It’s not what you say, it’s how you say it. Even if what you’re saying is nothing new, the tone matters.
In July, the European Securities and Marketing Authority (ESMA) issued a set of guidelines to both regulators and asset managers concerning the location of asset managers in the European Union (EU).
The key concern was that investment firms should not set up shop in the EU for rubber stamping purposes, instead they must show substantial commitment to doing business in the jurisdiction that they are based.
This is demonstrated in the paragraphs requiring asset managers to appoint full-time members, including standalone compliance officers.
Further, ESMA is keen to avoid investment firms attempting to circumvent rules on delegation. While investment advisors are permitted, firms must make their own “qualified analysis” and authorise the investment.
The opinion in the guidelines should not surprise anyone, but some say it highlights the long-standing complaints of market participants that the criteria to measure activity is too restrictive.
“One concern is that it is not sufficiently tailored to impose a specific number of personnel, and to assume that a single person could not efficiently monitor without considering the volume and complexity of services delegated,” said Patricia Volhard, partner at law firm Debevoise & Plimpton.
“I also think that it goes beyond what is required by law if ESMA requires a firm to justify why they set up a regulated entity in one specific member state,” she added.
Regulators have the tough ask of anticipating market trends and responding to them accordingly. A hands-off approach allows businesses to flourish and innovate, but they have to keep an eye on protecting investors’ interests.
The UK private debt industry, by far the largest market in Europe, has benefitted from strict, but clear regulation. “Firms don’t have a problem with being authorised if it is reasonable,” said one market source. “I’ve never heard any UK manager complain about the regulation and it was not soft, it was strict.”
What ESMA fears is a race to the bottom as cities compete to attract asset managers, namely US funds, which are looking to set up a base inside the EU and obtain the AIFMD passport. Luxembourg, Dublin, Frankfurt and Amsterdam are already reaching out to investment firms, giving rise to concerns of widespread forum shopping.
“[ESMA] … addresses cross-sectoral regulatory and supervisory arbitrage risks that arise as a result of increased requests from financial market participants seeking to relocate in the EU27 within a relatively short period of time,” the guidelines state.
The best regulation results from dialogue. As investment firms develop increasingly niche and complex strategies to get ahead of their own markets, regulators have to play catch up. Where it can go wrong is from misunderstanding, which can lead to undermining of the advantages of operating in the EU market.
“What the guidelines seem to suggest is that you only form a structure in one member state if you are actually going to be doing your business there, rather than using it as an access point to other, larger markets,” said Paul Ellison, partner at law firm Macfarlanes.
“But it’s a fundamental concept of the European project that you should be able to establish yourself in one member state and access counter parties in another jurisdiction without having to pass some kind of test,” he added.
ESMA’s guidelines are directed more at individual regulatory regimes than the asset managers themselves. The body itself cannot change the law over AIFMD rights, but the opinion might see a push “towards tougher appraisals of licence applications”, said Simon Crown, partner at law firm Clifford Chance in a note on the changes. It’s through the tone of the guidelines that firms can work out the true meaning.