The European Commission's recently published draft Directive on Alternative Investment Fund Managers (the 'Draft Directive') has excited a fair deal of comment in investment management circles.
The Draft Directive has arisen in the context of a European Commission programme aimed at extending appropriate regulation and oversight to 'all actors and activities that embed significant risks'. While the Commission concedes, in the Explanatory memorandum which introduces the Draft Directive, that hedge and other alternative investment fund managers were not the cause of the current financial crisis, and even (in the recitals to the Draft Directive) describes their impact on the markets as 'largely beneficial', it nevertheless seeks to subject such managers to an increased level of regulatory supervision. As will be shown below, as currently drafted the scheme of supervision proposed by the Draft Directive seems likely to generate significant problems for the investment management industry. While certain of the proposals in the draft are not in themselves contentious, and indeed are to some degree reflective of good market practice already adopted by alternative investment fund managers in many jurisdictions, other proposals appear significantly at odds with the way in which the funds concerned actually work, while adding little if anything in terms of likely investor protection.
An immediately striking point about the Draft Directive is that it casts a very wide net. It is stated to apply to all alternative investment fund managers ('AIFM') established in the European Community ('EU'), who provide 'management services' to one or more 'alternative investment funds' ('AIF'), whether those funds are domiciled inside or outside of the EU, whether they are open or closed-ended and regardless of their legal structure. AIFs are defined as any collective investment undertaking which is not required to be authorised as a UCITS (therefore, in effect, any investment fund other than a securities fund established in the EU and authorised for retail distribution). 'Management services' are somewhat loosely defined as 'the activities of managing and administering one or more AIF on behalf of one or more investors'. In principle therefore, although apparently aimed at the 'alternative investment' universe, the Draft Directive could catch a huge range of types of investment fund, from hedge, private equity and property funds through to more 'retail' varieties of fund such as investment trusts, non-UCITS retail funds and REITs. It is difficult to see how its provisions can be usefully applied to many of the fund types to which it may therefore extend.
Some AIFM are excluded, including those who do not provide management services to AIF domiciled in the EU and do not market AIF in the EU, those whose AIF assets under management (including assets acquired through 'leverage'- again, widely defined) do not exceed 100 million Euros (increased to 500 million Euros where the AIF concerned are not leveraged and have no redemption rights exercisable within 5 years- ie, in effect, private equity funds), credit institutions, pension funds and UCITS managers. One anomaly, therefore, which has attracted some adverse press comment is the fact that AIFM, which are, or are owned by, credit institutions (including, for instance, EU banking groups) would appear to be excluded from the Draft Directive's scope.
AIFM covered by the Draft Directive would not be permitted to provide management services to any AIF, or market shares or units thereof, without prior authorisation. This in itself appears uncontroversial: any such AIFM established in, or operating from a permanent place of business in, the United Kingdom, for instance, is already generally required to be authorised in order to conduct its business. However, the Draft Directive goes on to say that AIFM not covered by the Draft Directive, or authorised under the laws of a member state (therefore, presumably, AIFM established outside the EU, amongst others), will not be allowed to market shares of an AIF within the EU, except where any such AIFM is from a country recognised pursuant to certain 'equivalent' and market access tests (and which has an OECD Model Tax Convention agreement with the relevant member state). This appears to threaten the position of AIFM established in (say) the United States or Switzerland, who market their funds quite legitimately to professional and more sophisticated investors in the EU, for instance pursuant to the exemptions in favour of overseas persons pursuant to the UK's regulatory regime. It is further provided that no non-EU jurisdiction would be recognised, for the purposes of enabling AIFM, established in non-EU jurisdictions to access the EU on the basis mentioned above, for a three-year period after the Draft Directive's entry into force.
Other issues inherent in the Draft Directive as it currently stand include the requirement to appoint a 'depositary', which is an EU incorporated and authorised credit institution, and which takes responsibility for the actions of any other 'depositary' (for instance, the prime broker of a hedge fund) to which it delegates its duties, and requirements for disclosure of leverage beyond a stipulated threshold.
The requirements for independent administration and valuation might appear less controversial and more consistent with current industry practice, at least in the EU, although the Draft Directive appears to state that the rules applicable to such valuation must be those of the jurisdiction of domicile of the AIF, or its instruments of incorporation: it is unclear how this squares with (for instance) an AIF incorporated in one jurisdiction, for instance the Cayman Islands, and administered in another, for instance Ireland or Luxembourg (as is currently overwhelmingly the case in the hedge fund industry).
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