Governing Alt-Assets in Europe: A Level Playing Field

With AIFMD II implementation, MiCA enforcement for crypto assets, and SFDR refinements shaping the landscape, regulators are expected to increase scrutiny on risk management, ESG transparency, and fund liquidity, while industry bodies push for more harmonization across jurisdictions. The challenge remains balancing investor protection with the flexibility needed for market innovation.

The EU Alt-Assets Regulation: a Historical Discourse

Since 2016, the alternative investment asset under management (AUM) has tripled. Private market AUM is projected to grow at a rate more than double that of public assets, reaching $65 trillion by 2032. In Europe, the phrase "alternative investment fund" refers to a broad spectrum of investment funds that aren't regulated at the European level by the AIFM Directive. This category includes hedge funds, private equity funds, real estate funds, and various other types of funds.

AIFMs have become key players in the European financial landscape, and with it the regulatory demands on alternative investment managers are increasing, with a series of frameworks like AIFMD II, DORA, SFDR updates, and more rigid AML/KYC rules piling on the compliance requirements but also new regulations such as MiCAR that even though has not direct impact on alternative investment funds but may trigger some constraints in the operational model of crypto funds. However, the real challenge lies not only in the sheer volume of regulations but also in their inconsistent application across different jurisdictions. In this context, Brexit complicates matters further, creating a parallel framework that is starting to diverge.

AIFMD vs. AIFMD II

The Alternative Investment Fund Managers Directive, or AIFMD for short, plays a crucial role in the European Commission's efforts to establish a solid regulatory framework that ensures a safe financial system, ultimately benefiting the real economy. On 26 February 2024, the Council of the European Union announced the adoption of a proposal known as “AIFMD II.” This proposal makes amendments to the AIFMD, focusing on areas like delegation arrangements, liquidity risk management, supervisory reporting, and the provision of depositary and custody services. 

• And with the rollout of AIFMD II earlier in 2024, managers seeking to establish private credit funds in the EU are facing a new set of regulations. The main changes brought about by the Alternative Investment Fund Managers Directive II (AIFMD II) in April 2024 included greater emphasis notably on the following key points:

•  Loans will be limited to 20% for any single borrower.

• Fund managers must hold onto at least 5% of the loan’s nominal value for two years from the agreement date or until the loan matures, whichever comes first.

• Investors now must be informed about administrative costs in the pre-contractual disclosures.

• For open-ended funds, the leverage limit is set at 175% of the fund’s net asset value (NAV), while closed-ended funds can go up to 300%.

U.S., UK and Continental Europe AIFM Legacies: Similarities and Discrepancies

Interestingly, in line with G20 commitments, similar to those in Europe, the United States has taken steps to strengthen regulations in this area. New guidelines concerning hedge funds and private equity were put in place in July as part of the Dodd-Frank Act. These guidelines will require managers of private equity and hedge funds to register with the Securities and Exchange Commission. These managers will face significant regulatory requirements and will need to provide regular reports to supervisors to monitor systemic risk, as overseen by the newly established Financial Stability Oversight Council. The goals and strategies behind these reforms align with those of the AIFMD. However, the real challenge lies not just in the growing number of rules, but in their inconsistent application across different jurisdictions.

Since the UK exited the EU’s single market, financial institutions are now required to navigate two separate sets of regulations. This situation complicates compliance and drives up costs. Alternative Investment Funds (AIFs) dealing with crypto funds encounter even greater hurdles. 

CASP Licensing: Another Bar to Surmount

A CASP license refers to a Crypto-Asset Service Provider license under MiCAR. This type of license is now a mandatory authorization for companies engaged in specific financial services related to crypto-assets. Starting from January 1, 2025, all European companies involved in cryptocurrency activities will need to comply with new regulatory requirements to maintain uninterrupted operations. Fortunately, a "grandfather regime" is in place, providing an 18-month transition period. This means that virtual asset service providers can continue to operate under their existing national licenses until December 31, 2025. In some European Member State, this transition period might even be extended to July 1, 2026.

When a CASP license is issued in one EU member state, it’s generally "passportable." This means the provider can extend its services throughout the entire European Union, much like licenses in other financial sectors. To obtain a CASP license, one must meet specific prudential and organizational standards and be under the supervision of the relevant national competent authority (NCA) within the EU. Other considerations appear more standard for general financial companies’ compliance, such as guaranteeing strong anti-money laundering and counter-terrorist financing policies and procedures, etc.