FW moderates an online discussion focusing on the AIFM Directive between Stuart McLaren, a partner at Deloitte LLP, Peter Stapleton, a partner at Maples and Calder, and Neil Robson, an associate at Schulte Roth & Zabel International LLP.
FW: In your own words, could you provide a brief overview and background on the AIFM Directive (AIFMD) in its present form?
McLaren: The AIFMD was born out of European politicians’ understanding of the financial crisis and was a way to implement the G20’s commitment to regulate hedge funds. The AIFMD has been on the table for over three years now. During that time the hedge fund, real estate and private equity communities have been drip fed various versions, culminating in the publication of ‘Level 1’ in July 2011. The final directive contained over 100 areas where European Commission (EC) or ESMA were required to put flesh on to the bones of ‘Level 1’. This process started in December 2010 with the EC’s “request for advice” to ESMA and will imminently end when the EC publishes its implementing regulation. During the first half of this year ESMA’s technical advice had been put through the political mangle without appropriate technical debate and we are keenly awaiting the implementing regulation’s publication. It is important not to forget ESMA’s Discussion paper on Key concepts of the Alternative Investment Fund Managers Directive and types of AIFM, and the Consultation paper on Guidelines on sound remuneration policies under the AIFMD. These papers from ESMA will help shape the types of firms within the scope of the AIFMD and the extent to which the Level 1 remuneration provisions will apply.
Stapleton: The financial crisis in 2008 exposed a series of vulnerabilities in the financial system. Across the globe, politicians and regulators undertook a review of supervisory frameworks for global financial markets and decided to introduce a new set of rules resulting in, inter alia, Dodd-Frank, FATCA, UCITS V and of course, AIFMD. The new rules have been subjected to heavy criticism from their inception. Many commentators felt that they were rushed and an overly zealous ‘one-size-fits-all’ reaction to failures in heavily regulated sectors, including investment banking and insurance. Proponents of this view argued that proper supervision and enforcement of existing regulation rather than a completely new playbook was the way to go. However, that argument has lost out and the final position taken by the G20, European Commission and other international bodies was that all relevant actors in the financial markets needed to be subject to new regulation and oversight. The perceived wisdom was just because some sectors had not been directly responsible for the credit crisis did not mean that they would not be the cause of the next crisis. Within the EU a key area of focus was the activity of alternative investment fund managers and the alternative investment funds (AIFs) they managed – roughly defined as all non-UCITS funds. While the European Commission noted that the impact of AIFMs on markets had been largely beneficial, they also held the view that their activities could serve to spread or amplify risks through the financial system, particularly as the sector had grown exponentially in recent years to a point where it managed trillions of euros. Therefore, AIFMD was designed to establish a harmonised and stringent framework to cover the activities of all AIFMs managing or marketing in the EU, irrespective of whether their registered office was within the EU or in a ‘third country’ and to cover all domiciles of the AIFs they managed. This entailed the drafting of common requirements governing the authorisation, operation and supervision of AIFMs and, indirectly, their AIFs and other service providers. A ‘Level 1’ text in the form of Directive 2011/61/EU was adopted on 8 June 2011 (the ‘Directive’). EU Member States have until 22 July 2013 to implement it into domestic law although some, including Ireland, are likely to implement it at a much earlier date. Pursuant to the transitional provisions of Chapter X of the Directive AIFMs will have an additional year to comply with its terms and further transitional measures will exempt some existing funds, mainly closed-ended AIFs. In between now and 22 July 2013 the European Commission will finalise regulations (the ‘Regulations’) designed to implement detailed technical measures and guidelines supplementing the broad principles set out in the Directive (the ‘Level 2’ measures). At the time of writing, drafts of the Level 2 measures have been widely circulated are causing the most controversy. Many industry participants feel that the draft Level 2 is being used to rewrite certain provisions of the Level 1 text and go beyond the scope initially envisaged by AIFMD. There is also disappointment that they do not follow, in all respects, the detailed technical advice which ESMA provided to the European Commission in November of 2011.
Robson: The European Commission released the first draft of the AIFMD on 30 April 2009. The AIFMD requires the authorisation of managers in the EU providing management services to AIFs including hedge funds, real estate funds, private equity funds, non-UCITS regulated funds and funds of hedge funds – the definition is so broad that it pretty much encompasses all funds that are not UCITS funds. The AIFMD also subjects AIFMs to certain operational, organisational, reporting and capital requirements, all of which are more stringent than under the current EU MiFID rules under which EU-based fund managers are already regulated. The AIFMD also regulates the marketing of AIFs in the EU by non-EU AIFMs. The genesis of the AIFMD was the 2007-08 financial crisis, but with EU lawmaking set against a heavily politicised background and subject to intense lobbying and extreme criticism, it took over two years of debate to get it into an agreed form. However, as at the date of publication the AIFMD is still not finalised as we have already had in excess of a year of further debate on the subordinate regulation which lies underneath the AIFMD, and which provides much of the detailed rules with which AIFMs managing AIFs in the EU or AIFMs trying to market their AIFs into the EU will be required to comply. The final subordinate rules are anticipated to be published in September 2012, after which the full extent – and the detail – of the new AIFMD regime will be known.
FW: In your opinion, what is the potential impact of the AIFMD on the alternative investment market in Europe?
Stapleton: AIFMD has the potential to revolutionise the alternative investment market in the EU and further afield. The AIF market was recently estimated by the Commission to have €2.2 trillion in AUM. However, this represents only a fraction of the close to €6 trillion in AUM of the UCITS sector, leaving ample opportunity for the AIF industry to expand in the EU. Indeed, many expect EU authorities to encourage some ‘NewCITS’ strategies to move out of UCITS and into the AIFMD framework once it is established. To make this an attractive option and as a quid pro quo for adhering to the new harmonised standards, EU AIFMs will be offered the opportunity to market their AIFs throughout the EU on the basis of a passport. This will open up new distribution channels and give them access to markets which traditionally have been difficult or impossible to access. Non-EU AIFMs may have the opportunity to ‘opt-in’ from 2015 and the fears of a ‘fortress Europe’ barrier for the private placement of third country AIFs – such as Cayman or BVI – has largely been avoided with the private placement regimes in Member States due to continue until at least 2018, and as noted the passport option possibly opening up in 2015. It will be interesting to see whether non-EU AIFM’s choose to opt in to the directive and avail of the passport or continue to privately place their funds up until 2018. In any event, most commentators feel that allowing them the ability to do both is a welcome option. There is hope that in time, AIFMD will come to be viewed as a badge for investor protection and high-standards in much the same way as the success enjoyed by UCITS funds both inside and outside of the EU. However, AIFMD also poses some serious challenges with the costs of compliance likely to impact most on the smallest managers. While there are de minimus AUM threshold rules set out in Article 3 of the Directive, the rules governing leverage calculation and the uncertainty as to whether Member States will impose stricter measures to limit the small manager exemption – means that these thresholds may be less effective in practice. The costs of appointing a depositary under the new liability standards set out in Article 21, the uncertainty over delegation, incompatibility with MiFID, the remuneration controls and the issues surrounding third country cooperation agreements all pose serious issues for an efficient and balanced implementation. It is fundamental to the success of AIFMD that a level playing field between EU and non-EU entities is maintained.
Robson: EU-based AIFMs are already required to be authorised under MiFID and so will already be subject to registration, regulatory capital, compliance and reporting requirements. Under the AIFMD many of the same principles and requirements will apply, though the AIFMD imposes much more onerous reporting requirements. (It is worth noting that the EU legislative bodies in Brussels, including the European Commission, have specifically copied into the AIFMD many of the principles from both MiFID and UCITS directives, in many cases on almost a word-for-word basis. This approach shows the EU’s desire to ‘harmonise’ the rules across the financial services sector, but also shows, to a degree, a lack of understanding about how AIFs work, requiring AIFMs to comply with rules that have been formulated for the managers of UCITS funds – being fund vehicles specifically intended to be available to retail investors, whereas most AIFs are not.) However, we believe that one of the greatest areas of impact will be on the burden and cost to AIFMs of compliance, which will increase significantly. However, it is probably the depositary provisions of the AIFMD which will have the greatest impact since these requirements, which impose near strict liability on the depositary, are likely to result in significantly increased costs for those AIFs being managed or marketed in the EU – which will be borne by the AIF and thereby reduce the return on investment for fund investors.
McLaren: The crucial starting point is to answer the question “what do investors want?” When we speak to our clients the responses we receive vary wildly depending on their specific customer base and the markets where they are looking to raise funds. It would be highly speculative to say the AIFMD will be seen by investors as a kite mark of quality, however there are early indications that it will provide a route to markets that were previously closed, or will be closed going forward if national governments take the decision to turn off current private placement routes. If we look at two specific sectors – managed account platforms and pension fund investors – we can see clear trends. With pension investors there has been a clear trend to allocate money on a mandate by mandate basis rather than pooling funds within collective investment schemes, this is a sizable investor base and we don’t think the AIFMD will change this trend. Individual managed account platforms, however, have become increasingly popular among institutional investors but are specifically outside the scope of the AIFMD. As noted in the press Lyxor is considering moving these platforms onshore into a more regulated environment, presumably due to investor demand. We expect this trend to continue.
FW: What issues and challenges are associated with ‘level 2’ requirements that aim to incorporate the regime into each country’s legislative landscape? What domestic legal and regulatory preparations are underway in various European countries?
Robson: The Level 2 requirements are the subordinate legislation that is being prepared under the AIFMD. In the drafts we have seen to date the Level 2 requirements have been drafted in the form of an EU Regulation – which has direct effect in each country of the EU and which cannot be ‘softened’ in its application in the law of each country – the Regulation applies as the national law in each country, whether or not that country has actually implemented it into its national law. Nonetheless, it is currently anticipated that each country will amend its national laws to reflect the provisions of the AIFMD and the Regulation. The Regulation may be seen as the minimum requirements under the AIFMD; although countries cannot implement less strict rules, they do still retain national discretion to implement more stringent rules in their own jurisdiction. In the UK, the FSA usually uses what it refers to as an ‘intelligent copy-out’ approach, so that UK law and regulations will closely follow that in the AIFMD and the Regulation. Both the FSA and HM Treasury have already started looking at how the UK’s existing rules will need to change so that the UK can implement the AIFMD on time and so that market participants and AIFMs can get a clear understanding of the post-22 July 2013 rules as soon as possible – at present there is no indication that the FSA and HM Treasury will go further than the AIFMD and the Regulation, although it is possible that some other countries, which have traditionally been markets in which hedge fund marketing is not permissible, may implement a stricter set of rules after 22 July 2013. We are aware that some other countries’ regulators have started to look at how the new rules will be transposed into national law – though the big problem at the current time for all concerned is that we still do not have the final version of the Regulation, so there is no way yet for regulatory authorities to finalise national rules.
McLaren: The key point to note here is that Level 2 is coming out as a regulation, this means that, compared to a directive, local regulators have little to no scope to engage in ‘intelligent copy out’ for the benefit of their local market participants. The UK FSA and HM Treasury have separately issued discussion papers at the beginning of this year addressing those areas where there is local discretion. There are a number of challenges in the UK but perhaps it is worth just mentioning two. The first is in relation to the UK financial promotions regime and how this will need to be amended to take into account the marketing definition within the directive and the new transparency requirements when privately placing funds in the UK. Firms have historically understood what marketing activities can be undertaken in the UK without being considered to be making a ‘financial promotion’, the AIFMD uses a new definition of ‘marketing AIF’ which may catch practices that were previously out of scope. It will also be interesting to see what information the FSA will require of non-EU managers marketing funds in the UK and how the registration process will work in practice. The second relates to the position for managers below the €100m or €500m thresholds, as you are aware the AIFMD places fewer requirements on these firms but gives discretion to national authorities to ‘top up’. Our reading of the HM Treasury’s paper is that it appears to be positioning the market to expect significant additional provisions for AIFM that fall under these thresholds, perhaps equal to those fully in the AIFMD regime.
Stapleton: In my view, the challenge will not arise from the implementation of Level 1 or Level 2, particularly as much of Level 2 will be directly transposed by regulation into the laws of Member States. Rather, the challenges will come from the need for reform of domestic Member States laws governing existing AIFs and the creating of new regimes to cover those funds which may have fallen outside traditional alternative investment fund regulation. Some of the leading Member States for managers and fund domiciliation have begun drafting domestic legislation to implement the Level 1 Directive and to amend local rules covering their AIF regimes. For example, in Ireland the industry, Central Bank of Ireland and relevant governmental departments are all working towards the introduction of AIFMD by the end of 2012 and good progress has been made. If these measures stay on track this will give AIFMs just over six month prior to the formal deadline of 22 July 2012 to seek authorisation – noting it can take up to six months under Article 8 – and give non-Irish AIFMs a clear idea of how the Irish AIF regime will work for entities seeking to locate AIFs, internally managed AIFs or establish external AIFMs in Ireland. Outside of the EU, the impact AIFMD will have for non-EU AIFMs wishing to opt-in – for example to avail of the passport –and for leading third country AIF domiciles – such as Cayman, Delaware and BVI – will need to be taken into account. The Directive sets out a clear regime to govern third country AIFMs wishing to privately place AIFs in the EU or to potentially avail of the passport from 2015. However, the Level 2 measures have raised concerns over whether these measures can be adhered to in practice. For example, the extra-territorial nature of the cooperation agreements and the obligations they seek to impose on non-EU authorities has been criticised. In this regard, it is somewhat disappointing that EU and US regulatory reforms in the shape of Dodd-Frank and AIFMD are not more harmonised considering they were drafted in similar timeframes and with the same global financial crisis in mind. My colleagues in our other global offices inform me that the only remaining criteria to allow key third country fund domiciles such as the Cayman Islands and the British Virgin Islands to be able to be marketed across the EU in accordance with national private placement regimes is the negotiation of cooperation agreements between relevant regulators. The fact that ESMA is centrally negotiating a form of cooperation agreement will assist with the logistics of finalising these in good time. The Commission and ESMA both take the view that the agreements should substantially follow the form of the IOSCO Memorandum of Understanding on the subject, to which both the Cayman Islands and British Virgin Islands’ regulators are already a party, so we are optimistic that the substance of the agreements will not be problematic and the remaining barrier to entry will be cleared in good time for the 2013 deadline.
FW: What has been the general reaction of the market to the European Commission’s and ESMA’s handling of the AIFMD drafting and implementation process?
McLaren: The market’s reaction has been one of confusion because of the fundamentally different approaches taken to the drafting process – on one hand you have ESMA inviting technical experts to workshops to discuss and evaluate proposed rules during the drafting process and on the other hand we have the closed door approach of the EC, pushing away technical advice and relying on what some commentators have said is a political slanted interpretation of the Level 1 text to ignore some of ESMA’s advice. We expect that this will be replicated in UCITS V and PRIPS – unfortunately it is something the market will have to get used to.
Stapleton: One must accept that, once the decision was taken to regulate AIFMs and putting to one side whether that was the right or wrong decision, agreement on a set of measures to regulate the activities of AIFMs on a global basis was going to be a colossal task. Certain elements of the Directive, once objectively viewed, can be seen as reasonable. On a conceptual level, the mandatory provisions applicable to AIFs – for example depositary, valuation rules, transparency, and so on – are not too dissimilar to the most common types of AIFs currently operating in the EU, such as Irish QIFs. Allowing EU investors to continue access to third country AIFMs and AIFs pursuant to a common regulatory framework is also a sensible measure. However, getting the high-level concepts right is one issue, the manner in which they are implemented and the technical measures are another. Thus, from the beginning there has been wide spread criticism of the actual process followed by AIFMD; from the speed at which the first draft text appeared after the high-level conference in February 2009, which led many in the industry to believe their input had not been fully considered, to the divergent drafts emanating from the Council, Commission and Parliament during the Level 1 drafting process, and on to ESMA’s technical advice and the draft Level 2 Regulations. The majority of current criticism stems from the belief many participants hold that the proposed Level 2 Regulations would, if transposed in their current form reverse, or at the least misinterpret hard-fought compromises in the original Level 1 text. In key areas many feel the suggested Level 2 provisions ignore or go further than ESMA’s technical advice – these include, but are not limited to, the rules governing depositary liability, delegation, leverage calculations and scope of the Directive and its exemptions.
Robson: The general market reaction in the UK has not been positive, seeing the initial proposal as both unnecessary and excessive – and leading to almost certain increased costs for AIFs and, consequently, reduced returns for investors. The Commission has repeatedly set short timeframes – possibly intentionally – to try to achieve consensus, and this has itself led to difficulties and conflicts of opinion. ESMA had tried to find a balanced middle ground for the Level 2 Regulation, but significant elements of this were rejected outright by the Commission – including in the areas of the roles and responsibilities of depositaries, co-operation arrangements with regulators in non-EU countries, using and calculating leverage, professional indemnity insurance, appointing prime brokers and calculating assets under management. The Commission has instead sought much stricter and more onerous rules for AIFMs, although there is still heavy lobbying going on behind the scenes to try to get the final Regulation drafted in such a way that is similar to ESMA’s draft. Only once the final Regulation is published in September will it become clear to what extent the Commission is following a hard-line, or if those lobbying and the industry generally have been able to persuade the Commissioners to make the Regulation easier for industry to use.
FW: In what areas do you see additional costs arising for investment managers as a result of the AIFMD?
Stapleton: The most talked about cost is the likely increase in depositary fees. However, the market is still waiting to see whether the proposed Level 2 Regulations will be amended to reduce the application of strict liability in key areas – for example passing of collateral, delegation, appointment of prime brokers. It will also be interesting to see the movement in average depositary fees following competition between the main players and the comparison between EU AIFs and non-EU AIFs. Depositary groups who have large affiliated sub-custody networks and related prime brokerage units – noting the requirement of the Directive for functional and hierarchical separation – may be able to price risk more competitively. In addition, the managers of most AIFs currently operating in the EU are regulated under MiFID. ESMA’s interpretation of the Level 1 text is that they cannot seek dual authorisation under AIFMD. This raises a cost-benefit analysis as to whether they will convert from one regime to the other, seek to provide MiFID services to an AIFM or internally managed AIF pursuant to the delegation arrangements under Article 20 of the Directive, form new AIFM affiliates or provide the limited MiFID services permitted by AIFMD. Other heads of cost will likely include compliance with the new private equity rules, valuation requirements and, of course, the remuneration provisions bring financial restructuring requirements of a fundamental nature. On the other hand managers will see a fall in cross-border marketing costs where the avail of the passport. Due diligence costs and timing for managers complying with AIFMD may also fall as the market and investors becomes familiar with AIFMD as a brand and the acceptance of AIFs offered by these managers.
Robson: The AIFMD’s near-strict liability obligations on the depositary for its own failures and for those of any sub-custodians which it appoints will be the core area of change that leads to additional costs. Current market practice is that depositaries are not compensated for the risk of strict liability, so adding this new obligation will almost definitely lead to higher charges to cover the risk. Another area of increased costs for AIFMs will be on the compliance and risk management functions – since both will need to be significantly better resourced than they are at present to comply with their obligations under the AIFMD. AIFMs will almost certainly need to ensure that they have more personnel to cover these areas, with the associated costs that come with them. There will also be time-costs incurred in making sure that the AIF complies with all the AIFMD’s requirements – including the periodic and annual disclosures to investors and to EU regulators. AIFMs may well find that the volume of reporting and compliance work required by the AIFMD will mean in future that they have to have a dedicated, knowledgeable and responsible compliance officer, which for many smaller AIFMs could be a significant and costly change.
McLaren: We are seeing firms considering structuring changes which will have associated implementation costs. They are currently undertaking a cost benefit analysis of the different management company and fund structures to reduce ongoing regulatory costs whilst retaining beneficial tax treatments. Ongoing costs primarily relate to the additional fees payable to depositaries at a fund level. We understand that depositaries have not yet fully priced these new services and therefore this is an area of uncertainty. Additional costs at the AIFM level relates primarily to the global investment managers who will need to build a regulatory reporting solution to provide regulators with the information required by the AIFMD, but in a cost efficient way. Many firms are considering outsourcing to existing service providers – such as administrators – the operational production of fund level information in a form that can be sent directly to regulators, this may be a cost effective solution for some but the ultimate responsibility cannot be delegated. We are seeing tentative analysis of additional headcount increases. In the main this is being driven by the risk management provisions, partially among the mid-market or smaller players who have thinner governance structures.
FW: The delegation provisions have been a key area of contention between ESMA & the EC. How do you think this will impact fund and management company structures?
Robson: At the current time, we do not think that there will be any great impact on management company structures. Where a ‘typical’ hedge fund is formed in the Cayman Islands as a master and feeder structure – with a Cayman manager delegating authority for the portfolio management and the risk management to a UK-based FSA authorised investment manager – it seems likely that the UK-based investment manager will be defined as the AIFM, as the delegation provisions contain a requirement that the delegation by the manager should not be such that the manager is left as merely a ‘letter box entity’. The Cayman manager would have to have real substance, and personnel, to be able to be defined as the AIFM – meaning that the AIFM would be offshore and would not necessarily need to become registered in the EU and comply with the AIFMD requirements. Where the Cayman manager does not have substance, and is defined as a letter box entity, the default position will be that the UK or other investment manager will be the AIFM. In the typical structure the AIFM will be the current investment manager, which for UK investment managers will mean a switch away from that firm being registered with the FSA as a MiFID firm and it becoming re-registered as an AIFM. Unfortunately, until the Level 2 Regulation is finalised it is impossible to be sure exactly what the European Commission means by ‘letter box entity’, so for the next month or so we must wait and see…
McLaren: We think the delegation provisions, specifically the definition of a ‘letter box entity’ will be pivotal when firms are considering fund and management company structures. The area of contention is the day-to-day activities management companies will need to undertake to be considered by the AIFM. The ESMA advice focuses on governance and decision making, specifically that the AIFM must be able to effectively supervise its delegates and undertake senior management function at the delegate if required. The EC focuses more on the operational aspects, requiring that “the totality of the individually delegated tasks substantially exceeds the tasks remaining with the AIFM”. If the EC’s view wins out we expect there will be limited scope for hedge funds to structure themselves out of the directive without non-incidental costs, however, for private equity and real estate managers, the door to restructuring is still firmly open.
Stapleton: The delegation provisions have rightly been a key area for debate as AIFMD will need to create a world-class infrastructure whereby EU investors can access the best managers in the world. While the Directive requires that each AIF must have a single AIFM responsible for compliance with its provisions (Article 5), the Level 1 text also explicitly recognised – for example Recital 30 and Article 20 – that it may be necessary and, more importantly, efficient to delegate portfolio and risk management as well as other AIFM functions to third parties who have expertise in those strategies and services. However, the restrictions proposed by the current draft of the Level 2 Regulations risk imposing a set of impracticable limitations on delegation and the proposed ‘letter-box’ test in is inconsistent with leading EU and international principles – for example as established in many COMI cases involving investment fund and non-investment fund entities – and also with respect to the most successful EU investment fund product to date: UCITS.
FW: What opportunities do you see arising out of the AIFMD?
McLaren: We think that the opportunities arising out of the AIFMD will fall primarily on those European firms that are managing schemes that don’t fit into the UCITS framework, where there is ability to leverage institutional distribution challenges which may have previously been closed. We also understand that firms are taking a tentative look at management company restructuring, there is certainly benefit in having just one regulated entity in Europe but there is a worry that local authorities may place barriers so that this opportunity may not be fully utilised. Tax barriers will also need to be overcome. We do not currently see institutional investors demanding a more regulated product; some commentators consider that AIFMD may be used as a kite mark of quality that could potentially lead to higher levels of investment. This is not our view at the moment.
Stapleton: AIFMD offers tremendous opportunities. It will create an internal EU market for AIFMs and a harmonised framework to for the activities in the EU of all AIFMs, regardless of their domicile. If the politicians, regulators and industry participants get the balance right they have the ability to build a UCITS-type brand for alternative investment products in the EU. They also have the chance to offer balanced incentives via a marketing passport and investor protection to encourage – and ‘encourage’ rather than ‘force’ is the key word – global managers to opt-in to AIFMD regardless of whether they manage EU or non-EU AIFs. At the same stage, AIFMD will permit non-EU managers and non-EU funds to continue to be privately placed in the EU – and possibly sold via a passport from 2015 – giving European investors a wide choice of product. The potential for growth in a stable framework is enormous, with the AUM of AIFs in 2010 amounting to only 18 percent of EU GDP. Two thirds of this is made up of institutional investors with pension funds and insurance companies representing 70 percent of this amount.
Robson: One of the key opportunities for AIFMs – and for investors – under the AIFMD may turn out to be the ability to market interests in the fund cross-border in the EU under the marketing passport. Initially it will only be made available to EU AIFs with EU AIFMs, but it may be extended in 2015 to all funds if ESMA gives a positive opinion as to the passport’s effective functionality for EU AIFs and if the European Commission decides to extent the passport to non-EU AIFMs. At present the marketing rules for hedge funds in many EU countries are highly restrictive, even where the manager is in the EU, so a clear ability to conduct marketing in other EU countries could be a great benefit. The AIFMD also clarifies that reverse-solicitation marketing is permissible, which could open-up some EU jurisdictions to marketing opportunities where reverse solicitations are currently in something of a ‘grey-zone’. However, until each of the countries of the EU has implemented the AIFMD and the Regulation into national law in that jurisdiction there is no certainty yet as to whether, in fact, the passport will have real value. If certain countries close their markets to non-EU AIFs by withdrawing private placement rules in their home jurisdiction, then the only way to conduct marketing of AIFs could be by using the passport, forcing all AIFMs that wish to market in the EU to become registered somewhere in the EU. The real benefits of the AIFMD will probably only become apparent in years to come, after the dust has settled and after the passport is made available more widely – if that, in fact, ever happens.
FW: ESMA has been tasked with various guidelines and regulatory technical standards. Which of these do you see having greatest impact for investment managers?
Stapleton: ESMA has been tasked with providing guidelines and technical advice to cover the following. First, the general provisions, authorisation and operating conditions for AIFMs. Second, the depositary requirements – particularly delegation and liability. Third, transparency and leverage. Finally, supervisions of AIFMs and third country provisions. In addition to formal requests from the Commission they also have a general role in developing other technical standards and guidelines and we have seen some work in this area, for example ESMA’s key concepts of AIFMD and types of AIFM discussion paper in February 2012. The main difficulty we are hearing from managers in relation to the technical standards and guidelines is that they will add restrictions not envisaged by the Level 1 text nor set out in ESMA’s technical advice. As noted above, the depositary, delegation and leverage rules as well as the cooperation agreements would appear to be causing the most controversy at the moment.
Robson: Initially it was thought that the Level 2 remuneration rules could potentially have had a significant impact on AIFMs, but ESMA’s consultation on these suggests that these will contain proportionality provisions that may make them workable and potentially only a little more onerous than the FSA’s existing Remuneration Code, which UK hedge fund managers are already complying with. However, as is referenced earlier, the one delegated issue that may have the greatest impact on investment managers could be ESMA’s 2015 opinion to the Commission regarding the functioning of the marketing passport. If the passport is deemed to be a success, it is possible that ESMA’s opinion could lead to the marketing passport being made available by the Commission to all types of AIFs and AIFMs – and which would ultimately result in the abolition of all private placement rules across the EU – changing EU marketing practices forever.
McLaren: It is quite clear that the guidelines with the biggest impact are those relating to remuneration. ESMA published these guidelines on 28 June and immediately you can see the additional requirements for UK investment managers. Currently UK investment managers have to keep to the remuneration code which flows out of CRD III. In practice most firms have minimal requirements because of the way it has been implemented in the UK they can disregard certain element entirely. ESMA’s guideless explicitly say that none of the remuneration requirements can be disregarded, however AIFM will need to apply judgement as ESMA also says that “not all AIFMs should have to give substance to the remuneration requirements in the same way and to the same extent”.
FW: What advice would you give to investment managers on preparing for compliance with the Directive in the near future?
Robson: The advice at present would be to be aware of the areas where there will be substantial obligations placed on the managers as AIFMs, and to keep monitoring their compliance consultants and lawyers for guidance and briefings. The real action point for AIFMs in the UK will be once the FSA publishes the final text of its new rulebook for AIFMs (to be known as ‘FUND’), since this will be how the FSA will implement the AIFMD into UK requirements and it will set forth the specific requirements that UK-based AIFMs will have to comply with. The final Level 2 rules are not expected from the Commission until mid-September 2012, meaning that we may expect the FSA to publish a consultation on FUND in the month or so after that, with the final rules being published perhaps as early as November 2012. What is certain is that the final quarter of 2012 will see a flurry of activity and all the final details for the new AIFMD rules that will be taking effect from 22 July 2013.
McLaren: We have three pieces of simple advice. It is of primary importance that firms to check that easy ways to avoid the AIFMD have not been overlooked. The second piece of advice will be to consider the timelines: do you need to be ready by 22 July 2013 or 22 July 2014? If firms are capital raising in mid-to-late 2013, investor questionnaires may expect you to already be AIFMD authorised. If you are not authorised will this place you at a disadvantage? The directive is written as if one size fits all, this is obviously not true and therefore our last piece of advice is that, invariably, managers will need to use judgement. Regulators like to see that regulatory compliance manuals are engrained within the business, so firms should consider not just the letter of the law but its intentions. If they follow this advice we hope that there will not be any unwanted questions by regulators after site visits.
Stapleton: We have been advising our clients on preparation for compliance with an AIFMD regime ever since the initial high-level conference was held in February, 2009. Naturally, the advice has become more detailed as the Level 1 text was finalised and Level 2 appears to be heading towards sign-off. The main focus is now on how the remaining ‘hot issues’ will impact on post-AIFMD structures. In that regard we are working with our clients and international counsel on designing what we believe will be AIFMD efficient fund structures. This involves addressing the new AIFMD issues from an Irish, Cayman and BVI perspective including fund structures, the new depositary-prime broker models, internally managed funds, delegation options, third country cooperation agreements and leverage. While most are adopting a ‘wait-and-see approach’ others have started to move and the predominant trend we are seeing in the market at present is towards co-domiciliation. There are enough benefits in AIFMD to entice EU managers and non-EU managers with significant EU investor bases to set up EU AIFs. Many managers with a global investor base are opting to form additional Irish funds or UCITS to cater for certain categories of EU investors whilst at the same time continuing to form fund vehicles in Cayman or BVI for their non-EU investors or for those EU investors who may not need the UCITS or AIFMD compliant funds. These structures can also incorporate an element of traditional fund centre investment – for example via master-feeder structures as envisaged in Chapter VI of the Directive. However, for other managers AIFMD is a step too far and the regulatory burden and costs of compliance will result in them structuring part of their operations outside the EU with non-EU AIFs being sold on a private placement basis or in some cases EU AIFM affiliates set up to accommodate EU or non-EU AIF options where demand warrants it.
Stuart McLaren is a partner at Deloitte LLP. His current focus is the Alternative Investment Fund Managers Directive. Mr McLaren leads Deloitte’s investment management regulatory advisory practice, which most recently have included; management company reorganisation for a global multi-class asset manager and regulatory investigations on subjects including client money, institutional mischarging, governance and investment fund pricing. He can be contacted on +44 (0)20 7303 6282 or by email: email@example.com.
Peter Stapleton is a partner in the investment funds group at the Dublin office of international law firm Maples and Calder. He regularly advises investors, promoters, fund managers and investment banks on the establishment, structuring, financing, public and private distribution and ongoing operation of traditional and alternative investment funds including UCITS, QIFs, hedge funds, funds of funds, master-feeders, private equity funds, managed account platforms and bespoke structures. He also has significant expertise advising in the areas of derivatives, prime brokerage, investment services and securities law. Mr Stapleton can be contacted on +353 1 619 2024 or by email: firstname.lastname@example.org.
Neil Robson is a senior associate in the London office of Schulte Roth & Zabel International LLP. He has extensive experience providing regulatory advice regarding FSA authorisation and compliance; cross-border issues in the financial services sector, market abuse, anti-money laundering; regulatory capital requirements; formations and buyouts of financial services groups; structuring and marketing of investment funds; agreements with customers, custodians and service providers; and outsourcing arrangements. Mr Robson has written on regulatory matters for various professional trade publications, and speaks frequently at conferences on developments in UK financial services regulation. He can be contacted on + 44 (0)20 7081 8037 or by email: email@example.com.
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