As warnings are raised about severe unintended consequences, what could the EU’s ongoing AIFMD review mean for Switzerland’s unique relationship with the bloc? Jon Yarker reports.
In late 2020, the European Commission launched a review of the Alternative Investment Fund Managers Directive (AIFMD). Delegation of portfolio management functions is one of the areas under ongoing review, with questions now being asked about how this could impact third countries’ relationships with the EU.
Switzerland is one such country and, as Europe’s fourth-largest asset management hub, according to the European Fund and Asset Management Association (Efama), asset managers based in the alpine nation rely heavily on delegation of portfolio management duties to market funds into and throughout the trading bloc.
Changes to legislative arrangements are causing alarm in corners of the industry. In a February 2021 letter to the EC, International Investment Funds Association (IIFA) chair Jose Carlos Doherty wrote that “amendments to existing AIFMD delegation requirements … are neither necessary nor suitable. Any such change might have severe unintended implications, affecting delegation arrangements to key financial centres across the globe.”
Potential loss of delegation
Under AIFMD, delegation powers come with a degree of discretion, with firms choosing how to use them. Charles–Alexandre Houillon, director of alternative funds management at Zedra, says in its current guise, the delegation model is a benefit to firms operating in third countries. “The delegation model allows the investment adviser to provide investment ideas to the AIFM,” he explains, “with a framework provided for AIFM portfolio managers and risk managers to perform their duties in terms of control, with investments being approved or refused.”
He adds: “For the operational part, there are no real issues; an operating process will be put in place to formalise the relationship between the involved parties. The operating process works well and allows operational efficiency.”
This model lets the investment manager exercise discretion over investment decisions. The IIFA warned about the impact of discretion powers being curbed, with the European Securities and Markets Authority (Esma) pursuing greater transparency and standardisation.
Despite these good intentions, LPA head of regulatory compliance management Haojin Ba says such changes could be costly to the Swiss funds industry. “The regulator is not forbidding the delegation of core functions to third countries, but clearly they would like to have a picture of the delegation practices to third countries. The loss of delegation discretion will bring the industry into chaos relatively quickly.”
This apparent chaos could include the introduction of further reporting and administrative obligations, with the European Commission requiring greater transparency over cross-border relationships. Ba notes it is too early to tell what exactly this may look like, and what indeed may change, but he warns the delegation waiting period may be “prolonged” as a result.
Representatives from the Asset Management Association (AMA) of Switzerland have been vocal on this issue in the past, penning an open letter to Efama in 2020.
In this, concerns were again raised about the prospect of delegation being removed: “The existing delegation model functions well and it is very important, not only for asset managers from third countries, but also for the success of the AIFM/Ucits model itself, as well as for markets and investors within the EU,” the trade body wrote. “It is, therefore, essential to retain it.”
This view has become milder with time. Speaking to Funds Europe, Adrian Schatzmann, CEO of AMA, says: “We have no serious concerns right now about the ongoing AIFMD review. The proposed amendments are as expected and won’t move the big picture. There is no material change for us from a Swiss asset management perspective.”
One reason for Schatzmann’s unperturbed stance is the fact that Switzerland is home to several large asset managers, for which the regulation may have a muted impact.
A leveller for all?
The alpine nation is home to some of the largest asset managers in Europe. For these organisations, the cost of additional reporting and administrative procedures at an operational level may be easier to absorb.
“The large asset managers here already have investment teams across Europe, so they would have a natural edge anyway. Rather, it’s the smaller ones that would be affected,” says Schatzmann.
Scale is not the only advantage in some Swiss firms’ favour, according to Gregorio Pupino, head of funds services for Western Europe at Intertrust Group. He points to the fact that these organisations will already have regulatory permissions in some form throughout the EU.
“If an asset manager has sufficient resources and is in possession of a licence from a non-EU country, this change is likely to have little impact for them,” says Pupino. “This is because the local NCA [national competent authority] will already possess preliminary information on the asset manager’s operations, as it is subject to their supervision.”
The costs of additional reporting may be a burden for some firms, but this could be a better option than attempting to circumvent the directive altogether.
Switzerland is a third country, which means Swiss firms do not have to abide by EU laws such as the AIFMD. Circumventing the directive is an unlikely option, though, as abiding by different rules still entails costs, which can be more significant than compliance.
For this reason, Houillon does not see many asset managers attempting to circumvent the directive and believes firms will still collaborate with it post-review. This is largely because, in his view, the AIFMD gives comfort to all parties involved when managed effectively.
“We see less and less asset managers trying to circumvent the directive and managers trying to avoid the AIFMD,” he says. “Indeed, it takes more time and costs more money to try to avoid the AIFMD [than] to simply comply with it.”
Simply complying may still mean a significant cost for Swiss firms. For the smaller organisations, Pupino points out several immediate costs they may have to cover should delegation-based relationships change.
“In the medium term, additional costs would be from an increase in the outsourcing of the portfolio and risk management in the EU country, for example, by contracting a fully licensed EU AIFM, to hiring additional resources to strengthen the substance of the entities, up to the application for a full asset manager licence in the non-EU country, to comply with the more stringent need of regular on-site inspection by the local regulator,” he says.
The relationship of third countries with the EU has come under greater scrutiny since the UK voted to leave the bloc. Brexit has created numerous legislative issues over the English Channel but, with the outcome of the ongoing AIFMD review still unclear, some experts are questioning if Switzerland can continue to benefit from its own particular relationship with Brussels.
Some do not believe the review will bring about material change to the directive as far as Swiss AIFMs are concerned. Pupino explains he and his peers at Intertrust Group do not expect the AIFMD to change how Swiss firms operate on a fundamental level, but that any tweaks will be in line with the ongoing theme of EU regulation to support transparency.
“However, certain required information on the specific delegation arrangements could be simplified in the final form of the package,” adds Pupino. “Even a grandfathering could be considered for existing delegation arrangements, under the assumption any new fund launches will trigger a new notification.”
As a major asset management hub, and a neutral country with a unique history of avoiding conflict, some may ask whether Switzerland’s diplomatic credentials present an advantage. Could Swiss policymakers negotiate an exemption from greater scrutiny around delegation?
LPA’s Ba is unconvinced. “Unless the EU could establish an exemption list on certain countries in the delegation regime or establish a trusted third-country list, the chance Switzerland has of negotiating its own deal is slim.”
Stepping back, the compliance expert admits EU policymakers could amend the directive however they see fit. Theoretically, this could include a bespoke exemption for Swiss entities. Ba is still unconvinced this is a possibility, despite the heft of Switzerland’s fund industry.
“This is not likely to happen, as the regulator intends to map the delegation practice to third countries,” she says.
The review is designed to invite input from all corners of the EU. Though the AMA of Switzerland has already published its perspective on the review, Schatzmann is realistic about the country’s chances of negotiating its own deal. “The Swiss asset management industry has very limited possibilities and powers to intervene directly in the EU regulation,” he says. “That’s the price we pay for standing aside.
“You cannot stand aside and be too critical about the regulations we have decided not to work on. You have to know your place.”
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