An Irishman, Frenchman, Malteseman and a Dutchman (an AIFMD!) walk into a bar

Happy (fourth) anniversary to AIFMD and all its woes

An Irishman, Frenchman, Malteseman and Dutch walk into a bar at a conference in Spain and order Belgian beers. An Englishman, worse for wear after drinking Italian pinot grigio, says "Let me tell you about my new Jersey based investment fund". No one pursues it any further. Subsequently, a Danish employee of an Italian Bank's German branch hears about the Jersey fund independently. She makes an investment using a Danish SPV on behalf of a Cypriot family trust. After making the investment the employee goes on holiday to Norway, inadvertently taking the marketing material with her.

Is this:

1. the worst joke about national stereotypes in history?
2. the kind of fact set that has been causing headaches for fund managers since AIFMD came into force?

 If you've answered (1) then you haven't been paying enough attention for the last few years.

In this article we look at what the future holds for both EU and non-EU AIFMs and delve into certain key areas where we think fund managers can make life easier for themselves. In particular we look at the passporting and NPPR regimes, material changes, the categorisation of AIFs and the depositary regime.

Summary

You would be forgiven for missing AIFMD's fourth anniversary a few weeks ago. There hasn't been the big announcement some may have been (slightly nervously) expecting – AIFMD 2 is still a pipedream (except in the upper echelons of the European powerhouse) and third country passporting has been shelved because of Brexit (let's not get into that one – our jokes get worse). 

Our (slightly tongue in cheek) views on the Alternative Investment Fund Managers Directive (AIFMD) regime are well known and may be found here and here. Now a few years have passed since we set out our position, we wanted to provide an update as to where we think we have got to. There have been some developments in the past 12 months and so we are taking AIFMD's anniversary as a good time to bring you up to date (and we could no longer confine (our AIFMD expert associate) Greg Patton's AIFMD jokes to the walls of our regular team meetings!)

So in summary, there have been some changes such as the end of the transitional provisions in relation to the depositary requirement (set out below), extension of the reporting regime in the UK for non-EU fund managers (explained further in our previous briefing Change in FCA position on AIFMD Annex IV reporting) and new ESMA Q&As. What we have not seen is any possible extension of the passport to third country managers or significant steps towards AIFMD 2. 

Where we are and where we are headed

Before diving further into AIFMD it is worth looking at the wider EU financial services picture both over the last few years and in the future. Since the financialcrisis the focus has been on building a new pan-European financial services legislative programme for banks, investment firms, fund managers and insurers. The regulation of funds with broadly ‘institutional’ investors in AIFMD is just one part of this wider picture. 

ESMA is now shifting its focus from creating post-financial crisis legislation to building a framework for maximum harmonisation and convergence between member states. This is part of the Capital Markets Union (CMU) action plan to improve the functioning of the single market for financial services. An element of the CMU aims to reduce barriers to the distribution of investment funds, including AIFs.

The impact of this harmonisation for AIFMs will depend on how the CMU is implemented. On the face of it harmonisation will lead to a more consistent pan-EU approach to regulation (such as the meaning of certain terms, for example 'marketing'). This will be helpful to firms that have sometimes faced inconsistent (at best, and contradictory at worst) implementation and application of AIFMD across jurisdictions. It could also possibly reduce the final barriers which impede the use of the passport (a change which would be welcomed by fund managers and their investors).

The problem, however, as we have seen throughout AIFMD, is that ESMA generally does not take a proportionate or practical approach in its interpretation of AIFMD. The recent Q&As on delegation is a prime example (where ESMA's response to a question contradicts the legislation).

ESMA has made no secret of the fact that it would like to see more convergence between UCITS and AIFMD. It is anticipated that this may come in AIFMD 2. Recently ESMA has openly suggested a legislative initiative which could harmonise rules and further align AIFMD and UCITS requirements. In our view this would be a mistake. The creation of AIFs is generally down to heavily negotiated documents with professional/institutional investors. AIFs and UCITS are very different products for very different investors. The harmonisation of the UCITS and AIFMD regimes would likely increase the barriers to entry for AIFs which would be unnecessary and disproportionate.

Passport

One of the most positive aspects for EU fund managers was the introduction of the marketing passport. Despite some issues, the passport has been hugely beneficial for those fund managers who wish to market and manage funds across the EU. According to the EU, €5.4 trillion AuM (40% of total AuM) and 57% of all EU funds are marketed on a cross border basis (a quarter comprises 'round-trip funds' marketed cross-border to only one country, typically the country where the fund manager is located).

That said, it is clear the passport has not worked perfectly. France dropped the obligation to appoint a local agent but overseas regulators are charging fees or requiring changes to marketing documents after they have been approved by the home state regulator. This has put fund managers in an uncomfortable position - do they ignore these requests on the basis that the regulator has no right to make these demands or do they pay up in order to keep everyone happy?
In our experience fund managers have generally just seen demands as part of the cost of doing business and the passport has made things manifestly easier than pre-AIFMD. Equally, a few fund managers have avoided applying for the marketing passport in 'difficult jurisdictions' thus reducing the benefit of the passport and the EU's stated intention to create a single capital market.

The marketing passport is the key benefit for EU fund managers. As part of its commitment to the CMU, ESMA has indicated that it will reduce barriers to the use of the passport. As part of this we would like to see the passport apply on a per-AIFM basis, rather than per AIF basis. Discretion should rest with the home state regulator and host states should be prevented from imposing additional fees or requirements on AIFMs.

NPPR

For a non-EU fund manager the benefits of the AIFMD passport are not available. As referenced in our headline, fund managers need to consider which jurisdictions they are marketing in and whether they can rely on reverse solicitation. As marketing is not defined in AIFMD each jurisdiction has taken a different approach as to when a filing is required. For non-EU fund managers a careful approach is required between taking steps to determine demand for the fund without incurring unnecessary registration costs.

Fund managers have, once they have decided where to market, also had to deal with the sometimes divergent practices of regulators. Regulators have come to different views on, for instance, requirements in respect of what can be provided to potential investors prior to marketing, the 'key' Article 23 disclosures for investors, what counts as a delegation and the appointment of depositaries.

ESMA has looked at extending the passport to non-EU AIFMs and has taken a country-by-country approach to determining whether the passport should be made available. However, with the prospect Brexit and the possibility of UK AIFMs becoming non-EU AIFMs looming in the future, we do not expect any movement on this issue until the wider issues of Brexit have been considered. Some jurisdictions have indicated that they will 'turn off' NPPR. Given the delay in extending the passport we do not expect this will occur in the short to medium term.

Is it an AIF?

One of the most frustrating aspects of AIFMD for AIFMs has been the analysis of whether a vehicle is an AIF. Clearly some vehicles are AIFs, such as the main fund vehicles with multiple investors (unless they are a UCITS). Likewise, certain vehicles are clearly scoped out, such as carried interest vehicles for staff. For a deal specific co-invest vehicle (a partnership formed to make one investment, generally alongside a 'main' fund) the question of whether the vehicle is an AIF and, if so, whether it is has been 'marketed' is less clear cut. There are a number of factors that need to be considered. Broadly, the more ‘fund-like’ the vehicle, the more likely it is to be an AIF.

There is a strong case to make for AIFMD 2 to treat a deal co-invest solely made up of investors who are part of a main fund vehicle should not be considered as an AIF on the basis that investors gain all the protections in relation to the deal from their investment in the main fund vehicle.

New Funds and Material Changes

A key issue for fund managers has been negotiating when to obtain permission from the FCA in order to manage new funds because of the danger of subsequent material changes to the fund. Unfortunately the material change regime simply does not fit with the typical structure of negotiations undertaken when forming new funds. Asking for FCA approval too early means that there is a danger that subsequent changes to the documents and agreements are 'material', triggering additional filings to the FCA that potentially delay closings. File too late and the ability to market and close may likewise be held up. In particular, fund managers are sometimes tripped up on the 'automatic' material changes that, on the face of it are not material but require a filing (such as name changes and changing the depositary).

In our experience most changes negotiated with professional investors to the documents will not be material although, clearly some commercial changes can be, not to mention the change of fund name which is always material!

In an ideal world, AIFMD 2 would make it clear that material change notifications are just that, a notification. And that there is no need for managers to wait 30 days to implement the changes. In order to combat those managers who launch low risk vanilla funds only to change them into highly leveraged, speculative funds a month later (we haven't seen any by the way), it would be reasonable for regulators to insist on approval for these sorts of changes.

Depositary

From 22 July 2017 all EU AIFs must have appointed a depositary in the jurisdiction of the AIF. Therefore the final transitional provision to allow a fund to appoint a depositary in another jurisdiction has expired. That said, fund managers have considered this point and shifted depositaries where necessary.

From a private equity perspective, the depositary regime has generally not added a huge amount of value and is merely an additional cost.

Other issues

An AIFM is not only subject to AIFMD but also a significant array of other regulation. An AIFM marketing an AIF in the UK may need to comply with the financial promotion rules, the prospectus rules, the NMPI rules, MiFID II, PRIIPs, SFTR and now senior managers.

PRIIPS KID in particular will pose challenges to fund managers who will need to decide whether they need a KID.

Brexit

It isn't possible to get through an analysis of AIFMD without discussing Brexit. The UK was one of the more sensible voices in the initial drafting of AIFMD and the concern must be that under AIFMD 2 that voice will not be heard.

ESMA has made it clear it does not want jurisdictions to give UK firms relocating to Europe an easy ride. ESMA will also be reviewing arrangements to ensure there are no 'letterbox' entities. For instance, ESMA has informed regulators to give special consideration to the appointment of investment advisers in order to ensure the delegation rules are not circumvented.

Depending on the outcome of Brexit, the fear is that for the UK to benefit from any equivalence decision it will need to blindly follow future AIFMD 2 rules or risk UK fund managers accessing EU markets.

The joke's punchline

The fund was likely "marketed" in Sweden. If you understood this joke – you have been dealing with AIFMD too much!

Co-authored by Greg Patton, Associate.