This week’s recommendations by the European Securities and Market Authority (Esma) on extending passporting rights to alternative investment fund managers (AIFMs) in some non-EU jurisdictions* – including Australia, Hong Kong, Japan and Singapore – are not expected to have much of an impact in the short term. 

But they do mean that fund houses will have to consider what they would do if passporting rules under the Alternative Investment Managers Directive (AIFMD) replaced the widely used national private placement regime (NPPR). If that happens, as is the ultimate plan, then AIFMs in the affected markets will have to comply with AIFMD rules in areas such as remuneration. Managers in Hong Kong and Singapore, for instance, do not.

That said, the original target for AIFMD superseding NPPR was 2018, but that will probably be postponed to 2019 or 2020 because Esma’s advice was a year late and still not sufficient, said Rolfe Hayden, Asia head of the financial markets practice at law firm Simmons & Simmons. Advice is still needed regarding the abolition of NPPR, he added.

Under Esma’s recommendation, AIFMs in Australia and Japan would be able to manage and market funds directly in the EU, while Hong Kong and Singapore AIFMs could market products in the EU through an EU-based AIFM. This is because AIFMs in Hong Kong and Singapore do not satisfy AIFMD’s requirements on remuneration.

Performance fees are commonly charged by managers in Hong Kong and Singapore, which can give rise to issues around conflict of interest and excessive risk-taking by managers to the detriment of investors, noted an industry source.

Meanwhile, Esma has deferred giving advice on the Cayman Islands, where some Asian alternative managers domicile funds, because the jurisdiction is implementing a new regulatory regime and assessment will need to take into account the final rules.

Esma’s recommendations will be considered for approval by the European Union Commission, Parliament and Council.

Lee Kher Sheng, co-head of Asia Pacific at the Alternative Investment Management Association, said: “The Esma advice is an important step in the right direction in that Hong Kong, Singapore, the US and Australia have now received a positive assessment, albeit with reservations and conditions attached.” 

However, the recommendations are conditional and could amount to a delayed final decision, even though the indication is that the final ruling will be positive, he added. 

“Managers’ ability to use the passport will also be affected by the Esma advice on the Cayman Islands and other fund jurisdictions,” noted Lee. “So for now, nothing really changes.”

Esma’s advice will not have any impact until at least 2018, since Asian managers are still able to raise capital in Europe even without the passport,he added. Most managers use the NPPR on a country-by-country basis or rely on reverse solicitation from European investors.

“Beyond that, I think [asset] managers are a pragmatic bunch of people,” he added. “They will reposition their strategy depending on investor demand.”

Most of Asian AIFMs’ flows come from the US, although about 20% of capital is sourced from Europe.  

AIFMD’s main appeal is that it allows firms to market to those countries that don’t have NPPRs, noted Lee. In addition, if NPPRs were ever closed down, the third-country passport would become more valuable, he said, as it would be effectively the only way to actively market in the EU.

The end of the NPPR?

A key issue is whether Esma’s advice is ultimately considered sufficient by the EU Commission, Parliament and Council and leads to the NPPR rules being halted, said Hayden of Simmons & Simmons.

If that were to happen, the only way to sell in the EU for non-EU managers and funds would be through passporting under AIFMD, which means managers would have to comply with the AIFMD rules – something  many would not want to do, said Hayden. Yet Britain’s vote to leave the EU may mean that this issue never arises for non-EU managers marketing funds into the UK, he noted.

If the NPPR is terminated, it would be bad news for managers who want to sell into the European Economic Area but do not want to be subject to AIFMD’s rules on areas such as remuneration, said Hayden.

There are different ways the situation could proceed, he added: the EU Commission could ask for further advice and further delay extending passporting to non-EU countries; it could approve passporting only for six countries at this stage; or it could grant passporting to everybody. 

In the latter case, the clock may start ticking on the NPPR, in which case AIFMs in Hong Kong and Singapore must remain alert to developments, Hayden said.

Increased competition

Marc-André Bechet, director for legal and tax at the Association of the Luxembourg Fund Industry, said the association welcomed Esma’s recommendation to extend AIFMD to Hong Kong and Singapore AIFs and to Japan.

The marketing of funds domiciled in those non-EU jurisdictions to professional investors in Europe would mean increased competition for European fund managers, but also improved investor choice for European investors.

*Esma had been asked to assess 12 non-EU countries on their level of compliance with AIFMD: Australia, Bermuda, Canada, Cayman Islands, Guernsey, Hong Kong, Japan, Jersey, the Isle of Man, Singapore, Switzerland and the US.