The European Securities Markets Authority (ESMA) is in a difficult position that may become apparent in the years ahead.
Readers will recall that ESMA is embarking on an ambitious country-by-country review of regulatory regimes to determine which are fit enough to be extended the AIFMD passport. In a past comment letter, we criticized the strategy as having “No end in sight” , but didn't explore the possibility that the US and other major capital markets might be denied passport access. It seemed unlikely then, and is still unlikely today.
ESMA has little interest in barricading a majority of the world's private fund managers from EU shores. However, what the industry is beginning to discover is that ESMA is in the awkward position of explaining why it shouldn't.
Over the last few weeks, pfm has been speaking with onshore and offshore lawyers, fund managers and LPs about what should be taken into consideration when selecting a fund domicile in 2015 (subscribers will receive our findings in pfm's annual Fund Domiciles Guide this October). The ESMA decision was often cited by contacts, many of whom pointed out that ESMA only seems to be approving jurisdictions that provide managers an opt-in regime for full AIFMD compliance. Jersey and Guernsey therefore have been approved. And the Cayman Islands, after it finishes implementing its own AIFMD mirror fund later this year or early next, is expected to receive similar approval after it is reviewed.
So here's the rub: unlike offshore jurisdictions that must remain nimble in response to onshore regulatory developments, no one expects major jurisdictions like the US and Japan to introduce copycat AIFMD vehicles, all for the purposes of satisfying EU regulators. What then? Again, no one predicts ESMA will recommend that US managers be denied the passport. If private placement regimes wither away in the coming years, which AIFMD may force EU sovereigns to allow to happen, then the passport is third-country managers' only route to investors.
The logical conclusion then is that ESMA will evaluate the US and other onshore jurisdictions under a different set of criteria than offshore regimes. But this solution presents new problems. If American or Japanese managers can escape certain AIFMD requirements, because local rules do not impose them, expect German and French managers to call foul. Managers based in the EU are subject to the full brunt of AIFMD, and won't like the idea of seeing US managers travelling seamlessly across Europe, with passport in hand, but free from costly requirements like appointing a depositary.
We'd like to say there is an easy answer to all this, but none comes to mind. If ESMA recommends allowing US managers the passport, despite not meeting every AIFMD rule, then EU managers must simply accept that outcome with the understanding that US managers and others still have their own peculiar rules to follow under local law. In the off-chance ESMA recommends denying US managers the passport, expect US-based GPs to use the Cayman Islands or one of the Channel Islands as a stepping stone to reach EU investors, presumably by setting up parallel AIFMD-compliant structures offered by these jurisdictions.
ESMA's conundrum will have to be solved one way or another by 2018 at the latest – the time when ESMA will decide whether to scrap private placement regimes. With much interest, pfm will continue to observe the situation for any further wrinkles, and report back any additional knots the regulator will have to untangle before then.
For more on the current layout of private equity's most popular fund domiciles – and the emerging players looking to capture their market share – be sure to read the October edition of pfm, which will include our annual fund domicile special supplement.