Implications of the AIFMD for non-EU fund managers
April 2014 | TALKINGPOINT | INVESTMENT FUNDS
FW moderates a discussion on the implications of the AIFMD for non-EU fund managers between Fiona Le Poidevin, chief executive of Guernsey Finance, Barry Breen, a partner at Katten Muchin Rosenman UK LLP, and Ignatius Fogarty, head of Private Equity Products at Preqin.
FW: In your opinion, what impact is the AIFMD likely to have on the European private equity market, with specific regard to non-EU fund managers operating in the region?
Le Poidevin: AIFMD is likely to increase the compliance burden and therefore push up costs within the European private equity market. However, non-EU fund managers will continue to be able to distribute funds into the EU, both via the National Private Placement (NPP) regimes – which we expect will continue until at least 2018 – and also the single passport for third countries which is expected to be introduced from July 2015. Guernsey is in a very good position because we have signed cooperation agreements with 27 of the EU and EEA member states, including the UK, France and Germany, so that we can continue to market funds to investors in those jurisdictions under their NPP regimes. In addition, we expect to be in a very good position to avail of the passport when it is introduced, as in January this year we introduced an opt-in regime which is fully equivalent to AIFMD.
Breen: It is still too early to predict what the full impact of the AIFMD will be on the European private equity market, particularly for those sponsors or managers that are located outside of the EU. For those non-EU AIFMs, the immediate impact will depend on the extent to whether their investment strategy involves acquiring EU companies or whether they intend to raise capital from EU domiciled investors.
Fogarty: The full impact of AIMFD will not fully be known for many years. The outlook in the alternative asset fund industry by fund managers is currently rather negative; results of a study we conducted in December 2013 showed that 53 percent and 62 percent of hedge fund managers and private equity managers respectively felt that the AIFMD will have a negative impact on the industry. Investors on the other hand are taking more of a ‘wait and see’ approach, and will be looking at how the industry develops. For investors on the positive side, they feel that the AIFMD could be seen as a stamp of approval on a fund helping them in their investment decisions. Negatively, though, there are concerns this may impact their choice of funds for investment or even increase costs. In regards to non-EU fund managers, currently many will be relying on existing private placement regimes and reverse solicitation in the immediate future. I think most fund managers are aware that if they want to seriously grow their business from this region this will be something they will need to comply with going forwards, but they are not in a rush to comply now. For some fund managers, they may be content to not market within the EU; in fact a recent survey of private equity fund managers indicated that up to 28 percent of fund managers will choose not to market in the EU in the future.
FW: How would you describe general awareness among fund managers of the requirements imposed by the AIFMD?
Breen: While we find that most investment managers at this stage have a general awareness of the requirements under the AIFMD, there is still a lot of confusion in the marketplace. The confusion is particularly prevalent when discussing marketing because there have been inconsistent views expressed in the market regarding what actually happened on 22 July 2013, whether any transition periods applied and what will happen on 22 July 2014. It did not help that some of the member states had not implemented the AIFMD on time nor had many member states determined whether the transition period extended to non-EU AIFMs marketing their non-EU AIFs into their jurisdictions. It further confused the market when some member states announced the good news about allowing transition periods only to then apply inconsistent conditions across the member states.
Fogarty: Regulation has been discussed at great length since the financial crisis, and much of the most recent discussions – at conferences, meetings, and in the press – in the past two years have been particularly focused on the AIFMD. It’s been difficult for fund managers to avoid this conversation, so most fund managers are now fully aware of what is required in terms of the overarching objectives of the AIFMD; however, there may be some confusion in the difference from jurisdiction to jurisdiction. However before the 22 July deadline last year, the directive underwent many iterations and changes, and the whole process was a confusing and complex issue for fund managers to keep on top of.
Le Poidevin: Until recently, the awareness among fund managers of the requirements imposed by the AIFMD was extremely mixed, with some very much on top of the situation and others much more uncertain. Ironically, I think that this ‘wait and see’ attitude has been perpetuated by the fact that several jurisdictions, such as the UK, have had a transitory year. However, this is now coming to a close and so managers need to know what they are doing by the end of July. That said, manager attitudes have also been driven by where they stand in the fundraising process and so those with funds that have already closed or are below the minimum threshold to be caught by AIFMD have been less engaged than those who are currently fundraising.
FW: In what ways will the AIFMD impact on the marketing of non-EU AIFs and EU AIFs by non-EU AIFMs? How are these funds likely to respond?
Le Poidevin: In response to AIFMD, Guernsey has introduced a dual regulatory regime for its investment funds: the existing regime remains for those investors and managers not requiring an AIFMD fund, including those using EU NPP regimes and those marketing to non-EU investors; and from 2 January this year Guernsey introduced an opt-in regime which is fully AIFMD compliant. The NPP routes will continue to be available until at least 2018 and most Guernsey funds will opt for that route to distribute funds into Europe due to the lower compliance and therefore cost burden. An AIFMD compliant regime is most likely to be favoured by those who need to actively market funds to European investors, whereas some managers may rely on reverse solicitation. However, each of the EU Member States is interpreting the meaning of reverse solicitation in a different manner and therefore this route to market will need to be considered carefully before pressing ahead.
Breen: AIFMD is already having a significant impact on marketing activities and future capital raises. Managers have been engaged in assessing their marketing practices and activities, including with respect to investors in their current products. Historically, private equity managers had a stronger relationship with their investors than hedge fund managers. This often involved frequent conversations and in-person meetings taking place in Europe. All of these practices are in the process of being reviewed. For instance, can the managers continue to visit with their existing investor base? While a meeting to discuss performance of an existing product should be fine, what happens when the conversation turns to future product development? Another point worth mentioning is that we are seeing a greater percentage of managers taking a view that the level of increased disclosure and obligations are not worth the level of capital they raise from Europe, and many have decided to not market to investors domiciled in Europe at all. If they have a one off investor that comes to them then they will decide whether a reasonable basis exists to rely on reverse solicitation. So, while the intention by the EU Parliament was not to penalise European investors, if more and more managers take this view, then the European investors are the one’s penalised by not being able diversify their investments into these products.
FW: In your opinion, are non-EU funds prepared to comply with the transparency requirements of the AIFMD, including annual reports, disclosures to investors and reporting to regulators?
Fogarty: The shift towards greater transparency is something the industry has been moving towards – even without the regulation since the financial crisis – largely as a result of investor pressure. Investors have been much more demanding in the aftermath of the financial crisis from and have been lobbying for fund managers to disclose more information, more often, in a uniform way. Managers, on the whole, have responded positively to these calls, and in turn have seriously improved how they communicate to their investors by giving more information on their investments and holdings in a frequent and timely manner. They have also become better at speaking directly to investors on a regular basis, and responding to investor queries for more information. The fundraising environment has been fierce for the past few years, and funds have had to listen to investor calls for better transparency in order to gain assets. So, in general, I think both non-EU and EU funds will be comfortable with the transparency requirements the directive will exert on them. They have already enhanced their IR and back office operations to deal with these types of requests over the last few years in order to cope with the growing investor demand for more information.
Breen: The reality is that if the manager started with an industry standard offering document produced by a reputable law firm, then the investor disclosures will be 95 percent contained in the current offering document with an additional 3 percent in the DDQ or other material. So the Article 23 requirements will not be the problem for most managers. The areas that will cause problems for those managers that currently do not undertake a similar level of disclosure under their current regulatory regimes are the ongoing reporting to regulators on Annex IV; the transparency requirements with respect to portfolio companies; and the annual report. This last one is interesting because it is not the fact that an annual report needs to be provided one is already produced. Instead, the issue that is causing most concern relates to the remuneration disclosure that is now required and how to determine who falls inside and outside scope of ‘identified staff’.
Le Poidevin: A major advantage of using the Guernsey route is that some of the requirements are less onerous than those under AIFMD, for example in reporting and remuneration. For non-EU funds with EU managers who are required to comply with the Directive, there is little choice but to comply with such transparency requirements. However, depending on the level of marketing, Guernsey can provide a slightly less onerous offering. For example, Guernsey AIFs, and Guernsey and non-Guernsey AIFs which are managed by Guernsey AIFMs, and marketed within the EEA under the national private placement regimes will only have to comply with certain disclosure and transparency requirements contained in the Directive – eight of the 71 articles of the Directive. Notably, these do not include the remuneration, valuation and depositary provisions. In addition, the AIFMD Rules allow Guernsey AIFMs to decide, based on their individual marketing strategy, whether it is in their best interests to remain outside of Guernsey’s AIFMD equivalent regime or whether to opt in, providing flexibility.
FW: What compliance challenges are non-EU fund managers facing? To what extent will they need to change their strategies, functions and internal processes to adapt?
Le Poidevin: One of the main challenges is the requirement to split out the risk management and portfolio management functions. However, it remains to be seen exactly what view will be taken on how these functions should operate in practice because hedge funds and private equity funds, for example, are run very differently. Therefore, there needs to be pragmatism and a sense of proportionality in the application of the requirements otherwise they will prove extremely onerous for managers. Of course, investment houses can choose to have risk management or portfolio management functions carried out within EU-based management entities or they can designate a fund to be self-managed and therefore itself a non-EU AIFM. This has potential advantages in terms of the compliance and cost burden but investment houses will need to have sufficient substance in their AIFM as the management entity for carrying out the risk management and portfolio management functions if the fund is truly considered to be managed outside of the EU.
Breen: This is another difficult question to provide a general answer to as it entirely depends on each client. Some managers will have the necessary operational functions in place and handling the changes will cause incremental costs. However, many managers are not in this position and will find that adapting will require additional costs. The question then becomes whether the increased costs are a necessary expenditure as a result of the strategy or the need to raise capital. With regards to changing the strategy, I believe that this will depend on whether the ongoing disclosures to the underlying EU companies or the related asset stripping rules cause a significant problem for the strategy.
FW: What can non-EU managers do to ensure they establish AIFMD-efficient fund structures?
Breen: I would suggest that an AIFMD-efficient fund structure at this stage is not attainable without incurring potentially significant problems. Rather, the managers should sit down with counsel to discuss what their specific goals are with respect to Europe and counsel can then work with the managers to determine what the most efficient structure would be. I would anticipate a significant rise in EU domiciled products pushing for an internally managed fund structure. While this does provide for many benefits it also comes with certain potential problems particularly regarding remuneration restrictions. The key for these structures would be for the jurisdiction to provide certainty that the restrictions will not apply to delegates and that ESMA will not take any corrective action regarding that member state’s view.
Le Poidevin: One important factor is that AIFMs should ensure that they do not fall foul of the letter box entity provisions – that is, sufficient substance is needed to demonstrate that the management entity is established outside the EU and therefore it is also important for investment houses to ensure they have enough substance in the domicile of their fund if they opt for it to be self-managed. Guernsey has an advantage over a number of other third countries in that there is already significant substance to our fund structures. For example, hedge fund managers such as BlueCrest and private equity houses such as Apax, BC Partners and Permira not only have Guernsey domiciled funds but they have offices and staff based in the Island. In addition, there are also a range of fund administrators ranging from major international names such as Northern Trust and State Street to specialist independent private equity administrators. There are also a number of global custodians who will be acting as depositaries in the Island and they are soon to be supplemented by those specialist administrators who are applying to establish Guernsey-based depositaries, in particular to service private equity and real estate funds which have not previously had the requirement for a depositary, but who can also take advantage of a depositary ‘light’ regime for non-financial assets.
FW: What final advice can you offer to non-EU fund managers on addressing and operating under the provisions of the AIFMD?
Le Poidevin: It is important for managers to realise that the EU is not the only answer and that, in particular, Guernsey offers a dual regulatory regime: an opt-in regime which is AIFMD compliant and, on this basis, provides for the distribution of Guernsey funds into the EU on an equivalent basis, albeit with less onerous reporting and remuneration requirements; and our existing regime which is free from the compliance and cost burden associated with AIFMD and provides access to distribute funds into the EU under NPP regimes and is also very attractive for managers targeting non-EU investors. Indeed, where a manager has both EU and non-EU investors then it is possible and may be considered prudent to establish parallel or feeder funds so that the compliance and cost burden are limited to only those where it is absolutely required under AIFMD. The bottom line is that Guernsey offers optionality and flexibility which allows us to service our clients in the most appropriate manner as fits their specific circumstances.
Breen: My advice seems facile, however the first step to compliance is better understanding of what the AIFMD is, and how it impacts your existing business and the anticipated growth of your business. Managers should undertake a cost/benefit analysis to determine whether Europe still plays an important part in their capital raising or investment strategies. If so, then they have to simply make the changes , though these changes could be quite challenging. As an American having lived in Europe for many years, another piece of advice that I would convey is that the uncertainty in certain areas will continue for some time, until an industry practice develops.
Fiona Le Poidevin is chief executive of Guernsey Finance. She was previously a senior tax manager with a Big 4 accountancy firm, and has over 15 years’ experience working in financial services in both the UK and Guernsey. Miss Le Poidevin is a chartered accountant, a member of the Institute of Directors and holds the IoD Diploma in Company Direction. She can be contacted on +44 (0) 1481 720071 or by email: firstname.lastname@example.org.
Barry Breen is a partner at Katten Muchin Rosenman UK LLP. He advises clients on all aspects of asset management with a particular focus on hedge fund structuring and operations including single investor funds and managed accounts. In addition to mainstream hedge funds, he counsels start-up managers and established managers regarding hybrid and private equity structuring and operation across a broad spectrum of asset classes. Mr Breen is a qualified solicitor in England and Wales. He can be contacted on +44 (0) 20 7776 7635 or by email: email@example.com.
Ignatius Fogarty is head of Private Equity Products at Preqin. He joined the firm in 2005. Mr Fogarty is responsible for the commercial elements of Preqin’s Private Equity product suite, producing and editing Preqin’s private equity focused publications, developing, and promoting the products and managing other strategic initiatives. Mr Fogarty has a BA from the Kings College London. He can be contacted on +44 (0)20 7645 8858 or by email: firstname.lastname@example.org.
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