Malta: Practical Implementation Of AIFMD In Malta: The MFSA’s Authorisation Process

Article by Christopher P. Buttigieg and Clare Farrugia¹

Introduction

The Maltese legislation which implements the Alternative Investment Fund Managers Directive ('AIFMD') has been in place for over a year. This is set in the Investment Services Act ('the Act'), the legal notices issued by the Minister of Finance, and the Investment Services Rules issued by the Malta Financial Services Authority ('MFSA' or 'the Authority'), Malta's single regulator and supervisor for financial services.

All fund managers and self-managed schemes, which were licensed on or before the 22nd July 2013, were required to submit a request to the MFSA for re-authorisation by 31st March 2014. In the meantime, a number of new applicants have also requested authorisation as an AIFM.

The practical implementation of AIFMD has proven to be more challenging than originally anticipated. The processing of applications for authorisation as AIFM in an environment where there is lack of European uniformity in the interpretation of certain aspects of the regulation, such as the requirements on delegation, is one of the most significant challenges that the MFSA has faced to date in connection with AIFMD implementation.

This brief paper provides an overview of the transposition of the AIFMD in Malta and examines the procedure for the processing of applications for authorisation as an AIFM. The paper is divided into three additional sections. Section 1 provides an overview of the legislation which transposes the AIFMD. Section 2 examines the authorisation process and the resulting challenges. Section 3 sets out concluding remarks in relation to this paper.

Malta's Legislative Framework

The transposition of the AIFMD in Malta required amendments to the Act, which were supplemented by the following legal notices:

• Investment Services Act (Alternative Investment Fund Manager) Regulations, which enhance the MFSA's powers qua competent authority for the purpose of the AIFMD;
• Investment Services Act (Alternative Investment Fund Manager) (Passport) Regulations, which apply to AIFM exercising passporting rights;
• Investment Services Act (Marketing of Alternative Investment Funds) Regulations, which regulate the cross-border marketing of AIFs; and
• Investment Services Act (Alternative Investment Fund Manager Third Country) Regulations, which implement the third country provisions, including the framework applicable to the national private placement regime and the choice of the Member State of reference by third country AIFMs.

In addition to the Act and the legal notices, changes were made to the MFSA's Investment Services Rules. The Investment Services Rules for Investment Services Providers, which regulate the activity of investor firms, fund managers and depositaries, was amended to implement the governance, compliance, capital, risk management, conduct of business and transparency requirements applicable to AIFM.

The Rulebook also contains specific regulation applicable to de minimis AIFM. Malta decided to regulate de minimis AIFM with a stricter regime then what is prescribed in the AIFMD. In the MFSA's view a licensing regime is preferable than mere registration for de minimis AIFM as it is in the best interest of investor protection and financial integrity that all fund managers are subject to a robust but proportionate regulatory framework. Moreover, it was deemed important that fund managers, irrespective of the size and complexity of their operations, should be subject to Malta's anti-money laundering deterrence framework. This is in line with Malta's international commitments to combat financial crime. Therefore, de minimis AIFMs are subject to regulation, authorisation and supervision in Malta.

During the process that led to the implementation of the AIFMD in Malta, the MFSA decided to adopt the Investment Services Rules for Alternative Investment Funds, a rule book for the establishment of AIFMD compliant funds. While on the one hand the MFSA opted to retain the existing regulatory framework applicable to professional investor funds, it decided to reinforce the framework for the regulation of the industry by establishing a rulebook which regulates self-managed funds, which in terms of the AIFMD qualify as the AIFM, and third party managed funds that are targeted for distribution as AIFs across Europe.

The MFSA's Investment Services Rulebook:

Authorisation Process

This section examines the procedure for the processing of applications for authorisation as an AIFM and the resulting challenges.

The MFSA may only grant a licence if it is satisfied that the applicant is fit and proper and will comply with applicable regulation. The fit and proper test seeks to ensure that an applicant is honest, competent and solvent. These characteristics are critical for the sound conduct of business of a regulated entity. The fulfilment of the test requires a comprehensive assessment of the adequacy and effectiveness of the organisational structure and internal governance of the applicant. Robust governance structures are crucial to ensure, amongst others, the level of awareness of regulation and sophistication of compliance monitoring mechanisms that are required for the sound implementation of the Directive. Robust governance does not only focus on revenue and profits but promotes a culture that recognises that the decisions made by the AIFM do not simply have an impact on profit generation but also on the legitimacy of the system in which it operates.

As part of the application review process, due diligence enquires on the key officials and significant shareholders of the applicant are carried out with previous employers, bankers and other relevant parties, so as to ensure that the management of the business of the AIFM is conducted by persons of experience and good repute. Moreover, an applicant is required to provide extensive information on the applicant's proposed structure, activities and operating conditions, including remuneration, risk management, compliance, internal audit and on the mechanisms for the management of conflicts of interest. Furthermore, the Authority requires an AIFM to indicate whether it intends to delegate any of its activities in connection with its regulated business and to provide a detailed overview of the proposed delegation structure. In this regard, sufficient local presence is required from every applicant to ensure compliance with the requirements on letter box entities set in the Directive.

The Authority's Authorisations Unit is responsible for the processing of all applications for a financial services licence, including applicants in terms of the AIFMD. This governance mechanism for financial supervision seeks to ensure a consistent and proportionate approach to the processing of applications in all financial sectors. After reviewing the application documents, the Authorisations Unit would communicate with the applicant and may request clarifications in order to ensure proper understanding of the business proposal, particularly the operational set-up which must satisfy the strict conditions set in the Directive. Once all matters raised by the Authority are addressed and due diligence assessment is completed, the application is submitted for the consideration of the Authority's Supervisory Council, which is responsible for all decisions on regulatory and supervisory matters.

Once a licence is issued, the financial entity is allowed to operate in the local market and passport its activities to other EU member states. Hence, unless the review of the application process for a licence is thorough and robust to the extent that it identifies and manages to weed out rotten apples, regulatory concerns may arise once the financial entity becomes subject to on-going supervision. This is particularly the case where the financial entity does not have a robust compliance and prudent business culture. Therefore, to guarantee a higher level of vetting, the assessment of an application does not stop at the level of the Authorisations Unit and additional filters at higher-level also apply.

The legislative framework that establishes the MFSA demands that all applications for a licence should be considered and approved or rejected by the Authority's Supervisory Council, which is chaired by the Director General and is also composed of the Directors of the Authority's Regulatory and Supervisory Units. The Supervisory Council discusses and considers the acceptability or otherwise of the application and may request additional clarifications on the application before making a final decision. In Malta, the submission of an application is no guarantee that a licence will be granted by the Authority. Indeed, there have been a number of instances where, due to unsatisfactory outcomes resulting from the Authority's due diligence processes or inadequate proposed business models, the Authority's Supervisory Council rejected an application for a licence. Where an application is rejected, the applicant has a right of appeal from the Authority's decision at the level of the Financial Services Tribunal. This is a basic accountability mechanism which seeks to ensure that financial supervisors do not abuse the powers granted in terms of law.

Ensuring proper substance in Malta is a key element of the Authority's assessment when reviewing applications. The lack of a European convergent approach in this field has caused uncertainty over how the qualitative criteria and principles set in regulation should be interpreted and applied to AIFM delegation structures. Regulatory certainty is important for business development and to ensure that the investor protection and systemic stability objectives of the AIFMD are attained. The Authority has sought to address the uncertainty on delegation through an informal exchange of views and debate with the industry on the different delegation structures that could be applied in order to satisfy the requirements of the Directive. This has led towards a better understanding of what is expected in terms of substance. Moreover, it also had a positive impact on the quality of applications submitted to the MFSA and the overall on-going compliance with the requirements of the Directive, thereby making practical implementation more manageable. The debate also resulted in the establishment of an MFSA policy on substance and is a good example of the Authority's pragmatic approach to resolving the challenges resulting from the implementation of the Directive.

The MFSA's approach with regards to delegation structures of AIFMs are based on the principles of delegation as set out in the Directive. In this regard, while the Authority would be willing to exercise a degree of flexibility during the start-up phase of an AIFM, in assessing proposed structures, the Authority focuses on ensuring that an adequate degree of substance is retained by the AIFM. When the delegation concerns portfolio management, the MFSA would ordinarily require AIFMs to satisfy delegation requirements through a well-designed and fully operational risk management function in Malta. In such scenario, AIFMs would be required to demonstrate to the Authority how such function is proportionate in view of the portfolio management activities undertaken by the AIFM. Furthermore, AIFMs would be required to explain how the effectiveness of the function will be achieved; thereby ensuring that the setting up of the function is not merely a tick-box exercise and that it covers the range of risks identified in the Directive.

In line with regulatory requirements and to further strengthen the governance and substance of AIFMs in Malta, the fund manager would also be required to identify who is responsible for the company's remuneration policy and internal audit function and must also engage a compliance officer and an anti-money laundering officer in Malta. All the critical functions must report to the board of directors of the AIFM, which has overall responsibility for the company's business.

A critical feature of a delegation structure, which is closely examined by the Authorisations Unit during the application process, is the AIFM arrangements for monitoring/control of delegated functions. An AIFM is required to state who is responsible within its set-up for supervising the delegated functions, so as to ensure that the identified individuals are competent, experienced and have the level of seniority within the organisational structure of the AIFM that allows them to challenge decisions by senior management at the level of the AIFM and also the delegate. An AIFM is also required to provide information on the extent of due diligence undertaken by it on the proposed delegates, as well on the frequency of reporting in relation to the services provided by the delegates. Furthermore, an AIFM is also required to provide a detailed explanation and evidence of the objective reasons for the delegation arrangements. The MFSA also has the discretion to assess the competency aspect of key persons involved at the delegate level. This discretion is generally exercised where the delegate is not a regulated entity.

The Authority's processes inter alia aim at ensuring that delegation structures which may have the purpose of circumventing the Directive are rejected. For example where: [a] the aim of the delegation structure appears to be that of circumventing the regulatory requirements in another Member State (regulatory arbitrage); [b] the AIFM does not have adequate oversight over the delegate; and [c] the AIFM does not have an acceptable level of local substance. Each application is of course assessed and considered on its own merits, however, such structures are considered by the MFSA as being inconsistent with the AIFM's obligation to provide objective reasons for the delegation to a third party service provider. Indeed, circumvention is not consonant with the requirement that a delegation structure is justifiable as long as it increases the efficiency of the conduct of the AIFM's business.

Conclusion

The correct implementation of the AIFMD without undermining the competitive position of the Malta fund industry was the main objective of the Malta implementation process. This paper provided a brief outline of the legislation, which transposes the AIFMD in Malta. It examined the application process for authorisation as an AIFM and the resulting challenges. The point is made that the lack of an EU harmonised approach to the interpretation of the requirements on delegation, has created uncertainty on the correct meaning and implementation of these requirements. As a consequence, the practical implementation of the AIFMD has proven to be more demanding than originally anticipated. Nonetheless, pragmatic solutions have been identified and implemented to address these difficulties.

Footnote

1. Dr Christopher P. Buttigieg is the Director of the Securities and Markets Supervision Unit of the MFSA and a member of the Authority's Supervisory Council. He has a D.Phil. in Law Studies from the University of Sussex and is a lecturer in the Banking and Finance Department of the University of Malta. Ms Clare Farrugia has a Banking and Finance Hons. degree from the University of Malta and is currently reading for an MSc in Finance and Financial Law at University of London. She is an analyst in the MFSA's Authorisation Unit. The authors would like to thank Professor Joseph V. Bannister, Chairman of the MFSA and Mr Joseph Agius, Deputy Director of the MFSA's Securities and Markets Supervision Unit, for their comments and suggestions on the paper. The views expressed in the paper are solely those of the authors at the time of writing and do not engage the MFSA.

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