Where Are We Now?
The European Union’s Alternative Investment Fund Managers Directive (AIFMD or Directive) will finally come into force on July 22, 2013. That is the date by which regulators in EU member states must have implemented the Directive. It had been expected that by now the European Commission would have promulgated the second-tier regulations (Regulations) that will flesh out the underlying provisions of the framework Directive itself. The Regulations are not anticipated to be published until 2013, leaving a less than optimal time for fund managers to absorb the details and analyze the effect that the Regulations may have on their businesses.
Indeed, so late are the Regulations in appearing that the United Kingdom Financial Services Authority (FSA) has released its first Consultation Paper on the implementation of the AIFMD without being able to specify what its final rules will be in certain areas to be covered by the Regulations. It is hoped that the FSA’s second AIFMD Consultation Paper, expected in the first quarter of 2013, will be able to fill in the gaps.
In any case, as the FSA points out, as the AIFMD is a maximum harmonization Directive, there is little scope for the FSA to adapt the Directive to the UK market. For that reason, the text of the Directive will be largely copied into new FSA rules in the shape of a new single sourcebook called “FUND,” which will combine the requirements for alternative investment funds (AIFs), Undertakings for Collective Investment in Transferable Securities (UCITS) and the companies that manage them, and which will replace the Collective Investment Schemes sourcebook.
UK Regulatory Changes
As if the introduction of the AIFMD in and of itself were not enough, its implementation will coincide with the change of regulatory regime in the UK on April 1, 2013, when the FSA will be split into the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). Hopefully, that change will not be as significant as it sounds, given that it is intended for the provisions in the existing FSA Handbook to be adopted or designated by the FCA, such that the majority of the provisions in the Handbook will be carried forward to the new regulators and their respective rulebooks. For investment managers, only the FCA, and not the PRA (which is essentially the new banking regulator), will be relevant.
Authorization of AIFMs
The AIFMD allows alternative investment managers (AIFMs) that are already managing or marketing AIFs before July 22, 2013 a transitional period of 12 months to comply with the relevant laws and regulations and to apply for authorization. As a consequence of this, a firm managing one or more AIFs as of July 22, 2013 will be “grandfathered” through to the new regime. However, all firms must be AIFMDcompliant by July 22, 2014 and must have submitted an application for authorization as an AIFM by that date. The Directive requires national regulators normally to decide applications for authorization within three months of their submission. In the case of the UK, the FSA expects firms to submit an application for an AIFM authorization or a variation of permission (VoP) by July 22, 2014 (but will not accept and such application before July 23, 2013). A UK firm that wishes to begin managing an AIF for the first time after July 22, 2013 will not benefit from any transitional provision. It will first have to apply to the FCA for authorization and be fully compliant with the Directive before it can begin to manage an AIF.
For firms applying for authorization now, the FSA application pack remains as it has been for the last few years, with references to the Markets in Financial Instruments Directive (MiFID) remaining but with no reference to the AIFMD. We cannot, therefore, expect an FSA application pack that caters expressly to the AIFMD to be in place until the middle of next year.
AIFMD and MiFID
The FSA Consultation Paper casts some light on the interplay between the AIFMD and MiFID. The background to this is that a firm authorized under the AIFMD cannot be a MiFID firm. However, under the AIFMD, an AIFM is able to carry out ancillary activities relevant to managing an AIF, including managed account business and non-core services, including investment advice, safekeeping and administration in relation to interests in collective investment schemes, and reception and transmission of orders in relation to financial instruments. These additional activities require the consent of the local regulator in each member state.
However, an AIFM that does avail itself of these extra activities must comply with certain MiFID capital, organizational and conduct-of-business requirements. The FSA acknowledges in its Consultation Paper that there is some uncertainty about whether an AIFM that carries out these extra MiFID services has the right to “passport” them to other member states. The FSA’s view is that they do have that right, while some other member states think that they need to be authorized under either MiFID or the UCITS directive to do so; but the FSA implies that from its reading of the legislation that UK AIFMs are likely to be able to provide those services elsewhere in the EEA. (NB an AIFM may also act as a UCITS management company provided it is authorized to do so in accordance with the UCITS Directive).
MiFID firms that are not AIFMs will not need authorization under the AIFMD to provide MiFID investment services, such as discretionary portfolio management services to an AIF that has its own AIFM, and so there is some competitive disadvantage for AIFMs who may need to follow both the AIFMD and MiFID (as above). However, such MiFID firms may only offer to place (directly or indirectly) units in an AIF with investors in the EU to the extent that the units in question are able to be marketed in accordance with the AIFMD.
MiFID and AIFMD do therefore overlap, with both making some provision regarding:
- Authorization for investment managers
- Capital requirements
- Conduct of business and investor protection provisions
- Outsourcing/delegation requirements
- Organizational requirements
- Third-country equivalence provisions
Delegation under the AIFMD
One of the most anxiously anticipated parts of the Regulations concerns the ability of AIFMs to delegate their functions. The Directive provides that an AIFM may delegate its activities, provided that it does not do so to the extent that it becomes a “letterbox” entity. However, drafts of Regulations that have been in circulation have indicated that in the view of the Commission, an AIFM cannot delegate more of its functions than it in fact retains. If that was to be followed through in the final Regulations, it would cause significant problems for fund managers, and this issue is known to be one of the reasons for the now significant delay in publishing the Regulations.
Preparing for the Directive
One thing that is clear is that the “phony war” is now over, and all AIFMs will need to perform an AIFMD gap analysis to ensure that they comply with, and are not disadvantaged by, the advent of the new legislation. The purpose of that gap analysis is to identify necessary corporate, structural, compliance and operational changes which could, for example, include:
- Consideration of the substance of existing management arrangements and whether avoidance of the Directive is a viable option
- Consideration of whether to move offshore, migrate existing funds, or establish an offshore manager with adequate substance (see Delegation under the AIFMD above)
- Group restructuring
- Applications for authorization or variation of permission
- Identifying and contracting with a depositary where one is required under the Directive (especially relevant in scope to private equity advisers whose structures have rarely required a depositary)
- Reviewing and, if necessary, amending fund documentation (are any amendment and investor consents needed?)
- Reviewing service provider arrangements for any adjustments needed in light of the Directives’ delegation provisions
- Updating compliance manuals and operational procedures.
By way of reminder, the AIFMD impacts all fund managers who market alternative investment funds into the EEA, wherever they are based. Consequently, for example, a US fund manager who markets funds in the EU will need to be aware of the limitations and conditions that will apply to the continuation of that activity from July 2013 onward. A non-EU AIFM will not be able to use the passport under the Directive until 2015, having to rely on private placement exemptions in individual member states, as is the case currently. Nevertheless, some member states are likely to restrict their current private placement regimes once the Directive is in force, and also the marketing of AIFs by non-EU AIFMs is subject to meeting various conditions including concerning regulatory supervision and co-operation.
Non-EU AIFMs of EU funds will effectively be subject to the requirements of the Directive from 2015 when they will be regulated via their “member state of reference,” being the member state by reference to which they are most closely aligned. For example, a US manager managing an Irish fund would be likely to need to be regulated by the Irish Central Bank until 2015. Non-EU AIFMs in that position should decide whether they wish to maintain their EU fund or migrate it outside of the EEA, or whether they would prefer to have their member state of reference in a different member state from that of the fund, for example, by establishing an AIFM in the UK to take full advantage of the passport and other Directive benefits from July 2013 onward.
2013: A Busy Year
The new year therefore promises a flurry of activity with the publication of the Regulations and the unavoidable imperative for AIFMs counsel can advise EU and US clients who are, or affected by the Directive wherever located to assess and deal with its impact. Experienced may be, affected by the Directive of its impact on their business and the options available to them.