Investment Briefing

The Investment Briefing takes a look at current issues of interest to pension schemes and investors.

In this Briefing:

• AIFM Directive
• Dodd-Frank
• EMIR
• EU-IORP Directive
• FTT Directive
• FATCA
• UK OEICS: Protected Cell Regime
• Cases Round-up

AIFM Directive

• The Alternative Investment Fund Managers Directive came into force on 21 July 2011, and must be implemented by EU Member States by 22 July 2013.

• The Directive focuses on the regulation of Alternative Investment Fund Managers. It applies to managers of “collective investment undertakings (other than those which are subject to UCITS) including hedge funds, private equity funds and real estate funds.

• Both open-ended and closed-ended vehicles, as well as listed and unlisted vehicles can be Alternative Investment Funds for the purposes of the Directive. There are grandfathering provisions in respect of closed-ended funds, although in practice these may be of limited assistance.

• Among other things, the Directive sets out conditions and requirements for:

• authorisation of the manager;
• marketing of the fund;
• conduct of business;
• fund depositary; and
• transparency / disclosure.

• The EU was due to publish implementing regulations in September 2012 but the text has not yet been publicly released. As such, the full implications of the Directive remain unclear. However, the costs of compliance with the Directive might lead to increased internal expenses within funds and access to certain markets could become more limited.

Dodd-Frank

• The Dodd-Frank Wall Street Reform and Consumer Protection Act in the US (“Dodd-Frank”) created a structure for reporting and, in certain cases, clearing swap transactions in the US. Aspects of Dodd-Frank will come into force over the coming months but most pressing is that regulations governing external business conduct standards of swap dealers and major swap participants, which include disclosure requirements, become effective at the end of this year. From 31 December 2012, swap transactions with US swap dealers will have to be reported to a US swap data repository. For this purpose, “swap transactions” is broadly defined and includes, for example, foreign exchange options.

• Over the coming weeks, trustees may receive forms from their Investment Managers, seeking consent to report certain information or asking trustees to make certain representations to enable those managers to comply with the Dodd-Frank requirements on the trustees’ behalf.

EMIR

• The European Market Infrastructure Regulations (EMIR) set out measures designed to reduce risk in the over the counter (OTC) derivatives markets by the introduction of central clearing. A number the EMIR provisions need to be fleshed-out by technical and regulatory standards which are (subject to some important exceptions) contained in draft in the final report published by the European Securities and Markets Authority (ESMA). 1These standards will come into force when they are endorsed by the European Commission, which should take place later this year.

• The Regulations and underlying technical standards contain detailed provisions for establishing central counterparty banks that will take on the clearing role and put in place a range of other prudential standards for all participating parties.

• Pension schemes are “financial counterparties” within the scope of the Regulations. However, they will benefit from a three year exemption from the clearing obligation in respect of derivatives that are “objectively measureable as reducing investment risks directly relating to the financial solvency of pension scheme arrangements”.

• Even with the benefit of this exemption, risk mitigation techniques will apply to non-cleared derivatives under the new regime. The draft technical and regulatory standards contain detailed requirements on: the timely confirmation of trade; portfolio reconciliation; dispute resolution; and daily marking-to-market.

• There remain a significant number of practical issues to be addressed before the clearing obligation takes effect (expected to be in summer 2013). We are monitoring progress and will keep clients up-to-date with developments.

EU: IORP Directive

• A review of the ‘IORP’ (or EU Pensions) Directive2 is underway by the European Commission. Originally due to be delivered in 2012, it is now anticipated that a new draft directive will be tabled “before summer 2013”.3

• The Commission is seeking to “maintain a level playing field between insurance companies and pension funds when they supply similar and interchangeable products”. A key feature of the proposals is to provide a system that would allow pension schemes to be valued on the basis of the “Holistic Balance Sheet” (HBS). The HBS would require liabilities to be balanced by a mixture of assets, contingent assets, sponsor support and possible access to compensation schemes (such as the Pension Protection Fund).

• A quantitative impact study to determine the effect of applying the HBS proposal is taking place in autumn 2012, following an initial consultation on the draft technical specifications to be used. However, it is anticipated that further quantitative impact studies may be required. Meanwhile, the Government “remains resolute” in its intention to fight EU plans to apply the Solvency II funding requirements to occupational pension schemes.4

FTT Directive

• The European Parliament has adopted a legislative resolution on a proposal for a new directive on a common system of financial transaction tax (FTT). Very broadly, a tax would be levied on trades in securities issued within the EU.
• EU Member States are required to adopt the Directive and publish the legislation and administrative provisions needed to introduce it by 31 December 2013.
• The EU Parliament has confirmed that the tax would be waived on pension scheme transactions. 5

FATCA

• The US Foreign Account Tax Compliance Act is designed to crack down on tax avoidance by US tax residents using foreign accounts. It includes certain provisions on withholding taxes and on the reporting of information by foreign financial institutions for US tax compliance purposes.

• On 14 September 2012, a bilateral agreement was signed between the US and UK governments to implement FATCA in the UK.6 The effect of this agreement is to exempt UK registered pension schemes from the requirements of FATCA. However, trustees could be indirectly affected if the funds in which UK registered pension schemes are invested have other investors who are not exempt and find it hard to comply.

• HMRC is consulting on measures for implementing the bilateral agreement and compliance costs. The consultation period ends on 23 November 2012.7

UK OEICS: Protected Cell Regime

• Generally, UK Open-Ended Investment Companies (OEICS) operate as umbrella structures, under which a number of sub-funds are offered to investors. Whilst these structures are cost effective, until December 2011, the sub-funds did not benefit from segregated liabilities, unlike similar legal structures in Ireland and Luxembourg. This meant that if the liabilities of one sub-fund exceeded its assets, creditors of that insolvent sub-fund could make a claim against the assets of other sub-funds under the same umbrella (known as the “risk of contagion”).

• With the aims of enhancing investor protection and market confidence in OEICS, a ‘protected cell regime’ for UK OEICS was introduced from 21 December 2011. The new provisions apply to all types of UK authorised funds, including UCITS, non-UCITS retail schemes and qualified investor schemes.

• Nearly one year on from the introduction of the new regime, we are seeing funds taking advantage of this regime. Trustees may want to establish whether UK OEICS in which they are invested have or are proposing to take steps to benefit from the regime.

Cases Round-up

Wheels Common Investment Fund Trustees v HMRC8

• In 2008, Wheels Common Investment Fund and the NAPF agreed to bring a joint legal challenge regarding the application of VAT on the investment management services supplied to occupational pension schemes. This followed the ruling of the Court of Justice of the European Union (CJEU) in Claverhouse9 which concluded that, as special investment funds, investment trusts should be exempt from paying VAT on investment management services. The present challenge was brought because HMRC did not automatically extend the effect of the Claverhouse ruling from investment trusts to pension trusts.
• HMRC has continued to argue that occupational pension schemes do not fit under this description and should continue paying the tax.
• The CJEU heard this case on 12 September 2012 with the EuropeanCommission siding with HMRC. Among other things, they argued that in most cases, it is the employer that is the beneficiary of investment performance in a defined benefit pension scheme and as such there was no need to extend the VAT exemption.
• A ruling from the CJEU is expected within the next six months.

1 Published on 27 September 2012
2 Directive 2003/41/EC on the activities and supervision of institutions for occupational retirement provision
3 Announced by Commissioner Michel Barnier in a speech to the Insurance Europe Conference in Amsterdam on 1 June 2012
4 DWP Press Release (21 June 2012)
5 See EU Parliament Press Release (24 May 2012)
6 See HM Treasury Press Release (14 September 2012)
7 Implementing the UK-US FATCA Agreement -Consultation document (18 September 2012)
8 [2011] UKFTT 534 (TC)
9 J P Morgan Fleming Claverhouse Investment Trust plc; The Association of Investment Trust Companies -v-The Commissioners of HM Revenue & Customs (ECJ, 28 June 2007 (C-363/05))