The Alternative Investment Fund Managers Directive (the "Directive") establishes common requirements across the EU to regulate managers of alternative investment funds ("AIFMs"). With very limited exceptions, the Directive covers all funds that are not Undertakings for Collective Investment in Transferable Securities ("UCITS") funds. Almost all real estate funds will fall within the definition of a fund. Typical real estate fund structures that are likely to be caught include:
- Offshore unit trusts and limited partnerships
- English limited partnerships
- UK exempt unauthorised property unit trusts
- Luxembourg fonds commun de placement
- Property authorised investment funds
- UK real estate investment trusts
The Directive regulates fund managers rather than the funds themselves. Nonetheless, it will have an impact on both AIFMs and the funds they manage. Unless the AIFMs come within one of the exemptions contained in the Directive, they will be within the scope of the Directive. The relevant exemptions are as follows:
- AIFMs which manage funds whose only investors are the AIFM itself and group companies of the AIFM will not be required to comply with the Directive, provided that none of the investors are themselves funds;
- AIFMs who only manage small funds, i.e. AIFMs whose total assets under management do not exceed EUR 100 million (if the fund uses leverage) or EUR 500 million (if the fund does not use leverage and there are no redemption rights exercisable during a period of 5 years from the date of initial investment in the fund), will not be subject to full compliance with the Directive; and
- joint ventures, family office vehicles and property holding vehicles (SPVs) are intended to be exempted from the Directive, although the exact scope of such exemption is still to be determined and a number of interested parties have requested further guidance on this exemption.
AIFMs which fall within the second exemption must register with their home state regulator but will be exempt from most of the Directive's requirements. It is the responsibility of the AIFM to establish whether it must obtain authorisation under the Directive or whether it can benefit from this exemption. Certain countries have, however, already indicated that they will be "gold-plating" the Directive and will not permit the above "small fund" exemption. In the UK, the FSA is proposing to make these exemptions available.
The definition of AIFM is broad and covers any entity whose regular business is managing one or more funds in the EU. An entity providing investment management services or risk management services will be considered to be "managing" the fund. The Directive will apply to most real estate fund managers unless they fall within an exemption.
There are four basic options for AIFMs under the Directive:
- EU AIFM managing an EU fund
- EU AIFM managing a non-EU fund
- Non-EU AIFM managing an EU fund
- Non-EU AIFM managing a non-EU fund
An existing EU AIFM must be authorised by its home state regulator, but can delay application by one year to 2014. Firms should be aiming to submit their applications by 21 January 2014 to ensure that they are not in a position of needing to be fully compliant with the rules without the FSA having completed its review and sign off. Once authorised, an EU AIFM may manage EU funds, both in its home state and in other member states. In addition, it may manage a fund established outside the EU as long as it is not marketed in the EU. If it is to be marketed in the EU, separate provisions apply. A non-EU AIFM must comply with certain requirements of the Directive, such as transparency and reporting, but otherwise (at least until 2015) can continue to rely on the current private placement regime in the member state where it markets the non-EU fund.
In the UK, some real estate fund managers appoint a third party to carry on the regulated activity of establishing, operating and winding-up an unregulated collective investment scheme. Those managers might, therefore, not currently be FSA authorised. Following implementation of the Directive, they might need to be authorised as AIFMs. This means that they may need to apply for FSA authorisation for the first time, which would involve significant time, cost and regulatory burden for its business.
There is still some uncertainty about which entity in particular fund structures will be the AIFM. This is particularly the case for a limited partnership where the general partner is responsible under the limited partnership agreement for managing the business of the partnership. A general partner is, however, typically a £100 company and delegates the majority of its obligations to third parties. Under the Directive, a manager who delegates the majority of its management and risk function becomes a "letter box entity" and cannot be the AIFM. There are, therefore, several possibilities in terms of which entity will be the AIFM. If the AIFM turns out to be the general partner, the Directive will have a significant impact, as those companies are not typically in a position to apply for FSA authorisation. Please see further "Impact on AIFM" section below.
Application to common real estate fund structures
- Offshore unit trusts and limited partnerships will be non-EU funds. If the non-EU fund is to be marketed in the EU by a non-EU AIFM, the AIFM must comply with transparency, disclosure and reporting obligations under the Directive but will not be required to be authorised as an AIFM in a member state. If the AIFM is based in the EU, it will need to be authorised as an AIFM
- English limited partnerships and UK exempt unauthorised property unit trusts will be EU funds and their AIFMs will need to be authorised if they are also based in the EU
- Luxembourg fonds commun de placement are EU funds. Any Luxembourg fonds commun de placement already regulated in Luxembourg will be within the scope of the Directive
- Property authorised investment funds are set up as non-UCITS retail schemes or qualified investor schemes and will be EU funds. The AIFM is likely to be based in the UK and will therefore need to be authorised as an AIFM
- UK real estate investment trusts will be EU funds. Article 2(2) of the Directive states that the Directive will not apply to holding companies. There are some arguments to say that REITs fall within this exemption. The FSA has confirmed that REITs are not automatically within the regime and that this will be reviewed on a case by case basis. If REITs do fall within the scope of the Directive, the AIFM may be the REIT itself if it chooses to be self-managed
- Master/feeders will, typically, constitute two funds and will, therefore, each require an AIFM. It is common for UK real estate structures to comprise, for example, an English limited partnership as the master with an offshore unit trust as the feeder. In that example, the English limited partnership will be an EU fund and the offshore unit trust a non-EU fund. Each will have an AIFM, which might be different - the trustee might be the AIFM of the offshore unit trust and the manager the AIFM of the English limited partnership
The FSA's latest consultation paper (CP13/9) includes some questions and answers on scope, and updates the perimeter guidance, all of which are aimed at enhancing firms' understanding of the Directive.
Impact on AIFM
The Directive regulates AIFMs and introduces a number of provisions, not all of which can be discussed here. We have highlighted some requirements of the Directive which are particularly relevant to real estate funds below, but this is not an exhaustive list.
For example, in addition to the below, each fund will also require an independent valuer. An AIFM must also ensure that its remuneration policies do not encourage risk taking which is inconsistent with the risk profiles of the fund it manages.
Each fund which is managed by an authorised EU-AIFM must have a single depositary, appointed in writing to hold the fund assets. The depositary must generally be a credit institution or firm authorised under the Markets in Financial Instruments Directive or some other institution eligible to be the depositary of a UCITS fund. If the fund is registered outside the EU the depositary may be an equivalent institution outside the EU, as long as it is subject to equivalent prudential regulation. If the fund is established in the EU, the depositary must be in the same member state as the fund.
Many real estate funds do not currently have a depositary or custodian, as their only assets are real estate assets (e.g. title deeds). Going forward, real estate funds will need to appoint a depositary, involving additional cost for the fund. The Directive does, however, recognise that some private equity, venture capital and real estate funds that do not hold financial instruments, do not need to be subject to the same strict depositary requirements that will apply to hedge funds. There is provision, therefore, for a wider range of entities to act as depositary of those types of fund, to which a lower capital requirement might be applied. We understand that some administrators are considering offering this service.
Disclosure and transparency
These requirements apply to non-EU AIFMs as well as EU AIFMs. An AIFM is obliged to make available an audited annual report for each fund which it manages. This must be provided to investors on request and must also be made available to the regulatory authorities of the home member states of the fund and AIFM. The AIFM must also make certain information available to investors before they invest in the fund and investors must be told when there is any change to this information.
AIFMs are required to report regularly to their home regulator on the principal markets and instruments in which they trade on behalf of the funds which they manage.
Minimum capital requirements
Under the Directive, an AIFM is subject to minimum capital requirements to ensure the continuity and the regularity of the management of funds. This will be a major shock for managers that are not currently FSA authorised at all, but are required to become authorised as AIFMs.
An EU AIFM appointed as external manager must have an initial capital of at least EUR 125,000. When the value of the portfolios of the funds managed by the AIFM exceeds EUR 250 million, the AIFM will be required to provide an additional amount of own funds which is equal to 0.02 % of the amount by which the value of the portfolios of the AIFM exceeds EUR 250 million (the required total of the initial capital and the additional amount need not, however, exceed EUR 10 million). Member states may reduce the additional amount of own funds by half if the AIFM benefits from a guarantee of the same amount given by a credit institution or an insurance undertaking.
An AIFM which is an internally-managed fund must have an initial capital of at least EUR 300,000, but is not required to hold additional own funds.
Local regulators will have power to set limits on leverage in order to ensure the stability of the financial system. AIFMs using more than a certain amount of leverage will need to report to the authorities on a regular basis.
In addition to the above, AIFMs must have internal policies on risk management and other matters, they must have a conflicts of interest policy and they must comply with the Directive's rules on remuneration. As mentioned above, this would be particularly burdensome for a general partner of a limited partnership that, typically, would not have any pre-existing policies or employees.
As mentioned above, an AIFM authorised in the EU will be able to market EU funds which it manages to professionals both in its home member state and in other member states. Notification must be given in a prescribed form to the regulatory authorities of its home member state before the marketing begins. If marketing is to be in member states other than the home member state, then the regulatory authority of the home member state will notify the regulatory authorities in the other state where marketing is to take place. EU AIFM will be able to continue the marketing of non-EU funds without a passport until 2018.
Non-EU AIFMs may continue to rely on the current private placement regime in the relevant member state until these regimes are discontinued from 2018. Many private placement regimes are more restrictive than the rules that will apply to EU AIFMs. In addition, some member states have already indicated that they will further restrict the private placement of funds. AIFMs who rely on private placement will, therefore, be at a disadvantage to EU AIFMs who will have the certainty of being able to rely on the marketing passport.
From a future date (which is likely to be in 2015), there will be a passport under which an EU AIFM which complies with the Directive may also market non-EU funds which it manages to professionals in the EU. The AIFM's home state regulator will need to confirm that the requirements of the Directive are complied with. This passport will require a number of conditions to be fulfilled, for example, co-operation arrangements must be in place between the regulatory authorities of the AIFM's home state and the supervisory authorities of the country where the fund is established.
It is likely that the extension of the marketing passport will also allow non-EU AIFMs to market EU funds in the EU. This will require the non-EU AIFMs to become authorised.
The Directive will be implemented by regulations issued by the EU Commission ("Level 2"). National regulators must implement the parts of the Directive that are not dealt with in Level 2. Level 2 was published in December 2012.
In the UK, the FSA has published Consultation Papers 12/32 and 13/9 - Implementation of the Alternative Investment Fund Managers Directive. The deadline to respond to CP13/9 is 10 May 2013. The FSA proposes to issue a full policy statement on the Directive in June 2013. The UK Treasury has published two consultations on the Transposition of the Alternative Investment Fund Managers Directive. The deadline to respond to the Treasury's second consultation is 5 April 2013. The FSA (or its successor) will issue a further consultation paper to deal with additional changes to the FSA Handbook and to bring it in line with the rules consulted on earlier and to provide for the marketing and management passports for non-EEA AIFMs and non-EEA funds.
The FSA has indicated that firms who carry on the activity of managing one or more funds as at 22 July 2013 will be permitted to continue to manage those funds subject to the rules applying to them immediately before that date for a period of 12 months. Firms must have submitted their application for authorisation (and comply with the Directive) by the end of this 12 month transitional period (i.e. by 22 July 2014). This transitional period will not apply to new AIFMs who must comply from 22 July 2013.
The FSA requested (on 12 March 2013) that UK AIFMs who manage funds complete their online survey by 28 March 2013.
Action for AIFMs
- Even though the FSA has not published final rules yet, managers need to start preparing for the Directive. AIFMs should start to consider:
- Do any of the exemptions apply?
- Will the fund be an EU or a non-EU fund?
- Who will be the AIFM, and will it be based in the EU or offshore?
- Who might be appointed as depositary?
- Does fund documentation need to be updated to comply with the transparency rules?