By Dr Christopher Buttigieg and Dr Isabelle Agius, Malta Financial Services Authority – This paper attempts to summarise the legislative framework adopted in Malta for the implementation of the Alternative Investment Fund Managers Directive (‘AIFMD’).
Malta is considered a European domicile of choice for the establishment of investment funds and their services providers. The island’s achievement in this field came about primarily as a consequence of a highly developed regulatory framework applicable to investment funds and the Malta Financial Services Authority’s (‘MFSA’) approach to financial supervision characterised by a high degree of accessibility and robust supervision. Malta’s implementation of the AIFMD has developed and strengthened even further its regulatory and supervisory framework in the field of fund management.
The legislative framework for the regulation of investment services in Malta, including investment funds and their service providers, is the Investment Services Act, 1994 (‘the Act’). The Act, the legal notices issued by the Minister of Finance in terms of the Act, and the Investment Services Rules issued by the MFSA, set the national regulatory framework for the licensing and supervision of investment services. The Act and subsidiary legislation transpose inter alia the AIFMD. The regulatory framework is constantly under review in order to avoid the prospect of ossification and to remove rules that through the passage of time, and due to the development in financial markets, may not be adequate to attain the objectives of financial regulation.
The AIFMD focuses on the regulation of the manager. The regulatory framework in Malta regulates both the manager and the fund. Indeed, all types of funds established in Malta are subject to specific product regulation, the primary aim of which is that of protecting investors. The regulatory framework allows the establishment of different fund structures and the application of diverse portfolio management strategies. The supervision carried out by the Authority focuses on the investor and the integrity of the financial system. The intensity of supervision varies depending on the nature of the fund, the underlying investment strategies and the relevant target investor market.
The primary purpose of this paper is to examine Malta’s implementation of the AIFMD. The resulting position is that the changes brought about by the AIFMD have strengthened the regulatory framework in Malta. Given the investor demand for robust regulation, Malta is now better placed to grow as a jurisdiction of choice for international financial services.
For narrative ease the paper has been divided into two additional sections as follows: Section 1 examines the legislative framework for the implementation of the Directive in Malta; and Section 2 covers those areas of regulation which are particular to Malta and which add value to the positioning of Malta as a jurisdiction of choice for international financial services.
1. Malta’s legislative framework
In Malta the transposition of the AIFMD required amendments to the Investment Services Act, 1994 (‘the Act’). By way of background, the Act regulates the activity of investment firms, fund managers, collective investment schemes, custodians and fund administrators. The amendments to the Act, which implement the AIFMD, provided for the licensing of an AIFM and alternative investment funds [‘AIF’]. The first schedule to the Act was also amended to include ‘collective portfolio management of assets’ as an integral part of the service of management of investments.
The Act is supplemented by the following legal notices adopted by the Minister of Finance in terms of the Act:
• Investment Services Act (Alternative Investment Fund Manager) Regulations, which enhance the MFSA’s powers qua competent authority for the purpose of the AIFMD;
• Investment Services Act (Alternative Investment Fund Manager) (Passport) Regulations, which apply to AIFM exercising passporting rights in terms of the AIFMD;
• Investment Services Act (Marketing of Alternative Investment Funds) Regulations, which regulate the cross-border marketing of AIFs; and
• Investment Services Act (Alternative Investment Fund Manager Third Country) Regulations [‘Third Country Regulations’], which implement the third country provisions, including the framework applicable to the national private placement regime and the choice of the Member State of reference by third country AIFMs.
In addition to the Act and the legal notices, changes were also carried out to the MFSA’s Investment Services Rules. In terms of the Act, the MFSA, which is Malta’s single regulator and supervisor for financial services, has the power to issue Investment Services Rules stipulating requirements and conditions in relation to activities of licensed entities, the conduct of their business, their relations with customers, the public and other parties, their responsibilities to the MFSA and any other matters as the Authority may consider appropriate. The MFSA has issued (and/or amended, as the case may be) a number of Investment Services Rulebooks that generally aim at supplementing the high-level regulatory principles set in the Act and which transpose various pieces of EU regulation such as the AIFMD, the Markets in Financial Instruments Directive (‘MiFID’), the UCITS Directive and the Capital Requirements Directive.
The Investment Services Rules for Investment Services Providers [‘ISP Rulebook’] which regulates the activity of investor firms, fund managers and custodians (‘depositaries’), were amended to implement the governance, compliance, capital, risk management, conduct of business and transparency requirements applicable to AIFM. In addition, as part of the AIFMD project, the Authority decided to restructure the ISP Rulebook, the on-going obligations of which applied to investment services providers in general, into four parts which apply depending on the specific type of activity undertaken by the licensed entity, these being: [i] MiFID investment firms; [ii] UCITS managers; [iii] AIFM; and [iv] depositaries.
The following diagram provides an outline of the current structure of the MFSA’s Investment Services Rulebook.
2. Malta’s Approach to AIFMD Regulation
This section examines those areas of regulation which are particular to Malta and add value to the positioning of Malta as a jurisdiction of choice for international financial services, specifically the: [i] licensing framework for de minimis fund managers; [ii] implementation of the requirements on remuneration; [iii] transitional depositary passport and depositary-lite framework; and [iv] implementation of rulebooks applicable to AIFs.
2.1 De minimis Fund Managers
The part of the Investment Services Rulebook that applies to AIFMs contains specific regulation applicable to de minimis AIFMs. Malta decided to regulate de minimis AIFMs with a stricter regime than what is prescribed in the AIFMD for this type of manager. Policy makers in Malta were of the view that a licensing regime is preferable than mere registration as it is in the best interest of investor protection and financial integrity that all fund managers are subject to a robust but proportionate regulatory framework. Moreover, it was deemed important that fund managers, irrespective of the size and complexity of their operations, should be subject to Malta’s anti-money laundering deterrence framework. Therefore, de minimis AIFMs are subject to regulation, authorisation and supervision in Malta.
To allow the MFSA to be in a position to re-assess and re-authorise as AIFM or de minimis AIFM those fund managers already licensed by the MFSA prior to the coming into effect of the AIFMD in July 2013, the ISP Rulebook contains two self-assessment questionnaires which must be completed by applicants. These self-assessment questionnaires should allow the MFSA to assess existing fund managers’ preparedness to comply with the AIFMD and are presently being submitted for the Authority’s assessment.
2.2 Implementation of the Requirements on Remuneration
The MFSA has also implemented the ESMA Guidelines on sound remuneration policies under the AIFMD [ESMA/2013/232] with the exception of paragraph 18 of the guidelines. This paragraph stipulates that the delegate of an AIFM, who has been delegated investment management activities, must be subject to regulatory remuneration requirements which are equally as effective as those applicable under the Guidelines and that appropriate contractual arrangements must be in place to ensure that there is no circumvention of the remuneration rules. ESMA has therefore extended the remuneration provisions in the Directive with the intent that entities to which AIFMs delegate investment management activities are also subject to the guidelines. The recitals of the UCITS V Directive are demanding ESMA to take a similar position with regard to delegation structures in the context of UCITS.
The adoption and implementation of requirements on remuneration is fundamental in order to address the possible detrimental effect of poorly designed remuneration arrangements on the sound management of risks. It is a mechanism which seeks to control the risk-taking behaviour by individuals. However, as a result of the uneven approach to the regulation of remuneration between Europe on the one hand and the rest of the world, the ESMA guideline that is applicable in the event of delegation may cause serious difficulties in the setting up of delegation structures where the delegate is established outside the EU.
To address the concerns that delegation structures may be applied in order to circumvent the European requirements on remuneration, while at the same time allowing delegation structures between EU and non-EU fund managers to continue existing without restrictions, instead of implementing paragraph 18 of the ESMA Guidelines, the MFSA is applying a supervisory procedure for monitoring the effective implementation of remuneration requirements by local fund managers. This monitoring process aims at keeping management companies on their toes and reminding them that they may not use the delegation provisions to circumvent their responsibilities under the AIFMD, including their responsibilities under the remuneration rules. This procedure should achieve the same outcome, however without disrupting the existing delegation structures.
2.3 Transitional depositary passport and depositary-lite
Malta exercised the optional transitional provision that allows an AIF to engage a depository in another Member State. The implementation of AIFMD was an important step for the strengthening of investor confidence in the alternative investment fund industry. In this regard, the requirement to appoint a depositary to safe keep the assets of the fund and to monitor the fund manager is an important investor protection requirement. Nonetheless, the requirement that the depository should be established in the same Member State as the fund goes beyond what is necessary to achieve the investor protection objective of regulation. The restriction on the place of establishment of the depositary limits the jurisdictional options for promoters of investor funds, restricts the choice of depositaries and lessens the competition within the depositary industry. The restriction goes against the internal market objectives set in the Treaty of the European Union (TFEU) and the Directive.
EU harmonisation is implemented to allow the internal market to operate on the basis of single rulebook or mutual recognition. However, while as a result of AIFMD and the UCITS V Directive there is significant harmonisation of the conduct of business of depositary services, a depositary passport has not been implemented. This illogical position is the unfortunate outcome of European processes that are largely driven by national protectionist agenda, which are prevailing over and creating barriers to the operation of the European Internal Market project. In the EU, harmonisation is not implemented for harmonisation’s sake, but for the purpose of the Internal Market. On this basis one would expect that, sooner rather than later, the jurisdictional restriction on depositaries will be challenged at the level of the European Courts.
The transitional provision on the establishment of depositaries expires in 2017. To guarantee a wider range of depositaries established in Malta, the Authority developed a specific regulatory framework for entities that provide restricted depositary services. The AIFMD contemplates the provision of services by a depositarylite in the case of third country funds which are marketed in the EU and EU AIFs that have no redemption rights exercisable during a period of five years from the date of the initial investment and which, in accordance with their core investment policy, generally do not invest in assets that must be held in custody. Malta’s framework for depositary-lite operators allows licensed entities such as recognised fund administrators and investment firms that are subject to an initial capital requirement of EUR125,000 to apply for an authorisation to provide restricted depositary services. This is an area which is experiencing significant interest and should facilitate the process for private equity and venture capital type funds to be established in Malta.
2.4 MFSA Rulebook applicable to AIFs
During the process that led to the implementation of the AIFMD in Malta, the MFSA decided to adopt the Investment Services Rules for Alternative Investment Funds [‘AIF Rulebook’], a rule book for the establishment of AIFMD ready funds. While the MFSA opted to retain the existing regulatory framework applicable to professional investor funds, it decided to reinforce the framework for the regulation of the funds sector by establishing a rulebook which regulates self-managed funds, which in terms of the AIFMD qualify as the AIFM, and third party managed funds that are targeted for distribution as AIFs across Europe. Apart from stipulating an exhaustive list of service providers which the AIF is required to appoint, the AIF rulebook also sets requirements on the governance and transparency of the fund.
This paper has examined how Malta has approached the implementation of the AIFMD from a regulatory perspective. Experience in financial regulation and supervision however suggests that regulation on its own is not enough to ensure that the systemic stability objectives of financial regulation are realised. It is clear that without supervision and enforcement the industry may be inclined not to comply with regulation, which in turn may result in the failures of the past to be repeated in the future. Ultimately, the financial crisis did not only result from inter alia a failure to regulate the shadow financial system but also from a failure to carry out effective supervision. Therefore, robust supervision is equally important for the attainment of the objectives of regulation. The MFSA is fully committed towards maintaining high standards of supervision.
The authors would like to thank Professor Joseph Bannister, Chairman of the MFSA and Joseph Agius, Deputy Director Securities and Markets Unit of the MFSA, for their comments and suggestions on the paper. The views expressed in the paper are solely those of the authors at the time of writing and do not engage the MFSA.