Summary and implications
We have all been poised for months. It has been over a year and a half since the first draft of the Alternative Investment Fund Managers Directive (the AIFM Directive) was put on the table by the European Commission. On 11 November 2010 Europe reached agreement. The upshot is a messy compromise over the marketing of “third country funds”, a crackdown on pay and a heavy compliance burden for fund managers.
The AIFM Directive affects the worldwide activities of EU-based alternative investment fund managers (AIFMs) as well as activities in the EU of AIFMs based outside Europe (in “third countries”). This briefing gives an overview of the key issues in relation to the AIFM Directive, in particular its impact on third country AIFMs.
Some key headline points for non-EU AIFMs are:
- Marketing: Third country funds will continue to be marketed in the EU in accordance with national placement regimes until at least 2018 and the third countries in which they are based must meet various EU regulatory tests;
- Partial-compliance with Directive until 2018: Non-EU AIFMs which market EU or non-EU alternative investment funds (AIFs) in Europe need only comply with the AIFM Directive in full in 2018, once the national placement regimes come to an end. That said, individual member states can require full compliance before then if they wish; and
- Transparency and Reporting: Both non-EU and EU AIFMs will be subject to annual reporting and disclosure obligations to investors and to regulatory authorities.
Headline issues for fund managers
a ) Scope
The definition of an AIF is very broad and captures closed-ended, open-ended and listed funds and other vehicles, including trusts, limited partnerships and LLPs. There is an exemption for certain holding companies, including EU listed holding companies and REITS. There is an exemption for “joint ventures”, although there is no detail about the exemption and lobbying will need to continue as the AIFM Directive enters “Level 2”, in which national regulators sit down with the European Commission to formulate more detailed rules.
There is a partial exemption for “non systemically relevant” AIFMs which (a) manage total gross assets of less than €100m; or (b) manage unleveraged AIFs which have no redemption rights for five years, and manage total gross assets which do not exceed €500m.
As expected, AIFMs which manage EU AIFs will have a passport to market EU AIFs throughout the EU to professional investors.
So-called “third country funds” (set out below) may continue to be marketed in accordance with national placement regimes until at least 2018. The third countries in which these funds are based must meet various EU regulatory tests (set out in the case study at the end of this briefing). However the non-EU AIFM needs to, as a minimum, comply with the following parts of the Directive: annual report, disclosure to investors and reporting to regulatory authorities. This is subject to member states requiring tighter regimes. We expect that the UK will not impose any stricter requirements than set out in the Directive.
From 2015 the Commission may introduce a passport for third country funds. If it does, there will then be a “dual system” operating for three years, so that from 2015 to 2018 AIFMs can either continue to market under the existing national private placement rules or take advantage of the EU passporting regime. After this period, the Commission can decide to terminate the national private placement option. It is possible that third country funds may never benefit from the passport, which would chime with the preference of France and Germany for continuing the use of private placement regimes. If and when the passport is introduced for non-EU AIFMs, they will need to be authorised and comply with the Directive in full.
Please click here to view the table of marketing rules.
c) Timetable (which may change)
Please click here to view the timetable.
d) Transparency and reporting
AIFMs will be subject to reporting obligations to regulatory authorities, for example on leverage and remuneration. AIFMs will also be subject to enhanced reporting obligations to investors, including about arrangements with depositaries and sub-custodians.
EU AIFM managing non-EU AIF which are either (i) not marketed in Europe; or (ii) up to 2018 are marketed in Europe under private placement regimes, are not required to appoint a depositary under the Directive. Otherwise all EU AIFMs and non-EU AIFMs must ensure that AIFs which they manage appoint a depositary. The depositary of a non-EU AIF must either be in the country in which the non-EU AIF is established, in which case that country must meet certain EU regulatory tests (similar to those tests relating to non-EU AIFs obtaining a passport to market in the EU), or it can be located in the principal member state in which the non-EU AIFM markets the AIF.
New regulations, formulated with bankers’ bonuses in mind, will apply to the pay and bonuses (including carried interest) paid by an AIFM or an AIF (whether or not in the EU) to its senior managers and all other staff who have a material impact on its risk profile. European regulatory authorities can exercise some discretion in implementation but needs to take into account the following:
- At least 40 per cent of bonuses must be deferred for at least three to five years (60 per cent for “particularly high” remuneration), and can potentially be recovered if relevant investments perform poorly;
- At least 50 per cent of bonuses to be paid in the form of “contingent capital” (funds to be called upon first in difficult times) and shares (or equivalent ownership interests);
- Bonuses to be balanced appropriately with salary; and
- Cash bonuses are capped at 30 per cent (or 20 per cent for “particularly large” bonuses).
Set out below is an example of an Asian real estate fund structure. We have highlighted the impact the AIFM Directive will have on certain areas (assuming no exemption or exclusion can be used and assuming that the AIF will be marketed in the EU).
Please click here to view the diagram.
The Cayman LP is a non-EU AIF. The Hong Kong manager of the Cayman LP is a non-EU AIFM. Set out below is how the Hong Kong manager and the Cayman LP are affected by the AIFM Directive, both before and after 2018.
Marketing and managing
- The Hong Kong manager can only market the Cayman LP in the EU in accordance with national placement regimes until 2018 if Hong Kong meets various regulatory tests, including:
- A co-operation agreement in place between the principal member state where the Cayman LP is to be marketed and the Hong Kong regulator (and potentially also the regulator of the Cayman Islands);
- Neither Hong Kong nor Cayman have been placed on the Financial Action Task Force blacklist from an anti-money-laundering or terrorist perspective; and
- The Cayman LP complies with certain transparency and reporting requirements in the Directive. For instance, the Hong Kong manager will prepare an annual report for investors (and the regulator of the principal member state in which it markets) and disclose to the regulator certain information on liquidity and risk management arrangements.
- The Hong Kong manager does not need authorisation under the Directive to manage the Cayman LP.
- Once the national private placement regimes cease (expected 2018), the Hong Kong manager will need to comply with the proposed passporting regime in order to market the Cayman LP in the EU. To do this it will need to become authorised under the Directive in the principal member state in which it markets the AIF. In addition to the tests set out above the following conditions apply:
- The Hong Kong manager must appoint a legal representative in the principal member state in which it markets the Cayman LP;
- There must be a tax information exchange agreement in place between the Cayman Islands and each member state where the Cayman LP is to be marketed; and
- The Hong Kong manager will need to comply with the AIFM Directive in full – see details below.
- The Hong Kong manager must ensure that the Cayman LP appoints a depositary in the Cayman Islands or in the principal member state that the Cayman LP is marketed in. If the depositary is in Cayman, the Cayman Islands will have to meet certain regulatory tests.
- The depositary has strict liability to the Cayman LP.
- The Hong Kong manager must defer for at least three to five years not less than 40–60 per cent of any bonuses and carried interest payments of high earning staff. There will need to be clawback arrangements in place for these.
- Any cash bonuses must be capped at 30 per cent (20 per cent for “large” bonuses).
- The Hong Kong manager must maintain a minimum level of own funds (capped at €10m) of €125,000 plus 0.02 per cent of the amount by which the total value of its gross assets under management (being all funds managed by the Hong Kong manager other than funds which it manages as a sub-manager) exceeds €250m.