As the July 22 deadline for the implementation of the Alternative Investment Fund Managers Directive (the AIFMD, or the Directive) looms, events move apace with national and EU regulators are attempting to fill in the many gaps that remain in the regulatory infrastructure. This article summarizes the latest developments and highlights some of the key implementation issues.

Developments in the UK

As the UK is home to a significant majority of the EU’s hedge fund and private equity managers, who are considered “alternative investment managers” (AIFMs) for the purposes of the Directive, we are keenly watching the approach that the UK regulator takes in implementing the AIFMD. Yet, given that the Directive is a maximum-harmonization directive, there is limited scope for national regulators to embellish it or to modify its impact.

In this context, the date that the Directive comes into force coincides with the change of national regulator for UK AIFMs from the Financial Services Authority (FSA) to the Financial Conduct Authority (FCA) as of April 1. The handover is intended to be more administrative and procedural, and the edicts and rules of the FSA will (we hope) be transposed seamlessly to the FCA without any material change to the regulator’s approach and philosophy, or to the laws and regulations that govern fund managers, promoters and advisers.

On March 19 the FSA published its second Consultation Paper (CP) on the implementation of the Directive. Among other things, the Directive:

  • Sets out guidance about the scope of the AIFMD and explains the FSA’s thinking about delegation by alternative investment fund managers (AIFMs), as discussed further below
  • Proposes modifications to some existing organizational and conduct-ofbusiness rules that will affect full-scope UK AIFMs
  • Explains how the FSA intends to amend its rules and guidance to implement the UK Treasury’s proposals for specialized regimes for smaller AIFMs
  • Expands on prudential rules and guidance set out in the FSA’s previous CP and includes the proposed prudential regime for small authorized UK AIFMs
  • Explains how the FSA’s existing rules and guidance for the protection of client assets will apply to some types of depositary
  • Explains the FSA’s approach to marketing under the Directive and how AIFMs may exercise single-market passporting rights
  • Describes the FSA’s approach to registering funds being marketed through national private placement, and to approving non-UK alternative investment funds (AIFs) as recognized schemes that can be marketed to the general public.


The extent to which an AIFM may delegate to a submanager has been one of the most hotly debated aspects of the Directive. The context of the debate is that an AIF must have an AIFM, which effectively includes the AIF itself if it is self-managed. An AIF cannot have two AIFMs. Consequently, in order to apply the appropriate regulatory control and oversight of the AIF, the AIFM must have sufficient substance to be able to contract with the AIF to be its investment manager and risk manager, although these activities may be delegated, but not to such an extent that the AIFM becomes a letterbox entity.

The AIFMD implementing regulations (the Regulations), which will come into force at the same time as the Directive, set out a list of features regarding delegation designed to delineate the extent of permitted delegation by an AIFM. The key requirement (Regulation 82) is that the AIFM may not delegate investment management functions to an extent that exceeds by a substantial margin the investment management functions retained by the AIFM. Regulation 82 then specifies that local regulators (such as the FSA/FCA for the UK), when assessing the extent of delegation, need to take into account not only of the assets managed under delegation, but also certain qualitative criteria, including:

  • The types of assets of the AIF and the importance of the assets managed under delegation for the risk and return profile of the AIF
  • The importance of the assets under delegation for the achievement of the investment goals of the AIF
  • The geographical and sectoral spread of the AIF’s investments
  • The type of investment strategies pursued by the AIFM on behalf of the AIF
  • The type of tasks delegated and those retained
  • The configuration of delegates, their geographical sphere of operation, their corporate structure and whether the delegation is intra-group.

This is therefore one area where the local regulator’s policy does matter because under the Directive, a UK AIFM must notify the FSA/FCA of a proposed delegation so that it can evaluate the delegation against the above requirements.

It is of interest to note that in the CP the FSA says that it will not issue any guidance on how it will assess compliance with the AIFMD’s delegation requirements. Instead, the FCA will review delegation structures on a case-by-case basis, examining an AIFM’s compliance with the Directive’s risk management requirements, and the efficacy of its governance by the firm’s governing body and control by the firm’s senior management.

The FSA goes on to say that they will not automatically presume that a UK-authorized AIFM is a letterbox entity merely because a percentage threshold has been reached on the investment management tasks proposed to be delegated, versus those that are retained by the AIFM.

Senior management and the AIFM’s governing body will have to exercise effective oversight and control over risk and portfolio management. This is the case whether the investment management activities are retained in-house, delegated to another firm in the same corporate group, or delegated to an independent third-party service provider, irrespective of the service provider’s geographic location.

The FCA’s assessment of delegate risk will form part of a wider assessment to ensure that those responsible for the activities of an AIFM monitor and manage overall risk appropriately. This involves the AIFM carrying out suitable due diligence for a prospective delegate, and continually supervising them in an active rather than passive way. The FCA will look for evidence that there is no improper delegation resulting from an abdication of responsibility by senior management and the governing body.

Recognizing that the delegation requirements affect a broad range of AIFMs, the FCA will take into account the objective reasons and commercial imperatives for delegation, with reference also to specific, real-world operating models.

It should also be noted that the European Commission will monitor how European Economic Area (EEA)- competent authorities supervise AIFM delegation requirements and how the letterbox entity test is being applied in the AIFM sector. In 2015, the European Commission will consider whether to adopt any additional measures that specify the conditions under which a letterbox entity should be assessed.

Handling the Transition to AIFMD

Although there are differing views on the availability of the transitional period for compliance by AIFMs with the Directive, the UK Treasury has affirmed that all UK AIFMs will have one year, until July 21, 2014, to comply with the Directive.

However, in order to use the AIFMD passport to permit marketing to professional investors in other EEA member states, a UK AIFM will need to have been approved as such by the FCA by July 22, 2013. To do that, a UK AIFM must have applied to the FCA for a variation of permission (VoP) from a Markets in Financial Instruments Directive (MiFID) firm to an AIFM under the AIFMD. The catch-22 is that the FCA had said it would not accept AIFMD VoP applications before July 22.

Recognizing the quandary and mindful of its selfperception as a flexible regulator, the FSA has indicated that firms who have completed its AIFM survey by March 28 may be able to use the passport from July 22 without any interruption in their current marketing activities. Since several hundred firms responded to the survey, the regulator is left with the unenviable task of establishing an order of priority among the respondents. Those who are fast-tracked will, it is assumed, have their VoP applications processed by July 22, and the FCA has now said that application forms for AIFM status will be available on its website in May.

Under the Directive, the FCA must determine a VoP application within three months. Given the number of VoP applications the FCA will receive from AIFMs, it is likely that the FCA will not be able to process the initial volume within that time and inevitably many AIFMs will be in limbo from a passporting perspective from July 22 until their VoP applications are approved. Those who do not immediately require the passport may take a more leisurely approach to the AIFMD transition may be taken.

Use of National Private-Placement Rules

AIFMs based outside the EU, AIFMs within it who manage and market non-EU AIFs, and sub-threshold AIFMs, that is, hedge fund managers managing up to €100 million (including on a leveraged basis) and private equity managers managing up to €500 million, will only be able to market their AIFs under national private-placement rules (NPPRs) until 2015. Yet subthreshold AIFMs may opt in to the Directive in order to use the passport.

There are two potential problems with the availability and use of the NPPRs. First, some countries may disapply them or restrict them to such an extent that they are effectively unusable. Second, in order to use the NPPRs, cooperation agreements must be in place between the regulatory authorities in the member states where the fund is marketed, the regulator of the home country of the AIF and the regulator of the AIFM. For example, in order for Cayman Islands hedge funds to be marketed in the EU, a cooperation agreement needs to be in place with the Cayman and each appropriate EU member state regulator.

On the first point, the UK Treasury has affirmed that the UK NPPRs will remain intact and usable. Other countries, notably Germany, intend to remove their private placement regimes. On the second point, regarding cooperation agreements, there is a rush to negotiate these in time for the July 22 deadline.

The body responsible for negotiating the cooperation agreements is ESMA, the European Securities Markets Authority, which intends to have all of these in place by July, although some question whether that is an optimistic position. These agreements are also required for the delegation of investment management activities to non-EU investment managers. Thus, the need for them to be in place in time is, in many cases, critical to permitting not only private placement, but to the continuance of existing delegation arrangements.

Finally, third parties such as MiFID firms who market AIFs may continue to do so only to the extent that the AIFM itself can, and that includes, for example, the requirement that a non-EU AIFM marketing in the UK has to register details of the AIF with the FCA. It should be noted, however, that AIFMs may accept investors into an AIF as a result of reverse solicitations, which do not constitute “marketing” for the purposes of the Directive.

Actions to Take

AIFMs who wish to use the passport as soon as practicable must also be AIFMD-compliant in all other respects, and that includes ensuring that any delegation arrangements do not leave the AIFM as a letterbox.

Non-EU AIFMs who manage AIFs with EEA investors and who wish to market the AIF in the EEA will need to be aware of all pre-conditions to be met to do so, including checking that appropriate cooperation arrangements are in place in relation to the jurisdiction of the fund, and understanding the reporting and transparency requirements relating to the fund and the AIFM.

Funds offering documents should all be AIFMDcompliant, and country legends and selling restrictions checked and updated.

With less than four months to go until the Directive is live, it is imperative that affected AIFMs understand its impact on their business and take the appropriate steps to ensure compliance.