European Regulatory Update – June 2021

Latest developments at a European level

1. SFDR
ESAs publications on Level 2

On February 2021, the three European Supervisory Authorities (EBA, EIOPA and ESMA – the “ESAs”) published two documents to complete the content, methodologies and presentation of sustainability-related disclosures under Regulation (EU) 2019/2088 on sustainability-risk disclosures in the financial services sector (“SFDR”).

1. The first document is the Final Report on draft Regulatory Technical Standards (“RTS”) on SFDR and provides proposals to amend the RTS as follows:

i. Inclusion of certain rules on the information to be provided at entity-level (e.g. management company, AIFM, asset manager) on the consideration of principal adverse impacts (PAI) that investment decisions may have on sustainability factors. The ESAs have updated the list of indicators for PAI

ii. Requiring information to be provided at product-level (i.e. the fund) on:

• the environmental and social characteristics referred to in Article 8 of SFDR, and
• the sustainable objectives referred to in Article 9 of SFDR.

Mandatory templates for both pre-contractual and periodic information are provided in Annexes II to V to the RTS.
The proposed effective application date for the RTS is 1 January 2022.

2. The second document is the Joint Supervisory Statement on the application of SFDR, in which the ESAs recommend National Competent Authorities (“NCAs”) to encourage financial market participants and financial advisers to use the interim period from 10 March 2021 until 1 January 2022 to prepare for the application of the RTS.

The annex includes a summary table of the relevant application dates of SFDR, of the Regulation (EU) 2020/852 (the “Taxonomy Regulation”) and of the RTS.

Consultation of the ESAs on taxonomy-related sustainability disclosures

On 17 March 2021, a consultation was also published by the ESAs, which aims at integrating in the RTS certain taxonomy-related sustainability disclosures.

In this consultation, the ESAs propose a consolidated draft RTS which aims to:

• facilitate disclosures to end investors regarding the investments of financial products in environmentally sustainable activities, and
• create a single rulebook for sustainability disclosures under the SFDR and the Taxonomy Regulation. This should be done by amending the draft RTS under the SFDR, to minimize overlapping or duplicative requirements between the two regulations.

The ESAs foresee difficulties in the implementation as the two RTSs will come into force at different times and the templates implemented from the first RTS would have to be changed when the second RTS becomes applicable. ESAs therefore recommend to have provided an implementation period of at least six months in terms of the mandatory use of the templates. Assuming that the final RTS will not be published until Autumn 2021, it is expected that full compliance with the first obligations in January 2022 might prove unrealistic.

It would be advisable to already consider and anticipate the requirements that will apply to financial products which do or contemplate to do environmentally sustainable investments.

2. Performance fee
Reminder on the effective date of the ESMA Guidelines

As mentioned in our Regulatory Newsletter dated February 2021, we would like to remind you that the guidelines published by the ESMA on performance fees in UCITS and certain AIFs (the “ESMA Guidelines”) became applicable on 6 January 2021, as confirmed in Luxembourg by the CSSF Circular 20/764 on the integration of those ESMA Guidelines into its administrative practices and regulatory approach.

As previously mentioned, the ESMA Guidelines apply in connection to both UCITS and AIFs marketing their units to retail investors in the EU Member States. Closed-ended AIFs and open-ended AIFs which are either EuVECAs (or other types of venture capital AIFs), EuSEFs, private equity AIFs or real estate AIFs are out of scope of these PF Guidelines.

You will find below a reminder on the different effective dates to comply with the ESMA Guidelines:

1. Immediate effect as of 6 January 2021 for:
a. any new funds and classes of shares created after the date of application, or
b. any funds and classes of shares existing before the date of application that introduce a performance fee for the first time after that date.

2. At the latest beginning of the financial year following 6 months from the date of application of the ESMA Guidelines (i.e. as of 6 July 2021) for the funds with a performance fee existing before the date of application of the ESMA Guidelines. For investment funds with a financial year ending December the new performance fee requirements must be disclosed and as the case may be implemented by beginning of January 2022.

3. Supervision of costs and fees
ESMA’s common supervisory action

On 6 January 2021, ESMA launched a common supervisory action (“CSA“) with NCAs on the supervision of costs and fees of UCITS. This follows and takes into account the Supervisory Briefing on the supervision of costs published by ESMA in June 2020.

The aim of the CSA is:

• to assess the compliance of supervised entities with the relevant cost-related provisions in the UCITS framework and the obligation of not charging investors undue costs, and
• to assess whether entities employing Efficient Portfolio Management (EPM) techniques adhere to the requirements set out in the UCITS framework and ESMA guidelines on ETFs and other UCITS issues.

In this context, in a communication dated 5 March 2021, the CSSF indicated that the first phase of the CSA will consist of asking a sample of Luxembourg-based UCITS management companies to complete a dedicated questionnaire for all UCITS managed (Luxembourg and foreign-domiciled UCITS).

As a reminder, in the Supervisory Briefing on the supervision of costs published in June 2020, ESMA stated that NCAs should:

• require that UCITS management companies develop and periodically review a structured pricing process addressing certain specific aspects/elements listed in point 19 of the Supervisory Briefing, and
• incorporate the review of the IFMs’ pricing processes in their activity at different stages and in case of materialisation of undue costs charged to investors, NCAs should assess the possibility to request different actions including (but not limited to) investor compensation (where allowed under national provisions) or reduction of fees.

4.Cross-Border Distribution Directive and Regulation
New pre-marketing regime

As mentioned in our Regulatory Newsletter dated June 2019, the European Parliament voted in 2019 a legislative proposal to amend the existing legal framework for the cross-border distribution of AIFs and UCITS in the EU, with the aim to reduce the regulatory barriers that currently restrict such cross-border distribution.

The Directive (EU) 2019/1160 (the “Cross-Border Directive”) and Regulation (EU) 2019/1156 (the “Cross-Border Regulation”) on facilitating cross-border distribution of collective investment funds, came into force on 1 August 2019, with EU Member States required to implement the rules into national law by 2 August 2021.

Key changes

• New harmonised ‘pre-marketing’ regime under AIFMD across all EU Member States
• Distributors/placement agents carrying out pre-marketing must be EU regulated firms or tied agents, and will be directly subject to the new pre-marketing rules
• Signs that the EU authorities are focusing on reverse solicitation
• New marketing de-notification procedures for UCITS and AIFs, including restrictions on the pre-marketing of successor AIFs
• Aligned standards for marketing communications of UCITS and AIFs
• Changes to the notifications for marketing passports
• New facilities requirements for UCITS/AIF retail investors in the host EU Member States
• Increased power of ESMA to monitor the investment funds and their marketing procedures.

Specific remarks on the pre-marketing regime

The pre-marketing regime will initially apply only for AIFMs as of 2 August 2021. The European Commission will assess by 2 August 2023 whether these requirements should be extended to UCITS.

Pre-marketing will not be allowed if the information presented to the potential investors:

• is sufficient to permit investors to commit acquiring units or shares of a particular AIF
• amounts to subscription forms or similar documents in a draft or final form; or
• amounts to constitutional documents or offering documents in final form of an AIF that has not yet been established.

It is important to note that placement agents/distributors will be able to provide a draft offering document to potential investors, provided that:

• it does not ‘contain information sufficient to allow investors to take an investment decision’. In practice, this will depend in fine on the specific implementation in each EU Member State; and
• it explicitly provides that it is not an offer or invitation to subscribe, with a warning that information therein should not be relied upon because it is incomplete and may be subject to changes.

Any third party performing pre-marketing will need to be authorised as an investment firm or a tied agent as under the MiFID II regime, a credit institution or a management company. It is not excluded that certain EU Member States will chose “gold-plating” the rules by requiring a MiFID license.

Specific remarks on reverse solicitation

The new pre-marketing regime will have a direct impact on reverse solicitation. Commencing any pre-marketing activity will preclude reliance on reverse solicitation for a period of 18 months. Consequently, none of the investors who have been contacted during the pre-marketing stage can benefit from reverse solicitation.

Finally, any non-compliance with the provisions of the Cross-Border Directive and Cross-Border Regulation will be listed in the ESMA’s database and will be accessible to public.

Specific remarks on marketing communications

A notable change to the current rules is that the Regulation is imposing the application of similar standards of marketing information provided to investors for both UCITS and AIFs.

It shall be ensured that all marketing communications to investors:

• (1) are clearly identifiable as such, and
• (2) describe the risks and rewards of purchasing units/shares in an equally prominent manner. Such information should be provided in a “fair, clear and non-misleading language”.

The information provided shall be aligned with all other legal documentation; there shall not be any contradiction (or diminishing of significance of information) between the marketing communications.

The information must be provided in the EU Member States’ official language, as per the ESMA guidelines. ESMA has also provided guidance on what is to be considered as fair, clear and non-misleading language, including further information on risks and rewards, costs, past and expected future performance. Finally, ESMA provides clear information how the above mentioned aspects should be addressed in marketing materials in the best interest of the investor.

Marketing communications will also have to specify where, how, and in which language investors/potential investors can obtain a summary of investor rights, and shall provide a hyperlink to such a summary which must include, as appropriate, information on access to collective redress mechanisms at EU and national level in the event of litigation.

Competent authorities will be able to require prior notification of marketing communications used where the funds are marketed to retail investors. However this requirement for prior notification does not amount to a prior condition for marketing. The competent authority will have 10 working days following receipt of notification to request the amendment of the marketing communications.

5. DAC 7
Amendment of DAC 6

The European Council approved on 22 March 2021 the sixth amendment to the Directive 2011/16/EU on administration cooperation in the field of taxation (“DAC7”).

DAC 7 is extending the existing EU tax transparency rules to digital platforms. The platform operators are required to report information on the income earned by sellers on their platform and the EU Member States must automatically exchange this information. The objective of this amendment is to enable tax authorities to identify the income earned by sellers through digital platforms and determine the relevant tax obligations.

In addition, this amendment should improve the exchange of information (such as information on groups of taxpayers) between the EU Member States’ tax authorities, introduce royalties in the categories of income subject to mandatory automatic exchange of information, improve the rules for carrying out simultaneous controls and provide a common framework to conduct joint audits.

To note that these rules will only apply as of 1 January 2023 and the new framework on joint audits as of 1 January 2024.

6. MIFID II/MIFIR
ESMA updates Q&A on inducements

ESMA published on 29 March 2021 an update of the Q&A on MiFID II and MiFIR investor protection and intermediaries’ topics.

This update concerns one of the conditions under which an inducement can be considered as designed to enhance the quality of the relevant service to the client, which states that the inducement is justified by the provision of an additional or higher-level service to the relevant client, proportional to the level of inducements received (article 11(2)(a) of the MiFID II Delegated Directive (EU) 2017/593).

ESMA highlights in its Q&A that the assessment whether a particular quality enhancement complies with the said elements is ultimately to be performed on a case-by-case basis. Nonetheless, ESMA provides some guidance in the updated Q&A to ensure a consistent approach in the application of the requirements.

7. EMIR
ESMA Q&A on the implementation of EMIR

On 31 March 2021, ESMA published a Q&A on the implementation of the Regulation (EU) No 648/2012 on OTC derivatives, central counterparties and trade repositories (“EMIR”) to promote common supervisory approaches and practices in the application of EMIR. The Q&A provides responses to questions posed by the general public, market participants and competent authorities in relation to the practical application of EMIR.

Luxembourg regulatory developments

1. Use of securities financing transactions
New CSSF FAQ

The CSSF published an FAQ on 18 December 2020 (“FAQ”) on the use of the following securities financing transactions (“SFTs”) by UCITS (i.e. securities lending transactions, reverse repurchase agreement transactions, repurchase agreement transactions, buy/sell-back and sell/buy-back transactions), with purpose to bring further clarification concerning the use by UCITS of these SFTs, taking into consideration the applicable regulatory framework as well as the supervisory experienced gained by the CSSF over the last years.

The disclosure clarifications mainly refer to the pre-contractual information to be given to investors in accordance with Article 14 of the Securities financing Transaction Regulation (EU) 2015/2365 (“SFTR”) and Section B of the Annex to SFTR (i.e. in the prospectus for UCITS and in the disclosure to investors for AIFs, Part II UCIs and SIFs), such as:

• risks incurred by the use of SFTs and information on the potential impacts of those risks
• disclosures related to costs/fees
• potential material conflicts of interest arising from SFTs
• SFTs must be covered in the best execution policy and robust control processes must be in place to ensure that the best possible result as regards securities lending revenues (lending fee) and as regards the costs/fees charged to the related entity.

The CSSF expects the disclosure clarifications provided in the FAQ to be reflected in the prospectuses of UCITS and in the disclosure to investors of AIFs, Part II UCIs and SIFs by 30 September 2021.

2. CSSF Circular 21/770
Amendment of ESMA Guidelines on SFTR

On 13 April 2021, the CSSF published the Circular 21/770 to inform of the amended version of the ESMA Guidelines on the Reporting under Articles 4 and 12 of the SFTR (Ref. ESMA-70-151-2838).
The amendments introduced in the Guidelines relate notably to:

• reporting of collateral for margin lending
• event date vis-à-vis maturity date; and
• other corrections and alignment of paragraphs.

This Circular applied as of 13 April 2021.

3. UCITS Subscription tax related to ESG
Reminder on the coming bill of law for the 2021 budget

As mentioned in our Regulatory Newsletter of February 2021, the bill of law No 7666 for the 2021 budget (the “Bill of Law”) might introduce a new subscription tax rate linked to the percentage of net assets invested in sustainable economic activities as defined in the Taxonomy Regulation by amending article 174 of the UCITS Law.

For the portion of assets which is invested in sustainable economic activities (within the meaning of article 3 of the Taxonomy Regulation), a reduced rate would apply, as follows:

The correct assessment and application of the above mentioned rates will be controlled by the statutory auditor performing the audit of the fund and the amount of assets benefitting from a reduced rate and the relevant percentages must be published in the fund’s annual report and prospectus in line with both the Taxonomy Regulation as well as SFDR.

As an alternative to the fund’s statutory auditor performing that task in the course of the regular audit, the fund could obtain a separate ad-hoc assurance report in compliance with international audit norms. The auditor would issue a separate certificate confirming the above, which would be filed with the Luxembourg Indirect Tax Authorities together with the subscription tax return.

4. CSSF Circular 21/769 – Telework New Circular on FATF statement
New requirements applicable from 30 September 2021

On 9 April 2021, the CSSF published the Circular 21/769 on “Governance and security requirements for supervised entities to perform tasks or activities through telework” (the “Telework Circular”).

The Telework Circular will be applicable from 30 September 2021 (except under pandemic situations or in case of other exceptional circumstances having a comparable impact on the general working conditions) to:

• all entities supervised by the CSSF, and
• the branches of the Luxembourg regulated entities located abroad (if telework is authorised in this branches),

(each a “Supervised Entity”).

Key principles

• Supervised Entities will be required to have sufficient staff members at the premises to comply with central administration requirements
• The CSSF approval will not be required for teleworking, it will be the responsibility of the Supervised Entities to assess whether the internal rules comply with the requirements of the Telework Circular
• Supervised Entities shall identify all risks resulting from telework, as well as monitor and mitigate them
• The telework will need to be formalised in the corporate and regulatory framework, in case telework is accepted after the Covid-19 pandemic (e.g. establishing a telework policy, review/update the existing policies and procedures)
• A certain number of IT requirements shall be implemented and applied by the Supervised Entities, such as the requirement to encrypt data stored on device used remotely, to prevent any amendments to the security mechanisms in place and to encrypt the data in transit
• The Telework Circular also recommends Supervised Entities to have their staff use corporate devices (instead of employees’ own devices)

Other aspects have to be taken into consideration when implementing the Telework Circular, such as tax law, professional secrecy, data protection, etc.

This page is intended for information purposes only and should not be construed as, and should not be relied upon for, legal and/or tax advice on any particular set of facts or circumstances. In case of any doubt please contact your lawyer(s) or counsel(s) for advice on specific legal problems.