Funds Annual Briefing 2020 - Recap: what you may have missed

The Institutional Limited Partners Association ("ILPA") has published its first model limited partnership agreement (the "Model LPA"), based on ILPA Principles 3.0. The agreement applies to Delaware law-based partnerships offering "whole of fund" waterfall arrangements and can be used for traditional private equity buyout funds. Sections of the document can also potentially be inserted into existing LPAs upon agreement of the parties.

Additional versions of the Model LPA, including one based on a "deal-by-deal" waterfall, are planned for the future.

In June 2019, the Institutional Limited Partners Association ("ILPA") has released an updated version (version 3.0) of its private equity principles, setting out recommendations for private equity fund best practices and principles ("ILPA Principles 3.0" or the "Principles"), which are available on ILPA's website. The aim of the Principles is to encourage discussions between limited partners ("LPs") and general partners ("GPs") of private equity funds regarding key terms applicable to such funds.

The updated Principles are far more detailed than previous iterations and address a number of new and emerging issues (some through incorporation of separate ILPA publications), including co-investments, ESG integration, GP-led secondary transactions and conflicts of interest arising from parallel vehicles and cross-fund investments, as well as expanding and clarifying existing guidance.

One particular point of interest is in relation to clawbacks. ILPA states that clawbacks should, ideally, be paid gross, rather than net, and paid back no later than two years following recognition of the liability. This marks a departure from previous guidance and from current market norms. The first version of the principles stated clawback amounts should be gross of taxes paid, but this was switched to a net-of-tax recommendation for version 2.0 following feedback from GPs. ILPA does go on to say that where it is excessively burdensome or impractical to require clawback gross of tax, the hypothetical marginal tax rates applied in calculating clawbacks on a net basis should reflect the actual marginal rate that would apply to the individual members of the GP impacted.

Whilst adherence to the Principles is not required (with the Principles stating that they are not to be treated as a compliance checklist, as each fund should be considered separately and holistically), they nevertheless indicate LP's preferred approach to key fund provisions. As such, GPs and LPs alike should familiarise themselves with the ILPA Principles 3.0 and GPs should be aware that LPs may require explanatory information where a GP intends to deviate from the Principles.

In April 2019, ILPA published its first set of recommendations for LPs and GPs to consider when participating in a GP-led secondary fund restructuring, "GP-led Secondary Fund Restructurings: Considerations for General and Limited Partners" (the "ILPA Secondaries Guidance" or the "Guidance") (a summary of which is contained in the ILPA Principles 3.0). The guidance was published in response to the increasing prevalence of GP-led secondary transactions which has been raising questions for many LPs. The aim of the guidance is to encourage productive dialogue and foster more informed decision-making by LPs.

The ILPA Secondaries Guidance covers the following key areas:

• LP engagement and the role of the LP Advisory Committee ("LPAC"); the Guidance envisages an enhanced oversight role for the LPAC on GP-led secondary transactions, both before the process is launched to LPs and during its negotiation. GPs should engage the LPAC as the forum for driving the transaction and clearing issues. LPAC members whose organisations are participating in the transaction as bidders should disclose their interest and recuse themselves from formal deliberations, voting on the transaction and/or waiving any conflicts of interest;
  
  
• Adequate disclosure of information; the Guidance includes a list of disclosures the GP should make to the LPAC and to LPs and the timing of such disclosures;
  
  
• Key terms; GPs should provide existing LPs with a 'status quo' option in which an LP can elect to roll over its fund interest from the existing fund into the new fund with no change in economic terms. Where an LP does not respond to an election from the GP in relation to the GP-led restructuring, the election for such LP should be treated as an election to participate in the new fund with no change in economic terms (rather than being treated as an election to sell). Where there is follow-on capital in the new fund, LPs who have elected to roll into the new fund should not be compelled to make follow-on capital available and any resulting dilution of existing LPs should be effected on a fair and reasonable basis;
  
  
• Allocation of fees and expenses; allocation of transaction expenses should be disclosed in full and allocated according to which parties will benefit from the proposed transaction;
  
  
• The role of third-party advisors; the Guidance includes guidance in relation to the appointment of financial advisors by GPs, independent advisors appointed by the LPAC and independent fairness opinion providers appointed by selling LPs;
  
  
• Steps for LPs to take when engaging in a GP-led process; the Guidance suggests certain internal protocols that existing LPs should adopt when asked to participate in a transaction of this type.

Given the highly unique nature of these transactions and broad range in the scope of deals, ILPA states that its Guidance may not be universally appropriate or applicable to every circumstance.

The Law Society and the City of London Law Society have published a jointly produced series of Q&As regarding the PSC regime. The Q&As aim to highlight particular complexities that are not specifically addressed by either the legislation governing the PSC regime or the associated BEIS guidance.

Whilst English limited partnerships are not within the scope of the PSC regime, the Q&As include some useful, technical guidance relating to how the PSC rules apply to investment managers, GPs and LPs within limited partnership fund structures; including (i) where management rights in relation to an investment in a UK company, which are held by the general partner, have been delegated to an investment manager, the Q&A considers whether either, or both, the general partner and the investment manager be registered on the PSC register; (ii) the interpretation of the PSC legislation with regards to limited partners; whether the interests of multiple funds with the same manager/general partner should be aggregated for the purposes of the rules.

In December 2019, the 12^th edition of the annual report by PERG, the Private Equity Reporting Group, the body set-up in 2008 to monitor openness and transparency in the private equity industry and measure compliance with the Walker Guidelines, was published. Each year, a sample of approximately a third of portfolio companies that fall within the scope of the guidelines are reviewed for compliance with the disclosure requirements.

The 2019 report contains the results of a review of 55 portfolio companies that fall within the scope of the guidelines and the 47 private equity firms (including those operating in a private equity-like manner) that back them.

The key findings of the 2019 report are:

• 100% compliance against disclosure requirements in the sample of portfolio company annual reports reviewed (2018: 100%).
  
  
• 53% of the sample reviewed achieved at least a good rating, down from 73% in 2018, though one company produced excellent disclosures (2018: none).
  
  
• 80% of portfolio companies have published an annual report in a timely manner on their website (2018: 81%). 68% of portfolio companies published a mid-year update on their websites in a timely manner (2018: 74%).

Alongside the annual report, the PERG and PwC published the latest version of the Good Practice Reporting Guide for portfolio companies. The guide has been updated following a review of portfolio company disclosures in 2019 and highlights examples of good practice in order to aid portfolio companies with their narrative reporting in the following year.

In May 2019, the Cost Transparency Initiative ("CTI") published templates and tools for instituional investors to receive standardised cost and charges information to institutional investors from asset managers. The new templates can be used by institutional investors to access and assess critical information on costs. This gives investors clear expectations for standardised disclosure and should allow comparison of charges between providers.

The main account template covers the majority of assets and product types. It can also collect data in one place from other sub templates, for specific asset classes. The private equity sub-template (which can be used together with the main account template or as a standalone) is a sub-template aimed at specific types of investment. It may also be used for private debt where appropriate. Along with the templates, CTI has also published guidance for pension schemes and their advisers on how to make use of cost information, and for asset managers on how to provide cost information to their clients. The CTI says that the format of the templates is for illustrative purposes only and that institutional investors should discuss with their managers/consultants/investment advisers what format they want.

The CTI is an independent group working to improve cost transparency for institutional investors with the responsibility for progressing the work already undertaken by the Institutional Disclosure Working Group ("IDWG"). The CTI is supported by Pensions and Lifetime Savings Association, Investment Association and Local Government Pension Scheme Advisory Board. The IDWG was set up to support consistent and standardised disclosure of costs and charges to institutional investors.

The new templates have been welcomed by the FCA, although it makes the point that they have not been specifically on creating a method of delivering compliance with MiFID and other requirements.

The Prospectus Regulation is now in force and replaces the previous regime in its entirety. Whilst the new regime feels familiar, there are a number of new provisions and, in the case of the prospectus' risk factors and summary sections, a wholly new approach has been taken.

Some key points relating to the new regime include:

• All of the provisions of the Prospectus Regulation have come into effect. In the UK, the FCA has incorporated the regulation’s provisions in a new ‘Prospectus Regulation Rules’ chapter of the FCA Handbook;
  
  
• The summary section of a prospectus must now be in a Q&A format, limited to seven sides of paper. Where a comprehension alert is required under the PRIIPs Regulation in the fund's KID, the same alert must be included in the prospectus summary;
  
  
• Issuers, in conjunction with their sponsors and advisers, will need to conduct an internal assessment to identify the most material risk factors. Issuers should be prepared for competent authorities to raise more queries in relation to the risk factors section;
  
  
• The Annexes detailing the specific content requirements of a prospectus have been rewritten, although there are not many substantive differences; and
  
  
• Reduced disclosure regimes have been introduced for secondary issues and, for frequent issuers, by way of a Universal Registration Document. It is not expected these will be frequently used.

It is important to note that certain ESMA guidance is still relevant. In July 2019, ESMA published a consultation on the draft guidelines on disclosure requirements under the Prospectus Regulation. The draft guidelines apply to competent authorities and market participants and aim to help market participants comply with the disclosure requirements set out in the Delegated Regulation on the format, content, scrutiny and approval of prospectuses and to enhance consistency across member states in the way the annexes to the Commission Delegated Regulation are interpreted. The content of the draft guidelines generally follows the content of the CESR recommendations. The consultation closed in October 2019. ESMA expects to publish a final report containing a summary of all consultation responses and a final version of the guidelines in Q2 2020.

In October 2019, ESMA published the final version of its guidelines for competent authorities relating to risk factors (in materially the same form as previously published in draft form in March). The guidelines have applied since 1 December 2019.

New ESMA Q&As have also been introduced and ESMA published an updated version of its old Prospective Directive Q&As in July 2019 where certain Q&As were added, removed and/or updated. ESMA will continue to analyse the Q&As in relation to the Prospectus Directive to determine whether to update and carry them forward or not.

A detailed analysis of how the Prospectus Regulation applies to investment funds can be found in our Briefing published earlier this year, available here.

In June 2019, new rules implementing the Shareholder Rights Directive II ("SRD II") came into force. Funds with shares trading on the Specialist Funds Segment may have new requirements due to the new rules. There are two key areas of change that are relevant to listed investment funds:

Changes to the regime relating to directors' remuneration

The key changes, which are set out in the government's explanatory memorandum, relate to the scope of companies and officers caught by the regime and the content requirements for a company's remuneration report and remuneration policy. Companies preparing to put forward a new remuneration policy this year should note in particular the changes to content requirements.

Shareholder Rights Directive: The key changes relating to remuneration are:

• Change in scope of "directors" covered: A company's remuneration policy and report will cover any person not on the board of directors who carries out the function of chief executive officer or deputy chief executive officer (regardless of title).
• Approval of inconsistent payments: The provisions that previously allowed a payment which was inconsistent with the remuneration policy to be made pursuant to an ordinary resolution of the company will now require an amendment to the remuneration policy (also an ordinary resolution).
• Requirement to put forward a new policy: Where a remuneration policy is put forward at a general meeting but is not approved, the company must put forward a new policy at the next general meeting. The last approved policy will remain in place until a new one is approved.
  
  
• Remuneration policy content requirements: The remuneration policy will be required to include:
  
  - details of any deferral periods in relation to any element of a remuneration package;
  
  - details of any vesting periods and any holding periods in relation to share-based remuneration;
  
  - the duration of contracts or arrangements with directors;
  
  - an explanation of the decision-making process for its determination, review and implementation and measures to avoid or manage conflicts of interest; and an explanation and description of all significant changes compared to the previous policy.
  
  
• Remuneration report content requirements: The directors' remuneration report will be required to include:
  
  - the total fixed and variable remuneration for each director (in the "single total figure" table);
  
  - any change to the exercise price or date of any options;
  
  - the annual percentage change in remuneration over the five financial years preceding the relevant financial year in respect of each director, compared with the average annual percentage change for employees of the company on a full time equivalent basis (currently the regulations require a comparison of the CEO's remuneration against average employee remuneration since the previous year with the option to use a comparator group); and
  
  - any deviation there may have been from the procedure set out in the company’s remuneration policy for determining directors' remuneration.
  
  
• Remuneration reports must not contain certain types of sensitive personal data (such as racial or ethnic origin or sexual orientation).
  
  
• Availability of reports:  Remuneration reports will need to be retained on a company's website for 10 years (and may be retained for longer if they do not include personal data). The date and results of the vote on a remuneration policy will need to be retained on the website for as long as it is applicable.
  
  
• SFS funds are required to have auditors review certain sections of the remuneration report.

Changes to the related party regime

In order to comply with the requirements of SRDII in relation to related party transactions, a parallel Related Party Transactions regime has been established under the Disclosure Guidance and Transparency Rules ("DTRs"), which applies to all companies admitted to an EU regulated market (including those traded on the Specialist Funds Segment). This regime is less onerous than the Listing Rules regime, which currently applies to premium listed companies, in that only announcement and board approval of related party transactions, rather than shareholder approval, are required. In most cases, for premium listed companies, compliance with Listing Rule 11 will suffice for compliance with both regimes. However, as the DTRs apply the IAS definition of a "Related party", which is different to the Listing Rules definition, in cases where a transaction does not fall within Listing Rule 11, companies will need to consider whether it constitutes a related party transaction for the purposes of the DTRs.

AIFM responsibilities

The SRDII also contains rules applying to AIFMs.  Full-scope AIFMs must develop and disclose a shareholder engagement policy, describing how the AIFM integrates shareholder enegement in its investment strategy.  The AIFM must also disclose, on an annual basis, how the shareholder engagment policy has been implemented, a general description of its voting behaviour (explaining the most significant votes) and its use of proxy services.  AIFMs must also disclose information on the transaprency of its acitivities.

On 9 August 2019 the Upper Tribunal delivered its decision in the case of The Commissioners for HM Revenue & Customs v Hargreaves Lansdown Asset Management Limited. The tribunal held that the "loyalty bonuses" paid to investors by Hargreaves Lansdown Asset Management Limited (HL) were taxable income of investors in relation to which HL was potentially required to withhold tax. The bonuses were structured as "fee rebates"/"trail commissions", in that they were ultimately funded by the fund managers from their annual management charges.

For more on this development please see our briefing Asset management tax: what to know for the new autumn term.

In June 2019, the main derivatives regulation in the EU, the European Market Infrastructure Regulation on OTC derivative transactions, central counterparties and trade repositories (Regulation EU 648/2012) ("EMIR") was amended, and is now referred to in the market as "EMIR 2.1". EMIR 2.1 is intended to reduce certain of the burdens and costs associated with complying with the requirements of EMIR. EMIR 2.2, a separate amendment not covered in this briefing, makes certain changes the way in which central counterparties are supervised under EMIR.

Under EMIR 2.1 the definition of financial counterparty ("FC") has been broadened to include all EEA AIFs, whether or not they are managed by a manager authorised or registered under AIFMD. Previously, EEA AIFs that were not managed by a manager authorised or registered under AIFMD were categorised as non-financial counterparties ("NFCs").

In May 2019, the International Swaps and Derivatives Association ("ISDA") released an explanatory note on the expansion of the scope of the definition of AIFs that will be classified as FCs, however the position under EMIR 2.1 can be summarised as follows:

• EEA or non-EEA AIFs whose manager is authorised under AIFMD are FCs (as they were under EMIR);
  
  
• EEA AIFs whose manager is not authorised under AIFMD were NFCs but are now FCs; and
  
  
• Non-EEA AIFs managed by a non-EEA manager were deemed NFCs but are now deemed FCs (when facing EEA brokers/banks).

Implications for funds 

The key implication of the reclassification of certain AIFs as FCs (or deemed FCs) is that NFCs are generally not required to exchange collateral as variation margin or mandatorily to clear any derivatives transactions. FCs are however required to exchange collateral as variation margin in respect of most uncleared derivatives transactions on a daily basis and, depending on the product, clear certain derivatives transactions.

These requirements also apply to NFCs with significant derivatives exposures for non-hedging purposes, which are known as "NFC+s".

A small number of product-specific exemptions apply. For example physically-settled FX forwards and physically-settled FX swaps are carved out of the requirement to exchange collateral as variation margin. Separately, a new category of "small FCs" provides a derogation from the clearing obligation (but not the variation margin requirements for uncleared derivatives transactions) for some AIFs. Please refer to our previous client Note for more detail on small FCs.

Managers of AIFs who use, or may use, derivatives should think carefully about their EMIR classification. If an AIF that was previously and NFC has been reclassified as an FC, the increased cost, complexity and operational burden of collateralising/clearing derivatives transactions may incentivise the manager to enter into such derivative transactions elsewhere in the fund structure. Alternatively, there may be commercial, tax or operational reasons why the manager wants to continue to enter into derivatives transactions at the level of the FC. Either way, there are ways we can assist you with planning, structuring and regulatory optimisation as well as with any amendments required to your contractual arrangements.

In December 2019, a Delegated Regulation ((EU) 2019/820) supplementing the EuVECA Regulation came into force. The changes made pursuant to the Delegated Regulation relate solely to the provisions relating to conflicts of interest. The changes clarify the conflicts of interest rules governing EuVECA managers and what measures should be taken by EuVECA managers to prevent, manage and monitor conflicts of interest. The changes also provide for the management of consequences of conflicts of interest, strategies for the exercise of voting rights to prevent conflicts of interest and the disclosure of conflicts of interest.

The European Commission is scheduled to review the EuVECA Regulation by March 2022.

In September 2019,  the Law Commission published a Report and Summary Document setting out a statement of the law regarding the validity of electronic signatures, and making further recommendations for this area going forward. This report follows its consultation paper published in August 2018.  The report sets out a "Statement of the Law" regarding electronic signatures (see below) along with various recommendations for future work in this area.

The "Statement of the Law" (summarised below) applies both where there is a statutory requirement for a signature and where there is not. It has broad application and is not restricted to commercial and consumer documents.

• An electronic signature is capable in law of being used to execute a document (including a deed) provided that (i) the person signing the document intends to authenticate the document and (ii) any formalities relating to execution of that document are satisfied;
• Such formalities may be legislative, contractual, or may be laid down in another private law instrument under which a document is to be executed;
• An electronic signature is admissible in evidence in legal proceedings;
• Save where the contrary is provided for in relevant legislation, contractual arrangements, or case law, the common law adopts a pragmatic approach and does not prescribe any particular form or type of signature. The courts will adopt an objective approach considering all the surrounding circumstances when determining whether the method of signature adopted demonstrates an authenticating intention;
• The courts have, for example, held that the following non-electronic forms amount to valid signatures: (a) signing with an ‘X’; (b) signing with initials only; (c) using a stamp of a handwritten signature; (d) printing of a name; I signing with a mark, even where the party executing the mark can write; and (f) a description of the signatory if sufficiently unambiguous;
• Electronic equivalents of these non-electronic forms of signature are likely to be recognised by a court as legally valid;
• The courts have, for example, held that the following electronic forms amount to valid signatures in the case of statutory obligations to provide a signature where the statute is silent as to whether an electronic signature is acceptable: (a) a name typed at the bottom of an email; (b) clicking an “I accept” tick box on a website; and (c) the header of a SWIFT message; and
• The Commission’s view is that the current legal requirement that a deed must be signed ‘in the presence of a witness’ requires the physical presence of that witness and does not allow for ‘remote’ witnessing of documents, for example, by video link. This is the case even where both the person executing the deed and the witness are executing or attesting the document using an electronic signature.

Return to Funds Annual Briefing 2020.