AIFMD: five years on

In the run-up to its launch in 2013, the European Directive was expected to bring a big bang to the alternative fund management sector. So far, its effect has been more of a whimper

The Alternative Investment Fund Managers Directive (AIFMD) was first mooted in the wake of the financial crisis. It was intended to regulate the activities of the alternative funds sector. The aim was to improve and increase the monitoring of the systemic risks they might pose, and harmonise the rules for management and marketing of alternative investment funds (AIFs) into the EU. 

It was also expected to increase transparency for investors in alternative funds such as real estate, private equity, infrastructure, hedge funds, commodities and some types of derivatives. 

On the face of it, AIFMD seemed like a good idea. But the potential administrative, IT and compliance burden that it might have entailed wasn’t welcomed by the alternative funds industry. 

“The EU wanted to encourage alternative investment fund managers [AIFMs] to be physically situated in the EU if they intended to raise capital from EU investors,” explains Malin Nilsson, Managing Director of Duff & Phelps’ regulatory consulting team in Jersey.

“But it wasn’t quite necessary. Most AIFMs already had a manager in Europe, such as in Ireland, or they relied on a national private placement regime [NPPR] instead of making use of the EU passport regime. 

“It’s fair to say that many of us had reservations about how AIFMD would be implemented in practice and the additional work it would involve, as most of the players in this space were already operating to a sophisticated level.”

Furthermore, in the eyes of some, AIMFD was never going to be fit for purpose. It aimed for a one-size-fits-all solution to the problem of regulating AIFMs and their funds. Peggy Gielen, Technical Manager at Jersey Finance, believes it was a flawed approach for such a diverse range of funds that are quite different in their risks, such as private equity and hedge funds. 

“The high-level conclusion that can be drawn is that AIFMD hasn’t delivered on its promises,” she says. “We are now five years on from the original proposal and recent statistics published by the European Commission show that not all the main goals of AIFMD have been achieved. Most notably, AIFMD hasn’t created a fully harmonised regulatory framework for AIFMs and AIFs within the EU.” 

Risk and reward

Research carried out by Europe Economics among limited partners in private equity funds found that the measures didn’t provide enhanced investor protection either. “AIFMD may have induced some relatively insignificant benefits in terms of slightly better reporting and increased transparency, but at a high cost,” Gielen adds. “It’s apparent that AIFMD hasn’t made – even, could not make – any measurable difference in lowering the systemic risk associated with private equity.”

This is by no means the whole story for the Channel Islands, however. From the outset, they pursued a twin-track approach that has stood them in very good stead. Both Jersey and Guernsey achieved approval as ‘third countries’ under AIFMD, to be jurisdictions that would be well placed to gain passporting rights to all EU member states for funds domiciled in their islands. 

In the event, the passport issuance process has ground to a halt while Brexit negotiations proceed. In the meantime, NPPRs have proved to be successful.

NPPRs rely on the approval of a member state to allow particular third-country funds to be marketed in their jurisdiction. Far from leading to 27 separate sets of bilateral approvals, one with each member state, NPPRs have turned out to be a well-founded, practical way to do business. This is because most AIFs are marketed in few countries. 

Statistics released by the European Commission in the proposal to amend the Directive on the cross-border distribution of collective investment funds, revealed that ‘… the EU investment fund market is still predominantly a national market – in fact, only three per cent of EU AIFs are registered for sale in more than three member states’. 

NPPR arrangements are predominantly with the UK, Ireland, Luxembourg, Germany and Sweden – beyond these, there are very few significant markets for wholesale AIFs in Europe.

Due diligence

The job of obtaining approval under a jurisdiction’s NPPR falls to law firms acting on behalf of funds or their managers. Ben Morgan, a Partner and Head of the Corporate and Finance Group at law firm Carey Olsen in Guernsey, explains that such due diligence in the key jurisdictions is now a well-trodden path. 

In the context of AIFMD, he says: “Ideally, we would have had the best of both worlds. The option of the passport and the option to privately place into jurisdictions that allowed it. Why would you not want the best of both worlds? But for most of the funds that use Guernsey, the NPPR works just fine.”

In commercial terms, the NPPR approach has facilitated a flow of alternative funds to the islands. It has also demonstrated that while the UK financial services industry is in turmoil over its relations with the EU, it’s business as usual in Jersey and Guernsey. 

“AIFMD has demonstrated the ability of the Channel Islands to be flexible and innovative,” explains Guernsey Finance’s Acting Director of Strategy, Andy Sloan. “There wasn’t anywhere else in the world that was able to move as quickly and nimbly as we were, to create an AIFMD-compliant regime and a non-AIFMD one. We adopted a bifurcated approach to the European directive.

"And we are able to provide an environment where you could market directly into Europe using an NPPR. We’ve always contended that the NPPR can get to the European market quicker and cheaper.”

But it hasn’t all been plain sailing. Ben Morgan says that, following the introduction of AIFMD, there was a bit of a hiatus in deal flow. Fund managers delayed their plans to roll out new funds in the islands while they gauged the possible administrative and cost implications of the Directive.

In 2016, however, the market picked up again with a surge of new funds – that year was a record one for Guernsey.  

And the deals have continued to flow, confirms Kevin Smith, a Director at fiduciary and administration services firm Estera, based in Guernsey. He points to a series of year-on-year fund increases. He does note, however, that AIFMD is eventually likely to figure more highly on the alternative funds agenda. 

“We anticipate that at some stage, Guernsey will be issued with the passport. The NPPR regime might phase out in the future, but we are well positioned for that already – to adopt the full passport and compliance with AIFMD.”

Right now, five years on from the introduction of AIFMD, the islands continue to be in the sweet spot as the European domiciles of choice for alternative funds. And they are likely to remain so for the foreseeable future. 

Guernsey Finance’s Andy Sloan best summarises the current state of play. “Brexit is all upside for us,” he says. “In the short term, we have a boost to business – we’re able to provide greater security and certainty [than the UK]. There’s little change from where we’re sitting. We are a third country now and will remain so.” 

He ends with a call to action: “We know how to operate into mainland Europe using the NPPR and we have access into the UK. If you’re looking to sell into Europe we’re the proven route.”