Following heated political activity in Europe, the European Commission have issued a draft Directive which will introduce the regulation and supervision of EU domiciled Alternative Investment Fund Managers (AIFM) who manage and administer or market Alternative Investment Funds in the EU. An Alternative Investment Fund (AIF) is any fund which is not a UCITS fund.
The proposed Directive is therefore likely to impact on managers of property and private equity funds, as well as hedge funds and other non UCITS funds.
A UCITS is an investment fund established in accordance with the UCITS Directive which can be marketed to retail investors throughout the EU. The UCITS brand has been very successful, as UCITS are seen to (and do) enjoy a high level of investor protection.
De minimus Exemption
The Directive will not apply to AIFM where they manage portfolios of AIF with total assets of less than €100million of assets (including assets acquired through the use of leverage) or with total assets of less than €500million where the portfolio consists of AIF that are not leveraged and have a five year lock in period for investors. These AIFM will have no rights under the Directive and AIFM will be permitted to 'opt-in' to the provisions of the Directive.
Authorised AIFM will be permitted to market AIF to professional investors (as defined in the Markets in Financial Instruments Directive) in other Member States, subject to some notification, and will have the right to manage AIF in other Member States, again subject to notification.
Member States may allow for marketing of AIF to retail investors in their Member State and may impose additional requirements for this. There will be no passporting rights for marketing AIF to retail investors. Marketing non EU AIF in the EU
The proposal provides for an "EU passport" to enable EU authorised AIFM to market non EU funds to professional investors if the fund is based in a jurisdiction which has entered into an agreement with the Member State where the investors are located which complies with the OECD model tax convention and ensures the exchange of tax information between authorities. It is proposed that the rules allowing the marketing of non-EU funds will come into force three years after the rest of the Directive. In the meantime non EU funds will continue to be sold in those Member States which currently permit this.
The proposal provides for a mechanism to allow non-EU authorised AIFM to market AIF in Europe if the non EU country where the AIFM is located satisfies equivalent regulatory and information sharing standards and offers equivalent access to its markets for EU AIFM. Again, it is proposed that these rules will come into force three years after the rest of the Directive.
Authorisation and Organisational Requirements for AIFM
For authorisation, AIFM will be required to furnish information on the ownership of AIFM to demonstrate that they are suitably qualified to provide AIF management services and will be required to provide detailed information on the planned activity of the AIFM, the characteristics of the AIF managed, the governance of the AIFM (including arrangements for the delegation of management services), internal arrangements for risk management, valuation and safe-keeping of assets, audit arrangements, and systems of regulatory reporting. The AIFM will also be required to hold and retain a minimum level of capital (€125,000 and 0.02%of the amount by which the manager's portfolio exceeds €250m).
Notifications to Regulators An AIFM will be required to report to it's regulator on a regular basis on the principal markets and instruments in which it trades, its principal exposures and concentrations of risk. The AIFM will also be required to notify it's regulator of the identity of the AIF it manages, the assets in which the AIFs invest, their liquidity profile and arrangements, risk management arrangements and the use of short selling by AIF. Additional disclosure obligations will apply to AIFM managing leveraged AIF and controlling stakes in companies.
AIFM will be required to disclose to AIF investors, details of the AIF's investment strategy, leverage, risk and liquidity characteristics, details of the AIF's service providers (i.e. depositary, valuer, auditor), any delegation of management function, and the AIFM's risk management systems. For each AIF an AIFM manages, it shall periodically disclose to investors the percentage of the AIF's assets which are subject to special arrangements, such as side pockets, arising from their illiquid nature. AIFM will be also required to disclose all fees and charges which are directly or indirectly borne by investors as well as preferential treatment provided to other investors (and the identity of those other investors) by AIFM.
The Directive contains detailed provisions on AIFM managing AIF in non EU countries, delegation, Conduct of Business and Conflicts of Interest, Risk Management and Liquidity Management.
EU Regulators will co-operate and share information
EU regulators will be required to cooperate whenever necessary so as to achieve the aims of the Directive and to share information.
The draft AIFM Directive will be sent to the EU Parliament and EU Council where it is expected to be the subject of intense political discussion and negotiation. If political approval is reached by the end of 2009, the Directive could come into force in 2011 with the provisions regarding the treatment of third countries then only becoming applicable in 2014, after a transition period of three years. The draft AIFM Directive will be complemented by implementing measures adopted by the EU Commission on the basis of advice provided by CESR.
There is a great deal of debate on the provisions in this proposal and further detailed work will be required to achieve clarity and ensure useful regulation. Particular concerns have been raised on:-
- the practicality of non EU AIFM satisfying the Directive's criteria for equivalent regulatory, information and access standards;
- whether non EU regulated prime brokers will be in a position to do business with EU regulated AIFM;
- the imposition of strict liability on custodians (particularly for hedge funds) and the responsibilities of custodians;
- the obligation on the EU Commission to limit the level of leverage AIFM can employ;
- the requirement for an independent valuer which complies with this Directive (particularly where the AIFM is marketing non-EU AIF);
- the costs of compliance.
Early versions of the draft Directive were leaked throughout the industry and have been subjected to heated debate. The provisions are in a state of flux and while the text of the proposed Directive issued, it is likely to change. We will be monitoring the progress of this draft Directive and will provide updates in future Bulletins.