It’s not what you say; it’s how you say it. In July, the European Securities and Markets Authority published a series of guidelines for asset managers looking to relocate their investment management services to a jurisdiction inside the EU. While there was nothing to surprise alternative investment firms in the proposals, the statement was clear: getting authorised in Europe will be more than a rubber-stamping exercise.
“Most of the requirements are not really a problem, it is mainly the tone that is seen as problematic,” says Patricia Volhard, partner at law firm Debevoise & Plimpton. “ESMA’s opinion seems to be more specifically directed to regulators as the main concern seems to be to prevent forum shopping. The regulatory standards should be the same from one member state to another.”
From the outset, ESMA makes it clear that it wants Europe pulling together rather than tearing itself apart in competition for asset managers. “Against this background … [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,” the authority said.
ESMA wants to get ahead of the issue. Just days after the UK parliament delivered its notice to withdraw from the EU, Prime Minister Theresa May called a surprise election. While many were hopeful for a soft Brexit, both of the largest parties, Conservative and Labour, have committed themselves to leaving the single market.
The future relationship between the UK and the EU remains unclear, but many are expecting fund managers in London will lose the Alternative Investment Fund Managers Directive passport – a provision allowing asset managers, including private debt funds, to market across the EU market without approaching individual national regimes. It’s not surprising that many participants at the PDI Capital Structure conference last year named retaining rights under the AIFMD as the number one priority in the negotiations.
Frankfurt, Dublin, Luxembourg and Amsterdam have all been lining up to attract fund managers to their cities. This shifting scenario is taking place under the watchful eye of ESMA, which in its July guidelines was careful to remind parties that it requires a substantial commitment to Europe.
Among these guidelines are requirements that investment funds appoint at least three full-time employees, one of them being a compliance officer, and that risk management functions must be active prior to the investment, not limited to assessing it after completion. Paragraph 61 states that “national competent authorities should be satisfied that relocating entities have transferred a sufficient amount of portfolio management and/or risk management functions for the relevant funds to their new home member state”.
What is telling about ESMA’s approach is that it measures activities by the people firms employ. It is not necessarily an incorrect way to assess a firm’s presence, but it does limit how a firm can demonstrate its substantial presence inside a member state.
“The main concern I have is that it is not sufficiently tailored to say that you need at least two senior managers without knowing how much volume they are to manage and how complex these products are. I also think that it goes beyond what is required by law if ESMA requires a firm to justify why they set up their regulated entity in one specific member state,” says Volhard.
“It is clear that ESMA’s concern is that regulators do not apply the regulatory standards consistently. But if that really were the case, that could not be solved by imposing additional burden on the industry itself.”
One guideline that was welcomed was the affirmation of the advisory model that would only be considered a delegation, therefore a violation, under EU law if the firm itself relies solely on the advice of a third party to make an investment decision. While ESMA advises national regulators to watch these partnerships closely, they still provide a space for firms to solicit expertise from outside the jurisdiction. This will be important to funds accessing London’s deep advisory network post-Brexit.
It’s impossible to ignore the political context that has prompted the publication of this opinion. However, the regulator’s attempt to address new political challenges could potentially lead to the undermining of the principle foundations of the EU.
“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,” says 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.” Luxembourg and Dublin have emerged as places likely to benefit from US or UK funds moving to the continent. But for lenders the real target for opportunities is in Germany and France, where private debt markets continue to grow and have a sizeable mid-market.
The best regulation results from a dialogue between lawmakers and the markets they try to referee. Europe’s direct lending market is barely a decade old and it is only recently that laws in the larger economies such as Germany and Italy have loosened up to enable funds to originate more loans.
The UK’s direct lending market is undoubtedly the largest and London has served as a launch pad for many North American firms launching Europe-focused strategies. It is here that many of these questions regarding the ESMA proposals will be the most acute, but Europe has a lot to gain if the lawmakers and regulators get it right.