Implementing the ELTIF Regulation in the UK - Part 2 of FCA’s CP15/27

On 03 September 2015, the Financial Conduct Authority (FCA) published CP 15/27 "UCITS V implementation and other changes to the Handbook affecting investment funds" (the CP).

The CP is divided into three parts. This Note summarises Part 2 of the CP.

• In Part 1, the FCA sets out proposed Handbook changes by which it intends to transpose the changes made by UCITS V to the existing UCITS Directive.

• In Part 2, the FCA consults on changes to the Handbook to ensure that the European long term investment funds (ELTIF) Regulation will operate effectively from its start date of 09 December 2015.

  The consultation period for Part 2 closed on 05 October 2015

• In Part 3, the FCA puts forward a number of proposed Handbook changes intended to keep its rules and guidance for authorised investment funds up to date. The FCA also raises certain discussion points on which it may consult in the future if it sees a case for changing its rules.

Background - the ELTIF Regulation

The EU Regulation (the Regulation) on European long term investment funds (ELTIFs) creates a new type of collective investment vehicle that allows retail and professional investors to invest in companies and projects that need long term capital. The intention is that, by restricting the asset classes in which an ELTIF can invest, the new vehicles will provide investors with long term, stable returns and help stimulate employment and economic growth in the EU by increasing investment in, for example, infrastructure projects.

The Regulation became effective in all EU Member States on 09 December 2015.

To qualify as an ELTIF, a fund must (among other things):

• be an EU alternative investment fund (AIF) as defined under the Alternative Investment Fund Managers Directive (AIFMD)
• have a manager which is an EU AIF manager (AIFM), authorised under the AIFMD
• invest at least 70% of its capital in eligible investment assets
• comply with various requirements regarding investment and borrowing restrictions, and
• observe strict limitations on its use of leverage and derivatives.

ELTIF managers will be able to make use of an EU-wide passport, subject to a notification procedure established under the AIFMD.

Managers of ELTIFs will also be able to market their funds to retail investors, provided they meet certain additional requirements set out in the Regulation. However, the manager must (among other things) carry out an internal assessment of the ELTIF, taking into account its intended duration and investment strategy, before deciding whether or not it is fit to be marketed to retail investors. The manager or distributor of the ELTIF will have to perform a suitability test to ensure the product is appropriate for each retail investor.

For a summary of the ELTIF Regulation, please see here.

Why has the FCA consulted?

The ELTIF Regulation is directly applicable under EU law, which means that its provisions do not need to be transposed into UK law or the FCA's rules to be effective. However, to ensure that the Regulation can function adequately within the UK's regulatory framework as of 09 December 2015, the FCA has proposed a number of amendments to its rules - these are set out in the CP.

Changes arising from the ELTIF Regulation

AIFMs and depositaries

The FCA proposes to introduce a new section of the Investment Funds sourcebook (FUND), to be called "European AIF Regimes", section 4.2 of which will include rules and guidance in relation to ELTIFs (including the interaction between the ELTIF Regulation and FCA rules - in particular for the depositary of an ELTIF marketed to retail investors - and ELTIFs and authorised funds).

Permissions

Since the manager of an ELTIF must be an EU authorised AIFM, the FCA proposes that a full scope UK AIFM of an ELTIF will need to have the Part 4A permission of acting as a manager of an authorised AIF.

Similarly, a depositary of an ELTIF would, under the FCA's proposals, need to have the Part 4A permission of acting as a trustee or depositary of an authorised AIF.

The FCA's reasoning (as set out at proposed FUND 4.2.11G (3)(a)) is that where the requirements for an AIFM or a depositary of an ELTIF are concerned, "an ELTIF more nearly resembles an authorised AIF (ie a NURS or a QIS) than other types of AIF".

Depositaries

Under the ELTIF Regulation, as under AIFMD, a depositary must be appointed. Whereas both the ELTIF's manager (as an AIFM) and its depositary must, therefore, comply with applicable requirements under both pieces of legislation, the ELTIF Regulation contains specific provisions concerning the depositary of an ELTIF where the ELTIF is marketable to retail clients. These have the effect of amending the corresponding provisions of the AIFMD, being stricter than the standard AIFMD requirements for the appointment of a depositary.

So, where the ELTIF is marketed to retail investors, the depositary:

• must be an entity which would be eligible under the UCITS Directive, as amended by UCITS V (which will apply from 18 March 2016)
• will be unable to discharge itself of liability in the event of a loss of financial instruments held in custody by a third party
• will be unable to exclude or limit its liability by agreement - any agreement that contravenes this requirement will be void, and
• must comply with restrictions on the re-use of the assets held in custody.

The FCA proposes to disapply the more permissive provisions of AIFMD where an ELTIF can be marketed to retail investors.

The FCA proposes not to take advantage of the ability to allow an AIFM of a UK unauthorised AIF to have a depositary based in another EEA jurisdiction since, in its view, the depositary of a UK ELTIF should be authorised for that activity in the UK. However, depending on the position taken in other Member States, it is possible that a UK depositary could be appointed as depositary for an ELTIF established in another Member State. The FCA states that it will update its transitional provisions to take account of this possibility.

Marketing ELTIFs

To market an ELTIF, an AIFM must comply not only with the relevant provisions of AIFMD (Article 31 for domestic marketing, Article 32 for cross border marketing) but also with additional information and documentation requirements under the ELTIF Regulation. The FCA's proposed guidance in FUND 4.2 explains the latter requirements and specifies that the form set out in FUND 4 Annex 1R in the CP would have to be used when submitting the additional information and documentation to the FCA.

Application fees for ELTIFs

In respect of an application for authorisation of an AIF as an ELTIF, the FCA proposes to charge a fee of £2,400 for a single fund and £4,800 for an umbrella fund, payable when the application for the authorisation of an ELTIF is submitted.

Periodic fees for ELTIFs

In respect of periodic charges, the FCA proposes to include authorised ELTIFs in its "C" fee block for these purposes (see FEES 4.2.11R and FEES 4 Annex 4R, Part 1 in the FCA's Handbook) - the fees would, therefore, be the same as those charged for other types of authorised funds.

ELTIFs authorised before 31 March 2016 would be charged the level of periodic fees that apply for the fee year 01 April 2015 to 31 March 2016 (2015/16), as currently set out under FEES 4 Annex 4R, Part 1. The FCA consults each year on the periodic fees that will apply in the following fee year, so the periodic fees for ELTIFs for the fee year 2016/17 will be consulted on in the FCA's annual fees rates consultation paper, scheduled to be published in March 2016.

Periodic fees for A.7 and A.9 fee blocks

For the purposes of periodic fees, the AIFM of an ELTIF will be in fee blocks A.7 (portfolio managers) and A.9 (managers and depositaries of investment funds and operators of collective investment schemes), while the depositary of an ELTIF will be in fee block A.9.

Other consequential changes arising from the ELTIF Regulation

Under COBS 18.5.10AR, a full scope UK AIFM must provide certain disclosures to a retail client when it markets an unauthorised AIF. This rule will not apply where an ELTIF is being marketed to retail investors. Rather, the manager of the ELTIF will be required to comply with the rules under Article 23 of the ELTIF Regulation.

Next steps

The FCA's consultation period for Part 2 of CP15/27 closed on 05 October 2015. The ELTIF Regulation became effective on 09 December 2015. The FCA will now consider feedback received and publish final rules in time for the Handbook to be amended ahead of 09 December 2015, when the ELTIF Regulation becomes effective.