Funds Quarterly And Regulatory Update: 1 January 2013 - 31 March 2013

FUNDS QUARTERLY LEGAL AND REGULATORY UPDATE

UCITS, Non-UCITS & Hedge Funds

(i) SMICS UCITS- Outstanding Requirements – 1 July 2013 deadline

In 2011 UCITS self-managed investment companies ("SMICs") went through the exercise of updating SMIC Business Plans in order to ensure compliance by SMICs with the relevant requirements of the Directive by 1 July, 2011. By way of reminder, aside from certain organisational requirements, only certain Chapters of the Commission Directive 2010/43/EU (the "Directive") were required to be implemented by the 1 July, 2011 deadline, as set out below:

• Chapter II of the Directive: Article 6 (Complaints Handling) and Article 12 (Permanent Risk Management Function) only;
• Chapter III of the Directive (Conflicts of Interest);
• Chapter IV of the Directive (Rules of Conduct); and
• Chapter VI of the Directive (Risk Management).

While SMIC Business Plans and Risk Management Documents were required to be updated in 2011 to reflect the above requirements it was not necessary at the time to file the SMIC Business Plans with the Central Bank for prior review.

SMICs are required to comply with the relevant outstanding provisions of the Directive by the transitional date of 1 July, 2013. Accordingly, all Business Plans will need to be revised by that date.

The Central Bank clarified in its letter of 10 August 2012 that UCITS SMICs will be subject to the same basic regime as UCITS management companies. Accordingly, the outstanding sections of Chapter II of the Directive (which were not adopted in 2011) will apply to all SMICs from 1 July, 2013 with the exception of the following provisions:

• Article 10 of Chapter II of the Directive (Permanent Compliance Function); and
• Article 11 of Chapter II of the Directive (Permanent Internal Audit Function).

Chapter II of the Directive is headed "Administrative Resources and Control Mechanism". It covers a range of matters relating to the administration and control of UCITS to include requirements in relation to organisation, resourcing, accounting/recording procedures and record keeping.

In summary, the following sections of Chapter II of the Directive (as mirrored in the relevant paragraphs of UCITS 2 set out below) will apply to SMICs from 1 July, 2013:

The UCITS Notices were amended by the Central Bank on 15 February 2013. See section (ii) below for more detail.

Guidance Note 4/07: UCITS - Organisation of Management Companies

The Central Bank previously clarified that the relevant provisions of the following paragraphs of Section B of Guidance Note 4/07 will also be applicable to SMICs from 1 July, 2013:

• Paragraph 10: Organisational Requirements
• Paragraph 11: Resources
• Paragraph 12: Accounting Procedures

The above mentioned paragraphs flesh out the requirements in relation to the relevant provisions of UCITS 2 set out above.

Nature Scale and Complexity

While UCITS SMICs will be subject to the same basic regime as management companies, the Central Bank has stated that "....the requirements in relation to SMICs can be considered in light of the less complex nature of a SMIC. This means that for the most part while the same requirements will apply to SMICs and UCITS management companies, the steps to be taken to ensure compliance will differ for SMICs given their less complex nature." By way of interpretation of the foregoing, the Central Bank has clarified that SMICs should seek to apply the nature, scale and complexity concept to those requirements which are perceived as not readily falling within the remit of a SMIC's business model.

Collective Responsibility

Certain SMICs use "collective responsibility" to monitor and control the managerial functions set out in paragraph 10 of UCITS 2. With the exception of "Decision Taking", the "collective responsibility model" will no longer be permitted for SMICs from 1 July, 2013. Therefore, any SMICs currently using such a model will need to put in place alternative arrangements.

Filing Requirements

All UCITS SMICs must have Business Plans in place by 1 July 2013 which are compliant with the UCITS IV regime as specified by the Central Bank's letter of 10 August 2012. To facilitate the smooth and timely management of submissions, the Central Bank proposes to accept SMIC submissions in 3 tranches, namely end-January 2013, end-March 2013 and end-May 2013.

The Central Bank will neither review all submissions nor issue letters confirming UCITS IV compliance. However, they will carry out a spot checking exercise to get a feel for the level and extent of compliance. Comments may subsequently arise as a result of this process.

Policies and Procedures

SMICs will also be required to put in place certain new policies and procedures to satisfy the above additional UCITS IV requirements.

Side Letters

Finally, SMICs will also need to consider what amendments to existing contracts with its service providers will be necessary to capture the additional requirements above. This will depend on what existing Agreements/Side Letters are in place with such entities. In this regard, it is likely that SMICs may already have put in place Side Letters with its delegates following the UCITS IV update in July, 2011.

(ii) Revised UCITS Notices and related Guidance Notes 2/07, 3/03, and 4/07

On 15 February 2013, the Central Bank published amended UCITS Notices and revised Guidance Notes in order to implement the ESMA Guidelines on ETFs and other UCITS issues (the "ESMA Guidelines"). These ESMA Guidelines came into effect on 18 February 2013 (subject to certain transitional arrangements) and are reflected through the updated UCITS Notices and Guidance Notes 2/07, 3/03 and 4/07. On 28 March 2013, the Central Bank amended these revised Notices to rectify two errors that had been identified since February.

Summary of the main amendments:

• UCITS 2 and Guidance Note 4/07 (Supervisory and reporting requirements and conditions for UCITS management companies, UCITS self-managed investment companies and administration companies authorised by the Central Bank)

This Notice has been amended to apply a more extensive range of organisational requirements to SMICs from 1 July 2013 namely the provisions of paragraphs 4 (excluding 4(iii)), 5-8, 14-20(i), 21, 23(ii), 24, 25, 34-42, 44, 45 and 55-58 of this Notice. References to "management company" should be taken to refer to self-managed investment company. Section C of Guidance Note 4/07 has been amended accordingly to reflect these changes.

• UCITS 6 (Prospectus)

This Notice sets out new prospectus disclosure requirements for UCITS funds which employ efficient portfolio management techniques. It will now be necessary to include detailed information in relation to such techniques to include information on the impact of such techniques on the fund's performance. This revised Notice requires a UCITS fund to disclose more detailed information on its collateral management policy. There are also new specific disclosure requirements for Index-Tracking Funds and Index-Tracking Leveraged Funds.

• UCITS 8 (Publication of annual and half yearly reports)

This updated Notice requires additional disclosure in relation to financial derivative instruments and efficient portfolio management techniques in the financial statements and in the case of an indextracking UCITS, the size and tracking error at the end of the period under review must be disclosed.

• UCITS 10 (Financial derivative instruments) and Guidance Note 3/03

This Notice and Guidance Note have been revised to apply consistent criteria in relation to collateral in line with ESMA Guidelines. The Notice provides that where a UCITS fund enters into a total return swap then the assets held by that fund must comply with the investment limits which are prescribed in the UCITS Regulations. It should be noted that on 28 March 2013, the Central Bank amended Notice UCITS 10, paragraph 22 to include a reference to "leveraged" so that the amendments to this paragraph are also applied to leveraged index tracking UCITS.

• UCITS 12 – (Techniques and instruments, including repurchase/reverse repurchase agreements and securities lending for the purposes of efficient portfolio management)

This Notice has been revised comprehensively, especially in relation to collateral. It requires that the use of efficient portfolio management techniques must be in the best interests of the UCITS fund. It should be noted that on 28 March 2013, the Central Bank amended UCITS Notice 12, paragraph 14 to include a paragraph that re-instates eligibility criteria for counterparties to repurchase/reverse repurchase and securities lending agreements which were omitted in error in February. Subsequent paragraphs are re-numbered.

• UCITS 19 – (Key Investor information document ("KIID"))

This Notice has been revised to apply specific KIID disclosure requirements to index tracking UCITS and index tracking leveraged UCITS.

• UCITS 20 – (Exchange Traded Funds)

This is a new Notice on Exchange Traded Funds to reflect the provisions in the ESMA Guidelines.

• UCITS 21 – (Financial Indices)

This is also a new Notice on financial indices to reflect the provisions in the ESMA Guidelines. On 28 March 2013, the Central Bank advised Dillon Eustace that while the provisions of UCITS Notice 21 are consistent with the ESMA Guidelines they noted that there may be a conflict between the ESMA Guidelines and earlier guidelines issued by the Committee of European Securities Regulators ("CESR"). In particular, paragraph 49 of the ESMA Guidelines may not be consistent with paragraph 22 of CESR's guidelines concerning eligible assets for investment by UCITS (CESR/07-044). The Central Bank will consider whether it should raise this inconsistency with ESMA for further consideration and will also consider amendments to Guidance Note 2/07 "Undertakings for Collective Investment in Transferable Securities (UCITS) Financial Indices"

(iii) Central Bank publishes guidance on the Management Company Passport

On 15 February 2013, the Central Bank published an updated Guidance Note 4/07 which details the organisational requirements of UCITS management companies. This updated Guidance Note includes a new section E on the management company passport.

A management company authorised by the Central Bank may wish to carry on activities for which it has been authorised under the freedom of establishment or the freedom to provide services. The UCITS Regulations provide for procedures in such cases. This new section E provides management companies with guidance on this management company passport.

Summary of Guidance:

Managing non-Irish UCITS

Where a management company wishes to avail of this management company passport to manage a non-Irish UCITS it must assess how the nature, scale and complexity of its business will be affected. More specifically it should consider the impact this management company passport will have on its corporate governance, administration function and its interaction with the non-Irish trustee depositary. The guidance sets out more detailed factors to be considered in this assessment.

Management company passport notifications

A management company is required to notify the Central Bank if it wishes to avail of this management company passport either through the establishment of a branch or under the freedom to provide services. The Central Bank will review such applications on a case by case basis. This new section E provides guidance on these notifications, in particular the information to be set out in the programme of operations.

Provision of information or documentation to competent authorities

This new section also provides guidance to management companies if any changes to the programme of operations are to be made following submission of the initial notification. The management company must notify the Central Bank and the competent authority of the management company's host Member State before implementing the change.

This revised Guidance Note 4/07 can be found at the following link:

https://www.centralbank.ie/regulation/industrysectors/funds/Documents/Guidance%20Note%204%2007%20UCITS%20organisation%20of%20management%20companies.pdf

(iv) Investment Entities (Amendments to IFRS 10, IFRS 12 and IAS 27) (the "Amendments")

On 31 October 2012, the International Accounting Standards Board ("IASB") issued amendments titled Investment Entities (Amendments to IFRS 10, IFRS 12 and IAS 27). These Amendments were issued in response to feedback from preparers and users of financial statements. They provide an exception to the consolidation requirements in IFRS 10 and require investment entities to measure particular subsidiaries at fair value through profit or loss rather than consolidate them. The Amendments also introduce new disclosure requirements for investment entities in IFRS 12 and IAS 27. An investment entity under these Amendments refers to an entity whose business purpose is to invest funds solely for returns from capital appreciation, investment income or both and also evaluates the performance of these investments on a fair value basis. The Amendments also set out disclosure requirements for investment entities. The IASB is of the opinion that the most common types of investment entity will be private equity organisations, venture capital organisations, pension funds, sovereign wealth funds and other investment funds.

The Irish Funds Industry Association ("IFIA") Industry Technical Committee prepared a paper to assist in the preparation of financial statements and particularly the disclosure of interests in other entities as required by IFRS 12.

On 18 February 2013, the European Financial Reporting Advisory Group ("EFRAG") issued its endorsement advice to the European Commission ("Commission") supporting these Amendments concluding that the Amendments satisfy the technical criteria for EU endorsement. EFRAG's endorsement advice and effects study report can be found at the following link:

http://www.efrag.org/Front/n1-1106/EFRAG-s-endorsement-advice-and-effects-study-report-on-Investment-Entities--Amendments-to-IFRS-10--IFRS-12-and-IAS-27-.aspx

The Amendments are effective from 1 January 2014, however these amendments must be endorsed by the Commission before they can be adopted by EU investment companies. It is estimated that endorsement of these Amendments will occur later this year (Q3 2013).

(v) European Systemic Risk Board ("ESRB") issues recommendations on Money Market Funds

Following on from the recommendations of the Financial Stability Board (which carried out a review upon request from the G20), the ESRB published a paper on 18 February 2013 which sets out recommendations for the regulatory reform of Money Market Funds. The IFIA has noted these recommendations. While there is general consensus for the need for regulatory reform of Money Market Funds, the IFIA is of the view that in light of the global nature of this market, there is a need for a globally consistent and coordinated regulatory approach to the area. It is worth noting that the United States is still contemplating how it intends to proceed in relation to the regulation of Money Market Funds. Although the ESRB recommendations strongly support a move to variable net asset value, they also note that careful consideration should be given to ongoing international developments.

These recommendations cover:

• Mandatory move to variable net asset value;
• Liquidity requirements (i.e. explicit minimum amounts of daily and weekly liquidity);
• Public Disclosure (such as valuation procedures and the possibility of principal loss);
• Reporting and information sharing; and
• The implementation of these recommendations.

These recommendations also impose obligations on the Commission to report to the ESRB and the European Council on actions taken in response to the recommendations or adequately justify inaction. The Commission is requested to provide an interim report to the ESRB by end of June 2013 and a final report by end of June 2014. It is anticipated that the Commission may issue a legislative proposal later this year (which could potentially be included as part of UCITS VI).

The ESRB Recommendations can be found at the following link:

http://www.esrb.europa.eu/pub/pdf/recommendations/2012/ESRB_2011_1.en.pdf?06d49a31b1e76b49517f5e7d91557305

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