Further legal and regulatory developments

Social media and influencer – the newest marketing communication under MiFID II

As reminder, MiFID investment firms, in respect of financial promotions and marketing material, are required to give fair and prominent indication of risks when referring any benefit, with details on future performance (positive and negative market conditions) via “fair, clear and not misleading” communication.

In this context, on 16 January 2023, the ESMA launched a common supervisory action (the “CSA”) with the National Competent Authorities (the ”NCAs”) on an extension of the application of MiFID II disclosure rules in respect of marketing communications across the EU.

ESMA is now targeting its CSA on the young generation of investors and the impact of social media influence. Nine years after the introduction of MiFID II and the expansion of new communication, such as social media or influencers’ impact, NCAs will review whether those new communication networks (including advertisement) are fair, clear and not misleading and how investors select the target investment.

NCAs will also take the opportunity of the CSA to collect information concerning potential greenwashing marketing communications.

New CSSF form for critical or important information and communication technology (ICT) outsourcing arrangements

AIFMs must comply with the requirements of CSSF Circular 22/806 issued on 22 April 2022 on outsourcing arrangements (the “Circular”) when performing information and communication technology (“ICT”). This applies to all outsourcing arrangements that were entered into, reviewed, or amended on or after 30June 2022, especially in relation to the notification process as outlined in points 59 and 60 of the Circular.

The CSSF FAQ (the “FAQ”) on outsourcing arrangements indicates that the Circular applies only to authorised AIFMs in relation to any outsourcing or delegation arrangement which falls under the definition of ICT outsourcing meaning an arrangement of any form between the authorised AIFMs and a service provider by which that service provider performs an ICT process, an ICT service or an ICT activity that would otherwise be undertaken by the authorised AIFMs itself.

In addition, on 17 February 2022, the CSSF published the new form (the “Form”) to be completed in the following cases of outsourcing of a critical or important function:

(a) planned, new critical or important outsourcing arrangements;

(b) material changes to existing critical or important outsourcing arrangements; and

The notification must be done at least three months before the planned implementation date of the outsourcing project in the case (a) above; or without undue delay in the cases (b) and (c) above. The CSSF will consider any outsourcing arrangement as being not notified if it has not been notified within the above notification period, if it has been notified within the above notification period but without using this template and these instructions, or if the notification is incomplete.

CSSF liquidity stress testing framework for Luxembourg investment funds

On 9 March 2023, the CSSF issued a working paper introducing a liquidity stress testing framework for Luxembourg investment funds (including AIFs) to assess the preparedness of these investment fund types to potential future elevated redemption pressures, a deterioration in market liquidity conditions and/or increased valuation uncertainty, as well as to evaluate whether enhancements are necessary over a sample of investment funds covering a total net assets of EUR 1.1 trillion with the following findings:

Based on the macroeconomic model 83% of the investment funds can meet the redemption shocks in two days and 96% in five days.
The analysis of the results across investment fund strategies shows that investment funds with high yield bond investment strategies would have longer time to liquidation as only 87% of these investment funds can meet the macro-redemption shock within five days. Some mixed investment funds would also need more than five days, as a result of their larger size. The results also show that, across all sectors, small and middle-size well-diversified investment funds are generally able to liquidate their portfolios more rapidly.

Global debate on macro-prudential oversight of investment funds

On 21 March 2023, ESMA published the speech of its Chair, Ms Verena Ross, given at the 2023 ALFI Conference about the macro-prudential supervision of investment funds within Europe.

Ms Verena Ross recalled the progress and the strengthening of the regulatory framework relating to investment management since the 2008 crisis, emphasising that further regulatory developments are needed to remedy the vulnerabilities that the industry is facing, following Covid-19 and the war in Ukraine amongst other impactful events. These current vulnerabilities may be imaged by the liability-driven investment funds (LDIs) events which occurred in the United Kingdom, conducting to sudden losses for large investors. The risks faced by LDIs are the same as for any leveraged entity with concentrated directional exposures, inter alia, therefore it appears as essential to identify, monitor and address weaknesses in the asset management sector and to detect the channels of contagion to the rest of the financial system.

In the current economic and geo-political atmosphere, the resilience to economic shocks by investment funds is needed. It may be recalled that the liquidity and excessive leverage are the two main risks that concern the ESMA, even if the AIFMD sets out rules on leverage and liquidity management to mitigate this risk.

Furthermore, it was underlined that ESMA expects asset managers to take responsibility by managing their investment funds in a prudent manner in view of the difficult macroeconomic climate, in particular with regard to liquidity and leverage risks. In particular, AIFMs are required to check the fit between their investment funds' investment strategy, liquidity profile and redemption policy. AIFMs should implement accurate assessments and rigorous controls of liquidity risk management.

Furthermore, Ms Verena Ross recalled that Article 25 of the AIFMD empowers NCAs to implement limits on leverage to mitigate the accumulation of risks arising from leveraged funds. For instance, in November 2022, the Central Bank of Ireland declared its intention to impose leverage limits to Irish real estate investment funds under the AIFMD, which ESMA encourages and considers appropriate.

Overall, investment asset managers are invited to be ready for other adverse and protracted events, while supervisors should intensify their assessment of risks and take appropriate action to address the risks identified.

ELTIF 2.0: regulatory changes to open the investment opportunities to retail investors without compromising the level of protection

In 2015, the European Commission created the "European Long-Term Investment Fund" (ELTIF) label under the Regulation (EU) 2015/760 (the “ELTIF Regulation”). ELTIF is a regulated pan-European regime for AIFs managed by authorised AIFM and designed to increase the pool of capital available for long-term investment.

ELTIFs invest in long-term projects with a maturity date of between 10 to 20 years, and benefit from the EU passport for marketing across the European Economic Area (EEA). ELTIFs are unique in that they can be marketed to both professional and retail investors. As of today, we reckon only 84 ELTIFs have been set up across the EU, representing approximately EUR 7 billion of assets under management.

On 15 March 2023, the ELTIF Regulation was amended by Regulation (EU) 2023/606 of the European Parliament and of the Council (the “New ELTIF Regulation”), entering into force on 9 April 2023. It is expected to make ELTIFs more attractive to investment asset managers, particularly for retail investors seeking access to private assets with adequate investor protection. The New ELTIF Regulation introduces several changes which aim at increasing investment opportunities for ELTIFs while ensuring adequate investor protection and promoting cross-border investment in the EU. The New ELTIF Regulation includes the following key amendments:

Eligible Assets

The New ELTIF Regulation has decreased the minimum percentage of capital that ELTIFs must invest in eligible investment assets from 70% to 55%, to provide greater flexibility for ELTIFs in their investment strategies and allow for a more diversified investment portfolio.

Qualifying portfolio undertakings

With the New ELTIF Regulation, the maximum market capitalisation of listed qualifying portfolio undertakings for ELTIFs is increased to EUR 1.5 billion, compared to the previous limit of EUR 500 million. Additionally, this maximum market capitalisation requirement only needs to be met at the time of initial investment.

Investments in third countries

ELTIFs may now have an investment objective to invest mainly outside the EU, provided that it does not invest in third countries listed in the EU Council's conclusions on the revised EU list of non-cooperative jurisdictions for tax purposes.

Investments in funds

The New ELTIF Regulation allows ELTIFs to invest in EU AIFs and UCITS managed by an EU AIFM, subject to certain requirements. These include investing in eligible investment assets or UCITS eligible assets and not investing more than 10% of their assets in other funds.

When investing in funds, ELTIFs must look-through the target funds to assess the percentage of their assets invested in eligible investment assets versus UCITS eligible assets.

Real assets

The definition of "real asset" has been simplified to include any asset with intrinsic value due to its substance and properties. This definition covers immovable property (including commercial and housing), infrastructure assets, and other assets such as intellectual property, vessels, equipment, machinery, aircraft or rolling stock, as well as water, forest, building, and mineral rights. However, investments in works of art, manuscripts, wine stocks, and jewellery are excluded. Under the new regulations, ELTIFs are no longer limited to investing only in real assets with an individual minimum value of EUR 10 million.

Co-investments

The New ELTIF Regulation allows ELTIF managers, their affiliates, and staff to make co-investments alongside the ELTIF, provided that appropriate measures are in place to identify, prevent, manage, and monitor conflicts of interest. This includes disclosing any conflicts of interest that may arise from these co-investments.

Permitted investments in securitisations and green bonds

The New ELTIF Regulation allows ELTIFs to invest in (i) simple, transparent, and standardised securitisations with an STS Label as defined in Regulation (EU) 2017/2402, where the underlying exposures consist of commercial, residential, or corporate loans or trade receivables; (ii) green bonds issued by qualifying portfolio undertakings under EU legislation on environmentally sustainable bonds; and (iii) financial undertakings that have been organised or registered less than five years before the date of investment by the ELTIF.

Borrowing/leverage rules

The New ELTIF Regulation allows ELTIFs to borrow up to 50% of their NAV, while non-Retail ELTIFs can borrow up to 100% of their NAV. The borrowing limit will apply from a date set out in the ELTIF's rules or instruments of incorporation, not later than three years after the start of the ELTIF's marketing. The borrowing limit may also be temporarily suspended for up to 12 months under certain circumstances.

Term and liquidity - Redemption rules

The Amending Regulation introduces changes for open-ended ELTIFs. Investors will no longer have the right to request winding-up of the ELTIF if their redemptions are not satisfied within one year. However, redemptions before the ramp-up period will be permitted subject to an appropriate minimum holding period or lock-up. Additionally, the New ELTIF Regulation introduces an optional liquidity window mechanism for open-ended ELTIFs, allowing for a matching of exiting and subscribing investors organized by the ELTIF manager. This mechanism will be subject to an appropriate policy implemented by the ELTIF manager. ESMA will develop draft regulatory technical standards on open-ended ELTIFs, including criteria to determine the appropriate length of the minimum lock-up period and the optional liquidity window mechanism.

For closed-ended ELTIFs, investors will have the option to redeem their shares or units before the end of the fund's life on a secondary market basis, promoting the secondary trading of ELTIF units or shares.

No approval of ELTIF manager

The New ELTIF Regulation removes the requirement for EU authorized Alternative Investment Fund Managers (AIFMs) to obtain approval from the home Member State regulator of the ELTIF.

Cost disclosure requirements

The New ELTIF Regulation fully aligns the cost disclosure requirements for all ELTIFs, including non-Retail ELTIFs, with the requirements of the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation.

Bill of Law – enhancement and modernisation of the Luxembourg investment funds toolbox (AIFM, SIF, SICAR, RAIF, UCI part II)

On 27 March 2023, Luxembourg’s Parliament introduced a new bill of law with the purpose of providing a modernised Luxembourg investment funds toolbox and enhance the attractiveness and competitiveness of the Luxembourg financial center to suit the needs of investment fund investors and managers (the “Bill of Law”).

The Bill of Law suggests amendments to the five sectoral laws regulating investment funds (i.e., SICARs, SIFs, RAIFs, UCI Part II Funds) as well as their investment managers in Luxembourg, i.e. AIFMs).

These adjustments aim to ensure that Luxembourg remains at the forefront of progress in the constantly implementing pragmatic legal and supervisory framework providing a unique and innovative toolkit of investment products as well as consolidating its role as forward-looking and innovative global player. The Bill of Law is welcomed by the Luxembourg financial market participants.

The modernisation addresses key changes including (i) the amendments to the threshold of "well-informed investor" definition, (ii) marketing to retail investors, (iii) extension of the period during which the minimum capital must be reached, (iv) additional prohibitions on the issuance and redemption of units, (v) allowing AIFMs to use tied agents and (vi) amendments to the rules applicable to voluntary liquidation.

Please read more in our detailed NewsFlash.