ESMA approves cooperation arrangements with Guernsey
We reported in our December 2012 briefing that, with the release of the AIFMD Level 2 Regulations, we were optimistic that eligible Third Countries (such as Guernsey) would be able to continue to market their funds to professional investors within the EU after July 2013.
Since then, we have continued to closely monitor developments on AIFMD and have advised a number of clients how to prepare their businesses to best to meet the challenges under the Directive. This update looks at:
- How Guernsey has prepared for business post July 2013
- Letter box entity risk
- Transitional provisions
This memorandum has been updated on the basis of the law and practice in Guernsey as at 30 April 2014.
- AIFMs in Guernsey
Since July 2013 and subject to transitional arrangements at national level, managers of EU funds need to comply fully with the Directive in order to market to investors in the EU. The Directive brings with it significant and costly additional regulatory obligations in relation to depository requirements, capital adequacy, leverage restrictions, valuations and manager remuneration restrictions.
However, fund managers based in eligible Third Countries (such as Guernsey) are able to continue to market Third Country funds to professional investors in EU member states by using the existing private placement rules, subject to the following conditions:
- A supervisory cooperation agreement must be in place between the regulator of the EU Member State in which the fund is to be marketed and the Guernsey Financial Services Commission (the GFSC).
On 30 May 2013 the European Securities and Markets Authority (ESMA) announced that it had approved the cooperation arrangements on behalf of securities regulators from the 27 EU member states, Croatia and the wider European Area (Iceland, Liechtenstein and Norway) to be put in place with their counterparts in 34 Third Countries, including in Guernsey, with the GFSC. The GFSC has led the way in signing a bilateral agreement with each of the individual EU securities regulators so that Guernsey funds may be marketed in that country post July 2013.
- The Guernsey fund complying with certain transparency and reporting requirements set out in the Directive.
Guernsey has introduced the AIFMD (Marketing) Rules 2013 (the Marketing Rules) with effect from 22 July 2013. The Marketing Rules require persons, including fund managers and investment funds within scope of the Directive established in Guernsey, when marketing to investors in EU member states, to comply with Articles 42 and 43 of the Directive and to conduct marketing in accordance with the law and regulations in force in the relevant member state. They also contain notification and filing requirements in order that the GFSC may be kept informed of all such marketing activity. The Marketing Rules also allow the GFSC to co-operate effectively with the regulator in the relevant member state. The provisions of the Marketing Rules prevail over other Guernsey rules to which a Guernsey AIFM or AIF is subject. (c) Guernsey remaining off the Financial Action Task Force blacklist.
The initial focus in Guernsey has been on meeting the conditions required to be able to continue to take advantage of EU private placement regimes from 2013. However from 2015, it is anticipated that the full passporting regime will also be available to Guernsey managed funds. The Marketing Rules will also ensure that the requirements for passporting are met. This will provide options for Guernsey AIFs which are to be marketed into the EU from 2015, being either through private placement or passporting.
Third countries are not required to implement a Directive equivalent regime until 2015. However, Guernsey has also developed to sit alongside the Marketing Rules, the AIFMD Rules 2013 which provide with effect from 2 January 2014 an equivalent opt-in AIFMD regime for Guernsey investment managers and depositaries whose activities are caught by the Directive. Guernsey therefore operates a dual regime. Managers and funds within the scope of the Directive will be able to opt in to become AIFMD compliant. Meanwhile, managers out of scope of the Directive and funds established in Guernsey which are not to be marketed into the EU will remain unaffected.
- Letter-box entities
The Level 2 Regulations explain what could lead to an AIFM being deemed a "letterbox entity". Where an AIFM no longer retains the necessary expertise and resources to supervise a delegated task, or no longer has the power to take decisions in key areas or delegates the performance of more investment management functions than it retains, then the AIFM may be deemed to be a letterbox entity.
The Financial Conduct Authority (the FCA, previously the FSA), in a recent consultation paper, confirmed that it will take account of the criteria set out in the Level 2 Regulations and will also undertake a qualitative assessment as to whether any proposed delegation arrangement would lead to a "letter box entity".
There are a number of steps that fund managers can take to avoid characterisation as a letterbox entity, including:
- in the fund documents including an undertaking from the AIFM that it will continue to oversee and control any delegate and an acknowledgement from the delegate as to the limits of its role;
- ensuring the AIFM's operational policies and procedures are sufficiently robust, for example, by including a requirement for frequent oversight meetings by the AIFM of decisions made by any delegates;
- considering whether the AIFM needs its own permanent establishment in Guernsey, with its own employees and premises, from which to carry out operations. This is an effective method of demonstrating sufficient resources and expertise for the AIFM to perform senior management functions in relation to the implementation of an AIF's investment strategy.
- Transitional provisions
On 29 April 2013, HM Treasury published a Q&A on the transposition of the Directive into UK law, confirming its intention to extend the one year transitional arrangements to Third Country AIFMs marketing into the EU after July 2013.
This means that Guernsey AIFMs who have been managing a fund before 22 July 2013 will be able to continue to market AIFs in the UK from 22 July 2013 for up to 12 months without having to comply with the transparency and reporting requirements set out in the Directive.
This was welcome news given the UK's importance as a market for Guernsey AIFMs, although fund managers should be aware that member states other than the UK may have choosen to implement the transitional provision more restrictively.
Passive marketing (or reverse solicitation as it is also known) does not fall within the scope of the Directive. If a fund is not actively marketed, then its manager is not required to take any further action in connection with the Directive.
The Directive defines marketing as the "direct or indirect offering or placement at the initiative of the AIFM, or on behalf of the AIFM, of units or shares of an AIF it manages to or with investors domiciled or with a registered office in the Union."
It appears from recent draft guidance that the term "passive marketing" will be narrowly construed by the FCA and will apply only to communications specifically solicited by investors. AIFMs relying on reverse solicitation may wish to have policies in place to obtain such confirmation from investors prior to marketing the AIF to those investors.
It should also be noted that other member states may take a different approach to "passive marketing".