Public consultation on the review of the AIFMD is published

To some of us it feels like just yesterday that the asset management industry was grappling with the legislative powers in the EU to make sense of the early drafts of the AIFMD. And yet here we are again, as the European Commission yesterday published its public consultation on the review of the AIFMD (the “Consultation”). The Consultation marks the Commission’s first deep engagement with the public on the road to what could end up being a significant reform and it brings up again some of the issues that vexed engagement during the introduction of the AIFMD.

The Consultation comes at an uncertain time, for the UK at least. Firms within the UK seem unlikely to be directly within its scope, but will have a vested interest in steering its outcomes towards inclusivity, rather than further dislocation through a narrowing of the delegation provisions. The Consultation will affect more pointedly firms within EU member states, many of which will have intra-group firms in the UK to whom they delegate some services.

The Consultation covers much more ground than delegation, however, and could mark the start of a meaningful regulatory divergence in the supervision of asset management firms in the EU and the UK; adding further strain to the jigsaw of compliance obligations that multinational asset managers will have to piece together.

This briefing describes some of the key questions raised in the Consultation. Respondents have 14 weeks to respond, using the online questionnaire.

Scope and authorisation

Questions in this section seek to assess satisfaction with the AIFMD framework as a whole and solicit views on whether it is achieving its objectives. Of particular interest to firms might be the following:

• A question on what additional functions an AIFM should be permitted to perform. Answers, understandably, are to be justified by reference to conflicts of interest, pros/cons and costs. This is complemented by questions on whether further clarification of the ancillary/’bolt on’ services regime is needed and whether changes are needed to the regime in order to ensure a level playing field between AIFMs and other investment firms when providing competing services.
• A question has been included on how effective some of the exclusions are, for example for securitisation vehicles and employee saving schemes. Respondents might here also suggest additional exclusions that they consider would be sensible.
• There are questions on the capital regime that applies to AIFMs and whether it ought to be more risk sensitive and/or tied to the additional services an AIFM may perform. It will be important to ensure that the clear distinctions between asset managers and other financial institutions subject to prudential regulation are remembered here.
• On small AIFMs, questions are asked as to whether the AUM threshold is appropriate and whether the lack of passport impedes capital raising by them.
• A question is also asked on the functioning of the AIFMD marketing passport and ways in which it can be improved.

Investor protection

Questions in this section deal with client classifications and investor protection. Of particular interest to firms might be the following:

• A question on how AIFM access to retail investors can be improved. At present, this is left to member states to determine. The Consultation asks if there is a need to “structure an AIF” that could be marketed to retail under a passport. It is unclear if this is foreshadowing some form of product regulation.
• There is a detailed series of questions on the need to address more clearly and in more detail tri-party collateral arrangements and, in particular, the relationship between the depositary and third parties in this context. There is also a series of questions on the rules regarding prime brokers.
• There are questions on central securities depositories and how they should be treated in the context of the depositary regime (including a question on the complex issue of delegation in this context).
• There is a series of questions on investor-facing disclosures.
• Importantly, there are also questions on the rules around valuation. This is one area, in particular, which we have long thought to be unclear and cumbersome. These questions provide a good opportunity for respondents to seek to improve the position, for example in relation to intra-group valuation arrangements, ‘external valuers’ and pricing services.

International relations

This section may be of particular interest to asset managers affected by Brexit. These questions relate to how the AIFMD “interacts with the third country regulatory regimes”. Of particular interest to firms might be the following:

• There is an open question on the elements of the regime that can be changed to enhance the competitiveness of the EU AIF industry. This obviously opens the door to commentary on all the aspects of the regime that are cumbersome, costly and don’t serve a sensible investor protection outcome. Equally it may lead to responses encouraging greater protection of EU AIFMs from external competition.
• There is a question on whether national private placement regimes create an uneven playing field between EU AIFMs and non-EU AIFMs. This question harks back to ground that was covered a few years ago when debates were being had as to whether the third country marketing passports should be ‘switched on’ to the exclusion of national private placement regimes.
• There is also a series of questions on delegation which, no doubt, many commentators will seize on as opening the door to cutting UK asset managers off from EU assets that are managed on a delegated basis. For example, the Consultation asks if the delegation rules are currently clear enough to prevent the creation of “letter-box entities” and are appropriate to ensure effective risk management. The questions rehash debates that were ferociously had during the introduction of the AIFMD a decade ago on how to prevent letter-box entities being created. For example, they ask if quantitative criteria should be used to measure this (something that could not be agreed on previously) and whether there is a specific list of functions that must always be performed internally and not be delegated. Again, this is not a novel idea – and previously no sensible view was reached on what this finite list should be (partly because imagining ‘functions’ this way does not reflect the reality that it is rare to have any function wholly performed by any single entity –in fact, often ‘functions’ operate across different entities). Very careful thought should be given to responses to this section, as the implications may speak not only to relations with third countries but may also have unintended consequences for sound intra-group operations for asset management firms operating wholly within the EU.
• There is also a question on how the AIFMD delegation rules could apply to the UCITS world.

Financial stability

This section invites opinions on the tools available to the relevant supervisors; leverage; and debt funds. Of particular interest to firms might be the following:

• There is a long series of questions on additions and modifications to the Level II reporting template that will need to be reviewed in detail by teams responsible for reporting at asset managers. Some questions seem aimed at rationalising the process (for example, whether format and definitions should be harmonised with other reporting regimes) but a significant number of the questions relate to an expansion of the reporting data fields (for example, more detailed portfolio information; more details on liquidity and leverage; and the disclosure of loans originated by AIFs). It also asks if supervisory reporting for UCITS should be aligned with the AIFMD regime.
• There is a series of questions on the appropriateness of the leverage calculation methodologies (long thought by many to be problematic) and a solicitation of views on the 2019 IOSCO Framework Assessing Leverage in Investment Funds.
• As regards debt funds, the Consultation asks if the requirements for loan originating AIFs should be harmonised at the EU level, i.e. should these AIFs be subject to EU-wide regulation? At present, whether or not these funds are regulated in their lending activity varies from member state to member state. Ideas for such regulation that are floated include the provision of safeguards for borrowers; diversification and concentration limits; and the idea that only closed ended funds can originate loans.

Investing in private companies

The Consultation recognises the growth of the private equity industry and therefore raises questions on whether the existing provisions governing the taking of stakes by funds in private companies are “fit for purpose”. The reality of these provisions is that they impact much more widely than private equity transactions, and this should be borne in mind when responding. Of particular interest to firms might be the following:

• A question is raised as to whether the ‘asset stripping’ provisions (i.e. those dealing with distributions) are necessary, adequate and proportionate; and indeed how they can be “improved”.

The section is silent on the wide scope of these provisions and whether the provisions on carve outs and exclusions should be amended (for example to ensure that structuring vehicles and companies with no employees are outside scope).

Sustainability/ESG

Sustainability and ESG is obviously a hot topic at present, and amendments to the AIFMD have already been suggested in relation to this under a suite of proposed regulations. Nevertheless, it is a topic also dealt with here. Of particular interest to firms might be the following:

• The Consultation asks if AIFMs should be required to quantify sustainability risks. This of course will not be straightforward.
• Surprisingly, the Consultation also asks if the investment decision making processes of an AIFM should integrate non-financially material factors (such as principal adverse sustainability impacts). This would be a most slippery slope (as it goes beyond the integration of sustainability risks and seems also to reach beyond stewardship activities) and some may see this as possibly putting into tension purely financial investment objectives of investors with broader sustainability impacts. If such a provision were included, modifications to client best interest rules may also need to be made, and thought will need to be given to how to protect asset managers from aggrieved investors. Other questions cover similar ground (for example, the Consultation asks if the EU Taxonomy should play a role when AIFMs are making investment decisions).

The Consultation ends with a series of miscellaneous questions, including whether ESMA should be responsible for all AIFM authorisations and whether the AIFMD and UCITS rulebooks should be merged. It should be obvious from the above that the ambition of the review represented by the Consultation is wide. We would encourage respondents to take the time to consider their answers carefully as the implications could be material and long lasting.