• Julie Patterson, Director |
  • Zeynep Meric-Smith, Partner |
6 min read

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.

Regulators provide for new and improved fund structures

To assist economic recovery, regulators are creating new alternative fund structures, or reviewing existing ones, to encourage increased private investment in long-term assets, including infrastructure. For example, the new Limited Partnership Fund (LPF) regime, in Hong Kong (SAR), China caters for funds invested in private and real assets. It includes an opt-in registration scheme.

Ireland has enhanced its Investment Limited Partnership (ILP) regime for funds invested in private and real assets, and the Central Bank of Ireland (CBI) has confirmed that ILP general partners will not need to be regulated as an AIFM. The CBI has also provided wider guidance on the application of its rules to closed-ended Qualifying Investor AIFs that use private equity-type strategies or invest in illiquid assets. There is flexibility regarding the operational use of share classes, in line with private equity industry norms:

  • Differentiated share classes
  • Allocation of returns of an asset to a specific share class
  • Participation in a share class other than on a pro rata basis
  • Issuance of shares other than at net asset value
  • Staged investing
  • Management participation in share classes

To make the UK a more attractive location to set up, manage and administer funds, and to support a wider range of more efficient investments better suited to investors’ needs, the UK government has consulted on the introduction of incorporated and contractual funds that will be registered with the FCA (under existing AIFMD rules), but not authorised or listed.

The European Commission has consulted on how to encourage take-up of European Long-Term Investment Funds (ELTIFs). The funds can be marketed only to professional and semi-professional investors, and are subject to various operational constraints. As at June 2020, only 25 ELTIFs had been set up, with total funds under management of only €1.5 billion. Several more funds have since been set up in Italy, encouraged by tax incentives, but overall numbers are still very low. The Commission sought views on the scope of authorisation, eligible assets and qualifying portfolio undertakings, borrowing and leverage, conflicts of interest and co-investment, and portfolio composition and diversification.

If you would like to discuss further, please don't hesitate to reach out.