knowledge 22 December 2015 |

Christmas Update for Investment Managers

Recent Domestic Developments

Our last briefing, published on 15 October 2015, focused on the updated Central Bank Q&A for both UCITS and AIFMD and the newly published Investor Money Q&A (available here). 

Since then, there have been a number of additional developments at national level. The more significant of these include: the adoption of the ELTIF Regulations; the implementation of the OECD’s “Common Reporting Standard” (“CRS”); the publication of a Central Bank of Ireland (“Central Bank”) Report on Anti-Money Laundering Compliance by Funds and Fund Service Providers (“AML Report”); a Central Bank consultation on the Alternative Investment Fund (“AIF”) Rulebook; and the publication of the Central Bank’s programme of themed inspections for 2016.

The ELTIF Regulations

The ELTIF Regulations facilitate the implementation of EU Regulation 2015/760 on European Long Term Investment Funds in Ireland and came into force on 9 December 2015. ELTIF application forms are available from the Central Bank, which has confirmed that it is ready to accept ELTIF applications.

As outlined in our previous briefing, (available here), the ELTIF is a new form of investment fund which is designed for investing in companies and projects which require long-term capital. An AIF that is managed by an EU AIF Manager (“AIFM”) can become authorised as an ELTIF and use the label and passport for marketing throughout the EU to both professional and retail investors.

Common Reporting Standard (CSR)

The CRS is a new global information standard which requires financial institutions to obtain and report the tax identification number of non-resident account holders. The CRS was partially implemented in Ireland by the Finance Act 2014. Further provisions are contained in the Finance Bill 2015.

From 1 January 2016 reporting Irish funds must identify and confirm the tax residence status of all new and existing investors. This requirement will operate alongside the existing requirements under the US Foreign Account Tax Compliance Act (“FATCA”). In addition, according to the Office of the Data Protection Commissioner, from that date all new customer application forms should include relevant data protection information, such as the reason for collecting the data and the use to which it will be put.

Irish funds should have updated their application forms and/or subscription documents before 1 January 2016. From that date new investors must also provide additional information to investment funds when subscribing for units or shares in the fund. In this regard, Irish Funds have published joint FATCA/CRS Self- Certification Forms for both individuals and entities. According to the Revenue, self-certifications should be obtained and validated at account opening stage, or where this is not possible, within 90 days. Funds will also need to undertake due diligence on pre-existing accounts.

Anti-Money Laundering Compliance Report (AML Report)

The AML Report sets out the Central Bank’s expectations regarding Funds and Fund Service Providers’ compliance with requirements in the areas of anti-money laundering (“AML”), terrorist financing (“TF”) and economic sanctions. It is based on on-site inspections carried out by the Central Bank over the course of 2014. The Central Bank gives examples of the types of issues identified by it in respect of some inspections which include:

• a failure to perform adequate risk assessments in a timely manner and on an on-going basis;
• improper reliance on third parties and lack of oversight by funds of service providers carrying out AML/TF on their behalf;
• insufficient evidence of effective on-going monitoring of investor transactions;
• weaknesses in the suspicious transaction reporting processes; and
• inadequacies in staff training and record keeping.

AIF Rulebook Consultation

The Central Bank is conducting a full review of the AIF Rulebook and has identified a number of proposed amendments to it. Many of these are technical in nature while others propose a change in existing policy. The Consultation Paper sets out details of these amendments and seeks feedback from stakeholders on the proposed approach. The consultation closes on 24 February 2016.

Themed Inspections 2016

The Central Bank’s Market Supervision Directorate published its programme of themed-inspections for 2016, on 14 December 2015. According to the Central Bank, it is embarking on a large number of themed-inspections for 2016 which will focus on 12 areas, including:

• inspecting service level agreements and operational arrangements with outsourcing providers for investment firms, fund managers and fund service providers;
• reviewing AIFMs’ adherence to their programme of activity;
• analysing investment firms’ production costs;
• reviewing the use of financial indices as eligible investments for UCITS investment funds; and
• reviewing hedging arrangements at share-class level for investment funds.

The Central Bank has also indicated that it intends to increase its inspection activities for entities deemed to be low impact under PRISM and is further developing data analytics to sharpen the focus of supervisory resources.

EU Developments

At EU level, the most significant developments are undoubtedly the imminent entry into force of the Regulation on transparency of securities financing transactions (“SFT Regulation”) once it has been published in the EU’s Official Journal (“OJ”), and the Commission’s draft Delegated Regulation regarding the obligations of UCITS depositaries. However, there are also a number of other developments, including in particular the EBA’s final report and guidelines on shadow banking.

Securities Financing Transactions

Securities financing transactions (“SFTs”), broadly speaking, are any transaction where securities are used to borrow cash, or vice versa. Practically, this mostly includes repurchase agreements (repos), securities lending activities, and sell/buyback transactions. In January 2014, the European Commission (“Commission”) published a proposal aimed at improving the transparency of SFTs in the shadow banking sector. This proposal has now been approved by both the Council and the Parliament and is expected to be published shortly in the OJ.

The SFT Regulation covers SFTs conducted by any firms established in the EU, including UCITS Management Companies and Investment Companies (“UCITS Managers”) and AIFMs, regardless of where the individual branch is located. It also covers those SFTs conducted by EU branches of non-EU firms.

The SFT Regulation introduces requirements regarding the reporting of SFTs to trade repositories; investor disclosure requirements for funds; and requirements on counterparties engaged in rehypothecation. In particular:

• counterparties to an SFT will have to report the SFT’s details to a trade repository upon its conclusion, modification and termination and keep records of the SFT for at least five years following its termination. Where a UCITS or AIF is an SFT’s counterparty, the UCITS Manager or AIFM will be responsible for reporting on the funds’ behalf;
• parties reusing financial instruments received under a collateral arrangement will have to first disclose in writing the risks and consequences that may be involved and obtain written consent regarding the re-use; and
• UCITS Managers and AIFMs will have to disclose their use of SFTs and total return swaps to investors in their annual reports and in the case of UCITS in their half yearly reports. In addition, UCITS Managers will have to specify, in the UCITS prospectus, which SFTs and total return swaps they are authorised to use and include a clear statement that these transactions are being used. AIFMs must provide this information in their AIF preinvestment disclosure.

While generally the SFT Regulation will enter into force 20 days after its publication in the OJ, certain requirements apply from a later date. In particular, the UCITS/AIF half-yearly and annual reports disclosure requirements will apply 12 months after the SFT Regulation enters into force, while the investor disclosure requirements will apply 18 months thereafter for AIFs and UCITS that are already constituted before the SFT Regulation’s entry into force.

UCITS Depositaries

On 17 December 2015 the Commission published its much anticipated draft Delegated Regulation supplementing the UCITS Directive 2009/65 with regard to depositaries’ obligations. The draft Delegated Regulation contains detailed provisions about the obligations and rights of depositaries, including regarding:

• minimum requirements for the contract between the management company or the investment company and the depositary;
• the depositary’s duties relating to oversight; subscription and redemptions; valuation of units; the carrying out of UCITS’ instructions; the timely settlement of transactions; income calculation and distribution; cash monitoring; and the conditions for performing the depositary functions;
• obligations on the depositary relating to due diligence, segregation and insolvency protection;
• the conditions and circumstances in which financial instruments held in custody are considered to be lost; and
• independence requirements for management companies, investment companies, depositaries and third parties to whom the safekeeping function has been delegated. 

The draft Delegated Regulation will now be considered by the Council of the EU and the European Parliament and if neither of these object, it will be published in the OJ and enter into force 20 days following its publication. It will apply six months after the date of its entry into force.

EBA Shadow Banking Guidelines

The EBA has published its Guidelines on limits on exposures to shadow banking entities that carry out banking activities outside a regulated framework (“Guidelines”), which will apply from 1 January 2017.

The Guidelines apply to institutions subject to the large exposure provisions in Part Four of the Capital Requirements Regulation 575/2013. Such institutions must implement effective processes, as well as set internal aggregate and individual limits to exposures to individual shadow banking entities with an exposure value, after credit risk mitigation and exemptions, equal to or in excess of 0.25% of the institution’s eligible capital as defined in the Capital Requirements Regulation.

The Guidelines define shadow banking entities as undertakings that carry out one or more credit intermediation activities, that are not excluded undertakings. They define credit intermediation as bank-like activities involving maturity transformation, liquidity transformation, leverage, credit risk transfer or similar activities.

UCITS are largely excluded undertakings, with the exception of MMFs. AIFs are excluded to an extent: the exclusion does not cover AIFs 1) employing leverage on a substantial basis; or 2) allowed to originate loans or purchase third party lending exposures onto their balance-sheet under the relevant fund rules or instruments of incorporation. ELTIFs, EuSEFs and EuVecas are excluded.

Comment

Keeping up with regulatory developments is a key challenge for investment managers given the tsunami of change which has occurred over recent years impacting on the financial services sectors, including funds.

There appears to be little evidence of the pace of regulatory developments abating in the immediate future and over the next few months we expect to see, among other things, the domestic implementation of UCITS V, the entry into force of the Investor Money Regulations, and the possible replacement of the AIF Rulebook with regulations. We are also awaiting ESMA’s publication of its finalised Guidelines on sound remuneration policies under the UCITS Directive and AIFMD which should give UCITS Managers and AIFMs some degree of clarity regarding the practical implication of the UCITS remuneration rules.

We will continue to keep you advised on key regulatory developments and would be happy to discuss any questions you may have in relation to these, and any other developments.