The latest advice from the European Securities and Markets Authority (ESMA) on which third countries meet the conditions and criteria to enable their domestic fund managers to passport freely under the Alternative Investment Fund Managers Directive (AIFMD) has experienced a mixed reception from the industry. Firstly, the advice is not legally binding, and it still needs sign off from the European Commission, the European Parliament and the European Council before it can be rolled out in force. Attaining agreement could also take a while, particularly given other pressing priorities facing European policymakers at present, namely Brexit negotiations and the solvency challenges facing Italian banks.
ESMA has repeatedly said it will conduct equivalence assessments of third countries in batches, and this is likely to take around 18 months. This longevity is in part due to the fact ESMA is conducting analysis on countries individually. The July 2016 announcement by ESMA did not yield huge surprises. The regulator affirmed that Canada, Guernsey, Japan, Jersey and Switzerland all met its equivalence criteria meaning it saw no issue or objection as to why managers based in those countries cannot market freely across the EU using the AIFMD passport without the obligation to rely on national private placement regimes (NPPR) across the 28 (at present) member state bloc. NPPR is frustrating for managers and it is plagued by regulatory arbitrage and legal differences across member states, which can make compliance challenging.
Guernsey, Jersey and Switzerland were told in 2015 that they met equivalence by ESMA so the latest advice was hardly news. All three countries had made excellent efforts to bring their regulatory regimes up to speed with AIFMD. The ESMA advice to the US, Hong Kong, Singapore and Australia is less clear cut, although equivalence is likely to be granted. ESMA confirmed that potential impediments were minor and ought to be easily remedied. For example, Hong Kong and Singapore were advised to let UCITS from more EU member states sell into their respective jurisdictions. Australia was informed that EU member states required “class order relief” from its regulations.
Perhaps the biggest challenge lies with the US. While ESMA acknowledged there were no major impediments for US money managers attaining the passport, it said it “considers that in the case of funds marketed by managers to professional investors which do involve a public offering, a potential extension of the AIFMD passport to the US risks an un-level playing field between EU and non-EU AIFMs.” Resolving this issue could take time. Nonetheless, many US managers seem agnostic to ESMA’s advice and very few will likely embrace the passport. The majority of US firms manage North American assets only. Those that do market into the EU do so only in a handful of countries or regions, such as the UK, Holland or Scandinavia. These managers will probably rely on NPPR rather than the AIFMD passport for the foreseeable future.
It should not come as a surprise that offshore jurisdictions such as Bermuda, the Cayman Islands and the Isle of Man have been told by ESMA that they do not yet meet AIFMD equivalence to enjoy the passport. To its credit, Cayman Islands has been working hard to create a dual funds regime similar to that of the Channel Islands in what could convince ESMA to extend the passport in due course. However, the Cayman Islands was late to introduce this dual funds regime meaning ESMA did not have sufficient time to assess it properly. The Cayman Islands’ constitutional links to the UK, and the Panama Papers’ expose may have also made it politically unacceptable for ESMA to grant equivalence.
That offshore jurisdictions such as the Cayman Islands have not been granted equivalence does raise issues for managers in the hedge fund and private equity world. Many of these managers will have UK or US offices, but their funds will be domiciled in offshore centres. A manager cannot make use of the AIFMD passport if their fund is domiciled in a non-equivalent third country irrespective of whether the manager is based in an equivalent third country. In other words, the majority of the world’s hedge funds and private equity firms will not be able to take advantage of the AIFMD passport but will continue to rely on NPPR, or at least until offshore centres receive confirmation of equivalence. Relying on NPPR is not a foregone conclusion for managers as it is likely to expire once ESMA grants equivalence to more third countries. As and when this happens is unclear, but it could take a few years, with some estimating 2020 at the earliest.
The constitutional earthquake following Brexit cannot be ignored either. Depending on the negotiations and how they proceed (i.e. whether the UK maintains single market access or becomes a European Economic Area [EEA] country), it is possible that the UK will retain the passport. The UK has implemented AIFMD into local law and it is fully compliant with the rules so it should be fairly assured of its fund passporting rights. That being said, if the UK exits the single market, it will be designated a third country and would be required to reapply for the passport in what could be a time-consuming and potentially politically charged process. Furthermore, the UK’s role in EU policymaking decisions is going to be much reduced, and this could result in some of the more protectionist member states exercising greater clout, and restricting third country access despite ESMA’s advice.