Welcome to the latest edition of our Asset Management and Investment Funds Legal and Regulatory Update.
In this issue we consider the Central Bank's conduct risk and supervisory priorities for funds and the ESAs' level 2 measures under SFDR. We also consider the Central Bank's specialist depositary regime, its final share-class guidance for closed-ended AIFs and its recent consultation on stakeholder engagement.
If you would like to discuss any of the topics covered, please feel free to contact a member of our team.
Central Bank's Supervisory Priorities for Funds in 2021
In its first Securities Markets Risk Outlook Report the Central Bank has highlighted the main conduct risks that securities markets participants, including investment funds, should be taking into account and has also set out its supervisory priorities.
On 8 February 2021, the Central Bank published its first Securities Markets Risk Outlook Report. ("Report"). The Report details key conduct risks to securities markets and sets out actions firms, including those in the funds sector, should take in order to identify, mitigate and manage those risks. It also includes the Central Bank's supervisory priorities for the funds sector in 2021.
The Report highlights the key areas of conduct risk where the Central Bank expects to see firms take specific proactive steps in 2021. These include:
- dealing with the impact of external shocks, including shocks arising from COVID 19 and Brexit;
- successfully managing the migration to greener securities markets, which includes some comments on "greenwashing";
- managing the increasing complexity in securities markets and the rules that govern them;
- ensuring meaningful transparency for investors and other market participants, in particular on costs and fees;
- understanding the risks and implications of the increased use of indices, as well as being transparent with the market on their use;
- bolstering systems to identify, mitigate and manage misconduct risk, with a particular focus on the risk of market abuse;
- ensuring governance arrangements are fit for purpose and properly resourced, including as businesses expand or change; and
- improving the quality of the data firms use in their business and report to the Central Bank.
The Central Bank's supervisory priorities will include an industry-wide review of compliance with the Market Abuse Regulation ("MAR") and further work arising from findings in its 2020 thematic reviews in the funds sector. This work includes the findings from its review of CP86 and the ESRB/ESMA Review of Corporate Bond and Property Funds. The Central Bank will also complete its follow up actions to the ESMA CSA on Liquidity Management in UCITS and will conduct a CSA, together with ESMA, on costs and fees in UCITS. The Report also notes that 2021 will be another year of substantive projects to implement securities markets legislation and related technical standards and guidance. This will include, in particular, further implementation of requirements under the Money Market Funds Regulation and the Securities Financing Transactions Regulation.
The Report also states that the Central Bank's supervisory work and insights will feature prominently in its wider policy work at domestic and international level. Key topics where these supervisory perspectives will inform work in 2021 will include:
- work on potential reform of the framework for money market funds and the wider consideration of a better macro-prudential framework for investment funds;
- reviews of MAR, MIFID and AIFMD;
- the development and implementation of the framework for sustainable finance;
- work with IOSCO in undertaking a review of conduct-related issues in relation to index providers, with a specific focus on the asset management industry; and
- enhancing international coordination in the supervision of conduct risk in wholesale securities markets, with a particular focus on improved EU supervisory convergence and continued cooperation under the IOSCO Multilateral Memorandum of Understanding.
SFDR Level 2 Measures Published
ESAs submit their final level two measures under SFDR for endorsement by the European Commission.
On 4 February 2021, the ESAs (EBA, ESMA and EIOPA) announced that they had submitted their Final Report, including the draft Regulatory Technical Standards ("RTS"), on the content, methodologies and presentation of disclosures under the Sustainable Finance Disclosures Regulation ("SFDR") to the European Commission. The draft RTS also contain templates for pre-contractual and periodic product disclosures.
The draft RTS set out the more detailed disclosure requirements regarding:
- the details of the presentation and content of the information in relation to the principle of 'do not significantly harm' as set out in Article 2(17) of the SFDR;
- principal adverse impact reporting (Article 4);
- pre-contractual information for Article 8 and Article 9 products;
- website disclosures for Article 8 and Article 9 products; and
- periodic reporting requirements for Article 8 and Article 9 products.
The European Commission ("Commission") is expected to endorse the RTS within three months of their publication. While financial market participants and financial advisers are required to apply most of the level one provisions on sustainability-related disclosures laid down in the SFDR from 10 March 2021, the application of the RTS will be delayed to a later date according to the Commission's letter to the ESAs. The ESAs have proposed in the draft RTS that the application date of the RTS should be 1 January 2022.
The ESAs have also stated that they plan to issue a public supervisory statement before the application date of SFDR (10 March 2021) in order to achieve an effective and consistent application of the SFDR's requirements and consistent national supervision of the SFDR.
Central Bank Issues Final Share Class Guidance for CE QIAIFs
Final Central Bank guidance permitting differentiated share classes in certain closed-ended QIAIFs published
As previously reported, in late Q4 2020, the Central Bank consulted on guidance in relation to permissible features of closed-ended AIFs, which should be of particular interest to funds that invest in private equity, credit and other private asset investment strategies. On 2 February 2021, the Central Bank issued its final guidance ("Guidance") together with the feedback statement to its consultation.
In summary, the key elements of the Guidance include:
The availability of these features is limited to closed-ended AIFs authorised as QIAIFs ("CE QIAIFs").
Share class features
CE QIAIFs can create differentiated share classes and the Guidance:
- permits a fund to issue shares or other interests at a price other than net asset value without prior Central Bank approval;
- sets out the conditions applicable to the use of excuse provisions (which enable an investor to be excused from an investment that the fund proposes to make) and exclude provisions (which permits the fund to exclude an investor from a proposed investment that the fund proposes to make);
- permits new investors to acquire interests in the fund at a later stage in its life cycle (stage investing); and
- allows for the establishment of management or "carry" classes which permit portfolio managers of a fund to participate in investments of the fund, including on the basis of conditions which differentiate the class from other classes in the fund.
A number of general conditions apply to the establishment of differentiated share classes including that:
- the ability to establish the class has been provided for in the CE QIAIF's constitutional document and has been disclosed to investors in advance;
- the investor's interest in a CE QIAIF is proportionate to: (i) the capital it has paid into the CE QIAIF at a particular point in time; and / or (ii) the pre-determined flow of capital returns to the class; and / or (iii) the extent to which the class held by the investor participates in the assets of the CE QIAIF;
- where the investor has subscribed in the CE QIAIF on the basis of a capital commitment and periodic drawdowns from the investor, the CE QIAIF maintains records on a per-investor basis to enable it to clearly identify commitments paid and commitments outstanding for each investor ("capital accounting"); and
- the capital accounting methodology is consistent with the requirements under AIFMD.
Additional conditions apply to the use of the use of management classes and the use of excuse and/or exclude provisions including the following:
- the conditions applicable to management classes must be provided for in the prospectus, and capital payments (both committed capital and preferred returns) must be allocated to relevant investor classes in priority to management classes;
- the excuse and / or exclude provisions are predetermined and documented by the CE QIAIF; and
- a formal legal opinion must be provided by the investor or CE QIAIF (depending on the party invoking the provision) outlining the basis on which the excuse or exclude provision is being invoked.
Specialist Depositary Regime Established
Depositaries of assets other than financial instruments may now be authorised to be appointed to certain QIAIFs
On 2 February 2021 issued its Guidance for Depositaries of Assets other than Financial Instruments ("Guidance"), which sets out its authorisation requirements for Depositaries of Assets other than Financial Instruments ("DAoFI"). The Guidance follows from the Central Bank's November 2018 notice of intention to permit the authorisation of entities, under Regulation 22(3) (b) of the AIFM Regulations 2013, to act as a depositary for specific types of AIFs, which primarily invest in assets that do not fall within the categorisation of a financial instrument capable of being held in custody.
A DAoFI may only act for certain AIFs, i.e., QIAIFs which have no redemption rights exercisable for at least five years from the date of initial investment and which generally do not invest in financial instruments that can be held in custody. The QIAIF to which a DAoFI is appointed may, only to a limited extent, invest in financial instruments which are the subject of custody obligations. The Central Bank expects that a DAoFI will generally seek to delegate the custody of financial instruments to a depositary. The Guidance also provides for the holding of financial instruments by a DAoFI for and on behalf of the QIAIFs.
The Central Bank does not propose to establish an exhaustive list of the types of assets which would automatically be acceptable for a DAoFI to safe-keep. However, a list of asset classes is available in the Central Bank's AIFMD Q&A (ID 1139) and this list will be updated from time to time. The Central Bank considers that the asset classes of the types of funds envisaged by Regulation 22(3)(b) of the AIFM Regulations 2013 and in respect of whom the DAoFI will be appointed will include documents of title for asset classes such as infrastructure, intellectual property, plant and equipment, land, art and wine.
In all cases, (including for those assets referred to in the Central Bank's AIFMD Q&A), a DAoFI must provide satisfactory evidence to the Central Bank of its capacity to safe-keep and provide ongoing monitoring of assets for which it will provide services. This will assist the Central Bank in assessing, on the basis of evidence provided, the ability of the DAoFI to safe-keep these assets. In this regard the Central Bank will consider the extent to which the DAoFI has appropriate controls, policies and procedures to ensure that:
- the AIF has a clear title of ownership to the assets that is properly registered and documented;
- the AIF's ownership of the assets can be verified and confirmed on an ongoing basis;
- the assets are safeguarded in order to preserve them; and
- risks to safeguarding of assets are identified, managed, monitored and mitigated.
A DAoFI must be established as an investment business firm under the Investment Intermediaries Act 1995. In addition to satisfying the Central Bank in relation to its suitability (including the fitness and probity and expertise of its staff), a DAoFI must demonstrate to the Central Bank:
- its capacity and ability to meet safekeeping and oversight obligations as provided for under the AIFM Regulations 2013;
- that it has effective policies and procedures to ensure the depositary oversight role is carried out; and
- how it has the necessary systems access to effectively oversee the AIFM and any of its delegates, particularly those which are appointed to carry out fund administration or portfolio management.
A DAoFI and must also comply with certain requirements of Chapter 5 of the AIF Rulebook, which are set out in the Guidance.
As noted above, in conjunction with the Guidance, the Central Bank also updated its AIFMD Q&A. The new Q&A address questions relating to the authorisation of a DAoFI and the asset classes that may be safe-kept (ID 1136, ID 1137, ID 1138, ID 1139).
Central Bank Consults on Enhancements to Stakeholder Engagement
Central Bank proposes enhancements to stakeholder engagement
On 11 February 2021, the Central Bank issued Consultation Paper 136: Enhancing our Engagement with Stakeholders. The consultation includes proposals to enhance the Central Bank's stakeholder engagement in certain areas and will build on existing engagement with relevant stakeholders to facilitate greater discussion of cross-sector, strategic issues that affect the Central Bank's oversight of the financial system. The consultation closes on 11 May 2021.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.