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Investment Funds and Asset Management: EU Regulatory
Challenges
Trier, 21-22 November 2013
AIFMD implementation in practice: challenges for national
supervisory authorities
Our subject here today is national challenges in the implementation of the AIFMD. I
think it is useful if we take some time not just to view this in terms of the current
burning issues, but look at the national competent authority implementation issues in
the round. In this respect, the implementation of the AIFMD is characteristic of the
implementation of all the major post-crisis, post-Lisbon items of financial services
legislation.
Financial Stability
For example Recitals 49-51 and Articles 24 – 25 of AIFMD set out the financial
stability powers and objectives. The Recitals refer to the possibility of an AIFM
employing leverage and, under certain conditions, contributing to the build-up of
systemic risk or disorderly markets. A key objective of the AIFMD is to facilitate the
detection, monitoring and supervisory management of those risks in a consistent
way throughout the Union.
In order to achieve that end, AIFMs which employ leverage are required to provide
information to their national authorities including information on the types of leverage
employed and this information should be shared with other authorities in the Union,
with ESMA and with the European Systemic Risk Board (ESRB). Recital 49 in
particular refers to the need to “facilitate a collective analysis of the impact of the
leverage of AIFs managed by AIFMs on the financial system in the Union, as well as
a common response”. This Recital also notes the importance of shared information

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where AIFs potentially constitute an important source of counterparty risk to a credit
institution or other systemically relevant institutions in other Member States. National
competent authorities and/or ESMA are to be able to impose limits on the level of
leverage an AIFM may employ where the stability and integrity of the financial
system may be threatened.
In order to achieve the objectives set out in these Recitals, Article 24 sets out
reporting and leverage related requirements for AIFM and Article 25 outlines the
obligations of national competent authorities, ESMA and the ESRB when information
has been received. Article 53 sets down obligations with regard to the exchange of
information relating to the potential systemic consequences of AIFM activity between
these bodies.
If you look into the further detail set out at Level 2, you see that substantial leverage
within the meaning of Article 24 is set at three times the net asset value of an AIF,
using the commitment method to calculate leverage and after taking netting and
hedging arrangements into account.
It will only be towards the end of next year, as we begin to get data from across
Europe into ESMA, that we as national competent authorities can even begin to
grapple with the challenge of developing an analytical framework for understanding
the patterns of leverage that will emerge, for assessing the issues which will
undoubtedly arise around netting and hedging and to begin to ask to what extent it is
appropriate for regulators to envisage counter-cyclical action. The ESRB will play a
critical role in this regard. But there will be important national differences in the kinds
of AIFs which exist in different countries and their impacts on the wider economy
which will need to be taken into account in assessing that data.
If I am asked what is the key implementation challenge for national competent
authorities arising from the AIFMD, it is not remuneration, it is not reporting, it is not
non-EU AIFM. This is the key implementation challenge.
The recent publication by IOSCO of their second hedge fund survey is a timely
reminder of how important this issue is. The survey is recognised as a key tool in

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helping regulators to establish a globally coherent approach to the way in which they
measure and identify systemic risk in this sector. However, absent comprehensive
information, it has not been possible for IOSCO to draw definitive conclusions
relating to the global hedge fund industry as a whole. We are of course at the very
early stages of a global approach to reporting and until we build up more meaningful
information which regulators can rely on it is not going to be possible to assess the
systemic impact of investment funds, particularly those using leverage either at an
EU level as required under AIFMD or on a worldwide basis. From an EU perspective
therefore not alone must we focus on gathering this information but also on what we
are going to do with it once received. It is clear to me that this is work which remains
to be done and the AIFMD will not have been fully implemented until it has been
done.
Scope
A closely related aspect of the AIFMD has been the definition of the regulatory
frontier, a frontier which the AIFMD defines broadly. There are a number of
implementation challenges in this regard.
The definition of AIF in Article 4 of AIFMD provides a limited number of criteria on
which to base consideration of potential AIF i.e. a collective investment undertaking,
which raises capital from a number of investors, with a view to investing it in
accordance with a defined investment policy for the benefit of those investors. For
those AIF already subject to authorisation within Member States these criteria do not
generally raise any issues for consideration and Member States have focussed on
these known AIF during this early stage of implementation.
However, difficult questions continue to arise in relation to those undertakings which
have not been subject to authorisation to-date and which are potential AIF under
Article 4. To address those questions ESMA issued guidelines on key concepts of
AIFMD in a Final Report on 24 May last. The ESMA guidelines take each of the
criteria in Article 4 and set out how to understand each of; collective investment
undertaking; raising capital; number of investors; and defined investment policy.
This excellent work does not, however, exhaust the issue. Two types of entity are

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raising questions for national competent authorities across Europe – REITs and
SPVs.
REITS as we know exist in a number of Member States and involve a variety of
structures. But no Member State has yet reached a conclusion formally as to
whether they are in or out of scope. Non-EU REITs may also be marketed into the
EU and this is a further complicating factor. Perhaps the lack of national approaches
is, at this time, useful, because a common approach across the EU is desirable to
avoid situations where a structure, with cross-border dimensions, is not regarded as
an AIF in one jurisdiction but is in another. ESMA is committed to doing further work
on this. I welcome that.
Special purpose vehicles present a separate set of issues. The main financial
stability issues arising from securitisation vehicles are dealt with elsewhere by
imposing safeguards on banks making use of these vehicles. Consistent with that,
the AIFMD provides that what are called “securitisation special purpose entities”, as
defined in Article 4, are included in Article 3 as a category of entity to which AIFMD
does not apply. This is useful, but it only covers part of the universe of special
purpose vehicles.
In the case of SPV we recently, with some reluctance, provided some interim
guidance. Specifically we confirmed that:
- those SPVs which fall within the definition of Registered Financial Vehicle
Corporation under the ECB Regulation, i.e. securitisation special purpose entities as
the AIFMD defines them;
and
- those financial vehicles where economic participation is by way or debt or other
corresponding instruments which do not provide ownership rights in the financial
vehicle
are not required to seek authorisation as or appoint an AIFM until we advise
otherwise – and we do not intend to advise otherwise until ESMA completes its work
on this matter.

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Addressing these issues comprehensively will not be an easy matter for ESMA but
as we move towards 2014 progress must be made. AIFM of AIF in scope of AIFMD
will be required to seek authorisation in accordance with Article 61 by July 2014.
Individual Member States also have other categories of unauthorised AIF to consider
– in our case another potential type of AIF is a structure known as exempt unit trust
which limits investment to tax exempt investors such as pensions and charities. Our
consideration of this matter will not just involve consideration of AIFMD but also the
extent to which these trusts should be required to seek authorisation under our
domestic investment fund legislation.
A single market for AIFMs and AIF
Let me turn then to the promotion of the single market and the challenges national
competent authorities now face in this regard. There has been much scepticism in
industry about this aspect of the legislation. Imagining that all the main national
private placement regimes would remain unchanged, there was a widespread view
that private placement regimes were already adequate and that, in any case, the
unified regulation of management without the unified regulation of investment fund
authorisation would not work. I do not think this has proven true in practice. The well
defined process for passporting is working. It does not depend on the timing of
transposition in different countries and it will, I am sure become clear quite quickly
how much more effective this is. The fact that there was no 'big bang' in July 2013 is
a reflection of the fact that many funds and their managers have approached the
AIFMD with an element of caution. In Ireland we have completed the authorisation of
only four AIFMs and the figures for most other countries are proportionately similar.
But we will have approved something approaching 80 AIFMs by July 2014, I suspect.
That massive exercise will then open the way for a reconsideration of marketing and
management strategies in the second half of 2014.
I will just mention four challenges which arise in relation to the potential for the
AIFMD to deepen a single market. Firstly, the EU Commission has offered as its
interpretation of the AIFMD that it is not possible to passport the Article 6(4) services

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of individual portfolio management and related non-core activities across the EU
using an AIFMD passport and also not possible for an AIFM to hold a dual
authorisation as a MIFID firm in order to passport these services across the EU. I
confess that it remains unclear to me what underlying threat to investors or financial
stability we are protecting against with this constraint. Ireland will implement the
approach as laid out by the EU Commission because, in the absence of a shared
ESMA view, following the guidance from the EU Commission is the best way to
support and underpin the single market with regard to such passporting. However,
we do some with some hesitation.
Secondly, as you all know, the AIFMD sets out to regulate AIF management. It
leaves AIF regulation to the discretion of member States. As a consequence, unlike
Article 19 of the UCITS Directive, the AIFMD does not set out where the
responsibilities of the supervisor of the AIF end and the responsibilities of the
supervisor of the AIFM begin. Yet, in practice, clarity about this is likely to be
important. I don’t think such clarity needs to be embodied in law. It might be
something that emerges just as a matter of administrative convenience, but clarity is
going to help the development of the single market and the provision of AIFM
services on a cross border basis.
Thirdly, one of the great fears in relation to any cross border regime for the
supervision of funds is that funds themselves or their managers will have no
substance in the jurisdiction in which they are regulated and that the option of
arranging structures across multiple jurisdictions could be used to dilute the
protections for investors which should be built into the corporate structure of the
collective investment vehicle.
In UCITS legislation this concern has long since been tackled by provisions
addressing so-called ‘letterbox entities’. As many will know, the issuance of the
AIFMD Level 2 was substantially delayed while the EU Commission considered
carefully what the parallel provisions should be in relation to this Directive. What
ultimately emerged was a set of requirements which were somewhat more granular
than the parallel UCITS provision and with a clause requiring a review in 2015.

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At one level, this is an appropriate challenge for national supervisors. We can never
let Union funds legislation be abused by the establishment of hollow shell collective
investment vehicles which do not provide real protection for investors. However, I
am not personally convinced that trying to further and further refine definitions of a
concept of a ‘letterbox entity’ is any longer working as a way to set good regulatory
standards in this regard.
When the Commission does its review, which the Level 2 Regulation requires must
be carried out after 19 December 2014, there is, I think, a case for it to focus more
on the quality of the supervision of service providers, rather than merely the extent of
the delegation of functions. It is substance rather than form which matters most.
What is critical is that those who are paid to protect the interests of investors really
do so, that they look carefully at what is done in the name of investors to ensure that
it is always done in accordance with their best interests.
Perhaps the conclusion will be that the current provisions are working well and no
further change is needed. We must wait to see if that kind of conclusion is justified,
once the AIFMD settles down. It is too early to tell now. However, increasingly, I see
merit in an argument that, after the 2015 review, if further development of the
regulatory framework were deemed appropriate, there would be a case for a
recasting of the letterbox entity provisions in terms of the obligations of fund and fund
manager boards so that their obligations and our capacity to enforce the meeting of
those obligations supports confidence in the whole EU single market.
In the interim, our approach in Ireland has been to insist in some detail on the areas
where boards have to focus their attention. In that sense, our approach is super-
equivalent to what is in the AIFMD Level 2 requirements on letterbox entities. But we
make no apology for that. As supervisors we always need to be vigilant that funds
and their managers are meeting the standards we set for them and we are
committed to that goal.

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A fourth issue we need to consider when asking ourselves whether we have
successfully nourished a single market, is whether we have been successful in our
stated goal of developing a single rulebook.
AIFMD was signed into law in June 2011 with around 50 provisions which required
the European Commission to adopt Level 2 measures, either delegated or
implementing Acts. A provisional mandate was sent by the Commission to ESMA in
December 2010 with a request for advice in relation to each of these, divided into
four separate areas: General provisions, authorisation and operating conditions;
Depositary; Transparency requirements and leverage; and Supervision. This work
was completed by ESMA in November 2011 when the advice was submitted to the
Commission. At that time it was envisaged that the Level 2 Regulation would issue
by the end of the second quarter of 2012 to allow Member States and AIFM a full
year before the implementation date of 22 July 2013. As we all know this was not
the outcome and the final Level 2 Regulation finally put in an appearance in
December 2012 leaving a short 7 months to apply it.
It is well known that the cause of that delay was a number of areas where the
Commission did not agree with the advice it had got from ESMA. While my
sympathies are with ESMA on many of the points of substance, the Commission
were, to my mind, well within their rights not to agree with ESMA if they did not share
its judgement. I think some of the criticism of the Commission is misplaced. They
have a treaty-based role and they must fulfil it conscientiously. My interest in this
matter is to focus on the consequence of the short time to implementation once the
Level 2 did appear.
While the debate continued on delegation and other Level 2 measures during the
finalisation of the Level 2 Regulation, national competent authorities were
increasingly finding a number of questions cropping up as national implementing
measures were being prepared. These were shared with other authorities and with
the European Commission leading to the publication by the Commission of a series
of questions and answers in March 2013. A total of 67 items are addressed and
further questions can be submitted.

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Many of the responses provided by the Commission were not contentious – however
a number did raise further queries or raised concerns. A key concern related to the
transitional arrangements under Article 61 and the extent to which AIFM could avail
of the transitional period to 22 July 2014. The responses to this question were open
to interpretation – for example the responses given to the need for authorisation and
that given to first reporting dates. On the one hand AIFM are expected to comply on
a best efforts basis with the requirements of national implementing law and seek
authorisation within one year, whereas on the other these AIFM are expected to start
reporting from the implementation date of July 2013.
Within the compressed timetable between March and July 2013, such issues have
had to be dealt with in a pragmatic way. In practice, most Member States appear to
have adopted the “comply on a best efforts basis” without requiring reporting, in
recognition that transitional periods pass quickly and focus should be to ensure AIFM
submit applications in good time to allow for orderly authorisations. This is pragmatic,
but I think it’s fair to say that ideally we all could have worked together to make better
use of the period July 2011 to July 2013.
In addition to the Commission, ESMA has also a number of obligations under AIFMD
including those which require mandatory technical standards and guidelines in a
number of areas (for example regulatory technical standards to determine types of
AIFM in Article 4 and guidelines on remuneration in Article 13). Most of the other
technical standards and guidelines related obligations are not mandatory – there are
around 34 of these.
To my mind the correct goal for ESMA to aim at would be that national competent
authorities would not need to issue any significant guidelines or clarifications at
national level at all. All the national clarifications would be around the administration
of national authorisation processes and such like. Speaking for Ireland, I would say
that we have been very reluctant to issue supplementary guidance on any matter.
Yet we have had to issue a Q&A with almost seventy questions and answers and in

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terms of the success of our transition process, our willingness to do that has been
critical to the smoothness of our national process.
Given its incredible burden of work, no blame attaches to ESMA for not having quite
reached this goal; but it’s important to acknowledge that the goal was not reached. I
continue to receive complaints from industry about differing guidance being issued
on specific contentious points in different countries. Remuneration is one example.
Depositary duties is a second. There are others.
The problem here may be the compressed timeline I have just referred to. In part, I
think the problem is also that the ESA guidelines mechanism is still in its infancy.
The ESA Article 16 process has not been well tested and, in retrospect, may not be
fully enough elaborated in the legislation. A third possible cause of the problem is
that matters of real significance were left to be dealt with in Guidelines which should
have been dealt with at Level two or maybe even Level one.
That said, its important also to acknowledge successes. One area which, at this
juncture at least, appears to have worked well is the way in which ESMA agreed
guidelines on AIFMD cooperation agreements leading to a series of MoU between
national competent authorities and their counterparts in non-EU jurisdictions. To-
date [38] of these have been approved by the ESMA Board of Supervisors and the
majority have been completed by both sides. For some time, this was a major focus
of concern within industry, but that concern has proven unfounded.
Before I conclude I would like to take a look at the possibility for review of AIFMD.
The most substantial review will be that required under Article 69 which requires the
European Commission to have started a review of the application and scope of the
Directive by 22 July 2017. Before that of course the Commission will have been
required, as noted earlier, to have conducted a review of the delegation
arrangements. Another review which will predate that in Article 69 is a review by
ESMA of third country related issues in order to provide an Opinion as required by
Article 67. The ESMA Opinion must be issued to the European Parliament, the
Council and the Commission and must address the functioning of the passport for

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EU AIFMs managing or marketing EU AIFs, the functioning of the marketing of non-
EU AIFs by EU AIFMs and the management and/or marketing of AIFs by non-EU
AIFMs in the Member States under applicable national law.
The key matter to be addressed in this Opinion will relate to the application of the
passport regime for non-EU AIFMs and non-EU AIF which takes into account all of
the detailed criteria set out in Article 67. Should ESMA issue a positive Opinion and
considers there is no significant obstacle regarding investor protection, market
disruption, competition and monitoring of systemic risk, the Commission shall adopt
a delegated Act to “switch on” the rules set out in Articles 35, and 37-41 at which
point non-EU AIFM can commence activities under normal EU passporting
provisions. If all of this runs to plan, a possible effective date for this to come into
effect would be January 2016 – 18mths or so before the formal review of the
Directive as a whole.
Will all of these reviews lead to clarification of some of the questions raised – for
example the possibility for all AIF to have two AIFM: the investment manager and/or
the governing body. Unlike the UCITS Directive, where a single entity is obliged to
take responsibility for the totality of the UCITS operations, under AIFMD each AIF
must have a single AIFM, but that AIFM is only required to assume the role and
responsibility of investment and risk management of the AIF. Management of AIF
however involves other very important roles – fund administration and distribution.
While AIFMs must ensure that each of their AIF complies with AIFMD, which
includes for example rules on valuation and transparency, it is nevertheless possible
for an AIF to have a separate management company who may carry out or delegate
the administration and distribution functions. How these structures will operate in
practice is untested and it may be that some Member States will require AIFM to
take on the full range of management responsibilities. In Ireland, as set out in the
AIF Rulebook, the possibility for a dual structure, an AIFM and a management
company is recognised but we are aware that this structure will need to be kept
under review as time passes.

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In conclusion let me say this. Our implementation in Ireland, in its detail, looks a lot
like the implementation in many other Member States:
- taking the opportunity to consolidate non-UCITS rules even where not covered by
the AIFMD;
- establishing close consultation processes with industry;
- preparing for a Big Bang that never happened, but that’s OK;
- contributing as well as we can to the challenging ESMA work on technical
standards and guidelines;
- as we meet today, facing into a massive authorisation challenge;
- managing a number of key outstanding uncertainties that impact significantly on
fund industry business models, but where the EU position is not entirely clear.
That our approaches in different Member States is similar is not surprising. The
evolution of similar supervisory cultures is happening, even as some retain their
scepticism about that.
In a broader sense the AIFMD echoes many of the key features of all post-crisis,
post Lisbon financial services legislation;
- long timeframes from initiation to full implementation; in the case of the AIFMD from
2009, based on ideas originally discussed in 2008, and stretching out to 2015 and
maybe even 2016 when the non EU AIFM issue finally gets decided;
- compressed implementation timelines to commencement of the legislation with
more uncertainty than we as regulators would wish on issues we understand to be
important;
- substantial international coordination challenges;
- delayed roll-out of the financial stability supervisory aspects which initially
motivated the legislation.
These characteristics of the AIFMD are not to my mind a cause merely for complaint
at the authorities. They are all consequences of the difficulty of the important
challenges which legislators have set themselves. The complexity of the financial
sector is at the heart of the underlying problem. While I seeing failings in the AIFMD

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implementation process and while national competent authorities are particularly
conscious of those, I also see in the AIFMD implementation process many signs of
how well coordinated EU legislative development could be, if we can get just a little
better at it.