Alternative Investment Fund Managers Directive (AIFMD) – regulation memo

AIFMD has introduced a framework to regulate and supervise alternative investment fund managers and the distribution of alternative investment funds.

The Alternative Investment Fund Managers Directive (AIFMD) has introduced a framework to regulate and supervise alternative investment fund managers (AIFMs) and the distribution of alternative investment funds (AIFs) within the European Union (EU).

About the Alternative Investment Fund Managers Directive (AIFMD)

What are the key objectives of AIFMD?

The key objectives of AIFMD are to:

  • Reinforce investor protection
  • Limit systemic risk
  • Ensure proper risk management by asset managers
  • Provide common rules for the authorisation, organisation, and supervision of asset managers
  • Create a single market for alternative investment funds in the EU

AIFM passport under AIFMD

The AIFM passport allows marketing of EU alternative investment funds (AIFs) only to professional investors, which restricts the cross-border activities of EU AIFMs. Semi-professional and retail investors can only be approached under various National Private Placement Regimes (NPPRs). As AIF distribution is subject to the Markets in Financial Instruments Directive II (MiFID II) rules, which differentiate between retail and professional investors, any change to the definitions of the types of investors in MiFID II will affect the marketing of AIFs.

EU AIFMs also benefit from a management passport that allows them to manage AIFs established in another Member State than the AIFM’s home country.

Targeted changes of the latest AIFMD review

AIFMD contains a review clause which mandates the European Commission (EC) to assess the scope and functioning of this legal framework.

On 25 November 2021, the European Commission (EC) published a legislative proposal amending the Alternative Investment Fund Managers Directive (AIFMD—Directive 2011/61/EU) and the Undertakings for the Collective Investment in Transferable Securities Directive (the UCITS Directive 2009/65/EC).

This legislative proposal covers delegation arrangements, liquidity risk management, supervisory reporting, provision of depositary and custody services, and the establishment of a European framework for the origination of loans specifically applicable to AIFs.

In November 2023, the Council of the EU and the EU Parliament reached an agreement on the final text of the omnibus directive modifying AIFMD and the UCITS Directive, which is expected to enter into application in Q1 2026 (24 months after its entry into force).

This final text amending AIFMD (and the UCITS Directive) introduces targeted changes to key provisions in the current framework.

Harmonised liquidity management rules

In order to facilitate liquidity risk management in addition to the suspension of redemption of orders, open-ended funds are required to choose at least two liquidity management tools (LMTs) among a list of LMTs. The list includes redemption gates, notice periods, redemption fees, swing pricing, dual pricing, anti-dilution levy and redemption in kind. Money Market funds may only select one LMT. LMTs will be further defined by ESMA.

Side pockets or suspension of the subscription or redemption orders may also be activated in the interest of investors and in exceptional circumstances. In this case, the investment fund must notify its competent authority.

Management companies must implement detailed policies and procedures for the activation and deactivation of any selected LMT and the operational and administrative arrangements for the use of such tool.

Information on the conditions for the use of LMTs must be provided to investors in the fund’s prospectus.

Supervisory convergence over delegation arrangements of the asset manager is increased

Information about delegation arrangements will have to be provided to the competent authority when a fund manager is authorised or when a fund manager intends to put delegation arrangements in place. Asset managers must be able to demonstrate that they are able to monitor effectively and at any time the delegated activity, to give at any time further instructions to their delegates, and to withdraw delegations with immediate effect when it is in the interest of investors.

Harmonised rules on minimum and stable substance of asset managers require that at least two persons domiciled in the European Union are committed full-time to conduct the business of an EU AIFM or UCITS management company.

The marketing function performed by one or several distributors which act on their own is not considered to be a delegation of the function of asset managers.

Supervisory reporting requirements are reviewed for Alternative Investment Funds (AIFs) and introduced for UCITS

The review of the supervisory reporting produced by AIFs and their introduction for UCITS aim to improve the ability of supervisory authorities to identify risks to financial stability and to remove reporting duplications and overlapping data.

The obligation to report will be more granular than under the current AIFMD requirement. Information must be provided by asset managers on exposure and assets for each managed AIF/UCITS.

Information must also be provided regarding delegation arrangements concerning portfolio management or risk management functions and particularly on the amount and percentage of the assets of the managed AIFs that are subject to delegation arrangements concerning the portfolio management functions.

Central securities depositaries (CSDs) are considered as delegates of the depositary when they do not act as issuer CSD

This occurs when a CSD interposes in the custody chain between the depositary and the issuer CSD of a given security owned by a fund.

Two points in the final omnibus directive amend the AIFM Directive only

Originating loans is recognised as a legitimate activity of AIFMs and common rules are introduced to improve risk management and financial stability.

  • Loan Originating Funds (LOFs) are funds whose investment strategy is mainly to originate loans or whose notional value of originated loans represents at least 50% of their NAV.
  • The common rules include the obligation to:
    • Implement effective policies, procedures, and processes to grant loans, assess credit risk, and administer and monitor credit portfolios
    • Comply with risk diversification requirements (no more than 20% per borrower) when the borrower is a financial institution/AIF/UCITS and a leverage limit that varies depending on whether they belong to the open-ended or closed-ended type (No more than 175% for open-ended and 300% for closed-ended AIFs)
    • Retain at least 5% of the notional value of each loan it originates and sells off (with some derogations)
    • Provide information to investors

By way of derogation, the home Member State of an EU AIF may entitle its competent authorities to allow credit institutions established in another Member State to be appointed as a depositary provided that:

  • The aggregate amount in the national depositary market of the home Member State of the AIF and safekept by national depositaries does not exceed EUR 50 billion
  • The competent authorities have performed a case-by-case assessment of the lack of relevant depositary services in the home Member State of the AIF, given the investment strategy of this AIF

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Scope of the Alternative Investment Fund Managers Directive

AIFMD applies to all managers of non-UCITS investment funds that manage or market those funds in the European Union, whether the AIFM and/or the AIF are in the European Union or not.

Industry implications of the Alternative Investment Fund Managers Directive

AIFMD requires EU AIFMs to:

  • Implement three separate functions: the portfolio function, the risk management function, and the valuation function
  • Comply with specific rules on liquidity management, risk management, and reporting to the competent authority
  • Appoint a single depositary for each EU AIF established in the same Member State as the AIF

In its report published in June 2020 to assess the application and scope of AIFMD, the EC reported that, since the adoption of AIFMD in 2011, total net assets of AIFs more than doubled in size, increasing from EUR 2.3 trillion to EUR 5.9 trillion. The cross-border distribution of AIFs almost doubled between June 2017 and October 2019, rising from 3% to 5.8% of AIFs.

AIFMD has also translated into a harmonised depositary regime requiring an appointed depositary to safe keep the AIF’s assets and oversee the AIF’s compliance with national legislation and the AIF rules.

The review of AIFMD has remained targeted. The delegation framework remains largely unchanged and no list of functions which must be carried out internally by the management company has been drawn up. The introduction of a wide range of liquidity management tools (LMTs) is a positive development as they enable AIFMs or management companies to use them according to market conditions (e.g. Anti-Dilution Levy or Swing Pricing mechanisms under normal market conditions or a gate mechanism in more degraded situations) before using the suspension of subscription/redemption orders or side pockets as a last resort.

Moreover, loan origination is recognised as a legitimate activity for AIFMs and a comprehensive framework has been established to foster an efficient internal market for such funds. However, the requirement to retain 5% of the notional value of each loan (with some derogations) for a specified period of time may impede the evolution of the market.

Securities Services’ view

We welcome the clarification that CSDs acting as custodians are to be treated as delegates of depositaries, which will allow the latter to monitor their custody risks more effectively.

We also welcome the decision to not introduce a depositary passport. We believe the requirement for the depositary to share the same domicile as the fund is an essential safeguard for investor protection. Such provision guarantees legal certainty and swift means of redress for investors in case of a loss of the fund’s assets. Concurrently, the proximity between the depositary and the fund facilitates activities such as safekeeping, oversight, and cash monitoring as well as communication with fund managers and respective authorities, enabling the latter to carry out supervisory mandates – inspection, examination, or investigation of any misconduct – more efficiently.

Key dates of AIFMD

22 July 2014 – All AIFMs must comply with relevant AIFMD provisions (effective authorisation by national competent authorities)

8 October 2014 – ESMA’s guidelines on reporting obligations under AIFMD apply

30 October 2018 – Amendments of AIFMD delegated acts on safe-keeping duties of depositaries

1 April 2020 – Entry into application of the Delegate Regulation on safe-keeping duties of depositaries

Sept 2020 – EC consultation on the review of AIFMD

March 2021 – Entry into application of the sustainability-related disclosure regulation

August 2021 – Entry into application of the Cross-border Fund distribution package  

25 November 2021 – The Commission published a legislative proposal amending AIFMD and the UCITS Directive

November 2023 – Final agreement in trialogue

Q1 2024 – Expected publication in the European Union Official Journal – Entry into force

Q1 2026 – Expected entry into application

Q1 2029 – Expected review of the AIFM Directive, 5 years after its publication

The directive is complemented by Regulatory Technical Standards (RTS) established by ESMA:

  • Q1 2025:
    • Draft RTS on characteristics and use of LMTs and guidelines on selection and calibration of LMTs by AIFMs/ UCITS Management Companies including circumstances in which side pockets can be activated
    • Guidelines to specify the circumstances when the name of AIF/UCITS is unfair, unclear or misleading
    • For AIFs only draft RTS on requirements for Loan Originating Funds to maintain open-ended structure
  • Q1 2026:
    • Guidelines to specify the circumstances when the name of AIF/UCITS is unfair, unclear or misleading
  • Q1 2027:
    • Draft RTS to specify the details of the information to be reported in the supervisory reporting and its frequency

The AIFMD contains a review clause which mandates the European Commission (EC) to assess the scope and functioning of this legal framework. On 25 December 2021, the Commission published a legislative proposal amending AIFMD (and the UCITS Directive) to introduce targeted improvements to key provisions in the current framework, namely: