European Regulatory Update – January 2022

1. ESG
Taxonomy Regulation – reminder on the entry into force

As mentioned in our last Client Communications, the Taxonomy Regulation (EU) 2020/852 (“Taxonomy Regulation”), which supplements the SFDR Regulation (EU) 2019/2088 (“SFDR”), became partially applicable as of 1st January 2022.

The Taxonomy Regulation establishes a framework to classify environmentally sustainable economic activities and places additional disclosures on funds that invest in economic activities that contribute particularly to one of the following six environmental objectives defined by the Taxonomy Regulation:

(1) climate change mitigation;
(2) climate change adaptation;
(3) sustainable use and protection of water and marine resources;
(4) transition to a circular economy;
(5) pollution prevention and control; and
(6) protection and restoration of biodiversity and ecosystems.

As of 1 January 2022, the requirements under the Taxonomy Regulation apply for financial products which are promoting (Art. 8 SFDR) or have as their objective (Art. 9 SFDR) the two first environmental objectives, i.e. climate change mitigation and/or climate change adaptation.

For the four remaining environmental objectives, the Taxonomy Regulation rules will apply from 1 January 2023.

In addition, we would like to remind you that the periodic reporting obligation under Article 11 SFDR applies as of 1 January 2022 if your Fund qualifies as an Article 8 SFDR or Article 9 SFDR, meaning that such relevant information shall be disclosed in your annual reports to be published in 2022 (for the reporting year 2021).

SFDR RTS – New postponement of the application date to 1 January 2023

The European Commission confirmed in a letter dated 25 November 2021, that the date of application of the regulatory technical standards (RTS) under the SFDR and as amended by the Taxonomy Regulation, will be deferred by a further six months to 1 January 2023.

The European Commission also mentioned that the financial market participants that have published a statement on their due diligence policies on principal adverse impacts of investment decisions on sustainability factors (the statements referred to in Article 4(1)(a), 4(3) and (4) of SFDR) will have to comply with the related disclosure requirements on principal adverse impacts laid down in the RTS for the first time by 30 June 2023 (the first reference period for this reporting under the RTS will be 1 January – 31 December 2022).

ESG impacts on UCITS and AIFMD

With the adoption of delegated acts[1] by the European Commission, the UCITS Directive and AIFMD will be also impacted by ESG, especially in relation to the risk management function.
As such, management companies/AIFMs shall ensure having resources with the necessary expertise for managing the sustainability risks and include these risks as follows:

• In the organisational management, e.g. RMP, internal policies, record keeping, and control processes. When opting-in for PAI, management companies/AIFMs must implement due diligence policies and update the investment monitoring and selection policies by assessing and integrating sustainability risks into the organisation.
• In the conflicts of interest procedure for addressing risks of conflicts that may arise in connection to the greenwashing, mis-selling of investment strategies, remuneration, or other.

These changes are expected to apply as of 1 August 2022.

MiFID ESG: Sustainability delegated acts

These changes will be brought through updates to the MiFID II Delegated Acts 2017/565 and 2017/593, which means that the generic obligations of MiFID do not change but the way they are performed is impacted by the inclusion of clients’ sustainability preferences into their profile (required information, determination of the level of preference and the adaptation of the service and products to these new ESG requirements). In addition, there will be a new requirement to demonstrate by means of a suitability report how demands are met on an ongoing basis by presenting how the client portfolio converges with the ESG preference level.

In addition and similarly to the EMT and the ETP templates, a new EU industry standard for reporting is in the process of being developed, this time with a focus on ESG indicators. The new reporting format will be named the European ESG Template, or EET. Financial intermediaries must use the EET when showing their clients who wish to incorporate sustainability in their investments, how well the fund is doing against the clients’ respective criteria.

The EET is expected to be effective as of 1 May 2022.

2. AIFMD 2
Release of the first draft

On 25 November 2021, the European Commission published a legislative package aimed at revising the regulatory framework for managers of alternative investment funds (AIFMD). Further to the consultations that occurred one year ago, the European Commission issued concrete recommendations for changes, which will be reviewed and considered in the coming weeks by both the European Parliament and the Council of the EU, before the negotiations between the three institutions begin.

The AIFMD’s review includes:

• new requirements for AIFMs of AIFs that perform loan granting activities;
• ensuring the availability of liquidity management tools (LMTs) in exceptional circumstances;
• further details on the substance requirements (human and technical resources);
• new requirements in case of delegation (where managers delegate more portfolio or risk management functions outside of the EU than they retain, annual notifications by NCAs to ESMA of delegation arrangements with third country entities, peer review of application of the delegation regime);
• new additions to the list of “ancillary services”: AIFMs’ authorised activities will be extended to include benchmark administration and credit servicing;
• postponing the concept of a depositary passport to a later stage.

In addition, some of the changes proposed to the AIFMD will also impact the UCITS Directive in order to introduce the same regulatory requirements, specifically regarding the delegation regime, the regulatory treatment of custodians, supervisory reporting requirements, and the availability and use of LMTs.

Once the amended Directives are adopted, Member States will have 24 months to transpose and enforce the new rules.

3. PRIIPs KID
Extension of the UCITS exemption for PRIIPs & PRIIPs RTS enacted in the Official Journal

The following regulatory package has been published in the Official Journal of the EU on 20 December 2021, marking the completion of the lengthy discussion on the PRIIPs reporting requirements:

• Regulation (EU) 2021/2259 amending the PRIIPs Regulation as regards the extension of the transitional arrangement for UCITS and non-UCITS;
• Directive (EU) 2021/2261 amending the UCITS Directive to avoid that investors in a UCITS receive two pre-contractual disclosure documents, i.e. the PRIIPs KID and the KIID; and
• Commission Delegated Regulation (EU) 2021/2268 regarding new technical standards (RTS) for PRIIPs KIDs. Although presently applicable from 1 July 2022, it is expected that they shall be postponed to 1 January 2023.

The key points to be considered are as follows:

• the UCITS PRIIPs KID exemption has been extended until 1 January 2023 to allow market participants to prepare for the obligation to produce a PRIIPs KID for UCITS and non-UCITS;
• a choice to continue publishing a KIID will be made available with regards to investors other than retail unless a decision to publish a PRIIPs KID is taken.

In conclusion, the industry has been offered more time to prepare for the new PRIIPs RTS (e.g. implementing a modified methodology for performance scenarios, amendments to look-through requirements, changes to transaction costs, and the presentation of costs etc.).

We advise our clients to plan ahead and start the preparation process to ensure compliance with the new requirements by the deadline.

4. MiFID/MiFIR
ESMA updates its Q&A on MiFID and MiFIR

On 19 November 2021 ESMA updated its Q&A on MiFID II and MiFIR, especially on topics related to investor protection and intermediaries. Further to the question whether all bonds embedding a make-whole clause are exempt from the MiFID II product governance requirements, ESMA clarified that the mere presence of a make-whole clause is not sufficient for a financial instrument to be exempt from the MiFID II product governance requirements and provides explanatory examples thereon.

MiFID Quick Fix

Directive EU/2021/338 amending MiFID II as regards information requirements, product governance and position limits, and Directives 2013/36/EU and (EU) 2019/878 as regards their application to investment firms, to help the recovery from the COVID-19 crisis (the “Quick Fix”), marks the transition between the current MiFID II regime and the upcoming MiFID III.

The Quick Fix aims to support the Member States’ economic recovery from the COVID-19 pandemic, including by lowering certain administrative requirements on firms.

All Member States were required to transpose the Quick Fix into their national frameworks by 28 November 2021 and apply them by 28 February 2022.

The key changes introduced by the Quick Fix are as follows:

• Exemption from ex-ante costs and charges disclosure with respect to agreements to buy or sell financial instruments concluded by means of distance communication. Firms will be allowed to provide cost and charges information without undue delay after the conclusion of the transaction if the investor has consented to receiving the information after conclusion of the transaction or has been given the option of delaying the transaction until the investor has received the information.
• The default method of communication with the investors will change from paper-based to electronic means; retail investors may elect to continue receiving paper communications.
• A temporary suspension of best execution reports will be applicable until two years after the entry into force of the Quick Fix (i.e. until 27 February 2023). It is not excluded that the Commission may take action to apply the suspension from an earlier date due to the different dates of local transposition.
• A new requirement has been introduced for firms to carry out a cost benefit analysis where providing investment advice or portfolio management that involves switching of financial instruments. When providing investment advice, firms shall inform retail investors whether the benefits of switching outweigh the costs. Firms will be exempt from carrying out this analysis in relation to product switching for professional client, unless those clients decide to opt-in to receive the information.
• The scope of the commodity derivatives position limits regime will been reduced and it will apply only to critical or significant commodity derivatives that are traded on trading venues, and to their economically equivalent OTC contracts. Critical or significant derivatives are commodity derivatives with an open interest of at least 300,000 lots on average per year. ESMA is mandated to draw up a list of critical or significant commodity derivatives, as well as a RTS on the calculation methodology that authorities should use when setting position limits.

MiFID III

It is now four years since MiFID II entered into force and a new regulatory package, expected to go live in 2025, is currently under preparation by the financial supervisory authorities. The main changes between MiFID II and the anticipated MiFID III are as follows:

• an increased investment eligibility of retail investors to financial instruments will be allowed by potentially creating a new investor category of “super retail”, with less protection than the current one but with more opportunities to invest, benefiting from a quasi-professional status with accompanying simplifications in information requirements and potentially wider access to financial products or services;
• the potential inclusion of FX spot (currently not in scope) and custody within the scope of MiFID, which would result in the need to include a full set of new clients under the MiFID scope. Only FX or only custody clients will need to receive profiles, reports, and, potentially, be included in product governance. However, if this is applied to all clients (including retail) there will be a need to include transaction reporting in FX and application of best execution, price transparency, and reporting to authorities in the MiFID reporting, which would translate to a technical and operational challenge and
• changes in the market structure with adaptations to trading and commodity trading, notably the “merger” of EMIR and MiFID obligation with compulsory trading of cleared derivatives. At this stage, the European Commission is willing to push for a central and unique place, by asset class at least, where trading prices will converge, in real-time.

5. Benchmark Regulation
ESMA updates its Q&A

On 19 November 2021 ESMA updated its Q&A on Regulation (EU) 2016/1011 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds (“BMR”) by adding (i) a section on the disclosure requirements in Section 3 of Annex I of the benchmark statement (question 10.12) and (ii) a section dealing with ESG factors and ESG objectives (question 10.13).

The Q&A clarifies that, when BMR refers to benchmarks that “take into account ESG factors” or benchmarks that “pursue ESG objectives”, both terms should refer to the same situation and can be sued interchangeably, i.e. a benchmark that integrates ESG factors within its methodology.

6. Switzerland
New FinSA requirements

As mentioned in our client communication of 13 September 2021, the Swiss Financial Services Act (FinSA) came into force on 1 January 2020, changing the regulatory requirements for offering investment funds to Swiss clients. In addition to the already existing Collective Investment Schemes Act (CISA), which regulates products, FinSA dictates the rules of conduct for those providers offering financial products in Switzerland.

The FinSA expanded the requirements and now includes:

• affiliation to an ombudsman;
• registration of client advisors;
• professional insurance requirements:
• new organisational rules;
• new conduct rules;
• a new classification of clients.

The obligations that apply to each provider depend on their regulatory status and the targeted client categories.

From 1 January 2022, all providers offering products to Swiss clients must comply with the new regulation.

Waystone provides its clients with a comprehensive solution package for FinSA compliance. Should you have any questions, we invite you to reach out to your usual point of contact at Waystone.

7. Artificial intelligence
Proposed AI Act

The European Commission announced a proposal for a future EU regulatory framework on artificial intelligence (AI). The plans, which started back in April 2021, are a first attempt to enact horizontal regulation of AI to achieve trustworthy use of AI systems and increased client protection. The effective date remains, for the moment, subject to further clarifications from the legislator.

The European Commission came up with a combination of an innovative legal framework on AI and a Coordinated Plan with Member States which aims to guarantee the safety and fundamental rights of people and businesses, while strengthening AI investment and innovation across the EU. New rules are envisioned for adapting safety rules to increase users’ trust in this new environment.

The proposed legal framework focuses on the specific utilisation of AI systems and associated risks.

The European Commission proposes to establish:

• a technology-neutral definition of AI systems in EU law;
• a classification for AI systems with different requirements and obligations tailored on a “risk-based approach”;
• some AI systems considered presenting “unacceptable” risks would be prohibited.

A set of requirements and obligations will be defined in order to authorise “high-risk” AI systems, while AI systems presenting only ‘limited risk’ would be subject to very light transparency obligations.

The proposed penalties for non-compliance were set at up to EUR 30 million or, if the offender is a legal entity, at up to 6% of its total worldwide annual turnover for its preceding financial year.

The impact of the AI Act on national legal and administrative systems:

• National AI regulatory discretion is allowed in adjusting the AI regime to the local contexts. For example, each Member State may define its penalties regime, subject to compliance with the Regulation and provided that sanctions are effective, proportionate and dissuasive. Member States may also decide to exclude public authorities and bodies from the administrative sanctions regime.
• Monitoring and enforcement will fall within the responsibility of the Member States. Nevertheless, the European Commission may launch investigations and/or adopt corrective measures.
• If the proposed Act would be approved in the current form, public bodies, law enforcement authorities and the judiciary system would be deprived of the possibility to use AI systems that the Regulation qualifies as unacceptable, subject to a few exceptions.
• Some local authorities will be required to hire appropriate human resources and implement modernised technical tools and administrative processes.

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[1]Delegated act regarding the AIFMD: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32021R1255&from=EN
Delegated act regarding the UCITS Directive: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32021L1270&from=EN

1. Crypto assets
New CSSF FAQ on virtual assets

On 29 November 2021 the CSSF issued a new FAQ on virtual assets embracing the challenges raised by financial innovations such as virtual assets. The CSSF indicates in its press release that it is committed to promote an open, technology neutral and prudent risk-based regulatory approach.

For the moment the CSSF has answered four questions, as follows:

1. May a UCITS invest in virtual assets? While UCIs addressing non-professional customers and pension funds are not allowed to invest directly or indirectly in virtual assets, any assets that qualify as financial instruments (e.g. shares of companies active in the virtual asset ecosystem) could potentially fall within the scope of eligible investments for UCITS.
2. May an AIF invest in virtual assets? The CSSF indicates that an AIF with an authorised AIFM may invest directly and indirectly in virtual assets subject to two cumulative conditions that (i) the AIF markets its units only to professional investors, and (ii) the AIFM obtains an extension of authorisation from the CSSF for this new investment strategy.
3. Do Luxembourg IFMs need any authorisation for the management of virtual assets? The CSSF confirms that an IFM which intends to manage an AIF (whether regulated or not) investing in virtual assets needs to obtain prior authorisation from the CSSF for the strategy “Other-Other Fund-Virtual assets”.The FAQ details the information expected from the AIFM for obtaining such authorisation (e.g. description regarding the experience of the portfolio manager and other involved entities in the investment management process in virtual assets, details on the depositary function, RMP, etc.).In addition, the CSSF expects that each initiator of an AIF which intends to invest in virtual assets should present its project beforehand to the CSSF.
4. Specific considerations in relation to the mitigation of the Money Laundering and Terrorist Financing risks – Finally the CSSF expects that the Responsable du Contrôle (RC) and the Responsable du Respect (RR) of supervised entities investing in virtual assets possess, and can demonstrate, an adequate understanding of the new ML/TF, Proliferation Financing risks posed by virtual assets and the necessary measures to mitigate them.

2. Performance fees
CSSF eDesk application for performance fees

On 22 September 2021, the CSSF invited IFMs to declare via a new dedicated eDesk application the performance fee models applicable to Luxembourg UCITS or AIF they manage. The aim of this is to ensure compliance with the ESMA Guidelines on performance fees in terms of proper disclosures and collecting standardised key information in relation to performance fees.

The initial declaration must be performed before the end of the fund’s financial year. It should be updated in case of changes (such as for example the introduction of a performance fee for the first time after that date or when there are changes in performance fee models).

On 14 December 2021, the CSSF published directly on the eDesk platform an information letter containing four Q&As in relation thereto as follows:

• it clarifies that Luxembourg-based UCITS and regulated AIFs managed by an authorised AIFM are in scope of the declaration;
• it informs of the upcoming opening (first half of 2022) of the declaration to Luxembourg-based unregulated AIFs managed by AIFMs which are authorised pursuant to Chapter 2 of the AIFM Law and established in Luxembourg. Subject to further expected clarifications from the regulator, it appears that the CSSF will request that such unregulated AIFs also apply the ESMA guidelines immediately for new performance fees or, when applicable, by the beginning of a financial year starting after 6 July 2021 (the latter scenario for performance fees that were already in existence before the date of application of the ESMA guidelines, i.e. 6 January 2021);
• it updates the scope of the self-assessment (for AIFs): if an AIF/sub-fund of an out-of-scope predominant AIF type invests or is allowed by its issuing document to invest more than 20% of its assets in an investment strategy belonging to an in-scope predominant AIF type, such AIF/sub-fund is deemed to fall within the scope of the ESMA Guidelines, regardless of the AIF predominant type formally selected;
• finally, the CSSF added a new question on “carried interest” for AIFs. This information is collected by the CSSF for general supervisory purposes.

Should you be managing an unregulated fund using performance fees, we would recommend that you liaise with your legal advisor in order to assess whether the fund’s offering documents comply with the ESMA guidelines or if any amendments are required.

3. UCITS
CSSF updated FAQ on UCITS

On 3 November 2021 the CSSF updated its FAQ on UCITS with information on the holding of ancillary liquid assets by UCITS foreseen under article 41 (2) b) of the Law of 17 December 2010.

The update aims to clarify the circumstances and the extent to which UCITS are allowed to hold ancillary liquid assets which shall be limited to 20% of the net assets of the UCITS unless exceptionally unfavourable market conditions or circumstances so require this limit to be temporarily breached for a period of time strictly necessary and where such breach is justified having regard to the interests of the investors. In addition, the FAQ clarifies aspects of UCITS and money market funds diversification rules.

Finally, the CSSF further states that UCITS are expected to comply with the conditions described in these questions as soon as possible and by 31 December 2022 at the latest, considering the best interests of investors.

4. CSSF Circulars 21/788, 21/789 and 21/790
New CSSF Circulars concerning UCIs and IFMs

On 22 December 2021, the CSSF published circulars 21/788, 21/789 and 21/790 introducing a revised set of requirements relating to new reports and management letters to be completed via its eDesk platform on an annual basis (starting as from the first year end on or after 31 December 2021 for investment fund managers (IFMs) and 30 June 2022 for UCIs supervised by CSSF) in cooperation with their appointed external statutory auditors.

The key changes introduced by these new circulars to existing prudential requirements are as follows:

• extended scope of entities in scope (now all IFMs and UCIs supervised by CSSF);
• implementation of a new electronic reporting tool via eDesk to enhance prudential supervision;
• review of key controls at entity level; and
• harmonisation of the report dedicated to Anti-Money Laundering and Combating the Financing of Terrorism (“AML/CFT”) for all IFMs supervised by CSSF (including Luxembourg branches of IFMs established abroad).

CSSF Circular 21/788 – New AML/CFT external report

This circular provides for a detailed overview of the content of the new AML/CFT external report regarding the compliance by IFMs with their AML/CFT obligations to be prepared by an approved statutory auditor in line with CSSF regulation 12-02 as amended by regulation 20-05 (and, as the case may be, UCIs when they have not appointed an IFM, that being said the circular points out that UCIs having appointed an IFM are still subject to AML/CFT work to be carried out by their auditors).

Such AML/CFT external report will be split into two separate sections:

• The first section relates to the corroboration of answers given by IFMs and UCIs (as the case may be) in the context of their most recently completed CSSF annual AML/CFT survey on eDesk;
• The second section provides details on the sample testing or specific work carried out by the approved statutory auditor on basis of criteria on sample sizes and questions pre-determined by CSSF – such questions being “closed” i.e. not resulting in an opinion under audit, assurance or agreed upon standards.

External auditors and IFMs will also have the possibility to insert comments on the results of the work performed in the AML/CFT external report.

The deadline for submission of the AML/CFT external report is six months after the financial year end of the IFM – with an extension of three months being granted for the first submission as of 31 December 2021 – then by 30 September 2022 at the latest.

CSSF Circulars 21/789 and 21/790 – Self-assessment questionnaire (“SAQ”) to be prepared IFMs and UCIs, Separate report (“SR”), Management letter (“ML”) and Long form report (“LFR”) to be prepared by external auditors

The SAQ will be adapted to the licensing status of the relevant entities in scope and will consist in a self-assessment of their compliance with the applicable legal and regulatory requirements to be completed annually (see below table with applicable deadlines). Important point to note, the content of the SAQ will be focusing on other aspects than AML/CFT.

The conducting officers of the IFMs and the governing bodies of the UCIs must review and validate the content of the SAQ before submission to the CSSF on the eDesk platform and ahead of its review by external auditors.

All Luxembourg UCIs supervised by CSSF are in scope of Circular 21/790.

Once submitted by the relevant entities, their external auditors shall review certain sections of the SAQ and complete the SR on eDesk as per deadlines indicated below:

Procedures and practical guidance in terms of preparation and transmission of the self-assessment questionnaire are available on the eDesk portal.

The combination of the SAQ and its review by external auditors will form the basis for the LFR. The LFR requires external auditors to perform specific procedures covering various themes defined by the CSSF, the result of which consisting in responses to closed-ended questions that do not entail judgement by external auditors. Comments provided by auditors should be clear, concise and specific to the questions at stake.

In addition, external auditors will complete a dedicated form on eDesk in order to prepare the ML, to be then submitted via eDesk by the relevant entities within seven months of their financial year-end (starting as from the first financial year end on or after 31 December 2021 for IFMs and 30 June 2022 for UCIs).

The ML should take into account the following:

• any significant deficiency or area of improvement in accordance with audit norms ISA 260 (Communication with those charged with governance) and ISA 265 (Communicating deficiencies in internal control to those charged with governance and management); and
• any other deficiency or area of improvement deemed worth mentioning by external auditors.

The ML should also follow-up on any “ongoing” deficiencies or previously identified areas of improvement. IFMs should provide detailed explanation of the reasons and the circumstances related to the deficiency or area of improvement and a detailed explanation of the corrective measures implemented to avoid future similar deficiencies, including a remediation plan and timeframe.

Should auditors identify no deficiency or area of improvement, the ML template form still needs to be completed as a “No comment ML” in eDesk.

Specific information on modified audit opinions (e.g. in case external auditors issues a qualified opinion) will be made available on eDesk by 31 March 2022 at the latest.

Waystone will follow-up with a further direct client communication on the new Circulars detailed under this section.

5. EONIA/LIBOR/EURIBOR
CSSF updated the FAQ on AIFM Law

The CSSF published a press release 21/28 on 19 November 2021 on the communication to undertakings for collective investments (UCIs) and IFMs in the context of the imminent cessation of the major used interest benchmarks EONIA and LIBOR. The CSSF reminded all UCIs and IFMs subject to its supervision and using benchmarks to ensure that:

• all necessary action in view of a smooth transition to alternative rates to EONIA and to LIBOR have been taken;
• they have in place robust fall-back provisions covering a possible cessation of any other benchmarks used by them (if any) (in accordance with article 28(2) of the Benchmarks Regulation); and
• such fallback provisions are reflected in the contractual relationship with investors.

Overview on the different deadlines for the replacement

• EONIA discontinued on 3 January 2022.
• as mentioned in our previous Regulatory Newsletter LIBOR
  • ceased on 31 December 2021 for GBP, EUR, CHF and JPY settings, the one-week and two-month USD settings and will cease on 30 June 2023 for the remaining USD settings; and
  • continues to be published with a change of methodology (known as synthetic) for one-month, three-month and six-month GBP and JPY LIBOR settings until the end of 2022. However, they are not intended to be used for new contracts but only for legacy contracts that holders are unable to amend.

Alternatives to EONIA and LIBOR

• EONIA should be replaced by the risk-free rate €STR in accordance with the European Commission Implementing Regulation (EU) 2021/1848; and
• LIBOR should be replaced by SARON for the CHF settings in accordance with the European Commission Implementing Regulation (EU) 2021/1847.

Recommendations for GBP, JPY and USD settings
The European Commission might designate replacement benchmarks with respect to GBP, JPY and USD settings. In the meantime, the CSSF encourages UCIs and IFMs to take necessary actions to reduce exposure to LIBOR rates and mentioned in particular that

• SONIA was recommended by the UK Working Group on Sterling Risk Free Rates and
• SOFR by the US Alternative Reference Rates Committee as alternative rates for GBP LIBOR settings.

EURIBOR fallback recommendations
The CSSF is drawing UCIs’ and IFMs’ attention on the fallback trigger events and rates recommended by the European Central Bank working group to support market participants in developing contractual fallback provisions. The CSSF remains open to be contacted by e-mail at [email protected] in case UCIs face any difficulties in the transition or finding alternative rates.

We remind you that appropriate contingency plans should already be in place for ensuring the business continuity further to the cessations of these benchmarks detailed above.

6. IT outsourcing
Replacement of the prior authorisation obligation by a prior notification obligation in the case of material IT outsourcing

On 20 October 2021 the CSSF published a press release 21/25 in relation to the new CSSF Circular 21/785 on the replacement of the prior authorisation obligation by a prior notification obligation in the case of material IT outsourcing[2] to service providers that are not professionals of the financial sector under the supervision of the CSSF. The Circular 21/785 took effect on 15 October 2021, however transitional measures apply and the former regime remains applicable to authorisation applications that were submitted until 31 August 2021 (included).

The Circular replaced the regime of prior authorisation of material IT outsourcing (including outsourcing to a cloud based infrastructure) required in the four existing circulars by a three months’ prior notification to implementation, using the dedicated notification form made available on the CSSF’s website. In case the supervised entity does not receive anything from the CSSF within the notification period, the supervised entity may proceed as planned.

The EBA Guidelines define “material IT outsourcing” as IT outsourcing of “critical or important functions”, namely functions where the defect or failure would materially impair the soundness or continuity of the supervised entity’s services, activities, financial performance as well as regulatory compliance. The materiality assessment should be performed in light of the CSSF FAQ on materiality, which clarifies that IT outsourcing is an arrangement of any form between a supervised entity and a service provider (including of the same group) by which the service provider performs an IT process, an IT service or an IT activity that would otherwise be undertaken by the supervised entity itself.

The notification period is reduced to one month in case of outsourcing to a support PSF pursuant to Articles 29-3 to 29-6 of the law of 5 April 1993 on the financial sector, as amended.

Finally, the CSSF Circular 21/785 added that the service agreement signed with a cloud-computing provider must be subject to the law of an EU Member State and at least one data centre which must be capable of autonomously providing the cloud computing services must be located in the EU, unless the supervised entity can benefit from a group agreement which was signed by a non-EU company with the cloud computing provider.

7. CSSF Fees
Increased fees as of 1 January 2022

On 22 December 2021, a new Grand Ducal Regulation (“GDR”) has been published, increasing the CSSF fees and introducing new fees applicable to institutions and entities under CSSF supervision, and in particular to investment fund managers. The new fees are effective from 1 January 2022.

Below is a brief overview on the new (v. the old) fees applicable to different fund structures for certain major events:

*Number of sub-funds authorised and in the prospectus as at 31 December preceding the billing year. For umbrella UCITS, UCIs, SIFs that are authorised by the CSSF in the course of the year, it shall be considered the number of sub-funds when registered on the official list.
** This lump sum shall be due for each financial year in which the non-judicial liquidation has not been completed, except for the financial year in which the UCI, SIF or SICAR has been deregistered from the official list.

8. MiFID II
MiFID Quick Fix

With reference to the MiFID Quick Fix further described above under the European developments section, Luxembourg has transposed already the Quick Fix by means of the law of 21 July 2021.

9. Luxembourg Business Register
Upcoming requirements for individuals

On 1 October 2021 the Luxembourg Business Registers (“LBR”) published a public notice about upcoming changes starting at the end of the first quarter of 2022 concerning formalities to be carried out at the Trade and Companies Register (“RCS”). A more precise date will be communicated at a later stage.

Further to a format change of the requisition form from PDF to HTML format to be completed directly online, any natural person registered with the RCS will have to communicate the Luxembourg national identification number pursuant to Article 12bis of the amended law of 19 December 2002 on the register of commerce and companies and the accounting and annual accounts of undertakings.

For a natural person already registered with the RCS, the information relating to the Luxembourg national identification number will be required. While initially this information will have to be communicated by registered entities on a voluntary basis, it will subsequently become mandatory.

In case a natural person does not have a Luxembourg national identification number, the LBR will issue such a number at the moment of accepting the application for registration in the RCS, upon receipt and verification of certain additional information (being nationality, gender and private residence) and supporting documents (e.g. certificate of residence, declaration of honour certified by a competent authority, or even electricity bill).

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[2]Amending four existing CSSF Circulars governing, inter alia, IT outsourcing: CSSF Circular 12/552, CSSF Circular 17/656, CSSF Circular 20/758 and CSSF Circular 17/654.

1. FCA finalises rules for the Long Term Asset Fund (LTAF)

The FCA has published its final rules for the Long Term Asset Fund (LTAF) (the Final Rules). The LTAF regime creates a category of authorised open-ended fund designed specifically to facilitate investment in long-term, illiquid assets. Illiquid assets include venture capital, private equity, private debt, real estate and infrastructure.

Managers will be able to apply to the FCA for authorisation of an LTAF from 15 November 2021, although the FCA is encouraging early engagement from managers prior to any submission.

The key points which have changed following the Final Rules:

• Redemptions: will be available no more frequently than monthly.
• Depositary ownership of assets: the FCA will retain the rule applicable to all UK authorised funds requiring the depositary to take legal ownership of the LTAF’s assets.
• Valuation: FCA has removed the proposed requirement for depositaries to determine “without qualification” that the LTAF manager has the necessary knowledge, skills, and experience to value the LTAF’s assets.
• Distribution: FCA has taken the significant step of allowing the LTAF to be sold to certificated high net worth investors as part of a diversified portfolio via an amendment to the non-mainstream pooled investment rules.

2. FCA publishes IFPR final rules

On 22 October 2021, the FCA published the final rules from its first and second policy statements on IFPR, which came into force on 1 January 2022.

In addition to the final rules, the FCA has also published:

• a revised version of its general guidance on the application of ex-post risk adjustment to variable remuneration, providing further detail on its expectations in respect to regards “malus” and clawback arrangements; and
• a Remuneration Policy Statement (RPS) template and table of material risk takers, in which FCA investment firms can use to document their remuneration policies and practices and (where relevant) their material risk takers.

Finally, the FCA has sent a questionnaire to all firms within the scope of the IFPR in November asking for key information such as the firm’s expected small and non-interconnected investment firm status, “investment firm group” membership/composition, and expected Internal Capital and Risk Assessment reporting date.

3. EBA publishes final report on draft technical standards for EU IFR

On 19 October 2021, the European Banking Authority (EBA) published its final report on the regulatory technical standards on disclosure of investment policy by investment firms, in respect to Article 52 of the EU Investment Firms Regulation (EU IFR). The EU IFR applies to EU MiFID investment firms, not UK firms.

The investment policy disclosure obligation applies to EU investment firms:

• that are not SNIs, the conditions for which are set out in Article 12(1) IFR (Class 2 investment firms);
• those firms with on- and off-balance sheet assets on average greater than €100 million over the four-year period immediately preceding a given financial year; and
• in respect only of companies whose shares are admitted to trading on a regulated market and in which the proportion of voting rights exceeds 5% of all voting rights issued by the company.

The objective of the investment policy disclosure is to provide transparency (i) to a firm’s investors and wider market participants on the firm’s influence over the companies in which it directly or indirectly holds shares with voting rights and (ii) on how it exercises its voting rights.

The disclosed information must be published annually, alongside the firm’s financial statements.

Article 52 of the EU IFR requires certain EU investment firms to disclose information on their investment policy, including:

• the proportion of voting rights attached to shares they held directly or indirectly;
• voting behaviour;
• use of proxy adviser firms; and
• voting guidelines

The final draft RTS have been submitted to the Commission for adoption. The implementation date (first disclosure) shall be from 31 December 2021.

4. FCA publish policy statement on LIBOR Transition

On 15 October, the FCA published a policy statement (PS) on the LIBOR transition and the derivatives trading obligation (DTO) (PS21/13). This PS sets out the FCA’s finalised amendments to the UK regulatory technical standards (RTS) on the derivatives trading obligation (DTO RTS), which are set out in the on-shored version of Commission Delegated Regulation (EU) 2017/2417.

The changes to the DTO RTS follow the FCA’s July consultation (CP21/22), and the final rules can be found in the Technical Standards (Markets in Financial Instruments Regulation) (Derivatives Trading Obligation) Instrument 2021 (FCA 2021/36). Among other things, the FCA’s amendments to the DTO RTS remove derivatives referencing GBP LIBOR and replace them with overnight indexed swaps referencing SONIA. The amendments to the DTO RTS which came into force, 20 December 2021.

The FCA adds that these finalised amendments take account of the Bank of England’s changes to the scope of the derivatives clearing obligation, its updated liquidity analysis covering the period between January and July, and the responses it received to CP21/22. As the liquidity profile of the derivatives market will continue to evolve as the interest rate benchmark reform unfolds, the FCA may propose further amendments to the scope of the DTO in due course.

5. FCA publish Discussion Paper 21/4: Sustainability Disclosure Requirements and investment labels

FCA discussion paper DP21/4 “Sustainability Disclosure Requirements and investment labels” (the Discussion Paper or DP), published on 3 November, alongside the FCA’s revised ESG strategy, sets out the FCA’s proposals around Sustainability Disclosure Requirements (SDR) and a sustainable investment labelling scheme, as recently trailed in the UK Government’s Roadmap to Sustainable Investing.

The FCA’s aim in introducing these initiatives is to build trust in the market place, to enhance transparency for end consumers and to meet the information needs for institutional investors.

SDR has been described informally as the UK’s ‘answer’ to the EU’s Sustainable Finance Disclosure Regulation (SFDR) but in reality it is much wider. The UK SDR aims to address in one framework what the EU has sought to achieve with many pieces of sectoral legislation.

The Discussion Paper was open for comment until 7 January 2022 with a consultation paper expected in Q2 of 2022.

6.1 Required disclosures under SDR

The current proposal is that the disclosures will be set at two levels – (i) consumer facing and (ii) detailed underlying disclosures meant for sophisticated and institutional investors.

6.1.1 Consumer facing disclosures

The consumer facing disclosures will be aimed at retail investors and will deal with the most important sustainability information which will allow investors to make informed choices when they invest.

The FCA suggests that the disclosures will include the following:

• the product label (discussed in more detail below)
• the objective of the product, including any specific sustainability objectives
• the investment strategy
• the proportion of assets allocated to sustainable investment (as defined by the UK Taxonomy)
• a firm’s approach to investor stewardship
• wider sustainability performance metrics

The FCA is suggesting that they may be prescriptive as to how the disclosures are made, including potentially prescribing a template or using an ESG factsheet.  The disclosures will need to sit alongside the key information investor document to give extra information on the ESG aspects of a product.

6.1.2 Consumer facing disclosures

The FCA is asking for views on a second layer of disclosure that could be provided to sophisticated and institutional investors.  Like the SFDR, these disclosures would be made at entity and product level.

6.1.3 Product level disclosures

The product level disclosures will be in addition to the consumer facing disclosures highlighted above. The FCA proposes the following disclosures:

• information on how metrics have been calculated
• information on data sources, limitations and quality
• supporting narrative and contextual and historical information
• information about UK Taxonomy alignment
• information about benchmarking and performance

It is likely that there will be overlap with work that firms will have to do for TCFD disclosure and for SFDR to the extent that is relevant.

6.1.4 Entity level disclosures

The likelihood is that firms will be asked to build on the TCFD disclosure requirements which will take effect for asset managers and FCA regulated asset owners from 1 January 2022.

6.2 Sustainable investment labelling scheme

The FCA is proposing a labelling regime that will provide better disclosure and help institutional investors make more informed decisions.

It will apply to the full range of investment products available to retail consumers. Without further explanation, it is envisaged that this will cover open-ended and closed-ended funds sold to retail investors and packaged pension and insurance products. It is not clear at this stage whether investment services (wealth mandates, model portfolios etc.) will be in scope since traditionally these would be considered ‘services’ in the UK (but are captured as ‘products’ by recent EU regimes like SFDR).

6.3 Design principles

The Discussion Paper sets out key design principles for the labelling scheme and invites feedback on these:

6.3.1 Objective

The classification that determines the label should be objectively derived.  The classification will be based on objective criteria and descriptive labels.  The FCA wants the classification to be verifiable for obvious reasons.

6.3.2 Combination of intention and practice

The classification may take account both of the objective and strategies of the products themselves as well as the proportion of the portfolio that is categorised as being sustainable (potentially by reference to the UK Green Taxonomy).

6.3.3 Compatibility with other initiatives

The FCA is seeking to build consistency but ideally without upending existing terminology and practices; but with flexibility for future changes and innovations.

1. SFDR Level 2 Measures delayed until 1 January 2023

The European Commission announced in July 2021 that “Level 2” SFDR disclosure requirements (SFDR Level 2 Measures) will apply from 1 July 2022.

1.1 Application Date

The SFDR Level 2 Measures will apply from 1 January 2023. The EU commissions letter confirmed that the fund management companies which need to report on the principal adverse impacts (PAI) of their investment decisions on sustainability factors under Article 4 of the SFDR, will need to comply with the detailed disclosure obligations under the SFDR Level 2 Measures by 30 June 2023 in respect of the period between 1 January 2022 and 31 December 2022. Fund management companies will need to comply with the detailed PAI reporting during 2022 to publish a report which includes information regarding the relevant period of time by 30 June 2023.

1.2 MiFID II suitability assessment rules

MiFID II is introducing revised suitability assessment rules which will apply from 2 August 2022 (MiFID Suitability Assessment Rules). The EU investment firms which provide portfolio management or investment advice to their clients will need to check if they have any sustainability preferences and to establish if the client would like to invest in a fund with a minimum allocation to “sustainable investments” or “taxonomy-aligned” investments.

It is not yet confirmed if the MiFID Suitability Assessment Rules are to be delayed until 1 January 2023 as at that point in time the disclosures on asset allocation will have to be added to the fund’s pre-contractual documentation.

1.3 The Fast Track Process of the Central Bank

The Central Bank will also provide a fast-track process regarding the filings made to comply with the SFDR Level 2 Measures between March and May of 2022. The Central Bank has not yet confirmed if there is going to be a delayed fast-track process in respect of the filings for which will be a delay of entry into force of the relevant disclosure obligations until 1 January 2023.

2. Central Bank publishes consultation paper on Irish domiciled property funds

On 25 November 2021, the Central Bank published a consultation paper (“Consultation Paper”) with a proposal which will apply to Irish domiciled funds that invest over 50% directly or indirectly in Irish property assets and will include leverage limits and some orientation on how manage liquidity mismatches. The Central Bank is proposing a 50% leverage limit for such funds to be determined by ration of total assets to total liabilities. For those funds which are already in scope of the proposal they will have three years to comply with these new leverage limits.

The Central Bank believes these new measures are necessary to increase resilience of these funds in order for them to absorb future shocks in the real estate (CRE) market.

3. Covered Bonds Directive: Impact on UCITS

This is a new directive for covered bonds will come into force in Ireland on 8 July 2022 after the entry into force of the European Union (Covered Bonds) Regulations 2021 (“Irish Covered Bonds Regulation”). The Irish Covered Bonds Regulation gives effect to Directive (EU) 2019/2162 of the European Parliament and of the Council of 27 November 2019 (“Covered Bonds Directive”) which will enter into force on the same date.

The Covered Bonds Directive will implement specific structural features for bonds issued by EU credit institutions which are to be classified as “covered bonds” under the UCITS legislation.

According to the current UCITS regime, investment in covered bonds is not subject to the standard 5/10/40 issuer exposure rules, and funds may invest up to 25% of net assets in any one covered bond. The total value of investments in covered bonds issued by one issuer cannot exceed 80% of the net assets of the UCITS.

In order for a UCITS to avail of the higher diversification limits, these covered bonds need to comply with the criteria clarified in Regulation 70(3)(a) of the European Communities (UCITS) Regulations 2011 as amended (“Irish UCITS Regulations”):

• covered bonds have to be issued by a credit institution with registered office in a Member State and is subject by law to special public supervision; and
• sums deriving from the issue of covered bonds shall be invested in assets which during the period of validity of the bonds are capable of covering claims attaching to the bonds and which will be used on a priority basis for the reimbursement of the principal and the payment of the accrued interest.

3.1 The Irish domiciled UCITS

From 8 July 2022, UCITS can only avail of the higher investment restrictions applicable to covered bonds when the relevant bonds respect the specific criteria according to the Covered Bonds Directive. Covered bonds issued before 8 July 2022 are not affected by the new rules and remain subject to the existing requirements.

4. Central Bank publishes feedback statement on Consultation Paper 140: Cross Industry Guidance on Operational Resilience (OR)

The Central Bank recently published its Cross Industry Guidance on Operational Resilience (the Guidance) as part of its feedback statement on Consultation Paper 140 (CP140). The aim of the Guidance is to let the boards (Boards) and senior management of the RFSPs understand the Central Bank’s expectations regarding the management of operational resilience, to focus on the Board and senior management responsibilities when considering OR as part of their risk management and investment decisions and to require that they take appropriate action to ensure that their OR frameworks are operating effectively and sufficiently robust.

The RFSPs will need to put in place a flexible OR strategy to face potential disruptions and ensure coordination between risk management, business continuity management (BCM), incident management, third party risk management, Information Communication Technology (ICT) and cyber risk, and recovery and resolution planning.

4.1 The Guidance – Principles of OR

The principles of any OR framework are as follows:

• the Board and senior management need to assume the ownership of the OR Framework;
• the identification of critical or important business services and all activities, people, processes, information, technologies and third parties involved in the delivery of the services;
• the setting of impact tolerances for the identified services, and the testing of the RFSP’s ability to stay within those impact tolerances during a severe disruption; and
• the continuous review of how a RFSP responded and adapted to disruptive event.

5. Central Bank issue updates to AIFMD Q&A and UCITS Q&A

On 20 December 2021, the Central Bank issued the 44th Edition of the AIFMD Q&A and the 36th edition of the UCITS Q&A (collectively, the “Q&A”).

The updated Q&As clarify the Central Bank’s expectations in respect of (i) arrangements involving a non-discretionary investment advisor (the “Advisor”) which provides services to a qualifying investor alternative investment fund (“QIAIF”) whereby the Advisor receives a higher proportion of the fees than other service providers to the QIAIF; and (ii) compliance with ESMA guidelines on performance fees in fund structures with multiple managers/advisors.

(i) Non-discretionary investment advisors which provide services to a QIAIF

The Q&A clarifies the Central Bank’s expectations in respect of an arrangement involving an Advisor which provides services to a QIAIF operating a private equity strategy or investing in physical assets which do not qualify as financial instruments. The Q&A also provides for a disclosure-based process which must be complied with to allow for delegation to an Advisor, which include:

(A) Identification: details identifying the Advisor and the services provided should be ‘comprehensively disclosed’ in the prospectus of the QIAIF.

(B) Fee Structure: QIAIFs are required to disclose in its prospectus how fees of each service provider are accrued and paid. The Central Bank states that where such fees are payable directly from the assets of the QIAIF, the maximum fee and the potential to pay out of pocket expenses on normal commercial terms of each of the service providers is to be disclosed in the QIAIF’s prospectus. The Central Bank also states that where a single figure is disclosed in the prospectus that covers all of the fees payable out of the assets of the QIAIF, the prospectus should disclose that ‘the investment advisor will receive a fee greater than typically paid to a non-discretionary investment advisor’. The Central Bank also confirms that this disclosure should cross-reference details of the services that the Advisor is providing to the QIAIF in order to provide context for the fee.

(C) Oversight: Central Bank also expects the prospectus of the QIAIF to detail the role of the AIFM with respect to its ongoing oversight and review of services provided by the Advisor. Detail to be provided should include information on how the AIFM will discharge its functions under AIFMD Level 21, including, Article 75(e) and (f) which relate to delegation of the AIFM functions.

(ii) Performance fees in fund structures with multiple managers/advisors

New IDs 1152 and 1153 of the AIFMD Q&A and IDs 1105 and 1106 of the UCITS Q&A implement updates to the ESMA Q&As which confirm that in the case of a global underperformance of a fund with different delegated portfolio managers performance fees should not be paid to those delegated portfolio managers who have overperformed.

Key Deadlines below:

• UCITS: existing multi manager UCITS required to have transitioned performance fee models with the ESMA Q&A, by 1 January 2023. In addition, the Central Bank will not authorise new multi manager UCITS from 20 December 2021 which do not have a performance fee that complies with the ESMA Q&A.
• RIAIFs: existing multi manager RIAIFs required to have transitioned performance fee models with the ESMA Q&A, by 1 January 2023. In addition, the Central Bank will not authorise new multi manager RIAIFs from 20 December 2021 which do not have a performance fee that complies with the ESMA Q&A.