Asset Management and Investment Funds Update October 2018 Central Bank Announces Self-Certification Regime for UCITS Financial Indices, Depositary Agreements and other changes In a letter addressed to Irish Funds, the representative association for the funds industry in Ireland of 9 October 2018, the Central Bank of Ireland (CBI) announced certain changes to its authorisation procedures aimed at ensuring efficiencies whilst taking into account investor protection. These changes had been flagged during the summer but have only just been formalised and are with immediate effect. UCITS Financial Indices - Self-Certification/ Simplification The CBI has introduced a self-certification regime for indices used by UCITS funds in its updated Guidance on UCITS Financial Indices (Guidance). Prior to the issue of the revised Guidance, the CBI required that indices used by UCITS funds be submitted for CBI review where an index comprised of corporate issuers exceeded the usual UCITS concentration limits or where the index was comprised of ineligible assets, i.e. assets in which a UCITS cannot invest directly, such as commodity futures. The CBI review process involved the submission to the CBI of various due diligence documents. A confirmation of compliance of the index with the CBI requirements had to be submitted to the CBI as part of the index submission and also in instances where the index submission was not required. The New Index Certification Process The Guidance has introduced a self-certification regime for UCITS proposing to use an index. As before, the CBI requires a confirmation of compliance of the index with the CBI requirements. As part of the new certification process, this confirmation must now be provided by a director on behalf the UCITS management company. The CBI has also simplified the requirement for a submission in circumstances where the weighting of a single corporate issuer in an index makes up more than 20% and up to 35% of the index. This would arise in the context of indices comprised of corporate issuers whereby the usual UCITS "5/10/40" concentration limit for corporate issuers is exceeded. In these circumstances, the index could avail of the increased "20/35" concentration limit envisaged by the UCITS rules. Under the Guidance, the index submission in respect of "20/35" indices is now limited to setting out why the market conditions justify increasing the concentration limit for investment in a single issuer to 35%. The index due diligence documentation is no longer required to be provided to the CBI as part of the index submission. Index Quality Assessments The CBI expectations as to the information that a UCITS manager must maintain in respect of indices used by the UCITS under its management are set out in the Guidance for the first time. It is made clear in the Guidance that the CBI expects a UCITS manager to be in a position to demonstrate at all times that indices used by the UCITS under its management comply with the regulatory requirements. It is envisaged that the CBI would carry out spot checks and the Guidance sets out the following minimum information that must be provided to the CBI upon request: the rationale for the index being a benchmark for the market to which it refers; the methodology used to construct the index ; information on index constituents and their weights; details as to how the index calculation methodology is verified; information on any fees embedded in the index; any technical and marketing documents produced by the index sponsor.
William Fry Asset Management and Investment Funds Update 10 October 2018 Summary and Action Required Notwithstanding the simplification that the new certification regime brings, UCITS managers are likely to find that not a whole lot has changed as far as the CBI review process is concerned. In summary, index submissions have been done away with for indices comprised of ineligible assets and have been simplified for indices that rely on the increased "20/35" issuer concentration limits. A confirmation in respect of index compliance (now in the form of a certification from the UCITS manager) still has to be given for every index. The level of due diligence that UCITS managers have to carry out pursuant to the UCITS requirements on the indices they use has also not changed. Arguably of greater note is that the CBI has formally set out its expectations as to the level of information it expects to receive at short notice from a UCITS manager in relation to the indices used by the UCITS under its management. It is now timely for UCITS managers to review the index due diligence documentation maintained by them against the CBI requirements and ensure that it is in the form that could be provided to the CBI at short notice upon request. Self-Certification of Depositary Agreements, Trust Deeds/Deeds of Constitution Depositary Agreements for UCITS and retail AIFs will no longer be subject to the prior review of the CBI. Instead, the depositary will be required to confirm that the finalised Depositary Agreement is in compliance with the relevant legislation and CBI guidance and in particular that the provisions of the Depositary Agreement are in compliance with all relevant liability requirements. This confirmation together with the executed Depositary Agreement and relevant CBI form should be submitted on the authorisation day as part of the authorisation application. A similar self-certification process has also been introduced for Trust Deeds (in relation to funds established as unit trusts) and Deeds of Constitution (for funds set up as common contractual funds), which documents would include depositary duties. Amendments to these documents will also be subject to a self-certification process. This new process is similar to the self-certification regime currently in place in relation to Depositary Agreements (and other constitutive documents for detailing depositary duties) for qualifying alternative investment funds (QIAIFs). Review of Investment Limited Partnership Agreements Currently, the constitutive documents for funds established as companies or ICAVs are not subject to review by the CBI. Similarly, Investment Limited Partnership Agreements for retail AIFs will no longer be subject to prior review by the CBI. Establishment of New Share Classes The establishment of a new share class in an authorised UCITS or retail AIF fund will no longer be subject to prior review by the CBI. The revised prospectus/supplement should be accompanied by a confirmation from a director of the management company that the establishment of the share class accurately reflects the requirements of the relevant CBI form and of any relevant CBI guidance and legislation. Where it is intended to restrict share class ownership the confirmation must confirm that the restriction is "sufficient to allow that the class provides for public participation". CBI Random Checks The CBI will carry out quality assurance checks, selected on a random basis, following authorisation of the relevant fund in relation to the changed regime for Depositary Agreements, Investment Limited Partnership Agreements and new Share Classes. UCITS Merger Applications A UCITS Mergers Applications Form has been prepared in order to streamline the merger application process and will be available on the CBI's website shortly. The application form reflects the requirements under the Irish UCITS Regulations and does not introduce any new requirements. Brexit ESMA produces soothing sounds on Delegation of Asset Management to UK In his keynote address at the World Federation of Exchanges Annual Meeting in Athens on 3 October 2018, Steven Maijoor, Chair of the European Supervisory and Markets Authority (ESMA), indicated that ESMA has coordinated, with the EU27 national competent authorities (NCAs), memoranda of understanding/co-operation arrangements between NCAs (MOUs) for use in a "hard Brexit" scenario. This is a timely reassurance for the funds industry as a key eligibility requirement for delegation of asset management to third country asset managers under the UCITS, AIFMD and MiFID Directives is that an MOU be in place between the NCA of the third country and that of the relevant member state. Mr Maijoor stated "Taking the wider negotiations between the EU and UK into account, we plan to start negotiations with the UK FCA with the objective to have these MOUs in place sufficiently on time before the end of March 2019".
These MOUs are necessary to allow exchange of information and effective supervision and enforcement of EU legislation generally. Similar remarks have also been made by Mr Maijoor's colleagues, including Ms Verena Ross, Executive Director of ESMA at a presentation to the Institute of International and European Affairs in Dublin on 5 October. In his speech, Mr Maijoor also referred to the need for a comprehensive and harmonised EU regime for third country trading venues. MiFID II provides NCAs with substantial discretion and very diverse regimes are currently in place. Mr Maijoor argued that a harmonised third country regime would contribute to a level playing field between EU and non-eu trading venues and mitigate risk in relation to orderly markets, investment protection and ultimately stability. Such regime should: cover all types of trading venues; cover, in one equivalence decision, all purposes for which the trading venues would need to be recognised (e.g. placing of trading screen, post-trade transparency and trading obligations); ensure that third country trading venues accessing the EU comply with requirements that are equivalent to those of EU trading venues; and establish one point of entrance to the EU with effective supervisory tools. It should also be noted that on 26 September, ESMA sent a letter to the European Commission expressing concerns relating to third country firms providing investment services and performing investment activities within the EU, not just in the context of Brexit but on a more general level. Mr Maijoor was also supportive of the proposal that action be taken to ensure that European clearing members have access to UK based clearing counterparties (CCPs) post- Brexit. Such continued access is in line with the so-called "EMIR 2.2" proposal which permits systemically important CCPs (Tier 1 CCPs) from third countries to provide services in the EU. The Trouble With KIDs ESAs Call for Measures to Avoid Confusing Duplication Currently, UCITS (which are required to produce a UCITS KIID under the UCITS Directive) are exempted from producing a PRIIPs KID until at least 31 December 2019. The original rationale for this was to give enough time for the Packaged Retail and Insurance-Based Investment Products (PRIIPs) Regulation to be bedded-down and for the European Commission to review the impact of PRIIPs KIDs on other retail products before extending to UCITS or determining that the UCITS KIID should be replaced by or deemed equivalent to the PRIIPs KID. This review was to have been conducted by 31 December 2018 but is certain to be delayed. In the absence of corrective action, this would result in a burdensome, bureaucratic scenario whereby from 1 January 2020, UCITS would be required to produce both a UCITS KIID and a PRIIPs KID, containing seemingly conflicting information for retail investors who are intended to benefit from these documents. On 1 October 2018, the joint committee of the European Supervisory Authorities (ESAs) (i.e. ESMA, EBA and EIOPA) wrote to the European Commission indicating that overlap in disclosure documents could in fact deter investors from using these key information documents rather than facilitating important investment decision making. The ESAs are also not convinced that the UCITS KIID information can be "effectively articulated" together with the PRIIPs KID information. An example of where there might be confusion relates to risk factors; the PRIIPs summary risk indicator and UCITS synthetic risk reward indicator will result in different risk indications for a material number of PRIIPs. The ESAs are of the view that other solutions are needed, including legislative changes to avoid duplicate information requirements from 1 January 2020. The ESAs have indicated that they will conduct a public consultation to be launched in Q4 2018 with the aim of submitting proposed amendments to the PRIIPs delegated regulation in Q1 2019. This intervention by the ESAs is an important development for UCITS and other retail product promoters, as industry commentators have, for some time, been highlighting flaws in PRIIPs content (including regarding performance scenarios and transaction costs disclosures) and of the potential to damage the UCITS brand by extending current PRIIPs KID requirements to UCITS.
EU Council indicates no objection to Delegated Regulations on Depositaries' Asset Segregation Obligations On 2 October 2018, the Council of the EU indicated that it had no objection to the amending delegated regulations adopted by the European Commission in July 2018 which supplement AIFMD and the UCITS Directive. The draft delegated regulations follow up on ESMA's 20 July 2017 opinion to the Commission on asset segregation. The Commission acknowledged that securities and insolvency laws are not harmonised at EU level. However, it is imperative to have common rules to ensure protection of assets safe-kept by depositaries or sub-custodians for their clients. This should lead to the clear identification of assets belonging to a particular fund and to the protection of such assets in the case of insolvency of the fund's depositary or sub-custodian. The proposed amendments aim to clarify these rules in order to facilitate their uniform interpretation amongst EU member states. The next step is for the European Parliament to consider the amending delegated regulations. If the Parliament does not object, the amending delegated regulations will be published in the Official Journal of the EU (OJ). They will enter into force 20 days after their publication in the OJ and apply 18 months from that date. AIFMD Clarification on Cross-border Notifications of Umbrella AIFs On 4 October 2018, ESMA updated its AIFMD Q&As regarding cross-border notifications. The new Q&A confirms that an AIFM intending to manage an EU umbrella AIF on a passported cross-border basis pursuant to Article 33 of AIFMD must, in its notification, identify the umbrella AIF as well as the name and investment strategy of its subfunds to facilitate the administrative procedure in both the home and host states. Any change in the composition of an umbrella AIF managed on a cross-border basis must be notified to the competent authorities pursuant to Article 33 (6) of AIFMD. ESMA Publishes Work Programme for 2019 On 2 October 2018, ESMA published its 2019 work programme. Four strategic priorities have been identified, namely the promotion of supervisory convergence, assessing risk to investors, markets and financial stability, completing a single rulebook for EU financial markets and directly supervising financial entities. In the area of investment management, a key objective is to achieve greater convergence and consistency of the supervisory approaches and practices of national competent authorities in relation to EU legislation on investment management, with a particular focus on the UCITS and AIFMD Directives. Welcome Clarification on "Robust Written Plans" Requirements for Funds Using Benchmarks ESMA issued a further update to its Q&A on the Benchmarks Regulation (BMR) on 27 September 2018. This latest edition of the Q&A contains two welcome clarifications for investment funds in respect of the requirements under Article 28(2) of the BMR. Article 28(2) requires supervised entities, such as investment funds, using a benchmark to produce and maintain "robust written plans" setting out the actions that they would take in the event that the benchmark materially changes or ceases to be provided. Supervised entities must also reflect these written plans in contractual relationships with their clients: In the first instance, ESMA offered guidance as to the content of written plans that it would consider to be robust. The plans, which should be thorough and adequate in view of the nature and size of the relevant benchmark and be kept updated as appropriate, must cover: operational procedures and detailed courses of action; relevant communication channels; and arrangements for different scenarios and contingencies.
Secondly, ESMA provided sensible practical guidance for investment funds on the requirement to reflect these written plans in contractual relationships with clients. ESMA stated that where prospectuses form part of the contractual arrangement between the investor and the fund, the fund can ensure compliance with this requirement by setting out in the prospectus the plan of action in the event of the cessation of or material change to a benchmark. Prospectus updates have already been subject of ESMA s Q&A on BMR issued earlier this year where ESMA set out its expectation that, prior to the end of 2018, prospectuses of all funds that use benchmarks should disclose whether or not the administrators of the benchmarks used by the funds are listed in the register of administrators and benchmarks maintained by ESMA. The other clarifications contained in the 27 September update to ESMA's Q&A on BMR dealt with the following topics: when banks issuing certificates classify as users of benchmarks; classification of the NAV of an investment fund as input data and not as a benchmark; the application for endorsement of a family of benchmarks; the language in which benchmark statements should be published. Actions for investment funds using benchmarks Update the fund prospectus by the end of 2018 to state whether or not benchmarks used by the funds are listed in the register of administrators and benchmarks maintained by ESMA; Reflect in the prospectus or otherwise in contractual arrangements with shareholders the plan of action in the event of the cessation or material change to a benchmark. clarification of the reference to systematic internalisers in the definition of financial instruments in scope of BMR; Central Bank's Feedback Statement on the ETF Discussion Paper On 14 September 2018, the CBI issued the eagerly awaited feedback statement on its Discussion Paper on exchange traded funds (ETFs) Key Policy Statements The feedback statement contains two welcome policy changes. The CBI will now permit: listed and unlisted share classes within the same fund; and different dealing cut-off times for hedged and unhedged share classes in an ETF The third key outcome of the feedback statement is that the CBI did not relax its requirement that ETFs must make full daily portfolio disclosure to the public. It was hoped that a middle-ground would be found that would ensure that the market price of an ETF is close to its net asset value while enabling managers seeking to launch active ETFs to protect their strategies from public disclosure. The CBI left the door open for a potential change to this policy indicating, however, that this would be on foot of a broader international consensus on the matter being reached. These three key policy pronouncements as well as the other findings contained in the CBI's feedback statement are examined in more detail below. Background Ireland is the largest European ETF domicile and the CBI has been leading the international regulatory discourse on ETFs since publishing the Discussion Paper in May 2017. The Discussion Paper, which sought to identify ETFspecific issues of key regulatory importance, received significant attention from across the globe and was contributed to by some twenty-six responses from a broad range of stakeholders. The CBI's feedback statement summarises the CBI's findings on the key themes identified in the Discussion Paper and, as well as making the policy pronouncements already referred to, provides a focus for future international regulatory engagement on these topics. Listed and Unlisted Share Classes Listed (i.e., exchange traded) and unlisted share classes will now be permitted within the same fund. This is welcome news for ETF providers who will now likely offer unlisted share classes within their ETFs. It is also an exciting opportunity for promoters of mutual funds wishing to enhance distribution opportunities by adding ETF share classes to their existing products. The CBI noted that establishment of listed and unlisted share classes did not go against any of the principles set out in ESMA's opinion on UCITS share classes and that any potential concerns around investor confusion could be addressed by appropriate disclosure. As acknowledged by the CBI, the ESMA Guidelines on ETFs already contemplated listed and unlisted share classes in the same fund by providing that a UCITS which has a share class trading on an exchange is a UCITS ETF. As a UCITS ETF must contain the "UCITS ETF" identifier in its name, it follows that any UCITS mutual fund seeking to launch exchange traded classes will be required to change the name of the fund to include "UCITS ETF". The CBI indicated that it would issue guidance on disclosure requirements for both types of classes. Share Class Dealing Arrangements Hedged and unhedged share classes within an ETF may now have different dealing cut-off times. Earlier cut-off times are required for currency hedged share classes to
allow time for ETFs to place hedges on the same day. Unhedged share classes in the same ETF can therefore have later dealing times and permitting this enables authorised participants to place trades in shares of unhedged ETF classes as closely as possible to the close of the underlying markets. This is therefore a sensible and welcome deviation from the general CBI rule that dealing deadlines must be the same for all share classes in a fund. The CBI has also previously permitted different dealing cutoff times in the same fund for cash and in-kind dealing. It is not clear whether limiting the ability to have different cut-off times for hedged and unhedged classes is limited to ETFs simply because the question arose in an ETF forum or whether the CBI only sees merit in permitting different cut-off times for hedged and unhedged classes for ETFs alone. While some of the reasoning for allowing different cut-off times would equally apply to mutual funds, it remains to be tested with the CBI whether it would adopt the same approach for mutual funds. Portfolio Disclosure and Active Investment Strategies Disappointingly for active managers, the CBI has not relaxed its requirements on full portfolio disclosure. While acknowledging the arguments made by the majority of the respondents in favour of more limited portfolio disclosure as well as solutions proposed that would facilitate that, the CBI reiterated its view that full daily portfolio disclosure must be made to the public. The CBI was not convinced that additional investor choice in the form of active ETFs (with limited public portfolio disclosure) justified a departure from what the CBI considers a fundamental principle that investors are assured that the exchange price of ETF shares is close to the ETF net asset value. In the CBI's opinion, this can only be ensured by full portfolio transparency. The CBI observed that the balance of the protection of intellectual property within the investment strategy that may be revealed by granular portfolio disclosure therefore became a commercial question for managers who are considering the establishment of active ETFs. While the CBI did not change its policy on this occasion, it indicated that it would continue to consider the matter at European and international regulatory forums. One might speculate that should a more limited portfolio disclosure be acceptable in future, the alternatives to full disclosure set out in the CBI's feedback statement might be used to formulate future policy. The alternative forms of portfolio disclosure considered by the CBI seek to balance the protection of intellectual property rights and the prevention of front-running of active ETFs against the desirability for transparency and effectiveness of keeping the exchange traded price close to the ETF's net asset value. These included the provision of a full portfolio to a limited number of authorised participants and official liquidity providers, calculation of the indicative net asset value (inav) and provision of information on a proxy portfolio which closely resembles the actual portfolio of the ETF. 10 October 2018