AIFMD and UCITSD Review Published in the Official Journal!

The 2011 AIFMD was a key post-crisis regulatory initiative that introduced a coherent supervisory approach of Alternative Investment Fund Managers (AIFMs), i.e. managers of any type of investment fund, whether regulated or not, that does not qualify as a UCITS (e.g. private equity funds, real estate funds, hedge funds). The AIFMD also aimed to provide high-level investor protection while facilitating the integration of AIFs in the EU market.

Although there should be no doubt that the AIFMD has met its original objectives and facilitated the integration of the European investment funds market, the European legislators found that certain aspects could be improved. The Review therefore aims to facilitate the use of liquidity management tools (LMTs), harmonise the rules for AIFMs managing loan-originating AIFs, clarify the requirements applicable to delegation, ensure equal treatment of custodians, improve cross-border access to depositary services and optimise supervisory data collection. Similarly, a harmonised approach to the use of LMTs, a robust delegation regime, the equal treatment of custodians and a coherent supervisory reporting regime are introduced for UCITS and UCITS management companies.

Open-ended funds allow investors to freely exit the fund if they wish so. Under stressed market conditions, redemption pressure from investors may cause the fund to rapidly sell assets (‘fire sales’) in order to meet those redemption requests, which may negatively impact the remaining investors and other financial market participants.

The AIFMD and UCITSD currently both contain liquidity management requirements. AIFs need to have redemption policies that are consistent with their investment strategy and liquidity profile and conduct regular stress tests. UCITS are required to comply with detailed eligibility rules regarding the type of assets in which they may invest and must also conduct stress tests where appropriate.

In order to manage such redemption pressure, different liquidity management tools have been devised without the rules governing those LMTs being currently harmonised across the EU, leading to different LMTs being available in different Member States. The Review now provides a list of the following nine LMTs. Open-ended AIFs and UCITS are required to select at least two of these LMTs listed under points 2 to 8 (except when the fund is authorised as a money market fund, in which case it must only select one of these LMTs).

1. Suspension of subscriptions, repurchases and redemptions
2. Redemption gate
3. Extension of notice periods
4. Redemption fee
5. Swing pricing
6. Dual pricing
7. Anti-dilution levy
8. Redemptions in kind
9. Side pockets

The selection may not include only LMTs 5 and 6, and LMT 8 may in principle only be activated to meet redemption requests by professional investors and if the redemption in kind corresponds to a pro rata share of the fund’s assets. LMTs 1 and 9 may only be activated in exceptional cases where circumstances so require and where justified having regard to the interests of the fund’s investors. The UCITS or AIFM national competent authority (NCA) may also, in exceptional circumstances, require the activation or deactivation of LMT 1 where there are risks to investor protection or financial stability.

As the name indicates, the AIFMD only intended to govern the fund managers, while the product level remains regulated by national law. The Review will now introduce product related requirements on loan origination by AIFs. The Review recognises that direct lending by AIFs can be a source of alternative financing for the real economy and can provide critical funding for small and medium-sized enterprises, for which traditional lending sources are more difficult to access.

The Review adds the activities of originating loans on behalf of an AIF and of servicing securitisation special purpose entities to the list of functions in annex I of AIFMD that an AIFM may additionally perform in the course of the collective management of an AIF, including on a cross-border basis.

The risk management requirements are amended to:

1. include requirements for AIFMs managing AIFs that engage in loan origination;
2. provide for limits to the notional value of the loans originated where the borrower is a financial undertaking or another investment fund; 
3. place limits on the leverage of loan-originating AIFs (which are defined as AIFs whose investment strategy is mainly to originate loan or whose originated loans have a notional value that represents at least 50% of their net asset value, and which must in principle be closed-ended unless the AIFM that manages them is able to demonstrate that the AIF’s liquidity risk management system is compatible with its investment strategy and redemption policy); and
4. prohibit loan origination to certain entities or persons where a conflict of interest could arise.

Further, AIFMs may not manage AIFs that engage in loan origination for the sole purpose of transferring those loans or exposures to third parties, and when originating loans and transferring them to third parties, the AIF must retain 5 % of the notional value of each loan. Specific rules also apply to the origination of shareholder loans.

a.    Authorisation

AIFMs and UCITS management companies will need to provide more detailed information in order to receive a licence. The Review also explicitly provides that the conduct of business of an AIFM, UCITS management company or authorised UCITS investment company needs to be decided by at least two natural persons (which, under Belgian law, is already the case for AIFMs managing public AIFs, UCITS management companies and authorised UCITS investment companies) domiciled in the Union.

The Review further amends the list of ancillary activities that external AIFMs may provide by:

1. adding to the list of non-core services the provision of any other function or activity to third parties which is already provided by the AIFM in relation to an AIF that it manages or in relation to services that it provides, e.g. human resources or IT services; 
2. adding to the list of ancillary services the administration of benchmarks (unless those benchmarks are used in the AIFs they manage) and credit servicing activities; and 
3. no longer prohibiting the provision of non-core services without being authorised to provide discretionary portfolio management.

The list of ancillary services that UCITS management companies can provide is similarly amended, except that UCITS management companies will not be allowed to perform credit servicing activities and that the ancillary service of reception and transmission of orders in relation to financial instruments is now added to the list of non-core services (which is an ancillary service that can already be provided by external AIFMs).

b.    Delegation

Under the Review, delegation arrangements will remain possible and the recitals to the Review recognise that delegation can allow for the efficient management of investment portfolios and for sourcing the necessary expertise in a particular geographic market or asset class.

The Review does add additional supervision and administration requirements. An AIFM or UCITS management company that intends to delegate management functions or ancillary services must notify its home NCA. The AIFM or UCITS management company must demonstrate that the delegate is qualified and capable of undertaking the functions and providing the services in question, that it was selected with all due care and that the AIFM or UCITS management company is in a position to monitor effectively at any time the delegated activity. The AIFM’s or UCITS management company’s liability towards its clients, the fund and its investors now also includes delegated ancillary activities, and the AIFM may not delegate the functions or services to the extent that it becomes a letter-box entity. Sub-delegation of ancillary services is also recognised.

It is further clarified that where an AIF or a UCITS is marketed by one or several distributors which are acting on their own behalf, such marketing is not considered to be a delegation.
 

Under the current regime, the depositary must be established in the home Member State of the EU AIF or, for non-EU AIFs, the third country where the non-EU AIF is established or the AIFM’s home Member State.

The Review does not introduce a European passport for depositaries, but introduces a possibility for the NCA to allow a depositary established in another Member State to be appointed as a depositary if (a) the NCA has received a reasoned request from the AIFM that demonstrates the lack of depositary services in the home Member State of the AIF that are able to meet effectively the needs of the AIF having regard to its investment strategy; and (b) the aggregate amount in the national depositary market of the home Member State of the AIF of assets entrusted to safe-keeping on behalf of EU AIFs managed by an EU AIFM does not exceed EUR 50 billion or the equivalent in any other currency.

The Review also clarifies, for both AIFs and UCITS, that a due diligence by the depositary in the selection and appointment of a delegate is not required if the delegate is an investor central securities depository (CSD), and the provision of services by an issuer CSD is not considered a delegation of the depositary’s custody functions.

Disclosure obligations to investors and reporting obligations to NCAs are expanded. Pre-contractual disclosures must now include the name of the AIF, the possibility of, and conditions for, using LMTs selected in accordance with the requirements described above, and a list of fees, charges and expenses that are borne by the AIFM in connection with the operation of the AIF and that are to be directly or indirectly allocated to the AIF. Periodical disclosures must include the composition of the originated loan portfolio (where applicable), on an annual basis, all fees, charges and expenses that were directly or indirectly borne by investors and, on an annual basis, any parent undertaking, subsidiary or special purpose vehicle utilised in relation to the AIF’s investments by or on behalf of the AIFM.

Reporting obligations now include the total amount of leverage employed by the AIF, detailed information regarding delegation arrangements concerning portfolio management or risk management functions and the list of Member States in which the units or shares of the fund are actually marketed by the AIFM or by a distributor. UCITS management companies will become subject to similar reporting obligations in respect of each UCITS they manage.

The Review enters into force on 16 April 2024 and will need to be transposed by Member States by 16 April 2026. As usual, ESMA is mandated to develop several draft regulatory and implementing technical standards and guidelines.

Given these changes, fund managers would do well to familiarise themselves with the Review before the transposition deadline and update their documentation, procedures and policies in due course.

Please do not hesitate to contact any member of our Banking & Finance practice should you have any questions.