Small managers and sustainability rules
Will small managers fall within the scope of the upcoming sustainability rules?
There is a lot of fuzz around the upcoming sustainability rules. That is quite right, given that these rules will have a substantial impact on financial market parties that fall within its scope. The question that is raised – and answered – in this blog is whether small managers must also comply with the sustainability rules.
The AIFM Directive, which in principle applies to all fund managers (with the exception of UCITS), provides for an exemption for ‘small managers’. This exception is known in the market by several names: de minimis regime, registration regime, exemption regime, sub-threshold regime, and Article 3(2) exemption. The small managers regime is very popular in the Netherlands. A rough estimate based on the AFM register indicates about 700 small managers currently active in the Netherlands. By way of comparison: there are 94 active licensed AIFMs in the Netherlands. Many small managers are relatively small organizations (what’s in a name). Participations in the alternative investment funds (AIFs) under management are in principle only marketed within the Netherlands.
Although the small managers regime provides for an exemption from to the AIFM Directive, the small manager must nevertheless comply with various financial supervision rules. This includes – often cross-sectoral – rules pursuant to the PRIIPs Regulation, the Dutch Money Laundering and Terrorist Financing (Prevention) Act (the Wwft), the Sanctions Act 1977, the Unfair Commercial Practices Act (the Wohp) and the Market Abuse Regulation (MAR). The reference to ‘light regime’ is therefore somewhat misleading.
And so a new cross-sectoral legislative package is approaching in the short term, which the small manager cannot simply ignore. From 2021 and onward, detailed and far-reaching European rules on sustainability will enter into force in phases. These rules stem from the EU Action Plan for Financing Sustainable Growth (the Action Plan). A useful overview of the different rules can be found on the website of the European Commission. Earlier this year, the AFM already drew attention to this in a sector letter on sustainability (‘Sectorbrief over duurzaamheid’, only in Dutch). The consensus in the market is that these rules will have a significant impact on financial market participants, also on asset managers.
First in line of the Action Plan is the Sustainable Finance Disclosure Regulation (SFDR). In short, the SFDR provides for mandatory provision of information regarding sustainability in respect of, among others, collective investment schemes (AIFs and UCITS). Based on the SFDR fund managers must, among other things:
- Draw up a policy on the integration of sustainability risks in the investment process and publish it on their website;
- Make an explicit choice as to whether they consider significant adverse effects of investment decisions on sustainability factors in the due diligence process and draw up a policy for this, or provide a substantiated explanation why they do not do this and also publish this on their website;
- Include in the remuneration policy how the policy is consistent with the integration of sustainability risks and publish this on their website;
- Include in the prospectus how sustainability risks are integrated and their likely effects on the returns, or provide a substantiated explanation why sustainability risks are not relevant;
- Various additional rules if a collective investment scheme is promoted as sustainable, including additional information obligations with publication on the website and in the annual report.
Terms such as ‘sustainable investment’, ‘sustainability risks’ and ‘sustainability factors’ are separately defined in the SFDR. The SFDR affects the business of fund managers in various ways and is in principle relevant to all collective investment schemes, regardless of whether they are presented as sustainable.
The SFDR will enter into force on March 10, 2021. Various rules of the SFDR will be worked out in further detail in so-called Regulatory Technical Standards (RTS). These were submitted for consultation to the market on April 22, 2020, but the market is still waiting for the final RTS. The level of detail in the consultation paper is almost frightening. The entry into force of the RTS, initially scheduled for March 10, 2021, has apparently been postponed by the European Commission until further notice (rumors say until January 2022). Nevertheless, fund managers will still have to comply with general requirements of the SFDR from March 10, 2021.
The question that arises is whether small managers also fall within the scope of the SFDR. That question has been raised several times so far, but has not been answered yet. I will explain (and unfortunately this is a relatively technical legal analysis):
- The SFDR applies to an AIFM within the meaning of the AIFM Directive. This means ‘a legal person whose regular business is managing one or more AIFs’. This definition in the AIFM Directive concerns the activity of managing AIFs, regardless of any licensing requirement. In other words, a small manager is also ‘active’ as an AIFM. From a strictly legal point of view, the SFDR is therefore fully applicable to small managers.
- Interestingly, however, the list of entities within the scope of the SFDR also explicitly mentions managers of EuVECA and EuSEF funds. These are also AIFMs within the meaning of the AIFM Directive, but they manage specific types of AIFs, namely venture capital funds (EuVECA) or social enterprise funds (EuSEF). Both small managers and licensed managers can manage EuVECA and EuSEF funds. I derive from this that the European Commission has apparently found it necessary to explicitly involve these type of AIFMs within the SFDR. This would not have been necessary if the reference to AIFM included every AIFM. A contrario it can be argued that small managers do not fall within the scope of the SFDR.
- It is also interesting that various obligations from the SFDR link up with specific obligations under the AIFM Directive. This applies, among other things, to the provision of information in the pre-contractual phase. Article 6 paragraph 3 SFDR stipulates that AIFMs must include this information in the prospectus as referred to in Article 23 AIFM Directive. However, this obligation does not apply to small managers, because they are exempt from the AIFM Directive. I see a similar link in respect of the annual report and the remuneration policy. In both cases, reference is made to an obligation in the AIFM Directive, which does not apply to small managers. This is also an indication that the SFDR does not apply to small managers, at least not these specific obligations. In my opinion, it can in any event not be the case that these rules from the AIFM Directive would commence to apply to small managers through the back door of the SFDR.
In short: based on the SFDR it is not clear whether small managers fall within its scope. It does not appear to be the intention, but we certainly cannot rule it out completely either. The European Commission, ESMA and/or the AFM should express themselves explicitly about this – preferably as soon as possible. I feel free to take a stab at this below.
I can only applaud the ultimate goal of these sustainability rules. The resources required for this do however entail the necessary compliance for fund managers. The internal organisation of a licensed AIFMs must be set up for compliance with new financial regulatory rules; they must install an independent and effective compliance function to ensure this. More and more is expected from this compliance function due to increasing compliance pressure and a stream of new regulatory rules. However, such obligations do not apply to small managers. By their nature, in my opinion, the sustainability rules should therefore not apply to small managers. I see sufficient ground for this view in the SFDR. I would therefore argue that the SFDR does not apply to small managers. At the most, the SFDR can find a reflex effect for small managers in the requirements imposed on the provision of information by small managers on the basis of the Wohp. Hopefully the (European) supervisors are reading along now.