IFSRA Draft Guidance on Prime Brokers

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1 Investment A publication from Mason Hayes & Curran Solicitors Investment Autumn 2004 Elsewhere in this issue Page 2 Page 3 Page 4 Page 5 Page 6 Page 7 IFSRA Draft Guidance on Prime Brokers Fund Authorisation Times to Reduce further with new IFSRA Procedures Industry Funding Update Savings Directive Update IFSRA Guidance on Retail Fund of Hedge Funds Dublin Funds Statistics EU Recommendations on Directors IFSRA Consultation on Differing Fee Structures in Multi Class Funds IFSRA Client Money Requirements Developments IFSRA Consultation on UCITS and Financial Derivatives Instruments DFIA Trustee Committee Papers Proposal to amend Money Laundering Directive The Central Bank & Financial Services Authority of Act, 2004 Changes in relation to Diversification of non-cash Collateral in Stock Lending/ Repurchase Agreements DFIA Technical Committee Discussion Papers Guide to Sound Practices for Hedge Fund Administrators The Alternative Investment Management Association ( AIMA ), the global hedge fund and alternative investment association, and the Dublin Funds Industry Association ( DFIA ), the representative body for the international investment community in, recently launched a Guide to Sound Practices for Hedge Fund Administrators (the Guide ). The Guide is a result of a joint initiative between the two associations and was written following a consultation between a number of senior members of the global industry including administrators, accountants, lawyers, managers and their advisors. The Guide is not specific to any one jurisdiction and provides a good outline of the administrator s role as it relates to hedge. It sets out the main functions of a hedge fund administrator and describes the contribution that a hedge fund administrator may make to the fund. While the Guide seeks to identify the best practice in hedge fund administration, as befits an industry the size of the hedge fund administration industry, there will be differences between practices described in the Guide and practices employed by individual hedge fund administrators. In this respect, the Guide should not be seen as a benchmark or standard against which to measure a hedge fund administrator's performance but, rather, as an educational tool that describes what a typical hedge fund administrator will do. The Guide looks at key areas, including agreements, anti-money laundering, NAV calculation, other services and the relationships between all parties associated with the fund. In addition, it provides helpful examples of typical documentation as well as performance fee equalisation. The Guide follows on from the publication by AIMA of, A Guide to Sound Practices for Hedge Fund Managers, which was published in August 2002, and is to be welcomed by everyone involved in the global industry. The phenomenal demand for hedge and alterative investment products in recent times has necessitated the re-allocation of resources in many of the service providers. The publication of guides such as this one can only assist in ensuring that all participants have a proper understanding of the key issues involved in this important growth area.

2 IFSRA Draft Guidance on Prime Brokers In June 2004, IFSRA issued a draft Guidance Note on the Appointment of prime brokers and related issues (the Guidance Note ), in respect of marketed to sophisticated investors, namely Professional Investor Funds (PIFs) and Qualifying Investor Funds (QIFs). The DFIA has issued a response to the draft Guidance Note on behalf of the industry, pointing out a number of technical issues The points worth noting are as follows: (a) Exposure Limits (i) the appointment of a prime broker by a PIF is conditional upon the assets being passed to the prime broker not exceeding 140% (increased from the previous limit of 100%) of the PIF s indebtedness to the prime broker; or (ii) where a prime broker is appointed by a QIF, there is no limit to the level of assets which may be passed to the prime broker. However, the extent to which the assets of the QIF are available to the prime broker must be fully disclosed in the prospectus. (b) Prime Broker Eligibility The prime broker must be regulated by a recognised regulatory authority and it, or its parent, must have shareholders in excess of 200 million as well as having a minimum credit rating of A1/P1. (c) Other Counterparties (i) PIFs may enter into arrangements with other counterparties, including counterparties to OTC derivatives, on condition that the risk exposure to that counterparty does not exceed 20% (30% in the case of certain credit institutions) of net asset value and that the counterparty has a minimum credit rating of A2/P2. (ii) QIFs may enter into arrangements with other counterparties without limit, subject to the counterparty having a minimum credit rating of A2/P2. However, where the exposure to any single counterparty exceeds 40% of net asset value, the QIF must comply with the rules applicable to the appointment of prime brokers. (d) Trustee Role The trustee has responsibility for monitoring compliance with the requirements. This will involve confirmation from the trustee that it will, as a minimum, carry out certain functions including: receiving daily reports on assets held by the prime broker outside the custody network; reconciling assets on each valuation point; reporting discrepancies arising to the management of the fund; requesting confirmation that the prime broker does not hold assets other than in compliance with the requirements. (e) Prime Broker Agreement These agreements will not be reviewed by IFSRA, provided confirmation is received from the fund s legal advisers that the conditions relating to exposure limits are contained in the agreement, and that the agreement does not conflict with the Guidance Note. The DFIA has issued a response to the draft Guidance Note on behalf of the industry, pointing out a number of technical issues as well as highlighting the resistance among trustees to the additional responsibilities outlined above. A final Guidance Note is expected shortly, but in the meantime, the provisions of the draft Guidance Note will apply to Irish hedge appointing prime brokers. 2

3 Investment A publication from Mason Hayes & Curran Solicitors Fund Authorisation Times to Reduce further with new IFSRA Procedures Over the past few months, the Irish Financial Services Regulatory Authority ( IFSRA ) has implemented a number of new procedures aimed at streamlining both the fund authorisation process and its approval functions generally. These procedures should bring down fund authorisation times and serve to further enhance the Irish regulator's reputation, as a pro business regulator that is responsive to the changing dynamics of the global industry. The department within IFSRA responsible for investment, the IFSC and Funds Supervision Department, which has now been renamed the Financial Institutions and Fund Authorisation Department, issued the first set of new procedures in respect of UCITS on 25 June The new procedures are the result of a joint review, by representatives of the industry and IFSRA, of the fund authorisation process. The new procedures, which took immediate effect, mean that IFSRA will no longer review the memorandum and articles of association, or the administration and management agreements, all of which are now required to be filed in executed form immediately prior to authorisation. However, the regulator will continue to review the fund s prospectus and its trust deed/custodian agreement as before. The new procedures also involve the submission of a number of detailed application forms, which relate to each of the principal fund documents, which contain a series of confirmations from a fund's legal representatives that the documentation is in compliance with IFSRA's requirements. Furthermore, draft documentation being submitted for review should be at an advanced stage and should not be subject to any further amendments from the parties to the fund. On this basis, we would expect to be receiving first comments from IFSRA within a significantly shorter timescale, perhaps within 10 days of submission. IFSRA will no longer review the memorandum and articles of association, which are now required to be filed in executed form immediately prior to authorisation While the new procedures were initially expressed to apply to UCITS only, IFSRA have since advised that, pending the issue of the relevant non-ucits forms and subject to compliance with the requirements of the relevant sections of the recently issued UCITS forms, it will not be reviewing the management/ administration/transfer agent agreements; the investment management/adviser agreements; and the distribution/paying agent/representative agreements in advance of the authorisation of non- UCITS. In addition to this, IFSRA have implemented new procedures including new forms in respect of the following events: changes in service providers; the appointment of distribution/paying/transfer agents; revocation of fund authorisations; and approval of investment managers and investment advisers. Finally, more recently, IFSRA has implemented a new fast track approval procedure for when a fund is simply updating its prospectus to incorporate existing supplements/addenda, or when a fund is simply re-formatting the layout of its prospectus. The new procedure involves a confirmation from the fund s legal advisers that the insertions do not contain any new text and that the marked up document submitted contains all new wording and deletions. There is no doubt that these new procedures will improve the timing of fund authorisations and the approval process generally and will help to further enhance s reputation as a robustly regulated fund domicile, responsive to industry demands for a time and cost efficient fund authorisation process. 3

4 FOLLOW-UP FROM PREVIOUS ISSUES IFSRA issued a policy response on the funding of the regulatory agency, and confirmed that a 50:50 co-funding model would apply for Industry Funding Update The Regulations which formally introduce the industry funding of IFSRA were published on 16 July You will recall from our Summer 2004 issue, that in May 2004, IFSRA, in response to industry submissions, issued a policy response to its consultation on the funding of the regulatory agency, and confirmed that a 50:50 co-funding model would apply for the years It also stated that the industry would have to provide 18.9% of the total funding requirement which amounts to 3,690,000. Invoices have been issued since late July 2004 and the DFIA has circulated a schedule outlining the relevant charges payable by each scheme/service provider. Set out below is a brief summary: 1. Funds: A 1750 regulatory charge to be applied per fund structure plus an additional 550 per sub-fund. To ensure that the regulatory charge per fund structure does not exceed the charge applicable in comparable jurisdictions the additional charge per sub-fund is applicable to the first five sub- only. 2. Service Providers: The regulatory charge for service providers to will be determined by size/assets being serviced. A 4,500 regulatory charge will be applied for the first 3 billion of assets being serviced. An additional reducing scale charge will be applied to assets, being serviced, in excess of 3billion. 3. Agency Managers: 1,500 per manager. Savings Directive Update In our Summer 2004 issue, we reported that there were ongoing issues which raised doubts about the intended commencement date of 1 January 2005 for the main provisions of the Directive. At a meeting of the Council of the European Union, held on 19 July 2004, it was decided that, arising from these ongoing issues, the commencement date would be deferred until 1 July IFSRA Guidance on Retail Fund of Hedge Funds Our Summer 2004 issue highlighted the proposed amendments to the IFSRA Notice entitled Fund of unregulated schemes. Since then IFSRA has advised that the proposed amendments have been approved. Therefore, there is now a single and simple diversification requirement of not more than 20% of the net assets to be invested in the units of any one scheme. Also, the minimum subscription requirement has been disapplied for such schemes. Dublin Funds Statistics Recent figures obtained from IFSRA show that in July 2004, Irish registered collective investment schemes had a total net asset value of over $510 billion, which represents growth of 16% since 31 December During the same period, the number of Irish registered (including sub-) authorised by IFSRA grew by 3.1% from 3,507 to 3,616. According to Fitzrovia, the total net asset value of all non-irish registered being administered in reached US$259 billion in June This represents growth of 41% since the same time last year. 4

5 Investment A publication from Mason Hayes & Curran Solicitors EU Recommendations on Directors On 6 October 2004, the European Commission adopted two non-binding Recommendations relating to (i) directors remuneration and (ii) the role of non-executive directors. Member States are invited to implement the Recommendations by June Both Recommendations are drafted in the same spirit as the US Sarbanes-Oxley Act and aim to improve transparency and responsibility at management level in EU listed companies, with the ultimate aim of protecting investors. Firstly, the Recommendation on directors remuneration, which aims to deal with the conflict of interest where executives become involved in setting their own pay, provides for extensive disclosure obligations in relation to remuneration policy and individual directors pay. It also provides for enhanced shareholder control over remuneration policy and share option schemes. The second Recommendation is designed to reinforce the presence and role of independent non-executive directors on the boards of listed companies. The main principles of this Recommendation are: there should be a balance between executive and non-executive directors so that no individual or small group can dominate decision-making; boards should be organised so that a sufficient number of independent non-executive or supervisory directors play an effective role in defining and dealing with potential conflicts of interest. To this end, nomination, remuneration and audit committees should normally be created within the (supervisory) board; a director is considered independent when free from any business, family or other relationship (with the company, its controlling shareholder or the management) which might jeopardise his or her judgement; the (supervisory) board should be composed of members who, taken together, have the diversity of The Recommendation provides for extensive disclosure obligations in relation to remuneration policy and individual directors pay knowledge, judgement and experience to properly complete their tasks; and all directors should devote to their duties the necessary time and attention. When the appointment of a director is proposed, his or her other significant professional commitments should be disclosed. Both Recommendations apply to all listed companies, but Member States are further encouraged to consider the application of the Recommendation to collective investment undertakings of a corporate type in order to, as the European Commission puts it, avoid unnecessary unequal treatment between collective investment undertakings with different legal structures. The industry in has already successfully lobbied to have fund companies excluded from provisions of recent Irish domestic companies legislation seeking to impose onerous compliance obligations on directors and it remains to be seen how these new Recommendations will be dealt with in this context. Both Recommendations also take into account the efforts already made in several Member States and aims to identify best practices to ensure greater convergence in the EU. The Commission will closely monitor the application of the Recommendations to identify whether additional measures may be desirable in the medium term. 5

6 IN BRIEF The DFIA have expressed concern that should different share classes be unable to charge different fee structures in the future, there would be a capital outflow of institutional money from Irish IFSRA Consultation on Differing Fee Structures in Multi Class Funds During the summer, IFSRA issued a consultation document entitled Fee Structures for Multi-Class Collective Investment Schemes. The consultation document requested industry views in relation to the appropriateness or otherwise of charging different investment management fees to separate classes within a collective investment scheme. The DFIA, in its response, have expressed concern that the consultation might lead to a change in existing policy (which permits the charging of different investment management fees to separate classes) and that, in particular, should different share classes be unable to charge different fee structures in the future, there would be a capital outflow of institutional money from Irish. A response from IFSRA is due shortly. IFSRA Client Money Requirements Developments Since 2001, when IFSRA first issued its draft Client Money Requirements, there have been a number of redrafts of the proposal. The requirements have consistently provoked opposition within the industry, which is resisting the proposal on the grounds that it is inappropriate to and unworkable in the industry. The latest IFSRA draft was published in the latter part of This led to the establishment, by the DFIA, of a cross committee working group to examine the issue and produce a detailed response. This response was delivered to IFSRA in May 2004 and we now await a response from the regulator. IFSRA Consultation on UCITS and Financial Derivatives Instruments Following receipt of a Recommendation from the European Commission in April 2004, and in light of its experience of the operation of a UCITS Notice and Guidance Note in relation to Financial Derivative Instruments, IFSRA has issued a draft UCITS Notice and Guidance Note for consideration by the industry. The proposal would require the provision of additional information during the fund approval process as well as additional disclosure requirements. The proposal also identifies further requirements where a UCITS engages in credit derivatives. DFIA Trustee Committee Papers In July 2004, the DFIA circulated two papers which had been prepared by its Trustee Committee. The first paper is an information note, entitled Trustees review of annual and interim reports and financial statements of Irish UCITS and non-ucits collective investment schemes, and it is hoped that the paper will provide guidance to the trustees and custodians of Irish domiciled in their review of a fund s annual/interim reports and financial statements. The second paper is another information note, entitled UCITS III Trustees responsibilities and the risk management process, which focuses on the introduction of financial derivative instruments as part of a UCITS investment policy. The paper also considers the trustee s role with regard to the risk management process and suggests elements that might be considered in such a process. 6

7 Investment A publication from Mason Hayes & Curran Solicitors Proposal to amend Money Laundering Directive The European Commission has published a proposal for a draft Directive on money laundering in light of the latest Recommendations of the Financial Action Task Force ( FATF ). The new proposal would ensure that the definition of money laundering includes not only concealing or disguising the proceeds of serious crimes, but also the financing of terrorism with either criminally or legally acquired money. More specifically, the proposal would extend the anti-money laundering obligations to providers of services to companies, trusts and life insurance intermediaries. It would bring within its scope all persons dealing in goods or providing services for cash payment of 15,000 or more. The proposal also sets out more detailed know your customer requirements and, as with the FATF Recommendations, would introduce a risk-based approach meaning those subject to the Directive would have to concentrate their efforts on the higher risk situations rather than needlessly duplicating customer identification procedures. The proposal is to be forwarded to the European Parliament and the EU s Council of Ministers for adoption under the so-called co-decision procedure. The Central Bank & Financial Services Authority of Act, 2004 In July 2004, Central Bank and Financial Services of Act, 2004 (the 2004 Act ) was signed into law by the President of. The 2004 Act is complementary to the Central Bank and Financial Services Authority of Act, 2003 and provides for, inter alia, the establishment of a financial services ombudsman and the establishment of consumer and industry consultative panels to advise IFSRA. It also grants powers to IFSRA to impose sanctions directly on financial institutions for failure to comply with regulatory requirements, subject to a right of appeal to the Irish Financial Services Appeals Tribunal. The 2004 Act also introduces new regulatory requirements for money transmission and bureaux de change businesses. Changes in relation to Diversification of non-cash Collateral in Stock Lending/ Repurchase Agreements In October 2002, following discussions between the Central Bank of (the then regulator), the International Securities Lending Association ( ISLA ) and the DFIA, revised conditions applicable to the use of stock lending and repurchase agreements were agreed. These revised conditions were included in the relevant regulatory Notices at the time. However, the relevant Notice was then amended, in 2003, to require non-cash collateral to be aggregated with other investments to assess/determine diversification/concentration limits. This amendment caused difficulty for the industry, and as a result, a submission was recently prepared by the DFIA, and submitted to IFSRA. In response to the submission, IFSRA have accepted the arguments raised and have agreed to revert to the original 2002 position. DFIA Technical Committee Discussion Papers Also in July 2004, the DFIA circulated two discussion papers produced by the association's Technical Committee. The first discussion paper, entitled Hedged Currency Share Classes, considers and reviews a common currency hedging model, highlights how the share class is hedged and considers some of the factors which might result in a discrepancy between the performance of the hedged currency class and a class in the base currency of the fund. The second discussion paper is entitled Reporting or Performance Net Asset Valuations for Mutual Funds and describes and explains a non-dealing net asset valuation (NAV), considers the circumstances in which non-dealing NAVs are calculated and considers the implications for fund administrators of calculating non-dealing NAVs. The contents of this publication are to assist access to information and do not constitute legal or other advice. Readers should obtain their own legal and other advice as may be required. Copyright 2004 Mason Hayes & Curran. 7

8 CONTACTS DUBLIN Fionán Breathnach Partner Direct Line: David O Donnell Partner dodonnell@mhc.ie Direct Line: NEW YORK Dan Walsh of Counsel dwalsh@mhcny.com Direct Line: Dublin: 6 Fitzwilliam Square, Dublin 2, Tel: mail@mhc.ie New York: 261 Madison Avenue, Suite 400, New York, NY 10016, USA Tel: mail@mhcny.com CORPORATE HUMAN RESOURCES TECHNOLOGY LITIGATION INVESTMENT FUNDS