ESMA has published its advice to the Commission on the Level 2 measures under the Alternative Investment Fund Managers Directive (AIFMD). The advice covers:

  • General provisions for managers and authorisation: ESMA says it has tried to be consistent with other Directives, specifically the UCITS Directive and the Markets in Financial Instruments Directive (MiFID), while recognising that the UCITS requirements are aimed primarily at retail investors. This part of the advice covers:
    • identification of portfolios of alternative investment funds (AIFs) under management by a particular alternative investment fund manager (AIFM) and how to calculate the assets under management (AUM);
    • influence of leverage on AUM;
    • how to work out the value of AUM by an AIF in any given calendar year;
    • treatment of cross-holdings between AIFs managed by one AIFM: AIFMs will be allowed to exclude from their calculation of AUM investments in other AIFs they manage subject to appropriate adjustments for leveraged exposure to those AIFs;
    • treatment of AIFMs whose total AUM sometimes fall above or below set thresholds relevant for authorisation purposes: where the value is likely to exceed the threshold for more than three months, the AIFM should seek authorisation;
    • the content of obligatory registration with authorities and information gathering mechanisms;
    • registration for entities that fall below the thresholds in Article 3(3) of the AIFMD; and
    • procedures for managers who want to "opt in" to AIFMD regulation.
  • Operating conditions:
    • initial capital and own funds: ESMA assesses what additional own funds might be required to cover the risks of professional negligence, or alternatively what professional indemnity insurance might cover. It also considers when AIFMs might hold a mixture of extra capital and insurance;
    • conflicts of interest: in this section, ESMA looks at what might cause conflicts, again looking at UCITS and MiFID measures. It also draws on an International Organization of Securities Commission (IOSCO) report to suggest specific conflicts that might arise. This section also includes guidance on strategies AIFMs should develop for exercising voting rights;
    • risk management: this part of the advice covers the need for a permanent risk management function and policy, and the necessary processes and techniques for managing and measuring risk: ESMA has recognised that private equity firms in particular would struggle to separate risk and portfolio management activities and that risk management should be proportionate to the risks of the AIF/AIFM;
    • liquidity management: ESMA looks at the systems and procedures AIFMs will need to ensure the liquidity profiles of their AIFs comply with their obligation. It also looks at stress testing and when strategies of each AIF managed by any AIFM should be regarded as “consistent”;
    • investment in securitisation positions: ESMA’s advice on this takes account of relevant parts of the Banking Consolidation and Capital Requirements Directives and relevant existing advice from the (then) Committee of Banking Supervisors and the Committee of European Insurance and Occupational Pensions Supervisors. The aim of the relevant provisions is to prevent any misalignment between the interests of firms that repackage loans into transferable securities and originators;
    • valuation: ESMA has recognised the variation in existing valuation standards and provided general principles to guide AIFMs, who can then adapt the requirements to the specific AIF. The advice also takes into account the differences between national rules on valuation;
    • delegation of AIFM functions: the advice sets a general principle that delegation can be justified where the AIFM can show it is done for a more efficient conduct of its management of the AIF. ESMA has provided an indicative list of criteria to use when making the assessment, and sets out guidance on how to evaluate whether the delegate is of sufficiently good repute. An EU authorised firm, permitted to perform the relevant tasks, would be considered to be of good repute. This part of the advice also addresses what should be covered by co-operation agreements with third country regulators. Following comments, ESMA has removed the notion of “equivalence” from the advice. The advice also looks at situations when the AIFMD would be considered a ”letter box” entity. ESMA says this will be where the AIFM cannot effectively supervise delegated tasks and manage the risk of them, or where the AIFM no longer has power to take decisions in key areas that fall within senior management responsibility; and
    • general principles and organisational requirements: ESMA looks at the standards required by UCITS and MiFID in formulating its advice on how AIFMs should meet the standard to act with due skill, care and diligence. It calibrates the standards to cater for the different kinds of AIF.
  • Governance of depositaries: this covers:
    • the contract evidencing appointment of the depositary: ESMA took the UCITS requirements as its starting point for recommending content for a depositary agreement, and also has followed the UCITS advice stance of not recommending a model agreement;
    • criteria for assessing prudential regulation and supervision of third countries: ESMA’s advice was to cover how to assess whether the supervisory framework of a third country is effective enough to allow delegation to depositaries established there. The advice looks at capital requirements, operating conditions and enforcement powers in the relevant jurisdiction;
    • depositary functions: this part of the advice considers the two main functions of a depositary – safekeeping of AIF assets and overseeing its compliance with its internal rules and relevant regulation. ESMA has acknowledged an AIF may have cash accounts outside the depositary. The unpopular proposal that the depositary be a central hub for cash movements has been removed from the advice. ESMA acknowledges the depositary is not expected to interfere with an AIF’s distribution channels and that it should ensure cash accounts have been opened with properly authorised entities. Depositaries should also ensure proper procedures are followed to ensure cash is properly booked. It does not acknowledge that even these ex post monitoring activities are likely to duplicate the work of administrators. The advice recommends the AIFM must allow the depositary access to all information relating to each cash account it holds outside the depositary, and that the depositary should ensure, using the AIF’s register, that all payments made by investors on subscription have been received by the AIF. ESMA also considers what the depositary should do when delegating custody tasks;
    • segregation obligations: ESMA has based its advice on segregation of assets by third parties on the MiFID standards, but also recognises that sub-custodians may hold omnibus accounts; and
    • loss of financial instruments, external events beyond reasonable control and objective reasons to contract a discharge: ESMA has defined financial instruments as transferable securities (including those that embed derivatives), money market instruments and units in collective investment undertakings. It says the depositary should hold in custody those instruments of which it is in a position to instruct the transfer. It also says financial instruments should not be held in custody where they have been provided as collateral where the control or possession of the instrument has been transferred to the collateral taker.
  • Transparency requirements and leverage: this part of the advice looks at:
    • the definition of leverage and how to calculate it: the advice focuses on methods of calculating leverage, methods by which AIFMs increase the exposure of AIFs through borrowing, leverage or otherwise, and on when supervisors may impose leverage limits or other restrictions; and
    • content and format of an AIFM's annual report, disclosure to investors and information AIFMs must make available to regulators.
  • Third countries: the final part of the advice looks at co-operation with third country regulators and how to determine the Member State of reference for non-EU AIFMs.

The advice also includes detailed feedback setting out themes of responses to ESMA’s consultations and its reaction to them.

Alongside the advice, ESMA wrote to Michel Barnier, Sharon Bowles and Jonathan Faull (of the European Securities Committee), drawing attention to its existing workstreams on:

  • further calculation of additional own funds;
  • detailed guidelines on calculation of leverage;
  • further work on co-operation and exchange of information between authorities;
  • technical standards on types of AIFM;
  • working with the European Banking Authority (EBA) on guidelines on remuneration policies;a Memorandum of Understanding covering all EU competent authorities; and
  • prioritising its work on other guidelines and technical standards.

ESMA's work on this advice is now complete, and the Commission must now prepare the implementing measures. (Source: ESMA Final Advice on AIFMD and ESMA Press Release on Future Rules for AIFMD)