As a result of the new Alternative Investment Fund Managers Directive (AIFMD), and to increase transparency, AIFMs must now make additional information available to investors.
- As a result of the new Alternative Investment Fund Managers Directive (AIFMD), and to increase transparency, AIFMs must now make additional information available to investors.
- Specifically, alternative investment fund managers (AIFMs) must now ensure they provide investors with all of the information required by art 23 of AIFMD.
- Investors must be provided with this information before they invest and must be kept up to date afterwards.
- AIFMD clarifies that there is scope for AIFMs to treat certain investors differently, based on individual relationships.
- Among the other key materials investors are to be provided with are NAVs, historical performance reports, and annual reports.
Article 23 of the Alternative Investment Fund Managers Directive (AIFMD) provides that alternative investment fund managers (AIFMs) shall make certain information available to investors before they invest in the alternative investment fund (AIF), as well as providing any material changes to that information. This has implications for fund promoters both in relation to the type of information that should be disclosed and that what is disclosed should be kept under review and updated as necessary.
Prior to the implementation of AIFMD in Ireland funds established as qualifying investor funds were, as part of their authorisation process, subject to domestic requirements imposed by the Central Bank through the Non-UCITS Notices. Article 23(1) of AIFMD enhances these requirements so that the AIFM is now required to make available to investors, prior to any investment in an AIF, information in relation to a specific list of features of the AIF. AIFs should be looking closely at their existing prospectuses to see where disclosures that are required are already included and where new information should be inserted where the requirements of art 23(1) requires expansion of what is currently included in the prospectus.
The New Disclosures
- The circumstances in which the AIF may use leverage, the types and sources of leverage permitted and the associated risks, restrictions on the use of leverage, collateral and asset reuse arrangements and the maximum level of leverage which the AIFM is entitled to employ on behalf of the AIF: Previously, the Central Bank, in its Non-UCITS Notices and specifically in Guidance Note 2/11 had very prescriptive requirements in relation to leverage from OTC derivatives and in relation to OTC counterparties and prime brokers. These are no longer applicable and have been replaced with disclosures that relate more to the process involved in selecting counterparties/prime brokers and in relation to how leverage is calculated, which now must be done in one of two ways set out in AIFMD.
- The principal legal implications of the contractual relationships entered into for the purpose of investment, including information on jurisdiction, the applicable law and on the existence or not of any legal instruments providing for the recognition and enforcement of judgments in the territory where the AIF is established: Investors have a contractual relationship with the AIF or its management company by virtue of the application form for shares in the AIF and will be bound by the constitutive document of the AIF by virtue of them becoming shareholders, which will therefore give them a right of action against the AIF or its management company; they may not have any right of action against the delegates of the AIF or its management company. Most investors in Irish AIFs reside outside Ireland. At a minimum listing the various conventions for recognition of foreign judgments to which Ireland is a party is necessary both to comply with the requirement and to give investors in the AIF comfort that they can protect themselves if they need to do so.
- How the AIFM ensures a fair treatment of investors and, whenever an investor obtains preferential treatment or the right to obtain preferential treatment, a description of that preferential treatment, the type of investors who obtain such preferential treatment and, where relevant, their legal or economic links with the AIF or AIFM: GeneraHow the AIFM ensures a fair treatment lly, AIFs have, because of the principle of collective investment, always been considered by the Central Bank to have an obligation to treat investors in a share class equitably. This does not mean that investors must all be treated identically as being fair to investors is not always the same as treating them all alike. This new requirement is a welcome recognition that, while AIFs, may strive to treat investors fairly, they may treat some investors differently, provided they disclose the circumstances where those investors may be treated differently to others through side letters or similar arrangements. For more on side letters, please see below.
- The AIF’s liquidity risk management, including redemption rights both in normal and exceptional circumstances, and the existing redemption arrangements with investors: The Central Bank had always considered that a fund should be managed in a way that enabled it to meet its redemption obligations. The principle of fair treatment of investors mentioned above, together with the requirement to clearly set out the redemption arrangements for an AIF, mean that AIFMs should, at the design stage for each AIF that they structure, consider the appropriateness of the asset class for the liquidity profile of the particular AIF. Real Estate with its long transaction lead times is unlikely to be a suitable asset class for open ended funds while features such as gates, hold-backs, longer settlement periods, side-pockets are all options that should be carefully considered and policies on their use set out in the prospectus.
- The identity of the AIFM, and a description of its duties, identity of the AIF’s depositary and a description of its duties and the identity of the auditor, and a description of its duties: A prospectus must reflect the appointment of the AIFM, the remuneration policy of the AIFM, the expanded depositary role of the custodian (and discharge of liability) and other service providers, including in relation to any delegated management functions and the possibility of the depositary transferring and reusing company assets, and information on any transfer of liability to a prime broker that may exist.
- How the AIFM is complying with its capital adequacy requirements and professional indemnity: AIFMD requires that funds disclose this information in relation to their AIFMs.
- Annual reporting, historical performance and other required reporting that must be made available to investors: One of the main objectives of AIFMD is to increase investor protection by imposing additional transparency obligations in respect of the activities of AIFMs and their AIFs and specifically in relation to what they report to investors and to competent authorities. Annual reports are now required to include a description of: (i) any material changes in relation to required disclosures to investors that is deemed to be “material” if there is a substantial likelihood that a reasonable investor, becoming aware of such information, would reconsider its investment in the AIF, including because such information could impact an investor’s ability to exercise its rights in relation to its investment, or otherwise prejudice the interests of one or more investors in the AIF (e.g. changes in strategies and delegation arrangements); and (ii) the total amount of remuneration for the financial year, split into fixed and variable components and detailing the total remuneration of the entire staff of the AIFM, with an indication of number of beneficiaries, the total remuneration of those staff of the AIFM who in part or in full are involved in the activities of the AIF with an indication of the number of beneficiaries or the proportion of the total remuneration of the staff of the AIFM attributable to the AIF and an indication of the number of beneficiaries. Other information to be disclosed can be dealt with by means of periodic reporting to investors and either accompany the prospectus or the annual report (or be circulated at the same time as they are provided to investors).
- Implications: Some art 23 disclosure obligations relate to the structure of the AIF and it might not be possible to update them without either notifying investors or seeking investor consent. Many others describe processes which of their nature are subject to change. “Dusting-off” these disclosures presents an opportunity to an AIFM to keep in touch with investors to inform them of changes to policies and reflecting those changes in their AIF prospectuses.
Side Letters: Not Just For When An Investment Is Being Made
Side letters are a useful tool for investors in funds, and particularly those investing in the closed-ended private equity space where investors do not have the option of ‘voting with their feet’ by redeeming if they do not like changes to the structure of a fund. They impose contractually binding limitations on the capacity of the AIF and/or AIFM to exercise discretions given to them under the constitutive documents of an AIF, which protects the interests of investors by ensuring that funds and/or AIFMs exercise their discretions in a manner that is not prejudicial or at least limits prejudice to their particular interests.
Article 23 specifically requires disclosures regarding any preferential treatment of investors i.e. whenever an investor obtains preferential treatment or the right to obtain preferential treatment, a description of that preferential treatment, the type of investors who obtain such preferential treatment, and where relevant, their legal or economic links with the AIF or AIFM.
This means that fund promoters and AIFMs, where side letters are requested, need to give some consideration to what their policy should be. Fettering the discretion of AIF or AIFM in some respects will be attractive to procure investment from key investors but any agreed limitations should not be overly restrictive to the AIF.
Generally, an AIFM may decide to accommodate certain investors in relation to the application or calculation of fee provisions, indemnification obligations and/or additional representations, warranties and covenants. In some cases these are non-material requests derived from the constitution or status of the investor e.g. approval of transfers to parties related to the investor and waiving of lengthy dealing notice periods. Accommodating other requests, for example, in relation to choice of law or sovereign immunity from certain local or other governmental agencies investing pension monies can be challenging. In other instances, requests for variation of the terms of a subscription agreement cannot be accommodated as they may be contrary to the concept of treating investors equitably. Examples include providing an investor with different rights of access to portfolio information, disclosure of market sensitive events, or altering the liquidity provisions, redemption rights or voting rights of any investor. It might then be worthwhile considering amendment of the relevant fund’s constitutive documentation to extend the particular right to all investors.
For an AIFM, part of understanding what can be agreed in a side letter means knowing what has already been agreed in other side letters. In order to be able to carry out this level of analysis and to decide on appropriate disclosure to investors an AIFM must be aware of all side letters to which the AIFM and/or the AIF is party. It is no good agreeing to treat an investor as a “most favoured nation” unless measures are put in place to do so.
The implication is: do not put those side letters on a shelf where they may be forgotten. Create a register of side letters so that the AIFM personnel who need to know of the existence of and understand the implications of side letters are equipped to do so.
This article first appeared in the June 2014 issue of Butterworths Journal of International Banking and Financial Law.