Bermuda must strengthen its rules on enforcement and investor protection before it can become eligible for its European Union funds “passport”.

That is the view of the European Securities and Markets Authority, which was considering the island’s application — and that of eight other jurisdictions — for approval for island-based alternative funds to freely market their services throughout the 28-country bloc.

Esma delayed its opinions on both Bermuda and the Cayman Islands, while its review came up with “no significant obstacles” preventing hedge funds and private-equity firms based in Canada, Guernsey, Japan, Jersey and Switzerland from being awarded passports in the EU. The Paris-based regulator also backed passports for some types of US funds.

The passports are part of the Alternative Investment Fund Managers Directive, which is intended to help create a single European market for financial services. Whether a fund qualifies largely depends upon the regulations in its home market. The European Commission said it will consider Esma’s recommendations.

In findings published on its website today, Esma concluded: “Esma is of the view that there are no significant obstacles regarding competition, market disruption and the monitoring of systemic risk impeding the application of the AIFMD passport to Bermuda.

“With respect to investor protection, Esma is of the view that no definitive advice can be provided until the final version of the AIFMD-like regime referred to in the paragraphs above are available.

“With respect to the assessment of the effectiveness of enforcement, while Esma is also of the view that no definitive advice can be provided until the review mentioned in paragraph 223 is adopted, Esma is not in a position to provide the Parliament, Council and Commission with a more thorough assessment than the one presented in the paragraphs above, due to the nature and timeline of the assessment.”

Esma mentioned in its report that the Bermuda Monetary Authority, the island’s financial regulator, had said it expected an “AIFMD-like regime to be finalised and put in place in the coming months”.

The report also referred to extra teeth given to the BMA for enforcement actions against funds that break the rules.

“The BMA indicated that one of the more urgent aspects relates to enforcement in the funds sector on which they expect adoption of the legislation by July of this year,” the report states.

“This review would notably aim at adding the following powers to the enforcement toolkit related to the investment fund sector: application of civil penalties, injunctions, public censure and prohibition orders against individual directors and officers.”

These improvements were passed into law earlier this month after both the House of Assembly and the Senate passed the Investment Funds Amendment Act. But it came too late for Esma to assess it for the purposes of today’s report.

Tonight the BMA said Bermuda’s candidacy for an EU funds passport had taken “a step forward”, in that Bermuda had met three of the five criteria to be assessed.

Jeremy Cox, chief executive officer of the BMA, said: “The Authority commends Esma on releasing their detailed report in such a timely fashion and looks forward to demonstrating the strengths of Bermuda’s AIFM regime — notably the recent legislative approval of the Investment Funds Amendment Act which gives the Authority additional enforcement powers.

“We remain fully committed to Esma’s assessment process because it will benefit Bermudian-based investment managers with products and services for the European fund industry.”

Mr Cox said since May 2013, when Esma approved agreements between securities regulators from the 28 EU countries for the AIFM framework, the BMA had developed its own AIFM regime, which was due to “come into force shortly”.

Like the Solvency II third-country equivalency that allows Bermuda insurers to compete for EU business on a level playing field, the AIFM funds passport will allow unhindered access to the massive EU market for alternative asset managers based on the island.

• Esma’s full report is available under the heading of “Related Media” on this webpage.