Horizon Scan for Private Investment Funds: Key Recent and Expected Funds, Regulatory and Tax Developments to Look Out For

Draft legislative limited partnership reforms make up part of the Economic Crime and Transparency Bill (ECT Bill). If enacted, the changes will represent a significant reform to UKLP law, in parallel with reforms to the powers of Companies House and law enforcement for economic crime.

See our October 2022 client alert for background.

Once the ECT Bill is enacted, we expect a short (six month) transitional period for existing UKLPs to comply. This will include gathering the required information to be submitted to the registrar for each partner (including specifics on each individual limited partner), ensuring a UKLP has access to a Scottish or English registered office where its principal place of business is not also in the UK, and arranging appointments of individual registered officers of GPs.

The ECT Bill completed its committee stage in the House of Lords on 11 May 2023 and will now move to report stage for further scrutiny. It is expected to receive Royal Assent in mid-2023. Pending the legislation being finalised, secondary legislation being drafted, and the Authorised Corporate Service Provider (ACSP) regime becoming effective, GPs of existing UKLPs will want to make sure that they have the necessary information and make the necessary adaptations to their models within the six month transitional period.

Helpfully, various initial concerns have now been addressed through proposed legislative amendments — namely, on the protection of a limited partner’s liability following dissolution and during the UKLP’s winding up period and regarding any change to the current regulatory treatment of whether a UKLP is a UK alternative investment fund (AIF) or a non-UK AIF (due to the new concept of a UK registered office — see below). However, we would note the broad provision that remains in the ECT Bill giving the Secretary of State the power to make regulations that apply company law with modifications to fit the circumstances of limited partnerships (mirroring an existing power for LLPs). This is a far-reaching provision for potential future amendments to align partnership with company law (although it seems that there is no current initiative to extend the Persons of Significant Control regime to English limited partnerships).

UKLPs will be required to have a registered office in the UK. This is a new concept as previously the LP Act contained references only to a UKLP’s “principal place of business.” As the UK AIFM Regulations specify that a UK AIF is an AIF with a registered office in the UK, the concern was that many UKLPs with a principal place of business outside the UK (and therefore non-UK AIFs for regulatory purposes) would suddenly be treated as UK AIFs. Amendments to the UK AIFM Regulations tabled as part of the ECT Bill process should deal with this issue.

Available since November 2021, the LTAF is a new open-ended authorised fund structure that can invest in a full range of illiquid asset classes. With news of the first LTAF Financial Conduct Authority (FCA) authorisations in March 2023 and several other firms reportedly having formally applied to launch one (and many more exploring a launch), LTAFs are now a reality.

The development of the LTAF is significant to the retailisation agenda, as an investment platform to access retail wealth outside the listed market. A manager seeking to target the retail market would need to accept increased compliance, detailed authorisation requirements and regulatory risk.

The Productive Finance Working Group’s November 2022 publication "Investing in Less Liquid Assets – Key Considerations" includes a Legal Guide to the LTAF. It has also published a model instrument of incorporation for the LTAF.

On 24 November 2022, the FCA published guidance on valuation and unit pricing for LTAFs, broadly a high-level summary of the rules and expected policies and procedures.

To help ensure the success of the LTAF, in August 2022 the FCA consulted on its broader retail distribution. A final policy statement and FCA Handbook rules are awaited. This would potentially extend the LTAF’s investor base to restricted retail investors (up to 10% of their investable assets and subject to certain conditions being met) in addition to professional investors, certified sophisticated retail and high-net worth investors, and defined contribution (DC) pension schemes as either professional investors or using a unit-linked insurance wrapper. The proposals are aligned with the changes to the financial promotion rules for "high risk investments."

From April 2023, the government has introduced an option for pension scheme trustees to be able to exempt the performance-based element of investment arrangement fees from an 0.75% cap on annual charges that can be levied on auto-enrolled pension savers. This will again broaden investment opportunities for DC pension schemes to make it easier for them to invest in funds featuring carried interest or performance fees.

The authorised fund manager (AFM) of the LTAF need not appoint an external valuer if the depositary has determined that the AFM has the resources and procedures for carrying out asset valuation. Also for an LTAF that invests in other collective investment schemes or AIFs subject to external independent valuations, the AFM can rely on those.

LTAFs must publish monthly valuations, regardless of their dealing policy.

Broadening pension schemes and retail access may help increase the appeal of the LTAF as either an alternative to the Qualified Investor Scheme (QIS) or for those looking to the authorised funds market for the first time. The FCA authorisation timescale for LTAFs remains six months, which compares negatively with other regulated forms (the FCA aims to process applications to complete a QIS within one month and a Non-UCITS Retail Schemes (NURS) within two months).

There is growing interest in the evolution of different investment routes for retail wealth (including DC pension schemes) in less liquid assets. Alongside closed-ended options (listed investment companies, evergreen funds with fixed liquidity windows to align with the investment cycle of less liquid assets and European Long-Term Investment Funds (ELTIFs) in Europe – see below), and non-fund options such as bespoke investment management arrangements, the LTAF open-ended authorised vehicle provides an important route to consider.

The EU legislation on the ELTIF is to be repealed in the UK (as part of the Edinburgh Reforms package of provisions to address retained EU law), given the lack of take-up in the UK and the recently-introduced option of the UK-specific LTAF.

The Code aims to encourage the quality of engagement between institutional investors and companies to help improve long-term returns to shareholders and the efficient exercise of governance responsibilities.

It applies to asset owners, asset managers, and service providers. Asset owners include institutional investors, pension funds, insurance companies, local government pension pools, sovereign wealth funds, investment trusts, and other collective investment vehicles. Reports are to be made across an organisation’s business, i.e., as a single global organisation (if not possible it can be done as a UK entity).

A consultation on a review of the Code (most recently revised in 2020) is expected in Q4 2023. This Green Finance Strategy 2023 update stated that this would include:

• ways to evaluate and communicate the efficacy of stewardship activity and outcomes
• the need for a common language for stewardship, e.g., defining engagement
• the role of systemic stewardship in supporting the achievement of positive sustainability outcomes
• evolving expectations for stewardship in asset classes other than listed equity

The Financial Reporting Council expects improved disclosures of how rights and responsibilities are exercised on asset classes such as private equity, real estate and infrastructure.

Except for certain FCA-regulated investment firms (who have to disclose the nature of their commitment to the Code or where they do not, their alternative investment strategy), the Code and reporting on its application are voluntary. However, there is an expectation that asset managers and asset owners are seen to be taking active steps, including embracing environmental, social, and governance (ESG) considerations, in their stewardship role, regardless of whether or not they are a signatory to the Code.

As highlighted in the UK Green Finance Strategy (see below), evidence of active stewardship is seen as crucial to the successful management of risks, opportunities, and impacts presented by climate and environmental change.

On 27 April 2023 HM Treasury and HMRC published a consultation on the potential scope and design of a new type of investment fund: the Reserved Investor Fund (Contractual Scheme) (the RIF). The consultation closes on 9 June 2023. The aim is to add value to the existing range of UK fund structures.

The consultation followed HM Treasury’s January 2021 call for input on a review of the UK funds regime, covering tax and relevant areas of regulation.

The proposal under development is that of a UK unregulated contractual structure (in co-ownership form) that is an AIF that is closed-ended or hybrid and unlisted, but with tradable units. The RIF would be treated as a Non-Mass Market Investment that could be promoted to certified high-net-worth individuals and certified and self-certified sophisticated investors as well as professional investors.

It is hoped that the RIF would be able to convert to a Long Term Asset Fund (see below) that is an Authorised Contractual Scheme (ACS) with no tax friction.

See below (under UK Tax) for other developments on the tax side which that formed part of the original UK funds review, in particular on the VAT treatment of fund management services and further amendments to the REIT rules. We also cover other tax developments of interest in this section.

The RIF is designed predominantly for investment in real estate and the tax rules being consulted on include expanding SDLT seeding reliefs that apply to PAIFs and CoACS to seeding of schemes that elect into the RIF regime, with conditions applying. The proposal provides that units in a RIF may be issued only to those set out below (on the same basis for an ACS). GDO or non-close tests also apply.

• professional investors (but note that under the NMMI rules the RIF could also be promoted to other investor categories, namely certified high-net-worth individuals, certified and self-certified sophisticated investors)
• large investors (i.e., those who make a payment or contribute property with a value of not less than £1 million)
• a existing RIF investors

The government is keen to ensure that there is no risk of loss of tax from non-UK resident investors on disposals of UK property and is exploring various options to achieve this.

This FCA discussion paper (DP23/2) sets out thoughts on how the FCA might modernise, update, and improve the UK regime for asset management. Feedback is sought by 20 May 2023, following which the FCA will, as part of its Future Regulatory Framework Review, prioritise focus areas.

Some of the themes covered include:

• creating a common framework of rules for asset managers regardless of the type of firm (AIFM, MiFID portfolio manager, AFM of authorised funds, etc.)
• changing/removing the boundary of the UK authorised funds regime (e.g. rebranding NURS as “UCITS-plus,” allowing wider distribution to retail investors or creating a more basic fund category for certain investments in, for example, large/more liquid investments)
• amending the threshold at which AIFMs must apply full-scope rules; providing a core set of high-level rules for small authorised AIFMs (on valuation, liquidity management and investor disclosure)
• setting minimum contractual requirements between host AIFMs and portfolio managers
• reviewing rules and guidance on liquidity stress testing
• exploring digital tokenisation in UK authorised funds

The discussion paper also asks for input on potential reform of the UK regulatory regime for asset managers and funds in scope of the paper but not discussed in detail.

A goal of achieving a more streamlined and consistent approach (rather than a wholesale revision to the rules for asset management firms) is welcome, in particular to achieve:

• clearly distinguished rules between AIFs that admit retail investors and those that admit only professional investors;
• increasing the threshold at which the full-scope regime applies to an AIFM;
• continuing to engage on liquidity management issues to ensure best practice while not necessitating further regulation.

Related areas not specifically addressed in the discussion paper but on which clarity would be useful include: (i) the UK’s future alignment with the EU AIFMD and EU UCITS Directive; (ii) a framework that aligns with the EU rules (with a view to benefitting from any future third country passport in AIFMD, for example); and (iii) any separate UK regimes that would be more appropriate for those firms operating in the UK only.

On 24 March 2023, the Luxembourg government published the bill of law 8183 (the Bill), which is expected to amend the following key laws regulating investment funds and their managers in Luxembourg:

• the Luxembourg law of 17 December 2010 on undertakings for collective investment, as amended (the UCI Law)
• the Luxembourg law of 15 June 2004 on investment companies in risk capital, as amended (the SICAR Law)
• the Luxembourg law of 13 February 2007 on specialised investment funds, as amended (the SIF Law)
• the Luxembourg law of 23 July 2016 on reserved alternative investment funds, as amended (the RAIF Law)
• The Luxembourg Law of 12 July 2013 on alternative investment fund managers, as amended (the AIFM Law).

Among myriad proposed amendments, the following are of particular interest in the context of the aim to increase the attractiveness and competitiveness of the Luxembourg financial centre for retail investors:

• Amendment of the definition of “well-informed investors” under the RAIF Law, the SICAR Law and the SIF Law. The minimum investment threshold of €125,000 will be lowered to €100,000. The definition of “well-informed investor” will also be harmonised throughout the SIF Law and the SICAR Law to reflect the definition set out in the RAIF Law.
• Extension of the deadline to meet the minimum amount of assets under management. At present, (a) the minimum of €1,250,000 must be reached (i) within six months as of its authorisation for a Part II UCI, (ii) within 12 months of its authorisation for a SIF, (iii) within 12 months of its establishment for a RAIF and (b) the minimum of €1,000,000 must be reached within 12 months of its authorisation for a SICAR. The Bill proposes to extend the deadline to 12 months for a Part II UCI and to 24 months for SIFs, RAIFs and SICARs.
• New legal forms available to structure Part II UCIs. At present, Part II UCIs can be structured only as SAs. The Bill proposes that a Part II UCI may also be established as an SCA, an SCSp, an SCS or a S.à r.l., in line with what is allowed for RAIFs and SIFs.
• More flexible rules for the issuance price of closed ended Part II UCI units. At present, units of all Part II UCIs must be issued at NAV (as is the case for UCITs). The Bill proposes an amendment to the UCI Law pursuant to which the constitutive documents of closed-ended Part II UCIs could freely determine the issuance price.

Marketing of RAIFs, SICARs, and SIFs in Luxembourg. The Bill proposes amendments to the RAIF Law and the AIFM Law to allow RAIFs, SICARs, and SIFs to be marketed to non-professional investors in Luxembourg, provided they qualify as well-informed investors (noting that this is already possible for Part II UCIs in relation to retail investors).

The introductory section of the Bill clearly sets out its objectives, i.e. “to enhance and modernise the Luxembourg investment funds’ toolbox and to increase the attractiveness and competitiveness of the Luxembourg financial centre.”

The proposed changes, to be read in conjunction with the new ELTIF regime, are a response from the Luxembourg legislator to the increasing trend from alternative fund managers seeking to raise capital from retail investors across the world.

The Bill is very much welcomed by the Luxembourg fund industry and is considered to be an important milestone toward alternative offerings to retail investors by Luxembourg investment funds.

The proposals set out in the FCA’s October 2022 consultation CP22/20 aim to increase transparency on the sustainability profile of products and firms and to reduce the risk of harm from greenwashing. In addition, to protect consumers, providing better comparables among products and ultimately increasing capital flows into sustainable activities. As part of this package, the FCA proposes three sustainable labels that in-scope firms can use where they meet the relevant criteria.

Although not in scope to start, non-UK managers and overseas funds being marketed in the UK are expected to be brought into the new regime in due course.

See our October 2022 client alerts on SDR and on TCFD rules for background.

The consultation closed on 25 January 2023 and the FCA received about 240 written responses. A policy statement was originally expected by end June 2023 (with a subsequent consultation due to follow on bringing overseas funds within scope). However, this has been delayed to Q4 2023.

Apart from the anti-greenwashing rule (which will apply to all FCA-authorised firms immediately), the rules were originally expected to apply on a phased basis from September 2023. Given the delay to the Policy Statement, the effective dates will now be adjusted accordingly.

The FCA says it will use the extra time to consider more carefully its approach to various issues. In particular it recognises the challenges that many firms have raised (as set out below).

• Modifications can be expected in areas like the naming and marketing rules and in the criteria for the application of investment labels (including multi-asset and blended strategies)
• The FCA are not going to require independent verification of product categorisation in order to qualify for a label
• There will be a place in the regime for products that do not qualify for a specific sustainability label but nevertheless have some sustainability-related characteristics
• In relation to international coherence, the FCA will continue to consider how to further support compatibility, while stressing the need for robust UK standards

The FCA commented (see its 29 March 2023 press release) that there is broad support for the regime and outcomes it is seeking to achieve and it is grateful for the rich and constructive feedback on some of the detail.

The following key questions are still relevant, pending the outcome of the consultation: (i) the extent to which a firm and its products are in scope; (ii) how (and if) the labels may apply to their existing products; (iii) whether or not a firm wants to use a label for its future products, and if so, any changes it may have to make (for instance to strategic, governance, or resources matters) to achieve this; (iv) information to be disclosed and what information needs to be gathered to be able to comply, for instance to identify any challenges with data availability and how these can be best managed; and (v) how (and when) to have conversations with investors on what these rules mean for investment portfolios.

The government wants to ensure that the financial system plays a major role in the delivery of the UK’s net zero target, and is acting to secure the UK as “the best place in the world for responsible and sustainable investment.”

An update to the 2019 Green Finance Strategy, “Mobilising Green Investment: 2023 Green Finance Strategy,” was published on 30 March 2023, as part of the Green Day announcements, setting out updates on the government’s plans to achieve its green finance objectives.

The review of Solvency UK is mentioned in this paper — the government’s objective is to support insurance firms in supplying long-term capital to underpin growth, including innovative green assets and renewable energy infrastructure. There are no proposals to tailor the real estate Solvency Capital Requirements (SCR) of 25% (something the real estate sector has been arguing for some time, based on the argument that the volatility of non-listed real estate investments is lower than that represented in the short-term standard model applied in the legislation).

The following are the key points of industry to the asset management and investment funds industry:

• Consultation on a UK Green Taxonomy in Q4 2023 to provide investors with definitions of which activities should be labelled as green. This is likely to feed into the UK SDR proposals (set out above) in terms of demonstrating that assets meet a credible standard of sustainability. The government plans to mandate reporting after a two year voluntary reporting lead-in.
• Consultation on rules for UK largest companies on publication of TCFD-aligned transition plans in Q4 2023, once the Transition Plan Taskforce has finalised its framework. These are intended to complement the FCA’s existing transition plan “comply or explain” obligations in place for listed companies and asset managers/owners and to ensure consistency.
• A consultation (Q1 2023) on bringing ESG ratings providers within the regulatory perimeter (closes 30 June 2023).
• Supporting the work of the International Financial Reporting Standards (IFRS) Foundation’s new standard-setting board, the International Sustainability Standards Board (ISSB) and assessing it for adoption in the UK once finalised (expected summer 2023).
• The Financial Reporting Council — working with the FCA, government and the Pensions Regulator — will review the regulatory framework for effective stewardship, including the operation of the Stewardship Code (see above).

These refinements are intended to reinforce and expand the UK’s position as a world leader on green finance and investment. We would comment as follows:

• Nuclear energy is proposed to be included in the UK taxonomy, which would be consistent with the EU’s approach under the Complementary Climate Delegated Act (although this is causing controversy in some member states, and various NGOs have commenced legal proceedings against the European Commission (the Commission)).
• The ISSB standards will provide a standardised framework across the UK regulatory framework, including company law and FCA requirements for listed companies.
• A key area will be the outcomes of the FCA’s SDR and investment label proposals, in particular given the regulatory focus on identifying and addressing greenwashing.

The funds industry will welcome robust and clear standards as these initiatives take effect, and implementation taking place in a cohesive and structured way to avoid any uncertainty and disruption.

The EU sustainable finance legislative framework is dynamic and industry understanding and market practice are still evolving. Regulators continue to issue new guidance and statements on the application and interpretation of SFDR and the Taxonomy Regulation.

Although the European authorities did not intend SFDR, a transparency regulation, to create a product labelling/classification regime, the EU has acknowledged that SFDR is being used by market participants as if it were a product labelling regime. As a consequence, minimum standards/legislative amendments for the financial products in scope may well be produced in due course. In the meantime, the current legislative framework continues to apply.

The following developments are of note:

• On 12 April 2023, the European Supervisory Authorities (ESAs) published a consultation on SFDR Level 2 regulatory technical standards (RTS) amendments relating to principal adverse impact (PAI) indicators and product disclosures. See our client alert ESAs propose adjustments to the EU SFDR rules for more.
• On 20 February 2023, the SFDR RTS were amended in respect of information to be provided in pre-contractual documents, on websites and in periodic reports about the exposure of financial products to investments in fossil gas and nuclear energy activities (with updated Annexures II-V).
• Further guidance in the form of Q&A continues to be published (the most recent in the Commission’s April 2023 Q&A publication).
• On 5 April 2023 the Commission published a draft Delegated Act that amends the technical screening criteria (TSC) for climate change and a draft Delegated Act with TSC for the remaining four environmental objectives (which both closed on 3 May 2023). These will apply from 1 January 2024 (assuming the legislative process proceeds without objection).

A few points of interest from the April 2023 Commission Q&A:

• Noting that the SFDR does not prescribe specific criteria or minimum requirements that qualify concepts such as “contribution”, “do no significant harm” (DNSH) or “good governance”, firms must carry out their own assessment for each investment and disclose their underlying assumptions. A firm would have to demonstrate that any transitioning assets meet the DNSH and governance tests straightaway in order to qualify as a sustainable investment under SFDR.
• Funds that passively track Paris-Aligned Benchmarks or Climate Transition Benchmarks would be sufficient for an Article 9 categorisation.
• Firms that consider principal adverse impacts PAIs at the product level should disclose information on policies and procedures put in place to mitigate those PAIs (as well as PAI metrics).

This paper requests views across the financial sector on how to understand greenwashing (for sustainability-related claims relating to all aspects of ESG) and its main drivers.

This was open for comment until 10 January 2023, a progress report by the ESAs is expected by end May 2023 and a final report by end May 2024.

Tracking progress on this will provide insights in terms of evidence on potential greenwashing practices within and outside the scope of current EU sustainable finance legislation, and how the European authorities intend to address this, in terms of policy and regulatory risk and enforcement actions. Clarity and sectoral focus in this area will no doubt help to significantly reduce the potential harm or impact of any otherwise misleading or unsupported claims.

Following the Securities and Markets Stakeholder Group’s (SMSG) submission to the ESA’s joint call for evidence on greenwashing (outlined above), ESMA submitted four additional questions to SMSG requesting its input. These questions concerned whether there needs to be a more holistic definition of greenwashing, the so-called “greenbleaching” phenomenon, and what ESMA’s role should be in this area.

SMSG submitted its additional responses to ESMA on the 16 March 2023. These will inform the ESA’s final report on greenwashing which is due to be published by the end of May 2024.

SMSG has suggested that the current definition of greenwashing in European legislation is too narrow in scope and that there should be greater focus on ESG as a whole, rather than just the environmental aspects, which are the focus of many existing regulations.

SMSG has also taken the viewpoint that greenbleaching, where funds downplay their ESG credentials, should not be considered a misrepresentation. However, it has recommended that ESMA should monitor how many funds are undertaking this practice and if greenbleaching is widespread then ESMA should consider whether the existing sustainable finance legislation is achieving its goals. It has suggested that uncertainty in existing ESG legislation, such as what liquidity, hedging, and transition strategies are permitted for Article 9 funds, could be a cause of greenbleaching, with fund managers taking an overly cautious approach to avoid being accused of greenwashing. This could lead to ESMA recommending legislative reform to the Commission.

The purpose is to tackle greenwashing risk in funds by using quantitative thresholds for the use of ESG and sustainability-related terminology in fund names, to ensure that marketing communications are fair, clear, and not misleading and that fund managers are acting honestly.

This was open for comment until 20 February 2023, and expected to be finalised by Q2 or Q3 2023. To date, there has been no further output on this.

If a fund has any ESG or impact-related words in its name, a minimum proportion of at least 80% of its investments should be used to meet the E or S characteristics or sustainable investment objectives in accordance with the binding elements of the investment strategy to be disclosed in the Article 8 and 9 pre-contractual SFDR disclosures. If a fund has the word “sustainable” or any derivation of it in its name, 50% of the overall investments should be a minimum proportion of sustainable investments (as defined in Article 2(17) SFDR) (ESMA confirmed that the 50% proposal relates to overall investments not of the 80% figure referred to above).

This initiative is reflective of current developments elsewhere. For instance, in the UK, the FCA consultation CP22/20 on SDR and product labels (set out above) proposes restrictions to ensure that those marketing products to retail investors where those products do not use a sustainable label cannot promote them as sustainable through names or in marketing materials (although firms may use such terms in their disclosures.

Similar initiatives have been proposed in France, Germany, and the US.

The purpose of the CSDDD, according to the Commission, is to “foster sustainable and responsible corporate behaviour and to anchor human rights and environmental considerations in companies’ operations and corporate governance.” It seeks to establish a corporate due diligence duty (as well as duties for directors) on companies in relation to actual and potential humans rights adverse impacts and environmental adverse impacts.

The proposal by the Commission was published in early 2022 and it is currently in the legislative process, with the EU Council adopting its negotiating position in November 2022. The next step is for the European Parliament to publish its position, after which a trialogue period will begin. A finalised directive was expected in 2024 with implementation in 2026, but there are currently delays due to discussions on directors’ duties and whether it will apply to financial institutions. More clarity on these areas many be seen once the Parliament publishes its position.

While laudable for its aims, the CSDDD is yet another piece of legislation in relation to sustainability and corporate governance. The financial services industry is still getting to grips with SFDR and the interaction between this and CSDDD is currently uncertain. There are also concerns about the legislation grouping funds with their portfolio entities in which they take a majority stake, as there is currently no separation between “trade” groups and those entities linked only by financial investments.

It is worth noting that companies must meet a threshold (both by number of employees and turnover) in order for the CSDDD to apply. It will also apply to non-EU companies if they are active in the EU and their turnover generated in the EU meets the relevant threshold.

The CSRD came into force on 5 January 2023 and amends several EU laws: the Audit Regulation, Audit Directive, Transparency Directive, and Accounting Directive. It is designed to strengthen the rules for companies and the social and environmental information that they have to report on.

The Commission estimates that CSRD will apply to approximately 50,000 companies which includes a wider group of large companies and listed small and medium-size enterprises (SMEs).

It will apply to different groups of companies in stages, with the first group (public interest entities with more than 500 employees) having to report in 2025 in relation to the 2024 financial year. Large EU companies/groups (defined as an entity or group that meets two of the following three tests: (a) a balance sheet of €20m; (b) net turnover of €40m; (c) an average of 250 employees in the financial year) will have to report in 2026 in relation to 2025, and listed SMEs that are not micro-undertakings begin in 2027 in relation to 2026.

Lastly, non-EU parent companies with a subsidiary that is either a large EU company or a listed SME, or that has a large EU branch, will be required to report from 2029 in relation to 2028.

The CSRD amends some of the rules brought in by the Non-Financial Reporting Directive, but the requirements of the NFRD remain in force until the new rules start to apply.

Importantly, CSRD widens the scope of companies that are subject to the rules when compared to NFRD, with a major change being that listed SMEs are now included (unless they are “micro-entities”).

On 25 May 2022, the US SEC proposed ESG disclosure rules to address and enhance investor disclosure practices, and related policies and procedures regarding ESG investment considerations and objectives, as well as proposed changes to the existing “Names Rule” applicable to registered funds. The proposed ESG disclosure rules would require registered investment companies and registered investment advisers that employ ESG strategies in their investment processes to make ESG disclosures either in the fund prospectus for a registered investment company or in the brochure (Form ADV Part 2A) for a registered investment adviser. Disclosure requirements would vary based on the extent of ESG factor integration into investment strategies, characterized as “ESG Integration Strategies,” “ESG-Focused Strategies”, and “Impact Strategies.”

See our June 2022 client alert for background and more details.

Finalisation of the proposed rules and amendments is expected sometime in 2023. The SEC, however, is already actively engaged in enforcement activity based on inaccurate or misleading ESG-related disclosures.

The proposed ESG disclosure rules would apply to investment advisers to registered investment companies and private funds and other clients and are intended to provide investors with clear and comparable information about how advisers consider ESG factors.

The proposed changes to the Names Rule would, among other things, significantly expand the scope of the terms used in the names of registered funds that would subject the fund to the requirements of the Names Rule, including terms indicating that the fund’s investment decisions incorporate one or more ESG factors.

The proposed rules, meant to address greenwashing, are the US version of the EU’s SFDR that has applied since March 2021 and the UK’s SDR proposals (both of which are covered above). The focus, however, is solely on disclosures, and the SEC does not promote the adoption of a particular ESG strategy or any ESG strategy at all.

As proposed, the additional disclosure requirements applicable to “ESG-Focused” funds would be very easy to trigger. For example, the use of a single negative screen seemingly would cause a fund to fall within this category.

This relates to those amendments under Section 404(a) of the Employee Retirement Income Security Act of 1974 (ERISA) regarding the consideration of ESG factors by retirement plan fiduciaries. The amendments took effect on 30 January 2023.

See our January 2023 client alert for background and more details.

On 20 March 2023, President Biden vetoed a resolution passed by the US Congress that would have overturned this rule.

The DOL’s final amendments expressly reference ESG factors but take a neutral stance on whether investment fiduciaries should consider them and, to the extent they are considered, the weight to be afforded to them, providing investment fiduciaries leeway to determine whether and to what extent ESG factors are relevant in any given case.

This is taking place via new legislation, investment policies, attorney general opinions, letters, reports, statements, and unilateral state treasurer action, such as South Carolina’s divestment from BlackRock. Some states have also “blacklisted” certain companies that they have determined to act contrary to the principles and obligations that are the subject of the anti-ESG action.

States that have engaged in anti-ESG activity (pending or finalized) include: Alabama, Alaska, Arizona, Arkansas, Florida, Georgia, Idaho, Indiana, Iowa, Kansas, Kentucky, Louisiana, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, New Hampshire, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia, and Wyoming. By contrast, Connecticut, Illinois, Maine, Maryland, Nevada, New Hampshire, New Jersey, New York, Rhode Island, Vermont and Virginia have recently proposed or adopted policies or legislation to advance one or more ESG-related cause.

In response to the anti-ESG activity of certain states, representatives from California, Colorado, Delaware, Illinois, Maine, Massachusetts, Nevada, New Mexico, New York, Oregon, Rhode Island, Vermont, Washington, and Wisconsin released an open letter urging support for ESG-themed investment strategies.

The anti-ESG efforts, though widely acknowledged to promote a “red state” political agenda, are having a practical, if not a legal, impact. For example, a leading global investment company recently withdrew from the Net Zero Asset Manager initiative and was shortly thereafter excused from a hearing on ESG investment factors convened by the Texas Senate Committee on State Affairs.

On 5 April 2023 the FCA published its Business Plan for 2022/2023 which sets out how the FCA will continue to deliver the commitments it made in its April 2022 Strategy for 2022 to 2025 as well as how it will measure progress against these commitments.

The FCA Business Plan 2023/24 is structured around three areas of focus, namely:

• reducing and preventing serious harm
• setting and testing higher standards
• promoting competition and positive change

Key proposed activities under the area of “reducing and preventing serious harm.” include (among others):

• Reducing harm from firm failure. This will include introducing a new regulatory return requiring about 20,000 solo regulated financial services firms to provide a baseline level of information about their financial resilience. It will also involve continuing to imbed IFPR, developing FCA policies for cryptoassets, and assessing wind-down plans ahead of authorisation for higher-risk business models.
• Improving oversight of Appointed Representatives (see Appointed Representatives Regime below).
• Reducing and preventing financial crime including by improving capabilities to identify, alert and request that platforms take down unauthorised financial promotions, Associated websites and social media accounts.

Key proposed activities under the area of “setting and testing higher standards” include:

• Designing a new suite of regulatory returns for the consumer credit sector as well as making the consumer duty an integral part of the regulatory approach and further developing the consumer duty data strategy.
• Introducing an application gateway for firms that want to approve financial promotions for unauthorised firms. The FCA Register will include information about firms’ ability to approve promotions. Intervention will be increased against authorised firms issuing noncompliant financial promotions and unauthorised firms conducting activity that could lead to mis-selling and financial loss.
• Advance ESG aims including publishing Sustainability Disclosure Requirements and investment labels and consulting on changes to listing rules to reference the final ISSB standards once endorsed by IOSCO to strengthen sustainability-related disclosures.

A key proposed activity under the area of “promoting competition and positive change” includes (among others):

• Updating the regulatory framework including bringing forward proposals for changes to MiFID/MiFIR, and the Prospectus Regulation- including a new public offer regime.

The 2023/24 Business Plan largely represents a continuation of the strategies set out in the 2022/23 Business Plan with a view to fulfilling the same goals set out in the 2022-2025 Strategy.

The plan shows a clear priority of combatting financial crime, following the number of warnings about potential scams rising by a third to 1,882 last year. This will result in further scrutiny of financial promotions, compliance with the new consumer duty and oversight of firms’ anti-money laundering systems and controls. It also highlights the increasing importance of operational resilience, in particular where there is a risk to the consumer.

While the document is comprehensive in its summary of the FCA’s objectives and strategies, it largely represents an update of existing workflows and so does not introduce any particularly unexpected new developments.

As part of the Edinburgh Reforms (see The Edinburgh Reforms and the Future Regulatory Framework (FRF) below) the Chancellor of the Exchequer announced a promise to “commence a review into reforming the Senior Managers and Certification Regime in Q1 2023.” This has resulted in the FCA and Prudential Regulation Authority (PRA) publishing a joint discussion paper (FCA DP23/3 PRA DP1/23) and HM Treasury launching a call for evidence on the reform of SMCR.

On 30 March 2023 the FCA and PRA published a joint discussion paper (FCA DP23/3 PRA DP1/23) reviewing the operational aspects of the SMCR. Alongside this HM Treasury published a call for evidence on the legislative aspects of the regime. The discussion period and consultation period end on 1 June 2023.

The discussion paper requests views from firms, consumers and other stakeholders on the effectiveness, scope and proportionality of the current regime as well as other more specific potential improvements to SMCR. The call for evidence requests views on the objectives of SMCR and how effectively these are being delivered, some specific aspects of the regime that cause issues for firms as well as the scope of the regime.

The discussion paper and call for evidence represent an initial information gathering exercise to collect views on the regime’s effectiveness, scope and proportionality and to seek views on potential improvements and reforms. At this stage it appears unlikely that the responses will necessitate a fundamental reform of the SMCR. In particular, the discussion paper highlights the positive responses to previous reviews of the regime.

This review does, however, represent an opportunity for stakeholders to provide feedback on how effective the regime is and allow for more discrete optimisations to areas of the regime that may be creating friction. Areas that may be the subject of reform include (among others) the process for completing regulatory references and criteria for making conduct notifications, the frequency of SMCR-related submissions and the interaction of SMCR with other regulatory regimes.

The changes to the FCA’s Appointed Representative (AR) regime came into force on 8 December 2022. The changes impose additional requirements on FCA-authorised principals and on their ARs.

A principal is now required to provide additional and ongoing data to the FCA about the activities of its AR. There are also new additional obligations on a principal before taking on an AR and during the AR’s appointment.

The FCA has indicated it will work with HM Treasury to make further amendments to the regime.

The FCA has updated its perimeter report webpage to outline steps it is taking to increase scrutiny on principal firms operating with ARs. This includes submitting a section 165 data request to all principal firms to request information about new and existing ARs as well as writing to all firms providing regulatory hosting services in order to set out expectations under the new rules. Going forward, the updated webpage states that when applying for authorisation, the FCA will require principals to provide more information about the reasons for appointing ARs, their business activities, and the nature of their financial relationships.

The FCA Business Plan 2023/2024 (see above) lists key activities to be started or continued by the FCA in 2023/2024, including: (i) testing that firms are properly embedding rules across the appointed representatives regime; and (ii) strengthening scrutiny and engaging with principal firms as they appoint ARs.

The additional obligations are likely to result in an increase in the fees charged by third-party principals and the imposition of further obligations on ARs to ease a principal’s oversight of the AR. This may, in turn result in further scrutiny by a principal of its ARs. The FCA’s receipt of further data will put the FCA in a position to undertake further surveillance and exercise deeper scrutiny of the activities of ARs. The specific impact on private fund advisers (noting that a manager cannot be an AR) is difficult to determine because the changes were prompted by the FCA’s concerns about financial advisers and retail investors. If a private fund adviser finds itself with significant additional burdens imposed by its third-party principal, this may prompt the question of whether the increased cost of compliance as an AR justifies an application to the FCA to become authorised instead.

Data from the FCA’s updated perimeter report webpage indicates that the number of ARs operating in the UK has continued to decline, with January 2023 figures showing 36,600 active ARs compared to 41,652 in April 2021 and 38,200 in January 2022.

The FCA Consumer duty is captured in a new FCA Principle for Businesses, Principle 12, which states: “A firm must act to deliver good outcomes for retail customers.”

Three “cross-cutting rules” underpin the duty. These require firms to: (i) act in good faith toward retail customers; (ii) avoid causing foreseeable harm to retail customers; and (iii) enable and support retail customers to pursue their financial objectives.

The FCA also sets out four sets of “outcomes rules,” intended to help “define what is required by Principle 12." These relate to: (i) products and services; (ii) price and fair value; (iii) consumer understanding; and (iv) consumer support.

We addressed the likely impact of the Consumer Duty on private fund managers in our October 2022 client alert.

The FCA rules and guidance governing the duty, which the plan will need to address, come into force for: new and existing investments open for sale on 31 July 2023; and closed investments on 31 July 2024. There is also a deadline on 30 April 2023, for manufacturers, which includes in-scope managers, to have conducted cross-cutting rule reviews and shared information with distributors.

In its December 2022 Quarterly Consultation the FCA proposed making an amendment to the scope of the rules, so that firms in a distribution chain selling investment funds to retail customers where the minimum investment is £50,000 are no longer excluded. This is to clarify the policy intention that this “non-retail financial instrument” exclusion does not cover investment funds that are distributed to retail customers. If this change is introduced (with a consequent widening of scope of the Consumer Duty), it will impose further cost and disruption on affected firms, who have been working on the basis of the rules and definitions published in the FCA’s July 2022 policy statement (PS22/9).

On 25 January 2023 the FCA published feedback for firms on the implementation plans of the duty across a range of industry sectors. This emphasises three key areas that firms should particularly focus their attention on during the second half of the implementation period (to 31 July 2023), namely: effective prioritisation, embedding the substantive requirements of the duty and working with other firms.

On 22 February 2023 the FCA published a speech given by Sheldon Mills (executive director of competition and consumers) on the new consumer duty. This highlighted the final steps that firms should take to implement the consumer duty.

On 31 March 2023 the FCA published a portfolio letter on implementing the Consumer Duty in the Contracts for Difference (CFD) Portfolio. This letter provides detailed guidance on how the duty applies to firms (see Annex 1 of the letter) and key considerations for firms when embedding the duty in their CFD portfolio (see Annex 2 of the letter).

The duty applies to managers who provide services for a retail customer defined, in the context of an alternative investment fund, as an investor in the fund or the beneficial owner of interests in the fund, that is not a professional client. The duty will not, therefore, apply to professional investors in respect of whom the AIFMD by default, limits the marketing of private funds.

A point of direct contact for the managers of private managers will be per se retail clients, whom a manager cannot “opt-up” and treat as an elective professional client. This, in turn, highlights the role of the client categorisation processes, noted in our previous alert, and the FCA’s existing focus on these processes.

Likely retail client candidates include family offices, high-net worth individuals and manager employees to whom the manager may be offering carried interest or other employee incentives.

The FSM Bill is currently making its way through Parliament. The FSM Bill is the centrepiece for delivering the UK’s FRF.

Among its provisions are those that amend the Financial Services and Markets Act 2000 and implement proposals from the FRF review.

The main features of the FSM Bill include:

• delegating more rule-making powers to the FCA and PRA and giving them a secondary objective for growth and international competitiveness
• setting the process for revoking onshored EU financial services regulation, including a regime for designating activities as regulated activities
• the tightening of the process for the approval of financial promotion (see below)
• empowering the FCA and PRA to oversee the resilience of third parties providing critical services to the financial sector
• increasing the regulation of crypto-assets

On 23 March 2023 the FSM Bill completed the committee stage in the House of Lords. A revised version of the bill was published although it does not appear that any major amendments have been made since second reading on the 10 January 2023.

The FSM Bill will proceed to report stage in the House of Lords, a date for this has not yet been scheduled but it is expected to receive Royal Assent in Q2 2023.

Much has been made of the secondary objective for growth and international competitiveness, which is nearly identical to what was contained in the version of the Financial Services and Markets Act 2000 made over 20 years ago. This same provision was repealed in the wake of the financial crisis. The full impact of the secondary objective on the FCA and PRA rule-making and policy making powers is uncertain but the broader policy impact can be seen in the Edinburgh Reforms (discussed below).

See our comments below on the Edinburgh Reforms and FRF.

The FCA’s CP22/27, published in December 2022 and open for feedback until 7 February 2023, contains proposals to operationalise the proposed legislative changes (which form part of the FSM Bill) to create a new regulatory framework for authorised firms approving financial promotions of unauthorised firms.

The FCA states that the changes it has set out will address gaps in the financial promotions approvals regime and help it intervene faster in response to harmful financial promotions communicated by unauthorised firms in areas such as high-risk investments and "buy now pay later" products.

The proposed new regulatory gateway will impose a universal requirement on all authorised firms, prohibiting them from approving financial promotions of unauthorised firms. Any authorised firm wishing to undertake such activity will need to apply to have the requirement cancelled or varied. A transitional period is expected for the change to be implemented, and there are various exemptions.

The proposals currently being consulted on include provisions on how the FCA will assess applicants, the basis on which the FCA may grant or refuse permission, reporting (including half-yearly aggregate reporting) and notification requirements for eligible firms. On redress, the FCA does not intend to extend the Financial Ombudsman Service’s compulsory jurisdiction to approval of financial promotions. Neither is the Financial Services Compensation Scheme relevant.

These proposals do not affect the way authorised firms communicate their own financial promotions, approve their own promotions for communication by unauthorised persons, or approve promotions for their Appointed Representatives or unauthorised persons within the same corporate group. The key impact is that authorised firms will only be able to approve financial promotions for unauthorised persons where they have had the requirement to not approve financial promotions varied or cancelled.

The FCA’s December 2022 Quarterly Consultation (referred to above) also contains proposed amendments to clarify when the Consumer Duty applies to firms approving or communicating a financial promotion when there is no underlying regulated activity.

The changes to the FCA rules dealing with financial promotion address investment in "high-risk" assets and are addressed primarily at investment by retail investors.

The new rules are part of overall changes to the financial promotion regime, including changes proposed in the FSM Bill (covered above).

We addressed the changes to the financial promotion rules and the likely impact of the consumer duty on private fund managers in two recent client alerts (on new risk warnings and new financial promotion rules).

Under the new rules, there are two product categories: Restricted Mass Market Investments (RMMI) and Non-Mass Market Investments (NMMI). While the mass marketing of RMMI to retail clients is prohibited, any marketing of NMMI to retail clients is subject to further requirements. Non-mainstream pooled investments (NMPI) are a subset of NMMI and the additional rules. The rules on risk warnings came into force on 1 December 2022 and the remaining rules came into force on 1 February 2023.

The rules (some of which are the same as those that currently apply) impose requirements on FCA firms with respect to: the preliminary assessment of suitability; pre-promotion personalised risk warnings and “cooling off periods”; risk warnings in the promotions themselves; and restrictions on monetary and non-monetary benefits.

Firms that offer NMPI to retail investors, such as family offices, high-net-worth individuals, and employees, will need to consider the changes to the rules. For instance, where a manager offers carried interest or other employee incentives.

If the offers do not extend to retail investors but are limited to professional investors, the new rules will not be relevant.

On 9 December 2022, the Chancellor of the Exchequer, Jeremy Hunt, outlined a series of measures designed to drive growth and competitiveness in the UK financial services sector, now known as the Edinburgh Reforms. The reforms are divided into four categories: a competitive marketplace promoting effective use of capital; sustainable finance; technology and innovation; and consumers and business.

On the same day, HM Treasury published a Policy Statement that explained the government's approach to repealing and replacing retained EU law on financial services. The FCA also published the FRF Review setting out its approach to the FRF.

The Edinburgh Reforms and the Policy Statement, together with the FSM Bill, are designed to give effect to the FRF.

We would highlight the below main items of interest for private fund managers.

• The publication of draft Statutory Instruments to demonstrate how government can use the powers within the FSM Bill to reform the prospectus and securitisation regimes. Overhauling the prospectus regime to widen participation in the ownership of public companies and simplify the capital raising process for companies on UK markets.
• Plans to repeal the Regulation on European Long-Term Investment Funds without replacement on the basis that the recently-established Long Term Asset Fund regime provides a fund structure better suited to the needs of the UK market (covered in more detail above).
• Publishing a PRIIPs and UK Retail Disclosure consultation (discussed below).

The Edinburgh Reforms also included a proposed review of SMCR, which has led to the FCA and PRA publishing a joint discussion paper (FCA DP23/3 / PRA DP1/23) on the operational aspects of SMCR. See Senior Managers and Certification Regime (SMCR) Reform above.

In addition to this the Edinburgh Reforms promised secondary legislation to remove burdens for firms trading commodities derivatives as an ancillary activity. This has resulted in the 1 March 2023 publication of the Draft FSMA (Commodity Derivatives and Emission Allowances) Order 2023, which applies to firms trading commodity derivatives or emission allowances primarily for investment purposes or in support of the firm’s commercial business.

As a political statement, the Edinburgh Reforms have a strong signalling effect. The actual impact on the extent and burden of regulation on managers in particular is, however, difficult to predict.

The FCA’s statement is interesting, noting its work to encourage innovation and comments on how best to report and measure how it can contribute to the new secondary objective for growth and international competitiveness. It states that it will expect to distinguish between the FCA’s inputs and outputs, and the outcomes for the UK economy. It emphasises the importance of focussing on drivers it can measure and those it can influence directly and how this builds on the work it has already done on metrics and increased accountability.

This legislation is to be repealed by the FSM Bill as a “matter of priority” and replaced with an alternative framework for retail disclosure as part of the FRF review.

A consultation (that closed on 3 March 2023) was published as part of the Edinburgh Reforms. The intention of this limb of the proposals is to remove prescriptive requirements and increase flexibility, remove PRIIPs-type comparability from the future framework, create an FCA-led regime, and facilitate the FCA to integrate UCITS and PRIIPs disclosure by 2026.

Shortly after this HMT consultation, the FCA published a discussion paper (DP22/6) discussing the future retail disclosure framework setting out how the consultation proposals provide an opportunity to tailor the disclosure framework to the UK market. This discussion paper closed to responses on 7 March 2023. Following this the FCA will issue a feedback statement followed by a consultation paper for new rules for UK retail disclosure.

This is welcome news. The PRIIPs KID has been widely criticised as “not fit for purpose”, requiring misleading information to be provided to retail investors and placing an unnecessary burden on firms. The UK regulation also diverges from that of the EU. This is therefore a welcome opportunity to create a new retail disclosure regime that is proportionate and aligns with FCA’s high level requirements — being clear, fair and not misleading and in a client’s best interests.

At the end of 2020, the government called for evidence on the overseas regulatory framework, including the overseas persons exemption (OPE), and published its response in July 2021. The OPE, addressed in parts of the Regulated Activities Order, allows UK fund managers and certain types of investors to receive services from advisers and managers based outside the UK without those non-UK advisers or managers having to be FCA-authorised.

The Overseas Funds Regime was introduced in the Financial Services Act 2021 with the aim of introducing new equivalence regimes for retail investment funds and money market funds established outside the UK to enable recognised funds to be marketed to the public in the UK. The majority of provisions were commenced in February 2022 and the government has begun its equivalence assessment of the EEA under the Overseas Funds Regime. However HM Treasury has so far not made any equivalence decisions and the FCA has not yet published details on how the Overseas Funds Regime will work in practice.

The FCA had concerns that the OPE was not being used correctly and was working with HM Treasury to clarify the extent of the OPE and also to address the “characteristic performance” test (CPT). This holds, in essence, that where an activity, such as investment management, is performed outside the UK on behalf of or for the benefit of a UK client, that activity will not be deemed to occur in the UK and, therefore, not be a regulated activity.

The FCA’s Regulatory Initiatives Grid published in February indicated that the Treasury will continue to undertake engagement on potential changes to the overseas person exclusion, the overseas regulatory perimeter, and the exemption for overseas long-term issuers in 2023.

The Regulatory Initiatives Grid also indicated that the FCA is now working on operationalising the Overseas Funds Regime and will be consulting on various aspects of its Handbook rules in Q2 2023 to ensure that overseas funds are appropriately captured.

The OPE and CPT are vital pillars in the current cross-border regime and ensure that non-UK businesses, such as US investment advisers, can provide services to UK managers. If the OPE and CPT were to be restricted, this would likely increase the burden on non-UK businesses and potentially restrict investor choice. In light of the growth and international competitiveness objective set for the FCA under the FSM Bill (see above), it is difficult to see how a restriction could be justified.

In December 2022, ESMA published its final report on implementing technical standards and regulatory technical standards to specify the information to be provided and the content and format of notification letters to be submitted by AIFMs (and UCITS ManCos) to national competent authorities (NCAs) to undertake cross-border marketing or cross-border management activities in host member states. These complement the EU legislative package on cross-border distribution of funds (which has applied since August 2021).

This ESMA work aims to foster convergence and standardization of information and templates for cross-border management and marketing activities, so that NCAs can gather meaningful data that serves a supervisory purpose. ESMA has confirmed that the standards do not apply retrospectively. However, the new templates will result in increased costs (filing fees along with IT development and associated compliance burden), even though ESMA states this has been taken on board in developing the final report.

The Commission has three months (extendable to four) to adopt these standards so we expect this to happen in the very near future.

The cross-border legislation includes provisions on pre-marketing, reverse solicitation, ceasing marketing and minimum requirements for retail investors. In addition, new rules on marketing communications, are supplemented (since February 2022) by ESMA’s final guidelines.

There remain various grey areas in the practical application and interpretation of some of these rules, including, for instance: questions on the definition of "marketing communications"; the 36-month blackout period following a marketing de-notification; that any subscription within 18 months of the start of pre-marketing is considered to be marketing under AIFMD; and how the rules impact non-EU AIFMs/AIFs marketing under the national private placement regime (NPPR). The publication of these standards does not shed any light on these areas of uncertainty.

Since the Commission’s October 2020 consultation on a proposed Amending Directive, the Council of the EU and the European Parliament have been proposing further amendments. Once finalised, the Amending Directive will enter into force 20 days following its publication in the Official Journal of the EU; EU member states will then have 24 months to implement. The passage of a directive through the legislative process is typically 18 months (this would mean implementation in 2025) but it can be quicker.

See our December 2021 client alert for background on the original AIFMD II proposals and our most recent client alert in relation to the European Parliament proposals published in late January 2023.

The key areas of review relate to loan-originating AIFs, third party delegation, minimum stable substance within the AIFM, cross-border access to depositary services and the use of liquidity management tools. In addition, new transparency requirements on providing information on AIF loan portfolios are to be fed into investor disclosures and reporting to NCAs.

The final shape of these rules is yet to be determined, pending the outcome of the trialogue negotiations. The European Parliament published its proposals in late January of this year and the trialogue discussions began in March. The final Amending Directive is expected to be finalised in 2023, meaning full implementation by member states would be in 2025. Detail on implementing legislation is due to be produced by ESMA (and a consultation on this is expected in Autumn 2023).

UK AIFMs will not be directly impacted by the proposed amendments, unless the UK applies equivalent changes through the FCA Handbook and UK AIFM Regulations.

Loan-originating/private debt funds are an important and growing source of financing; also expected to help facilitate the transition to investing in a sustainable green economy.

Even if the UK does not take an aligned approach, the changes could still be relevant — for example, when marketing cross-border using the NPPRs, or contractually when acting as a delegate of an EU27 AIFM (or, if a UK AIFM chooses to voluntarily comply, on a grouped basis or in response to investor demand).

Available since December 2015, a European Long-Term Investment Fund is a collective investment framework for both professional and retail investors looking to invest in long-term assets. A review of the ELTIF Regulation was finalised in March 2023 and the amending regulation (the introduction of the ‘ELTIF 2’) entered into force on 9 April 2023 and applies 9 months later (i.e. from 10 January 2024). See our client alert for more.

Level 2 regulations to supplement the amending regulation are to follow on liquidity provisions, including for instance on:

• Manager requirements and regulator disclosures for an appropriate redemption policy and liquidity management tools
• Criteria for determining the minimum holding period when redemptions cannot be granted
• Redemption limits (based on an ELTIF’s expected cashflows and liabilities)
• How the life of the ELTIF is to be considered consistent with the long-term nature of an ELTIF and compatible with the life-cycles of each individual asset
• Circumstances for the use of secondary market matching and information to be disclosed to investors

See above in respect of the UK’s expected repeal of the ELTIF Regulation.

Some of the amendments are set out below.

• An extended list of eligible assets to include those outside the EU and reduce the threshold of eligible investment assets from 70% to 55%
• A broader and simpler definition of ‘real assets’ to include all assets that have intrinsic value due to their substance and properties. This captures a broader range of potential real asset investment strategies. Of note is the removal of both the requirement that real assets are owned directly or via ‘indirect holding via qualifying portfolio undertakings’ and a €10 million minimum investment value.
• Clear differentiation between ELTIFs to be marketed exclusively to professional investors and those that are marketed to retail investors. Provisions on diversification and concentration are disapplied for ELTIFs marketed only to professional investors. The rules applicable for ELTIFs targeting retail investors also provide more flexibility.
• ELTIFs solely marketed to institutional investors can borrow up to 100% of the net asset value of the ELTIF (and ELTIFs marketed to retail investors, up to 50%).
• ELTIFs can utilise master-feeder structures, where a feeder invests at least 85% of its assets in a master (provided sufficient investor protection is ensured). Both feeder and master structures must be ELTIFs.
• ELTIF managers and affiliated entities are permitted to co-invest in the ELTIF or co-invest with the ELTIF in the same asset; however managers must ensure organisational and administrative safeguards are in place to monitor and manage conflicts of interests (and that these are adequately disclosed).
• A reduction of barriers for retail investors (i.e. removing the €10,000 initial investment requirement and 10% exposure threshold for retail investors with portfolios below €500,000) and aligning the suitability test with that of MiFID.
• Removal of the provision for investors’ ability to require the winding down of an ELTIF where that ELTIF is unable to satisfy redemption requests within one year.

The aim of the amendments is to make ELTIFs more appealing to investors, in particular retail investors; minimise the restrictions and reduce the barriers; and provide more flexibility and accessibility to the regime and more favourable redemption options.

Although AIF structures are likely to continue to dominate the institutional end of the non-listed fund market, the ELTIF may be an appealing alternative for those managers targeting retail investors (e.g. local government pension schedules, HNWIs, affluent retail market, charities and institutions) as well as professional investors. The benefit of an EU wide marketing passport may also appeal to sub-threshold managers who do not have AIFMD passport rights.

Potential challenging issues are that:

• the final rules on liquidity provisions are yet to be published/determined. This may put off those ELTIFs authorised before 10 January 2024 to take advantage of their ability to opt in to the revised rules; and
• some more restrictive and complex requirements than other structures (i.e. fund of funds can only invest in other EU funds that make eligible investments and master-feeder structures can only invest in underlying ELTIFs).

There is a five year transitional period for pre-existing ELTIFs that are still raising capital and, for those ELTIF managers who want to opt into the revised rules, they can do so by notifying their member state NCA. For new ELTIF applications, there is a competitive two month approval window for regulator approval.

Regulation 2022/2554 on digital operational resilience for the financial sector (DORA) establishes uniform requirements for the security of network and information systems used by businesses in the financial sector. It imposes requirements on EEA regulated companies and organisations operating in the financial services sector as well as unregulated EEA and non-EEA based critical third parties providing services relating to information and communications technologies (ICT).

The regulation prescribes rules relating to firms ICT governance structures targeting enhanced ICT risk management, incident reporting, information sharing and operational resilience testing. The rules also require critical third parties providing ICT services to financial institutions to establish a presence in the EU within 12 months of being designated as a critical ICT third party service provider.

In addition to the internal governance requirements, DORA implements rules for the establishment and conduct of a new oversight framework for critical ICT third party service providers providing services for financial entities.

DORA is complemented by Directive (EU) 2022/2556 amending Directives 2009/65/EC, 2009/138/EC, 2011/61/EU, 2013/36/EU, 2014/59/EU, 2014/65/EU, (EU) 2015/2366 and (EU) 2016/2341 as regards digital operational resilience for the financial sector (the DORA Directive). This amends existing risk management provisions in certain financial services directives to better complement DORA.

Both DORA and the DORA Directive were published in the Official Journal of the European Union on 27 December 2022 and entered into force on 16 January 2023. The provisions of the Act and the Directive will apply from 17 January 2025, requiring EU member states to apply national measures implementing the DORA Directive from the same date.

The Regulation requires the ESAs to develop various delegated acts and technical standards to supplement the provisions of DORA. The ESAs are required to deliver technical advice to the Commission on two delegated acts before 30 September 2023 and submit technical standards required under Articles 15,16,18, and 28 before 17 January 2024. Before 17 July 2024 the ESAs are required to submit technical standards to the Commission under articles 20,26,30, and 41 as well as guidelines under Articles 11 and 32.

DORA and the DORA Directive represent a very significant step up in the regulatory requirements placed on firms’ ICT operational resilience. While some financial entities and critical service providers may already be fulfilling some of the requirements as a matter of good practice, many will have to implement significant changes to their systems and controls to comply with the detailed new rules.

Given the significant scope of the changes required and the relatively short implementation time frame, it is important that firms undertake a detailed review of their ICT risk management framework and leave adequate time to implement the requirements before they come into force on 17 January 2025.

This EU regulation is designed to address “distortions caused by foreign subsidies” and to ensure a level playing field for all companies in the EU single market. It targets companies that receive “subsidies” from third country state entities, as subsidies from member states are subject to close scrutiny while those from outside the EU are not.

This regulation is now in force as of 12 January 2023, and will apply from 12 July 2023 to EU entities with a turnover of €500 million or more (generated in the EU). The notification obligations apply from 12 October 2023 if the transaction involves a “foreign financial contribution” of more than €50 million.

Fund managers acquiring larger companies whose turnover threshold will meet the €500 million test will need to take note of this requirement. It is drafted extremely widely and those managers with commitments from sovereign wealth funds and potentially public pension funds of non-EU countries may well be caught by the notification obligations. The €50 million test is on a cumulative basis, so all relevant financial contributions must be aggregated. The notifications must be made prior to the transaction, and cannot complete until approval is received.

The changes in the DTT are now expected to be effective in 2024.

While it was expected that changes in the DTT would take effect in 2023, the changes are now not expected to be effective until 2024 at the earliest.

Under the revised DTT, the changes agreed in July 2022 between the UK and Luxembourg will take effect (in respect of UK income tax, capital gains, and corporation tax) in April of the calendar year following the year in which the DTT enters into force.

Although the UK ratified the Treaty in October 2022, Luxembourg did not ratify the changes before 31 December 2022, and so (provided Luxembourg ratifies the Treaty during the course of 2023), the earliest date on which the changes relating to capital gains are expected to take effect is April 2024.

The revised DTT will allow the UK to tax Luxembourg investors on any capital gain made on the disposal of a UK real estate-rich entity (including gains accrued prior to the amendments taking effect). Affected investors will welcome a further year of being able to rely on the existing exemption from UK tax.

However, certain helpful changes to the DTT will also be postponed. For instance, the revised DTT provides most UK parent company recipients with an exemption from withholding tax on dividends paid by Luxembourg holding companies (whereas the existing DTT reduces only the withholding tax rate), in circumstances where Brexit had meant that UK dividend recipients were not, under Luxembourg law, automatically benefitting from a full exemption available to EU recipients. Investors will now also have a longer wait for the anticipated DTT changes extending the treaty’s benefits to certain Luxembourg corporate collective investment vehicles (CIVs), where the relevant qualifying conditions are met.

Market uptake of the UK’s new QAHC regime, which took effect in April 2022, has steadily increased.

The Spring Finance Bill 2023 (FB) includes a number of proposed amendments to the regime.

The UK QAHC regime was implemented to provide for a tax-efficient UK-resident corporate holding vehicle that enables qualifying investors (including funds) to invest using a UK asset holding structure, with minimal additional UK tax leakage.

The proposed amendments in the FB include changes to enable:

• certain funds constituted as a body corporate (e.g., Delaware LPs) to meet the diversity of ownership (GDO) condition, such that the fund is a “good” investor for QAHC purposes;
• QAHCs to hold listed securities (provided the QAHC elects to be taxable on dividend income from such securities);
• allowing certain qualifying alternative finance arrangements to constitute a relevant interest, for the purposes of determining whether the ownership condition is met;
• the widening of the GDO condition so that it can more readily be satisfied in the context of “multi-vehicle arrangements” (e.g. where there are feeder, parallel, and aggregator vehicles).

The government has made a number of targeted changes to the initial rules since implementation to deal with points that were raising practical issues, and it has continued to discuss further helpful changes with the industry.

Through our participation in industry working groups, we are closely involved in working with HMRC to continue to refine and improve the operation of this regime. Please contact us if you would like to receive a more in-depth summary of the QAHC regime, including the potential advantages, conditions of eligibility, and practical points to note.

Further to its announcement on 9 December 2022, the government has included proposed amendments to the REIT rule in the FB, aimed at increasing the attractiveness of the UK REIT regime.

The amendments include:

• removing removing the requirement for a REIT to own at least three properties, where it holds a single commercial property worth at least £20 million;
• amending the rule that deems the disposal of a property within three years of its being significantly developed to be outside of the property rental business, so that the valuation used when calculating what constitutes a “significant development” better reflects increases in property values;
• allowing the payment of a property income distribution (PID) to a partnership to be made partly with tax withheld and partly gross with the components determined based on the extent to which the partners would be entitled to gross payment of the PID if they held an interest in the REIT directly.

The changes are expected to take effect from the date of Royal Assent of the FB, save for the amendments to the three-year development rule (which take effect in relation to disposals made on or after 1 April 2023).

These amendments will be welcomed amid the growing trend for large and midsize pan-European real estate funds to structure UK investments using a REIT rather than, e.g., a master holding company taking the form of a Luxembourg S.à r.l. (see also the comments above on the changes to the UK-Luxembourg double tax treaty).

It should be noted that the amendment to allow differential withholding on PIDs may be of limited practical impact for many funds, given that only a handful of categories of investor have gross payment status (almost exclusively UK entities). For example, sovereigns do not have gross payment status, despite being able to reclaim all UK withholding tax on PIDs.

The government published its consultation on the VAT treatment of fund management services on 9 December 2022. The consultation closed on 2 February 2023.

The government proposes codifying the UK's existing policy (based on UK law, retained EU law, general principles, case law, and guidance) to provide certainty on the VAT treatment of fund management. VAT is chargeable on supplies of fund management services to most private funds in the UK (e.g. AIFs), other than certain, limited exempt supplies (including supplies to special investment funds (SIFs)). It is not proposed that this VAT treatment will significantly change following the review.

The government proposes establishing criteria to identify SIFs as follows:

• the fund must be a collective investment operating on the principle of risk-spreading
• the investment return must depend on the performance of the investments with holders bearing the risk connected with the fund
• the fund must be subject to the same conditions of competition, and appeal to the same investors, as a UCITS (retail investors)

However, a fund will not need to be subject to "State Supervision" to qualify as a SIF. A definition of "Collective Investment", broadly mirroring that in FSMA 2000, will also be introduced.

Views on the proposals, as well as whether any further VAT related modifications would improve the fund management regime for taxpayers, are being sought.

Greater certainty over whether a fund is a SIF is welcome and may improve the UK's attractiveness to funds. However, ruling zero rating for fund management services out of the consultation's scope (as announced in the government's response to its call for input on the review of the UK funds regime) will disappoint some, as this would have addressed irrecoverable VAT for UK private fund managers.

The UK continues to set the pace on this, following the publication of the first draft of the UK legislation in July 2022.

In March 2023 the government published further draft legislation in the FB setting out the UK’s new multinational top-up tax (MTT) and qualified domestic minimum top-up tax (QDMTT), both of which are due to take effect in respect of accounting periods beginning on or after 31 December 2023.

As expected, the UK draft legislation closely follows the OECD’s Model GloBE Rules published in December 2021, and contains similar exceptions and carve-outs in relation to funds.

The draft legislation published in March 2023 expands upon the first form of draft legislation (published in July 2022), with the changes made in respect of the MTT primarily reflecting various technical clarifications that had been included in the OECD’s Administrative Guidance (published in February 2023).

The new QDMTT will, broadly speaking, impose a UK top-up tax on the UK members of a group (domestic or multinational) in respect of UK profits which are otherwise taxed at below the minimum rate of 15% required by OECD Pillar 2.

On paper the draft legislation principally impacts the UK tax system. However, it is expected to be of wider significance for the global Pillar 2 project given the consultative role undertaken by the UK government at the OECD level.

The publication of this draft legislation represents another significant step toward the UK’s adoption of Pillar 2, with the UK and other jurisdictions seeking to bring into effect domestic implementing legislation for the start of 2024.

While many funds will be excluded from the scope of Pillar 2 (because, for example, their consolidated revenues fall below the €750m threshold, or because the “excluded entity” provisions apply to the fund vehicles and their holding companies), it is still possible, depending on the fund structures and/or accounting policies adopted, that their portfolio investments will be caught by the rules. In particular, the implementation of QDMTTs means that it should not be assumed that a fund will fall outside of the rules simply because it only operates in one jurisdiction.

A number of fund managers have started to examine the impact of the rules on their portfolios, whether they might fall outside the scope of the regime and/or how to manage compliance with any applicable provisions.

The government published draft legislation in the FB that would allow UK individual taxpayers who expect to receive carried interest to make an election for their carried interest to be taxed on an accruals basis. The provisions are expected to apply to 2022/23 and subsequent tax years.

The time at which carry is treated as arising to a carry holder in the UK for tax purposes can be significantly later than the time at which it arises for tax purposes in other jurisdictions (e.g. the US). This can be problematic for individual fund managers holding carried interest rights who are subject to tax in both jurisdictions. In particular, issues can arise regarding the availability of tax refunds and credits for tax paid across the relevant jurisdictions.

The new draft legislation aims to resolve the difficulties arising in relation to refunds / credits by allowing individuals to make an (irrevocable) election, the effect of which will be to bring forward the point at which UK tax becomes due on carried interest (i.e. taxation on an accruals basis).

The legislation is expected to primarily benefit individual fund managers who are UK tax resident but who also have US citizenship.

The European Parliament adopted the proposed text of the ATAD 3 Directive, as amended by the European Parliament’s Committee on Economic and Monetary Affairs (ECON), on 17 January 2023.

The EU Council will now need to vote on whether to adopt the Parliament’s proposal as the final text of ATAD 3 (the timing of this is unclear).

The softening of the minimum substance indicators required to be reported by in-scope undertakings (as discussed in more detail in our January 2023 Horizon Scan) has made its way into the Parliament’s proposed text (such softening, broadly, allows group companies to share premises and removes certain restrictions in relation to their directors), as has the requirement that the Commission submit a report five years from the date of transposition that, among other things, assesses whether it is appropriate to extend the obligation to report on minimum substance requirements to “regulated financial undertakings” and, if necessary, review the exemption that such undertakings would (on current drafting) benefit from.

As noted in our January 2023 Horizon Scan, there had been support during committee debates for removing the exemption for “regulated financial undertakings” (broadly, vehicles established as an AIF managed by an AIFM) from the in-scope undertakings. However, this exemption has been retained in the Parliament’s proposed text (although there is no guarantee that this key carve-out will be included in the Directive’s final text).

ATAD 3 has made significant progress under the Swedish presidency of the Council, and the Directive (as currently drafted) is still scheduled to take effect from 1 January 2024. However, given the need for unanimous approval by all 27 EU member states, it is possible that adoption could slip to the second half of 2023 (when the Council will be under Spanish presidency), in which case it is likely that the Directive will not take effect until 1 January 2025 at the earliest.

As the Parliament’s proposal is non-binding, the EU Council does not need to adopt this draft version of ATAD 3, and so it remains to be seen what the final form of the Directive will entail.

The Marketing Rule came into effect on 4 November 2022.

The new Marketing Rule overhauls the regulatory requirements for SEC-registered investment advisers (RIAs) with respect to placement agents for their private funds. It captures a wide range of communications by placement agents as “advertisements” of the RIA and imposes oversight requirements on the RIA with respect to placement agents.

For non-US fund managers, the Marketing Rule will not apply to “exempt reporting advisers” (ERAs), nor will it apply to non-US RIAs in relation to non-US funds (even if US investors commit to these non-US funds). If a non-US RIA is marketing a fund based in the US, then the Marketing Rule will apply.

Non-US RIAs marketing non-US funds should take care to minimise references in marketing documents to the fact that the manager is SEC registered, and include appropriate disclaimers/qualifications where they do make such references.

On 9 February 2022, the SEC proposed a package of new rules that, if adopted, will have a significant impact on fund managers.

Following the publication of the proposed rules, there was a period of consultation with the funds industry during 2022. The SEC has yet to issue amended proposals following the consultation but that is expected as some point in the next few months.

The proposed rules include (among other issues):

• a prohibition of certain activities such as charging investors accelerated monitoring fees or regulatory expenses for SEC examinations, etc.
• clawback of carried interest would need to be gross of any tax paid
• a prohibition on preferential treatment
• mandatory quarterly statements to investors on fund performance, fees and expenses

On 3 May 2023, the SEC published rules that amend the Form PF, which is a confidential reporting form for certain SEC registered investment advisers.

The new rules will become effective on the date that is six months following publication.

The changes apply to hedge fund and private equity advisers, and in some cases only to “large” private equity advisers (those with more than $2 billion assets under management). Please see our client alert from 2022, which highlights the fact that these terms are very wide ranging and not totally aligned with how they are used in the market. For example, some private equity, credit and real estate funds actually fall within the definition of “hedge fund”.

The new requirements include an obligation to report events that could indicate “significant stress at a fund or investor harm.” For private equity advisers, this includes reporting within 60 days of a quarter end if there is a removal of a general partner, a fund termination event, or a GP-led secondary transaction.

Large private equity advisers will also be required to report annually on any LP or GP clawbacks, and provide more information on their fund strategies and borrowings.

Please see our recent client alert for further information and comment.

• Consultations on Local Government Pension Scheme (LGPS) asset pooling
• HM Treasury consultation and call for evidence on a future financial services regime for cryptoassets
• A review of UK MiFID (including the unbundling of research rules)
• FCA report on diversity and inclusivity in financial services
• Ongoing work on how to address structural liquidity mismatches in open-ended funds
• FCA and Bank of England Discussion Paper on Artificial Intelligence and Machine Learning (DP5/22)
• FCA discussion paper on ESG governance, remuneration, incentives, and training

• Additional requirements for cross-border tied agency passporting
• Taskforce on Nature-related Financial Disclosures (TNFD): draft framework under consultation
• Amendments to MiFID II rules and guidance for NCA on supervision of investment firms’ cross-border activities
• The Commission opened its call for evidence on the Business in Europe: Framework for Income Taxation (BEFIT)
• EU Faster and Safer Tax Excess Refund (FASTER) proposals

• Global Task Force on Nature-Related Financial Disclosures and implementation of a Global Biodiversity Framework, as part of the COP15 goals
• Adoption of International Sustainability Standards Board (ISSB) standards for sustainability-related financial disclosures