The alternative investment fund managers directive[1] (the AIFMD), enacted by EU lawmakers in 2011 and implemented into Luxembourg's legal framework by the law of 12 July 2013 on alternative investment fund managers (the AIFM Law) sought to establish a unified regulatory system for the oversight of alternative investment funds (AIFs) through their managers (AIFMs), aiming at protecting investors, augmenting transparency, and fostering stability within the European Union’s (EU) financial landscape.
Over the past decade, the AIFMD regime has demonstrated its effectiveness in cultivating a resilient market that garners international recognition of the AIFMD label. It has further undoubtedly supported a substantial expansion of the alternative investment fund industry and it is intuitive for AIFMD to undergo a revision to adapt and respond to changing market dynamics, including fluctuations in the economic and financial landscape. This revision brought by the AIFMD II seeks to reinforce the existing regulatory ecosystem by broadening its reach and fostering greater legal certainty and consistency between the supervisory practices of the national competent authorities (NCAs) throughout the EU, inter alia through the introduction of a fresh set of regulations covering such an emerging and successful investment strategy as loan origination.
The most salient features of AIFMD II
- Specific framework for AIFs which originate loans
After years of diverging national supervisory practices by NCAs as summarised below, AIFMD II finally introduces a harmonised regime for AIFs which originate loans.
- Common rules applicable to all AIFs engaging in loan origination:
AIFMD II places significant importance on AIFs which originate loans. In this respect, one of the notable provisions of AIFMD II requires that an AIF keeps throughout its life 5% of the nominal value of the loans it has granted. Such 5% risk retention obligation aligns with the current risk-retention requirement outlined in the EU Securitisation Regulation.[2]
Additionally, AIFMs should be prohibited from managing AIFs which originate loans with the sole purpose of selling them to third parties (‘originate-to-distribute strategy’), regardless of whether those AIFs meet the definition of loan-originating AIFs.
While the AIFMD did not explicitly provide that AIFs may originate loans, the NCAs were free to interpret its application to loan origination activity. Since 2016, the Luxembourg Commission de Surveillance du Secteur Financier (CSSF)[3] has considered that, in the absence of explicit prohibition by the AIFM Law and Luxembourg AIF product laws, AIFs in the meaning of the Luxembourg AIFM Law can engage in loan-origination activity.
AIFMD II now explicitly allows AIFMs to engage in loan origination activities, addressing the inconsistency criteria in certain EU Member States which prior AIFMD II resulted in legal uncertainty. This ensures that AIFs can engage in loan origination activities throughout the EU, fostering fair competition between different regulatory markets within the EU and a harmonised level of investor protection.
To illustrate these diverging supervisory approaches among EU NCAs, it is worth mentioning that the French financial regulatory authority, the Autorité des Marchés Financiers (the AMF) had issued in June 2016, a detailed instruction setting forth the organisational requirements applicable to asset management companies intending to manage loan-granting AIFs[4]. This publication coincided closely with the CSSF FAQ update on the AIFM Law on 9 June 2016, which introduced a new section on loan origination.
Furthermore, AIFMD II requires AIFMs to implement effective policies, procedures, and processes for the granting of credit, for assessing the credit risk, for administering and monitoring credit portfolios. These tailored policies require annual review.
All of these requirements seem to be already captured by the CSSF FAQ on AIFM Law[5] and should not result in substantial changes of the CSSF’s approvals and supervisory approach for the performance of investment strategies involving loan origination.
- Set of top-up rules applicable only to loan-originating AIFs
The AIFMD II has further introduced a definition of a ‘loan-originating AIF’ describing it as an AIF whose investment strategy is mainly to originate loans or whose originated loans have a notional value representing at least 50% of its net asset value.
AIFMD II also implements a leverage limit for loan-originating AIFs, capping the allowed level of leverage to 300% for closed-ended loan-originating AIFs and 175% for open-ended loan-originating AIFs. The leverage of a loan-originating AIF must be expressed as the ratio between the exposure of that AIF calculated using the commitment method and its net asset value.
- Liquidity Management Tools (LMTs) – is there something really new?
AIFMs managing open-ended AIFs must now choose at least two LMTs suitable with the AIF investment strategy (list set out in Annex V to AIFMD II), with an exception for AIFs authorised as money market funds for which the AIFM may decide to select only one LMT, and must implement detailed policies for tool activation and deactivation and the operational and administrative arrangement for the use of such LMT.
This should not be an enormous challenge for Luxembourg AIFMs who often at the same time hold the licence of a UCITS management company under the amended law of 17 December 2010 relating to undertakings for collective investment (the UCI Law). In this respect, Luxembourg market participants should be able to rely on decades of experience in the field of management of investment funds pursuing liquid investment strategies which are well known instruments for Luxembourg UCITS management companies and regulator, as in March 2009[6], following the global financial crisis of 2008 and long before the implementation of AIFMD in Luxembourg, the CSSF had put in place a fast-track procedure for the approval of applications of side pockets for AIFs facing liquidity issues.[7]
Further to the recent ESMA Market Report on EU Alternative Investment Funds 2023[8] and ESMA article on the risks posed by leveraged AIFs in the EU[9], both dated 30 January 2024, it is likely that monitoring liquidity risks will become a top focus for NCAs and EU authorities in the coming times.
In this context, the CSSF has already made clear to Luxembourg market players that the monitoring of liquidity management will be one of the main points of attention of its supervisory practice in the next years.
The LMTs list set in annex V to AIFMD II is not exhaustive, thereby giving flexibility to AIFMs. Nevertheless, except for money market funds, at least two LMTs should be picked up from the list and included in the AIF’s rules or instruments of incorporation.
This new requirement to include the selected LMTs in the instruments of incorporation of the open-ended AIFs under management will require AIFMs to ensure a coordinated review of the articles of incorporation, management regulations and limited partnership agreements of the AIFs they manage.
From a practical perspective, time will tell how NCAs will monitor timely compliance by open-ended AIFs and their AIFMs with this obligation to add the two selected LMTs.
We may expect that the CSSF will put-in place a “fast-track” procedure requesting AIFMs to confirm that they have conformed to this requirement for the open-ended AIFs under their management (i.e. ensured that the instruments of incorporation of such AIFs are compliant with this requirement). The inclusion of redemption suspension clauses in open-ended AIFs has been market practice in Luxembourg for decades and is even prescribed by Article 94a (applicable to Part II UCIs which always qualify as AIFs[10]) of the UCI Law.
Based on the above elements, it seems reasonable to expect that Luxembourg AIFMs and the CSSF are well-prepared to comply with the new requirements in terms of LMTs brought by AIFMD II.
- Clear vision of the AIFM’s substance and operations
AIFMs must now employ at least two conducting officers domiciled in the EU, and in consideration of their application should disclose a description of (i) their role, title, and level of seniority, (ii) their reporting lines and responsibilities in and outside the AIFM, (iii) time each person allocates to each responsibility and
(iv) technical and human resources that support their activities.
Most of this information is already regularly being requested by the CSSF during the application process for authorisation as AIFM or as a conducting officer.
This addition to AIFMD II should not bring substantial changes to the CSSF’s regulatory practice as CSSF Circular 18/698 on the authorisation and organisation of investment fund managers incorporated under Luxembourg law already requires that the number of conducting officers be at least two, that the conducting officers be, in principle, Luxembourg residents and possess sufficient skills and professional experience having regard to the types of UCIs concerned and to the investment strategies of the managed UCIs.
- Fees, costs and charges disclosure
In addition to disclosing maximum fees, AIFMs must now disclose as part of the pre-contractual information the fees, charges and expenses directly or indirectly borne by the investors in connection with the operations of the AIF and that will be directly or indirectly allocated to the AIF.
The AIFM will be required to annually report those fees and charges to the CSSF.
On 17 May 2023, ESMA published an opinion on undue costs of UCITS and AIFs[11]. AIFMD II has prompted the ESMA to submit a report to the European Parliament, the Council and the Commission assessing the level of, reasons for, and the differences in, the costs charged to retail investors, including differences resulting from the nature of the AIFs and UCITS concerned, and analysing whether the criteria set out in its supervisory briefing are to be complemented with regard to the notion of undue costs.
- Extension of AIFM ancillary (non-core) services
The list of ancillary (non-core) services that may be provided by an AIFM under a top-up licence has been extended to cover (i) administration of benchmarks, (ii) credit servicing functions and (iii) any other function or activity that is already provided to the managed AIFs, provided that any potential conflict of interest created by the provision of that function or activity to other parties is appropriately managed.
A further essential update is that AIFMD II allows (by deleting Article 6 (5) (b) of AIFMD) AIFMs to apply for top-up authorisation for non-core services comprising (i) investment advice, (ii) safe-keeping and administration in relation to shares or units of UCIs and (iii) reception and transmission of orders in relation to financial instruments) without also being licensed for the top-up provision of portfolio management services.
- Depositaries in another EU Member State
At present, a depositary must be established in the same EU country as the AIF to which the depositary is providing its services. The AIFMD II exceptionally permits the appointment of a depositary in another EU Member State under certain conditions, allowing Member States with smaller depositary markets to derogate from the rule that a depositary in respect of an EU AIF in that EU Member State must be a depositary also established in that Member Sate.
In other words, AIFMD II does not grant an EU depositary passport but introduces the possibility to derogate, on a case-by-case basis, from the general principle that the appointed depositary of an EU-AIF be established in the home Member State of the AIF.
In order to benefit from this derogation, the AIF is required to establish that its domestic market lacks a competitive supply of depositary services for a specific investment strategy and that the national depositary market of the home Member State of the AIF is not exceeding EUR 50 billion.
Although speculative, it is foreseeable that Luxembourg AIFMs will update their procedures to include oversight of a depositary appointed in another EU Member State.
- Enhancing transparency towards investors
The investors disclosure Article 23 of AIFMD, as revised by AIFMD II, requires (i) an explanation of the circumstances and terms governing the potential use of LMTs by the AIFM, (ii) an annual compilation of fees, charges, and expenses incurred by the AIFM in the AIF's operations, directly or indirectly allocated to the AIF, and (iii) detailed information on the composition of the originated loan portfolio, including associated administration costs and expenses.
AIFMs are required to enhance transparency regarding incurred costs and charges applicable to any fund vehicle they manage. Upon launching an AIF, AIFMs are obligated to disclose a pricing policy, including upfront considerations of costs.
Furthermore, the AIF's name must be considered as pre-contractual information (along with existing redemption arrangements) and hence included in the information disclosed under Article 23 AIFMD. In that respect, ESMA should issue in the near future guidelines to clarify when the name of an AIF might be deemed unfair, unclear, or misleading, aligning with the final report containing guidelines on funds’ names using ESG or sustainability-related terms published by ESMA on 14 May 2024[12].
- Explicit reference to the SFDR framework in the AIFMD II
AIFMs must comply with Regulation (EU) 2019/2088 on sustainability‐related disclosures in the financial services sector (the SFDR) and ensure that their remuneration policies are consistent with long-term risks, including Environment, Social and Governance (ESG) risks and sustainability goals.
AIFMD II adds the requirement for an AIFM to describe in its programme of activity how the AIFM intends to comply with its obligations under Articles 3 (1) “transparency of sustainability risk policies”, 6 (1) a. “transparency of the integration of sustainability risks” and 13 “marketing communications” of SFDR and requires a detailed description of the appropriate human and technical resources that will be used by the AIFM to this effect.
Again, this should be no surprise for Luxembourg AIFMs, as the CSSF clearly stated in its communication of 6 April 2023, in its list of supervisory priorities in the area of sustainable finance for the asset management industry, that it will monitor organisational arrangements of AIFMs, including the integration of sustainability risks by financial market participants.
- Marketing ban for high-risk non-EU AIFs and non-EU AIFMs
Non-EU AIFs and non-EU AIFMs targeting EU domiciled professional investors under a national private placement regime (Art. 42 AIFMD) must be located in a country that is not identified as high-risk third country pursuant to Article 9 (2) of the 4th anti-money laundering Directive[13].
Article 42 AIFMD has also been revised to provide that (i) the country of establishment of the non-EU AIF or non-EU AIFM has signed with the Member State in which the units or shares of the non-EU AIF are intended to be marketed an agreement that fully complies with the standards laid down in Article 26 of the OECD Model Tax Convention on Income and on Capital and ensures an effective exchange of information in tax matters, including any multilateral tax agreements and that (ii) the relevant third-country is not mentioned in Annex I to the Council conclusions on the revised EU list of non-cooperative jurisdictions for tax purposes.
Before the AIFMD II update, access to the internal EU market was possible if the relevant non-EU AIF or non-EU AIFM was not listed as a non-cooperative country and territory by the Financial Action Task Force (FATF). The purpose of this amendment is to align the requirements for third-country entities with access to the internal market to the standards applicable under the 4th anti-money laundering Directive.
- Improvement of the supervisory reporting regime
AIFMD II seeks to enhance reliability and utility of data provided by the AIFMs to the regulators by expanding certain economic information. ESMA has been assigned by the EU co-legislators to develop draft regulatory technical standards (RTS) specifying the details of the required information, including the appropriate level of standardisation, reporting frequency, and timing.
As part of its prudential supervision role, the CSSF already required a fair amount of reports from Luxembourg-authorised AIFMs. It is hence understood that Luxembourg AIFMs will already be substantially aligned with the revisions to the AIFMD supervisory reporting regime brought by AIFMD II.
- Adjustments to the delegation regime
The AIFMD II highlights the significance of delegation and sub-delegation arrangements, requiring AIFMs to furnish additional information on such arrangements to their NCA during authorisation applications and as part of ongoing regulatory reporting. These reports must now include details on delegates and sub-delegates, as well as quantitative information on delegated portfolio management function.
Where an AIFM manages or intends to manage an AIF at the initiative of a third party – the AIFM shall demonstrate that it has taken reasonable steps to prevent, identify, manage, monitor and, where applicable, disclose conflicts of interest in order to prevent them from adversely affecting the interests of the AIF and its investors.
Timing for implementation and five years monitoring
AIFMD II entered into force on 15 April 2024. For five (5) years following this date, the EU legislators will examine the performance and appropriateness of those new requirements to AIFMs, such as:
- impact on financial stability of the availability and activation of LMT;
- AIFM authorisation requirements in relation to the delegation regime, by preventing the creation of letter-box entities within the EU;
- functioning of the derogation allowing the appointment of a depositary in another Member State;
- managing an AIF on the initiative of a third party and the need for additional safeguards to prevent conflicts of interest arising from the relationship; and
- where the AIFM manages AIFs marketed to retail investors, their protection should be ensured by the appointment of at least one non-executive or independent director in the governing body of the AIFM.
Luxembourg market participants may continue to rely on the stability and effectiveness of the current Luxembourg regulatory structure. Moreover, this continuity not only ensures the smooth operation of existing investments but also strengthens the attractiveness of Luxembourg as a premier destination for capital, professionals, and investors in the EU funds industry.
[1] Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010.
[2] Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for simple, transparent and standardised securitisation.
[3] CSSF FAQ on the AIFM Law, question 22.
[4] AMF Instruction Doc-2016-02 last updated on 25 October 2023.
[5] CSSF FAQ on the AIFM Law, question 22, B. “What are the aspects to be addressed by an AIFM/AIF engaging in Loan Origination?”
[6] Elvinger, Hoss & Prussen newsletter May 2009, page 6. “CSSF approves fast-track procedures for side pockets.”
[7] Luxembourg open-ended AIFs and “compulsory LMTs – a look at the state of play of redemption suspension decisions and side pocket creation as well as the potential developments expected on the subject matter under the AIFMD II, Prof. Ezechiel Havrenne, LL.M., JurisNews vol.11-No 1/2023, p,208, § (46).
[8] ESMA50-524821-3095.
[9] ESMA60-1389274163-2572.
[10] Article 88-1 of the UCI Law provides: “Any UCI governed by Part II qualifies as an AIF within the meaning of the Law of 12 July 2013 on alternative investment fund managers,”
[11] ESMA Opinion on undue costs of UCITS and AIFs of 17 May 2023 (ESMA34-45-1747).
[12] ESMA final report on guidelines on funds’ names using ESG or sustainability-related terms of 14 May 2024 (ESMA34-472-440).
[13] Directive (EU) 2015/849 of the European Parliament and of the Council of 20 May 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, amending Regulation (EU) No 648/2012 of the European Parliament and of the Council, and repealing Directive 2005/60/EC of the European Parliament and of the Council and Commission Directive 2006/70/EC.
The alternative investment fund managers directive[1] (the AIFMD), enacted by EU lawmakers in 2011 and implemented into Luxembourg's legal framework by the law of 12 July 2013 on alternative investment fund managers (the AIFM Law) sought to establish a unified regulatory system for the oversight of alternative investment funds (AIFs) through their managers (AIFMs), aiming at protecting investors, augmenting transparency, and fostering stability within the European Union’s (EU) financial landscape.
Over the past decade, the AIFMD regime has demonstrated its effectiveness in cultivating a resilient market that garners international recognition of the AIFMD label. It has further undoubtedly supported a substantial expansion of the alternative investment fund industry and it is intuitive for AIFMD to undergo a revision to adapt and respond to changing market dynamics, including fluctuations in the economic and financial landscape. This revision brought by the AIFMD II seeks to reinforce the existing regulatory ecosystem by broadening its reach and fostering greater legal certainty and consistency between the supervisory practices of the national competent authorities (NCAs) throughout the EU, inter alia through the introduction of a fresh set of regulations covering such an emerging and successful investment strategy as loan origination.
The most salient features of AIFMD II
- Specific framework for AIFs which originate loans
After years of diverging national supervisory practices by NCAs as summarised below, AIFMD II finally introduces a harmonised regime for AIFs which originate loans.
- Common rules applicable to all AIFs engaging in loan origination:
AIFMD II places significant importance on AIFs which originate loans. In this respect, one of the notable provisions of AIFMD II requires that an AIF keeps throughout its life 5% of the nominal value of the loans it has granted. Such 5% risk retention obligation aligns with the current risk-retention requirement outlined in the EU Securitisation Regulation.[2]
Additionally, AIFMs should be prohibited from managing AIFs which originate loans with the sole purpose of selling them to third parties (‘originate-to-distribute strategy’), regardless of whether those AIFs meet the definition of loan-originating AIFs.
While the AIFMD did not explicitly provide that AIFs may originate loans, the NCAs were free to interpret its application to loan origination activity. Since 2016, the Luxembourg Commission de Surveillance du Secteur Financier (CSSF)[3] has considered that, in the absence of explicit prohibition by the AIFM Law and Luxembourg AIF product laws, AIFs in the meaning of the Luxembourg AIFM Law can engage in loan-origination activity.
AIFMD II now explicitly allows AIFMs to engage in loan origination activities, addressing the inconsistency criteria in certain EU Member States which prior AIFMD II resulted in legal uncertainty. This ensures that AIFs can engage in loan origination activities throughout the EU, fostering fair competition between different regulatory markets within the EU and a harmonised level of investor protection.
To illustrate these diverging supervisory approaches among EU NCAs, it is worth mentioning that the French financial regulatory authority, the Autorité des Marchés Financiers (the AMF) had issued in June 2016, a detailed instruction setting forth the organisational requirements applicable to asset management companies intending to manage loan-granting AIFs[4]. This publication coincided closely with the CSSF FAQ update on the AIFM Law on 9 June 2016, which introduced a new section on loan origination.
Furthermore, AIFMD II requires AIFMs to implement effective policies, procedures, and processes for the granting of credit, for assessing the credit risk, for administering and monitoring credit portfolios. These tailored policies require annual review.
All of these requirements seem to be already captured by the CSSF FAQ on AIFM Law[5] and should not result in substantial changes of the CSSF’s approvals and supervisory approach for the performance of investment strategies involving loan origination.
- Set of top-up rules applicable only to loan-originating AIFs
The AIFMD II has further introduced a definition of a ‘loan-originating AIF’ describing it as an AIF whose investment strategy is mainly to originate loans or whose originated loans have a notional value representing at least 50% of its net asset value.
AIFMD II also implements a leverage limit for loan-originating AIFs, capping the allowed level of leverage to 300% for closed-ended loan-originating AIFs and 175% for open-ended loan-originating AIFs. The leverage of a loan-originating AIF must be expressed as the ratio between the exposure of that AIF calculated using the commitment method and its net asset value.
- Liquidity Management Tools (LMTs) – is there something really new?
AIFMs managing open-ended AIFs must now choose at least two LMTs suitable with the AIF investment strategy (list set out in Annex V to AIFMD II), with an exception for AIFs authorised as money market funds for which the AIFM may decide to select only one LMT, and must implement detailed policies for tool activation and deactivation and the operational and administrative arrangement for the use of such LMT.
This should not be an enormous challenge for Luxembourg AIFMs who often at the same time hold the licence of a UCITS management company under the amended law of 17 December 2010 relating to undertakings for collective investment (the UCI Law). In this respect, Luxembourg market participants should be able to rely on decades of experience in the field of management of investment funds pursuing liquid investment strategies which are well known instruments for Luxembourg UCITS management companies and regulator, as in March 2009[6], following the global financial crisis of 2008 and long before the implementation of AIFMD in Luxembourg, the CSSF had put in place a fast-track procedure for the approval of applications of side pockets for AIFs facing liquidity issues.[7]
Further to the recent ESMA Market Report on EU Alternative Investment Funds 2023[8] and ESMA article on the risks posed by leveraged AIFs in the EU[9], both dated 30 January 2024, it is likely that monitoring liquidity risks will become a top focus for NCAs and EU authorities in the coming times.
In this context, the CSSF has already made clear to Luxembourg market players that the monitoring of liquidity management will be one of the main points of attention of its supervisory practice in the next years.
The LMTs list set in annex V to AIFMD II is not exhaustive, thereby giving flexibility to AIFMs. Nevertheless, except for money market funds, at least two LMTs should be picked up from the list and included in the AIF’s rules or instruments of incorporation.
This new requirement to include the selected LMTs in the instruments of incorporation of the open-ended AIFs under management will require AIFMs to ensure a coordinated review of the articles of incorporation, management regulations and limited partnership agreements of the AIFs they manage.
From a practical perspective, time will tell how NCAs will monitor timely compliance by open-ended AIFs and their AIFMs with this obligation to add the two selected LMTs.
We may expect that the CSSF will put-in place a “fast-track” procedure requesting AIFMs to confirm that they have conformed to this requirement for the open-ended AIFs under their management (i.e. ensured that the instruments of incorporation of such AIFs are compliant with this requirement). The inclusion of redemption suspension clauses in open-ended AIFs has been market practice in Luxembourg for decades and is even prescribed by Article 94a (applicable to Part II UCIs which always qualify as AIFs[10]) of the UCI Law.
Based on the above elements, it seems reasonable to expect that Luxembourg AIFMs and the CSSF are well-prepared to comply with the new requirements in terms of LMTs brought by AIFMD II.
- Clear vision of the AIFM’s substance and operations
AIFMs must now employ at least two conducting officers domiciled in the EU, and in consideration of their application should disclose a description of (i) their role, title, and level of seniority, (ii) their reporting lines and responsibilities in and outside the AIFM, (iii) time each person allocates to each responsibility and
(iv) technical and human resources that support their activities.
Most of this information is already regularly being requested by the CSSF during the application process for authorisation as AIFM or as a conducting officer.
This addition to AIFMD II should not bring substantial changes to the CSSF’s regulatory practice as CSSF Circular 18/698 on the authorisation and organisation of investment fund managers incorporated under Luxembourg law already requires that the number of conducting officers be at least two, that the conducting officers be, in principle, Luxembourg residents and possess sufficient skills and professional experience having regard to the types of UCIs concerned and to the investment strategies of the managed UCIs.
- Fees, costs and charges disclosure
In addition to disclosing maximum fees, AIFMs must now disclose as part of the pre-contractual information the fees, charges and expenses directly or indirectly borne by the investors in connection with the operations of the AIF and that will be directly or indirectly allocated to the AIF.
The AIFM will be required to annually report those fees and charges to the CSSF.
On 17 May 2023, ESMA published an opinion on undue costs of UCITS and AIFs[11]. AIFMD II has prompted the ESMA to submit a report to the European Parliament, the Council and the Commission assessing the level of, reasons for, and the differences in, the costs charged to retail investors, including differences resulting from the nature of the AIFs and UCITS concerned, and analysing whether the criteria set out in its supervisory briefing are to be complemented with regard to the notion of undue costs.
- Extension of AIFM ancillary (non-core) services
The list of ancillary (non-core) services that may be provided by an AIFM under a top-up licence has been extended to cover (i) administration of benchmarks, (ii) credit servicing functions and (iii) any other function or activity that is already provided to the managed AIFs, provided that any potential conflict of interest created by the provision of that function or activity to other parties is appropriately managed.
A further essential update is that AIFMD II allows (by deleting Article 6 (5) (b) of AIFMD) AIFMs to apply for top-up authorisation for non-core services comprising (i) investment advice, (ii) safe-keeping and administration in relation to shares or units of UCIs and (iii) reception and transmission of orders in relation to financial instruments) without also being licensed for the top-up provision of portfolio management services.
- Depositaries in another EU Member State
At present, a depositary must be established in the same EU country as the AIF to which the depositary is providing its services. The AIFMD II exceptionally permits the appointment of a depositary in another EU Member State under certain conditions, allowing Member States with smaller depositary markets to derogate from the rule that a depositary in respect of an EU AIF in that EU Member State must be a depositary also established in that Member Sate.
In other words, AIFMD II does not grant an EU depositary passport but introduces the possibility to derogate, on a case-by-case basis, from the general principle that the appointed depositary of an EU-AIF be established in the home Member State of the AIF.
In order to benefit from this derogation, the AIF is required to establish that its domestic market lacks a competitive supply of depositary services for a specific investment strategy and that the national depositary market of the home Member State of the AIF is not exceeding EUR 50 billion.
Although speculative, it is foreseeable that Luxembourg AIFMs will update their procedures to include oversight of a depositary appointed in another EU Member State.
- Enhancing transparency towards investors
The investors disclosure Article 23 of AIFMD, as revised by AIFMD II, requires (i) an explanation of the circumstances and terms governing the potential use of LMTs by the AIFM, (ii) an annual compilation of fees, charges, and expenses incurred by the AIFM in the AIF's operations, directly or indirectly allocated to the AIF, and (iii) detailed information on the composition of the originated loan portfolio, including associated administration costs and expenses.
AIFMs are required to enhance transparency regarding incurred costs and charges applicable to any fund vehicle they manage. Upon launching an AIF, AIFMs are obligated to disclose a pricing policy, including upfront considerations of costs.
Furthermore, the AIF's name must be considered as pre-contractual information (along with existing redemption arrangements) and hence included in the information disclosed under Article 23 AIFMD. In that respect, ESMA should issue in the near future guidelines to clarify when the name of an AIF might be deemed unfair, unclear, or misleading, aligning with the final report containing guidelines on funds’ names using ESG or sustainability-related terms published by ESMA on 14 May 2024[12].
- Explicit reference to the SFDR framework in the AIFMD II
AIFMs must comply with Regulation (EU) 2019/2088 on sustainability‐related disclosures in the financial services sector (the SFDR) and ensure that their remuneration policies are consistent with long-term risks, including Environment, Social and Governance (ESG) risks and sustainability goals.
AIFMD II adds the requirement for an AIFM to describe in its programme of activity how the AIFM intends to comply with its obligations under Articles 3 (1) “transparency of sustainability risk policies”, 6 (1) a. “transparency of the integration of sustainability risks” and 13 “marketing communications” of SFDR and requires a detailed description of the appropriate human and technical resources that will be used by the AIFM to this effect.
Again, this should be no surprise for Luxembourg AIFMs, as the CSSF clearly stated in its communication of 6 April 2023, in its list of supervisory priorities in the area of sustainable finance for the asset management industry, that it will monitor organisational arrangements of AIFMs, including the integration of sustainability risks by financial market participants.
- Marketing ban for high-risk non-EU AIFs and non-EU AIFMs
Non-EU AIFs and non-EU AIFMs targeting EU domiciled professional investors under a national private placement regime (Art. 42 AIFMD) must be located in a country that is not identified as high-risk third country pursuant to Article 9 (2) of the 4th anti-money laundering Directive[13].
Article 42 AIFMD has also been revised to provide that (i) the country of establishment of the non-EU AIF or non-EU AIFM has signed with the Member State in which the units or shares of the non-EU AIF are intended to be marketed an agreement that fully complies with the standards laid down in Article 26 of the OECD Model Tax Convention on Income and on Capital and ensures an effective exchange of information in tax matters, including any multilateral tax agreements and that (ii) the relevant third-country is not mentioned in Annex I to the Council conclusions on the revised EU list of non-cooperative jurisdictions for tax purposes.
Before the AIFMD II update, access to the internal EU market was possible if the relevant non-EU AIF or non-EU AIFM was not listed as a non-cooperative country and territory by the Financial Action Task Force (FATF). The purpose of this amendment is to align the requirements for third-country entities with access to the internal market to the standards applicable under the 4th anti-money laundering Directive.
- Improvement of the supervisory reporting regime
AIFMD II seeks to enhance reliability and utility of data provided by the AIFMs to the regulators by expanding certain economic information. ESMA has been assigned by the EU co-legislators to develop draft regulatory technical standards (RTS) specifying the details of the required information, including the appropriate level of standardisation, reporting frequency, and timing.
As part of its prudential supervision role, the CSSF already required a fair amount of reports from Luxembourg-authorised AIFMs. It is hence understood that Luxembourg AIFMs will already be substantially aligned with the revisions to the AIFMD supervisory reporting regime brought by AIFMD II.
- Adjustments to the delegation regime
The AIFMD II highlights the significance of delegation and sub-delegation arrangements, requiring AIFMs to furnish additional information on such arrangements to their NCA during authorisation applications and as part of ongoing regulatory reporting. These reports must now include details on delegates and sub-delegates, as well as quantitative information on delegated portfolio management function.
Where an AIFM manages or intends to manage an AIF at the initiative of a third party – the AIFM shall demonstrate that it has taken reasonable steps to prevent, identify, manage, monitor and, where applicable, disclose conflicts of interest in order to prevent them from adversely affecting the interests of the AIF and its investors.
Timing for implementation and five years monitoring
AIFMD II entered into force on 15 April 2024. For five (5) years following this date, the EU legislators will examine the performance and appropriateness of those new requirements to AIFMs, such as:
- impact on financial stability of the availability and activation of LMT;
- AIFM authorisation requirements in relation to the delegation regime, by preventing the creation of letter-box entities within the EU;
- functioning of the derogation allowing the appointment of a depositary in another Member State;
- managing an AIF on the initiative of a third party and the need for additional safeguards to prevent conflicts of interest arising from the relationship; and
- where the AIFM manages AIFs marketed to retail investors, their protection should be ensured by the appointment of at least one non-executive or independent director in the governing body of the AIFM.
Luxembourg market participants may continue to rely on the stability and effectiveness of the current Luxembourg regulatory structure. Moreover, this continuity not only ensures the smooth operation of existing investments but also strengthens the attractiveness of Luxembourg as a premier destination for capital, professionals, and investors in the EU funds industry.
[1] Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010.
[2] Regulation (EU) 2017/2402 of the European Parliament and of the Council of 12 December 2017 laying down a general framework for simple, transparent and standardised securitisation.
[3] CSSF FAQ on the AIFM Law, question 22.
[4] AMF Instruction Doc-2016-02 last updated on 25 October 2023.
[5] CSSF FAQ on the AIFM Law, question 22, B. “What are the aspects to be addressed by an AIFM/AIF engaging in Loan Origination?”
[6] Elvinger, Hoss & Prussen newsletter May 2009, page 6. “CSSF approves fast-track procedures for side pockets.”
[7] Luxembourg open-ended AIFs and “compulsory LMTs – a look at the state of play of redemption suspension decisions and side pocket creation as well as the potential developments expected on the subject matter under the AIFMD II, Prof. Ezechiel Havrenne, LL.M., JurisNews vol.11-No 1/2023, p,208, § (46).
[8] ESMA50-524821-3095.
[9] ESMA60-1389274163-2572.
[10] Article 88-1 of the UCI Law provides: “Any UCI governed by Part II qualifies as an AIF within the meaning of the Law of 12 July 2013 on alternative investment fund managers,”
[11] ESMA Opinion on undue costs of UCITS and AIFs of 17 May 2023 (ESMA34-45-1747).
[12] ESMA final report on guidelines on funds’ names using ESG or sustainability-related terms of 14 May 2024 (ESMA34-472-440).
[13] Directive (EU) 2015/849 of the European Parliament and of the Council of 20 May 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, amending Regulation (EU) No 648/2012 of the European Parliament and of the Council, and repealing Directive 2005/60/EC of the European Parliament and of the Council and Commission Directive 2006/70/EC.