AIFMD reforms: ‘Not the car crash everyone was expecting’

The proposal seeks to amend the Alternative Investment Fund Managers Directive including disclosures to investors and the scope of ELTIF regulation.

The European Commission’s long-anticipated draft proposals amending the Alternative Investment Fund Managers Directive have been more modest than the stricter requirements expected, industry sources have told Private Equity International.

In late November, the commission published its proposed changes to AIFMD, a review of which has been going on since 2017. It also proposed amendments to the Undertakings for the Collective Investment in Transferable Securities directive on delegation, liquidity risk management, data reporting and regulatory treatment of custodians so that it and AIFMD are aligned.

“The changes are not the car crash that everyone was expecting, although there’s still a fair amount of detail to come out in terms of the loan origination fund regulation,” Steven Ward, a partner at Squire Patton Boggs, tells PEI. There may be even tighter requirements, he adds.

“What the European Commission seems to be saying now is, ‘We will bide our time because we need to build our picture of how we manage this without damaging the financial systems of the EU at a particularly sensitive time’,” Ward says.

The proposals note the continued trend of UCITS and AIFMD convergence, particularly as authorities seek to democratise illiquid assets for retail investors through the UK’s Long-Term Asset Fund and the European Long-Term Investment Fund structures.

What’s ahead for ELTIFs?

As part of the review, the European Commission had proposed to broaden the scope of the ELTIF, an investment framework that aims to increase retail participation in long-term private investments. Only around 28 ELTIFs have been established, with a total asset base of less than €2 billion, the commission said in October.

Revisions to ELTIF regulation include allowing ELTIFs to invest in fund of funds managers; clarifying the definition of real assets; including securitisations in the scope of ELTIF-eligible assets and removing barriers for retail investors.

The proposals, however, are unlikely to result in much greater interest in the vehicles by direct PE managers, sources told PEI.

“The structure itself hasn’t done anything near what it’s intended to do,” says the founder of a London-based advisory firm that helps structure private market products for retail investors. ELTIFs are mostly used by private banks to sell products to high-net-worth individuals who are not classified as professional investors under the EU’s Markets in Financial Instruments Directive regulations, he adds.

While the commission’s reforms contemplate ‘retail’ and ‘professional’ ELTIFs, policymakers opted against pursuing a ‘semi-professional’ option comprising a vehicle with a lower regulatory burden, according to Samuel Brooks, a partner at law firm Macfarlanes.

“All non-professional investors remain subject to full suitability assessments, even under the proposed reformed rules. This will be new to most PE managers, and entails costs, operational changes and regulatory risk,” Brooks says.

Brooks also notes that the ELTIF rules provide retail investors with a two-week window after subscription in which they have a right to withdraw. “This right could apply after each capital call and drawdown, and as such does not work well with PE managers’ investment and operating models,” he says.

How the UK responds to these proposals will be key, according to Ward.

“The UK has left the EU, so it doesn’t have to implement these changes. The Treasury and FCA had previously stated that the UK did not intend to diverge from the AIFMD, but as time goes on… the UK may decide that hewing close to the EU on fund regulation is not worthwhile and that it may derive some competitive advantage from streamlining some of the requirements,” Ward adds.

Delegation will continue

The commission’s draft proposals tighten the rules on delegation – which allow alternative investment fund managers to delegate certain tasks, such as portfolio and risk management functions – in the form of additional reporting and information gathering, while ensuring delegation models are preserved.

The UK’s departure from the EU gave rise to an increasing focus on delegation as the UK went from being a member state to a ‘third country’.

While Brexit is not mentioned in the commission’s proposed changes, there is anxiety about portfolio management functions being carried out in third countries outside of the EU’s regulatory net, Ward notes.

“The commission seems to be quite measured in its approach,” he says. “Rather than looking to impose restrictions, what it effectively seems to be saying is, ‘We are going to hold fire for now, collect further information on delegation of portfolio management or risk management functions to non-EU entities, and then see where we are’.”

Heavily restricting delegation outside of the EU for AIFMD would mean also applying it for UCITS, which has already been successful in the amount of cash it manages in both Asia and the US, Ward explains.

“If delegation is then restricted to third countries, you can’t just pinpoint the UK – you are also effectively cutting off huge amounts of management in Asia and US for the UCITS regime, which will be hugely detrimental for European investors and damaging for the UCITS brand,” he says.

No third country passport

Given the multiple references to how private placement regimes create an unlevel playing field for third country AIFMs, the industry was expecting a substantial increase in the compliance burden for third country AIFMs using the National Private Placement Regimes. This has not happened, and there has been no mention of third country passport.

“That has been kicked well and truly into the long grass and no one is looking for it,” Ward says.

He adds that the lack of mention of the third country passport may also be a pragmatic realisation that many European regulators simply do not have the bandwidth to supervise the activities of third country AIFMs and their compliance with the AIFMD.

The proposals are open to feedback until 21 January, after which they will be presented to the European Parliament and Council.

– Adam Le contributed to this report.