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Funds Annual Briefing 2021 - Headline grabbers

Funds Annual Briefing 2021 - Headline grabbers
Brexit: Key considerations

Following the end of the Brexit implementation period on 31 December 2020 ("IP completion day"), the UK is no longer treated as an EEA Member State; from the perspective of the EEA, the UK is now a third country. Under the European Union (Withdrawal Act) (2018) all EU law in effect as at 31 December was, broadly, converted and preserved in domestic legislation (known as retained EU law), with amendments made by way of statutory instruments ("SIs")) to correct "deficiencies" in retained EU law. These corrections were designed to ensure that the domesticated and onshored legislation makes sense and operates properly in the UK: the SIs are not intended to make policy changes other than to reflect the UK's new position outside the EEA.

The FCA has reiterated that it expects issuers, investors and other market participants to have taken reasonable steps to be able to comply with the new regulatory obligations from the end of the implementation period. Directions made by the FCA under its Temporary Transitional Power ("TTP") apply in some specific instances, allowing firms and other regulated persons to rely on the legislation or rules which applied before 31 December 2020 and giving them additional time (until March 2022) to prepare to meet the changes to their UK regulatory obligations brought about by onshoring.

On Christmas Eve 2020, the UK and EU finally agreed a post-Brexit Trade and Cooperation Agreement. Much of the 1,259-page Agreement is devoted to matters of cooperation, trade and services in areas other than financial services.

What we can say about the Trade and Cooperation Agreement and financial services is as follows:

  • International standards: The UK and EU agree to use their best endeavours to ensure that internationally agreed standards in the financial services sector are implemented and applied – these standards include those from the Basel Committee, IOSCO, FATF and OECD.

  • Prudential carve-out: While general provisions relating to services and investment (including most favoured nation treatment) apply, specific provisions governing the supply of financial services apply to (and override) these, including a significant "prudential carve-out", meaning that neither Party is prevented from adopting or maintaining unilateral measures for the protection of investors, depositors, policy-holders or persons to whom a fiduciary duty is owed by the financial services supplier or to ensure the integrity and stability of the Party's financial system.

  • Clearing and payment systems: Financial service suppliers from the UK and EU will have access to each other's payment and clearing systems operated by "public entities" and to funding and refinancing facilities in the normal course of business (but not access to "lender of last resort" facilities).

  • Regulatory cooperation: in a non-binding declaration outside the terms of the Trade and Cooperation Agreement itself, the UK and the EU will "aim to agree" by March 2021 a Memorandum of Understanding between them establishing a framework for regulatory cooperation on financial services. 

What the Trade and Cooperation Agreement does not, and was not expected to, address, however, is the question of equivalence for financial services. This is a matter of respective unilateral decisions, not bilateral negotiation and takes account of national interests: it is not an objective assessment of "equivalence". In many ways, this is the critical question for financial services firms. The European Commission's process of assessing the UK is continuing. It remains to be seen how long it will take before there are meaningful mutual equivalency declarations and, if so, in which of the regulatory regimes there is such mutuality. It should be stressed that, while the assessment process might result in the introduction of something analogous to the passport if the European Commission assesses the UK's regulatory regime as "equivalent", it is not the same as single market access under a passport. In the meantime, in January 2021 ESMA published a statement reminding firms of the requirements under MiFID II concerning the provision of investments services to retail or professional clients by firms not established or situated in the EU. The statement does not contain any new guidance but instead can be seen as warning to UK firms seeking to rely upon the reverse solicitation exemption now that the passporting regime has ended due to Brexit.

Some key points to note:

Considerations for AIFMs

Loss of AIFMD management passport: 

UK alternative investment fund managers ("UK AIFMs") will now be regarded by the EEA as third country AIFMs and will therefore be treated in the same way as any other non-EEA AIFM. Therefore, if the local law of a relevant EEA jurisdiction governing an alternative investment fund established here ("EEA AIF") requires the AIFM of such an AIF to have a passport or other local licence, a UK AIFM will be unable to manage such an AIF. Some Member States have implemented transitional contingency measures: UK AIFMs will be required to comply with applicable national rules and may need to apply to the relevant regulator for authorisation. This process will vary from Member State to Member State.

Loss of AIFMD marketing passport:

UK full-scope AIFMs which previously relied upon the AIFMD marketing passport to market their funds into EEA jurisdictions, will instead need to identify on a jurisdiction-by-jurisdiction basis whether local law permits the fund to be marketed by a third-country AIFM. Where it does, the UK AIFM must continue to register under the Member State's national private placement regime ("NPPR"). Where the relevant jurisdiction does not offer an NPPR, investment in the AIF by investors in that jurisdiction will only be possible by way of valid reverse solicitation or by establishing an EEA AIFM. 

Similarly, full-scope EEA AIFMs will no longer be able to use the AIFMD marketing passport to market their funds into the UK. As regards those funds which were in existence and being marketed in the UK prior to the termination of the transition period, EEA AIFMs had until 30 December 2020 to register to use the FCA's temporary marketing permission regime ("TMPR"). Under the TPMR EEA AIFMs can continue to market such pre-existing funds in the UK - in practical terms as if the passport was still in existence – for up to three years (although coverage is likely to end sooner than that in respect of specific funds depending on circumstances). Otherwise, and in respect of all new funds marketed after 31 December 2020, EEA AIFMs will need to rely on the UK NPPR regime instead.

There are a two marketing scenarios not covered by the TPMR given that it only extends to  marketing previously undertaken under the AIFMD passport. These are covered by transitional relief under directions made under the FCA's TTP which provide that:

  • a UK AIFM can continue to market an EEA AIF in the UK that was being marketed in the UK immediately before IP completion day in accordance with the UK implementation of AIFMD as it stood immediately at that time: the effect is to relieve the UK AIFM from having to immediately re-notify the marketing under the UK NPPR (i.e. because the EEA AIF is now, from a UK perspective, a third country AIF), and

  • an EEA AIFM can continue to market a non-EEA AIF (or a feeder AIF of a non-EEA AIF) that was being marketed in the UK immediately before IP completion day in accordance with the UK implementation of AIFMD as it stood immediately before IP completion day: the effect is to relieve the EEA AIFM from having to immediately re-notify the marketing under a different provision of the UK NPPR (i.e. because the EEA AIF is now, from a UK perspective, a third country AIFM).

The TTP applies until 31 March 2022.

Sub-threshold UK AIFMs will continue to market into the EEA under NPPR regimes, if available. Sub-threshold AIFMs marketing into the UK under the NPPR must report transparency information to the FCA.

Under the EU AIFMD, the depositary of an EEA AIF must be established in the home member state of that AIF. Under the onshored AIFMD regime, an AIFM of a UK AIF must ensure the appointment of a depositary "established in the UK". "Established" in either case (when referring to an unauthorised AIF) means "having its registered office or branch in". Therefore, leaving aside other issues (such as licensing requirements and other factors, and unlike a specific location requirement under UK UCITS as regards depositaries) it remains possible for the depositary of a UK AIF to be the London branch of an EEA bank and for the depositary of an EEA AIF to be the EEA branch of a UK bank.

UK Market Abuse

The UK has adopted a broadly similar regime to the European Market Abuse Regulation ("UK MAR"). Under UK MAR, issuers that are based in an EU member state who have financial instruments admitted to trading or traded on a UK trading venue, will be required to:

  • send notifications of delayed disclosure of inside information to the FCA;

  • obtain consent from the FCA, in the case of credit and financial institutions, when delaying disclosure of inside information; and

  • send (or their Persons Discharging Managerial Responsibilities ("PDMRs") must send) PDMR transaction notifications to the FCA.

Amendments to be made to the UK regime (as set out in the Financial Services Bill in October 2020), will consist of:

  • clarifying who is required to maintain an insider list, establishing that issuers and any person acting on their behalf or on their account are all required to maintain such a list;

  • extending the time allowed for companies to notify PDMR dealings to two working days after receipt of the notification; and

  • extending the maximum criminal sentence for market abuse from seven to ten years, aligning the sentence length to comparable economic crimes in the UK.

The UK MAR requirements are in addition to any notification requirements that continue to apply under EU MAR. This will require a broader scope of issuers to report to the FCA and, in some cases, result in dual reporting requirements.


To make a public offer of securities in the UK or seek admission to trading on a UK regulated market, a prospectus will need to be approved by the FCA (as the existing prospectus passporting regime will cease to apply to the UK).  This will be the case irrespective of whether the prospectus has already been approved by a national competent authority of an EEA member state.

Issuers will need prospectus approval by an EEA competent authority before being able to make a public offer in EEA jurisdictions.  Issuers who have chosen the UK as their home Member State for prospectus approval, and issuers who currently have the UK as their home Member State for prospectus approval due to their registered office being in the UK, will have to choose a new home Member State.

For placing programme prospectuses approved by the FCA prior to 31 December 2020, from 1 January 2021, a prospectus will need to be approved in the issuer's new EEA home member state for the part of the offer that will take place in the EEA.  This means that it is likely that the issuer will have to start a new offer once a prospectus is approved within the EEA.

For placing programme prospectuses approved by an EEA competent authority prior to 31 December 2020, the FCA has put in place grandfathering provisions and will continue to accept prospectuses approved by other EEA competent authorities prior to 31 December 2020 until their validity expires (i.e. 12 months from the date it was originally approved).  These prospectuses will be treated as if they had been originally approved by the FCA.  Supplements must be approved by the FCA.

PRIIPs regime

The UK has adopted the UK's PRIIPs KID regime, which is operationally equivalent to the EU PRIIPs  regime although some divergence between the two regimes will occur once the UK implements its proposed targeted amendments to the UK regime (see below).  Funds will therefore require (i) a key information document ("KID") in relation to anyone advising on, selling or otherwise making available a PRIIP to a retail investor in any member state of the EEA, pursuant to the EU PRIIPs Regulation; and (ii) a second KID in relation to any such retail investor in the UK.

The FCA's TTP apply in respect of PRIIPs KIDs which were first made available before 31 December 2020. This means that a person can continue to rely on a KID that was prepared before 31 December 2020 in compliance with the EU PRIIPs Regulation and in respect of a PRIIP that was first made available to retail investors in the EU or the UK before 31 December. The powers apply until 31 March 2022.

For the most up to date Brexit analysis, please visit the Travers Smith Brexit website.

Post-Brexit landscape for funds operating in the UK

The UK has already started to consider both short and long-term opportunities for reform brought about by Brexit.

Short term initiatives include the Financial Services Bill (the "FS Bill"), introduced to Parliament in October 2020, to ensure that the UK’s regulatory framework continues to function effectively for the UK after leaving the EU. Included in the FS Bill is the introduction of a new Overseas Funds Regime to allow overseas domiciled retail funds (and money market funds) to be marketed to investors in the UK (see further details here). 

The government has also launched Lord Hill's review of the UK's listing regime by publishing Policy paper: Call for Evidence – UK Listings Review. The review is driven by Brexit and will inform proposals to boost the UK’s reputation as a destination for IPOs. Views are sought on the following areas:

  • Free floats - In particular around whether the UK's 25% free float requirement is calibrated at the right level.

  • Dual class share structures - Whether there is demand for, and whether they should be permitted, as well as how to address related corporate governance issues.

  • Track record requirements - Whether they are a barrier to some companies listing and whether further flexibility in this regard is required.

  • Prospectuses - Whether the requirements for when a prospectus has to be produced (currently harmonised at EU-level) are appropriate for the UK market, how these requirements could be changed and if the general exemptions to a prospectus are widened whether the loss of disclosure or liability attached the prospectus document should be replaced.

  • Dual and secondary listing - Whether the requirements around dual and secondary listing are a barrier to dual listing in the UK, and whether anything could be changed to further encourage dual and secondary listings in the UK.

Many see Brexit as an opportunity to re-evaluate the choice of funds vehicles currently available in the UK and to carve-out a more suitable and competitive vehicle for today's markets. A number of longer-term initiatives have begun in relation to this. HM Treasury have published the Future Regulatory Framework (FRF) Review: Consultation. The consultation is the second phase of the FRF Review, which considers how the regulatory framework for financial services needs to adapt to be fit for the future, in particular to reflect the UK's new position outside of the EU. Further details on the 'HMT launch the Future Regulatory Framework's' section here

The Government's promised consultation on a wider review of the UK funds regimes is shortly due. Given the commitment of Rishi Sunak for a new fund structure for longer term investments being up and running within the year, it is likely that this will encompass the 2019 proposal by the Investment Association for a new UK Long-Term Asset Fund ("LTAF"). These proposals involve adapting the existing NURS framework, to create a new, more flexible, open-ended, FCA authorised fund for investing in long-term assets, while maintaining an appropriate degree of investor protection. While redemptions could be daily, it is anticipated that the fund could permit these to be more akin to the liquidity of the underlying investment, possibly up to 2 years. The Investment Association anticipates that the target market for the LTAF would be DC pension schemes, professional investors and private wealth/discretionary portfolio managers. The final structure of the LTAF is yet to be seen, but it is assumed that it could fit into one or more of the existing alternative investment ("AIF") structures and the existing AIF tax regime. Travers Smith has published a detailed paper 'The retailisation of alternative investment strategies' which considers the opportunities (and pitfalls) of retailisation structures.

The Association of Real Estate Funds, also published proposals for a new fund vehicle, the Professional Investor und ("PIF"). This is intended to fill an important gap in the UK’s fund offering for professional investors (when compared to other jurisdictions). In particular, fund managers looking for a flexible, unlisted, unregulated, income transparent fund to hold UK real estate investments, currently often have to use an offshore structure to achieve the required commercial and tax efficiency. The PIF would be a new UK contractual fund, largely modelled on the authorised contractual fund (ACS), but as an unregulated collective investment scheme (UCIS), open to professional investors investing at least £1m. Being unauthorised, it could offer considerable flexibility around liquidity, gearing and investment criteria: in particular, it could be closed or open-ended or a hybrid. Ideally, the tax position should follow that of the ACS (broadly income transparent, with gains only taxable on disposal of interests by investors (not in the PIF) and transfers of units being outside the scope of stamp duty land tax and stamp duty). Seeding relief has also been asked for. While initially focussed on the real estate market, it is envisaged that it could potentially work for other types of investments also.

In addition, the government has proposed the introduction of a new tax privileged regime for asset holding companies (AHCs) in alternative fund structures. While the final rules need to be sufficiently simple to be operationally attractive, the proposals are nonetheless an exciting development, with the Government clearly having taken on board much of the industry feedback in relation to how the UK rules for AHCs could be improved and looking to introduce a regime which will make the UK a highly competitive jurisdiction for AHC location. For more details please click here.

Travers Smith has published a detailed paper 'The UK Alternatives Asset Management Industry Blueprint for a Bright Future'. The paper outlines the importance of the industry and details how it can now be protected in order to maintain the UK's status as a world leader in the sector.

Wide-ranging review of UK funds regime

WHAT IS THIS? The Government is in the process of carrying out a wide-ranging review of the UK's fund regime covering tax and relevant areas of regulation.

WHO DOES THIS APPLY TO? The review is relevant to the asset management sector generally.

WHEN DOES THIS APPLY? The review is under way.

In its March 2020 Budget, the Government announced that it would undertake a review of the UK funds regime, covering taxation and relevant areas of regulation. The overarching objective of the review is to identify options which will make the UK a more attractive location to set up, manage and administer funds and which will support a wider range of more efficient investments better suited to investors’ needs. The review consists of three workstreams:

  • a "call for input" published on 26 January (the "CFI");

  • proposals for a new tax privileged regime for asset holding companies in alternative fund structures (discussed further below); and

  • a review of the VAT treatment of fund management fees, which the government intends to take forward this year (discussed further below).

The CFI is very broad in scope. A number of specific issues are raised, but HMT makes clear that it also wants to hear about any other measures that enhance the UK funds regime. It does not discuss any potential changes to corporate law, so that may be one, though we understand that any initiative here would be led out of a different team in the Government.

One area covered by the CFI is the possible introduction of new fund structures.

Given the commitment of Rishi Sunak for a new fund structure for longer term investments being up and running within the year, it is unsurprising that the Investment Association's Long-Term Asset Fund ("LTAF") proposals are discussed. These proposals involve adapting the existing NURS framework, to create a new, more flexible, open-ended, FCA authorised fund for investing in long-term assets, while maintaining an appropriate degree of investor protection. While redemptions could be daily, it is anticipated that the fund could permit these to be more akin to the liquidity of the underlying investment, possibly up to 2 years. The Investment Association and HM Treasury (HMT) anticipates that the LTAF would be attractive for DC pension schemes.

The CFI explains that the FCA plans to consult early in 2021 on setting up a framework for the LTAF and that, in addition, HMT, Bank of England and FCA are convening an industry working group to address current impediments to investment in long-term assets, which will be important in supporting the successful delivery of the LTAF. To complement those workstreams the CFI itself focuses on the tax treatment of the LTAF, with the starting point being that the current rules for authorised investment funds are likely to be adopted. Notably here, different tax rules can apply for such funds, depending on the relevant legal and regulatory structure.

The CFI also discusses different options for a flexible, tax-efficient, unauthorised fund structure, capable of investment in alternative asset classes, which would be aimed at professional investors aimed at filling another gap in the current UK offering. The proposals being considered which the CFI seeks views, are (1) those of the UK Funds Regime Working Group and the Alternative Investment Management Association that the fund could be structured as either a corporate or as a partnership; and (2) the Association of Real Estate Fund's suggestion that it could be structured as a contractual scheme.

From a tax perspective, specific issues raised in the CFI include:

  • considering whether authorised funds should be exempted from tax altogether (noting that this could make claiming treaty relief under double tax treaties difficult);

  • improving the position of multi-asset/balanced authorised funds;

  • after observing that the number of registrations of UK-domiciled limited partnership funds has declined over recent years, exploring whether bespoke partnership taxation rules could provide the opportunity for improved tax administration and certainty of tax outcomes;

  • exploring how features of the UK's double tax treaty network could be enhanced for funds; and

  • changing the REIT rules (see below)
Proposed introduction of a new regime for asset holding companies in alterative fund structures

WHAT IS THIS? Government proposals for a new tax privileged regime for asset holding companies in alternative fund structures.

WHO DOES THIS APPLY TO? The asset management sector generally.

WHEN DOES THIS APPLY? The consultation ends on 23rd February 2021, with a current aim to introduce the new regime next year (2022).

As part of the Government's review of the UK funds regime (see above), HMT, last year, undertook a consultation considering the attractiveness of the UK as a location for asset holding companies (AHCs) in alternative fund structures.  Building on that, in December, HMT published a further consultation containing proposals for of a new tax privileged regime for such AHCs.

While the proposals leave lots of points open for discussion, amongst other things, they envisage qualifying AHCs potentially benefiting from an exemption from tax on gains and being subject to tax on income at a level commensurate with their role. The expectation here is that, on the basis that that role typically does not require much activity, this is likely to lead to AHCs being subject to very low levels of tax on income. In addition, the proposals envisage capital gains realised by AHCs retaining their character as capital when they are returned to investors. The new regime will not, however, be open to all and eligibility criteria, especially around non-close or widely-held requirements are anticipated.

The proposals recognise that the position of real estate is different, in particular, with the general taxation of income and gains at source level and, so, it is recognised that alternative mechanics may be needed here, at least for UK real estate. In addition, as part of the consultation, targeted reforms to the REIT rules are being considered (which are discussed further below).

The proposals are an exciting development, but it will be critical to the success of the new regime that it is sufficiently simple - operationally, technically and cosmetically - to compete with its offshore rivals in an international context and that it does not become mired down by local UK tax concepts and concerns.  HMT and HMRC do seem to be listening, but they need (and are asking for) industry to give them sufficient anecdotal evidence and constructive solutions to help them develop their thinking and produce a competitive regime.

The timetable for the proposals for a new AHC regime is tight. Our understanding is the government is looking to publish draft legislation in the summer, with a view to enactment in 2022. While the consultation ends on 23 February 2021, HMT have said that they would be very happy to take comments and have discussions before then, in order to have as much time as possible to digest and then work through points raise. This is all actively happening, which is good news.

Introduction of revenue raising measures in response to Covid-19 - Office of Tax Simplification capital gains tax (CGT) review

WHAT IS THIS? Introduction of revenue raising measures to fund the Government's response to Covid-19

WHO DOES THIS APPLY TO? Unknown, at this stage, but potentially a wide range of taxpayers. We may find out more in the upcoming Budget on 3 March.

WHEN DOES THIS APPLY? Unknown at this stage. We may find out more in the upcoming Budget in March.

The UK Government’s response to Covid-19 has come at a high financial cost to the Exchequer. It is widely anticipated therefore that the Budget will include tax increases and there has been a lot of speculation about what measures may be introduced. Perhaps the most likely is a change in the tax treatment of the self-employed, as the Chancellor alluded to this in his announcement of the Self-Employment Income Support Scheme. This would likely be in the form of increased NICs for the self-employed at a rate more equal that for to employees.

Of particular interest to the Funds sector has been the question of whether significant changes could be made to the UK's CGT regime. The speculation here has been fuelled by the Chancellor's request to the Office of Tax Simplification (OTS) last July to carry out a review of CGT and aspects of the taxation of chargeable gains in relation to individuals and smaller businesses and by the OTS' publication in November of it first report on the issue (another report is due soon on key technical and administrative issues).   

This November report contained a series of recommendations that could have a significant impact on UK taxation of chargeable gains. Notably, however, it did not specifically recommend that CGT rates be aligned with income tax rates. It did, nonetheless (amongst other things), recommend that, if the government considers the simplification priority to be to reduce distortions to behaviour, it should consider either (1) aligning those rates more closely or (2) addressing boundary issues between the two taxes. 

Other areas of speculation have included increasing corporation tax and introducing a new net wealth tax.

UK Taskforce on Climate-related Financial Disclosures

WHAT IS THIS? Outline of the UK's approach to mandatory climate-related disclosures.

WHO DOES THIS APPLY TO? UK-authorised asset managers (AIFMs & UCITS management companies).

WHEN DOES THIS APPLY? In 2022 for large asset managers and large occupational pension schemes; 2023 for other asset managers; and 2024/2025 for other occupational pension schemes.

In November 2020, the UK's Joint Government-Regulator Taskforce on Climate-related Financial Disclosures ("TCFD") published its Interim Report accompanied by A Roadmap towards mandatory climate-related disclosures.

These outline at a high level the UK's approach to making TCFD-aligned, climate-related disclosures mandatory across the UK economy by 2025 at the latest.

The proposals will apply to a number of financial services firms including UK MiFID investment firms which provide portfolio management services, UK AIFMs (including small AIFMs with managing permissions), UK UCITS management companies and UK UCITS funds without an external management company. UK occupational pension schemes will also be caught.

Further details can be found in our briefing.

EU Sustainable Finance measures

WHAT IS THIS? New rules requiring firms to make disclosures in respect of sustainability.

WHO DOES THIS APPLY TO? EU portfolio managers, investment advisers and AIFMs and UCITS management companies and non-EU firms marketing or distributing financial products in the EU.

WHEN DOES THIS APPLY? The first set of requirements apply from 10 March 2021.

Three important areas of EU sustainability legislation are set to be introduced in the EU: the EU Regulation on sustainability-related disclosures in the financial services sector ("SFDR"); the integration of sustainability risks and factors in existing EU legislation and the framework to facilitate sustainable investment (Taxonomy Regulation).

It has been confirmed that the UK will not implement those pieces of legislation directly but will instead put in place its own sustainable finance regime. It has already set the ball rolling with respect to climate-rated disclosures (see 'UK Taskforce on Climate-related Financial Disclosures' above) and has confirmed that it will implement a UK-specific version of the EU's taxonomy. We also expect that the UK will implement a more principles-based version of the SFDR but an announcement is said to be "imminent" on that. In addition, EU sustainability legislation will continue to be relevant for UK and international firms marketing or distributing financial products in the EU.

EU sustainable finance disclosure regulation

The majority of the provisions in the EU SFDR will apply from 10 March 2021.

Broadly, EU SFDR requires disclosures on the integration of so-called "sustainability risks" by firms in their investment decision-making and an assessment of the likely impact of such risks on investment returns. Firms will also have to say whether they consider the "principal adverse impacts of investment decisions on sustainability" and, if they do, make disclosures in relation to those impact. Products which promote environmental and/or social characteristics, and those that have sustainable investment as their objective, are subject to further requirements. Disclosures are required to be made on the firm's website as well as at the pre-contractual stage and in periodic reports.

EU SFDR applies to portfolio managers, AIFMs, UCITS management companies, EuVECA managers and EuSEF managers as well as investment advisers.  Although it principally applies to EU firms, some obligations in EU SFDR are also applicable to non-EU firms marketing or distributing financial products in the EU. UK and international firms will therefore be caught.

A consultation on a draft technical standards was published in April 2020 but was widely criticised and is expected to change significantly before being finalised in 2021. As a result of COVID-19 and in order to allow firms time to prepare, the date on which the implementing measures will come into force has been delayed until (probably) January 2022. This has inevitably created some difficulties for firms which are now faced with having to comply with the high level provisions in EU SFDR but without having the details of the final technical standards which will specify how they should be doing this, for instance by way of more granular details of the presentation and content of the information to be disclosed.

It has also become clear that there remain a number of areas of uncertainty which may not be clarified in implementing measures in any event.  These include the extent of the application of EU SFDR to non-EU firms marketing or distributing financial products in the EU, the application of SFDR to legacy products and the circumstances in which a financial product is considered to be promoting environmental or social characteristics.

Integration of sustainability risks and factors - MIFID II, AIFMD and UCITS directive

The European Commission has now issued draft delegated regulations on the integration of sustainability risks and factors. These are in the form of amendments to certain existing EU legislation including the Alternative Investment Fund Managers Directive ("AIFMD") Delegated Regulation, the MiFID II Delegated Regulation and Delegated Directive and the UCITS Delegated Directive. 

The draft delegated regulations require AIFMs, UCITS management companies and MiFID investment firms (including portfolio managers and adviser/arrangers) to integrate sustainability risks and factors into their policies and procedures. This includes by taking sustainability into account when complying with organisational requirements, including (where relevant) risk management and conflicts of interest requirements. MiFID investment firms will also need to factor sustainability factors and preferences into their product governance processes. In addition, AIFMs and UCITS management companies will need consider sustainability risks when selecting and monitoring investments and when carrying out investment decisions.

It is not yet clear when these changes, if adopted, would apply to EU-regulated firms – or whether the UK will adopt them – but (since drafts suggest that the changes will be effective 12 months after publication in the Official Journal) it is unlikely to be before the end of 2021.

EU taxonomy regulation

The Taxonomy Regulation introduces an EU-wide taxonomy or classification system for determining whether and to what extent an economic activity can be considered environmentally sustainable. Environmental sustainability is one element of sustainability under SFDR. Parts of the Taxonomy Regulation take effect as from 1 January 2022 with the remainder coming into effect as from 1 January 2023.

The Taxonomy Regulation sets out six environmental objectives: climate change mitigation; climate change adaptation; sustainable use and protection of water and marine resources; transition to a circular economy; pollution prevention and control; and protection and restoration of biodiversity and ecosystems. In order to be "taxonomy compliant" (meaning the relevant activity is classified as environmentally sustainable according to the EU's criteria and is also compliant with basic social standards) an activity must contribute substantially to at least one of these and do no significant harm to any of the others. The activity must also comply with certain social safeguards.

draft Commission Delegated Regulation has now been issued setting out the (very granular) technical screening criteria for determining whether an economic activity qualifies as contributing substantially to climate change mitigation or climate change adaptation (which are the first two of the environmental objectives in the Taxonomy Regulation and which will come into effect first, on 1 January 2022) and for determining whether that economic activity causes no significant harm to any of the other environmental objectives in the Taxonomy Regulation.

In addition, ESMA issued a consultation paper on its draft advice to the European Commission under Article 8 of the Taxonomy Regulation.  This addresses the obligation for undertakings which fall under the Non-Financial Reporting Directive (and which are therefore required to disclose how/to what extent their activities are associated with environmentally sustainable economic activities) to publish information on how and to what extent their activities are associated with economic activities that qualify as environmentally sustainable under the Taxonomy Regulation. Broadly, the Non-Financial Reporting Directive applies to "large undertakings" (as defined by the EU Accounting Directive) which are "public-interest entities" (as defined in the same Directive), with more than 500 employees. There are, however, proposals to expand the scope to cover more companies and in some EU member states the Directive has already been applied more widely.

The draft advice covers the content, methodology and presentation of the three key performance indicators (turnover, capital expenditure and operating expenditure) to be used by non-financial undertakings under the Non-Financial Reporting Directive when making the disclosures required under Article 8.  It also includes advice on the content, methodology and presentation of those three key performance indicators for asset managers.  In both cases, it recommends that the disclosures should be provided in a standardised table. The final advice is to be provided by the end of February 2021.


Return to Funds Annual Briefing 2021.

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