Member States of the European Union (EU) are required to transpose the provisions of the Alternative Investment Fund Mangers Directive (AIFMD) into national law by 22 July 2013: fund managers of alternative investment funds (AIF) who fall within its scope should be investigating how to adapt their businesses in preparation for its introduction.
This article examines the position of fund managers who are currently authorised as "investment firms" under the Markets in Financial Instruments Directive (MiFID). While some of the considerations detailed below may also be relevant to fund managers with no MiFID authorisation, we will be specifically examining the position of such managers in a later article.
The core requirement of the AIFMD is that all AIFs must have a designated alternative investment fund manager (AIFM) with responsibility for portfolio and risk management. The AIFMD also makes it clear that it is not possible for entities to be authorised as both a MiFID investment firm and an AIFM. Fund managers authorised as MiFID investment firms will therefore need to consider whether it is appropriate to retain their current authorisation or seek to become authorised under the AIFMD to act as the AIFM for the AIF which they manage.
Fund managers facing this question will need to be cognisant of the implications of electing to replace their authorisation and the alternative options which are available to them to satisfy the requirement to have a designated AIFM without having to duplicate their investment management function. This article considers two of the alternative options:
- establishing a new entity to act as an AIFM;
- or electing for the AIF to be self managed.
Under both options the portfolio management of the AIF would continue to be performed by the existing fund manager on a delegated basis.
Conversion of Existing Authorisation
Fund managers may initially consider that replacing their current authorisation is an attractive option: by maintaining only a single authorised entity the costs and the burden of regulatory compliance can be minimised. However, fund managers need to be mindful that the range of activities that an AIFM may be authorised to undertake is more limited than for a MiFID investment firm. A key question for fund managers considering whether to replace their current authorisation must therefore be whether this might impact on the scope of work they are currently undertaking and whether it is compatible with their future growth plans.
Article 6(2) and 6(4) of the AIFMD together specify the range of activities that an AIFM is permitted to undertake.
Comparing this to the range of activities that may be undertaken by MiFID investment firms, it is clear that there are significant activities that an AIFM is not permitted to undertake, including the following:
- execution of orders on behalf of clients;
- dealing on own account;
- underwriting of financial instruments or placing of financial instruments on a firm commitment basis;
- placing of financial instruments without a firm commitment basis; and
- operation of multilateral trading facilities. For fund managers who engage in
these activities and wish to continue to do so following the introduction of the AIFMD, converting their authorisation will not be a viable option.
What then are the alternative options available to fund managers to ensure that they will be in a position to continue managing alternative investment funds while retaining their authorisation as a MiFID investment firm? Two of the options Alternative Optionsavailable to fund managers are:
- to elect for the individual alternative investment funds under their management to become self managed by becoming authorised as an AIFM; or
- to establish a new entity to act as an external AIFM.
The appropriate choice for fund managers will depend upon their individual circumstances but some of the factors which are likely to influence this determination are as follows.
Number of funds under management
For fund managers who only manage a single fund, the costs associated with establishing an external manager are likely to be a deterrent. Conversely, the greater the number of funds under management the more attractive the establishment of an external AIFM is likely to prove, due to the economies of scale afforded, and the ability to avoid having to make multiple authorisation applications.
Number of Domiciles
Where a fund manager manages AIFs which are domiciled in a single jurisdiction they may favour pursuing the self managed route. However, should the AIFs be domiciled in a number of Member States, the costs and practical difficulties of interacting with multiple competent authorities to have the individual AIF authorised are likely to be unappealing.
A further consideration will be the capital implications of the chosen option. External AIFMs must maintain minimum capital of at least €125,000 while self managed AIFs must maintain minimum capital of €300,000. Furthermore, where the value of the portfolio exceeds €250 million an additional amount of capital equal to 0.02% of this excess is required to be maintained, subject to an overall maximum of €10 million. Despite the higher requirement applicable to self managed AIF, this may be a more attractive option for some fund managers as depending on the fund structure, it may prove possible to use investor funds to satisfy this minimum capital requirement.
A further option available to those fund managers who already control UCITS management companies is to extend the authorisation of the UCITS management company to permit it to manage AIF. This approach offers obvious cost benefits associated with using an existing vehicle. Furthermore the capital requirements for UCITS management companies are equivalent to those for an AIFM. Accordingly, this approach may have limited or no capital implications. A further advantage is that the AIFMD provides for a simplified authorisation process for UCITS management companies providing that competent authorities shall not request documentation which has already been provided to them as part of the UCITS management company authorisation process.
Delegating Investment Management Functions
A key aspect in the feasibility of the above options is the extent to which it will be possible for the AIFM to delegate the portfolio management function to the existing investment manager. Article 20 of the AIFMD provides that any delegation arrangements must receive the prior approval of the AIFM's competent authority and details high level principles which are to apply to any form of delegation. These principles include the following:
- the AIFM must be able to justify its entire delegation structure on objective criteria;
- the delegate must have sufficient resources to perform the delegated tasks;
- where the delegation concerns portfolio management or risk management, it must be conferred only on undertakings which are authorised or registered for the purpose of asset management; or if that condition cannot be met, only subject to prior approval by the competent authorities of the home member state;
- the delegation must not prevent the effectiveness of supervision of the AIFM from acting, or the AIF from being managed, in the best interests of its investors;
- the AIFM must be able to demonstrate that the delegate is qualified and capable of undertaking the functions in question; that it was selected with all due care and that the AIFM is in a position to monitor effectively, at any time, the delegated activity; to give at any time further instructions to the delegate and to withdraw the delegation with immediate effect when this is in the interests of investors.
While these principles offer some guidance, the precise scope of permitted delegation will only become apparent when the European Commission publishes its Level 2 measures on the subject. It should also be noted that the AIFM will retain ultimate responsibility for the performance of the delegated functions and its liability towards the AIF and its investors cannot not be avoided or limited.
However, fund managers who view delegation arrangements as being an easy solution to avoid the obligations of the AIFMD must be mindful of the terms of Article 20(3), which provides that an AIFM shall not delegate its functions to the extent that it can no longer be considered to be the manager and it becomes a letter-box entity.
While the appropriate course of action will depend on the individual circumstances of each fund manager, it is prudent and advisable for all fund managers to begin the process of considering the factors which are relevant to them. The material in this article is for general information only. Professional legal advice should be sought in relation to any specific matter.