ESMA's advice on whether AIFMD passports should be made available to non EU AIFMs and AIFs was published on 30 July, together with an ESMA Opinion on the current functioning of the AIFMD EU passport and of national private placement regimes.
This Briefing Paper highlights key points arising and also flags some of the separate initiatives which are consequential upon AIFMD issues being progressed by some of the offshore jurisdictions.
Third country AIFMD passports?
The AIFMD is intended to provide both management and marketing passports, and currently does so for EU AIFMs and AIFs. ESMA's new advice considers whether or not Articles 35 and 37 to 41 of the Directive might be activated whereby there may be a passport available to non EU AIFMs and AIFs (in place of the existing need to comply with the national private placement regimes under Articles 36 and 42).
Assessment per country
ESMA is assessing the position per country. It has identified 22 countries which are domiciles of non EU AIFMs that market AIFs into Member States or domiciles of non EU AIFs marketed in Member States but, at the moment, has decided that it only has a sufficient level of information to provide advice in respect of these six jurisdictions.
It is necessary to distinguish between the very different situations of a diverse range of third countries in terms of the demand for the passport, the access to the market of these non EU countries for EU funds and managers and their regulatory framework as compared to that of the AIFMD. Inevitably, any country which is not given a positive decision will be at some potential disadvantage.
ESMA is suggesting that the European institutions (the Commission, Parliament and Council) may wish to consider waiting until ESMA has delivered positive advice on the sufficient number of non EU countries before introducing the third country passport in order to avoid any adverse market impact as a decision to extend the passport to only a few non EU countries might have.
Of the assessments provided so far:
Positive opinions – i.e. "no obstacles" indications are provided regarding only three countries:
ESMA has confirmed that there is no significant obstacle impeding the application of the AIFMD passport to Guernsey: the MoU is viewed to work well, the joint Jersey and Guernsey Financial Services Ombudsman Scheme and alternative dispute resolution mechanisms are noted. The AIFMD-like regime which is an opt in regime for Guernsey AIFMs is noted, and the amendment to the depositary regime so that the AIFMD Depositary rules will apply under the opt in regime for all Guernsey AIFMs wishing to market their AIFs in the EU.
Similarly in relation to Jersey, ESMA is of the view that there are no significant obstacles impeding the application of the AIFMD passport to Jersey. The requirements for depositaries are similar to those under AIFMD but based on IOSCO principles rather than AIFMD requirements. The requirements for a custodian relate to open ended funds rather than closed ended funds whereas AIFMD focuses on the types of assets, custody or recordkeeping. A Jersey AIF depositary will need to comply with the AIFMD requirements in addition to the Jersey requirements. The Jersey requirements do though show the level of detail regarding functional independence which is similar to AIFMD (for recognised funds/OCIF funds) in more detail than for expert funds (under the Expert Fund Guide), whether closed or open ended, having to have an independent Jersey monitoring function in relation to the actions of the investment manager.
ESMA is of the view that there are no significant obstacles impeding the application of the AIFMD passport to Switzerland upon enactment of amendments to the Swiss Federal Act on Stock Exchanges and Securities Trading (SESTA) which are underway including provisions on co-operation. The amendments are due to enter into force on 1 January 2016. One potentially problematic current provision relating to the possibility for a decision of FINMA on the transmission of information to a foreign financial markets supervisory authority to be challenged by a client before the Federal Administrative Court is being changed. The amendments will introduce the possibility for FINMA to choose not to inform the client in advance of information being shared with a foreign regulator in cases where such prior information would undermine the purpose of the request and adversely affect the objectives of the requesting authority.
Delayed decisions are indicated in respect of a further three countries:
- United States:
ESMA advises a delay in decision to apply the passport to the US until such time as conditions which might lead to a distortion of competition are addressed. ESMA flags up that it remains generally more difficult to market foreign funds in the US especially to retail investors. Also ESMA thinks it would benefit from more time to assess detailed information on investor protection aspects to see whether the differences between the US regulatory framework and AIFMD are material.
- Hong Kong:
Detailed information on the regulatory framework is incomplete and therefore ESMA indicate they need more time to analyse the extent to which the potential differences in the Hong Kong regulatory framework and AIFMD are material. ESMA notes that some EU Member States are considered as "acceptable inspection regimes" for Hong Kong authorities but most of them are not and therefore it also not clear whether there is a level playing field between EU and non EU AIFMs as regards market access and whether EU AIFMs and EU AIFs are treated in the same way as managers and collective investment schemes of Hong Kong in terms of regulatory engagement.
There is however an indication of positive experiences of co-operation with the Hong Kong authorities with the expectation of good supervisory co-operation; ESMA is of the view that there is no evidence of complaints not being adequately tackled by the regulator in Hong Kong and the monitoring of systemic risk is regarded as assessed as "broadly implemented" in line with IOSCO objectives and principles regarding Principle 6.
Having assessed the information, ESMA advises a delay in their decision on the potential application of the AIFMD passport to Singapore. Reasons given include that information regarding the co-operation between regulators and the Monetary Authority of Singapore (MAS) is scarce and difficult to assess; and there is a need to assess the obstacle to competition further – the requirement that managers should have sufficient nexus with Singapore may create a barrier to market access in the context of making the AIFM passport available to Singapore managers, and there is some comment that currently only UCITS from Luxembourg, Ireland, France, UK and Germany are recognised in Singapore. There is also insufficient evidence to assess the position on monitoring systemic risk. ESMA does though think that overall the requirements in terms of investor protection do seem to be fulfilled.
The countries in respect of which ESMA has not yet issued an opinion are Australia, Bahamas, Bermuda, Brazil, BVI, Canada, Cayman Islands, Curacao, Isle of Man, Japan, Mexico, Mauritius, South Africa, South Korea, Thailand and US Virgin Islands. ESMA seem to envisage that there will be batches of assessments of these other countries.
It is interesting to note that given the predominance of third country fund structures, and notably hedge funds, in the Cayman Islands that it is not within the initially as-sessed countries. The Cayman Islands Government has recently proposed amendments which it is hoped will in-troduce a regime which is consistent with AIFMD after which ESMA may consider the Cayman Islands for an AIFMD passport extension when it carries out its forth-coming country by country review later this year.
In addition, ESMA has gathered intelligence particularly in responses to its Call for Evidence on the various criteria in respect of Malaysia, Egypt, Chile, Peru, India, China and Taiwan. Although some of these countries are viewed by market participants as countries where the access to the market for EU UCITS and AIFs is less difficult than the rest of the world, they have not been assessed in detail by ESMA currently because no MoU has been agreed with the relevant regulators and/or the current level of activity does not currently justify a detailed assessment. For these countries, ESMA will continue to endeavour to agree an MoU with the authorities for the relevant jurisdictions and will monitor the evolution of the level of activity.
Relevant criteria to be applied
ESMA indicates that it will "require a reasonable body of evidence" before considering the provision of a positive assessment for any jurisdiction against various criteria, with particular emphasis being put on the quality of super-visions liaison/engagement between the EU regulators and the relevant non EU regulator in that jurisdiction.
ESMA has identified criteria which is used to assess whether or not to extend the passport to non EU countries.
Articles 35 and 37 contain certain conditions about appropriate co-operation agreements, the third country not being listed as a non co-operative country and territory by FATF and a signed agreement being in place which complies with the standard Article 26 of the OECD Model Tax Convention on Income and on Capital and ensures an effective exchange of information in tax matters. ESMA have also focused on the Article 67 wording though which indicates that it should look at the following:
- investor protection
This heading may cover review of a diverse set of information including investor complaint handling by the local regulator; the local rules regarding the roles of the AIFM and depositary compared with those under AIFMD; and whether the regime is assessed as being broadly or fully implemented under each of IOSCO Principles 10 to 12.
- market disruption
Usefully, ESMA considers that the types of questions that could be applied under this heading encompass whether there is evidence that granting of the passport to non EU AIFMs would reduce or improve investor choice in the short long or the long run. One of the major issues with over regulation (and, in this instance, extending the scope of regulation under an EU Directive to have an impact outside of the EU) is that the actual impact is likely to reduce investor choice. It is therefore a positive that the issue is considered within the criteria.
This heading is also designed to prevent circumvention of AIFMD. The other example of market disruption issues which ESMA gives is the extent to which granting of the passport to non EU AIFMs and AIFs would unduly underline the activity of existing EU AIFMs due to differences in the regulatory environment in the non EU country and allow them to change their operating arrangements so as to circumvent AIFM.
Under this heading, ESMA will look at whether:
- the relevant non EU regulator (NCA) treats all EU jurisdictions equally;
- EU AIFMs and EU AIFs are treated in the same way as managers and collective investment undertakings of the relevant country in terms of regulatory engagement including fees and documentation to be provided prior to authorisation; and
- the process of the relevant non EU regulator for authorising EU AIFMs or allowing marketing of EU AIFs in the non EU country is reasonable looking at terms of clarity, predictability, costs and regulatory expectation.
Note that this leads on to consideration of whether there is a level playing field between EU and non EU AIFMs as regards market access, particularly in view of the procedures that would apply to non EU AIFMs under Article 37 if a passport were to be extended.
- monitoring of systemic risk
Questions ESMA has applied under this heading include whether there is tangible evidence of adequate surveillance of market developments with a view to tracking potential or actual systemic risks by the non EU country regulator (NCAs) and how the regulatory regime in a non EU country measure up against IOSCO Principle 6 that "the regulator should have or contribute to a process to monitor, mitigate and manage systemic risk, appropriate to its mandate."
Article 67 indicates that, where ESMA considers that there are no significant obstacles regarding these matters impeding the application of the passport for marketing of non EU AIFs by EU AIFMs or in the management and/or marketing of AIFs by non EU AIFMs in Member States, it shall issue positive advice. It is therefore focusing on these four areas.
ESMA however notes that the Commission and co-legislators may also wish to consider other matters – for example fiscal matters in the non EU country and the latest intelligence on the anti-money laundering and counter terrorism financing regime in the relevant country.
What if the third country passports are switched on?
Obviously this initial ESMA advice provides initial encouraging news for Jersey, Guernsey and Switzerland but it is only really the first step in this process as ESMA continues its work in assessment of other countries and then the European Parliament and the Council and the Commission then need to review ESMA's submissions. It would seem prudent for the European institutions to take up ESMA's suggestion that the new passports are not introduced until a sufficient number of the most relevant non EU countries have been the subject of positive advice from ESMA.
If and when there is a switching on of Article 37, it would appear that non EU AIFMs could continue to operate under Article 42 at least during the transitional period under Article 68 of the Directive, but ESMA asks for clarification as to whether this is the case. Also, ESMA asks for clarity on the fact that Article 37 refers to authorisation but not to registration and so, if Article 37 is switched on, the position for sub-threshold firms will need to be made clear.
Are the current EU AIFM and AIF passports, and NPPR regimes working?
ESMA's advice on extending the AIFMD passports should be reviewed in conjunction with ESMA's Opinion, also issued on 30 July, regarding the current functioning of the AIFMD EU AIF and EU AIFM passports and of the national private placement regimes. This looks at the functioning of Articles 36 and 42 which are currently in operation. Interestingly, ESMA comments that it sees merit in the preparation of another Opinion on the functioning of the passport after a longer period of implementation on Member States. Again therefore, whilst this initial Opinion is of interest in identifying some of the concerns, it is only really the beginning of the story on review of the AIFMD provisions.
In outline, ESMA takes the view that there is insufficient evidence to indicate that the AIFMD EU passport has raised major issues in terms of functioning and implementation but it has identified various issues:
- divergent approaches with respect to marketing rules including regarding local regulator's fees charged where AIFs are marketed and the definition of what constitutes a professional investor;
- varying interpretations of what constitutes marketing and material changes under the passport in different Member States.
In both areas ESMA wishes to see greater convergence. In relation to the assessment of the function of the national private placement regimes, ESMA suggests preparation of another Opinion after a longer period of implementation but is of the view that there is insufficient evidence to indicate that the regimes have raised major issues in terms of the functioning and implementation of the AIFMD framework. Various issues which we know to be of concern are flagged up. For example:
- If marketing for AIFMD purposes is limited to marketing after all fund documents are final and therefore ready for subscription, as indicated in the UK (see FCA Handbook PERG 8.37), this differs from the position in other jurisdictions where a wider approach is adopted regarding preliminary promotional activities. In the UK of course we are aware that we have our financial promotion regime covering items which are not AIFMD marketing but of course this is not replicated in all other Member States.
- To give another example, one can contrast the approach of the French authorities in requiring a local correspondent with that of the German authorities undertaking additional checks with the more straightforward approach of the UK or Dutch authorities. There seem to be various examples given of additional criteria inhibiting the functioning of the current arrangements.
The upshot with all these differences between Member States is that each country's position needs to be reviewed individually, which costs time and money.
Although ESMA delivered their Opinions within July as required under the Directive, as can be seen from the above outline of their content,
- they only cover some of the third countries so far and so would be incomplete regarding switching on Article 37, and
- in respect of reviewing the performance of the existing passport and NPPR regimes, ask for further time to process before ESMA forms a view.
These Opinions cover some of the most contentious issues discussed when the AIFMD Level 1 text was being settled in the first instance, so a considered approach is necessary. Contradictions in approach are still evident. In relation to its flagship initiative of Building the Capital Markets Union (CMU) in the EU, the Commission welcomes market led ap-proaches to facilitate in the creation of a European private placement market, and so one wonders how this fits with the perceived need to shut off the private placement option under AIFMD. Maybe relevant AIFMD Level 1 provisions is required and in particular whether the NPPR regimes should be switched off?
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.