After a significant period of negotiation, the level 2 regulations pursuant to the AIFM Directive (the Directive) were issued by the EU Commission on 19 December. The controversial areas of negotiation between EU member states are understood to have been focused particularly on the areas of delegation and depositary requirements.
While there are still a number of areas to be finalised and clarified (and indeed ESMA has this week published two further consultation papers regarding technical standards and key concepts relating to the Directive), we consider that the regulations provide a clear indication of the likely final position.
From July 2013 onwards, alternative investment fund managers (AIFMs) of private equity funds based within the EU will need to fully comply with the Directive in order to offer their fund to professional investors in the EU. The Directive will bring with it significant and costly additional regulatory obligations in relation to areas such as capital adequacy, leverage restrictions, valuations, manager remuneration restrictions and depository requirements.
AIFMs of private equity and alternative investment funds based in Third Countries, which include Jersey and Guernsey, will, however, be able to continue to market their funds to professional investors within the EU using existing national private placement regimes until 2018, without having to comply with the more onerous regulatory requirements of the Directive, subject to meeting certain conditions outlined below.
This briefing looks at:-
- why a typical fund structure with a Jersey or Guernsey general partner will be treated for the purposes of the Directive as having its AIFM within Jersey or Guernsey and, hence, fall outside the full ambit of the Directive; and
- how Jersey and Guernsey are meeting the conditions to enable funds with Jersey or Guernsey AIFMs to continue to be marketed in the EU under EU private placement regimes, as well as, in the medium term, passporting.
AIFMs in Jersey and Guernsey
A typical structure for a European closed-ended alternative investment fund is a limited partnership with a Jersey or Guernsey general partner and an investment adviser based in the EU or elsewhere. In relation to this structure, we consider that the AIFM, for the purposes of the Directive, will be treated as being the Jersey or Guernsey general partner for the following reasons:-
- The general partner is legally responsible for the overall management of the fund, including risk management and portfolio management. Although the investment adviser will typically provide the general partner with investment advisory recommendations, the investment decision-making and investment execution authorisation lies with the general partner;
- The board of the general partner will typically consist of a majority of Channel Island resident directors who are not employees or partners of the investment adviser;
- Regular board meetings will be held by the general partner and there will be ongoing regular oversight of the performance and operation of the fund carried out by the board of directors of the general partner and the administrator, which will be carried out in Jersey or Guernsey;
- The substance of the administration of the fund will be outsourced to a professional administrator based in Jersey or Guernsey. This will include, for instance, the keeping of accounting records, the preparation of accounts, capital calls, valuations and distributions;
- Jersey and Guernsey have regulatory policies in place which restrict the extent to which regulated parties (which would include the administrator and, for most categories of funds, the general partner) can outsource services to the investment adviser or any other third party. These policies in particular require that ultimate responsibility for the discharge of those services remains with the administrator or general partner and that the administrator and general partner retain the ability to appropriately monitor the performance of any outsourced services;
- The administrator of a fund and, for most categories of fund, the general partner will be subject to regulation in Jersey and Guernsey which will require them, for instance, to operate to high corporate governance standards;
- A number of larger private equity and alternative investment fund managers have their own permanent establishments in Jersey and Guernsey, with their own employees and premises from which to carry out administrative operations. This adds further weight to the proposition that the Channel Islands have appropriate professional infrastructure and fund administration expertise to be leading jurisdictions in which to establish substantive management and control of an investment fund.
Conditions for Private Placement
In order to be able to continue to take advantage of existing EU private placement regimes, the following conditions will need to be met by Jersey and Guernsey:-
- Jersey or Guernsey must not be on the Financial Action Task Force Blacklist
Both Jersey and Guernsey are highly regarded in terms of their regulatory standards and are not on the FATF blacklist.
- Jersey and Guernsey AIFMs must comply with the Directive requirements in relation to transparency, reporting and asset stripping
Jersey and Guernsey will be satisfying this condition through enhancements to existing codes and regulations.
- Co-operation agreements must be in place between Jersey and Guernsey and the relevant EU member state
Jersey and Guernsey are on ESMA's priority list of Third Countries in terms of agreeing a standard form of Co-operation Agreement and the expectation is that there will be a single form of Co-operation Agreement that all EU Member States will sign up to. A key condition for a Co-operation Agreement is that all relevant categories of funds to be marketed into the EU are subject to an appropriate degree of regulatory supervision. Jersey Expert Funds and Guernsey Authorised and Registered Funds are expected to meet this condition with no changes. In relation to Jersey Eligible Investor Funds and Jersey Private Placement Funds, recently introduced regulations include the requisite supervisory powers to meet this condition.
It is worth emphasising that for funds which are not to be marketed into the EU, the existing regulatory regimes for professional investor funds (which are typically used for private equity funds) will remain in place and unaffected. Funds to be marketed in the EU will continue to be established under existing regulatory regimes, which are enhanced to meet the requirements of the Directive.
The initial focus in Jersey and Guernsey is on meeting the conditions required to be able to continue to take advantage of EU private placement regimes from 2013. However, from 2015, the full passporting regime will also be available to Jersey and Guernsey managed funds, and regulations which are being implemented will in due course also ensure that the requirements for passporting are met. This will provide options for Channel Islands funds which are to be marketed into the EU from 2015, being either through private placement or through passporting. As mentioned above, funds established in Jersey or Guernsey and which are not to be marketed into the EU will, in any case, remain unaffected.