UCITS V regulation on depositaries’ obligations comes into force
The Commission’s delegated regulation (EU) 2016/438 of December 17, 2015, which updates the UCITS regime provisions on the obligations of depositaries, has taken effect as of October 13. The UCITS V Level 2 regulation sets out detailed uniform rules in particular regarding the duties of the depositaries of UCITS funds.
The regulation lays down requirements regarding depositaries’ duties, delegation arrangements and the liability regime for UCITS assets under custody, designed to provide a high level of investor protection.
Written agreement
To ensure that the depositary performs its duties properly, the regulation provides a detailed list of all the elements to be included in the written depositary contract. It should notably provide adequate detail on the categories of financial instruments in which the UCITS may invest and the geographical regions where investments may be made.
In addition, the contract should set out the escalation procedure to be followed should any discrepancies be detected, including notification of the management company or investment company, and provide for termination of the agreement as a last resort if the depositary believes the required level of investment protection is not ensured.
Depositary’s duties
The regulation states that as a rule, the depositary must perform four types of duty. With regard to oversight, it must ensure consistency between the number of shares or units issued and the subscription proceeds received, ensure that appropriate valuation policies and procedures for the assets of the UCITS are effectively implemented, verify the fund’s compliance with applicable law and regulations as well as its rules and instruments of incorporation, and check that its income is calculated accurately.
As part of its cash monitoring duties, the depositary must maintain a clear overview of all inflows and outflows of cash and maintain periodically updated procedures for monitoring of the UCITS’ cash flows. It should also ensure that all payments made by investors for subscription to the shares or units of the UCITS have been received and booked in one or more cash accounts.
Its safekeeping duties include keeping in custody all financial instruments held by the UCITS that may be registered or held in an account directly or indirectly in the name of the depositary or a third party to which safekeeping functions are delegated. For assets that are not financial instruments subject to custody, such as certain derivatives or cash deposits, the depositary must verify and maintain records of their ownership.
The due diligence duties of the depositary entail implementing and applying a due diligence procedure for the selection and ongoing monitoring of any third party to which safekeeping functions are delegated. The depositary’s obligations correspond to those applicable both to the UCITS itself and to its management company.
Liability for losses
The depositary is liable in the event of loss of a financial instrument held in custody by the depositary itself or by a third party to which safekeeping has been delegated, unless the depositary can demonstrate, by according to a list of conditions, that the loss has resulted from an external event beyond its reasonable control and whose consequences would have been unavoidable despite all reasonable efforts to the contrary.
Operational independence
To ensure the protection of investors, the management company or investment company and the depositary must be operationally independent. Any existing or arising group link between them must be addressed with appropriate policies and procedures.
The measures set out in the Commission’s delegated regulation update the depositary rules in line with the most recent iteration of the retail fund regime, UCITS V, while bringing the UCITS requirements into line with those applicable to alternative funds and their depositaries under the 2011 Alternative Investment Fund Managers Directive.
CSSF confirms AIFs’ ability to grant loans in updated AIFM law FAQ
On June 9, the CSSF issued the latest update of its Frequently Asked Questions document on the grand duchy’s law of July 12, 2013 implementing the AIFMD and the European Commission’s Level 2 regulation on implementation of the directive, last revised on August 10, 2015.
The new version provides clarity about the ability of Luxembourg-domiciled alternative funds to conduct loan origination, participation and acquisition, an important issue given the role of the grand duchy as a leading centre for funds conducting or investing in loans.
The FAQ document, which has now run to 10 versions over the past two-and-a-half years, is intended to highlight aspects of the AIFMD rules from a Luxembourg perspective, for the benefit primarily of alternative funds and fully AIFMD-authorised managers established in the grand duchy. It complements Q&A documents on the AIFMD and its subsidiary legislation published by the European Securities and Markets Authority and by the European Commission.
The FAQs cover issues including the scope of the law, the authorisation and registration regimes applicable to alternative managers, delegation requirements, entry into force of the law and duration of transitional provisions, the scope of authorised managers’ activities, depositary requirements, the application of the AIFMD passport to Luxembourg managers and funds as well as to foreign managers marketing in Luxembourg, reporting, valuation, transaction costs, managers’ capital requirements, marketing and reverse solicitation, notification of investment in non-listed companies, and co-operation agreements signed by the CSSF with non-EU regulators.
Loan business permitted in principle
The new version clarifies that loan origination, participation and acquisition are in principle permissible activities for Luxembourg-domiciled alternative investment funds under the 2013 legislation as well as specific product laws and regulations governing the various fund vehicles designated for AIFs. The granting of loans is also explicitly permitted under certain conditions in the EU regulations governing European Long Term Investment Funds, European Social Entrepreneurship Funds and European Venture Capital Funds.
However, the CSSF says various factors should be considered by an alternative fund or its authorised manager, before and during any loan origination transactions, and the regulator will consider these aspects on a case-by-case basis as part of its process of authorisation and ongoing supervision of the AIFM and where appropriate the fund.
All general requirements for AIFMs with regard to the AIFs they manage under the 2013 legislation according to the Law of 2013 apply in the case of loan origination, participation or acquisition, as well as any particular requirements on the fund arising from relevant product laws or regulations.
Organisation and governance
The CSSF says the AIFM or where relevant the fund should ensure to address all aspects and risks of lending activity. In addition, they should have in place proper organisational and governance structures, processes and procedures; expertise and experience in origination, participation or acquisition activity plus the necessary technical and human resources, with a focus on credit and liquidity risk management within an overall risk management process; concentration and risk limitation mechanisms; clear policies regarding assets and investors such as loan and investor categories and avoidance of conflicts of interest; proper disclosure and transparency.
It is the responsibility of the AIFM or AIF itself to ensure the implementation of an appropriate approach for lending activity, to be evaluated by the regulator as part of its authorisation and ongoing supervision process.
ESMA prefers closed-ended loan funds
The CSSF’s guidance follows the issue by the European Securities and Markets Authority on April 11 of its opinion on key principles for a European framework on loan origination by funds for the European Parliament, Council and Commission, taking into account the existing approach of various member states. ESMA says a common EU framework would help create a level playing field in the sector and curb opportunities for regulatory arbitrage, and in turn encourage increased loan origination by investment funds.
ESMA notably says that because of the illiquid nature of loans, it believes loan-originating funds should be set up as closed-ended vehicles that do not offer investors the right to redemption of units on a regular basis. However, the authority says that provided certain conditions are fulfilled, the opportunity for repayment by the fund at the recommendation of its manager could be offered to investors on a non-preferred and equal basis during the life of the AIF. This could take place at fixed intervals, on the same lines at the procedures set out in the ELTIF Regulation.
The latest edition of the CSSF’s AIFMD FAQs can be consulted at http://www.cssf.lu/fileadmin/files/AIFM/FAQ_AIFMD.pdf. ESMA’s opinion on key principles for a European framework on loan origination by funds is available at https://www.esma.europa.eu/sites/default/files/library/2016-596_opinion_on_loan_origination.pdf.
UCITS V legislation to come into force in Luxembourg in June
Luxembourg’s Chamber of Deputies has approved legislation incorporating the European Union’s UCITS V directive into national law, following a legislative odyssey lasting just over nine months. Bill of law no. 6845 amends the grand duchy’s fund legislation of December 17, 2010, which transposed UCITS IV, and was finalised by publication on May 12 in the Mémorial, the country’s official journal, as the Law of May 10, 2016, the day it was signed by Grand Duke Henri. The legislation will come into force at the beginning of June.
The main changes brought by the new legislation affect depositary functions, remuneration policies and sanctions applicable to the management of UCITS funds, bringing the UCITS regime into line with that governing alternative funds.
It enshrines the responsibility of depositaries for the assets they oversee, sets out rules to ensure that remuneration structures do not incentivise portfolio managers or other key employees to take inappropriate risks, and sets out a framework of sanctions for breach of the rules.
In addition, the law makes non-UCITS funds established under Part II of the fund legislation also subject to the UCITS V depositary requirements, rather than the rules applicable to alternative fund managers under Luxembourg’s law of July 12, 2013, which transposed the Alternative Investment Fund Managers Directive, or those set out in Circular 91/75 issued by the grand duchy’s financial regulator, the Financial Sector Advisory Authority (CSSF).
Part II funds are now subject to the more stringent UCITS depository rules irrespective of whether the assets overseen by their managers are above or below the threshold set out in the AIFMD. The Law of May 10, 2016 also amends the 2013 legislation by requiring an independent audit of alternative investment fund managers’ accounting documents and providing clarification on rules governing the provision of non-core services on a cross-border basis.
The passage of the Luxembourg law follows the issue by the European Commission on March 24 of a level 2 delegated regulation supplementing the UCITS V directive. The key provisions include:
• The regulation sets out minimum requirements for written agreements between the investment company or management company and the depositary for each fund run by the management company.
• It adds details regarding duties of the depositary including oversight, cash monitoring, safekeeping of custody and other assets, due diligence in selecting and appointing third parties, and segregation and insolvency protection of UCITS assets when delegating custody. The insolvency protection requirement, new to EU fund rules, requires the depositary to obtain legal assurance that in the event of insolvency of a third-country custodian, the UCITS assets may not be used to pay the custodian’s creditors.
• The regulation defines the conditions and circumstances, first set out in the AIFMD, in which financial instruments held in custody are considered lost and what constitutes a force majeure event that would relieve the depositary of liability.
• It clarifies independence requirements for management companies, investment companies, and depositaries, including rules on composition of the management body of the management or investment company as well as the depositary and any sub-custodians. Additional rules apply when an ownership link exists between the management or investment company and the depositary.
The Commission’s delegated regulation came into force on April 12 and will be applicable from October 13 this year.
The full text of the Law of May 10, 2016 can be viewed at: http://www.cssf.lu/fileadmin/files/Lois_reglements/Legislation/Lois/L_100516_OPCVM.pdf
The Commission’s delegated regulation is available at:
http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=OJ%3AJOL_2016_078_R_0004&from=EN
Proposed Luxembourg legislation introduces changes affecting SIFs, SICARs and Part II UCIs
The Luxembourg government has placed before parliament on January 18 draft legislation amending provisions relating to specialised investments funds (SIFs), risk capital investment companies (SICARs) and non-UCITS funds issued under Part II of the grand duchy’s collective investment fund legislation. The proposals would notably restrict SIF funds and sub-funds that invest in so-called exotic assets to professional investors, a tighter definition than that for eligibility for SIF investments in general.
Under the SIF law of February 13, 2007, specialised investment funds may invest in virtually any type of asset class, including illiquid and other assets that are hard to value. Investment is restricted to three categories of ‘well-informed investor’, including professional investors as defined by appendix II to the EU’s MiFID II directive and institutional investors. Under existing administrative practice of Luxembourg’s Financial Sector Supervisory Authority, the latter may include professionals who manage significant volumes of assets but are not subject to specific financial services legislation.
In addition, other investors are eligible to invest that qualify neither as institutions nor professional investors, but that declare in writing their well-informed status, invest a minimum of €125,000 in the SIF, or are certified by a bank or fund management company as possessing the expertise, experience and knowledge to be able to appraise investment in the SIF adequately.
The proposed changes to the eligible investment rules for SIFs would restrict to professional investors alone the ability to invest in SIFs or compartments that hold non-traditional assets, including wine, diamonds, insurance contracts, economic rights to sports professionals, art and animals.
As a standard rule, such SIFs must ensure that their investors all qualify as professional investors and any existing vehicles must of need be redeem the shares, units or interests of other types of investor. The legislation would authorise the CSSF to grant derogations to SIFs that invest in exotic assets and whose constitutional documents allow investment by non-professional investors, but there are no transitional arrangements foreseen for Funds that do not benefit from such an exemption.
The legislation also includes amendments to the SICAR law of June 15, 2004 to bring it into line with the SIF legislation as well as with changes to company law, especially the introduction of special limited partnerships and changes to the provisions applicable to common limited partnerships as part of the AIFMD implementation law of July 12, 2013.
The changes mostly correspond to existing practice, and include prohibiting the issuance of interests when a SICAR is in the process of liquidation; enabling the CSSF to remove the authorisation of an individual SICAR compartment, but not the structure as a whole; requiring a SICAR to be authorised before launching activities and requiring its management body as well as portfolio managers to meet suitability tests; requiring notification of substantive changes, including to key personnel; confirming the CSSF’s ability to order the suspension of a SICAR’s redemptions in the interests of investors; enabling the regulation to impose financial penalties on the management board, managers and officers of a SICAR, as well as on service providers; and confirming that non-cash investments in a SICAR are subject to a report from a statutory auditor.
Requirements on a SICAR to establish a risk management system and other stipulations with regard to delegation will be subject to a transition period up to the end of this year.
The draft bill also removes a requirement that undertakings for collective investment subject to part II of Luxembourg’s investment fund law of December 17, 2010, which implemented the UCITS IV directive into national legislation, must issue units at net asset value, plus commission and expenses.
The legislation would allow constitutional documents of a Part II fund to set different rules determining the issuance price per unit. For instance, alternative funds investing in private equity or real estate could issue units at a fixed price, with an equalisation mechanism established on a contractual basis applicable to the issue of units to subsequent investors.
RAIF: unregulated funds coming soon to Luxembourg
At its meeting on November 27 the Luxembourg government formally approved draft legislation creating a new type of fund vehicle, the reserved alternative investment fund (fonds d’investissement alternatif reservé). The most important characteristic of the RAIF (or FIAR, its French acronym) is that it is not subject to regulation by the Financial Sector Supervisory Authority (CSSF), although it must have an authorised manager. Further details of the fund and its requirements will become clear once the parliamentary bill has been published.
In a statement, the government says it is designed to benefit from the structuring flexibility of non-UCITS collective investment vehicles, specialised investment funds (SIFs) and risk capital investment companies (SICARs). However, the system of dual supervision of managers and funds applicable to these vehicles, which adds costs and places restrictions on the management of the funds, may not be necessary or desired by institutional and professional investors.
What kind of investors may place money in RAIFs?
The RAIF is restricted to sophisticated, institutional and professional investors, and are subject to a minimum investment of €125,000.
What advantages does the RAIF offer?
The RAIF is based on the alternative investment fund regime established by the European Union’s Alternative Investment Fund Managers Directive and its application in Luxembourg to specialised investment funds. However, it is designed to speed up time to market through the absence of a requirement for authorisation or ongoing supervision by the CSSF. This means that future changes to the fund’s constitutional, information or other documents, will not require regulatory approval.
Must a RAIF have a manager established and regulated in Luxembourg?
No. There is no requirement for a Luxembourg-based manager, but it must have an alternative investment fund manager authorised under the AIFMD and domiciled in a European Economic Area member state in order to benefit from the AIFM’s marketing passport.
Are there restrictions on the kind of strategy a RAIF may follow?
With the reservation that the terms of the legislation have not yet been published, it appears that the manager of the RAIF may follow any kind of investment strategy, with no restrictions regarding eligible assets. RAIFs whose investment policy is restricted to risk capital investments will not be required to follow risk-spreading rules.
What kind of tax treatment will RAIFs receive in Luxembourg?
RAIFs will enjoy the same tax treatment as SIFs, paying an annual subscription tax amounting to 0.01% of its net assets but enjoying complete exemption from corporate income tax or withholding tax on the distribution of returns, whether in the form of dividends or interest income. RAIFs limited to risk capital investments will be subject to the same tax regime applicable to SICARs.
What kind of structure can a RAIF take?
Like SIFs and SICARs, RAIFS can take any corporate or contractual legal form, including a public limited company, partnership limited by shares, or common or special limited partnership.
Is the RAIF more attractive than Ireland’s new ICAV for targeting US investors?
The ICAV is a regulated fund vehicle, unlike the RAIF, with the attendant costs and time requirements. When structured as a partnership limited by shares (SCA), the RAIF may, like the ICAV, elect treatment as a partnership for US tax purposes. This is important for hedge funds marketed to US taxpayers, since it allows the use of master-feeder structures.
Can a RAIF have multiple compartments?
Yes, it appears that a RAIF can be created as an umbrella structure with multiple sub-funds, as well as multiple share classes.
When is the draft legislation likely to become law?
Now that the law has been approved by the government, it will be introduced to the lower house of Luxembourg’s parliament, the Chamber of Deputies, for debate and approval. Although the bill has not yet been published, current estimates suggest enactment of the legislation could take place by the second quarter of next year.
ESMA issues additional updates to AIFM Directive Q&A
The European Securities and Markets Authority has issued a fresh update on October 1 to its Questions and Answers document providing guidance and interpretation of the EU’s Alternative Investment Fund Managers Directive as well as the European Commission’s level II delegated regulations on implementation of the directive issued in December 2012 and May 2013.
The Q&A document, first issued in February 2014 and since updated nine times, aims to promote common supervisory approaches and practices in the practical application of the AIFMD and its implementing measures through responses to questions posed by the general public and regulators themselves. It complements a Q&A document on the AIFMD published by the European Commission.
The ESMA Q&A covers remuneration, notification of alternative investment funds and their managers, reporting to national regulators, services covered by MiFID, depositaries, calculation of leverage, delegation, calculation of assets under management, additional own funds, and scope of the authorisation requirement.
The latest version contains just a single new question, regarding depositaries. ESMA says that when fund assets held in custody by the fund’s depositary are provided to an EU or third-country central securities depositary as defined under Regulation (EU) No 909/2014 (CSDR) to be held in custody in accordance with AIFMD Article 21(8), the CSD must comply with the provisions on delegation set out under the directive’s Article 21(11).
The previous update, issued on July 21, covered reporting to national regulators and calculation of the total value of assets under management:
• When a non-EU AIFM reports information to the regulator of an EU member state under Article 42, only funds marketed in that member state need to be taken into account. Where EU members apply ESMA’s opinion on collection of additional information under Article 24(5), managers should also report on non-EU master funds, even if not not marketed in the EU, if they have either EU feeder funds or non-EU feeders marketed in the EU under Article 42.
• To convert the total value of assets under management into euros, AIFMs should take the rounded values of the funds in their base currency and divide them by the corresponding value of one euro into the base currency of the funds. For example, if the base currency of a fund reporting for the March 31, 2015 period is the US dollar, using the ECB rate AIFMs should divide the rounded US dollar value of the fund by 1.0759, the spot rate on that date. ESMA says AIFMs should report the rounded values in the base currency as well as in euros in questions 33 and 34 of the consolidated reporting template for AIFM-specific information and in question 48 for AIF-specific information. They should also report the value of the exchange rate used for the conversion in question 37 of the template for AIFM-specific information and in question 50 for AIF-specific information.
• Since the procedure for first reporting of funds should be the same as for first reporting of managers, according to ESMA’s guidelines on reporting obligations, AIFMs should not report any information on AIFs for the reporting period during which they were created. However, ESMA has clarified that AIFMs should include AIFs created during the reporting period in their total value of assets under management for the period. In this case, the total value of assets for the manager at the reporting date will not match the sum of assets for its funds.
• ESMA says AIFMs should include short non-derivative positions for the calculation of the total value of assets under management, under Article 2(1)(b) of the implementing regulation, which says AIFMs should include assets acquired through leverage.
Luxembourg moves ahead with UCITS V adoption
Luxembourg is pushing ahead with legislation to adopt the UCITS V directive into national law. Bill no. 6845, transposing Directive 2014/91/EU of July 23, 2014, was approved by the cabinet on July 10 and placed before parliament on August 5. It is expected to be debated and adopted during the fourth quarter of the year.
The legislation amends directive 2009/65/EC (UCITS IV) on co-ordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities with regard to depositary functions, remuneration policies and sanctions.
The Luxembourg bill contains significant amendments to the investment funds law on December 17, 2010 on undertakings of collective investment and the law of July 12, 2013, adopting into the national law the EU’s Alternative Investment Fund Managers Directive. The AIFMD is the source of many of the UCITS V provisions and one of the new directive’s main aims is to bring the two regimes into line regarding depositary rules, remuneration and sanctions provisions.
The preamble to the legislation states that its main purposes are to define clearly the tasks and responsibilities of UCITS depositaries, including clarification of their responsibility for safekeeping of assets, set out rules on remuneration policies designed to curb incentives for excessive risk-taking by portfolio managers and others, and harmonise administrative penalties for breaches of the rules applicable to both funds and their managers.
The bill, which faithfully follows the language of the UCITS V directive, also proposes separate changes to the December 2010 legislation, notably to apply the UCITS V depositary rules to non-UCITS funds established under Part II of the Luxembourg fund law. At present the depositary rules applicable to Part II funds are those set out in CSSF Circular 91/75 if the fund’s assets are below the AIFMD threshold.
It also introduces additional amendments to the 2013 AIFMD implementation law, requiring alternative managers to have their accounts audited by a certified auditor, as is now the case for UCITS management companies.
In addition, authorised AIFMs may henceforth provide non-core investment services, such as discretionary individual portfolio management or investment advice, on a cross-border basis subject to the notification requirements. This amendment implements changes to the AIFMD introduced by the MiFID II directive of May 15, 2014.
CSSF clarifies marketing rules in updated AIFMD law Q&A
On August 10, the CSSF issued the latest update of its Frequently Asked Questions document on the grand duchy’s law of July 12, 2013 implementing the AIFMD and the European Commission’s Level 2 regulation on implementation of the directive, last revised on December 29, 2014.
The FAQ document has now run to nine versions over the past year and a half. Its aim is to highlight aspects of the AIFMD rules from a Luxembourg perspective, for the benefit primarily of alternative funds and managers established in the grand duchy. It complements Q&A documents on the AIFMD published by ESMA, itself most recently updated last month, and by the European Commission.
The FAQs cover issues including the scope of the law, the authorisation and registration regimes applicable to alternative managers, delegation requirements, entry into force of the law and duration of transitional provisions, the scope of authorised managers’ activities, depositary requirements, the application of the AIFMD passport to Luxembourg managers and funds as well as to foreign managers marketing in Luxembourg, reporting, valuation, transaction costs, managers’ capital requirements, and co-operation agreements signed by the CSSF with non-EU regulators.
The new version most notably aims to provide clarity on how marketing and reverse solicitation are understood by the CSSF. The regulator says that since there is no guidance on European level regarding exactly what marketing consists of, the views of different EU regulators may vary, and the same applies to “reverse solicitation” or “passive marketing”, activities to which the AIFMD marketing rules do not apply.
Luxembourg’s 2013 legislation defines marketing as a direct or indirect offering or placement at the initiative of the manager or on its behalf of units or shares of an alternative investment fund it manages to or with investors domiciled or with a registered office within the EU. Marketing takes place when the fund, the manager or an intermediary seeks to raise capital by actively making fund shares or units available for purchase by a potential investor.
The CSSF says merely presenting draft documentation on a fund to prospective investors does not in itself constitute marketing, provided that the documents cannot be used to make a formal subscription or investment commitment. The manager may present documents to potential investors even before the regulator has received notification, although no subscriptions can be validly made until it has been duly informed. However, once such documentation has been provided to investors the manager can no longer claim that an investment is the product of reverse solicitation.
Marketing consists of any offering or placement manifested by means such as advertising, distribution of documentation to prospective investors, roadshows or distance marketing, the CSSF says, provided that investors receive material allowing them to make a formal subscription or commitment.
Marketing in Luxembourg does not require a physical presence by the manager on the territory of the grand duchy; it can be carried out by Luxembourg-based intermediaries such as management companies, banks or financial sector professional entities that are authorised to do so. The activity must take place on national territory in order to qualify as marketing in Luxembourg.
Distance marketing means such as telephone or web site, qualifies as marketing in Luxembourg when the investors are domiciled or have their registered office in Luxembourg, without requiring the simultaneous presence in the grand duchy of the fund, the manager or an intermediary, and the investor, if the materials in question can be used by the investor to make a formal subscription or commitment.
The regulator says reverse solicitation occurs where the manager provides information regarding a fund and/or makes its units or shares available for purchase at the initiative of an investor or their agent, without any solicitation by the fund, manager or any intermediary acting on their behalf. The manager has the burden of proving reverse solicitation, for example through a written declaration by the investor that they have sought information on or decided to invest in the fund in question at their own initiative.
The CSSF says three cases that do not constitute marketing are investments in alternative funds under discretionary individual investment mandates; proposals to invest in funds at the initiative of an adviser under an investment advisory agreement; and investments by alternative or other funds in AIFs at the initiative of the fund, its management company, AIFM or portfolio manager. Nor does marketing include secondary trading of fund units or shares, except in the case of an indirect offering or placement via intermediaries at the initiative or on behalf of the manager or fund.
Other issues dealt with by the latest update to the CSSF Q&A include:
• Credit institutions and investment firms cannot combine that status under Luxembourg’s 1993 legislation with that of authorised AIFM under the 2013 law, although they may manage alternative fund assets under a delegation arrangement. Banks may become registered AIFMs, as may investment firms provided that their authorisation under the 1993 law covers management of third-party assets.
• A professional depositary of assets other than financial instruments (PDAOFI) may be appointed as a depositary for alternative funds with a five-year lock-up, and whose main investment policy does not involve investment in assets subject to custody requirements or that makes private equity-style investments.
• Under the single depositary rule of the 2013 legislation, a PDAOFI that has been appointed as depositary for an alternative fund is also responsible for the safekeeping of financial instruments that can be held in custody. Although it will have to delegate custody of those assets to an eligible provider, the duty of restitution in the event of loss of financial instruments remains with the PDAOFI, unless the loss is due to unavoidable external events beyond its control.
• There are no restrictions on the type of alternative fund for which a PDAOFI may provide safekeeping of assets other than financial instruments.
• A non-EU AIFM will have to report to the CSSF only if it is marketing funds to professional investors in Luxembourg, and as long as the passport regime is not available to such managers. A non-EU AIFM managing or marketing in Luxembourg a feeder fund, whether EU-domiciled or not, must report to the CSSF on the non-EU master fund, even if this is not marketed in the EU, if it manages both funds.
• Where a non-EU AIFM is marketing alternative funds to professional investors in Luxembourg as well as in other EU member states, reporting to the CSSF only covers data for funds marketed in Luxembourg and in applicable cases their non-EU master funds.
• The amount of assets under management and other positions of a non-EU master fund that must be reported to the CSSF in a separate AIF reporting file should not be included in the aggregate reporting to the CSSF for the manager.
• The 2013 law and the European Commission’s AIFMD level 2 regulation should be taken into account when assessing the initial capital and own funds requirements applicable to external AIFMs that are not licenced as Chapter 15 ManCos (that is, Chapter 16 ManCos or other Luxembourg-based AIFMs).
• The professional liability risks to be covered relating to AIFMD comprise the risk of loss or damage caused by a relevant person through negligent performance of activities for which the AIFM has legal responsibility, as set out in the Commission regulation.
• A Chapter 15 or Chapter 16 ManCo authorised as the appointed AIFM of a fund in a master-feeder alternative fund structure and carrying out activities regulated by the AIFMD for the other fund must have professional liability risk cover at both master and feeder level, applicable to activities for which the AIFM has legal responsibility.
The FAQs dealt with by the CSSF can be consulted at http://www.cssf.lu/fileadmin/files/AIFM/FAQ_AIFMD.pdf, those posted by ESMA at http://www.esma.europa.eu/system/files/2015-11_qa_aifmd_january_update.pdf, and those published by the European Commission at http://ec.europa.eu/yqol/index.cfm?fuseaction=legislation.show&lid=9.
ESMA says Jersey, Guernsey and Switzerland are ready for AIFMD passport
The European Securities and Markets Authority has published – with a slight delay of six days beyond the July 22 deadline – its advice on extending access to the EU market under the Alternative Investment Fund Managers Directive to non-EU alternative investment fund managers and funds, recommending that the AIFMD passport be granted to Guernsey, Jersey and Switzerland.
ESMA has not yet reached a conclusion on whether managers and funds in Hong Kong, Singapore and the United States should also gain access to the EU market. However, it suggests holding off on any AIFMD passport extension until more jurisdictions have been assessed.
ESMA has also published its opinion on the functioning of the passport for EU alternative managers and of national private placement regimes, as stipulated by the directive. The two documents will now be considered by the European Commission, Parliament and Council, which will decide whether to activate the provision in the AIFMD allowing the passport to be extended to non-EU entities, which can currently access individual European markets under local private placement rules, via a delegated act.
ESMA says it has conducted a country-by-country assessment in order to have the flexibility to take into account the different circumstances of different non-EU jurisdictions regarding the regulatory issues to be considered, namely investor protection, competition, potential market disruption and the monitoring of systemic risk.
The authority selected six jurisdictions for assessment – Guernsey, Hong Kong, Jersey, Singapore, Switzerland and the US – based on various of factors including the amount of private placement distribution activity already being carried out by entities from these countries and territories, the knowledge and experience of EU national regulators in dealing with their counterparts in the jurisdictions considered, and the efforts by stakeholders from these countries and territories to engage with ESMA’s process.
In its advice, ESMA concludes that no obstacles exist to the extension of the passport to Guernsey and Jersey, while Switzerland will remove any remaining obstacles with the enactment of a pending amendment to the Federal Stock Exchanges and Securities Trading Act. However, it has not reached a definitive view on the other three jurisdictions due to concerns related to competition, regulatory issues and lack of sufficient evidence to assess the relevant criteria properly.
ESMA aims to finalise the assessment of Hong Kong, Singapore and the US as soon as practicable and to assess further groups of jurisdictions until it has provided advice on all the non-EU countries and territories that it considers should be included in the extension of the passport. The jurisdictions still to be assessed are Australia, the Bahamas, Bermuda, Brazil, British Virgin Islands, Canada, Cayman Islands, Curaçao, Isle of Man, Japan, Mexico, Mauritius, South Africa, South Korea, Thailand and US Virgin Islands.
The authority says the European institutions may consider waiting to take a decision on extending the passport to non-EU jurisdictions until it has delivered positive advice on a sufficient number of non-EU countries and territories, to avoid any adverse market impact that might result from a decision to extend the passport to only a few non-EU countries.
In its opinion on the functioning so far of the AIFMD passport and of national private placement regimes, ESMA’s preliminary view is that, given the short time period since the implementation of the AIFMD as a result of the delay in implementation of the directive followed by further delays in its transposition into national law in several member states, a definitive assessment is difficult. It “sees merit” in the preparation of a further opinion on the functioning of the passport after a longer period of implementation.
However, even at this early stage, ESMA has identified a number of issues. These include divergent approaches to marketing rules, including wide differences in the fees charged by national regulators in the countries where the alternative funds are marketed, and in the definition of what constitutes a professional investor.
The authority says there are also differences in interpretation of what activities constitute ‘marketing’ and of ‘material changes’ under the AIFMD passport between different member states, and it advocates greater convergence in the definition of these terms. However, ESMA has not so far uncovered evidence to suggest that the passport has raised major issues in terms of the functioning and implementation of the AIFMD framework.
The various delays in full implementation of the directive also make a definitive assessment of the functioning of national private placement regimes difficult, and again ESMA suggests preparing a second opinion later, although this issue to lined to the decision to be taken in the meantime by the European institutions on whether to extend the passport to one or more non-EU countries or territories. In this area too it sees no evidence that the regimes raise major issues regarding the operation of the AIFMD framework.
The full text of ESMA’s opinion on the functioning of the passport and private placement regimes is available at http://www.esma.europa.eu/system/files/2015-1236_advice_to_ep-council-com_on_aifmd_passport.pdf, and its advice on extending the passport is at http://www.esma.europa.eu/system/files/2015-1235_opinion_to_ep-council-com_on_aifmd_passport_for_publication.pdf.
ESMA issues new updates to AIFMD Q&A
The European Securities and Markets Authority has issued a fresh update on May 12 to its Questions and Answers document containing guidance and interpretation of the EU’s Alternative Investment Fund Managers Directive as well as the European Commission’s delegated regulation on implementation of the directive issued in December 2012 and May 2013.
ESMA says the Q&A document, first issued in February 2014 and since updated seven times, is designed to promote common supervisory approaches and practices in the practical application of the AIFMD and its implementing measures through responses to questions posed by the general public and regulators themselves. It complements a Q&A document on the AIFMD published by the European Commission.
The ESMA Q&A covers remuneration, notification of alternative investment funds and their managers, reporting to national regulators, services covered by MiFID, depositaries, calculation of leverage, delegation, calculation of assets under management, additional own funds, and scope of the authorisation requirement.
The latest version principally updates information regarding regulatory reporting requirements, as well as calculation of leverage. The previous update, issued on March 26, covered reporting, notification of managers, calculation of leverage, calculation of additional own funds, and the scope of the authorisation requirement.
• ESMA says the reporting requirements apply to all alternative investment managers for the fund they manage and or market within the EU, regardless off whether they are sister companies or owned by another AIFM, according to the reporting frequency set out in Article 110 of the implementing regulation.
• Managers of private equity funds should consider actual capital drawdowns rather than commitments when they report information on fund subscriptions.
• Once a registered AIFM has opted in under the directive it must comply fully with its requirements, including reporting to its national regulator, but opting in does not impact its reporting frequency, which should remain on an annual basis unless total assets under management exceed the Article 110 thresholds. In member states where all AIFMs must be authorised, sub-threshold managers must report the information required under in Article 24 of the directive.
• Non-EU AIFMs whose total assets under management do not exceed the thresholds set out in Article 3(2)(a) and (b) and that market their funds in the EU through a national private placement regime should report at least the information listed in Article 3(3)(d) of the directive to the regulators of the jurisdictions where the funds are marketed. National private placement regimes may require non-EU AIFMs to report additional information.
• Where a fund invests exclusively in assets denominated in its base currency, the manager should report long and short positions in that currency.
• AIFMs should not consider the distribution of dividends as redemptions for the purposes of the consolidated reporting template.
• Managers should not apply the same reporting frequency to sub-funds of the same umbrella fund structure; each must be considered separately in respect of reporting requirements.
• AIFMs should take into account cash and cash equivalents in reporting the main instruments in which the fund trades and the five most important portfolio concentrations.
• The procedure for the first reporting of funds should be the same as for that of AIFMs, as set out in ESMA’s guidelines on reporting obligations under Articles 3(3)(d) and 24(1), (2) and (4) of the directive.
• When calculating their exposure under the commitment approach under Article 8 of the implementing regulation, AIFMs should take into account the absolute value of all positions of their funds in accordance to the criteria set out in the AIFMD and the regulation. For derivative instruments, managers should convert each position into an equivalent position in the underlying asset using the methodologies set out in the directive and regulation.
• Information on the long and short value of exposures should be provided in the base currency of the fund.
• Non-EU managers marketing their funds in the EU under Article 42 should report the results of stress tests where this is required by the private placement regime of the member states where the funds are marketed, or if the managers have carried out such stress tests.
• An AIFM that is already managing funds in a host member state under Article 33 of the directive does not have to undertake a new notification under Article 33(2) of the AIFMD every time it wishes to manage a new fund in that member state. The original notification is valid for all funds, but an update under Article 33(6) should be sent to identify each new fund, clarifying if necessary that the new fund is of a different type from those specified in the original notification.
• When calculating the exposure of a fund using the gross method under Article 7(a) of the implementing regulation, AIFMs should exclude the value of all cash held in the base currency as well as cash equivalents.
• In calculating own funds under Article 9(3), AIFMs should exclude investments by their funds in other AIFs they manage. However, they should not exclude investments in other funds they manage for the calculation of additional own funds to cover potential liability risks arising from professional negligence, because investment in other AIFs run by the same manager increases the operational risk.
• Under Article 36(1) of the AIFMD, member states may allow an authorised EU AIFM to market to professional investors on their territory the units or shares of EU-domiciled feeder AIFs with a non-EU master fund managed by a non-EU AIFM. Whether the non-EU manager must be authorised depends on how the member state has transposed Article 36 into national law.
ESMA’s Q&A document can be consulted at http://www.esma.europa.eu/system/files/2015-850_qa_aifmd_may_2015_update.pdf, while the European Commission has published its own list of issues and responses at http://ec.europa.eu/yqol/index.cfm?fuseaction=legislation.show&lid=9.
