ESMA CONSULTATION PAPER ON DRAFT REGULATORY TECHNICAL STANDARDS UNDER THE ELTIF REGULATION (the Consultation Paper )

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1 European Securities and Markets Authority 12 Throgmorton Avenue 14 October 2015 Dear Sir/Madam ESMA CONSULTATION PAPER ON DRAFT REGULATORY TECHNICAL STANDARDS UNDER THE ELTIF REGULATION (the Consultation Paper ) BlackRock, Inc. ( BlackRock ) [1] is pleased to have the opportunity to respond to ESMA s Consultation Paper on draft regulatory technical standards under the ELTIF Regulation. BlackRock s asset management business incorporates numerous ranges of UCITS funds domiciled across Germany, Ireland, Luxembourg and the UK and we have drawn on experience from these ranges and these jurisdictions in responding to the Consultation Paper. Executive Summary BlackRock supports the development and future success of the ELTIF regime. As pointed out in the BlackRock response to the initial ELTIF consultation, it is important to ensure that the ELTIF regime remains attractive and competitive when compared to the existing AIF regime. We would, therefore, recommend that any regulatory technical standards applicable to ELTIFs be no more restrictive than those applicable to AIFs and that, in fact, the harmonisation of the ELTIF regime would benefit by having the same technical requirements as AIFs and/or UCITS, where appropriate. This would allow investors to easily compare products. Restrictions on the flexibility afforded to the ELTIF over and above an AIF will, in our view, hamper the attractiveness of the ELTIF regime to both investors and potential sponsors in the asset management community. Yours faithfully Stuart Corrigall Director Head of Product Structuring Strategic Product Management EMEA Martin Parkes Director Public Policy EMEA [1] BlackRock is one of the world s leading asset management firms. We manage assets on behalf of institutional and individual clients worldwide, across equity, fixed income, liquidity, real estate, alternatives, and multi-asset strategies. Our client base includes pension plans, endowments, foundations, charities, official institutions, insurers and other financial institutions, as well as individuals around the world. 1

2 SCHEDULE 12 Throgmorton Avenue Response to Consultation Paper Questions Q1 Do you agree that the abovementioned pieces of legislation and associated regulatory framework are relevant for the purpose of the present advice on Article 9(3) of the ELTIFs Regulation? Which other pieces of legislation and associated regulatory framework do you identify for that purpose? We agree that the legislation listed is relevant but it is notable that there is no product specific legislation which considers the practice of portfolio hedging. IFRS would not be an appropriate point of reference in our view since the standards are international (not European) and are not tailored to investment funds. It is perhaps helpful to consider the UCITS Directive in this context (although the risk profile of the fund types will of course be different to the ELTIF). Historically, there has been no definition of hedging applicable to UCITS funds and accordingly local regulators and asset managers have adopted different practices relating to the use of derivatives for these purposes. Broadly speaking, where a fund uses derivatives for something other than investment purposes the use is described to be for hedging or for efficient portfolio management purposes. In the Eligible Assets Directive 2007/16/EC (Article 11) a harmonised approach to the use of derivatives (for non-investment purposes at least) was achieved through the introduction of the defined term efficient portfolio management. In the ELTIF context, ESMA is here seeking to restrict the use of derivatives to non-investment/non-speculative purposes, i.e. efficient portfolio management. There may therefore be advantages to using the well understood UCITS definition either via cross reference the Eligible Assets Directive (Article 11) description or copy out in the RTS. In the context of the restriction of investment in commodities, it would be helpful if ESMA could expressly mention that the use of derivatives for commodity risk hedging is permitted. This will be a material risk for infrastructure projects (e.g. hedging the price of building materials) that will need to be hedged so certainty in this regard would be helpful. Q2 Do you think that the main risks that are necessary to be covered at the level of the ELTIF are currency, inflation and interest rate risks? If no, which types of risk would the manager of an ELTIF potentially have to cover in your view? In terms of long term financial risks that can be hedged, we would agree that the risks referenced are important, but there are others that will be equally relevant commodity risk, credit risk, liquidity risk, market risk and volatility risk for example. We are unsure how it is helpful or necessary to catalogue all risks, especially when this is something not done in the AIFMD or UCITS context. Different risks will of course arise in relation to different asset classes: some it may be possible to hedge (through the use of derivatives); and others cannot be hedged these are the risks which the investment manager is being paid to take (see examples below). The ELTIF should have the ability to hedge any risk for which it can arrange cover. Risks that can be hedged Currency Inflation Examples of risks that cannot be hedged Operational Government/sovereign 2

3 Interest rate Credit Liquidity Market Commodity Political Regulatory Concentration Settlement Emerging Market Derivatives Tax Fund liability Valuation Terrorism Litigation Foreign investment Market disruption/suspension 12 Throgmorton Avenue We note that EOIPA has recently identified in its Consultation Paper No. CP15004 on the Call for Advice from the European Commission on the identification and calibration of infrastructure investment risk categories, a series of risks which investors in infrastructure will need to consider. There are a number of hedging strategies which managers might need to use to minimise these risks as well as a number of qualitative measures. Q3 Do you think that the approach to hedging should not limit ex ante the scope of risks that ought to be covered by the manager of the ELTIF? Yes, there should be no limitation. Any ex ante restriction will limit investment flexibility and further disadvantages the ELTIF regime against existing AIF regimes. We are unclear why ESMA is seeking to limit hedging activities. It is clear from the Regulation that the use of derivatives for speculative purposes is not permitted and so this should provide the investor protection being sought by ESMA. To limit the risks that may be hedged could be equally dangerous as allowing speculative investment, since it may prevent a fund manager from protecting fund positions from unforseen risks. We suggest that the ability to hedge risks should be flexible (see related comments at Q1). Q4 On the contrary, do you think that the approach to hedging should be tailored to the specific case of ELTIFs, and their possible eligible investments? Do you think that in this case the risks that might have to be covered by the manager of the ELTIF should be limited to the types of risk that were mentioned in question 2? There should be no limitation on the types of risk that can be hedged. Due to the myriad of eligible assets available to the ELTIF, the risks will be varied and may not be known or fully understood at the time of ELTIF inception (see related comments at Q2). AIFMs have ongoing requirements to identify and manage risks and should be left the full flexibility to do this within an ELTIF. We suggest that any guidance here is principles based rather than rules based. Q5 Do you identify any consequences in terms of costs or scope of the eligible investments of the ELTIF if the risks that might be covered at the level of the ELTIF are limited to those that were mentioned in the impact assessment of the Commission? 3

4 12 Throgmorton Avenue Any limitation on the types of risk that can be hedged may result in the uncovered exposure to a particular risk which could result in an asset class being avoided, or in significant loss for investors and conceivably damage to the integrity of the ELTIF brand. Due to the prohibition on the use of derivatives for investment or speculative purposes the ELTIF will be less flexible than the AIF regime and so may already be perceived to be at a disadvantage. Further restrictions in this context could be damaging to the attractiveness of the ELTIF regime to asset managers and clients already invested in the same asset classes through AIF structures. Q6 Do you agree with the proposed approach? Should you disagree, please provide reasons and propose an alternative approach and justify it. Yes. It is logical that the term of the ELTIF should be correlated with the lifespan of the underlying asset. We would highlight, however, that a multi-asset and/or multi project ELTIF is something that might prove attractive, so here perhaps the correlation should be just with the longest asset term. We suggest that the constitutional documents of the ELTIF permit the reduction/extension of the term of the ELTIF, to allow for flexibility in the event that the life of the asset changes. Consider the following scenarios for example: -an infrastructure ELTIF may invest in numerous projects with different and overlapping timelines so may need to extend the ELTIF term in light of this and likely project delays; -a real estate ELTIF should not be forced to sell assets leading up to the termination date of an ELTIF if the market is not good, so may need to extend term until the market is more favourable; and -a SME debt ELTIF may invest in numerous corporate bond issuances with different maturity periods and may reinvest sale proceeds received during the term in issuances with longer maturities, requiring an extension of the ELTIF term. For SME equity and debt issuances the term of these asset classes is not necessarily long term. Here we would assume that the intention is that an ELTIF holding such qualifying issuances should keep them in the portfolio for a long term period, rather than having regular portfolio turnover. ESMA comments in this regard would be helpful. Q7 Do you agree with the risks identified and the related proposed criteria? Would you suggest the introduction of any additional/alternative risks/criteria? Please provide details and explain your position. We agree that the risks quoted are relevant when assessing the market for potential buyers. We are, however, unsure why ESMA is seeking to catalogue such risks for the purposes of the RTS. We are also unsure why it is important that ELTIFs assess potential buyers for scheme assets on the same basis. Asset managers are well practiced in such activities and it might be considered anticompetitive to force asset managers to sell ELTIF assets in the same way. Identification of buyers in advance of redemption could also have a crowding affect which might have a negative impact on the value of assets exclusivity can command a premium. It might be helpful to consider the European Fund for Strategic Investment in this context. That initiative proposes a pipeline or portal of investment projects. Perhaps a pipeline of ELTIF assets could be similarly constructed therefore providing a ready, consistent market place for the sale of 4

5 12 Throgmorton Avenue ELTIF assets. Asset managers should however be free to sell assets outside of those arrangements where it feels better terms can be achieved for the ELTIF and its investors. Q8 Do you agree with the proposed valuation criteria? Would you suggest the introduction of any additional/alternative criteria? Please provide details and explain your position. Yes, alignment with the AIF regime is sensible. In the AIFMD valuation context our experience has been that it is difficult to find external valuers that can meet the stringent requirements of Article 19(5)(b). This may lead to an uncompetitive market or managers relying on internal non-specialist valuations. Q9 Do you agree that the abovementioned pieces of legislation and regulatory material are relevant for the purpose of the RTS on Article 25(3) of the ELTIFs Regulation? Which other pieces of legislation and regulatory material do you consider relevant for that purpose? Yes. Asset managers have systems set up to accommodate relevant requirements. Our preference would be for the same to apply to the ELTIF to avoid building new systems. PRIIPs is also relevant: the level 2 guidance does not cover ELTIFs and since PRIIPs can invest in assets that are not UCITS eligible, that regime would appear be closer to the ELTIF than a UCITS. For ELTIFs, the alignment should be with the PRIIPs KID rather than the UCITS KIID, as the former is being designed to be MiFID compliant whereas the latter is not. In addition, the PRIIPs KID will apply to a larger scope of assets (as per the ELTIF) than the UCITS KIID (i.e. UCITS eligible assets only). We do note, however, that the form of the PRIIPs KID will not be finalised before 9 December We would recommend guidance on the approach managers should adopt during the transitional period. Q10 Do you agree with the abovementioned assumptions? Yes. A harmonised costs disclosure methodology not only promotes transparency but enables investors to make a comparison between products. It is therefore important that the components of the quoted figure are the same across ELTIFs so it would not therefore be appropriate to include optional charges (e.g. subscription charges, redemption charges, performance fees) in that figure but to quote these separately alongside that figure. This will prevent misleading disclosure practices from emerging. We refer for example to the UCITS KIID Regulation regarding the ongoing charges figure. 5

6 Q11 Do you agree that the types of costs mentioned in the present paragraph are annual costs that could be expressed as a percentage of the capital? 12 Throgmorton Avenue Yes, it should be possible to quote such fees on an annual basis, assuming that service providers are prepared to charge in this way. One notable omission from the list of charges is valuation costs (e.g. a standing independent valuer for real estate assets). Consistency with PRIIPs costs regime will be important. It would not be efficient to require asset managers to support different operational processes to produce costs figures for AIFs and ELTIFs that are sold to retail investors. Q12 Do you think that performance related fees would be relevant costs to be taken into account in the case of ELTIFs? Yes. ELTIFs should be able to levy performance fees where deemed appropriate. Q13 How would you include performance related fees in the overall ratio referred to in paragraph 2 of Article 25? We suggest that they would not be included, rather being stated separately alongside the overall ratio. This is something that is already common practice with UCITS funds see A.13 KIID Regulation 583/2010. (See related comments at Q10). Q14 Do you agree that the types of costs mentioned in paragraph 54 are fixed costs and that an assumption on the duration of the investment is necessary to calculate these costs in the numerator of the overall ratio mentioned in Article25(2), provided that this overall ratio is a yearly ratio? We agree that establishment costs would be a fixed cost, however, distribution costs are often calculated on an ad valorem basis and so not always fixed. An assumption on duration of an ELTIF will be required as part of calculating many costs and the more certainty that exists the more likely the fund costs will be fixed rather than ad valorem. Further guidance in relation to PRIIPs will be relevant here. Q15 Do you agree that the types of costs mentioned in paragraph 54 may be considered as fixed costs in the case of an ELTIF? We suggest that exit costs should be quoted separately to the overall costs ratio (see related comments at Q10). Q16 Do you agree with the proposed requirements? Would you suggest the introduction of any additional/alternative requirements? Please provide details and explain your position. We agree that it is important for retail investors to have access to information and help in their local language, but do not agree that local physical facilities are necessary given the technology available 6

7 12 Throgmorton Avenue today. We believe that there is a need to reconsider the requirements in fund legislation (UCITS, ELTIF and at national level for AIFMD) to appoint a local facilities and paying agent and bring them up to date with technological progress. A key part of the original UCITS regulations was the requirement for a local facilities and paying agent. These rules were set up at a time when cross-border bank transfers in the EEC were slow and expensive and it was difficult to obtain adequate information (in the appropriate language) on a cross-border basis (before the Internet was widely available). Furthermore the rules assume a model of direct sales of UCITS whereas in practice the vast majority of UCITS sales are intermediated through a local advisor or execution platform which is designed to facilitate payments and provide access to all the information a retail investor may need. The result is that currently managers put in place facilities agents and paying agency agreements around Europe which are in practice never used (and can be expensive). We recommend that the investor protection mechanisms set out in UCITS Article 92 and in ELTIF Article 23 should be updated with rules which reflect the widespread use of the internet, the ease with which cross-border payments can be made and the reality of contemporary distribution models. In the table below shown in the Appendix to this letter, we set out how these requirements are typically applied and how they could be updated in a way which would reduce the costs charged to the fund without reducing the level of protection consumers are entitled to expect. In our view a failure to bring the requirements up to date may act as a barrier to cross border passporting of the ELTIF and therefore be contrary to the CMU objective. Q17 What would you consider as appropriate specifications for the technical infrastructure of the facilities? Our view is that a physical presence should not be necessary, rather internet and telephony facilities in the local language are more appropriate in today s marketplace. In addition, as the sale of ELTIFs to retail investors will be possible only on an advised basis, a retail investor will always be able to refer to his adviser for relevant materials, should they not have access to the internet. Q18 In the event that the RTS enter into force after the date of application of the ELTIF Regulation and authorisations are granted between the date of application of the ELTIF Regulation and the date of application of the proposed RTS, do respondents see a need for specific transitional/grandfathering provisions for the proposed RTS? The need would depend on the circumstances but it would be a good idea to build in the flexibility for grandfathering, although we think the problem is unlikely to arise. Local regulator readiness for the regime will also impact the desire to launch and cross register an ELTIF. (See related comment at Q9). Q19 Do you agree with the above-mentioned reasoning in relation to the possible costs and benefits of the options as regards hedging? Which other costs or benefits would you consider in this context? We agree that harmonisation should be the principal objective. See related comments in Q1 above. 7

8 12 Throgmorton Avenue Q20 Do you agree with the assessment of costs and benefits above for the proposal on the sufficient length of the life of the ELTIF? If not, please explain why and provide any available quantitative data on the one-off and ongoing costs (if any) that the proposal would imply. No objection to the costs assessment. We agree that the term of the ELTIF should reflect the (longest) term of an underlying asset. See related comments in Q6 above. Q21 Do you agree with the assessment of costs and benefits above for the proposal on the criteria for the assessment of the market for potential buyers? If not, please explain why and provide any available quantitative data on the one-off and ongoing costs (if any) that the proposal would imply. No objection to the costs assessment, but we are unsure why ESMA is seeking to identify potential buyers of ELTIF assets. Asset management companies are well practiced in disposing of fund assets. See related comments in Q7 above. Q22 Do you agree with the assessment of costs and benefits above for the proposal on the criteria for the valuation of the assets to be divested? If not, please explain why and provide any available quantitative data on the one-off and ongoing costs (if any) that the proposal would imply. No objection to the costs assessment. It makes sense for AIFMD provisions to apply. Q23 Do you agree with the above-mentioned reasoning in relation to the possible costs and benefits of the option taken by ESMA as regards common definitions, calculation methodologies and presentation formats of costs of ELTIFs? Which other types of costs or benefits would you consider in this context? We agree that it is necessary to have a common definition of what costs can be included in the costs ratio, similar to the ongoing charge figure in a UCITS context. Investors must be able to compare ELTIFs (and ideally against other funds (e.g. UCITS) also) on a total cost of ownership basis so harmonisation is paramount. See related comments in Q10 and Q11 above. Q24 Do you agree with the assessment of costs and benefits above for the proposal on the facilities available to retail investors? If not, please explain why and provide any available quantitative data on the one-off and ongoing costs that the proposal would imply. We understand why ESMA has looked to the UCITS Directive here, but as set out in Q16 we believe 8

9 12 Throgmorton Avenue that UCITS requirements in this area are not fit for purpose and so we do not think it would be a suitable model to follow. We suggest that ESMA take this opportunity to bring the relevant requirements into line with modern advancements in technology. As set out in our response to Q17, our view is that a physical presence should not be necessary, rather online and telephony facilities in the local language should be sufficient. 9

10 APPENDIX 12 Throgmorton Avenue Supporting material for Question 16 Typical national requirements for facilities/paying agents and how we recommend these requirements should be updated. Requirement The entity providing the facilities should belong to certain specific categories only. Facilities should include the possibility to directly subscribe to the units or shares of the fund and to make repurchase and redemption requests. The entity should act as a contact point for investors and facilitate the handling of any issues that retail investors have relating to the fund. Facilities should ensure payments to retail investors, including in relation to any distribution of proceeds and capital. The rules or instruments of incorporation of the fund, its sales document and its latest annual reports should be made available to retail investors through the facilities agent. Example of how national legislation currently requires the requirement to be met Local bank. In some cases, an affiliate of the management company may fulfil some of the duties Local bank Local bank. Sometimes local affiliate of the asset manager e.g. local sales branch Local bank. In some cases, local regulators allow payments directly to the fund s principal transfer agent Local bank. Sometimes local affiliate of the asset manager e.g. local sales branch Alternative less costly methods of meeting investor needs The investor does not usually understand the role that a local paying agent plays and does not use them. The investor will seek information on the fund, such as prices or reported amounts on the Internet, from the management company or from their distributor or execution platform. Our experience is that investors do not seek additional information local banks acting as paying agent unless they also fulfil the role of a local distributor. This is only required in a minority of cases where sales occur away from the investor s local distributor or execution only platform. As European legislation has been amended to facilitate cross-border payments only two key elements are needed in the case of the direct sale: 1. the account details of the UCITS transfer agent this is generally set out in the prospectus and / or application form 2. Account details for making redemption or dividend payments. These should be specified in the UCITS account opening form and the subscriber s identity verified upon account opening to ensure payments can be made without delay. Investors usually contact their local distributor or execution platform to resolve issues they may have. Fund managers typically include clauses in their distribution agreements requiring intermediaries to ensure that investor queries are properly and promptly handled. Investors do not however contact a bank, such as a paying agent, which is not directly linked to the distribution process All European investors now possess an IBAN which facilities effective low costs cross-border payments the need for a local correspondent bank to facilitate cross payments to the fund s transfer agent or registrar is largely redundant. Reducing the number of stages between the end investor s account and the transfer agent should lead to a corresponding decrease in the costs of transacting. In some jurisdictions managers may decide to employ the services of a sub-transfer agent to facilitate the management of flows to the transfer agent. We believe this should be an option for the manager rather than mandated as a direct obligation placed on the fund. All distributors are required to make the KIID available to investors on a pre-sale basis We recommend that asset manager terms of business/distribution agreements require intermediaries to make all necessary information about the UCITS available to their clients. This is already current best practice. We recommend that UCITS managers have a website where information can be obtained as is common practice for most managers. Where the UCITS is planning direct sales without a local execution platform or distributor, then in addition to internet site, we recommend the alternative of a low cost / Freephone number to assist investors who require operational support. In the longer term a central filing platform for fund documentation (see answer to could also be opened up to individual investors 10