Fund managers continue to be challenged in implementing the evolving rules on sustainability disclosures — see here. They are also grappling with changes to the key information document (KID) for package retail investment and insurance-based products (PRIIPs) and the demise of the UCITS KIID. Regulators are now focused on several other areas, which could have significant ramifications for the sector.

Under the Capital Markets Union banner, the European Commission has issued proposals to tighten some rules and to ease others. Proposed changes to the UCITS Directive and AIFMD cover delegation, liquidity risk management, data reporting for market monitoring purposes and the rules for depositaries. AIFMD will also be amended as regards activities of loan-originating funds and access to depositary services across borders. The rules for European Long-Term Asset Funds (ELTIFs) are to be made more flexible in an attempt to encourage take-up of these vehicles and investment by individual investors in these types of asset. See below for more detail.

Meanwhile, national supervisors are shining the spotlight on industry practices as regards fund governance, the use of third-party management companies and controls in a hybrid working model. And both central banks and supervisors continue to call on the industry to improve its liquidity management practices in open-ended funds.

The wide-ranging regulatory agenda for the sector highlights the need for firms to reconsider every aspect of their business models to ensure they meet changing regulatory expectations and are fit for purpose.

Questions for CEOs

  • Do we have the appropriate technical and human resources to carry out our functions and to supervise delegates? In particular, do we employ (or engage) at least two persons full-time?

  • What proportion of our risk and portfolio functions are delegated to third-country entities? Can we justify to regulators our entire delegation structure, based on objective reasons?

  • Do we have effective Board engagement and supporting governance arrangements? Do we regularly assess the suitability of our management body/senior management?

  • Do we have access to sufficient liquidity management tools and do we exercise them effectively?

  • Will the proposed changes to the ELTIF regime make them a more attractive business opportunity for us?

Changes to UCITS and AIFMD

The Commission refers to KPMG's study (PDF 5.7 MB) and notes that many AIFMD rules are working well and remain appropriate. It proposes targeted changes in certain areas, which will apply two years after they have been adopted.

Delegation: the new rules will apply to all UCITS management company (ManCo) functions, including ancillary functions. Both UCITS ManCos and AIFMs will have to employ at least two persons full-time or engage two EU-residents on a full-time basis.

When applying for authorisation, managers will have to describe in detail how they have the appropriate technical and human resources to carry out their functions and to supervise delegates. UCITS managers will also be required to justify to the national regulator their entire delegation structure, based on objective reasons.

ESMA will receive notifications of delegation arrangements where “more” risk or portfolio management is delegated to third-country entities (i.e. outside the EEA) than is retained, and will maintain a central public register. It will conduct a regular review of national supervisory practices in applying the rules, with a particular focus on preventing the creation of letter-box entities.

Note that the Commission has stepped back from enshrining a threshold at Level 1 and the text does not specify how “more” is to be calculated. However, the Commission will adopt a delegated act specifying further the conditions for delegation and the conditions under which a UCITS ManCo is to be deemed a letter-box entity and therefore no longer considered the manager of the UCITS. The Commission will also review the AIFMD delegation regime and consider necessary amendments to preclude the formation of letter-box entities.

Liquidity management tools (LMTs): managers of open-ended funds will be able to suspend temporarily the repurchase or redemption of fund units or shares. They will be required to choose at least one other LMT, which they can activate should circumstances so require.

Regulatory reporting: the Commission notes that market data submitted to the supervisory authorities has gaps or lacks the requisite detail, thus impairing the authorities' ability to identify the build-up and spill-over of risks to the broader financial system. It is proposed to improve relevant data collection and remove inefficient reporting duplications that exist under other EU or national rules by including AIFM and UCITS ManCo reports into an integrated data collection system.

An in-depth feasibility study by national supervisors is mandated and the European Supervisory Authorities and the European Central Bank (ECB) will be involved in a study on the feasibility of merging the duplicative reporting requirements and expanding data coverage to enable better monitoring of markets.

Loan-originating AIFs: AIFMs will have to implement effective policies, procedures and processes for the granting of loans by AIFs they manage. They will have to assess credit risk, and administer and monitor their credit portfolios, which should be reviewed periodically.

Where loan-origination will be more than 60% of the fund's portfolio, the AIF must be closed-ended. AIFs will be able to extend credit cross-border, but lending to a single financial institution will be restricted and lending to the AIFM, its staff, its delegate or the depositary will be forbidden. AIFs will be required to retain an economic interest of 5% of the notional value of the loans they have granted and sold off.

Ancillary services: AIFMs will be able to provide services covered by other EU laws, such as administration of benchmarks and credit servicing.

Depositary: a passport is not deemed feasible at present given the absence of EU harmonisation of securities and insolvency laws. Cross-border access to depositary services will be extended where needed until further harmonisation becomes feasible. This will be welcomed by Cyprus and Malta.

Given feedback to the Commission's consultation, depositaries will not be required to perform due diligence where “delegating” to central securities depositaries (CSDs). Instead, CSDs will be brought into the rules applying to the custody chain where they are providing competing custody services, thus levelling the playing field among the custodians and ensuring that depositaries have access to the information needed to carry out their duties.

Additional disclosures to investors: on conditions for using LMTs, fees that will be borne by the AIFM or its affiliates, periodical reporting on all direct and indirect fees and charges that were directly or indirectly charged or allocated to the AIF or to any of its investments, and the portfolio composition of originated loans.

Flexing the ELTIF rules

The ELTIF Regulation was adopted in April 2015 and is a voluntary framework for AIFs that invest in long-term investments, such as social and transport infrastructure projects, real estate and SMEs. ELTIFs must be closed-ended.

As of October 2021, only 57 ELTIFs had been launched, with a relatively small amount of net assets under management (approximately EUR 2.4 billion). Moreover, ELTIFs are domiciled in only four Member States (Luxembourg, France, Italy and Spain). The Commission notes that restrictive fund rules and barriers to entry for retail investors have the combined effect of reducing the utility, effectiveness and attractiveness of ELTIFs for both managers and investors.

ELTIF managers are AIFMs and will be subject to the above changes to AIFMD. In addition, various rule changes are proposed to the ELTIF Regulation that will broaden the scope of qualifying portfolio undertakings (QPUs) and investments, allow more flexible investment rules, reduce “unjustified” barriers to entry for retail investors and ease selected rules for professional-only ELTIFs:

  • Doubling the market capitalisation threshold for listed undertakings to EUR 1 billion (which will apply only at the point of investment), broadening the definition of eligible real estate, and permitting minority co-investment and investment in non-EU assets.
  • Clarifying the scope of eligible securitisations and imposing a 20% limit on the aggregate exposure of a retail ELTIF to securitisations.
  • Reducing the threshold of total investment in QPUs from 70% to 60%, raising to 20% the maximum exposure of retail ELTIFs to any single QPU, and imposing a 10% aggregate limit on OTC derivative exposures.
  • Allowing fund-of-fund strategies.
  • Increasing cash borrowing limits to 50% for retail ELTIFs and 100% for professional ELTIFs.
  • Deleting the EUR 10,000 initial investment requirement and the maximum 10 % aggregate threshold requirement for those retail investors whose financial portfolios are below EUR 500,000.
  • Instead, requiring managers and distributors to carry out suitability assessments in line with the MiFID II provisions, when directly offering or placing ELTIFs.
  • Introducing an optional liquidity window mechanism to provide extra liquidity to ELTIF investors and newly subscribing investors without requiring a drawdown from the capital of ELTIFs.

The quantum of proposed changes is significant, as is the change in attitude to access by retail investors. When the Regulation was first debated, many policymakers were cautious about allowing retail investor access, which resulted in the requirements about minimum investment and maximum of an individual's financial portfolio. The post-pandemic need to encourage economic growth and private investment appear to have supplanted those concerns.

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Contact us

The EMA Financial Services Regulatory Insight Centre monitors and tracks the evolving regulatory landscape. If you would like to discuss this update in more detail, please contact:

Gabrielle Jaminon

Head of Regulatory Centre of Excellence Asset Management
Tel.: +352 22 51 51 7635

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