Please note there was a typographical error in our Law-Now issued on 18 July. As set out below, the insurance coverage limit for any one claim must be 0.7% of the value of the portfolios managed.
The Alternative Investment Fund Managers’ Directive (‘AIFMD’) applies to managers (‘AIFMs’) of non-UCITS collective investment undertakings, referred to as Alternative Investment Funds (‘AIFs’). This term encompasses a wide range of funds, including hedge funds, private equity funds, and real estate funds, as well as investment trusts. AIFMs are generally aimed at professional investors, but individual Member States can allow AIFMs to be marketed to retail investors as well.
Professional Indemnity Requirement
Article 9(6) of AIFMD requires that AIFMs hold either professional indemnity insurance, oradditional own funds, to cover the risks arising from professional negligence.
These risks include:
- loss of documents evidencing title of assets;
- negligent misrepresentations or misleading statements made to the AIF or its investors;
- breach of legal and regulatory obligations;
- breach of duty of skill and care;
- breach of fiduciary duties;
- breach of confidentiality;
- breach of the AIF’s rules or instruments of incorporation;
- breach of the AIFM’s terms of appointment by the AIF;
- failure to implement and maintain procedures to prevent fraud;
- negligent valuation of assets or calculation of unit or share price; and
- losses arising from business disruption, system failures, failures of transaction processing, etc.
The Professional Indemnity Insurance Option
The insurance coverage must be at least:
- 0.7% of the value of the portfolios managed for any individual claim; and
- 0.9% of the value of the portfolios managed for claims in aggregate per year.
There are additional requirements that must be fulfilled as well:
- the policy must have an initial term of no less than one year;
- the notice period for cancellation must be at least 90 days;
- it must be taken out from a third party entity which is authorised by law to provide professional indemnity insurance; and
- it must cover the professional liability risks listed above
The AIFM must review the insurance policy every year, including whether it complies with the requirements above.
The Own Funds Option
As an alternative, AIFMs can hold own funds of at least 0.01% of the value of the portfolios of AIFs managed, although in certain circumstances Member States can require an AIFM to hold a higher or lower figure. The FCA has confirmed that it will make use of the power potentially to require an AIFM to hold a higher figure, where appropriate.
Article 9(3) of AIFMD includes an additional, separate own funds requirement where the value of the portfolios managed by an AIFM exceeds €250m in total. While Member States can opt to allow up to 50% of this additional own funds requirement to be met by a guarantee from an insurance undertaking or credit institution to cover 50% of the requirement, the FCA does not intend to allow UK AIFMs to make use of such guarantees.
Issues for Insurers
The new requirement for AIFMs to hold professional indemnity insurance (or set aside own funds) will be watched closely by the FI insurance market. Insurers can expect an increasing number of queries from new and existing fund manager clients (and their brokers). However, as well as a potential opportunity for FI insurers, the new rules raise a number of questions including:
- Is the scope of the current fund manager cover sufficient to cover all of the risks set out in the Directive?
- If there is a combined programme (e.g. PI/D&O/Crime) will the PI limit need to be ring-fenced?
- If the policy covers a number of entities, not all of whom are AIFMs, will the limit for the AIFM entities need to be ring-fenced?
- What will be the impact on Insured-v-Insured claims and will policy wordings need to be adapted accordingly?
- Will insurers come under pressure to waive or limit avoidance rights?