On 4 April 2023, in a welcome development the Central Bank of Ireland (the "Central Bank") updated its AIFMD Q&A (47th edition) to increase the investment limits for qualifying investor alternative investment funds ("QIAIFs") seeking exposure to digital assets:
- where a QIAIF is open-ended it can gain exposure to digital assets of up to 20% of net asset value ("NAV"); and
- where a QIAIF is closed-ended or is open-ended with limited liquidity it can gain exposure to digital assets of up to 50% of NAV.
The requirements in order for QIAIFs to avail of these limits are set out in ID1145 of the revised Q&A as follows.
Where a QIAIF proposes to invest indirectly in digital assets the following requirements apply:
a) the AIFM must have an effective risk management policy to address all risks relevant to investment in digital assets. This must address, at a minimum, risk relating to liquidity, credit, market, custody, operational, exchange risk, money laundering, legal, reputational and cyber risk;
b) the AIFM must carry out appropriate stress testing on the proposed investment in digital assets. The stress testing should be extreme yet plausible, reflecting asset price volatility of digital assets including the potential entire loss of value in the investment;
c) the AIFM must have an effective liquidity management policy in place which includes a sufficient suite of tools to enable the AIFM to manage liquidity events arising in the QIAIF;
d) the prospectus of the QIAIF must contain clear disclosure in relation to the nature of the proposed investment in digital assets and must contain a clear articulation of the risks associated with that investment;
e) the QIAIF should assess the overall construction of its portfolio to ensure that there is an alignment between the redemption profile, the level of investment in digital assets and the likelihood of illiquidity (both in normal and stressed conditions) in the types of digital assets invested in. In this regard,
- where a QIAIF proposes to invest up to 20% of its NAV in digital assets, the QIAIF may be structured as having open-ended liquidity provided that the portfolio as a whole is determined by the AIFM to be suitable for an investment fund providing open-ended liquidity;
- where a QIAIF proposes to invest up to 50% of its NAV in digital assets, the QIAIF must have either limited liquidity or be closed-ended.
The revised Q&A does not change the Central Bank's position in relation to retail investor alternative investment funds ("RIAIFs"), namely that the Central Bank is highly unlikely to approve a RIAIF proposing any exposure (either direct or indirect) to digital assets, taking into account the specific risks attached to digital assets and the potential that retail investors may not be able to appropriately assess the risks of making an investment in a fund which gives such exposures.
Additionally, the revised Q&A notes that direct investment by QIAIFs in digital assets is not permitted until such time as it is demonstrated to the Central Bank that a depositary can meet its obligations under AIFMD to provide custody or safe-keeping services to digital assets.
In light of the above, the Central Bank has removed its pre-submission requirement for QIAIFs investing indirectly in digital assets in accordance with the requirements of ID1145.
Details of the Central Bank's updated pre-submission process for QIAIFs proposing to invest indirectly in digital assets in excess of the limits outlined above or for QIAIFs seeking any direct investment in digital assets are available on the Central Bank's website here.
This Q&A comes in the wake of the publication last month of the Central Bank's Securities Markets Risk Outlook Report for 2023 (the "Report"), in which the Central Bank emphasised that crypto assets are highly risky and speculative and it presently considers exposure to crypto assets to be unsuitable for retail investors in line with the joint position of the European Supervisory Authorities. In the Report the Central Bank also urged regulated financial service providers to note the requirements of the Markets in Crypto Assets Regulation which is intended to enter into force in 2024 and is designed to address some of the regulatory concerns regarding crypto assets.
Please refer to our previous advisory which outlines the Central Bank's supervisory priorities for 2023 and the key areas of focus contained in the Report for funds and their service providers.
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