European Systemic Risk Board considerations regarding the Alternative Investment Fund Manager Directive

Objective

The AIF market represents 40% of the EU fund market and is due to grow further with the Capital Market Union’s ambitious target to increase non-bank financing. In a letter issued on 3 February 2020, the European Systemic Risk Board (“ESRB”) provided the European Commission with a list of shortcomings identified in the Alternative Investment Fund Manager Directive (“AIFMD”) from a financial stability perspective. Although other stakeholders’ views will be expressed and might conflict with ESRB recommendations, they are likely to influence the legislative proposals the European Commission (“EC”) is mandated to make to the European Parliament and Council in the context of the AIFMD review conducted this year.

Primary Change

Building upon ESRB experience with the scope and application of AIFMD, recommendations aim (i) to improve the suitability of the reporting framework for monitoring systemic risk, (ii) to operationalise existing macro prudential policy instruments, and (iii)  to improve the macroprudential policy framework.

Key points

Reporting framework

ESRB outlined the following considerations:

• Legal Entity Identifier should not be an optional item in AIFM reporting template. Such inconsistency limits the understanding of complex group structures and the interaction with other regulatory reporting  such as under EMIR or SFDR.
• The approach to fund classification should be revised to better reflect the type of funds registered as AIFs and where the “Other” category is reduced in size.
• A more complete portfolio breakdown, using international identifiers (e.g. ISIN, LEI)  and going beyond current reporting of aggregate holdings and top five instruments, would enhance systemic risk analysis. The geographical breakdown of investment exposures by asset classes, investors, counterparties and sponsorship arrangements could be reported at country level rather than at continental level in order to allow for a more comprehensive assessment of potential contagion risks.
• AIFMD reporting should provide sufficient data to enable computation of leverage by national competent authorities (“NCA”) in order to facilitate comparisons and data quality assessments. Reporting of additional metrics capturing potential losses and liquidity demands stemming from leverage would facilitate identification of vulnerabilities.
• Reporting of the liquidity management tools that are available to fund managers and under which conditions. The objective is to allow supervisors  to better understand contagion risk in crisis scenarios. The measurement of the liquidity of investments and investors’ ability to redeem their shares/units should be harmonized and more objective.
• The reporting frequency should be harmonized and the lag for data provision could be reduced in order to improve timely monitoring of risks. The ESRB also suggests to build upon the EC’s recent fitness check to align further data reporting requirements and improve data quality.
• Access to AIFMD reporting datasets should be granted to all ESRB member institutions with a financial stability mandate.

Operationalisation of existing policy instruments

In order to mitigate the risk of regulatory arbitrage, the ESRB:

• reiterates the recommendation made to ESMA on 30 April 2018 to operationalise leverage limits by providing guidance on how NCAs should apply article 25(3) AIFMD. ESMA has launched a consultation on this topic on 27 March.
• suggests to define “public interest” in the context of the power granted to NCAs to suspend redemptions in the public interest provided for by article 46(2) AIFMD, with the objective of helping NCAs to consider this legal instrument as a macroprudential tool
• calls for the extension of the liquidity management tools available across Member States

Further policy proposals

The ESRB suggests that IOSCO’s ongoing peer review on liquidity risk management should contribute to the reflection of policymakers on the appropriate alignment between portfolio assets and redemption terms.

Practical considerations & next steps

The European Commission should publish a report soon, to be followed by a consultation and the publication of a legislative proposal in the first quarter of 2021.

Development of additional metrics (e.g. leverage) or reporting fields (e.g. exposures) would drive significant compliance costs across the alternative investment fund value chain. Increasing the frequency of reporting would also bring additional burden and costs, in particular for smaller firms.

It is likely that the fund industry will advocate for progressive, technical updates rather than the introduction of new reporting methodologies and requirements during the consultation process.

Implementation of the public interest suspension could make the risk of suspension more difficult to quantify since interventions imposed by the supervisors might be difficult to anticipate by investors. Public interest needs also to be delineated where institutional investors (such as pension funds and insurance companies which are mandated to manage the interests of a significant portion of the “public”) are investors in a fund.