AIFMD 2 – Little in the way of change, with an AML twist to the story
Seven years after the Alternative Investment Fund Managers Directive (AIFMD) was first introduced, proposals are now in train for an AIFMD 2 following an extensive industry-wide consultation by the European Commission (EC).
The contents of AIFMD 2 do not represent a radical departure from the existing provisions although they do contain some potentially important changes. INDOS takes a look at what AIFMD 2 could mean for the industry.
Tweaks to the NPPR
Under Article 42 of AIFMD, non-EU alternative investment fund managers (AIFMs) can market their alternative investment funds (AIFs) to European Union (EU) investors through national private placement regimes (NPPRs).
In order to leverage NPPRs, non-EU AIFMs and non-EU AIFs cannot be located in countries that are identified by the Financial Action Task Force (FATF) as being high risk in relation to money laundering and terrorist financing. AIFMD 2 tightens this provision even further stipulating that non-EU AIFMs and non-EU AIFs cannot be based in high-risk jurisdictions under the EU’s Anti-Money Laundering (AML) Directive, nor are they allowed to operate out of countries on the EU’s list of non-cooperative tax jurisdictions.
In practice, major asset management hubs such as the UK and US will not be affected while none of the offshore fund centres are currently on the EU’s proscribed AML or Tax lists. Despite this, the Cayman Islands was put on the EU’s tax list briefly in 2020 and, more recently on 7 January 2022, the European Commission adopted a draft regulation to add nine countries including the Cayman Islands to their AML list. If the Cayman Islands were to remain on the list in 2024 (when AIFMD II is due to take effect) it would impact a Cayman fund’s ability to be marketed into Europe through NPPR.
Despite indications when AIFMD was first introduced that the EU-wide marketing passport might one day be extended to non-EU managers and funds, there are no intentions in AIFMD 2 to do so. The good news, however, for non-EU managers and funds is that marketing via NPPR is set to continue.
An updating of delegation arrangements
Concerns had been expressed that AIFMD 2 might introduce significant changes to the current delegation model where EU managers delegate portfolio or risk management to entities outside the EU. One of the EC’s biggest fears around delegation was that it could potentially result in letterbox entities, or companies with limited physical substance, cropping up inside the EU.
The European Securities and Markets Authority (ESMA) is looking to contain this risk by requiring member state regulators to notify ESMA on an annual basis when an AIFM “delegates more portfolio or risk management to entities in third countries than it retains”. ESMA will be required to conduct a member state peer review every two years and a five year letterbox review. In order to demonstrate substance, AIFMs must appoint two EU residents to conduct the business of the AIFM. As this is already a standard market practice, the changes will have limited impact.
Largely status quo for the existing depositary regime
AIFMD 2’s impact on the current depositary set-up are not material. An original AIFMD concession allowing AIFs located in countries, where the number of depositaries is lacking, to use providers outside of their home jurisdictions – will continue. The EC added an assessment will be made in due course on establishing a pan-EU depositary passport, an issue it has been grappling with for many years now. The rules also said that central securities depositories (CSDs) can be delegates of depositaries with no additional due diligence checks being needed as part of their appointment – again, this has little bearing on the wider industry.
Much ado about nothing?
The old adage that ‘no news is good news’ generally rings true for AIFMD 2. The EC’s amendments did not contain any nasty shocks meaning there is little cause for alarm at managers, although they should keep vigilant for any long lasting revisions to the EU’s AML and tax blacklist of third countries lest it unduly impacts their marketing arrangements once AIFMD II takes effect.
Although it is disappointing the AIFMD passport has been kicked yet again into the long grass, most managers will be quietly relieved that the amendments are limited. Accordingly, the proposals will now go through the EU’s legislative process, meaning AIFMD 2 is unlikely to become law before 2024 or 2025. It remains to be seen if the UK’s Financial Conduct Authority will implement any of the EU changes to its own AIFMD requirements.
ESG Measuring and Reporting: Transparency and Standards
Ahead of the COP26 Climate Change Conference, Bill Prew, CEO at INDOS Financial, a JTC Group Company, moderated a panel at the BVCA Limited Partner [LP] Summit 2021 which examined how institutional investors are obtaining and measuring environmental, social and governance [ESG] data from their private equity holdings and asset managers. But what were main discussion points at this year’s LP Summit?
Transparency improvements are still needed
Although disclosure of ESG data by private equity managers to LPs has improved over recent years, investors noted that procuring information can still be a challenge.
The reticence of some GPs to share ESG data is compounded by the fact that it can be difficult to gather post investment information such as carbon emissions from private businesses, at least in comparison to publicly listed companies. Moreover, understanding how companies manage carbon emissions and other ESG risks can also be quite challenging. Assuming private equity managers are happy to share their various ESG metrics, there is also an absence of standardisation in how this information is collected and reported, creating further problems for LPs, especially those invested across multiple funds and asset classes.
One LP highlighted the lack of harmonisation is partly a result of the “alphabet soup of standards” and ESG frameworks being promoted by various industry bodies and supranational groups. Elsewhere, ratings agencies often do not deploy the same methodologies when scoring companies on ESG, meaning that it is not uncommon for the same company to have multiple – or occasionally conflicting – ESG ratings.
All of this makes it difficult for GPs to report accurately on ESG – and in turn enable LPs to obtain a good grasp of ESG risks across their portfolios. Panellists agreed that there could be greater investor collaboration on ESG issues noting that it would help GPs focus more on gathering the right data to report to investors.
Obtaining standards are key
In order to mitigate these challenges, experts at the LP Summit said there needed to be industry-wide agreement on how ESG information is reported to end clients. Some believe GPs should leverage the template being developed by the Institutional Limited Partners Association [ILPA] and other initiatives such as the PRI ESG Due Diligence Questionnaire. Having introduced a common set of principles for GP fee disclosures, ILPA recently launched its ESG Assessment Framework, a toolkit designed to help LPs benchmark their GPs’ ESG credentials. Speakers concurred that the new ILPA ESG Assessment Framework will help support the drive towards greater ESG standardisation.
In addition to industry-led initiatives, Prew noted that a number of regulators are also looking to bring about clarity around how GPs report ESG data.
Although the EU is widely considered to be an ESG reporting trailblazer, one speaker said regulators in the US and UK are also taking a close interest in the issue, adding that TCFD [Task Force on Climate-related Financial Disclosure] reporting requirements will increasingly apply in the UK to pension funds, asset managers, listed companies and other businesses. With TCFD reporting now becoming a regulatory and compliance obligation, there will be greater accountability on asset managers around ESG. Speakers cautioned, however, that GPs need to do more than treat ESG reporting as a compliance exercise and concentrate on integrating ESG into risk and investment management processes to ensure there is tangible progress being made towards achieving net zero.
Service providers can support the industry
Panellists agreed there is a role for service providers to support the industry. While some investors have established their own in-house ESG teams, there are many institutions which need to consider ESG matters and will be reliant on external service providers, particularly in areas such as carbon assessments and collection together with analysis of data.
Pressure on private equity managers will continue
With sustainability now becoming a critical component of the manager selection process, the private equity industry will need to continue to improve its ESG reporting and disclosure to LPs. Regulation and industry-led initiatives such as the ILPA ESG Assessment Framework are likely to play a major role in facilitating this.
INDOS Financial expands services with Specialised Depositary licence in Ireland
INDOS Financial (Ireland) Depositary Limited, a JTC Group company, is pleased to announce it has received regulatory approval from the Central Bank of Ireland to provide depositary services to private equity, real estate and other alternative investment funds under Regulation 22(3)(b) of Ireland’s AIFM Regulations.
The approval builds upon INDOS’ leading alternative investment fund depositary offering in the UK providing full depositary and depositary-lite services to 75 managers, 150 funds and $38bn of hedge, private equity, real estate and infrastructure funds.
Bill Prew, CEO of the INDOS Financial Group commented “We are delighted to have obtained a specialised depositary licence in Ireland. We established operations in Co. Wexford, Ireland in 2014 and therefore, extending our services to act for Irish alternative investment funds was a natural next step”
Bill continued “We are starting to see a number of managers establish private equity, real estate and other alternative asset funds in Ireland following the introduction of the Investment Limited Partnerships Act in 2020. We are excited to bring the INDOS depositary model, where we provide a depositary solution that adds value and enhances fund governance, to this growth area of the Irish funds market”
The Irish office of Simmons & Simmons advised INDOS Financial on the licensing and approval process with the Central Bank of Ireland.
Contacts for further information:
Bill Prew, CEO, INDOS Financial +44 (0) 203 876 2220
Founded in 2012, INDOS has grown to become recognised as a provider of industry-leading solutions within the fund oversight and depositary service space. As of September 2021, client assets under depositary oversight had grown past $38 billion and a further $11bn which form part of INDOS AML (Anti-Money Laundering) officer services. In June 2021, INDOS was acquired by JTC Group.
JTC is a publicly listed, global professional services business with deep expertise in fund, corporate and private client services. Every JTC person is an owner of the business and this fundamental part of our culture aligns us with the best interests of all of our stakeholders. Our purpose is to maximise potential and our success is built on service excellence, long-term relationships and technology capabilities that drive efficiency and add value.
Moving with the times on ESG
Bill Prew, CEO of INDOS Financial, a JTC Group company which provides depositary and specialist oversight services for investment funds, participated in an IFI Global webinar, where he shared his insights on how ESG [environmental, social, governance] is being incorporated into asset management.
The focus on ESG only grows
After a fifth successive quarter of AUM [assets under management] growth, sustainable funds now control around $2.3 trillion, according to the latest Morningstar data. [1] “A number of asset managers sense that there are excellent opportunities to be realised through ESG investing, which is why so many of them are incorporating it into their decision-making processes,” notes Prew. This jump in ESG funds’ AUM is being driven by increasing investor interest in sustainability and climate change. Data from Natixis shows that the percentage of institutions implementing ESG rose by 18% between 2019 and 2020 to 72%.[2] For many retail and institutional allocators, ESG investing offers them the opportunity to obtain both superior and socially responsible returns – relative to traditional investing.
Regulation is also accelerating ESG investing globally. The EU – for example – introduced the Sustainable Finance Disclosure Regulation [SDFR] in March 2021 while its Taxonomy – a benchmark categorising sustainable economic activities – will shortly follow. Although the UK has decided not to implement the EU’s SFDR as part of its Green Finance Strategy, it is imposing new climate reporting requirements on asset managers[3], insofar as they will be expected to publicly disclose climate change metrics in a template modelled on the Financial Stability Board’s [FSB] Taskforce for Climate-related Financial Disclosures [TCFD]. The US – which was once hostile to the notion of ESG reporting and investing – could eventually implement its own ESG reporting rules on asset managers following the recent leadership changes. As regulators and investors take ESG increasingly seriously, fund managers are following suit.
A shifting way of working
Although asset managers are repositioning their portfolios by concentrating more heavily on ESG investing, a majority of financial services firms told an IFI Global that they do not consider their businesses to be carbon neutral. The study found just 7% of respondents were carbon neutral. Prew expressed his surprise at the findings, although adds the process of becoming carbon neutral is perceived by many as being more complicated than what it actually is and expects more firms to undertake the exercise in due course. He continues that some forward-thinking investment firms are also analysing the carbon footprints in their own supply chains – including service providers. “We are starting to see some managers consider the ESG characteristics of their service providers,” comments Prew.
It is also widely expected that international travel – an activity synonymous with asset management [and the financial services industry more generally] will reduce as a result of the growing concerns about climate change and as a lasting consequence of the Covid-19 pandemic. The IFI Global study revealed that 77% of respondents said there would be reduced air travel in the funds industry, especially in light of the IPCC’s [Intergovernmental Panel on Climate Change] Climate Change Report, which was published in August. Prew believes that although the structure of the funds industry itself is unlikely to change, video conferencing calls will continue to replace a number of physical meetings that previously would have required international travel. “Working practices have evolved dramatically – through the adoption of digitalisation – over the last 18 months owing to the pandemic, and the industry has continued without much disruption,” he says.
A gradual ESG learning curve
ESG investing is still in its early stages of development in terms of adoption across the asset management world. “In the next three to five years, the industry is going to become a lot more knowledgeable about ESG. Understanding issues like ESG will take time, but I do believe it will become a mainstream component of asset management,” says Prew.
[1] Reuters [July 27, 2021] Global sustainable fund assets hit record $2.3 trillion in Q2, says Morningstar
[3] 3 FCA CP21/17 [June 2021] Enhance climate-related disclosures by asset managers, life insurers, and FCA-regulated pension providers
INDOS Financial hires Clay Dupuy to Head Anti-Money Laundering Services
Fund oversight and governance provider INDOS Financial, now part of JTC Group, has appointed Clay Dupuy to lead its expanding outsourced Anti-Money Laundering (AML) Officer team. Clay will operate from INDOS’s Ireland offices in Enniscorthy (Co. Wexford) and will be responsible for the teams which provide AML Officers to funds domiciled in the Cayman Islands, Ireland, and Luxembourg.
A graduate of the University of Florida, and of the Business Schools of the Universities of Dublin and Manchester, Clay was an AML specialist at BNY Mellon Fund Services (Ireland) until June 2019. He joins INDOS Financial from consultants KB Associates where he acted as Money Laundering Reporting Officer to a broad range of investment funds.
“Focus on anti-money laundering has grown rapidly over recent years with new and evolving regulations. The demand for expert and committed individuals to enable investment managers and funds comply with the requirements and appropriately manage their AML risk is significant,” said INDOS Financial CEO, Bill Prew. “INDOS is therefore delighted to be able to announce the appointment of Clay Dupuy whose extensive experience in this field will prove of immeasurable value to our investment management clients,” he added.
The INDOS outsourced AML officer operation provides active hands-on support and oversight to fund managers and their funds and supports investment funds with over $10 billion of assets.
“I am excited to have been selected to head this key service line within INDOS,” said Clay. “Ensuring compliance with anti-money laundering regulations is a significant and growing area of focus within the global investment industry, and I look forward to making my contribution to ensuring efficient and effective support to the increasing number of INDOS clients who are facing this challenge.”
About INDOS Financial
Founded in 2012, INDOS has grown organically, developing solutions recognised as industry-leading within the fund oversight and depositary service space. As of June 2021, client assets under depositary oversight represented $35 billion and a further $10bn which form part of the INDOS MLRO (Money Laundering Reporting Officer) service clients. INDOS also provides a range of Environmental, Social, Governance (ESG) services for funds. INDOS Financial was recently acquired by JTC plc, a publicly listed, global professional services business providing fund, corporate and private client services.
About JTC
JTC is a publicly listed, global professional services business with deep expertise in fund, corporate and private client services.
Every JTC person is an owner of the business and this fundamental part of our culture aligns us with the best interests of all of our stakeholders.
Our purpose is to maximise potential and our success is built on service excellence, long-term relationships and technology capabilities that drive efficiency and add value.
