EU AIFMD2 - Implications of the Final Text
On 26 March 2024, the final legislative text (Final Text) of the directive amending the EU Alternative Investment Fund Managers Directive1 (AIFMD and, as amended, AIFMD2) was published in the Official Journal of the EU.
AIFMD2 follows several years of legislative process, including the European Commission (Commission) publication in 2021 of its proposal for AIFMD2 (Commission Proposal), which we discussed in our previous Update, EU AIFMD II — Implications of the Commission Proposal.
As noted in our previous Sidley Update, AIFMD2 amounts to a series of targeted amendments rather than a complete overhaul of the AIFMD framework.
AIFMD2 will enter into force 20 days following its publication in the Official Journal of the EU (i.e., 15 April 2024). EU Member States will then have two years to implement the requirements of AIFMD2 under local laws. That means that AIFMD2 should be introduced into the local law of each Member State by 16 April 2026 at the latest. Certain requirements are subject to grandfathering provisions, as discussed below.
Note that, as the UK is no longer part of the EU, AIFMD2 applies only to EU Member States. The result is that the AIFMD regime in the UK and EU will differ materially once AIFMD2 is implemented in EU Member States.
FOCUS OF THIS UPDATE
This Sidley Update focusses primarily on the changes most relevant to U.S. and other non-EU managers. As such, it focusses first on those changes applicable to non-EU alternative investment fund managers (AIFMs) that market one or more alternative investment funds (AIFs) in the EU. The other changes are directly applicable only to EU AIFMs but may still have an impact, albeit indirectly, on any non-EU managers that act as a delegate of an EU AIFM.
Note that the Final Text also amends various aspects of the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive to align with the changes being made to AIFMD. However, the focus of this Sidley Update is on the changes made to the AIFMD.
The amendments in the Final Text applicable to non-EU AIFMs marketing one or more AIFs in the EU (as well as EU AIFMs) include:
- the national private placement regime (NPPR) framework;
- investor disclosure requirements; and
- Annex IV reporting.
The changes applicable to EU AIFMs include:
- changes to the delegation regime;
- changes to EU AIFM authorisation and substance requirements;
- the introduction of a loan origination regime;
- changes to the liquidity management requirements;
- new permitted activities for EU AIFMs; and
- changes to the depositary framework.
We consider each item below. For ease of reference, we refer to the existing AIFMD text as “AIFMD1.”
CHANGES APPLICABLE TO NON-EU AIFMS MARKETING AIFS IN THE EU (AND TO EU AIFMS)
The National Private Placement Regime (NPPR) framework
Since the AIFMD took effect in July 2014, the most significant element of the rules for many non-EU managers has been the NPPR framework under Article 42. Many U.S. and other non-EU AIFMs have used this to market their AIFs into the EU.
Among the threshold conditions for the availability of the NPPRs under AIFMD1 are that the third country (i.e., non-EU country) where the non-EU AIFM or the non-EU AIF is established is not listed as a “Non-Cooperative Country and Territory” by the Financial Action Task Force (FATF) (in essence, countries on the FATF’s list of “High-Risk Jurisdictions” in relation to money laundering, terrorist financing, and proliferation financing).
Consistent with the Commission Proposal, the Final Text makes the following changes to Article 42:
- The above condition relating to the FATF list is deleted. Instead, marketing will be subject to the condition that neither the non-EU AIFM nor the non-EU AIF be domiciled in a “high risk jurisdiction” pursuant to the EU Anti-Money Laundering (AML) Directive2 (EU AML List).
- A new two-pronged condition is added, so that the jurisdiction of both the non-EU AIFM and non-EU AIF must:
- have signed an agreement with each Member State in which the AIF is to be marketed that fully complies with the standards in Article 26 of the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (Model Tax Convention) and ensures an effective exchange of information in tax matters, including any multilateral tax agreements; and
- not be on the EU list of non-cooperative tax jurisdictions (EU Tax List).
Similar changes are being introduced to the NPPRs used by EU AIFMs marketing non-EU AIFs under Article 36 AIFMD as well as the passporting provisions for third-country AIFMs under the third-country passporting regime (that has, to date, not been activated). In addition, note that the Model Tax Convention requirement is not new, as it is already a condition under AIFMD1.
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Sidley comments As discussed in our previous Sidley Update, the changes to the Article 42 NPPR conditions mirror those made to the EU Securitisation Regulation that took effect from 9 April 2021, when the same two conditions regarding AML and tax were applied to the domicile of securitisation special purpose entities (SSPEs). Other EU legislation (e.g., the EU Crowdfunding Regulation3) have also included these two conditions. So there is already a precedent for this requirement. The new conditions are unlikely to be problematic in relation to non-EU AIFM jurisdictions such as the UK, U.S., Hong Kong, and Switzerland. As to the major non-EU AIF jurisdictions such as Cayman, British Virgin Islands, Jersey, and Guernsey, while none of these jurisdictions is currently on either the EU AML List or the EU Tax List, Cayman was previously on both the EU Tax List (from February to October 2020) and the EU AML List (from March 2022, having been removed only as recently as February 2024), illustrating the potential risk for non-EU AIFMs marketing Cayman AIFs into the EU. In addition, the EU AML List and EU Tax List are the subject of a political process, and it is therefore concerning that AIF marketing could be subject to political processes that might not be transparent. Although discussed during the trilogue negotiations between the Council and the Parliament, the Final Text does not provide for any transitional or grandfathering provisions in relation to the NPPR changes, which gives rise to significant uncertainty should a major AIF domicile be added to either the EU AML List or the EU Tax List at any time. |
Investor disclosure requirements
AIFMD2 broadens the investor disclosure requirements under Article 23 AIFMD, which apply to non-EU AIFMs marketing under the NPPRs (as well as EU AIFMs). The new disclosure items include:
- the name of the AIF (with the European Securities and Markets Authority (ESMA) mandated to develop guidelines by 16 April 2026 on unfair, unclear, or misleading names);
- for open-ended funds, in addition to the existing description of the AIF’s liquidity risk management, information on the possibility and conditions for using liquidity management tools; and
- a list of fees and charges that are borne by the AIFM in connection with the operation of the AIF and that are to be directly or indirectly allocated to the AIF.
In addition, the periodic investor disclosures will be expanded to include:
- the composition of the originated loan portfolio (if any — see Loan origination regime section below);
- on an annual basis, all fees and charges that were directly or indirectly borne by investors; and
- on an annual basis, any parent undertaking, subsidiary, or special purpose vehicle (SPV) utilised in relation to the AIF’s investments by or on behalf of the AIFM.
Notably, certain of the new disclosure items have been scaled back in the Final Text compared with the Commission Proposal, which had, for example, proposed quarterly reporting of fees and charges and of parent and subsidiary undertakings or SPVs established in relation to the AIF’s investments.
Annex IV reporting
AIFMD2 expands the Annex IV reporting rules set out in Article 24 AIFMD, most significantly in relation to delegation arrangements concerning portfolio or risk management.
AIFMD2 will require Annex IV reports to include details of any delegation arrangements concerning portfolio or risk management functions, including:
- for each delegate, its name and domicile, any close links with the AIFM, whether they are regulated, and, if so, their supervisory authority;
- the number of full-time equivalent human resources employed by the AIFM to perform day-to-day portfolio management or risk management within the AIFM and the number that monitor any delegation arrangements;
- a list and description of the delegated activities concerning portfolio management and risk management;
- the amount and percentage of AIF assets that are managed under delegation;
- the number and dates of periodic due diligence reviews carried out by the AIFM, a list of issues identified, and any measures adopted to address those issues;
- where subdelegation arrangements are in place and the information required under the first, third, and fifth sub-bullets above in respect of such arrangements; and
- commencement and expiry dates of the delegation and subdelegation arrangements.
The reporting requirements have been expanded in other respects, in particular to include reporting on:
- all instruments in which the AIF is trading, markets of which it is a member or where it actively trades, and exposures and assets of each AIF it manages (as opposed to the current position under AIFMD1, where only the “principal” or “main” instruments, markets, exposures, and assets need to be reported on);
- the total amount of leverage employed by the AIF; and
- the list of Member States in which the AIF is marketed by the AIFM or by a distributor on its behalf.
ESMA is mandated to develop new regulatory and implementing technical standards to supplement the changes in the Annex IV reporting templates by 16 April 2027 — that is, a year after the implementation date of AIFMD2, when the changes to Article 24 will take effect. It is unclear in practice what will be expected of AIFMs during the one-year period between Article 24’s being expanded to include the additional items above and the publication of the updated reporting templates.
A specific provision has been inserted in the Final Text noting that ESMA may not introduce any additional reporting obligations in respect of delegation arrangements.
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Sidley comments The investor disclosure and Annex IV reporting requirements expand on existing rules and hence should have a basis in processes established for the purposes of AIFMD1. However, AIFMs in scope of the requirements should familiarise themselves with the changes ahead of 16 April 2026 (and with the ESMA reporting templates, once available) to ensure they are in a position to provide the additional information once the changes take effect. |
CHANGES APPLICABLE TO EU AIFMS
Delegation
Extension of the scope of the delegation framework
Consistent with the Commission Proposal, the Final Text extends the AIFMD delegation rules to apply to the delegation of:
- all functions listed in Annex I AIFMD, including ancillary functions such as fund administration, marketing, and fiduciary services. There is a specific carveout for the appointment of a distributor authorised under the EU Markets in Financial Instruments Directive4 (MiFID) or the EU Insurance Distribution Directive5 and acting on its own behalf. The recitals indicate an example would be an independent financial adviser marketing an AIF without the AIFM’s knowledge; and
- the additional “top-up” services for which EU AIFMs may be authorised, which include MiFID top-up activities such as portfolio management (in the MiFID sense, that is, of segregated portfolios), investment advice, and custody.
The effect of this change is that EU AIFMs will need to notify their National Competent Authority (NCA) of a broader range of delegation arrangements. Such arrangements will become subject to the AIFMD delegation framework, which includes requirements such as the AIFM’s being able to justify the delegation to its NCA on “objective reasons.”
The delegation rules have also been amended to include the specific provision that the EU AIFM must ensure that its delegates (and subdelegates) comply with the AIFMD. In practice, this may result in EU AIFMs’ seeking to impose more extensive contractual obligations on their delegates to comply with AIFMD as a result of this change.
Helpfully, the Final Text does not include the ambiguously worded provision originally included in the Commission Proposal that would have required NCAs to notify ESMA on an annual basis where an AIFM “delegates more portfolio or risk management to entities in third countries than it retains.”
Extension of the information provided to NCAs at authorisation
EU AIFMs will be required to provide more detailed information to their NCA on proposed delegation arrangements as part of their authorisation application, including:
- the name, jurisdiction, and supervisory authority of each delegate;
- a detailed description of the human and technical resources of the AIFM performing day-to-day portfolio or risk management within the AIFM and monitoring the delegation;
- a brief description of the delegated portfolio or risk management function, including whether it amounts to a partial or full delegation; and
- the periodic due diligence the AIFM will conduct to monitor the delegation.
As discussed above, these matters (and others) will also be reported to NCAs periodically under the expanded Annex IV reporting requirements.
Host AIFMs
The Final Text amends the conflicts of interest obligation of an EU AIFM in Article 14 AIFMD, to provide that where an AIFM manages or intends to manage an AIF at the initiative of a third party, including where the AIF uses the name of a third-party initiator or the AIFM appoints a third-party initiator as a delegate, the AIFM must submit to its NCA detailed explanations and evidence of its compliance with the AIFMD conflicts of interest requirements, including specifying the reasonable steps it has taken to prevent conflicts arising from its relationship with the third party.
This is effectively aimed at third-party host AIFM service providers, enhancing the scrutiny of such firms’ compliance with AIFMD conflicts of interest requirements.
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Sidley comments Given the political desire among EU policymakers to redomicile fund management to the EU, the investment management industry had feared significant changes to the delegation regime. The changes in the Final Text on this topic are less drastic than anticipated. In particular, the fundamental ability to delegate functions to third parties, including non-EU entities, remains, and the core control framework surrounding delegation remains substantially the same, subject to certain targeted enhancements. That said, the additional information provided to regulators, together with a renewed focus from NCAs on this area, given the need to monitor compliance with the new requirements, will place such arrangements under closer scrutiny from NCAs. The host AIFM model specifically is put under the spotlight through the revisions to the conflicts of interest requirements noted above. These changes are, in turn, likely to affect delegate managers, who may feel the impact of the new rules in the form of stricter contractual provisions as well as more extensive due diligence and monitoring from their EU AIFMs. It remains to be seen how or whether the main NCAs (being those of Ireland and Luxembourg) will seek to restrict the activities of such host AIFMs when the new rules come into effect. |
EU AIFM authorisation and substance requirements
Under the Final Text (and consistent with the Commission Proposal), the information that AIFMs will need to provide to NCAs in their authorisation application will be expanded to include additional details, including in relation to the staff effectively conducting the business of the AIFM, reporting lines (within and outside the AIFM entity), time allocated to their responsibilities, and the human and technical resources supporting such functions. Additional details on delegation will also need to be provided, as noted above.
The Final Text retains the requirements in the Commission Proposal that the business of the AIFM must be conducted by at least two natural persons who are (i) domiciled in the EU and (ii) either employed full-time or committed full-time to conducting the business of the AIFM.
Non-independent directors
The Final Text notes in a recital that AIFMs managing AIFs marketed to retail investors should be “encouraged” to appoint at least one independent or non-executive director (NED), where possible under national law.
While this is not an operative, binding provision, ESMA is mandated to consider the appropriateness of introducing a binding rule to this effect as part of its review, discussed further below.
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Sidley comments As noted in our previous Sidley Update, given the fairly detailed substance requirements imposed by the main AIFM/AIF domiciles such as Ireland and Luxembourg as well as the appointment of NEDs to AIFM governing bodies being relatively common practice at present, the new substance requirements do not appear to be a significant change. |
Loan origination regime
The most substantial change under AIFMD2 for EU AIFMs — as well as the most extensively negotiated topic during the legislative process — is the introduction of a loan origination regime into the AIFMD framework.
The aim of this new regime is to facilitate an internal market within the EU for loan-originating funds by harmonising the framework for this activity across the EU.
“Loan origination” and “loan-originating AIFs”
Most of the new rules apply in respect of any AIFs, managed by an EU AIFM, that originate loans, whether or not loan origination is their principal activity or conducted only on an ancillary basis.
Certain additional requirements (discussed below) apply only to “loan-originating AIFs,” defined as AIFs whose investment strategy is mainly to originate loans or whose originated loans have a notional value that represent at least 50% of the AIF’s net asset value.
“Loan origination” is defined as the granting of a loan, either:
- directly by an AIF as the original lender; or
- indirectly through a third party or SPV on the AIF/AIFM’s behalf, where the AIF/AIFM is involved in structuring the loan, defining or pre-agreeing its characteristics.
The definition does not, on the face of it, include secondary loan acquisition where the AIFM/AIF does not have a role in either structuring the loan or defining or pre-agreeing the loan’s characteristics.
An exclusion applies in relation to “shareholder loans,” defined as loans granted by an AIF to an undertaking in which it holds, directly or indirectly, at least 5% of the capital or voting rights and which cannot be sold to third parties independently of the capital instruments held by the AIF in the borrower. This exclusion will be particularly relevant to private equity funds whose lending is limited to portfolio company borrowers in which the AIF holds equity.
Requirements for all AIFs that originate loans
EU AIFMs that manage AIFs that originate loans are required to comply with rules including the following.
- Loan origination policies: The AIFM must implement, maintain, and review at least annually policies, procedures, and processes for the granting of loans, including for the assessment of credit risk and for administering and monitoring its credit portfolio.
This is subject to a carveout for the origination of shareholder loans, provided their aggregate notional value does not exceed 150% of the AIF’s capital. - Concentration limits: Lending to any single borrower that is a financial undertaking, an AIF, or a UCITS must not exceed 20% of the AIF’s capital. This limit must come into effect no later than two years following the first subscription for units in the AIF.
- Related party lending: An AIF is prohibited from lending to its AIFM, any delegate of its AIFM, staff of any of the foregoing, the AIFM’s depositary, or any delegate of the depositary or to affiliates of the AIFM (other than affiliated financial entities that exclusively finance borrowers).
- Consumer lending: Member States have the option to prohibit AIFs from granting loans to consumers and to prohibit AIFs from servicing credits granted to such consumers in their territory.
- Originate to distribute: AIFMs are prohibited from managing an AIF that pursues wholly or partly an “originate-to-distribute” strategy (the origination of loans with the sole purpose of selling them to third parties).
- Risk retention: Where an AIF originates a loan and subsequently sells the loan on the secondary market, it will be required to retain 5% of the notional value of the loan (until maturity for loans with an eight-year term or loans of any maturity granted to consumers or for eight years in any other case). The risk retention requirement is disapplied in certain cases (such as on the AIF’s liquidation).
Additional requirements for “loan-originating AIFs”
EU AIFMs that manage “loan-originating AIFs” are required to comply with the following additional requirements.
- Requirement to be closed-ended: A loan-originating AIF must be closed-ended, unless the AIFM can demonstrate that the AIF’s liquidity risk management system is compatible with its investment strategy and redemption policy.
- Leverage limits: A leverage limit of 175% applies for open-ended AIFs and of 300% for closed-ended AIFs (open-ended and closed-ended AIFs being treated distinctly following extensive negotiation on this topic during the legislative process).
Leverage is calculated according to the commitment method, excluding subscription line credit. This limit does not apply to loan-originating AIFs whose lending is limited to shareholder loans, provided that those loans do not in aggregate exceed 150% of the AIF’s capital.
The definition of “leverage” for these purposes remains unchanged since the AIFMD1 text and hence refers to any method by which the AIFM increases the exposure of an AIF, including borrowing of cash and securities and leverage embedded in derivatives.
Grandfathering provisions
Certain grandfathering provisions apply to the loan origination rules.
Existing AIFs
AIFMs managing AIFs established prior to AIFMD2 coming into force on 15 April 2024 (Existing AIFs), and that do not raise capital after such date, will be deemed compliant with the concentration limits, leverage limits, and requirement for loan-originating AIFs to be closed-ended indefinitely.
Existing AIFs that do raise capital after 15 April 2025 will be grandfathered for a five-year period from such date (i.e., until 16 April 2029).
Given that AIFMD2 is not required to be implemented into local law by Member State until 16 April 2026, this amounts in practice to a three-year grandfathering period.
However, the practical benefit of the latter grandfathering provision is limited by provisions to the effect that:
- an Existing AIF that exceeds the concentration or leverage limits during the grandfathering period may not increase its lending to the relevant borrower or its leverage (as relevant) above the respective levels applied by the Existing AIF on 15 April 2024; and
- an Existing AIF that is below the concentration and leverage limits during the grandfathering period may increase its lending to the relevant borrower or its leverage only to the extent the relevant limits would not be breached.
Existing loans
In respect of loans originated before 15 April 2024, AIFMs will not need to comply with the rules on loan origination policies, related party lending, originate to distribute, and risk retention.
Liquidity management
Liquidity management tools for open-ended AIFs
AIFMD2 expands on the existing liquidity management requirements under Article 16 AIFMD.
EU AIFMs that manage open-ended AIFs will have to select at least two liquidity management tools (LMTs) from a prescribed list, including redemption gates; extension of notice periods; redemption fees; swing pricing; dual pricing; anti-dilution levies; and redemptions in kind.
The LMTs of suspensions of subscriptions, repurchases, and redemptions and side pockets are available in exceptional circumstances, in addition to the two LMTs the AIFM selects from the prescribed list.
The AIFM will be required to implement policies and procedures for the activation and deactivation of any selected LMT and set out the operational and administrative arrangements for using such tool.
ESMA is mandated to develop regulatory technical standards to specify the characteristics of the LMTs as well as guidelines on the selection and calibration of LMTs by AIFMs (including the circumstances in which side pockets can be activated).
Notification
AIFMs must notify their NCA within a reasonable timeframe prior to activating or deactivating the side pockets LMT.
Notification must be made to the NCA without delay where the AIFM activates or deactivates the suspension LMT or any other LMT where the activation or deactivation is in a manner outside the AIF’s ordinary course of business.
ESMA and NCA powers to compel suspension LMT
NCAs will be empowered to require EU AIFMs to activate or deactivate the suspension LMT in exceptional circumstances and after consulting the AIFM.
Separately, ESMA will be empowered to request NCAs to require non-EU AIFMs marketing one or more AIFs in the EU, as well as EU AIFMs managing a non-EU AIF, to activate or deactivate the suspension LMT.
While this power may only be exercised in exceptional circumstances and after consulting the AIFM, and where ESMA considers there to be risks to investor protection or financial stability, on a reasonable and balanced view, the extraterritorial scope of the power should be noted by non-EU AIFMs marketing under the NPPRs.
No lending passport
Consistent with the Commission Proposal, the Final Text amends the list of permitted ancillary activities an AIFM may undertake in Annex I AIFMD to include loan origination (as well as servicing SSPEs).
Accordingly, an EU AIFM in one Member State could use the AIFMD management passport to manage an AIF in another Member State that engages in loan origination.
However, while the recitals to the Final Text suggest an intention to create a lending passport, allowing AIFs managed by EU AIFMs to lend to borrowers on a cross-border basis across the EU, there is no explicit operative provision to this effect. As such, it is unclear whether AIFMD2 will effectively facilitate cross-border lending throughout the EU by AIFs managed by EU AIFMs.
New permitted activities for EU AIFMs
In addition to the new AIFM functions of loan origination and servicing of SSPEs, AIFMD2 expands the list of services in Article 6(4) AIFMD for which an AIFM may be authorised to include two new services:
- benchmark administration; and
- credit servicing in accordance with EU Directive on Credit Servicers and Credit Purchasers6.
Furthermore, AIFMD2 removes the current restriction on an AIFM holding top-up permissions (such as for investment advice, custody, and reception and transmission of orders) without also being authorised for portfolio management.
As such, an AIFM could, for example, hold a top-up permission for the services of investment advice without also needing a portfolio management permission.
Changes to the depositary framework
At present, AIFMD1 requires that the depositary of an EU AIF must be established in the home member state of the AIF.
Acknowledging that some concentrated markets lack a competitive supply of depositary services, AIFMD2 adds a carveout to permit AIFMs to procure depositary services from depositaries authorised in a Member State other than that of the AIFM.
This will be conditional on the AIFM’s having provided a reasoned request to the NCA that demonstrates the lack of effective depositary services in its home Member State, and the national depositary market of that home Member State’s not exceeding €50 billion in aggregate assets in custody.
Where third-country depositaries are used (i.e., in respect of non-EU AIFs), AIFMD2 will extend the conditions to their appointment to include that such depositaries be in jurisdictions that are not on the EU AML List or the EU Tax List.
ESMA report and Commission review
By 16 April 2029, ESMA is required to report to the European Parliament, the Council of the European Union (Council), and the Commission on market practices regarding delegation and compliance with the new delegation and substance requirements under AIFMD2.
Following ESMA’s report, the Commission is required to initiate a review of the functioning of AIFMD2, including the effectiveness of the delegation regime (with regard to prevent the creation of letter-box entities in the EU), the appropriateness of the loan origination regime, the revised depositary framework, and the host AIFM requirements.
Following its review, the Commission must report to the European Parliament and the Council on its findings.
Changes to the UCITS Directive
Consistent with the Commission Proposal, the Final Text makes various changes to the UCITS Directive7 to align with the changes being made to AIFMD (e.g., additional reporting on delegation and the new LMT rules). It remains the case in the Final Text that UCITS are not permitted to engage in loan origination.
1Directive 2011/61/EU.
2Directive (EU) 2015/849.
3Regulation (EU) 2020/1503.
4Directive (EU) 2014/65.
5Directive (EU) 2016/97.
6Directive (EU) 2021/2167.
7Directive 2009/65/EC.
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