The Alternative Investment Fund Managers Directive (the "Directive") is due, this July, to be transposed into national law in each of the European Union member states. This briefing provides an update on recent developments in the implementation process.
Overview of the Directive
Although the Directive was published by the EU in July 2011 and "entered into force" on 21 July 2011, EU member states have until 22 July 2013 in which to "transpose" the Directive into their national laws. This is the key date for the commencement of the new regime.
The regulatory framework
The Directive establishes a framework for regulating the managers of Alternative Investment Funds ("AIFs"). Essentially, these funds consist of those collective investment funds which are not EU-regulated "UCITS" funds. Therefore, private equity funds, hedge funds and real estate funds are all types of AIF.
The main aim of the Directive is to regulate EU-established managers of AIFs. However, the Directive will also affect managers established outside the EU. First, under the current timetable, from 2015, non-EU managers of EU-established AIFs will need to be authorised under the Directive. Secondly, and perhaps most controversially, the Directive contains provisions which will apply to non-EU managers who market their AIFs into the EU. These will apply even if the funds are not EU funds, and even if the funds are marketed in reliance on, and in compliance with, the national private placement regimes applicable in the countries into which the funds are marketed. As a result, the Directive will, for example, affect US managers who market their funds to European investors.
The Identity of the AIFM
Under the Directive, each AIF has a manager (the "Alternative Investment Fund Manager" ("AIFM")). If the fund's legal form permits internal management, and if the fund's governing body has decided not to appoint an external manager, the fund itself will be the AIFM under the Directive. This is in contrast with externally managed funds, where the AIFM is the entity responsible for "managing" the fund. In this context, "managing" means providing at least portfolio management or risk management services to the fund (where risk management involves managing risks relevant to the fund's investment strategy).
Authorisation Requirements
The Directive applies in different ways according to whether the AIFM and the AIF are established in the EU. From July 2013, if the AIFM is established in the EU, it must, unless an exemption applies, be authorised by the relevant national regulator (subject to EU AIFMs operating before that date being given a further year in which to apply for authorisation).
In the case of a non-EU AIFM of an EU AIF, authorisation will not be required until 2015 (under the current timetable). A non-EU AIFM of a non-EU AIF does not require authorisation (however, as discussed below, it is intended that it will be permitted to apply for authorisation from 2015 so as to obtain the "passport", and it will be subject to some of the provisions of the Directive from July 2013 if it markets its AIFs in the EU).
There is a significantly lighter regulatory regime applying to AIFMs managing small funds (i.e., those AIFMs managing AIFs with assets under management, which, in total across all such AIFs, do not exceed Euro 100 million, or do not exceed Euro 500 million where the funds are not leveraged and investors have no redemption rights for the first five years).
Brief summary of the obligations on AIFMs regulated under the Directive
Authorised AIFMs are to be subject to minimum capital requirements and to a number of organisational requirements covering matters such as delegation, conflicts of interest, risk management, liquidity and the valuation of fund assets. Such AIFMs must have remuneration policies in place for certain senior staff which promote sound and effective risk management, including restrictions on the amount of variable remuneration that can be paid without deferral.
The Directive contains requirements for each AIF to have a depositary. Managers must set a maximum level of leverage which they may employ on behalf of each fund. The Directive includes a number of disclosure and reporting obligations on managers in respect of their funds, including a requirement for an annual report, disclosures to investors and reporting to regulators. There are disclosure and "asset stripping" provisions (designed to restrict the level of distributions for two years following the acquisition of control by the AIF) directed at managers of private equity funds with substantial stakes in EU companies.
Marketing of funds
The Directive also includes provisions on the marketing of funds within the EU. These make the Directive important to all managers, both within and outside the EU, who wish to market their funds to investors in the EU.
The passport
From July 2013, EU AIFMs will be obliged to use the "passport" if they wish to market EU AIFs to "professional investors" in other EU countries (the passport is due to be available to EU AIFMs in respect of their non-EU AIFs from 2015). The passport will permit an AIFM authorised in one EU member state to market its AIFs to professional investors in other EU member states without the need for separate authorisation in those states. It is hoped that the AIFMD passport will make it easier to market AIFs across Europe, since it will avoid the necessity of complying with the differing private placement regimes across the EU.
Non-EU managers will only be able to apply for the passport to market their AIFs from 2015 (under current plans). To qualify for the passport, they will need to become authorised under the Directive (there will also need to be cooperation arrangements in place between the relevant non-EU and EU regulators).
Private placement regimes
Accordingly, from July 2013 until the availability of the passport in 2015, non-EU managers will need to rely on and comply with the relevant national private placement regimes in order to market their funds to professional investors in the EU. Even then, they will be subject to certain aspects of the Directive (those concerning annual reports, disclosure to investors, regular reporting to regulators, requirements on managers of funds that acquire substantial stakes in EU companies and anti-asset stripping provisions). There will also need to be cooperation arrangements in place between the relevant non-EU and EU regulators.
The current intention is to phase out the private placement regimes in 2018, and so this marketing option for non-EU managers is only expected to be available from 2013 to 2018. Even during this period, there will be a wide variation in the extent to which the private placement route can be used in each EU country; member states are not obliged to maintain private placement regimes. For example, although the UK has indicated that it will retain its current fairly liberal private placement regime during this five year transitional period (subject to a new approval and registration requirement), Germany has proposed that its existing private placement regime will be replaced this July.
Reverse solicitation
The Directive does not restrict professional investors in the EU who wish to invest in funds on their own initiative (so-called "reverse solicitation"). National regulators may, however, police the use of reverse solicitation more closely than they have in the past.
Which route should non-EU managers use to market their funds in the EU?
This will depend on the extent of the marketing intended to be conducted in each EU member state. If there is only to be limited marketing and if the potential investors are mainly to be sought in countries such as the UK which have fairly liberal private placement regimes, then it may be possible to rely on the private placement route for a few more years. However, if a non-EU manager wishes to market its funds in many countries across the EU, it may wish to consider establishing an affiliate entity in an EU jurisdiction to become an AIFM under the Directive.
As noted above, the availability of the passport is due to be extended to non-EU managers from 2015, but until it is so extended, the AIFM will need to be based within the EU to be eligible for the passport.
The relative merits of relying on private placement, in comparison with becoming an AIFM authorised under the Directive, and so eligible for the passport, but subject to all the requirements of the Directive, will be easier to assess once the new regime is operational later this year and once the principal EU countries clarify the extent to which their private placement regimes will continue over the next few years.
Recent developments in the development of the new regime
The Directive empowers the European Commission (the executive body of the EU) to adopt a number of delegated acts, known as â€~Level 2 Measures', in which much of the detail of the new regime is to be found. On 19 December 2012, the Commission published its long anticipated Level 2 Regulation. On the same day, the European Securities and Markets Authority ("ESMA") published two consultation papers regarding the nature of the managers and funds falling within the ambit of the Directive. Responses to ESMA's two consultations were published in early February 2013.
The Commission's Level 2 Regulation
The Commission's Level 2 Measures (which, as noted below, will apply from 22 July 2013) had originally been expected in the summer of 2012, but were delayed whilst controversial areas such as depositary liability were considered further. The Commission's Regulation contains detailed provisions on the delegation of the AIFM's functions, risk and liquidity management, depositary liability, transparency requirements, third country provisions, the calculation of assets under management, valuation methods and the maximum leverage to be employed by AIFs.
The Commission chose to employ the legal form of a regulation for these Level 2 Measures, since an EU regulation, unlike a directive, has direct effect in EU member states (and so does not need to be implemented by member states). The use of a regulation, rather than a directive, ensures greater uniformity in the standards to be adopted across the EU and gives the Commission a greater degree of control over those standards.
The Regulation's restrictions on delegation arrangements are designed to ensure that the AIFM retains overall responsibility for decision making and is not a mere "letter-box entity". The Regulation provides that if the AIFM delegates the performance of investment management functions to an extent that exceeds by "a substantial margin" the investment management functions performed by the AIFM itself, then it shall no longer be considered to be managing an AIF. To the extent that delegation is allowed, portfolio management can only be delegated to a suitably regulated entity. Although the Regulation is meant to apply in a uniform manner across the EU, it may be that different national regulators will adopt different interpretations as to the practical consequences of these delegation provisions on current fund structures.
The Regulation is now subject to the scrutiny of the European Parliament and the Council of Ministers, each of whom has the right to object to the Regulation. If, as is expected, neither of these bodies objects within the three month scrutiny period, it will apply from 22 July 2013, the implementation date of the Directive.
ESMA's Consultation Paper on "Draft regulatory technical standards on types of AIFMs"
The Directive provided that ESMA was to develop draft "regulatory technical standards" to determine the types of AIFM within the scope of the Directive, and to ensure uniform conditions for the application of the Directive. In the draft regulatory technical standards annexed to this consultation paper, ESMA only addressed the difference between open-ended and closed-ended funds. This distinction is relevant in that it affects the application of certain provisions under the Directive (notably those concerning liquidity management and valuation procedures). In summary, open-ended funds are those where redemption rights may be exercised at least once a year at a price that does not vary significantly from the net asset value per unit. This was therefore a fairly narrowly focused consultation paper, but ESMA noted that it may, where relevant, develop further measures in order to establish additional categories of AIFM.
ESMA's Consultation Paper on "Guidelines on key concepts of the AIFMD"
ESMA's other December consultation paper included its proposals for guidelines to ensure a common, uniform and consistent application of the concepts in the definition of an AIF. The Directive itself defines AIFs as "collective investment undertakings" which "raise 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". The consultation paper attached draft guidelines on the meaning of each of these terms. "Collective investment undertakings" are those undertakings that: (a) are not ordinary companies with general commercial purpose; (b) pool together capital raised from their investors for the purpose of investment with a view to generating a pooled return; and (c) whose unitholders have no day-to-day control over the management of the undertakings' assets. The consultation paper confirms the breadth of the applicability of the Directive.
Future developments
Despite these measures, there are still significant areas of uncertainty as regards the scope of the Directive and its practical effect on investment funds and their managers. Notwithstanding the Commission's aim to create a single European rulebook by the use of a regulation, it is possible that these areas of uncertainty will result in the Directive being implemented in different ways by different EU member states. ESMA will, over time, produce further guidelines on the precise scope and meaning of the Directive, which it is hoped will reduce any such uncertainties and inconsistencies.
Differing attitudes to the Directive across the EU
Some EU member states, notably Luxembourg and Ireland, view the Directive as opening new business opportunities. They hope to emulate their successes in building significant fund industries based on the EU UCITS regime that has existed for a number of years. However, many in the industry, particularly in the UK, are more sceptical about whether there is a genuine need for the proposed level of regulation of AIFMs, and are not convinced that the new regime will result in any great benefit to investors.
UK implementation of the Directive
The precise nature of the regime is likely only to become apparent once the member states and national regulators have finalised the detailed rules and regulations that will implement the Directive (which are required in addition to the Commission's Level 2 Measures). In the UK, it will be implemented by way of new UK legislation and through amendments to the rulebook of the Financial Conduct Authority (which is to be the successor body to the Financial Services Authority).
In November 2012, the FSA published the first of its two planned consultations on the new rules and guidance needed to implement the Directive in the UK. It included the FSA's proposals for a new Investment Funds sourcebook to cover the requirements for AIFs, UCITS and their managers.
Furthermore, in January 2013, the Treasury published its first consultation paper on the proposed changes to the UK legislation required in order to transpose the Directive into UK law, notably by way of the "Alternative Investment Fund Managers Regulations 2013", which will come into force on the Directive's implementation date, 22 July 2013. In addition, the European Commission's Level 2 Regulation, described above, will apply directly in the UK.
Conclusion
Despite the breadth of the Directive and the complexity of its subject matter, there are still significant uncertainties about the precise scope and the practical effects of the new regime. It seems that the full consequences will only be known once the approach of each national regulator towards implementation has become apparent. Nevertheless, what is already clear is that the new regime will increase the compliance burden on EU based fund managers, and that it will affect non-EU managers who wish to market their funds in the EU and the way in which they market those funds in the EU.
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