ESMA’s Cunning Plan

Those who have whiled away a covid summer afternoon enjoying ESMA’s note to the European Commission on improvements to AIFMD  ( esma_letter_on_aifmd_review ), will have formed the vaguest suspicion that despite its noises about Wirecard, it is really Woodford that is still on ESMA’s mind. The fact that the highest profile Woodford funds were UCITS need not deflect that thought – ESMA’s No 1 complaint is the extent of pointless differences between the two directives. It was Sybil Fawlty who was identified as the master of statements of the bleeding obvious and there are signs that ESMA may have become confused between the hotel sketch and the investment fund disaster.

There is a sense emerging from its note, that ESMA has been looking forward to this opportunity. In between the told-you-so remarks and the statements of the BO, there are the wonderfully unoriginal bids for more regulation and more Europe. They have wisely abandoned their attempt to dress up their naked protectionism as investor protection – remarks about the appalling prospect of business being done with London and other haunts of ill repute abound.

As is so often the case, the main attraction is Delegation. What else could be said on this subject that has not already been dismissed? Nothing new, it seems, but quite a lot that can be re-heated. It is after all a subject where Woodford can help. So, we have observations, after a passing reference to possible benefits, that delegation

  • “may also increase operational and supervisory risks”
  • “may raise questions as to whether AIFs and UCITS can still be effectively managed by the licensed AIFM or UCITS management companies”

This is not revealing stuff – except perhaps to the extent that it suggests that either ESMA’s understanding is worryingly superficial or that it has decided to recite points that it believes will best chime with Commission fixations. There is in this treatise something approaching a real failure to grasp how, in the context of regulation, delegation is supposed to work. There is no recognition that almost any delegation, whether in the context of investment funds or any other area, involves the prospect that an activity is carried out by a party that is not itself subject to at least some applicable regulations. There is no reflection on how that is usually dealt with. There is no proper emphasis on the retention of responsibility when delegation is effected and that delegators are required to execute due diligence, apply clear duties and carry out sufficient monitoring to ensure that all relevant regulatory obligations are fulfilled and that consumers suffer no disadvantage from the delegation. If it was that they thought that to make such obvious points would be to trespass on Sybil Fawlty territory, there is no sign that that has stopped them elsewhere.

What tempts one to think that ESMA’s professed concerns are not substantive, but merely uttered for effect, is the careful incision of references to the horrors of the non-EU delegate. Consider

  • “In the case of delegation to non-EU delegates, the regulatory arbitrage and investor protection concerns may be further increased since the non-EU delegate will not be directly subject to the AIFMD or UCITS frameworks.”

Most would say that the stated impact was far from peculiar to the circumstances of delegation to non-EU parties, but rather that the majority of EU funds have a portfolio manager that is a MiFID firm. In fact delegation to a firm that isdirectly subject to AIFMD or UCITS would be so peculiar that it would raise questions as to how such an arrangement was in the interests of investors. So it is either time to be troubled at ESMA’s ignorance or suspicious that it is playing politics to the audience.

You will of course be unable to guess what remedies ESMA proposes. Perhaps a sample or two will provide a clue.

  • “To avoid regulatory arbitrage and protect EU investors, legislative amendments should ensure that the management of AIFs and UCITS is subject to the regulatory standards set out in the AIFMD and UCITS frameworks, irrespective of the regulatory license or location of the delegate.”
  • “the Commission may in particular wish to reconsider and/or complement the qualitative criteria set in Article 82(1)(d) with clear quantitative criteria or provide a list of core or critical functions that must always be performed internally and may not be delegated to third parties.”

So ESMA is at the same time calling for action and studiedly vague about what should and should not be a permitted delegation. They don’t expressly call for a ban on delegating portfolio management, inside or outside the EU, but there is more than a hint that protectionism is what really matters. Some say that this would be very damaging to the UK investment management industry. Others note that it is EU funds that will be hobbled by absurd restrictions – and the UK is safely outside. Perhaps the reference to protecting EU investors is tacit recognition that there may soon be no others.

It is said that the intention of the SNP is to alienate the English in order to get them to support Scottish independence. If there were to be any truth in that, the strategy would be logical and seemingly pretty effective. What it may not sufficiently take into account is the longer-term impact of being on bad terms with your most important trading partner.

And so you may have wondered whether a similar strategy is at work here, with ESMA and others falling prey in our wicked web. There can be no doubt that the EU aspires to wrest financial services business from the UK, but there is certainly doubt over whether their tactics will damage business in this country more than it does on the Continent.

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