Navigating new rules

Ropes & Gray partner, Eve Ellis, takes a look back at private equity fund regulations throughout 2021, and looks ahead to what’s in store for 2022 and beyond

Looking back over 2021, it has been a year with some key regulatory changes for the private equity fund industry. These changes will continue to evolve in 2022 and beyond, and there will be further regulatory change in other areas which managers will have to prepare for. Below are some of the key areas we have discussed with clients this year which will remain a focus over the year ahead.

Impact of increasing ESG regulation

Arguably the most significant change this year was the introduction of the EU’s Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation. The SFDR came into effect in March 2021 and introduced mandatory disclosure obligations for all asset managers established in the EU or selling their funds there. SFDR has two key components; firstly it requires all managers in scope to integrate ESG considerations into their investment decision making process and secondly it tries to mitigate “greenwashing”. The way SFDR addresses the latter is by creating the three fund categories (Article 6, 8 and 9). Despite the product classification, ultimately SFDR is a disclosure regime, not a product badge or classification system. However, the market reaction has been more focused on the latter and managers who determine their funds are Article 8 or 9 need to be comfortable they can meet the relevant disclosure requirements. SFDR continues to evolve. In particular, the implementation date for the detailed regulatory technical standards (RTS) has again been postponed to 1 January 2023 and remains subject to change. How SFDR will interact with the Taxonomy regulation, which is due to come into force on 1 January 2022 (with the RTS being delayed to 1 January 2023), is also a key consideration for managers offering environmentally sustainable products. A number of key areas still remain unclear along with its ever changing implementation timeline.

ESG regulation is not just the focus of the EU. The FCA in the UK published a consultation on its disclosure regime for asset managers. The key difference is that this regime will be more aligned to the Task Force on Climate-related Financial Disclosures framework as opposed to SFDR. Whilst this is a more proportionate approach than SFDR, it means global managers will need to comply with differing regimes.

More broadly, various regulators including the FCA and the SEC are clearly focused on greenwashing and ensuring managers can deliver on what they say to investors. This increased scrutiny from regulators, investor interest and increasing regulatory requirements mean that ESG considerations need to be a key focus for PE managers.

EU Cross Border Marketing Rules

The EU Cross-Border Marketing Rules came into force on 2 August and introduced a new definition of pre-marketing as well as a new pre-marketing notification obligation. The Cross-Border Marketing Rules were introduced to streamline aspects of marketing investment funds under the AIFMD regime. However, the position continues to evolve as not all EU countries have implemented the rules and not all have applied them to non EU managers. Broadly, the new rules:

• Create a definition of pre-marketing (the period when a manager can test the market before the NPPR registration or AIFMD marketing passport are made).
• Require a pre-marketing notification to be filed within two weeks of commencing pre-marketing.
• Restrict who can pre-market a fund on behalf of the manager, which will have more of an impact for non EU regulated distributors or sub advisers.
• Have an impact on the ability to rely on reverse solicitation when also undertaking pre-marketing.
• Impose content requirements on pre-marketing documents.
• Create new requirements when deregistering a fund from being marketed.

Given the different ways in which countries across the EU are implementing the new rules, it is critical that managers check the position before reaching out to investors to ensure the new rules are complied with.

Financial Crime

Addressing and managing financial crime risk remains a high priority for European regulators and the UK’s FCA. At the start of 2020, the FCA issued a Dear CEO letter to asset managers highlighting areas of focus. One of which was financial crime. This is an area where PE managers should expect the FCA to continue to review in 2022 and beyond. One of the other considerations in this area for global managers is integrating differing AML regimes into their policies and procedures. This is particularly relevant for managers with Luxembourg parallel funds.

UK Investment Firm Prudential Regime (IFPR)

The IFPR is a new prudential regime applying to all UK MiFID investment firms authorised and regulated by the FCA in the UK, which will come into force on 1 January 2022 and has kept many managers within the industry busy this year.

The IFPR introduces two new categories of firms: Small and Non-Interconnected firms (SNIs) and all other investment firms (non-SNIs) and will require firms to account for the risks they pose to consumers and to markets in their prudential assessments. Managers will need to consider whether their firm is a SNI or a non-SNI as new capital requirements and associated rules will apply depending on this status. The IFPR is set to impact the Exempt CAD status of firms and increase permanent capital requirement minimums to at least £75,000 from €50,000. The new rules will also impose a fixed overheads requirement which will be significant for some UK advisors.

Hybrid Working Environment

The FCA has expressed its concerns and expectations for firms carrying out regulated activities that are operating under a hybrid working model, where work takes place both remotely and in the office. It is important for the relevant firms to assess the risks of any hybrid model and how they will continue to meet regulatory standards and obligations. Firms operating under hybrid working arrangements may need to notify the FCA of these arrangements and provide a written plan on how they will meet certain threshold conditions set out by the FCA. The FCA is particularly concerned there is appropriate governance and oversight by senior managers in place and evidence that this governance can be maintained.