AIFMD II: Proposals from the European Parliament

The direction of travel on delegation is broadly positive so far. The European Parliament's draft removes the concept of reporting in situations where an AIFM delegates more portfolio management or risk management functions than it retains. Instead, relatively detailed information on delegation arrangements would form part of the AIFM's annual Annex IV reporting obligations. If implemented, this would be a material improvement for the industry compared to the Commission's original proposal.

In light of the expected clarification that the AIFMD delegation regime applies to all AIFM activities, including marketing and administration, the Report seeks to recognise that there may also be circumstances where funds are distributed by third parties who are not acting as the delegate of the AIFM. Marketing carried on by distributors who are acting on their own behalf and not that of the AIFM (such as where an independent financial advisor markets a fund without the AIFM’s knowledge) would not be considered a delegation and therefore would not be subject to the AIFMD II delegation requirements. The test for this would effectively be whether there is an agreement between the AIFM and the distributor(s) for that marketing.

In a potentially significant development, the Report proposes extending the definition of "professional investor" to include, not just professional clients as defined by the Markets in Financial Instruments Directive (MiFID II), but also (i) persons investing a minimum of EUR 100 000 who have acknowledged the risks of the investment in writing; and (ii) senior staff members, portfolio managers, directors, officers, agents and employees of the AIFM or its affiliate who have sufficient knowledge of the relevant alternative investment fund (AIF).

This would extend the scope of investors to whom an AIF may be marketed under the passport and will be particularly welcome for arrangements involving investment by employees or staff members, such as co-invest arrangements. As yet, however, there is no proposal to make corresponding changes to the scope of application of the PRIIPs Regulation and therefore a Key Investor Document may potentially be required under the PRIIPs Regulation even if the investor qualifies as a professional investor for the purposes of AIFMD II.

In addition to the extension of the scope of permitted activities for AIFMs to include benchmark administration and credit-servicing as additional "top-up permissions", the Report also proposes that AIFMs be permitted to carry out any other "ancillary service" which is not a MiFID II investment service and which represents a continuation of the services already undertaken by the AIFM or a use of internal competences and which does not create conflicts of interest that could not be managed by additional rules. The exact scope of this proposed extension is currently unclear.

The Report includes a number of changes to the proposals on loan origination. The expansion of loan originating funds in the EU is seen as a positive development and therefore the changes seek to remove unnecessary risk retention requirements and avoid the creation of product specific rules.

The changes include a specific definition of "loan origination": "the granting of loans by an AIF as the original lender". This relatively narrow definition will be welcome as it should, for example, exclude funds acquiring mostly syndicated debt. There is also an exemption from the requirements to implement certain loan origination policies and procedures in respect of "shareholder loans".  Whilst the intent of this exemption is to ensure that private equity and venture capital funds do not inadvertently fall into the loan origination regime, it is not clear that the proposed definition adequately captures all common shareholder loan arrangements, so some further finessing may be required.

The draft rules on concentration have also been slightly amended and now permit lending to a single borrower which is a financial undertaking or a collective investment undertaking where the loan is in excess of 20% of the AIF’s capital, commitments or overall subscriptions (the wording in italics is new) which would potentially increase the amount that an AIF would be permitted to lend. On the other hand, the list of persons to whom the AIF would be prohibited from lending would be extended to include entities within the AIFM's group and delegates of the depositary. The restriction on lending to group entities could have some broad ramifications for PE-backed deals where the acquisition stack is grouped with the AIFM (which is typically the case on US fund structures).

The Report also suggests that a different approach be taken to risk retention. Rather than have a minimum retention requirement of 5% for loans originated by the AIF and sold on the secondary market, the Report proposes instead a general prohibition on AIFMs managing AIFs whose investment strategy is to originate loans with the sole purpose of transferring those loans to third parties (so-called “originate-to-distribute”). This would not prevent AIFs from trading at least some loans on the secondary market but, if adopted, the extent to which this would be possible is likely to depend on the approach taken by the competent authorities.

The original requirement for an AIF to be closed-ended if it originates loans exceeding 60% of its net asset value has also been amended to a requirement for the AIF to be closed-ended when the AIFM is not able to demonstrate to the relevant competent authorities that the AIF has "liquidity robustness". The criteria for this will be based on regulatory technical standards developed by ESMA. There is some concern around whether this will catch a broader range of AIFs such as AIFs with flexible and opportunistic strategies. 

The liquidity management provisions have been reworked slightly to reflect that the primary responsibility for liquidity management lies with the AIFM. Intervention by competent authorities in an AIF's liquidity management is intended to be a last resort. The range of liquidity management tools from which an AIFM must select at least one as part of its liquidity management policy are proposed to be extended to include swing pricing, an anti-dilution levy and side pockets. The Report also proposes some form of grace period for existing AIFs.

The Report also proposes completely removing the ability for competent authorities to require non-EU AIFMs marketing in the EU to activate or deactivate liquidity management tools. The rationale behind this change is not clear from the text.

The Report also makes some positive amendments to the information that would additionally be included in Article 23 investor pre-contractual disclosures under the Commission's original proposal, particularly in respect of fees and charges. 

The requirement to disclose a list of the fees and charges in connection with the operation of the AIF that will be borne by the AIFM or its affiliates is removed as is the requirement to report all direct and indirect fees and charges directly or indirectly charged to the investments of the AIF (the requirement to disclose those charged to the AIF, however, remains).

The frequency of some new proposed reporting requirements is also reduced from quarterly to annually.

Less positively, the regulatory reporting obligations have been extended to include "any other relevant economic and accounting information" in respect of matters to be reported under Article 24 of AIFMD and a new requirement to report on the total amount of leverage of the net asset value employed by the AIF. This could have the potential to be interpreted broadly and capture commercially sensitive investment level information.

As regards depositaries, the Report suggests that any decision by a competent authority to allow AIFMs to appoint a depositary in another Member State must be taken on case by case basis.  This would effectively prevent competent authorities from granting a general recognition of all depositaries in the EU or a particular Member State and therefore avoid passporting "by the back door". However, the European Parliament is supportive of a depositary passport and has proposed an obligation for the European Commission to carry out, within two years of AIFMD II coming into force, a comprehensive study on the potential benefits and risks of introducing an EU depository passport.

If you would like further information or assistance in understanding the European Parliament's Report or the AIFMD II proposals more generally, please speak to your usual Travers Smith contact or any of the individuals below.