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ESMA Letter to European Commission on AIFMD Review

28 August 2020

ESMA wrote a letter to the European Commission on August 18th highlighting areas to consider during the forthcoming review of the AIFMD. The Commission is expected to publish a consultation on AIFMD in September and a legislative proposal amending AIFMD is targeted for publication in Q2 2021.

While there are some positive elements included in the ESMA letter, many of the suggestions could pose challenges for our member firms both from a cost and business model perspective. Additionally, ESMA propose that many of their AIFMD recommendations should also be applied to the UCITS Directive when it is reviewed. Irish Funds will be engaging with the European Commission and ESMA in advance of the publication of any legislative proposal and with the co-legislators (Council and European Parliament) throughout the upcoming review.
The ESMA letter includes recommendations for changes in 19 areas. This note highlights the main points from the most relevant recommendations.

1. Harmonisation of AIFMD and UCITS regimes
ESMA is calling for more granular rules for UCITS to match those provided by AIFMD Level 2 requirements. ESMA notes that harmonisation is particularly relevant in terms of reporting – changes should include reporting obligations that cover both manager and fund-specific data while also reflecting the specificities of UCITS. ESMA argues that UCITS reporting should ultimately closely match the revised AIFMD Annex IV reporting. Duplicative reporting should be avoided to reduce unnecessary burdens. ESMA suggests that harmonised reporting for UCITS will allow centralised information to be accessed by ESMA and NCAs. The MMF reporting regime is listed as an example of how the same information can be used for both supervisory purposes and for systemic risk monitoring. At a principles level, the letter notes the unnecessary complexity for market participants and supervisors due to relevant EU rules being spread across numerous Level 1 and Level 2 Directives and Regulations.

2. Scope of additional MiFID services and application of rules
The list of permissible business activities of AIFMs in some Member States is broader than others due to interpretational issues surrounding Art. 6 (4) AIFMD and Annex I of MiFID. EMSA also points to differing views with respect to whether investment management functions performed on a delegation basis constituted discretionary portfolio management or not and, consequently, if MiFID or AIFMD/UCITS rules applied. ESMA calls for legal clarification around the application of the rules. ESMA also highlights the importance of ensuring that AIFs/UCITS and their managers and MiFID investment firms always remain subject to the same regulatory standards while providing the same type of services.

3. Delegation and substance
ESMA notes that delegation of portfolio management functions to non-EU entities is likely to increase from 2021 following the end of the UK’s transition period. They argue that such extensive delegation arrangements may result in a situation where the majority of human and technical resources needed for day-to-day operations are maintained by several third parties or even a single third party, potentially outside of the EU. They also indicate a concern that the majority of staff would not be directly employed by the authorised AIFMD or UCITS management company. ESMA suggests that delegation may increase operational and supervisory risks and raises questions as to whether those AIFs and UCITS can still be effectively managed by the licensed AIFMD or UCITS management company. ESMA wants more legal clarification on the maximum extent of delegation to ensure AIFMs and UCITS management companies maintain sufficient substance in the EU. They are seeking a review of Art. 82 of Commission Delegated Regulation (EU) No 231/2013 that would reconsider or complement the qualitive criteria in Art 82 (1)(d) with quantitative criteria or provide a list of core or critical functions that must always be performed internally and may not be delegated to third parties – they argue that this should also be matched in the UCITS Directive. We also expect more on secondment arrangements, possibly restricting these. ESMA highlight divergences between NCAs on the distinction between collective portfolio management functions and “supporting tasks” and call for more granular requirements.

4. Availability of additional liquidity management tools
ESMA propose that liquidity management tools should be available in all jurisdictions in a consistent manner – a common legal framework governing the liquidity management tools would support this. They suggest that AIFMD should include all liquidity management tools outlined in ESRB recommendation A – and this should similarly be the case for the UCITS Directive, noting that some tools will not be suitable for all types of funds. ESMA further argues that its facilitation, advisory and coordination role should be increased in relation to suspension of redemptions and subscriptions, in particular where there are cross-border financial stability implications.

5. Leverage
ESMA believes IOSCO recommendations give rise to a need to amend the current reporting of the gross method calculation in Art. 7 of the Commission Delegated Regulation (EU) No 231/2013 to ensure alignment with the IOSCO framework. In addition, ESMA suggests there is merit in considering amending the commitment amount calculation by adjusting the notional amounts of interest rate derivatives contracts by the duration of the ten-year bond equivalent. This would allow comparability among contracts with different underlying duration, which makes aggregation and comparison possible for systemic risk monitoring purposes.

6. Harmonisation of supervision of cross-border entities
ESMA argues that there is a need to further clarify the roles and responsibilities of home and host NCAs where AIFs are managed on a cross-border basis under Art. 33 AIFMD. They suggest that clarification regarding supervision of cross-border activities of UCITS and AIFs, their manager and delegates would reduce uncertainty regarding cross-border activities within the internal market and benefit the CMU.

7. Semi-professional investors
ESMA sees merit to clarify the definition of “professional investors” under AIFMD, and is of the view that any possible introduction of any new categories of investors under the AIFMD should be accompanied by appropriate investor protection rules and that passporting activities should only be allowed in relation to the marketing to professional investors.

8. Loan origination in AIFMD
ESMA believes there should be a specific framework for loan origination within the AIFMD, which they believe would be helpful to promote the CMU. They also note that the ELTIF review will be an opportunity to consider the product characteristics of loan origination funds.

9. Application of depositary rules to CSDs
ESMA recommends that AIFMD be clarified to allow depositaries not to apply the delegation rules to CSDs in their capacity as Issuer CSDs. Depositaries should be required to apply the delegation rules to CSDs in their capacity as Investor CSDs. This change should also be made in the UCITS Directive.

10. Sub-thresholds AIFMs
AIFMD exempts small AIFMs from most of the Directive but leaves discretion to Member States on what to require from sub-threshold AIFMs. ESMA points out that some NCAs would prefer to have an explicit EU legal basis for Member States to introduce additional national requirements with a view to supervising sub-threshold AIFMs sufficiently.

11. Amendments to definitions
ESMA argues that the current definitions are too vague and not specific enough which will mean that different national implementation will continue, leading to uncertainty and fragmentation across the Single Market.

12. Depositary passport
ESMA asks the Commission to study the benefits but does not go so far as to recommend the creation of a depositary passport.

13. AIFMD reporting regime and data use

Please reference Annex II of the ESMA letter for detailed proposals on the key reporting issues where ESMA feels improvements can be made.

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