Introduction
Since the European Union introduced Directive 2011/61 on Alternative Investment Fund Managers (“AIFMD”) in 2011, the alternative investment fund industry has changed considerably. The Directive was introduced in the aftermath of the 2008 global financial crisis, not because alternative investment funds (“AIFs”) had caused the crisis, but because regulators recognised that the growing size and interconnectedness of the sector could create wider financial stability risks if left insufficiently supervised.
AIFMD responded by placing greater responsibility on alternative investment fund managers (“AIFMs”), introducing a harmonised regulatory framework designed to improve oversight, transparency and investor protection across the EU.
The framework achieved a number of important objectives. It established common minimum regulatory standards, reducing the scope for regulatory arbitrage between Member States, and introduced the AIFMD passport, allowing authorised AIFMs to market qualifying AIFs to professional investors across Member States without requiring separate authorisation in each jurisdiction. Authorisation requirements also allowed regulators to assess an AIFM’s competence and organisational structure before it began operating.
Transparency and investor protection were strengthened through reporting requirements, independent depositaries, valuation rules, conflict-of-interest requirements and independent risk management. Together, these measures gave regulators greater visibility over fund.
Changes in Market Trends required Changes to the Framework
Over the following decade, AIFs became larger, more diverse and increasingly important to the European economy. The sector expanded beyond traditional investment strategies into areas such as private credit, renewable energy and other complex or less liquid assets. The increased use of leverage also made risk management, valuation and liquidity management more challenging.
Perhaps the most significant development was the rise of loan origination and private credit. As the EU sought to develop its Capital Markets Union and reduce businesses’ reliance on traditional bank lending, AIFs increasingly became an alternative source of finance.
Yet the original AIFMD had not been designed for this role. It contained no comprehensive, harmonised EU framework for loan-originating funds, leaving Member States to develop their own approaches. This created differences in national regulation and made cross-border lending more difficult. The result was a clear tension between an increasingly integrated European capital market and a regulatory framework that remained fragmented in important areas.
At the same time, the EU financial regulatory landscape had expanded significantly since 2011. Measures such as the Sustainable Finance Disclosure Regulation, the Taxonomy Regulation, the Securitisation Regulation and the Capital Requirements Regulation and Directive introduced new obligations affecting the wider financial sector. Because these measures were adopted after AIFMD, questions arose about how they should interact with the existing framework. The need for reform was therefore becoming increasingly difficult to ignore.
Supervisory Concerns
Practical experience also revealed weaknesses in how AIFMD operated across Member States:
Delegation: These supervisory concerns included the risk of AIFM’s over delegating their own management functions due to inconsistencies between Member States regarding such limits, allowing the possibility of AIFMs to be formally established and authorised in the EU but essentially hold little actual decision-making capacity. This would create difficulties when EU regulators would attempt to hold managers accountable and supervise risk effectively, AIFMD II therefore seeks to maintain greater transparency regarding such delegation arrangements.
Liquidity Management: Inconsistencies across Member States were also present regarding the availability and use of liquidity management tools. During periods of market stress, when large numbers of investors may seek to withdraw their investments simultaneously, funds whose assets were invested in illiquid assets, such as real estate, could experience liquidity difficulties. Consequently, AIFMD II sought to introduce a more consistent EU-wide approach to liquidity management tools, thereby strengthening the resilience of investment funds during periods of financial stress.
Regulatory Reporting: Although the AIFMD framework did impose reporting obligations on the fund’s manager to allow regulators to identify potential risks before their effects may be felt, in practice, such obligations proved to require further legislative intervention. This was due to the fact that reports were not always sufficiently detailed to be able to provide proper insight on the activities of the funds, thus the AIFMD II serves to establish more standardised and strengthened reporting obligations.
The market trend of loan-originating funds also gave rise to several supervisory concerns amongst regulators concerning limited legislative intervention and harmonisation amongst member states regarding their associated risks. Such risks include credit risks where borrowers may default, liquidity risks if investors request to withdraw funds due to the illiquidity of loans, concentration risk, where excessive exposure to a single default may magnify losses and, leverage concerns where borrowing money may amplify either returns or losses, thereby increasing systemic risk. Hence, the Commission recognised the need for a harmonised regulatory framework to ensure that these risks were supervised consistently across the European Union.
Under the regime of the AIFMD framework there existed a general principle that the depositary of an AIF should be established in its same member state as that of the AIF. However, this raised problems for smaller member states which had a restricted choice of depositary providers, thereby restricting competition and increasing costs for such services. To eliminate such inequalities the AIFMD II introduced greater flexibility, under specified conditions, for appointing depositaries established in another Member State.
Why AIFMD II matters
AIFMD II is therefore not a complete departure from the original Directive. Instead, it represents the next stage in its development.
The AIFMD established the foundations for a more transparent, consistent and investor-focused alternative investment market. But more than a decade of regulatory experience and market growth exposed areas where those foundations needed to be strengthened.
The rise of private credit, increasingly complex investment strategies, greater use of leverage and the growing importance of AIFs to European capital markets all created new challenges. At the same time, differences between Member States in areas such as delegation, liquidity management, loan origination and depositary services limited the consistency of supervision across the EU.
AIFMD II responds to these developments by bringing the regulatory framework closer to the reality of the modern alternative investment industry. Its importance lies not simply in adding new requirements, but in addressing the gaps that emerged as the market evolved, strengthening supervisory convergence, improving risk oversight and ensuring that the EU’s regulatory framework remains capable of supporting a growing and increasingly sophisticated AIF sector
