This week the European Commission revealed its proposals for a directive on Alternative Investment Fund Managers (Directive) . It has been followed swiftly with fierce criticism from numerous sources.
What is the Directive?
The Directive contains proposals for the greater regulation of alternative investment fund managers. It has been anticipated for some time. It was originally aimed at hedge fund managers as a result of concerns raised over perceived excessive financial risk-taking and the inadequacy of the regulation/supervision of such managers. More recently private equity funds have been targeted. However the draft directive has a much broader application – it will apply to fund managers of hedge funds, private equity funds, commodity funds, real estate funds and infrastructure funds (among others) that are not currently regulated under the Undertakings for Collective Investment in Transferable Securities (UCITS) Directive.
Smaller funds are excluded from the application of the Directive. The Commission believes that the burden of applying the Directive to smaller funds would not be proportionate. It will only apply to managers of alternative investment funds (AIFs) with an asset value of €100 million (or if the AIF has no leverage this minimum increases to €500 million). However it is felt that few funds would fall below the €100 million level.
How will fund managers be affected?
Fund managers falling within the Directive will be subject to increased regulation. In particular they will need to:
a. register and seek government authorisation (the fund itself will not need to be registered). Fund managers will need to demonstrate that they are suitably qualified to provide management services;
b. report on a regular basis to the regulator on the principal markets in which it trades, its principal exposures, performance data, governance of the fund, arrangements for the valuation and safe keeping of assets and concentrations of risk;
c. disclose to investors information on risk, return and liquidity, fees, charges and expenses associated with the investment, the characteristics of the fund, conflicts of interest, the identity and ability of service providers and the risk management systems to be employed. Any preferential treatment provided to one investor must be disclosed to the others;
d. comply with minimum capital requirements (currently stated to be €125,000 but higher if the assets under management exceed €220 million); and
e. have robust systems in place to manage risk, liquidity and conflicts of interest.
The cost of compliance could be very significant.
Once authorised, a fund manager will be able to market the fund to professional investors (as defined by Markets in Financial Instruments Directive (MiFID)). The aim is to restrict the marketing to those investors considered able to understand the risks associated with the investment.
How are funds/fund managers in other jurisdictions affected?
The Directive provides that only AIF managers established in Europe can provide their services in the community. Similarly, only funds domiciled in Europe can be marketed by EU-authorised AIF managers in the European territory. There are additional rules regulating the marketing of third country funds (namely countries falling outside the EU) to professional investors in Europe and additional rules apply if a member state wishes to authorise a fund manager from a third country to market an AIF in the community. It is stated that these provisions may take three years to become effective.
Why does the Directive not focus simply upon hedge funds and private equity funds?
While public discussion has been centred on hedge funds and private equity, the Commission believes that it would be "ineffective and short sighted to limit any legislative initiative" to these two categories. Particularly as any definition of these categories might not capture all relevant concerns or provide a route for the rules to be circumvented.
The draft Directive has received strong criticism from a number of quarters. The Alternative Investment Management Association has criticised the draft as "rushed through in a very tight timeframe without anything like the usual standards of consultation that we expect from the Commission". Concern was also expressed at the level of political pressure thrown at the Directive when a number of independent reviews, directed at the industry, have concluded that hedge funds and other funds have had little role to play in the financial crisis. The European Venture Capital Association has also called the proposal "disproportionate, inappropriate and anti-competitive".
What is next?
The draft Directive will be sent to the European Parliament and European Council where it will be the subject of negotiation. If approval is reached by the end of 2009 then the Directive could come into force in 2011.
We will be keeping a close eye on the Directives as it progresses. If you have any immediate queries or concerns please contact us.
For more information please see the draft Directive and a list of frequently asked questions and answers.