The review by the European Commission of the Alternative Investment Fund Managers Directive (AIFMD) has been in progress for some time. The consultation indicated the breadth of issues now under consideration, prompted by the advice of the European Securities and Markets Authority (ESMA). The review is also influenced by wider EU debates around “substance” and delegation.
Meanwhile, AIF managers (AIFMs) are subject to the Sustainable Finance Disclosures Regulation (SFRD) and amendments to AIFMD relating to environmental, social, governance (ESG) factors. Regulation is also opening up new investment opportunities. In response to the need to encourage greater private investment to assist economic recovery, national regulators, including in the UK, are providing for new and improved fund structures for alternative asset classes.
Key considerations for alternative fund managers
- How reliant are you on national private placements regimes to market non-EU funds around Europe?
- Do you have an EU AIFM or do you use a service provider?
- To what extent do you delegate activities, especially portfolio management, to other jurisdictions, within the EU or to third countries?
- Do you have a good understanding of the impact of the new EU ESG requirements on you and the market? Do you have an action plan for implementation? Do you have the data you need on fund assets?
- Have you considered what opportunities there may be to use new and improved fund structures?
The AIFMD Review
KPMG’s report to the European Commission on the operation of the AIFMD found no need for a wholesale review of the directive, but highlighted a few key areas for consideration:
- Marketing: approaches to non-EU AIFs and AIFMs vary markedly between Member States. Whether or not the AIFMD passports for third countries are introduced, national private placement regimes (NPPRs) should be permitted to continue.
- Regulatory reporting: large volumes of data are submitted by AIFMs to national regulators, but not all the data may be essential and there is duplication with other reporting requirements.
- Investments in non-listed companies: the extent of notifications to regulators was viewed as not useful or essential, and overly burdensome.
- Leverage: survey data indicated that high leverage is rare in AIFs, but it would be helpful to harmonise leverage calculation methodologies across AIFMD and other relevant legislation.
- Valuation: the binary choice between using internal or external valuation, and differing national interpretations of the extent of the liability of external valuers, have impaired the effectiveness of the rules, especially for real estate funds
The European Commission’s much-awaited report in June 2020 was short and indicated that amendments would be few and targeted, and that a fundamental rewrite of AIFMD was not on the cards. The main topics were as per KPMG’s report, but the Commission also noted that it was reassessing the case for setting common standards for loan-originating AIFs. However, ESMA’s report to the Commission raised many other issues, including delegation and substance, risk management, liquidity management tools, the application of the remuneration requirements to delegates and “reverse solicitation”.
Most regulators in the EU recognize that the delegation of portfolio management, both within the EU and to third countries, can provide EU investors with the best knowledge and skills from around the globe. EU officials say they have no wish to change the current model, only to clarify it and mitigate the risk of over-concentration, because Brexit has increased the proportion of functions delegated by EU funds outside the bloc. ESMA’s report noted:
- The need to ensure management of operational and governance risks
- That much of the management fee is being paid over to other entities
- Concerns about the use of seconded staff, who may not be working in the AIFM’s domicile
- The risk of “regulatory arbitrage”
ESMA says there needs to be greater legal clarity between core and supporting tasks, and whether supporting tasks (e.g. legal and compliance, investment research, quantitative analysis etc) are subject to the delegation rules. It also notes a conflict of interest for white-label service providers (“hosting ManCos”), which are permitted in some member states and not in others, between investors’ interests and its commercial contract with its client, the portfolio manager/initiator.
Environment, social and governance (ESG)
The European Commission has issued ESG-related amendments to existing rules under AIFMD. Fund managers need to incorporate consideration of sustainability risks into their investment risk processes, product governance and conflicts of interest policies. Firms must consider conflicts that might arise from remuneration or personal transactions of relevant staff, or between funds managed by the same firm, and whether conflicts could give rise to greenwashing, mis-selling or misrepresentation of investment strategies.