European Union: Funds Quarterly Legal And Regulatory Update, January - March 2021

1. APPROACHING DEADLINES

2. UCITS & AIFMD

2.1. ESMA launches common supervisory action on costs and fees of UCITS

On 6 January 2021, the European Securities and Markets Authority (ESMA) launched its Common Supervisory Action (CSA) with national competent authorities (NCAs) on the supervision of costs and fees of UCITS across the EU. The CSA will also address the use of entities employing efficient portfolio management (EPM) techniques to assess whether they adhere to the requirements set out in the UCITS framework and ESMA Guidelines on ETFs and other UCITS issues.

As part of this CSA, the Central Bank of Ireland (CBI), along with other EU NCAs, issued both a qualitative and quantitative questionnaire to certain UCITS management companies in March 2021 with such UCITS management companies being required to complete these questionnaires by 31 March 2021.

The aim of the CSA is to assess the compliance of supervised entities with; (i) the relevant cost-related provisions in the UCITS framework, and (ii) the obligation of not charging investors with "undue costs". The CSA will be conducted with reference to the ESMA supervisory briefing on this topic, published on 4 June 2020, in which ESMA provided guidance to NCAs on the notion of "undue costs" which it noted had been interpreted differently across the EU. It also provided guidance on how to supervise UCITS management companies and AIFMs to ensure that end investors are not subject to any such "undue costs". The briefing indicated that "In order to allow NCAs to appropriately supervise that investors are not charged with undue costs, NCAs are expected to require that management companies develop and periodically review a structured pricing process" which addresses ten specific elements identified therein (paragraph 19). A copy of the ESMA supervisory briefing of 4 June 2020 can be accessed here.

The briefing paper also includes elements to be taken into account by NCAs for the purpose of their supervision of the duty to prevent undue costs being charged to investors.

An ESMA press release on the CSA can be accessed here.

2.2. ESMA publishes final report on draft ITS under Cross Border Distribution Regulation

On 29 January 2021, ESMA published its final report on draft implementing technical standards (ITS) under the Regulation on cross- border distribution of funds ((EU) 2019/1156) (Cross Border Distribution Regulation)(Report).

The ITS address the publication of information by NCAs on their websites regarding the national rules governing marketing requirements for funds and the regulatory fees and charges levied by NCAs relating to fund managers' cross-border activities. It also addresses the information to be provided by NCAs to ESMA to enable ESMA, with effect from 2 February 2022, to publish and maintain a central database of UCITS and alternative investment funds (AIFs) marketed cross-border.

The ITS have been submitted to the European Commission for endorsement. Once adopted by the European Commission, the ITS will enter into force on the twentieth day following their publication in the Official Journal of the EU (OJ).

The majority of the provisions of the ITS, the Cross Border Distribution Regulation and the Directive with regard to cross-border distribution of collective investment undertakings ((EU) 2019/1160) (Cross Border Distribution Directive), are due to apply from 2 August 2021. Whilst Member States are required to transpose the Cross Border Distribution Directive into national law by this date, Ireland has not yet issued the draft implementing legislation to do so.

The Report can be accessed here.

2.3. Update - Cross Border Distribution Regulation and the Cross Border Distribution Directive due to apply from 2 August 2021

The Cross Border Distribution Regulation and the Cross Border Distribution Directive are due to apply from 2 August 2021. They contain new requirements applicable to UCITS Management Companies/AIFMs (Management Companies) in relation to the marketing and distribution of UCITS and AIFs. More generally, readers should be aware that these include:

• Rules governing marketing communications: the Cross Border Distribution Regulation sets down specific conditions that all marketing communications addressed to investors must comply with. These include an obligation to ensure that all information contained in marketing communications is fair, clear and not misleading. Marketing communications will also need to comply with ESMA's finalised guidelines on marketing communications under the Cross Border Distribution Regulation which are expected enter into force on 2 August 2021 (ESMA Marketing Guidelines which can be accessed here).
• Introduction of pre-marketing requirements for AIFMs: the Cross Border Distribution Directive introduces a new concept of "pre-marketing" for EU AIFMs (whereby an EU AIFM can test investor appetite for a particular investment idea or investment strategy) and sets down the conditions under which an EU AIFM can engage in pre-marketing.
• De-Registration Requirements: the Cross Border Distribution Directive introduces new rules which must be followed by Management Companies where a decision has been taken to discontinue the marketing of a fund in an EU jurisdiction. These include for example an obligation to make public the intention to terminate marketing arrangements in the relevant jurisdiction.
• Facilities for retail investors: under the new framework, AIFM which are marketing shares of an AIF to a retail investor must now provide local facilities to such investors, in line with the revised requirements which are also applicable to UCITS management companies.

Whilst Member States are required to transpose the Cross Border Distribution Directive into national law by 2 August, 2021, Ireland has not yet issued the draft implementing legislation to do so.

The text of the Cross Border Distribution Regulation can be accessed here.

The text of the Cross Border Distribution Directive can be accessed here.

2.4. CBI publishes final Guidance on Share Classes in Closed-Ended Funds

On 2 February 2021, the CBI published its finalised guidance on share class features of closed-ended QIAIFs (Guidance). The Guidance was issued following the publication of the CBI's Consultation Paper 132 on the Guidelines, in November 2020.

On the same date, the CBI published its feedback statement on the Guidance which provides the rationale for some of the positions taken by the CBI in the finalised text (Feedback Statement).

While this will be of relevance to closed-ended ILPs, the Guidance will also apply to closed-ended QIAIF established as ICAV, investment company, unit trusts and CCF.

The Guidance can be accessed here.

The Feedback Statement can be accessed here.

2.5. CBI publishes Guidance on Real Asset Depositaries

On 2 February 2021, the CBI published Guidance on Depositaries for AIFs under Regulation 22(3)(b) of the AIFM Regulations (Depositaries of Assets other than Financial Instrument or DAoFI) (Guidance). These types of depositaries are generally referred to as "Specialised Depositaries" or "Real Asset Depositaries". This follows the issue by the CBI of a Notice of Intention in November 2018, whereby the CBI had proposed a regulatory framework for entities applying to act as DAoFI under Regulation 22(3)(b) of the AIFM Regulations.

The Guidance sets out the requirements for authorisation as a DAoFI as follows:

• The eligible firm must be incorporated in Ireland and authorised as an investment firm pursuant to the Investment Intermediaries Act 1995, and must fulfil certain procedural and oversight standards to satisfy the CBI of its suitability;
• The firm must comply with certain AIF Rulebook requirements;
• The firm must meet certain capital requirements;
• The firm must hold a certain level of professional indemnity insurance cover;
• A DAoFI can only act as a depositary for certain AIFs, namely those 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.
  Where the firm invests in financial instruments subject to custody obligations, the DAoFI must either appoint a sub-custodian or hold additional capital;
• Although the CBI does not propose to establish an exhaustive list of assets which would automatically be acceptable for a DAoFI to safe-keep, wine. A list of asset classes will be available in a CBI Q&A and will be updated from time to time;
• In all cases, a DAoFI must provide satisfactory evidence to the CBI of its capacity to safe-keep and provide ongoing monitoring of the assets for which it will provide services;
• A DAoFI may only be appointed to authorised AIFs which are Qualifying Alternative Investor AIFs; and
• The firm will be subject to certain investor disclosure obligations, such as the limited nature of the DAoFI's activities and the standard of liability applicable to its activities.

The DAoFI will complement the renewed Investment Limited Partnership fund product. Both are central to the further growth of Ireland as a domicile for private equity and real estate funds in particular, as well as other funds investing in illiquid or less liquid assets.

The Guidance can be accessed here.

2.6. ESMA publishes results of its common supervisory action on UCITS liquidity risk management and the CBI issues a letter on the importance of effective liquidity risk management to fund management companies

On 24 March 2021, ESMA published a statement outlining its findings from the CSA action conducted by it and each of the EU competent authorities on liquidity risk management (LRM) in UCITS management companies in 2020 (Statement).

While it found that in most cases UCITS management companies were complying with their regulatory obligations under the UCITS framework and have adopted "sufficiently sound" LRM processes, it has identified some shortcomings in the LRM arrangements of certain UCITS management companies.

In addition, on 10 March 2021, the CBI issued a letter to certain "fund management companies" (Letter) with corporate bond funds under management reminding them of the importance of effective LRM and ensuring compliance with relevant legislative and regulatory obligations for UCITS and AIFs. Whilst the Letter was addressed to that specific cohort of management companies, when publishing the Letter, the Central Bank noted that the findings outlined in the Letter more broadly are important and should be noted by all management companies.

Dillon Eustace has prepared a briefing entitled "Liquidity Management: The Regulatory Spotlight Remains" on the implications of the Statement and the Letter, which can be accessed here.

The Statement can be accessed here.

The Letter can be accessed here.

2.7. ESMA updates UCITS and AIFMD Q&As on performance fee guidelines

On 30 March 2021, ESMA updated each of its Questions and Answers documents on the application of the UCITS Directive (ESMA UCITS Q&A) and the AIFMD (ESMA AIFMD Q&A) to incorporate two new Q&As on its guidelines on performance fees in UCITS and certain types of AIFs (Guidelines).

These are incorporated as a new Section XI in the ESMA UCITS Q&A and as a new Section XV in the ESMA AIFMD Q&A. The UCITS Q&A and AIFMD Q&A each confirm that in ESMA's view, the Guidelines do not prevent a performance fee from being crystallised in the first years of a fund's existence. Under the Irish regime, the ESMA AIFMD Q&A will only relate to RIAIFS which charge performance fees. In addition, the new Q&As also deals with the application of certain requirements set out in the ESMA "Guidelines on performance fees in UCITS and certain types of AIFs" (ESMA Guidelines) which relate to a "performance reference period" of 5 years. This is not relevant to Irish UCITS or AIFs as the Irish model does not currently allow negative performance to be cleared after a period of 5 years.

The ESMA AIFMD Q&A also addresses the scope of the application of the Guidelines to European Long-Term Investment Funds (ELTIFs). The Q&A confirms that to the extent that an ELTIF is (i) marketed to retail investors, (ii) is not a closed-ended structure and (iii) is not a venture capital/private equity or real estate AIF, it must comply with the provisions of the ESMA guidelines.

The updated ESMA UCITS Q&A can be accessed here.

The updated ESMA AIFMD Q&A can be accessed here.

2.8. CBI updates Q&A on AIFMD

On 1 April 2021, the CBI published the thirty-eighth edition of its AIFMD - Questions and Answers" (CBI AIFMD Q&A). It contains new Q&As as follows:

• a new Q&A at ID 1141 which relates to raising capital from investors by way of a shareholder (unitholder) loan. The Q&A states that the CBI does not consider that such arrangements are in principle consistent with the objective of collective investment on behalf of an authorised AIF's members (investors). The Q&A further sets out the CBI's expectations in this regard. The CBI notes that it may revisit this matter during future public consultations.
• a new Q&A at ID 1142 which relates to whether or not an authorised AIF can enter into transactions with its investors. The Q&A states that the AIF Rulebook does not envisage that such transactions would take place, therefore the AIF Rulebook does not currently apply rules which relate to transactions with connected parties to transactions with investors. The CBI notes that it may revisit this matter during future public consultations.

The new Q&A at 1140 confirms the scope of the defined term "issuing body" in relation to the AIF Rulebook

This new Q&A also includes Q&As introduced as part of the thirty-seventh edition AIFMD Q&A (2 February 2021) which address the authorisation of DAoFI (ID 1136, ID 1137, ID 1138 and ID 1139)

The thirty-eighth edition CBI AIFMD Q&A can be accessed here.

2.9. CBI publishes final Guidance on performance fees of UCITS and certain types of retail investor AIFs

On 1 April 2021, the CBI published final Guidance on performance fees of UCITS and certain types of Retail Investor AIFs (CBI Guidance). The CBI Guidance incorporates, to the extent currently possible and practicable, the ESMA "Guidelines on performance fees in UCITS and certain types of AIFs" (ESMA Guidelines) into the CBI's regulatory framework.

The CBI Guidance applies to UCITS and to Retail Investor AIFs other than those Retail Investor AIFs that are closed-ended and open- ended Retail Investor AIFs that have been established as EuVECA, EuSEF or follow venture capital, private equity or real estate strategies.

The CBI Guidance applies at fund level. New classes within an existing in-scope fund with performance fees availing of the transition period shall continue to comply with the regulatory regime that applies to other classes within the fund.

Where the CBI Guidance is being applied in the context of a UCITS, responsibility for compliance with the CBI Guidance rests with the UCITS management company, or in the case of self-managed UCITS, the UCITS itself. Where the CBI Guidance is being applied in the context of a Retail Investor AIF, responsibility rests with the Retail Investor AIF.

The date of application for the CBI Guidance is as follows:

• for in-scope funds which are established or which amend or introduce a performance fee on or after 5 January 2021, the CBI Guidance applies from the date of establishment, amendment or introduction; and
• for in-scope funds with existing performance fees as at 5 January 2021, the CBI Guidance will apply from the beginning of the accounting period, which occurs six months after the Effective Date (5 July 2021). The CBI has explained in a footnote to the Guidance that for a fund with an accounting period ending on 31 December 2021, that fund must comply with the CBI Guidance for the financial period beginning on 1 January 2022 and that for a fund with an accounting period ending on 30 September 2021, the CBI Guidance must be complied with from 1 October 2021.

On the same day, the CBI also published its Feedback Statement on its Consultation Paper 134 on the Guidance (Feedback Statement). The Statement sets out the CBI's feedback to the one response received to its consultation. Retail AIFS marketing to Irish retail investors will also be required to comply with the Guidance.

The CBI Guidance can be accessed here.

The ESMA Guidelines can be accessed here.

The Feedback Statement can be accessed here.

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