Welcome to the latest edition of Five by Five.
Five by Five is a short summary of the key developments that we have discussed with our fund clients over the last few months.
This edition covers: the European Commission's AIFMD review consultation; an update on the UK's temporary permissions regime; the Short Selling Regulation; and the ISDA IBOR Protocol.
European Commission's AIFMD review consultation
Further to its report assessing the application and the scope of the AIFMD in June 2020 and ESMA's letter to it regarding the review of the AIFMD in August 2020, the European Commission has opened a public consultation on the review of the alternative investment fund managers directive (AIFMD). The consultation will be open until 29 January 2021.
The consultation itself does not offer much insight into the details of what AIFMD II may contain, although the questions that have been selected by the Commission are informative. The only certainty, however, is that AIFMD II is coming.
The paper is split into seven sections and we have highlighted the points in each section that stood out for us below.
I. Functioning of the AIFMD regulatory framework, scope and authorisation requirementsThere are several questions here about the regulatory capital requirements for AIFMs and, in particular, those AIFMs with top-up MiFID permissions. One question asks how to ensure a level playing field between MiFID firms and AIFMs providing competing services.
There are a few questions about sub-threshold/small AIFMs relating to (a) the thresholds and (b) introducing a marketing passport for small AIFMs. The treatment of small AIFMs is something that the Commission and ESMA have both highlighted before the consultation. It is certain, however, that any positive benefits will go hand in hand with more onerous requirements.
II. Investor protectionThe Commission says, "Views are sought on the conditions that will make it possible to open up the AIF universe to a larger pool of investors while considering the varying degrees of financial literacy and risk awareness". There are questions suggesting that the Commission is looking at ways to permit marketing to EU investors that are not "professional investors". We doubt that the AIFMD will be opened up to retail investors but note that ESMA's letter referred to "semi-professional investors" and feel that this would be the more likely outcome.
The Commission also notes, "The introduction of the depositary passport is desirable from an internal market point of view" and asks three questions relating to its possible introduction. We believe that the introduction of a depositary passport could improve the attractiveness of certain EEA fund domiciles and give investors and managers greater choice.
There are a number of questions relating to initial and ongoing disclosures to investors and the AIFMD rules on conflicts of interest.
There are seven questions about the AIFMD rules on valuation and there may possibly be a change to the rules on the liability of an external valuer.
III. International relationsThe focus of this section "is on the appropriateness of the AIFMD third country passport regime and the delegation rules". Reading between the lines, perhaps we will finally see the AIFMD passport be activated for certain third countries. This would also start the clock ticking towards the end of the National Private Placement Regimes (NPPRs).
Picking up on a major theme in ESMA's letter (pretty much word for word), the Commission asks whether the delegation rules should be complemented with: "quantitative criteria", "a list of core or critical functions that would be always performed internally and may not be delegated to third parties" or "other requirements".
The Commission also picks up ESMA's concern about changes to the AIFMD rules on delegation to avoid regulatory arbitrage. ESMA suggested that legislative amendments should be made to ensure that the management of AIFs is subject to the regulatory standards set out in the AIFMD, irrespective of the regulatory license or location of the delegate. ESMA also noted that it was unclear whether the MiFID rules or the AIFMD rules should apply directly to an EU investment manager delegate of an AIFM.
There is certain to be change here.
IV. Financial stabilityThis section (a) "invites opinions whether the intervention powers and a tool-kit available to the relevant supervisors are sufficient in times of severe market disruptions"; (b) asks about the adequacy of supervisory reporting (including Annex IV reporting) and, interestingly, whether the supervisory reporting by AIFMs should be submitted to a single central authority (like ESMA); (c) asks about loan originating AIFs and "suggestions on the optimal harmonisation of the rules that could apply to these"; and (d) asks whether leverage calculation methods under the AIFMD could benefit from "further standardisation of metrics".
There is also a question on remuneration hidden away that asks whether the AIFMD rules on remuneration should be adjusted to provide for de minimis thresholds.
V. Investing in private companiesThis section asks questions about the AIFMD rules regulating investing in private companies (i.e. Articles 26-30 of the AIFMD, which aim to increase transparency and accountability of collective investment funds holding controlling stakes in non-listed companies).
VI. Sustainability/ESGThis section seeks to gather input to better understand and assess the appropriateness of the AIFMD rules in assessing sustainability risks. It seems to be asking whether AIFMD II should go further than the EU's sustainable finance disclosure regulation 2019/2088 and the EU Taxonomy Regulation 2020/852.
This section contains some interesting questions about ESMA and, in particular, asks whether ESMA should be granted additional competences and powers beyond those already granted to them under the AIFMD.
UCITS are mentioned in various places through the consultation but question 101 may sum up the Commission's thinking on this when it asks, "Should the UCITS and AIFM regulatory frameworks be merged into a single EU rulebook?"
Temporary permissions regimeAt the end of the transition period (11pm on 31 December 2020), passporting rights for EEA firms will cease, and those firms currently operating through a passport in the UK under the existing European passport framework will require either (i) a Part 4A permission under FSMA to be able to continue carrying out regulated activities in the UK; or (ii) UK recognition to continue to market to the general public in the UK or notifying under the National Private Placement Regime (NPPR), as appropriate.
The FCA has established a temporary permissions regime (TPR) and a temporary marketing permissions regime (TMPR) to allow EU firms and funds, which passport into the UK (e.g. under MiFID, AIFMD and UCITS) on a cross-border or branch basis, to continue operating in the UK on the basis of their existing passporting permissions for a limited period of time after the end of the transition period. The TPR and TMPR are expected to last for a maximum of three years (though HM Treasury has the power to extend the duration by increments of 12 months).
In order to benefit from the TPR and TMPR, certain notifications are required to be made to the FCA. The TPR and TMPR notifications need to be made via the FCA's Connect system, by 30 December 2020, but this should not be left until the last minute. The TPR will cover the firm’s pre-existing business contracts and any new business contracts entered into during the TPR and will allow firms to continue operating in the UK within the scope of current permissions for a limited period after the end of the transition period, while applying for full UK authorisation, if required. Further details on the application process can be found on the FCA's webpage: https://www.fca.org.uk/brexit/temporary-permissions-regime-tpr
Continuing with Brexit, HM Treasury has launched Phase II of its Financial Services Future Regulatory Framework Review. This consultation will affect the institutional framework for financial regulation in the UK post-transition period. The consultation will remain open for three months, closing on 19 January 2021.
FCA fines over transparency failures
The Financial Conduct Authority (FCA) has fined Asia Research and Capital Management Ltd (ARCM) £873,118 over transparency failures. The firm failed to notify the FCA and disclose to the public its net short position in Premier Oil Plc built between February 2017 and July 2019.
The Short Selling Regulation 2012 (SSR) sets out thresholds for when a firm is required to notify the FCA and disclose to the public details of net short positions held. From 24 February 2017 to 5 July 2019, ARCM failed to make 155 notifications to the FCA and 153 disclosures to the public of its net short position in Premier Oil. By 5 July 2019, ARCM had built a net short position equivalent to 16.85% of the issued share capital in Premier Oil, which was then held by ARCM for a further 106 trading days before being notified to the FCA and disclosed to the public.
ARCM agreed to resolve this matter and qualified for a 30% discount under the FCA’s executive settlement procedures, reducing the fine from £1,247,312 to £873,118.
This is the first time the FCA has taken enforcement action for a breach of the SSR.
ESMA renews its decision on net short position holders
Continuing with short selling, ESMA has renewed its decision to temporarily require the holders of net short positions in shares traded on an EU regulated market to notify the relevant national competent authority if the position reaches or exceeds 0.1% of the issued share capital.
The measure applies from 18 September 2020 to 18 December 2020.
The ISDA IBOR Protocol
Further to the discussion in the last edition of Five by Five, ISDA launched the IBOR Fallbacks Supplement (the "Supplement") to the 2006 ISDA Definitions and the ISDA 2020 IBOR Fallbacks Protocol (the "Protocol") on 23 October 2020.
Please refer to our note The ISDA IBOR Protocol: Should you adhere and when?
We have been analysing for some clients the impact that the Protocol and Supplement will have on their IBOR-linked portfolio. This analysis can help clients decide whether and/or when to adhere to the Protocol.
Even if clients intend to adhere (which we suspect most will, given the regulatory and market pressure to do so) the analysis will help clients understand the economic and documentary impact adherence will have and can give guidance on whether certain transactions should be carved out.
Please contact us if you would like to discuss this, or any of the other points we have raised in this edition.
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