On 30 April 2009, after much speculation and political debate, the European Commission published the text of its proposed Alternative Investment Fund Managers Directive. Although widely heralded as a measure directed at the hedge fund industry, the draft Directive will affect the operations of managers of all non-UCITS funds with private equity, commodity funds, real estate and venture capital funds falling within its remit. It is intended that the draft Directive will introduce a harmonised, comprehensive and effective regulatory and supervisory framework for alternative investment fund managers (AIFMs) in the EU.
Pressure for regulation of AIFMs on a pan-European basis has been steadily increasing in recent months in response to concerns as to the impact of the activities of highly-leveraged investment vehicles on the financial system’s stability, and a perceived lack of oversight and supervision of the activities of managers of investment funds. This is despite the Commission recognising in the Explanatory Memorandum of the draft Directive that “AIFMs were not the cause of the [financial] crisis.” The European Commission has consulted extensively on the adequacy of regulatory arrangements for non-UCITS fund managers and for the marketing of non-UCITS funds in the EU. The Commission’s work in this area included an open hearing on non-harmonised retail investment funds, a consultation on open ended real estate funds, and most recently, a consultation on policy issues arising from the activities of the hedge fund industry, the results of which were discussed at a high-level conference on private equity and hedge funds in Brussels in February 2009. Those discussions and responses to the various consultations contributed to the preparation of the draft Directive and served as the basis for European input into the G20’s parallel reflections on the international financial markets.
The draft Directive had already been the subject of considerable press comment based upon leaked earlier texts and since its official publication on 30 April 2009 has again provoked criticism from a number of high-profile European politicians and industry participants. It is inevitable that a period of intense lobbying will now ensue at European level.
An outline of some of the key provisions of the draft Directive are set out below.
- Application: Management and marketing of non-UCITS funds can only be undertaken by an authorised entity and in accordance with the requirements of the draft Directive. AIFMs who have assets under management of more than €100 million will need to be authorised by their home state, and be subject to continuing obligations. If, however, the alternative investment fund (AIF) has no leverage and a lock-in period of five years or more, the threshold is raised to €500 million. This significantly higher threshold is because AIFMs of un-leveraged funds are considered unlikely to cause systemic risks. According to the Commission’s analysis, a threshold of €100 million would bring within the Directive’s ambit roughly 30 per cent of hedge fund managers, managing almost 90 per cent of assets of EU domiciled hedge funds.
- Authorisation Requirements: AIFMs operating in the EU will be required to show that they are suitably qualified to provide AIF management services. In order to become authorised, AIFMs will have to provide detailed information on their planned activities, the identity and characteristics of the AIF to be managed, and their internal arrangements for governance, risk management, valuation and safe-keeping of assets, audit and regulatory reporting arrangements.
- Capital requirements: The minimum capital for AIFMs is €125,000 and additional capital is required if the assets under management exceed €250 million. Due to the fact that the equivalent of that €125,000 figure under MiFID is €50,000, certain small managers who are currently subject to MiFID and who become subject to the Proposed Directive may find that their regulatory capital requirements are increased. The draft Directive does not impose capital requirements for the fund itself.
- Marketing provisions: An AIFM authorised in its home Member State will be entitled to market its funds only to professional investors (as defined in the MiFID Directive), although Member States may permit the promotion of AIFs to retail investors in limited circumstances. The cross-border marketing of AIFs will be subject to a notification procedure under which relevant information is provided to the home Member State and passed on to the host. AIFMs will also be able to “passport” management services into other Member States, subject to a notification procedure.
- Third country aspects: The Directive provides that only AIFM established in the EU will be granted a passport to market their managed AIF throughout the Community, however provision is also made for the EU-wide marketing of third country funds (such as those domiciled in the Cayman Islands) subject to compliance with stringent requirements on regulation, supervision and cooperation including OECD tax matters. This will, however, only be possible three years after the proposed Directive has come into force because of the need to provide for additional requirements in implementing measures. Decisions on the equivalence of the relevant third country legislation and comparable market access will be taken by the Commission. The Commission anticipates that during this period offshore financial centres will have a strong incentive to deliver the necessary improvements and to comply with OECD standards and that this approach is consistent with the objective of the G20 to enhance the transparency of such jurisdictions.
- Reporting requirements: An AIFM is obliged to report regularly to the competent authorities of its home Member State on the principal markets and instruments in which it trades for its AIFs, their principal exposures, performance data and concentrations of risk. The AIFM must notify the regulator of the AIF’s identity, the markets and assets in which it will invest and of its organisational and risk management arrangements. Extra disclosure obligations will apply to AIFMs managing leveraged AIFs and for AIFMs acquiring controlling stakes in companies.
- Disclosure requirements: AIFMs are required to make various disclosures to investors, both pre-investment and on a continuing basis, including disclosures relating to the AIF’s risk, return and liquidity characteristics, its service providers and the AIFM’s risk-management systems. They must also disclose the percentage of the assets of the fund that are subject to special arrangements because of their illiquidity (for example, held in side pockets).
- Appointment of a valuation agent: AIFs must be valued by an EU domiciled independent valuation agent and, if the registered office of the valuation agent is outside the EU, the Commission must first have determined that the valuation rules and standards used by valuation agents in the relevant third country are equivalent to those applicable in the EU.
- Appointment of a depositary: An AIFM will be obliged to ensure that each AIF appoints an EU credit institution as a depositary of its cash and other assets. The draft provides that the depositary may appoint a sub-depositary in the country of the AIF’s incorporation where that sub-depositary is subject to prudential regulation, supervision and anti-money laundering rules equivalent to those under EU law and, for third country funds, that the third country is a signatory to a reciprocal tax disclosure treaty with the EU.
Matters not covered by the proposed directive
The Commission has acknowledged that a number of concerns which have been expressed about the activities of AIFMs are linked to behaviours, for example short selling, which are not unique to the investment funds sector. Such activities will be the focus of review of the relevant EU directives.
The draft Directive will now pass to the Council and the European Parliament for consideration under the co-decision procedure and the Commission has indicated that it hopes the Directive can be adopted by the end of the current year with implementation by Member States required by the end of 2011. On this time-table it will be 2014 before any third country funds could benefit from the new passporting regime.