A new collective investments sector- EU directive, i.e., Directive (EU) 2024/927 (the “Directive”) was published on 13th of March 2024. The Directive introduces the necessary improvements to the renovation and standardization of the regulatory framework of the Alternative Investment Fund Managers? ?Directive 2011/61/EU (the "AIFM Directive") and the Undertakings for Collective Investment in Transferable Securities Directive 2009/65/EU (the "UCITS Directive").
In this regard, #AIFMs, on one hand, and #UCITS management companies, on the other hand, (both hereinafter the “UCIs Managers”), underwent mostly the same changes, among others, regarding their delegation regime, their regulatory treatment of custodians, their supervisory reporting requirements, and the formal establishment of consistent use of liquidity management tools (“LMTs”).
As explained in the recital n.46 of the Directive, the harmonization and alignment of the above-mentioned provisions between AIFMs and UCITS management companies ??enhance regulatory convergence while promoting economies of scale for the UCIs Managers but also for the ones having the double AIFM and UCITS licenses and so-called “Super Mancos". In parallel, the removal of duplications and redundant reporting requirements was introduced to enhance efficiencies, remove the “red tape”, create the conditions for better allocation of resources for UCIs Managers and finally reduce the costs and fees for the funds' investors.
In this light, the totality of the provisions of the Directive has amended or supplemented the existing texts of the AIFM and UCITS Directives by providing further clarifications and regulating certain transparency or operational gaps to the benefit of the investors, the UCIs Managers, and the integrity of the EU funds market. Here is a breakdown of the key revisions and their implications:
- Provision of more detailed information is mandated on the delegation arrangements of UCIs Managers to the competent regulator.
- The concerned data is required not only during the authorisation procedure of each of the UCIs Managers, but also is included in the regular reporting, the frequency and type of which is to be defined by the ESMA.
- Novelties regarding the information to be provided concern the staff/persons responsible (at least two natural persons) within the UCIs Managers for the oversight of delegates as well as the persons reserved in the delegate to perform the delegated tasks, identification of sub-delegates, controls in place. In this context, the Directive requires UCIs Managers to ensure that any of these delegates and sub-delegates, regardless of their status and location, will respect the Directive requirements.
- Apart from the above, it is clarified that ESMA is going to issue relevant guidelines for the standardisation of the data to be provided to the EU regulators regarding the delegation arrangements while the EU Commission will adopt delegated acts defining, amongst others, the notion of “letterbox entity”.
- In terms of marketing, further clarification is provided that when a fund distributor markets the units/shares of the UCIs on its own behalf and not on behalf of the UCI or the UCI Manager, then the third-party “distributor” cannot be considered as delegate or distributor regardless of characterisation of the agreement between the UCI Manager and the third party.
Robust Risk Management Systems:
- AIFMs are now mandated to establish comprehensive risk management systems covering identification, measurement, management, and monitoring of all relevant risks associated with each AIF's investment strategy.
- Specific provisions targeting loan origination activities have been introduced for AIFs, including effective loan origination policies, leverage ratio restrictions, and consumer protection requirements.
- To address the increasing lack of competitive supply of depositary services in some countries and the potential excessive costs borne by AIFMs, the EU competent authorities will be able to allow the appointment of a depositary located in another EU member state. This possibility will be provided if the conditions laid down by the Directive are met after analysis on a case-by-case basis exhibited by the competent authority of the AIF. In the case of appointment of a depositary based on a third country, the conditions already imposed, regarding the AML/CFT high-risk countries and the OECD list of non-cooperative jurisdictions in terms of tax, are still valid and further embellished.
- On a different note, depositaries, when they provide custody services to UCIs, are obliged to include central securities depositories (“CSDs”) in the custody chain to ensure that, in all cases, there is a stable information flow between the custodian of an UCI’s asset and the depositary. To avoid unnecessary work, depositaries should not perform ex ante due diligence if they intend to delegate custody to CSDs. On this point, distinction is drawn in case that the CSD acts as an investor CSD and not as an intermediary of the depositary. In such instances, the CSD is considered as a delegate of the depositary’s custody functions, and appropriate due diligence should be normally carried out.
Comprehensive Reporting Obligations:
- UCIs Managers must adhere to detailed reporting obligations to competent authorities, focusing on transparency and accountability. Reporting encompasses aspects such as market risk, delegation arrangements, and information on where UCI units or shares are marketed, aiming to facilitate effective monitoring of systemic risk and promote financial stability.
- Reporting to competent authorities also includes aspects such as markets and instruments traded, liquidity management arrangements, risk profiles and stress test results.
- Enhanced reporting obligations on the part of the UCIs Managers are also established towards the investors (see below on transparency and investors protection).
Effective Liquidity Management:
- UCIs Managers are required to implement robust liquidity management systems and conduct regular stress testing under various liquidity conditions to accurately assess and monitor liquidity risks.
- Emphasis is placed on aligning investment strategies, liquidity profiles, and redemption policies to ensure consistency and mitigate liquidity-related challenges efficiently.
Liquidity Management Tools:
- UCIs are now required to have access to a range of LMTs, with detailed policies and procedures for their activation and deactivation.
- The review mandates open-ended funds to select two LMTs from a standardised set, including suspension of subscriptions (soft or hard closure), swing pricing, redemption gates, extended notice periods, redemption fees, dual pricing, anti-dilution levy, redemption in kind, and side pockets. The legitimisation of these measures improves transparency and effectiveness in liquidity management in the face of stressed markets.
- Redemption in kind may be activated under certain conditions to preserve fund liquidity and ensure fair treatment of investors but it is clarified that this provision concerns only professional investors.
- The amendments strengthen loan origination policies for better credit risk management, imposing a 20% cap limit on loans taken by single borrowers to mitigate risk. In addition, the Directive introduces leverage caps, with a maximum of 175% for open-ended funds and 300% for closed-ended funds.
- On the other hand, the securitisation provision of “skin in the game” is also adopted for loan originating funds. According to this provision, AIFMs are required to retain 5% of originated loans until their maturity or for a minimum of 8 years, depending on the loan type.
- As anticipated, loans provided to “related parties” are prohibited, and the loans must align with a certain investment strategy. This strategy should not involve an “originate-to-distribute” approach. In other words, the AIFs must keep the loans, administering them as “assets” and dispose them only under certain circumstances for the benefit of the investors.
- In the same vein, loan originating funds due to their nature should be, by default, “closed-ended” to avoid liquidity risks due to mismatches in maturity transformation. On the contrary, if a loan originating fund intends to be incorporated as open-ended, such deviation must be justified by the AIF and approved by the competent regulator.
- AIFMs should also be required to report to investors on the originated loan portfolio's composition.
- On a different vein, EU Member states are given the liberty to provide, upon implementation of the Directive, for the prohibition on the part of retail investors to subscribe to loan originating funds as a matter of public interest. This comes in contrast with the EU Regulation 2017/2402 which provides special rules for the availability of securitisation titles to retail clients under certain circumstances to establish a level playing field for EU securitisation vehicles.
Transparency and investors protection: To enhance transparency and investors protection, the EU legislator requires, on one hand, more information to be provided to competent regulators while mandates ESMA for drafting regulatory technical standards (“RTS”). Currently, the Directive is not detailed enough or technically sufficient and we expect RTS to clarify some of these new requirements. The new requirements targeting to enhance transparency and investors protection pertain the following:
- It is clarified that the name of the UCI holds equal importance to any other pre-contractual document and is subject to equal standards of fairness and transparency. Thus, the name of the UCI must not be misleading regarding the investment strategy followed by it.
- In cases where an AIFM manages AIFs marketed to retail investors, the governing body of the AIF must include at least one non-executive or independent director.
- UCIs Managers should establish a sound pricing process, which should comprise the identification, analysis and review of costs charged, directly or indirectly, to investment funds or their unit holders, and introduce a requirement to compensate investors where undue costs have been charged. ESMA is going to define and further clarify the notion of “undue cost”, while UCIs Managers are obliged to periodically report to the investors on all direct or indirect fees and expenses of each UCI.
- In a similar vein, UCIs Managers should integrate environmental, social and governance (“ESG”) parameters into their current governance and risk management internal rules to be taken into consideration upon supporting their investment decisions. In this context, ESMA will update its guidelines on sound remuneration policies regarding aligning incentives with ESG risks in remuneration policies.
- Provisions have been established to manage conflicts of interest in case of “white labelling” funds managed by UCIs Managers and initiated by third party investment advisors entrusted with the investment advisory services of the UCI.
- An extra layer of transparency is added with the establishment of communication channels between the regulators of the UCI’s Manager and depositary as well as the regulator of the UCI itself to facilitate the exchange of information. Therefore, a prior cooperation agreement between the relevant EU regulator and the regulatory authority of a third country must exist beforehand, where the UCI, the UCIs Manager or the depositary might be established in a non-EEA/EU country.
- Non-EU UCIs and non-EU UCIs Managers dealing with depositaries established in a third country, they should ensure that the depositary is not located in a high-risk third country pursuant to Directive (EU) 2015/849, nor in a third country that is deemed non-cooperative in tax matters. However, certain cases allow for a grace period where a country is later identified as a high-risk third country or non-cooperative for tax purposes.
- Last but not least, ESMA is going to create common for all the EU Member States and publicly available lists with all the EU UCIs Managers, the UCIs managed by EU UCIs Managers and the UCIs marketed by EU UCIs Managers.
In conclusion, the updates introduced by the Directive mark a significant milestone in the evolution of the EU investment funds regulatory landscape. By enhancing transparency, bolstering risk management practices, and promoting investor protection, these changes aim to strengthen the resilience of the financial system and provide the right conditions for a prosperous EU market. The updated regulatory provisions of the Directive took effect on 15th of April 2024, and therefore should be implemented by 16th of April 2026, in each EU jurisdictions with a derogation with regard to the implementation of the measures related to regulatory reporting which shall take place by 16th of April 2027, the latest.? Even if the EU industry is eagerly awaiting the RTS, Luxembourg funds market is looking to them with more confidence as is more mature in terms of regulation having already in place some of the above-mentioned requirements adopted by the Directive (e.g. in terms of delegation arrangements or the application of LMTs).
