1.Background:
On 25 November 2021, the European Commission (the Commission) put forward its 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. On 19 July 2023, the European Parliament (the EP) and the Council of the European Union (the Council) reached a provisional agreement. After two years, including several months of technical trilogues, the final text of the political agreement on the amendment of AIFMD (the AIFMD II) is finally out. This final text must be formally approved by both the EP and the Council (cf. section What’s next below).
This publication highlights the most important features of the current text on AIFMD II.
2.Key highlights of AIFMD II:
A) Loan-originating AIFs
Closed-ended vs. open-ended
AIFMD II provides the principle that loan-originating AIFs[1] should adopt a closed-ended form, unless the AIFM is able to demonstrate to the NCA of its home Member State that the AIF’s liquidity risk management system is compatible with its investment strategy and redemption policy.
Prohibition of originate-to-distribute investment strategy
AIFMD II prohibits AIFMs from managing AIFs whose investment strategy or part of whose investment strategy is to originate loans[2] with the sole purpose of transferring those loans or exposures to third parties (so-called “originate to distribute strategy”).
Secondary market and retention
AIFMD II provides for the right for AIFs to originate loans and trade those loans on the secondary market subject to a 5% risk-retention requirement to avoid situations in which loans are originated with the sole purpose of selling them. Such percentage shall be retained: (i) until maturity for those loans whose maturity is up to eight years, or for loans granted to consumers regardless of their maturity; and (ii) for a period of at least eight years for other loans. However, such requirement shall not apply where (a) the AIFM starts to sell assets of the AIF to redeem units or shares as part of the liquidation of the AIF, (b) the disposal is necessary for the purposes of compliance with restrictive measures imposed by regulations based on Article 215 TFEU (EU sanctions) or with product requirements, (c) the sale of the loan is necessary to enable the AIFM to implement the investment strategy of the AIF it manages in the best of interest of the investors, and (d) the sale of the loan is due to a deterioration in the risk associated with the loan, detected by the AIFM as part of its due diligence and risk management and the purchase is made aware of such deterioration.
Effective policies, procedures and processes
AIFMD II also provides that AIFMs managing loan-originating 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[3] that do not exceed in aggregate 150% of the capital of the AIF. These must always be up to date and effective, and must be reviewed at least annually.
Diversification
AIFMD II provides that AIFMs managing loan-originating AIFs must comply with diversification rules where the borrower is a financial institution, i.e. an AIFM shall ensure that the notional value of the loans 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 24 months.
Leverage
New leverage limits are introduced for loan-originating AIFs. An AIFM shall ensure that the leverage of a loan-originating AIF it manages does not represent more than 175% if such AIF is open-ended or 300% if it is closed-ended, the leverage being understood as the ratio between the exposure of that AIF (according to the commitment method) and its net asset value.
Borrowing arrangements which are fully covered by contractual capital commitments from investor in the loan-originating AIF shall not constitute exposure.
These requirements shall not apply to a loan-originating AIF the lending activities of which consist solely of originating shareholder loans, provided that the notional value of those loans does not exceed in aggregate 150% of the AIF’s capital.
Transitional provisions
AIFMD II includes transitional rules for existing open-ended loan-originating AIFs that have been established before the date of entry into force of the directive, including among others the following: such AIFs will benefit from a period of 5 years to comply with (i) Article 16(2a) of AIFMD II i.e., the obligation to adopt a closed-ended form unless AIFM is able to demonstrate to the NCA of its home Member State that the AIF’s liquidity risk management system is compatible with its investment strategy and redemption policy – and (ii) Article 15(4a) to (4c) – i.e., the obligation to comply with the above-mentioned diversification and leverage rules). AIFMD II also provides, inter alia, that AIFMs managing AIFs that originate loans that have been constituted before the date of entry into force of the directive and that do not raise additional capital after the date of entry into force of the directive shall be deemed to comply with the above-mentioned requirements relating to the obligation to be closed-ended and with the obligation to comply with the above-mentioned diversification and leverage rules.
AIFMD II also provides for an opt-in regime whereby already existing loan-originating AIFs can voluntarily choose to be subject to newly introduced rules, to the extent that the AIFM’s NCA is notified thereof.
B) Liquidity management tools
An AIFM that manages an open-ended AIF shall select at least two appropriate liquidity management tools (set out in Annex V of AIFMD II) 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), to the exception of money market funds under Regulation (EU) 2017/1131 which may only select one liquidity management tool. 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, 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.
ESMA shall develop draft regulatory technical standards (RTS) to determine the requirements to be complied with by a loan-originating AIF to maintain an open-ended structure and to specify the characteristics of the liquidity management tools set out in Annex V. Moreover, ESMA shall develop guidelines on the selection and calibration of liquidity management tools by AIFMs liquidity risk management and for mitigating financial stability risks.
C) Reporting requirements
Investors (Article 23)
Under Article 23, AIFMD II now includes inter alia the obligation to disclose to investors (i) a description of the AIF’s liquidity risk management, including existing redemption arrangements with investors and the possibility and conditions for using liquidity management tools selected in accordance with Article 16(2b)and (ii) on an annual basis, all direct and indirect fees and charges that were directly or indirection charged to the AIF, (iii) the composition of the originated loan portfolio, (iv) on annual basis, any parent company, subsidiary or special purpose vehicle entity established in relation to the AIF’s investments by the AIFM.
NCAs (Article 24)
As part of its reporting obligations to its home Member State’s NCA, the AIFM shall, for each of the EU AIFs it manages and for each of the AIFs it markets in the EU, provide information regarding delegation arrangements concerning portfolio management or risk management functions, namely (i) information on the delegates including name, domicile, whether they have close links with the AIFM, and whether they are authorised or regulated for the purpose of asset management; (ii) the number of full-time equivalent human resources employed by the AIFM for performing day-to-day portfolio or risk management tasks; (iii) a list and description of the activities concerning risk management and portfolio management functions which are delegated; (iv) where portfolio management function is delegated, the amount and percentage of the AIF’s assets which are subject to delegation arrangements concerning the portfolio management function; (v) the number full-time equivalent human resources employed by the AIFM to monitor the delegation arrangements; (vi) the number and dates of periodic due diligence reviews carried out by the AIFM to monitor the delegated activity, including a list of identified issues and the adopted measures to address those; (vii) where sub-delegation arrangements are in place, information required in (i), (ii) and (iii) should also be provided; and (viii) the commencement and expiry dates of the delegation and sub-delegation arrangements.
The AIFM shall inter alia also provide (i) information on instruments in which it is trading, on markets of which it is a member or where it actively trades, and on the exposures and assets of the AIF, which shall include identifiers which are necessary to connect the data provided on assets, AIFs and AIFMs to other supervisory or publicly available data sources, (ii) the current risk profile of the AIF, including the market risk, liquidity risk, counterparty risk, other risks including operational risk and the total amount of leverage employed by the AIF, and (iii) the list of Member States in which the units or shares of the AIF are actually marketed by the AIFM or by a distributor which is acting on behalf of that AIFM.
ESMA is to prepare draft RTS, namely detailing the information to be provided, the appropriate level of standardisation, the frequency and timing.
D) AIFM’s application for authorisation and operating conditions
Delegation to third parties
AIFMD II outlines the exact information to be included by AIFMs in the authorisation application with respect to delegation and sub-delegation to third parties, namely (i) for each delegate, its legal name and relevant identifier, its jurisdiction of establishment, and where relevant, its supervisory authority; (ii) a detailed description of the human and technical resources employed by the alternative investment fund manager (the AIFM) for performing day-to-day portfolio or risk management tasks within the AIFM, and monitoring the delegated activity; (iii) in respect of each of the AIFs it manages or intends to manage, a brief description of the delegated portfolio management and risk management functions, including whether such delegation amounts to a partial or full delegation; and (iv) a description of periodic due diligence measures to be carried out by the AIFM for monitoring the delegated activity.
Substance
In terms of substance, AIFMD II requires that the conduct of the business of the AIFM must be decided by at least two natural persons who are either employed full-time by that AIFM or executive members or members of the governing body of the AIFM who are committed full-time to conduct the business of the AIFM and are domiciled in the European Union (EU) (i.e, having their habitual residence), while meeting the reputation and experience requirements.
AIFs marketed to retail investors
While the EP 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 requirement has been removed in the AIFMD II and replaced by a recital on this topic. Under Article 69b, the European Securities and Markets Authority (ESMA) is nevertheless mandated to produce a report inter alia on the appropriateness and impact on investor protection of the appointment of at least one non-executive or independent director in the governing body of the AIFM, where it manages AIFs marketed to retail investors, on which the Commission shall base its review of the function of the rules laid down in the AIFMD II five years after the entry into force of AIFMD II.
Fair treatment of investors and undue costs
AIFMD II prescribes that ESMA shall, by 18 months from the date of entry into force of AIFMD II, submit a report to the EP, the Council and the Commission assessing the costs charged by AIFMs to the investors of the alternative investment funds (AIFs) that they manage and explaining the reasons for the level of those costs and for the differences between them, including differences resulting from the nature of the AIFs concerned. For that purpose, national competent authorities (NCAs) shall provide ESMA on a one-time basis with date on costs including all fees, charges and expenses which are directly or indirectly borne by the investors, or by the AIFM in connection with the operations of the AIF, and that will be directly or indirectly allocated by the AIF.
Conflicts of interest
Where an AIFM manages or intends to manage and AIF at the initiative of a third party, including AIFs using the name of the third-party initiator or appointing the third-party initiator as a delegate pursuant to Article 20 AIFMD, AIFMD II provides for an obligation for AIFMs to submit detailed explanations and evidence of its compliance with the AIFMD’s rules on conflicts of interest, notably specifying how they prevent systematic conflicts are effectively managed in the best interest of investors and disclosed to them.
E) Extension of ancillary services list
AIFMD II provides for an extension of the ancillary services that can be provided by AIFMs under Article 6(4) of the AIFMD to also include (i) benchmark administration, (ii) credit servicing, and (iii) any other function or activity which is already provided by the AIFM in relation to an AIF that it manages, provided that any conflict of interest created by the provision of that function or activity to other parties is appropriately managed.
F) Update of ESMA guidelines on sound remuneration policies
AIFMD II outlines that AIFMs should ensure that their remuneration policies are consistent with long-term risks, including ESG risks and sustainability goals. In this respect, AIFMD II invites ESMA to update its Guidelines on sound remuneration policies under the AIFMD as regards aligning incentives with ESG risks and remuneration policies.
G) 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. AIFMD II 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 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.
H) Depositary
The current AIFMD requirement is that a depositary should be located in the same Member State as the appointing EU AIF. AIFMD II entitles the NCA of the AIF’s home Member State, only after a case-by-case assessment of the lack of relevant depositary services in such home Member State, to allow institutions established in another Member State to be appointed as depositary under the following conditions: (a) the NCA has received a motivated request by the AIFM to allow the appointment of a depositary in another Member State demonstrating the lack of relevant depositary services in the home Member State of the AIF that are able to effectively meet the needs of the AIF having regard to its investment strategy; and (b) the aggregate amount in the national depositary market of the home Member State of the AIF of assets safekept, authorised or registered under the applicable national law in accordance with Article 4(1), point (k)(i) AIFMD, and managed by an EU AIFM, does not exceed EUR 50 billion or the equivalent in any other currency (such threshold shall exclude assets safekept by depositaries acting under Article 36(1), point (a) AIFMD, and the own assets of such depositaries). When allowing the appointment of a depositary in another Member State, the relevant NCA shall notify ESMA accordingly.
AIFMD II further clarifies that, with respect to the appointment of a depositary established in a third country, the conditions of such country (i) not being identified as a high-risk third country pursuant to Article 9(2) of Directive (EU) 2015/849, (ii) having signed an agreement with the home Member State where the depositary is established and (iii) not being mentioned in Annex I to the Council conclusions on the revised EU list of non-cooperative jurisdictions for tax purposes shall apply at the time of the depositary’s appointment. Should it become the case after appointment, a new depositary shall be appointed within an appropriate period (i.e., no longer than 2 years), taking due account of the interests of investors.
I) Marketing rules
Employee participating schemes
In terms of marketing rules, AIFMD II introduces an additional paragraph to Article 43, enabling an EU AIFM to market units or shares of an EU AIF, which invest predominantly in the shares of a particular company, to employees of that company or of its affiliated entities within the framework of employee savings or participating schemes, on a domestic or cross-border basis; in the latter case, the Member State where the marketing takes place shall not impose any additional requirements.
High-risk jurisdictions
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. 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.
3.What’s next
The final text of the political agreement on AIFMD II is the result of informal negotiations between representatives of the EP and Council (so-called trilogues). It will now have to be formally approved by both EU institutions. The EP’s vote is scheduled for February 2024 and the Council’s vote is likely to follow shortly after. We can therefore reasonably expect the entry into force of AIFMD II by the end of Q1 2024. Member States will then have 24 months to implement AIFMD II in national rules, meaning that implementation can in principle be expected by Q1 2026.
[1] AIFMD II has added a definition of “Loan-originating AIF” which is defined as “an AIF (i) whose investment strategy is mainly to originate loans, or (ii) where the notional value of the AIF’s originated loans represents at least 50% of its net asset value”.
[2] AIFMD II has added a definition of “Loan origination” or “originating a loan” which is defined as “the granting of a loan directly by an AIF as the original lender or indirectly through a third party or special purpose vehicle, which originates a loan for or on behalf of the AIF, or for or on behalf of the AIFM in respect of the AIF, where the AIFM or AIF is involved in structuring the loan, or defining or pre-agreeing its characteristics, prior to gaining exposure to the loan”.
[3] AIFMD II has added a definition of “Shareholder loan” which is defined as “a loan which is granted by an AIF 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.
