“Christmas has come early” was one fund industry professional’s reaction to recent European Commission proposals for AIFMD II reform. On the whole, changes have been kept to a minimum. For Luxembourg this means the alternative fund industry’s current business model will not change, but the country will have some more back-office tasks to manage, and to ensure some more substance.
Luxembourg fund industry professionals have been making numerous public and private pleas in recent months to “not try to fix what isn’t broken,” and these prayers appear to have been answered. “It is a restrained proposal: it leaves many sections of the AIFMD untouched, with any changes quite moderate,” noted Charlotte Chopping, a senior associate at Clifford Chance, speaking at the recent ALFI PE & RE conference.
Tweaks to delegation rules
A particular worry had been that the current ease of delegating portfolio management outside the EU could be restricted. “What ultimately has been proposed is very much a ‘let’s gather data and watch this space position’,” said Chopping. She went on to detail the main proposed changes to delegation rules.
If an AIFM delegates more portfolio management, or more risk management functions to entities located in third countries than it itself retains, the AIFM’s regulator will need to make an annual notification to ESMA of that delegation. “Managers are probably going to be required to provide this data to their regulator,” Chopping noted. She also highlighted that quantifying delegation flows might be difficult to define. There will also be some minimum substance requirements for a fund’s key regulatory functions.
No depositary changes
ESMA itself will have to report to the European Parliament, the Council and the Commission at least every two years on market practices regarding delegation to entities located in third countries. As well, ESMA will have to report on how competent authorities supervise delegation, including how they work to prevent the use of “letterbox” entities.
Another concern for the industry had been that passporting arrangements would be introduced for depositary banks as part of this package. These ideas have been dropped.
New norms for debt funds
Debt funds will see an up-tick in regulation. “The focus will be on mapping risks and taking very limited measures, mainly aimed at the AIFM,” said Joachim Cour, a partner at Elvinger Hoss Prussen, also speaking at the ALFI conference. So, while stating that “loan origination is an activity that can be conducted by AIFs and AIFMs throughout the EU, but when you harmonise such an activity you need to put a number of limitations around them,” he noted.
He detailed these limitations: debt fund AIFMs will need clear policies and procedures; there will be limitations in terms of investment - 20% for certain loans to certain financial sector participants; risk retention of 5% aligned with other market players; increased reporting to investors; and a limitation of 60% investment in loan originations by funds that are not closed ended.
On leverage, he noted that the “EU Commission acknowledges that loan originating funds do not use excessive leverage.” Hence the choice to not impose leverage limits, but that liquidity management tools should be made more widely available in all member states. By this he meant techniques such as redemption suspension, gating, deferrals of redemption, and swing pricing.
No Brexit factor?
Also worth noting, that Brexit has swirled around this discussion. It is a relief to many in the industry that political considerations over London’s status as Europe’s leading asset management hub have not intervened to force major change. But yet, life for UK, US and Swiss managers it to be made a touch more complicated. Could this be a nudge to decision-makers to consider the need to move more functions to the EU?
It probably won’t be until 2024 or 2025 until these new reform proposals go live. The legislative process will take time, as adjustments will be needed to both AIFMD and UCITS.