European Regulatory Update – June 2022
Our latest update includes the following:
A few developments happened on the Environmental Social and Governance (ESG) front, the summary of which is detailed below.
EU Commission adopts RTS under the SFDR
The EU Commission finally announced on 6 April 2022 that the regulatory technical standards (RTS) to be used by financial market participants when disclosing sustainability-related information under the Sustainable Finance Disclosures Regulation (SFDR) has been adopted.
As a reminder, SFDR mandated the ESAs to develop draft RTS to further specify the content, methodologies and presentation of information to be provided pursuant to SFDR. The ESAs submitted a draft RTS to the EU Commission in April 2020 and February 2021, and final draft RTS were submitted in October 2021. In a letter dated 8 July 2021, the ESAs stated their intention was to “bundle all 13 of the regulatory technical standards in a single delegated act”. The delegated act published by the EU Commission on 6 April 2022 comprises all the various RTS required under the SFDR.
The RTS include:
- the main text of the delegated act that includes all 13 RTS, together with an explanatory memorandum;
- template principal adverse sustainability impacts statement (Annex 1);
- template pre-contractual disclosure documents for Article 8 and Article 9 financial products (Annex 2 and Annex 3); and
- template periodic disclosure documents for Article 8 and Article 9 financial products (Annex 4 and Annex 5).
Next steps and application date
Once the European Parliament and the Council approve the final text, the RTS will be published in the Official Journal of the EU.
Subject to the confirmation by the European Parliament and the Council, current expectation is that 1 January 2023 will be the effective date.
Updated supervisory statement on the application of the Sustainable Finance Disclosure Regulation
The ESAs has clarified in an updated supervisory statement on the application of the SFDR (replacing the initial joint supervisory statement released in February 2021) issued on 25 March 2022 that, under Article 5 and 6 of the Taxonomy Regulation, the supervisory expectation for disclosures during the interim period is that financial market participants should provide an explicit quantification, through the numerical disclosure of the percentage, of the extent to which investments underlying the financial product are taxonomy-aligned.
In addition, while estimates should not be used, where information is not readily available from investee companies’ public disclosures, financial market participants may rely on equivalent information on taxonomy-alignment obtained directly from investee companies or from third party providers.
Following such updated supervisory statement, the CSSF has published a press release on 1st April 2022 to provide, among others, guidance on the application of the RTS during the interim period (please refer to Luxembourg – regulatory developments – section ESG for more information).
Publication of the Taxonomy delegated acts on sustainable activities
In relation to Taxonomy Regulation (TR) and especially sustainable activities, two delegated acts have been published:
- The Climate Delegated Act, published in the Official Journal of the EU on 9 December 2021, which specifies the technical screening criteria:
- for determining the conditions under which an economic activity qualifies as contributing substantially to (i) climate change mitigation or (ii) climate change adaptation, and
- for determining whether that economic activity causes no significant harm to any of the other environmental objectives.
- The delegated act supplementing the TR, published in the Official Journal of the EU on 10 December 2021, by specifying the content and presentation of non-financial information to be disclosed by undertakings subject to Articles 19a or 29a of the Non-Financial Reporting Directive (Directive 2013/34/EU) concerning environmentally sustainable economic activities, and specifying the methodology to comply with that disclosure obligation.
As a reminder, article 8(1) of the TR provides that certain large undertakings that are required to publish non-financial information under the Non-Financial Reporting Directive should disclose since 1st January 2022 information to the public on how and to what extent their activities are associated with environmentally sustainable economic activities, as defined under the TR.
Proposal of a complementary delegated act on gas and nuclear activities
On 2 February 2022, the EU Commission published a proposal for a Taxonomy Complementary Climate Delegated Act which includes a list of criteria that classifies investments in nuclear or gas power generation as “sustainable” (“Taxonomy Complementary Climate Delegated Act“).
Natural gas and nuclear can be seen as a means to facilitate the transition towards a predominantly renewable-based future, according to the EU Commission’s proposal.
However, in January 2022, the EU Commission submitted the proposal to the Member States expert group on Sustainable Finance and to the Platform on Sustainable Finance.
The experts of the Platform on Sustainable Finance rejected on 24 January 2022 the EU Commission’s proposal to include gas and nuclear activities in the taxonomy, concluding that these activities are not in line with the TR and most members see a serious risk of undermining the sustainable Taxonomy framework. They also had doubts about how the draft criteria would work in practice and many members were concerned about the environmental impacts that may result. The EU Commission’s plans to include gas and nuclear in the taxonomy has also met with considerable opposition from a number of EU member states, notably Luxembourg, Germany and Austria.
As regards the next steps, once translated into all official EU languages, the Taxonomy Complementary Climate Delegated Act will be formally transmitted to the European co-legislators for scrutiny. Once the scrutiny period of four months, with a possible extension of two months, is over and if neither of the co-legislators objects, the Taxonomy Complementary Climate Delegated Act will enter into force and apply as of 1 January 2023.
On 23 February 2022, the EU Commission published a proposal for a directive of the European Parliament and of the Council on corporate sustainability due diligence (the “CSDD Directive“), amending the Directive (EU) 2019/1937 on the protection of persons who report breaches of Union law.
The due diligence rules as proposed under the CSDD Directive would apply to the following companies and sectors:
- EU companies:
- Group 1: all EU limited liability companies of substantial size and economic power (with 500+ employees and EUR 150 million+ in net turnover worldwide);
- Group 2: other limited liability companies operating in defined high impact sectors, which do not meet both Group 1 thresholds, but have more than 250 employees and a net turnover of EUR 40 million worldwide and more. For this group, the rules would start to apply 2 years later than for the Group 1.
- Non-EU companies active in the EU with a turnover threshold aligned with Group 1 and 2, generated in the EU.
- Small and medium enterprises (“SMEs“) will indirectly fall in the scope of the CSDD Directive.
The CSDD Directive would apply to the operations of the company in scope, its subsidiaries and their value chains (direct and indirect established business relationships).
In addition, in order to achieve a meaningful contribution to the sustainability transition, due diligence under the CSDD Directive should be carried out with respect to all adverse human rights and environmental impacts identified in its annex.
The CSDD Directive also introduces directors’ duties to set up and monitor the implementation of due diligence and to integrate it into the corporate strategy. Directors will also have to take into account the human rights, climate change and environmental consequences of their decisions. The EU Commission has also published its frequently asked questions document (QANDA/22/1146 — the “FAQ Document“).
Once the CSDD Directive has been adopted by the European Parliament and the Council for approval, Member States will have 2 years to transpose the CSDD Directive into national law and communicate the relevant texts to the EU Commission.
National authorities will be responsible for supervising these new rules and may impose fines to companies in case of non-compliance. Victims will have the opportunity to take legal action for damages that could have been avoided with appropriate due diligence measures.
ESMA consultation on MiFID II suitability requirements
Directive 2014/65/EU (“MiFID II“) and Regulation (EU) No 600/2014 (“MiFIR“) on markets in financial instruments are applicable since 3 January 2018. Delegated and implementing acts have been adopted to specify how to comply with the obligations laid down in the MiFID II (the “Delegated and Implementing Acts“), which include the EU Commission delegated regulation (EU) 2017/565 supplementing the MiFID II with regard to organisational requirements, operating conditions for investment firms and defined terms for the purposes of the MiFID II (the “Delegated Regulation 2017/565“).
One of the most important requirements for investor protection in the MiFID II framework is the assessment of suitability. It applies to the provision of any type of investment advice, whether independent or not, and portfolio management. Investment firms providing investment advice or portfolio management must provide suitable personal recommendations to their clients or have to make suitable investment decisions on behalf of their clients. Suitability has to be assessed against clients’ knowledge and experience, financial situation and investment objectives. To achieve this, investment firms have to obtain the necessary information from clients.
ESMA published on 27 January 2022 a consultation paper (ESMA35-43-2998, the “Consultation Paper“) on the revised 2018 Guidelines (the “Draft Revised Guidelines“) in relation to certain aspects of suitability requirements under the MiFID II, which take into account:
- the recent changes made to the Delegated Regulation 2017/565 and specifically on the topic of sustainability such as:
- the collection of information from clients on sustainability preferences;
- the assessment of sustainability preferences; and
- the organisational requirements: firms shall need to give staff appropriate training on sustainability topics and keep appropriate records of the sustainability preferences of the client (if any) and any updates of these preferences.
- the results of the 2020 common supervisory action conducted by national competent authorities (“NCA(s)“) on the application of the MiFID II suitability requirements, complementing the 2018 Guidelines with the good and practices emerged and providing some practical guidance to firms; and
- the amendments introduced through the MiFID Quick Fix (as further detailed in our Regulatory Update of January 2022). The Draft Revised Guidelines aim to ensure a common, uniform and consistent implementation of the MiFID 2 requirements as recently amended in order to integrate:
- client’s preferences in terms of sustainability in addition to the suitability assessment; and
- sustainability risks into the organisational requirements.
Comments to the Consultation Paper shall be sent to ESMA by 27 April 2022. ESMA will consider the feedback received from the industry to the Consultation Paper in Q2 2022 and expects to publish a final report in Q3 2022.
FinDatEx issues the EET Version 1 and EMT Version 4.0
Following the information provided in our Regulatory Update of January 2022, FinDatEx published on 14 March 2022:
- the 1st version of the European ESG Template (EET), which serves to facilitate the necessary exchange of data between product manufacturers and distributors for the purpose of fulfilling ESG-related regulatory requirements in accordance with SFDR, TR and delegated acts complementing MiFID II and the Insurance Distribution Directive (Directive (EU) 2016/97).
- the 4th version of the European MiFID Template (EMT), the update of which became necessary with the publication of the EET. Any ESG-related data fields are now subject to the EET. This 4th version is intended to be used as of 1 August 2022. As of that date, V4 will be the only current version of the EMT.
The EET and EMT templates can be used on a voluntary basis, free of charge and it is recommended to have them updated at least once a year.
FinDatEx’ recommendation is to have the EET ready for distributors by 1 June 2022.
2. ATAD 3
New Directive proposal
On 22 December 2021, the EU Commission published a Directive proposal laying down rules to prevent the misuse of shell entities for tax purposes, which is to be implemented into Member States’ national law by 30 June 2023 and become effective from 1 January 2024.
While stating in its explanatory memorandum that legal entities with no minimal substance and economic activity (so-called “shell entities”) continue to pose a risk of being used for improper tax purposes, the Directive aims at combating tax avoidance and evasion practices, being “part of the central EU strategy on direct corporate taxation with a view to ensuring that everybody pays their fair share”.
It applies to all undertakings that are considered tax resident and are eligible to receive a tax residency certificate in a Member State, subject to certain exclusions from its scope covering, among others, the following entities which are considered from the outset as being low-risk:
- companies which have a transferable security admitted to trading or listed on a regulated market or multilateral trading facility;
- certain regulated financial undertakings as explicitly listed in the draft Directive (e.g. credit institutions, investments firms, UCITS and their management companies, AIFs within the meaning of the AIFMD, AIFMs including a manager of European Venture Capital Funds – EUVECA, a manager of European Social Entrepreneurship Funds – EUSEF and a manager of European Long Term Investment Funds – ELTIF);
- undertakings that have the main activity of holding shares in operational businesses in the same Member State while their beneficial owners are also resident for tax purposes in the same Member State;
- undertakings with holding activities that are resident for tax purposes in the same Member State as the undertaking’s shareholder(s) or the ultimate parent entity;
- undertakings with at least five own full-time equivalent employees or members of staff exclusively carrying out the activities generating the relevant income.
The draft Directive lays down a test that will help Member States to identify undertakings engaged in an economic activity, but which do not have minimal substance and could be misused for the purpose of obtaining tax advantages (commonly referred to as a “substance test”). This substance test includes 7 steps as follows:
- “Gateway“ criteria: three cumulative criteria used to establish whether an undertaking is at risk for lacking substance and, therefore, is subject to the reporting obligation:
- more than 75% of the revenues accruing to the undertaking in the preceding two tax years is relevant income;
- the undertaking is engaged in cross-border activities;
- in the preceding two tax years, the undertaking outsourced the administration of day-to-day operations and the decision-making on significant functions.
- Reporting obligation: An undertaking considered at risk under step 1 is required to declare in its annual tax return, for each tax year, if it meets the following indicators of minimum substance:
- the undertaking has own premises in the Member State, or premises for its exclusive use;
- the undertaking has at least one own and active bank account in the Union;
- the undertaking has at least one director and/or the majority of relevant employees being resident close to its undertaking.
- Presumption of lack of minimal substance and tax abuse
- Rebuttal of the presumption of lack of minimal substance: it involves the right of the undertaking which is presumed to be “shell” and thus misused for tax purposes to prove otherwise, i.e. to prove that it has substance or in any case it is not misused for tax purposes.
- Exemption for lack of tax motives: an undertaking that might cross the gateway and/or does not fulfil the minimum substance could be used for genuine business activities without creating a tax benefit for itself, the group of companies of which it is part or for the ultimate beneficial owner.
- Tax consequences: the Member State of tax residence of the shell entity will either not issue a tax residence certificate at all or will issue a certificate with a warning statement which prescribes that the shell entity is not entitled to double tax treaty benefits and, where applicable, benefits of the Parent-Subsidiary and the Interest Royalty Directives.
- Exchange of information and penalties: all Member states shall have access to information on EU shells, at any time and without a need for recourse to request for information. Furthermore, a Member State should be able to request from another Member State to conduct an audit on any entity that passes the gateway of the Directive, if it suspects that the entity lacks the minimal substance.
The proposed legislation leaves it to the Member States to lay down penalties applicable but shall be effective, proportionate and dissuasive and should include an administrative pecuniary sanction of at least 5% of the undertaking’s turnover.
3. AIFMD 2
Discussion on new requirements concerning loan funds
As mentioned in our Regulatory Update dated January 2022, the EU Commission published a legislative package aimed at revising the regulatory framework for managers of alternative investment funds (“AIFMD 2”). We mentioned that one of the changes to be brought by AIFMD 2 concerns new requirements for AIFMs and AIFs that perform loan granting activities such as:
- implementation and maintenance of effective policies, procedures and processes for the granting of loans including at least a yearly review;
- ran AIFM shall ensure that restriction of loans to any single borrower by the AIF it manages does not exceed 20% of the AIF’s capital (subject to the applicable specific provisions under the ELTIF, EuSEF or EuVECA regulations);
- an AIFM shall ensure that the AIF it manages retains, on an ongoing basis, 5% of the notional value of the originated loans and subsequently sold off on the secondary market provided that the loans have not been purchased on the secondary market;
- prohibition against granting loans to its AIFM, depositary or the entity to which its AIFM has delegated functions;
- adoption of a closed-ended structure where the engagement in loan origination exceeds 60% of the AIF’s net asset value.
These new requirements are currently discussed at European level between the institutions and the relevant fund organisations.
Once the amended Directive is adopted, Member States will have 24 months to transpose and enforce the new rules.
Proposal for new EU Regulation
On 25 November 2021, the EU Commission published a proposal for a regulation amending the Regulation (EU) 2015/760 on European long term investment funds (“ELTIF”) aiming at making the ELTIF regime more attractive. The review of the ELTIF Regulation by the EU Commission includes changes to ELTIF fund rules and barriers for the entry of retail/professional investors. In particular, the changes are related to:
- extension of the scope of eligible assets, such as: eligible real assets, exposure to securitizations and investment in target funds;
- possibility for ELTIFs to be structured as master-feeder funds, to make minority co-investment or for an ELTIF manager, its affiliated entities and staff to invest in this ELTIF;
Amongst other changes to the fund rules that means:
- for retail ELTIFs:
decrease of minimum investment in eligible assets to 60%, and
increase of investments in a single real asset, in a single ELTIF, EuvECAs, EuSEFs, UCITS or EU AIFs or in instruments issued by or loans granted to a single qualifying portfolio undertaking to 20%, aggregate value of investments in ELTIF, EuvECAs, EuSEFs, UCITS or EU AIFs 40%; concerning the diversification requirements: increase of the concentration on a single ELTIF, EuvECAs, EuSEFs, UCITS or EU AIF to 30%
- for professional ELTIFs:
decrease of minimum investment in eligible assets to 60%, and
no limits concerning abovementioned limits for retail ELTIFs
In addition, the borrowing limit will be increased to 50% for retail ELTIFs and 100% to professional ELTIFs and the encumbrance limit of 30% will be removed (retail and professional ELTIFs) introducing a clarification that borrowing fully secured by investors’ capital commitments shall not constitute borrowing.
- Removal of 10,000 minimum investment threshold and removal of the maximum 10% aggregate threshold requirements;
- Suitability assessment aligned with MiFID II rules;
- Ease of selective fund rules for ELTIFs distributed to professional investors only.
ESMA updates its FAQ on UCITS
ESMA updated its FAQ on UCITS on December 2021 and added a question on notification requirements for a new share class of a UCITS already notified for cross-border marketing. ESMA states that in this case, the UCITS should give written notice to the NCA of both the UCITS home and host Member State, at least one month before the marketing of the new share class starts.
6. Fee rebates
New ESMA/EU position
The EU Commission answered a question on fee rebate arrangements added by ESMA in its FAQ on UCITS in November 2021 (in accordance with Article 16b (5) of the ESMA Regulation), and more specifically whether ESMA/EU Commission agree that:
- restrictions under Article 29 of the EU Commission Directive 2010/43/EU shall not be applicable to a rebate arrangement, if management companies pay these rebates from their own resources (payment vis-à-vis an individual investor); and
- management companies may pay fees from their own resources to separate investors (e.g. by concluding side letters with institutional investors, which buy investment fund units on behalf of their clients).
According to the EU Commission, because management fee discount arrangements entail payments to certain investors based on the fees charged by the UCITS IFMs to remunerate investment management and/or administration activities, they should be analysed as payments for the activity of the investment management and administration of the UCITS. This means that they should fall within the scope of the UCITS inducement rules. Upon national competent authorities’ request, UCITS IFMs should be able to provide accurate and documented justifications.
7. ESAP project
Proposal for a new EU regulation
The EU Commission has published proposals for a new EU regulation to establish a European Single Access Point (“ESAP“) to “improve public access to entities’ financial and non-financial information”, which might be helpful to financial services firms (in providing centralised access to some useful information), but will also impose new compliance obligations to submit information to the ESAP.
The purpose of this new project is to provide an easy centralised point of access to information about financial services, capital markets and sustainability, that entities and competent authorities are required to make public, which would be collected by designated “collection bodies”. The collection bodies will then make the information available to ESAP in automated ways through a single application programming interface. The information will have to be submitted to the collection body in a data extractable format or in a machine-readable format simultaneously to its publication.
The Annex to the proposed ESAP Regulation sets out a list of EU Regulations and Directives in scope of the ESAP, which will need to be amended as well in order to integrate the ESAP requirements, which basically covers any information, document and report that is “made public“ under EU law by an entity (including issuers of securities, auditors, funds and fund managers, insurance companies, companies, institutions, investment firms, or credit institutions, as applicable) but also information relevant to financial services and capital markets that is made public on a voluntary basis by any EU entity.
The EU Commission adopted the proposals on 25 November 2021. As per the EU’s ordinary legislative procedure, the European Parliament and the Council will negotiate a final legislative text on the basis of the proposals. The average length of the ordinary legislative procedure is around 18 months. The proposals envisage the first submissions to ESAP being phased-in between 2024 and 2026.
ESMA’s expectations on tied agents
On 2 February 2022, ESMA published a supervisory briefing setting out ESMA’s and NCA’s supervisory expectations under the MiFID II framework for firms that use tied agents, especially:
- when firms appoint tied agents; and
- on firms using tied agents in their on-going activities.
This briefing is likely to impact third country firms currently using a tied agent model as part of their EU operations, including UK firms currently operating in the EU via a third party tied agent platform.
According to Article 4(29) of MiFID II, a tied agent is a natural or legal person who, under the full and unconditional responsibility of only one firm on whose behalf the tied agent acts, “promotes investment and/or ancillary services to clients or prospective clients, receives and transmits instructions or orders from the client in respect of investment services or financial instruments, places financial instruments or provides advice to clients or prospective clients in respect of those financial instruments or services”.
ESMA provides, via this briefing, general guidance on how to comply with the MiFID II provisions relating to tied agents, with specific focus on cases where these agents are legal persons and cases where they are controlled by or have close links to other entities, including third-country entities.
For third-country entities, ESMA expressly states that further to the Brexit, firms’ behaviour has been monitored to understand whether their interaction with EU-based clients is done in a way that is compliant with the MiFIR and MiFID legislation (including the regimes providing the conditions for third-country firms to provide investment services and activities in the EU) and observed that “some practices concerning investment firms using tied agents recently emerged as a potential source of circumvention of the abovementioned legal framework”.
For ESMA, firms “should avoid appointing a tied agent which is a legal person and whose employees involved in the provision of the activities on behalf of the firm (e.g., sale staff) are also at the disposal or under the control of other entities, including third-country entities” because other “entities could exercise inappropriate influence over the way in which a tied agent carries out the activities on behalf of the firm or may prevent the firm from effectively monitoring the activities of their tied agent“, for example, instances where the tied agent is a legal person and is owned, controlled or has close links with a third-country entity that is itself involved in activities concerning for example establishing, managing and/or marketing investment funds.
ESMA also sees a potential exercise of inappropriate influence in instances where sales staff employed by a third country firm (without appropriate substance) are involved in the provision of the activities carried out by a tied agent as a result of arrangements with that third country firm “such as staff sharing agreements or secondment.”
ESMA goes on to say that it believes that allowing a tied agent to carry out activities on behalf of an EU-firm by mainly using the resources of another entity, especially a third-country entity, constitutes a “serious impediment to the [EU-] firm’s compliance with the duty of the firm to monitor the activities of its tied agents so as to ensure that they continue to comply with MiFID II when acting through tied agents”.
This is the reason why, ESMA expects that “tied agents have sufficient substance in the EU and do not mainly rely on resources based outside of the EU in the provision of activities on behalf of the appointing firm“.
In the case of the former, existing tied agent entities (more specifically, those which have been set up on a third-party tied agent platform) might need to be re-examined by their principal firms, particularly with regards to their current operations and substance in the EU. The main focus will likely be around substance requirements, given that ESMA raises questions about the viability of “dual-hatting” or secondment arrangements.
For EU firms contemplating appointing a tied agent, it might be the case that the supervisory bodies will be more focused on these appointments going forward and EU firms will need to be able to show a clear understanding of the model and the related regulatory requirements.
9. Markets in Crypto-assets Regulation
Upcoming EU Regulation
On 14 March 2022, the European Parliament’s Economic and Monetary Affairs Committee (the ‘Committee’) adopted the draft Markets in Crypto-assets Regulation (‘MiCA’), aiming to regulate the crypto-markets and promising an easier and uniform regime for crypto firms to expand their EU-reach by facilitating a ‘passportable’ license that would be valid on EU territory.
The main approved provisions relate to transparency, communication, authorization and control of operations.
As such, MiCA includes three main pillars:
- uniform legal framework for crypto-assets;
- consumer protection and safeguarding against market manipulation and financial crime;
- inclusion of crypto-assets mining within the EU taxonomy for sustainable activities.
Environmental and sustainability considerations occupied a prominent place in the Committee’s decision process and going forward will continue to play a major role in the development of the crypto-regulatory framework, especially within the ESG context.
As such, one of the main concerns of the European Parliament related to the significant environmental impact linked to the activity of crypto-currencies. More specifically, the mechanisms used for the validation of transactions in crypto-assets, in particular the mechanism of ‘proof-of-work’, are considered to have a significant environmental impact resulting in high carbon footprint and generation of electronic waste.
The Committee has finally agreed to leave out the initially proposed and controversial limitation on the use of crypto-currencies that rely on the proof-of-work mecanism, and which, if approved, would have banned the use of bitcoin across the EU.
Instead, the Committee chose an alternative approach and called for the European Commission to draft a new legislative proposal by 1 January 2025, for setting-out in the EU Taxonomy a classification system for crypto-asset mining activities that contribute substantially to climate change.
Finally, the expected supervision framework has been clarified. Firstly, MiCA made a differenciation between crypto assets in general, ARTs – asset referenced tokens/stable coins, and electronic money tokens primarily used for payments. The European Parliament proposed that European Securities and Markets Authority (ESMA) shall supervise the issuance of ARTs, and the European Banking Authority (EBA) shall supervise the e-money tokens.
The MiCA draft will now move on to further negotiations with EU governing bodies.
For the moment there is no information available on an expected date of coming into force of the Regulation.
 ESAs issue updated supervisory statement on the application of the Sustainable Finance Disclosure Regulation (europa.eu)
 Announcement on the application of Regulation (EU) 2019/2088 on the sustainability-related disclosures in the financial services sector and on the taxonomy-alignment related product disclosures of Regulation (EU) 2020/852 – CSSF
 EU Commission Delegated Regulation (EU) 2021/2178
 COM(2022) 71 final
 On 28 May 2018, the European Securities and Markets Authority (“ESMA”) published its final report on updated guidelines on certain aspects of the MiFID II suitability requirements (ESMA35-43-869, the “2018 Guidelines”).
 EU Commission Directive 2010/43/EU of 1 July 2010 implementing Directive 2009/65/EC of the European Parliament and of theCouncil as regards organisational requirements, conflicts of interest, conduct of business, risk management and content of the agreement between a depositary and a management company (OJ L 176, 10.7.2010, p. 42).
1. Ukraine Crisis
CSSF FAQ on the application of Liquidity Management Tools by UCITS and AIFs
On 31 March 2022, the CSSF published a FAQ on the use by investment funds of liquidity management tools (“LMTs”), addressing certain issues with Russian and Belarussian assets that have become illiquid or non-tradeable due to the Ukraine crisis and the sanctions imposed by the EU and other countries. In more detail, the FAQ provides guidance to the governing bodies of investment funds on the evaluation of a fund’s specific circumstances and the alternatives available by segregation of assets (side-pocketing) in addition to other LMTs like swing pricing.
The FAQ mainly relates to the application of possible LMTs by UCITS, but the CSSF indicates that theses LMTs might also be applied by AIFs.
The following elements (non-exhaustive list) should be considered when deciding about the application of temporary or more structural measures for the respective fund(s):
- Provisions of the fund documentation (prospectus, articles of incorporation, management regulation)
- The fund’s investment policy and strategy
- The overall exposure to illiquid/non-tradeable assets in absolute size and in relation to total net assets.
- Any restrictions due to the current sanction’s regime.
The CSSF points out that a distinction has to be made to determine appropriate LMTs between (i) funds having a limited exposure to illiquid assets, which allows the funds to continue their operations in accordance with current investment objectives and in compliance with the investment policy and (ii) funds having a higher exposure to such illiquid assets, which may cause problems for the investment and liquidity management of the funds.
Funds with a limited exposure are expected to use more straightforward and temporary options to deal with the situation, including fair valuation adjustments of the affected assets and a possible suspension of the subscriptions into the impacted fund.
For funds with a higher exposure to illiquid assets, the CSSF expects the governing body to immediately suspend the fund for protecting the interests of the investors, then as a second step (after having duly established a continuing structural issue regarding the liquidity of affected assets for the fund) to apply one of the segregation options listed below, depending on the exposure to the illiquid assets, or, as a last resort, to put the fund into liquidation.
Segregation options available to funds
According to the CSSF, the following segregation options could be considered, without prejudice of any other options that could be assessed by the CSSF on a case-by-case basis:
Accounting segregation of the illiquid assets of the impacted sub-fund/fund by allocating the illiquid assets to a new closed-ended share class created within the same sub-fund/fund, with the aim of realising the illiquid assets in the best interest of the investors.
Split of the impacted sub-fund/fund in two sub-funds/funds, the initial sub-fund/fund retaining the illiquid assets, and the liquid assets being transferred to a new (UCITS compliant) sub-fund/fund to be created. Existing investors would be invested in both funds/sub-funds in a proportionate manner.
Split of the impacted sub-fund/fund into two sub-funds/funds in reverse of Option 2, meaning in this case that the initial sub-fund/fund would retain the liquid assets and the illiquid assets would be transferred to a sub-fund/fund newly created that would immediately be put into liquidation.
Option 1 seems to be the preferred and most straight forward one.
If the option chosen involves a transfer of sanctioned assets, we recommend that you liaise with your legal advisor in order to assess whether a potential transfer of those assets complies with the applicable sanctions regime.
Prior to any decision for a specific option, the governing body is required to conduct a thorough analyse and must be able to demonstrate that the selected option is the best possible solution.
The implementation requires prior approval from the CSSF.
Investors must be informed of the selected option.
2. Marketing communications
CSSF Circular 22/795
On 31 January 2022, the CSSF issued the Circular 22/795 on the application of the Guidelines of the European Securities and Market Authority (ESMA) on marketing communications under Regulation (EU) 2019/1156 on facilitating cross-border distribution of collective investment undertakings (the “CBDF Regulation“) which became applicable as of 2 February 2022.
This Circular confirms that the CSSF has integrated the ESMA Guidelines on marketing communications into its administrative practices and regulatory approach.
All entities issuing the marketing communications are expected to comply with ESMA’s Guidelines and they shall assess, on the basis of the examples mentioned in the Guidelines, whether or not a certain message or communication addressed to investors or potential investors qualifies as “marketing communication”.
The CSSF intends to perform testing to verify compliance with the applicable requirements under Article 4 of the CBDF Regulation and the related ESMA Guidelines. Practical and/or technical aspects of the implementation of the collection of relevant information (if any) will be communicated by means of additional Annexes to the Circular and supplemented by a FAQ.
3. ATAD 3
Relevance and impact on the fund industry in Luxembourg
Further to point 2 of the above European Developments section on ATAD 3, it is relevant to note the potential impact of this new Directive on the fund industry in Luxemburg.
Investment platforms used by asset managers that use outsourcing and do not have qualified and independent decision makers on the ground could be particularly impacted by the draft Directive. On the other hand, investment and fund structures should anticipate the impact of the proposed ATAD 3 Directive, and potentially proceed to an evaluation of their existing structures already in 2022, as the gateway criteria established by the Directive will be assessed based on the information available during the two years preceding the reporting year.
4. Covered bond reform
New Luxembourg Law
The Directive (EU) 2019/2162 on the issue of covered bonds and covered bonds public supervision (“Covered Bonds Directive“) has been transposed into Luxembourg legislation by the law of 8 December 2021 amending inter alia the provision of the UCITS Law on the single issuer limit applicable to UCITS.
Previously, article 43 of the UCITS Law allowed Luxembourg UCITS to raise the general 10% single issuer limit up to 25% when they invest their assets in certain covered bonds issued by the same issuer.
According to the new law of 8 December 2021, the benefit of the 25% single issuer limit will be limited in the future to UCITS investing in the following covered bonds:
- bonds falling under the definition of covered bonds provided for by the Covered Bonds Directive; and
- certain bonds (including mortgage bonds) that have been issued before 8 July 2022 and meet the previous requirements set out in Article 43(4) of the UCITS Law on their issuance date, i.e. bonds that have been issued by a credit institution which has its registered office in a Member State and is subject by law, to special public supervision designed to protect bondholders.
In this case, these bonds may continue to be referred to as covered bonds in accordance with the Covered Bond Directive and to remain invested by Luxembourg UCITS under the benefit of the 25% single issuer limit until their maturity.
The new regime will apply as of 8 July 2022.
CSSF Press release on the updated ESAs supervisory statement on SFDR
On 1 April 2022, the CSSF published a press release encouraging financial market participants and financial advisers to use the draft RTS on the content, methodologies and presentation of sustainability-related disclosures as a reference for the purposes of applying the provisions of art. 2a, 4, 8, 9, 10 and 11 of the SFDR and art. 5 and 6 of the TR in the interim period until RTS are applicable (i.e. 1 January 2023)..
6. Tax update on Real Estate Levy (impact on RAIF, SIF, UCI Part II)
New Tax Circular
On 20 January 2022, the Luxembourg tax authorities published Circular PRE IMM n°1 on the real estate levy for certain “non-transparent” Luxembourg investment funds holding Luxembourg real estate, and clarifying the related filing obligations.
As such, the tax concerns certain RAIF, SIF and UCI Part II vehicles with a legal personality distinct from their shareholders (excluding those incorporated as a SCS) (the “In-scope Entities“) and owning – directly or indirectly – Luxembourg real estate assets.
The real estate tax levy of 20% (“REL“) is applicable effectively from 1 January 2021 on the following incomes:
- all income from real estate assets located in Luxembourg (i.e. income from rental or capital gains from the alienation of real estate assets located in Luxembourg); and
- income received or realized directly from the real estate asset located in Luxembourg or indirectly through any interposed tax transparent entity such as a Luxembourg SCSs, SCSps, SNCs, etc. or FCPs.
The total amount subject to the REL and the amount of tax for (received or realized) qualifying income shall be declared via the Luxembourg platform MyGuichet, at the latest by the 31 May of the year following the calendar year in which the qualifying income derives from (e.g. by 31 May 2022 in respect of any 2021-qualifying income).
The REL must be paid before 10 June of the following year. It is not deductible for determining the taxable real estate income and it cannot be deducted / credited by a corporate or individual investor.
In addition, the Circular clarifies that all In-scope Entities must file an additional declaration for the years 2020 and 2021, notifying Luxembourg tax authorities whether or not they held or hold, directly or indirectly, Luxembourg real estate assets. Moreover, In-scope Entities which changed their legal form during 2020 or 2021, to the extent such entities owned directly or indirectly at least one Luxembourg real estate at the time of its transformation, shall notify Luxembourg the tax authorities.
The penalty for failing to provide the requested information can go up to €10.000 for default or late filling.
In line with our specific client communication, we advise all clients with an in-scope RAIF, SIF or UCI Part II vehicle to prepare and file the necessary declaration to the Luxembourg tax authorities by latest 31 May 2022.
7. Common Supervisory Action on UCITS and open-ended AIFs across the EU
CSSF Press release
On 24 January 2022, CSSF issued a press release to launch the ESMA Common Supervisory Action (“CSA“) that was initiated by ESMA on 20 January 2022 on valuation of UCITS and open-ended AIFs with NCAs across the EU (“CSA on valuation“).
The aim of the CSA is to assess compliance of supervised entities with the relevant valuation-related provisions in the UCITS and AIFMD frameworks, in particular the valuation of less liquid assets (e.g. unlisted equities, unrated bonds, corporate debt, real estate, high yield bonds, emerging markets, listed equities that are not actively traded, bank loans). The CSA will be conducted throughout 2022 and is intended to achieve a greater convergence in the approach of NCAs to the supervision of valuation-related issues.
The first phase of the CSA has been launched in March 2022, by asking a selection of Luxembourg-based authorised investment fund managers (“IFMs“) of UCITS and open-ended AIFs and a limited number of EU IFMs managing Luxembourg UCITS and AIFs to complete a dedicated questionnaire for all UCITS and AIFs managed.
8. Transparency Law and Market Abuse Regulation
New CSSF Platform
On 4 March 2022, the CSSF published a Communication on the launch of eRIIS, which is the new CSSF web platform for entities subject to the Transparency Law and the Market Abuse Regulation.
This new application replaces the current CSSF filing process via email for the major legal filing requirements applicable to the following two types of persons:
- issuers of securities, and
- holders of securities (for notifications of major holdings and for notifications of persons discharging managerial responsibilities within an issuer).
In addition, eRIIS will also be used:
- as main communication channel between these persons or entities and the CSSF;
- to follow-up on regulatory filings, notably by consulting various dashboards and tracking the status of individual filings,
- to file and validate annual financial reports drawn up under the new ESEF format;
- to manage the reporting entities’ data while at the same time offering the possibility of delegating administrative tasks to third parties by defining various levels of access rights for different users.
Practical information: A LuxTrust certificate is required to access the eRIIS platform and get an eRIIS user account. A page dedicated to eRIIS has been added on the CSSF website which contains an FAQ document, User Guides as well as other useful information. Finally, the Circulars CSSF 08/337 and CSSF 08/349 have also been updated accordingly.
Transition period: While the CSSF encourages all persons concerned to use eRIIS as soon as possible, filings per email will be tolerated until 30 May 2022 to allow sufficient time to complete all administrative tasks necessary for accessing eRIIS.
9. CSSF/CAA’s sanctions power related to SFDR and TR
New Luxembourg Implementing Law
The new Luxembourg law of 25 February 2022 implementing inter alia the SFDR and the TR sets out and clarifies the CSSF and CAA’s supervisory and investigation powers concerning financial market participants and financial advisers under their supervision in relation to the control of the implementation of the SFDR and the TR, as well as their administrative sanctioning powers in case of non-compliance by in-scope firms.
This new law confirms that the CSSF and the CAA are the competent authorities responsible in Luxembourg for the supervision of the proper implementation of the SFDR and the TR by all financial market participants and financial advisers, and they may, among other:
- access and request any document or data in any form;
- require financial market participants or financial advisers to provide information without delay or from any person connected to their business;
- carry out on-site inspections of the persons subject to their respective supervision;
- take appropriate measures to ensure that financial market participants and financial advisers continue to comply with the provisions of the SFDR, the TR and the measures taken to implement them;
- order financial market participants and financial advisers to comply with the provisions of the SFDR, the TR and their implementing measures, and to refrain from repeating any conduct that constitutes a breach of those provisions;
- order financial market participants and financial advisers to publish information required to be published under the SFDR and the TR on their website, in pre-contractual information or in periodic reports, or to amend or remove published false or misleading information in order to bring it into conformity with the criteria laid down in the SFDR and TR, and the measures taken to implement them, and to require the publication of a corrective statement;
- communicate information to the State Prosecutor for criminal prosecution;
- instruct approved statutory auditors (réviseurs d’entreprises agréés) or experts to carry out audits or investigations.
In case a breach of SFDR/TR obligations, the CSSF and the CAA are empowered to pronounce against the firms/persons subject to their respective supervision, against the members of their management bodies, and/or against any other person responsible for a breach:
- a public statement specifying the identity of the person responsible and the nature of the violation; and/or
- a temporary prohibition of a person exercising managerial functions or of any natural person responsible for such a violation from exercising managerial functions; and/or
- an administrative fine of between EUR 250 and EUR 250,000.
10. New securitisation regime
Reform in the Luxembourg legislation
On 8 March 2022, another new Luxembourg law, the law of 25 February 2022, entered into force bringing about long-awaited reform of the Luxembourg’s securitisation regime by clarifying certain aspects of the law dated 22 March 2004 on securitisation (the “2004 Law”) as well as adapting the 2004 Law to the requirements of the current securitisation market (the “Reform“).
The purpose of this Reform is to increase the appeal of Luxembourg securitisation vehicles and to bring new opportunities for the Luxembourg financial services industry.
- additional financing options: prior to the Reform, a Luxembourg securitisation vehicle (a “SV“) had to finance the acquisition of the risks that it intended to securitise by issuing securities. In principle the SV could not make use of other sources of financing, such as entering into a traditional loan agreement that was not structured as a debt security.
Now SVs are allowed to finance, partially or totally, their activities by entering into contractual types of borrowing (for example, borrowing by way of a loan agreement) and the term “securities” has been replaced by “financial instruments”, which is, unlike the previous term, clearly defined under the Luxembourg law of 5 August 2005 on financial collateral arrangements.
In addition, to extend the scope of means by which a SV can finance its securitisation activities, it also aligns the Luxembourg regime with the European Securitisation Regulation by ensuring that any securitisation transaction subject to such EU Regulation can be performed by and through Luxembourg SVs (including securitisations resulting from entering into loan agreements).
- active management of debt portfolios: the Reform allows SVs to actively manage, directly or indirectly through a third-party manager, a portfolio of assets consisting of debt financial instruments or claims, provided that their acquisition is not financed by the issuance of financial instruments to the public.
- clarification of the criteria for SVs to be approved by the CSSF: for receiving the CSSF’s authorisation to issue securities on a continuous basis, the SVs must fulfil conditions which were clarified by adding the below definitions:
- “offering financial instruments on a continuous basis” means to the public more than three times during the course of one financial year, taking into consideration the total number of issuances by all compartments of the SV;
- “offered to the public” means:
- it is not reserved to professional clients;
- the nominal value of the financial instruments is lower than EUR 100,000; and
- it is not distributed by means of a private placement.
- increased flexibility to grant security interests: SVs are now allowed to grant security interests over their assets in order to cover obligations relating to the securitisation transaction.
- subordination: a set of rules has been included to clarify the ranking between the claims that holders of instruments issued by an SV may have against the SV. Although these rules apply by default, they may be overridden by specific contractual arrangements between the parties to the securitisation transaction.
- more flexibility as to the legal form of the SV: securitisation companies can now be set up as common limited partnerships (sociétés en commandite simples/SCS), special limited partnerships (sociétés en commandite spéciales/SCSp), simplified limited liability companies (sociétés par actions simplifiées) or general partnerships (sociétés en nom collectif/SNC).
- accounting requirements: the Reform now provides that an SV that is set up as an SCS, SCSp or SNC (which are legal forms that are in principle subject to less strict accounting requirements) is subject to the same obligations in terms of accounting preparation and publication as an SV that is set up as an SA or a Sàrl. In addition, when a compartment is financed by the issue of shares, it is possible to have the accounts prepared at the level of the compartment and such accounts need to be approved by solely the shareholders of that compartment.