On November 25, 2021, the European Commission (the “EC”) published its proposal (the “EC Proposal”) 1 for a directive amending the directive on alternative investment fund managers (“ AIFMD ”) 2. The EC proposal is a key element of the Capital Markets Union Package with the other proposals relating to: (i) the establishment of a single European access point; (ii) modifications to the ELTIF framework; and (iii) the revision of the rules of MiFIR3.
In the explanatory memorandum preceding the text of the draft directive in the EC proposal, the EC describes the preliminary work that was completed prior to the publication of the EC proposal and notes that “AIFMD standards to ensure high levels of investor protection are mostly effective ”. The walkers have posted a number of notices on this preliminary work which are available at the following links: Consultation on how the AIFMD works: a brief overview of the Irish-specific feedback and the way forward and AIFMD – Opportunity for Improvement.
Notwithstanding the overall assessment that the AIFMD “generally achieves its objectives”, the EC has identified a number of areas under the AIFMD that they believe could be improved. The following is a brief overview of some of the main proposed amendments to the AIFMD described in the EC proposal.
It is proposed that each National Competent Authority (“NCA”) inform the European Securities and Markets Authority (“ESMA”), on an annual basis, when an Alternative Investment Fund Manager (“AIFM”) approved in an Member State concerned “delegates more portfolio or risk management to entities in third countries than it retains”.
In terms of assisting ESMA under their proposed mandate to consider certain issues set out in the EC proposal, the requirement for NCAs to notify ESMA in cases where the managers delegate more risk or portfolio management activities than what is retained, potentially relevant for a significant number of existing alternative fund managers, who delegate the management of investments to third country / non-EU entities.
It is proposed to extend the delegation provisions to cover all the services listed in Annex I of the AIFMD (which would include the additional services that managers are authorized to provide under MiFID II4). Consequently, managers delegating Annex I services, including ancillary services, would be required to notify their NCA and demonstrate how the delegation is justified on the basis of “objective reasons” (as is currently the case. case during risk delegation or portfolio management).
2. Mailbox entities
ESMA has been given a very specific role in monitoring the application of the AIFMD rules which aim to prevent AIFMs from being “letterbox entities”, that is to say in delegating risk or portfolio management responsibilities to such an extent that they discharge their material responsibility for these core AIFMD activities. As part of this mandate, ESMA is required to peer review NCAs’ oversight of delegation agreements every two years and report to the European Parliament (the “EP” and the Council of the European Union). (the “Board”) on their findings ESMA is then mandated to conduct a separate 5-year review to identify how the AIFMD delegation framework has contributed to the prevention of letterbox entities.
3. Requirements for AIFM substances
The EC proposal sets out the intention to modify the AIFMD to require managers to provide, as part of the NCA authorization process, detailed information on the human and technical resources that will be used. in the course of the business activities of the candidate manager. With this, the EC proposes that the AIFM employ or otherwise hire a minimum of two persons residing in the EU to conduct the affairs of the AIFM on a full-time basis.
From an Irish perspective, these rules are consistent with the current approach of the Central Bank of Ireland regarding minimum substantive requirements for AIF managers.
4. National Private Placement Schemes (“NPPR”)
The EC proposal aims to strengthen the conditions that apply to the access of non-EU AIF managers and non-EU AIFs to the NPPR in each EU member state. Under the EC proposal, access to NPPRs under Articles 36 and 42 of the AIFMD will require that:
- non-European alternative investment funds (“AIFs”) and non-European AIFMs are not domiciled in a country considered to be a “high-risk jurisdiction” within the meaning of the Fourth Anti-Money Laundering Directive5; and
- the jurisdiction in which a non-Community manager or a non-Community AIF is domiciled has signed an agreement with the relevant EU Member State committing to comply with the standards of Article 26 of the model tax convention of the OECD on income and capital, thus ensuring the effective exchange of information in tax matters and that the non-EU jurisdiction concerned is not on the list of non-cooperative tax jurisdictions in the EU.
The requirement to agree to comply with the OECD Model Tax Convention is already a requirement under the AIFMD.
5. Origin of the loan
Under the EC proposal, loan origination should be added to the list of activities that can be undertaken by licensed managers. This is complemented by recently offered non-essential additional services such as ‘maintenance of special purpose securitization vehicles’, ‘benchmark administration’ and ‘credit administration’.
In addition, the EC proposal seeks to put in place rules for maintaining specific lending policies and procedures regarding the granting of loans, assessment of credit risk and establishes lending bans. certain types of borrowers, including the AIFM, the custodian of the loan issuing the AIF and their delegatees. In concrete terms, an original loan AIF would be prohibited from lending more than 20% of its capital to a single borrower who is a financial company or a fund.
Under the EC proposal, the original AIF loan would be required to retain an interest of 5% of the notional value of any loan it issued that is sold in the secondary market.
There are also: (i) rules to ensure that an AIF that originates a loan is of the closed type when more than 60% of the NAV of that AIF consists of loans issued by the AIF; and (ii) provisions relating to the regular declaration of the composition of the portfolio of loans issued to investors.
From an Irish perspective, the Central Bank of Ireland’s rules on original AIFs for loans already cover much of what is set out in the EC proposal and in some cases are more restrictive / go further than the provisions proposed by the EC.
While stopping to offer an EU-wide passport for depositaries, the EC proposal contains measures that would allow an AIF in one Member State to procure the services of a depositary in another. Member state. It is proposed that these measures be put in place pending further examination of the feasibility of introducing depositary passport provisions.
There are provisions in the EC proposal that will see central securities depositories considered as delegates of a depositary (which has not been the case so far). This development aims to facilitate depositaries better access to information in order to ensure enhanced protection for investors.
7. Liquidity risk management
Managers of variable capital AIFs will have to take into account the liquidity management tools available in a new Annex V of the AIFMD. In addition to the possibility of temporarily suspending the repurchase or redemption of shares or units of these AIFs in exceptional circumstances, it is proposed that the managers of these AIFs be required to choose at least one other liquidity management tool that could be activated. if the circumstances so require.
The EC proposal includes specific modifications to Article 16 of the AIFMD. These modifications propose that AIF managers implement specific policies and procedures regarding the activation or deactivation of liquidity risk management tools, which should include a description of the operational and administrative arrangements for the use of liquidity risk. a liquidity risk management tool.
ESMA will also have broad powers to activate liquidity risk management tools for any AIF.
We expect the industry to want more clarity on the circumstances under which ESMA can use the powers set out in the EU proposal to activate liquidity management tools, to include specific information. on any quantitative or qualitative criterion that triggers its ability to intervene.
8. Annex IV Reports
Managers will be relieved that there are no meaningful proposals to increase the reporting obligations under Annex IV of the AIFMD in the EC proposal. However, there were a few tweaks, summarized as follows:
- Whereas previously a manager was required to report the “principal” markets, “principal” instruments and “principal” exposures that applied to AIFs under management, the EC proposal seeks to remove references to the terms “principal”. “And” principal “(among other deletions), which means that the declaration should now cover all markets, instruments and exposures; and
- ESMA has been mandated to produce regulatory and implementing technical standards to reflect the changes made to the reporting template in Annex IV.
Although we have focused on the changes to the AIFMD, the EC proposal also foresees similar changes to the UCITS Directive6, except more specifically in the areas of original loan funds and cross-border depository services.
The EC proposal must be considered by the EP and by the Council. Once the text is approved by these bodies, further discussions will take place between the EC, the EP and the Council, before the measures set out in the EC proposal are adopted and published in the Official Journal of the European Union ( the newspaper ” ). Under the current provisions set out in the EC proposal, Member States will have to transpose these measures into local law within 24 months of the publication of these measures in the Journal. As a result, it is estimated that these measures (as they may be amended during the EU legislative process) will enter into force across the EU at the end of 2024 or early 2025 at the earliest.