Q4 Funds Regulatory Update

The fourth quarter of 2024 was an interesting period in terms of regulatory developments in the European fund management space, particularly in the United Kingdom where the change of government prompted a renewed focus on financial services reform (focussed in part on asset management) with a view to driving economic growth.

This briefing summarises some key developments observed during this period, including:

• ESMA's consultation paper on draft RTS on open-ended loan-originating AIFs under AIFMD 2
  
  
• ESMA's consolidated report on regulatory sanctions (including under AIFMD)
  
  
• The UK Chancellor's Mansion House Speech and her plans for LGPS "megafunds"
  
  
• The FCA's guidance on the change in control regime, encouraging "pre-engagement" and forewarning greater scrutiny of private equity and hedge fund investment in regulated firms
  
  
• Publication of the CCI Regulations, paving the way for a new retail disclosure regime to replace the UK PRIIPS Regulation

AIFMD 2: ESMA's consultation paper on draft RTS on open-ended loan-originating AIFs

On 12 December 2024, the European Securities and Markets Authority ("ESMA") launched its consultation paper on draft regulatory technical standards ("RTS") on open-ended loan originating alternative investment funds ("AIFs"), in context of forthcoming amendments to the Alternative Investment Fund Managers Directive ("AIFMD 2").

By way of recap, AIFMD 2 requires that loan-originating AIFs be closed-ended unless the alternative investment fund manager ("AIFM") is able to demonstrate to the AIFM's competent authority that the AIF's liquidity risk management system is compatible with its investment strategy and redemption policy. AIFMD 2 mandates ESMA to establish criteria for the determination by competent authorities of whether a loan-originating AIF can be open-ended, taking account of the nature, liquidity profile and exposures of the relevant AIF.

The consultation paper poses 22 questions and a short set of draft RTS, prescribing factors to consider when determining the appropriateness of the redemption policy and proportion of the AIF's liquid assets, rules around liquidity stress testing and ongoing monitoring obligations with respect to liquidity management systems. On an initial reading, the RTS do not appear hugely problematic from an industry perspective, but the devil will be in the detail and their practical application.

The final RTS were initially scheduled to be submitted by ESMA to the European Commission by 16 April 2025, but are now expected to be delayed until Q3/Q4 2025, which unfortunately gives the industry and competent authorities less time to prepare before the underlying AIFMD 2 rules take effect in April 2026.

ESMA's consolidated report on regulatory sanctions

On 11 October 2024, ESMA published a consolidated report on EU regulatory sanctions and measures, including (but not limited to) sanctions imposed under the Alternative Investment Fund Managers Directive ("AIFMD") up to the end of 2023.

The following notable points relating to the AIFMD sanctions were included in the report:

• Between 2013 (when AIFMD came into force) and the end of 2023, a total of 1,190 administrative sanctions and measures were imposed by EU competent authorities, with fines totalling approximately €103.5 million.
  
  
• During this period, the highest aggregate amount of fines issued under AIFMD in any one year were issued by the AMF in 2021 (c. €38 million).
  
  
• In 2023, of the 239 sanctions and measures issued across the EU, the highest number (42) related to breaches of article 12(1)(c) of AIFMD, which requires EU AIFMs to maintain and employ effectively the resources and procedures that are necessary for the proper performance of their business activities. Breaches of Annex IV reporting requirements, which requirements apply to both EU AIFMs and non-EU AIFMs marketing under the National Private Placement Regimes, were also listed amongst the most sanctioned breaches.
  
  
• Perhaps surprisingly, given Ireland is a significant fund management centre, it remains the case that the Central Bank of Ireland has not imposed any sanctions under AIFMD since 2013. In addition, enforcement action by the CSSF still appears modest relative to Luxembourg's market share.
  
  
• The report concludes that sanctioning powers are not used equally amongst national competent authorities and that there is a need for greater convergence among EU regulators. However, it also acknowledges that sanctions are not the only key to effective supervision, and that enforcement tools used by regulators may vary.

UK Chancellor's Mansion House Speech and plans for LGPS "megafunds"

The UK Chancellor of the Exchequer, Rachel Reeves, delivered her inaugural Mansion House speech on 14 November 2024, focusing on the Government's plans for improving economic growth and, to that end, potential reforms to UK financial services laws, with asset management identified as one of five priority growth areas.

The UK has been "regulating for risk, but not regulating for growth" since the 2008 financial crisis, the Chancellor said, and made a number of announcements intended to "spur innovation and growth." Relevant highlights included that:

• The Chancellor has written new "growth-focused" remit letters to the Financial Conduct Authority ("FCA") (amongst others), emphasising the Government's ambitions on economic growth. The FCA responded to the Chancellor's remit letter on 9 December 2024, announcing, among other things, that it will set out next steps on streamlining its rulebook, following a Call for Input.
  
  
• The Government intends to make the "UK a global leader in sustainable finance" and has published, to coincide with the speech, the results of its consultation on the regulation of ESG rating providers and a new consultation on a UK Green Taxonomy.
  
  
• There will be reform of the Senior Managers and Certification Regime, elements of which are acknowledged to have become "overly costly and administratively burdensome" for firms to comply with, with a commitment to consult on abolishing the current certification regime.
  
  
• The Treasury is working closely with the FCA and the Financial Ombudsman Service to reform the latter to create a surer climate for investment by developing a new agreement on how the two cooperate.
  
  
• The Government plans to consolidate 86 local government pension scheme ("LGPS") administering authorities into eight (Canadian- and Australian-style) pension "megafunds," with a view to driving pensions capital into private assets. The Chancellor estimated that, based on previous domestic and international experience, this might unlock around £80bn for investment in private equity.

Rachel Reeves' plan to consolidate 86 LGPS administering authorities into a handful of so-called "megafunds" poses interesting questions to sponsors who routinely seek to raise capital from the LGPS space.

For sponsors, this drive for consolidation will present both opportunities and obstacles. Investment decision-making amongst these investors should become more centralized and professional, allowing sponsors to engage with fewer, larger entities. However, competition for investor allocations will likely only intensify as the new funds seek to deploy larger amounts of capital. If Rachel Reeves' intentions come to fruition, the increased scale should lead to a shift in investment strategy-sponsors will be under pressure to scale their deals to meet the capital requirements of theses larger investors. As ever, a sponsor's ability to demonstrate robust track records, scalability, efficiency in managing larger commitments and sourcing higher volume deals will remain critical.

In addition, under the proposals, the new megafunds will be required to meet rigorous standards to ensure delivery of performance for their underlying savers. Managers will need to be able to accommodate the more stringent governance and reporting requirements imposed by such investors.

Whilst the plans could, in many respects, simplify fundraising and capital allocation, it will undoubtedly elevate the level of sophistication expected from sponsors. One can envisage larger established players in the private funds market benefitting from these proposals, with smaller sponsors left at the wayside.

FCA provides guidance on change in control regime

On 1 November 2024, the FCA (and PRA) published detailed guidance on its prudential assessment of acquisitions and increases in control (i.e., change in control regime), that applies when any person seeks to acquire "control" in a regulated firm or a parent thereof (the "Guidance"). For these purposes, "control" typically means 10% or more of the shares or voting power in a regulated firm or its parent, or any shares or voting power as a result of which that person is able to exercise significant influence over the management of the regulated firm. The Guidance becomes effective immediately without a transitional period.

The Guidance provides a useful indication as to the FCA's approach to various technical issues, and in particular the circumstances in which related parties should be treated as "acting in concert." There are several helpful worked examples with structure charts.

Perhaps the most impactful development is the suggestion that before making a notification to the FCA seeking approval as a controller, the applicant should seek some form of "pre-notification engagement," with the possibility that this may lead to a more streamlined approval process.

Pre-engagement is particularly "welcomed" by the FCA in certain stated contexts, including where the investment is being made by private equity or hedge fund sponsors. Such sponsors are warned to expect increased information/diligence requests, where their interest in the regulated firm will be 20% or more. Additional information requests may include details of the relevant sponsor's previous acquisitions of FCA-regulated firms, their investment policies, restrictions and processes, their decision-making framework and anti-money laundering procedures.

Though the prospect of additional scrutiny is not a particularly welcome development from the perspective of the industry, the prospect of pre-engagement could be helpful, particularly if it helps streamline the application process and reduce approval timelines. Unfortunately, it is not clear from the Guidance what form this pre-engagement should take in practice, which may mean it is simply left to front-line FCA staff who may not be best placed to deal with it in the most efficient way.

Publication of CCI Regulations to replace UK PRIIPS Regulation

On 21 November 2024, HM Treasury published the Consumer Composite Investments (Designated Activities) Regulations 2024 (the "CCI Regulations"), together with an explanatory memorandum, which entered into force the following day.

The CCI Regulations pave the way for the FCA to develop a new retail disclosure framework for the regulation of Consumer Composite Investments ("CCIs"), replacing the (often criticised) UK Packaged Retail and Insurance-based Investment Products Regulation (the "UK PRIIPs Regulation").

HM Treasury ambitiously expects this new retail disclosure regime to be in place during H1 2025, though this is subject to parliamentary approval and an FCA consultation.

The CCI Regulations broadly mirror the UK PRIIPs Regulation and apply to manufacturers of "Consumer Composite Investments" (a concept broadly similar to "Packaged Retail and Insurance-based Investment Products") and firms conducting "designated activities" with UK retail investors, regardless of whether the manufacturers are FCA-regulated and regardless of whether they are based in the UK. Like the UK PRIIPS Regulation, the rules are expected to apply to both UK and non-UK managers of funds that are made available to retail investors in the UK.

The new regime is expected to simplify current disclosure requirements under the UK PRIIPS Regulation. The existing format and content requirements of a Key Information Document, and the detailed methodologies one is required to employ for calculating cost, risk and performance, are expected to fall away, in favour of more flexible and proportionate disclosure requirements.

Whilst this is generally perceived by the asset management industry as a welcome development, managers which market funds to retail investors in both the UK and the EU will need to be mindful of significant divergence between the EU and UK disclosure regimes going forward.

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