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1 Take aim for AIFMD implementation The UK must implement the Alternative Investment Fund Managers Directive (AIFMD) by 22 July. Kam Dhillon and Emma Radmore line up the fi nal rules and arrangements. AIFMD fundamentals The AIFMD requires alternative investment firm managers (AIFMs) who manage alternative investment funds (AIFs) to be authorised or registered in their home member state. Its purpose is to regulate the distribution and marketing of AIFs as well as the organisation and operation of their managers. UK implementation plans were hindered by the delay in the EU s publication of the AIFMD Level 2 Regulation, which was finally published in late December 2012 and was then subject to a threemonth scrutiny period before it was confirmed. Its contents were in places controversial and many member states, including the UK, complained about the way in which the Commission had used its powers, and the amount of change to the original advice the European Securities and Markets Authority (ESMA) had given it. The UK needed to see the Level 2 Regulation to finalise its rules dealing with key areas where the regulation embellished upon the AIFMD. Some of the consultations discussed in this article had to be published before the Level 2 Regulation was completed and, as a result, were subject to change depending on its ultimate contents. At the end of June, the Financial Conduct Authority released its final rules implementing the AIFMD into its Handbook. Recent ESMA publications ESMA published its draft regulatory technical standards in April 2013 to determine types of AIFMs, where relevant, in the application of the AIFMD. These distinguish AIFMs managing AIFs of the open-ended type and AIFMs managing AIFs of the closed-ended type. The definitions set out in the regulatory technical standards are needed in order to apply the rules on liquidity management, the valuation procedures and the transitional provisions of the AIFMD. In May 2013 ESMA published its final guidance on key concepts in the AIFMD. The purpose of these guidelines is to ensure a common and consistent application of the concepts that comprise the definition of AIF, by clarifying each of these. The guidance includes ESMA s views on what is meant by a collective undertaking, raising capital, a number of investors and a defined investment policy for the purposes of the AIFMD. Despite several respondents asking for further clarification as to whether joint ventures and commercial special purpose vehicles should fall outside the scope of the directive, ESMA made few changes from its consultation draft. ESMA is also consulting on guidelines for national authorities, to which AIFs will report under the directive. The guidelines cover the information that AIFMs should report to national authorities, the timing of reports and the procedures to be followed when AIFMs move from one reporting obligation to another. Memoranda of Understanding (MoUs) One of ESMA s key tasks was to negotiate ESMA MoUs with third-country regulators on non-eu AIFMs compliance with the AIFMD. It has to date approved MoUs with 34 regulators around the world. The MoUs are a pre-condition to allowing certain cross-border activities to take place, and are designed to help EEA securities regulators supervise compliance with AIFMD requirements when a non-eea entity is involved in the management or marketing of an alternative investment fund within the EEA. The non-eea authorities include securities regulators in jurisdictions such as the USA, Switzerland, Hong Kong, Singapore, Canada, Australia, India and Brazil. Following the conclusion of ESMA s negotiations, the FCA has confirmed it has also signed up to all 34 MoUs. The MoUs will come into effect from 22 July 2013.

2 Compliance Monitor July 2013 Changes to UK law The UK has regulated managers of all types of fund that met the Financial Services and Markets Act 2000 (FSMA) definition of a collective investment scheme (CIS) for many years. Because of the way in which FSMA regulation works, this means AIFMs are already subject not only to the authorisation requirement but also to key systems and controls requirements, such as FCA rules on conflicts management and outsourcing. Also, the FSMA financial promotion regime addresses how CIS and unregulated CIS (UCIS) can be marketed to potential UK investors. As a result, UK AIFMs and AIF distributors will to some extent see fewer changes as a result of the AIFMD than their counterparts in certain other EEA jurisdictions. But some of the amendments to UK law necessitated by the AIFMD are nonetheless significant. Key changes include the need to address within regulatory requirements applicable to AIFs particular collective investment arrangements that are not CIS for FSMA purposes, the requirements on AIFMs when appointing depositaries, and the treatment of third country AIFs and AIFMs. Treasury transposition of the AIFMD The Alternative Investment Fund Managers Regulations 2013 HM Treasury is responsible for transposing changes to primary and secondary legislation. The Alternative Investment Fund Managers Regulations 2013 introduce the new regulated activities of managing an AIF, as well as that of acting as a trustee or depositary of an AIF, and constitute the key legislative measure for the UK s implementation of the directive. The regulations are still in draft, as aspects of them need approval from both Houses of Parliament. Treasury published two consultations on transposing the directive (the first in January 2013 and the second in March) and revised secondary legislation; it subsequently published feedback on the proposals. Key aspects of the consultations and regulations include: Amendment of the FSMA (Regulated Activities) Order 2001 (RAO) to include the new regulated activities mentioned above. There will be no need for the permitted activity of acting as sole director of an open ended investment company. There will however be new activities of acting as a depository of a UCITS (Undertakings for Collective Investment in Transferable Securities) to replace the current trustee and depository activities, and to mirror the new regulated activities relating to AIFs. Following consultation, ancillary activities will be part of the regulated activity of managing an AIF, as respondents felt this would simplify the look of the Part 4A permission; A new regime for sub-threshold managers of authorised funds. Originally, Treasury had proposed to apply AIFMD standards to all subthreshold managers of Non-UCITS Retail Schemes (NURS) and Qualified Investor Schemes (QIS) to avoid a two-tier effect. But respondents said this would be costly and investors are already well protected; In respect of closed-ended investment companies, which are not CIS under the FSMA definition but which fall within the AIFMD definition of AIFs, Treasury will apply a registration regime where these non-cis AIFs are internally managed, but will require external managers to comply with the same level of regulation as individual portfolio managers as they currently do. Where a subthreshold AIFM manages funds that are UCIS under FSMA, Treasury will replicate current requirements for CIS operators, but not apply AIFMD provisions over and above these. Following responses to consultation, Treasury confirmed it will introduce a registration-only scheme for subthreshold managers of property funds but will also require there to be an authorised operator (to mirror the current practice); Treasury decided it was not possible within the implementation timescales to change FSMA to reflect more clearly the overlapping definitions of AIF and CIS, and new activities of managing an AIF and managing a UCITS. Respondents had asked for separate and mutually exclusive definitions, but this cannot be achieved at the moment; Treatment of common investment funds and common deposit funds: these vehicles are established under charities legislation and are UCIS for FSMA purposes. The funds are regulated as charities by the Charities Commission and their managers and corporate trustees are regulated under FSMA. Treasury intends to keep this system, notwithstanding the funds will usually be AIF for AIFMD purposes. As a result, the operators must comply with the FCA s rules for AIFMs unless they are within the sub-threshold regime. The Charity Commission is considering requiring managers 2 Informa UK Ltd 2013

3 Follow us on and join discussions in our LinkedIn group who set up such funds in future to be authorised as full-scope AIFMs. Meanwhile, Treasury will amend charities legislation to allow any charity satisfying certain conditions to invest in common investment and deposit funds; Creation of a single gateway for non-uk fund managers to market funds to retail investors in the UK, subject to compliance with UK retail investor rules which Treasury will assess on a case-bycase basis. Treasury wants to reform the current regime for marketing recognised funds managed and authorised in (a) the Isle of Man, Guernsey or Jersey and (b) elsewhere outside the EEA. It plans to bring marketing of all non-ucits funds within a modified FSMA section 272 regime, which will require the fund to meet certain conditions. These would include ensuring there is adequate protection to investors. The FCA would undertake a gap analysis that it would use to assess equivalence. If it granted recognition, the AIFM would have to make annual reconfirmation that the AIF continues to meet the conditions. Treasury can then use this approach to allow EEA AIFs to market to UK retail investors; The approved persons regime will not be applied to internally managed funds; and Application of the Financial Services Compensation Scheme (FSCS): Treasury will restrict FSCS coverage so it applies compulsorily to non-uk EEA managers of UK authorised AIFs; EEA AIFMs that provide other services under a passport can participate if they wish. This mirrors the approach the UK applies to UCITS. Treasury also confirmed that UK AIFMs which will not be managing AIFs after 21 July 2014 will not need to apply for authorisation and that during the transitional year the depositary of an authorised AIFM need not have the new required FSMA Part 4A permission. It also published some additional FAQs confirming various aspects of operation during the transitional period. The regulations will address: Authorisation of full-scope UK AIFMs Small AIFMs Operating conditions for full-scope AIFMs, depositaries and external valuers Rules for AIFs that acquire control of non-listed companies and issuers Marketing of AIFs (including the national private placement regime) Duties and powers of the FCA, and Transitional arrangements. FAQs Treasury also issued a set of FAQs on the transposition of the directive. FCA Handbook UK AIFMs will be subject to conduct and prudential regulation by the FCA. Its predecessor, the Financial Services Authority, published two consultation papers on the proposed rules and guidance in respect of UK implementation of the AIFMD (in November 2012 and March 2013). These papers indicated that the remainder of the AIFMD will be transposed into UK law by way of FCA Handbook rules and guidance. A new Investment Funds Sourcebook (FUND) will be issued, replacing the rules and guidance notes in the Collective Investment Schemes Sourcebook (COLL). In its first consultation, published before the EU AIFMD Level 2 measures were finalised, the FSA had proposed to take a flexible approach to the few options and derogations AIFMD allows, while using the copy out approach for areas where it has no flexibility under the EU legislation. In any event, it did not plan to include all the measures in the Level 2 Regulation in its Handbook, as the regulation will be directly applicable in law. FCA rules will cover: the prudential regime for all types of AIFM: this includes capital requirements, professional negligence issues, the liquid assets requirement and reporting. For prudential purposes, the FSA proposed three types of firm collective portfolio management firms, internally managed AIFs and collective portfolio management investment firms; the depositary regime: FCA rules will cover eligibility, capital requirements and the requirement to act independently. The two new depositary regulated activities will replace the current activities of acting as trustee or depositary of an authorised fund; the Level 1 Directive requirements on AIFMs, such as organisational matters, duties in relation to management of funds, as well as transparency obligations towards investors and the FCA. These rules also address conflicts of interest, dealing with prime brokers, and the requirements that Markets Informa UK Ltd 2013 If you are reading a photocopy of Compliance Monitor please contact Informa to check that you have permission on

4 Compliance Monitor July 2013 in Financial Instruments Directive (MiFID) and UCITS firms already comply with. It also looks at delegation and remuneration; and marketing: the consultation noted the differences between the AIFMD concept of marketing and the FSMA definition of financial promotion. It also confirmed the UK s intention to maintain the current private placement regime for as long as the EU legislation allows. The consultation upheld the regulator s decision, despite some requests to the contrary, to proceed with its plan to implement appropriate parts of AIFMD in the relevant rules, specifically the Senior Management, Systems and Controls Sourcebook (SYSC) and the Conduct of Business Sourcebook (COBS). The FSA s second consultation addressed: progress at that time on EU measures to implement the AIFMD since the FSA s first consultation paper; how it planned to give guidance about the scope of the AIFMD and its views on delegation by AIFMs; changes to some existing organisational and conduct of business rules that will affect full-scope UK AIFMs, and how it planned to amend its rules to implement the specialised regimes for smaller AIFMs; further proposals for prudential rules and guidance, including the prudential regime for small authorised UK AIFMs; which types of AIFM and depositary will be within the scope of the Financial Ombudsman Service (FOS), the FSCS, or both; depositaries, and how current client assets rules will apply to some types of depositary; marketing and how AIFMs may exercise single market passporting rights. The paper also covered the UK approach to registering funds being marketed through national private placement, and approving non-uk AIFs as recognised schemes that can be marketed to the general public; and fee proposals. At the end of June, the FCA made its final rules. These, and the accompanying policy statement, reflect the two consultations on implementation. The rules additionally take account of transposition, also on 22 July, of the EU Regulations on Venture Capital Funds (EuVECA) and Social Entrepreneurship Funds (EuSEF). Like the AIFMD Level 2 Regulation, they did not have to be implemented into UK laws, so are not reproduced in the FCA s rules, but the rules refer to them as appropriate. The rules amend many parts of the Handbook, some fundamentally. Key areas covered include: the new FUND sourcebook applying to all UK AIFMs, whether full-scope or small, branches of EEA AIFMs and depositaries of AIFs managed by full-scope AIFMs. FUND is still not complete, but sets out requirements on different types of AIFM in terms of reporting, investment, restrictions on business, risk management, leverage, prime brokerage selection, delegation, marketing and cross-border issues. It contains specific rules on depositary functions and liabilities. It also contains a list of transitional provisions; many new definitions in the Glossary; amendments to SYSC to reflect the extent to which it applies to AIFMs and to introduce the AIFM Remuneration Code; amendments to FEES to reflect the AIFMD fee structure; amendments to the prudential sourcebooks to take into account new definitions (particularly that of a collective portfolio investment management firm ) as well as AIFMD requirements, and to reflect that the UCITS Managers Prudential Sourcebook (UPRU) will be deleted in its entirety on 22 July 2014; changes to COBS to show which rules apply to which type of AIFM or UCITS management company; changes to the Client Assets Sourcebook (CASS) in respect particularly of depositaries and trustees; changes to the Supervision Manual (SUP) regarding controlled functions, passporting and reporting; changes to reflect application of the FOS and FSCS; and changes to the Perimeter Guidance (PERG) to include a new section on marketing AIFs, along with a new chapter on the scope of the AIFMD. The scope chapter includes the FCA s views on what is an AIF and what managing an AIF means, as well as guidance on which regulated activities are relevant. The Dispute Resolution: Complaints (Alternative Investment Fund Managers Directive) Instrument 2013 also amends the definition of eligible complainant. 4 Informa UK Ltd 2013

5 Follow us on and join discussions in our LinkedIn group The FCA has not yet consulted on some aspects of implementation, where it did not have to put rules in place for 22 July. It is likely to consult on many of these later in 2013, such as: consequential changes for all parts of the FCA and PRA Handbooks; rules on fees for managers of EuSEFs and EuVECAs; rules for the eventual implementation of European passports for non-eea AIFMs managing EEA AIFs and for non-eea AIFs being marketed in the EEA; integration into the Handbook of ESMA guidelines on key concepts of the AIFMD, remuneration of key personnel and reporting by AIFMs; guidance on a proportionality framework for remuneration requirements; and the transition of rules and guidance affecting UKauthorised funds from the Collective Investment Schemes Sourcebook (COLL) to FUND. FCA forms The FCA has created an AIFMD page on its website, where it has published a number of draft forms, together with guidance on key implementation issues. It published for comment various draft forms including: a form that authorised firms wanting to vary their permission to become AIF depositaries can use. Firms not currently authorised cannot use this route to becoming a depositary and must complete a full application for authorisation as well as the form; a draft variation of permission (VOP) form for full scope AIFMs; a form for an authorised full scope UK AIFM and full scope EEA AIFM; a form for a third country above threshold AIFM ; and a third country national private placement regime (NPPR) form. The FCA had already separately contacted firms who told it of an urgent need to be fully authorised as an AIFM. Transitional provisions The AIFMD allows firms that are already managing or marketing AIFs before 22 July 2013, a transitional period of 12 months to comply with the relevant laws and regulations, and to apply for authorisation. However the AIF must be AIFMD-compliant and have submitted an application for authorisation by the end of that 12-month period. The FCA s web page on AIFMs contains information on the transitional provisions that will allow sub-threshold, EEA or third-country AIFMs to carry on business after 22 July. It has also updated firms on whether AIFMs will be allowed to provide services covered by MiFID on a cross-border basis. The FCA s stance is that they should be able to do so, but the European Commission s position is that MiFID services are not covered by an AIFM passport and that AIFMs are not allowed separately to apply for MiFID authorisation. Accordingly, the FCA warns firms that some member states may share the Commission s view. Key information for firms At last, shortly before implementation of the AIFMD, there is sufficient certainty in several key areas: UK firms managing and/or marketing AIFs in the UK will be able to make full use of the 12-month transitional period, whether these AIFMs become authorised or registered. This will be the case irrespective of whether the AIF concerned is an EEA or non-eea AIF. Firms that manage AIFs from an establishment in the UK will have until 21 July 2014 to apply to become a UK-registered or UK-authorised AIFM, or to vary their permission. Authorised firms wishing to apply for VOP to become trustees or depositaries of AIF can also benefit from transitional provisions, which will allow these firms to carry on the regulated activity of acting as trustee or depository of an authorised or unauthorised AIF for up to 12 months, provided they obtain the VOP by 21 July The FCA notes these firms must comply with all applicable rules in its Handbook during the transitional period. It will also ask AIFMs who they intend to use as their trustee or depositary and will contact that firm to ensure its suitability as well as its ability to use the transitional arrangements. Sub-threshold AIFMs can take advantage of transitional provisions to continue to provide their services after 22 July. In any case, they are not eligible for AIFMD passports. The FCA will consider the six-month period it has within which to determine completed applications will start on 22 July and cannot Informa UK Ltd 2013 If you are reading a photocopy of Compliance Monitor please contact Informa to check that you have permission on

6 Compliance Monitor July 2013 commit to processing applications any quicker than this. It plans to assess any delegation arrangements on a case-by-case basis in a robust and flexible way, while taking account of the EU requirements. It plans no supervisory assessments of a firm s delegation arrangements during the transitional period from 22 July 2013 to 21 July 2014, until the firm applies for authorisation or a VOP to become an AIFM. EEA firms currently providing services into the UK under a passport will be able to continue to do so under transitional provisions. Firms wishing to do so for the first time must follow their home state s notification process and the FCA will react to notices it receives from other regulators. Third-country firms can also benefit from transitional arrangements in the Treasury s regulations to continue to market funds in compliance with the financial promotion restriction and national private placement regimes. Conclusion The transposition of the directive has proven to be a lengthy process. However, we now find ourselves fast approaching the implementation date. While much of the legislation is still being finalised in the UK and an element of uncertainty remains, it is clear the UK is applying as little gold plating as possible and the regulators are aiming to ensure firms that are already authorised can carry on business as normal while adapting to the changes. Emma Radmore (managing associate) and Kam Dhillon (associate) are members of Dentons UK fi nancial services and funds practice. Contact them on emma.radmore@ dentons.com and kam.dhillon@dentons.com. 6 Informa UK Ltd 2013