AIFMD II: Practical Implications for EU and Non-EU Fund Managers

Although AIFMD II is not an entire change of the current legislation and less impactful than initially expected, it includes material amendments targeting provisions of the previous directive that fund managers need to be aware of and assess the result on their private funds business or operation.

Changes affecting the marketing rules and reporting for non-EU AIFs/AIFMs:

Non-EU managers marketing into Europe via the National Private Placement Regime (‘NPPR’) will be caught by the enhanced reporting obligations and requirements (specifically asset and market related data) under Annex IV reporting – the regulatory requirement triggered by formally marketing a non-EU fund in most European states.

Changes affecting EU AIFs/AIFMs:

1. Loan origination: New requirements on EU AIFs that carry out ‘loan origination’ (defined as providing a loan either directly, or indirectly through special-purpose vehicles), as AIFMD II targets the compliance and governance associated, including but not limited to, policies and procedures of the AIFM, risk retention, diversification, conflicts of interest and the leverage limits of the AIFs involved.
2. Liquidity management: Conditions on liquidity management for open-ended AIFs, whereby the managing AIFMs must use at a minimum two liquidity management tools from an explicit list. Practically speaking this is already prevalent, however the update now requires that the liquidity management tools be selected from a specific list and be appropriate in relation to the investment strategy, fund profile and redemption policy of the AIF.
3. Depositary: AIFMD II provides flexibility for a depositary to be domiciled in a different EU state than the appointing AIF, subject to certain conditions and approval from the AIF’s regulator. For example, it is appreciated that some markets have a lack of competitive supply of depositary services, leading to increased costs and inability to effectively meet the needs of the AIF in regard to its investment strategy. Nevertheless, this is not automatically permitted even if conditions are met and would only be considered by authorities after a case-by-case assessment. To be clear, AIFMD II does not permit depositary passporting, contrary to the expectations of the amendments.
4. Annex IV reporting: Enhanced reporting obligations and requirements, as mentioned above.

Non-EU GPs

Even though we are seeing an increasing number of non-EU fund managers set up parallel funds in Luxembourg, marketing via NPPR is still the preferred route to raise capital in Europe for most non-EU managers, which allows targeted county by country marketing. Even under the NPPR route, there are certain continuing regulatory requirements including Annex IV reporting. Although many North American and UK GPs may feel that AIFMD (and any amendments) would not apply directly to them, it is important to understand the impact to their cross-border business model, especially those who have (or intend to) market their products in Europe. AIFMD II will implement enhanced scope under Annex IV reporting, a service we provide to many non-EU managers, specifically around the delegation of portfolio or risk management, markets, instruments, exposures and assets of AIFs managed.

It remains possible under AIFMD II for an EU AIFM (or ‘host AIFM’) to delegate portfolio management of an EU AIF to a non-EU fund manager, however the amendments impose closer scrutiny of the delegation arrangement and as such, non-EU fund managers involved in this model should expect to be subject to increased supervision and enhanced monitoring by the EU AIFM.

Although ‘depositary passporting’ in Europe is still not permitted under the new rules for an EU domiciled fund under AIFMD, depositary-lite services to a non-EU fund (for the purposes of registering for NPPR in Germany and/or Denmark) remains possible from a non-EU state (for example from our London office).

EU AIFs/AIFMs

Many of the amendments targeted at loan origination in fact mirror legislation already prevalent across EU states, so although on the surface the amendments do not appear to be too onerous or practically challenging, it achieves the objective to ‘level the playing field’ across Europe and is considered particularly significant as we see an increased number of credit funds launched in recent years.

Material impacts to EU AIFs involved in loan origination, how these are managed and related exemptions:

1. Policies and Procedures: AIFMs managing debt funds must ensure effective and frequently reviewed policies and procedures are in place for the granting of loans, however, this does not apply to shareholder loans where the value of the loans is below 150% of the fund’s capital.
2. Diversification: Restricts lending to a single borrower if they are a financial institution, whereby the loan may not exceed 20% (directly or indirectly) of the fund’s capital – this is intended to limit relationship in the lending business with financial companies.
3. Conflicts: Forbids lending to the fund’s governing bodies and/or related parties (i.e., fund manager, depositary, employees) – exemptions are permitted for lending to entities under the consolidated group of the fund, if such entity is a financial undertaking which only finances borrowers that are not one of the above.
4. Risk retention: Ensures that the loan originating AIF retains 5% of the value of its granted loans and does not pass them on, for instance on secondary markets or further syndication. Exemptions apply if the fund is being wound down and assets liquidated to enable investor redemptions.
5. Leverage limits: Differentiates limits of open-ended and closed-ended funds regarding ratios for value of the loan and total fund value.

Taking everything into account, the impact of AIFMD II is arguably limited aside from the most significant of amendments targeted particularly at debt fund managers and funds involved in loan origination, enforcing regulation where there previously may have been a lack of consistency across Europe. That being said, whether or not managers are targeting European capital with an EU AIF under a European marketing passport, or registering a non-EU AIF through NPPR, compliance of AIFMD and any amendments should be of utmost importance.

To lighten the regulatory burden and offer efficiencies, we offer host AIFM and depositary services to support managers achieve their marketing strategies in the EU for their funds. Increasingly, we are also seeing non-EU fund managers opt for our hosted premarketing service to assist navigating the decision between NPPR or a Lux parallel route. Langham Hall specialise in providing host AIFM services for investments in illiquid assets for European and non-European managers without regulatory permissions, working closely with GPs to navigate the changing regulatory environment and challenges associated with fundraising in Europe and the ongoing operation, reporting and compliance of EU and non-EU alternative investment funds.