The AIFMD will increase the regulatory burden for AIFMs and this regulatory burden will increase operating costs and establishment costs for authorised AIFMs. The AIFMD will therefore have a significant impact on smaller EU-based hedge fund managers and raise the barriers to entry higher for smaller EU-based start-up hedge fund managers.
The AIFMD does, however, provide that smaller hedge fund managers are exempt from all the provisions of the AIFMD other than Article 3(3) and Article 3(4). Article 3(2)(a) provides:
“AIFMs which either directly or indirectly, through a company with which the AIFM is linked by common management or control, or by a substantive direct or indirect holding, manage portfolios of AIFs whose assets under management, including any assets acquired through use of leverage, in total do not exceed a threshold of EUR 100 million”.
This briefing note explores how valuable this exemption will actually be to smaller EU hedge fund managers and start-ups and, based on what we know at the time of writing, what the regulatory situation will be for smaller hedge fund managers that are based in the EU.
According to the AIFMD, a smaller hedge fund manager who can rely on the Article 3(2)(a) exemption does not have to be authorised as an AIFM under the AIFMD. It only needs to be “registered” with its regulator, to provide initial information to its regulator at the time of registration (e.g. identification of the AIFs that it manages and information on the investment strategies of those AIFs) and to regularly provide ongoing information to its regulator concerning “the main instruments in which they are trading and on the principal exposures and most important concentrations of the AIFs that they manage” (see Article 3(3)(a) to (d)).
It is important to note, however, that the AIFMD’s exemption for smaller hedge fund managers is “without prejudice to any stricter rules adopted by Member States” (see the penultimate paragraph of Article 3(3)).
For instance, the UK authorities (in their March 2012 discussion paper) have stated that they are considering two options – full application of the AIFMD to smaller AIFMs or the application of “a lighter regime selectively, differentiating between AIFM” – and have indicated that they are minded to choose the latter option. In the UK therefore smaller hedge fund managers could be subject to registration only, selective application of AIFMD authorisation requirements or full AIFMD authorisation.
There won’t be clarity on this until later in the year.
Do registered AIFMs fall under the AIFMD or MiFID?
EU legislation distinguishes between three different fund management activities: UCITS management, which is subject to the UCITS directive; the activity of “collective portfolio management” (i.e. managing one or more AIFs as an AIFM), which is subject to the AIFMD, and “individual portfolio management” (i.e. managing one or more AIFs but not as an AIFM), which is subject to MiFID.
Whilst a registered AIFM will be exempt from the AIFMD, it will still be carrying out the activity of “collective portfolio management”. This is confirmed by Recital 20, which provides that “[w]here an external AIFM has been appointed to manage a particular AIF, that AIFM should not be deemed to be providing [individual portfolio management under MiFID], but, rather, collective portfolio management in accordance with this Directive”.
This means that, at least at an EU level, a registered AIFM will not be required to be authorised under the AIFMD or MiFID but will not be able to benefit from any of the passporting rights granted under those directives.
Registered AIFMs and managing AIFs in the EU
The AIFMD’s management passport will only be available to fully authorised AIFMs. It will therefore be a matter for national law as to whether an AIFM that is registered in one member state would be able to manage an AIF that has been established in another member state.
An EU AIF designed for registered AIFMs?
Even if it were possible for an AIFM that is registered in one member state to be able to manage an AIF that has been established in another member state, would any registered AIFM want to manage an EU AIF?
Currently, the most popular EU non-UCITS hedge fund vehicles are the Irish QIF, the Luxembourg SIF and the Maltese PIF. Each of these jurisdictions are amending the regulatory regimes that apply to these fund vehicles in order that they become “AIFMD-ready”. A registered AIFM, however, may not be required to manage an EU AIF that complies with the AIFMD. In particular, a registered AIFM may not be required to manage an EU AIF that has a depositary and this will consequently reduce the ongoing operating costs.
It remains to be seen whether the above jurisdictions (or other member states such as Gibraltar, Cyprus or even the UK) will introduce or maintain a non-AIFMD AIF option. If there is not such an EU option then it is difficult to see why a registered AIFM would want to manage an EU AIF.
Even if there were such an EU option, the only potential advantage that such an AIF would have over a non-EU AIF is that it would be regulated in an “onshore” (read “EU”) jurisdiction and may therefore give some investors more comfort than a non-EU AIF that is regulated in an “offshore” jurisdiction such as the Cayman Islands.
Registered AIFMs and marketing AIFs in the EU
Under the AIFMD, an authorised AIFM is able to market EU AIFs to “professional investors” throughout the EU. This is the so-called “marketing passport”.
Initially, an authorised AIFM may also be able to market non-EU AIFs to investors in EU member states, although it will be a question of national law as to whether it will be able to market to investors in a particular member state. As a minimum, however, each member state must require the AIFM to comply with the requirements of Article 36. In particular, Article 36(1)(a) requires that, whilst the non-EU AIFs do not need to appoint a depositary, the AIFM does need to ensure that one or more entities are appointed to carry out the duties referred to in Article 21(7), (8) and (9) (i.e. monitoring of cash flows and the payment of subscription monies etc, holding financial instruments of the AIF in custody, verifying the ownership of assets of AIF that cannot be held in custody, monitoring subscriptions/redemptions, valuation, transaction settlement etc. and related record keeping).
The AIFMD makes it clear that member states may impose stricter rules on the AIFM in respect of the marketing of units or shares of non-EU AIFs to investors in their territory.
The AIFMD is silent on the marketing of EU AIFs and non-EU AIFs by a registered AIFM. It will therefore be purely a question of national law as to whether a registered AIFM will be able to market to investors in a particular member state. It may therefore be possible and/or easier for a registered AIFM to market a non- AIFMD EU AIF through the EU than a non-EU AIF. At the very least, such marketing may be permitted without the AIF having to satisfy the requirements of Article 36(1)(a).
This situation should be monitored as national laws are amended to reflect the implementation of the AIFMD as it may affect the choice between managing an EU AIF or a non-EU AIF.
Under Article 3(4), a smaller hedge fund manager who can rely on the Article 3(2)(a) exemption can choose to “opt in” under the AIFMD. By doing so, the smaller hedge fund manager would have to become an authorised AIFM. The management and the marketing passports would therefore both be available but the rest of the AIFMD would also become applicable to the smaller hedge fund manager in its entirety.
The increased establishment and operating costs alone make this unappealing but it is another question that smaller EU-based hedge fund managers and start-ups will need to consider.