Client Alert. Financial Services Regulation. Update on UK and EU implementation of the AIFM Directive

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Dustin Parsons
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1 Client Alert Algiers Tel (0) Beijing Tel Financial Services Regulati Update UK and EU implementati of the AIFM Directive Alternative Investment Fund Managers Directive (2011/61/EU) ("AIFM Directive") needs to implemented by memr states, including the UK, by 22 July In the UK, it is the Financial Services Authority ("FSA") (and its successor organisatis), in cjuncti with Her Majesty's Treasury ("HM Treasury") which must ensure this happens. Implementati will require changes to primary and secdary legislati and to the FSA s Handbook. This note discusses the UK and EU steps implementati and aims to answer some questis the directi apparently ing taken in the UK some key aspects, including private placement, marketing to retail investors, authorisati, issues existing MiFID and UCITS managers, prudential categories, depositary, smaller AIFMs and approved perss 1. What next in the UK? FSA published a discussi paper implementing the AIFM Directive (DP12/1) 23 January 2012, which closed to comments 23 March HM Treasury published an inmal discussi paper the policy optis implementing the AIFM Directive in the UK 14 March 2012, which closed to comments 4 May Csultati papers in Q3 or Q4 2012, followed by policy statements in early 2013, are due from the FSA and/or HM Treasury. FSA aims to in a positi to receive potential AIFM applicatis authorisati in Q Octobre August References to MiFID mean the Markets in Financial Instruments Directive (2004/39/EC). References to UCITS and the UCITS directive relate to Directive 2009/65/EC the coordinati of laws, regulatis and administrative provisis relating to undertaking collective investment in transferable securities (recast). Brussels Tel. +32 (0) gln.brussels@gide.com Bucharest Tel gln.bucharest@gide.com Budapest Tel gln.budapest@gide.com Casablanca Tel (0) gln.casablanca@gide.com Hanoi Tel gln.hanoi@gide.com Ho Chi Minh City Tel gln.hcmc@gide.com Hg Kg Tel gln.hgkg@gide.com Istanbul Tel gln.istanbul@gide.com Kyiv Tel gln.kyiv@gide.com Ld Tel. +44 (0) gln.ld@gide.com Moscow Tel gln.moscow@gide.com New York Tel gln.newyork@gide.com Paris Tel. +33 (0) info@gide.com Saint Petersburg Tel gln.saintpetersburg@gide.com Shanghai Tel gln.shanghai@gide.com Tunis Tel tunis@gln-a.com Warsaw Tel gln.warsaw@gide.com

2 2. Key implementati issues re are issues arising from the interacti tween the current structure regulating activities and perss cnected with funds under the Financial Services and Markets Act 2000 ("FSMA") and the AIFM Directive's requirements. UK's current regime is relatively highly- than in some other memr states. FSA's and HM developed, entailing more complex implementati issues Treasury' discussi papers do not specifically state how the AIFM Directive will implemented in the UK, but key transpositi issues are as follows. Firstly, there is the questi of how the definiti of an alternative investment fund ("AIF") under the AIFM Directive should transposed and the potential effect this may have secti 235 of FSMA. Secti 235 ctains a definiti of a collective investment scheme ("CIS") and could impacted by transposing the AIFM Directive definiti of an AIF into UK law. AIF definiti's implementatin is an opportunity to address lg-standingg issues arising from the definiti of a CIS under secti 235 of FSMA, where the terms "arrangements", "day-to-day ctrol" and "operator" used in secti 235 give rise to legal uncertainty. However, inmal indicatis at this stage suggest that the approach taken will not amount to any real overhaul of secti 235. Secdly, the FSA and HM Treasury are csidering amending the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 ("RAO") to include a new regulated activity of managing AIFs, as well to distinguish tween the activity of ing a depositary from other activities associated with the management or operati of AIF and CIS. Thirdly, we are likely to see a new sourcebook, provisially referred to as FUND, within the FSA Handbook. FUND will replace the current Collective Investment Schemes sourcebook ("COLL") and will ctain requirements both UCITS and alternative investment fund managers ("AIFMs") (and also, in due course, the new venture capital and social entrepreneurship funds ing proposed by the European Commissi) ). re will also amendments to the n-fund sourcebooks within the FSA Handbook to include AIFM Directive equirements systems and ctrols and cduct of business. What is the UK approach to implementati? UK government expects to adopt a "copy-out" approach to the AIFM Directive in order to minimise the regulatory burden firms. This means that strg justificati willl required proposed additial measuress that exceed the terms of EU legislati (knownn as gold-plating). Will the UK ctinue to permit private placement? Once the AIFM Directive is transposed, EU (including UK) AIFMs will able to manage and market EU AIFs in the UK and in other memr states having ly en authorised in a single memr state. This means that the AIFM Directive will replace the UK's existing rules marketing of EU AIFs managed by EU AIFMs to UK professial investors. However, the AIFM Directive permits memr statess to ctinue natial marketing private placement regimes at least the first five years of the applicati of the AIFM Directive (although it is, of course, open to individual EU memr states which choose to do so to tighten up their regimes by applying additial requirements). Will the UK investors? permit marketing to retail AIFM Directive prohibits the marketing of AIFs to retail investors, but gives memr states the discreti to permit marketing selectively and impose greater restrictis than those marketing to professial investors. Under the current UK regime, certain n-ucits funds (n-ucits retail schemes ("NURS") and companies that are exempted from the FSMA CIS regime, but which are subject to the general rules of company law, including investment companies) may marketed to retail investors and are within the scope of the AIFM Directive. UK authorities will csider under what cditis an AIFM will entitled to market to UK retail investors and have sought views extending or restricting the range of funds permissiblee as ing marketed to retail investors. When will UK firms able to apply authorisati as AIFMs? HM Treasury has indicated its intenti to ctinue to permit the marketing of n-eu AIFs managed by EU AIFMs, and EU and n-eu AIFs managed by n-eu AIFMs, to UK professial investors, subject to compliance with ly the minimum requirements specified in the AIFM Directive, with no impositi of additial third country equirements. This means that in many cases the private placement of n-eu and EU AIFs managed by n-eu AIFMs in the UK will ctinue. However, changes to the existing marketing (financial promotis) regime are likely. FSA aims to in a positi to receive potential AIFM applicatis authorisati in Q2 2013, in time to nefit potential authorised AIFMs wishing to make use of the EUright wide passports marketing and/or AIF management from the outset of the AIFM Directive's implementatin 22 July 2013.

3 3. What about existing MiFID or UCITS managers? Implementati of the AIFM Directive will result in changes those firms currently authorised under MiFID. AIFM Directive has not en interpreted as allowing a firm to authorised under both the AIFM Directive and MiFID (while an AIFM may, however, also authorised under the UCITS directivee to manage UCITS). However, the AIFM Directive permits an external AIFM to provide some MiFID- requirements, organisatial requirements and cduct of like activities the basis that MIFID rules initial capital business requirements will apply to these activities. UK managers likely to fall into this category will wish to ensure that they are not required by the FSA to comply with both AIFM Directive and MiFID requirements in relati to all their activities, which would amount to double authorisati. UK managers have aired ccerns that they will need to de-authorised as MiFID firms, and then re-apply AIFM Directive authorisati and that, if so, the process must streamlined. FSA points out that existing MiFID firms and UCITS management companies thatt csider they will AIFMs should aware of several new general principles, such as additial due diligence respsibilities; requirements relating to the appointment of counterparties and prime brokers; and fair treatment. What prudential category will AIFMs fall within? FSA expects that there will at least six prudential categories of AIFM (excluding smaller AIFMs) and that these will include internal AIFMs; external AIFMs; AIFM investment firms; UCITS AIFM firms; and UCITS AIFM investment firms. However, not all stakeholders are cvinced that all these categories are appropriate, suggesting that there may some double counting. Moreover, the FSA appears minded to make the AIFM investment firm (in other words external AIFMs which also provide the core service of individual portfolio management) category subject to the BIPRU Limited Licence Firm requirements as well as the AIFM Directive requirements external AIFMs. As mentied above, the AIFM Directive permits an external AIFM to provide some MiFID-likmanagement, activities, in particular individual portfolio the basis that MiFID rules initial capital requirements, organisatial requirements and cduct of business requirements will apply to these activities. It has en pointed out thatt this should not mean making such firms subject to all the MiFID capital requirements as the ly requirements relating to capital applicable to such AIFMs should the initial capital requirements (and not, example, the fixed overhead requirements). Who will the UK permit to act as depositary y? provisis of the AIFM Directive mean that a UK AIFM will required to ensure that a single depositary is appointed each UK AIF it manages. Moreover, a UK AIF must have a depositary established in the UK. However, and while not coming to any definite cclusi, the FSA notes that the AIFM Directive gives some discreti to allow a UK AIF to use a depositary established in another memr state until 22 July Generally the AIFM Directive ly permits three types of firm to a depositary, in summary an EU credit instituti; a MiFID investment firm subject to the same CRD capital requirements as credit institutis; or a prudentially regulated and supervised instituti eligible to a UCITS depositary under the UCITS IV Directive. In additi, however, memr states may permit other entities to act as depositary as a depositary AIFs whose investors have no redempti rights five years from the date of their initial investment and generally do not invest in financial instruments that must held in custody or invest in issuers or n-listed companies to potentially acquire ctrol. FSA correctly recognises that this opti would useful private equity or real estate AIFS. Will the UK permit smaller AIFMs to register ly? AIFM Directive requires AIFMs to authorised, but permits memr states to establish a minimum registrati regime AIFMs managing AIFs with assets low certain thresholds. Memr states have the opti of imposing additial requirements. UK government is csidering either fully applying all requirements of the AIFM Directive to all small AIFMs or applying a lighter regime selectively to some small AIFMs. HM Treasury is minded to select the secd opti, so that depending the type of AIFM it could subject to registrati ly, selective applicati or full authorisati. However, it does seem likely that in practice most smaller AIFMs will subject to at least some additial requirements over and above the minimum registrati requirements referred to in the AIFM Directive. A key factor when looking at the type of AIFM would seem to whether its investors are retail or professial. Will the UK apply its approved perss regime to AIFMs? FSA has an approved perss regime, which applies to individuals carrying ctrolled functis ( example, directors, portfolio managers, advisors and many others) within authorised firms (including fund managers). This means firms cannot, example, simply appoint a director or take a new employee who will carry a ctrolled functi without first submitting a successful applicati prior FSA approval. Once approved, approved perss are

4 4. subject to various going compliance requirements (which are separate but parallel to the regulatory obligatis of the firm). UK is permitted, but is not compelled, to apply its approved perss regime under the AIFM Directive. Indicatis are that HM Treasury is minded to apply the approved perss regime to AIFMs, while recognising that this would regarded as gold-plating. It is worth noting that other EU memr states do not all have approved perss type regimes. However, the UK's approved pers regime may seen as positive rather than negative by AIFMs, given increasing investor focus corporate governance and staffing. Which UK firms will affected by the AIFM Directive? Based internal and industry estimates, the FSA csiders that over 1,000 UK firms and funds are likely to within the scope of the AIFM Directive. Some, or all, of the following, may csidered UK AIFs: hedge funds, hedge fund of funds, private equity funds, venture capital funds, property funds, investment trusts, real estate investment trusts ("REITs"), FSA-authorised n-ucits funds (including NURS, funds of alternative investment funds ("FAIFs") and qualified investor schemes ("QIS")), charity funds, commodity funds and infrastructure funds. FSA has said it will undertake a preliminary firm categorisati exercise to determine more clearly the likely populati of UK AIFMs thatt will fall within the scope of the AIFM Directive. It is not clear when this exercise will completed. Which new UK regulator will regulate AIFMs? FSA's work implementing the AIFM Directivee is ing carried against the backdrop of the UK government's rem of the current regulatory system. FSA in its current m will abolished and three new regulatory bodies established in its place in early se are the Financial Policy Committee ("FPC"), the Prudential Regulati Authority ("PRA") and the Financial Cduct Authority ("FCA"). PRA and the FCA will inherit the majority of the FSA's existing functis. FCA is the likely new regulator most fund managers. Ongoing EU implementati of secdary measures Significant detail is ing defined in implementing measures (including delegated acts, and implementing acts), developed by the European Commissi in light of advice from the European Securities and Markets Authority ("ESMA"); technical standards drafted by ESMA subsequent adopti by the European Commissi; and guidelines adopted by ESMA. European Commissi is expected to adopt these subordinate measures based ESMA s advice in the course of However, the European Commissis draft regulati implementing the AIFM Directive released in April 2012 has caused ctroversy given the extent to which it diverges from ESMA's advice. European Commissi previously indicated that it planned to adopt the regulati in July 2012 but we are now looking at this happening in Septemr Meanwhile, ESMA ctinues to draft the technical standards and guidelines which it has en given respsibility, such as leverage calculati, remunerati policies and supervisory co-operati arrangements. In June ESMA published a csultati paper draft guidelines remunerati under Article 13 of the AIFM Directive, which it intends to finalise by the end of ESMA is working towards the establishment of co- Although the relevant agreements will tween n- operati arrangements with n-eu authorities. EU and EU authorities, ESMA intends to centralise the process and negotiate half of the EU competent authorities. ESMA is, according to an April 2012 press release, in the course of discussis with n-eu that ESMA's approach will to ensure that it is the n-eu jurisdictis with active investment fund industries which will prioritised. ESMA published a discussi paper key ccepts of supervisors. Unofficial indicatis are the AIFM Directive and types of AIFM in February It closed to comments 23 March ESMA has indicated that some of these issues will probably addressed in the m of ESMA guidelines or a Q&A, rather than in regulatory technical standards. While progress towards natial implementati can and is ing made against this backdrop, in the final analysis UK implementati of the AIFM Directive will depend the outcome of the secdary measures. FSA has cfirmed that it is engaged with the development of technical standards and guidelines by ESMA and, in cjuncti with HM Treasury, the adopti of implementing measures by the European Commissi. Cclusi FSA says it is committed to working with the asset management industry to ensure that the AIFM Directive implementati is "thoughtful and subject to appropriate csultati". It is important that stakeholders ctinue to actively engaged in shaping the final outcome by respding to further HM Treasury and FSA csultatis, in order to try and ensure that implementati of the AIFM Directive is as workable and neficial as possible. Please do not hesitate to ctact the author to discuss any of the issues raised above or in relati to AIFM Directive related matters more generally.

5 5. Gide Loyrette Nouel LLP 125 Old Broad Street Ld EC2N 1AR United Kingdom Tel. +44 (0) Ctact Lucy Frew, Head of Investment Funds & Financial Regulati Tel. +44 (0) For further inmati:

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