On 30 July 2015, the European Securities and Markets Authority (ESMA) published its advice to the European Parliament, the Council and the European Commission on the application of the AIFMD Passport to non-EU AIFMs and AIFs1. The advice was published a little over a week later than it was due to be published, perhaps reflecting the difficulties that ESMA has found in assessing the different factors that it is bound to take into account pursuant to the Level 1 AIFM Directive, particularly as a result of its adopted approach of providing advice separately for each non-EU country whose funds and fund managers are active in one or more EU member states.
The AIFM Directive2 applies to managers (AIFMs) of alternative investment funds (AIFs) as defined in the Directive. It currently provides for EU AIFMs, once they have passed the conditions for authorisation in one EU member state, to be permitted to market EU AIFs managed by them in any member state of the EU without further authorisation. This so-called “passport” is currently available only to EU AIFMs. At present, non-EU AIFMs are only able to actively market their funds in an EU member state if such marketing is permitted by the National Private Placement Regime (NPPR) of that member state, and a separate application is required for the NPPR of each state in which active marketing is intended to occur.
However, Article 67(1) of the AIFM Directive establishes that ESMA is under a duty to provide advice by 22 July 2015 to the European Parliament, the Council and the Commission on the extension of the passport to non-EU AIFMs and non-EU AIFs. In addition, ESMA is also to deliver in the same timescale an opinion on the functioning of the passport for EU AIFMs, pursuant to Articles 32 and 33 of the AIFM Directive, and an opinion on the functioning of the NPPRs.
Within three months of receipt of positive advice and a positive opinion from ESMA, the European Commission must adopt a delegated act, specifying the date when the passporting regime should be extended to non-EU AIFs and non-EU AIFMs.
In order to produce the opinion and the advice, ESMA is required to investigate the elements listed in Articles 67(2) and 67(4) of the AIFM Directive. These include factors such as the use that has been made of the passport by EU managers and any problems encountered in that context, the functioning of the NPPRs and whether there are any issues such as investor protection, market disruption, competition and the monitoring of systemic risk that might impede the extension of the passport.
In addition to input provided by the national competent authorities of each EU member state via quarterly surveys, ESMA also launched a Call for Evidence in November 2014 to gather information from stakeholders (both EU and non-EU) on the functioning of the passport, the NPPRs and the potential extension of the passport to non-EU countries.
As mentioned in the Call for Evidence, ESMA has decided to adopt a country-by-country assessment of the potential extension of the passport. This is designed to allow for distinctions to be drawn between different non- EU countries in terms of the relative level of demand for the passport, the level of access to their home market for EU funds and managers, and their regulatory framework as compared to the AIFM Directive.
ESMA has identified 22 non-EU countries as being the domicile either of non-EU AIFMs that market AIFs in the EU or of non-EU AIFs that are marketed in the EU3. However, from these 22 countries, ESMA has identified six jurisdictions to prioritise in terms of making their assessment, based upon those jurisdictions where it feels there is a sufficient level of information about that jurisdiction for it to make its assessment. The six non-EU countries that were prioritised are the United States, Guernsey, Jersey, Hong Kong, Switzerland and Singapore. The list takes account of a number of factors, including the levels of activity already being carried out by entities from these countries under the NPPRs, the existing knowledge and experience of the European national competent authorities with respect to their counterparts in these jurisdictions and also the efforts made by stakeholders from these countries to engage with the process of assessing whether the passport should be extended.
Although these six countries have been prioritised for now, ESMA states that their assessments will be followed by assessments of other batches of the remaining non-EU countries in the coming months.
ESMA found that, overall, the rules in the United States seemed comparable to the rules in the EU as regards diversification, disclosure requirements and limitations on ability to borrow money. In relation to custodians, ESMA noted that the Investment Company Act of 1940 (the 1940 Act) permits a mutual fund, under certain conditions, to act as its own custodian, whereas this is not permitted for any AIFMs and AIFs that intend to use the passport.
In relation to the alignment of incentives between the AIFM and its investors, ESMA noted that the United States does not apply remuneration restrictions of the kind set out in the AIFMD and therefore that the rules on remuneration appear to be significantly different as between the United States and the EU.
In relation to market access, ESMA noted that it is possible for EU fund managers to market funds in the United States by organising a fund in the United States and registering this fund under the 1940 Act. Since the 1940 Act imposes the same regulatory standards on all funds, regardless of whether they are managed by a domestic or foreign manager, EU managers can therefore manage a United States fund established by them.
However, ESMA noted that it is generally much more difficult to market foreign funds in the United States, especially to retail investors and that a foreign manager wishing to market a foreign fund in the United States essentially has two options. The first option is to use s ection 7(d) of the 1940 Act which provides that an investment company organised in a foreign jurisdiction may publicly offer its securities if the SEC concludes that it is legally and practically feasible to effectively enforce the provisions of the 1940 Act against the fund. However, very few foreign funds use this option because section 7(d) imposes constraints on their ability to sell their shares in the United States due to differences in business and regulatory environments between the United States and foreign country of origin. The second option is that the foreign manager can sell its foreign fund shares privately so long as it:
- claims an exception for the fund itself under the 1940 Act;
- claims an exemption for the shares of the fund under the Securities Act;
- registers or claims an exemption for itself and the fund under the Commodity Exchange Act; and
- qualifies the fund under state blue sky laws by making a notice filing and paying a fee in each state in which an investor in the fund resides.
As a result of these regulatory hurdles, ESMA is currently of the view that extending the passport to United States funds and fund managers would create a risk of there being an unlevel playing field as between the United States and the EU.
ESMA has therefore advised the European Parliament, the Council and the Commission that, if the relative ease of market access as between the United States and the EU is to be considered as a predominant criterion, in terms of whether the passport should be extended to the United States, then the decision on the extension to the United States should be delayed until better conditions of market access are granted by the United States authorities to EU AIFMs and AIFs.
Guernsey and Jersey
ESMA has concluded in relation to both these jurisdictions that there are no significant obstacles regarding investor protection, competition, market disruption and the monitoring of systemic risk that would impede the extension of the AIFMD passport to these jurisdictions.
ESMA has noted that it has yet to receive detailed information on the Hong Kong regulatory framework and therefore that it needs more time to analyse the extent to which potential differences between the Hong Kong framework and the AIFMD may be material to the assessment of the extension of the passport. It also notes that a few EU member states are considered as “acceptable inspection regimes” by the Hong Kong authorities but that most of them are not, and therefore it is not clear whether there would be a level playing field between the EU and Hong Kong as regards market access if the passport were extended to Hong Kong managers and funds.
ESMA has advised that a process is currently underway in Switzerland to amend the relevant statutes that would allow transmission of information from Swiss authorities to foreign national competent authorities. It considers that when these amendments are enacted, there would be no significant obstacles that would impede the potential extension of the passport to Switzerland.
ESMA is of the opinion that the methods of ongoing supervision employed by the Monetary Authority of Singapore in Singapore might lead to difficulties with the reporting and monitoring of systemic risk. Therefore they are of the view that there is not enough evidence to assess whether there will be significant obstacles regarding investor protection. In terms of market access, ESMA also notes that managers are required to have a sufficient nexus with Singapore, including having at least 500 million Singapore dollars in assets under management in Singapore, in order to be authorised. It therefore has concerns that this could create a barrier to market access and therefore an unlevel playing field if the EU were to extend the passport to Singapore funds and managers. ESMA has therefore advised the European Parliament, Council and Commission to delay their decision on the potential extension of the passport to Singapore.
Given the lack of “positive advice” being provided by it, ESMA has suggested to the European Commission delaying any decision until ESMA has delivered further positive advice in relation to other non-EU jurisdictions in order to avoid the possible negative market impact of extending the passport initially only to a few non-EU jurisdictions.
As to when that further advice will be forthcoming, ESMA provides no detail other than to say it will be in the coming months.
Since it seems that some non-EU jurisdictions will not be the subject of “positive advice” from ESMA, this raises the question of whether AIFMs from those jurisdictions will continue to be able to market their AIFs using the NPPRs of various EU member states as they have been doing to date. The AIFMD envisages a further opinion being provided by ESMA, within three years after the entry into force of the legislation extending the passport, as to whether the system of NPPRs should be abolished in parallel with the existence of the passport. The express link between the existence of the passport and the abolition of the NPPRs seems to suggest that ESMA may recommend that an EU member state’s NPPR does not have to be abolished in relation to a non-EU country whose AIFs and AIFMs do not have access to the passport.