After a protracted period of negotiation, the AIFM Directive was finally approved by the European Parliament on 11 November 2010.
The Directive is expected to be brought into force shortly and the member states will be required to implement it by early 2013. The Directive will regulate the activities of managers of alternative investment funds (“AIF Managers”) as follows:
(a) if the AIF Manager is based in the EU, on its worldwide activities; and (b) if the AIF Manager is based in a country outside the EU (a “Third Country”), only to the extent that it has activities within the EU.
The position of Third Country AIF Managers was initially contentious but has now been resolved by creating a dual system of allowing the existing private placement rules to continue until at least 2018, while also phasing in an option for Third Country AIF Managers to qualify under an EU passporting regime.
Private Placement Rules
Third Country AIF Managers will be able to continue to market Third Country funds to professional investors in EU Member States by using the existing private placement rules until at least 2018, subject to the following conditions:
- Regulatory Co-operation
A supervisory co-operation agreement must be in place between the regulator of the EU Member State in which the fund is to be marketed and the Third Country regulator of the AIF Manager. The Cayman Islands Monetary Authority is a signatory to the IOSCO multilateral memorandum of understanding and already has bilateral regulatory agreements with major regulatory authorities in the US, the UK, Canada, Latin America and Europe, including the SEC and the CFTC in the US, and the UK FSA.
- Financial Action Task Force (“FATF”)
The Third Country where the AIF Manager and the fund is established must not be on the FATF blacklist. The Cayman Islands are not on the FATF blacklist. Cayman has extremely high anti-money laundering standards and its implementation of the FATF’s 40 recommendations on money laundering and nine special recommendations on terrorist financing if significantly more advanced than a number of EU Member States.
- Transparency and Reporting
The Third Country fund must comply with certain transparency and reporting requirements set out in the Directive. In summary, the fund’s annual report must disclose, as relevant, its principal counterparty exposures, liquidity arrangements, risk management arrangements, any controlling interests and certain other matters prescribed under the Directive.
Private placement has been the standard distribution model for the marketing of alternative investment funds both within and outside the EU for a number of years. Cayman Islands general partners of limited partnerships and Cayman incorporated managers of corporate funds set up in the Cayman Islands will continue to be able to rely on private placements for marketing of alternative investment funds in the EU, until at least 2018 when the Directive will be subject to review. However, once the Directive comes into effect, EU AIF Managers will no longer be permitted to use the private placement rules for marketing alternative investment funds, even on a domestic EU distribution basis. Instead, such EU AIF Managers will be required to comply with the more onerous requirements of the proposed passporting regime. This may lead arrangers to prefer to use a Third Country AIF Manager and alternative investment fund formed in the Cayman Islands.
Third Country funds which are based in jurisdictions whose regulatory regimes qualify as equivalent in effect to EU standards will be able to apply for a passport for the fund to be marketed throughout the EU. Passporting for Third Country funds is expected to become available within two years of the Directive being implemented and will be subject to compliance with the Directive and to the following conditions:
- Regulatory Co-operation
In addition to the requirement for supervisory co-operation agreements to be in place (similar to those provided above in relation to the private placement rules), the Third Country AIF Manager must also appoint a representative in the EU Member State with which it has the most substantive connection.
The Third Country must not be on the FATF blacklist (as provided above in relation to the private placement rules).
- Tax Information
A tax information exchange agreement (“TIEA”) must be in place between the Third Country where the fund is based and each EU Member State where the fund is to be marketed. Cayman currently has TIEAs with the UK, France and Germany and with five other EU Member States.
On the basis of current regulatory policy and the continuing enchancements following the IMF’s review in 2009, Cayman is expected comfortably to satisfy the equivalence requirements when passporting becomes available.
However, the costs of complying with the full requirements of the Directive, in terms of capital adequacy, leverage restrictions, appointment of external valuation agents, depository and other requirements may impact adversely on a fund’s total expense ratio. The benefits of passporting are likely to accrue principally to retail funds which are marketed on a pan-European basis. Alternative investment funds, in contrast, have traditionally been marketed on a selective distribution basis to professional and institutional investors and for such funds the benefits of passporting may prove to be illusory.
The Directive does not apply to passive marketing or to reverse solicitation. This means, in effect, that EU investors may contact Third Country AIF Managers and invest in Third Country funds even if the AIF Manager does not satisfy any of the provisions of the Directive.
Marketing outside the European Union
EU AIF Managers and EU alternative investment funds will become subject to significant additional requirements under the Directive, including disclosure requirements, leverage limitations, concentration restrictions, reporting requirements and caps on remuneration for managers. As a result, it is expected that a number of arrangers will wish to establish Third Country funds and/or feeder funds and associated Third Country AIF managers for the purposes of marketing alternative investment funds to investors based in the US or Asia.