It has been five years now since the original introduction of the Alternative Investment Fund Managers Directive (AIFMD), a post-financial crisis regulation designed to enhance investor protection and risk management at asset managers managing or marketing alternative investment funds inside the EU.
The Directive’s provisions included a pan-European marketing passport for EU managers of EU funds, additional investor disclosures, rules around risk management and leverage, enhanced regulatory reporting (Annex IV), and in many cases an obligation to appoint a depositary, an entity assigned to safe-keep and verify ownership of assets, oversee a fund’s compliance with its prospectus and monitor cash flows daily. We consider how AIFMD and the industry’s approach to it continues to evolve.
Firms warm to the independent depositary model
The industry has adapted well to AIFMD, while service providers have developed solutions to enable firms to meet their various compliance obligations. Depositaries – having not been required by non-EU funds prior to AIFMD – are now viewed more favourably as firms, fund directors and investors increasingly recognise the benefits of having independent oversight of their operational processes and administrator service providers.
While many organisations offer fund administration and depositary as a bundled service offering, concerns about potential conflicts of interest in this model have prompted more managers to transition towards an independent depositary.
Marketing: Third country passport kicked into the long grass
Plans to extend the AIFMD marketing passport, which gives EU-based managers with EU domiciled funds the right to distribute and sell products across member states, to some non-EU managers and funds have come to a standstill.
While ESMA provided positive opinions recommending that AIFMD passporting rights be given to a handful of countries including Jersey, Guernsey, Japan, Canada and Switzerland in 2015 and 2016, discussions appear to have been deferred following the Brexit Referendum as the EU looks to reassess its existing equivalence regime. Third countries awaiting a passporting decision have seemingly acknowledged a resolution will not be swift.
Pre-marketing takes a hit
In March 2018, the European Commission (EC) announced proposals to amend some of the marketing provisions in AIFMD following differences in their application across member states. One of the proposals seeks to coherently define ‘pre-marketing’ under AIFMD as “a direct or indirect provision of information on investment strategies or investment ideas by an AIFM or on its behalf to professional investors domiciled or registered in the Union in order to test their interest in an AIF which is not yet established.”
Under the proposals, pre-marketing will be unavailable to existing AIFs, and firms will no longer be able to share details about their prospectuses and constitutional documents of soon-to-be-established AIFs with investors, unless they comply with the necessary AIFMD requirements. Some industry bodies have come out against the provisions, warning the rules introduce added complexity and restrictions for asset managers looking to sell into the EU while making it harder for firms to rely on reverse solicitation.
Tightening up on asset segregation
AIFMD contains provisions around fund asset segregation and the delegation of custody to third parties. In May 2018, the EC announced proposals changing the existing asset segregation practices, a decision which will be felt industry-wide. The proposals include stricter record keeping and reconciliation requirements and further segregation of assets impacting omnibus account structures. Following a short consultation period, the final proposed legislation changes were formalised and are likely to come into effect in 2019.
AIFMD 2 review
Article 69 of the AIFMD obliged the EC to conduct a review of the Directive assessing its progress so far, something it duly began in July 2017. KPMG has since been entrusted by the EC to review AIFMD and it is presently considering industry feedback following a consultation exercise. The outcome of the review is not yet clear, although many in the industry are opposed to the regulator making wholesale changes to the Directive.
However, some experts have urged the EC to revise the existing methodologies used in leverage calculations; standardise cross-border marketing rules, clarify its position on the continuation of national private placement rules and status of third country passporting, as well as simplify the Annex IV reporting framework.
The emergence of AIFMD as a brand?
When AIFMD was first introduced, some commentators believed it would eventually emulate the success and brand of UCITS. UCITS has evolved over the past 25 years but it is too early to speculate if AIFMD will scale similar heights. While the alternatives industry has grown since AIFMD was introduced, it is difficult to qualify whether this is a by-product of the regulation. Some argue AIFMD has actually impeded the growth of alternatives in Europe as smaller managers have found it more challenging to launch funds while investors face higher costs due to the regulation’s compliance obligations.
AIFMD’s impact on managers’ investment processes has been limited, but it has had a positive effect on risk management, governance and oversight (such as the role of the depositary) which ought to be viewed favourably by allocators. AIFMD certainly divides the industry, and it is going to be quite a few years before its place in funds’ history is sealed.
AIFMD in a post-Brexit world
The UK, having had its proposal for mutual recognition of financial services firmly rejected by the EU, is now advocating an expanded form of equivalence instead. If this arrangement is given the go-ahead by all parties, the UK is unlikely to deviate from existing or future EU regulation, so rules such as AIFMD will stay in place. Managers optimistic about a regulatory cull post-Brexit are therefore likely to be left disappointed. Even in the event of a no-deal Brexit, it is doubtful the UK will revise AIFMD dramatically so as to keep its hopes for equivalence alive.