Maltese Implications from the EU’s AIFMD II Directive

The regulatory landscape for investment fund management within the EU underwent an evolution with the enactment of ‘Directive (EU) 2024/927 on Delegation Arrangements, Liquidity Risk Management, Supervisory Reporting, the Provision of Depositary and Custody Services and Loan Origination by Alternative Investment Funds’, commonly referred to as AIFMD II (or the “Directive”).  The legal regime regulates alternative investment funds (“AIFs”) and their fund managers. AIFMD II replaces the first AIFMD.

The publication of the AIFMD II in the EU’s Official Journal on the 26^th of March 2024 marked the commencement of this new phase in European fund regulation, with the Directive taking effect on the 15^th of April 2024. Malta and all the other EU Member States are accorded until the 16^th of April 2026 to integrate this Directive into their national legal systems, with specific mandates effective from the 16^th of April 2027.

The first AIFMD was transposed into Maltese Law in the Investment Services Act, (Chapter 370 of the Laws of Malta) and its subsidiary legislation; and the AIFMD II is likely to follow suit. The Malta Financial Services Authority (the “MFSA”) published a circular on the 19^th of April 2024 titled ‘Publication of the AIFMD II’ which delineates the changes brought by the new Directive.

Similar to the implications which the first AIFMD had in Malta, AIFMD II will also leave an impact on the Maltese legal framework. Malta’s adaptation to AIFMD II is twofold—presenting both opportunities and challenges to its investment services industry. On the one hand, compliance with these new requirements could boost investor confidence, attracting more institutional and professional investors to Maltese AIFs managed by Maltese AIFMs whilst being able to choose an EU depositary outside of Malta due to Malta’s small size in terms of Article 1(10) of AIFMD II which amends Article 21 of the consolidated version of the AIFM regime.  On the other hand, smaller fund managers might view the additional regulatory obligations as onerous requirements which might not be proportionate to their small number of investors or assets under management.

AIFMD II predominantly affects full-scope Alternative Investment Fund Managers (“AIFMs”) within the European Economic Area (“EEA”) but also holds relevance for non-EEA AIFMs that engage in marketing AIFs within the EEA or serve as delegates to EEA AIFMs. It is notable that AIFMD II does not directly impact UK-authorised AIFMs; however, potential regulatory alignment discussions are anticipated in due course by the UK’s Financial Conduct Authority.

A detailed overview of the regulatory changes emanating from AIFMD II are as follows:

• Loan origination: The Directive delineates a more transparent and structured regime for loan origination by AIFs. It defines and differentiates direct loan origination activities from indirect loan origination processes facilitated through third parties or special purpose vehicles (“SPVs”). Noteworthy is the imposition of concentration limits which restrict AIFs from exceeding a 20% capital allocation to any single borrower under specific conditions, along with prohibitions against lending to affiliated entities such as the AIFM itself or its delegates, barring exceptions.

• Depositary functions: The Directive permits EU depositaries to service AIFs in other EU Member States, subject to approval from the competent authority of the relevant AIF Member State. This amendment will significantly impact Malta and other small jurisdictions because this option is only applicable if the total assets safekept on behalf of AIFs managed by an EU AIFM in the AIF’s home Member State depositary market do not exceed €50 billion (or its equivalent). The objective of this Directive is to enable AIFs in Member States with smaller depositary markets to access a wider range of depositary services. Depositaries looking to offer cross-border services should evaluate how this regulatory change could benefit their operations. Using a depositary outside of the fund’s domicile will also require notification to the European Securities and Markets Authority (“ESMA”)

• Substantive presence and delegation: AIFMD II fortifies the requirement for AIFMs to substantiate a significant operational presence within the EU. This includes the stipulation that senior personnel must be full-time and domiciled within the EU, a measure aimed at curtailing the prevalence of nominal ‘letter-box’ entities.

• Liquidity management tools: The new legislation contains a regulatory framework designed to facilitate AIFMs in managing liquidity and market stress, thereby safeguarding investor interests. It improves the pre-existing provisions of liquidity management within the AIFMD, instituting augmented duties and powers for AIFMs that oversee open-ended AIFs. A particular amendment compels AIFMs managing open-ended AIFs to incorporate at least two supplementary liquidity management tools after duly evaluating the investment strategy, liquidity profile, and redemption policies of the AIF. The MFSA’s circular of the 19th of April 2024 outlines that the liquidity management tools will also be transposed in the MFSA’s AIF Rules.

• Disclosure and reporting protocols: Updates to the existing disclosure frameworks requires more comprehensive reporting by AIFMs, including detailed disclosures on fee structures, loan portfolio compositions, and the leverage employed by managed AIFs. Additional scrutiny and reporting obligations are now required for AIFMs that delegate portfolio or risk management functions, ensuring compliance with established AIFMD protocols.

• Third-party AIFM marketing: New provisions require third-party AIFMs to demonstrate adherence to conflict-of-interest policies and to show robust internal controls designed to protect investor interests. Moreover, the Directive imposes stricter criteria for non-EEA AIFMs marketing within the EEA, particularly targeting entities from jurisdictions identified as high-risk or non-cooperative in fiscal matters.

The responsibility for detailed rulemaking to support the Directive, focusing on several key areas, has been entrusted by the AIFMD II to ESMA. These include developing Regulatory Technical Standards (“RTS”). ESMA will also standardise the supervisory reporting for AIFMs and UCITS, and provide guidelines on selecting and calibrating liquidity management tools. The guidelines will also (i) clarify when the naming of an AIF or UCITS could mislead investors; and (ii) clarify the updates required to remuneration policies to integrate ESG risks.

Additionally, ESMA is required to produce reports for the EU authorities on AIF costs and charges by the 16^th of October 2025, and on delegation arrangements, the loan origination regime, and the impact of liquidity risk management tools on financial stability by the 16^th of April 2029.  Furthermore, the grandfathering provision in AIFMD II incorporates transitional measures that afford certain leniencies to pre-existing AIFs until 16^th April 2029, contingent on the non-raising of additional capital post-implementation.

The introduction of AIFMD II is a key component of Malta’s continuous enhancement of its financial sector. It provides an opportunity to strengthen its offering as a location for investment funds within the EU, while allowing greater flexibility for AIFMs in choosing the jurisdiction of the AIF’s depositary. These developments will further establish Malta as a preferred jurisdiction for launching EU alternative investment funds, particularly for private wealth management through family offices or smaller funds managed by boutique investment managers.