Research

The European Securities and Markets Authority (“ESMA”) announced on 18 July 2013 that it has approved global supervisory cooperation arrangements between the securities regulators of the European Union and their third country counterparts. The arrangements were negotiated by ESMA on behalf on the EU Member States, the additional three countries which make up the European Economic Area (Iceland, Liechtenstein and Norway) and Croatia, whose accession process completed on 1 July 2013 making it the EU’s 28th Member State.

What are these arrangements?

Under the provisions of the Alternative Investment Fund Managers Directive (“AIFMD” or the “Directive”), the access of third country alternative investment fund managers (AIFMs) and alternative investment funds (AIFs) to European markets through national private placement regimes (or, from potentially 2015, through a pan-European passport regime) raises a number of challenges for EU regulators who want consistency in the regulatory protections afforded to professional investors based in the EU.

The AIFMD contains a broad framework for the regulation and supervision of such third country entities, including requirements for EU and third country regulators to enter into cooperation and exchange of information arrangements. The operational detail of these provisions was provided in the European Commission’s (the “Commission”) Level 2 Delegated Regulation No. 231/2013 (the “Level 2 Regulation”) which was issued in December 2013. The stipulated cooperation arrangements were required to be in place by the AIFMD’s implementation deadline of 22 July 2013.

Prior to the publication of the AIFMD in the Journal of the European Union in July 2011, the Commission sent a request to the Committee of European Securities Regulators (ESMA’s predecessor) requesting assistance in relation to the content of the Directive’s implementing measures, i.e., the Level 2 Regulation. In response, ESMA issued two consultations setting out its draft advice on these measures in summer 2011, the latter of which dealt with the various third country issues raised by the Directive including the required supervisory cooperation arrangements.

The advice contained in ESMA’s initial consultation on these issues did not distinguish between the potentially relatively light “systemic risk information only” provisions, which the Directive makes clear could be appropriate as the minimum amount of information required before non-Directive private placement marketing could be permitted, and fuller information which could be appropriate if and when EU authorisation and passporting is available for third country AIFMs. Instead, ESMA applied the same standards to both and then added that any final decisions made on whether any additional safeguards will have to be place with respect to the third country passport would be made at a later stage. This issue was evidentially a point of contention for respondents to ESMA’s consultation paper as the report containing ESMA’s finalized advice (published in November 2011) addresses this matter, noting that while ESMA did consider whether to make such a distinction, it feels that systemic risk is sufficiently important to justify the exchange of the same level of information in both cases.

Directive makes clear could be appropriate as the minimum amount of information required before non-Directive private placement marketing could be permitted, and fuller information which could be appropriate if and when EU authorisation and passporting is available for third country AIFMs. Instead, ESMA applied the same standards to both and then added that any final decisions made on whether any additional safeguards will have to be place with respect to the third country passport would be made at a later stage. This issue was evidentially a point of contention for respondents to ESMA’s consultation paper as the report containing ESMA’s finalized advice (published in November 2011) addresses this matter, noting that while ESMA did consider whether to make such a distinction, it feels that systemic risk is sufficiently important to justify the exchange of the same level of information in both cases.

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Following ESMA’s final advice, the Level 2 Regulation therefore imposes the following requirements. The cooperation arrangements shall:

• be in writing; establish the specific framework for consultation, cooperation and exchange of information for supervisory and enforcement purposes between the EU and third country regulators;
• include a specific clause for the transfer of information received by an EU regulator from a third country regulator to other relevant entities, specifically other EU regulators, ESMA and the European Systemic Risk Board; and,
• establish all mechanisms, instruments and procedures required for:
  • enabling EU regulators to have access to all information necessary for performance of their duties under the Directive;
  • enabling on-site inspections to be carried out where required for the exercise of such duties; and,
  • the third country regulator to assist EU regulators with the enforcement of EU legislation and national implementing legislation.

The language which imposes a duty on a third country regulator to assist EU regulators in taking enforcement action against a third country AIFM for breaches of “EU legislation” was a controversial aspect of ESMA’s initial consultation. The reference to the enforcement of EU legislation by EU regulators raises a number of legal and practical issues if it is intended to go beyond the provision of information of the kind envisaged by the International Organisation of Securities Commissions (“IOSCO”). Rather unhelpfully, the term was not actually defined in the consultation and so the scope of this power was initially very unclear with no guidance on how it would actually work in practice. Fortunately, ESMA took heed of the criticisms of respondents to its consultation paper who noted that the term was very broad and created uncertainty. Consequently, ESMA stated in its final report that it agreed with the respondents and had amended the advice to make clear that the breaches should be understood as relating to the AIFMD and its implementing measures.

Additionally, ESMA’s initial consultation was met by requests from respondents for further clarity on the responsibilities under the cooperation agreements of the EU regulatory authorities and their third country counterparts, specifically the precise remit of each regulator given the constraints of having to act within their respective national legislative frameworks. However, ESMA simply responded by stating that the allocation of responsibilities would be addressed during the negotiation of the cooperation arrangements and, as such, currently no further detail is available.

In addition to the cooperation arrangements required to address the marketing considerations outlined above, the AIFMD also requires such arrangements to be in place in order for an AIFM to assign its portfolio or risk management activities (as permitted under the Directive) to a delegate in a third country or in order to appoint a third country depositary. There is some uncertainty as to why ESMA feels it is necessary to require a further written agreement between countries in this instance when both parties are already signatories to the IOSCO Multilateral Memorandum of Understanding Concerning Consultation and Co-operation and the Exchange of Information of 2002 (“IOSCO MMoU”), although as noted above the scope of the arrangements under the Level 2 Regulation includes on-site visits and assistance in enforcement action which goes beyond the levels of cooperation envisaged by the IOSCO MMoU.

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What form do these arrangements take?

The supervisory cooperation agreements take the form of Memoranda of Understanding (“MoUs”) whose content is aligned with the IOSCO Principles on Cross-Border Supervisory Co-operation of 2010 and the terms and conditions of the IOSCO MMoU. The MOUs for the 38 individual agreements negotiated before the July 22nd deadline are available on ESMA’s website.

To ensure consistency of approach and avoid the proliferation of bilateral agreements, ESMA has consistently expressed a preference for a single agreement to be negotiated between ESMA and the relevant third country regulators. The negotiations have progressed and concluded accordingly, however, it will now be up to the individual regulators in each EU Member State to decide precisely with which third countries they wish to enter into cooperation arrangements as it is the regulators themselves who will be responsible for the supervision of the relevant AIFMs.

Which countries are included?

Cooperation arrangements have been entered into with the following regulatory bodies: Alberta Securities Commission (Canada), Australian Securities and Investments Commission, Autorité des Marchés Financiers du Quebec (Canada), Bermuda Monetary Authority, British Columbia Securities Commission (Canada), British Virgin Islands Financial Services Commission, Capital Markets and Securities Authority of Tanzania, Capital Markets Authority of Kenya, Cayman Islands Monetary Authority, Comisión Nacional Bancaria y de Valores (Mexico), Comissão de Valores Mobiliários do Brasil, Commodity Futures Trading Commission (US), Conseil Déontologique des Valeurs Mobilières of Morocco, Dubai Financial Services Authority, Emirates Securities and Commodities Authority, Federal Reserve Board (US), Financial Services Commission of Mauritius, Financial Supervision Commission of the Isle of Man, Financial Supervisory Authority of Albania, Guernsey Financial Services Commission, Hong Kong Monetary Authority, Hong Kong Securities and Futures Commission, Israel Securities Authority, Japan Financial Services Agency, Jersey Financial Services Commission, Labuan Financial Services Authority, Ministry of Agriculture, Forestry and Fisheries (Japan), Ministry of Economy, Trade and Industry (Japan), Monetary Authority of Singapore, Office of the Comptroller of the Currency (US), Office of the Superintendent of Financial Institutions (Canada), Ontario Securities Commission (Canada), Republic of Srpska Securities Commission, Securities and Exchange Board of India, Securities and Exchange Commission (US), Securities and Exchange Commission of Montenegro, Securities and Exchange Commission of Pakistan, Securities and Exchange Commission Thailand, Securities Commission (Bahamas), Securities Commission (Malaysia) and Swiss Financial Market Supervisory Authority (FINMA).

Editor’s note: After the transposition deadline of 22 July 2013, non-EU managers in jurisdictions in which the financial services regulator has not signed a co-operation agreement with ESMA will not be permitted to market or manage alternative investment funds in the European Union.

What are the other private placement regime requirements?

In addition to the requirement for supervisory cooperation agreements with third country regulators, non-EU AIFMs managing either EU or non-EU AIFs seeking to take advantage of the private placement regimes of EU Member States will nevertheless have to comply with certain obligations under the AIFMD. The level of compliance required is far less substantive than that required under the passporting regime for EU AIFMs. Non-EU AIFMs are required to comply with the “transparency requirements” of Articles 22, 23 and 24, i.e., the preparation of an annual report, the requirement to make certain disclosures to investors and the reporting obligations to the relevant EU regulatory authorities.

Additionally, in the event that a non-EU AIFM manages an AIF which acquires a substantial stake in an EU company, the portfolio company provisions will also apply. These require the non-EU AIFM to make a notification to the relevant regulatory authority, provide additional disclosure regarding the acquisition to its investors and comply with the Directive’s “asset stripping” provisions.

EU AIFMs marketing non-EU AIFs are also not required to comply with the Directive in its entirety, although their obligations are much more comprehensive than those of their non-EU counterparts. In practice this means that such entities must comply with the full AIFMD requirements with the exception of the provisions relating to the appointment of a depositary under Article 21 (since the relevant jurisdiction for the non-EU AIF may not recognise the depositary concept), although an independent party must still perform the duties of the depositary.

As mentioned above, it is expected that national private placement regimes will continue in most Member States until at least 2015 at which point a marketing passport is expected to be made available to non-EU AIFMs and EU AIFMs managing non-EU AIFs. It is currently envisaged that the two regimes will then exist in parallel until 2018, providing a degree of choice about the level of compliance with the AIFMD.

About the Author

 

Gregg Beechey is a Partner with SJ Berwin
specializing in financial markets.