On 4 March 2009, the Commission published its Communication for the Spring European Council which stated that in April 2009 the Commission would propose:
“A comprehensive legislative instrument establishing regulatory and supervisory standards for hedge funds, private equity and other systemically important market players.”
On 29 April 2009, the Commission published its draft Directive on alternative investment fund managers (the AIFM Directive). The AIFM Directive does not introduce European legislation for alternative investment funds (AIFs). Instead it introduces an authorisation and supervisory regime for alternative investment fund managers (AIFMs) managing AIFs in the European Union, which extends well beyond the supposedly systemically important players to touch most EU participants of any size across the panoply of the alternative investment world.
However, by requiring AIFs marketed in the EU to meet certain structural requirements, such as an independent valuation and a depositary, the Commission is moving away from permitting full flexibility in the alternative investment fund universe. At this stage the draft proposals are unwieldy for many strategies, for example it is difficult to see how the depositary rules sit comfortably with many limited partnership funds or funds employing prime broking strategies.
The valuation models are prescriptive, the rules restricting delegation prejudice many multi-manager strategies and the rules on marketing remain unclear. Other key controversies include the protectionist restrictions on marketing non-EU domiciled AIFs and the powers of the Commission, rather than Member States, to determine limits on leverage, levels of investor disclosure and equivalence of third party countries’ regulatory regimes and service providers.
To become law, the AIFM Directive must be adopted by both the European Parliament and the Council of the European Union (Council). This means that the original draft is considered, amended and voted upon at a political level by Member State governments in the Council, whilst at the same time it is subject to consideration, amendment and voting by the European Parliament. Therefore, different versions of the draft AIFM Directive are currently circulating. The original draft produced by the Commission had been widely criticised as being “not fit for purpose”. Acting through their respective committees with Commission support, legislators now have to try to come to an agreement between the European Parliament and Council of Ministers. The European Parliament’s ECON (Committee on Economic and Monetary Affairs) Rapporteur’s draft report was published on 25 November 2009, (“Gauzès Report”) and the Council has produced numerous (under the Presidency of Sweden then Spain) compromise proposals, the latest being published on 10 March 2010.
What funds are covered?
Nearly all funds that are not currently subject to product regulation (and even some that are), regardless of domicile or form. The key is that the AIF has an AIFM providing management or marketing services from within the EU, subject to the thresholds discussed below.
What was unclear from the original draft is the extent to which advisory only or pure placement agent services are caught within the scope of the AIFM Directive, including for example US managers that wish to approach potential EU investors in their funds. It was also unclear whether self-managed investment entities are expected to become AIFMs.
Article 3 provides that an AIF is any collective investment undertaking (including investment compartments thereof) whose object is the collective investment in assets and which does not require authorisation under the UCITS Directive. This means that a wide range of AIFs are potentially captured by the AIFM Directive including hedge funds, private equity funds, commodity funds, real estate funds, debt funds, energy and carbon funds and infrastructure funds. In addition, UK authorised funds that do not qualify as UCITS funds and listed investment companies also fall within the definition.
The Gauzès Report broadly adopts the Commission’s position on this issue.
The compromise draft has broadened the Commission’s position by stating that an AIF means any collective investment undertaking which raises capital from a number of investors, with a view to investing in accordance with a defined investment policy for the benefit of those investors.
The Commission has inserted into the AIFM Directive certain thresholds and these are found in Article 2 and provide that the AIFM Directive does not apply to:
- AIFMs managing AIF portfolios that have total assets of less than €100 million.
- AIFMs managing AIF portfolios that have total assets of less than €500 million subject to the AIFs not being leveraged and which do not grant investors redemption rights during a period of five years following the date each AIF is constituted.
- UCITS or their management or investment companies authorised in accordance with the UCITS Directive.
- Credit institutions within the Capital Requirements Directive (the CRD).
- Institutions covered by the Pensions (IORP) Directive.
- AIFM established in the EU that do not provide management services to AIF domiciled in the EU and do not market AIF in the EU.
The Report removes the de minimis provisions and the exclusion for EU managers of non-EU funds. It also expands the exemptions in Article 2 of the Directive such that it should not apply to the managers of non-pooled investments such as endowments, sovereign wealth funds, central banks, or assets held on own account by credit institutions, pension funds, or insurance/reinsurance undertakings.
The compromise draft retains the de minimis provisions and in addition has extended the exemptions found in Article 2 and provides that the AIFM Directive does not apply to:
- Group entities;
- National central banks;
- National, regional and local governments and bodies or institutions which manage funds supporting social security and pension systems;
- Employee participation schemes or employee saving schemes; and
- Securitisation special purpose entities.
Article 4 provides that AIFMs that come within the AIFM Directive must be authorised to provide management services to, or market the shares or units of, AIFs. Authorisation is granted to the AIFM by its home Member State regulator. Once authorisation has been granted it is valid for operating in all Member States.
No doubt the regulatory regime for UCITS management companies’ weighs heavily on the Commission’s thinking, though it is unclear why a separate regime for AIFMs is really necessary rather than, for example, including management, administration and marketing of AIFs as new activities under the MiFID regime.
The Report incorporates additional wording to ensure that an AIFM authorised in a Member State’s territory complies with the Directive’s conditions for initial authorisation at all times. It also provides that where AIFM are authorised pursuant to the AIFM Directive or an investment management company is authorised under the UCITS IV Directive regulators shall also authorise AIFM under the UCITS IV Directive and investment management companies under the AIFM Directive “subject to the fulfilment of relevant additional authorisation requirements”. However, regulators can only ask for information that has not been submitted in the original authorisation provided that it is not changed.
The compromise draft provides additional wording that Member States will authorise AIFM managing AIF that carry out certain investment strategies. The text then provides that the Committee of European Securities Regulators will produce guidelines on classifying different investment strategies for these purposes. In addition the compromise draft inserts a new Article 4a that sets out a further layer on what activities AIFMs can do, drawing a distinction between “externally appointed AIFM” and AIF “that are internally managed”. For example, Article 4a provides that:
- no externally appointed AIFM shall engage in activities other than the management of one or more AIF in accordance with the Directive with the exception of the administration and marketing functions listed in Annex I of the Directive (these match the permitted activities of a UCITS management company);
- no internally managed AIF shall engage in activities other than the internal management and activities referred to under the administration and marketing functions in Annex I of the Directive;
- an externally appointed AIFM may be allowed to provide the following services:
- Management of portfolios of investments; and
- As non-core services: investment advice; safekeeping and administration in relation to units of collective investment undertakings and reception and transmission of orders in relation to one or more financial instruments.
Conduct of business
Articles 9 to 13 cover ongoing conduct of business obligations for AIFMs, which are very similar to the equivalent provisions of the Markets in Financial Instruments Directive (MiFID).
Article 9 places some very wide and general requirements on AIFMs including the requirement to act in the best interests of the AIF it manages, the investors of the AIF and the integrity of the market. The Article also provides that no individual investor shall receive preferential treatment unless this is disclosed in the AIF’s rules or incorporation documents.
Article 10 covers conflicts of interest. The general requirement is for AIFMs to take all reasonable steps to identify conflicts of interests between it and the investors in the AIF or between one investor and another that arise in the course of managing one or more AIF. AIFMs are also required to maintain and operate effective organisational and administrative arrangements “with a view to taking all reasonable steps designed” to prevent conflicts of interest from “adversely” affecting the interests of the AIF and its investors. Where such arrangements are insufficient the AIFM is required to make disclosures of the conflict of interest to investors before undertaking business on their behalf.
Provisions concerning risk management are contained in Article 11. The general principle is for AIFMs to separate the risk management function from the portfolio management function. AIFMs will be required to review their risk management systems at least once a year and to adapt them when necessary. As a minimum AIFMs will be required to implement and document a due diligence process when investing on behalf of the AIF and ensure that the risks associated with each investment position of the AIF and their overall effect on the AIF’s portfolio can be accurately identified, measured and monitored at any time through stress testing procedures.
Liquidity management is covered in Article 12. The general provision is that AIFMs should use an appropriate liquidity management system and adopt procedures that ensure that the liquidity profile of the investments in the AIF complies with its underlying obligations. AIFMs should also regularly conduct stress tests both under normal and exceptional liquidity conditions. Redemption policies also need to be appropriate for each AIF managed and must be laid down in the AIF’s rules or incorporation documents.
The Gauzès Report proposes additional wording to Articles 9 to 11 in relation to the conduct of business obligations for AIFMs, in particular proposing new provisions relating to remuneration policies.
An amendment has been proposed to Article 9 to include a provision for an AIFM to “ensure that the remuneration rules are compatible with the rules applicable to credit institutions and investment firms” (although of course there are significant differences between the remuneration of the buy side and the sell side). Additional wording for Article 10 providing that the AIFM “shall set up and implement remuneration policies and practices that are consistent with effective risk management, counter short-term profit motives and are in line with the business objectives and the long-term interests of the AIFM and investors.” It also places an obligation on the AIFM to inform Member States’ competent authorities about the characteristics of its remuneration policies and practices.
In relation to risk management and in particular AIFMs engaging in short selling, the Gauzès Report inserts additional wording into Article 11 which requires AIFMs to regularly disclose information on its significant short positions to the Member States competent authorities. The competent authority shall then provide this information to European Securities and Markets Authority (ESMA). In exceptional circumstances the ESMA may make the decision to restrict short selling activities in order to ensure the stability and integrity of the financial system.
The compromise draft inserts into Article 9 a number of new general principles including a requirement for AIFM to “have, and employ effectively, the resources and procedures necessary for the proper performance of its business activities”. Another general principle is that shall “comply with all regulatory requirements applicable to the conduct of its business activities so as to promote the best interests of the AIF or the investors of the AIF it manages and the integrity of the market.”
The compromise draft also places some new restrictions on AIFM that conduct discretionary portfolio management. For example such AIFM will not be permitted to invest all or part of the client’s portfolio in units or shares of the AIF unless it receives prior general approval from the client.
Like the Gauzès’ Report, the compromise draft also includes amendments to Article 9 relating to remuneration policies and practices. A new Article 9a provides that an AIFM’s remuneration policies and practices must be “consistent with and promote sound and effective risk management”. Such policies and practices must also not “encourage risk-taking which is inconsistent with the risk profiles, fund rules or instruments of incorporation of the AIF it manages.”
Article 11 has been amended to provide for derogation from the requirement for an AIFM to separate their risk management function from the portfolio management function. However, this is only permitted where the Member State approves the derogation on the terms of nature, scale and complexity of the AIF it manages. In addition, the AIFM must be able to demonstrate that the risk management process satisfies the requirements of Article 11 and is consistently effective.
The compromise draft has also introduced in Article 11 the obligation for the Commission to adopt implementing measures to specify the appropriate frequency and review of the risk management system.
Capital requirements for AIFMs are set out in Article 14, which closely follow the regime for UCITS management firms. In particular it should be noted that the calculation is based on funds under management and there is no cap on the capital that a firm might need to employ. It is difficult to see how this is appropriate in terms of comparative treatment of, for example, real estate and hedge fund managers with billions under management but the very different systemic risks each may pose. Again, following the MiFID capital regime (perhaps with appropriate modifications) might be considered to result in a more proportionate treatment.
As a minimum AIFMs shall have own funds of at least €125,000. Where the AIF portfolios managed by the AIFM exceed €250 million, the AIFM will need to have an additional amount of own funds. This amount will be equal to 0.02% of the amount by which the value of the portfolios in the AIFM exceeds €250 million.
Irrespective of the above AIFMs shall not hold an amount of own funds which is less than that required under the CRD.
As per the Commission’s draft the Gauzès Report provides in Article 14 that where the value of the AIFM’s portfolio exceeds €250 million, the AIFM shall provide an additional amount of own funds; that the additional amount of own funds shall be equal to 0.02% of the amount by which the portfolio exceeds €250 million. However, the Gauzès Report adds that the required total of the initial capital and the additional amount must not exceed €10 million. The justification for this is to ensure alignment with Article 7 of the UCITS Directive.
The Gauzès Report goes on to amend the classifications of the portfolios of the AIFM by stating that portfolios that AIFMs are managing under delegation are excluded. The reason for this exclusion is to remove the double counting of delegated funds in AIFM capital requirements. It also adds that portfolios deemed to be portfolios of the AIFM include other collective investment undertakings (CIS) managed by the AIFM including CIS for which it has delegated one or more functions but excluding CIS that it is managing under delegation.
The Gauzès Report also inserts new wording into Article 14 stating that Member States may authorise AIFM not to provide up to 50% of the additional amount of own funds if they benefit from a guarantee of the same amount given by a credit institution or an insurance undertaking which has its registered office in a Member State, or a third country where it is subject to prudential rules considered by the competent authorities as equivalent to those laid down in European Union law. The own funds required by this new provision shall be invested in liquid assets or assets readily convertible to cash in the short term.
The compromise draft makes provision for Article 14 in Article 6a and adopts similar amendments as the Gauzès Report with the additional stipulation that Member States shall require that an AIFM which is an internally managed AIF has an initial capital of at least €300,000.
It also goes further to say that the initial capital and own funds requirements do not apply to AIFM which, either directly or indirectly through a company with which the AIFM is linked by common management or control, or by a direct or indirect holding, manage portfolios of AIF whose assets under management, in total do not exceed a threshold of €500 million.
Outsourcing provisions are contained in Article 15. These are significantly more restrictive than are imposed on investment firms under MiFID.
The general requirement is that AIFMs shall use at all times adequate and appropriate resources that are necessary for the proper performance of their management activities.
Article 16 deals with valuation and provides that AIFMs will appoint for each AIF they manage an independent ‘valuator’. Under the AIFM Directive ‘valuator’ means:
“…. any legal or natural person or company valuing the assets or establishing the value of the shares or units of an AIF.”
The valuation of assets, shares and units should occur at least once a year and if more frequent each time shares or units of the AIF are issued or redeemed. The AIFM must ensure that the valuator has appropriate and consistent procedures to value the AIF’s assets.
Article 17 provides for the appointment of a depositary which shall be a credit institution having its registered office in the EU and be authorised in accordance with the CRD. The depositary must act independently and solely in the interests of AIF investors. It may delegate tasks to other depositaries.
Under the original text the depositary will be liable to the AIFM and the AIF’s investors for any losses suffered by them as a result of its failure to perform its obligations under the AIFM Directive, which liability would not be affected by delegation.
The Gauzès Report removes the requirement for an independent valuer under Article 16. AIFM must ensure that independence is embedded into the processes adopted for the valuation of assets and the calculation of NAV of the AIF and within any party appointed to undertake valuation. The Gauzès Report states that the AIF and depositary are jointly responsible for proper valuation of AIF assets as well as for the calculation of the NAV of the AIF. However, it does propose that AIFs which are private equity funds are excluded from the requirement in Article 16.
Article 17 is amended so that the depositary shall be either an EU credit institution or a MiFID authorised investment firm. The Report permits non EU-domiciled AIFs to have a non-EU depositary provided that: (a) a Tax Information Exchange Agreement (TIEA) is in place; and (b) the jurisdiction of establishment has equivalent regulation to the EU (as determined by the Commission) and there is a co-operation agreement in place between the home Member State of the AIFM and the depositary’s regulator.
The Gauzès Report states that a depositary shall be liable to the AIFM and the investors of the AIF if losses arise as a result of an “unjustifiable” failure to perform its obligations or “its improper performance of them.” It also inserts a new provision that provides that where a depositary is prevented from exercising its custodial functions under the national law of the country where the AIF invests it may shift its liability to a third party. However, this shift in liability needs to be evidenced in a contract between the AIFM, the depositary, the third party and the AIF investors.
The compromise draft requires appropriate and consistent valuation procedures to be established. It calls for ‘functional independence’ of the valuation function and the portfolio management function. An external valuer may be used but the AIFM must be able to show that the third party is qualified and capable of undertaking the functions in question and has been selected with due care. When an external valuer is not used the home Member State may require the AIFM to have its valuation procedures and/or valuations verified by an external valuer or auditor.
The compromise draft extends the types of entities that may be a depositary under Article 17. Like the Gauzès Report a depositary can be an EU credit institution or a MiFID authorised investment firm. However, two further categories of entity are added. The first new category are institutions that are subject to prudential regulation and ongoing supervision and are eligible to be a depositary under the UCITS IV Directive. The second category is rather curious and relates to AIF which are not leveraged and which have no redemption rights exercisable during a period of five years from the date of initial investments in each AIF. In these circumstances Member States may allow a depositary to be an entity that carries out “depositary functions as part of professional or business activities in respect of which it is subject to mandatory professional registration recognised by law or to legal or regulatory provisions or rules of professional conduct and which can furnish sufficient financial and professional guarantees to be able to effectively perform the relevant depositary functions and meet the commitments inherent in those functions.”
The compromise draft includes a provision whereby a depositary may contractually discharge its liability when delegating to a sub-custodian. In order to do this the depositary must prove that it had completed certain pre-appointment due diligence on the sub-custodian and that such a discharge of liability is reasonable. The contract must clearly establish the reasons for the discharge, the parties assuming liability and the conditions under which liability is assumed. Also, the AIFM must be informed of the arrangements before they are implemented.
Delegation of AIFM functions
Delegation to third parties is provided for in Article 18. Once again, these are highly restrictive and delegation of portfolio management to other best of breed managers, particularly outside the EU, will be more challenging for managers of multi-manager products.
Before an AIFM can delegate any functions it first needs prior authorisation from its Home Member State regulator and certain conditions need to be complied with.
An AIFM may not delegate to the depositary, valuator or to any other undertaking whose interests may conflict with the AIF or its investors. Third parties may not sub-delegate any functions that have been delegated to them. AIFMs are not allowed to delegate their functions to such an extent that, in essence, they could no longer be considered to be the manager of the AIF.
The Gauzès Report provides that competent authorities will have one month in which to reflect an AIFM’s request to delegate functions. In addition a new duty is inserted requiring the AIFM to inform investors as to which functions have been delegated. There is also a requirement for AIFMs to be able to withdraw their mandate to delegation with immediate effect where such a withdrawal is in the best interests of investors.
The compromise draft requires prior notification for delegation to authorised and supervised entities whilst any other cases would require approval from the regulator. In the latter case, the draft does not set out any deadline as to when a competent authority must reject an AIFM’s request to delegate function. Delegation of portfolio management to non-EU firms is also permitted provided prior approval is obtained or certain conditions regarding supervision are met and there are agreements in place between relevant supervisors.
Transparency provisions are set out in Articles 19 to 21. This goes to the core of the primary stated aim of the new legislation, which is to provide an effective mechanism for gathering, pooling and analysing information on the impact the activities ofAIFs have on macro-prudential risks. These provisions are detailed and remain potentially quite onerous even as proposed to be revised.
Articles 19 and 20 cover information that an AIFM needs to provide its investors. Article 20 deals with periodic information an AIFM needs to provide its Home Member State regulator.
Like the Commission’s draft, the Gauzès Report calls on the Annual Report referred to in Article 19 to be made available to investors and competent authorities no later than four months following the end of the financial year. The Gauzès Report also agrees with the Commission draft as to what information the Annual Report should at least contain but adds a further requirement that it should also include information on remuneration paid by the AIFM and AIF.
In relation to Article 20 and disclosure to investors the Gauzès Report follows the approach taken by the Commission draft but adds two additional categories of information covering the domicile of underlying funds (if the AIF is a fund of funds) and the domicile of any master fund.
Like the Gauzès Report the compromise draft includes additional requirements in relation to remuneration disclosure in the Annual Report and expands on the type of information that needs to be disclosed to investors under Article 20. The compromise draft also inserts new provisions regarding the notification of any arrangements the depositary has taken contractually to discharge itself from liability and requiring periodic disclosure of leverage employed to investors.
Leveraged AIFs and AIFs acquiring controlling interests
Some of the most controversial provisions in the draft AIFM Directive are those relating to the requirement on the Commission to impose limits on the leverage that AIFMs may employ and duties on AIFMs to monitor and report high levels of leverage. In addition, the draft sets out notification and detailed reporting requirements on private equity managers that acquire controlling stakes in companies.
Articles 22 to 25 set out specific obligations for AIFMs managing leveraged AIFs. The provisions apply where an AIFM manages one or more AIFs that employ “high levels of leverage on a systematic basis”. Article 22 provides that:
“…..an AIF shall be deemed to employ high levels of leverage on a systematic basis where the combined leverage from all sources exceeds the value of the equity capital of the AIF in two out of the past four quarters.”
AIFMs are required to check whether their AIFs employ a high level of leverage on a systematic basis every quarter. Where this is the case the AIFM has to make certain disclosures to the AIF’s investors and also to its Home Member State regulator. Member State regulators can then use this information to identify the extent to which the use of leverage contributes to the build up of systemic risk in the financial system.
Articles 26 to 30 set out specific obligations for AIFMs managing AIFs which acquire a controlling influence in companies. Article 26 provides that these sections apply to:
“AIFM managing one or more AIF which either individually or in aggregation acquires 30% or more of the voting rights of an issuer or of an non-listed company domiciled in the Community, as appropriate;
AIFM having concluded an agreement with one or more other AIFM which would allow the AIF managed by these AIFM to acquire 30% or more of the voting rights of an issuer or the non-listed company, as appropriate.”
However, the provisions do not apply where the issuer or non-listed company employs fewer than 250 persons, has an annual turnover not exceeding €50 million and/or an annual balance sheet not exceeding €43 million.
Article 27 provides that when the AIFM reaches a position where it can exercise 30% of the voting rights it has to notify the non-listed company and all other shareholders within four trading days. Article 28 provides that the AIFM also has to make certain disclosures to the issuer, the non-listed company, their respective shareholders and employee representatives, or where there are no such representatives, to the employees themselves.
The Gauzès Report proposed few changes to Articles 22 to 24, whilst an amendment to Article 25 states that funds will set and specify limits on leverage in advance, taking account of various factors, which will be subject to Commission rights of intervention in extremis.
In relation to controlling interests, the Gauzès Report removes the reference in Article 26 to a specified percentage of voting rights and replaces it with the acquisition of a “controlling influence” of the issuer. The Gauzès Report states that the amendment brings consistency with EU company law. In addition the requirement under Article 28 for the Commission to adopt implementing measures has been deleted.
Articles 22 to 24 have been deleted. Individual member state regulators can apply leverage caps if exceptional circumstances merit it, or to avoid cyclical activity. However, this would be on a temporary basis only.
In respect of controlling interests, in Articles 26 to 28 the reference to 30% or more of the voting rights has been replaced with the word “control” which is defined as being more than 50% of the voting rights of a non-listed company.
Marketing in Member States
The marketing of AIF shares or units in Member States is covered in Articles 31 to 33. As mentioned above, the original draft is unclear as to the extent this only applies to a management company that is sponsoring/promoting a product as opposed to an independent broker or placement agent. Nevertheless, the introduction of a cross-border passport for marketing AIFs to professional investors represents the one carrot amongst the forest of sticks contained in the AIFM Directive.
An AIFM authorised in its home Member State will be entitled to market its funds to professional investors (as defined in the Markets in Financial Instruments Directive) in any Member State. The cross-border marketing of AIF is subject only to a notification procedure, under which relevant information is provided to the host Member State.
The AIFM Directive does not provide rights in relation to marketing AIFs to retail investors. Member States may allow for marketing to retail investors within their territory and can impose stricter regulatory requirements on the AIFM or AIF.
Article 31 of the Commission’s draft states that Member States shall ensure that AIF managed by AIFM are only marketed to professional investors. The Gauzès Report provides an extension to this stating that subject to national law, the AIFM home Member State may permit the AIFM to market an AIF domiciled outside the EU. This is only possible where the AIFM is domiciled in the EU or where a co-operation agreement exists and there is an efficient exchange of all relevant information for monitoring systemic risks. Although Article 32 states that Member States may allow the marketing of AIF to retail investors in their territory, the Gauzès Report qualifies this by stating that Member States shall not allow this when such AIF invests more than 30% in other AIFs, which do not themselves benefit from the European passport.
However, significantly the Gauzès Report qualifies the use of the passport only to AIF domiciled in the EU.
The compromise draft also amends Article 33 to restrict use of the passport to AIF established in a Member State.
Articles 31 to 33 of the compromise draft ensures that funds may only be marketed to professional investors, but provides a wider definition allowing for any investor to be treated as a professional investor on a request within the meaning of Annex II of MiFID. The compromise draft also permits “reverse solicitation” i.e. passive marketing.
Passporting of management services
Article 34 gives AIFMs the right to provide management services in relation to an AIF domiciled in another Member State either directly or via the establishment of a branch.
The Gauzès Report follows the Commissions position, except for including a provision for the Member State in which management services are carried out to be responsible for supervising compliance of the AIFM with the functioning of the AIF and marketing rules.
The compromise text substantially adopts the Commission’s position with minor expansion, though also acknowledges that the host Member State may impose additional authorisation requirements on an AIFM.
Marketing of third country AIFs
The provisions on marketing non-EU funds have provoked the most press comment on the AIFM Directive to date. In what appears to be a blatantly protectionist measure, though still does not go nearly far enough for certain Member States, the initial draft proposed a complete ban on AIFMs marketing non-EU domiciled products.
Article 35 permits the marketing of an AIF domiciled in a third country to professional investors domiciled in a Member State if that country has entered into an agreement based on Article 26 of the OECD Model Tax Convention with the Member State on whose territory the AIF shall be marketed. However, this right to market AIFs to professional investors only becomes effective three years after the transposition period.
Three years after the transposition period the AIFM Directive will allow third country AIFMs to market their funds in the EU provided that the regulatory framework and supervisory arrangements in that third country are equivalent to that proposed in the AIFM Directive, and EU operators have comparable access to that third country market. Decisions on the equivalence of the relevant third country legislation and comparable market access will be taken by the Commission.
Until the three year period has elapsed AIFM domiciled in a Member State will be permitted to continue to market AIFs domiciled in a third country in other Member States under the existing domestic private placement rules currently in force in those Member States.
The Gauzès Report permits marketing under national private placement regimes to continue without any interruption but only where there is an information sharing co-operation agreement, which is in line with international standards, and the Member State and ESMA have signed up.
Marketing of third party funds would continue to be permitted under domestic private placement rules. However, the compromise draft imposes certain conditions in a new Article 34b and Article 35, including the requirement for appropriate co-operation arrangements which are in line with international standards to be agreed between the Member State and the relevant third party. It also contains a further amendment to ensure uniform application of Article 35 by stating that the CESR shall develop guidelines to determine the conditions of application of the measures adopted by the Commission regarding the co-operation arrangements.
The Alternative Investment Management Association (AIMA) has expressed concern regarding the compromise draft on the basis that EU investors such as pension funds might be prevented from accessing non-EU funds and managers. This provision in Article 35 had been removed from a previous draft produced by the Swedish Presidency but reinserted by the Spanish Presidency. Andrew Baker, Chief Executive Officer of AIMA, said:
“Stipulating that these co-operation arrangements must be in place sounds reasonable enough but we are worried that they would be difficult to establish and to comply with. The practical consequence would be that the EU market would be closed to non-EU funds and managers with obvious protectionist implications…..Any restrictions imposed on European investors would also hit asset managers in financial centres around the world.”
Andrew Baker went on to say:
“With the Council Working Group debating the Spanish compromise text this month, this represents a critical moment in the process. We hope all parties concerned reflect on the global consequences of this provision and reach a sensible and workable solution.”
Delegation of AIFM functions in third countries
Articles 36 to 38 set out specific rules in relation to the AIFM delegating tasks to third country entities. The general principle in Article 36 provides that AIFMs shall only delegate administrative services to third country entities where:
- the requirements relating to delegation in Article 18 are fulfilled;
- the third country entity is authorised to provide administration services or registered in the third country in which it is established and is subject to prudential supervision; and
- there is an appropriate co-operation agreement between the competent authority of the AIFM and the supervisory authority of the entity.
Specific requirements on third country valuators, depositaries and AIFMs are set out in Articles 37, 38 and 39 of the original draft directive respectively.
The report removes Article 39.
The compromise draft removes Articles 36 to 39.
The AIFM Directive is based on the Lamfalussy process for regulating financial services. In a number of areas the Directive foresees the adoption of detailed implementing measures through comitology procedures. For instance, the rights granted under the AIFM Directive to market to professional investors AIF located in third country domiciles will only become effective three years after the transition period, because of the time needed to provide for additional requirements in implementing measures.
The transatlantic element
At the time of writing this briefing the Financial Times ran a feature article under the headline “Geithner warns of rift over regulation”. The FT reported that Tim Geithner, US Treasury Secretary, had delivered a blunt warning to the European Commission that the AIFM Directive would cause a transatlantic rift by discriminating against US groups.
Mr Geither warned that US hedge funds, private equity groups and banks could be discriminated against if proposals to restrict the access of EU investors to funds based outside the EU were included in the final draft of the AIFM Directive.
The so-called “third country” elements of the AIFM Directive would force non-EU funds to comply with the new rules if they wished to market themselves at all within the EU. The AIFM Directive could also force EU based private equity and hedge funds to use only locally based banks as custodians and depositaries.
However, the FT also reported that senior EU officials have hit back at US criticism arguing that the Commission’s decision to act on hedge funds is in line with the G20 decision to reinforce transparency in the financial system.
Next steps for the AIFM Directive
The Council, the Commission and the European Parliament now have to liaise to see to what extent there can be common agreement on the draft as a whole. If any differences can be reconciled, the AIFM Directive will be in an agreed form and ready to become EU law. If there remain substantive differences, then the AIFM Directive has to move to a second reading in European Parliament and further meetings between the Council and the European Parliament will be necessary in order to reconcile and create an agreed joint text. The timing of adoption depends on how quickly differences between them can be resolved.
Until the end of 2009, the AIFM Directive proceeded within the Council under the Swedish Presidency. The initial optimism expressed by the Swedish Presidency, that there could be political agreement on a near final draft of the AIFM Directive by the end of 2009, has proved unfounded. Whilst there appeared to be progress on a range of issues, there was ultimately little political agreement on significant elements. The AIFM Directive may well still be on the agenda when the Belgian Presidency starts in July 2010.
Amendments that have been tabled in European Parliament will be debated. EU finance ministers were due to discuss the AIFM Directive at the March 2010 ECOFIN meeting but it was removed from the agenda before the meeting, reportedly after the personal intervention of the British Prime Minister Gordon Brown. The next formal meeting of ECOFIN is 18 May 2010 and it is likely that the Spanish Presidency will seek agreement then. There is an informal meeting of ECOFIN on 15-18 April and the Spanish may seek to provide another compromise text reflecting recent bilateral discussion for review at that informal meeting, but a formal decision would be made only at the meeting in May.