Private funds radar - December 2023

Our Private Capital Advisory team have published their insights on key themes and developments from the SuperReturn North American and Private Credit US 2023 conference, including:

• private debt managers reported the 2023 vintage as the “Goldilocks” market conditions of high interest rates and low signs of distress;
• fundraising is down but projected to return to a growth trajectory from 2025;
• there is an increasing interest in differentiated strategies, including specialty and asset-based;
• lower M&A deal volumes have contributed to an increase in discussions on non-sponsored lending, with the potential for higher margins to be achieved by such deals; and

the tougher fundraising environment is fuelling the secondaries market in which GPs looking for liquidity and those with secondaries strategies may find opportunities.

On 20 June 2023, the New York State Legislature passed the New York LLC Transparency Act which, if signed into law by Governor Kathy Hochul will create the first public database of the beneficial owners of limited liability companies.

The federal Corporate Transparency Act will begin implementation on 1st January 2024, and requires corporations and LLCs to make a filing to identify their beneficial owners. Like the New York law, it is intended to target the use of corporates in money laundering and other criminal activities. However there is no public access to the filings under the federal law. By contrast, if entered into law either by the signature of the governor or by a two-third majority vote of both houses of the New York State Legislation, the New York law will make the names and business addresses of limited liability companies established in the state of New York freely available to the public through an online database.

On 16 October 2023, the Securities and Exchange Commission Division of Examinations released its 2024 examination priorities. The Division of Examinations prioritizes examinations where it considers there to be and increased risk to investors and/or the integrity of the US capital markets.

The examination priorities for 2024 include:

• investment advisers’ adherence to their duty of care and duty of loyalty to clients, in particular in relation to: (i) complex products such as derivatives and ETFs; (ii) high cost and illiquid products such as REITs; and (iii) unconventional strategies that purport to address rising interest rates;
• registered investment companies’ compliance programs and fund governance practices, disclosures to investors and accuracy of reporting to the SEC; and
• broker-dealers’ recommendations to customers including: (i) recommendations of products, strategies and account types; (ii) conflict of interest disclosures; (iii) mitigation of conflicts; (iv) processes for reviewing reasonably available alternatives; and (v) how individuals’ investment goals and account characteristics are factored into recommendations.

On 25 September 2023, PitchBook published their Global Private Debt Report on activity in the private capital markets.

Key points, as further described in our analysis note, include:

• continued interest in private debt strategies, with commitments expected to be above $200bn in 2023, which would be the fourth year in a row;
• private debt strategies consistently outperforming other private market strategies and the S&P 500. PitchBook’s final estimate of fund performance is that private debt funds returned 4.2% in H1 2023;
• retain fundraising slowed in H1 2023 but continues to be important, with an estimated $16.6bn being committed over the period and a significant increase in the number of product launches; and
• whilst certain strategies are preferred options in certain sectors, there is a clear diversity of strategy across the top private debt funds closed in H1 2023, with direct lending accounting for 32% and mezzanine funds 27.9%.

On 11 September 2023, the chair of the FCA gave a speech setting out the regulator’s approach to the reform of the UK’s asset management regulatory regime, focusing on a “smart approach to proportionality”. The initial aims are:

• to make AIFMD more proportionate by moving to a single set of rules that are applied “proportionately depending on the nature and scale of a firm’s business”;
• to simplify the rules when an AIF, such as a NURS is solely marketed to retail investors; and
• to continue work on the tokenisation of funds alongside the Treasury’s Asset Management Taskforce, to support asset managers’ use of distributed ledger technology.

In addition, the speech emphasised the creation of the Long-Term Asset Fund and other activities to channel domestic savings into growth-building activities in the UK; upcoming changes to the financial advice/guidance boundary; and the scrapping of the PRIIPs legislation and replacement with a new principles-based Retail Disclosure Regime.

On 28 November 2023, the FCA published its SDR final rules alongside draft guidance on anti-greenwashing. The FCA has retained the broad framework set out in the consultation paper published in October 2022, but has sought to address almost all of the areas of concern raised by Macfarlanes and other respondents.

Broadly, the FCA has introduced more flexibility and practicality into the regime to account for current market approaches, such as in relation to the fund labels and naming and marketing rules, while also tightening certain rules to prevent greenwashing, such as requiring all labelled funds to have a minimum of 70% of assets that align with the fund’s sustainability objective.

The FCA have given firms sufficient time to comply with the SDR, with the first part, the anti-greenwashing rule, to take effect from 31 May 2024 (subject to further consultation on guidance) and a staggered implementation of the subsequent requirements. Most importantly, firms can begin to use the fund labels from 31 July 2024.

However, there are areas where the industry still needs clarification. It is not yet clear how and whether the SDR will apply to overseas funds, portfolio management, and pensions products, although there will be consultations on these topics.

The FCA has attempted to map its labels against the current EU SFDR, but notes that the EU’s regime is subject to change with the possible introduction of a fund labelling regime. As first mover, the FCA says that it “stand[s] ready to work with the EU authorities on this important issue”.

Some of the main changes as compared to the initial consultation are:

• the introduction of a new fourth fund label, “Sustainability Mixed Goals”, an intermediate category that will allow managers to blend the other SDR labels if the fund meets the minimum criteria for each label.
• all fund labels will be required to hold a minimum of 70% of the fund’s assets that align with the fund’s sustainability objectives.
• the labels have become more flexible:
  • the Sustainability Label no longer requires managers to demonstrate a causal link between their stewardship activities and the fund’s improvement of its assets;
  • the Sustainability Impact label will not require firms to demonstrate “financial additionality” through the deployment of new capital, but may contribute to positive impact through a range of investment activities; the Sustainability; and
  • managers may now apply the Sustainability Focus label by complying with internal frameworks, subject to an independent assessment, and not only with reference to external third-party frameworks.
• the naming and marketing rules have become less restrictive to allow firms to use sustainability terms subject to specified conditions.
• firms that do not have any funds with labels will still be required to produce disclosures, but must also include an explicit statement that the manager has no funds labelled under the SDR; and
• applicability to overseas funds will be subject to further consultation, but managers must still produce a warning for investors. The final rules require a statement that a fund is not “UK” authorised, rather than “FCA” authorised per the draft rules which might confuse some investors.

Prior to the release of the SDR final rules, the FCA released its review of asset managers’ adherence to its “Guiding Principles” for ESG and sustainable investment funds, which found that firms still had further to go to meet their expectations, in particular concerning the clarity of information given to retail investors and consumers in relation to such funds.

We will be producing a detailed note summarising the SDR in due course and look forward to continuing the conversation with you on this topic.

The UK government has confirmed the revised rules concerning making financial promotions in reliance on exemptions for high net worth individuals (HNWI) and self-certified sophisticated investors.

The Financial Promotion Restriction in the Financial Services and Markets Act 2000 (FSMA) makes it a criminal offence for a firm which is not authorised under FSMA to make a financial promotion unless its content is approved by an authorised firm, or an exemption under the FSMA (Financial Promotion) Order 2005 is relied upon. Authorised firms are restricted from issuing financial promotions in relation to unregulated collective investment schemes unless they are doing so in accordance with certain FCA rules or relying on an exemption under the FSMA (Promotion of Collective Investment Schemes) (Exemptions) Order 2001. Both authorised and unauthorised firms may rely on such exemptions to make financial promotions to HNWI and self-certified sophisticated investors in relation to investments in unlisted companies.

The changes to rules governing the exemptions, which will apply to financial promotions made after 31 January 2024, include:

• updates to the qualifying criteria for the HNWI and self-certified sophisticated investor exemptions;
• a new requirement for businesses to provide identifying details in any communications made using the exemptions (i.e. company address, contact information and registration details); and
• updates to the prescribed form of investor statements for HNWI and self-certified sophisticated investors.

We set out the changes to the rules in more detail in our analysis note, and describe the key matters that firms should be considering now in preparation for the change.

The Chancery Division of the High Court has declined to grant summary judgment against a claimant acting as general partner of a limited partnership after its dissolution.

Frontiers Capital I Limited Partnership (the Partnership), acting by Frontiers Capital General Partner Limited (the GP), is seeking the defendant, Mr Thomas Flohr, to account for profits and/or be granted damages or equitable compensation in relation to losses suffered by the Partnership in relation to a joint venture entered into between the parties. The defendant sought summary judgment striking out the claim, on the basis that the GP does not have standing to act on behalf of the Partnership since the Partnership has already been dissolved, and that the bringing of the claim is not necessary to wind up the affairs of the Partnership.

The High Court held that the claimant had more than a fanciful prospect of establishing that the Partnership was dissolved in a manner that would permit the GP still to act in its behalf in accordance with the terms of the limited partnership agreement. The court will determine whether the claimant does have standing, on the facts of the case, at a later date.

Section 38 of the Partnership Act 1890 permits partners to bind the other partners after dissolution of the partnership only “so far as may be necessary to wind up the affairs of the partnership”. This is the first case to consider this provision in the context of a cause of action (as opposed to a transaction which began but was not finished at the time of dissolution). Referring to Australian authorities, the High Court held that section 38 permits doing “what is reasonably required in order to get in and wind up the affairs of the partnership”, and this would include bringing a claim against a third party on behalf of the partnership in relation to a cause of action arising its before dissolution, even if the person winding up the partnership mistakenly believes that it has been completed. Accordingly, the court declined to strike out the claim on the basis that section 38 does not permit the bringing of the proceedings.

The Economic Crime and Corporate Transparency Act, which reforms Companies House and aims to improve UK company transparency with a view to reducing economic crime received Royal Asset on 26 October 2023.

Our note in October 2022 set out the key implications for UK limited partnerships, and we have now published an update setting out the changes to limited partnership law imposed by the final Act, which include:

• disclosure of significantly more information in respect of each proposed general partner and limited partner than is currently required;
• the requirement that both the general partner and each corporate managing officer must themselves identify at least one managing officer who is a natural person. The identity of the registered officer of the general partner must be verified;
• having a registered office which is an “appropriate address” within the UK and an “appropriate email address” where emails sent to it by the registrar of companies would be expected to come to the attention of a person acting on behalf of the partnership;
• a new requirement for an annual filing by the general partner to the registrar confirming any notices required where certain requirements under the act have not been met;
• a power of HMRC to require the general partner to prepare audited accounts of the partnership in such for as HMRC may require;
• prohibition on general partners who are disqualified under the directors disqualification legislation from continuing to act as general partners;
• new notification obligations on the general partner in relation to certain changes to the partnership;
• obligations on limited partners to (i) provide the general partner with the information required to be filed with the registrar; (ii) take all reasonable steps to ensure that the partnership’s affairs are wound up by a person who is not a limited partner, if the partnership has no general partner which is solvent and not disqualified at that time; and
• both the general partner and each limited partner being prohibited from using or disclosing protected residential address information and from making false statements to the registrar.

On 12 October 2023, the Court of Appeal upheld the decisions of the Upper Tribunal and the First Tier Tribunal, rejecting an appeal from BCM Cayman LP and BlueCrest Capital Management Cayman Limited.

In the course of determining the entity liable for corporation tax on allocations of profit, the Court considered whether partners in a Cayman LP became partners in an English LP when the Cayman LP acquired an interest in an English LP. The Court of Appeal concurred with the Upper and First Tier Tribunals, that there was no legal principle that operated to make the corporate limited partner of the Cayman LP a partner in the English LP merely because of the partnership interest in it that the Cayman LP held.

On 31 October 2023 INREV, the European Association for Investors in Non-Listed Real Estate, published an updated version of its Due Diligence Questionnaire (DDQ) for real estate debt and fund of fund managers, to bring it in line with the standard real estate DDQ which was updated earlier in 2023. Through the DDQs, INREV aims to introduce a standardised due diligence process to assist investors to easily access vehicle and investment manager information. Key changes to the DDQ include:

• a new section to gather detailed information on funds’ ESG strategy, and disclosures made under SFDR;
• a new question concerning the extent to which AML processes are integrated into investment decision-making; and
• new questions regarding firms’ IT solutions and strategy.

On 24 November 2023, the Investment Association (the IA) published the Interim Report on UK fund tokenisation from the Technology Working Group to the Asset Management Taskforce.

The Report considers how the application of “distributed ledger technology through fund tokenisation [can] present a strategic opportunity to improve efficiency, transparency, and the international competitiveness of the UK’s investment sector”.

The IA’s Technology Working Group sets out a long-term vision for three registers using distributed ledger technology of end investors, primary market investors and of securities making up a fund's portfolio. An initial “stage one” is recommended, that does not require legislative or regulatory changes, which can be considered in the future to foster innovation across the investment management industry. At this stage, the blockchain would primarily be used to act as the fund register, for an authorised fund holding traditional assets.

The Working Group noted the importance of industry involvement in development future stages of fund tokenisation, alongside the FCA and in particular the HMT which announced its plans to create the UK Digital Securities Sandbox in 2023 to enable new technologies to be tested and adopted across financial markets.

On 30 November 2023, the FCA published its updated Regulatory Initiatives Grid. Developments to note include:

• the FCA is undertaking engagement on the property fund notice period rules now through to mid-2024;
• the Government will work on a new Reserved Investor Fund (an Authorised Contract Scheme for onshore professional investors);
• the FCA will continue work on fund tokenisation through to Q3 next year; and

The FCA will consult on its investment research reforms in Q1 2024 and make rules in H1 2024.

On 10 November 2023, the “final text” of the amending directive (AIFMD II) on the amendment of Directive 2011/61/EU on alternative investment fund managers (AIFMD).

Earlier this year, we published a note setting out the main areas of interest for AIFMs based on the draft, which we now supplement with a summary of the key changes to the final text, which we hope will be helpful to readers. The substantive changes to the final text include:

• an indication that indirect loan origination activities via a third party or special purpose vehicle would fall in scope of the new regime on Loan Origination Funds, as well as those loans which are directly created and granted by the fund;
• confirmation that the European Commission will be responsible for determining the form and content of supervisory reporting the templates for and frequency of reporting. ESMA will develop draft rules which the Commission can amend and/or adopt; and
• strengthening of ESMA’s role in reviewing and reporting on delegation arrangements.

Next, ESMA will produce level 2 rules on liquidity management by open-ended AIFs that originate loans, supervisory reporting content and processes, guidelines for regulators on initiating or ending the suspension of a fund and fund naming conventions, and will publish a report analysing market practices on delegation, substance requirements and compliance with the EU’s delegation rules.

We draw readers’ attention to this helpful summary of regulatory updates to European Long-Term Investment Funds (ELTIFs) during 2023.

The ELTIF wrapper permits retain investors to access closed-ended funds and less liquid assets classes which are generally only available to institutional investors. In 2023, updates to the ELTIF regulation permit a wider range of investments permitted to be held by an ELTIF, including simple, transparent and standardised securitisations, and reducing the minimum percentage that must be held in illiquid assets.

It is hope that the increased flexibility introduced to the ELTIF regulation will enhance uptake of the use of the ELTIF structure.

On 5 October 2023, ESMA launched a second consultation on the Markets in Crypto-Assets Regulation, inviting submissions on rules covering:

• sustainability indicators for distributed ledgers;
• disclosures of inside information;
• technical requirements for white papers;
• trade transparency measures; and
• record-keeping and business continuity requirements for crypto-asset service providers.

The consultation will close on 14 December 2023, and ESMA is expected to publish a final report and the draft RTS during H1 2024.

On 27 November 2023, the Jersey Financial Services Commission (JFSC) has announced that its first thematic examination for 2024 will be politically exposed persons.

Examination will commence in January 2024, and the JFSC notify the supervised persons that have been selected for examination soon. The JFSC will review the supervised persons’ adherence to their obligations in relation to politically exposed persons, including the implementation of measures to prevent the misuse of products and services by such persons, and procedures to detect potential abuse, apply enhanced due diligence measures, and enhanced ongoing monitoring.

On 27 October 2023, the Financial Action Task Force (FATF) removed the Cayman Islands increased monitoring list (the Grey List).

FATF affirmed that the Cayman Islands has addressed the strategic deficiencies that were identified in its anti-money laundering regime in February 2021, including:

• applying sanctions that are effective, proportionate and dissuasive;
• imposing adequate and effective sanctions where relevant parties do not file adequate and accurate beneficial ownership information; and
• demonstrating that they are prosecuting all types of money laundering.