France - The Achilles’ heel of the AIFM Directive

The EU Commission published recently its legislative proposals  to amend the Alternative Investment Fund Managers Directive (AIFMD) but they may not solve some of the legal uncertainties ESMA suggested to expurgate. Legal column by Philippe Gianviti, Lawyer admitted to the Paris Bar, NMW.

The initial intention of the drafters of Directive 2011/61/EU of the European Parliament and the European Council (dated 8 June 2011) on Alternative Investment Fund Managers (AIFMD) was to prevent a systemic crisis, which could arise from the absence among EU member States of any harmonized regulation on the management of collective alternative investments (other than collective investments in securities and financial instruments, which have been regulated pursuant to a Directive adopted on December 20, 1985, known as the UCITS Directive).

Overambitious and consequently too broad

The drafters' objective was to pose conditions to the exercise of the freedom of establishment and the freedom to provide services in connection to alternative investment funds, by establishing common rules and requiring a control/license at the level of each Member State. 

Undoubtedly, the drafters of the Directive succeeded in this respect, but the legal framework they created was overambitious and consequently too broad.

The consequent literature it has generated – mainly views from regulators, lawyers, and academics – may be a sign, however, that the AIFMD may have raised more issues than those it has solved.

In section 15 of its letter to the European Commission dated 18 August 2020, the European Securities and Market Authority (ESMA) recognized that some residual uncertainties remained in the very core of the AIFMD, i.e., the key concepts and definitions used by the Directive. 

Different national implementations

ESMA explained that “it is difficult to explain structural and economic differences and to distinguish on a legally sound basis between vehicles that fall under AIFMD and those that do not”.

It concluded that definitions in the AIFMD were “too vague and not specific enough”, which could lead to “different national implementations” and “continue to lead to uncertainty and fragmentation across the Single Market”… 

Lawyers know too well how crucial definitions are in a legislative, regulatory or contractual instrument and how brutal the consequences can be if a word used in such an instrument is too vague.  The European Court of Human Rights now formally assesses the quality of Member States’ laws and considers that undefined vague terms used in legislative or regulatory instruments lead to arbitrary decisions resulting in a breach of the European Convention on Human Rights. 

Words can be the Achilles’ heel of a legislation; even when it is guided by lofty ambitions, if these words are obscure and may give rise to conflicting interpretations.

In its booklet entitled guidelines on the AIFMD (ESMA/2013/611), ESMA provided some explanations as to the key concepts used in the AIFMD.

ESMA’s modest attempt to clarify these concepts is no more than an opinion with no official legal basis, although the AIFMD put ESMA in charge of certain matters relating to the enforcement of the AIFMD.

Indeed, the penultimate sentence of Article 4 of the AIFMD empowers ESMA to issue draft regulatory technical standards to ensure uniform conditions of application of the AIFMD while, according to the last sentence of Article 4, the power to adopt such standards as legally binding regulations is delegated to the European Commission.

Interesting and relevant remedies

It is not clear, however, that the European Commission could interpret the definitions in the AIFMD. These definitions might be seen as part of the backbone of the AIFMD itself rather than a “uniform condition of application”.  Therefore, the European Parliament and the European Council might have the exclusive power to give a substance to such definitions.

When the European Commission initiated the process of reviewing the AIFMD, ESMA suggested some interesting and relevant remedies in its letter to the European Commission.

It is generally agreed that an entity with a “general commercial or industrial purpose” is not a fund falling within the scope of the AIFMD and therefore its manager is not required to be licensed as a management company by a Member State’s regulator.  This is the view taken by ESMA in section 12 of its guidelines on the AIFMD, but it’s not expressly written anywhere in the AIFMD.

In this respect, ESMA suggested to add in the AIFMD, a specific definition for “general commercial or industrial purpose(s) in connection with real estate projects”.  

The intent of the AIFMD’s drafters was to regulate all forms of pooled investments under delegated management including those in real estate but some situations remain unclear. 

Should entities building real estate projects and managing them be regarded as funds falling within the scope of the ISDA? Should a distinction be made between assets built by the entity and those it has only acquired and managed? 

It seems that EU member States do not share the same approach when it comes to provide an answer to these questions.  

ESMA also addressed that the AIFMD should define the concept of “pool returned”’s expectations.  Actually that expression does not appear in the Directive itself but ESMA considered in its guidelines that it aimed at regulating investments made “with a view to generating a pooled return for” investors. 

A definition for investment policy

More interestingly, ESMA suggested a definition for “investment policy”.

As strange it might seem, the AIFMD does not provide any definition for this concept, although it is the key criterion when it comes to determining whether an entity is a fund falling within the scope of the AIFMD or not. 

According to the AIFMD, the investments made through an entity gathering investors must be performed pursuant to an “investment policy” in order to become subject to the regulation it imposes.

ESMA provided some clarification in section 12 of its aforementioned guidelines by stating that an investment policy implies that “investors have no day-to day discretion or control”.

But again, as mentioned before, ESMA’s position has no textual basis in the Directive. 

On 25 November 2021, the European Commission finally issued a draft proposal for a future directive amending the AIFMD (COM/2021/721 final).

A disappointment

The proposal is a disappointment as it does not reflect all ESMA’s thoughts, in particular those suggestions to amend the definitions in the AIFMD, which would have improved the quality of the reading of the AFMD and led to a better implementation among EU Member States.