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12 December, 2016
On 16 November 2016, ESMA published an updated Q&A on the Alternative Investment Fund Managers Directive (AIFMD). The AIFMD sets out certain activities which a fund manager (an AIFM) may carry out, such as marketing. Importantly, ESMA has now said that it considers that any such activities which are not performed by the AIFM should be considered to be delegated by the AIFM to the third party who is performing them. This is contrary to the position that most national authorities and the market had previously taken, and would require most AIFMs to make multiple additional notifications to their regulators and to update their internal compliance procedures. However, the position may not be quite as drastic as it may first appear: there are arguments to suggest that industry should wait and see how national regulators apply ESMA's Q&A before fund managers take action.
Before ESMA updated the Q&A it was accepted that if the AIFM was not appointed to carry out the additional activities which are set out in the directive (and which we list below), including functions such as valuation, property management etc., then the AIFM was not delegating these activities. Instead the fund (the AIF) could directly appoint third party providers to undertake these roles. In practice, this was a pragmatic solution for AIFMs who would be absolved from the obligations on delegation and compliance monitoring of providers in respect of such activities, particularly where the AIFM may not have in-house capabilities in these areas.
What are the paragraph 2 activities that may be carried out by the AIFM or must be subjected to delegation rules if the AIFM appoints a third party?
(a) Administration:
(i) legal and fund management accounting services;
(ii) customer inquiries;
(iii) valuation and pricing, including tax returns;
(iv) regulatory compliance monitoring;
(v) maintenance of unit-/shareholder register;
(vi) distribution of income;
(vii) unit/shares issues and redemptions;
(viii) contract settlements, including certificate dispatch;
(ix) record keeping;
(b) Marketing;
(c) Activities related to the assets of AIFs, namely services necessary to meet the fiduciary duties of the AIFM, facilities management, real estate administration activities, advice to undertakings on capital structure, industrial strategy and related matters, advice and services relating to mergers and the purchase of undertakings and other services connected to the management of the AIF and the companies and other assets in which it has invested.
However, ESMA has now clearly stated in its updated Q&A (the text of which is set out below) that activities which are not performed by the AIFM should be 'considered as having been delegated by the AIFM to the third party'. This means that the AIFM is responsible for ensuring that: (i) the AIFMD requirements on delegation are fulfilled; and (ii) there is compliance oversight of the relevant service providers, as set out in the AIFMD and irrespective of whether the AIFM or the AIF has made the appointment. That is contrary to how most national regulators and fund managers have dealt with this issue to date.
ESMA Updated Q&A (November 2016)
Where the AIFM does not itself perform the functions set out in Annex I of the AIFMD, does this release the AIFM from its responsibility to ensure compliance of the relevant function(s) with the AIFMD?
No. Where a third party performs a function stated in Annex I of the AIFMD, this function should be considered as having been delegated by the AIFM to the third party. Therefore, the AIFM should be responsible for ensuring compliance with the requirements on delegation set out in Article 20 of the AIFMD and the principle expressed in Article 5(1) of the Directive according to which the single AIFM appointed for an AIF is responsible for ensuring compliance with the AIFMD. For the avoidance of doubt, this applies to all functions stated in point 1 and point 2 of Annex I of the AIFMD.
If AIFMs are ultimately required to follow ESMA's stated position, then many would have to file a raft of notifications to the regulator setting out those activities for which third party providers were previously considered to be appointed by the AIF directly, as well as amending their internal procedures to ensure compliance of those third party providers. Article 20 of the AIFMD (and article 19 in relation to external valuers) requires AIFMs to provide information to their national regulators and investors when applying for authorisation / marketing of new funds. That may be particularly tricky in the case of sub-distributors where the AIFM would need to have consented prior to the sub-delegation and which would also need to be reported to the national competent authority of the AIFM prior to the sub-distribution agreement entering into force (see article 20(4) AIFMD). If taken literally, ESMA's updated Q&A would result in some changes to current distribution arrangements which may be of concern to established fund distribution networks.
Nevertheless, there are some arguments that could limit the impact of ESMA's statement. It can be argued that ESMA's Q&A is at odds with the level 1 text of the AIFMD. Recital 11 and article 5 of the AIFMD suggest that an AIF (rather than an AIFM) can be responsible for certain functions. It seems possible to argue that if the AIFM has no control over a matter it can't be delegating. To contrast the AIFMD position with the position under the UCITS directive, there is a clear distinction in the wording of the directives. AIFMD uses 'may' whereas UCITS uses 'shall' when referring to functions the manager performs. ESMA's updated Q&A appears to ignore this distinction in the drafting of the level 1 text.
In addition, national regulators have clearly taken a different view in the domestic measures that have implemented the AIFMD, particularly the UK's FCA. Previously, the FCA (and other national competent authorities) provided some helpful advice on whether an AIFM that has appointed a third party to perform a function is delegating. For example, the FCA suggested that where an external valuer is appointed but the AIFM retains responsibility for making final determinations, they would not consider this to be delegation. Applying this more widely, the argument is that many third parties are merely providing services or assistance to the AIFMD, but the AIFM retains responsibility and therefore there is no delegation as the third party is not performing a function in the place of the AIFM.
Whilst the main issue raised by the updated Q&A is the question of delegation, there are other answers which will impact fund managers. ESMA also states that AIFMs cannot delegate activities to an externally managed AIF as the AIF cannot be responsible for any of these activities. ESMA also considers that material change notifications require the AIFM to submit a full set of documentation with the revised notification letter. Further, AIFMs are asked to highlight any amendments to the original notification letter and accompanying documentation, which presumably would mean highlighting all amendments including those that were not material changes.
None of this is good news for fund managers at a time when they were finally getting to grips with the AIFMD regime and the impact on their businesses. Nor is it useful for many national regulators who will need to consider how ESMA's position stacks up against their own. Until national regulators set out their views, fund managers will be situated between a rock and a hard place.
For further information, please contact:
Jonathan Gordon, Partner, Ashurst
jonathan.gordon@ashurst.com
