Passport control: inside ESMA’s review of the AIFMD passport

This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.

Summary and implications

The European Securities and Markets Authority (ESMA) published the results of its consultation on the AIFMD marketing regime last week. In short, there is little ground-breaking news: ESMA says it is too early to properly comment on the functioning of the passport and it looks like it will adopt a laboured, jurisdiction-by-jurisdiction approach to extending the passport to non-EU jurisdictions; all of which was widely expected in advance of ESMA's official publication.

• ESMA essentially dodges the main question: how well is the AIFMD marketing system working? Instead, ESMA recommends a further opinion in the future when there has been more time to properly evaluate the marketing regime. It highlights some concerns (such as, surprise surprise, varying definitions of "marketing"), but concludes for now that the AIFMD is causing no serious impediment to the European funds market.
• ESMA concludes that no significant obstacles exist to impede the extension of the passport to Jersey, Guernsey and Switzerland (although in the Swiss case, this is subject to some legislative amendments being passed).
• ESMA suggests the passport should not be extended to the US, Hong Kong or Singapore yet, whilst ESMA continues to assess the supervisory regimes in those jurisdictions.

The current position

At present, only EU AIFMs managed by EU AIFs, are able to use the AIFMD passport in order to market to investors in different EU jurisdictions. However, the AIFMD allows for the passport potentially to be extended in the future. This is the context for ESMA's review.

In anticipation of ESMA's opinion and advice, we considered the positive and negative responses provided in the various responses to ESMA's call for evidence (the consultation), which was launched in November 2014. These included:

The good…

• The AIFMD passport provides investors with a harmonised ability to access different jurisdictions. Therefore, extending the regime will provide increased internal market competition and efficiency.
• A number of non-EU jurisdictions such as Switzerland, Jersey and the Cayman Islands have already taken positive steps to align their national private placement regimes ("NPPRs") with the AIFMD – therefore an extension of the AIFMD passport should not be too difficult.
• The majority of EU-managed hedge funds are established in non-EU jurisdictions. Extending the AIFMD passport would make them more accessible to investors.
• Extension of the AIFMD passport will significantly reduce operational complexity and legal costs, particularly due to the harmonisation of reporting requirements.
• EU AIFMs are already required to comply with the requirements under the AIFMD passport so implementation should be straightforward.

And the bad…

• Inconsistent interpretations of "pre-marketing" and "marketing" between different Member States.
• Different approaches taken by regulators of different Member States, for example some regulators impose additional fees and some jurisdictions have gold-plated rules.
• It is too early to extend the AIFMD passport, given the current lack of experience with AIFMD in practice.
• Conflicts between EU legislation and non-EU jurisdiction legislation mean that the extension of the AIFMD passport would be unworkable in practice.
• Not all non-EU jurisdictions have AIFMD equivalent standards. Implementation of the AIFMD passport in these jurisdictions could be a challenge.
• Extending the AIFMD passport will lead to market disruption for investors and increased operational costs.

Opinion on the functioning of the AIFMD passport and NPPRs

In its assessment of the functioning of the AIFMD passport and the NPPRs, ESMA concludes that certain Member States' delay in implementing the AIFMD has contributed to a lack of experience with the AIFMD in practice. This makes a definitive assessment of the functioning of the AIFMD passport and the NPPRs difficult at this stage.

ESMA believes there would be merit in preparing another opinion on the functioning of the AIFMD passport and the NPPRs. This opinion should be published after a longer period of implementation of the AIFMD in all Member States.

At this early stage, there is insufficient evidence to indicate that either the AIFMD passport or NPPRs have raised major issues. However, ESMA raises the following concerns in relation to the functioning of the AIFMD passport:

• varying interpretations between different Member States of what activities constitute "marketing" and "material changes" under the AIFMD passport between different Member States;
• different interpretations of what constitutes a "professional investor"; and
• contradictory approaches to marketing rules, including different levels of fees charged by the national competent authorities of different Member States.

ESMA has, therefore, suggested greater convergence between Member States in their interpretations of these terms but has not offered any recommendations as to how this might be achieved.

Advice on extending the AIFMD passport to non-EU jurisdictions

ESMA's advice on extending the AIFMD passport to non-EU jurisdictions is structured as a country-by-country assessment of the potential extension of the AIFMD passport to the following six jurisdictions:

• Guernsey;
• Jersey;
• Switzerland;
• the United States;
• Hong Kong; and
• Singapore.

These six jurisdictions were selected on the basis of a number of factors, including the amount of activity already being carried out by entities from these jurisdictions under the NPPRs, the existing knowledge and experience of EU national competent authorities with respect to their counterparts in these jurisdictions and the level of information available to ESMA in relation to these jurisdictions. A summary of ESMA's advice in relation to each of these jurisdictions is provided below.

United States

A potential extension of the AIFMD passport to the US would lead to the risk of an uneven playing field between EU AIFMs and non-EU AIFMs with regard to market access. Due to requirements under the US regulatory framework, the market access conditions of US funds which are dedicated to professional investors in the EU would be less restrictive than market access conditions for EU funds dedicated to professional investors in the US.

ESMA therefore advises that any decision on the application of the AIFMD passport to the US be delayed until such time as conditions which might lead to a distortion of competition are addressed.

Guernsey and Jersey

Guernsey and Jersey have the framework in place in order to address systemic risks and which entails similar obligations to those under the AIFMD. Therefore, ESMA is of the view that there are no significant obstacles regarding investor protection, competition, market disruption and the monitoring of systemic risk which would impede the application of the AIFMD passport in Guernsey and Jersey.

Hong Kong

A potential extension of the AIFMD passport to Hong Kong would lead to the risk of an uneven playing field between EU AIFMs and non-EU AIFMs with regard to market access. Hong Kong Authorities consider only some EU Member States to be "acceptable inspection regimes" and, therefore, there is some uncertainty as to whether all EU AIFMs would benefit from the same market access conditions in Hong Kong as Hong Kong managers would benefit from in the EU.

Detailed information on the Hong Kong regulatory framework remains incomplete. When ESMA's advice was finalised, ESMA was still in contact with the Securities and Futures Commission with a view to gathering more information on the Hong Kong regulatory framework.

Therefore, ESMA advises that any decision on the application of the AIFMD passport to Hong Kong is delayed until the extent of the potential differences between the Hong Kong regulatory framework and the AIFMD are clear and can be analysed. Such differences may be material to the assessment on the potential application of the AIFMD passport to Hong Kong.

Switzerland

A process is underway in Switzerland to enact certain amendments to the Stock Exchanges and Securities Trading Act ("SESTA") which relate, in particular, to the sharing of information in certain circumstances by the Swiss Financial Market Supervisor Authority ("FINMA") to foreign regulators without a requirement on FINMA to inform clients of this.

Subject to the enactment of the amendments to SESTA, ESMA is of the view that there will be no significant obstacles impeding the application of the AIFMD passport in Switzerland.

Singapore

The 2013 IMF financial sector detailed assessment of implementation on IOSCO objectives and principles of securities regulation on Singapore (the "FSAP Report") concluded that the Monetary Authority of Singapore ("MAS") does not meet high standards with regard to the ongoing supervision of authorised firms. The FSAP Report suggests that this may lead to difficulties with the reporting and monitoring of systematic risk.

Detailed information on the Singapore regulatory framework remains incomplete. When ESMA's advice was finalised, ESMA was still in contact with MAS to gather more information on the Singapore regulatory framework. ESMA therefore advises that any decision on the application of the AIFMD passport to Singapore is delayed as there is not enough evidence to assess if there could be significant obstacles to monitoring systemic risk which would impede the application of the AIFMD passport to Singapore.

What next?

ESMA's opinion and advice have been provided to the European Parliament, the Council and the Commission, who may decide to extend the AIFMD passport by passing a Delegated Act through the European Parliament or, alternatively, consider waiting until ESMA has delivered further advice supporting the extension of the AIFMD passport to additional non-EU jurisdictions.

In the coming months, ESMA intends to deliver further submissions about extending the AIFMD passport to other non-EU jurisdictions. ESMA also intends to prepare a further opinion on the functioning of the AIFMD passport and NPPRs, but intends to deliver when it considers the AIFMD has been implemented for a sufficiently long period.