Will the MiFID Tied Agent Model Benefit from the New AIFMD II Delegation Rules? 

Success of the first iteration of AIFMD is undoubted. The AIFs market in Europe touched seven trillion by the end of 2022. It provided at least 250 billion to local businesses and enterprises, making it the most successful tool to finance European enterprises under the Capital Markets Union. And whilst you do not want to fix what is not broken, during the preparation works for the revised directive it became apparent that additional standardisation in the business of managing alternative investment funds was needed at European level. AIFMD II comes with a new European regime on liquidity management tools, applicable also to UCITS, as well as rules on Loan Originating Funds and related European passport. 

The new rules on AIFMD II delegation relative to the marketing and distribution function are the ones receiving less attention so far. We believe that these come with the potential of a significant impact on cross-border distribution dynamics in Europe going forward.  

For one, it is legitimate to ask whether the AIFMD II delegation rules on the marketing and distribution function will end up supporting – unintendedly so – further growth of the MiFID Tied Agent model in Europe. 

 Addressing The Pink Elephant in the Room 

For us to understand the potential to disrupt European distribution that comes with the new AIFMD II delegation rules, we need to zoom out and look at the bigger picture of the fund management landscape in Europe first. Especially the evolution experienced since the first introduction of the directive a decade ago. 

Conceived as dedicated providers of so-called substance in Europe, AIFMs and management companies have mushroomed with the dawn of the AIFMD era. Due to the sophisticated on-the-ground alternative investments experience of their personnel, the growth of the independent AIFMs and management company model as we know it has been sustained by a significant push from overseas managers. For years now, European UCITS and AIFs are managed by independent AIFMs and management companies at the initiative of third-party initiators or promoters. For the risk management outsourcing model to make commercial sense for both sides, third-party initiators have been able to brand funds to their liking and link them to their existing product offering.  

With reference to the forthcoming value for money assessments in Europe, we already hinted at the fact that commercial relationships between independent AIFMs/management companies and third-party fund initiators are prone to conflicts of interest. If nothing else, for initiators being clients of the AIFMs/management companies, whose business is predominantly made of managing third party funds, it is a fair conclusion in our view that conflicts of interest might not be a mere happenstance in this environment.  

It makes only sense that a revision of AIFMD would consider the landscape of the management of alternative investment funds as it exists today, rather than at the time when the directive was first enacted. AIFMD II introduced provisions to cater for strengthened measures on conflicts of interest prevention in the context of the new model of independent management of alternative investment funds. Dedicated provisions under the new version of article 14 AIFMD impose new obligations on third party AIFMs and management companies. They will have to offer detailed explanations to Home State Authorities on how they comply with the AIFMD provisions on conflicts of interest and explain the actual steps taken to prevent them with external fund initiators. Where conflicts of interest are unavoidable as such, explain how these are managed and disclosed to investors.  

Same measures are extended to the corresponding model for the independent management of third-party UCITS funds. 

AIFM II Delegation Rules on Distribution 

One of the pillars of AIFMD, namely the one that allowed for the growth of the independent AIFMs and management companies model as we know it, is delegation. AIFMD II delegation rules stay pretty much unaltered under the new iteration of the directive. That is for what concerns the ability to delegate functions and services to third parties under AIFMD and UCITS directive, including portfolio and risk management.  

Notwithstanding rumours about phasing out delegation, we can’t really see a valid justification for European authorities to ever give up on the concept. The ones who even entertain the thought do not look at the full picture. Delegation benefited the labour market in Europe. The growth of the fund management company industry received a considerable boost by the demand for these services from managers based outside of Europe. Thinking of negating the ability of these foreign entities to receive the delegation of the portfolio management from the AIFM, for instance, is simply unrealistic. It would kill the European fund management industry and with it the induct of jobs it created in Europe.  

The fact that the benefit for the European labour market is very much the issue here, is confirmed also by the second iteration of the ELTIF regulation. Initially conceived as a European centric type of investment product, European long-term investment funds will be now open to underlying investment opportunities not necessarily located within geographical Europe. Whilst we would not necessarily agree that ELTIFs could be now used to finance long-term endeavours that are totally divorced from Europe, the bottom line is that ELTIFs remain European funds and need European AIFMs to manage them. If nothing else, where broadening the geographical scope of investments will end up boosting the ELTIFs market, Europe will benefit by being able to sustain its fund management industry and related labour market.  

AIFMD II Delegation – the MiFID and IDD exemptions 

The revised directive does not change the main paradigm of delegation. It instead tightens the rules on reporting to national competent authorities on delegation arrangements. AIFMD II delegation rules also create a new dimension for what concerns marketing and distribution. A distinction is introduced between marketing and distribution made on behalf of the AIFM or on its own behalf by a distributor. As we look at this change in perspective, we sense clearly that concerns at European level have shifted significantly since Brexit kicked in. From portfolio management to marketing and distribution.  

Marketing and distribution remain a function that can be indeed delegated, hence in scope for the heightened reporting requirements under AIFMD II delegation rules. No delegation as such will be construed though in instances where this function is carried out by MiFID licensed entities or within the context of distribution of life insurance-based investment products. The new rules reference to distribution agreements. The existence of a distribution agreement with the AIFM/management company will not create a delegation relationship on marketing and distribution in cases where the entities carrying out the function operate under above-mentioned MiFID or IDD exemptions.  

The new AIFMD II delegation rules shall be read in conjunction with the amended rules on reporting. AIFMs/management companies will have to report to their home state regulators the list of member states where the AIFs/UCITS are marketed by or on behalf of the AIFM/management company. According to the new rules, where the entity marketing or carrying out the distribution does so outside of the MiFID and IDD exemption, it will be deemed to be marketing on behalf of the AIFM/management company and as such in scope for the reporting. 

Implications of Distribution Outside MiFID and IDD Exemptions 

The big picture seems to be clear enough now. Independent AIFMs/management companies will have to provide detailed explanations on how conflicts of interest with third-party initiators are prevented or managed. A new look through approach is adopted on the delegation of the marketing and distribution function. Reporting is imposed on AIFM/management companies of all the instances where marketing entities and distributors, operating outside MiFID and IDD exemptions, have been delegated the marketing and distribution function.  

As we piece the puzzle together, it is noteworthy to mention that certain member states in Europe already impose on local AIFMs and management companies to report on an annual basis about the entities appointed to carry out the marketing and distribution function. The tightening of reporting standards applicable to the delegation of the marketing and distribution function with AIFMD II aims at establishing a European regime aligned with existing practices in the most advanced European distribution gateways. The new reporting requirements will also serve another purpose. Allow national competent authorities across Europe and ultimately ESMA to have a better picture of distribution practices within the Union.  

We are not here to speculate whether national competent authorities and ultimately ESMA will use or not – and if so for what purposes – the information reported on the delegation of the marketing and distribution function. What seems to be certain though is that the combination of these new rules under AIFMD II is set to alter the existing status quo. It is still early days in the implementation of the revised directive and it will take quite some time before administrative and market practices will fully form on this topic. What we can say now though is that it would not be entirely surprising to see certain delegation arrangements in vogue for many years now, where non-European entities act as global distributors of European funds, become suddenly no longer fashionable. The same goes for sub-delegating the marketing and distribution function to entities whose business model is based entirely on reverse solicitation, for the lack of a European local license. When weighing the increased reputational and regulatory risk for independent AIFMs/management companies that comes with the new AIFMD II delegation rules, we find that it will be incredibly more difficult for them to justify or tolerate engagements with non-regulated marketing and distribution entities going forward. 

Conclusions 

If that is the case, what are the options available? Is setting up a MiFID proprietary entity the only solution? Not necessarily. Nowadays for marketing and distribution firms to be able to operate within the MiFID ecosystem there are solutions that come with a lesser commitment than setting up a proprietary MiFID entity.  

The MiFID Tied Agent model has evolved to a satisfactory degree in Europe now. Of course, some European member states are more palatable than others for different reasons, but there are options to choose from when it comes at setting up Tied Agent arrangements. We like to think that part of the changes under AIFMD II delegation rules have also been inspired by the intention to boost this sector, which will favour the European labour market. At the same time, a push towards this type of arrangements will also create higher common standards in the administrative and regulatory practices applicable in the various domiciles where Tied Agent arrangements have flourished over time.   

An additional cost for non-European managers but a much better option overall for Europe than continuing to chase down reverse solicitation approaches.