1. Background
On 25 November 2021, the European Commission (the Commission) put forward its proposal (the Initial Proposal) for amendments to the Directive 2011/61/EU on alternative investment fund managers (the AIFMD) as regards delegation arrangements, liquidity risk management, supervisory reporting, provision of depositary and custody services and loan origination by alternative investment funds, and a draft report from the European Parliament (the Parliament) was published on 16 May 2022 (the Report).
The Council of the European Union (the Council) in turn issued its proposal on 21 June 2022 (the Council Proposal). After months of negotiations, the Parliament’s Committee on Economic and Monetary Affairs (ECON Committee) has finally reached a political agreement on 24 January 2023 (the EP Proposal). While the EP Proposal confirms some helpful amendments introduced by the Initial Proposal or the Council Proposal, some other changes which would have been beneficial for the fund industry did not make it to Parliament’s final position. This publication highlights the most important features of the EP Proposal (bearing in mind that additional changes may be introduced during the trilogue discussions, as described below under section 3).
2. Key features
a. Concept of professional investor
The EP Proposal does not include the suggestion it made in its own initial report to include a new sub-category of professional investor. Indeed, the Report suggested that the term “professional investor” should no longer exclusively correspond to the definition given to such term in Annex II of MiFID II and should instead also capture two additional types of investors, namely those:
- who have committed to investing a minimum of EUR 100 000 and have 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
- who are members of senior staff, portfolio manager, director, officer, agent or employee of the manager or of an affiliate of the manager and have sufficient knowledge about the relevant alternative investment fund (AIF).
As we are witnessing a progressive expansion of the investor base of alternative investments funds, originally reserved to institutional and professional investors, to include more and more retail investors (e.g. through the reform of the ELTIF regime), such change would have contributed to a retailisation of alternative funds. While we are awaiting their outcome, one will need to monitor the trilogue negotiations to see whether such an aspect could return to the negotiating table later in the legislative process.
b. AIFM’s application for authorisation
Delegation to third parties
The Parliament initially included the requirement for a “delegation notification” to the European Securities and Markets Authority (ESMA) by the national competent authority (NCA), on an annual basis, where an AIFM delegates more portfolio management or risk management functions to entities located in third countries than it retains. Fortunately, this change has not been included in the final text. However, the text now outlines the exact information to be included in the authorisation application with respect to delegation and sub-delegation to third parties.
The Parliament also added the requirement for the AIFM to report to the NCA any material changes that may affect the scope of the authorisation 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 the authorisation.
Substance requirements
In terms of substance, the EP Proposal kept the Commission’s requirement for AIFMs to employ at least two persons full-time or engage two persons who are not employed by the AIFM but nevertheless are committed to conduct that AIFM’s business on a full-time basis, and who would be resident in the European Union.
AIFs marketed to retail investors
The Parliament added the obligation for an AIFM managing an AIF marketed to retail investors to ensure that at least one member of its governing body is a non-executive director who is independent in character and judgment and has sufficient expertise and experience to be able to make judgments on whether the AIFM is managing AIFs in the best interest of investors. Such a non-executive director shall contribute to ensuring that the AIFM complies with the requirements regarding conflicts of interests and acting in the best interests of the AIFs and their investors.
Conflicts of interest
The EP Proposal suggests that, where an AIFM intends to manage an AIF on behalf of a third-party, including but not limited to under a mandate in accordance with Article 6(4)(a) (Conditions for taking up activities as AIFM) or in accordance with Article 20 (Delegation), and where the third-party is to have significant control over the AIF’s design, distribution and management, the AIFM shall employ heightened scrutiny of the potential of conflicts of interest and shall submit to the NCA detailed explanations and evidence on their compliance with AIFMD’s rules on conflicts of interest, notably specifying how they prevent systematic conflicts of interest and how any existing or potential conflicts are effectively managed in the best interest of investors and disclosed to them.
ESMA report on undue costs
For the purpose of fair treatment amongst investors, the EP Proposal states that ESMA shall submit a report to the Parliament and the Council (i) assessing the costs charged by AIFMs to investors in AIFs, and the reasons for costs levels and differences between them, (ii) proposing criteria for assessing whether the level of such costs is or is not appropriate in comparison to other jurisdictions worldwide, and (iii) proposing options for action by NCAs or by legislators in respect of inappropriate or undue levels of such costs. Such a report shall be submitted 18 months following the entry into force of the directive.
c. Extension of ancillary services list
With a view to increasing efficiency of AIFM activities, both the Initial Proposal and Council Proposal provided for an extension of the ancillary services that can be provided to by the AIFMs under article 6(4) of the AIFMD to include benchmark administration and credit servicing, which change has been carried over to the EP Proposal. However, the Commission’s suggestion, confirmed by the Council, to extend the list to “any other ancillary service where the ancillary services represent a continuation of the services already undertaken by the AIFM and does not create conflicts of interest that could not be managed by additional rules” has not been included the EP Proposal.
d. ESMA Guidelines on sound remuneration policies
The Parliament outlines that AIFMs should ensure that their remuneration policies are consistent with long-term risks, including ESG risks and sustainability goals. In this respect, the EP Proposal invites ESMA to update its Guidelines on sound remuneration policies under the AIFMD as regards aligning incentives with ESG risks and remuneration policies
e. Loan origination funds
The Initial Proposal introduced new rules governing loan origination funds to ensure a uniform level of investor protection throughout the European Union (EU), both allowing AIFs to develop their activities by originating loans in all EU Member States and broadening the access to finance by EU companies. Such regime has been corroborated by both the Council Proposal and the EP Proposal.
Risk management
The EP Proposal confirms the prohibition for AIFMs from managing AIFs whose investment strategy is to originate loans with the sole purpose of transferring those loans to third parties (so-called “originate to distribute strategy”).
The EP Proposal also aligns with both the Initial Proposal and the Council Proposal on the right for AIFs to originate loans and trade those loans on the secondary market subject to a 5% risk-retention requirement, on an ongoing basis and until maturity, to avoid situations in which loans are originated with the sole purpose of selling them.
In line with the Council Proposal, the EP Proposal also provides that AIFMs managing loan origination AIFs but also AIFs acquiring loans should have effective policies, procedures and processes for assessing credit risk and administering and monitoring their credit portfolios, except if such loans are shareholder loans that do not exceed in aggregate 150% of the capital of the AIF.
It also reaffirms that AIFMs managing loan origination AIFs must comply with diversification rules where the borrower is a financial institution, i.e. an AIFM shall ensure that a loan originated to any single borrower by the AIF it manages does not exceed 20% of the AIF’s capital where the borrower is a financial undertaking, an AIF or a UCITS, with a ramp-up period of 1 year. It confirms the definitions of “loan origination” as “the granting of a loan by an AIF as the original lender”, and “shareholder loan” as “an advance or current account granted by an AIFs to an undertaking in which it holds directly or indirectly at least 5% of the capital or voting rights and which cannot be sold to third-parties independently of the capital instruments held by the AIF in the same undertaking”, as suggested by the Parliament in its initial Report.
Liquidity management
The EP Proposal imposes loan-originating AIFs to adopt a closed-ended form when the AIFM is not able to demonstrate to the NCA that the AIF has a sound liquidity management system that ensures the compatibility of its liquidity management system with its redemption policy. The Parliament initially advanced that this should not apply when the assets under management of the AIF do not exceed EUR 5 billion, but this exemption has been removed from the EP Proposal. ESMA is expected to develop regulatory technical standards (RTS) as regards the assessment of “sound liquidity management”, having regard to the underlying loan exposure, average repayment time of the loans and overall granularity and composition of AIF portfolios.
The EP Proposal confirms the Council’s position that, following an assessment on the suitability based on the investment strategy, the liquidity profile and the redemption policy, an AIFM that manages an open-ended AIF shall select at least two appropriate liquidity management tools for possible use in the interest of the AIF’s investors (such tools being redemption gates, notice periods, liquidity fees on redemption, swing/dual pricing, anti-dilution levy, redemptions in kind). The AIFM shall also implement detailed policies and procedures for the activation and deactivation of any selected liquidity management tool.
An AIFM shall, without delay, notify the NCA of its home Member State when activating/deactivating suspension of redemptions and subscriptions or redemption gates in situations of liquidity stress, side pockets, or any other liquidity management tool in a manner that is not in the ordinary course of business as envisaged in the fund documentation. The NCA shall then notify, without delay, the NCA of a host Member State of the AIFM and ESMA of any notification received and notify the ESRB if there is any potential risk to the stability and integrity of the financial system.
The EP Proposal states that ESMA shall develop guidelines (and not RTS, as included in the Parliament’s first draft of the text) to specify best practices as regards the characteristics of the liquidity management tools set out in Annex V, considering the diversity of investment strategies and underlying assets.
Transitional provisions
As initially suggested by the Council Proposal, the EP Proposal includes transitional rules for existing closed-ended origination loans that have been established before the adoption of the directive (5 years before having to comply Article 16(2a)) – i.e. the obligation to adopt a closed-ended form when the AIFM is not able to demonstrate to the competent authorities of its home Member State that the AIF has a sound liquidity risk management system.
f. Distribution
The marketing of AIFs is not always conducted by the AIFM directly but can be performed by one or several distributors either on behalf of the AIFM or on their own behalf. The Council Proposal provided that the diversity of distribution arrangements should be acknowledged and should recognise the existing safeguards for the arrangements whereby a distributor acts on its own behalf when it markets the AIF under Directive 2014/65/EU (MiFID II) or through life-insurance based investment products in accordance with Directive 2016/97/EU (the Insurance Distribution Directive), in which cases the provisions of the AIFMD regarding delegation should not apply, irrespective of whether any distribution agreement between the AIFM and the distributor is concluded. The EP Proposal confirms the Council’s view against what was included in its initial Report on this point, which provided that a distributor should be considered as a delegate of the AIFM under the AIFMD rules only when it is appointed by the AIFM pursuant to a contractual agreement.
g. Depositary
The current AIFMD requirement is that a depositary should be located in the same Member State as the appointing EU AIF. However, the Commission notes the lack of service providers and competitiveness in some smaller markets. In that context, the Initial Proposal enables Member States to authorize competence authorities to permit AIFMs or AIFs to procure depositary services located in other Member States, only where all the conditions of the directive are fulfilled and with prior approval of the competence authorities. Prior approval shall only be granted on a case-by-case assessment on the lack of relevant depositary services in the jurisdiction of the AIF, while taking into account its investment strategy.
While the EP Proposal largely takes over the conditions introduced under the Council Proposal under which the home Member State of the AIF may entitle its competent authorities to allow, on a case-by-case basis, institutions to be appointed as depositary, it modifies the threshold of aggregate amount in each market of assets safekept from EUR 30 billion to EUR 60 billion. The conditions under the EP Proposal for an institution established in another Member State to be appointed as depositary are as follows:
- the competent authorities must have received a motivated request by the AIFM which shall demonstrate the lack of the relevant depositary services able to meet the needs of the AIF having regard to its operational strategy; and
- the national depositary market of the home Member State of the AIF should fulfil at least one of the following conditions:
a. such market consists of fewer than 7 depositaries providing depositary services to EU AIFs (authorised under Article 4 (k) (i)) of the AIFMD) and managed by an EU AIFMs (authorised under Article 7(1)) and where no depositary has AIF assets under custody which exceed EUR 1 billion or the equivalent in any other currency (such threshold shall excluded depositaries acting under Article 36 (1a) of this Directive and the own assets of the depositary); or
b. the aggregate amount in such market of assets safekept on behalf of EU AIFs (authorised under Article 4 (k) (i) of the AIFMD) and managed by an EU AIFMs (authorised under Article 7(1) of the AIFMD) does not exceed the amount of EUR 60 billion or the equivalent in any other currency (such threshold shall excluded depositaries acting under Article 36 (1a) of this Directive and the own assets of the depositary).
Although this regime may not be considered as a “depositary passport”, it still gives the possibility for a manager to use a depositary based in a third country under strict conditions.
h. Reporting
Investors
Under Article 23, the EP Proposal now includes the obligation to disclose to investors (i) the possibility and conditions for using liquidity management tools selected in accordance with Article 16(2b) and disclose, (ii) on an annual basis, all direct and indirect fees and charges that were directly or indirection charged to the AIF, and (iii) on annual basis, any parent company, subsidiary or special purpose vehicle entity established in relation to the AIF’s investments by the AIFM.
NCAs
Under Article 24, the EP Proposal adds the disclosure to NCA of the AIFM’s home Member State of (i) the total amount of leverage of the net asset value employed by the AIF, and (ii) with respect to each AIF managed or marketed in the Union by an authorised AIFM, information regarding delegation arrangements concerning portfolio or risk management functions, including the identity of the entities to which such functions have been delegated, a description of the human and technical resources employed, information of the function delegated (type, date of conclusion and expiration), information on sub-delegation arrangements (if any), and a confirmation that the AIFM has implemented periodic due diligence measures to oversee, monitor and control the delegate and kept records of issues identified and, where relevant, the measures adopted to address those issues.
ESMA is expected to develop RTS specifying the details to be reported and set out the appropriate level of standardization of such information.
i. Marketing rules
In terms of marketing rules, the EP Proposal introduces an exemption to Article 31 and Article 43, which shall not apply to AIFs constituted exclusively for the purpose of purchasing company shares and proposed to employees of these companies within the framework of employee savings schemes.
With respect to non-EU AIFs, references to a Non-Cooperative Country and Territory by FATF have been replaced by references to a high-risk third country pursuant to Article 9(2) of Directive (EU) 2015/849 at the time of the AIFM’s application for authorisation. Moreover, such third country must have signed an agreement with the home Member State of the authorised AIFM and with each other Member State in which the units/shares of the non-EU AIF are intended to be marketed, in accordance with the standards of the OECD Model Tax Convention on Income and on Capital, and that country must not be listed as a non-cooperative jurisdiction for tax purposes in Annex I of the Council conclusions on the revised EU list of non-cooperative jurisdictions (the Council Conclusions) at the time of the AIFM’s authorisation. The EP Proposal further clarifies that (i) if the third country is added to Annex I of the Council Conclusions after the time of the AIFM’s authorisation, closed-ended funds shall continue to be considered to meet that criterion for a period of 2 years, and (ii) a third country that has been continuously mentioned in Annex II of the Council Conclusions (the “grey list”) for a period of over three years shall be considered to be mentioned in Annex I (the “black list”).
j. Other relevant features
It is noteworthy that the EP Proposal does not include any change to Annex II on remuneration policy, nor any change to the asset stripping rules. One will have to follow the upcoming trilogue negotiations to see whether these topics may be reconsidered.
3. Next steps
Following the Parliament’s adoption of its formal position, trilogues – i.e. informal tripartite meetings on legislative proposals – will begin between representatives of the Parliament, the Council and the Commission to reach an agreement on a final version of the text of the AIFMD II, which will hopefully occur later this year. If all goes according to plan, the AIFMD II regime is likely to come into force in 2025, considering that the Member States will have 24 months after the proposed amendments enter into force to transpose these into national laws.
Aurélien Hollard
Partner | Avocat à la Cour
Benjamin Bada
Partner | Avocat à la Cour
Julien Robert
Professional Support Lawyer | Avocat à la Cour
