EU and global regulation a Tsunami building up?

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Ashley Jones
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1 DDF Finance Conference Private Wealth Management EU and global regulation a Tsunami building up? Ronald Paterson, Eversheds LLP 28 February 2013 #

2 A Tsunami building up? too early to say (Chinese Prime Minister Zhou Enlai s analysis in 1972 of the French Revolution)

3 AIFMD Timeline 1 Jul 2011 Directive published in Official Journal 22 July 2015 ESMA to report on functioning of passport and on marketing of non- EU AIFs/by non-eu AIFMs 2015/16 Authorisation/registration required for non-eu AIFMs managing EU AIFs Passports available for non-eu AIFMS and AIFs Nov 2012 FSA Consultation Paper 12/32 21July 2014 Final date for EU AIFM to apply for authorisation or registration and be fully compliant 2018/19 Possible termination of national private placement regimes 19 Dec 2012 Level 2 Regulation published 22 July 2013 Implementation by Member States FCA to receive VOP applications Jan 2013 HM Treasury first Consultation Paper published Q FSA and HM Treasury to publish second consultation papers 3

4 AIFMD Timeline Original proposal published in April 2009 Directive published 1 July 2011 Level 2 published 19 December 2011 Member States must transpose by 22 July 2013 Existing EEA AIFMs must comply by 21 July 2014

5 September 2008 Lehman Bros files for bankruptcy Lehman Brothers, the fourth-largest US investment bank, has filed for bankruptcy protection, dealing a blow to the fragile global financial system. The news led to sharp falls in share prices around the world, and officials took measures to reassure markets. Source: BBC NEWS

6 December 2008 Bernard L Madoff arrested On December 11, 2008, Mr. Madoff was arrested at his Manhattan home by federal agents and charged in a 20-year Ponzi scheme that was the largest fraud in Wall Street history. On March 12, 2009, Mr. Madoff pleaded guilty to all the federal charges filed against him. On the eve of the fraud s collapse in 2008, the total shown on Madoff investor account statements was nearly $65 billion, the sum of fictional paper profits that had accumulated in some accounts for decades. Source: The New York Times

7 AIFM depositary regime For each AIF it manages the AIFM shall ensure that a single depositary is appointed in accordance with the Directive Depositary has a variety of cash monitoring and other duties All assets of the AIF must be entrusted to the depositary for safekeeping Different obligations apply to Financial instruments Other assets

8 Depositary liability In case of loss of financial instruments held in custody by the depositary or a sub-custodian the depositary must return identical financial instruments or an equivalent amount of cash to the AIF (or the AIFM on its behalf) without undue delay

9 Exemption of depositary from liability Depositary can only exempt itself from liability for loss of financial instruments in custody if: Depositary can prove that the loss has arisen as a result of an external event beyond its reasonable control which would have been unavoidable despite all reasonable efforts or Instruments were held in custody by a subcustodian and the depositary has transferred its liability for loss of financial instruments to the sub-custodian

10 UCITS V depositary liability Depositary liability align with AIFMD but liable for all loss unless external event beyond reasonable control and unavoidable despite reasonable efforts all other losses caused by negligence or internal failure to fulfil duties

11 Substantial liability A limited number of depositaries mostly EU credit institutions ECB supports the stringent liability regime introduced by AIFMD but notes that this liability regime together with UCITS V could subject depositaries to very substantial liability claims In the case of some depositaries such claims could amount to losses sometimes in excess of multiples of their entire capital Source: Opinion of the European Central Bank of 24 May 2012

12 Consequences Liability for depositaries Risks factored into capital requirements Increased duties for depositaries compared to current custodian charges Increased costs to AIFs Reduced returns to investors Some AIFs may not be able to find depositaries Operating models between depositaries and custodians uncertain

13 EU agrees to cap bankers' bonuses European Union officials have struck a provisional deal on new financial rules, including capping bank bonuses Under the agreement, bonuses will be capped at a year's salary, but can rise to two year's pay if there is explicit approval from shareholders EU ministers must approve the deal although this is considered a formality The UK was opposed to any caps Source: BBC NEWS

14 AIFMD: ESMA Remuneration Guidelines ESMA rules aim to curb excessive risk taking by alternative fund managers Stronger governance of how fund managers are paid will ultimately lead to improved investor protection Pay rules aligned with other financial sectors ESMA co-operated with the European Banking Authority in order to ensure alignment of guidance on remuneration policies across financial sectors Source: ESMA 11/02/2013

15 AIFMD Remuneration Policy AIFM must ensure that their remuneration policies do not encourage risk taking which is inconsistent with the risk profiles of the AIF(s) they manage Guaranteed bonuses should be exceptional and should occur only in the context of hiring new staff and be limited to the first year Proportionality of application of Remuneration Code to be determined Subject to legal structure at least 50% of variable remuneration may have to be paid in AIF shares/units 40% or more of variable remuneration must be deferred to align with the nature of the risks of the AIF(s) 15

16 Will this drive business outside the EU? "It will drive up fixed salaries to compensate. Businesses that do not need to be inside the European Union will leave. And when banks invest in future divisions, it will be outside the EU. Joe Rundle, ETX Capital (Source: BBC NEWS)

17 AIFMD consequences of being in or out of EU EU AIFM/EU AIF Full AIFMD compliance (including full depositary compliance) from date of authorisation or 21 July 2014 at latest Full passport to market to professional investors across EU Non EU AIFM/EU AIF Full AIFMD compliance (except that there must be a depositary but full depositary compliance not required) No passport before 2015, AIF can be marketed in the EU by private placement only on an EU state by EU state basis Non EU AIFM/Non EU AIF No AIFMD impact unless AIF is marketed in the EU No passport before 2015, AIF can be marketed in the EU by private placement only on an EU state by EU state basis Marketing requires same reporting to EU regulators as an exempt EU AIFM No depositary required 17

18 Passport:EU AIFM marketing EU AIFs EU AIFM Marketing EU AIFs EU AIFM Marketing EU AIFs in AIFM s home Member State in another Member State Notify its home Member State Regulator and obtain approval before marketing begins AIFM s home regulator will need to notify the regulatory authorities in the other Member State(s) where marketing is to take place 18

19 Marketing: EU AIFM/non-EU AIF EU AIFM Marketing non- EU AIFs (pre Passport) AIFM to comply with full AIFMD, appoint Article 36 custodian (no depositary liability), apply to host state regulator for Article 36 registration Cooperation arrangements must be in place between FCA and regulator in country where AIF formed Country where AIF formed must not be on FATF blacklist 19

20 Marketing: Non-EU AIFM Non-EU AIFM Marketing AIFs (pre Passport) Comply with reporting obligations, annual report (including remuneration), disclosure to investors (and if applicable asset stripping) and obtain FCA Article 42 registration from host state Cooperation arrangements must be in place between FCA and regulator in countr(ies) where AIF and AIFM formed Countr(ies) where AIF/AIFM formed not on FATF blacklist 20

22 Thoughts for the day A tsunami or a python? Will any depositary bank face losses in excess of multiples of its entire capital? Will it drive business out of the EU? Do you want to be inside or outside the EU? Will it improve investor protection? Will it improve investor returns?

23 too early to say

24 24 EVERSHEDS LLP Eversheds LLP is a limited liability partnership.

The Alternative Investment Fund Managers Directive What you need to know

The Alternative Investment Fund Managers Directive What you need to know The below is intended to be a high level summary of key areas as the precise implications of the AIFMD may differ for each firm.