AIFMD An Increasingly Friendly Modifying Directive and Another Involved Fund Marketing Demand

Two recent European developments are interest to the asset management industry:

• a European Parliament Report published on 16 May 2022 (the Parliament Report), proposing amendments to the European Commission's 25 November 2021 proposal to amend AIFMD (the Proposal); and

• an ESMA Consultation Paper published on 17 May 2022 on the standardisation of European marketing and management passport notifications (the Consultation).

At this point, there are no certainties, but asset managers may wish to highlight these with industry bodies as areas of potential improvement.

The key takeaways are as follows:

• Amended definition of "professional investor": the definition of a "professional investor" under AIFMD would be expanded to effectively include high net worth individuals (HNWIs) and family offices. A welcome move for some, and hopefully this does not create more conflict with local definitions, such as the "semi-professional investor" in Germany, for example. A single definition and scope across Europe would surely be better for all?
• Distribution is not always delegation: the appointment of a third-party distributor by an AIF would not be considered a delegation under AIFMD, whereas such appointment by an AIFM would. We can all see what's going to happen here…
• Loan originating funds: the suggested removal of certain quantitative thresholds that were made in the Proposal.

The "professional investor" definition and when third-party distribution constitutes delegation under AIFMD are two issues that have been problematic for fund managers since AIFMD entered into force, and have become increasingly difficult over time. The proposed changes would be welcome amendments that would align AIFMD with market practice that has always provided significant investor protection for sophisticated investors.

Background to the Parliament Report

On 25 November 2021, the European Commission published the Proposal to amend AIFMD, the UCITS Directive and other fund-related directives and regulations. We examined the key proposed amendments made in the Proposal in our briefing, which were not as bad as some feared. The Parliament Report details the European Parliament's response and proposed amendments to those made in the Proposal. These are, if anything, more sensible than those contained in the Proposal.

Expanded definition of "professional investor"

Key proposal: Widening the definition of professional to include some groups that have been traditionally harder to define as a "professional investor" because of the nature of the MiFID test, which has traditionally been more difficult for long term private equity funds to allow some investors to invest.

The Parliament Report includes a proposal to expand the definition of a "professional investor" under AIFMD, which currently mirrors the definition of a "professional client" under MiFID. The Parliament Report proposes that the following persons would also be considered "professional investors" under AIFMD:

• persons who committed to investing a minimum of EUR 100,000 in an AIF, and who have provided written agreement to be treated as a professional investor and an acceptance of the associated risks of this classification (this is similar to the criteria for investing in ELTIFs, EuVECAs and EuSEFs); and
• persons who are senior staff members, portfolio managers, directors and employees of the AIFM or an affiliate and who are sufficiently knowledgeable about the AIF concerned.

This proposed change would make it easier for European managers to market to HNWIs and family offices using the EU marketing passport, reducing the existing complexity of marketing to such investors that do not currently meet the definition of a "professional investor". This would align AIFMD at a European level with national law in certain jurisdictions such as Luxembourg and Ireland, where there is currently greater scope to consider HNWIs and family offices to be professional or sophisticated investors. In certain circumstances it may allow the admission of new investors who were previously harder to offer to or unable to be offered to.

This change does not apply to offerings by non-EU AIFMs, as this is still determined by national rules. It may be that this proposed change to the definition of a "professional investor" under AIFMD could enable non-EU AIFMs to market to HNWIs and family offices in certain jurisdictions under NPPRs in future. However, this is very much a "wait and see" and depends on how the changes are implemented into the national law of Member States. This would be another reason to consider using an EU vehicle to offer funds in the EU.

When is distribution a delegation?

Key proposal: Finally (!) some sensible alignment of when something is delegated that aligns with commercial and legal reality.

The Parliament Report acknowledges that marketing an AIF is not always conducted by the AIFM, but can be conducted by third-party distributors, either on behalf of the AIFM or on their own behalf, or by an independent financial advisor without the AIFM's knowledge. Something that Ashurst and all distributors have known about for some time! Glad to see the legislative bodies finally catching up with reality.

The Parliament Report consequently contains proposed changes to AIFMD delegation rules that would result in the appointment of a third-party distributor by the AIFM being considered a delegation (and therefore subject to the AIFMD delegation rules). However, the appointment of a third-party distributor by the AIF or where the third-party distributor acts on its own behalf would not be a delegation (and therefore not subject to the AIFMD delegation rules). Unfortunately the rules do not go further to consider other activities typically carried on for funds/AIFs by service providers, such as fund administration or the appointment of a manager. Europe seems fixated on the concept that anything done for the fund must be a delegation by the AIFM, which surely cannot be correct. Picking out distribution alone is an awkward carve out which merely papers over a very large crack.

The proposed amendments in the Parliament Report would also remove previous proposals by the Commission that would have required national competent authorities to report annually to ESMA on AIFMs delegating "more portfolio management or risk management to third countries than they retain". This effectively imposed a quantitative threshold of 50%. These proposals would be replaced by additional reporting requirements on AIFMs in their annual reports under Article 24 of AIFMD, such as a brief description of the delegation of any risk or portfolio management and information on each delegate. Whilst this is a sensible proposed change, AIFMs will still have to provide more reporting on delegation in future, and that national competent authorities will require managers to include this information in their regular reporting requirements.

New rules for debt funds

The Proposal contained numerous new proposals for loan-originating funds, including requirements on AIFMs to implement effective policies, procedures and processes for the granting of loans, which must be periodically reviewed. The Parliament Report does not materially amend the thrust of these proposed changes, but would exempt shareholder loans that do not exceed 150 per cent of the net asset value of an AIF from these requirements.

The requirement for an AIF to adopt a closed-ended structure if the notional value of its originated loans exceeded a quantitative threshold of 60 per cent of its net asset value would be removed under the proposed changes in the Parliament Report, and replaced with a requirement to adopt a closed-ended structure where the AIFM cannot demonstrate to its national competent authority that the AIF has sufficient liquidity robustness.

Proposals for AIFs to be required to retain an economic interest of five per cent of the notional value of the loans they have granted and sold off are deleted in the proposed amendments in the Parliament Report, and effectively replaced by a prohibition on AIFs having an investment strategy of loan origination with the "sole purpose" of transferring such loans to third parties.

Additional services and functions an AIFM can perform

The Proposal introduced additional services that an AIFM will be able to provide, including loan origination, the servicing of securitisation special purpose entities, benchmark administration and credit servicing in accordance with the 2021 EU Directive on Credit Purchasers and Credit Servicers (see our briefing). The Parliament Report extends these additional services to any other ancillary service other than those detailed in Annex I of MiFID.

Mandatory liquidity tools and requirements

The Parliament Report does not materially change the requirements contained in the Proposal, but would narrow the scope of the proposed requirement that AIFMs managing open-ended AIFs will be able to temporarily suspend the repurchase or redemption of the AIFs units by using one of the liquidity risk management tools set out in points 2 to 4 of Annex V. This would now only apply in "exceptional circumstances" as opposed to whenever this is in the "public interest" (this still applies when it is in the interests of investors).

A depositary passport in practice, and now (potentially) in name

The Proposal contained amendments to AIFMD that would effectively relax the requirements for AIFs to appoint a depositary in the AIF's home Member State, and provided clarity that depositaries can effectively passport in Europe without formally having a passport. Ironically, this was the original AIFMD starting point, but is a welcome change that will minimise dependency on a small number of depositaries.

These amendments are not materially altered by the Parliament Report, however the Parliament Report does propose requiring the European Commission to "carry out a comprehensive study on the potential benefits and risks of introducing an EU depositary passport". So still some time away, but the words have now been spoken (written).

Background to the Consultation

EU AIFMs may utilise the EU marketing and management passports to market and manage EU AIFs throughout the EU, provided they notify their home state national competent authority in accordance with the applicable national laws implementing Articles 32 and 33 of AIFMD. The form and content of these notifications differs between EU Member States.

In the Consultation, ESMA states that the European Commission adopted an action plan in 2015 for building a single European Capital Markets Union (CMU) to facilitate cross-border investing in the single market. Seven years later, the Consultation states that the purpose of the draft ITS is to ensure that notifications for the cross-border marketing and cross-border management of AIFs will "facilitate the exchange of information between NCAs and eventually facilitate the use of the marketing and management passports set out in the AIFMD". We look forward to the CMU coming to fruition in 2029…

Harmonised European marketing and management passport notifications

Articles 32(8) and 33(8) of AIFMD permit ESMA to develop technical standards to establish standard forms, templates and procedures for marketing and management passport notifications across Member States. The Consultation contains draft Regulatory Technical Standards (the RTS) detailing the information and content of an EU cross-border marketing notification, and draft Implementing Technical Standards (the ITS) detailing the form and content of an EU cross-border management notification. The good news is that the form and content of the proposed notifications in the RTS and ITS do not appear to be significantly more onerous than the current marketing and management notifications in most European jurisdictions, albeit there are some areas where additional information is required.

The proposed template management passport notification will require AIFMs to detail what MiFID services the AIFM will perform in accordance with Article 6(4) of AIFMD (such as investment advice, safekeeping and the reception and transmission of orders). AIFMs would also be required to detail controls over delegation arrangements to third parties (we expect ESMA may or may not have had the UK in mind here).

The proposed template marketing passport notification would require AIFMs to:

• provide a "short description of the envisaged marketing strategy" in Member States where marketing is intended, including the media used (such as at roadshows, by telephone or online); and
• include all domain names of any websites marketing would be conducted through, and details of any third-party distributors used by the AIFM to market in Europe.

ESMA seemingly expects AIFMs to have their marketing strategies close to final even at the more granular level before the marketing passport notification is submitted, and to detail this as part of the notification. Additional information is required should an AIF be marketed to retail investors.

What about "pre-marketing"?

Whilst extolling the benefits of standardised and harmonised notification requirements for the marketing and management of EU AIFs in other Member States, the Consultation does not extend this thought process to the "pre-marketing" notification requirements introduced by the Cross-Border Distribution of Funds Directive, which are (mostly) made through an "informal letter" to the EU AIFM's home state national competent authority. However, this may be a positive outcome, as a template "pre-marketing" notification of any real substance would be over-engineering this notification requirement.

The Consultation is open for comment until 9 September 2022.

Author: Adam Clenton, Associate