As noted in our earlier OnPoint1, on 25 November 2021, the European Commission (the Commission) adopted a package of measures2 that aimed to deliver on several key commitments in the 2020 Capital Markets Union action plan, including a proposal to review the Alternative Investment Fund Managers Directive (AIFMD)3 (the Proposals)4 (and, to the relevant extent, the Directive relating to Undertakings for Collective Investment in Transferable Securities Directive (UCITS)).5 Since November 2021, there have been ongoing discussions between the various EU legislative bodies over the Proposals suggested by the Commission. The Council of Europe (the Council) formalized its position with regards to the Commission’s proposals in June 2022,6 and on 24 January 2023 the European Parliament’s Committee on Economic and Monetary Affairs (ECON) voted to approve the position taken by the Parliament regarding the Proposals.7 The next stage is for the Council, Commission and Parliament to debate the various points via the Trilogue process.8 The first Trilogue meeting took place on 8 March 2023, and the second meeting took place on 9 May 2023 (having been delayed from an earlier mid-April expected date). The Swedish Presidency of the Council has indicated that it hopes the Trilogue process will be completed by the end of June 2023 (when its term ends). In terms of timing, once the co-legislators have come to agreement the changes to AIFMD would be made by a directive (AIFMD 2.0), which EU member states would have 24 months to transpose into national law. AIFMD 2.0 is unlikely to take effect until 2025.
Our November 2021 OnPoint examined the Proposals set forth by the Commission. This OnPoint looks at the positions taken by the Council and Parliament on some of the key areas on which the Proposals focus. Our commentary is based on the current positions taken by the co-legislators as they commence the Trilogue process, and the final AIFMD 2.0 legislation may differ from what is described below.
The AIFMD delegation structure currently allows alternative investment fund managers (AIFMs) to delegate certain tasks if prescribed conditions are met. The core requirement of the AIFMD is that an AIFM must not delegate its functions to the extent that, in essence, it is no longer the manager of the relevant AIF.
Notably, no co-legislator is proposing to abolish the delegation model.
The Commission proposed that where an AIFM delegates portfolio management or risk management functions to entities located in third countries, competent authorities would be required to notify ESMA on an annual basis of all such delegations (‘delegation notifications’). The Council and Parliament have not taken this proposal forward.
The Council and Parliament are aligned in that on applying for authorization – the AIFM will need to provide: information about the persons effectively conducting the business of the AIFM, in particular with regard to the functions referred to in Annex I; a programme of activity setting out the organizational structure of the AIFM, including information on how the AIFM intends to comply with its obligations under Chapters II, III, IV, and, where applicable, Chapters V, VI, VII and VIII and a detailed description of the appropriate human and technical resources that will be used by the AIFM to this effect; information on arrangements made for the delegation and sub-delegation to third parties of functions as referred to in Article 20.
The Parliament proposes that an explanation of the added value of the delegation to the investor the information also be provided. The Council proposes that Member States require authorized AIFMs to keep the information provided to its competent authority updated.
The Parliament expands what is included in Annex I and also proposes that the AIFM reports to the competent authority any material changes that may affect the scope of the authorization by that authority and in particular any modification on the arrangements of the delegation and sub-delegation to third parties provided at the time of authorization.
The Parliament also proposes that ESMA develop draft regulatory technical standards to specify the information to be provided to the competent authorities in the application for the authorization of the AIFM, including the programme of activity, and to specify situations where the name of the AIFs it intends to manage could be materially deceptive or misleading to the investor.
With regards to a peer review of the application of the delegation regime, Parliament proposes that 12 months before the review of AIFMD 2.0 (which is to be five years after AIFMD 2.0 comes into force), ESMA would conduct a one-off comprehensive peer review analysis of the supervisory activities of the competent authorities in relation to the application of delegation regime. This allows more time for the new delegation provisions in AIFMD 2.0 to become established before any review takes place. In addition, having a review too soon could leave delegation open to review for years to come with ongoing policy uncertainty.
Loan Origination Funds
The Commission’s Proposals include the following highlights:
- new retention requirements intended to "avoid the moral hazard" of originated loans being immediately sold off on the secondary market. Specifically, AIFs will be required to retain an economic interest of 5% of the notional value of any loans they grant and then sell off;
- an AIF that originates loans in excess of 60% of its net asset value must be closed-ended;
- a new concentration limit of 20% of capital for a loan originated to any single borrower that is a financial undertaking or a collective investment undertaking, but significantly not to other borrowers; and
- new reporting requirements under Article 23. AIFMs will also be required to report to investors the portfolio composition of originated loans.
The Council has proposed introducing a leverage cap of 150% for loan-originating AIFs. There is no apparent rationale as to why the leverage cap is needed nor why the cap is set at 150%. The AIFMD framework already provides a way to manage the use of leverage. The introduction of a cap is not something that the Commission or Parliament support.
The Parliament has proposed introducing a definition of loan-originating AIF that would be “an AIF whose principal activity is to originate loans and for which the notional value of its originated loans exceeds 60% of its net asset value”, similar to the Commission’s referencing a 60% threshold. Including a specific threshold means that the provisions relating to loan origination AIFs apply to AIFs that undertake a significant amount of loan origination and do not inadvertently capture any fund that issues just one or two loans and who would (in the absence of a threshold) be subject to the additional rules and restrictions reserved for loan funds.
The Council and Parliament both propose that a loan originating AIF may be open-ended provided that its liquidity risk management system is compatible with its investment strategy and redemption policy. The Council position also proposes that ESMA develop draft regulatory technical standards to determine the requirements with which a loan-originating AIF must comply to maintain an open-ended structure.
The 20% concentration limit included in the Proposals is retained in both the Council and Parliament positions.
Like the Commission’s Proposals, the Council proposes that under Article 23 information be provided on the originated loan portfolio. The Parliament position requires that information be provided on the portfolio composition of the originated loans.
The Council proposes introducing five-year transitional arrangements for loan origination funds with a derogation for existing AIFs that do not raise additional capital, however, it is important to note that the five-year time starts from the date of adoption of AIFMD 2.0, not the date of transposition.
Liquidity Risk Management
The Commission’s Proposals include specific provisions relating to liquidity risk management. By way of background, the European Systemic Risk Board and ESMA made recommendations for harmonization of the rules on the use of liquidity management tools (LMTs), which although widely used, are not currently explicitly referenced in AIFMD or UCITS. The Proposals aim to address this. The Proposals also include provisions enabling the competent authorities to require that an AIFM activates or deactivates a relevant LMT, remarkably a power that is expressed to extend to cover non- EU AIFMs.
The Parliament and the Commission provide in a new Article 47(4)(d) that provides that ESMA’s powers and competences include the ability to require non-EU AIFMs that are marketing AIFs in the EU that they manage or EU AIFMs managing non-EU AIFs to activate or deactivate an LMT referred to in point 1 or 2 of the newly created Annex V or selected by the AIFM, whichever is more suitable considering the type of open-ended AIF concerned and the investor protection or financial stability risks that necessitate this requirement. In contrast, the Council does not support the Commission and Parliament – its position would mean that the AIFM would have the freedom to decide whether an LMT should be (de-) activated.
One other point to note with regard to LMTs is whether there should be ESMA guidelines or regulatory technical standards (RTS) on the characteristics and on the selection of the LMTs. The Council supports ESMA developing (i) guidelines determining criteria for the selection and use of appropriate LMTs by the AIFMs for liquidity risk management, including appropriate disclosures to investors, and (ii) RTS to specify the characteristics of the liquidity management tools. In contrast, Parliament is in favour of ESMA developing (i) RTS on the disclosure to competent authorities and to investors of information related to the selection and calibration of LMTs, and (ii) guidelines to specify best practice regarding the characteristics of the liquidity management tools.
The Commission’s Proposals include an interim measure permitting depositary services to be sourced cross-border pending further review. The Council and the Parliament have set out a proposal that Member States should be able to authorize, on a case-by-case basis AIFMs and AIFs to appoint depositaries located in other Member States. Related to this, depositaries must cooperate, not only with their home state competent authorities but also with the competent authorities of the AIF’s and its AIFM’s home states. For depositaries in non-EU jurisdictions, the depositary should not be established in a high-risk third country pursuant to Article 9(2) of the AML Directive.
The home Member State of an AIF may allow its national competent authorities to permit depositaries established in another Member State to be appointed, following a case-by-case assessment, provided that the following conditions are fulfilled:
- The competent authorities must receive a motivated request from the AIFM for the appointment of a depositary in another Member State. This request should demonstrate the lack of relevant depositary services that can meet the needs of the AIF, considering its operational strategy.
- The depositary market of the home Member State of the AIF must fulfil at least one of the following conditions:
- The market consists of fewer than seven depositaries providing depositary services to EU AIFs and none of these depositaries have assets safekept exceeding EUR 1 billion or the equivalent in any other currency.
- The aggregate amount of assets safekept, on behalf of EU AIFs, does not exceed EUR 60 billion in the Parliament proposal/30 billion in the Council proposal or the equivalent in any other currency.
The Commission’s Proposals for a new Article 23(4)(e) include reporting, on a quarterly basis, all direct and indirect fees and charges that were directly or indirectly incurred or allocated to the AIF or to any of its investments. Both the Council and Parliament appear to be closely aligned in taking the position that such reporting should be made on an annual basis, although their positions vary as to what precisely is to be reported.
The Council and Commission are more aligned with regards to what is to be reported to the competent authorities under Article 24. In contrast, Parliament proposals are somewhat open-ended in scope.
In summary, the reporting obligations under articles 23 and 24 are likely to be significantly expanded in AIFMD 2.0.
Parliament has proposed that where an AIFM manages an AIF that is marketed to retail investors, the AIFM ensures that at least one member of its governing body is a non-executive director.
In earlier drafts of the Parliament’s position, the definition of “professional investor” had been expanded to mean not only a MiFID II ‘professional investor’, but someone “which has committed to investing a minimum of EUR 100 000 and has stated in writing, in a separate document from the contract to be concluded for the commitment to invest, that they are aware of the risks associated with the envisaged commitment or investment; or which is a member of senior staff, portfolio manager, director, officer, agent or employee of the manager or of an affiliate of the manager and has sufficient knowledge about the AIF concerned.” This expanded definition is not included in the final Parliament position.
It would appear the co-legislators are broadly aligned in their view on LMTs and delegation (although there is still disagreement on technical matters, including the proposed requirement to report the amount and percentage of assets that are subject to delegation arrangements, which is being advanced by the Council but opposed by the Parliament). It is clear that the reporting obligations will be expanded. Loan origination seems to be the area where the co-legislators have different views (in particular regarding risk retention), and it is probable that this is the area where there will be most debate and negotiation.
It remains to be seen how quickly the co-legislators will be able to progress and move towards a common position on some of the more hotly debated points. The Council working party is scheduled to meet again on 26 May, to be followed by the third and fourth political trilogies expected on 13 June and 27 June. Time is therefore short for the outstanding points to be resolved before the Swedish presidency finishes at the end of June.
This update was authored by Patrick Goebel, Angelo Lercara, Philippa List and Colin Sharpsmith.