Regulatory outlook: what to expect in 2024?

Financial law has evolved a lot in the past decades with the rise of new topics, such as digital and sustainable finance, the creation of new vehicles and the recast of key pieces of regulation. In these kinds of scenarios, agility and adaptability are essential skills. In order to help market participants get ready for the upcoming changes, we have prepared this article addressing the key regulatory changes foreseen in 2024.

AIFMD II reaching the final steps

The proposal reviewing AIFMD and the UCITS Directive (the Review) is reaching the final steps of the legislative process. Its publication in the Official Journal is expected in Q1 2024. Member States will then have 24 months to transpose the Directive into their national law and it is expected to apply  from Q1 2026. Among the changes the Review brings, we would like to draw the industry’s attention to the upcoming changes impacting AIFMD provisions on delegation, liquidity management tools, loan origination, depositary and ancillary services.

(1) Delegation, authorization and reporting

The Review further details the information required when applying for AIFM authorization.1 In addition, it also requires AIFMs to provide detailed information regarding their delegation arrangements,2 such as:

• For each delegate, its legal name and relevant identifier, its jurisdiction of establishment,3 and, where relevant, its supervisory authority
• A detailed description of the human and technical resources employed by the AIFM for performing day-to-day portfolio or risk management tasks within the AIFM, and monitoring the delegated activity
• In respect of each of the AIFs it manages or intends to manage, a brief description of the delegated portfolio management functions and a brief description of the delegated risk management functions, including whether each such delegation amounts to a partial or full delegation
• A description of periodic due diligence measures to be carried out by the AIFM for monitoring the delegated activity

Delegation arrangements will also be in the scope of the reporting obligations4 to competent authorities. AIFMs will be required to report on, inter alia, the amount and percentage of the AIF’s assets which are subject to delegation arrangements concerning the portfolio management function.

(2) Liquidity Management Tools (LMTs)

The Review determines that an AIFM managing an open-ended AIF and UCITS management company  must select at least two LMTs, which must be suitable to the pursued investment strategy, the liquidity profile and the fund’s redemption policy. For money market funds, one LMT is sufficient. The allowed LMTs are the following:

• Suspension of redemptions and subscriptions 
• Redemption gate
• Extension of notice periods
• Redemption fee
• Swing pricing 
• Dual pricing
• Anti-dilution levy
• Redemptions in kind 
• Side pockets

Note that IFMs will have to implement detailed policies and procedures for the (de)activation of LMTs and that they will have to, without delay, notify the competent authorities of its home Member State:

• When an AIFM activates or deactivates the suspension of redemptions and subscriptions
• When activating or deactivating side pockets, in a reasonable timeframe prior to the activation or deactivation of that LMT
• When activating or deactivating any other LMT in a manner that is not in the ordinary course of business as envisaged in the fund rules or the instruments of incorporation of the AIF

(3) Loan-originating AIFs

The Review not only defines loan origination  and loan-origination AIF  but also determines that loan origination is a permitted activity for AIFMs. In addition, loan-origination AIFs will now benefit from the AIFM passport which will allow them to be marketed/distributed across the EU.  

The Review also specifies the requirements concerning risk and liquidity management. For instance, AIFMD II determines that, inter alia:

• In the context of risk management, effective policies, procedures and processes for the granting of credit and for assessing the credit risk and for administering and monitoring their credit portfolio must be implemented and reviewed on a regular basis 
• An AIFM must ensure that the notional value of the loans originated to any single borrower by that AIF does not exceed in aggregate 20% of the capital of the AIF where the borrower is a financial undertaking , an AIF or a UCITS
• The leverage cap, which will be at 175% for open-ended AIFs and at 300% for closed-ended AIFs
• Loan-originating AIFs must be closed-ended, unless the AIFM is able to demonstrate to the competent authorities of the AIFM's home Member State that the open-ended AIF's liquidity risk management system is compatible with its investment strategy and redemption policy

(4) Depositaries

Institutions established in another Member State will be allowed to be appointed as depositary, provided the following conditions are met:

• The competent authorities have received a motivation request by the AIFM to allow the appointment of a depositary in another Member State (note that the request must demonstrate the lack of the relevant depositary services in the home Member State of the AIF that are able to effectively meet the needs of the AIF with regard to its investment strategy), and
• The aggregate amount in the national depositary market of the home Member State of the AIF of assets safekept, on behalf of EU AIFs, authorized or registered under the applicable national law, and managed by an EU AIFM, does not exceed EUR 50 billion or the equivalent in any other currency

(5) Ancillary services

The list of ancillary services  has been extended to include the administration of benchmarks in accordance with the Benchmark Regulation  and credit servicing in accordance with of Directive (EU) 2021/2167.

AIFMD/UCITS Review key point

As part of the legislative process, in the beginning of October, the first report from the Committee on Economic and Monetary Affairs was published. The report proposes some key amendments, such as the deletion of provisions on benchmarks in the context of value for money and on the ban on inducements in execution-only environments, addressing some industry concerns.

As regards inducements, the rapporteur defends that conflicts of interest can be addressed by enhancing transparency and claims that the introduction of a partial ban might be a first step towards a full ban. 

The rapporteur has also proposed that the notion of “cost-efficiency” should be clarified and claimed that products that are offered to the consumers must be tailored to their specific needs and objectives, therefore not only the price but also the quality of the product should be considered.

Regarding value for money, the rapporteur is of the view that the proposal is not clear enough regarding the methodology to be applied to design the benchmarks. They propose to delete benchmarks, with the view that further discussions on value for money are needed in order to find the right and balanced approach.

PRIIPS Regulation Review

In the context of RIS, a proposal reviewing the PRIIPs Regulation has also been published. Among the key changes, the proposal provides for the amendment and creation of new sections in PRIIPs KID as you can see in the table below:

In the ECON Report, the rapporteur has also included some comments on this proposal. In this sense, in line with industry’s argument, they suggested the deletion of the section “Product at a glance” due to the fact that the content would be redundant , take up additional space in a document that is already very dense, and not concur to the simplification of PRIIPs KID.

The RIS and PRIIPs Review are expected to be published in the OJEU in mid-2024.

Sustainable Finance

2024 holds several changes to Sustainable Finance. From 1 January, the Corporate Sustainability Reporting Directive will start applying to companies that are currently under the scope of NFRD. Throughout the year, EFRAG is expected to publish some guidance and FAQs on the implementation of the first set of reporting standards. In addition, the adoption of sector-specific standards has been postponed15 to 2026. 

Concerning SFDR, in the beginning of the year, ESMA is expected to publish the final report on the SFDR RTS, which updates the pre-contractual and periodic disclosure templates, and which add some new PAIs (mainly social indicators). In addition, ESMA is consulting on the implementation of SFDR, raising questions regarding the possible creation of a labelling system, level of disclosure (whether SFDR is the right instrument to require entity-level disclosures) and the end of a default list of mandatory PAIs at the entity level. In case the consultation leads to a review of the Regulation, a proposal would only be published at the earliest in late 2024.

Regarding the use of ESG terms in fund names, a mandate to ESMA was included in the AIFMD review. In this sense, ESMA’s final Guidelines on fund names are expected to be published at the end of 2023/early 2024.

In the context of the EU Taxonomy, from 1 January 2024, non-financial and financial undertakings will have to report taxonomy eligibility for the new four environmental objectives, and financial undertakings will start disclosing the full KPIs on taxonomy-alignment under Article 8 of the Taxonomy Regulation Delegated Act.

Regulatory outlook summary

In this section, we will provide an overview of the main regulatory updates that happened in 2023 and those that are expected for the following years:

Capital Markets Union

UCITS VI/AIFMD II

AIFMD II will introduce a loan origination regime and will extend the list of ancillary services. Substance requirements will be harmonized. LMT will become mandatory for open-ended AIFs and new disclosures will be introduced on LMT, fees and costs. 

Luxembourg Fund Toolbox (Law of 21 July 2023)
The Law of 21 July 2023, inter alia, eases the ramp-up phase for funds raising capital on a commitment basis and offers an exemption of subscription tax for ELTIFs and PEPPs.

MiFID III/MiFIR II 
The review focuses on the consolidated tape, dark trading and the ban of compensations received by brokers for routing trades for execution to a particular market maker (PFOF). Targeted changes are expected on costs and charges, product governance and research unbundling requirements. 

ELTIF II
Rules on portfolio composition have been revised to enhance the attractiveness of the regime for promoters. Further flexibility is granted to ELTIFs solely marketed to professional investors. The retail regime will offer a tailor-made product for alternatives, safeguarding key protection features and allowing for semi open-ended structures.

Retail Investment Strategy

This omnibus directive proposal will amend, inter alia, MiFID II, IDD, the UCITS Directive and AIFMD. This proposal foresees a ban on inducements for execution-only services and extended value for money provisions, including an obligation for product manufacturers and distributors to assess their cost structures against benchmarks to be developed by ESMA.

CSDR Refit 
Mandatory buy-in regime is expected to be adapted. A (de minimis) threshold, below which cash penalties would not be applied given the significant operational cost of transfer, should be introduced. 

European Single Access Point (ESAP)
The ESAP will establish a central, public register of financial information, including sustainability-related information and the information already disclosed by market participants that are covered in other regulations and directives.

European Market Infrastructure Regulation III (EMIR III)

The EMIR Review aims to improve the attractiveness of EU CCPs. It provides rules on, inter alia, intragroup transactions, clearing obligation, active accounts, reporting requirements and authorization to provide clearing services and activities in non-financial instruments.

Sustainable Finance

SFDR

SFDR introduced disclosure requirements for financial institutions with regard to their sustainability performance. It does interact with the EU Taxonomy and has been complemented by delegated acts detailing pre-contractual, website and periodic report disclosures at the entity and product level. 

CSRD
CSRD standardizes the disclosure of non-financial information in management reports and extends the scope of the non-financial reporting directive (NFRD). Reporting requirements will be applicable to non-EU companies with a substantial activity in the EU or which have a subsidiary or a branch in the EU. Companies will be expected to have their sustainability information subject to third-party assurance and disclosed in a machine-readable format. 

EFRAG ESRS
The first set of sustainability reporting standards specifies the minimum level of non-financial disclosures to understand companies’ impacts on sustainability matters and how sustainability matters affect the companies’ development, performance and position. 

EU Taxonomy
The EU Taxonomy Regulation defines the minimum criteria which economic activities must comply with in order to be considered as environmentally sustainable. An environmentally sustainable economic activity must contribute substantially to one or more of the six environmental objectives, must not significantly harm any of the other environmental objectives, must be carried out in compliance with minimum safeguards set out in the regulation and must comply with the TSCs developed for each activity and objective. 

ESG Ratings
This Regulation will introduce a common regulatory approach to enhance the integrity, transparency, responsibility, good governance, and independence of ESG rating activities.

Green Bonds Regulation
It lays down uniform requirements for issuers of bonds that wish to use the designation of European green bond for their environmentally sustainable bonds, establishes a registration system and supervisory framework for external reviewers of European green bonds, and provides for some voluntary disclosure requirements for other environmentally sustainable bonds and sustainability-linked bonds issued in the EU.

ESMA’s Guidelines on fund names
ESMA’s Guidelines on the use of ESG or sustainability-related terms in fund names are expected to introduce a minimum percentage of contributing, sustainable or taxonomy-aligned investment for funds using certain keywords in their names.

Digital Finance

DLT Pilot Regime

The DLT Pilot Regime introduces three categories of DLT market infrastructures (DLT Multilateral Trading Facilities, DLT Trading and Settlement Systems and DLT Settlement Systems) which can request limited exemptions from specific requirements in EU legislation (MiFID II, CSDR), provided they comply with specific conditions and compensatory measures requested by the relevant NCA. Permissions are granted for a period of up to six years and aim at developing the trading and settlement of tokenized securities. 

The Law of 15 March 2023 amends the Law of 5 April 1993 on the financial sector, the Law of 5 August 2005 on financial collateral arrangements and the Law of 30 May 2018 on markets in financial instruments to enable temporary exemptions provided in the DLT Pilot Regime Regulation. 

DORA
The Digital Operational Resilience Act enables a comprehensive framework at the EU level with consistent rules addressing the digital operational resilience needs of all regulated financial entities. Rules cover existing typical requirements on ICT governance and ICT risk management, ICT-related incident reporting, digital testing, information sharing and management of ICT third-party risks as well as supervisory tools. 

MiCAR
The Regulation on Markets in Crypto-Assets (MiCAR) introduces a comprehensive framework for crypto-assets, crypto-assets issuers and service providers. A proportionate set of rules will apply to the issuance of asset-referenced tokens, e-money tokens and other crypto-assets. The different types of service providers will be subject to tailored capital requirements, rules of organization and rules of conduct.

Documentation, AML and other topics

Packaged Retail and Insurance-based Investment Products Key Information Document (PRIIPs KID)

Since 1 January 2023, UCITS have required a PRIIPs KID when marketing to retail investors. In the context of the Retail Investor Strategy, a proposal aiming to review the PRIIPs Regulation has been published. 

CSSF Circular 02/77
The CSSF Circular 02/77 which covers NAV calculation errors is expected to be reviewed in 2024. The new Circular should clarify further requirements applicable in the case of NAV calculation errors, breaches of investment compliance rules and should specify rules in case of errors in fee payments. 

AML Package
The AML Package contains four different proposals aimed at strengthening the European AML/CTF rules. The proposals will cover, inter alia, direct rules on customer due diligence and beneficial ownership, a limit to large cash payments, the traceability of crypto-asset transfers and the establishment of a European AML Authority.

Regulation on information accompanying transfers of funds and certain crypto-assets (TFR)
The TFR requires crypto-asset service providers (CASPs) to ensure traceability of crypto-asset transfers through submission of information on the transaction’s originator and beneficiary.

Footnotes: 
[1] For instance, the text specifies that Member States should require the following information on the persons effectively conducting the business of the AIFM:
(i) A description of their role, title and level of seniority
(ii) A description of their reporting lines and responsibilities in the AIFM and outside the AIFM
(iii) An overview of the time each of those persons allocates to each responsibility
(iv) A description of the technical and human resources that support their activities

[2] These provisions will also apply to UCITS management companies.

[3] The original proposal required competent authorities to notify all the delegations of AIFMs which delegate more portfolio or risk management functions to entities located in third countries than they retain to ESMA annually. This provision has been deleted from the final text.

[4] These provisions will also apply to UCITS management companies..

[5]   UCITS management companies are not allowed to select only swing pricing and dual pricing.

[6] An AIFM that manages an open-ended AIF may, in the interest of AIF investors, temporarily suspend the repurchase or redemption of the AIF units or shares or, where those tools are included in the AIF's rules or instruments of incorporation, activate or deactivate other liquidity management tools. The AIFM may also, in the interest of AIF investors, activate side pockets.

[7] Redemption in kind can only be activated to meet redemptions requested by professional investors and if the redemption in kind corresponds to a pro rata share of the assets held by the AIF.

[8] An AIFM may only use suspensions or side pockets in exceptional cases where circumstances so require and where justified having regard to the interests of the AIF investors.

[9] The granting of a loan directly by an AIF as the original lender or indirectly through a third party or special purpose vehicle, which originates a loan for or on behalf of the AIF, or for or on behalf of AIFM in respect of the AIF, where the AIFM or AIF is involved in structuring the loan, or defining or pre-agreeing its characteristics, prior to gaining exposure to the loan.

[10] An AIF whose investment strategy is mainly to originate loans or where the notional value of the AIF’s originated loans represents at least 50 % of its net asset value.

[11] Financial undertaking means any of the following entities:
(a) A credit institution, a financial institution or an ancillary banking services undertaking within the meaning of Article 4(1), (5) and (21) of Directive 2006/48/EC respectively
(b) An insurance undertaking, or a reinsurance undertaking or an insurance holding company within the meaning of Article 212(1)(f)
(c) An investment firm or a financial institution within the meaning of Article 4(1)(1) of Directive 2004/39/EC; or
(d) A mixed financial holding company within the meaning of Article 2(15) of Directive 2002/87/EC

[12] For UCITS management companies the list of ancillary activities has been extended by adding: 
- To non-core services : (iii) reception and transmission of orders in relation to financial instruments; (iv) any other function or activity which is already provided by the management company in relation to a UCITS that it manages in accordance with this Article, or in relation to services that it provides in accordance with this paragraph, provided that any potential conflict of interest created by the provision of that function or activity to other parties is appropriately managed
- Administration of benchmarks in accordance with the Benchmark Regulation

[13] Regulation (EU) 2016/1011 of the European Parliament and of the Council of 8 June 2016 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds, as amended.

[14] Directive (EU) 2021/2167 of the European Parliament and of the Council of 24 November 2021 on credit servicers and credit purchasers.

[15] To see more details on the postponement, please refer to the flash news CSRD: new date for the sector-specific reporting standards.