This Focusing on Funds looks at some of the European Commission consultation paper on the AIFMD.
The Consultation follows an intervention by ESMA with its letter to the Commission raising numerous concerns about the AIFMD (e.g. harmonisation and clarification issues). In this briefing we focus in on some of the issues raised in the ESMA letter (relevant to real estate funds) and consider how questions raised in the Consultation relate to the EMSA issues. We briefly comment on the likely direction of travel.
ESMA considers that there is a lack of clarity concerning the responsibilities of home and host supervisors in cross-border marketing, management and delegation cases. ESMA believes that due to AIFMs often delegating a variety of functions to multiple third parties across different Member States, there needs to be clarification of the supervisory responsibilities regarding cross-border activities within the EEA market.
UK firms (without the benefit of a passport) might need to rely more on reverse solicitation mentioned in Recital 70 of the AIFMD, to do business in the EEA. In order to provide greater protection to investors, ESMA has briefly highlighted the importance of clarifying the scope of reverse solicitation mentioned in Recital 70 of the AIFMD, which is currently subject to divergent practices and interpretation at national level. It is possible there will be rule changes to deal these divergent practices and this could make it harder (or easier) for UK firms to do business in the EEA.
The Consultation asks questions on AIFM passport about:
the scope of the licence;
the extension of the licence to smaller AIFMs;
clarification of the ability to provide ancillary services under article 6 of the AIFMD.
the role of the national private placement regimes in creating an uneven playing field between EU and non-EU AIFMs;
whether the delegation rules are sufficient to prevent letter-box entities and to ensure effective risk management;
whether the AIFMD standards should apply to delegates irrespective of location to avoid regulatory arbitrage; and
whether quantitative criteria or lists of core or critical functions should be applied in delegation.
In light of Brexit, the ESMA issues and the Consultation questions being asked, changes to rules on how EEA funds can delegate to non-EEA managers could be introduced as well as new private placement rules.
A big impact is likely to come from the proposal to harmonise elements of AIFMD and the UCITS frameworks. UCITS have more complex rules on delegation and sub-investment compared to the AIFMD.If there is to be harmonisation between the AIFMD and UCITS this might affect how an EEA AIFM may delegate to a UK manager in a post Brexit world. The concern for AIFMs is that more harmonisation and ESMA’s concerns about delegation practices might lead to future rules which are less attractive for UK AIFMs.
External valuer liability issue
The AIFMD provisions state that the external valuer shall be liable to the AIFM for any losses suffered by the AIFM as a result of the external valuer’s negligence or intentional failure to perform its tasks. In certain jurisdictions, the reference to negligence is interpreted as covering not only ‘gross negligence’ but also ‘simple negligence’, acting as a disincentive for external valuers due to liability concerns. ESMA believes that the definition of “negligence” could be limited to “gross negligence” in the legislation.
Questions on valuation rules include:
whether the AIFMD rules on valuation are appropriate;
whether the AIFMD legal framework be improved further given the experience with asset valuation during the recent pandemic;
what measures ought to be taken to mitigate/offset the liability of valuers in the jurisdiction of your choice.
It appears likely that there might be some change in the valuation rules affecting AIFMs or the scope of liability of valuers appointed by AIFMs.
The AIFMD has two measures of leverage calculation, the gross notional exposure (GNE) method and the commitment method.
ESMA sees merit in the IOSCO recommendations issued in December 2019 recommending a two-step approach for assessing leverage in investment funds. The two-step approach was based on use of GNE or adjusted GNE.
The direction of travel appears to be that regulators will be looking how to measure leverage more uniformly by a suitable measure and also to collect more data. That could result in not only clearer rules on how to calculate leverage, but also more perspective rules on measurement and reporting of leverage.
Questions raised in the Consultation include questions about:
requiring more details on leverage;
requiring more details on liquidity;
whether the leverage calculation methods gross and commitment are appropriate;
whether the leverage calculation methods for UCITS and AIFs should be harmonised.
Whereas more harmonisation between AIFMs and UCITS could have some benefits in terms of efficiencies, it could result in a heavier compliance burden for AIFMs.
The above is not exhaustive and other questions raised in the Consultation Paper relate to topics such as depositories and the Sustainable Finance Disclosure Directive.
Next steps and general issues
The responses to the Consultation are due on 29 January. If the Commission decides to propose changes to the existing legislation (at Level 1 and/ or Level 2), these are unlikely to be published until mid-2021.