PRIMER: Alternative Investment Fund Managers Directive
In IFLR’s latest primer, lawyers and regulators discuss the impact of one of Europe’s most influential directives
Having been adopted in 2011, the Alternative Investment Fund Managers Directive (AIFMD) is about to go through some its biggest adjustments yet - whether the proposed AIFMD 2 or the choices for both regulators and fund managers when it comes to dealing with the UK’s potential divergence.
IFLR spoke with market participants about what we can expect next.
What is the AIFMD?
AIFMD is a directive requiring all covered AIFMs to obtain authorisation from national competent authorities (NCA) while making disclosures in line with compliance requirements.
Its creation followed the 2008-9 financial crisis. Fund managers had never been regulated like this before.
“AIFMD has contributed to a more uniform, harmonised European market,” said a spokesperson for the Netherlands Authority for the Financial Markets (AFM). “The European passport is often used as a way to access the markets of various member states, while many firms effectively engage in cross-border activities based on the regime provided by AIFMD.”
However, the spokesperson added that there is still room for improvement, for example, through further harmonisation of passporting procedures and costs, as well as a more harmonised explanation of definitions and specific regulatory requirements – some of these already being accounted for in the cross-border distribution directive and regulation.
“The directive creates a much more level playing field, even though member states such as Ireland and Germany have goldplated the rules in some specific areas,” pointed out Dentons partner Michael Huertas. “It’s created a minimum common understanding that is quite advanced, while having flexibility for different kinds of funds.”
Huertas added that its levelling effect has allowed asset managers to scale their business in a way they hadn’t before.
Is it business as usual by now?
“A reasonable amount of firms, particularly in the UK and US, were unhappy at the start,” said Sidley Austin partner and co-head of their EU Financial Services Regulatory group, Leonard Ng. “However, if you said to fund managers now that this would be up for a complete overhaul, they’d probably say don’t.”
Ng continued that some improvements could be made, but firms fundamentally don’t want more change, considering they have put a lot of time and expense into the new framework, something that was echoed by Chiara Sandon, senior policy advisor at the European Fund and Asset Management Association (EFAMA). “When it comes to the review of this directive, tweaks would be welcome but we are not pushing for a complete reopening of level one,” she said. “This has now been in place for some time and if there are to be changes made, then they must be targeted toward the provisions that need to be addressed.”
Sandon referenced KMPG’s 2018 report into the efficiencies of the regulation, which indicated that improvements could be made in harmonising laws between member states, as well as disclosure reporting overlaps.
“The biggest challenge with AIFMD was the initial implementation and the compliance costs that those in scope came up against,” said Sandon. “The various data fields in Annex IV proved time consuming and demanding.”
Gibson Dunn partner Michelle Kirschner added that while a lot of US managers decided to give Europe a wide berth, firms are now marketing again. “We now know where the disparities are, which in the immediate aftermath of implementation wasn’t the case,” she said, adding that the client advice has shifted to issues such as Brexit and the upcoming EEA cross-border marketing reforms.
What do firms struggle with most?
“We’ve seen many managers are struggling with the AIFMD reporting requirements, and there is work to be done on this topic,” said a spokesperson for the Swedish regulator Finansinspektionen.
Under article 24, it is required that ‘an AIFM shall regularly report to the competent authorities of its home Member State on the principal markets and instruments in which it trades on behalf of the alternative investment funds (AIFs) it manages’. The reporting guidelines have been issued by ESMA under annexe IV.
“Although most information as required in annexe IV will be available to firms, specific formats, levels of aggregation or reporting frequencies usually require a substantial operational effort,” agreed the AFM spokesperson. This includes information on the main instruments in which it is trading, on the markets that it operates in, and where it actively trades. It is also required to report on the principal exposures and most important concentrations of each of the funds it manages.
“One issue has been the disclosure of leverage – this proves tricky for some firms,” added Ng. The directive provides a list of items managers must disclose to investors, which includes a disclosure of the maximum level of leverage.
According to Article 4, which covers definitions, leverage is defined as the ‘method by which the AIFM increases the exposure of an AIF it manages whether through borrowing of cash or securities, or leverage embedded in derivative positions or by any other means’.
However, while EU-authorised AIFMs are required to set a maximum level of leverage, non-EU managers marketing into the EU do not. “This means the disclosure is not the same, and might be confusing for some investors,” Ng pointed out.
Kirschner agreed. “The definition of leverage has been industry driven, with firms coalescing around how to interpret it,” she added. “The regulators have never explicitly said ‘yes we agree’ but equally haven’t taken another point of view.”
The spokesperson added that the authorisation process has also been a challenge for some market participants. “Some managers have had difficulties adopting a business model in line with the requirements in the AIFMD,” he said.
To gain authorisation, an AIFM has to provide information on personnel, direct and indirect shareholders as well as a programme of activity that sets out the organisational structure of the fund manager. This includes information on how it will comply with its obligations considering the directive’s requirements.
How to market?
One of the crucial issues that has come with AIFMD has been the marketing requirements. Marketing is defined in Article 4 as a ‘direct or indirect offering or placement at the initiative of the AIFM or on behalf of the AIFM of units or shares of an AIF it manages to or with investors domiciled or with a registered office in the Union’.
The AIFMD was impactful in creating a single marketplace for AIF marketing, known as the marketing passport.
“There is an issue with the dividing line between marketing and pre-marketing, only the former being covered by AIFMD,” argued Kirschner. Pre-marketing is interpreted as the promotional activities a fund manager can undertake that fall short of the marketing definition.
She added that this has given rise to lots of different interpretations of pre-marketing and has meant that different member states have taken a different point of view – though jurisdictions such as the UK and the Netherlands have been more liberal. “The upcoming cross border marketing regime is intended to address this disparity, in particular by introducing a harmonised definition of pre-marketing,” she said.
“Stumbling blocks may exist around more trivial matters, but there’s no major roadblocks that we know of,” said Sandon, referencing the informal notification requirement by the AIFM to its NCA within two weeks from the de facto start of the pre-marketing regime in a given jurisdiction was deemed problematic.
“We understand why the Commission wanted a pre-notification requirement in place, even if via an informal letter,” she continued. “However, two weeks risks being too little time for prospective investors to decide if they want to invest into an AIF or not.”
What about AIFMD2 and Brexit?
AIFMD is being reviewed by the European Commission, with proposals expected in early 2021.
“Most managers don’t appear to want to a complete change, but they do want harmonisation on a cross-border basis,” said Ng. For example, if you’re a non-EEA AIFM and you market your funds into the trading bloc, you need to do a private placement in each member state under Article 42.
“The issue here is that the directive is implemented differently in different member states, resulting in multiple forms and processes for reporting, for example, the Annex IV reports,” Ng continued, with firms arguing it would make sense for it to be one single form, submitted via Esma.
“How players decide to move after Brexit is something that will take time – considering marketing and fundraising. If there is a move by the asset management industry to not branch out into Europe with a physical presence, then you will have to consider where, when and how quickly to get a private placement regime approval,” said Huertas. “There is also the argument that some EU-domiciled asset managers could start new or expand existing UK operations, but at present I see this as less likely for smaller firms.”
“What we do think is essential is for continental funds to be allowed to delegate the management of a portfolio to a non-EU domicile,” said Sandon, adding that EFAMA has found ESMA is concerned about continental funds being managed out of non-EU entities. “Cooperation agreements between continental authorities and their non-EU counterparts are already in place to verify whether any activities have been delegated to so-called letterbox entities, so limiting delegation agreements would be harmful and disproportionate.”
Sandon's colleague, senior regulatory policy advisor Federico Cupelli said that, on the opportunity to introduce a third-country passport, the association feels it should not happen until an agreement is reached. “The national private placement regimes should remain in place. Until the negotiations are finalised, it would be counterproductive for the Commission to change the system.”
Debate has also begun on whether the UK should or will remain aligned. Sources suggest that authorities in the UK are waiting on the Commission’s review to take place before they decide. The AIFMD has a disproportionately negative impact on UK firms, given the concentration of fund managers in London.
“The UK was one of the key drivers for MiFID II and the Investment Firms Directive/Regulation, so divergence there is less likely,” said Ng. “However, the UK government has already signalled its intent to go its own way, perhaps so that it can compete on its own terms with other fund management centres like New York.”
“As of yet we’ve not seen an interest in UK AIFMs moving business to Sweden,” said the Finansinspektionen. “There are however a number of AIFMs and AIFs in UK that will need to apply to a new marketing licence should they wish to continue to carry out marketing in Sweden following a potential no-deal Brexit.”
The current stance of the regulator is to hold off with any such Brexit-driven applications, at least until July 1 2020, depending on whether the transition period will be extended.