Q1 Regulatory Update: February

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As the second month of 2020 begins, regulatory enhancements across the asset management industry show no sign of slowing down. The investment management space faced a huge amount of regulatory change in 2019, not only with regards to fund regulation, but also following a global surge in data protection regulation.

2020 looks set to be the year of environmental regulation. With the World Economic Forum in Davos being dominated by environmental concerns over the past few days, it is clear that there will be a keen focus on this in 2020. Not surprisingly, the EU has already started to take action with an Action Plan.

European Focus

In response to growing concerns around climate change and Macro impacts, sustainability and Environmental, Social and Governance (“ESG”) investing has risen to the forefront of the asset management space. The European Commission’s ‘Action Plan’ on Sustainable Finance was published as far back as 2018 and stated,

To achieve more sustainable growth, everyone in society must play a role. The financial system is no exception. Re-orienting private capital to more sustainable investments requires a comprehensive rethinking of how our financial system works. This is necessary if the EU is to develop more sustainable economic growth, ensure the stability of the financial system, and foster more transparency and long-termism in the economy.” (The EU Commission)[1]

This mean that investors will be required to:

  • Provide information on how ESG factors are integrated in their investment and voting decisions;
  • Advise how the financial risks coming from climate change, resource depletion, environmental degradation and social issues is managed;
  • Foster transparency in financial and economic activity with a focus on the long term.

The next step in enforcement came on December 9, 2019 where a regulation was published in the Official Journal (Regulation EU 2019/2088) requiring sustainability‐related disclosures in the financial services sector. This regulation requires transparency with regards to sustainability-related information with respect to MiFID firms, AIFMs and UCITS management companies. It requires that pre-contractual sustainability disclosures are made to investors, such as explaining how sustainability risks are integrated into investment decisions.

New EU transparency requirements explained:

The requirements can be split into three key areas:

  1. The integration of sustainability risks in the investment advice or decision-making process, through a set of policies and procedures (“ESG Disclosure Regulation” proposal).
  2. The consideration of key adverse impacts and risks of an investment decision on sustainability factors – this must be made available and included in the pre contractual disclosures.
  3. Information on how remuneration policies are consistent with the integration of sustainability risks.

In terms of  financial services products, firms will be expected to explain the following:

  1. The manner in which sustainability risks are integrated into their investment decisions;
  2. The likely impacts of sustainability risks on the returns of the financial products made available.
  3. How the financial products made available consider principal adverse impacts on sustainability factors.

When will this be applicable?

The regulation will come in to force on March 10, 2021 with product rules being implemented the following year (December, 2022). Yet some regulators are already investigating conduct within their jurisdictions to ensure that strategies being launched under the guise of sustainability can actually stand up to pressure and scrutiny, therefore it is important that managers build these transparent procedures in sooner rather than later.

2020 will likely see the adoption of the ‘ESG Taxonomy Regulation’ (“ESG TR”) which aims to establish a framework for a unified criteria for deeming economic activity as environmentally sustainable.

The goal is to clarify and define the criteria that EU Member States must apply when developing systems for environmentally sustainable financial or ESG related products. They will be required to disclose ‘how’ and ‘to what extent’ the criteria set out in the ESG TR have been used to determine the environmental sustainability of those products.

More recently, on January 14, 2020, the EU presented the Sustainable European Investment Plan which is announced following the release of the European Green Deal in December 2019 which delivered the EU’s ambition to become the first climate-neutral bloc in the world by 2050. Based on this, it is safe to assume we can expect additional ESG and sustainability focused regulation in 2020 and firms must ensure they are ready to respond to this by taking transparency action now.

Contact us to enquire about Apex ESG Rating and Scoring product to support your ESG evolution.

AIFMD and UCITS Update

In April 2019, the European Parliament released amends to the existing regimes and improvements to cross-border distribution for AIFs and UCITS funds within the EU.

The key changes to the AIFMD and UCITS frameworks were in relation to the safekeeping of assets by depositaries and any sub-delegates to whom safekeeping functions have been delegated to (i.e. custodians or prime brokers acting as custodians).

The key enhancements include:

  1. Alignment of AIFMD and UCITS provisions on segregation of delegates: this could have a possible impact on the contractual agreements for depositary services.
  2. Reconciliation: depositaries must carry out reconciliations between their own internal accounts and the records of their delegates. Custodian banks are required to provide the depositary with statements on a regular  basis (or in case of any change).
  3. Recordkeeping: Where the custody of assets has been delegated to a third party, records must be kept and maintained to enable the depositary to:
    1. distinguish assets of the depositary’s clients from the third party’s own assets,
    2. distinguish assets of the third party’s other clients and assets held for the depositary for its own account,
    3. identify the precise nature, location and ownership status of those assets at any time,
    4. ensure solid contractual terms in the agreements between the depositary and the delegated third parties covering rights to identify all the entities in the custody chain as well as execution of oversight rights and duties on delegated third parties. ( the right to information, inspection and access to the relevant records/accounts of the third parties). This principle has to be cascaded down in the entire sub-delegation chain.
  4. Asset Segregation: Assets of UCITS clients, AIF clients and other clients of one depositary must be segregated from the delegate’s own assets, the depositary’s own assets and from the assets belonging to the other clients of the delegate.
  5. Third Country Depositary: cover obligation to obtain a legal opinion from an independent party as to the adequacy of the insolvency law protection of the third country and compliance of the third party to their national laws. (includes securing benefits of segregation of assets, escalations of breaches and changes to applicable insolvency laws).

Depositaries of UCITS funds and AIFs have until April 1, 2020 to comply with the new common rules and are revisiting any delegation arrangements with their Custodian Banks to include the required changes.

Whistleblowing

In October 2019, the European Parliament adopted the new Whistleblowing Directive to protect  individuals reporting breaches of EU law. The directive aims to implement a set of minimum standards for whistleblowing protection across the region. EU member states must implement the Directive into national law by  December 17, 2021. Only after being implemented will its content be binding.

The Directive covers actual or potential violations of EU Laws in areas such as (amongst others):

  • public procurement
  • prevention of money laundering and terrorist financing
  • protection of the environment
  • data privacy and data protection
  • IT security
  • tax avoidance
  • fraud
  • corruption

The scope of the Directive is extended to existing and former employees, members of management or the supervisory board, contractors, subcontractors, suppliers, legal entities (directly owned or in any way connected to the reporting person) and/or to any third parties related to the reporting person.

Whistle-blowers are granted immunity from any liability for reporting information or submitting documents that they lawfully acquired or obtained access to. They also have the right to publicly disclose information on breaches if appropriate action is not taken.

In conjunction with the GDPR requirements, the Directive defines that:

  • The whistle-blowers personal identity shall be disclosed only by limited authorised persons (unless specific consent is obtained).
  • The whistle-blower must be notified in case his/her identity is disclosed otherwise (e.g. in court).
  • the reports may only be retained by the company(s) for a period of time that is necessary and proportionate
  • any data collected that no longer relates to the case, must be deleted with no delay.

Balancing Rights with Obligations

The Whistleblowing Directive asks member states to take measures to protect or sanction whistle-blowers, depending on the validity of the information reported.

  1. protection must be granted for those whistle-blowers who have reasonable grounds to believe that the information they are reporting is true at the time of reporting.
  2. introduction of the principle of reverse burden of proof in case of disciplinary measures.
  3. member states are also asked to impose penalties and compensating damages on the whistle-blower if it is established that he/she knowingly made false reports.

In any case, internal and external investigations must always be handled with the greatest care, confidentiality and referring to the principle of “innocent until proven guilty”.

Americas Focus

Outsourcing Requirements – Bermuda

In June 2019, the BMA published Guidance Notes on Outsourcing for all “Relevant Licensed Entities” (“RLE”), including Banks, Deposit Companies, the Bermuda Stock Exchange, Corporate Service Providers, Trust Companies, Money Service Businesses, Investment Businesses, Fund Administrators and the Credit Union.

The Guidance Notes require these entities to have adequate policies and procedures in place (by May 2020) in order to manage and monitor existing activities that have been outsourced, as well as to assess the risks arising from outsourcing new activities.

Although it applies to all outsourcing arrangements, the BMA is mainly interested in regulating the outsourcing defined as “material”, as any failure in provision or performance of the outsourced activity would have a material impact on business operations, financial performance, risk management, compliance risk.

The BMA has provided the RLEs seven months for the transposition of the new requirements. 

Phase 1 – review of all existing outsourcing arrangements

During the first phase the RLE will need to review all existing outsourcing agreements and ensure they either (i) seek BMA approval for all of them or (ii) provide BMA with an attestation from CEO[2]declaring  that each material outsourcing arrangement fully complies with the Guidance Notes.

Phase 2 – new outsourcing arrangements

During phase 2 (from January till May 2020) the RLEs that wish to enter into a new material outsourcing arrangement can still use either the pre-approval or attestation method.

From Live Date onwards

From May 1, 2020, the RLEs that wish entering into new material outsourcing arrangements will be required to:

  1. make prior notification submission to the BMA (BMA will have 20 working days to revert to the applicant);
  2. have clear policies and process in place;
  3. demonstrate risk assessment has been performed and mitigation measures are in place to perform adequate due diligence on the outsourcing providers, including but not limited to, business contingency plan and disaster recovery. For intra-group material and non-material outsourcing, the RLE must have formal written agreement with the group service provider;
  4. in case of sub-contracting/sub-outsourcing/chain outsourcing, all subcontracting arrangements should be detailed in the outsourcing agreement and any sub-contractor should be subject to the same levels of due diligence by the RLE as the primary Service Provider. 

Investment Funds Amendment Act

Bermuda is enhancing its regulatory framework by extending the scope of the Bermuda Investment Fund Amendment Act to categories of investment funds that previously did not require any registration or regulation; such as closed-ended investment funds and overseas investment funds.

The Bermuda Investment Fund Amendment Act (2019) came into force this month (January 2020), replacing the existing Investment Fund Act 2006.

What’s New?

  1. The introduction of a new class of fund for closed-ended investment funds namely the “Professional Closed Fund”. Professional Closed Funds will need to apply to the BMA for recognition and registration prior to launch. Those already in existence have a six month transition period to comply.
  2. Professional Closed Funds will have a new obligation to file an annual certification to the BMA demonstrating that the fund continues to satisfy the relevant requirements; including information on NAVs and underlying assets, a copy of the latest audited financial statements and a statement of material changes to the fund’s terms of offering that may have taken place during the reporting period.

If an investment fund qualifies as a Professional Closed Fund,  it must comply with defined criteria, such as:

  • being a closed-ended only opened to qualified participants[3];
  • participants are provided with fund information/warning prior investment;
  • the fund is administered in Bermuda or has appointed a representative who is in Bermuda;
  • the fund has appointed an auditor.
  1. Introduction of a mandatory registration with the BMA for new overseas investment funds that are managed locally or carry out promotion in (or from within) Bermuda, while the existing impacted funds will still have the 6 month transition phase to do so.

The new requirements for designation and obligation of overseas funds are:

  • To be incorporated or established in a jurisdiction outside of Bermuda;
  • To comply with the applicable rules and requirements of the overseas regulatory authority;
  • To comply with the requirements of section 5A of the Funds Act and any conditions imposed on it by the BMA.

Notification to BMA

At the time of filing, the overseas fund should also provide:

  • a copy of the offering document;
  • details of any regulatory approval given by, or notification given to the overseas regulatory authority where the overseas fund is incorporated or established; and
  • the prescribed notification fee.

The notification should be submitted before June 2020.

Cayman Islands Government Bills – Private Funds Bill

Similar to Bermuda, the Cayman Islands is also introducing legislative changes to enhance oversight of open and closed-ended funds in order to provide additional transparency for investors – aligning with best practices, enhanced anti-money laundering and other key regulatory requirements.

The two key Government Bills are:

  1. The Mutual Funds Bill: which removes the existing exemption from registration for hedge funds with 15 or less investors , which are therefore now in scope for registration with the Cayman Islands Monetary Authority (“CIMA”) and subject to the same regulations;
  2. The Private Funds Bill: which creates a regulatory regime for private closed-end funds requiring them to register with the CIMA and includes the following obligations:
  • Audit: private funds will need to have their financial statements audited by a Cayman Islands-based, CIMA approved auditor annually. The audit must be filed with CIMA within 6 months of the private fund’s financial year end along with an annual return.
  • Valuation: asset valuation will need to be conducted by private funds on an appropriate and consistent basis and must be done at least annually.
  • Safekeeping of fund assets: a private fund must appoint a custodian to (i) hold assets which are capable of physical delivery or capable of registration in a custodial account except where that is neither practical nor proportionate given the nature of the private fund and the type of asset held; and (ii) verify title to, and maintain records of, assets.
  • Cash Monitoring: the Bill requires a private fund to monitor cash flows, cash account receipts and payments to investors. This may be done by an independent party, such as an independent administrator.
  • Identification of securities: the bill required a private fund that regularly trade securities or holds them on a consistent basis, to maintain records of the identification codes (e.g. ISIN or LEI) of the relevant securities.

Who is in scope?

Closed-ended funds with more than one investor are expected to fall within the scope of the bill.  A fund is considered to be a “private fund” if it has been structured as a Cayman Islands company, unit trust or partnership including if;

  • its principal business is offering and issuing investment interests, the purpose or effect of which is the pooling of investor funds with the aim of spreading investment risk and enabling investors to receive profits or gains from the fund’s acquisition, holding, management or disposal of investments;
  • its investment interests are not redeemable at the option of the investor;
  • its investors do not have day to day control over the acquisition, holding, management or disposal of the fund’s investments;
  • its investments are managed as a whole by or on behalf of its operator, directly or indirectly, for reward based on the assets, profits or gains of the fund.

There are exemptions to fulfilling all of the obligations set out in the bill.  For instance, it is expected that Alternative Investment Vehicles will be required to register with CIMA but will be exempt from the other requirements of private funds. 

The bill provides a description of entities that are excluded from registering with CIMA. The full list can be found in the Bill (http://www.gov.ky/portal/pls/portal/docs/1/12910545.PDF ).

An implementation date has not been yet disclosed by the Cayman Government.

For other regulatory updates and information on directives around the globe, please  visit our regulatoty corner.

Please contact us if you have any questions.

 

 

 

[1] https://ec.europa.eu/commission/presscorner/detail/en/IP_19_1571

[2] The CEO attestation can take the form of a short statement that says, for example, “I attest that as of this date the material outsourcing listed below that the RLE entered into on 01/01/2020 is in full compliance with all aspects of the Authority’s new Outsourcing guidance. Where the RLE has a number of material outsourcings the CEO attestation can take the form of statement that says, “I attest that as of this date the material outsourcings listed below that the RLE entered in to on the various dates listed below are all in full compliance with all aspects of the Authority’s new Outsourcing guidance.” (Source: https://www.bma.bm/viewPDF/documents/2019-06-28-10-38-02-Outsourcing-Guidance-Note.pdf)

[3] Amongst the qualified participant, the IFA introduced the “high net worth private investors” (more than $1 mn). The change introduced by the IFA Amendments is to specify that the net worth amount must exclude the value and any benefits or rights under a contract of insurance.

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