The alternative investment fund managers directive has arrived and co-operation agreements shaken hands on. Now comes tricky implementation
At long last, the EU’s alternative investment fund managers directive (AIFMD) has been implemented. Years in the making and the source of much political disagreement and wrangling, the AIFMD has been touted as a new dawn for managers of alternative investment funds.
But implementation comes at a difficult time for some of these managers. Preqin, a data provider for the alternative assets industry, reported just days before AIFMD’s implementation that the hedge funds industry had posted negative returns for the first time in 12 months in June, with returns for Q2 barely sneaking into positive territory.
There was better news for the private equity and regulated funds industries, with fundraising for private equity funds at its highest level since 2008 in the last quarter and the number of hedge funds operating within an Undertakings for Collective Investment in Transferable Securities (Ucits) wrapper continuing to increase. That would seem to indicate there is an appetite for regulated funds structures.
In support of the rollout of AIFMD, the European Securities and Markets Authority (Esma), which will regulate funds set up under the new regulations, has been negotiating co-operation arrangements with regulators around the world that enable fund managers with funds domiciled outside the EU to continue marketing them in the EU and, conversely, EU-based managers to market to third countries.
The only big country Esma is yet to conclude an agreement with is China, with negotiations continuing there.
However, the central agreement between Esma and individual securities regulators also has to be backed up with bilateral agreements between regulators within and outside the EU. As a briefing by King & Wood Mallesons (KWM) published on TheLawyer.com in July points out, non-EU managers will only have to comply with some of the provisions of the AIFMD, including various disclosure and transparency requirements.
“The annual report obligation will require the most thought,” notes KWM’s briefing. “Unless the AIF is newly established this will be an existing document at the time of contemplating any marketing activities in the EU.”
It also reminds clients that should an Australian manager establish a fund in the EU it will have to comply fully with the directive. The same applies to other third-country managers.
Many offshore jurisdictions have also been negotiating agreements with Esma and local authorities. Although Asia and the US are the source of much investment into offshore funds, especially those domiciled in the British Virgin Islands (BVI) and the Cayman Islands, managers will want to ensure they can continue to seek investment from EU sources such as pension funds in the UK and the Netherlands.
Mourant Ozannes’ May briefings, looking at the ways key offshore jurisdictions including the BVI, Cayman and the Channel Islands have been preparing for AIFMD, stated that regulators are likely to look at the way the directive should be interpreted in differing ways.
“Note that ‘reverse solicitation’, whereby EEA [European Economic Area] investors invest in AIFs at their own initiative, is not restricted by the AIFMD, but different EEA member state regulators are likely to adopt their own interpretation of what is permitted in their territory, so local EEA legal advice should be sought as appropriate,” Mourant Ozannes said.
In the EU, the funds-heavy states have moved fastest to transpose the directive into national legislation. A study produced by the Alternative Investment Management Association (Aima) and Ernst & Young found only 12 member states had completed the process – the Czech Republic, Cyprus, Denmark, France, Germany, Ireland, Luxembourg, Malta, the Netherlands, Slovakia, Sweden and the UK.
Ireland, Luxembourg and Malta have long positioned themselves as an alternative to offshore jurisdictions for funds, while the UK and the Netherlands are among the biggest sources of investment for alternative managers.
Austria, Bulgaria, Hungary, Italy, Latvia and Romania have drafted their AIFMD laws and are awaiting parliamentary approval. Five states, Belgium, Finland, Portugal, Slovenia and Spain, have not begun the process and Aima could not get any information from Estonia, Greece, Lithuania or Poland.
Luxembourg was one of the first countries to get its legislation sorted, in typical pioneering fashion. Its law of 12 July implemented the AIFMD and, as Luxembourg firm Molitor outlined in its July briefing on the topic, expanded existing Luxembourg funds legislation.
“The Luxembourg legislator also introduced a new vehicle to the law, the special limited partnership (société en commandite spéciale) which may be used by entities qualifying as AIF or not,” said Molitor. “In addition to that, the Luxembourg legislator opted for the creation of a new type of depositary, which will be a new professional of the financial sector according to the law of 5 April 1993 on the financial sector, as amended.”
Lawyers in the Grand Duchy are confident that fund managers will be attracted to the jurisdiction as they have been to Luxembourg for Ucits funds.
“A number of requirements in the directive are Ucits-inspired and give Luxembourg the possibility to leverage its strong Ucits position,” stated Arendt & Medernach lawyers Emmanuelle Entringer and Bishr Shiblaq earlier this year. “In particular, it is significant that the operational requirements imposed by the AIFMD on AIFMs are similar to those applicable to existing Ucits management companies and service providers, notably in terms of substance and operating conditions.”
Other jurisdictions are probably not going to attract quite as many funds as Luxembourg or Ireland, but instead are home to fund managers – notably the UK, which is Europe’s hedge fund capital. Financial Conduct Authority (FCA) guidance accordingly focuses on the requirements for managers in the UK.
The UK’s legislation allows a year-long transition between the old and the new.
“Notwithstanding this confirmation the FCA has emphasised that firms must be giving serious consideration to preparing for full compliance with the applicable AIFMD provisions when the transitional period comes to an end,” warns Nabarro in a recent briefing. “Firms should also take note of how other EU member states have interpreted the transitional provisions and adapt their approach in each member state accordingly. The implementation of the AIFMD in some member states has not kept pace with the implementation in the UK and […]there is still much uncertainty across the EU. Firms are advised to tread carefully.”
The FCA will be strict on applying provisions that prevent the establishment of “letter-box entities”, Nabarro adds, and also notes that managers should ensure they have an audit trail for situations where there has been ‘reverse solicitation’ by an investor wishing to invest in a fund.
The firm also warns that for UK managers, remuneration could be an issue. The AIFMD introduces guidelines for paying staff of an AIFM, including bonuses, although proportionality will apply, so smaller managers should avoid most of the burdens.
“There are still uncertainties surrounding the application of the AIFMD remuneration issues under UK law as Esma is yet to publish its official version of its remuneration guidelines,” says the Nabarro briefing. “The FCA expects them to be published very shortly and once they have been published, the FCA will have two months to notify Esma of whether it intends to comply with them.”
Something fewer people may be aware of is that AIFMD will not only capture those working in investment management companies.
“A perennial gripe of many Anglo-Saxon lawyers about European legislation is that it is often opaque, poorly drafted and has unintended consequences,” comments Allen & Overy partner Bob Penn in a mid-July briefing, “The AIFMD […] is a particular offender in this regard. While investment managers are generally clear that they are foursquare within the sights of the new regime, banks appear to be less attuned to its application – particularly to [special purpose vehicles].”
Penn says there continues to be uncertainty over whether financing vehicles used by banks will be caught by AIFMD, noting that Esma’s guidance suggests vehicles with multiple compartments where a single compartment meets the AIF criteria will be subject to the directive. He adds that Germany, Ireland, Luxembourg and the UK have issued “helpful guidance” that should avoid re-characterisation of SPVs as AIFs, but overall, “confusion reigns”.
Accordingly, banks and AIFMs running SPVs are advised to carry out proper due diligence to make sure their vehicle does not fall foul of the regulations.
The full impact of the directive will not be known for some time, with the transition period in many countries lasting until July 2014. ‘Alternative Ucits’ have already become popular, demonstrating there is an appetite for alternative funds in a regulated wrapper, but equally offshore firms say clients are still keen on traditional offshore funds.
For Esma, getting the regulation of AIFMs right will be a key challenge, but if lawyers’ predictions are correct the directive may also prove more burdensome for managers than most would like.