ESMA makes recommendations on Brexit delegation model for investment managers of EU funds

On 19 August 2020, the European Securities and Markets Authority (ESMA) wrote to the European Commission (Commission) making recommendations for the forthcoming review of the Alternative Investment Fund Managers Directive (AIFMD).

ESMA’s letter includes recommendations for changes in 19 areas including harmonising the AIFMD and UCITS regimes; liquidity management tools; leverage; the AIFMD reporting regime and data use; and the harmonisation of supervision of cross-border entities. Of particular interest, in the context of Brexit, are its recommendations on delegation and substance.

ESMA recommends additional legislative “clarifications” in the AIFMD and UCITS frameworks with respect to delegation and substance requirements. These build on the guidance provided in the ESMA Brexit opinion (ESMA34-45-344). 


The UK manages c.£1.7 trillion for EU funds on a delegated basis which is exposed to significant political risk related to what may result in changes in level 1 and level 2 EU legislation. Indeed, this is of greater consequence for the City of London than whether equivalence arrangements are arrived at under MiFID/AIFMD.

Extent of delegation 

ESMA notes that in many cases AIFMs and UCITS management companies delegate portfolio management functions to a large extent leaving only some control functions to be performed internally (notably risk management functions). ESMA further notes that in light of Brexit, delegation of portfolio management functions to non-EU entities is likely to further increase.

Such extensive delegation arrangements may result in the majority of operational staff performing portfolio/risk management, administration and other functions working on a delegation basis for the relevant funds being located outside the EU and therefore not directly employed by the authorised AIFM or UCITS management company.

While ESMA accepts that such delegation arrangements may increase efficiencies and ensure access to external expertise taking into account the global nature of financial markets, they may also “increase operational and supervisory risks and raise questions as to whether those AIFs and UCITS can still be effectively managed by the licensed AIFM or UCITS management companies”. ESMA recommends legal clarifications on the “maximum extent of delegation” to ensure sufficient substance remains in the EU.

In particular, ESMA sees merit in reviewing Article 82 of the Commission Delegated Regulation (EU) No 231/2013 (addressing when an AIFM becomes a letter-box entity that should no longer be considered to be managing an AIF) which it says may benefit from a clearer legal drafting. ESMA invites the Commission add quantitative criteria (to the current qualitative criteria) or provide a list of core or critical functions that must always be performed internally and may not be delegated to third parties. Such considerations should be matched also in the UCITS Directive. 

The City of London will be watching these developments closely and will be sensitive to any politicisation of regulation by the Commission.

Applicable regulatory regime in case of delegation  

ESMA states that in many cases, delegates are subject to different regulatory regimes which adds regulatory complexity and supervisory challenges for NCAs. Questions may also arise about the regulatory level playing field and possible circumvention of AIFMD/UCITS regulatory standards. 

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.

To avoid regulatory arbitrage and protect EU investors, ESMA recommends legislative amendments to 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. 

Whilst the delegation of AIFM investment management functions can currently only be conferred on a delegate that is authorised or registered for the purpose of asset management and subject to supervision, ESMA appears to be encouraging a broader ‘back door’ equivalence requirement for non-EU portfolio managers of EU funds.

Use of seconded staff 

ESMA has also observed an increasing use of secondment arrangements where staff from professional services firms/consultancies or group entities are seconded to the AIFM or UCITS management company on a temporary basis. In some of those cases, the seconded staff were operating outside of the EU.

ESMA considers that this raises questions whether those secondment arrangements are in line with the substance and delegation rules set out in the AIFMD and UCITS frameworks. It states that further legislative clarifications could be helpful to address these questions. 

List of collective portfolio management functions and distinction from ‘supporting tasks’ 

Delegates, in particular group entities, often provide ‘supporting tasks’ to the authorised AIFM or UCITS management company. ESMA considers that it is difficult to assess whether the ‘supporting tasks’ provided by delegates are subject to the delegation rules set out in the AIFMD and UCITS Directive (as collective portfolio management functions) or not.

ESMA gives as examples:

  • whether legal or compliance tasks should be viewed as a delegation of the legal or compliance functions listed in Annex I of the AIFMD and Annex II of the UCITS Directive; and
  • the status of portfolio or risk management-related tasks such as investment research activities or (quantitative) risk data analyses or calculations. 

ESMA sees merit in implementing legislative clarifications to eliminate any residual legal uncertainties as to responsibilities of AIFMs for ensuring that the collective portfolio management functions set out in Annex I of the AIFMD are performed in compliance with the AIFMD rules. 

White-label / host platform service providers 

ESMA recommends more specific requirements on ‘white-label service providers’ or AIFM host platform solutions. These are fund managers that provide a platform to firms by setting up funds at the initiative of the latter and typically delegating investment management functions to those firms or appointing them as investment advisers or informally following their instructions. The model has represented one way in which firms have managed Brexit risk by using host platforms based in the EU.

ESMA notes uncertainty as to compliance of the host model generally and, in particular, notes the potential for significant conflicts of interest and investor protection risks. These risks are described as arising mainly because the initiator firm of white-label (or third-party) funds is also the client of the authorised AIFM or UCITS host platform so the platform “will face significant conflicts of interest since controlling and challenging the delegate/investment adviser in the best interest of investors may come at the risk of losing a client”. Changes should also be reflected in the UCITS Directive. 

Finally, ESMA recommends that in clarifying the AIFMD, UCITS and MiFID frameworks to ensure that AIFs/UCITS and their managers and MiFID investment firms always remain subject to the same regulatory standards, while providing the same type of services.