From ESMA’s press release summarizing the four broad areas AIFM addresses:

1. General provisions for managers, authorisation and operating conditions
The first part (p.16-135) of the advice clarifies the operation of the thresholds that determine whether a manager is subject to the Directive. ESMA proposes to require AIFMs to have additional own funds and/or professional indemnity insurance to cover risks arising from professional negligence. Many of the rules in this section, such as on conflicts of interest, record keeping and organisational requirements are based on the equivalent provisions of the MiFID and UCITS frameworks.

2. Governance of AIFs’ depositaries
This part of the advice (p. 136-187) sets out the framework governing depositaries of AIFs. Key issues include the criteria for assessing whether the prudential regulation and supervision applicable to a depositary established in a third country has the same effect as the provisions of the AIFMD. ESMA has identified a number of criteria for this purpose, such as the independence of the relevant authority, the require-ments on eligibility of entities wishing to act as depositary and the existence of sanctions in the case of violations.

Another crucial point is the liability of depositaries, the first element of which relates to the circumstances in which a financial instrument held in custody should be considered as ‘lost’. This assessment is crucial in determining whether a depositary must subsequently return an asset. ESMA’s advice proposes three conditions, at least one of which would have to be fulfilled in order for an asset to be considered lost. These are that a stated right of ownership of the AIF is uncovered to be unfounded because it either ceases to exist or never existed; the AIF has been permanently deprived of its right of ownership over the financial instruments; or the AIF is permanently unable to directly or indirectly dispose of the financial instruments. Another important concept which ESMA’s advice aims to clarify relates to which events would constitute external events beyond the reasonable control of the depositary. Finally, the advice clarifies the objective reasons that would allow a depositary to contractually discharge its liability.

3. Transparency requirements and leverage
One of the key objectives of the AIFMD is to help prevent the build-up of systemic risk. To help achieve this aim, ESMA’s advice clarifies (p. 188-239) the definition of leverage, how it should be calculated and in what circumstances a competent authority should be able to impose limits on the leverage a particular AIFM may employ. ESMA considers it appropriate to prescribe two different calculation methodologies for the leverage (commitment and gross methods) as well as a further option (the advanced method) that can be used by managers on request and subject to certain criteria. The AIFMD also aims to increase transparency of AIFs and their managers. In this context, ESMA’s advice specifies the form and content of information to be reported to competent authorities and investors, as well as of the information to be included in the annual report.

4. Third countries
With a view to ensuring the smooth functioning of the new requirements with respect to third countries, the AIFMD puts in place an extensive framework regarding supervisory co-operation and exchange of information. ESMA’s advice (p. 240-246) envisages that the arrangements between EU and non-EU authorities should take the form of written agreements allowing for exchange of information for both supervisory and enforcement purposes.

Next step

The Commission must now prepare the implementing measures on the basis of this advice.

“In testimony on Capitol Hill and in comment letters to the Securities and Exchange Commission, the Coalition of Private Investment Companies supported more detailed reporting to the regulators by registered advisers to private investment funds. Today’s rule draws the appropriate line between determining public disclosures and protecting proprietary information, while ensuring that regulators have the information needed to monitor systemic risks. We look forward to working with the Commission to provide counsel in implementing the rules.”

The Coalition of Private Investment Companies is diverse in size and in the investment strategies pursued. Established in 2005, CPIC informs policymakers, the media, and the public about the private fund industry and its role in capital markets.

“Under the version of the rule proposed by the SEC on Jan. 26,” Bloomberg reports (“SEC to Weigh Hedge Fund Rule on Systemic Risk Data Analysis”), “firms managing more than $1 billion would have to file quarterly information on fund assets, leverage, investment positions, valuation and trading practices on a new Form PF. That added oversight would also come with routine inspections.” Form PF information would not be made public.

Some big hurdles must be jumped over to complete the whole package, including: the “generosity” of the exemptions; opt out by national regulators for short periods; and, the definition/process for determining “naked,” or uncovered, short selling.

For equities, a permanent ban, too, would be placed on on naked, or uncovered, short selling and new disclosure requirements of short positions (already in place in France, for example) would be established throughout the EU.

“Trades would only be considered naked if the underlying stock was not owned by the trader or if the trader had not made arrangements to borrow it in time to settle the deal. The definition of the steps traders need to take to borrow shares is still under discussion,” F.T. reports.

And, according to Reuters ( “EU hopes for deal on short-selling, CDS curbs” ) language to distinguish covered and uncovered short positions: “Shorting stocks would only be allowed if prior arrangements have been made to borrow the stock to ensure prompt settlement of trades or that there is reasonable certainty the stock will be available.”

“Our cross-sectional tests suggest that the decline in stock prices was not significantly driven or amplified by short selling. Short selling does not appear to be the root cause of recent stock market declines. Furthermore, banning short selling does not appear to prevent stock prices from falling when firm-specific or economy-wide economic fundamentals are weak, and may impose high costs on market participants.”

“The study says prohibiting bearish bets did little to stem volatility or reverse losses after concern about the European debt crisis sent banks in the Stoxx Europe 600 down more than 30 percent from their February highs. France banned short sales in companies such as Societe Generale (GLE) SA and BNP Paribas SA, and Italy’s rules covered almost 30 companies such as UniCredit SpA.”

Another report on the short-sale ban from Credit Suisse Group AG said “banned financial stocks fell 10.4 percent from Aug. 12 to Sept. 20, while German, Dutch and British constituents of the MSCI Europe Financials Index declined 4.4 percent. The study, published today, says the rules didn’t stop share price declines in affected European stocks. Analysts Mark Buchanan, Jonathan Tse and Drew Vincent, based in London, wrote the report.”

Noting the “useful role” of short selling in the pricing and liquidity of shares, Minister Jan Kees de Jager cited the views of experts who doubt the ban’s effectiveness long-term, Dow Jones reported.

The second consultation paper covers:
• Cooperation arrangements for third country alternative investment funds (“AIFs”) and alternative investment fund managers (“AIFMs”)
• Delegation of portfolio/risk management functions to third country undertakings
• Assessment of third country depositaries
• Identifying the “Member State of reference”

Admission of third-country managers and funds to EU markets through national private placement regimes, or, after 2015, a passport regime for alternative funds will involve a framework of supervisory cooperation and exchange of information between EU regulatory authorities and their counterparts in non-EU countries.

ESMA proposes written agreements between EU member-country and non-EU based regulators to exchange information for supervisory and enforcement. As one analysis described, in ESMA ‘s view, “The agreements should impose a duty on the third-country authority to assist the EU regulator in question whether it is necessary to enforce EU or national legislation, and provide for exchange of information for the purposes of systemic risk oversight.”

There should be a single written agreement, ESMA advises, to ensure consistency rather than many different bilateral agreements. The template produced by the International Organization of Securities Commission should guide this agreement.

ESMA Chairman Steven Maijoor has acknowledged the importance of ensuring that “an effective and efficient regulatory framework is in place in Europe for the recognition of third country service providers.”

The first consultation paper (July 13) contains draft advice on other implementing measures to align proposed solutions as much as possible with existing provisions of the UCITS directive, CRD, and MiFID. Comments on more than 70 questions raised from 110 draft measures are due September 13.

Belgium

http://www.fsma.be/en/OtherNews/Article/press/div/2011-08-25_shortselling.aspx

France

http://www.amf-france.org/documents/general/10122_1.pdf

Greece

http://www.hcmc.gr/photos/anakoinoseis/files/25.8.2011_Press_Statement_short%20selling.pdf

Italy

http://www.consob.it/mainen/press_release/comunicato_20110825.htm

Spain

http://www.cnmv.es/Portal/AlDia/Comunicaciones.aspx?lang=es

The Financial Times (“European Shorting Ban Extended,” August 25) reported that, “Dealing in the banned stocks has since dropped 62 percent from its pre-ban spike, according to Bloomberg data. This has however left trading at just three-quarters of its pre-spike average. The drop in liquidity implies investors will pay more to buy or sell those stocks. Trading in the biggest European banks not covered by the ban also more than halved after the bans.”

A story appearing earlier this week in the Financial Times (“Short Sellers Remain Calm Despite Bans,” August 23) reported that “securities lending data show that the amount of stock on loan – used as a proxy for tracking the scale of short positions – has dropped just 0.1 per cent on average since immediately before the bans were announced.

“The latest figures, provided by Data Explorers, also show that, on average, just 2.35 per cent of each stock is on loan. The low numbers will fuel the pro-shorting lobby’s argument that shorting is not the problem, not least because bank shares have continued to decline.

Complete details of EU member-countries’ short selling regulations (August 25) available at:
http://www.esma.europa.eu/index.php?page=home_details&id=595 .