Will the Alternative Investment Fund Managers Regulations – or AIFMD 2.0, as the amended version is being termed – bring much needed stability to the EU funds sector?
The EU fund landscape is changing. The European Commission published legislative proposals in November 2021 to amend the existing Alternative Investment Fund Managers Regulations (AIFMD).
The review of AIFMD is part of an EU initiative called the Capital Markets Union, which has an overarching objective of creating a single market for capital across the EU and, in doing so, making the EU financial system more stable, resilient and competitive.
Now, almost two years since the initial proposals, what benefits could AIFMD 2.0 tangibly bring to the European investment funds sector?
Nick McHardy, Group Head of Funds at Belasko, believes the legislative outcome of the review should increase stability of the funds industry as it includes measures to reduce the risk profile of loan originating funds.
It should also increase the focus on liquidity management and promote a model of leveraging technical expertise through transparency in respect of delegation as opposed to restriction.
“One may argue that with any regulatory framework change, there will inevitably be a short-term period of adjustment while new requirements are embedded, but uncertainty will now be reduced by having an agreement of the rule changes under AIFMD 2.0 and should therefore be seen as a key milestone for longer-term stability.”
Joy Kershaw, Senior Manager in Deloitte’s EMEA Centre for Regulatory Strategy, shares some of McHardy’s positivity and believes the agreement on new rules for European capital markets will provide greater clarity and certainty.
“It allows for firms to understand the final direction of travel for AIFMD 2.0 and to enhance their internal operating models to support the successful adoption of it,” says Kershaw.
She points out that on delegation, during the policymaking process there had been some arguing for significant restrictions on delegating portfolio management to firms in non-EEA countries, including the UK. However, under the agreed text the delegation model is maintained.
“Some of the new requirements – such as for AIFMs and UCITS management companies to have at least two full-time senior managers who are resident in the EU – are already required under national rules in major fund domiciles such as Ireland and Luxembourg.
“Nevertheless, we do expect to see a strong supervisory focus on whether locally based managers are sufficiently senior and experienced, have adequate human and technical resources, and are providing effective oversight.
“We also expect to see a strong interest from ESMA in ensuring that national competent authorities are taking a consistent supervisory approach.”
Transparency and liquidity
Kershaw believes new supervisory reporting requirements on delegation will increase transparency and inform supervisors – that overall firms will have greater clarity and certainty around the continuation of the delegation model and supervisory expectations in this area.
She welcomes the fact that the agreement recognises the primary responsibility for liquidity management remains with the fund manager.
“Firms will need to review and enhance their liquidity risk management frameworks and ensure they have detailed policies and procedures for the activation and deactivation of each liquidity management tool, as well as effective operational processes and escalation mechanisms,” she says.
Mirek Gruna, Chief Commercial Officer at IQ-EQ in Jersey, believes the new rules for European capital markets represent progress.
“By updating and harmonising these rules, the agreement aims to improve the functioning of capital markets and enhance investor protection,” he explains.
“It could also contribute to increasing the competitiveness and attractiveness of the European investment funds market. Overall, the provisional agreement has the potential to be a significant step towards a new version of AIFMD.”
Challenges ahead
That all sounds positive. So what, if any, shortcomings might AIFMD 2.0 have? According to McHardy, there isn’t yet clarity on the precise reporting and notification obligation changes that will be applicable under AIFMD 2.0.
However, he concedes that this is likely to follow once the provisional agreement is finalised, legislation is updated and supervisory authorities along with ESMA issue guidance.
“Once the requirements are clarified, it will be interesting to assess the industry reaction to the cost of compliance of the changes against the ability by supervisory authorities to leverage the data/reporting collected for net benefit and whether any costs are passed on to investors or absorbed,” he says.
Gruna takes a similar line, suggesting AIFMD 2.0 may include an increased regulatory burden, with additional reporting requirements and compliance obligations on fund managers potentially increasing costs for market participants.
He also believes adjusting to new regulatory requirements could pose challenges for fund managers and regulators, especially if the changes are significant or complex, resulting in potential delays or confusion during the implementation phase.
He highlights an investor protection versus market efficiency trade-off. “Striking the right balance between investor protection and maintaining market efficiency is always a challenge,” he says. “The revisions may introduce stricter provisions to protect investors, which could impact market liquidity and increase costs for investors.”
Post-implementation
McHardy insists it is too early to consider post-implementation impact while there is still significant market uncertainty and AIFMD 2.0 is still provisional.
“As an initial step, however, I would expect existing AIFMs to start reviewing the scope of the changes to assess impact on their operational and risk frameworks,” he says. “Time will tell if AIFMD 2.0 is perceived to add a net increase in value and investor protection against the cost of compliance.”
Kershaw maintains that overall the new regime is an evolution rather than a revolution, explaining: “It will increase scrutiny in some areas (including delegation and fund liquidity), and open up new opportunities – for instance, for loan origination funds to operate on a cross-border basis.”
She adds: “We would expect to see an increase in focus on enhancing second line capabilities across AIFMs to meet the additional risk management needs of the AIFMD 2.0, and increased costs as a result of more detailed investor disclosures with better informed clients possibly challenging fund charges.”
Kershaw also anticipates an increased emphasis on governance through clarification of the delegation oversight requirements, as well as a greater spotlight on the independence of boards and committees of AIFMs.
Impact of NPPRs
How effectively do National Private Placement Regimes (NPPRs) provide a way for alternative investment fund managers to promote alternative investment funds that cannot be marketed under AIFMD’s domestic or passporting provisions?
Elliot Refson, Head of Funds at Jersey Finance, explains that Jersey’s AIFMD offering complements that of the onshore jurisdictions but Jersey’s key differential is its ‘opt in/opt out’ approach.
“When marketing into the EU, AIFMs opt in to AIFMD via the NPPR, but opt out when marketing to the rest of the world. Within EU jurisdictions, AIFMs are in scope for the full AIFMD wherever they market,” he says.
In terms of marketing into the EU, Refson says that by the EU’s own statistics only 3% of all AIFMs market into more than three European countries.
He notes that this statistic is pre-Brexit and, with the UK being the largest investment pool, this number is likely to be significantly lower. “If an AIFM is part of the 3% that market on a pan-European basis or to the retail market, then they will most likely need to access EU markets via another jurisdiction under full scope of AIFMD or UCITS,” he says.
“But if an AIFM is one of the 97% that do not market so widely within the EU, then Jersey and its European Private Placement agreements offers a more cost effective, faster and more efficient solution, outside the full scope of AIFMD.”
According to Refson, the extent to which Jersey has provided a complementary offering to that of onshore jurisdictions is best reflected by more than 200 non-EU AIFMs marketing their funds into the EU through the NPPR via Jersey.
“In terms of service provision, I would say there are two sides to this – infrastructure and service providers,” he says.
“Jersey’s world-class infrastructure is highlighted, for example, by its accessibility – via a double-digit number of daily flights to and from London and many other places, the second fastest broadband in the world and the new IFC buildings.
“In terms of service providers, there is a wide range of law firms, administrators and auditors encompassing global firms as well as local firms.
“These firms are supported by broad and deep expertise from the nearly 14,000 people – or 44% of the working population – who work in the finance industry.”
Gruna accepts that NPPRs provide a good mechanism for AIFMs to access investors in jurisdictions where they don’t have a passport to market their funds.
However, he appreciates that NPPRs are not harmonised across the EU and each country may have different requirements and procedures.
“This can create complexities and increase compliance costs for AIFMs, especially if they seek to market their funds in multiple jurisdictions,” he explains.
As examples of how the NPPR regime may vary in different EU member states, Gruna explains that some member states impose extensive administrative requirements, such as additional documentation or lengthy registration processes, making it burdensome for AIFMs to utilise NPPRs effectively.
Then there are language barriers, Gruna says: “If the NPPR regime is only available in the local language, AIFMs from other EU member states may face difficulties in understanding and complying with the requirements. This can create barriers to entry and limit their effectiveness in promoting AIFs across borders.”