This INDOS Financial article was first published in the July 2015 edition of Hedge Fund Intelligence’s InvestHedge and can also be read here.
Following the final introduction of the European Alternative Investment Fund Managers Directive (AIFMD) in July 2014, both non-EU managers and EU managers running non-EU domiciled alternative investment funds (AIFs) have been restricted to marketing their investment vehicles into the EU via national private placement regimes (NPPR). By contrast, EU managers of EU funds, or full-scope alternative investment fund managers (AIFMs) are now able to market their funds via a pan-European marketing passport. That is the theory anyway, but what is happening in reality, and how are EU policymakers going to shape the marketing rules going forward?
Current state of play
A number of EU managers have sought to restrict marketing of their non EU funds to within their home country or countries with the simplest and most flexible NPPR requirements, such as the UK and the Netherlands. The increased compliance obligations – namely regulatory registration and/or authorisation, increased investor disclosures, filing the the detailed Annex IV regulatory report and, in some cases, the appointment of a depositary service provider – has prompted a number of non-EU managers to stay away from Europe or to rely on ‘reverse solicitation’, a presently undefined concept whereby investors seek out managers at their own free will rather than the other way round. Other managers are simply waiting for the European Commission (EC) to announce whether the AIFMD marketing passport will be extended to non-EU AIFMs and non-EU AIFs.
ESMA review of the extension of the passport
The European Securities and Markets Authority (ESMA) is required under AIFMD to give advice to the EC about the extension of the pan-EU marketing passport to non EU mangers and funds by 22 July 2015. The EC is required to act on the advice of ESMA within three months. ESMA is considering whether a passport extension would result in any issues with respect to investor protection, market disruption, competition and the monitoring of systemic risk. ESMA has said it will not treat all non-EU countries as a single block, indicating that the passport will only be extended to AIFs or AIFMs operating in non-EU countries that are deemed to have regulatory equivalence. Almost 50 industry participants provided ESMA feedback following its November 2014 “call for evidence”. There are divisions between those who advocate an extension of the passport, and those who feel ESMA has not had enough time to digest the impact of AIFMD to provide meaningful analysis to the EC. Others have urged ESMA to review gold-plating of the passport by EU member states, such as the levying of fees and the introduction of additional regulatory requirements.
What have non-EU countries been doing?
All of the main non-EU fund markets have already signed co-operation agreements with EU member states laying the foundation for regulatory information exchange. Being able to demonstrate AIFMD equivalence will be a pre-requisite for the passport extension. A number of non-EU countries, most notably Guernsey, Jersey and Switzerland have been quick to implement what they regard as AIFMD equivalent regimes. Other major fund domiciles such as the Cayman Islands are yet to confirm details of their AIFMD ‘opt-in’ fund regimes although CIMA has recently issued a public statement seeking to provide re-assurance that work is on-going “to ensure Cayman funds can continue to be marketed within the EU and elsewhere in the foreseeable future”.
There are several possible outcomes. ESMA could issue negative advice, which would result in the continuation of the status quo, at least until the inevitable AIFMD II is introduced. Given the limited timeframe ESMA has had to undertake analysis of AIFMD implementation, ESMA might delay any determination about the extension of the passport to third country AIFs and AIFMs. Another outcome could be that ESMA will consider an extension on a country-by-country basis. There are rumours that a list of initial non-EU AIFM and non-EU AIF countries is currently being considered. The chairman of the ESMA committee reviewing the potential extension of the passport said in a speech recently that his preference was for “ESMA to prioritise quality over haste”.
While extending the passport to third country managers and funds would enhance competition in the EU asset management market and provide greater investment choice for European investors, the decision whether to extend the passport is politically sensitive and it is possible the EC could reject ESMA’s advice or introduce additional hurdles for third countries seeking equivalence so as to avoid granting them passports for pan-EU distribution.
If the EC does extend the AIFMD passport, ESMA will be required to issue advice to the EC on the termination of NPPR by 2018. Until this point, there will be a dual regime for funds to market – NPPR and the pan-EU passport.
Is the passport something that managers of non-EU funds and non-EU managers want or will utilise?
There has been a relatively low take up of the passport by EU managers of EU funds. Whether or not EU managers of non-EU funds or non-EU managers will embrace the passport is an interesting question.
For EU managers of non-EU funds, the extension of the passport should be attractive. These managers are already subject to the majority of AIFMD and will no longer need to comply with the myriad of NPPRs. The incremental AIFMD obligations to access the passport would not be significant.
Conversely, the extension of the passport to non-EU AIFMs is likely to present more challenges. Broadly speaking managers will need to become fully compliant with the AIFMD (which means they need to get authorised as an AIFM by the competent authorities of the EU member state that is its “Member State of Reference”) to use the passport. This is a significantly greater compliance burden than the investor disclosure and regulatory reporting obligations today for those marketing via NPPR. The AIFMD equivalence rules are also such that it may not be possible for some non-EU AIFMs subject to different or conflicting regulatory regimes to meet the equivalence test.
Some of the responses to the ESMA call for evidence suggest non-EU managers are not enthusiastic about subjecting themselves to AIFMD. Some might argue this is short-sighted as these managers are shutting themselves out from a $15 trillion investor market. Nonetheless, it could take some time for non-EU AIFMs to avail of the pan-EU passport through compliance with the directive. In the meantime, we could see an increasing number non-EU managers marketing into a handful of EU member states through NPPR.