The European Commission is currently reviewing the Alternative Investment Fund Managers Directive (the “AIFMD”). The European Securities and Markets Authority (the “ESMA”) wished to contribute to this review. In an open letter addressed to the European Commission, the ESMA suggested to the European Commission changes in 19 areas including harmonising the AIFMD and UCITS regimes, delegation and substance, liquidity management tools, leverage, the AIFMD reporting regime and data use and the harmonisation of supervision of cross-border entities.
This briefing focuses on the area of delegation and substance, which is very important in practice for management companies. The ESMA is aware that the delegation is widely used by management companies and anticipates that in light of the withdrawal of the UK from the EU, delegation of portfolio management functions to non-EU entities is likely to further increase.
Extent of the Delegation
The concern of the ESMA is that an extensive use of delegation may increase operational and supervisory risks. This also raises questions as to whether AIFs and UCITS would still be effectively managed by the licensed AIFM or UCITS management companies having recourse to a delegation to a large extent.
Currently, the limit is the following: delegation shall not result in the AIFM management companies being a letter-box that could not be considered anymore to be the manager of the relevant AIF. Article 82 of the Commission Delegated Regulation (EU) No 231/2013 that supplements the AIFMD (the “Delegated Regulation”) provides further criteria (e.g. “the AIFM no longer retains the necessary expertise and resources to supervise the delegated tasks effectively and manage the risks associated with the delegation”). However, the ESMA is calling a more concrete drafting. In particular, the ESMA suggests to complement the Delegated Regulation mentioned above with “clear quantitative criteria or provide a list of core or critical functions that must always be performed internally and may not be delegated to third parties”.
Applicable regime in case of delegation and regulatory arbitrage
The ESMA notes that in practice, the delegates are subject to different regulatory regimes, which adds further regulatory complexity for the EU National Competent Authority (the “NCAs”). This may result in differences of regime at national level for such delegates, and, as noted by the ESMA, “possible circumvention of AIFMD/UCITS regulatory standards” (i.e. regulatory arbitrage). One of the main concern of the ESMA is that in the case of delegation to non-EU delegates, “the regulatory arbitrage and investor protection concerns may be further increased since the non-EU delegate will not be directly subject to the AIFMD or UCITS frameworks”. As a result, AIFs could actually be largely managed on a dayto-day basis by third parties that are not directly subject to the AIFMD. The ESMA would recommend legislative amendments to ensure that “the management of AIFs and UCITS is subject to the regulatory standards set out in the AIFMD and UCITS frameworks, irrespective of the regulatory license or location of the delegate.” This remains vague and if extra-territoriality is what the ESMA has in mind, it may be difficult to be implemented in practice.
Use of seconded staff
The ESMA has observed an increasing use of secondment arrangements where seconded staff was not operating in the Member State of establishment of the authorised AIFM or UCITS management company, but in another Member State including outside of the EU. Unsurprisingly, the ESMA mentioned the case where the staff of other group entities are seconded to the authorised entity in the EU but continue to work from their usual offices outside of the EU on a secondment basis, rather than a delegation basis. The ESMA does not provide further view on the preceding but points out that “this raises questions whether those secondment arrangements are in line with the substance and delegation rules set out in the AIFMD and UCITS frameworks. Further legislative clarifications could be helpful to address these questions”. One may expect (and hope) that the European Commission will provide more guidance for this to avoid differences of assessment between NCAs.
List of collective portfolio management functions and distinction from “supporting tasks”
As reminded in preamble (77) of the Delegated Regulation, the delegation limitations and requirements should apply to the management functions set out in Annex I of the AIFMD, whereas “supporting tasks, like administrative or technical functions assisting the management tasks such as logistical support in the form of cleaning, catering and procurement of basic services or products, should not be deemed to constitute delegation of AIFM functions”. This list is not comprehensive and the ESMA mentioned the current uncertainties in respect of (i) legal or compliance tasks, (ii) research activities or (iii) risk data analyses or calculations. NCAs expressed divergent views as to whether such activities qualify as mere “supporting tasks” or rather as collective portfolio management functions subject to the delegation regimes set out in the AIFMD and UCITS frameworks.
White-label service providers
White-label occurs in the fund industry where AIFM management companies provide services to third parties delegate investment managers that are not themselves subject to the AIFMD. As noted by the ESMA, NCAs in other Member States have expressed doubts as to whether those business models would be in line with the AIFMD and UCITS regimes. The ESMA recommends to strengthen the regulatory framework of such business model in particular to tackle potential conflicts of interests (where the initiator/business partner is appointed as investment adviser, the authorised AIFM or UCITS management company will face significant conflicts of interest since controlling and challenging the investment adviser in the best interest of investors may come at the risk of losing a client/business partner and therefore losing its own revenue/management fees).
Next steps
The European Commission plans to launch a public consultation on its proposed changes to AIFMD in early autumn 2020. No further guidance of European Authorities on the topics mentioned above is expected by then. Subsequent legislative proposals should follow in mid-2021.
