Andrew Lowin published an article in Compliance Monitor entitled ‘Fund managers face up to the AIFMD’.
It’s decision time for non-UCITS Collective Investment Schemes, report Andrew Lowin, as practical details of the controversial Alternative Investment Fund Managers Directive begin to emerge
This year will see the enactment of the long-awaited Alternative Investment Fund Managers Directive, which will have far-reaching consequences for any Collective Investment Scheme (CIS) or Collective Investment Undertaking that is not a UCITS scheme – categorized as Alternative Investment Funds (AIF). Before the Level 2 Regulations (AIFMR) were formally published on 19 December 2012, the investment industry held back on making any major decisions. Since then, AIFMD/R seminars at corporate law firms have been overflowing with weary investment managers jostling for the latest news and what this means for marketing and managing their funds in the EU. With AIFMR firmed up, this is the time to get up to scratch quickly with the AIFMD/R and establish the impact and issues faced by AIF investment schemes.
Fund managers hoping for an escape route out of AIFMD will be disappointed to find that it does not solely affect hedge funds and private equity funds. The AIFMD/R also affects other types of funds that are not UCITS, such as the types of regulated funds that are designed for retail clients like NURSs and QIFs in the UK and mutual funds from the US. A key question here is – does the non-UCITS CIS intend to market or manage in the EU and, if so, where are the funds currently domiciled?
Where the AIFMD/R does apply, the next step is deciding which entity in their group structure will be the Alternative Investment Fund Manager (AIFM). The term ‘manager’ in this instance means the operator, in UK parlance, who is actually policing the activities of the AIF and their service providers. What has confused matters is that the AIFM, in addition to being the ‘policeman’ has two key functions – 1) to undertake the portfolio management of the AIF and 2) to undertake the risk management of the AIF (but much depends on the AIFM’s ability to delegate these responsibilities, which has been happening in the UCITS world very successfully, efficiently and safely for many years).
The AIFM’s purpose is to ensure that the AIF is meeting all its obligations under the AIFMD. Time is precious – firms have until 22 July 2013 when the AIFMD/R actually comes into force to decide on some key issues and even to create new entities for this purpose. The trend seen so far is that the UK regulated entity (investment manager) is being earmarked as the EU-AIFM. Another point to note is that in small firms that become the AIFM, the FSA has stated that proportionality will be considered when looking at how duties are apportioned, which should alleviate reasonable concerns over how a small team can appropriately comply with the new requirements. Some AIFMs may choose to delegate the activity, but not the responsibility, of some of their duties.
At the moment, many UK investment managers will undertake portfolio management or act as investment advisors to non-EU AIFs (where, typically, the AIF is Cayman-based, for example) and, as mentioned above, will have an EU-AIFM. Private equity firms however, will have either an EU or non-EU AIF (where their Channel Island AIF falls outside the EU) and if the UK regulated entity is classified by the FSA as an advisor/arranger, they may turn that into the EU-AIFM. This will be a significantly higher hurdle for PE firms to jump, since they start from a much lower point than MiFID investment firms.
AIFMD/R is about marketing the AIF in the EU as well as managing, therefore does the AIFM need to be an EU-based entity? The short answer is ‘not necessarily’. However, if a firm has an EU AIF and a formally authorised EU AIFM then it can enjoy a significant advantage in being able to market their EU AIF, under the AIFMD passport, to any professional investor in the European Economic Area (EEA) straight away after July 2013. This includes all 27 EU member states plus Iceland, Liechtenstein and Norway.
A non-EU AIFM managing either an EU AIF or non-EU AIF is only permitted to market through the private placement regulations (PPRs) where they exist (not all EEA states have PPRs), but to do so, an ESMA negotiated co-operation agreement will need to be in place between all the competent authorities in each EEA state in which the AIF is to be marketed and the supervisory authorities of the countries for both the non-EU AIFM and the non-EU AIF. While the reporting requirements and other such regulatory demands are less onerous for the non-EU AIFM, the quid pro quo is they may not take advantage of the AIFMD passport.
It may never be possible – unless subject to a positive ESMA recommendation, from 2015 at the earliest – to market non-EU AIF (either through EU and non-EU AIFM) and EU AIF with non-EU AIFM, through the Third Country Passport (TCP). The TCP is not guaranteed to happen at all or from 2015, so there is a risk it may be later. Also, AIFMD does not prevent EEA states from repealing their PPR regimes. Firms with a non-EU AIF may therefore decide to re-domicile their fund into the EU and appoint an EU AIFM to avoid any delays and uncertainties in marketing and/or managing.
As mentioned above, firms could choose their existing UK investment manager as the AIFM. As a consequence of the AIFMD Transitional (which both HM Treasury and the FSA/FCA plan to adopt), from 22 July 2013 it can continue to remain authorized under MiFID and not the AIFMD. In this case, the firm should apply to the FSA for a ‘Variation of Permission’ to be formally authorized as an AIFM under UK regulations during the implementation period for AIFMD/R at any time through to July 2014, which is the latest date a ‘proxy’ AIFM can defer its application for formal AIFM authorization. During this 12-month transitional period acting as a proxy AIFM, the FSA/FCA and HM Treasury have confirmed their intention that none of the AIFMD/R provisions will apply. However, there may be issues for a proxy AIFM which result from this, including the inability to market under the PPRs in any other EEA state than the UK and through an AIFMD passport (even for EU AIFs).
Firms that do not want an EU AIF – such as non-UCITS US fund managers where the fund and the investment manager are based in the US, but wish to market to the EU, will only be able to do so through PPRs where these exist in each EEA member state. Some EEA states will implement domestic regulations allowing the marketing of these to retail clients (the UK has stated already that it plans to continue the ability to do so). As mentioned before, because of the AIFMD, some EU states are rumored to be considering repealing their PPR regimes before the directive is in force, which could further limit where these non-EU AIFs market even though they are designed for retail investors.
Assuming no EEA states repeal their PPR regimes, then the non-EU AIF and non-EU AIFM (managing both EU AIF and non-EU AIF) situation will remain status quo. Initially, Germany appeared on the verge of repealing its PPR regime, but challenges from its own electorate may indicate the chances of this are less likely now. This means that with a non-EU AIF and with the AIFMD in full swing, there is no major impact on their marketing strategy to the EU prospective investor base for these types of firms.
Overall, the changing regulatory landscape is unlikely to deter alternative investment managers or private equity firms from marketing in Europe, as the Continent still provides an attractive and willing investor base. While the reporting requirements and other AIFMD-driven rules are more demanding and will drive up costs, investors are not likely to favor less regulated jurisdictions elsewhere (particularly when high-profile failures like the Madoff scandal and Lehman Brothers’ collapse are still fresh). The positive side to this is that professional investors in the EU will be afforded better protection under the AIFMD than before, but whether these investors wanted or needed it to this degree is a moot point.
AIFMR has provided some clarity on the key areas for firms to work on and, for the most part, the transition should be possible in the given time frame once the fundamental decisions have been made. The next steps include the FSA’s second consultation paper, ESMA’s Level 2 Technical Standards and Level 3 Guidance; these will provide further insight as to how AIFMD/R will, in practice, apply here in the UK and the rest of the EEA. HM Treasury published on 11 January 2013 its proposed domestic implementing legislation.