Any review of the Alternative Investment Fund Managers Directive (AIFMD) by the European Securities and Markets Authority (ESMA) is likely to make material changes to the current regulatory reporting framework.
Nearly all fund managers who do not comply with UCITS must file an Annex IV under AIFMD. This impacts a broad mix of firms, and comprises hedge funds, private equity, real estate, long-only managers, and even some family office and securitisation vehicles. The prescriptive nature of Annex IV is increasingly viewed as not being entirely relevant to some of these asset classes.
“The AIFMD is not 100% complete, and if we look at the reporting data firms are expected to submit, not all of it is relevant,” said Jean-Pierre Gomez, head of regulatory and public affairs in Luxembourg at Societe Generale Securities Services (SGSS), speaking at the Association of the Luxembourg Funds Industry (ALFI) conference.
“There is also recognition that institutional products – which manage capital on behalf of sophisticated clients – may not necessarily require such in-depth regulatory reporting. I believe the reporting requirements will change depending on the asset class involved following the review of AIFMD by ESMA.”
Any amendments to Annex IV would broadly be welcomed by the asset management industry, who regularly complain that aspects of the report are not entirely relevant to their business. The status of AIFMD’s review is presently unknown, although regulators have articulated that remuneration rules are not going to be altered despite industry pressure. The review is also likely to set the scene for ESMA’s review of the AIFMD passport, expected in 2018. As matters stand, the prospects do not look good for third countries, certainly following the UK’s departure from the Single Market.
Regulators – speaking at the ALFI conference in November 2016 – said reciprocity was key to any discussions with third countries. Third country equivalence has certainly slowed down, and very little in the way of development has been made since ESMA gave encouraging feedback to the first batch of jurisdictions in 2016. There is speculation that any US roll back of Dodd-Frank era reporting on fund managers or consumer protections would do it few favours in the equivalence process.
Any turmoil around equivalence could weaken the UK, particularly in its fund management industry. The issue may be slightly complicated for UK UCITS which will lose all passporting rights following Brexit. Some firms set about plans to establish Luxembourg or Irish master feeder structures but were immediately rebuked by lawyers and regulators who pointed out UCITS were restricted in how much of their assets could be invested into non-UCITS, third country funds.
“We may have a situation where UK UCITS convert into AIFs and use the National Private Placement Regime (NPPR),” acknowledged Gomez. Many are confident the UK will not diverge from the EU’s regulatory agenda. It is becoming increasingly likely the UK will permit certain EU bodies to retain oversight in some of its affairs during any transition period. Any major digression from EU law risks creating even more work for fund managers if the reporting templates are not the same, not to mention infuriating European regulators. Furthermore, many of the rules introduced under AIFMD or UCITS such as depositary liability and independent third party valuation have bettered the industry, and are supported by institutional investors.
Experts are confident equivalence is achievable. “The UK will obtain some form of equivalence. The country is complying with rules such as the Markets in Financial Instruments Directive II (MiFID II), and this should help its cause,” said Gomez.
Some UK firms are assessing how much substance will be required following Brexit. Management Companies (Mancos) which provide risk management oversight out of Luxembourg, Ireland or Malta, and delegate the running of the portfolio back to the investment manager, have seen good business and inquiries of late from UK firms. But this model is not guaranteed, a point made in a report by Brown Brothers Harriman (BBH).
“The question in a post-Brexit world is whether cross-border management companies will still be allowed to oversee UK funds? And will UK asset managers be able to oversee funds in other EU countries? If not, asset management firms will have to bifurcate their cross-border management companies, causing them to lose economies of scale as they will incur extra costs and inefficiencies for creating one for the UK and one for the EU,” read the BBH report.
Nonetheless, firms have been warned by a number of EU regulators that they must obey the EU’s rules on substance, a point reinforced by the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg.
Brexit has caused understandable angst in the asset management community. A study by PricewaterhouseCoopers (PwC) on behalf of FTFM found 85% of asset managers thought it was going to be necessary to relocate some UK based investment staff to the EU following Brexit. Nearly a quarter told the PwC study that they were in the beginning stages of relocating staff.