Summary: The European Commission has released a report on the operation of AIFMD. Whilst it finds that it is broadly working as intended, it is yet to prove itself, suffers from uneven implementation and duplicates requirements already covered elsewhere. We provide a summary of its findings.
On 10 January 2019 the European Commission (the Commission) published a report, produced by KPMG, on the operation of the Alternative Investment Fund Managers Directive (AIFMD). This forms part of the Commission’s wider review under Article 69 AIFMD (due to have started by July 2017) and which will culminate in a report (expected in the next year) to the European Parliament and Council. This evidence-based study provides a comprehensive account of industry’s and regulators’ experiences in applying AIFMD, its impact on Alternative Investment Funds (AIFs) and Alternative Investment Fund Managers (AIFMs) in the EU and third countries, investors and other concerned parties, and the achievement of AIFMD’s objectives. However, it cannot yet be considered a roadmap for hypothetical future revisions of the AIFMD regime, not least because the report found that “AIFMD has yet to prove itself” given the relatively short time since in came fully into effect. Indeed, one of the report’s conclusions is that, although there are various areas where rules should be improved, clarified, rationalised or enhanced, the asset management industry continues to be impacted by a swathe of new rules and by regulatory uncertainty. Adding to that already considerable burden would not be welcome and could cause yet more disruption and costs for investors, the industry and regulators.
The findings of the report are not, of themselves, perhaps surprising – the general themes are that AIFMD is broadly working as intended but that: (i) it suffers from uneven interpretation and implementation across the EU; and (ii) many of the disclosure requirements are excessive and duplicative. What will be interesting is to see how the Commission responds to these findings as and when the AIFMD II process is launched and whether this study re-opens some of the more thorny issues. Given that AIFMD specifically accommodates the very wide range of types of AIFs that exist around the EU and elsewhere, there are bound to be some differences between member states. However, much of the report’s criticism is levelled at particular and nuanced areas of uneven implementation and lack of harmonisation. We wait to see the extent to which these divergences are allowed to continue.
We have set out below the principal points of interest arising from the report, both positive and constructive.
Salutary impact on institutional investors
AIFMD has had a major role creating an internal market for AIFs and a harmonised and stringent regulatory and supervisory framework for AIFMs. Usefully, institutional investors (in third countries as well as in the EU) have found little difference as between EU AIFs and non-EU AIFs, or as regards asset classes. Investment appetite has not been affected; neither has AIFMD had any material impact on the size of the EU AIF market.
However, reportedly AIFMD overall has led to less choice in the retail market (including for high net worth clients and semi-professional investors).
Benefit of marketing passport being diminished
Inconsistent application of the AIFMD marketing rules, coupled with additional national requirements, have led to frustrations around passporting. These are familiar issues, for example, that some AIFMs are having to wait a month before they can start to market; some member states charging additional fees (eg France, Austria, Luxembourg) with opaque approaches to their calculation; additional requirements (eg Spain, for a local agent) and also some regulators raising queries on passporting notifications. As a result, 59% of those responding to the review expressed concern with the passporting process (rising to 73% if those expressing no opinion are excluded).
This lack of transparency results in higher industry cost, resource and burden. This is not the case for the EU management passport, which is reportedly working well.
Draft omnibus directive on cross-border marketing falls short of a fully-harmonised regime
Uncertainty over the application of marketing and pre-marketing under AIFMD was also a cause for concern. In March 2018 the Commission published draft legislation (subsequently revised by the Council, still being considered by the co-legislators and expected to be finalised by May 2019) that seeks to facilitate the cross-border marketing of funds, and includes a new proposed “pre-marketing” definition. Depending on the final outcome, this package should address some of the marketing passport concerns.
However, interviewees felt that further work was needed in this area, for instance, establishing a notification framework for fees, introducing non-EU passports and retaining “added value” national private placement regimes, even if the non-EU third country passports are introduced.
Need for better coordination and consistency in approach between the National Competent Authorities (NCAs) and ESMA
There was criticism from respondents and interviewees that data that AIFMs submit to NCAs can be duplicated, both by virtue of AIFMD and alongside other EU reporting requirements, is not always essential and at times insufficient. Also, that differences in national interpretation and filing procedures exacerbate costs.
There was a request for consistent application of the AIFMD reporting requirements and a rationalised template. This will have to be considered in the context of implementation costs and the need to look at regulatory reporting in the round for asset managers.
Periodic disclosures to investors: despite expanded content and frequency, there has been no corresponding increase in quality or consistency
Article 23 AIFMD requirements on disclosures to investors were thought to be excessive in quantity and often duplicating what was available or required elsewhere. Respondents felt that this resulted in disclosures being ignored or prevented investors from obtaining a clear understanding of the AIF’s investment proposal. The report also reported misalignment with reporting requirements under MiFID II and the PRIIPS KID, the upshot being that in many cases experienced and well-informed investors would prefer to opt out of the AIFMD reporting requirements and instead agree bespoke packages with their respective managers.
The one-size fits all depositary rules do not accommodate different asset classes or geographies
A key concern in relation to depositary requirements was around cash monitoring, where for private equity and real estate funds significant cash holdings and cash movements at fund level are relatively rare. This means that the consideration of all cash flows within the AIF at fund level, as well as in the underlying target funds and companies, is not feasible from an operational standpoint.
Other concerns were raised regarding the treatment of assets that cannot be held in custody (ie real asset funds) and the implications for depositaries specialising in these types of assets. The theme of a lack of clarity and consistency in NCA interpretation re-appeared, in respect of the look-through provisions, the cash monitoring duties and delegation in respect of custody (especially to a prime broker).
These two areas of concern are indicative of a general finding that some aspects of AIFMD did not lend themselves to a one-size fits all approach to regulation.
Finally, there was a request to extend the historic benefit of allowing a depositary that is an EU credit institution to be in a different domicile to the AIF, which might otherwise have hindered smaller member states developing domestic AIF markets.
Valuation function undermined: binary choice between internal or external valuation and the differing national interpretations of the extent of the liability of external valuers
The binary choice in the AIFMD valuation rules between internal or external valuation, and the differing national interpretations of the extent of the liability of external valuers, have impaired the effectiveness of the rules for some asset classes and in some member states. Reportedly, there are fewer available external valuers in some member states (which lowers the level of competition and could result in higher fees charged to AIFs/ AIFMs), which has placed more focus on internal valuation processes.
This runs counter to AIFMD’s intention to introduce greater independence in the valuation process. The report notes that an independent external valuer remains the market norm for real asset funds.
Issues for smaller AIFMs
A number of member states apply additional provisions to sub-threshold AIFMs (including requiring full authorisation in some cases). AIFMD provides for national discretion in this regard, and the report acknowledged that isolated assessment of the impact of the AIFMD threshold provisions is difficult.
Further, staffing issues will often be pertinent for small AIFMs. It does not seem that interaction between AIFMD, MiFID II and the PRIIPs Regulation will simplify the problem.
The report found that the threshold between small and full-scope AIFMs appears to be set at a “reasonable and appropriate” level. As such, we would not expect this to fundamentally change under AIFMD II.
Concerns by private equity and real estate managers on separation of risk function
Private equity and real estate sectors were particularly critical of the need for full functional and hierarchical separation of risk and portfolio management, especially for smaller AIFMs. Interviewees felt that it was impracticable to hierarchically separate the two areas for unlisted and illiquid asset classes (such as private equity and real estate) because risk management and portfolio management processes are intrinsically linked.
A few other points of interest:
- AIFMD has not materially impacted the extent of delegation, other than in France and Luxembourg (no doubt amplified by recent debates about the “substance” requirements and prompted by the UK’s decision to leave the EU).
- 56% (66% if those expressing no opinion are excluded) were concerned about inconsistent definitions of an AIF or an AIFM: there was a comment that this can lead to the AIFMD rules being applied to common non-fund vehicles that were not intended to be covered. On the other hand, vehicles that are fund-like could fall outside the scope.
- The survey data indicated that the use of high leverage is rare in AIFs. Respondents and interviewees noted that it would be helpful to harmonise the calculation methodologies for leverage across AIFMD, the Undertakings for Collective Investments in Transferable Securities Directive (UCITS) and other relevant legislation, as well as aligning it with IOSCO and ESMA initiatives in this area.
- Question were raised about the efficacy and coherence of the AIFMD remuneration rules with other pieces of EU legislation and guidelines (especially for AIFMs that are part of corporate groups or conglomerates with MiFID firms or CRR institutions) as well as additional national provisions that may apply.