The European Securities and Markets Authority told the European Commission last week that it was premature to grant passport rights to US alternative investment fund managers (AIFMs) that would enable them to manage or market alternative investment funds (AIFs) in the European Union without authorization by each member state where they proposed to conduct business. This is because ESMA did not find equivalence in overall oversight and potential access rights under the EU and US regulatory schemes.

However, ESMA said that AIFMs and AIFs from Guernsey, Jersey and Switzerland should be permitted to benefit from passport rights because there is equivalence in regulation between those jurisdictions and the European Union.

According to ESMA, if passport rights were granted to relevant US entities at this time, US persons would have easier access to EU professional investors than equivalent EU entities would have to professional investors in the US due to registration requirements under the US framework.

Generally, ESMA found equivalence between the US and EU regulatory oversight of AIFMs and AIFs in most areas, although ESMA found that EU rules on remuneration are significantly more restrictive than in the United States, and that there is no ability under applicable EU rules for a mutual fund to act as its own custodian, as there is in the United States.

In addition to deciding to make no determination regarding US AIFMs and AIFs at this time, ESMA also deferred a decision to grant passport rights to AIFMs and AIFs from Hong Kong and Singapore. ESMA declined to consider at all at this time the equivalence of EU rules and the rules of 16 other jurisdictions, including Australia, Canada and Japan

In general, under relevant EU law – the Alternative Investment Fund Managers Directive – where ESMA finds equivalency in regulation regarding investor protection, market disruption, competition (i.e., equivalence in access) and the monitoring of systemic risk, it should recommend granting a passport. The AIFMD is an EU directive that was implemented in 2013 and regulates entities that manage or market alternative investment funds within the European Union.

(Click here to access additional information on this development in the article “AIFMD Marketing Passport: ESMA Provides European Commission With Advice on Its Possible Extension to Non-EU Jurisdictions” in the July 31, 2015 edition of Corporate & Financial Weekly Digestby Katten Much Rosenman LLP.)

My View: First there was the failure of the European Commission to find that the regulatory oversight of clearinghouses in the United States was equivalent to that in the European Union. This failure, if not resolved, will cause European banks to incur substantial capital charges for clearing on US-based clearinghouses. Now there is the reluctance of ESMA to find that the oversight and potential access of European alternative investment funds managers and funds to US institutional persons is equivalent to that of US AIFMs and AIFs. Soon, ESMA and the European Commission will need to determine whether the oversight of US-based high frequency traders and direct electronic access sponsors to EU markets is equivalent to the requirements for EU-based HFTs and DEAs under the Markets in Financial Instruments Directive II and the Markets in Financial Instruments Regulation. If not, access to EU markets by US-based DEA sponsors and HFTs will potentially require authorization by relevant EU member states. The more complicated it is to conduct international financial transactions, the more likely that fewer of such transactions will be conducted, with concomitant decreases in product liquidity and/or fragmentation of markets. Neither outcome is desirable, and regulators on both sides of the Atlantic should strive to avoid such an outcome.