Provisional agreement reached on AIFMD and UCITS reforms

Background

As detailed in our in-depth briefing on proposed reforms to the AIFMD and UCITS frameworks, the European Commission published a package of targeted changes to both the AIFMD and UCITS frameworks in November 2021. These proposals, which form part of the European Commission’s Capital Markets Union measures, were identified as necessary to bring proportionate improvements to the existing regulatory frameworks to address a number of regulatory gaps in the areas of liquidity management, delegation, supervisory reporting and loan-originating funds amongst others.

Trialogue negotiations between the Council of Europe, the European Parliament and the European Commission began in March 2023. As outlined in our March 2023 briefing, there were a number of key areas of interest to Irish fund management companies to be finalised as part of these negotiations.

On 20 July 2023, the Council of Europe announcedthat it had reached political agreement with the European Parliament on the proposed reforms to the AIFMD and UCITS frameworks.

This represents the first step in the legislative process to implement targeted changes to the two frameworks. We would note that the political agreement reached last week is provisional, we do not yet have sight of the finalised amending directives agreed between the two institutions and the delegated acts which will supplement the amending directives and provide much of the detail as to how these measures will be implemented have yet to be drafted. All that taken into account, we understand that some of the key outcomes from last week’s trialogue negotiations include the following:

Loan Origination Funds

One of the key sticking points during the trialogue negotiations was the establishment of a pan-EU framework containing common minimal rules for loan-originating funds.

While Irish loan-originating funds are already subject to a domestic framework which imposes requirements to ensure relevant risks are managed appropriately (including rules on risk retention and risk diversification), the introduction of a set of common minimal rules for loan-originating funds across the EU should facilitate the greater harmonisation of the loan-origination market within the EU, particularly in light of the fact that under the new framework, AIFMs will be permitted to originate loans on behalf of AIFs under management on a cross-border basis within the EU.

We understand that under the finalised rules for loan-originating funds, a leverage limit, calculated using the commitment approach, of 175% of net asset value for open-ended funds and 300% of net asset value for closed-ended funds will be imposed. Given that tighter leverage limits were originally sought by the Council of Europe, the limits eventually agreed upon will likely be welcomed by those managers currently operating loan-origination strategies within EU funds. Furthermore, we understand that the finalised text excludes subscription financing from such limits and also contains a derogation under which shareholder loans which do not exceed in aggregate 150% of the AIF’s capital are not included when calculating leverage for the purposes of determining compliance with these leverage limits.

We also understand that the concept of a “loan-originating fund” will be defined as including any AIF whose investment strategy is mainly to originate loans or where the notional value of the AIF’s originated loans represents at least 50% of the net asset value of the relevant fund. While we will need to see the finalised legislative text and delegated acts to fully assess the implications of this on the scope of the proposed rules, it would seem to indicate that those funds which originate loans on an ancillary basis only will not fall within the full scope of the loan-origination rules established under the EU framework.

Finally, we understand that at the request of the European Parliament, the definition of “loan origination” will capture loans originated indirectly through a third party on behalf of the relevant AIF.

Delegation

As expected, delegation by UCITS management companies and AIFMs to third parties will remain possible under the new rules. However, an enhanced reporting regime will be introduced under which any fund management company which delegates investment management to a third party will be subject to additional reporting obligations, including providing their national competent authority with information on the amount and percentage of the relevant fund(s) subject to delegation arrangements.

We also understand that the European Parliament’s proposal to require management companies providing “white labelling” services to monitor potential for conflicts of interests arising and to submit detailed explanations to their national competent authorities of the steps taken to manage and prevent those conflicts of interest will be retained in the finalised legislative text.

Liquidity Management Tools

As outlined in greater detail in our previous briefings, in order to ensure that fund management companies can deal with significant outflows during periods of financial turbulence, the legislative package includes new rules relating to the selection, activation and use of liquidity management tools by UCITS management companies and AIFMs managing open-ended AIFs.

The interplay of the finalised rules governing the use of liquidity management tools set down in the revised UCITS and AIFMD frameworks with the policy recommendations which are expected to be finalised by IOSCOand the Financial Stability Board later this year on the management of liquidity mismatch in open-ended funds will be of interest to global asset management firms.

Depositary Passport

Under the revised framework, subject to certain conditions, it will be possible to appoint a depositary located in another Member State to the home Member State of the AIF, if regulated, or of the AIFM, where the AIF is not regulated. We understand that while the relevant review clause will not contain reference to the possibility of an EU-wide passport for depositary services, it will provide for the possibility of extending the derogation to allow depositaries to provide depositary services to funds located in another Member State in line with the objective of the Capital Markets Union.

Next Steps

The political agreement reached between the institutions remains provisional and has yet to be finally confirmed. We understand that final technical meetings are expected to take place in the first half of September with the intention of bringing the text to COREPER in the second half of September for confirmation. Once the legislation has been formally approved and published in the Official Journal, we understand that Member States will have 24 months to transpose the finalised rules into national law, meaning that we would expect the new frameworks to begin to apply in the second half of 2025 or the first half of 2026 at the earliest.

It will be interesting to see whether the national competent authorities of all Member States will remain faithful to the finalised agreed legislative text or whether any individual Member States will choose to supplement the new rules with additional domestic provisions.

We will update you on the detail of the finalised legislative package as soon as it has been published, however in the meantime, if you have any questions arising from this briefing, please get in touch with any of the authors or your usual contact in Dillon Eustace.