On 25 November 2021, the European Commission (Commission) published its proposal (the Commission Proposal) for a directive amending the existing EU Alternative Investment Fund Managers Directive (AIFMD), as part of its Capital Markets Union package. The Commission Proposal will in effect result in “AIFMD II.”
The Commission Proposal does not amount to a complete overhaul of the AIFMD framework; rather, the Commission has proposed some targeted amendments to improve the functioning of the AIFMD.
The most noteworthy amendments proposed by the Commission involve:
- changes to the Article 42 AIFMD national private placement regime (NPPR) framework;
- changes to delegation arrangements of EU-authorised alternative investment fund managers (AIFMs);
- AIFM substance requirements;
- loan origination by alternative investment funds (AIFs);
- liquidity management;
- investor disclosure requirements;
- Annex IV reporting;
- new “non-core” services; and
- changes to the depositary framework.
We consider each item in turn below. For ease of reference, we refer to the existing AIFMD text as “AIFMD I.”
For completeness, we also refer at the end of this Update to certain corresponding changes to the Undertakings for the Collective Investment in Transferable Securities (UCITS) Directive.
Changes to the Article 42 AIFMD NPPRs
The Article 42 National Private Placement Regimes (NPPRs) have been used by many U.S. and other non-EU AIFMs to market their AIFs into the EU since the AIFMD took effect in 2014. Among the threshold conditions for the availability of the NPPRs in the current text under AIFMD I are that the third country (i.e., non-EU country) where the non-EU AIFM or the non-EU AIF is established is not listed as a “Non-Cooperative Country and Territory” by the Financial Action Task Force (FATF) (in essence, countries on the FATF’s list of “High-Risk Jurisdictions” in relation to money laundering, terrorist financing, and proliferation financing).
The Commission’s AIFMD II proposal deletes the reference to the FATF list and instead requires that the non-EU AIFM and non-EU AIF cannot be domiciled in a “high risk jurisdiction” pursuant to the EU Anti-Money Laundering (AML) Directive (Directive (EU) 2015/849) (EU AML List).
In addition, the Commission Proposal adds a new condition, that each of the non-EU AIFM’s and non-EU AIF’s jurisdiction
- must have signed an agreement with each Member State in which the AIF is to be marketed that fully complies with the standards laid down in Article 26 of the OECD Model Tax Convention on Income and on Capital and ensures an effective exchange of information in tax matters, including any multilateral tax agreements; and
- must not be on the EU list of non-cooperative tax jurisdictions (EU Tax List).
For completeness, note that similar changes are being introduced to the NPPRs used by EU AIFMs marketing non-EU AIFs under Article 36 AIFMD as well as the passporting provisions for third country AIFMs under the third country passporting regime (that has yet to be activated). In addition, note that the OECD Model Tax Convention requirement is not new, as it is already a condition under existing AIFMD I provisions.
Implications for managers
The change/addition to the Article 42 NPPR conditions mirrors the changes made to the EU Securitisation Regulation (Sec Reg) that took effect from 9 April 2021, when the same two conditions regarding AML and tax were applied to the domicile of securitisation special purpose entities (SSPEs). So there is already a precedent for this requirement.
The new conditions are unlikely to be problematic in relation to non-EU AIFM jurisdictions such as the UK, U.S., Hong Kong, and Switzerland. And, at present, none of the major AIF non-EU jurisdictions such as Cayman, British Virgin Islands, Jersey, or Guernsey are on either the EU AML List or the EU Tax List. However, Cayman was on the EU Tax List (from February to October 2020), illustrating the potential danger with the inclusion of such a condition. In addition, the EU AML List and EU Tax List are the subject of a political process, and it is therefore of concern that AIF marketing could be subject to political processes that might not be transparent.
The AIFMD II proposal does not provide for any transitional or grandfathering provisions in relation to these new conditions, which gives rise to significant uncertainty should a major AIF domicile be added to either the EU AML List or the EU Tax List at any time.
Changes to delegation arrangements by EU AIFMs
Notification where AIFM delegates “more” portfolio or risk management than it retains
EU Member State national competent authorities (NCAs) will be required to notify the European Securities and Markets Authority (ESMA) on an annual basis when an AIFM “delegates more portfolio or risk management to entities in third countries than it retains.”
It would appear that this data-gathering exercise is for purposes of helping ESMA when it carries out its two-year and five-year reviews discussed below. However, the requirement is, as written, unclear.
First, it is unclear what it means to delegate “more” portfolio management or risk management. Portfolio management and risk management activities are not easily quantified, so it would be difficult, for example, to determine that an AIFM has delegated, say, 51% of portfolio or risk management.
Secondly, the provision refers to an AIFM delegating more portfolio or risk management. If that is really the test, then it would appear that a large number — perhaps even the vast majority — of EU AIFMs today would be notified by the NCAs to ESMA. That is because the typical EU AIFM delegation model typically contemplates that the AIFM will keep or carry on all risk management but then delegate almost all portfolio management to its delegate.
Delegation regulatory framework extension
The Commission Proposal extends the regulatory framework of delegation arrangements to all delegation functions listed in Annex I AIFMD, including ancillary functions. This includes MiFID top-up activities.
The effect of this change would be that AIFMs delegating such activities will need to notify their NCA in the same manner as having to notify their NCA under AIFMD I of any delegation of portfolio or risk management activities, and such delegation would be subject to the general requirements including the AIFM being able to justify the delegation on “objective reasons.”
Two-year peer review and five-year ‘letter box’ review
ESMA will be required to conduct a peer review analysis, at least every two years, of NCAs’ supervision of delegation arrangements with a focus on measures taken to prevent AIFMs becoming letter-box entities. ESMA will also be required to report to the European Parliament and the Council at least every two years on market practices regarding delegation to entities located in third countries.
Separately, ESMA will be required to initiate a review five years after the entry into force of AIFMD II to assess how the delegation regime has influenced the prevention of letter-box entities.
AIFM substance requirements
To receive authorisation from NCAs, AIFMs will need to provide a detailed description of the appropriate human and technical resources that the AIFM will use to carry on its business. The conduct of the business of the AIFM must also be decided by at least two natural persons who are (i) either employed full-time or are committed full-time to conducting the business of the AIFM and (ii) resident in the EU.
Given the fairly detailed substance requirements imposed by the main AIFM/AIF domiciles such as Ireland and Luxembourg, this new requirement does not appear to be problematic.
Loan origination by AIFs
The Commission Proposal includes an amendment to Annex I AIFMD to add, to the list of AIFM activities, the activity of “originating loans” (and also “servicing securitisation special purpose entities”). There is currently no detailed definition of which activities may be included within “originating loans,” notably whether this extends only to the initial legal lender of record.
The result of this amendment is that an EU AIFM in one Member State could utilise the AIFMD management passport to manage an AIF in another Member State that engages in loan origination, but the proposal does not, for example, appear to establish a “passport” for loan funds to originate loans across the EU. Accordingly, unless the Commission Proposal is clearly extended, the separate loan origination regimes of each Member State would remain relevant when assessing the regulatory requirements of loan origination transactions themselves.
The Commission Proposal does not clarify which entity in a typical fund structure may trigger these new requirements: the AIFM, the AIF and/or special purpose vehicles (SPVs) related to the AIF. It is important to note also that the Commission Proposal is not limited to loans originated with EU borrowers: all loan origination activity would be in scope irrespective of the location of the borrower or collateral.
Risk management — 5%, 20%, 60% thresholds
The Commission Proposal introduces some new provisions in Articles 15 and 16 AIFMD to address risk and liquidity management relating to loan origination activities.
An AIFM is required to ensure that the AIF it manages retains, on an ongoing basis, 5% of the notional value of the loans it has originated and subsequently sold on the secondary market.
AIFMs will be required to ensure that AIFs it manages do not originate a loan to any single borrower that is a financial institution in an amount that exceeds 20% of the AIF’s capital. This limitation must come into effect no later than at half the life of the AIF, although an NCA may approve an extension of up to one year.
Finally, if the value of an AIF’s originated loans exceeds 60% of its net asset value, an AIFM will be required to ensure that the AIF is closed-ended.
An AIF shall not be permitted to grant loans to (i) its AIFM/staff of its AIFM; (ii) its depositary; or, (iii) a delegate.
Article 23 AIFMD reporting obligations will require AIFMs to disclose information on their originated loan portfolios. The level of detail required is unclear at this point.
Liquidity management tools
The Commission Proposal introduces new provisions on liquidity management under Article 16 AIFMD.
Authorised (i.e., EU) AIFMs that manage open-ended AIFs will have to select at least one liquidity management tool from a new Annex V AIFMD to be used in exceptional cases.
The AIFM will be required to implement policies and procedures for the “activation” and “deactivation” of any selected liquidity management tool and set out the operational and administrative arrangements for using such tool.
Note that Article 16 AIFMD does not apply to non-EU AIFMs marketing AIFs under the Article 42 NPPRs.
When activating or deactivating a liquidity management tool, AIFMs will be required to notify NCAs.
ESMA shall have a power to require AIFMs to activate or deactivate a liquidity management tool in particular circumstances. The proposals do not provide specifics on the anticipated circumstances or thresholds in which ESMA would consider it appropriate to exercise such powers.
Investor disclosure requirements
The Commission Proposal includes an amendment to the Article 23 AIFMD disclosures, to include:
- for open-ended funds, in addition to the existing description of the AIF’s liquidity risk management, information on the possibility and conditions for using liquidity management tools; and
- a list of fees and charges that will be applied in connection with the operation of the AIF and that the AIFM or its affiliates will bear.
In addition, the ongoing disclosures of AIFMs will be expanded to include disclosure of:
- the AIF’s originated loan portfolio (if any);
- on a quarterly basis, all direct and indirect fees and charges that were directly or indirectly charged or allocated to the AIF or to any of its investments; and
- on a quarterly basis, any parent company, subsidiary, or special purpose entity established in relation to the AIF’s investments by the AIFM, the staff of the AIFM, or the AIFM’s direct or indirect affiliates.
Annex IV reporting
The Commission Proposal includes some tweaks to the Annex IV reporting rules set out in Article 24 AIFMD.
At present, an AIFM is required to report to the relevant NCAs the “principal” markets and instruments in which it trades on behalf of the AIFs it manages, the “main” instruments it is trading, the “principal” exposures, “most important concentrations” of each of the AIFs it manages, and the “main categories of assets in which the AIF invested.”
The AIFMD II text would delete the relevant words above so that an AIFM would be reporting in relation to all markets, instruments, and exposures.
ESMA is to publish new regulatory and implementing technical standards, reflecting the changes in the Annex IV reporting templates.
Interestingly, the Commission Proposal does not seek to harmonise the requirement across the Member States as to whether Annex IV reports should be filed only for a feeder AIF or also for the master AIF, so the practice may continue in an inconsistent manner across Member States.
New “non-core” services
In addition to the new AIFM functions of loan origination and servicing of SSPEs being added to Annex I AIFMD, the AIFMD II text would amend Article 6(4) AIFMD to include two new “non-core” services:
- benchmark administration and
- credit servicing in accordance with the recently adopted EU Directive on Credit Servicers and Credit Purchasers (not yet published in the EU Official Journal).
Changes to the depositary framework
The current rule in AIFMD I is that the depositary of an EU AIF must be established in the home Member State of the AIF. The recitals to the Commission Proposal note that some concentrated markets lack a competitive supply of depositary services. To address this shortage of service providers, NCAs should be able to permit AIFMs or AIFs to procure depositary services located in other Member States while the Commission assesses, in the context of its review of the AIFMD, whether it would be appropriate to propose measures to achieve a more integrated market. However, there is no operative amendment to Article 21 AIFMD to reflect this proposed change.
Where third country depositaries are used, the Commission Proposal requires that such depositaries be in jurisdictions that are not on the EU AML List or the EU Tax List.
The Commission Proposal also provides that a Central Securities Depositary (CSD) can be a delegate of a depositary and that no additional due diligence checks will be required as part of its appointment.
Changes to the UCITS Directive
The Commission Proposal also includes certain changes to the UCITS Directive, which mirror many of the changes above (e.g., NCAs notifying ESMA or delegation of “more” portfolio or risk management, the requirement of two full-time employees, delegation rules applying also to Markets in Financial Instruments Directive (MiFID) ‘top-up’ services, and liquidity management tools), although unsurprisingly there is no provision for UCITS to engage in loan origination.
The Commission Proposal will now go through the standard EU legislative process. At this point, the Commission Proposal will need to be considered by each of the European Parliament (the Parliament) and the Council of the European Union (the Council). Once the Parliament and the Council agree on their respective texts, they will, together with the Commission, enter ‘trilogue’ negotiations for a final text for adoption and, some months thereafter, publication in the EU Official Journal. Member States would then be required to implement the AIFMD II text two years after publication in the Official Journal.
It could therefore not be until late 2024 or 2025 before AIFMD II is implemented.
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