A few months ago, we published a client alert reporting that the European Securities and Markets Authority (“ESMA”) had published an investment management “sectoral opinion” that set out certain principles in the context of Brexit, many of which – if implemented – could impact on the ability of EU Alternative Investment Fund Managers (“AIFMs”) to effectively delegate certain functions.
Recent developments continue in the same, rather disappointing, direction.
The European Commission recently consulted on various changes to the way in which the European Supervisory Authorities (“ESAs” - of which ESMA is just one) should operate in future. A proposal was adopted in September (the “Proposal”) for a new European Regulation to amend the operation of the ESAs and bring certain aspects of European financial services regulation within their remit. The Proposal has broad ranging implications for European financial markets participants generally, but of particular interest to AIFMs is the proposal that ESMA be granted jurisdiction over whether delegation arrangements by EU regulated firms are appropriate, or are excessive and should be struck down as non-compliant.
The Proposal is a long way from being settled, but this is an alarming extension of the apparent skepticism towards delegation by EU regulated firms, and questions the faith that European authorities have in national regulators to police delegation. Although this may be an understandable political reaction in the context of Brexit, it could have much more wide-reaching consequences in the context of non-EU sponsors working with EU AIFMs, where these delegation arrangements may be fundamental.
ESMA Q&A – Remuneration disclosures by delegates
More recently, ESMA published its updated Questions and Answers on certain aspects of AIFMD (the “ESMA Q&A”) that go further again, indicating that AIFMD remuneration disclosures ought to apply to delegates carrying out portfolio management or risk management. It suggests methods by which EU AIFMs should satisfy themselves as to their delegate’s compliance. It should be noted that the legislation is clear that these specific disclosure requirements apply to the AIFM, not to its delegates. This appears to be an example of ESMA overreaching its existing powers by moving the boundaries of the legislation through the use of their Q&A – a concern that has been raised by various European investment industry bodies in the past.
Some might argue that this is simply a logical extension of the existing position whereby elements of AIFMD remuneration requirements are extended to delegated portfolio managers, and further that since any such disclosure would be made in aggregate, rather than on an individual basis, and would relate only to the elements of remuneration that relate to management of the relevant EU fund, it should not really be of that much concern to non-EU sponsors. However, whilst that might be objectively correct, it still looks like a significant change to the position under which existing delegation arrangements have been agreed.
The practical outcome of the ESMA Q&A remains to be seen: the ESMA Q&A are directed at EU member states’ regulatory authorities as a tool to ensure regulatory convergence, and are not directly applicable to individual firms. However, obviously firms are likely to take note of ESMA’s stated view, so unless and until there is any further clarity on this, the issue remains a live concern – and certainly something for non-EU sponsors to consider carefully when looking at arrangements with third-party AIFMs in the EU.
The developments outlined above are illustrative of the rising tide of skepticism toward AIFM delegation arrangements. Whilst neither of these developments currently have the force of law, nor are in and of themselves fundamental changes, they nevertheless provide an important indication of the direction of travel, which should be noted not only by UK AIFMs seeking to relocate but also third-country managers considering operating under third-party AIFM structures.