Fund managers working with alternative investment funds believe that they have been unfairly targeted by a draft EU Directive for a financial crisis that was not of their making.
On 30 April, the European Commission published a draft Directive on Alternative Investment Fund Managers (the AIFM Directive). The main reason given for the proposed legislation is the alleged susceptibility of Alternative Investment Fund Managers (AIFMs) to risk and their ability to undermine the integrity of the European financial markets.
The draft Directive has already invited a lot of criticism from industry experts and AIFMs for what they see as a knee-jerk reaction to a financial crisis not precipitated by their activities. Some industry commentators have argued that the increased levels of supervision and compliance required under the AIFM Directive threatens to increase the already onerous reporting requirements placed upon them by the Markets in Financial Instruments Directive and could be detrimental to the industry due to the added expense it will generate in compliance and oversight.
The AIFM Directive will apply to fund managers that manage or market non-UCITS funds with assets under management exceeding €100 million. There is also provision for managers of unleveraged funds with assets exceeding €500 million, where investors are the subject of a five-year lock-in period. Managers of hedge funds, private equity funds, real estate funds, commodity funds, infrastructure funds and other alternative institutional funds will all be affected by the Directive.
AIFMs require authorisation from their home member state to operate within the EU. This will require fund managers to demonstrate that they are suitably qualified to manage alternative investment funds (AIFs) and to submit detailed information about planned activities, details regarding the characteristics of the AIFs under management and extensive information where it is intended to delegate management of a fund.
On top of these onerous disclosure requirements, AIFMs will also be required to provide details of their internal risk management systems, including how it is intended to deal with the liquidity and counterparty risks associated with short selling, the fair valuation of assets and the security of custodial arrangements.
AIFMs will also be required to observe a minimum capital requirement. Where assets under management are less than €250 million, the fund manager will need to show a minimum level of capital of €125,000. Where assets exceed €250 million, the AIFM will be required to boost the level of its own funds by 0.02% of the excess.
AIFMs will be permitted to market to professional investors in the EU subject to a notification procedure and may 'passport' management services to another member state. In some limited circumstances, the fund manager may be permitted to market to retail investors.
Third Country AIFMs
The AIFM Directive makes provision for the marketing of third country (that is, non-EU) alternative investment funds in the EU. The third country will need to meet the supervisory and regulatory standards demonstrated in the EU model and will need to have a cooperative tax framework in place. The draft directive stipulates that these provisions will only be possible three years after the directive has come into force to allow off-shore jurisdictions to improve their regulatory infrastructures.
Fund managers will need to comply with frequent and detailed reporting requirements depending on their activities. These will include:
- The percentage of the alternative investment funds assets that are the subject of special arrangements arising from their illiquid nature;
- Any new arrangements for managing the liquidity of an AIF;
- The actual risk profile of the AIF and the risk management tools employed by the AIFM to manage those risks;
- The main categories of assets in which the AIF invests; and
- The use of short selling during the reporting period.
Where an AIFM manages a leveraged fund or acquires a controlling interest in a public or private company, extra reporting requirements will apply. Fund managers will also be required to disclose relevant information to their investors.
The AIFM Directive demands that fund managers appoint an EU-domiciled valuator to value the assets of any alternative investment funds under its management where they fall within the scope of the Directive. The valuator must ensure that the shares and units of the AIF are valued at least once a year and each time the shares or units of the fund are issued or redeemed, if this is more frequent.
The draft Directive now goes to the European Council and Parliament for consideration under the co-decision procedure. The Commission would like to see the directive adopted before the end of 2009 so as to ensure that member states have implemented the relevant provisions before the end of 2011. On this timescale, it will be 2014 before third countries can passport their activities into the EU. There has already been significant commentary on the effects of the proposed AIFM Directive. Many within the EU feel that it does not achieve what it sets out to do in that the detailed reporting requirements may in fact create a form of regulatory arbitrage that will be exploited by AIFMs located off-shore and in the United States. In any event, the coming months are bound to see a period of intense lobbying in Brussels by those most deeply affected in the industry.