The guidelines create new obligations for financial, payment, and electronic money institutions that will impact cloud outsourcing and deployment of FinTech.

By Fiona M. Maclean and Laura Holden

On 25 February 2019, the European Banking Authority (EBA) published a final report on its draft guidelines on outsourcing arrangements (Guidelines). The report followed the EBA’s publication of draft guidelines in June 2018 (Draft Guidelines) and the ensuing public consultation in September 2018 (Public Consultation).

The Guidelines replace the 2006 Committee of European Banking Supervisors (CEBS) Guidelines on Outsourcing (CEBS Guidelines) and replace and incorporate the EBA’s final recommendations on outsourcing to cloud service providers (Cloud Recommendations). Financial institutions will now only need to consult one set of guidelines for cloud and non-cloud outsourcing.

The Guidelines apply to a wider range of entities (Covered Entities for the purpose of this article) than the CEBS Guidelines and the Cloud Recommendations, including payment or electronic money institutions. The Guidelines now apply to all financial institutions that are:

  • Within the scope of the EBA’s mandate, including credit institutions
  • Investment firms subject to Directive (EU) 2013/36 IV (Capital Requirements Directive)
  • Payment institutions
  • Electronic money institutions

As a result, a wider range of companies, such as FinTech companies, will now face the challenge of remaining agile and competitive in fast-moving markets, whilst managing the administrative and practical challenges of maintaining compliance with the Guidelines.

The Guidelines come into force on 30 September 2019. Any outsourcing arrangements entered into, reviewed, or amended by Covered Entities after that date must comply with the Guidelines. Covered Entities must also update all existing outsourcing arrangements in line with the Guidelines by 31 December 2021. For Covered Entities that are already subject to the Cloud Recommendations, these deadlines will not have any effect on their obligation to comply with the cloud specific requirements – these requirements will continue to apply as they did prior to publication of the Guidelines. An overview of the status of the Cloud Recommendations, per jurisdiction, can be found here.

While “critical and important functions” are subjected to stricter rules, the Guidelines generally apply to all outsourcings by Covered Entities, including intragroup outsourcings, representing a further widening of scope when compared with the CEBS Guidelines. Covered Entities will therefore face additional administrative burdens that they must balance with the need to stay ahead of the competition. Following concerns raised at the Public Consultation, the EBA clarified in the Guidelines that regulators will not consider every outsourcing to a cloud solution as critical or important; rather the same test applies as with other non-cloud service providers, taking into account “cloud specificities”.

Under the Guidelines, the definition of “outsourcing” is based on the Commission Delegated Regulation (EU) 2017/565 and defined as: “an arrangement of any form between an institution, a payment institution or an electronic money institution and a service provider by which that service provider performs a process, a service or an activity that would otherwise be undertaken by the institution, the payment institution or the electronic money institution itself”.

The Guidelines define “critical or important functions” based on the wording of MiFID II and the Commission Delegated Regulation (EU) 2017/565, which includes functions that “if a defect or failure were to occur, would materially impair the continuing compliance of the firm’s activities and obligations”.

To outsource banking and payment services to a third country (i.e., non-EU) service provider, the Guidelines require the competent authorities responsible for supervising each party to have a co-operation agreement in place. Therefore, post-Brexit, the UK’s Financial Conduct Authority will need to agree a co-operation agreement with EU regulators to ensure that cross-border outsourced arrangements can continue between the UK and the EU27.

Increased competition among insurers and improved policy terms suggest the German W&I insurance market is becoming more favourable to investors.

By Christian Thiele

In real estate transactions, buyers and sellers naturally pursue conflicting interests when negotiating a sale and purchase agreement. On the one hand, sellers will strive to achieve the highest possible purchase price, and will also want to keep their liability exposure low. Private equity investors in particular will try to achieve a “clean exit” when selling real estate directly or indirectly, so that they can dissolve the selling entity quickly. On the other hand, buyers will want to minimize the purchase price. At the same time, they will know the asset only from their due diligence. Therefore, buyers will try to obtain a comprehensive set of representations and warranties from the seller. However, even if the seller gives such representations and warranties, asserting claims will often be unsatisfactory for the buyer because the selling entity lacks assets. The buyer will therefore insist on a security for his claims. These conflicting interests often put a significant burden on contract negotiations and can even turn into a deal-breaker.

Sell-and-buy-side W&I policies

Parties to a deal can secure the buyer’s claims in different ways, such as a purchase price retention or escrow accounts. In the current seller’s market, however, such structures are becoming increasingly rare. So-called warranty and indemnity insurances (W&I insurances), however, are becoming an increasingly popular method of securing the buyer’s claims. Either the seller or the buyer can take out such W&I insurances. If the seller takes out the insurance, the insurer reimburses the seller — similar to a liability insurance — for claims asserted by the buyer. Such policies have risks for the buyer, e.g., if the seller acts intentionally or violates his obligations under the insurance policy and the insurer refuses to reimburse the damage. Sell-side W&I policies, therefore, have almost no practical relevance, at least in real estate private equity transactions. The buyer’s preferred option is the buy-side W&I policy. Such policy grants the buyer a direct claim against the insurer in case of a damage. The buyer, therefore, does not have to assert any claims against the seller. Such policies also cover instances in which the seller has not disclosed the relevant facts and has therefore acted with gross negligence or even intentionally.

Many auto advisers and automated discretionary investment managers risk poor outcomes for customers by falling short of FCA expectations.

By Nicola Higgs and Brett Carr

The Financial Conduct Authority (FCA) has issued a statement outlining its expectations of firms providing automated online discretionary investment management (ODIM) services and retail investment auto advisers (auto advisors). The FCA uses its statement to remind firms that the regulator’s rules, including those in relation to suitability and advice, apply equally to services regardless of the medium through which they are offered. Current providers and planned new market entrants should heed the warnings and the learnings of this statement.

What was the FCA analysing?

The FCA conducted two reviews:

  • The first review looked at seven ODIM providers (at the time these firms represented more than half of the firms in this particular market).
  • The second review looked at three auto advisers (being three of the early entrants to this nascent market).

By Matthias Rubner, Denis Criton, Olivia Rauch-Ravise and Bénédicte Bremond

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President Macron recently unveiled employment and tax reforms to increase France’s appeal for deal makers. While France ranks highly as an investment destination for private equity firms, complex and inflexible French employment laws have been perceived as a hindrance — perpetuating the belief that France can be an unfriendly jurisdiction for businesses and investors. In our view, these reforms — which focus on employee termination, collective bargaining, and employee consultative bodies — will make doing business in France easier and, coupled with proposed tax reforms, should facilitate an even stronger French dealmaking environment.

France ranks just 31st in the World Bank’s 2017 Ease of Doing Business index — the Macron reforms aim to improve this.

Collective Bargaining and Employee Termination – Developments and Implications for Private Equity

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Rules on collective bargaining agreements, a key feature of the French labour market, are changing. Previously, French companies could not change employment terms with workers if such changes were less favourable to employees than the rules set by industry-level agreements. Under the reforms, employers can now agree to company-level deals with unions that will supersede industry-level rules. This allows PE owners more flexibility to tailor agreements that better align with their actual business needs.

By Isabella Porchia

The Italian Securities Commission (CONSOB) has approved two handbooks, “Management of Inside Information” and “Investment Recommendations,” which offer guidelines under Market Abuse Regulation no. 596/2014 (MAR) and delegated acts. These publications have implications for a range of market participants, including companies with listed equity and debt securities on both Italian regulated markets and multilateral trading facilities, as well as financial analysts and financial institutions acting as dealer managers and underwriters. In particular, the long-awaited handbooks clarify issues that certain provisions of MAR had raised while offering guidance on MAR’s full implementation.

The handbook on management of inside information provides guidelines for creating and implementing internal procedures involving inside information. In addition, the handbook imparts recommendations for developing and maintaining the insider register, as well as for complying with MAR’s disclosure requirements.

By Tom Alabaster and Nick Benson

Increasingly complex fund structures and documentation mean that analysing how potential portfolio acquisitions interact with the fund at the top of any deal structure is more important now than ever.

Investor Excuse Rights for Environmental, Social, and Corporate Governance (ESG) Compliance

As investors focus on ESG compliance, requirements for “excuse rights” for non-compliant investments are expanding. Firms usually avoid the most obvious red flags with ease but in our view, restrictions on investing in businesses breaching environmental or anti-corruption standards are more problematic, as even blue-chip multinationals are not immune from these issues. Where an investor is excused, the GP must source cash elsewhere — ideally from remaining investors, who can often be required to increase participation to fill the gap. With many funds accepting commitments representing significant proportions of the total fund size from a small number of large LPs, sophisticated investors are increasingly concerned about the consequences of large LPs being excused from investments and have sought to mitigate such risks through negotiating restrictions on “topping-up” participation. Deal teams must engage in careful diligence early in the deal process and be cognizant of the impact of LP opt-out rights on a fund’s capacity to participate in a deal.

By Paul Davies and Michael Green

Broadly defined, conservation finance is the raising of capital to support the conservation of land, water and resources. This concept started with “debt for nature” swaps during the 1980s and 1990s whereby developing countries agreed to protect ecosystems using revenues freed up by sovereign debt relief (such deals usually being arranged by international environmental groups). Recently, there has been an increasing focus on cash generating investments in this area, thereby excluding certain philanthropic and grant based activities. Market commentators note that, ideally, conservation finance should capture both elements. For example, in two reports (2014 and 2016), Credit Suisse and McKinsey suggest that “cash flow” should “in part remain with the ecosystem to enable its conservation” and also, in part, be “returned to investors”. In Ecosystem Marketplace’s assessment of the current market, it was emphasised that the key focus should be on “conservation impact” and that this should not be a “by-product of an investment made solely for financial return”. The difficulty appears to lie in striking the right balance between the conservation of the environment and financial gain.

Against this shifting landscape, a wider range of investors are being drawn to conservation finance projects. For example, “impact investors” such as high net worth individuals, family offices or foundations are increasingly attracted to this area as they place a greater emphasis on the environmental or social impact of their investments. They are often prepared to take on high risk projects or accept lower returns in exchange for these positive impacts. In addition, private sector investors (clients of banks, asset management firms and beneficiaries of public pension funds) are looking into investment products in this area, drawing into sharper focus the shift away from traditional philanthropic element of conservation finance. As Ricardo Bayon, a partner at Encourage Capital (an investment management firm offering conservation finance funds) recently told Environmental Finance Magazine, high impact investments no longer means investors are giving up their returns – it is possible to “have your cake and eat it.”

By Paul Davies and Michael Green

Commercial risks to businesses can no longer be neatly divided into financial and non-financial considerations. For example, there is growing recognition, particularly in the pensions sector, that a failure to take account for environmental and social governance (ESG) risks (in particular, climate change risks) can result in adverse financial consequences. While a revised EU directive  will impose an obligation on pension fund managers to consider ESG issues, pension trustees may already be subject to potential legal liability if they ignore material financial risks resulting from climate change (traditionally considered only a moral or ethical concern) in investment portfolios, according to legal counsel.

By Paul Davies and Michael Green

A new pensions directive was passed by the European Parliament on 24 November securing 512 votes (only 77 votes against and 40 abstentions), requiring EU workplace pension funds to consider environmental, social and governance (ESG) issues. This is considered a ‘landmark’ moment for responsible investment.

The new pensions directive stipulates that:

  1. ESG criteria is to be considered in investment decisions and their practical implementation should be disclosed in regular reports.
  1. Pension funds have to include their ‘stranded asset‘ strategy as part of their risk management procedure.
  1. The integration of ESG considerations will not be considered as conflicting with fund managers’ fiduciary duties. Fund managers will not be exposed to legal liability for an alleged failure to act prudently by prioritising ESG factors over financial risk returns in their investment decisions.