AIFMD passports for the Channel Islands and Switzerland could backfire
David Bailey, group head of marketing at private equity fund administrators Augentius, has warned that the proposed liberalisation of the rules governing the distribution of alternative investment funds (AIFs) in the European Union (EU), announced last week by the European Securities and Markets Authority (ESMA), may have unintended consequences.
On 30 July – more than a week later than expected - ESMA recommended that both Guernsey and Jersey be granted “third country” passports under the Alternative Investment Fund Managers Directive (AIFMD). Of six jurisdictions assessed, ESMA cleared Guernsey and Jersey only, and endorsed Switzerland on the basis of legislative measures about to be finalised by the enactment of impending legislation.
Provided the European Commission and the European Parliament agree with the ESMA recommendations, probably this autumn, it gives fund managers domiciled in Guernsey, Jersey and Switzerland the right to market alternative investment funds (AIFs) to institutional investors throughout the European Union (EU).
“The biggest issue that we have as an industry is that certain countries, including Germany, have said that, as soon as non-EU manager passports become available, they will withdraw their private placement regimes,” says Bailey. “That could mean that, if the EU decided to give passports to Guernsey, Jersey and Switzerland, some countries could close their private placement regimes to the rest of the world. That is massively important.”
It is massively important not just because EU institutional investors investing by private placement account for a quarter of the money raised by American private equity funds. It is massively important also because, whatever the Commission or Parliament eventually decide, they have no formal jurisdiction over the private placement regimes, which are run by individual member-states of the EU. In other words, multiple countries could start ditching national private placement regimes much sooner than the private equity and hedge fund industries had until now assumed.
“The potential withdrawal of the national private placement regimes is, in my view, a major issue,” says Bailey. It is not hard to see why he says this. It is through the use of national private placement regimes that non-EU managers have avoided the full rigour of the AIFMD. Private equity, hedge and real estate funds have continued to raise money from sophisticated European investors. They had expected to be able to continue to do so, and the legislation allowed for this, until the national private placement regimes were abolished in 2018, on the assumption that third country passports were seen to be working well.
If national private placement regimes do disappear, smaller managers in particular will face the unenviable choice of incurring the cost of being fully AIFMD-compliant, or ceasing to market their funds to EU investors. Many large managers are already AIFMD-compliant. In addition, institutional investors that are not big enough to secure allocations to the major funds will be denied a full range of investment choices.
The two Channel Islands – both of which have pronounced themselves delighted with the prospect of a change in status - and Switzerland are effectively being rewarded for their willingness to embrace AIFMD by proxy. Jersey became the first offshore jurisdiction to offer an opt-in AIFMD-compliant regime back in 2013. Guernsey has had an opt-in equivalent AIFMD regime since January 2014. Switzerland has passed its own version of AIFMD, and has further measures in hand.
There is a possibility that the Parliament and the Commission will want ESMA to look at its recommendation further before endorsing it. But even this is unhelpful. As Bailey points out, the provisional nature of the recommendation has added uncertainty to a timescale fund managers had until now assumed was predictable. “We face continued uncertainty for non-EU managers, who just do not understand what is going on,” he says. “If they do delay a decision, it would almost certainly push a final outcome into at least the summer of next year, which is just 18 months ahead of the final deadline of January 2018.”
The Channel Islands and Switzerland are not large markets, making admission to passport status relatively easy. But it is not unthinkable that Parliament and the Commission use that knowledge to delay matters, by urging ESMA to look more closely at other markets before giving any jurisdiction a third country passport.
“No definitive view” was offered on the other three jurisdictions assessed by ESMA - Hong Kong, Singapore and the United States - “due to concerns related to competition, regulatory issues and a lack of sufficient evidence to properly assess the relevant criteria." The Cayman Islands were not assessed at all, which is a significant omission from a hedge fund perspective.
As the Cayman omission indicates, prospects of progress on admitting managers from countries with major alternative fund management industries look bleak. The United States in particular, despite the growing aggression of Securities and Exchange Commission (SEC) inspections of alternative managers, is still not regulated to the same level as Europe. ESMA specifically commented on the ability of a fund to act as its own custodian (which would not be permitted for AIFMs and AIFs intending to passport) and the lack of similar remuneration rules. “It is difficult to conceive when AIFMD-compatible regulation will be agreed in the US,” says Bailey. “And if the national private placement regimes are removed, will that preclude US-domiciled funds from coming to market in Europe again?”
He adds that the exclusion of US and other non-EU managed funds from Europe will be to the detriment of European investors. “This is all about investor choice, and the regulators allowing investors to properly gain access to the sort of funds they want to gain access to,” explains Bailey. “If you preclude and prevent lots of managers from marketing into Europe that is going to create problems for investors. Institutional investor money is ultimately made up of monthly pension contributions from individuals. The performance of the savings vehicles of `the man and woman in the street’ could be adversely affected.”