Q3 2024 – European Regulatory Update for Funds

Authors:Gregg Beechey, Zac Mellor Clark, Cameron Mitcham, Nishkaam Paul, Emirali Mustafa

There was no summer lull on the regulatory front as the third quarter of 2024 saw some key regulatory updates, in particular the apparent conclusion of the long-running saga of the ELTIF RTS and the continued divergence of the UK and EU regulatory regimes.

Highlighted developments this quarter include:

1. ELTIF Regulation - Publication of RTS
2. Bundled Payments for Investment Research Reintroduced by the FCA
3. FCA Publishes Final Overseas Funds Regime Rules
4. Consultation on Liquidity Management Tools Under AIFMD II Regime
5. Preparing for the UK's New Securitisation Framework - Not Long to Go!
6. Autumn Mixed Bag:
   
   1. Date of Application of ESMA Guidelines on ESG Terms in Fund Names
   2. UK SDR (Partially) Comes into Force and is (Partially) Deferred
   3. LIBOR Cessation

1. ELTIF Regulation - Publication of RTS

On 19 July, the European Commission published its eagerly anticipated final draft Regulatory Technical Standards supplementing the ELTIF Regulation (2015/76) (the "ELTIFRTS").

The publication of the draft ELTIF RTS follows an unusually dramatic drafting process (see our "Q2 2024 - European Regulatory Update for Funds"), brings some much-needed clarity on the mandatory liquidity features of a European long-term investment fund ("ELTIF") and has generally been well received by managers offering, or contemplating offering, semi-liquid retail funds in Europe. Although the ELTIF RTS are not perfect from an industry perspective, they are a significant improvement on the European Securities & Markets Authority's ("ESMA's") original draft, and to the extent they are adopted as drafted, it is generally anticipated that the open-ended ELTIF will prove to be a viable model.

The draft ELTIF RTS are currently with the European Parliament and Council for scrutiny, but it is expected that they will be finalised and published in Q4 2024. At the time of writing, an update is expected imminently.

For further information, see our previous client alert "Regulatory Technical Standards Pave Way for Open-Ended ELTIFs".

2. Bundled Payments for Investment Research Reintroduced by the FCA

The FCA has confirmed in its Policy Statement PS24/9 ("Payment Optionality for Investment Research") that, with effect from 1 August 2024, United Kingdom ("UK") MiFID investment firms will now have a third means for funding investment research.

Previously, investment research had to be either paid for by the firm out of its own resources or funded by a dedicated research payment account (with the cost borne by clients). The new rules facilitate joint payments for third-party research and execution services, subject to certain criteria. This development represents a partial reversal of the prohibition on payment bundling for investment research introduced under MiFID II.

Whilst these rules are ostensibly applicable to all UK fund managers authorised as MiFID investment firms, they are of greatest relevance to portfolio managers. For example, whilst the rules technically apply to advisers/arrangers (i.e., those firms providing restricted advice to professional clients), they are in practice likely to be less relevant to such firms given that they are already subject to the more flexible rules on receiving inducements in COBS 2.3A.5 - 6 R (whereby the receipt of research may otherwise by justified).

Although these changes have not yet been extended to UK AIFMs, the FCA is consulting on doing so in Q4 2024.

3. FCA Publishes Final Overseas Funds Regime Rules

On 17 July 2024, the FCA published Policy Statement 24/7 ("Implementing the Overseas Fund Regime") which sets out the final rules and guidance necessary to implement the UK's new Overseas Funds Regime ("OFR").

The OFR has been developed in response to the perceived inefficiencies of the existing individual recognition scheme under section 272 of FSMA and, as the temporary marketing permissions regime which followed the UK's departure from the European Union wraps up, the UK government's desire that non-UK investment funds should still be available to the domestic retail market. The OFR permits certain investment funds domiciled overseas to be recognised by the FCA for marketing to UK retail investors on an in-principle basis, rather than pursuant to a fund-by-fund assessment of the home regulatory regime to which a fund is subject as was the case under section 272 of FSMA.

Broadly speaking, under the OFR, HM Treasury has the power to declare that another country's regime for investment funds is equivalent to the UK regime (an "Equivalence Decision"). Once HM Treasury has made an Equivalence Decision under this power in respect of a particular country's investment fund regime, an investment fund domiciled in that country (and falling within the relevant regime) may apply to the FCA for recognition under the OFR. Once recognised, the relevant fund can be marketed to professional or retail investors in the UK.

Currently, the only Equivalence Decision relates to European Economic Area ("EEA") Undertakings for the Collective Investment in Transferable Securities ("UCITS") that are not authorised as Money Market Funds. Notably, no Equivalence Decision is in place in respect of EEA ELTIFs (to the great disappointment of the private funds industry). Firms should therefore continue monitoring developments in this area, particularly in respect of any potential expansion of the OFR to EEA ELTIFs.

4. Consultation on Liquidity Management Tools Under AIFMD II Regime

On 8 July 2024, ESMA published draft Regulatory Technical Standards on Liquidity Management Tools under the AIFMD and UCITS Directive (the "LMT RTS") and draft guidelines (the "LMT Guidelines") addressing the scope and use of liquidity management tools ("LMTs") for open-ended funds.

The LMT RTS and the LMT Guidelines are addressed at all open-ended funds, both retail mutual fund UCITS funds and private AIF funds. The application of the RTS and the Guidelines to non-EU funds marketed into the EU remains unclear at this point.

By way of reminder (see our previous client alert "ESMA Consults on Liquidity Management Tools for Open-Ended Funds"), the list of LMTs available to managers under AIFMD 2 are:

• Suspension of subscriptions, repurchases and redemptions
• Side pockets
• Redemption gates
• Extension of notice periods
• Redemption fees
• Swing pricing
• Dual pricing
• Anti-dilution levies
• Redemptions in kind

The LMT RTS include details on the characteristics of these LMTs and define the constituting elements of each LMT, such as calculation methodologies and activation mechanisms. The LMT Guidelines provide guidance on how managers should select and calibrate LMTs, in light of their investment strategy, their liquidity profile and the redemption policy of the fund.

ESMA will be consulting on the LMT RTS and LMT Guidelines until 8 October and expects to publish a final report by 16 April 2025. The consultation can be found here and we would encourage those of our clients who will be impacted by the LMT RTS to engage in the consultation process.

5. Preparing for the UK's New Securitisation Framework - Not Long to Go!

The onshored version of Regulation (EU) 2017/2402 laying down a general framework for securitisation and creating a specific framework for simple, transparent and standardised securitisation (the "UK SR") is scheduled to be repealed and replaced by a new UK securitisation framework with effect from 1 November 2024.

This new framework will consist of three sets of overlapping rules: (i) the Prudential Regulation Authority's ("PRA") firm-facing provisions in the PRA Rulebook ("PRA Rules"); (ii) the FCA's firm-facing provisions in the FCA Handbook ("FCA Rules"); and (iii) the Securitisation Regulations 2024 (as amended)(collectively, the "New UK SR").

Key Considerations for Market Participants

We set out below some of the key considerations and targeted policy changes which will be implemented in the New UK SR. A more detailed Client Alert on the New UK SR and related considerations will follow.

• Jurisdictional Scope - Clarifying a question from market participants on jurisdictional scope, the New UK SR will apply to relevant entities "established in the UK," being entities constituted under UK law with either a registered or head office in the UK. Note that AIFMs which are not authorised by the FCA will be out of scope of the New UK SR.
  
  
• Risk Retention
  
  • "sole purpose test" - Each of the New UK SR and the EU Securitisation Regulation (the "EU SR") provides that an entity shall not be considered to be an originator (i.e., eligible retention holder) where it has been established or operates for the "sole purpose" of securitising exposures. However, there will now be a divergence in the "sole purpose test" under the UK and EU regimes.
    
    • The New UK SR adopts a principles-based approach whereby specified factors must be taken into consideration when making this assessment which arguably provides firms more flexibility, while the EU rules provide greater certainty akin to a safe harbour in that "an entity shall not be considered to have been established or operate for the sole purposes of securitising exposures" where certain requirements are met.
    • Both jurisdictions require that the risk retainer does not rely on the securitised exposures, retained interest or any corresponding income therefrom to meet its payment obligations. However, the EU rules contain an additional requirement that this income not be its "sole or predominant source of revenue," potentially making it easier for some originators to comply with the New UK SR in this regard.
    • Notwithstanding the above, we do not anticipate the rules on sole purpose, in practice, presenting a significant divergence for compliance between the UK and the EU or to otherwise impact existing transactions in the market.
  • change of risk retainer - The New UK SR permits a change of risk retainer and a transfer of the risk retention if the retention holder becomes insolvent. Note that the rules will not permit a change in risk retainer in connection with a corporate reorganisation or disposal process.
    
    
  • NPEs - Similar to the EU SR, the New UK SR will allow the securitisation of non-performing exposures ("NPEs") where the minimum 5% retained interest can be calculated by taking into account any non-refundable purchase price discount (i.e., being calculated on the net value rather than nominal value). However, unlike the EU SR, the New UK SR will not permit NPE servicers to be eligible risk retention holders.
• Due Diligence& Transparency Requirements
  
  • template reporting - The good news is that the New UK SR will not prescribe the format in which information must be provided to a UK institutional investor for its due diligence obligations (unlike the prescribed asset level and reporting templates required under the UK SR and EU SR).
  • delegation - Clarifying a point of uncertainty in the market, the New UK SR has made it clear that when one UK institutional investor delegates (the delegating party) its due diligence obligations to another UK institutional investor (the managing party), the managing party will be responsible for any non-compliance (not the delegating party). The rules do not prohibit the delegation of due diligence obligations from a UK institutional investor to another entity which is not subject to the UK rules (e.g., a non-UK AIFM), but in this case, the delegating party will not transfer its legal due diligence obligations and will remain responsible for compliance under the New UK SR.
• Resecuritisations - The securitisation of underlying exposures which are securitisation positions is prohibited other than in a narrowly defined set of circumstances.
  
  
• Hedging - The New UK SR clarifies the prohibition on the hedging of the retained interest and will permit hedging where it "is undertaken prior to the securitisation as a prudent element of credit granting or risk management and does not create a differentiation for the retainer's benefit between the credit risk of the retained securitisation positions and the securitised positions transferred to investors."
  
  
• Grandfathering - With some exceptions, the transitional provisions will preserve the treatment of securitisations under the UK SR issued before 1 November 2024.
  
  
• The Future - The PRA and the FCA expect to consult on further changes to the New UK SR later in 2024/early 2025, e.g., on template reporting and the definition of "private" securitisations.

6. Autumn Mixed Bag

a. Date of Application of ESMA Guidelines on ESG Terms in Fund NameWhilst the "ESMA Guidelines on ESG-related Fund Names" (the "Fund Names Guidelines") were published in their final form back in May, the date of their application remained unclear while translations of the guidelines into the various official languages of the EU were prepared.

These translations were published on ESMA's website on 21 August 2024, meaning that the Fund Names Guidelines will formally apply to all newly created funds from 21 November 2024. Pursuant to a six-month transitional period, funds which are in existence as of 21 November 2024 have until 21 May 2025 to comply.

Attention now turns to the manner in which the guidelines are incorporated into the national law of individual Member States…

b. UK SDR (Partially) Comes into Force and is (Partially) Deferred

The UK's Sustainability Disclosure Requirements regime (collectively, the "SDR") consists of a number of distinct rules and requirements, including an anti-greenwashing rule, an investment labelling regime, "naming and marketing" rules as well as detailed, consumer-facing product and entity-level disclosure requirements.

Whilst the anti-greenwashing rule has applied since 31 May 2024, the sustainable investment labelling and disclosure regime came into force this quarter on 31 July 2024.

The "naming and marketing" rules are due to technically come into force on 2 December 2024, but the FCA announced in early September that it would offer market participants a limited and temporary reprieve. Firms are still required to comply with the rules as soon as they can but, where a firm has submitted an application to amend disclosures in line with the relevant rules by 5pm on 1 October 2024, it will have until 5pm on 2 April 2025 to comply. For the avoidance of doubt, firms must continue to comply with all other relevant rules, including the anti-greenwashing rule.

c. LIBOR Cessation

On 5 September 2024, the FCA issued a press release noting that, after their final publication on 30 September 2024, the various surviving US dollar LIBOR settings will cease permanently. The cessation of these settings is the final milestone in the transition away from LIBOR and will mark the end of LIBOR overall.

LIBOR is dead! Long live SOFR?

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