Summary of the Association of Luxembourg Funds (ALFI) Conference, Luxembourg

26 Mar, 2015

Key points


  • ESMA said any decision as to whether the pan-EU passport would be extended beyond AIFMs to non-EU managers is likely to be within months. ESMA is currently analysing the current state of play of the passport before it reports to the European Commission. As per extending the passport to third countries outside of the EU, ESMA said this would be done on a case by case or market by market basis. In other words, this could take a long time. However, one would hope core markets such as the US which is home to a substantial fund manager market will be prioritised. ESMA also said an AIFMD brand akin to UCITS could emerge one day. Again, UCITS has been around since 1985 so any rapid emergence of an AIFMD brand is unlikely.


  • There are concerns as to what happens to managers of non-EU funds marketing into multiple EU jurisdictions as to who their regulator will be under AIFMD should the passport be extended. This is known as the Member State of Reference and most expect it to be the jurisdiction where most of the AIFMs’ marketing activities are taking place. However, what constitutes “most” has not been clarified. There is speculation that regulators could look at how many prospectuses have been distributed in an EEA country, the number of meetings arranged in an EEA country, Assets under Management (AUM) raised in a particular EEA country, or the time that the non-EU AIFM has spent in countries while marketing.


  • ESMA wants regulators to have greater convergence on their implementation of the AIFMD. As AIFMD is a directive, national regulators have flexibility to tinker with the minutiae of the rules. ESMA said there would be clampdowns on regulators perceived to be adopting a laissez faire approach towards the Directive’s implementation. This could be perceived as a challenge to jurisdictions such as Malta and even the UK to a lesser extent which have adopted liberal approaches towards fund manager remuneration policies.


  • Depositary liability was briefly discussed. The geopolitical events of late have raised questions as to what extent a depositary could realistically rely on the unforeseeable external events clause in AIFMD to avoid making right investors should assets be lost or misappropriated at the sub-custodian level.  It will all come down to a subjective interpretation of what is a foreseeable event to determine whether depositary banks are actually bound by the strict liability clauses contained within Article 22 of the Directive.


  • ESMA has said that UCITS funds and money market mutual funds should not be dubbed shadow banks, something which the European Banking Authority (EBA) is considering. ESMA said regulators need to be more specific about what they considered to be shadow banks, and said highly leveraged hedge funds needed to be monitored as they could be construed to be systemically important financial institutions (SIFIs). Regulators are taking a growing interest in the repo and securities lending markets. This appears to be a reference to the Securities Financing Transaction Regulation currently being discussed in the EU, and which could require financial institutions to report details of their securities financing transactions to trade repositories in a manner not too dissimilar to the European Market Infrastructure Regulation (EMIR) as well as document their re-hypothecation practices.


  • Shadow banking through the form of non-bank loans from private equity and other asset managers is only going to increase as banks feel pressure through Basel III capital requirements to take surplus risk off their balance sheets. The reluctance of bulge bracket banks to lend to small and medium sized enterprises because of perceived risk is going to open doors to asset managers to enter the fray. However, regulatory arbitrage on non-bank lending across the EU must be fixed. Some countries mandate that lending can only be done by a bank (Italy) whereas others such as the UK are more liberal. As a mechanism by which to stimulate the real economy, panellists said the EU should assist in encouraging non-bank lending to proliferate.


  • Central to the EU’s efforts to revitalise the Eurozone economies is through infrastructure projects. European Long Term Investment Funds (ELTIFs), which will come into being around 2016, allow retail (and institutional) allocators to invest in illiquid assets such as infrastructure, real estate and loans. They will be a sub-category of AIFMs and a passport will be available to them. There is scepticism as to whether ELTIFs will take off as they will be the preserve of only the largest managers, and many private equity houses and infrastructure funds will not want to manage retail money given the added regulatory headaches it can bring. Furthermore, ELTIFs are prohibited from having more than 10 per-cent exposure to any one infrastructure project and must have 30 per-cent of their assets invested in securities that are in accordance with UCITS eligibility criteria. As these funds could struggle to raise meaningful capital, any infrastructure projects they invest in will be small. Furthermore, these managers will potentially have to enter into club deals if they want to have a meaningful impact on any infrastructure project and this could be challenging. One delegate suggested ELTIFs should adopt a REIT structure but conceded this could be problematic as REITs were the preserve of English law only.


  • There is a lack of awareness among asset managers about the implications Solvency II and Basel III will have on their businesses. Both rules will require insurers and banks respectively to hold capital based on the riskiness of their investments. However, banks and insurers can lower their capital requirements on their investments if fund managers provide significant transparency and even position level data. This could alarm managers who fear there could be an increase in copycat trading or potential short-squeezes. Some worry regulators, particularly the Securities and Exchange Commission (SEC) could accuse fund managers providing this data as required under Solvency II and Basel III of offering certain investors preferential treatment. A solution to this would be to open separately managed accounts for any insurance and banking clients.


  • Base Erosion and Profit Shifting (BEPS) is an OECD-led initiative designed to clampdown on multinational corporations -particularly technology giants – and their tax structures whereby the latter shift profits to low-tax countries or use innovative double taxation treaties to minimise their tax bills. This initiative does not exempt fund managers (and unwittingly ensnares them as it was not the OECD’s intention), many of whom in an effort to attain “tax neutrality” for investors will have their funds domiciled in a low tax jurisdiction. BEPs through Action 2 will seek to end the concept of double taxation whereas Action 6 is likely to clampdown on firms. A Clifford Chance paper highlights funds and special purpose vehicles reliant on tax treaties to receive income from debt and equity investments free from withholding tax will be impacted. The OECD does however seem to differentiate between collective investment vehicles (regulated mutual funds or UCITS) and non-collective investment funds (private funds such as hedge and private equity funds), with the former looking likely to get better treatment as they will be able to benefit from treaty benefits. The OECD’s definition of a collective investment vehicle is a regulated fund, but it does not seem to believe that funds regulated under AIFMD count as being regulated. The OECD said that there has been no decision made yet on the status of AIFMs under these rules.


  • The overall consensus is that Hong Kong Stock Connect, which permits trading in mainland shares, has not had as much impact as predicted. This is because of a number of operational risk concerns that exist. China has a trade settlement time of T+1 for cash and a T+0 settlement time for securities whereas Hong Kong adopts a T+2 for both cash and securities. As such, financial institutions selling securities must wait an additional day to receive cash after transferring securities thereby exposing them to counterparty risk. However, there are suggestions this risk can be mitigated through an integrated broker-custodian model. Furthermore, there are question marks as to whether investors have beneficial ownership over A Shares in China through Stock Connect. Mainland China law theoretically recognises both the concept of nominee holder and beneficial owner but it is not entirely straightforward. Stock Connect ultimately recognises the Hong Kong Securities and Clearing Company (HKSCC) as the nominee and investors should therefore be beneficial owners.  However, this is untested and were HKSCC to enter into bankruptcy, would the shares be the possession of the general creditors or beneficial owners? China’s policymakers have also confirmed that Stock Connect will be extended beyond Shanghai to the Shenzhen Stock Exchange. Hedge funds are uninterested in Stock Connect by and large because there are curbs on short-selling with short positions on securities capped at one per-cent or five per-cent over 10 days.