Legal Special: Under the regulatory spotlight

These three recent regulatory developments should be on private equity firms’ radars in the US, Europe and Asia.

Globes

CFIUS’s jurisdiction widens in ‘critical’ industries

The Committee on Foreign Investment in the United States’ Foreign Investment Risk Review Modernization Act of 2018 came into effect on 13 February 2020. The final regulations expand CFIUS’s authority to review minority and non-controlling investments by foreign investors in US businesses involved in technology, infrastructure or data activities that are deemed to be “critical”.

CFIUS would generally have jurisdiction to review such investments in US TID businesses where the foreign investor has access to non-public technical information, board membership or observer rights, or substantial decision-making relating to critical technologies, infrastructure or US citizens’ sensitive personal data.

CFIUS declarations are mandatory for transactions in which a single foreign government has a 49 percent or more direct or indirect interest in the GP engaging in the transaction, and in which the acquisition would result in a 25 percent or more direct or indirect voting interest in the TID business.

Exemptions include investors from Australia, Canada and the UK if they meet certain qualifying criteria.

Private equity sponsors should assume that CFIUS will likely impact them in many ways, including across fundraising, investment (and co-investment), and exit scenarios, says Mario Mancuso, partner at Kirkland & Ellis. He adds: “Sponsors should also think of CFIUS – at least for deals – as a gating, strategic legal issue. In some cases, a CFIUS filing will now be mandatory and not filing would breach an affirmative legal requirement. More generally, CFIUS may well impact a deal’s feasibility, risk allocation decisions and timing considerations. So, CFIUS should be considered early by sponsors on the buy and sell-side. It is not a follow-on, check-the-box exercise.”

In cases where a sponsor has some LP optionality, there are ways to raise and structure funds appropriately to mitigate the impact of CFIUS, says Mancuso. The identity of an LP and how they are brought into an investor syndicate should also be assessed from a CFIUS perspective when a US business (or a non-US business with a US piece) is in the mix, he explains. “A lack of careful planning in this regard can have very serious impacts on the fund’s underlying strategy, especially if the fund has a sector focus which would likely invite a relatively greater amount of CFIUS scrutiny.”

EU’s Disclosure Regulation targets sustainability

The EU’s Disclosure Regulation will place more stringent sustainability disclosure requirements on financial market participants. Institutional investors will need to reveal how they integrate environmental, social and governance risks into their decision-making processes, including their methods for considering adverse impacts on ESG matters. Where financial products or services are marketed as sustainable, firms will be required to demonstrate how they measure sustainable performance or how they meet their sustainability objectives.

According to the EU Commission, the new disclosure requirements aim to prevent greenwashing and heighten market awareness of sustainability issues; provide a disclosure toolbox that can be applied in the same manner by different financial market operators; and level the playing field by including investment funds, insurance-based investment products, pension funds, individual portfolio management, and insurance and investment advice within its scope.

The regulation entered into force on 29 December 2019 and it will apply from 10 March 2021.

Simon Witney, special counsel at Debevoise & Plimpton, says: “The European Union’s new sustainability rules will have an important impact on private fund managers operating or marketing funds in Europe, along with many other asset managers and advisors. Private equity is an asset class that is already used to accommodating the ESG preferences of its institutional investors and these additional requirements should not require most firms to make dramatic changes to existing policies and procedures.

“However, new public disclosure and reporting requirements will apply to all managers, and funds that claim to have sustainability objectives will have enhanced obligations. We await the final detail, but many obligations will apply from March 2021. It remains unclear whether the UK will implement these rules.”

Hong Kong issues private equity licensing guidelines

On 7 January 2020, the Securities and Futures Commission published a circular clarifying its guidance for private equity funds seeking to be licensed to carry on a business of regulated activities in Hong Kong under the Securities and Futures Ordinance.

The circular states that a GP will generally need to be licensed for Type 9 regulated activity (asset management) if they conduct fund management business in Hong Kong, unless these activities are fully delegated. Those who perform these activities for GPs in Hong Kong must be licensed as representatives and approved as responsible officers where appropriate.

The SFC will consider the composition of a fund’s entire portfolio when determining licensing requirements. Shares and debentures in a private company within the meaning of the Companies Ordinance are carved out from the SFO’s definition of “securities”. However, if a firm has set up a special purpose vehicle for investment holding purposes and the SPV’s underlying investments fall within the SFO’s definition of “securities”, then it would require the private equity firm to have a Type 9 licence.

If a licensed private equity firm has an investment committee in Hong Kong then members should be licensed as representatives and approved as responsible officers, with the general exception of members who do not have any voting rights or veto power for investment decisions.

Separately, Hong Kong has been looking at ways to draw more private equity funds to the region, including introducing a limited partnership funds regime. The proposed LPF regime was put forward for discussion in the Legislative Council in December 2019, with first and second readings of the bill slated for this year.

In his 2020-21 budget speech in February, financial secretary Paul Chan Mo-po confirmed that Hong Kong also plans to provide tax concessions for carried interest “with a view to attracting more private equity funds to domicile and operate in Hong Kong”. It intends to launch an industry consultation on its proposals.