Godfrey from the Investment Association was seen by many commentators as a sign that some parts of the industry were unhappy with the rhetoric from its trade body regarding improvements to the transparency of pricing structures.

In addition to asking questions about charging structures, the industry can expect to face detailed investigation to answer the following questions:

  • how do asset managers compete to deliver value;
  • are asset managers willing and able to control costs and quality along the value chain; and
  • how do investment consultants affect competition for institutional asset management?

Charges for asset management products vary significantly. The FCA will want to map out charges across the value chain, and firms should be prepared to respond holistically to these questions.

Proxies are also used to assess the future performance of asset managers and these should lead to good outcomes for investors. The factors investors and asset managers use to assess value for money will need to be understood by the FCA. The perceived time/effort in finding an alternative fund and the tax complexity of switching will also be assessed.

The FCA has also stated that it will consider whether and why there is a high concentration in certain mandates (e.g. the reputedly high concentration of Liability Driven Investments); and whether there are barriers to entry and expansion that reduce the incentives of existing firms to offer value for money (for example, is it difficult for the consumer to understand and monitor asset management services and switch funds? Does vertical integration have an anti-competitive effect?).

In several areas, the FCA will consider the customer journey and the information available to customers to enable them to make informed decisions. Firms should be aware that the regulator is particularly interested in investors’ ability to monitor the costs and quality of services which are paid out of fund assets. The FCA is concerned that when asset managers outsource services, they may not have the same imperative to control costs as an investor would have. Further, where service providers bid for work for asset managers, the managers are likely to consider maximising returns on their entire business, rather than any particular fund. Overall, the FCA will want to understand whether asset managers can control costs along the value chain, and whether there are any idiosyncrasies of the current market which prevent effective competition amongst service providers for asset managers’ use.

Unsurprisingly, the industry is bracing itself for potentially significant reform arising out of the market study. Clearly, preparing responses thoroughly and effectively presents a good opportunity for firms across the market to impact the shape of what is to come.

The FCA expects to publish an interim report in summer 2016 and a final report in early 2017. If the FCA reaches the conclusion that the market is not working well, it has wide-ranging remedies powers including - rule-making, firm specific remedies or enforcement action, publishing general guidance or proposing enhanced industry self-regulation. In addition, the FCA has the power to refer the market to the CMA for a further “market investigation”, but it is likely to prefer to use its other powers rather than to take this step.

Carried interest – new UK tax rules

Author Andrew Roycroft

The tax treatment of the carried interest of asset managers is potentially set to change in the UK with effect from April 6, 2016 - only carry calculated by reference to investments held for at least four years will continue to be taxed entirely as capital gain.

Currently, carried interest is usually taxed as capital gain (rather than income) in accordance with a long-standing practice agreed with the UK tax authority (HMRC). In recent years the rates at which income and capital are taxed in the UK have diverged, with income being taxed at much higher rates than capital gains. Conscious of perceived public concern about fund managers being taxed at lower rates than most of their employees, recent Governments have introduced a succession of changes designed to increase the amount of tax paid on capital gains accruing to fund managers.

In April , the disguised investment management fee (DIMF) rules came into force. These rules were very broadly-drafted, taxing as income certain sums arising to any individual who performs “investment management services” for a collective investment scheme or unit trust. The arrangement had to involve at least one partnership, but – significantly – carried interest was specifically excluded from these rules.

The Summer Budget of 2015 saw two further developments. Immediate action was taken against certain arrangements (base cost shifts) which enabled very little capital gains tax to be paid on carried interest, and a review was announced into the circumstances in which the carried interest of fund managers would continue to benefit from capital treatment. It is this review which resulted in the changes which are likely to take effect on 6 April. In broad terms:

  • capital gains treatment will continue to be available for carried interest where the assets which the carried interest is calculated by reference to have an average holding period of at least four years;
  • where the average holding period of such assets is less than three years, the entire return will be subject instead to income tax;
  • for average holding periods of between three and four years, a percentage will be taxed as income rather than capital – 75 per cent, 50 per cent or 25 per cent depending on how near the holding period is to four years;
  • this is achieved by treating part (or all) of the carry as “Income-based carried interest”, which is no longer excluded from the DIMF rules;
  • there are special rules for carried interest in the first four years after the fund begins to make investments, which allow such carry to be ‘conditionally’ exempt from income tax but provide for adjustments if it proves not to be the case;
  • direct lending funds are singled out for special treatment; subject to one exception, carried interest in such funds will be taxed as income regardless of how long the (debt) assets which it is calculated by reference to are held for; and
  • external investors are not subject to these rules.

In seeking to define the border between ‘genuine’ capital gains and a return which is perceived to be a reward for services further complexity has been added to the UK’s tax system. This is perhaps inevitable; a more radical solution (of aligning the rates of capital gains and income tax) is not open to it. 


Asset management update

Author Donnacha O’Connor, Partner at Dillon Eustace

The first half of 2016 is going to be a busy period for Irish funds with the timing of the implementation of a number of new legislative and regulatory measures coinciding.

As the transposition deadline for the UCITS V Directive looms, the Central Bank of Ireland (the Central Bank) issued updates to its UCITS regulatory application forms in January to reflect the requirements of the Directive. With European Commission Level 2 Regulations still in draft form, the European Securities and Markets Authority (ESMA) recently provided Member States with some welcome clarification as regards the timing of the implementation of certain requirements in its updated Q&A on the Directive. The Central Bank can be expected to follow ESMA’s recommendations.

The Central Bank has re-issued and updated its UCITS regulatory rulebook in the form of a piece of secondary legislation called the Central Bank (Supervision and Enforcement) Act 2013 (Section 48(1))(Undertakings for Collective Investment in Transferable Securities) Regulations 2015. The first challenge of this legislation will clearly be to remember its name! UCITS will need to reflect this development in their prospectuses, business plans, policy documentation and other relevant documentation in due course.

Irish alternative investment fund managers, UCITS management companies and fund management companies are subject to new guidance on how they oversee their delegates. On November 4, 2015, the Central Bank published recommendations which cover delegate oversight, organisational effectiveness and directors’ time commitments. This guidance is linked to the Central Bank’s previous consultation paper No. 86. While some directors may grumble about having to reduce the number of boards which they sit on, and the ever-increasing duration of board meetings, the guidance would generally be considered to reflect what is currently good practice in fund governance. The rules will become applicable to existing entities on a phased basis over the year. Further guidelines in the areas of managerial functions, management companies’ ability to rely on the policies and procedures of their delegates, recordkeeping obligations, regulatory authorisation applications and passport notifications are expected to be issued by the Central Bank later this year.

In March 2015, the Central Bank published new investor money regulations together with detailed guidance. The regulations apply to Irish fund service providers (including fund administrators, depositaries, fund management companies and alternative investment fund managers) holding investor money in collection accounts. The regulations are effective from April 1, 2016. It is anticipated that most fund service providers will put in place arrangements which are out of scope of these regulations. These arrangements will require investor consents in some cases and clear disclosure, which funds need to be mindful of.

Fund fees are on the Central Bank’s radar this year. On December 14, 2015, the Central Bank's Market Supervision Directorate published its programme of themed inspections for 2016 and included among its areas of interest will be the production costs of investment funds. It is expected that the Central Bank’s principal focus will be retail-oriented funds with relatively high total expense ratios and that it will look in particular for transparency, clear disclosure and at the impact of conflicts of interest. Watch this space!

In a well-received development in November, the long-standing requirement for a promoter or sponsor, with a minimum level of financial resources, to be pre-cleared by the Central Bank before an Irish UCITS could make an application to be authorised was abolished. The requirement was previously abolished for alternative investment funds. This is good news for managers.


Market trends in Luxembourg

Author Florence Stainier, Partner at Arendt & Medermach

Over the course of the past few years Luxembourg has consolidated its position as a hub for investment funds. The evolution of global assets under management of collective investment undertakings and specialized investment funds (SIF) over the past 15 years has confirmed Luxembourg’s prime position. From a value of EUR 874 billion in 2000, this figure had reached EUR 3,506 billion on December 31, 2015.

In a changing international, legal regulatory and fiscal framework, the investment fund sector in Luxembourg is increasingly seen as an opportunity for generating attractive returns. More particularly there has been growing interest in SIFs as opposed to other types of collective investment undertakings while the total number of vehicles has tended to remain stable. This demonstrates the willingness of asset managers to benefit from new flexible tools meeting investors’ needs in terms of strategy.

These developments have also driven the introduction of the special limited partnership regime in 2013. To date nearly 1,000 new limited partnerships have been launched which demonstrates that market participants no longer perceive product supervision as a must-have. Instead, speed to market and structuring flexibility (in the context of regional, international or global offerings) remain at the forefront. Although umbrella funds remain popular due to various practical and cost considerations, the trend over the last few years has been towards simplification of structures and strategies, a tendency which was again in evidence during 2015.

In line with this trend, the Luxembourg government announced in last December its intention to introduce a new form of alternative investment fund, the ‘reserved alternative investment fund’ or ‘RAIF’, which is expected to enter into law during the second quarter of 2016.

This new type of fund which will be managed by an externally authorized alternative investment fund manager subject to the requirements of the AIFMD but no supervision of the fund will be performed by the Luxembourg financial regulator, the Commission de Surveillance du Secteur Financier.

This will ensure that the RAIF can benefit from a quicker time to market and will also have as the advantage of access to the AIFMD marketing passport. Only well-informed investors will be eligible to invest in a RAIF, namely institutional investors, professional investors and parties investing at least EUR 125,000. Market participants predict that the RAIF will serve to increase the competitiveness of Luxembourg as a financial center and is a welcome addition to the Luxembourg fund structuring toolbox.

Positive developments in the real estate fund market in Luxembourg have continued. According to the Association of the Luxembourg Fund Industry (‘ALFI’) this sector will grow further over the coming years. SIFs account for all of the real estate investment funds launched in the last 30 months (excluding manager-regulated alternative investment funds) and the SIF regime is now firmly established as the favoured regime for regulated real estate and fund of real estate funds in Luxembourg.

On the debt fund side, the market for debt funds continued to grow during 2015. Luxembourg is seen as an ideal platform for pan-European and global marketing, with a proven track record in cross-border distribution. All types of debt strategy including origination, secondaries, mezzanine and distressed fund types are catered for. Over 70 per cent of the top 30 debt fund managers worldwide are operating in Luxembourg.

On the asset management side, market participants are still looking to implement more alternative and sophisticated strategies under the UCITS format (assets under management in this type of structure have been on the constant rise with more than EUR 300 billion of assets under management in 2015). A variety of asset classes and strategies are covered by these collective investment undertakings with a specific focus on CTA and credit strategies.

More conventional asset managers have also shown confidence in distressed debt, convertible contingent debt and high yield investment strategies. In November 2015, fixed income represented 22 per cent of the total amount of fund units (out of a total of 14,098 units) and 30.2 per cent of the net assets (which represents more than EUR 1.8 million).

Finally, asset managers have shown ongoing interest in Chinese markets with the creation of various collective investment undertakings as RQFII funds using specific RMB RQFII quotas (including the 50 billion quota granted to Luxembourg) or via investments through Stock Connect.

Germany, France and Italy

Loan originating funds - update on the state of play

In the post “GFC” world, loan origination by investment funds in the European market has been increasing dramatically. This increase has led to competing responses from regulators.

On the one hand, a concern about the lack of transparency and appropriate regulation has led regulators to introduce various initiatives to review and regulate this particular area of the “shadow banking” world. On the other, it is increasingly recognised by policy makers that investment funds provide a potentially important source of alternative financing to the economy.

In particular, the European Commission’s recent “Action Plan on Building a Capital Markets Union” acknowledged that small and medium sized corporates benefit from a more diversified lending market and increased financing opportunities. The Commission noted in its action plan that while direct lending by funds “could emerge as a potentially important future source of non-bank credit”, alternative investment funds operating cross-border in the European Union (EU) currently face numerous different regulatory requirements. The UCITS Directive (Directive 2009/65/EC) does not permit loan origination by funds. Certain EU Member States do allow loan origination by funds pursuant to national legislation but those funds cannot benefit from passporting in order to market to retail investors on a cross-border basis. As noted in the ESMA Report No. 1 2015 on Trends, Risks and Vulnerabilities, ESMA deems loan originating Alternative Investment Funds (AIFs) permissible, on the basis that EU Directive 2011/61/EU on Alternative Investment Fund Managers (AIFMD) does not prohibit this.

However, raising a fund is one thing. The other big obstacle raised by credit funds looking to originate loans in European markets is the need in some jurisdictions for banking or other lending licenses or for complex structuring to avoid them.

Currently a slew of initiatives are being considered in Member States that look to address the objective of liberalising the lending market to promote the growth agenda, whilst not giving rise to unmanageable shadow banking concerns. Below we focus on the changing position for loan origination funds in Germany, France and Italy.


Prior to the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin)’s announcement of changes to its administrative practice in May 2015, loan origination by, or for the account of, an investment fund was generally not permitted. This was due to the fact that according to the German Banking Act (Kapitalwesengesetz or KWG), providing loans in Germany commercially, or on a scale which requires commercially organised business operations, generally requires a banking licence. As a consequence, investment funds were only allowed to invest into loans originated by fronting banks or concluded by way of reverse solicitation. Further issues arose when such acquired loan receivables had to be restructured, as except in very limited circumstances, BaFin considered this activity “loan origination”, triggering the banking licence requirement.

By a letter of recommendation dated May 12, 2015, BaFin announced that going forward it would consider both the granting and restructuring of loans by AIFs part of collective investment management and therefore permissible, insofar as the activity was consistent with the provisions of the German Capital Investment Act (Kapitalanlagegesetzbuch or KAGB). Investment supervision pursuant to the KAGB is distinct from banking supervision, as a consequence BaFin no longer considers loan origination by German funds as falling within the scope of banking supervision pursuant to the KWG. German AIFs may therefore now provide loans to German commercial clients without holding a banking licence. However, BaFin made it clear that its views are subject to the pending legislative amendment of the KAGB to reflect the changed approach to loan origination, due to come into effect in March 2016 as part of a general overhaul of the KAGB to implement the UCITS V Directive in Germany (the OGAW-V-Umsetzungsgesetz or OVU). Therefore, market participants have since then had to be aware of a potential legislative tightening.

The OVU passed by the German Bundestag on January 27, 2016. It is expected to enter force on March 18, 2016. It permits loan origination (other than shareholder loans, which are separately addressed) by closed-ended German special AIFs only. Where a loan is acquired by an open-ended special-AIF and this loan is then restructured/prolonged, this will not be considered “loan origination”, which is prohibited for open-ended AIFs (other than in the context of a shareholder loan).

The OVU includes provisions on diversification (loan origination to a single borrower is limited to 20 per cent. of the AIF’s investment capital), borrowing is restricted (up to 30 per cent of the AIF’s investment capital) and consumer loans are prohibited. All loan originating funds are subject to rules on risk and liquidity management, as well as conduct rules, comparable to those applicable to credit institutions. Rules on shareholder loans provide that an amount of double the equity investment should not be exceeded, as well as capping such loan at 50 per cent. of the AIF’s investment capital (these rules are relaxed where subordinated loans are granted to subsidiaries).

EU-AIFs are likely to be able to benefit from the new legislative permission. As regards third country AIFs, there is a possibility that in limited cases, where a third-country AIF can demonstrate equivalent regulation, loan origination may be permissible. However the legislative stance in this respect has yet to be clarified and loan origination in Germany by such funds is likely to be very difficult.


The Autorité des marchés Financiers (AMF) on October 22, 2015 published a consultation on the possibility of loan origination by investment funds. The consultation closed on December 4, 2015 and  measures in relation to the AMF’s consultation are currently awaited.

There is a legal restriction on French investment funds granting loans, notwithstanding the banking monopoly exemption which permits the acquisition of loan receivables by certain funds. The AMF’s consultation relates to this restriction in light of the entry into force of Regulation 2015/760 on European Long-term Investment Funds (ELTIFs) in December 2015, which sets out specific conditions under which certain investment funds may lend.

French management companies currently authorised to acquire loan receivables are not necessarily AIFMs. The AMF consultation suggests that rather than creating a new licence requirement for managing companies wishing to grant loans, the AIFMD should apply to such managers, reinforced by an additional obligation to carry out certain risk assessments (which are already applicable to insurance companies investing in loans). The AMF considers that in addition to the conflict of interest rules that an AIFM is subject to, a manager granting a loan to a company with a capitalistic tie to the management company should be required to have the risk of the loan assessed by an independent external assessor.

The AMF proposes that only three types of funds should be permitted to grant loans, namely specialised professional funds (fonds profesionnels spécialisés), securitisation vehicles (organismes de titrisation) and professional private equity investment funds (fonds professionels de capital-investissement).

Since the 1st January 2016, the French Code monétaire et financier  already provides that French specialised professional funds, securitisation vehicles  and professional private equity investment funds may grant loans to companies under the conditions set out in (i) the Regulation 2015/760 on ELTIFs (if they are licensed as ELTIFs) or (ii) a French décret. As the French décret is currently awaited, all conditions under which the abovementioned French specialised professional funds (fonds profesionnels spécialisés), securitisation vehicles (organismes de titrisation) and professional private equity investment funds (fonds professionels de capital-investissement) other than ELTIFs can grant loans have not yet been set out.

The AMF also considers in its consultation that loans may only be granted to non-financial companies (preventing loans to individuals) and for a term of at least two years, providing that the loan’s maturity date does not extend beyond the lifetime of the fund.

The AMF recommends certain constraints on funds originating loans, such as a prohibition on leveraging, short-shelling, securities lending and repurchase transactions and financial derivative transactions (which are not entered into for hedging purposes). There is no minimum credit quality requirement proposed, however the consultation does envisage a potential limitation of loans to European investment companies only.

A fifth AMF discussion point concerns debt collection, which is regulated by the French Code of Civil Enforcement Procedures. The AMF therefore, does not consider it necessary to impose supplementary regulations in respect of debt recovery by a management company, provided that amounts collected are exclusively used for the benefit of the fund and any costs involved are clearly disclosed in the prospectus.


Historically lending to the public has been a regulated activity in Italy pursuant to the Banking Act (Decree No. 385/1993), which may only be carried out by banks and financial intermediaries authorised by the Bank of Italy. As a consequence of the economic crisis, the Italian government has in recent years taken various legislative steps to provide alternative sources of financing to Italian companies and businesses.

The key piece of legislation is Law Decree no. 91 of June 24, 2014 (the “Competitiveness Decree” or “Decreto Competitività”), which allowed certain non-bank entities to carry out direct lending in Italy and created withholding tax exemptions in relation to interest payments made by Italian borrowers to certain foreign lenders.

The perimeter of the new rules in relation to matters such as loan origination and direct lending by credit funds, however, was not entirely clear. The legal regime has been clarified by a Law Decree approved by the Italian government on February 10, 2016. This decree, which must be converted into law by the Italian Parliament within sixty days, has created a level playing field for Italian AIFs and EU-AIFs by providing that both – if certain conditions set out in the relevant legislation and implementing regulations issued and to be issued by the Bank of Italy are met, are permitted to carry out loan origination (which for these purposes involves approaching borrowers in Italy with an offer to provide financing packages or other loan products) and lend directly to borrowers in Italy. As far as EU-AIFs are concerned, they must notify the Bank of Italy of their intention to carry our lending transactions in the Italian territory and they can commence their activities in Italy 60 days from the above notification (to the extent the regulator has not forbidden that in the interim).

An example of the sorts of fund we expect to be approved for loan origination in Italy would be an appropriately authorised Irish QIAIF, i.e. an Irish fund whose interests may be offered only to qualifying investors under the applicable laws (including Italian law), such as banks, pension funds, insurances and other institutional investors. Ireland was the first EU Member State to introduce a dedicated regulatory regime for loan originating funds. The “Loan Originating Qualifying Investor Alternative Investment Fund”, introduced in September 2014 by way of amendment to the AIF Rulebook, operates under the AIFMD and allows an authorised Alternative Investment Fund Manager (AIFM) of a closed-ended fund, subject to compliance with additional rules set out in the AIF Rulebook, to market the loan originating fund under the AIFMD passport.

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