Join Ropes & Gray's asset management partners, Eve Ellis and Joel Wattenbarger, as they delve into key regulatory issues impacting clients with interests in both the United States and Europe. On this podcast, they explore pertinent topics and developments for private fund managers, such as new rules, firm culture, valuation practices, and the evolving landscape of ESG factors.


Joel Wattenbarger: Hello, and thank you for joining us today on this Ropes & Gray podcast. I'm Joel Wattenbarger, an asset management partner in our New York office, and co-head of our private fund regulatory group. Joining me today is my colleague Eve Ellis, an asset management partner in our London office. Many of our clients have touchpoints in the United States and Europe, and we've designed this podcast series to help provide an overview of some of the topics and regulatory issues we are seeing that are relevant to all of these clients. Today, we're going to touch, in particular, on a few of these topics, relevant specifically to private fund clients. We'll start with comparison of European and U.S. approaches to regulation of private fund managers.

European/U.S. Approaches to Regulation of Private Fund Managers

Eve Ellis: I'm sure many of our listeners are aware, but the Securities and Exchange Commission ("SEC") adopted significant new regulation, which will impact private fund managers. That was introduced last August, and there's obviously been a lot of discussion around the new rules. Joel, could you just provide a little bit of an overview as to what the new rules are, and, particularly, how they might impact managers that don't have an obvious U.S. nexus, but are more European based?

Joel Wattenbarger: Of course. The new private fund adviser rules impose a number of new obligations on managers of U.S. private funds, including mandatory quarterly reporting, new preferential treatment prohibitions and obligations, and rules restricting certain practices with respect to expense allocations, amongst other things. The rules generally go into effect this September for large advisers, except for the quarterly reporting rules, which go into effect in March 2024. And unlike most prior Advisers Act rules that are on the books today, these new rules, in substantial part—with an exception for rules relating to quarterly reporting adviser-led secondaries, and private fund audits—will apply to both registered investment advisers, as well as exempt reporting advisers to private funds. So, as a result, if you're a European or other non-U.S. fund manager that is an exempt reporting adviser for U.S. Advisers Act purposes that manages one or more private funds organized in the U.S., we recommend that you put policies and procedures in place now to comply with these new rules, and to prepare for a potential SEC exam, as the SEC does have the authority to examine exempt reporting advisers.

We, at Ropes & Gray, presented a four-session webinar series on these new rules last September. Recordings of that series are available on our website, and I would commend them to any listener who wants to fully immerse themselves in the details of the new rules. For now, I'll just note that the preferential treatment rules, in particular, will have a significant impact on the fundraising process for private funds, with respect to U.S. investors. They'll impose greater transparency on special treatment provided to certain fund investors, and not others, whether that comes in the form of side letter terms, waivers of fund terms for particular investors, or reporting that's provided to certain fund investors and not others. And then, especially for open-end fund managers, these new rules will potentially restrict the ability of fund managers to offer different redemption rates or information about portfolio holdings to certain fund investors and not others. In addition, many of our registered investment adviser clients are already working with their finance teams, portfolio companies, and external service providers to prepare for the burdensome quarterly reporting requirements that will come into effect next year.

Eve Ellis: Thanks, Joel. I think there's been some litigation around the new private fund rule, and the Fifth Circuit is analyzing that at the moment. Do we know what the status of that litigation is?

Joel Wattenbarger: The litigation is rolling along. The parties to that case—which are on the one hand, the private fund industry groups that are bringing a challenge to the rulemaking, and on the other hand, the SEC—have agreed to an expedited schedule on the case, and they've requested a decision from the Court by May 31. But it's not certain that we'll see a resolution by then—ultimately, it's up to the Court when the case will be decided. It's also possible that whatever decision the Fifth Circuit reaches will then be appealed to the U.S. Supreme Court. In any event, our advice to our U.S. and European clients is to carry on with preparations for complying with the new rules, just given the timing and, of course, pending the resolution of this litigation. And so, with that, Eve, let's shift to a European focus for a moment.

We know that the EU and the UK have focused on private fund manager regulation for over a decade now, primarily through the Alternative Investment Fund Managers Directive ("AIFMD") rules. I understand that AIFMD II is now making its way through the European rulemaking process. What should U.S. and other non-European managers know about AIFMD II, and can you speak to how those rules compare or contrast with the U.S. private fund adviser rules we've just been discussing?

Eve Ellis: As you say, we've been living and breathing AIFMD for over a decade now. And, as with many European regulatory regimes, Europe loves a sequel, and so, we are now in the near-final stages of AIFMD II. We've seen the near-final version, and, I think, it's probably best described as more of an evolution, rather than a revolution in relation to the changes, though I suspect most sponsors, particularly U.S. sponsors that are touched by AIFMD because they market their funds into Europe, won't see significant changes. But there are a number of areas that it's worth noting that will have some impact.

The biggest change that we're going to see is that AIFMD II is going to create additional rules for funds that originate loans, and then, also, funds that are considered loan origination funds. That's obviously going to have a big impact for a number of credit fund managers. The scope of those rules is likely to apply just to European managers—so, for U.S. managers that don't have a European management entity, these rules will be less relevant. But it may impact U.S. sponsors that have, for example, a Luxembourg sleeve that's managed by a third-party fund manager. There are various rules that are going to apply as a result of the new loan origination rules. They'll include concentration limits: there are restrictions on funds making loans in excess of 20%. There's also risk retention rules that will apply, certain policies and procedures that will need to be put in place, and additional requirements that will apply to those sorts of funds. So, that, I think, is the biggest change that's going to be relevant, particularly for any credit fund managers. But some of the rules, as I say, also apply to funds that just originate loans, so it may have certain implications for other strategies. Not all of those provisions will apply, but some of those provisions may apply even within a private equity, infrastructure, or real estate strategy.

There are some other changes which are a little bit more tinkering around the edges of the existing regimes, but the key one, I think, is delegation—managers can still delegate to non-European managers. So, that's good news. There was some concern the AIFMD may restrict delegation to non-European portfolio managers, but actually, what the new rules will do will increase some of the reporting around delegation and require some additional supervision. I think the key takeaway, for example, for managers that have Luxembourg structures with third-party managers is they may see an increased supervision from a compliance perspective when it comes to the delegation process, so there may be a little bit more compliance monitoring. Additional requirements will also apply in relation to reporting, particularly around costs and charges. There are some liquidity management rules that invest or are going to be introduced for open-ended funds, and some restrictions on marketing funds into Europe if those funds or the managers are based in high-risk AML jurisdictions, or non-cooperative tax jurisdictions. That's less of an issue now that Cayman has come off the European AML high-risk list, but, that provision has still stayed in AIFMD II.

Looking at provisions that are similar, I think, the biggest area that we've obviously lived with for a while with AIFMD I is the preferential terms point. There are restrictions and requirements in AIFMD which will stay in AIFMD II which require you to disclose preferential terms to all investors, and that's part of the broader requirement to treat investors fairly. I suspect your rule, Joel, is going to be more prescriptive—and knowing the difference in how regulators enforce and supervise, I suspect the SEC will enforce that more aggressively. So, although we have similar provisions in place, I think, the way that they are implemented, and the more prescriptive nature of the private fund adviser rules is such that there will probably be a difference there in terms of how managers live and breathe that rule in practice.

Focus on Fund Manager Culture

Joel Wattenbarger: That sounds right. Now, let's move on to our next topic, which is a focus on fund manager culture. I understand that a current focus of European financial regulators is on firm culture at fund managers. Can you speak a little to what that looks like in practice?

Eve Ellis: Sure. This is a really big topic for the Financial Conduct Authority ("FCA"). This is particularly relevant in the UK, so for anyone that's got UK-regulated entities. At the end of last year, the FCA published a consultation paper on diversity, equity, and inclusion ("DE&I"), and non-financial misconduct, which had been a long-awaited consultation paper. It includes requirements for larger firms to consider and have policies and procedures in place around DE&I, but also to set targets on diversity and inclusion. In addition, and importantly, all firms must consider non-financial misconduct when assessing whether individuals within that organization are fit and proper. Just taking a quick step back, the UK's has a Senior Managers and Certification Regime which requires firms to make sure that individuals undertaking certain functions are fit and proper—so, the change will require firms to ensure that they consider non-financial misconduct in this assessment. Now, these rules are still at an early stage—they're not in final form yet—but it certainly indicates that firms having healthy culture, as I say, has been a key focus for the FCA for a number of years, and are beginning to enshrine that into proposed rules.

Other ways that, I think, the FCA has also highlighted culture in multiple speeches and letters to the industry, particularly within the alternative sector, include statements that non-financial misconduct and culture are considered as part of remuneration setting, ensuring that senior managers in an organization set policies and procedures to help develop a healthy culture, and that there is a speak-up culture, which historically, I think, had been more focused on compliance issues. But looking forward, that certainly is something that, I think, the FCA would expect to consider more non-financial conduct issues, as well. So, I think, everyone should expect that this is something that the FCA is going to be very interested in during the course of 2024.

Joel, from your perspective, has there been anything similar or recent developments in the U.S. on that side of things?

Joel Wattenbarger: It's interesting, Eve. SEC officials regularly speak to the importance of instilling a so-called "culture of compliance" at investment adviser firms, and we continue to see SEC exam staff assessing firm culture as part of the exam program. But recently, we're seeing a particular focus on the SEC's Whistleblower Program. I think it's safe to say that many of our clients would view the SEC's promotion of whistleblowing as in some tension with instilling an internal culture of trust and transparency, but there's no question that the SEC views that program as critical to its enforcement efforts. Just to give a sense of the scale of this program, a couple of statistics:

  • The SEC reported that there were more than 18,000 whistleblower tips in fiscal year 2023, which was approximately 50% more than in the preceding year.
  • In total, the SEC has awarded more than $11 billion to whistleblowers since inception of the Program in 2011.
  • Most recently, the SEC fined JP Morgan Securities $18 million in civil penalties for violations of the whistleblower protections under Exchange Rule 21F-17(a). This rule makes it a violation for any person to impede an individual from communicating with the SEC about a possible violation of federal securities laws. The case is notable really for two reasons:
    • First, the case involved confidentiality provisions in settlement agreements with customers of JP Morgan. Historically, the focus of both industry participants and the SEC with respect to this rule has been on confidentiality provisions applicable to employees—so, making sure, from the SEC's perspective, that employees were not restricted from communicating with regulators about potential securities law violations. This case effectively sends a message that investment advisers should also be thinking about whistleblower provisions in other contexts, including confidentiality agreements with clients or fund LPs.
    • Secondly, JP Morgan had whistleblower language in the agreements in question—so, it's not that they didn't have language that was intended to address, in some respect, this Rule 21F-17—however, the language that was in these form settlement agreements only authorized parties to respond to regulatory inquiries. The SEC noted in the settlement order in this case that, in order to comply with this rule, the agreements needed to permit proactive communications with regulators, not just responses to inbound inquiries.

I guess the takeaway here for listeners is that I would encourage you all to review confidentiality provisions in your agreements with U.S. persons of whatever description to ensure that appropriate whistleblower carveouts are included in those provisions, in accordance of the requirements of Rule 21F-17.


Eve Ellis: Switching topics, I think, another area that is of particular focus in the U.S. relates to valuations, particularly as that relates to marketing. What are the latest developments there?

Joel Wattenbarger: There's a very interesting recent settlement in an enforcement case in this area where the SEC took issue with senior personnel of a fund manager sending out performance information or performance-related information to both existing and potential investors in the private fund, with numbers and references that had not been approved by the firm's valuation committee, in violation of the adviser's valuation policies and procedures. Emails sent by the adviser in this case included such information as "embedded gains" as estimated by personnel, but again, not yet subject to a formal valuation procedure internally. The SEC did not say in the order that the email communications violated the SEC's marketing rule, but the order did note that the adviser had policies and procedures that any written communication addressed to more than one person was subject to prior approval by compliance personnel as an advertisement; and that, in any such advertisement, performance data was required to be presented fairly, in an anonymous leading manner, and with explanatory footnotes. The emails violated those internal policies and procedures, as well. And finally, the case involved misuse of confidential information—so, per the order, the adviser in question was sharing confidential investment information in a manner inconsistent with the adviser's policies and procedures.

So, that case was a bit of a trifecta in terms of the violations, but it was an interesting case in that it connected valuation and marketing in addition to failures to implement the adviser's policies and procedures. I think the takeaway here is that private fund managers need to take care to ensure that any sort of valuation information or performance information provided to investors or prospective investors in any form reflects the results of the adviser's valuation policies and procedures, and is otherwise shared in a manner consistent with the adviser's compliance policies and procedures. And so, it's just really important to emphasize to everyone internally, whether it's in a formal marketing document, or a less formal email, the SEC is really focused on providing valuation and performance information in whatever context.

With that, let me turn the question back to you, Eve: Are regulators in Europe focused on valuations by private fund managers—and if so, what does that look like?

Eve Ellis: It's probably fair to say that they have been less focused on that area historically, but, I think, the tide is turning. It's an area that the Luxembourg regulator is probably focusing on in 2024, and we understand that the FCA in the UK is about to commence a pretty detailed review in relation to valuations of private market, and that will include private fund advisers. I think it's going to be predominantly focused on managers in the UK, so fund managers in the UK, but I suspect it will have indirect implications for any UK sub-advisers to U.S. sponsors when involved in valuations. And I think it will focus on private equity and other private advisor strategies, including real estate infrastructure—but, I think, there will be a particular focus on private equity. So, this is definitely something that the FCA is focusing on. We understand they're going to conduct their review during the course of this year, so it may be that we have guidance or the results of the review by the end of the year—but, certainly, an area of interest, and something to watch during 2024.


Rounding out our hot topics, Joel—I don't think we properly can talk about key areas of focus for fund managers without mentioning ESG. ESG continues to be a focus for regulators in the U.S. and Europe. What is the latest in the U.S. on the topic?

Joel Wattenbarger: You're absolutely right, Eve. The SEC certainly continues to be active on multiple fronts with respect to ESG, but, I think, the primary focus at the moment is on rulemaking. We expect that potentially two new ESG rules will be adopted by the SEC in the relatively near future—these are rules that were originally proposed back in 2022. So, the first is an ESG rule for issuers. The SEC originally proposed an issuer ESG rule in March 2022. That proposed rule generally would require public companies to include certain climate-related disclosures in their registration statements and periodic reports, including information about greenhouse gas emissions and climate-related financial metrics in audited financial statements. We also expect, while the public company issuer rule will likely be first, that there will also be in the relatively near future an ESG rule adopted with respect to investment advisers and investment companies. So, the SEC proposed an ESG rule for those entities in May 2022. That rule would require advisers to determine, for any fund they manage, whether the fund considers ESG factors at all in their investment process, and if they do, they'd then be required to categorize those funds as either "integration," "ESG-focused," or "impact funds," and various reporting obligations would apply depending on a fund's categorization under these rules.

So, if and when the SEC adopts these rules, we'll stand by, ready to help clients assess their funds (the funds they manage) under the new ESG framework, including seeking to harmonize a categorization of funds under these new rules and relative to the Sustainable Finance Disclosure Regulation ("SFDR") categorization of such funds today. We'll also be helping clients prepare to comply with the new ESG reporting obligations.

Eve, let me now turn to you and say, I think, it's been our observation for some number of years that U.S. regulators are, to a degree, playing catch-up to their European counterparts when it comes to ESG. What's the latest on this topic in Europe?

Eve Ellis: ESG just remains a really significant area of regulatory focus, both for EU regulators, and in the UK. I definitely agree that Europe led the way with SFDR from a rulemaking perspective, although, I suspect people may say that the first mover advantage may not have paid off or may not pay off in the long run. The main reason is that SFDR is currently being substantially reviewed, and that's not unusual. As I mentioned, we've got AIFMD II, so European regulation is reviewed relatively regularly, but, I think, the possibility is that SFDR may be substantially rewritten. And the main reason for that is, it was designed as a disclosure regime, but has been used in practice as a labeling regime, which, I think, has of itself actually increased risks around greenwashing. If they do happen and a labeling regime is put in place, that will shift SFDR dramatically, and will potentially create minimum criteria that sponsors will need to comply with in order to use a particular label. But as I say, this is not something that's going to happen overnight—it'll be a change that would happen over a few years. But, I think, it just shows the regulatory environment around ESG, even though we've led the way on rulemaking, it is still certainly evolving. A more subtle change: sponsors should be aware of is that there were some changes to the regulatory technical standards that were suggested at the back end of last year which will be implemented sooner, probably during the course of this year, which will impact templates that managers use for the pre-contractual disclosures. For "light green" Article 8 funds, that shouldn't be a huge lift—it may be a slightly bigger lift for "darker green" Article 8 funds and for Article 9 funds, so again, managers should watch this space to make sure, when those changes happen, that they adopt the correct template. And there may also be changes to the Principal Adverse Impacts ("PAI") regime by extending the scope of some of the indicators that are included in that regime. So, those are some more subtle changes that will be happening to SFDR ahead of potentially big changes in the next couple of years.

Then, from a UK perspective, the UK has been a little bit slower from a rulemaking perspective, but again, at the end of last year, the FCA published its final rules on its Sustainability Disclosure Requirements ("SDR") regime. The UK has gone down a labeling approach, and so, we've got four labels that managers can adopt. It's a relatively high bar for most of those labels, but it's an opt-in regime, compared to the SFDR, which is a compulsory regime. And it also currently only applies to UK funds, so it's not something that's actually applicable to U.S. funds that are marketing into the UK. So, again, that may change over time, and it's likely it will get extended—but, at the moment, the scope of the labeling regime is limited to UK funds. The piece that is relevant to all firms, which will be relevant for anyone listening that's got a UK-regulated entity, is that there's an anti-greenwashing rule that's going to come into force at the end of May this year, which requires any statements that you're making around ESG or sustainability to be clear, fair, and not misleading. The FCA is currently consulting on guidance to accompany that rule, so that's something that managers that have got UK-regulated entities will need to be thinking about in this first quarter, just to make sure that they're in compliance with the rule. So, yes, it's certainly an area that continues to evolve.

Joel, just in terms of the U.S. rules, have we got an idea of when the final ESG rules, in terms of those that will impact investment advisers, may be published?

Joel Wattenbarger: It's a great question. The SEC publishes a regulatory agenda every six months, and the most recent version of that agenda indicated a date of April 2024 for both the issuer ESG rule and the investment adviser and investment company rule. That date is very much not written in stone, but, I think, in this case, it's broadly consistent with our expectations. I will observe it's, of course, a presidential election year here in the U.S. There are some reasons, including administrative law reasons why, for any rule that Chair Gensler and the SEC want to adopt and be sure that it is protected from being overturned by a prospective Republican Congress next year, that rules need to be adopted relatively sooner rather than later, probably in the first half of this calendar year. So, I do expect that we will see the SEC move forward on those rules within the next several months.

Eve Ellis: Great. Certainly, there's a lot to navigate when it comes to ESG. And just for listeners, if they're not aware, we're hosting a series of roadshows over the next few months in our U.S. offices and also in our London office, which will give a really detailed, deep dive into a lot of the issues that our asset management clients are grappling with. If you would like details of that, please let either Joel or I know, and we can let you have those details.

Thank you, everyone, for listening. For more information on the topics that we've discussed or other topics of interest that impact asset managers, please do visit our website, And, of course, if you have any queries or if we can be of any assistance on any of these topics, please do get in touch. You can also listen to this and subscribe to the podcast series wherever you regularly listen to podcasts, including Apple or Spotify. Thank you again for listening.

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