AIFMD 2, Change in Continuity
This article was written with the collaboration of Marine Pouzoulet.
Following the agreement reached on the revision of directive 2011/61/EU on Alternative Investment Fund Managers (AIFMD 2) in July 2023, the European authorities finally issued their political agreement on 6 November 2023. The purpose of the revision is mainly to harmonise and endorse existing regulatory developments and practices. This should make it easier to structure and market alternative investment funds (AIFs) across the EU while ensuring sound governance at the level of the alternative investment fund managers (AIFMs) and adequate investor protection. The relevance of AIFMD 2 has also increased because of recent global challenges, including pandemics, economic crisis, conflicts and inflation, meaning AIFMs have to adapt to new market dynamics. Overall, AIFMD 2 brings substantial amendments to the regime currently in force.
Introducing a legal framework applicable to liquidity management tools and direct lending AIFs
Liquidity Management Tools1
Regarding liquidity management, recent events have highlighted that not all AIFs can effectively use appropriate liquidity management tools (LMTs). This inefficiency arose either because the fund documentation did not permit these tools or the tools were not suited to the AIF’s liquidity risk profile or investment strategy. Consequently, practices diverged across jurisdictions, resulting in unequal outcomes and inconsistent investor treatment. To address these disparities, AIFMD 2 establishes a European framework, enabling AIFMs to manage market stress and liquidity issues in a coherent, effective and harmonised way while safeguarding investor protection. AIFMD 2 defines a list of LMTs that AIFMs have to choose from and include at least two LMTs into each AIF’s constitutional documents, aligning with its investment strategy, liquidity profile and redemption policy.
AIFMs should also always have the authority to temporarily suspend subscriptions and redemptions. This means implementing detailed policies and procedures for activating and deactivating LMTs, along with operational and administrative arrangements for their use.
AIFMD 2 also enhances the supervisory powers of national authorities by requiring AIFMs to notify their competent authority of the activation and deactivation of LMTs. Enhanced disclosure is also important to ensure the LMTs can function properly. AIFMs have to disclose to investors the conditions for using LMTs as part of Article 23(1) AIFMD.
Direct Lending AIFs2
By June 2022, EU AUM within private debt funds reached EUR267.8 billion. Direct lending has become a crucial alternative financing source for the real economy, especially when traditional lending channels are less accessible. Nonetheless, disparities in national regulations on lending have led to competitive imbalances between jurisdictions that prohibit non-banking system lending and those with more flexible regulations permitting free deployment of debt funds. AIFMD 2 addresses this by expanding the ancillary services AIFMs can provide to include loan origination for AIFs.
AIFMD 2 also establishes common rules to ensure effective risk management and mitigate conflicts of interest. These rules apply both at the level of AIFMs and the loan originating AIFs themselves.
At AIFM level, effective policies and procedures must be set up for granting loans. They’re designed to properly assess and monitor credit risk and are subject to a periodic review. In addition, the AIFM (including its staff, delegates and affiliates), and the depositary of the AIFs it manages, are prohibited from receiving loans from the AIF managed by the AIFM. AIFMD 2 also specifically addresses and regulates shareholders’ loans.
At AIF level (even through an SPV), AIFs generally have to be closed-ended to avoid liquidity mismatches (open-ended AIFs are permitted if they comply with additional requirements).
AIFMD 2 also provides specific guidelines regarding leverage for loan origination AIFs. It allows loan origination AIFs to leverage up to 300% for closed-ended and 175% for open-ended AIFs, calculated using the commitment method against the AIF’s NAV. It imposes diversification and exposure limits, especially when lending to financial institutions, other AIFs, or UCITS, capping loans to a single borrower at 20% of the AIF’s capital. “Originate to distribute” strategies are prohibited, requiring AIFs to retain 5% of each loan’s notional value. All loan proceeds must be attributed to the AIF. And costs related to loan administration must be disclosed to investors.
Strengthening governance to enhance substance
The revised directive also brings an opportunity to strengthen other governance rules around substance, aligning with industry practices and regulatory shifts, especially post-Brexit. AIFMD 2 formalises minimum human and technical resources within AIFMs. The new rules clearly spell out minimum staffing requirements for AIFMs to hire at least two full-time equivalents or executive managers, domiciled within the EU. AIFMs will also need to consider the time commitment of their conducting officers and the resource allocation for both internally retained and externally delegated functions. This includes thorough supervision and monitoring to ensure effective governance and compliance.
In terms of delegation, AIFMD 2 reinforces the current regulatory framework. All functions and services the AIFM is authorised for fall under delegation requirements and require regulatory approval. This extends to non-core services provided under a “MiFID top-up” license. In particular, AIFMD 2 addresses a common scenario where a third-party AIFM manages an AIF initially backed by a delegated portfolio manager or a related group entity. In this set-up, potential conflicts of interest are expected. And AIFMD 2 emphasises the need for AIFMs to prevent – or if unavoidable – identify, manage and monitor these conflicts to protect the interest of the AIF and its investors.
To alleviate concerns about this broad scope, distributors authorised under Directive 2014/65/EU (MiFID II) or Directive 2016/97/EU (IDD), acting independently, are not deemed “delegates”. And they’re exempt from the delegation requirements, irrespective of any distribution agreement with the AIFM.
Regarding both substance and delegation, AIFMD 2 also strengthens reporting obligations for AIFMs. They now have to include these aspects in the quantitative information periodically submitted to national regulators.
Enhancing cross-border aspects and marketing to retail investors
AIFMD 2 introduces the option to provide depositary services across borders. But it doesn’t introduce a full-fledged cross-border depositary passport. Using this provisional passport requires enhanced collaboration between depositaries and their respective competent authorities, as well as the competent authorities of the AIF and of the AIFM, if they differ. Importantly, applying the passport under AIFMD 2 is subject to the “necessity principle”. The AIFM will have to demonstrate the lack of relevant depositary services in the Member State of the AIF, with regard to the investment strategy. The relevant cross-border depositary authorisation will only be granted on a case-by-case basis, based on the AIF’s investment strategy. This mechanism is intended to remain until a full depositary passport is adopted.
AIFMD 2 expands data reporting obligations for custodians by integrating the concept of “central securities depositary” (CSD) and introducing CSDs in the custody chain. The requirement for depositaries to perform ex-ante due diligence checks where the custodian qualifies as a CSD will be removed. In terms of delegating depositary custody functions, AIFMD 2 introduces a distinction: services provided by a CSD acting as an issuer CSD will not be considered a delegation, whereas those offered by a CSD acting as an investor CSD will be viewed as such.
AIFMD 2 finally reflects the latest updates of the EU regulatory framework, with, for instance, the update of the references to MiFID II, the last AML Directive and the list of non-cooperative jurisdictions for tax purposes. Importantly, it encompasses updates to this list and subsequent actions required of depositaries or AIFMs based in jurisdictions newly added to it.
Other aspects
As part of the extension of the ancillary services an AIFM can provide, AIFMs will also be entitled to apply for an extension covering “administration of benchmark” and “credit servicing” services.3 This is in addition to the individual portfolio management, investment advice, safe-keeping, reception and transmission of orders services that AIFMs could provide under a “MiFID top-up” license.
Finally, under AIFMD 2 national competent authorities will benefit from enhanced cooperation and data sharing.4 And ESMA and national competent authorities will also see their supervisory powers increase more generally (merely counterbalanced by a new obligation on those authorities to professional secrecy).5
Conclusion
The impending formalization of AIFMD 2, now largely a formality, will initiate a two-year transposition phase, with EU-wide implementation anticipated by Q1 2026. The AIFMD review elicited a mix of concern and optimism. It addresses key issues and has been broadly accepted across diverse segments of the investment management industry. Originating from the 2007-2008 global financial crisis, the initial AIFMD proved resilient, helping the European investment management sector through several significant crises over its first decade. AIFMD 2 is seen as a series of positive, albeit small, steps forward, offering tangible solutions to many critical issues identified during AIFMD’s ten-year tenure. While it doesn’t resolve every issue, it effectively addresses the most urgent concerns.
1See recitals 21 to 23 and Articles 16(2b) to 16(2h)
2See recitals 9 to 15(a) and Articles 6(a)(apa) and (apb), Articles 15 to 16.
3Article 1(2)
4Article 1(11)
5Article 1(18) to (21)
