AIFMD permits funds to be marketed in the EU under either the Passport (available to EU AIFs with EU AIFMs) or, in all other cases, the national private placement regimes (“NPPRs”) of each member state. Non-EU AIFMs or the AIFMs of non-EU AIFs can currently only access EU investors under the NPPRs, which can be difficult and costly to navigate and, for some jurisdictions, is not possible at all. CMS has published guides to marketing AIFs under the both the Passport and the NPPRs.
AIFMD contemplates the extension of the Passport to third country AIFs and AIFMs. The process for “switching on” the third country Passport begins with ESMA providing advice to the EU legislators. ESMA’s preparation for giving this advice began with a Call for Evidence published in December 2014 and a first advice paper published on 30 July 2015. See our previous report for details.
Following a request from the Commission, ESMA has now published further advice. ESMA considers each jurisdiction on a case by case basis by reference to certain criteria and has now assessed twelve jurisdictions in total: Australia, Bermuda, Canada, the Cayman Islands, Guernsey, Hong Kong, the Isle of Man, Japan, Jersey, Singapore, Switzerland and the United States.
The approach ESMA has adopted has been to consider whether there are any significant obstacles to the extension of the Passport to third countries in relation to: investor protection; market disruption; competition; and the monitoring of systemic risk.
Investor protection
While ESMA may consider a number of factors in relation to investor protection, it particularly highlights the following:
- The approach that the third country’s national competent authority (“NCA” – eg the FCA in the UK) takes to investor complaints and whether there is evidence of complaints not being adequately tackled by the NCA.
- The rules or mitigants of the relevant country in relation to (a) the safeguarding of assets, (b) the function of the depository and management of conflicts of interest between the AIFM and the depository, (c) the prudential soundness of the AIFM, (d) the timeliness and accuracy of disclosures to investors and (e) the alignment of incentives between the AIFM and investors and in particular, insofar as those rules or mitigants exist in the relevant third country, the extent to which they measure up to those in AIFMD.
- How the third country’s regulatory regime measures up against the relevant IOSCO principles, in particular principles 10 to 12 relating to regulatory and supervisory engagement (including whether the regime is assessed as being at least “broadly implemented” under each of these principles).
- The scope of the relevant NCA’s regulatory oversight with respect to the range of intermediaries and vehicles operating in the particular third country.
ESMA notes that a non-EU AIFM intending to market or manage under the Passport will have to be authorised by the NCA of their Member State of reference. In ESMA’s view, this means that the relevant NCA will have to verify that the non-EU AIFM will comply with AIFMD. Accordingly, it is not necessary that the local regulatory regime of the third country be assessed as equivalent to AIFMD, since AIFMD (notably the remuneration rules and the depositary rules) will have to be complied with regardless. That said, ESMA notes that where there are considerable gaps between the third country regulatory regime and AIFMD, it will be more challenging for the relevant NCA to verify compliance with AIFMD. Accordingly, ESMA considers it relevant to assess the regulatory regime of the third country in order to identify any key areas of difference or incompatibility with AIFMD.
In relation to the twelve countries assessed so far, ESMA has clearly found it easy to conclude there are no significant obstacles to investor protection in those jurisdictions that have adopted regimes that simply replicate AIFMD (eg Guernsey and Jersey). Bermuda and the Cayman Islands are also adopting this approach but, since their regimes are still being implemented, ESMA has not been able to give positive advice that there are no significant obstacles to investor protection.
ESMA’s role was more difficult in relation to countries such as Australia, Canada, Japan and the US, whose systems of regulation have evolved independently of AIFMD.
ESMA noted that the regulatory systems in these jurisdictions tended to adopt a different approach to safeguarding assets than that set out in AIFMD and also that the AIFMD rules on remuneration are generally not reflected in those countries, potentially leading to a different approach to investor alignment. However, bearing in mind that there is no need for exact compatibility, ESMA did not see these factors as presenting significant obstacles to extending the third country Passport to those countries.
Market disruption
Particular questions highlighted by ESMA are:
- The extent to which granting a third country Passport would unduly undermine the activity of existing EU AIFMs due to differences in the regulatory environment in the third country and allow EU AIFMs to change their operating arrangements so as to circumvent AIFMD.
- The extent to which the granting of the third country Passport would reduce or improve investor choice (in the short term or the long term).
Having set these questions, in the majority of cases, ESMA found itself unable to answer them. For all twelve jurisdictions, it was felt that the extension of the third country Passport would probably or might result in more AIFs from that jurisdiction on the EU market but that it was difficult to predict this or the impact on investor choice.
In relation to Guernsey, the Guernsey Financial Services Commission had attempted to put some numbers around possible net inflows into the EU and had particularly commented on the possibility that an increased number of infrastructure funds might become available on the EU market. Conversely in the Cayman Islands, the Cayman Islands Monetary Authority indicated that it thought there would be limited impact on EU markets since most Cayman funds are managed by US managers and marketed outside the EU. For Japan, it was felt that the main effect might be on the availability of the J-REIT on EU markets. However, since J-REITs are traded on exchange, it is difficult to assess current levels of EU ownership of J-REITs for comparison purposes.
Competition
The general approach appears to be that you can show us your funds if we can show you ours. In other words, ESMA will consider whether the extension of the Passport to a third country would give that third country greater access to EU investors than EU managers have to investors in that third country.
Where ESMA identified possible issues with the level playing field, it was careful to draw a distinction between the regimes for marketing EU funds to retail investors in a third country and the regimes that would apply to marketing to professional investors. The AIFMD Passport only permits marketing to professional investors in the EU and it would seem appropriate to adopt a “like for like” approach to assessing the level playing field.
In commenting on whether competition concerns presented a significant obstacle to the extension of the third country Passport, ESMA noted that, if assessed by reference to the regime for AIFs only, there were no concerns in relation to Hong Kong and Singapore but that both jurisdictions operate regimes that facilitate the access of UCITS from only certain EU Member States to retail investors in their territories. If Australia extends to all EU Member States the ‘class order relief’, currently available only to some EU Member States, from some requirements of the Australian regulatory framework then there would be no significant obstacles from a competition perspective. In relation to the US, ESMA considers there is no significant obstacle for funds marketed by managers to professional investors which do not involve any public offering. For other cases, there is a risk of a non-level playing field and therefore it might be appropriate to limit any extension of the Passport, or make it subject to conditions, in order to mitigate this risk.
Monitoring systemic risk
Questions posed by ESMA include:
- Is there tangible evidence of adequate surveillance of market developments with a view to tracking potential or actual systemic risks by the NCA in the third country?
- How does the regulatory regime in the third country measure up against IOSCO principle 6 [1]?
In most cases, ESMA found that there were no issues in relation to the monitoring of systemic risk that would represent a significant obstacle to the extension of the third country Passport. It was noted that the Cayman Islands are working on the development and implementation of a framework expected to enhance existing systemic risk monitoring and that ESMA will not be in a position to provide definitive advice until these changes have been put in place (expected to take 12-18 months).
The implications for the UK, post-Brexit
If the UK were to leave both the EU and the EEA and thus become a “third country” for AIFMD purposes, how would it measure up against ESMA’s criteria?
- Investor protection. The FCA has indicated that, at least in the short term, there are no plans to make major changes to UK financial services law and regulation, even where it implements EU legislation. Assuming that this does not change during the Brexit negotiations, the UK would retain a system that is, ipso facto, AIFMD-compliant. It would therefore be difficult, we suggest, for ESMA to advise that there were significant investor protection obstacles to the extension to the UK of the third country Passport.
- Market disruption. The inability to assess the impact on the EU of the extension of the third country Passport to the third countries assessed to date, has not led ESMA to conclude that there would be significant market disruption obstacles to the extension of the third country Passport. We would not expect ESMA to approach the assessment of the UK any differently. Of course, the UK would be in a somewhat unique position among third countries in that refusing to extend the third country Passport to the UK would have the practical effect of removing the Passport from certain AIFs and AIFMs that currently benefit from it. If ESMA takes this into account, it would be reasonable to conclude that extending the third country Passport to the UK would have a beneficial effect on EU markets, inasmuch as refusing to extend it would potentially reduce EU investor choice.
- Competition. Much depends on the politics of the Brexit negotiations. UK negotiators will no doubt bear in mind the approach taken by ESMA in formulating its advice in relation to, for example, the US, Hong Kong and Singapore, and will think carefully before withdrawing EU managers’ access to UK investors. Provided the UK keeps an open approach (and there is every reason to think that it will), we think it would be difficult for ESMA to advise that there were significant competition obstacles to the extension to the UK of the third country Passport.
- Monitoring systemic risk.To date the only third country not given a “green light” in relation to monitoring systemic risk is the Cayman Islands. This seems to stem mainly from the fact that improvements to current systems that are currently underway make assessment of the position difficult. Given the UK’s established and developed approach to monitoring systemic risk, we suggest it is unlikely that ESMA’s assessment were to be that there were significant systemic risk obstacles to the extension to the UK of the third country Passport. The position of a post- or pending-Brexit UK under AIFMD is somewhat unique. The published criteria and the fact that these are applied by ESMA as regulator, give grounds to suppose that the UK will be treated like other third countries. We can therefore use the assessments carried out in relation to twelve other jurisdictions, and the advice ESMA has published, to draw conclusions as to the UK’s continuing ability to access EU investors. [1] “The Regulator should have or contribute to a process to monitor, mitigate and manage systemic risk, appropriate to its mandate.”
