Investment Funds Update

AIFMD 2015 Update – Implications of ESMA’s Opinion and Advice on the AIFMD Passport for Non-EU Managers and Funds

August 3, 2015

Introduction

In our last Sidley Update on the Alternative Investment Fund Managers Directive (AIFMD) (AIFMD 2014 Update – private placements: where did we end up, and where are we going?¹) we noted that, by July 22, 2015, the European Securities and Markets Authority (ESMA) was required to issue to the European Parliament (Parliament), the Council of the European Union (Council) and the European Commission (Commission):

an opinion on the functioning of the marketing passport for EU AIFMs² and on the functioning of the marketing of AIFs under the national private placement regimes (NPPR); and
advice on the application of the passport to the marketing of non-EU AIFs managed by EU AIFMs and of AIFs managed by non-EU AIFMs in EU Member States.

On July 30, 2015, ESMA published its opinion (Opinion) and (the first batch of) its advice (Advice).³

This Sidley Update considers the implications for non-EU AIFMs arising from the Opinion and the Advice.

Some interesting data on marketing by non-EU AIFMs

Before considering the implications of the Opinion and the Advice, it might be interesting to highlight some data presented by ESMA in both documents.

ESMA notes that, as at March 31, 2015, 1,777 non-EU AIFMs had marketed their AIFs in the EU under the NPPR, with 1,013 marketing in the UK alone. Based on separate data provided by the UK Financial Conduct Authority, it appears that, of these 1,013 AIFMs marketing in the UK under the NPPR, over 500 were from the U.S., around 30 were from Hong Kong and around 20 were from Singapore.

When it comes to other EU Member States, U.S. AIFMs account for the vast majority of notifications or registrations under the NPPRs; countries like Hong Kong and Singapore account only for one or two AIFMs in each of those EU Member States. As at March 31, 2015, 78 U.S. AIFMs had marketed into Ireland using the NPPR, 85 into Sweden, 67 into Luxembourg, 32 into Finland, 26 into Belgium and 11 into Denmark. Figures for other EU Member States were not provided.

Sidley comment

With just over 500 U.S. AIFMs marketing into the UK, compared to what is likely to be over 8,000 hedge and private equity firms in the U.S., it is clear that only a small fraction of U.S. AIFMs have thus far marketed their AIFs into the EU under the AIFMD regime. However, based on our experience, that figure is increasing as U.S. managers become more comfortable with the process and the basic AIFMD obligations of investor disclosure, Annex IV reporting, annual reporting and certain obligations where large positions in EU companies are acquired.⁴

The Opinion

As noted above, ESMA was required to issue an opinion on how the AIFMD marketing passport and NPPR were functioning.

ESMA states in its Opinion that the delay in the implementation of the AIFMD, together with the delay in the transposition in some EU Member States, make a definitive assessment of the passport and NPPR difficult. ESMA would thus see merit in the preparation of another opinion on the functioning of the passport and NPPR after a longer period of implementation in all EU Member States. At this stage, ESMA says that there is insufficient evidence to indicate that the AIFMD passport and NPPRs have raised major issues in terms of the functioning and implementation of the AIFMD framework.

Specifically in relation to the EU passport, ESMA has identified several issues, including:

divergent approaches with respect to marketing rules, including as regards fees charged by individual EU Member State regulators and the definition of what constitutes a “professional investor”; and
varying interpretations of what activities constitute “marketing” and “material changes” under the AIFMD passport in the different EU Member States.

ESMA sees merit in greater convergence in the definition of these terms.

Sidley comment

As we noted in our last Update, the definition of “marketing” has been interpreted and implemented differently across EU Member States. For example, the UK has taken the view that “marketing” takes place when a person makes AIF units or shares “available for purchase” by a potential investor; this implies that preliminary marketing material may not constitute “marketing” in the UK. However, other EU Member States such as France and the Netherlands appear to have taken a broader interpretation of that term.

The Advice

The countries assessed

Based on information provided by EU Member State regulators, ESMA has identified 22 non-EU countries to be assessed (country-by-country) for purposes of the extension of the AIFMD passport.⁵

However, the Advice covers only the following six countries:

United States;
Guernsey;
Jersey;
Hong Kong;
Switzerland; and
Singapore.

ESMA chose to assess the above six countries first, on the basis that ESMA had a “sufficient level of information” in relation to those countries. ESMA will be assessing the remaining 16 countries in batches. There are thus expected to be further Advice releases from ESMA as each batch is completed.

Of the six countries above assessed by ESMA, only Guernsey, Jersey and (pending an amendment to local legislation)⁶ Switzerland have been assessed positively. That is, in ESMA’s view there are no obstacles to the AIFMD passport being extended to Guernsey, Jersey and Switzerland.

However, ESMA has recommended that the extension of the AIFMD passport to the U.S., Hong Kong and Singapore be delayed due to concerns related to competition, regulatory issues and a lack of sufficient evidence to properly assess the relevant criteria. These criteria are examined in greater detail below.

Given the number of countries yet to be assessed, ESMA has suggested in its Advice that the Commission, Parliament and Council “may wish to consider whether to wait until ESMA has delivered positive advice on a sufficient number of non-EU countries” before triggering the legislative procedures to activate the passport, “taking into account such factors as the potential impact on the market that a decision to extend the passport might have.”

Sidley comment

If the AIFMD passport is “activated” in respect of the countries for which a positive assessment has been made (each, a Positive Country):
- an EU AIFM managing an AIF domiciled in a Positive Country would be able to market that AIF throughout the EU on the basis of the AIFMD marketing passport; and
- an AIFM from a Positive Country:
  - who manages non-EU AIFs domiciled in a Positive Country may apply to the relevant EU Member State regulator⁷ for full authorisation under (and be subject to full compliance with) the AIFMD and may then market those non-EU AIFs throughout the EU on the basis of the AIFMD marketing passport; and
  - who manages EU AIFs must apply to the relevant EU Member State regulator for full authorisation under (and be subject to full compliance with) the AIFMD; it will then also be able to market those EU AIFs throughout the EU on the basis of the AIFMD marketing passport.

Should the Commission decide not to wait for ESMA to complete the assessments for the remaining 16 non-EU countries, and decide instead to “activate” the passport for Guernsey, Jersey and Switzerland immediately, then in theory that would make Guernsey, Jersey and Switzerland attractive as AIF domiciles for EU AIFMs, since such EU AIFMs would be able to market AIFs from those jurisdictions throughout the EU using the AIFMD passport.⁸
Since the U.S., Hong Kong and Singapore have not been assessed positively (and thus would not be granted the passport at this time), AIFMs from those countries will not be able to market their AIFs throughout the EU using the AIFMD passport. However, the question is whether AIFMs from the U.S., Hong Kong and Singapore would wish to become fully authorised under the AIFMD (in addition to already being registered with the SEC, SFC and MAS, respectively) and be subject to AIFMD remuneration restrictions, single depositary and other rules in order to be able to market their funds throughout the EU using the AIFMD passport.
As a separate matter, the U.S., Hong Kong and Singapore are not widely used by EU AIFMs as domiciles for their AIFs and so the absence of a passport for AIFs from those three countries might not be too problematic.
It should be noted that ESMA’s advice as regards the U.S., Hong Kong and Singapore is that the decision as to extending the AIFMD passport to those countries should be delayed; ESMA has not closed the door on those countries as such, pending further information and analysis. It is also fairly clear that ESMA feels that it has not had enough time properly to carry out all the investigations necessary to be able to make a proper assessment of some of those countries.

The criteria used by ESMA in the assessment

ESMA is required under the AIFMD to consider certain criteria in its assessment of non-EU countries in relation to the potential extension of the AIFMD passport to those non-EU countries. Specifically, the criteria are: investor protection, market disruption, competition and monitoring of systemic risk. For purposes of the Advice, ESMA also considered how the existing Memoranda of Understanding (MoU) between the relevant non-EU countries and EU Member States have been operating.

As noted above, ESMA’s advice as regards the U.S., Hong Kong and Singapore is that the decision as to extending the AIFMD passport to those countries should be delayed at this time. Set out below are the principal reasons for ESMA’s recommendation of the delay.

Sidley comment

In assessing “market disruption” and “competition,” ESMA took the approach of assessing whether there would be a level playing field between EU AIFMs and AIFMs of those non-EU countries – e.g., whether EU AIFMs could market their funds into those non-EU countries. ESMA’s approach appears to be based on Article 67(2)(c) of the AIFMD, which provides that ESMA should base its opinion and advice on: “the potential market disruptions and distortions in competition (level playing field) or any general or specific difficulties which EU AIFMs encounter in establishing themselves or marketing AIFs they manage in any third country.”

ESMA’s assessment of the U.S.

ESMA’s primary objections to granting a positive assessment to the U.S. at this time are that:

it is more difficult for EU AIFMs to market funds to U.S. investors than it is for U.S. AIFMs to market funds to EU investors; and
the Volcker Rule⁹ “might have implications for European actors in the asset management industry notably in relation to the scope of the entities that might qualify as ‘banking entities’ or ‘covered funds’.”

That is, in ESMA’s view, EU AIFMs would not be competing on a level playing field with U.S. AIFMs were the passport to be extended to the U.S.

Sidley comment

It is curious that, in discussing the issue of EU AIFMs marketing their funds into the U.S., ESMA seems to focus on how it appears to be difficult to market such funds to U.S. retail investors, given that the AIFMD marketing regime is focused entirely on the marketing of funds to professional investors.
ESMA’s statement on the Volcker Rule is fairly generic and it is not clear what ESMA’s precise concerns are; it might be a reference to the fact that there are many EU AIFMs that are part of banking groups that might be affected by the Volcker Rule.

ESMA’s assessment of Hong Kong

ESMA’s primary objections to granting a positive assessment to Hong Kong at this time are that:

detailed information on the Hong Kong regulatory framework as regards funds and their managers remains incomplete; there is not enough evidence to assess how it compares to the AIFMD framework. More time is needed to analyse the potential differences; and
some EU Member States are considered as “acceptable inspection regimes” by the Hong Kong authorities but most of them are not; it is therefore not clear whether there is a level playing field between EU and non-EU AIFMs as regards market access.

Sidley comment

It would appear that ESMA’s primary concerns have to do with the lack of information; it is possible that ESMA might take a more positive view once the information is available and a more complete assessment is carried out.

ESMA’s assessment of Singapore

ESMA’s primary objections to granting a positive assessment to Singapore at this time are that:

there is not enough evidence to assess the extent to which there would be significant obstacles regarding investor protection that might impede the application of the AIFMD passport to Singapore;
detailed information on the Singapore regulatory framework remains incomplete; more time is needed to analyse the potential differences between the Singapore regulatory framework and the AIFMD; and
there appear to be some barriers to entry for EU AIFMs into Singapore based on a requirement that managers should have a “sufficient nexus with Singapore”; also, only UCITS from certain EU Member States appear to be recognised in Singapore.

Sidley comment

As with the assessment of Hong Kong, it would appear that ESMA’s primary concerns with Singapore have to do with the lack of information; it is possible that ESMA might take a more positive view once the information is available and a proper assessment is carried out.

What happens next?

The AIFMD provides that, within three months of receiving “positive” advice and an opinion from ESMA, the Commission should adopt a “delegated act” (Delegated Act) specifying the date on which the legislative provisions in the AIFMD will become applicable, whereupon the AIFMD passport would be extended to non-EU AIFs and non-EU AIFMs.

Given that ESMA has only provided “positive” advice in relation to Guernsey, Jersey and Switzerland in the Advice, the question is whether the Commission will adopt its Delegated Act and “activate” the passport for AIFMs and AIFs from those three countries within three months of the Advice and Opinion, or wait until more countries have been assessed positively by ESMA.

In the meantime, ESMA will continue to work on its assessment of the remaining 16 non-EU countries and, presumably, will release further advice as each batch is completed.

Sidley comment

If the Commission takes on board ESMA’s suggestion and waits until “a sufficient number” of non-EU countries have been assessed positively, then it might not be until sometime in 2016 that the Commission publishes its Delegated Act.
The timing of the Commission’s Delegated Act is important because Article 68 of the AIFMD provides that, three years after the entry into force of the Delegated Act, ESMA shall issue to the Parliament, Council and Commission: (i) an opinion on the function of the passport for non-EU AIFMs and AIFs; and (ii) advice on the termination of the NPPRs. That is, for so long as the Commission does not adopt the Delegated Act, the clock does not start ticking on the potential termination of the NPPRs.

Conclusion

As noted in our last Update, much of the AIFMD is going to be the subject of a review in 2017, which may lead to “AIFMD II.” Given all that has happened in the EU regulatory landscape since the AIFMD was adopted – including the focus of the Commission on the development of a Capital Markets Union, as well as tricky “equivalence” assessments under EMIR and MiFID II – it is not certain what the outcome of that review will be. Amongst other things, it is possible that the entire regime relating to the marketing of AIFs may be overhauled. Clearly, it is too early to speculate as to what might happen.

If you have any questions regarding this Sidley Update, please contact the Sidley lawyer with whom you usually work, or

Leonard Ng
Partner
LNg@sidley.com
+44.20.7360.3667

¹ Sidley Update, AIFMD 2014 Update – private placements: where did we end up, and where are we going? (September 8, 2014), available at: http://www.sidley.com/en/news/2014-09-08-investment-funds-update. See also AIFMD 2014 Update – Action Points for Non-EU Managers in 2014, available at: http://www.sidley.com/en/news/aifmd-2014-update--action-points-for-non-eu-managers-in-2014-01-24-2014.

²Capitalised terms are as defined in previous Sidley Updates on the AIFMD.

³ ESMA, ESMA advises on extension of AIFMD passport to non-EU jurisdictions (July 30, 2015).

⁴ A detailed description of these obligations is set out in Sidley Update AIFMD 2014 Update – Action Points for Non-EU Managers in 2014, available at: http://www.sidley.com/en/news/aifmd-2014-update--action-points-for-non-eu-managers-in-2014-01-24-2014.

⁵Australia, Bahamas, Bermuda, Brazil, British Virgin islands, Canada, Cayman Islands, Curacao, Guernsey, Hong Kong, Isle of Man, Japan, Jersey, Mexico, Mauritius, Singapore, South Africa, South Korea, Switzerland, Thailand, United States of America, and the U.S. Virgin Islands.

⁶ESMA raised an issue regarding the exchange of information between the Swiss regulator (FINMA) and EU Member State regulators. However, the Swiss Federal Act on Stock Exchanges and Securities Trading (SESTA) is due to be amended January 1, 2016 in a manner that appears should resolve the issue raised by ESMA.

⁷The regulator would be that of the AIFM’s EU “Member State of reference”; the AIFMD provides a test as to how to determine which EU Member State should be that AIFM’s EU Member State of reference.

⁸To date, EU AIFMs with AIFs in non-EU countries could only market those AIFs under the NPPR regime set out in Article 36 of the AIFMD.

⁹The Volcker Rule was introduced as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act; ESMA notes that the Volcker Rule “provides different obligations/restrictions regarding proprietary trading and investment in ‘covered funds’ by ‘banking entities.’”

Investment Funds Practice

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