The European alternative investment funds industry is dealing with what is perhaps the most fundamental change in its history as it now comes to terms with the significant implications and potential opportunities offered by the EU Directive 2011/61/EU on Alternative Investment Fund Managers (the "Directive" or "AIFMD").
The subject of daily information releases from regulators, advisors, industry representative bodies, the AIFMD could perhaps be best described as "Big Bang" for the hedge and private equity and real estate fund communities. Not only will fund managers be faced with a broad swathe of new regulation as to how they run their businesses, the changes introduced also involve significant powers of regulatory intervention, additional investor disclosure and regulatory reporting obligations, an onerous liability regime for depositaries, limits on remuneration arrangements, new notification and asset stripping limitations for the private equity industry as well as limiting investment in securitisations to those where originators retain "skin in the game".
However, the Directive also opens up Europe as a single market place for alternative funds whether these are hedge funds, private equity funds, real estate funds or simply those structures which are unable to fit within the UCITS regime due to liquidity or portfolio concentration issues. The Directive should offer investors access to a broader range of asset classes, create greater competition between fund managers and offer greater protection to investors through transparency obligations, custody liability rules, fund valuation and fund manager level organisational requirements. Although causing quite some level of pain for fund managers, it should ultimately be to their advantage as they will be able to operate on a more level playing field and will have a greater market to target. They will however need to offer investors something more, in particular greater transparency.
In many ways some level of anxiety about AIFMD is warranted. Those of us who have been working in the UCITS and MiFID sectors for years realise the restrictions placed by working in a regulated environment. There are also legitimate concerns that the benefits offered by the single market will come with ever more co-ordinated and harmonised regulation and, perhaps even more relevant, co-ordinated and centralise interpretation through European supervisory bodies such as the European Securities and Markets Authority ("ESMA"). Although AIFMD offers opportunities, it also creates challenges and in many ways it is a good example of the challenges, frustrations and opportunities which are the reality of the European Union.
The principal aim of the AIFMD is to establish common requirements across the EU Member States for the authorisation and supervision of the managers of investment funds, other than UCITS funds, to address the potential prudential risks which might arise from the activities of "alternative investment fund managers" or "AIFMs" and to create a single market for the marketing of non-UCITS collective investment schemes or "AIFs" to EU professional investors. In addition to managers based in the EU, the Directive applies to any non-EU based fund manager (including for example US or Asian based fund managers) who manages one or more alternative investment funds (AIFs) domiciled in the EU and/or who markets AIFs, irrespective of their domicile, to investors in the EU. For instance, US based fund managers that manage Cayman based offshore funds marketed to EU investors in a master-feeder structure would typically fall under the scope of the Directive.
As noted above, the Directive will also create, for the first time, a single marketplace within the EU for the marketing of AIFs, known as a marketing "passport", something which until now was only available to UCITS funds. Initially, until at least October 2015, only entities established in the EU can be authorised as AIFMs to obtain the marketing passport for their EU domiciled AIFs. In or around October 2015, the European Commission may decide to "switch on" certain provisions of the AIFMD, which will enable a non-EU based manager to apply to become authorised as an AIFM under the Directive and to market its funds in the EU under the marketing passport. Until then, non-EU based managers may continue to market in an EU Member State under the EU Member State's own national private placement rules (as amended by the Directive) without the marketing passport.
No-EU managers do, however, need to bear in mind that the European Commission has stated in its Q & A documents that from July 22, 2013 non EU managers marketing AIFs, irrespective of their domicile, to investors in the EU will nevertheless need to comply with certain marketing restrictions, additional disclosure requirements and transparency provisions under the Directive.
Although sometimes portrayed as exclusively manager related, AIFMD also impacts on the funds, or AIFs, they manage. That impact is not only structural (for example, depositary requirements, valuation rules and, for self-managed funds, a variety of organisational rules) but it also adds new layers of reporting obligations (to investors and to regulators) as well as some restrictions on certain types of strategies, particularly in the private equity space.
In Ireland, the implementation of AIFMD is grounded not only on the Directive and the European Commission's Delegated Regulation (EU) 231/2013 (the "Level 2 Regulation") but importantly builds on the almost quarter century old international alternative funds industry in Ireland. Sitting side by side with the UCITS industry, the international alternative funds business in Ireland has grown from a standing start in 1990 to over 2,100 domiciled funds with in excess of EUR 260 billion of assets under management (AUM) and if you include non-Irish alternative funds administered from Ireland, to approximately 8,500 funds and over USD 1 trillion in AUM.
Prior to AIFMD becoming a "twinkle in the eye" of European regulators, the Irish regulator, the Central Bank, had created a three pronged regulatory regime for non-UCITS schemes, applying its investment and borrowing/leverage restrictions by reference to the type of investors targeted – retail, professional or qualifying investors. As this regime evolved, the professional investor structure became somewhat redundant and the retail structure predominantly focused on the domestic market. The qualifying investor fund (or "QIF") structure, however, became one of the principal European regulated fund products for all types of alternative strategy and liquidity profile. In setting out its rules for AIFs and AIFMs, Ireland is building on that strong foundation.
Finally, when considering the new regime and how it might affect your business, it is important to recognise some fundamental differences between the AIFMD regime and the other two pillars of the European asset management industry – UCITS and MIFID.
UCITS was originally a product related regime, where the original UCITS "passport" attached to the UCITS fund itself. It was only much later – with UCITS III and IV – that it developed a second limb as a manager related directive, adding not only MIFID style organisational requirements for the managers of UCITS but also granting them a passport to act as manager to UCITS domiciled in other EU Member States.
MIFID, which grew out of the original EU Investment Services Directive, was always a service, not product, related directive and granted a passport to investment firms to provide a wide range of investment services to clients in other EU Member States, including portfolio management and investment advice.
Although AIFMD is principally a manager/service related directive, it also has elements which directly relate to the product (i.e. the AIF). However, the "passport" under AIFMD is not a product passport (i.e. unlike UCITS), rather the passport is granted to the AIFM and it is a passport to manage and/or market (i.e. a service passport) on a cross-border basis.
Given the fact, however, that AIFMs "manage" and "market" AIFs, one cannot focus exclusively on the service. One has to look at the product and, for that reason, our analysis looks at both the treatment of the manager - the AIFMs - as well as at the product – the AIF– and how AIFs can be set up in Ireland under the new AIFMD regime.
As the implementation process for AIFMD continues to evolve, with almost daily updates, and as domestic Irish implementing legislation has yet to be finalised, we do intend to update this Guide regularly.
Asset Management and Investment Funds
Group
Dillon Eustace
June 4, 2013
1. Who, What and When?
In this Section we explain who the AIFMD applies to, what an AIFM can do and from when. We explain who is exempt from the AIFMD, the difference in capacity between an authorised AIFM and a registered AIFM and what is involved in the activity of "managing AIFs".
In order to make it, hopefully, easier to understand, in a later Section titled "Managing and Marketing under AIFMD" we explain the different scenarios for EU based AIFMs and for AIFMs based outside the EU who wish to manage EU AIFs or market AIFs, wherever based in the EU.
1.1 Who does AIFMD apply to?
Unless a partial or complete exemption is available or the activities in question fall outside the scope of the Directive, the Directive applies to:
(i) any legal person (an "alternative investment fund manager" or "AIFM") established in an EU Member State whose regular business is managing one or more "alternative investment funds" or "AIFs", meaning any collective investment undertaking, including investment compartments thereof, established within or outside the EU:
(a) which raises capital from a number of investors, with a view to investing it in accordance with a defined investment policy for the benefit of those investors; and
(b) which does not require authorisation pursuant to Article 5 of Directive 2009/65/EC (the UCITS Directive);
(ii) any non-EU AIFM managing one or more AIFs established in the EU, irrespective of whether they are marketed in the EU or not; and
(iii) any non-EU AIFM marketing within the EU any AIF (wherever domiciled) that it manages.
See Section 2.1 for more detail on the definition of "AIF".
1.2 Out of Scope
The Directive does not apply to the following entities (i.e. they are outside its scope):
- holding companies;
- institutions which are covered by Directive 2003/41/EC on the activities and supervision of institutions for occupational retirement provision (IORP), including, where applicable, the authorised entities responsible for managing IORP and acting on their behalf referred to in Article 2(1) of that Directive or the investment managers appointed pursuant to Article 19(1) of the same Directive, insofar as they do not manage AIFs;
- supranational institutions such as the ECB, the European Investment Bank, the European Investment Fund, the European Development Finance Institutions and bilateral development banks, the World Bank, the IMF, other supranational institutions and similar international organisations, in the event such institutions or organisations manage AIFs and in so far as those AIFs act in the public interest;
- national central banks;
- national, regional and local governments and bodies or other institutions which manage funds supporting social security and pension systems;
- employee participation schemes or employee saving schemes; and
- securitisation special purpose entities.
1.3 Exemptions
The Directive provides certain full and partial exemptions from its scope depending on the nature of the entity or the relationship between the entity and the investors.
Full Exemptions
The full exemption provides that the Directive will not apply to AIFMs insofar as they manage one or more AIFs whose only investors are:
- the AIFM; or
- the parent undertakings or the subsidiaries of the AIFM; or
- other subsidiaries of those parent undertakings provided that none of those investors itself is an AIF.
Partial Exemption: Registration
The following AIFMs will be subject to a lighter registration (not full authorisation) regime in their home Member State:
- AIFMs which either directly or indirectly through a company with which the AIFM is linked by common management or control, or by a substantive direct or indirect holding, manage portfolios of AIFs whose assets under management, including any assets acquired through use of leverage, in total do not exceed a threshold of EUR 100 million; or
- AIFMs which either directly or indirectly through a company with which the AIFM is linked by common management or control, or by a substantive direct or indirect holding, manage portfolios of AIFs whose assets under management, in total do not exceed a threshold of EUR 500 million when the portfolio of AIFs consist of AIFs that are unleveraged and have no redemption rights exercisable during a period of 5 years following the date of initial investment in each AIF.
Although registration is a lighter regime by comparison to authorisation, registered AIFMs will still need to comply with certain requirements, including those relating to monitoring of systemic risk. The Irish rules for registered AIFMs are set out in Section 10.9.
Note also that registered AIFMs do not benefit from any of the rights granted under the Directive unless they choose to "opt-in" to full authorisation. That means that they cannot manage AIFs in other EU Member States, nor can they market their AIFs in other EU Member States.
The European Commission has issued Implementing Regulation No. 474/2013 which establishes the "opt-in" procedure.
1.4 What can an AIFM do?
The principal scenarios dealing with the different types of AIFM and their capacities to manage and/or market AIFs are addressed in Section 3 of this Guide, but, in summary, an AIFM can manage AIFs and can market them to professional investors in the EU either under a marketing passport or, if available, a private placement regime. What is meant by "managing AIFs" and "marketing AIFs" is addressed in detail in Section 2 of this Guide.
However, it is important to appreciate that the capacity to manage or market AIFs on a cross-border basis within the EU will depend on whether the AIFM is an EU AIFM or a non-EU AIFM, whether it is authorised or registered, the types and domiciles of the AIFs it manages or markets as well as when certain of the capacities under the Directive – particularly relevant for non-EU AIFMs – are "switched on". It will also depend on whether the AIFM is an external AIFM or an internally managed AIF and whether it also holds a UCITS authorisation. Initially, only EU authorised AIFMs will be able to use a marketing passport and initially only in respect of EU AIFs.
Non-EU AIFs can, however, continue to be marketed by EU and by non-EU AIFMS under a private placement regime in EU Member States until at least 2018, provided the individual EU Member State allows for private placement. Once the private placement regime is turned off, the marketing passport should be available to all.
EU authorised AIFMs can also manage non-EU AIFs and non-EU AIFMS can manage EU AIFs, in each case subject to compliance with the Directive, again as detailed in Section 3 of this Guide.
To view the complete guide, please click here.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
