The impact of ESMA’s AIFMD passport ruling

Industry experts have told Global Custodian that the effect of Europe’s ruling on AIFMD passports for the Cayman Island should be minimal.

The European Securities and Markets Authority (ESMA) deemed that it could not give definitive advice with respect to the criteria on investor protection and effectiveness of enforcement for the Cayman Islands.

This sparked a quick response from Cayman Finance CEO Jude Scott, who said their rules around combatting corruption, money-laundering and tax evasion, along with international standards should have been “sufficiently good grounds to enable Cayman to be favourably reviewed”.

Scott believes that the Cayman Islands will satisfy regulators in the near future though. This was echoed by the Alternative Investment Management Association has said it hopes the ESMA takes “a second look” in the “not too distant future”.

The news would have come as a shock to AIMA who said a year ago it thought the Cayman Islands would receive approval. CEO Jack Inglis said in July 2015 that “the global industry as a whole needs Cayman AIFs to be approved under the AIFMD passport”.

Ultimately though, the sentiment among industry experts is that the status quo will continue as Cayman funds can still market into the EU using the existing national private placement regimes (NPPRs).

This is more typical in the alternative space and can continue until at least 2018, when there will be a further consideration of whether the NPPRs should continue indefinitely or not.

A statement from law firm Maples and Calder said: “In our view, it seems likely that the status quo will continue to apply for managers looking to access investors globally.

“We expect that the majority of managers will continue to operate on a parallel fund structure basis. When AIFMD compliance is a critical factor in selecting fund structure, for example when looking to market across the EEA, they will establish fund structures in jurisdictions which are fully AIFMD-compliant and have a proven track record of EEA management and marketing (e.g. Ireland).”

One source told Global Custodian that the AIFMD passport remains more of a theory than a reality at present and that ESMA has previously admitted that issues remain and the process has not worked as planned.

Of the 12 non-EU countries five countries were deemed to have no significant obstacles at all Canada, Guernsey, Japan, Jersey and Switzerland. There were no obstacles found with Australia, Hong Kong, Singapore or the US either, however ESMA did add some comments on each. ESMA could not provide advice on the Cayman Islands, Bermuda or the Island of Man.

The European regulator seemed to claim there were no obstacles in the US but was hesitant in its approval.

ESMA said it considers that in the case of funds marketed by managers to professional investors which do involve a public offering, a potential extension of the AIFMD passport to the US risks an un-level playing field between EU and non-EU AIFMs.

“ESMA suggests, therefore, that the EU institutions consider options to mitigate this risk,” the regulator added.

Sean Tuffy, senior VP investor services at Brown Brothers Harriman, said that there were two issues with the US from ESMA’s perspective.

“The first is that there are no equivalent depositary or remuneration rules, though the same could be said of pretty much everywhere not in Europe.

“I think the larger issue is that ESMA’s review looked beyond just alternative funds and looked at general market access for European funds and managers.

“ESMA seemed very concerned that 40 Act funds may get an unfair advantage, which is why they were specifically included from their recommendation.”

US funds could be paying the most attention to ESMA’s moves, even its advice for the Cayman Islands, which is home to over 11,000 regulated investment funds.

Tuffy believes that about 75% of the assets in Cayman funds are managed by US groups. “This effectively means the US managers won’t have access to the passport because they cannot use is for their Cayman funds. For various reasons, tax chief among them, US managers don’t typically sell US domiciled to non-US investors.”

So while some associations may be slightly riled by ESMA’s advice, nothing is really changing for hedge funds as the European Commission ponders the ruling. The Cayman Islands will likely be revisited in the near future and while the NPPR regime remains and the AIFMD passports aren’t sworn in, then the status quo remains.