Summary and implications
In April 2009 the European Commission published its politically charged draft Directive on regulating Alternative Investment Fund Managers ("AIFMs"). Fund managers in the real estate sector accept it will affect them and that all fund managers will have to be authorised. Unintentionally property companies could also be burdened with additional regulation.
The AIFM Directive is being passed through the EU decision making process at rapid speed. It is clear that the real estate funds industry needs to act now or it will be subject to a set of proposals more widely suited to the private equity or hedge fund sectors or the UCITS regime.
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The Directive has been drawn up hastily without proper consultation, and in many ways looks like a classic EU compromise. It therefore satisfies neither side of the debate, by increasing the regulatory burden on property, hedge and private equity funds (to howls of complaint in the City) without directly regulating the funds themselves (to equally loud complaints from MEPs). The Commission intends the proposal to become law in 2011.
Organisations and industry bodies have raced to make their submissions to HM Treasury. The feedback from the European Council of Finance Ministers' discussion held in Brussels in early July has clarified some of the headline issues.
The industry welcomes that AIFMs can market funds to professional investors throughout the EU. There will be a three year delay before funds established off shore (for example, in Cayman or the Channel Islands) benefit from this regime. The Commission intends that until then the existing regime will apply. Some countries are opposed to allowing non-EU funds to market in their jurisdiction until they have regulations similar to the EU and that tax authorities can obtain all information on tax.
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b) Exemptions One of the biggest gaps in the Directive is the lack of sensible exemptions. We can only hope that exemptions contained in other regulatory directives (such as MiFID) are replicated to enable, for example, managers not to require authorisation where they are managing inter-group funds.
Definition of "a Fund"
It is also extremely important that the Directive contains a proper definition of what is meant by "a Fund". The current definition would catch normal commercial companies and joint venture arrangements which would be an absurdity. This point has recently been recognised by the property industry and some lobbying has been done. It is expected that the Commission will come up with a sensible definition of "a Fund". Any provision may look very similar to the wording which sought to exclude joint ventures from being a "collective investment scheme" in the UK.
The Directive has a very definite view of the roles played by third parties in helping the AIFM. Each fund must have a depositary that is a Bank that is to be responsible for custody of fund assets and the receipt of investors' cash. A couple of issues arise:
1. In the UK, the receipt of investors' money is typically the role of an Operator, and money will be received into an Operator's account at a bank – the Operator itself is not likely to be a Bank.
2. Most funds hold property assets in SPVs or by a general partner and nominees. It is vital that there is a differentiation between real estate funds and traditional hedge/securities funds as the issues relating to safe keeping of their assets are fundamentally different.
Where AIFMs manage funds that employ leverage, there are new reporting obligations where leverage exceeds 50% LTV in two out of the past four quarters. Regulators can also limit the amount of leverage an AIFM can use. Real estate funds commonly use long term debt and it is essential that this is not confused with the leverage generated using complex derivatives strategies as are common in hedge funds. Regulators are looking for flexibility in the Directive so they can determine what they want to review, otherwise they will be overwhelmed with documentation on low risk matters rather than focussing on where real risk lies.
e) Delegation The Directive imposes strict limitations on the ability of AIFMs to delegate:
- delegation requires the consent of the Regulator;
- the AIFM will remain responsible for the subcontractors' activities; and delegation of portfolio management has to be to an AIFM.
In real estate funds it is common that management services are delegated but property managers are not usually authorised. The proposal is inconsistent with the current position in the UK, that real estate is not regulated by the FSA. Also, if a Fund is based in the EU but has assets in non-EU countries, there needs to be delegation to local managers who will not be authorised as an AIFM. This would make some real estate funds unworkable.
AIFMs will need to meet detailed investor disclosure requirements. Many of these replicate existing practices, but there are new details on, for example, disclosing the precise identity of investors that receive preferential treatment and the nature of that preferential treatment. This may affect the use of side letters common in real estate funds.
Administrative burden to increase
It is clear that managers of AIFMs will need to comply with additional disclosure requirements in the future. How much of a change this becomes will depend upon the final version of the Directive and of the implementing legislation that will be issued under it. But the administrative burden is certain to increase.
What is the German view? The Directive is highly political. Our Alliance firm, GSK Stockmann + Kollegen, believe that with a German election coming up later in the year, their government wants to be seen to be taking action to protect against future economic crises. The German government generally approves of:
- the proposals put forward by the Directive;
- the Directive's approach of regulating fund managers (and not the funds themselves); and
- the Directive's approach of treating all fund managers in the same way.
However, the German real estate industry, much like the UK real estate industry, regards the Directive as too broad.