Private funds radar - September 2023

In arguably the biggest development over the period, the widely anticipated private fund adviser rules were adopted by the SEC on 23 August 2023. The new rules, which are summarised in this helpful SEC factsheet, impose additional reporting requirements and compliance obligations on private fund advisers but observers have noted that many activities previously targeted for outright prohibition have been significantly diluted. The following new rules have been adopted.

For private fund advisers registered with the SEC:

• Quarterly Statement Rule: requires advisers to provide investors with quarterly statements disclosing certain fund-level information;
• Private Fund Audit Rule: requires advisers to obtain an independent annual financial statement audit of each private fund they advise that meets the requirements of the audit provision in the Advisers Act; and
• Adviser-Led Secondaries Rule: requires advisers to obtain either a fairness or valuation opinion from an independent provider when conducting an adviser-led secondary transaction.

For all private fund advisers:

• Restricted Activities Rule: requires advisers to disclose and, in some cases, obtain investor consent, for “restricted activities”, including charging certain fees and expenses to the fund and engaging in conflicts of interest; and
• Preferential Treatment Rule: prohibits advisers from providing preferential terms to investors regarding redemptions from the fund if the adviser reasonably expects such terms would have a material, negative effect on other investors in the fund or in a similar pool of assets, unless required by law or if such terms are offered to all present and future investors.

The proposed transition periods of the new rules vary, with an 18-month transition period for the Quarterly Statement Rule and Private Fund Audit Rule, and staggered compliance dates for the Adviser-Led Secondaries Rule, the Restrictive Activities Rule and the Preferential Treatment Rule as follows:

• for advisers with $1.5bn or more in private funds assets under management: a one-year transition period; and
• for advisers with less than $1.5bn in private fund assets: an 18-month transition period.

Compliance with the amended Advisers Act compliance rule (Rule 206(4)-7) will be required 60 days after publication in the Federal Register.It should be noted that the Restricted Activities Rule and the Preferential Treatment Rule will not apply to non-US advisers of an SEC registered offshore adviser, regardless of whether they have US investors, which is consistent with the SEC’s historical treatment of offshore advisers.We will keep clients informed on the potential impact over the coming weeks.

The US Government announced a new Outbound Investment Program (OIP) in early August which aims to restrict US investment in China, Hong Kong and Macao in a bid to prevent further developments in Chinese military technology. The restrictions include outright prohibitions and enhanced notification requirements and currently apply to three tech sectors, namely quantum computing, artificial intelligence and advanced semiconductors & microelectronics. The OIP is forward-looking and imposes no requirements until the regime takes effect (expected in 2024) but the Treasury may request information about transactions completed or agreed after 9 August 2023.

Transactions that are restricted include:

• acquisitions of equity interest or contingent interest;
• debt financing, where such debt is convertible into equity interest;
• “greenfield investments” that could result in the establishment of a covered foreign person; and
• joint ventures, wherever located, with a covered foreign person or that could result in the establishment of a covered foreign person.

Although the OIP’s scope is narrow, careful diligence and planning will be required for any US person contemplating future investment in China (whether directly or indirectly) to ensure compliance, particularly for private funds that may have structures in place through various jurisdictions around the world.

The FCA has expressed its concerns regarding the greenwashing potential of sustainability-linked loans (SLLs), despite acknowledging that it does not directly regulate the SLL market. The concerns were reflected in a letter sent to bank Heads of ESG/Sustainable Finance and published on the FCA website. SSLs aim to support sustainable economic activity and growth, with interest rates linked to meeting certain agreed sustainability goals as well as general corporate purposes. The FCA have confirmed they will continue to monitor the market, but FCA-regulated credit fund managers should take note of the FCAs increasing focus on sustainability and consider a more transparent approach to prevent any allegations of greenwashing. More information on the contents of the letter and the FCA’s comments can be found in our article.

Our clients will be familiar with grappling issues surrounding fund formation and choosing the right structure for their investment aims, particularly in the context of side cars and co-investment deals, which often include bespoke governance items. Here is a brief reminder of the key characteristics of an alternative investment fund (AIF) and a joint venture (JV).

AIF characteristics:

• consists of a collective investment undertaking which pools together capital raised from investors;
• raises capital from a number of investors; and
• invests that capital in line with a defined investment policy.

JV characteristics:

• typically, all parties have control over the strategic, financial and operational decisions and are involved in the overall strategic direction of the JV;
• with enhanced control given to investors, JVs are usually made up of a small number of parties; and
• no external capital is raised – the investors jointly invest capital for themselves, rather than capital being raised and invested on their behalf.

The distinguishing characteristics between an AIF and a JV are important to consider as an AIF carries a number of stringent obligations with respect to reporting, disclosure and marketing under the AIFMD (as it applies in the UK). Clients should be cautious when negotiating the terms of the JV so as to not become within the scope of the AIFMD and regulatory supervision of the FCA.

The Chancellor has welcomed a City lawyer-led investment research review recommending the curtailment of the EU's MiFID II rules. One particular focus is on eliminating the rule that prohibits the provision of free research to clients, indicating a desire to loosen the restrictions imposed on financial institutions regarding the distribution of research materials. Under the current MiFID rules, firms that provide both research and execution services are prohibited from bundling them together, with each element being charged separately. Under the new recommendations, brokers and managers will be able to bundle services together, and have the ability to provide "free" research in return for other services. Read more on the proposals.

Reforms to UK stamp duty could mean that partnership interests will be removed from the scope of stamp duty. This will be particularly welcome to fund managers involved in secondary transactions. The UK’s archaic stamp duty (and stamp duty reserve tax) system are currently the subject of a government consultation, which proposes, amongst other things, to remove the dual stamp duty/stamp duty reserve tax system with a new single tax.

In practice, as HMRC acknowledges in its consultation, stamp duty is not normally paid on the transfer of partnership interests. We see this unfold in practice in two ways. First, there is no legal requirement to submit a transfer to be stamped, so if it is concluded that a stamped transfer of a partnership interest will never be required as a practical matter, stamping the transfer might be viewed as unnecessary (particularly as the absence of a stamped transfer should not prejudice the ability to write up the register of partners to reflect the transfer). Second, if the partnership interest has no UK nexus and the transfer is executed outside of the UK, then the transfer would be out of the scope of stamp duty.

That said, particularly in commercial secondary transactions, parties may (in view of stamp duty concerns) opt to execute a transfer of a partnership interest outside of the UK. In this respect, there is often detailed provision in secondary transaction documents allocating liability between the parties for paying any eventual stamp duty with respect to the transfer.

As a result, while UK stamp duty is unlikely in practice to be an actual cost within secondary transactions and other partnership transfers, its existence can create uncertainty and complication for the parties involved.

You can read more on these proposed reforms from our tax colleagues. 

On 19 July 2023, the EU’s institutions reached a provisional agreement on revisions to the AIFMD (AIFMD II) and parts of the UCITS regime. The agreement concludes the political negotiations. A period of technical negotiation follows, to clarify and agree the drafting of the final text. We expect the final text to be published in late September, with finalisation in the EU’s Official Journal to occur in early 2024. Member States will have 24 months to apply the reforms in national law, meaning that implementation can be expected by early 2026.

The reforms include the creation of a new regime for Loan Origination Funds, which will be able to access the EU’s passport, subject to limits on leverage, liquidity risk management, and requirement to retain 5% of the value of an originated loan. The AIFMD II will also require EU AIFMs to report details of their delegation arrangements to national competent authorities on authorisation. The EU has stopped short of introducing restrictions on the delegation of portfolio management to non-EU jurisdictions such as the UK and the US, but the new reporting mechanism is likely to be a precursor to further attempts to introduce stricter rules. The reforms also introduce new disclosure requirements relating to liquidity risk management and to costs and charges. You can read more about the AIFMD II in our analysis note.

From 30 September, Finnish AIFMD reports concerning non-EU AIFMs are to be submitted through a new electronic reporting system. For further advice and instructions on how to use the system, please visit the Financial Supervisory Authority's website.

The consultation contains amendments to the JFSC’s anti-money laundering/countering the financing of terrorism/countering proliferation finance (AML/CFT/CPF) reflecting new guidance in respect of politically exposed persons, virtual asset providers, non profit organisations and housekeeping matters following the adoption of the Proceeds of Crime (Financial Intelligence) (Amendment) (Jersey) Regulations 2022. More information can be found in this note by Jersey law firm, Walkers.

The new outsourcing policy will apply to a broader range of regulated entities and includes updates to existing outsourcing arrangements. Carey Olsen have produced a helpful briefing on the material amendments to the policy.

The Australian Treasury has recently published draft legislation for consultation in relation to the extension of the licensing exemptions available when investing in Australia. Clients looking to make investments in Australia will be able to use one of the four new exemptions published, if they meet the applicable criteria, and will not need to apply for an Australian financial services license. Considering this new development, the previous passport relief and limited connection relief exemptions have also been extended and are now due to expire on 31 March 2025. Any clients that are using these exemptions have until the expiration date before they will need to consider the four new options. The Treasury is currently accepting submissions.