AIFMD 2: A New Era for AIFs and UCITS

The enactment of Directive (EU) 2024/927, widely recognized as the Alternative Investment Fund Managers Directive 2 (AIFMD 2), signifies a pivotal transformation in the regulatory landscape for both Alternative Investment Funds (AIFs) and Undertakings for Collective Investment in Transferable Securities (UCITS) within the European Union. Unveiled on 13 March 2024, AIFMD 2 systematically updates and enhances several key aspects of the existing financial regulatory framework, with an aim to:

• Elevate liquidity management standards,
• Streamline the operations of delegation and depositary functions,
• Increase transparency throughout financial markets,
• Refine and improve reporting mechanisms, and
• Strengthen investor protection measures.

Source

Published in OJ – AIFMD 2

On 26 March 2024, there was published in the Official Journal of the EU, Directive 2024/927 of 13 March 2024, amending the Alternative Investment Fund

Global Regulation TomorrowClaire Guilbert, Cyril Clugnac

AIFMD II Regulatory Approach

AIFMD II signifies a pivotal advancement in regulating alternative investment funds. It addresses crucial aspects such as investor safeguarding, risk management, and operational efficacy.

GrandAlessandro Micagni

Key Updates Introduced by AIFMD 2:

• Enhanced Liquidity Management Frameworks: Building upon Directives 2011/61/EU and 2009/65/EC, AIFMD 2 institutes advanced liquidity management protocols, emphasizing a primarily closed-ended structure for loan-originating AIFs to manage liquidity risks effectively.

• Streamlined Delegation and Depositary Operations: It introduces rigorous oversight and detailed disclosure requirements for delegation and depositary functions, ensuring operational integrity and accountability within management companies to prevent them from becoming mere "letter-box entities.

• Boosted Transparency Across Financial Activities: AIFMD 2 mandates comprehensive disclosure and reporting requirements, facilitating informed decision-making by investors through in-depth insights into investment strategies, leverage, and risk management practices.

• Refined Reporting Mechanisms: The directive tasks the European Securities and Markets Authority (ESMA) with developing regulatory technical standards to ensure reporting standardisation and adaptability, aligning with international regulatory standards.

• Amplified Investor Protection Measures: AIFMD 2 places a strong emphasis on protecting investor interests by closing regulatory gaps and eradicating operational inefficiencies that might compromise market integrity.

Strategic Goals of AIFMD 2:

AIFMD 2 is meticulously designed to address the complex demands of contemporary financial markets, with the ultimate goals of:

• Fostering transparency and sustainability in financial market practices

• Aligning EU financial market operations with global standards

• Showcasing the EU’s commitment to creating a secure, transparent, and resilient financial ecosystem.

By implementing these strategic enhancements, AIFMD 2 not only sets new industry benchmarks for the management and oversight of AIFs and UCITS but also reinforces the EU's position as a competitive and trusted financial hub on the global stage. This landmark directive is a testament to the EU's dedication to modernizing its financial market regulation, ensuring it remains adaptable and competitive in response to the evolving demands of the global finance sector. As AIFMD 2 ushers in a new era of financial regulation, it marks a significant step forward in enhancing market competitiveness, ensuring rigorous investor protection, and facilitating regulatory compliance and market integration within the EU's asset management industry.

AIFMD 2: Liquidity Management and Oversight

The Alternative Investment Fund Managers Directive 2 (AIFMD 2) heralds a transformative phase in European Union financial regulation, concentrating on refining liquidity management and enhancing regulatory supervision. This critical update, integral to bolstering the EU's financial infrastructure, aims to revolutionize the management of liquidity risks by Alternative Investment Funds (AIFs) and Undertakings for Collective Investment in Transferable Securities (UCITS), striving for a market that is both more resilient and stable.

Key Enhancements in Liquidity Management under AIFMD 2:

• Closed-ended Structures for Loan-originating AIFs: AIFMD 2 champions a shift towards primarily closed-ended structures for loan-originating AIFs, aligning investment strategies with redemption policies to mitigate liquidity mismatches and enhance market and investor stability.

• Mandatory Liquidity Management Tools for UCITS: The directive mandates the integration of at least two standardized liquidity management tools within UCITS, ensuring funds' redemption policies are in sync with their investment strategies and significantly boosting operational integrity.

Liquidity Management across the EU:

• ESMA's Role in Standardization: The European Securities and Markets Authority (ESMA) is pivotal in operationalizing AIFMD 2’s liquidity objectives, tasked with crafting regulatory technical standards by April 2025 to standardize liquidity management practices EU-wide, promoting a consistent and effective liquidity risk management framework.

Enhancing Market Stability and Investor Confidence:

• Robust Framework for Liquidity Risks: AIFMD 2 lays down a clear framework for liquidity risk management, aiming to safeguard investor interests and ensure a stable, efficient market environment, highlighting the EU's dedication to protecting its financial ecosystem from systemic risks.

Delegation and Depositary Functions with AIFMD 2

The Alternative Investment Fund Managers Directive 2 (AIFMD 2) revolutionises delegation and depositary operations across the European Union's financial markets, forming a cornerstone of the EU's agenda to enhance the operational frameworks of Alternative Investment Funds (AIFs) and Undertakings for Collective Investment in Transferable Securities (UCITS). AIFMD 2 focuses on fostering transparency, upholding accountability, and maintaining operational integrity among financial institutions. Here's how AIFMD 2 redefines regulatory standards for delegation and depositary functions:

Elevating Delegation Practices:

• Rigorous Disclosure Requirements: AIFMD 2 introduces stringent requirements for management companies to disclose detailed information about their delegation practices, ensuring operations maintain high levels of transparency and accountability.

• Enhanced Oversight Mechanisms: The directive mandates enhanced oversight mechanisms for delegated functions, protecting the operational integrity of AIFs and UCITS and safeguarding investor interests.

• Prevention of "Letter-Box Entities": By requiring comprehensive information on delegation arrangements, AIFMD 2 aims to prevent the creation of "letter-box entities," ensuring management companies maintain substance and accountability in their operations.

Advancing Depositary Functions:

• Cross-Member State Depositary Appointments: AIFMD 2 allows for the appointment of depositaries from other Member States under strict conditions, promoting a more integrated and competitive European financial market.

• Stringent Criteria for Non-EU Depositaries: The directive tightens the requirements for non-EU depositaries, insisting on adherence to ethical financial practices and effective tax information exchange agreements, enhancing the security and transparency of fund assets.

Strengthening the EU's Financial Ecosystem:

• AIFMD 2's comprehensive overhaul of delegation and depositary standards illustrates the EU's dedication to raising the bar for financial market practices. These reforms ensure entities managing and overseeing AIFs and UCITS meet the highest standards of accountability and ethical conduct.

• The initiative enhances regulatory frameworks, preventing the dilution of management quality and securing investor assets, pivotal in preserving the integrity of the EU's financial markets.

Transparency and Global Standards with AIFMD 2

The Alternative Investment Fund Managers Directive 2 (AIFMD 2) inaugurates an era focused on transparency enhancement, unparalleled reporting quality, and the synchronization of global regulatory standards within the European Union’s financial markets. This seminal directive is pivotal in:

• Comprehensive Disclosure and Reporting Overhaul: Mandating an exhaustive revamp of disclosure and reporting protocols to significantly raise transparency levels, facilitating better-informed investment decisions.

• Deep Dive into Operational and Risk Management Strategies: Requiring management entities to offer detailed insights into investment approaches, leverage dynamics, liquidity risk countermeasures, and the deployment of liquidity management tools, granting investors access to vital investment-impacting data.

• Standardization of Reporting Practices: Tasked by AIFMD 2, the European Securities and Markets Authority (ESMA) is instrumental in crafting regulatory technical standards that promise consistency and adaptability in reporting across diverse market scenarios, ensuring market resilience amid global financial evolutions.

Key Initiatives Under AIFMD 2 Include:

• Elevating Market Transparency: By instituting comprehensive disclosure obligations for management companies, AIFMD 2 propels market transparency to new heights, enabling investors to make decisions based on thorough insights into financial strategies and risk management protocols.

• Reporting and Global Compliance Standards: AIFMD 2 aligns the EU with international financial regulatory practices, thanks to ESMA’s role in harmonizing reporting standards. This ensures the EU’s financial markets remain competitive and conducive to cross-border investments.

• Incorporating Sustainability in Financial Operations: Reflecting a commitment to sustainable growth, AIFMD 2 integrates environmental, social, and governance (ESG) considerations into the operational frameworks of AIFMs and UCITS management companies, underscoring the significance of sustainability in financial decision-making.

• Diversifying Revenue and Enhancing Market Competitiveness: By aiming to expand revenue sources for European financial institutions and boost the availability of competitive depositary services, AIFMD 2 addresses market concentration issues, promoting a vibrant and competitive financial landscape.

EU Financial Markets with AIFMD 2: Final Insights

The launch of Directive (EU) 2024/927, integral to the introduction of the Alternative Investment Fund Managers Directive 2 (AIFMD 2), represents a transformative shift in EU's financial regulation landscape. Targeting Alternative Investment Funds (AIFs) and Undertakings for Collective Investment in Transferable Securities (UCITS), this legislation is a comprehensive revamp rather than a mere update, aiming to reshape key aspects of financial regulation including liquidity management, oversight of delegation, market transparency, and investor protection. AIFMD 2's forward-looking regulations are poised to render the EU's financial markets more resilient, transparent, and sustainably focused, thereby elevating the EU's global financial standing.

Key Components of AIFMD 2:

• Elevating Financial Stability and Market Integrity:

• Establishes stringent liquidity management standards, empowering AIFs and UCITS to effectively anticipate and mitigate liquidity risks.

• Enhances oversight on delegation practices, ensuring management companies uphold high levels of operational integrity and accountability, acting always in investors' best interests.

• Enhancing Market Transparency and Investor Protection:

• Implements exhaustive disclosure and reporting mandates, offering investors access to critical data on investment strategies, risk management, and liquidity tools, fostering informed decision-making.

• This transparency initiative is vital for bolstering investor trust and confidence in the EU's financial sectors.

• Advancing Sustainability and Market Competitiveness:

• Integrates Environmental, Social, and Governance (ESG) considerations directly into financial operational frameworks, aligning with the EU's sustainable growth objectives and reinforcing investor protections.

• Aims to diversify revenue streams for financial institutions and improve the availability of competitive depositary services, addressing market concentration issues and promoting a vibrant, competitive financial ecosystem.