Key items for your agenda in 2024
Our standout items
EU Artificial Intelligence (AI) Act
What’s happening?
AI will be the top strategic priority for many firms in 2024. The nature of the technology gives rise to novel regulatory challenges – 2024 will see the race to regulate AI continue.
The world’s first comprehensive laws to regulate AI were agreed in December 2023 (involving a 37 hour marathon negotiation between the European Parliament and EU member states!) – putting the EU ahead of the US, China and the UK. The EU’s proposed AI Act takes a risk-based, product-safety-type approach. Certain use cases would be banned outright (for example, social scoring and harmful behavioural manipulation), with others ranked according to risk. There are dedicated rules for general purpose AI models.
So what?
It is expected to become law in 2024. There’s then a 24-month transition period before most requirements will apply, although the banned practices and general purpose AI provisions will apply earlier than this (after 6 months and 12 months respectively).
We know that firms are avidly innovating and exploring AI use cases – whether in relation to predictive AI (already widely deployed in the industry) or looking to unlock the benefits of generative AI – whilst analysing AI risks and keeping a keen eye on the developments in regulation. The AI Act will be at the forefront of minds as firms look to understand and mitigate risks.
The compliance burden under the AI Act, particularly for systems categorised as high-risk, is likely to be significant and, as you’d expect, substantial fines could be imposed for breaches.
AIFMD II: the next phase of the EU alternative investment fund regulation
What’s happening?
The final agreement reached in November 2023 followed months of negotiations and EU AIFMs will no doubt be relieved to have the final rules even if they are not exactly what they would have wanted. In many respects, outside the provisions relating to loan origination, the changes are relatively limited in scope; this is not a full overhaul of the entirety of EU AIFMD but rather a series of targeted amendments.
The key changes include new requirements and restrictions for AIFs which originate loans; leverage limits for AIFs with significant loan origination activity; the application of delegation requirements to non-EU distributors; additional disclosure and reporting requirements and new rules on liquidity management for open-ended funds.
What does this mean for me?
AIFMD II is expected to come into force in 2024, with most provisions having effect in 2026.
The changes will be relevant for all EU full-scope AIFMs and some of the provisions will also be relevant for non-EU AIFMs marketing in the EU.
The impact of the provisions will, in many respects, depend on the strategies employed by the AIFM. In particular, credit fund managers should focus on the provisions for “Loan Originating AIFs” (and other AIFs which originate loans) as a priority. Private equity sponsors should pay careful attention to the provisions around shareholder loans when structuring deals: there may be a need to ensure that loans are stapled to the equity in order to meet the definition of shareholder loan.
Other things to keep a close eye on
Expected consultation on UK AIFMD
What’s happening?
The emphasis of the UK consultation is expected to be on making the regime more proportionate and tailored to the UK market, with a particular focus likely to be the distinction between full-scope, small authorised and small registered AIFMs. The FCA may also include proposals to modify the rules which prevent full-scope AIFMs from carrying out other activities within the same legal entity.
So what?
The initial consultation is expected in 2024. In a second phase, the FCA is expected to consider regulatory reporting requirements.
This will be of great interest to UK AIFMs. The expected impact is currently unknown but indications are that the UK is seeking to alleviate some of the regulatory burdens on UK AIFMs.
EU Digital Operational Resilience Act (DORA)
What’s happening?
This EU regulation will apply operational resilience requirements to EU-regulated financial services firms, including full-scope AIFMs and MiFID investment firms (which includes portfolio managers), in their use of information and communication technology (ICT) services. These include governance related requirements; ICT-related incident reporting requirements; digital operational resilience testing requirements; and ICT third-party risk management requirements.
So what?
DORA will apply to EU financial services firms and third-party ICT service providers from 17 January 2025.
Affected firms will need to ensure that they have the relevant procedures in place before that date.
UK FCA to review valuations in private markets
What’s happening?
Valuations will continue to be a hot topic in 2024. Nikhil Rathi, CEO of the FCA, has said that the FCA will be “very, very focused on monitoring and mitigating” the risks that higher interest rates place on valuations of assets in private markets.
It has since been reported that the FCA plans to launch a review of valuations in private markets that will examine “disciplines and governance” over valuations and that failings might be publicly called out.
So what?
The review (assuming it goes ahead) is expected to begin in early 2024.
Despite the uncertainty around the potential review and its scope, we’d suggest that firms revisit the robustness of their valuation processes and related governance procedures now.
We are expecting the FCA to launch a formal review of valuation procedures in all UK asset managers in the first half of 2024. GPs and investors will want to keep a keen eye on whether the FCA imposes more prescriptive rules in relation to valuations.
Victoria Bramall
Partner
UK Economic Crime and Corporate Transparency Act 2023 (ECCT Act)
What’s happening?
Transparency and the prevention of abuse of UK corporate structures and limited partnerships (LPs) remains high on the agenda in 2024. The ECCT Act contains several important reforms in this regard. The Act not only creates additional disclosure and administrative requirements for UK LPs, companies and LLPs, but introduces a range of new criminal offences. Criminal offences include providing false statements to Companies House and failure to prevent fraud (the latter applying to large organisations only).
What does this mean for me?
Some measures applying to company information will come into force in early 2024, with other reforms expected to become effective later in the year (subject to transitional provisions).
Unhelpfully for LPs, the full impact of the Act isn’t clear – we are optimistic that the expected secondary legislation will provide some clarity.
In the meantime, we recommend that firms start to prepare now for the new additional administrative requirements and conduct a review of existing fraud prevention measures.
Legal challenge against new US private fund adviser rules
What’s happening?
Few will have missed the SEC’s adoption of new private fund adviser rules last August.
AIMA and others are challenging these new rules in the US courts on the grounds that they exceed the SEC’s statutory authority and are “arbitrary, capricious and otherwise unlawful.”
So what?
AIMA are hoping for a decision by the end of May/early June 2024.
Their hope is that the challenge will result in the rules being set aside. Frustratingly, the timing means firms will need to comply with the new rules and can’t hold off for the outcome of the challenge.
Ironically, the grounds upon which the petition was made also suggests that the new rules “…were adopted without compliance with notice-and-comment requirements…” Unsurprisingly, alternative asset managers will continue to pay close attention to how the legal challenge evolves, and depending on the outcome, whether this signals a new frontier in increased regulatory scrutiny of private fund managers.
Tosin Adeyeri
Partner
UK’s Overseas Funds Regime (OFR)
What’s happening?
Many funds marketed to UK retail investors are Luxembourg or Irish structures.
The UK Government is proposing to introduce a new regime, the OFR, to enable overseas retail funds to access the UK market. Currently, they must rely on (i) the Temporary Marketing Permissions Regime (TMPR) if they are EEA retail funds which were passported into the UK before 31 December 2020, or (ii) the (cumbersome) regime for individual fund recognition. The OFR will allow the UK Treasury to grant equivalence to jurisdictions (including non-EEA ones) based on their regulatory standards, thereby allowing retail funds located there to apply for access to the UK market.
So what?
The FCA issued a consultation paper on 4 December 2023 and is seeking feedback until 12 February 2024. The date of application of the OFR is not yet known but it may be as early as 2024 with the EEA expected to be the first “jurisdiction” to be granted equivalence.
We anticipate that the application process for overseas funds under the OFR will be more complex and costly than under the TMPR. In addition, fund managers operating under the OFR will be subject to certain ongoing obligations and enhanced disclosure requirements to UK investors.
