In a few weeks, the draft Alternative Investment Fund Managers (AIFM) Directive of the European Union (EU), which is designed to provide regulatory framework for the alternative asset industry, celebrates its first birthday. This article outlines the current status of the draft.
On 29 April 2009, the European Commission issued the first draft of a proposed European Union Directive on Alternative Investment Fund Managers designed to provide the background for harmonised regulatory supervision of the alternative investment business across the European Union. According to this “AIFM Directive”, certain EU-domiciled managers (fund managers) of alternative investment funds would be required to register in their EU member state of residence, and would become subject to significant reporting and organisational requirements and marketing restrictions.
Numerous drafts of the AIFM Directive have been circulated. In November 2009, the Swedish Presidency over the EU Council expressed optimism that agreement on a final version could still be reached in 2009. Today, facing more than 1,000 single amendment proposals, it is expected that the Directive will be still on the Agenda when the current Spanish Presidency over the EU Council will be replaced by Belgium in July 2010.
Scope of the Directive
AIFM and AIF
The AIFM Directive would apply to all EU-domiciled “legal or natural persons or companies, whose regular business is to manage one or several alternative investment funds”. Management services include “the activities of managing and administering one or more alternative investment funds on behalf of one or more investors”. The AIFM Directive would not apply on alternative investment funds (AIF) directly. Rather, the Directive prefers an indirect approach by regulation of the managers (“AIFM”) of such AIFs.
Except for certain exemptions from regulations designed to exempt small-market participants, the managers of “any collective investment undertakings…with a defined investment policy… which does not require authorisation pursuant to Article 5 of Directive 2009/XX/EC (UCITS IV Directive)” will become subject to regulation. This definition would include all pooled investment vehicles formed with the purpose of raising capital from investors with a view to investing in accordance with a defined investment policy, irrespective of the location or place of management of the pooled investment vehicle.
Each EU-domiciled fund manager subject to the AIFM Directive would be required to obtain authorisation from the applicable competent national regulatory authority to provide investment management services to AIFs or to market securities of AIFs within the European Union. At present, the AIFM Directive does not provide grandfathering or transition rules for existing funds.
To apply for authorisation, a fund manager must submit to competent regulatory authorities of the Member State where the fund manager has its registered office (which also needs to be the fund manager’s “head” office). The fund manager must provide detailed information on the shareholders, the organisation of the fund manager, its business plan and its activities with respect to the managed AIF.
Fund managers subject to the AIFM Directive would also be subject to a number of substantive requirements summarised briefly below:
Capitalisation requirements: Fund managers would be required to maintain a minimum capitalisation equal to at least €125 thousand plus .02 percent of the value of the portfolio directly or indirectly managed by the fund manager in excess of €250 million. In addition, fund managers would be required to fulfil the minimum capital requirements for investment firms and credit institutions specified in the Basel II Directive
Conduct of business. Each fund manager would be required to act in the best interests of the AIFs it manages, the investors in such AIFs and the integrity of the market.
Conflicts of interest. The AIFM Directive would require fund managers to use reasonable best efforts to (i) identify conflict of interest between it (and any related person of the fund manager) and investors in its AIFs, and (ii) prevent conflicts of interest. The fund manager would also be required to disclose to investors arrangements to manage conflicts of interest in AIFs managed by the fund manager.
Risk management. Each fund manager would have to implement appropriate risk management tools tailored to the risk profile and the size, portfolio structure and investment strategies of the AIFs under management.
Liquidity management and depository requirements. Fund mangers would also be obligated to install a liquidity management system for each AIF under management, and also ensure that each such AIF has a redemption policy appropriate for the liquidity profile of the alternative investment fund’s investments.
Acquisition of controlling stakes. The fund manager of an AIF that acquires a controlling stake1 in a company would be required to satisfy a number of notification and disclosure requirements.
Use of leverage. Fund managers that manage highly leveraged alternative investment funds would be subject to additional reporting requirements.
Quite late in the process of the AIFM Directive, the EU introduced a completely new field by adding a Section on Remuneration Policies. Managers of AIFs need to establish a remuneration system complying with the AIFM Directive. Whether or not these principles should also apply to Carried Interest was subject to intense discussion. The latest draft of the Directive, issued on 15 February 2010 under the Spanish Presidency, seems (to some extent, surprisingly) to exclude Carried Interest structures being drafted on the basis of a Fund Carried Interest with full pay out of the investors.
The Critical Points
With respect to the technical level of the Directive, a number of key issues remain (such as depositary and valuation issues, remuneration aspects and third country aspects). With respect to the political and economic dimension of the AIFM Directive, the treatment of managers of AIFs from outside the EU seems to be the most important aspect. Different from the Swedish compromise proposal made in November, the latest draft of the Directive issued under the Spanish Presidency on 15 February 2010 refuses to provide for a passporting provision for non-EU managers. In a detailed statement issued 10 February 2010, the European Union Committee of the UK’s House of Lords argued that respective provisions may herald a new era of protectionism and would affect the attractiveness of the EU for investments.
Interestingly, an especially critical aspect of the AIFM Directive has not been discussed in detail at all: The management definition of the Directive is rather broad and provides for tensions with other terms such as marketing, administration and other services. Some of these services are rendered by servicers acting as investment advisors to the funds. Would such investment advisors become managers under the Directive, and if so would they still remain as advisors for tax purposes? It is not unlikely that these aspects will have considerable impact on the competitive landscape for AIFs in Europe.
The rules of the AIFM Directive provide the framework for substantial and comprehensive regulation of the alternative asset industry in the European Union. The draft released by the EU Commission will be forwarded to the European Parliament and EU Council. Reflecting the intensity of the political discussions and negotiations, the final version of the AIFM Directive is not likely to be released before late 2010.
If adopted, the AIFM Directive can be expected to change the competitive landscape for alternative asset managers in the EU. Notably, multinational investment houses with offices both in and outside of the EU would be required to register with the applicable competent national authority and abide by the substantive restrictions of the AIFM Directive. In addition, absent the introduction of transition rules into the AIFM Directive, pre-existing AIFs would be required to evaluate their operations and structure to procure compliance with the AIFM Directive.