Anna Moran
McCann FitzGerald, Dublin
Anna.Moran@mccannfitzgerald.com

Tony Spratt
McCann FitzGerald, Dublin
Tony.Spratt@mccannfitzgerald.com

Introduction

EU Directive 2011/61/EU, commonly known as the Alternative Investment Fund Managers Directive (the ‘Directive’ or ‘AIFMD’), came into force on 22 July 2013 and had a profound effect on the alternative investment fund industry, not just within the European Union but across the world. By way of reminder, the overriding purpose of the original AIFMD regime was to help create a single market for the management and marketing of alternative investment funds (AIFs) and to strengthen investor protection and financial stability across the industry. More than ten years after the introduction of the original Directive, the EU legislature is now at an advanced stage of introducing amendments which will update the provisions of AIFMD with a view to enhancing the Directive. The amendment proposals are commonly referred to as ‘AIFMD II’.

This article provides a brief overview of (1) the proposed timeline for AIFMD II; (2) the latest developments in the process; and (3) the likely impact of the proposed changes on the alternative investment funds industry.

Timeline

The proposals to review the AIFMD regime, to ensure that the regime is fit for purpose, have been signalled for some time. On 25 November 2021, the European Commission (the ‘Commission’) issued a proposal for AIFMD II in the form of a draft Directive. The Commission stated that while AIFMD has been working well in principle, some targeted changes were needed to better integrate the market for AIFs to ensure investor protection and to better monitor risks to financial stability.

On 16 May 2022, the European Parliament issued its draft report on the Commission’s proposals, and, on 21 June 2022, the Council of the European Union (the ‘Council’) published its compromise text (the ‘Compromise Text’).

The next step in the legislative process will be for the Council, the European Parliament and the Commission to enter into trilogue negotiations to agree on a final version of the text of the AIFMD II Directive for publication in the Official Journal of the EU.

Latest developments

The Compromise Text contains five key developments in the areas of delegation, loan origination, liquidity management tools (LMTs), depositaries and alternative investment fund manager (AIFM) activities. We look at each of these developments in turn below.

Delegation

A key development in the Compromise Text is the inclusion of delegation reporting within regular supervisory reporting requirements for AIFMs.

The Commission had originally proposed that detailed reporting obligations should be contained in regulatory technical standards (RTS), which would be developed at a later stage. However, the Council has stated that reporting on delegation arrangements needs to be clearly detailed in the text of AIFMD II, while RTS should be limited to setting an appropriate level of standardisation.

The Compromise Text states that the European Securities and Markets Authority (ESMA) will draw on the reporting obligations of AIFMs to competent authorities and analyse this data. The results will feed into ESMA’s report analysing market practices regarding delegation.

It is worth noting that the issue of delegation, more generally, has been the subject of much debate and scrutiny, particularly given the wider focus by EU regulators on delegation models in a post-Brexit world. Earlier drafts of the text under different EU presidencies raised the concern that AIFMD II might seek to restrict the extent to which AIFMs could delegate portfolio management to non-EU third countries. It would appear, however, that the proposals will not represent fundamental changes to existing global delegation models (particularly with regard to delegation to non-EU third countries) but rather, will seek to fine-tune the existing delegation requirements, including the introduction of reporting requirements, as referenced above, to enable ESMA to analyse market practices regarding delegation. This approach to delegation is largely welcomed by the stakeholders although this area will be one to watch for the future across the global asset management industry. It is worth noting also that substantial work has already been undertaken in certain EU Member States to enhance delegation and substance requirements.

Loan origination

AIFMD II will introduce common minimal rules for loan-originating AIFs with a view to achieving a level playing field across all EU Member States. The Council has made a number of revisions to the minimal rules proposed by the Commission. These revisions are further detailed in the table below.

Liquidity management tools (LMTs)

The Commission had proposed that AIFMs, when determining an appropriate set of LMTs, should choose at least one LMT from the list of LMTs set out in a new Annex V to the Directive. Such LMTs include:

• suspension of redemptions and subscriptions;
• redemption gates;
• notice periods;
• redemption fees;
• swing and/or dual pricing;
• anti-dilution levy;
• redemptions in kind; and
• side pockets.

However, the Council has revised this requirement to provide that AIFMs should select at least two LMTs (in addition to the possibility to suspend redemptions and activate side pockets).

By way of derogation, the AIFM of an open-ended AIF authorised as a money market fund may select only one LMT from the list of LMTs.

The Commission had proposed that AIFMs should be required to notify competent authorities when a decision is taken to activate or deactivate any of the listed LMTs. However, the Council has amended this requirement to require notifications only for the (de)activation of the suspension of redemptions, redemption gates and side pockets. The Compromise Text does allow for Member States to require additional notifications to competent authorities in respect of other LMTs, if they deem it appropriate.

The Compromise Text now provides that ESMA should issue guidelines determining the criteria for the selection and use of appropriate LMTs.

These proposals build on previous recommendations from European institutions with regard to the need to harmonise the rules relating to liquidity risk management requirements.

Depositaries

Another area of interest relates to the so called ‘depositary passport’. The notion of a depositary passport had first been mooted under the original Directive. However, AIFMD II falls well short of providing a depositary passport and, in fact, the Compromise Text revises the Commission’s original proposal in respect of depositaries to make it clear that those provisions do not constitute a form of ‘depositary passport’. On this basis, the Compromise Text provides that an authorisation to procure depositary services located in other Member States should not be automatically granted. An AIFM needs to provide a ‘motivated request’ to demonstrate a lack of depositary services and the national depositary market of that AIFM must satisfy certain conditions. Competent authorities should grant their prior approval based on a case-by-case assessment.

AIFM permitted activities

The Compromise Text now clarifies that AIFMs may carry out any other ancillary service where that ancillary service represents a continuation of the services already undertaken by the AIFM provided that doing so does not create conflicts of interest that could not be managed by additional rules.

Conclusion

As stated above, the Compromise Text will form the basis for trilogue discussions between the Council, the European Parliament and the Commission in order to agree a final version of AIFMD II. It is likely that the Compromise Text will be subject to further changes as a result of the trilogue process. However, the general direction of travel in both the Compromise Text and the European Parliament’s report appear to be viewed positively by the alternative investment funds industry.

In terms of timing, the European Parliament is likely to want to finalise its report by the end of October 2022. This leaves little time for the trilogue process, which may, therefore, slip into 2023. This would then point towards AIFMD II coming into force in 2025, given that the Directive will not take effect until 18 months after the trilogue process has been completed and the final AIFMD II Directive has been published in the Official Journal of the EU.

It is worth noting also that the Commission’s proposal suggests making corresponding amendments to the Undertakings for Collective Investment in Transferable Securities Directive 2009/65/EC (the ‘UCITS Directive’). Accordingly, it is likely that the relevant provisions set out in the final AIFMD II Directive will subsequently be applied to UCITS funds as well, which will create compliance efficiencies for those asset managers who operate under both regimes.

Many stakeholders and industry participants believe that AIFMD is generally working well and has substantially achieved its original aim of ensuring high levels of investor protection and also creating an effective supervisory regime for AIFMs. While the legislative process is ongoing, there are positive signs at this stage that AIFMD II will represent targeted enhancements to the regime rather than representing any substantial deviation from the existing requirements. A good example of this would be the proposals in the context of delegation, as referenced above. Investor access to the ‘best in class’ of global asset managers has been a core part of the EU’s Capital Markets Union plans since the outset. Limiting the extent to which an AIFM could delegate portfolio management to non-EU asset managers would have cut across this aim and would have been politically motivated, rather than in the interests of investors.

Overall, it is expected that the relatively benign changes proposed under AIFMD II will be largely welcome news for industry participants, particularly given the existing success of the AIFMD regime to date and also bearing in mind the already increasingly demanding and evolving regulatory landscape which the industry continues to face.