On July 30, 2015, the European Securities and Markets Authority (ESMA) published its advice to the European Commission (EC) on which non-EU jurisdictions it felt should benefit from the pan-EU fund marketing and distribution passport under the Alternative Investment Fund Managers Directive (AIFMD). At present the passport is only available to EU managers of EU funds.
ESMA had already confirmed it would not issue a blanket recommendation on all third countries but would rather make qualitative assessments (considering investor protection, market disruption, competition and monitoring of systemic risk) on a case-by-case basis as to which jurisdictions it felt ought to gain access to the passport.
As such, ESMA said it had so far reviewed just six out of 22 countries: the US, Hong Kong, Singapore, Jersey, Guernsey and Switzerland. ESMA said it could see no reason as to why the passport should not be extended to Switzerland, Jersey and Guernsey although it added it needed to carry out further assessments on the regulatory regimes in the US, Hong Kong and Singapore.
While traditional hedge fund domiciles such as the Cayman Islands (domicile of choice to the majority of the world’s hedge funds), British Virgin Islands (BVI) and Bermuda were not in the initial batch of countries, this does not mean the passport will not be extended to them and the broad range of other countries at a later date.
It is important to remember that Jersey and Guernsey enacted dual funds AIFMD regulation at a very early stage enabling fund managers to attain compliance with AIFMD. The Cayman Islands has only just announced its AIFMD dual funds regulation, and ESMA presumably did not have time to provide a qualitative assessment as to whether these rules meet AIFMD equivalence.
Some of the media has reported (somewhat sensationally) that Cayman Islands-domiciled fund managers have been shut off from the passport. This is not the case, and ESMA has confirmed that it will be reviewing whether the Cayman Islands meet equivalence at a later date. However, it is interesting to note that Singapore and Hong Kong were assessed ahead of the Cayman Islands. This is despite (based on data included in ESMA’s advice) considerably fewer Singapore and Hong Kong-domiciled managers and funds registering to market in the EU following the introduction of the AIFMD relative to the Cayman Islands. It could be argued this might be a snub to some offshore centres, but only time will tell.
The remaining jurisdiction-by-jurisdiction equivalence assessments will undoubtedly take time and ESMA has noticeably not committed to a timetable for completion of its reviews. A number of non-EU managers of non-EU funds had said they would wait until ESMA had issued its consultation before marketing their investment vehicles to institutional allocators either through the national private placement regimes (NPPR) or via the passport (assuming it was extended to them). Many non-EU managers, who had been sitting on the side-lines, may now elect to bite the bullet and market to EU institutional investors through NPPR, or by establishing an onshore EU presence either directly or via an AIFMD management company.
Nowhere is this more evident than in the US. Data set out in the ESMA advice shows there are around 500 US AIFMs currently marketing into the UK and a lesser number in a handful of other countries which provided data to ESMA. This is a fraction of the US hedge and private equity industry. There is a growing recognition that relying on reverse solicitation is a risky strategy if managers are seeking capital from Europe. As such, these managers may recognise that filing an Annex IV regulatory report, providing some additional investor and annual report disclosures, and in some limited cases the appointment of a ‘depositary-lite’ service provider, might be a price worth paying to access EU institutional investors and diversify their client base.
The majority of US managers will most likely market into a handful of EU jurisdictions through national private placement instead of establishing a wholly AIFMD-compliant vehicle, which can be distributed across all 28 member states. NPPR requires compliance with only limited elements of AIFMD and may end up being far more palatable for US managers than full AIFMD compliance in order to access the passport. However, any decision will ultimately be driven by the financial costs-versus-rewards of being able to distribute freely throughout the EU.
Nonetheless, equivalence with the US could be some way away, meaning the passport might not be available to US fund managers for quite a while yet. The equivalence criteria outlined by ESMA could lead to confusion, particularly because it appears to make a reference to the challenges facing EU AIFMs marketing to US retail investors. This is inconsistent as the AIFMD refers only to marketing AIFMs to professional investors. Other areas of contention surround custody and remuneration.
In addition, US managers with offshore domiciled funds (i.e. those based in Cayman Islands or BVI, for example) would only be able to access the passport if both the US and their fund domicile were granted equivalence by ESMA. Again, this would make the passport approval process longer as it is not just a case of granting the passport to US managers but their fund domiciles too.
It is business as usual for the time being for UK managers managing non-EU funds. It is apparent from the ESMA data that many have simply registered under Article 36 of the AIFMD to market their non-EU funds in the UK. Based on our discussions with a number of managers, there are those that simply do not care about the passport and are happy to market in a handful of EU countries via NPPR, but others are following developments with the passport closely.
It is worth remembering that ESMA is only advising the European Commission (EC). Because its advice only includes a few countries, ESMA has suggested that the EC should wait to extend application of the passport until it has delivered positive advice on a sufficient number of third countries. This would avoid any adverse market impact that could be caused by a decision to extend the application of the passport to only a few third countries. We suspect the EC could accept this recommendation and delay its decision meaning the passport could also be a way off yet for Guernsey, Jersey and Swiss managers and funds. The EC also has the power to reject ESMA’s findings which wouldn’t be unprecedented in the history of AIFMD. This is a possibility as ESMA has arguably deviated from its original mandate as its jurisdictional assessments on the extension of the passport were not strictly meant to be conducted on a country-by-country basis.
Irrespective, the EC and European Parliament must now determine whether to extend the passport to the initial list of recommended countries through a Delegated Act. The EC has three months to decide. Should this come into fruition, it is unlikely this Act will be passed before the beginning of 2016 at the earliest. It is only once the Delegated Act has come into force that a three year clock starts ticking on the potential termination of NPPR as a method of marketing to EU investors, something which industry bodies such as AIMA are keen to continue as an alternative to full AIFMD compliance. As such, the status quo and NPPR could continue well beyond 2018.
The ESMA advice is positive and a small step in the right direction for non-EU managers and EU managers managing non-EU funds, insofar as it shows intent to extend the passport to third countries. However, there will be disappointment that there is no clear timetable to conclude a process that could take some considerable time. We will now have to wait until late October to receive feedback from the Commission.