The European Securities and Market Authority’s 500 pages of technical advice to the European Commission on Level 2 measures implementing the Alternative Investment Fund Managers Directive have helped to bring greater certainty to the global fund industry on what it can expect in July 2013 and thereafter.
Nevertheless, until the Commission comes up with the final rulebook and all primary and secondary AIFMD-related legislation is adopted into the national law of European Union member states, questions will remain about the overall impact of the directive, especially as it affects managers, funds or service providers located in jurisdictions outside the EU.
‘Equivalence’ dropped
For industry members, one of the most important aspects of the final advice document sent to the Commission on November 16 is the removal of reference to the ‘equivalence’ of third-country jurisdictions, which had already been dropped from the legislative text finally agreed by the European Council and Parliament in November 2010.
The concept of equivalence was re-introduced in Esma’s consultation paper on possible implementing measures relating to supervision and third countries, published in August 2011. With regard to the delegation of investment management or depositary functions to entities outside the EU, the requirement for equivalence was regarded as a potential barrier to investment by funds in non-EU jurisdictions, as well as creating the probably impossible task of assessing the equivalence or otherwise of dozens of jurisdictions before the directive came into force.
Regulatory co-operation approach
Esma’s advice to the Commission tackles the issue of regulatory co-operation between third countries where funds or managers are domiciled and EU member states by proposing an approach based on Iosco’s Multilateral Memorandum of Understanding Concerning Consultation and Co-operation and the Exchange of Information.
It proposes that an MMoU be centrally negotiated by Esma to avoid the need for third-country regulators to conclude multiple bilateral co-operation arrangements, ensuring a level playing field by removing the opportunity for regulatory arbitrage. However, details what this would mean in practice and how co-operation agreements should be concluded may not be announced before mid-2012.
Article 20 of the directive provides that where portfolio or risk management functions are delegated by an EU-based manager (or sub-delegated) to an entity located outside the union, regulatory co-operation arrangements should be in place between the manager’s home regulator and the third-country supervisor of the entity to which the functions are delegated.
The regulatory co-operation arrangements should be based on written agreements and enable the manager’s home regulator to obtain on request information required for its supervisory duties under the AIFMD, obtain documents held in the third country and conduct on-site inspections of the entity to which portfolio or risk management functions have been delegated (either directly, by the third-country regulator, or jointly).
The co-operation arrangements should also ensure notification by the third-country regulator of any breach of the directive’s requirements and the ability to perform “sufficiently dissuasive” enforcement actions in such a case.
The third-country entity will be deemed to meet the AIFMD’s requirements for delegation if it is authorised or registered to carry out asset management based on local criteria and is effectively supervised by an independent regulator. Independence in this case means compliance with the criteria and methodology set out in Part II of the Iosco Objectives and Principles for Securities Regulation and the Basel Committee Core Principles.
The EU manager’s home regulator must approve in advance the delegation of portfolio or risk management to a third-country entity that is not authorised as an asset manager, as it would also have to do if such an entity was based in the EU.
Framework for depositaries
As with the criteria for delegation of portfolio or risk management, the concept of equivalence of third-country regulation has been removed from the advice on assessing the prudential regulation and supervision of non-EU depositaries to alternative funds.
Instead Esma says the depository should be authorised and supervised by an independent regulator with adequate resources to fulfil its tasks. The local regulatory framework should set out eligibility criteria for depositaries “that have the same effect” as those applicable to credit institutions or investment firms within the EU.
The minimum capital requirements and operating conditions applicable to the depositary should have the same effect as those applicable within the EU, depending on whether it is a bank or an investment firm, while the local requirements regarding performance of the depositary’s duties should have the same effect as those set out in the AIFMD. Esma advises that the third-country legislation should be assessed by comparing eligibility criteria and operating conditions with EU requirements.
The local regulatory framework should provide for the application of enforcement action in the event of breaches of the directive’s requirements, and ensure that the liability of the depositary to investors in the event of loss of assets should be capable of being invoked either directly or indirectly through the manager, depending on the nature of the investment structure. If the depositary is supervised to more than one regulatory authority, all of them should meet the requirements.
Under Article 21 of the directive, if the criteria are met, the Commission should adopt implementing acts stating that the prudential regulation and supervision of a particular third country have the same effect as EU law and are effectively enforced.
Private placement rules
Regarding co-operation between EU and third-country regulators for the marketing of non-EU funds within the EU under national private placement arrangements – and subsequently the marketing of non-EU funds or EU funds run by non-EU managers under a passport – Esma says the agreements should cover exchange of information for supervisory, enforcement and other regulatory purposes, as well as the ability of the EU regulator to carry out on-site inspections directly or jointly with the non-EU regulator.
The latter should co-operate in the event or breach of either EU or local regulation, and assist the EU regulator by providing information required for systemic risk oversight. Co-operation agreements should allow information provided to the EU regulator to be passed on to its counterparts in other member states, to Esma itself or to the European Systemic Risk Board.
This part of the Esma advice, as well as that regarding depositaries, stresses that managers, funds or service providers should not benefit from more lenient regulatory treatment as a result of being based in a non-EU jurisdiction, and that regulatory co-operation arrangements should take this into account.
Determining the member state of reference
Finally, the Esma advice proposes more detailed guidelines for determination of the member state of reference that will supervise non-EU managers taking advantage of the AIFMD passport in or after July 2015.
In the event of a dispute over the designation of the member state of reference, the decision should take into account in which EU member state the manager intends to develop effective marketing to investors for most of its funds, either through direct relationships or third-party distributors. The criteria should include the domicile of most targeted investors, the language of the offering and promotional documents, and the member states where advertisements are “most visible and frequent”.
EU regulators identified by the manager as being potentially its member state of reference should contact each other and Esma. Following consultation or receipt of relevant documentation, they should exchange views within a week and subsequently take a joint decision on the designation. The Level 1 text of the directive provides that where the regulators cannot agree, Esma will decide.