The pace of regulatory developments in the areas of AIFMD and UCITS continues unabated. This briefing discusses two of those developments, namely ESMA’s papers on the AIFMD Passport and third country AIFMs and on UCITS share classes.
The AIFMD Passport
ESMA launched a Call for Evidence (Call) on the AIFMD passport and third country AIFMs on 7 November 2014. This Call seeks information on two main issues. First, the use of the AIFMD passport for EU AIFMs, including any problems encountered and any issues of investor protection that have arisen. Secondly, the functioning of the national private placement rules (NPPRs) in the various Member States.
By way of background, under AIFMD, EU AIFMs managing or marketing EU AIFs benefit from a passport by virtue of which they can carry out managing and/or marketing activities throughout the EU. In contrast, EU AIFMs marketing non-EU AIFs and non-EU AIFMs managing or marketing AIFs within the Member States remain subject to the NPPRs. AIFMD requires ESMA to provide an opinion on the functioning of the AIFMD passport for EU AIFMs and on the NPPRs by 22 July 2015. It also requires it to provide its advice on the extension of the AIFMD passport to AIFMs currently within the scope of the NPPRs. In order to issue positive advice, ESMA must be convinced that no significant obstacles arise “regarding investor protection, market disruption, competition and the monitoring of systemic risk”.
The issue as to whether the AIFMD passport should be extended to cover EU AIFMs marketing non-EU AIFs and non-EU AIFMs is obviously a significant one. While the Call is essentially an information gathering exercise, it does give some indication as to how ESMA intends to approach its advice. Specifically, it will assess whether or not significant obstacles exist on a country by country basis rather than treating all non EU countries as a single bloc.
ESMA’s Call comes hot on the heels of the end of AIFMD’s transitional period. Several of the respondents, including the Irish and Luxembourg Funds Industry Associations, argue that ESMA should delay its advice on the passport’s extension. According to those respondents, it is too soon to meaningfully assess the passport’s operation given the implementation delays across Member States combined with the decision by many EU asset managers to avail of transitional arrangements.
Even if ESMA’s advice is positive, there is no guarantee that the passport will be extended in the near future, or at all. Specifically, while on receipt of positive advice from ESMA the Commission must adopt a delegated act extending the passport, AIFMD does not lay down a time period in which this extension is to be realised, apparently leaving the Commission with considerable discretion on this issue. More significantly, it is clear that the Council and/or Parliament can object to the delegated act, thus preventing it from being adopted.
The lack of certainty regarding the passport’s extensions is likely to be of concern to non-EU AIFMs and EU AIFMs marketing non-EU AIFs within the Member States. Not all Member States have NPPRs, effectively preventing such AIFMs from operating in those states. In addition, there is uncertainty as to whether some Member States intend to phase out their NPPRs. Moreover, Member States have divergent registration processes and reporting requirements meaning that managing/ marketing under the NPPRs can be complicated, expensive and bear on-going compliance risks.
The Call can be accessed here.
UCITS Share Classes
On 23 December 2014, ESMA published a discussion paper on UCITS Share Classes (Discussion Paper). While the UCITS Directive permits UCITS to customise their offerings to investors through the use of share classes, it appears that Member States are taking divergent approaches as to the types of permitted share classes. The Discussion Paper’s purpose is to achieve a common understanding both on what constitutes a UCITS share class, including how to distinguish share classes from UCITS sub-funds, and on the extent to which differentiation between share classes should be permitted.
According to ESMA, the key difference between share classes and sub-funds is that sub-funds usually have legally segregated assets while investors in different UCITS share classes all own a portion of the same pool of assets. ESMA identifies three principles for assessing the legality of different share classes:
- share classes of the same UCITS should follow the same investment strategy;
- the specific features of one share class should not impact adversely on other share classes; and
- if investors have a choice of share class, then the UCITS should disclose to them the differences between those classes.
The Discussion Paper also lists on a non-exhaustive basis types of share class that are, respectively, compatible and incompatible with these principles.
Compatible share classes include those differentiated on the basis of: investment amounts; type of investor; types and amounts of charges and fees; currency; revenue allocation; share characteristics; and voting rights. In addition, ESMA considers that currency hedging at share class level is compatible with the principle of a common investment strategy and should be permitted as long as it cannot have an adverse impact on the unit holders of the UCITS other share classes and the share class bears the costs of the hedging.
Incompatible share classes include: those exposed to different pools of underlying assets; those where the underlying portfolio is swapped against different portfolios of assets; share classes that offer differing degrees of protection against market risks including interest rate and/or volatility risks; and share classes that are exposed to the same pool of assets but with different levels of capital protection and/or payoff. According to ESMA, interest rate hedging at share class level should not be permitted as it is incompatible with the principle of having the same investment strategy.
ESMA’s approach to UCITS share-classes is largely in line with that of the Central Bank of Ireland. However, in contrast to ESMA, the Central Bank is prepared to permit interest rate hedging at share class level as long as this is clearly disclosed in the prospectus and as long as the fund’s constitutional documents contain unambiguous valuation and allocation provisions. Moreover, the Central Bank’s approach to financial derivative instruments at share class level does not appear be fully compatible with ESMA’s views.
ESMA is seeking feedback on its Discussion Paper by 27 March 2015 and lists 14 questions on which it is soliciting submissions including any alternatives that ESMA should consider. ESMA will take into consideration the submissions received with a view to establishing a common position on the use of share classes by UCITS.
The Discussion Paper can be accessed here.