Funds Quarterly Legal And Regulatory Update - Q4 2013

UCITS, NON-UCITS & HEDGE FUNDS

(i) ESMA publishes updated Q&A on their Guidelines on ETFs and other UCITS issues

On 11 July 2013, the European Securities and Markets Authority ('ESMA') published an updated Q&A document on its Guidelines on ETFs and other UCITS issues (the 'ESMA Guidelines'). The aim of this Q&A document is to promote common supervisory approaches and practices in the application of the UCITS Directive and the ESMA Guidelines. The Q&A is directed at the various competent authorities but it is also intended to help UCITS management companies by providing clarity on the requirements.

The updated Q&A document provides further clarification on the following topics:

• Information to be inserted in the prospectus;
• UCITS ETF labels;
• Secondary markets;
• Efficient portfolio management techniques;
• Financial derivative instruments;
• Collateral management; and
• Financial indices.

The Q&A document is intended to be continually edited and updated on a regular basis. It can be accessed at the following link:

http://www.esma.europa.eu/content/ESMA%E2%80%99s-Guidelines-ETFs-and-other-UCITS-issues-0.

(ii) Central Bank Guidance on the Regulatory Reporting Requirements of Irish Authorised Investment Funds

The Central Bank published an updated guidance note relating to the extension of the Central Bank's ONR System to investment funds (the 'Guidance Note'). The Guidance Note is of relevance to all Irish authorised investment funds and their service providers. This document provides guidance in relation to the following returns:

1. Investment Funds Annual Audited Financial Statements;
2. Investment Funds Interim Financial Statements;
3. Investment Funds Annual Sub-Fund Profile Return;
4. UCITS Annual Update of Key Investor Information Document;
5. UCITS Annual Financial Derivative Instrument Return; and
6. Investment Funds Regulatory Report.

The Guidance Note provides that investment funds will no longer be required to file paper reports/returns with the Central Bank.

A copy of the Guidance Note is available on the Central Bank's website at:

http://www.centralbank.ie/regulation/industry-sectors/funds/Documents/Guidance%20Note%20Regulatory%20Report%20ing%20Vol%201.6%20May%20%2013.pdf.

(iii) ESMA Publishes Research on the Sale of Complex Products to Retail Financial Consumers

ESMA recently published a report on the growth in the sale of complex financial products to retail financial consumers in the European Union. The report focused on two specific types of complex products; (i) alternative UCITS and (ii) structured retail products.

The report found that while the sale of these two specific complex products to retail financial consumers has increased, there is evidence to show that these products have produced a relatively low return. ESMA will use the findings of the report in its policy work on improving investor protection by promoting increased disclosure of the total costs of investing in complex products and the specific risks of investing in such complex products.

(iv) Central Bank Clarifies Position in Relation to UCITS Notice 21 and Investments in Derivatives on Financial Indices by Non-Index Tracker Type UCITS Funds

The Central Bank confirmed to Dillon Eustace that where a UCITS, which is not an index tracker, uses derivatives on financial indices this is considered to be an investment in a derivative on the underlying asset and UCITS Notice 21 which applies to financial indices does not apply.

Therefore, a non-index tracker type UCITS can continue to take exposure to financial indices where the financial index does not meet the index diversification requirements as long as it complies with the eligible assets and diversification requirements.

(v) European Parliament Rejects Proposed Bonus Cap for Fund Managers in the Draft UCITS V Directive

On 3 July 2013, the European Parliament voted to reject a proposal to cap fund managers' bonuses to 100% of their salary. Instead, it is now proposed that:

• Bonuses should be required to correspond to fund performance so as to reflect reduced levels when the fund has "subdued or negative financial performance"; and
• Competent authorities should be given the power to scrutinise bonus levels of UCITS management companies to ensure consistency with the principles of sound and effective risk management and appropriate levels of risk taking.

The European Parliament in plenary session also:

• Rejected a proposal for performance fees to be permitted only for UCITS that market exclusively to MiFID professional investors;
• Provided more detail regarding the categories of staff proposed to be subject to the UCITS V remuneration provisions;
• Introduced a new proposed requirement for UCITS management companies to disclose details of remuneration policies in the KIID;
• Introduced a proposal for the establishment of a remuneration committee by those management companies that are significant in terms of their size or the size of the UCITS they manage or where their internal organisation and the nature or complexity of their activities warrant it; and
• Revised the UCITS V text so that it provides that guaranteed variable remuneration should be exceptional and should not form part of prospective compensation plans.

Further negotiations between the European institutions have to take place before the text of the UCITS V Directive becomes final.

(vi) European Venture Capital Funds and European Social Entrepreneurship Funds Regulations

Regulation (EU) No. 345/2013 on European venture capital funds ('EuVCF') and Regulation (EU) No. 346/2013 on European social entrepreneurship funds ('EuSEF') became effective as of 22 July 2013.

These two (directly applicable) regulations create two new regimes for funds wishing to invest in European small and medium enterprises. EuVCF aims to provide a common framework for European venture capital funds while EuSEF aims to provide a common framework for European social entrepreneurship funds.

The purpose of EuVCF and EuSEF is to strengthen venture capital financing in order to fully realise the commercial potential of European small and medium enterprises and provide the means by which investment management products could intermediate capital from investors to social businesses.

The Regulations apply to alternative investment fund managers who manage portfolios of EuVCFs/EuSEFs that are;

• Established in the EU and having assets under management (AUM) which do not exceed the threshold referred to in point (b) of Article 3(2) of AIFMD (i.e. a total AUM of less than €500million comprised of closed ended and unleveraged funds); and
• Subject to registration with the competent authorities of their home member state in accordance with point (a) of Article 3(3) of AIFMD.

If a manager and its funds are registered, the manager will be entitled to use the 'EuVECA' label for its EuVCFs or the 'EuSEF' label for its EuSEFs. These labels will entitle the manager to sell such funds across the EU by way of a marketing passport, thereby avoiding the uncertainty of the private placement regimes across the EU.

EUROPEAN MARKET INFRASTRUCTURE REGULATION ('EMIR')

(i) ESMA Advises European Commission (the 'Commission') on Equivalence of Non- European Derivatives Rules

On 3 September 2013, ESMA published its advice to the Commission on the equivalence of the regulatory regimes for OTC derivatives clearing, central counterparties ('CCPs') and trade repositories ('TR') of non-EU countries with the requirements under EMIR.

To assess the equivalence of non-EU countries, ESMA compared the non-EU country rules with the EMIR requirements regarding central clearing, reporting CCPs, TRs and non-financial counterparties as well as risk mitigation techniques for uncleared trades.

ESMA has published its technical advice regarding the CCP requirements in respect of the US, Japan, Australia, Hong Kong, Switzerland and Singapore. ESMA noted that CCPs from third-countries who wished to continue to offer clearing services directly to EU clearing members had to apply for ESMA recognition by 15 September 2013.

The country specific advice can be found at the following link:

http://www.esma.europa.eu/page/Post-trading-documents.

(ii) ESMA publishes Consultation Paper on Draft Regulatory Technical Standards on Contracts Having a Direct, Substantial and Foreseeable Effect Within the Union and Non-Evasion of Provisions of EMIR

On 17 July 2013, ESMA published its Consultation Paper on Draft Regulatory Technical Standards on contracts having a direct, substantial and foreseeable effect within the Union and the non-evasion of provisions of EMIR.

This consultation paper considers OTC derivative contracts that are entered into between two non-EU counterparties and provides clarification on the conditions where EMIR's provisions on central clearing or risk mitigation techniques would apply to those OTC derivative contracts which have a direct, substantial and foreseeable effect in the EU.

The draft regulatory technical standards would only apply when two counterparties to the same transaction are non-EU counterparties, their jurisdictions' rules are not considered equivalent to EMIR, and where one of the following conditions are met:

• One of the two non-EU counterparties is guaranteed by an EU financial counterparty for at least €8bn of the gross notional amount of the OTC derivatives entered into and for an amount of at least 5% of the OTC derivatives exposures of the EU financial counterparty; or
• The two non-EU counterparties execute their transactions via their EU branches.

This consultation closed on 16 September 2013. ESMA intends to publish the responses received and these responses will help ESMA in finalising the draft technical standards. The Commission has revised the deadline for the submission by ESMA of the draft regulatory technical standards to 15 November 2013 in order to ensure that ESMA is in a position to fully analyse and take into account the results of the consultation.

(iii) ESMA Publishes Discussion Paper on the Clearing Obligation under EMIR

On 12 July 2013, ESMA published a discussion paper on the Clearing Obligation under EMIR to seek views from stakeholders which will help with the preparation of the regulatory technical standards that ESMA is required to develop under Article 5(2) of EMIR, in relation to the obligation to centrally clear OTC derivatives.

The aspects which are covered in the discussion paper include the following:

• The procedure for the determination of the classes of OTC derivatives to be subject to the clearing obligation;
• Preliminary analysis of the readiness of asset classes vis-à-vis the clearing obligation;
• Determination of the phase in period for the clearing obligation and the categories of counterparties to which the clearing obligation would apply; and
• The clearing obligation in specific cases, for example, the case of contracts concluded with covered bond issuers or with cover pools for covered bonds and the case of FX OTC derivatives.

ESMA sought comments from interested stakeholders, in particular from financial and non-financial counterparties of OTC derivatives transactions which will be subject to the clearing obligation, as well as CCPs. Responses received will help ESMA in drafting the Regulatory Technical Standards. Following this, a public consultation will be conducted on the draft technical standards before they are submitted to the Commission for endorsement.

The closing date for comments on this discussion paper was 12 September 2013. Responses to the consultation received by ESMA are available at this link to the ESMA website:

http://www.esma.europa.eu/consultation/Discussion-Paper-Clearing-Obligation-under-EMIR#responses.

(iv) ESMA publishes Final Report on Draft Implementing Technical Standards Amending Implementing Technical Standards With Regard to the Format and Frequency of Trade Reports to Trade Repositories under EMIR

On 6 August 2013, ESMA published its Final Report on draft implementing technical standards ('ITS') amending Commission Implementing Regulation (EU) No 1247/2012 laying down implementing technical standards with regard to the format and frequency of trade reports to trade repositories under EMIR.

This Final Report sets out the proposed amendment to Article 5 of Commission Implementing Regulation (EU) No 1247/2012) to postpone the reporting start date for exchange traded derivatives ('ETDs') by one year (from January 2014 to January 2015).

This postponement is proposed following recognition that there is a need to develop guidelines and recommendations on reporting of ETDs as the current reporting start dates to TRs contained in the Implementing Technical Standards do not distinguish between the methods of trading (ETDs versus OTC). Without further guidance, ETD reporting would not be consistent across the EU nor would it be efficiently used. ESMA considers that the reporting of ETD transactions should not occur before clear guidance is provided in this respect. The Final Report considers it essential to develop guidelines and recommendations to cover the following aspects:

• A clear identification of the counterparties of ETDs;
• A consistent application of reporting requirements under EMIR and MiFID, to the extent possible; and
• The compatibility of the models, logic and formats used to identify all the details to be reported under the two regimes.

This Final Report is being submitted to the Commission. The Commission has three months to decide whether to endorse ESMA's draft implementing technical standards.

(v) ESMA Publishes Updated Q&A Document on EMIR

On 5 August 2013, ESMA published its updated Q&A document on the practical implementation of EMIR throughout the EU. This document provides responses to questions from various stakeholders. The purpose of this document is to ensure convergence in supervisory practices in line with ESMA's responses but it should also help other investors and market participants by providing clarity on EMIR's requirements.

This document is intended to be continually edited and updated as and when new questions are received.

The latest version of the Q&A document includes new general questions on funds as counterparties and the principal-to-principal model as well as updating the following sections:

OTC Questions

• Definition of OTC derivatives;
• Article 10 of EMIR – Calculation of the clearing threshold;
• Article 11 of EMIR – Timely confirmation;
• Article 3, 4(2) and 11(6) to 11(10) of EMIR – Intragroup transaction;
• Article 10(3) of EMIR – Hedging definition;
• Article 11 of EMIR – Risk Mitigation techniques for OTC derivative contracts not cleared by a CCP;
• Status of Entities not established in the Union;
• Article 11 of EMIR – Portfolio Reconciliation; and
• Article 11 of EMIR – Dispute Resolution

CCP Questions

• Article 47 of EMIR – Deposit of financial instruments;
• Article 39 of EMIR – Segregation and portability;
• Article 42 of EMIR – Default Fund;
• Article 26 of EMIR – Organisational requirements;
• Article 2 of EMIR – Definitions; and
• Article 35 of RTS on CCPs requirements– Allocation of additional resources.

Trade Repositories Questions

• Article 1 of EMIR – Classification of financial instruments;
• Article 9 of EMIR – Reporting of collateral and valuation;
• Article 9 of EMIR ITS – Reporting to TRs (Table of Fields);
• Article 9 –Codes – LEI ('Legal Entity Identifier') and UPI ('Unique Product Identifier') and UTI ('Unique Trade Identifier');
• Article 9 of EMIR – Frequency of reports;
• Article 9 of EMIR – Intragroup transactions;
• Article 9 of EMIR – Transactions within the same legal entity; and
• Article 9 of EMIR – Non-European subsidiaries of European entities.

The updated Q&A is available at this link:

http://www.esma.europa.eu/system/files/2013-1080_qa_iii_on_emir_implementation.pdf.

(vi) Financial Stability Board Publishes Update on Global OTC Derivatives Reform

The Financial Stability Board has been tasked by the G20 with monitoring global progress in implementing agreed reforms to OTC derivatives markets. It has recently published a summary update on progress (http://www.financialstabilityboard.org/publications/r_130902a.pdf) and a more detailed progress report (http://www.financialstabilityboard.org/publications/r_130902b.pdf).

(vii) IOSCO and BCBS Publishes Margin Requirements for Non-Centrally Cleared Derivatives (Final Report)

The International Organization of Securities Commissions ('IOSCO') and the Basel Committee on Banking Supervision ('BCBS') have now published the final framework for margin requirements for non-centrally cleared derivatives. The press release and final report are available via the links set out below:

Press release: http://www.bis.org/publ/bcbs261.htm

Consultation Paper: http://www.iosco.org/library/pubdocs/pdf/IOSCOPD423.pdf

The final requirements have been developed taking into account feedback from two rounds of consultation as well as a quantitative impact study. Under the requirements, all financial firms and systemically important non-financial entities that engage in non-centrally cleared derivatives will have to exchange initial and variation margins commensurate with the counterparty risk arising from such transactions. The requirements will be phased-in over a four-year period, beginning in December 2015.

These requirements will be implemented in the EU through new binding technical standards under Article 11 of EMIR. The European Banking Authority, in co-operation with the other European Supervisory Authorities, will consult on these rules in due course.

(viii) Updated EMIR Reporting Timetable

ESMA has published an updated version of its EMIR implementation timetable. The key change in the implementation timeline relates to the registration of the first TRs which was not expected to occur until at least 24 September 2013.

ESMA now expects to make those first registration decisions by 7 November 2013. Consequently, counterparties' reporting to trade repositories is not expected to start before February 2014.

You will find the updated EMIR implementation timetable at this link:

http://www.esma.europa.eu/news/Trade-Repository-registration-approval-not-expected-7-November-reporting-begin-February-2014?t=326&o=home.

(ix) ISDA EMIR Portfolio Reconciliation Operational Guidance Note

ISDA published a Portfolio Reconciliation Operational Guidance Note on 10 September 2013 (the 'Guidance Note'). The Guidance Note contains answers compiled by the ISDA EMIR Portfolio Reconciliations Working Group to some frequently asked questions relating to EMIR's portfolio reconciliation and dispute resolution obligations which came into effect on 15 September 2013. The Guidance Note deals with the following issues;

• Who is subject to the portfolio reconciliation and dispute resolution obligations;
• Frequency and the content of reconciliations;
• How do market participants agree to the terms upon which they will reconcile their portfolios;
• Use of a third party vendor to reconcile portfolios; and
• Comparison of EMIR's portfolio reconciliation requirements with the equivalent US rules.

(x) Regulation 876/2013 Containing Regulatory Technical Standards on Colleges for Central Counterparties Published

On 13 September 2013, delegated Regulation 876/2013 containing the regulatory technical standards on colleges for central counterparties relating to EMIR was published in the Official Journal. The regulatory technical standards, required under Article 18 of EMIR, address operational aspects related to the organisation and governance of supervisory colleges that must be set up to assess applications by CCPs for authorisation under EMIR. The delegated Regulation will enter into force on 3 October 2013 and is available to view here:

http://new.eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=oj:JOL_2013_244_R_0019_01&from=EN.

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