Background
The Consultation was prompted by ESMA’s letter3 outlining areas of the AIFMD that could be developed and improved which ESMA submitted to the Commission in August 2020. The Consultation picks up many of the issues ESMA highlighted and invites respondents to provide feedback on a range of areas covered by the AIFMD. The Consultation closes on 29 January 2021 and any resulting legislative changes are unlikely to materialise until mid-to-late 2021 at the earliest. This alert focuses on a number of key topics covered by the Consultation that may give an insight into what changes the AIFMD 2 will bring.
Key topics for consultation
Functioning of the AIFMD regulatory framework, scope and authorisation requirements
In this section of the Consultation views are sought on how to enhance the functioning of the AIFMD framework. The questions focus on improving the AIFMD passporting process and levelling the playing field between Alternative Investment Fund Managers (AIFMs) and other financial intermediaries.
The Consultation raises the potential of extending the licence to sub-threshold AIFMs. Sub-threshold AIFMs currently have to navigate the National Private Placement Regimes (NPPRs) of each EEA Member State. Negotiating disparate NPPRs can be a costly operational and regulatory exercise. Some EEA Member States have particularly restrictive NPPRs which include ‘depositary-lite’ requirements. Notwithstanding the potential benefits of extending the licence to sub-threshold AIFMs, it is not at all clear that there would be an appetite for this change. The level of interest would be determined in no small part by the extent to which the full AIFMD requirements applicable to full-scope AIFMs would be applied to a sub-threshold AIFM. The introduction of a passport for sub-threshold AIFMs may not be entirely welcome in the market if its introduction resulted in such managers being prevented from marketing under EEA Member State NPPRs.
The Consultation seeks further feedback from stakeholders on the scope of the AIFM licence as it relates to AIFMs that also undertake activities regulated by the Markets in Financial Instruments Directive (MiFID). Views are sought as to whether the AIFMD should be amended to clarify the requirements relating to AIFMs authorised to provide ancillary MiFID activities and, importantly, whether such AIFMs should be subject to capital requirements that correspond to those applicable to investment firms providing similar services. The Consultation further focuses on levelling the regulatory playing field between AIFMs and MiFID firms, credit institutions and UCITS managers.
The Consultation makes clear that the Commission is seriously considering harmonisation between the AIFMD and UCITS regimes. Questions are posed as regards to the treatment of UCITS, including as to whether Alternative Investment Fund (AIF) and UCITS managers should be subject to a single licensing requirement, whether harmonised metrics should be used for leverage calculations and what the reporting requirements should be when using liquidity management tools. Respondents are also asked to consider whether delegation rules under the AIFMD Level 2 Delegated Regulation should also be extended to UCITS.
In addition the Consultation highlights a number of areas that may benefit from harmonisation, including the strengthening of consistent enforcement of the AIFMD delegation rules. However, it does not address issues arising from a lack of clear delineation of the supervisory responsibilities of the home and host regulators. This was a subject raised by ESMA and such lack of clarity increases regulatory compliance costs. Its exclusion from the Consultation does not, however, mean that this issue will not be picked up later in the legislative process.
Investor protection
This section of the Consultation focuses on investor classification and protection, and on the potential to increase AIFM access to the retail market. The Consultation also contemplates the creation of a depositary passport, whether this is desirable from an internal market perspective and whether a passport, or any other methods, could address issues of short supply and the concentration of depositary services in smaller markets, which increases risks to investors.
In its letter to the Commission, ESMA highlighted the need for a harmonised definition of ‘professional investor’ in light of the variety of definitions across the EEA. However, the Consultation does not address this issue. ESMA has now raised this issue with the Commission on a number of occasions, and in doing so has noted that differing interpretations of this category of investor result in significant regulatory hazard where AIFMs seek to access investors. Greater harmonisation would be welcomed by stakeholders and there may be a hope that the Commission intends to address this in the later stages of formulating the AIFMD amendments.
The Consultation also invites opinions on what measures need to be taken to mitigate the liability of valuers in their jurisdiction. It is worth noting that the Consultation asks stakeholders to provide suggestions as to improvements to the AIFMD valuation rules, while contemplating whether it should be possible to combine input from internal and external valuers – though this may pose additional issues in terms of where liability would fall.
International relations
The Consultation invites feedback on issues relating to the interaction of the AIFMD with third country regulatory regimes. The questions posed cover a wide range of delegation issues, including whether current AIFMD delegation rules ensure effective risk management. The Consultation indicates that the Commission is considering whether the delegation rules need to be strengthened by reserving core critical functions that must always be performed by AIFMs internally and/or whether to use other quantitative criteria to ensure that delegation arrangements do not diminish effective risk management and oversight. The Consultation also seeks feedback on whether the AIFMD standards should apply irrespective of the location of a third party delegate of collective portfolio management functions.
This can be seen as a response to the issues raised in the ESMA letter, which paid particular attention to delegation and substance under the AIFMD. ESMA raised concerns at what it saw as a prevalence in AIFMs delegating collective portfolio management functions to third parties. In ESMA’s view, this poses increased operational and supervisory risks, and raises questions as to whether AIFs with such structures are effectively managed by the authorised AIFM. Focus on such arrangements is increased by the desire of both the Commission and ESMA to avoid regulatory arbitrage and protect investors.
Harmonisation of regulatory oversight between National Competent Authorities (NCAs), particularly in the event of cross-border operation and/or where functions are delegated to third parties outside of the EEA, is a key focus of the Consultation.
The delegation route is a tried and tested mechanism that has been used by third country investment managers to access EEA retail investors under the UCITS Directive and professional investors under the AIFMD. A tightening of the rules may lead to a reduction in the launch by third country managers of fully regulated EEA domiciled funds (whether UCITS or AIFs) and an increase in the use of non-EEA AIFs and in turn the use of NPPRs to access EEA domiciled investors. Given non-EEA AIFs do not have the same protections as EEA passportable funds, the real-world consequence of adopting a more conservative stance may well prove counterproductive to ESMA’s stated purpose.
Financial stability
The introduction of the original AIFMD was routed in the fallout from the 2008 economic crisis, with its core objectives to increase regulatory oversight, understanding and mitigation of systemic risks in financial markets from different sources. This section of the Consultation focuses on the powers of NCAs in relation to oversight and intervention to promote financial stability.
The Consultation invites respondents to provide opinions on the benefits and disadvantages of harmonising the availability of risk management tools for AIFMs across the EEA, particularly in situations where there could be cross-border implications. Such changes may be aimed at eliminating confusion as to which NCA is responsible for supervising the suspension of redemptions and subscriptions where an AIF is established in one Member State but its AIFM in another, as well as setting out the circumstances in which an intervening NCA may invoke suspension powers.
This section also includes questions on the appropriateness of reporting requirements under the AIFMD and the AIFMD Level 2 Regulation’s Annex IV. For those familiar with Annex IV reporting requirements (which involve the submission of complex risk calculations and transparency information), it would appear that the Commission may consider the introduction of more detailed portfolio reporting, including even more granular breakdowns by asset classes, investors, counterparties and sponsorship arrangements. It is not yet clear that increased information gathering will be supported by stakeholders, who are already subject to significant reporting obligations even though much of the burden of regulatory reporting is outsourced to compliance consultants.
The Consultation requests feedback on the IOSCO4 calculation methods and whether leverage calculation metrics would benefit from harmonisation at the EU level, and possibly across the UCITS market, in order to allow NCAs to have a complete picture of the level of leverage engaged by the collective investment funds.
Investing in private companies
The Consultation focuses on whether existing AIFMD rules restricting asset stripping are proportionate and appropriate, as well as whether the requirements applicable to AIFMs managing AIFs which acquire control of non-listed companies and issuers are effective.
Integration of sustainability risks
This section looks at whether AIFMs should be required to quantify sustainability risks in line with the Disclosure Regulation.5 Further, stakeholders are asked whether investment decisions should integrate the assessment of non-financial materiality, for example, any potentially adverse sustainability impacts.
Implementation
The Consultation is wide ranging and should be seen as a clear warning that the AIFMD 2 is on the horizon. Legislative changes are unlikely to materialise until mid-to-late 2021 at the earliest and will give far greater clarity as to how the Commission intends to address many of the issues identified by both the ESMA letter and the Consultation responses.
Whilst we wait for what may be sweeping changes to the AIFMD arising from the ESMA letter, closer on the horizon are the changes brought about by the final texts of the Directive and Regulation on facilitating the Cross-border Distribution of Collective Investment Undertakings (CBDF) and the ESMA consultation paper of the draft guidelines6 marketing communications under the CBDF.
It would seem that the ESMA letter, and the Commission’s quick response in publishing the Consultation, may have been driven by Brexit because such material concerns, for example on delegation, have not been raised to the same degree by ESMA historically. For UCITS, which have been in place since the mid 1980s, there should be a wealth of historical data for ESMA to draw on to justify a view that the current UCITS regime (and, by extrapolation, the AIFMD regime) could lead to a lowering of investor protection or regulatory oversight. Taking a more restrictive approach and increasing the regulatory burden for non-EEA managers may make the EEA a less attractive jurisdiction for asset managers to capital raise (in particular, U.S. and UK firms), thereby leading to a reduction in AIF/UCITS platform usage and resultant reduction in product choice for EEA investors.
There are significant changes to the EEA regulatory landscape in the pipeline for AlFMs and managers of UCITS funds. Such shifts will be compounded by issues around Brexit. The extent to which the UK will implement changes to the AIFMD and indeed the UCITS regime is still unclear, but issues will continue to arise around access to the EEA single market and these may be exacerbated by any UK divergence.
- Alternative Investment Fund Managers Directive 2011/61/EU.
- Undertakings for the Collective Investment in Transferable Securities (UCITS) Directive 2009/65/EC.
- esma.europa.eu/56636.
- The International Organization of Securities Commissions iosco.org/library.
- Regulation on sustainability-related disclosures in the financial sector ((EU) 2019/2088) available at eur-lex.europa.eu/CELEX.
- esma.europa.eu/61853.
Client Alert 2020-591
