The purpose of the Commission's review is to examine the scope and application of AIFMD to establish its impact on investors, AIFs and both EU and non-EU AIFMs, and to determine the extent to which AIFMD's objectives have been achieved.
The Commission is also mandated to propose legislative amendments to AIFMD on foot of its review. In this context, ESMA has written to the Commission with a number of recommended changes to AIFMD. Notably, a number of the recommendations proposed by ESMA also include corresponding amendments to the UCITS framework and so the proposals are of relevance not only to AIFMs, but also to UCITS and UCITS Management Companies.
ESMA's letter is extensive and includes recommendations for both policy and reporting enhancements to the AIFMD legislative framework. Changes are proposed across nineteen areas, including:
- harmonising the AIFMD and UCITS regimes;
- delegation and substance
- permissible MiFID services;
- liquidity management tools;
- the harmonisation of supervision of cross-border entities; and
- the AIFMD reporting regime.
The recommendations relating to delegation and substance will be of keen interest to all authorised AIFMs and UCITS Management Companies (including self-managed UCITS) and our detailed briefing on this aspect of ESMA's letter is available here.
This briefing will focus on some of ESMA's other key recommendations, as follows:
The harmonisation of the AIFMD and UCITS regimes
As an example of an area for potential harmonisation, ESMA cites the differences with regard to the risk management and liquidity management provisions in the AIFMD and UCITS regimes. ESMA recommends that the Commission should consider aligning the frameworks where appropriate, especially given that applying different requirements to management companies managing both UCITS and AIFs creates additional burdens for these firms as well as divergences in supervisory/regulatory outcomes and introduces unnecessary complexity for stakeholders.
ESMA also recommends that that once the AIFMD Annex IV reporting improvements have been made, that harmonised UCITS reporting should be generally aligned with these requirements, while allowing for tailoring to the characteristics of UCITS funds.
Scope of additional MiFID services - "MiFID top-ups"
ESMA notes that Member States have applied different interpretations to the rules around permissible business activities for AIFMs and UCITS Management Companies that are authorised to provide additional MiFID services. Consequently, the list of permissible business activities is broader in some Member States than in others. ESMA recommends clarifying the precise application of the MiFID rules (and/or AIFMD or UCITS rules) in a number of aspects including:
- the extent to which MiFID and/or UCITS or AIFMD rules could be applied to discretionary portfolio management or investment advice in relation to assets that are not financial instruments under MiFID, such as real estate; and
- which rules apply when investment management for an AIF or UCITS is performed on a delegated basis. There are divergences between national regulators on this point with some seeing it as discretionary management and so subject to MiFID, while others do not.
ESMA also recommends that the AIFMD, UCITS and MiFID frameworks should be clarified to ensure that AIFs, UCITS and their management companies, as well as MiFID investment firms always remain subject to the same regulatory standards when providing the same type of services (e.g. marketing).
Liquidity Management Tools
ESMA believes that the availability of additional liquidity management tools should be consistent throughout the EU. Noting the ESRB's recommendation on liquidity management tools ("LMTs") (available here), ESMA is proposing that the Commission include the availability of all the LMTs in AIFMD, and states that the availability of LMTs should also be included in the UCITS Directive (noting that certain LMTs will not be appropriate for a UCITS, e.g. side pockets).
Leverage and Reporting of Leverage
ESMA recommends that the means of calculating leverage be reviewed taking into account the IOSCO Recommendations for a Framework Assessing Leverage in Investment Funds, available here. This framework uses leverage as a baseline to identify funds that may pose a risk to financial stability. After this initial assessment, a risk-based analysis should be carried out on any such funds identified. When calculating leverage, the gross notional exposure method and the commitment method should be used. To ensure that AIFMD is aligned with IOSCO's framework, ESMA recommends amending the current reporting of gross method calculation as set out in the AIFMD Level 2 Regulation (Article 7). ESMA also sees merit in amending the commitment amount calculation.
In its recommendations on the AIFMD reporting regime, ESMA proposes the introduction of a definition of "leveraged AIF" and the removal of the current exemption for PE funds to report leverage at the level of the SPV.
ESMA's letter notes that the lack of clarity around what is meant by a "leveraged fund" creates difficulties for reporting entities who have to demonstrate to national regulators that they are in compliance with their leverage policy. Therefore, ESMA recommends that the definition of "AIF" and "leverage" should be linked and that a "leverage AIF" would mean:
"an AIF whose exposures are increased by the managing AIFM, whether through borrowing of cash or securities, or leverage embedded in derivative positions or by any other means".
ESMA notes in its letter that PE funds do not have to report leverage at the level of the structure that they invest in, which ultimately results in PE leverage being under-reported and could also "provide a way to bypass potential limits on leverage under Article 25". Accordingly, ESMA is recommending that the reference in the recital to AIFMD that PE funds do not have to report leverage at the level of the SPV be deleted. Additional amendments to Level 2 measures would also be required.
Framework for Loan Origination
ESMA recommends that there should be a specific framework for loan origination within the AIFMD. ESMA already issued an opinion on key principles for a European framework on loan origination by funds in April 2016. That opinion contains recommendations on authorisation for loan originating funds, types of funds (closed-ended vehicles), admitted investors (complying with ELTIF rules), and organisational and prudential requirements for loan-originating funds (e.g. leverage, liquidity, stress testing, reporting, diversification, etc.).
ESMA also states that should a need for loan funds to play a role in the post-COVID-19 economic recovery be identified, the recommendations in ESMA's opinion could be taken as a basis to ensure a sustainable role for loan funds, especially given that loan funds can only be closed-ended and can only be marketed to professional and semi-professional investors. ESMA notes that the ELTIF review is also an opportunity to consider the product characteristics of loan origination funds.
ESMA recommends that the Commission consider further clarifying the power of Member States to apply additional requirements under local law to sub-threshold AIFMs.
Harmonisation of cross-border supervision
AIFMs often use branches or third parties to delegate functions to across several different Member States and non-EU jurisdictions. ESMA recommends that the supervision of cross-border entities be harmonised across the EU and seeks clarification around what the responsibilities of the home and host supervisor are when it comes to marketing, management and delegation.
Annex II of ESMA's letter sets out the proposed changes to AIFMD reporting regime and data use. The Annex provides a detailed statement of the problems, and ESMA's proposed solutions, in respect of the following issues:
- Obligation to acquire a Legal Entity Identifier ("LEI") - ESMA recommends that AIFMs should be explicitly required to acquire and report an LEI for themselves and their AIFs.
- Detailed information on the composition of a fund's
assets and liabilities – AIFs are only
required to report certain information on the assets and
liabilities they hold, such as the main instruments involved, the
main categories of assets or liabilities held and the five main
sources of borrowed cash and securities. This lack of information
affects the overall usability of the data provided on foot of AIFMD
and creates additional reporting costs as internal data needs to be
transformed according to AIFMD-specific taxonomies, which are not
applicable outside of AIFMD. ESMA proposes amending AIFMD to
support the request of more granular information, which would be
prescribed in a delegated act. The objective would be to establish
minimum content that provides relevant information to allow
national regulators to analyse systemic risks. The information to
be reported should follow a number of principles, including that:
- it should be comprehensive so as to allow for comparison with the aggregated figures on AUM and NAV;
- detailed information on counterparties and issuers should be provided, including LEI numbers;
- when possible, the required data should be a direct extraction or straightforward transformation of internal data already maintained by AIFMs;
- the reported information should be based on strong international standards;
- the reporting template should consider other reporting regimes, such as MiFIR, EMIR, SFTR and ECB statistics, and the reporting template and data fields should be designed in the same way to allow for the internal data to be reused;
- information on the liabilities of AIFs should cover cash, deposits and /or loans held by the funds and the liabilities of the funds, both given short positions. Details on shares, units, loans, maturity and / or liquidity profiles and special arrangements should also be provided;
- for certain types of assets and liabilities some aspects of the reporting template under the Securitisation Regulation should be used as a reporting model, for other types of assets a general provision on minimum reported content should be included;
- any key information provided in the AIFM's annual report should be included in its report to its national regulator; and
- each item above should also consider its impact on AUM, NAV and leverage metrics.
Importantly, the above reporting obligations should apply to all funds and in particular those under the National Private Placement Regimes ("NPPRs"). Any new provision should also empower ESMA to draft technical standards on reporting.
Scope of entities in ESMA register – Sub-threshold AIFMs, funds under the NPPRs and non-EU AIFs managed by a non-EU AIFM with a passport are currently not submitted to the ESMA register. ESMA recommends that these entities are included in the ESMA register going forward. This will facilitate access to important information for investors and market participants required for their due diligence activities.
Timeline for the NCAs to update the ESMA register – ESMA recommends that NCAs should be required to update the ESMA register on a monthly rather than quarterly basis.
Reporting in percentages – as the use of percentages causes persistent quality issues for authorities, ESMA recommends that monetary values should be used instead.
Restrictions in the use and publication of the reported data – AIFMD provisions on professional secrecy are stricter than equivalent provisions in other sectoral legislation. Consequently, there is uncertainty as to whether AIFMD data can be shared even if anonymised. ESMA recommends that the use, distribution and publication of data in summary or aggregated form be permitted as long as market participants cannot be identified.
Delegated act defining reporting – ESMA suggests that they should be tasked with drafting the technical standards which support reporting by AIFMs to national regulators and the reporting from national regulators to ESMA.
Requirement to report ESG metrics – ESMA recommends that ESG factors should be considered in AIFMD reporting in order to monitor ESG related risk.
European mandate for ESMA and ESRB to analyse systemic risks
National regulators are tasked with analysing systemic risk, however, there is no express mandate to analyse this data by ESMA or ESRB at European level. ESMA recommends that ESMA and ESRB are given an express mandate to analyse systemic risks.
ESMA has also included recommendations in respect of:
- amendments to definitions;
- a potential depositary passport;
- the application of depositary rules to CSDs;
- convergence in the treatment of significant influence;
- semi-professional investors;
- convergence in the treatment of significant influence; and
- increasing digitalisation in AIFMD.
The Commission is expected to issue a consultation on its proposed changes to AIFMD in Q4 2020. If ESMA's recommendations are taken on board by the Commission, then they are likely to be included in the Commission's consultation. This will provide an opportunity for AIFMs and UCITS Management Companies to comment on these and other proposals. Any subsequent legislative proposals are likely to follow in mid-2021. The legislative proposals will then be subject to the EU's legislative process. Corresponding amendments to the UCITS framework can be expected if ESMA's recommendations are incorporated into the AIFMD framework.
We are closely monitoring the AIFMD review and will keep you updated on developments.
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.