AIFMD; the light at the end of the tunnel is… still likely to be a train!


There was mild relief in London this week as the European Commission’s proposed revision of the Alternative Investment Fund Managers Directive (AIFMD) circulated. The fear had been that it would impose stringent new requirements on fund managers preventing delegation of portfolio and risk management functions from EU funds back to London. It is true that the only concrete new requirement in the text is that a delegating entity must employ a minimum of at least two full time equivalents at the Europe end. However, if anyone thinks that pressure for fund relocation through tightening the rules on delegation ends there, this would be a mistake and ignores the politics of the EU legislative system.

There are three institutions involved in agreeing most EU legislative proposals, including this one; the Commission, the Parliament and the Council of Ministers. The Commission proposes an initial draft and the Parliament and the Council work to pass it, subsequent to any amendments which they must ultimately agree in order for the directive to go through. Regardless of the detailed content, the Commission and Parliament seek to increase the regulatory power of European institutions because this increases their power and, conversely, the Member States in the Council seek to resist this drift, except where they consider it absolutely necessary to collectively pool decision-making power.

In many sectors, the Commission knows that it is unlikely to be given direct supervisory powers. It has therefore sought a half-way house. Persuading the Member States to set up Agencies to draft rules, and increasingly to make draft implementing decisions, which the Commission must then endorse. The Member States are more comfortable with this because the boards of the Agencies comprise of the collective Heads of national regulators. Financial services are no exception to this approach.

What Next?

As regards delegation, what the Commission is now proposing is that the European Securities and Markets Agency (ESMA) will propose detailed rules on annual reporting of third country delegation at individual company level to ESMA and ESMA will have the ability to call in the national authority to explain what it has agreed with a company. Note that ESMA has already published a paper saying it wants to crackdown on “letterbox” entities in the light of Brexit. Every two years, ESMA must report to the Commission, Parliament and Council in order to allow the latter to assess whether there is unacceptable variation in national application of the rules and whether additional modifications of the rules on delegation are required.

The Commission’s proposals likely mean a steady indirect pressure on national authorities acting outside the consensus. If a national authority decides to ignore it, they could ultimately be subject to an infringement process, passing by the Court of Justice. This would not be a rapid process.

The European Parliament may well look at the proposed text and say that one of two things need to happen, either there needs to be more proscriptive rules on delegation in the text of the Directive or ESMA gets the powers to immediately overrule a national authority which is too lax or both. Such a reaction is all the more likely given that the Commission’s introduction says that such a result would indeed be more “efficient” but that it does not currently fit with subsidiarity (i.e. not enough member states would support this).

So the result is likely going to come down to who has the most leverage in inter-institutional negotiations, the Parliament or the Council? This will be a function of a number of variables including which institution wants the revised legislation most, the deals that have been done on other dossiers, and, the degree of irritation being provoked by Brexit.  If the Parliament takes a strong view, it’s not obvious that the Council will put up much resistance simply to assert the principle of resisting EU regulatory creep. They have just folded on transferring power to EU-level in the Digital Markets Act. The City of London’s allies do not extend much beyond Ireland and Luxembourg, just about the weakest two country voting coalition which it is currently possible to imagine and far short of a blocking minority. The power of ESMA would primarily impact on firms and employees outside the EU and the result would be easy to spin as a populist win for domestic EU political audiences.

So what’s the difference between having something concrete in the text or ESMA/the Commission’s having extended powers. The answer in practical terms is probably largely one of timing. The train is already running, it will just take 3-5 years to arrive in the latter case, although many national authorities will probably start to ratchet requirements up earlier in anticipation. Fund managers need to be engaged, explaining to legislators how rules around delegation need to be structured to protect investors, while avoiding protectionism.

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