The European Securities and Markets Authority (ESMA) published a letter to the European Insurance and Occupational Pensions Authority (EIOPA) answering two AIFMD-related questions raised by EIOPA in the context of EIOPA advice to the European Commission on specific issues in the Solvency II Delegated Regulation.
The questions are set out below:
1. Are Alternative Investment Funds (AIFs) that use:
a) borrowing arrangements pursuant to Article 6(4) of Commission Delegated Regulation (EU) No 231/20132
b) derivative instruments pursuant to Article 8(7) of Commission Delegated Regulation (EU) No 231/2013
considered as ‘leveraged’ under the AIFMD?
2. Are AIFs that are managed by AIFMs as defined in Article 3(2) of the AIFMD (often referred to as “registered” or “sub-threshold” AIFMs) to be considered as ‘AIFs’ as defined in Article 4(1)(a) of the AIFMD?
The letter clarifies that:
1 a) ESMA is of the view that AIFs using borrowing arrangements which comply with the conditions of Article 6(4) of EU Regulation 231/2013 (whereby the borrowings are temporary in nature and are fully covered by contractual capital commitments from investors in the AIF) should be considered unleveraged.
1 b) The question of whether AIFs using derivative instruments pursuant to Article 8(7) (which, subject to Article 8 (6), are used for currency hedging purposes and do not add any incremental exposure, leverage or other risks) should be considered as leveraged is more challenging and is narrow in scope. ESMA notes that there is no definition of leveraged AIFs or of unleveraged AIFs in the AIFMD. ESMA then looks to use the provisions of EU Regulation 231/2013 as a foundation for its analysis. References below to Articles are to Articles of Regulation 231/2013.
ESMA references Article 6 (which sets out general provisions on the calculation of leverage). Article 6 provides that the leverage of an AIF must be expressed as the ratio between the exposure of an AIF and its net asset value. Article 6 then provides that exposure must be calculated (for reporting purposes) using both the gross method and the commitment method. ESMA points out that the gross method for calculating overall exposure (Article 7) does not exclude currency hedging, whereas the commitment method (Article 8) does exclude the financial derivative instruments pursuant to Article 8(7) (which are the subject of the question).
To qualify as derivative instruments "pursuant to Article 8(7)", the derivative instruments must, subject to Article 8 (6), be used for currency hedging purposes and must not add any incremental exposure, leverage or other risks. Notwithstanding that the use of these derivative instruments must not add any incremental exposure, leverage or other risks, it would appear that their use may cause AIFs to be considered as "leveraged" because of the requirement to calculate exposure using the gross method as well as the commitment method. In our view, this would need to be looked at on an AIF by AIF basis and so no broad conclusion could be reached.
2. The second question concerns whether AIFs managed by registered or sub-threshold AIFMs should be considered as AIFs (for the purposes of the definition in Article 4(1)(a) of the AIFMD). ESMA confirms that they should.