Investors hurt by slow progress of AIFMD rollout

The European Securities and Markets Authority is moving forward on its work to extend an EU passport to non-EU countries under the Alternative Investment Fund Managers Directive, but uncertainties remain on the future of the system, experts say. 

In its advice paper to the European Parliament, which the European Council and the European Commission published last week, ESMA assessed six countries – Jersey, Guernsey, Switzerland, the US, Hong Kong and Singapore – should be among the first non-EU jurisdictions to get access to an Europe-wide passport under the AIFMD.

The European passport under the directive allows the marketing of an alternative fund product to professional investors through the EU, subject to the member state’s regulatory approval.

Only Jersey, Guernsey and Switzerland, however, have been recommended for inclusion by ESMA in the regime, as the regulator didn’t find any “significant obstacles” regarding investor protection, competition, market disruption as well as the monitoring of systemic risk, in these countries.

Decisions on Singapore, the US and Hong Kong have been deferred “due to concerns related to competition, regulatory issues and a lack of sufficient evidence to properly assess the relevant criteria”, ESMA said.

Pinsent Masons consultant Elizabeth Todd says the fact that ESMA has not been able to recommend the creation of the AIFMD passport for alternative fund managers based outside the EU is “not unexpected”.

She says: “[The decision is not unexpected] given that 18 months after the July 2013 transposition deadline, a number of the 28 member states had still not implemented AIFMD, so the EU AIFMD passport has not really had an opportunity to work.” 

Law firm CMS funds partner Cathy Pitt says “one of the slightly disappointing outcomes” of the advice paper by ESMA is that although it has only given positive advice in relation to Guernsey, Jersey and Switzerland, it still leaves an uncertain timeframe on when it will switch on the passport for third countries.

She says: “I don’t think we really have any nearer visibility on when or whether the passport will be extended to the other three jurisdictions or to others.” 

For Singapore, ESMA was concerned about barriers to market access and did not have enough information to assess the monitoring of systematic risk by the Monetary Authority of Singapore.

Additionally, because the Hong Kong regulator does not consider all EU countries to have “acceptable inspection regimes” and so restricts access to its markets, the decision on the country is delayed until all European managers have the same ease of market access in Hong Kong. 

However, experts say the assessment of the US by ESMA remains the most critical to look at.

According to ESMA, the extension of the AIFMD passport to the US can create an unlevel playing field between EU and non-EU AIFMs as regards market access.

ESMA said: “The market conditions of US funds dedicated to professional investors in the EU in the event that the AIFMD passport is extended to the US would be different from the market access conditions of EU funds dedicated to professional investors in the US, notably due to registration requirements under the US regulatory framework which generate additional costs.” 

It is “generally more difficult” to market foreign funds in the US especially to retail investors, EMSA also says. 

A foreign manager that does not want to establish funds in the US, which is the common practice to enter the market, but wants to market its existing foreign funds in the US can either sell its fund shares privately without registering the fund or receive approval to sell the fund from the Securities and Exchange Commission.

However, so far, only a few foreign funds use these routes, ESMA finds, as the US regulatory requirements “impose constraints on their ability to sell their shares in the US because of differences in business and regulatory environments between the USA and the country of origin”.

For all these reasons, ESMA’s recommendation is delayed until ”such time as conditions which might lead to a distortion of competition are addressed”. 

“The extension to the US remains absolutely critical,” says international law firm Hogan Lovells partner Nicholas Holman, as the very different regulatory environment as well as different political forces in the US could take the EU passport rules “quite a long time” to be extended.

ESMA also suggests that among the obstacles to extend the EU passport to the US is the conflict between European fund regulations and the US Volcker Rule.

The Volcker rule, which provides different obligations and restrictions on investment in hedge funds and private equity by banking entities, might have implications for European managers in the asset management industry “notably in relation to the scope of the entities that might qualify as ‘banking entities’ or ‘covered funds’”, ESMA says. 

Pitt says: “There are significant obstacles to European fund managers marketing foreign funds in the US and so if Europe wants to extend the passport to US fund managers that’d put US fund managers in a better position vis-à-vis Europe than European managers vis-à-vis the US.”

She concludes: “One of the effects of the AIFMD directive is supposed to increase investors protection but one of the consequences that European investors have seen is that they are being offered fewer funds because non-EU fund managers are effectively restricted to marketing their funds into the EU. They don’t have access to the passport, the national private placement regime is costly and in some jurisdictions basically doesn’t exist so we’ve seen a significant drop in investors’ choice. 

“If the passport can be rolled out to third countries then we can come closer to achieving the EU’s objective of investor protection.”