Q1 2025 - European Regulatory Update for Funds

Authors: Zac Mellor-Clark(London), Gregg Beechey(London), Cameron Mitcham(London), Nishkaam Paul(London) and Stephanie Leslie(London)

The first quarter of 2025 got off to a busy start with some key regulatory developments both in the UK and on the continent.

In this update, we outline the following developments, which will be of interest to both European private fund managers and non-European private fund managers that are active in Europe:

1. Pending Q&As on the ELTIF Regulations
2. Entry into force of DORA
3. Publication of the ESA's final report on the Securitisation Regulation
4. European Commission's proposal on an omnibus sustainability package
5. Launch of the FCA's consultation on the replacement of the UK PRIIPS regime with the CCI regime
6. FCA's publication of its Private Markets Valuation Review findings

1. Pending Q&As on ELTIF Regulations

On 14 March 2025, the European Securities and Markets Authority ("ESMA") forwarded a number of important technical questions it had received regarding the interpretation of the European Long-Term Investment Funds Regulation to the European Commission ("Commission") (which ESMA will do where questions require interpretation of EU law).

These questions addressed the following points (amongst others):

• whether, in the case of an open-ended European Long-Term Investment Fund ("ELTIF"), the minimum holding period should run from the initial launch date of the ELTIF or from each new subscription;
• whether, in the case of an open-ended ELTIF, an ELTIF can use borrowings to meet redemption requests;
• when should an ELTIF calculate its liquid assets;
• how the rules in relation to the suspension of calculations of portfolio composition, diversification and borrowing requirements apply to an open-ended ELTIF;
• whether an ELTIF can invest in a non-EU AIF;
• in a fund-of-funds context, whether the underlying funds must exclusively invest in ELTIF eligible investments; and
• the treatment of intermediary entities.

Market practice around a number of these points was previously well settled (notwithstanding any ambiguity in the legislation), and so managers now eagerly await sight of the Commission's response which, given the "right" or "wrong" answer in any given case, could have significant implications for the ELTIF industry.

1. Entry into force of DORA

The EU Digital Operational Resilience Act ("DORA") came into force on 17 January 2025. DORA seeks to enhance the security of network and information systems supporting financial system participants' business processes and thereby the operational resilience of the financial sector as a whole.

The DORA regime is constituted of Regulation (EU) 2022/2554 on digital operational resilience for the financial sector, which is directly effective across the European Economic Area, and Directive (EU) 2022/2556 as regards digital operational resilience for the financial sector, which clarifies and amends certain existing EU financial services directives and which Member States were required to implement into national law.

DORA applies to a broad swathe of financial market participants, including investment firms and full-scope alternative investment fund managers ("AIFMs"), though firms are only required to comply with the new regime on a proportional basis, taking into account their size, the nature of their activities and their risk profile.

DORA made amendments to the Alternative Investment Fund Managers Directive and the Markets in Financial Instruments Directive ("MiFID"), which amendments require AIFMs and MiFID investment firms (respectively) to have arrangements in place for the control and safeguard of network and information systems, including where they rely on third-party information and communication technology ("ICT") service providers. At an entity level, firms are required to ensure that their internal governance and control frameworks effectively and prudently manage ICT risk, and critical ICT systems must be tested at least annually. In addition, DORA requires firms to institute a structured approach to detect, manage and, in major instances, notify to competent authorities ICT-related incidents.

Note that DORA does not have effect in the UK, though UK firms may be in scope of DORA if the financial services activities they undertake are deemed to take place in the EU.

1. ESAs publish final report on Securitisation Regulation

On 31 March 2025, the Joint Committee ("JC") of the European Supervisory Authorities ("ESAs") published its final report on the implementation and functioning of the EU Securitisation Regulation ("SECR"). While the report contains a number of findings, it has made a recommendation clarifying an issue in regards to the 'sole purpose' test in a manner which could prove problematic for some 'originators' under the SECR (and not just for the CLO market which was specifically mentioned in the report).

The ESAs have sought to clarify the expression 'predominant source of revenue' used in the sole purpose test to determine whether an 'originator' is a valid risk retention holder under the SECR. The ESAs have recommended that 'predominant' in this context corresponds to a threshold of more than 50%. This means that the "entity's revenues should correspond to no more than 50% on the exposures to be securitised, risk retained assets or proposed to be retained in accordance with [the risk retention rules] of the SECR, or any corresponding income from such exposures and risk retained assets".

The report states "going forward, any new issuance should apply this interpretation". It is clear that the recommendations will not apply to deals which have closed. However, question marks arise in relation to transactions which may have priced before the report but will not close until after.

The report does not affect the sole purpose test which applies in the UK under the UK securitisation framework, creating increased disparity between the two regimes.

1. EC proposal on Omnibus sustainability package

On 26 February 2025, the European Commission adopted a so-called omnibus package of proposed simplification measures of several key pieces of sustainability legislation (the "Omnibus") designed to aid the EU's drive to regain competitiveness and unleash growth by fostering a favourable business environment.

The package includes proposals postponing: (i) the application of all Corporate Sustainability Reporting Directive ("CSRD") reporting requirements for companies due to report in 2026 or 2027 (capturing all but the largest EU companies, which have previously been subject to similar reporting requirements under the now-replaced Non-Financial Reporting Directive or "NFRD"), and (ii) the transposition deadline and first wave of application of the Corporate Sustainability Due Diligence Directive ("CSDDD") by one year to 2028. On 1 April 2025, the European Parliament voted to fast track its work on the postponement of the application of CSRD and CSDDD, with a final vote being held at the time of writing.

In addition to the proposed postponements of the application of CSRD and CSDDD, the proposal includes several proposed amendments to the CSRD and CSDDD including:

• a change to the size thresholds of companies in scope of CSRD, which the Commission expects would reduce the number of companies in scope by c. 80%;
• a voluntary CSRD reporting standard to act as a "shield" for companies that are not in scope of CSRD, by limiting the information that in-scope companies are able to request from them;
• amending European Sustainability Reporting Standards ("ESRS") under CSRD in order to substantially simplify the number of data points, clarify provisions deemed to be unclear, and improve consistency with other pieces of legislation;
• removing the eventual introduction of additional "sector-specific" ESRS;
• removing the possibility of a "reasonable" assurance requirement under CSRD;
• removing the need for companies to conduct in-depth assessments of adverse impacts under CSDDD that occur at the level of indirect business partners;
• simplifying other aspects of sustainability due diligence requirements under CSDDD to reduce complexity and cost;
• limiting information that CSDDD in-scope companies may request from business partners with fewer than 500 employees; and
• aligning the CSRD and CSDDD requirements with respect to transition plans.

The Omnibus also contains proposed amendments to the Taxonomy Disclosures and Delegated Acts (subject to public consultation), proposed amendments to the Carbon Border Adjustment Mechanism Regulation, and a proposal for amending the "InvestEU" Regulation.

The Omnibus now will work its way through the EU legislative process. The final results of any changes could differ from the Commission's initial proposals.

1. Launch of the FCA's consultation on the replacement of the UK PRIIPS regime with the CCI regime

The Packaged Retail Investment and Insurance-based Investment Products ("PRIIPs") Regulation came into force in the EU in 2014 (and was retained in UK law following Brexit). The PRIIPs Regulation (in)famously requires the production of a Key Information Document ("KID") outlining specific pre-contractual information in a heavily prescribed template, so as to allow retail investors to more easily compare different investment products-a laudable aim that has unfortunately proved relatively difficult to fulfil in the context of private funds, where the features of the product often sit uneasily with the requirements of the KID template.

Since Brexit, the content and format requirements of a UK KID under the UK PRIIPS Regulation have diverged from the requirements of the EU KID under the EU PRIIPS Regulation, and in Q1 2025 the Financial Conduct Authority ("FCA") consulted on replacing the UK PRIIPs regime in its entirety. This followed HM Treasury's publication of the Consumer Composite Investments (Designated Activities) Regulations 2024 in November 2024 (see our Q4 2024 update).

The FCA has proposed a new category of Consumer Composite Investment ("CCI"), defined as an investment where the returns are dependent on the performance of or changes in the value of indirect investments, with rules clarifying this general definition and providing a number of explicit inclusions and exclusions. Funds, both open and closed ended, are explicitly included in the draft rules.

The CCI regime is intended to apply to anyone manufacturing or distributing a CCI to retail investors in the UK, and is intended to move away from the rigid template of the PRIIPS KID to allow firms to adapt their communications to better meet the needs of retail investors, with increased flexibility as to the format and timing of the relevant disclosures and the way in which cost, risk and performance information should be provided. This will likely be a welcome development for firms that target retail investors, though of course may require a more thoughtful approach than slavishly following the existing template.

The consultation closed on 20 March 2025 and the FCA anticipates providing a policy statement incorporating feedback on the consultation with final rules later this year. Firms are expected to have 18 months to comply with the rules once finalized.

1. FCA publishes Private Markets Valuation Review findings

On 5 March 2025, the FCA published the findings of its Private Markets Valuation Review, assessing valuation practices across private markets. The review covers both good industry practices and areas requiring improvement across eight focus areas:

• Governance arrangements - Firms should ensure clear accountability for valuation and robust oversight of the valuation process, including keeping accurate and detailed records of how valuation decisions are reached.
• Conflicts of interest - Firms should ensure they thoroughly identify and document conflicts of interest, both between the firm and investors, and between different groups of investors. Where employee remuneration is linked to valuations, investment professionals should be separated from valuation decision-making.
• Functional independence and expertise - Firms should assess whether they have sufficient independence in both their valuation functions and the voting membership of their valuation committees to enable and ensure effective control and expert challenge.
• Policies, procedures and documentation - Firms should ensure their valuation policies are sufficiently comprehensive to allow for a clear valuation process to which adherence can be tested.
• Ad hoc valuations - Firms should consider implementing a defined process for ad hoc valuations to mitigate the risk of stale valuations, including the thresholds and types of events that would trigger ad hoc valuations.
• Transparency to investors - Firms should consider where they can improve their reporting to and engagement with investors on valuations to increase transparency and investors' confidence in their valuation process.
• Application of valuation methodologies - Firms should apply valuation methodologies and make valuation adjustments solely on the basis of fair value; consider using industry guidelines to ensure their approach is in line with standard market practice; and consider whether they should apply secondary methodologies to corroborate their judgement.
• Use of third-party valuation advisers - Use of third-party valuation advisers should be appropriately overseen and potential commercial conflicts identified and managed. Firms should consider the strengths and limitations of the service provided and disclosing the nature of the services used to investors.

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