The recently published review of the AIFMD regime highlights areas that work, those that could be improved, and those that require further analysis. However, it also shows once again the crucial role of the UK within the EU funds sector, and the possible disruptive effect of Brexit.
The Alterative Investment Fund Manager Directive (AIFMD) – a regulatory framework for alternative funds – was approved in 2011 and took effect mid-2013. At the time, the directive indicated it would come back and revisit two critically important topics. These were:
- Consider extending management company passport to non-EU (also known as “third-country”) managers
- Review and report on the effectiveness and functioning of AIFMD with a view to ensure it was working as intended.
In relation to the promised review of AIFMD’s functioning, on January 10, the European Commission published a long awaited and much anticipated report, assisted by a well-known consulting firm on the operation of the AIFMD.
The report outlines the key findings of a survey of various stakeholders (748 responses in total) who operate under AIFMD including managers, investors, regulators, and depositories. The detailed 437-page report addresses areas of relative success, possible weakness, and those that require further assessment. The report is likely the beginning of a process that will ultimately result in AIFMD 2, although the timing is unknown. Brexit has also fundamentally changed the landscape since AIFMD was first put in place and will continue to shape the future.
Overall, the report suggests the robust and broadly consistent AIFMD framework across the continent has been a significant contributory factor in creating an EU-wide market for alternative investment funds (AIFs). The findings further suggest that main provisions of AIFMD have both worked well and remain valid and fit for purpose. The report is particularly complimentary of the functioning of the Management Company passport where an AIFM based in one country may manage funds in another country.
The report candidly points out several areas in need of improvements and areas of divergence which should be rectified to prevent arbitrage and inconsistencies. These include:
The Commission suggested increasing consistency and transparency regarding differing national rules and supervisory processes relating to the marketing passports. There are divergent authorisation practices across EU member state regulators and the definitions and application of both “marketing” and “pre-marketing” are inconsistent across the bloc. The report further highlights that those surveyed strongly believe that retention of national private placement regimes is merited, even in the case of non-EU passports being introduced for non-EU AIFs and AIFMs in the future. The Commission has already attempted to enhance cross border distribution of funds through policy changes, but this report suggests there is more work to do. As it stands, cross border distribution in the EU remains more difficult, complex, and expensive than asset managers would like.
The report describes existing AIFMD investor disclosure requirements as “excessive,” and “sometimes duplicative,” which could lead to a lack of understanding by investors or worse to the investors totally ignoring the AIF disclosures. It also suggests that professional and institutional investors be given a choice to “opt out” of certain disclosures given their specific expertise and appetite.
The report highlights concerns from the industry with regards to the Annex 4 and other AIFMD reporting requirements, some calling it “inadequate” and “duplicative.” The Prospectus Directive, UCITS 5, MiFID 2, EMIR, PRIIPs, SFTR, and CSDR have all added reporting and disclosure requirements to asset managers operating within Europe since AIFMD was introduced. Therefore, some feel that regulators should review overlapping reporting obligations with a view to increase consistency, reduce duplication, and minimize complexity of such reporting.
AIFMD imposed very prescriptive asset valuation methodologies aimed at removing conflicts of interests and increasing transparency. The report suggests that the effectiveness of these asset valuation rules is somewhat impaired due to the binary choice between an internal (in house AIFM valuation process) or external valuation agent (third-party valuation or pricing vendor) and the diverging member states’ interpretations of the extent of the liability of external valuers. Some AIFMs remain concerned that even though they have appointed a third-party valuation agent to price certain assets, they ultimately remain liable for the authenticity and accuracy of such valuation.
Of course, it’s almost impossible to address any issue of EU cross border fund activity without considering Brexit. The report’s statistics highlight the primacy of the UK currently in terms of its scale and importance to the EU alternative funds industry. The UK is listed within the report as a top three location for both AIF funds and AIFM managers’ head offices. It also ranks highest out of all EU member states in terms of exported AIF, AIFM, and MiFID services.
Upon exit from the EU, all UK AIFM will immediately lose their authorisation they are currently allowed under AIFMD. The UK becomes a third-country, so managers become third-country AIFMs, and UK domiciled AIFs become third-country AIFs. There is no temporary permissions regime for AIFMs. A UK-based AIFM may no longer rely on passporting but rather must adhere to the National Private Placement Regime of each EU member state. This requires the UK regulator (the FCA) to put in place cooperation arrangements with the various supervisory authorities across the EU.
The third-country passport issue goes beyond the UK, but it is inextricably linked to the Brexit debate. As we have written about extensively before, Brexit has prompted the EU to fundamentally re-evaluate its position on granting of third-country equivalence and passporting. Until the terms of the future relationship between the EU and the UK exist, any extension of third-country AIFMD passports appears highly unlikely. For now, the EU remains steadfast in its desire to ensure that UK firms don’t use EU passporting or equivalence decisions as a backdoor into the EU post-Brexit.
However, there have been two positive developments for asset managers. First, the FCA introduced a temporary permissions regime (TPR) allowing EU firms currently passporting into the UK to continue new and existing regulated business within the scope of their current permissions in the UK. The FCA will also allow EU-domiciled investment funds that are currently in the UK under a passport to continue temporarily marketing in the UK. The notification window to avail of the TPR closes at the end of March.
Second, in a recent speech, Ed Sibley, Deputy Governor of the Central Bank of Ireland, stated he was “confident that the necessary [memorandum of understanding] MOUs will be in place” to allow UK entities to maintain status quo on business conducted with the EU, adding “it is reasonable for firms to plan on the basis that MOUs will be place by 29th March. Firms that delegate portfolio management to the UK can have sufficient confidence that this will continue to be allowed post 29th March.”
These comments strongly suggest that all delegation of portfolio management to UK entities for UCITS and AIFMD funds is likely to continue as is, even in the case if a no-deal Brexit.
The EU Commission, ESMA, and national regulators will continue their work on the AIFMD review and pick up areas identified within the report. They will aim to report back to the EU Parliament and EU Council on formal next steps for policy in 2020.
For asset managers, it is important at this juncture to familiarise themselves with the main findings of the report and engage with industry responses to areas of concern highlighted within the market survey.