1 Legal & Regulatory
1.1 UCITS and AIFMD Costs and Fees
Fees and costs in UCITS and AIFs continues to be, a key priority at a European level - most recently evidenced by the issuance of the ESMA Opinion on undue costs of UCITS and AIFs, published 17 May 2023 (the "ESMA Opinion").
By way of background, ESMA published a Supervisory Briefing back in June 2020 on the supervision of costs in UCITS and AIFs in which it identified the significant impact of costs on the final returns for investors, as well as noting that there was a lack of convergence on the way the notion of "undue costs" is interpreted across the EU.
In January 2021, ESMA launched a Common Supervisory Action ("CSA") with national competent authorities ("NCAs") on the supervision of costs and fees of UCITS across the EU / EEA. The CSA's aim was to "assess, foster and enforce the compliance of supervised entities with key cost-related provisions in the UCITS framework, in particular the obligation of not charging investors with undue costs".
ESMA has suggested clarifications to the legislative provisions under the UCITS Directive and the AIFMD relating to the notion of undue costs. The proposed clarifications include an obligation on fund management companies to act in such a way to prevent undue costs being charged to a fund and its investors and to develop a pricing process. More significantly, the proposals would obligate managers to indemnify investors where undue costs have been charged.
This follows on from the Dear CEO letter from the Central Bank of Ireland (the "Central Bank") of 24 March 2023, which we noted in our Q1 update, which requires fund management companies to conduct a gap analysis of the findings / expectations contained in the letter (e.g. annual review of costs and fees, formal pricing policies and procedures) and, where appropriate, put a plan in place by 30 September 2023 to address any gaps identified.
For further information please see our client update, Central Bank of Ireland Findings Following EU Review of Costs and Fees in UCITS.
1.2 Provisional Agreement for AIFMD 2.0
On 20 July 2023, the European Parliament, Council and Commission, the European Council and European Parliament announced their provisionally agreed position on proposed amendments to AIFMD. The final text will not be available for some time, as such the new requirements are subject to the final text when published (expected to be November), and there may still be some finer details to be worked out. Thereafter allowing for an implementation period for member states, it may be late 2025 or early 2026 before it comes into force. From what we are aware the headline points are set out below.
- Delegation: It has been recognized that delegation can be highly beneficial to investors, by allowing the AIF to access global expertise. However, there will be greater substance / oversight and reporting requirements for AIFMs both on authorisation and thereafter - regular reporting will be required on both the amount and percentage of assets under delegation.
- Loan Originating AIFs (LO-AIFs)
There will be a new European regime for loan origination by funds. We understand that the legislation should also make clear LO-AIFs can engage in cross border lending in the EU, and albeit by default are closed-ended, they may be opened-ended in certain circumstances. Some of the notable features of the new regime include:
a) Risk Retention: There will be a risk retention requirement (i) until maturity, for (x) loans up to eight years or (y) loans to consumers and (ii) at least eight years for loans of longer maturity. There will be derogations for compliance with product requirements and cases where risk associated with a loan deteriorates.
b) Definition of a LO-AIF: a LO-AIF will be in scope of the requirements when the investment strategy of the fund is mainly to originate loans and / or when the notional value of the AIF's originated loans represents at least 50% of NAV.
c) Leverage Limits: There will be differing limits for open-ended and closed-ended loans after discussion on what the limits will be and the methodology to calculate same it appears the parties settled on using the commitment approach only, with respectively 175% NAV for open-ended AIFs and 300% closed-ended AIFs. Subscription line financing would not count towards the limits and there will be flexibility to rectify unintentional breaches of the limits beyond the AIFM's control.
d) Shareholder Loans: Funding portfolios by debt, i.e. a fund lending to a company it has equity / voting rights by way of loan rather than note, will be permitted and not subject to the LO-AIF requirements up to 150% of the AIF's capital.
- White Label Products, i.e. products using a
hosted / third-party ManCo, – there will be a limited
amendment in the operative part of the Directive requiring
increased conflicts obligations, and regulatory
transparency/investor disclosure around same.
- Sustainability - the prevailing view is that this should be addressed 'horizontally', i.e. cross sectoral rather than in individual pieces of legislation, to prevent fragmentation. So it is expected that rather than have material new provisions added to AIFMD, this will be addressed as part of Sustainable Finance Disclosure Regulation ("SFDR") more generally. AIFMs will have to add some detail in their programme of activity to demonstrate compliance with certain specific obligations (e.g. regarding website disclosure, integrating sustainability risks into investment decisions and marketing communications)
For more information, please see our update, A Step Closer to AIFMD 2.0.
1.3 Updates to the ESMA Q&As
On 14 June 2023, ESMA updated its Q&A on the application of the AIFMD and its Q&A on the application of the UCITS Directive ("Q&A"). The purpose of the Q&As is to promote common supervisory approaches and practices in the application of the AIFMD and UCITS frameworks and their respective implementing measures.
Cross Border Marketing: In both Q&As, ESMA confirmed as follows:
- It is not possible to passport 'ancillary' services such as administration or marketing services into a host Member State without also passporting the investment management function.
- The de-notification obligations set down in Article 32a(1) of AIFMD and Article 93a(1) of the UCITS Directive must be complied with by an AIFM or UCITS management company in circumstances even where there are no investors in a host Member State. ESMA confirms that the sole exception to this requirement arises in the case of closed-ended ELTIF funds.
The revised Q&A on the application of the AIFMD confirms as follows:
- ESMA confirms that when calculating the leverage of an AIF real estate fund (being one whose core investment policy is to invest in real estate directly or indirectly), the AIFM must include the exposure contained in financial or legal structures involving third parties controlled by the AIF where those structures are specifically set up to directly or indirectly increase the exposure at the level of the AIF.
- Without prejudice to any national rules, registered AIFMs are not subject to / cannot avail of the pre-marketing provisions set down in AIFMD.
- In an earlier Q&A on the application of the AIFMD published by ESMA on 26 May 2023, it also confirmed that non-EU AIFMs cannot carry out pre-marketing activities under AIFMD unless this is permitted under the national laws of an individual Member State.
The Q&A on the application of the UCITS Directive also confirms the following:
- UCITS management companies are permitted to manage AIFs as a 'registered' (or subthreshold) AIFM, i.e. registered under Article 3 of the AIFMD Directive; and
- UCITS management companies are permitted to manage pension schemes under Directive (EU) 2016/2341 (the "IORP Directive") provided that they are authorised by their national competent authority to manage investment portfolios on a mandate basis in accordance with Article 6(3)(a) of Directive 2009/65/EC (the "UCITS Directive").
Access a copy of the most recent Q&A on the application of AIFMD published by ESMA here.
A copy of the ESMA Q&A on the application of the UCITS Directive is available.
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