The Level 2 regulations pursuant to the EU Alternative Investment Fund Manager (AIFM) Directive were issued by the European Commission on December 19 2012 (for further details please see "Alternative investment funds: impact in Jersey of new EU regulations" and "Investment funds: recent regulatory and legislative changes").
From July 2013 onwards, managers of EU funds will need to comply fully with the directive in order to market to investors in the European Union. The directive will bring with it significant and costly additional regulatory obligations in relation to depository requirements, capital adequacy, leverage restrictions, valuations and manager remuneration restrictions.
However, AIFMs of funds based in so-called 'third countries' (of which Jersey is one) are expected to be able to continue to market third-country funds to professional investors in EU member states by using the existing private placement rules, subject to the following conditions:
- A supervisory cooperation agreement must be in place between the relevant EU member state in which the fund is to be marketed and the third-country regulator of the AIFM - building on the positive relationship built up between the Financial Services Commission and the European Securities and Markets Authority, on May 30 2013 Jersey entered into a cooperation agreement with the regulators of the EU member states coordinated by the authority that will enable Jersey funds to be marketed in the European Union from July 2013.
- The fund must comply with certain transparency and reporting requirements set out in the directive - Jersey will satisfy this condition by enabling Jersey funds to opt into new alternative investment fund codes, a draft in relation to which is expected to be released shortly. The codes will contain a number of requirements, but managers privately placing their funds in the European Union will be required to comply only with those elements of the directive necessary for private placement, and not the more detailed provisions relating to full passporting.
- The jurisdiction must not be on the Financial Action Task Force blacklist - Jersey remains off the blacklist.
The new directive is expected to have some impact on Jersey funds:
- Expert funds will continue to comply with the existing codes and will simply opt into the transparency and reporting requirements contained in the new codes on alternative investment funds. There will be no change in the regulation of managers of expert funds.
- Funds which require consent under the Control of Borrowing (Jersey) Order 1958 will adhere to the transparency and reporting requirements contained in the new codes. Managers of such funds will be licensed for alternative investment fund services business on what is hoped to be a fast-track approval process.
- Unregulated funds will become subject to both the existing fund codes and the new alternative investment fund codes, although they will continue to benefit from the minimum prospectus content requirement and will be able to use a fast-track approval process for their directors. Managers of unregulated funds will need to be regulated for fund services business and to comply with the codes of practice for such business issued by the Financial Services Commission.
- Non-domiciled funds being marketed in the European Union will be granted an alternative investment fund certificate and will be required to comply with the new alternative investment fund codes. There will be no change in the regulation of managers of non-domiciled funds.
The alternative investment fund regulations introduced in response to the directive not only will enable continued marketing into Europe, but have been drafted with sufficient flexibility to ensure that their provisions will not apply unless a fund is marketed into Europe. This means that there will be no change for business related to the rest of the world.
The Level 2 regulations also explain what could lead to an AIFM being deemed a 'letter-box entity'. Where an AIFM no longer retains the necessary expertise and resources to supervise a delegated task, no longer has the power to take decisions in key areas or delegates the performance of more investment management functions than it retains, the AIFM may be deemed a to be letter-box entity.
The UK Financial Conduct Authority (previously the Financial Services Authority) confirmed in a recent consultation paper that it will take into account the criteria set out in the Level 2 regulations and will undertake a qualitative assessment as to whether any proposed delegation arrangement would lead to a letter-box entity being formed.
Fund managers can take a number of steps to avoid characterisation as a letter-box entity, such as:
- including in the fund documents an undertaking from the AIFM that it will continue to oversee and control any delegate and an acknowledgement from the delegate as to the limits of its role;
- ensuring that the AIFM's operational policies and procedures are sufficiently robust (eg, by including a requirement for frequent oversight meetings by the AIFM of decisions made by any delegates); and
- considering whether the AIFM needs its own permanent establishment in Jersey with its own employees and premises from which to carry out operations. This is an effective method of demonstrating sufficient resources and expertise for the AIFM to perform senior management functions in relation to the implementation of a fund's investment strategy.
On April 29 2013 the UK Treasury published a set of questions and answers relating to the transposition of the directive into UK law, confirming its intention to extend the one-year transitional arrangements to third-country AIFMs marketing into Europe after July 2013.
As a result, Jersey AIFMs which have been managing a fund up to July 22 2013 will be able to continue to market their funds in the United Kingdom from July 22 2013 for up to 12 months without having to comply with the transparency and reporting requirements set out in the directive.
This is welcome news, given the United Kingdom's importance as a market for Jersey AIFMs, although fund managers should be aware that other EU member states may choose to implement the transitional provision more restrictively.
Passive marketing (also known as reverse solicitation) does not fall within the scope of the directive. If a fund is not actively marketed, then its manager need take no further action in connection with the directive. The directive defines 'marketing' as:
"the direct or indirect offering or placement at the initiative of the AIFM, or on behalf of the AIFM, of units or shares of an [alternative investment fund] it manages to or with investors domiciled or with a registered office in the Union."
It appears from recent draft guidance that the term 'passive marketing' will be narrowly construed by the UK Financial Conduct Authority and will apply only to communications specifically solicited by investors. It is likely that UK regulations will be amended so that the marketing restrictions will apply only to offering or placement made at the initiative of, or on behalf of, the AIFM.