If European regulators always seem to be busy writing new rules that affect asset managers, that’s because they are. Or at least they have been for the last few years, and 2023 was no exception. New UK sustainability disclosure rules were finalised at the end of the year, and many EU regulatory initiatives came to fruition.
As it happens, the coming year may see fewer new rules being written – in part, because the European Commission will be on an election hiatus. But that doesn’t mean there will be any let up for alternative asset managers: 2024 is the year when many of these recently agreed rules will come into force. And some of them will require a significant amount of work.
UK Regulation
Perhaps the good news is that most of the recent UK initiatives that affect asset managers will have relatively limited impact on private equity sponsors. The new “consumer duty”, which took effect last year, is a big change – but one that is predominantly aimed at firms with retail clients. Although some alternative asset managers are looking at the retail market, for many that is not (yet) a significant focus. Unfortunately, the way the rules are written means that most firms did have to make some changes to their processes, but these were relatively light. Implementation was much more onerous for mainstream asset management businesses.
Another rule change in the works for UK-regulated firms – new regulations on Diversity and Inclusion (“D&I”) – will also affect most UK regulated firms to some extent, but will only apply more prescriptive rules to larger firms: those with 251 employees or more. Following a consultation in 2023, the rules will probably get finalised this year and some provisions – most notably, the explicit addition of non-financial misconduct to certification requirements for those working in regulated firms – will apply to most UK-regulated firms. But the more detailed provisions, including a requirement for a D&I strategy with defined targets, will only affect larger firms.
It is true, of course, that the first stage of the UK’s sustainability disclosure regime has added a considerable reporting obligation for firms with more than £5 billion of assets under management: a requirement to report on climate related risks and opportunities using the Taskforce on Climate-related Financial Disclosures (TCFD) recommendations. For many UK firms – those with between £5 billion and £50 billion of AUM – the first mandatory TCFD reports will need to be published in 2024, covering last year. Depending on the existing reporting and data collection processes in the firm, this can be quite a significant lift.
The second phase of the FCA’s sustainability reforms for asset managers – the UK’s new sustainability disclosure requirements (SDR) and labelling regime – was mainly aimed at firms targeting retail investors. The finalised rules, which come into force in stages from 31 May 2024, will apply a general anti-greenwashing rule to all UK firms, and mandate some additional sustainability disclosures for those with assets under management of £5 billion or more. But the sustainability labelling regime, and the more detailed naming and disclosure rules, will not have much immediate impact on firms with an institutional investor base – unless they choose to opt into the ESG labels.
UK policymakers are also keen to help the private markets, believing them to be a helpful partner in their mission to boost growth and productivity. To this end, several initiatives aimed at stimulating investment from UK pension funds – including the defined contribution (DC) schemes that have historically been harder for private funds to access – were announced in 2023 and work is ongoing with the BVCA to bring them to fruition this year. Meanwhile, attention has turned to reforms to the UK’s version of the Alternative Investment Fund Managers Directive (AIFMD), which could ease some regulatory burdens for smaller firms.
EU Regulation
If the additional regulatory burdens in the UK are generally manageable for most alternative asset managers, it is harder to keep up with the pace and scale of regulatory change in the EU. Most of the new regulation to hit private equity sponsors has come from Brussels and will apply across the whole of the European Economic Area (EEA), although some member states have also passed domestic legislation that could bite hard on some portfolio companies; for example, new rules on supply chain liability.
The Sustainable Finance Disclosure Regulation (SFDR), which was first implemented in 2021, is still causing headaches for private equity firms. It affects firms regulated in the EU (for example, because they are headquartered there, or because they have a regulated fund manager in Luxembourg or Ireland) and many who are outside the EU but promote their funds to EU investors. The constantly evolving nature of the SFDR has been a major issue for firms, and further changes are on the horizon.
After June’s Parliamentary elections, the new European Commission is likely to start work in earnest on SFDR 2.0, perhaps with some fundamental changes to the underlying architecture – adding a proper ESG fund labelling regime to the disclosure rules. But it will be some years before that is implemented. In the meantime, fairly dramatic changes to the reporting templates for Article 8 (“light green”) or Article 9 (“dark green”) funds are under active consideration. It is not yet known when, or even whether, these will replace the existing templates, but firms will need to keep a close eye on that.
While changes agreed last year to the AIFMD were relatively benign for most firms, they will have more significant consequences for loan origination funds. For the first time these funds will be covered by pan-EU rules, including restrictions on leverage and risk retention requirements.
Meanwhile, the biggest regulatory change on the horizon for many firms and, in particular, their large EU portfolio companies is the Corporate Sustainability Reporting Directive (CSRD). This revolution in non-financial reporting is coming into force in stages. It will affect some larger asset management groups directly – imposing new reporting obligations at house level – while for many the main challenge will be at investee company level.
The twelve reporting standards that underpin the CSRD include very detailed requirements, but the first step will be to map an entity’s value chain – a crucial concept under the CSRD, because impacts in the value chain must be reported alongside impacts arising from a firm’s own operations – and this is not a straightforward task. A materiality assessment is also needed, and it would be wise to turn to these questions early. Most (although not all) private equity firms and their investees will be out of scope for the first wave of reports that must be published in 2025, but many more will need to report in 2026.
In anticipation of the looming EU election, a number of other legislative initiatives were agreed at the end of last year. One that needs to be watched very closely is the Corporate Sustainability Due Diligence Directive (CSDDD, or CS3D). This directive is still a few years away from implementation, and European lawmakers are hammering out the technical details at the moment, but when it does come it will impose significant new obligations for in-scope entities to identify and end or mitigate adverse impacts in their operations and their value chain.
There is also some good news for firms that are seeking to access more individual – usually high net worth, rather than mass retail – investors in the EU. Changes to the ELTIF – the European Long Term Investment Fund structure, first introduced in 2015 – should make it easier to emulate an evergreen, open-ended fund. That would make it more appealing as a vehicle for funds targeting the wealthy individual investors who have historically found it hard to access private funds.
All in all, legal and compliance teams will continue to have their hands full in the coming year. They will welcome the fact that the EU’s flood of new rules may turn into a steady trickle for a year or two, while the UK’s post-Brexit regulatory agenda seems more focused on larger firms and those targeting a less sophisticated investor base. If you want to know more, our checklist for the year ahead includes some other legal, tax and regulatory changes that European alternative asset managers should have on their agenda for 2024 – including possible changes to carried interest taxation in the UK and the EU’s AI Act.
