Regulators continue to create new fund vehicles to offer more flexibility to fund management companies and investors, and to compete for market share. Authorities are also aiming to bolster private investment in illiquid assets to assist economic recovery. New vehicles and strategies are increasingly being made available to sophisticated and retail investors, enabling them to diversify their portfolios into wider asset classes. Regulators are keen, though, to mitigate potential conduct risks and prevent harm.
Amidst volatile markets, some regulators have been clarifying their expectations of fund managers regarding the inclusion of crypto-assets in portfolios. Many regulators remain cautious.
See below for more detail on:
Key questions for firms
Are we utilizing the full range of emerging products and fund structures to deliver investment strategies to investors?
If we plan to invest in alternative assets, do we understand the available regimes, existing requirements and proposed amendments?
Where we provide similar products in different jurisdictions, are we tailoring our disclosure sand distribution agreements?
Do we fully understand regulators' expectations regarding the inclusion of crypto-assets in our portfolios and the distribution of such products?
In the detail
New and enhanced products
Since last year's report, regulators have continued to make new fund vehicles available and to revisit existing frameworks.
The new Australian Corporate Collective Investment Vehicle (CCIV) became effective from July 2022, offering fund managers a new corporate structure with the possibility of establishing sub-funds to cater to retail or professional clients. The CCIV is designed to increase the competitiveness of the Australian asset management industry and is expected to appeal to overseas investors who are more familiar with a corporate vehicle. Regulations were also passed to facilitate the development of "Innovative Retirement Income Stream Products". The regulations provide the guiderails that need to be met to qualify for certain tax and social security treatment. Such products are said to be gaining traction.
The Securities Commission Malaysia (SCM) liberalized its framework for unit trusts, enabling retail funds to invest in and offer a wider range of investment instruments and activities, potentially enabling management companies to develop more innovative products. And in Mainland China, the Securities Regulatory Commission (CSRC) published new rules, standardizing the framework for public pension investments and allowing Chinese investors to purchase pension funds that meet certain eligibility and size criteria.
Amendments to the rules for Polish-domiciled ETFs1 are being considered as part of the implementation of the government's capital market development strategy. The intention is to enable Polish ETFs to be established as UCITS2, which raises challenges around admitting units of open-ended funds to trading.
In Brazil, it is proposed to increase the level of permitted leverage for funds with retail and qualified investors. Additionally, the proposals would allow retail investors to invest in funds that can invest 100 percent of their assets in Brazilian Depositary Receipts (BDRs) where the underlying securities or ETFs are traded abroad, and in other assets with certain restrictions. Currently, retail investors can only invest in BDRs directly and not through fund structures. The proposals would also increase by 20 percent the amount that funds can invest in offshore assets, up to 40 percent of NAV3 for retail investors and 60 percent for qualified investors. In a similar move, the South African Pension Funds Act was amended to enable them to increase investment in private assets up to 15 percent of total assets.
The rules for Italian “reserved” alternative investment funds (AIFs), which were intended mainly for professional investors, have been updated. The minimum initial investment was lowered from EUR 500,000 to EUR 100,000, provided the investor has received financial advice and their holding does not exceed 10 percent of their total financial portfolio. There have also been revisions to the regulations that govern Italian Individual Savings Plans (“piani individiali di risparmio” — PIRs) and to their tax treatment. For ordinary PIRs, the annual investment limit has increased from EUR 30,000 to EUR 40,000, and the maximum total investment from EUR 150,000 to EUR 200,000. The rules for “alternative” PIRs have been aligned more closely with those for ordinary PIRs, to allow investment in more than one alternative PIR and to make some adjustments to tax arrangements.
Allowing long-term and illiquid assets
Across jurisdictions there appears to be an increased appetite for mainstream asset managers to move into alternative assets.
The new Australian government has pledged to reduce barriers to superannuation investment in priority areas, including infrastructure, energy, manufacturing and housing to play a greater role in financing the real economy. In addition to the increase in the private assets limit mentioned above, proposed amendments to the South African Pension Funds Act encourage investments in infrastructure. As part of the changes, the definition of infrastructure was revised to align more closely with the UN principles for responsible investment. The existing limits on infrastructure investments were also reviewed, but the overall investment limit was kept at 45 percent of FUM4.
The new UK open-ended Long Term Asset Fund (LTAF) regime was launched in November 2021. LTAFs must be authorized, be at least 50 percent invested in illiquid assets, be valued at least once a month and have a minimum 90-day notice period for investor redemptions. Currently, LTAFs are available only to professional, sophisticated and high-net-worth investors, but the Financial Conduct Authority (FCA) is consulting on making these funds available to a broader subset of retail investors. In Switzerland, the planned Limited Qualified Investor Fund (L-QIF) regime is expected to be available for fund launches from April 2023. It will allow for the inclusion of various alternative assets for the first time.
The EU European Long-Term Investment Fund (ELTIF) regulation is under review. ELTIFs are closed-ended and can invest in long-term investments, such as social and transport infrastructure projects, and real estate. As of October 2021, only 57 ELTIFs had been launched, in only a handful of member states and with low FUM. Various rule changes have been proposed to broaden the scope of ELTIFs’ qualifying portfolio investments, allow more flexible investment rules, reduce “unjustified” barriers to entry for retail investors and to ease certain rules for professional-only ELTIFs. Members of the European Parliament are calling for the creation of a sub-category of ELTIFs to be marketed as environmentally sustainable (meeting stricter requirements and being aligned with the EU Taxonomy Regulation), and for the possibility of open-ended ELTIFs. In the meantime, individual countries are considering how best to optimize the regime, including consideration of national tax treatments.
As part of the review of the Alternative Investment Fund Managers Directive (AIFMD), there are discussions about EU rules for loan-originating funds. Such funds already exist in some member states, which are reviewing their national regimes, for example in Cyprus.
Crypto-assets and retail funds — yes or no?
Sentiment towards crypto-assets has changed. The volatility of crypto-asset markets has increased, and some types of crypto-asset have experienced significant challenges – for example, the collapse of a prominent stablecoin5 in May 2022. Although some ETFs referencing virtual assets continue to be approved and listed, regulators across the world have published warnings for retail investors regarding the risks involved in crypto-assets.
In February 2022, the Financial Stability Board (FSB) assessed risks to financial stability from crypto-assets. It found that while hedge funds are allocating increasing amounts to crypto-assets, mainstream asset managers’ interest remains limited. However, IOSCO’s6 2022 consultation report noted an “exponential increase” in retail interest in crypto-assets. Regulators are considering enhancing the emerging regulatory framework around the trading and settlement of crypto-assets to prevent fraud and enhance investor protection (see Chapter 3). This might increase managers’ and investors’ confidence in such assets.
Regulators are also considering asset managers’ involvement in crypto-assets, particularly regarding the ability for retail funds to invest in crypto-assets (or derivatives based on crypto-assets). There have been different approaches and responses to date. Most regulators remain cautious about allowing crypto-assets as eligible assets in retail funds, but some are allowing greater flexibility for funds promoted only to professional investors.
In September 2021, the Mainland Chinese authorities said they deemed cryptocurrency-related business to constitute illegal financial activities — a statement which impacted global crypto-asset prices. In Hong Kong (SAR), China, such business is not outlawed, but the regulator imposed additional investor protection measures on the distribution of crypto-asset products, including selling restrictions and a crypto-asset “knowledge test”.
In South Africa, the proposed amendments to the Pension Funds Act also included a new restriction on retirement funds investing in crypto-assets because of the high risks involved. The national treasury noted that this restriction would be consistent with an intergovernmental approach that does not permit collective investment schemes and pension funds to have exposure to crypto-assets.
In November 2021, the Luxembourg regulator (CSSF)7 noted that pension funds and UCITS for retail investors are not allowed to invest directly or indirectly in virtual assets, but that for funds for professional investors, investments in virtual assets “could be compatible” if this would not prevent compliance with existing rules. The CSSF also noted that managers of AIFs that invest in virtual assets must obtain prior authorization, provided guidance considerations regarding anti-money laundering and terrorist financing risks, and clarified that depositaries of such funds would need to comply with certain conditions. The Central Bank of Ireland (CBI) has permitted certain funds for professional investors to invest in listed cash-settled bitcoin futures. It also considered whether a UCITS can invest directly or indirectly in crypto-assets and concluded that it would be “highly unlikely” to approve such UCITS.
In December 2021, ESMA8 noted that the application of the EU AIFMD to fund managers investing in crypto-assets would need to be assessed on a case-by-case basis. ESMA reminded fund managers of the high risks involved in crypto-asset investments but stated that AIFs may in principle invest in any assets if the fund manager ensures compliance with AIFMD.
Regulators are also considering how funds can be made available to investors in a more streamlined way and reduce costs and inefficiencies. Increasingly, the industry is exploring solutions to “tokenize” funds using distributed ledger technology (DLT). The CSSF has clarified that service providers in Luxembourg may use DLT to maintain a fund’s unit/shareholder register. And in Germany, the finance ministry published a new law in 2021 (known as the “KryptoFav”) allowing for the possibility of issuing units of funds using DLT.
Factors to consider in the choice of fund vehicle
The SCM is committed to deepening the Islamic capital market in Malaysia through widening access to Shariah-compliant funding, instilling greater impetus for Islamic social finance and encouraging Islamic fintech growth. It has launched a Shariah Screening Assessment Toolkit for micro, small and medium-sized enterprises, to facilitate shariah-compliant financing, which must fall below the specified benchmark ratios for business activities, cash and debt.
Overseas funds — in or out?
Some authorities are open to overseas funds being marketed to investors in their jurisdiction, while others are considering new restrictions.
Switzerland is open to a wide range of investors and businesses, including the marketing of overseas funds in the country. For qualified investors and wealthy retail clients who have signed an opt-out declaration, no regulatory approval is required, but rules on designation and marketing apply. For wealthy retail clients, a Swiss-based representative and paying agent must also be appointed. Marketing to retail clients requires prior regulatory approval, which requires equivalent supervision (verifiable by means of bilateral agreement between the supervisory organizations), investor protection and documentation.
The CBI has revised its guidance on the requirements for non-EU AIFs that wish to market to retail investors in Ireland. It has clarified the information and documentation required, to assist fund managers with the application process. The provisions establishing the new UK Overseas Funds Regime (OFR) commenced in February 2022. The FCA is considering how the OFR will work in practice and will consult during 2022 on necessary amendments to its rulebook. The OFR will allow the UK to recognize other jurisdictions as having equivalent fund rules. Funds domiciled in those jurisdictions could then apply under a fast-track process to be permitted by the FCA to market to UK retail investors. In the meantime, the FCA has clarified that EEA funds will need to continue to produce current disclosures, rather than the new requirements being introduced by the EU in January 2023. As a result, there will be different requirements for EEA funds marketing in both jurisdictions.
To improve the cross-border distribution of products within the EU, ESMA consulted on templates to be used by firms when making notifications to regulators about cross border marketing and management activities. The goal is to develop common templates and to harmonize the information to be notified to regulators. On the other hand, there are moves to tighten the marketing of overseas funds to EU investors. The passports provided for under AIFMD, which would allow foreign managers to manage EU funds and overseas funds to be marked into the EU to professional investors, have not been enacted and there are no signs that they will be.
Moreover, the ability for EU professional investors to seek out investment in overseas funds on their own initiative (“reverse solicitation”) is also under scrutiny, with calls for national regulators to adopt a more consistent approach between member states. As a first stage, there may be calls for managers or investors to provide data on the extent to which reverse solicitation is used. A letter from ESMA to the European Commission highlights that most national regulators do not possess such data.
Chinese markets open and tighten
China continues to open its capital markets to both domestic and foreign firms and investors, but is also imposing restrictions. Some overseas-owned subsidiaries in China have been approved for the first time.
To deepen mutual stock market access between Mainland China and Hong Kong (SAR) (“Stock Connect”) and to promote the development of both capital markets, the CSRC and the Hong Kong Securities and Futures Commission (SFC) agreed in principle to the inclusion of eligible exchange-traded funds (ETFs) by Mainland China/Hong Kong exchanges in Stock Connect. Trading commenced in July 2022. The regulators have agreed arrangements for cross-boundary regulatory co-operation and investor education, and will enhance co-operation on enforcement against cross-boundary illegal activities and market misconduct. Ashley Alder, SFC Chief Executive Officer said that ETF Connect “will catalyse Hong Kong’s growth as an ETF hub and underscore Hong Kong’s unique role connecting global capital with the Mainland.”
According to public commentary, establishing “offshore” China funds has become one of the main channels for foreign investors to invest in underlying Chinese products. Such funds may invest in the Chinese market through Stock Connect, and through the Qualified Foreign Institutional Investor (QFII) regime, under which a wide range of financial transactions are permitted.
The Qualified Foreign Limited Partnership (QFLP) pilot program marks its tenth anniversary in 2022 and, together with the foreign direct investment (FDI) scheme, has become a major route for foreign institutions to access Chinese equity markets. Thirteen cities have established the QFLP pilot program, each with distinct characteristics that provide diverse options for foreign institutions. For domestic investors, the Qualified Domestic Limited Partnership (QDLP) — which permits qualified institutions to raise funds onshore to invest in offshore markets — also has its tenth anniversary in 2022. Along with the Qualified Domestic Institutional Investor (QDII) and Qualified Domestic Investment Enterprise (QDIE) schemes, it has become a major offshore asset allocation channel for domestic institutions and high-net worth individuals.
In January 2022, the State Administration of Foreign Exchange (SAFE) introduced a pilot program to facilitate further cross-border investment and financing activities in certain regions, highlighting the existing QFLP and QDLP pilot programs as important examples. Subsequently, the relevant regional bureaus of SAFE issued detailed implementation rules for the reform of foreign exchange administration and other relevant operational guidelines for the QFLP and QDLP pilot programs.
In a counter move, in December 2021, the CSRC proposed to exclude mainland China investors from the scope of “Stock Connect” between the Mainland China and Hong Kong (SAR) stock markets. The CSRC had noted that some Mainland China investors had opened securities accounts in Hong Kong (SAR) and traded A shares through Stock Connect (“Northbound Trading”). Although the overall scale and trading volume of Northbound Trading by mainland investors was not significant, such investors had also opened securities accounts to trade A shares directly within Mainland China, which the CSRC believed “may give rise to concerns of violations if trading through two channels concurrently”. The CSRC was also concerned that such “round tripping” may not be conducive to the stable operation and future development of Stock Connect. The amendments aimed to strengthen the regulation of cross-border securities trading, balance the needs for the opening-up and security of the financial sector, protect the legitimate rights and interests of mainland China investors, and maintain the stable operation of Stock Connect.
Around the globe, jurisdictions are competing for market share as fund and asset management domiciles. Many initiatives involve the consideration of funds for professional or sophisticated investors. They include various tax-related provisions to enhance the attractiveness of these jurisdictions to establish businesses or funds, but also regulatory changes to both rules and supervisory approach.
China, Hong Kong (SAR) and Singapore are competing for market share as portfolio management centers in the Asia Pacific region. In India, a new working group is reviewing the role and eligibility of mutual fund sponsors to facilitate growth and innovation in the industry. It is considering whether an alternative set of eligibility requirements may be introduced to enable new players to act as sponsor. The aims are to foster competition, to facilitate consolidation through mergers and acquisitions (to reap economies of scale and scope, to facilitate fresh flow of capital and to foster innovation).
The Malta Financial Services Authority (MFSA) consulted until January 2022 on Malta’s Asset Management Strategy, with the aim of strengthening the jurisdiction’s position as an asset management domicile. A broad range of initiatives is proposed, from improvements to the current regulatory regimes to new ones. For example, the proposal for “notified” professional investment funds will complement existing regimes and aims to increase the jurisdiction’s share of market growth with better time-to-market solutions.
The proposed strategy has four pillars:
- Supervisory lifecycle processes
- Revisiting current fund manager and collective investment scheme regulatory frameworks
- Innovation through regulation
- Regulatory outreach and collaboration efforts with industry stakeholders and internationally
The UK government has set out its responses to feedback on the UK funds regime and next steps. It will:
- Make the taxation of funds simpler and more efficient
- Expand the range of investment products available in the UK, including authorized fund structures that are permitted to distribute capital and a new unauthorized contractual scheme aimed at professional investors
- Explore opportunities to support the wider funds environment, including by providing additional information on the fund authorization process and by promoting the UK funds regime abroad.
Key topics captured within the report
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1 Exchange-traded funds
2 Undertaking for collective investment in transferable securities
3 Net asset value
4 Funds under management
5 Asset-backed crypto asset
6 International Organization of Securities Commissions
7 Commission de Surveillance du Secteur Financier
8 European Securities and Markets Authority