The European Securities and Markets Authority (ESMA) has assessed six non-EU jurisdictions to render an opinion on an extension of the AIFMD passport. The hedge fund industry is understandably anxious about any impediments to the integration of U.S. operations in particular with those of Europe, and the US was one of the jurisdictions to be assessed, along with: Guernsey, Hong Kong, Jersey, Singapore, and Switzerland.
The bottom line for the U.S.: passport status remains in abeyance, and the reasons for that abeyance are shrouded in the fog of bureaucrat-speak. In order to understand, let’s take this a step at a time.
The “No Obstacles” Test
The pertinent test, according to article 67(4) of the AIFMD, is whether ESMA considers that there are no significant obstacles regarding investor protection, market disruption, competition and the monitoring of systemic risk, impeding the application of the passport to the marketing of non-EU AIFs by EU AIFMs in the member states, and/or marketing of AIFs by non-EU AIFMs in the member states. In the absence of such obstacles the non-EU jurisdictions under review should get the go-ahead for passport status.
ESMA has concluded, accordingly, that: “[N]o obstacles exist to the extension of the passport to Guernsey and Jersey, while Switzerland will remove any remaining obstacle with the enactment of pending legislation.” It says “no definitive view has been reached on the other three jurisdictions due to concerns related to competition, regulatory issues and a lack of sufficient evidence to properly assess the relevant criteria.”
AIMA Says: Keep Moving Forward
The Alternative Investment Management Association Friday expressed satisfaction with progress with regard to the positively assessed three jurisdictions, and urged more work along the same lines. Jack Inglis, the CEO of AIMA, said in a statement, “The passport is just one of a set of marketing options for hedge fund management firms. We look forward to engaging further with ESMA on the continuation of the national private placement regimes which we feel should be allowed to run alongside passports indefinitely.” Such private placement regimes, he added, “are extremely useful in making it possible for European pension funds and other European investors to access non-EU funds managed by some non-EU firms.”
AIMA has urged ESMA to complete the as-yet incomplete assessments, especially in the matter of the United States. This brings us back to where we began.
On the subject of the US in particular, ESMA has expressed the view that the rules concerning funds are comparable to the rules in the EU (which is presumably a good thing). ESMA has in mind here “diversification, disclosure requirements, limitation in ability to borrow money” and so forth.
There is a difference as to valuation, in that U.S. funds may value assets in accordance with US GAAP rather than in accordance with IFRS, but ESMA doesn’t see this as a wide divergence.
A difference that is potentially more important -- and not a good thing -- involves the role of the custodian. ESMA observes with a cluck of the tongue that in the United States “under certain circumstances … the fund can act as its own custodian.” That can’t happen, though, for AIFMs and AIFs “that intend to use the EU passport.”
ESMA’s Advice also makes reference to principle 24 of IOSCO. I'll quote the principle here: “The regulatory system should set standards for the eligibility, governance, organization and operational conduct of those who wish to market or operate a collective investment scheme.”
The Good and the Bad
What ESMA was trying to say about principle 24 in the context of the United States seems a bit ambiguous. We’re told on the one hand that “the current framework broadly achieves the objectives of the principle,” but on the other hand that the authorities in the U.S. might want to “add an explicit rule so as to comply with IOSCO Principles and ensure their expectations in this area are well understood by the market.”
On the third hand: a footnote to that discussion says that a more “detailed assessment” of this point may be found in a recent (April 2015) IMF report, and links thereto.
The IMF report also gives an on-the-one-hand but on-the-the-hand assessment of the U.S. regulatory scheme, including how it measures up to principle 24. So this is fractal ambivalence. On the one hand, mutual fund boards in the U.S. “have the responsibility of selecting and overseeing the IAs and in practice exercise this role in a proactive manner both at the moment of the initial selection and on an on-going basis through reporting and meetings.” Gee, that sounds good. Yet on the other hand, the coverage of the SEC’s monitoring “is limited despite the importance of the sector.” That sounds bad.
Where does this leave us? The road to passport status for the U.S. may yet be rocky, and ESMA is as yet disinclined to offer a clear map.