On 29th November I attended the 6th AIFM (Alternative Investment Fund Managers) Directive 2016 Conference held by the Private Equity Forum and hosted in the auditorium at the London office of Simmons & Simmons. The content was heavy on regulation and had a large focus on Brexit. I was also able to have a conversation with the Director of Regulatory Policy at EFAMA (the European Fund & Asset Management Association) to discuss the increasing amount of EU regulation in further depth.
Over the past 8 years the increase in financial services reform has been driven by the 2008 crisis, resulting in 39 EU Directives & Regulations, 305 Implementing Measures and 232 Guidelines/Recommendations. AIFMD really is just the tip of the iceberg (although an important one to anyone in the alternative funds industry).
PRIIPS – Packaged Retail and Insurance-based Investment Products
This piece of regulation introduces the KID (Key Information Document) across the whole range of packaged investment products available, previously a KID or KIID was only applicable to collective investment schemes (funds). Whilst this was previously due to be implemented in 2017 it looks increasingly likely that it will be delayed until 1st January 2018 to coincide with implementation of MiFID II (see below), itself previously delayed.
Other than the matching implementation one of the delaying factors is clearly the unprecedented political decision (by the EU Parliament) to reject the Regulatory Technical Standards (RTS) developed between the European Supervisory Agency’s (ESA’s) and adopted by the European Commission. It remains to be seen how long it will take to come to a mutually agreed set of RTS.
Two main concerns regarding the PRIIPS KID still have to be addressed:
- Serious flaws in the methodology for calculating transaction costs giving erroneous / misleading results
- Past performance is no longer included in the KID – giving no easy opportunity for potential investors to compare the past performance of investment managers
MiFID II (Markets in Financial Instruments Directive 2)
MiFIR (Regulation on Markets in Financial Instruments)
The new updated directive and its accompanying regulation are set to have a major impact on the future of Asset Management. Whilst the asset management of UCITS (Undertaking for Collective Investments in Transferable Securities) funds and AIFs (Alternative Investment Funds) are covered under the UCITS V Directive and AIFMD (Alternative Investment Fund Management Directive) respectively, MiFID II and MiFIR will apply to any other asset management (e.g. bespoke, segregated portoflios), other services being provided in respect of UCITS funds or AIFs (e.g. distribution) will be covered under MiFID II/MiFIR.
Originally slated for implementation on 1st January 2017 this was pushed back by a year, however with 13 months left to go many aspects (e.g. the third country provisions) still require more details prior to implementation. Currently ESMA is consulting on guidelines for target markets for distribution, however given that the consultation documents indicate that ESMA thinks that portfolio management is a form of distribution clearly more work is required in this area.
CMU – Capital Markets Union
CMU is not a single directive or regulation, but rather a whole raft of reforms designed to “standardise” Capital Markets in the European Union under one single regime. Work is being carried out in phases, and success in some areas has been limited resulting in amendments to already “finalised” regulations.
To complete the first phase still requires implementation of the securitisation package and modernisation of the prospectus rules. The first phase also implemented two new fund “brands”, the EuVECA (European Venture Capital Fund) and EuSEF (European Social Entrepreneurship Fund), yet these fund types are already undergoing redesign. In a Briefing Paper to the European Parliament dated October 2016 it is stated that “take-up of EuVECA could be considered successful, the EuSEF results have been disappointing”.
The EU is clearly trying to come up with branding to follow the success of UCITS, however given that these funds are already subject to AIFMD the additional regulation is just adding more complexity & work. Given the low take-up in the EuVECA and EuSEF does not necessarily bode well for the ELTIF (European Long-Term Investment Fund) or PEPP (Personal Pensions Product), especially given that many EU countries already have national standards/products for personal pensions.
Many of the barriers to a true “market union” lie in the arena of taxation. Differences in national tax rates, some countries applying Financial Transaction Tax (“Tobin Tax”) and the levying of Withholding Tax (WHT) with differing and often complex refund procedures are all obstacles to the CMU. So long as tax discrimination remains within the EU true “union” will remain difficult to achieve.
AIFMD II or AIFMD Review?
Before leaping into what may come next for the Alternative Investment Fund Managers Directive, I would say that the prevailing feeling of the conference was that implementation of the third country passport has been firmly put on the backburner. This may well be to use as a stick or carrot in Brexit negotiations, however this may also be due to two of the five countries that have the ESMA recommendation being British Crown Dependencies.
Under Article 69 of AIFMD from 22nd July 2017 the European Commission commences a review of the application and scope of the Directive (yes it really will be three years since implementation!). This will include an analysis of the extent to which the objectives of AIFMD have been achieved and will also include a general survey. There is no deadline for the completion of this review, although it seems fanciful that any meaningful review can take place until the impact of the third country passport can be observed.
One big question is whether the scope of AIFMD is too broad, as currently any collective investment vehicle that is not a UCITS is an AIF (Alternative Investment Fund) if in the EU/EEA or may be an AIF if outside. Given that managers (not funds) are regulated under AIFMD this may require fundamental changes to the structure of the Directive.
Another area of potential change is to address the difference in remuneration treatment between AIFMD and UCITS V. Whether alignment comes via change to AIFMD or UCITS remains to be seen.
One area that personally I would like to see addressed in any review of AIFMD is the onerous reporting requirements, the results of which are presumably just sitting on servers somewhere since the national regulators must be wondering what to do with this mass of data. If it is truly designed to prevent systemic failure, then surely reviewing quarterly data received a month after the quarter-end is going to highlight any potential failure after such failure has or has not occurred. It is also ludicrous that when choosing the investment strategy of an AIF “equity” or “bond” is not an option and instead “other” must be selected.
The EC has no immediate plans to review the UCITS Directive again and move on from the current 5th version (or 4th if you take into account the absence of UCITS II). There is a specific clause to review the Sanctions regime in September 2017, but other than that UCITS currently seems largely fit for purposes (within the EU/EEA).
If AIFMD undergoes any significant changes it is likely that some of these will also be applied to UCITS, which may fit into the next sequel, along with alignment of the remuneration regimes applied under the two directives (whichever is updated to harmonise this).
There may be work to amend OTC derivative exposure limits to be consistent with EMIR (European Markets Infrastructure Regulation). There may be work done to amend leverage or share classes. There may also be some tidying to be done of outstanding “issues”. Regardless, UCITS VI is currently very low on the agenda.
Looking at the third country provisions within both AIFMD and MiFID II/MiFIR as well as any possible extension of the EuVECA and EuSEF brands to third countries, is there any possibility of extending to third country UCITS provisions? This is highly unlikely given the protectionist stance of the majority of EU member states. Some countries (Luxembourg, Malta, Ireland) may like to see the option of reciprocal recognition as a future tool to extend their offering into new jurisdictions or secure recognition of UCITS in countries where such recognition is currently available. These are clearly in a minority, and I feel a further article coming on about the “one-way” UCITS ultimately hampering global distribution of the brand…
My EU Regulatory Change: Conclusion
I haven’t even touched on some directives and regulations (the 4th Anti-Money Laundering Directive and General Data Protection Regulation being amongst them, and have sought to focus on fund and investment specific regulation. Clearly financial services businesses are going to have to continue to deal with a mass of changing EU regulation/legislation and this isn’t even considering ongoing international tax initiatives (FATCA, CRS, BEPS) or the requirements for selling funds into non-EU jurisdictions whether via registration or private placement.
Compliance Officers, Money Laundering Reporting Officers, Data Protection Officers, Lawyers, Accountants and Consultants clearly have employment for a long time to come. What is scary, and something that we all acknowledge, is that most international regulation is set by politicians with little understanding of the functioning of the financial services industry and markets. Sense does not often prevail, and industry is left counting the cost of increased compliance in an age where passing that on to the client is not easy.