London Hedge Fund Summit

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Monica Stevens
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London Hedge Fund Summit Tuesday 29 April 2014

3 Overview Regulation of OTC Derivatives in the US: Dodd- Frank Title VII Regulation of OTC Derivatives in the EU: EMIR MiFID II Commodity Pool Operator / Commodity Trading Advisor Registration klgates.com 3

5 Dodd-Frank Title VII Objectives Key Dodd-Frank objectives for derivative regulation: Improve transparency Reduce the potential for defaults, excessive risk taking, and systemic risks Minimize unfair dealing, fraud, and manipulation Dodd-Frank rulemaking is an ongoing process Different regulators proceed according to different schedules klgates.com 5

6 Dodd-Frank Title VII U.S. Regulators SEC Security-based swaps ( SB Swaps ) and mixed swaps SB Swap Dealers, major SB Swap participants, broker-dealers, SB Swap clearing agencies, SB Swap exchanges, SB Swap facilities, SB Swap data repositories CFTC Swaps (everything that is not an SB Swap) and mixed swaps (with security and non-security characteristics) Swap dealers, major swap participants, futures commission merchants, swap clearing organizations, exchanges, and swap data repositories Banking Regulators ( Prudential Regulators ) Regulate standards of conduct of and regulatory requirements for banks and related entities in swaps, SB Swaps, and mixed swaps FSOC Mediates jurisdictional disputes between CFTC and SEC FERC Potentially overlapping jurisdiction with CFTC for natural gas and electric power markets klgates.com 6

7 Dodd-Frank Scope of Regulation Scope - Swaps and Security Based Swaps CFTC regulates Swaps Interest rate swaps FX Covered under Dodd Frank: FX options, swaptions and non-deliverable forwards Not covered under Dodd Frank (except for Business Conduct): FX swaps, FX forwards Not covered at all under Dodd-Frank: FX spot; securities transactions Broad Index CDS and equity derivatives Commodity derivatives Guarantees of swaps are considered to be swaps Not covered under Dodd-Frank: Forward contracts (for nonfinancial commodity or security; intended to be physically settled) Futures and exchange-traded options SEC regulates Security-Based Swaps Single name CDS Narrow index CDS (9 names or less) Single name equity TRS Narrow index equity TRS (9 names or less) Guarantees of security-based swaps are considered to be securities subject to federal securities law regulation Security-Based Swaps are securities under the 33 and 34 Acts Compare to scope of EMIR! 7

8 Summary of Dodd-Frank Changes to Swaps Regulation in the U.S. Market Structure: Swap Data Repositories (all swaps) Central Clearing Counterparties Interest rate swaps and certain CDS More classes to be added over time Swap Execution Facilities Position Limits Entity Regulation: Swap Dealers (entities that make markets in swaps) and Major Swap Participants (entities that engage in significant swap trading) Business conduct requirements Reporting and recordkeeping requirements klgates.com 8

9 Dodd Frank Act Key Derivatives Provisions 9

10 Impact on the Buy-Side Reporting obligations (unless SD or MSP reports) Relationship with SD and MSP counterparties Provide information that allows SDs and MSPs to comply with regulations Define settlement and dispute process Typically achieved through adherence to the DF Protocol Commercial End-Users are exempt from most requirements Business Impact: Reporting Position limits New trading documentation Margin requirements for cleared swaps Margin requirements for uncleared swaps (look for these in 2014) klgates.com 10

11 Bilateral and Centrally-Cleared Markets klgates.com 11

12 New Documentation for Swaps Trading Cleared Swaps Futures & Options Agreement OTC cleared addendum (FIA/ISDA form (product/clearinghouse neutral) Give-up agreement (FIA/ISDA execution agreement) Potential master netting arrangement to net futures, cleared and uncleared swaps Clearinghouse Rules SEF User Agreement and/or SEF rulebook Both DF Protocol Swap Dealer must comply with Business Conduct Rules when they face a customer for a swap, whether cleared or not Off-SEF Give-up agreement (FIA/ISDA execution agreement) Schedule to the ISDA Master Agreement Credit Support Annex If segregation of IA is elected, then Account Control Agreement with third party custodian and CSA amendments Uncleared Swaps Schedule to the ISDA Master Agreement Credit Support Annex If segregation of IA is elected, then Account Control Agreement with third party custodian and CSA amendments klgates.com 12

13 Swap Reporting Real-time post-trade reporting and Swap Data Repository (SDR) reporting Dodd-Frank mandates Real Time Reporting for price forming transactions and Regulatory Reporting (SDR Reporting) of Positions and Valuations One party to the trade is designated the Reporting party per the following hierarchy: Swap Dealer (regardless of whether it is a US person or not) Major Swap Participant End User Parties that share the same registration status must agree on the reporting party; however, a U.S. party is the reporting party when trading with a non-u.s. party. Trades executed on a SEF or cleared through DCO are reported by the SEF/DCO All parties need to obtain a legal entity identifier - CICI / GMEI 13

14 Extraterritorial Application of Dodd-Frank CFTC Cross-Border Guidance Commodity Exchange Act 2(i) Title VII of Dodd-Frank shall not apply to activities outside the United States unless those activities have a direct and significant connection with activities in, or effect on, commerce of the United States as the Commission may prescribe or promulgate as are necessary or appropriate to prevent the evasion of any provision of this Act that was enacted by the Wall Street Transparency and Accountability Act of CFTC approach clarified in July 12, 2013 Guidance Statement Swap Dealer (or MSP) category Counterparty category Category of requirement Entity Level (1 st and 2 nd ) Transactional Level (1 st and 2 nd ) Legal challenge to CFTC Guidance Statement 14

15 Extraterritorial Application of Dodd-Frank U.S. Person Definition selected issues 8 prongs to U.S. Person Definition, including: A legal entity (e.g., corporation, partnership, LLC, fund or any similar form of enterprise) that (A) is organized or incorporated under US law or (B) has its principal place of business in the United States. Principal place of business nerve center where high-level officers direct, control and coordinate the entity s activities For collective investment vehicles- location of senior personnel responsible for formation/promotion of vehicle implementation of investment strategy, depending on facts and circumstances The Commission generally believes that [a non-u.s.] person would not come within the U.S. person interpretation solely because it retains an asset management firm located in the United States (see FR 45312) 15

16 Extraterritorial Application of Dodd-Frank U.S. Person Definition selected issues (continued) Any commodity pool, pooled account, investment fund, or other collective investment vehicle not described in the legal entity prong that is majority-owned by one or more US persons, unless it is publicly offered only to non-u.s. persons and not offered to U.S. persons Majority ownership test Direct beneficial owners and looking-through the beneficial ownership of entities controlled by or under common control with the fund May rely on representations of an unrelated investor entity unless formed for the purpose of avoiding looking through Reasonable due diligence Publicly offered Not defined but the publicly offered vehicle could be a UCITs (see FN 224) Exception is intended to address comments that ownership verification would be particularly difficult for publicly offered vehicles 16

17 Non-U.S. Persons That Raise Issues CFTC Non-US affiliates of US persons Guaranteed by a US person Acting as a conduit (whether or not guaranteed for a US person) Non-US registered SD/MSPs Non-US aggregated affiliates SEC Non-US person guaranteed by a US person Non-US person conducting a transaction in the US Non-US registered SB/MSPs Non-US aggregated affiliates Limited importance today, but expect differences between CFTC and SEC positions to cause problems in the future 17

18 Key Takeaways Presently concerned with a limited universe of transactions swaps Only one party to a trade is the reporting party U.S. Person definitions require analysis; end-users should: Know their treatment for representations / DF protocol adherence Be aware of clearing / execution mandates 18

19 Current / Upcoming Issues SEF trading mandates Recordkeeping issues Collateral requirements for uncleared swaps New position limit regulations 19

21 European Market Infrastructure Regulation ( EMIR ) Key Provisions 5 Collateral and Margin Margin requirements for non-cleared swaps Daily variation calls Eligible collateral has to be transferred as initial margin Collateral management process to be updated 6 1 Clearing Connection to affirmation platform has to be established Connection to at least two clearing members has to be established 2 Reporting All derivatives (OTC and ETD) will start to be reported from 12 February 2014 onwards Backlog derivative transactions have to be reported Customers Portfolios OTC derivative activities have to be mapped and monitored Portfolios have to be assessed in the light of collateral eligibility 4 EMIR Agreements Existing legal documentation with counter- parties, custodian bank and collateral manager has to be updated New contractual relation-ships with clearing members and affirmation platforms providers have to be set up 3 Risk Management & Valuation New capital requirements have to be fulfilled Risk mitigation techniques for non- standard OTC derivatives have to be implemented Risk valuation method has to be aligned with requirements

22 EU Regulation of OTC Derivatives MiFID II and CRD IV EMIR: Derivative contracts existing on August 16, 2012 Regulatory Technical Standards March 15, 2013 September 15, 2013 November 18, Direct, substantial and foreseeable effect in the EU and non-evasion Expected later Margin and capital for non-centrally cleared OTC derivatives 22

23 Overview of EMIR Central counterparty ( CCP ) and trade repository ( TR ) requirements Clearing of standardised OTC derivative contracts Risk mitigation for uncleared trades Trade repository reporting 23

24 Key Elements of EMIR Meaning of Derivatives Counterparty categorisation Financial Counterparties ( FCs ) Non-Financial Counterparties ( NFCs ) Third country entities ( TCEs ) Clearing thresholds NFC and NFC+ 24

25 The clearing obligation The clearing obligation under EMIR will apply: Between two FCs Between an FC and an NFC+ entity Between two NFC+ entities Between an FC or an NFC+ entity and a TCE (only where the TCE would be subject to clearing obligation if it was established in the EU) Between two TCEs if the contract has a direct, substantial or foreseeable effect in the EU (or where it is necessary or appropriate to prevent the evasion of EMIR s requirements) 25

26 Extra-territorial effect Direct, substantial and foreseeable the contract is guaranteed by an FC; or the transaction is executed via the EU branches of the two TCEs Anti-Evasion Rule Primary purpose test Artificial arrangements 26

27 Risk mitigation techniques Uncleared OTC trades FCs and NFCs (all) From March 25, 2013: Timely confirmations From September 15, 2013: Reconciliation, portfolio compression and dispute resolution Additional requirements for FC and NFC+ counterparties Initial and variation margin (see April 2014 RTS consultation) Daily valuation Extraterritorial effect of risk mitigation requirements 27

28 Trade Reporting All contracts entered into on or after August 16, 2012 Timing T+1 Back-loading If outstanding on February 12, 2014: 90 days If no longer open, but outstanding on August 16, 2012: 3 years 28

29 Key Takeaways Applies to all OTC derivatives Note issues with definition and treatment of spot contracts Exact requirements drive by party classification and location Trade reporting for ETD and OTC contracts Trade reporting applies to both parties if in the EU No equivalence yet between DFA and EMIR for reporting Central clearing and collateral requirements to commence

30 Timings August 2012 March 2013 August 2013 September 2013 November 2013 EMIR in force Technical standards on OTC derivatives, Trade Repositories and requirements for Trade Repositories and CCPs NFC+ notification requirement in force Timely confirmation requirement in force Draft technical standards on format and frequency of trade reports Risk management of non-cleared OTC derivatives Draft technical standards on direct, substantial or foreseeable effect February 12, 2014 April 2014 Q / Q Late 2015 to 2019 Reporting of derivatives (OTC and ETD) commences Non-Cleared Collateral and Margin RTS Consultation (to be finalised December 2014) Clearing obligation comes into effect Margin requirements for non-cleared trades come into effect 30

32 The MiFID Review Mandated review Greater competition / pan-european trading Exchange consolidation Advances in technology (smart order routing, algo/hft trading, latency and co-location) Rise of dark pools Liquidity incentives klgates.com 32

33 Market Issues Broker Crossing Networks Pre-trade transparency waivers Regulation of exchanges vs OTC markets Systematic Internalisers Fragmentation Quality of execution Access to post-trade infrastructure Extension of post-trade transparency to nonequity markets klgates.com 33

34 Key Changes Trading and clearing access Introduction of OTFs Expansion to commodity markets Automated trading Introduction of position limits Consolidated tape Amendments to Article 2 exemptions Timings klgates.com 34

36 Registration of CPOs and CTAs Commodity Pool Operators (CPOs) and Commodity Trading Advisers (CTAs) operate and advise funds or commodity pools that trade certain derivatives or commodity interests CPOs and CTAs (the managers not the funds) must register with the CFTC, unless exempt Limited exemptions for non-u.s. operators If you solicit U.S. investors, you are likely a CPO or a CTA If you trade derivatives with U.S. counterparties, you are likely a CPO or a CTA 36

37 What is a Commodity Pool An investment trust, syndicate, or similar enterprise that invests in the following commodity interests : futures contracts (including security futures ) options on futures retail forex and as of December 31, 2012: CFTC-regulated swaps (not security-based swaps ) A fund falls into the commodity pool definition even if it invests in commodity interests indirectly through another fund 37

38 What is a Commodity Pool SWAPS (including swaptions) on commodities, interest rates, currencies, etc. on broad-based securities indices, government securities, and municipal securities Mixed Swaps on one or more components of a security-based swap and one or more components that are not within the security-based swap definition excluded: security-based swaps excluded: FX swaps and FX forwards 38

39 What is a CPO? Someone who operates a commodity pool and who solicits assets from investors for the purpose of trading commodity interests CFTC reads the definition broadly to include any person that handles or exercises control over the commodity pool assets, regardless of whether or not they engage in solicitation CFTC also looks at the person who has the authority to hire and fire the pool s CTA and select and change the pool s FCM Generally is the GP or Managing Member, but could be the adviser 39

40 What is a CTA? Someone who provides trading advice with respect to futures and swaps The investment adviser to a fund is usually both the CPO and the CTA A sub-adviser to a fund generally is a CTA but not a CPO A sub-adviser that does not provide derivatives trading advice to a fund is not a CTA In a separate account, the investment adviser is a CTA 40

41 Changes to Exemptions 4.13(a)(4) Rule 4.13(a)(4) Exemption for Pools with Highly Sophisticated Investors and non-u.s. Investors In 2012, the CFTC rescinded Rule 4.13(a)(4), which contained a broad exemption from most of the CPO requirements Rule 4.13(a)(4) did not contain any limit on the amount of a pool s trading in commodity interests As a result of the rescission of Rule 4.13(a)(4), private fund managers must either comply with Rule 4.13(a)(3), or register as a CPO 41

42 Changes to Exemptions 4.13(a)(3) Rule 4.13(a)(3) Unchanged, but now commodity interests include swaps Rule 4.13(a)(3) requires that pool investors either be non-u.s. persons or meet a sophistication standard Pool must trade a de minimis amount of commodity interests; either: the aggregate initial margin and premiums cannot be more than 5% of the pool s NAV; or the aggregate net notional value of such positions may not exceed 100% of the pool s NAV 42

43 Questions for Non-U.S. Managers Do you trade in the U.S. and/or market to U.S. investors? Are you a CPO or a CTA? Have you filed an appropriate exemption with the U.S. National Futures Association? Do you meet the requirements of CFTC Rule 4.13(a)(3) Taking into account swaps trading? Immediately after each commodity interest transaction? 43

45 Overview AIFMD and EU Private Placements UK Crowd-funding U.S. Fund-raising and JOBS Act klgates.com 45

47 Cross-border Marketing (1) What is an offering? Directive does not apply if no marketing into EU, or only reverse solicitation (i.e., no direct or indirect offering or placement at the initiative of the AIFM or on its behalf) How will this be understood/interpreted in different EU Member States?

48 Cross-border Marketing (2) Local private placement exemptions in EU Member State where fund marketed allow it; and Any local application procedure has been followed in each EU Member State where fund is to be marketed

49 Cross-border Marketing: Fund and Manager Non-EU (1) Can privately place if: Manager complies with Art 22 (Annual Report), Art 23 (Disclosure to Investors) and Art 24 (Reporting to Regulator) Also need three-way co-operation agreements among regulators (including regulator in each Member State where fund marketed)

50 Cross-border Marketing: Fund and Manager Non-EU (2) Regulator Co-operation Agreements Must be in writing Specific framework for consultation, co-operation and exchange of information for supervisory and enforcement purposes Procedures to ensure EU regulators have access to everything they need to perform their duties under AIFMD Must enable on-site inspections (which can be carried out by non-eu regulator with assistance from EU regulator)

51 Cross-border Marketing: Fund and Manager Non-EU (3) If considering EU AIFM managing EU AIF to get passport, does not work if feeding into a non-eu fund (85% + investment) Also cannot invest in parallel masters with identical investment strategies

52 End of AIFMD Transitional Arrangements Transitional relief assists many up to July 21, 2014 Note possible different interpretations in other EU Member States UK firms must be fully compliant with AIFMD from July 22, 2014 Marketing provisions only apply once authorised as an AIFM Pass-porting only available post-authorisation Non-EU firms must submit notification forms by July 21, 2014 to continue marketing in the UK after that date klgates.com 52

54 Crowd-funding: UK Regulatory Change FCA Policy statement issued in March 2014 (PS 14/4) Where crowd-funding platforms allow investment in units in unregulated collective investment schemes ( UCIS ) or other non-mainstream pooled investments, the existing marketing restrictions applying to NMPIs will apply (a possible bear trap). FCA: loan-based crowd-funding Platforms have been regulated from April 1, 2014 as peer-to-peer lending platforms; considered to be lower risk than equity-based platforms (but market may become riskier). Minimum Prudential Requirements - Requirement for firms to maintain adequate capital buffers this is the higher of a fixed capital amount ( 50,000) and a percentage of a volume-based measure (e.g. 0.2% of the volume of loaned funds up to 50m i.e. 100,000 at 50m). The volume-based measure is a percentage of the total amount of loaned funds on the platform. Transitional regime until April 1, klgates.com 54

55 Crowd-funding: UK Regulatory Change Client Money Rules - CASS rules already apply to investment-based crowdfunding platforms. FCA now requiring that CASS rules be applied to loanbased crowd-funding platforms insofar as the firm holds money on behalf of clients. No FSCS protection. FCA Reporting Requirements - Requirement to provide FCA with client money reports, financial position reports, complaints reports. FCA: loan-based crowd-funding Requirements for firms to take reasonable steps to ensure that existing loans continue to be managed and administered in accordance with contract terms in the event of platform failure. Communications, clear, fair and not misleading and investors to be provided with all the information they need to make informed investment decisions. klgates.com 55

56 Crowd-funding: UK Regulatory Change FCA: investment-based crowd-funding New rules also from April 1, Firms continue to be subject, for example, to prudential requirements. Now, new requirements upon all firms that promote and sell non-readily realisable shares or debt securities whether web-based or not. Requirements apply to authorised firms and their appointed representatives. Apply to firms that use internet, telephone, meetings, mailings or any other media to communicate and transact with customers. Overarching goal is consumer protection. FCA has no evidence to show that the wrong type of investor is investing in unlisted shares or debt securities and acknowledges possibility that prior approach worked. However, FCA has historically identified instances of noncompliant promotion of unlisted shares by firms using mailings or telephonebased business models and expects its proposals to minimise the risk of such promotions in future. klgates.com 56

57 Crowd-funding: UK Regulatory Change FCA: investment-based crowd-funding FCA now restricts direct offer financial promotion of non-readily realisable shares or debt securities (which excludes NMPI) by firms to one or more of the following retail clients: certified or self-certified sophisticated investors; self-certified high net worth investors; those who confirm that, in relation to the investment promoted, they will receive regulated investment advice or investment management services from an authorised person; Retail clients that are corporate finance contacts or venture capital contacts; A restricted investor i.e. those who certify that they have not invested over a 12 month period more than 10% of their net investment portfolio in unlisted shares or unlisted debt securities (excluding their primary residence, pensions and life cover). In fact means crowd-funding investment opportunities are available to more retail investors than previously (because previously restrictions were being imposed at the point of FCA authorisation of the platform firm). klgates.com 57

58 Crowd-funding: UK Regulatory Change FCA: investment-based crowd-funding Appropriateness Test Where advice is not provided, the FCA expects firms to apply an appropriateness test to clients before issuing to them promotions for unlisted equity or debt securities. This may involve firms needing to design automated systems to assess client knowledge and experience and to check clients understanding of risks. Firms will need to ensure compliance with the FCA s rules on appropriateness. FCA plans to conduct a formal review of the crowd-funding regime in klgates.com 58

60 How to Market Investment Funds Into the United States Any investment fund organized outside the U.S. that wishes to market its securities into the U.S. must do so pursuant to the private placement exemption in Section 4(a)(2) of the Securities Act of klgates.com

61 Section 4(A)(2) Section 4(a)(2) provides in its entirety: The provisions of Section 5 shall not apply to: Transactions by an issuer not involving any public offering. 61 klgates.com

62 Rule 506 of Regulation D Rule 506 of Regulation D was adopted by the SEC in 1982 to provide a safe harbor: if an issuer of securities complies with the requirements of Rule 506, it is deemed to have made a valid Section 4(a)(2) offering. The essence of an offering under Section 4(a)(2) is that the investors should be sufficiently sophisticated that they do not need the protections that the Securities Act of 1933 was intended to afford. However, whether any given investor is sophisticated is a highly subjective determination. One of the cornerstones of Regulation D is the definition of Accredited Investor in Rule 501. Accredited Investors include individuals with a net worth in excess of $1 million (exclusive of primary residence), individuals with an annual income in excess of $200,000 in the last two years who expect to have income in excess of $200,000 in the current year, entities that were not formed for the purpose of making the investment with at least $5 million in assets, etc. When the SEC adopted Regulation D, it intended Accredited Investor status to serve as a relatively objective proxy for sophistication. Regulation D simplifies the process of meeting the requirements of the Section 4(a)(2) exemption. 62 klgates.com

63 General Solicitation Rule 506 has always forbidden general solicitation and general advertising. That changed on September 23, 2013, when new Rule 506(c) became effective. 63 klgates.com

64 Effect of New Rule 506(c)-General Solicitation and General Advertising Permitted This is an extraordinary shift in public policy brought about by the JOBS Act. Any issuer relying on Rule 506(c) may solicit the public to purchase the issuer s securities. Issuers may publicly advertise their offerings through any form of advertising, such as on their websites, or through newspapers, magazines, Internet, T.V., radio or other media. 64 klgates.com

65 Rule 506(c) Required Elements Offerings by general solicitation may be made to anyone, but all purchasers must be accredited investors. The issuer must take reasonable steps to verify that each purchaser is an accredited investor before the sale. Rule applies a principles-based approach to verification. Must continue to comply with other Regulation D conditions Resale restrictions apply 65 klgates.com

66 The Verification Process is Burdensome (1) In order for a private fund to verify an individual s income, the individual must usually provide copies of his or her tax returns. In order for a private fund to verify an individual s net worth, the individual must usually provide bank statements, brokerage statements and credit reports. 66 klgates.com

67 The Verification Process is Burdensome (2) Although new Rule 506(c) of Regulation D permits general solicitation, most private funds are not taking advantage of it because of the requirement to verify the accredited status of each investor. The requirement imposes a burden not only on the private fund but also on potential investors. Consequently, most private funds are conducting private placements as they have in the past, pursuant to Rule 506(b) of Regulation D. 67 klgates.com

68 Crowd-funding (1) The JOBS Act also added the Section 4(a)(6) exemption from registration under the Securities Act to provide a foundation for crowdfunding. Crowdfunding is the raising of relatively small amounts of capital from a large number of investors, generally using the Internet or social media. 68 klgates.com

69 Crowd-funding (2) Until the SEC adopts final rules, no one can rely on new Section 4(a)(6). More importantly, however, companies that rely on Section 3(c) of the Investment Company Act of 1940 (the 1940 Act ) to be excepted from registration under the 1940 Act cannot rely on new Section 4(a)(6). Because any investment fund organized outside the U.S. that wishes to offer its securities into the U.S. must rely on the Section 3(c)(1) or Section 3(c)(7) exception from registration under the 1940 Act, Section 4(a)(6) is not helpful to our private fund clients. 69 klgates.com

70 Conclusion About the JOBS Act The opportunities that have been created by the JOBS Act thus far are not likely to be helpful to you either because they impose onerous requirements or because they are not available to you. 70 klgates.com

71 Considerations Under the U.S. Investment Advisers Act Of 1940 If a non-u.s. investment adviser sells interests in a private fund into the U.S. or enters into an investment management contract with a client in the U.S., it must register as an investment adviser under the Investment Advisers Act of 1940 ( Advisers Act ) unless an exemption is available. 71 klgates.com

72 Foreign Private Adviser Exemption An exemption that might be available to a non-u.s. manager is the Foreign Private Adviser Exemption in Section 203(b)(3) of the Advisers Act. This is a complete exemption from registration under the Advisers Act. That exemption is available to a manager that has no place of business in the U.S., has fewer that 15 clients and investors in the U.S., has aggregate assets under management attributable to clients and investors in the U.S. of less than $25 million, has no place of business in the U.S., and does not act as an adviser to a registered investment company or a business development company. Because this exemption is so restrictive, very few of our clients have found it to be helpful. 72 klgates.com

73 Private Fund Adviser Exemption (1) A non-u.s. manager that sponsors an investment fund that is privately-offered into the U.S. may be able to rely on the Private Fund Adviser Exemption in Section 203(m) of the Advisers Act. That Section exempts an adviser whose only clients in the U.S. are Qualifying Private Funds and who manages less than $150 million from a place of business in the U.S. If a non-u.s. manager has no place of business in the U.S., the dollar amount of its assets under management from a place of business in the U.S. will be zero. Funds that rely on the Section 3(c)(1) or Section 3(c)(7) exceptions are Qualifying Private Funds. 73 klgates.com

74 Private Fund Adviser Exemption (2) A non-u.s. manager may take advantage of this exemption regardless of the type or number of its non-u.s. clients or the amount of assets it manages outside the U.S. The Private Fund Adviser Exemption has therefore been very helpful to our non-u.s. investment adviser clients that sponsor private funds. 74 klgates.com

75 Private Fund Adviser Exemption (3) The Private Fund Adviser Exemption is not a complete exemption from registration under the Advisers Act. An adviser wishing to rely on that exemption must make a filing with the SEC and become an Exempt Reporting Adviser. 75 klgates.com

77 AIFMD Insurance Requirements AIFM should cover professional liability risks by either: Maintaining an amount of additional own funds (equivalent to 0.01% of total AUM) Buying professional indemnity insurance (equivalent to 0.7% of total AUM for individual claims and 0.9% of total AUM in aggregate per year) with the amount of any policy excess and any exclusions fully covered by additional own funds klgates.com 77

78 AIFMD Insurance Requirements (2) Professional liability risks defined as including: Loss of documents evidencing title of assets Misrepresentations or misleading statements made to the AIF or investors Acts, errors or omissions resulting in breach of: Legal and regulatory obligations Duty of skill and care towards the AIF and its investors Fiduciary duties Obligations of confidentiality AIF rules or instruments of corporation Terms of appointment of the AIFM by the AIF klgates.com 78

79 AIFMD Insurance Requirements (3) Failure to establish, implement and maintain appropriate procedures to prevent dishonest, fraudulent or malicious acts Improperly carried out valuation of assets or calculation of unit share/price Losses arising from business disruption, system failures, failure of transaction processing or process management klgates.com 79

80 AIFMD Insurance Requirements (4) Deadline for compliance: July 22, 2014 Options Additional capital v PI insurance What does it really mean in practice? PI insurance as part of overall risk management Real question is whether that cover is effective Benefits of stand-alone v composite PI and D&O policies Adequacy of cover for system failures/cyber attacks klgates.com 80

81 Common Types Of Claim Purely contractual claims Negligence claims Operational errors e.g. trading errors or fat finger losses May need to be settled pre-claim Voluntarily or required by FCA Mitigation costs cover klgates.com 81

82 Common Types Of Claim (2) Fraud or dishonesty Often result in collapse of Fund May impact PI and D&O cover Beware fraud and dishonesty exclusions Investor claims multiple claim scenarios potential aggregation issues klgates.com 82

83 Regulatory And Enforcement Issues FCA supervisory function exposure of individuals/approved persons Closer regulatory scrutiny FCA, SEC, CFTC Co-operation between regulators worldwide eg LIBOR Significant legal costs In several jurisdictions PI and D&O cover may not be triggered from outset Fines and penalties not recoverable klgates.com 83

84 Regulatory And Enforcement Issues (2) May lead to civil claims and proceedings Additional legal costs Beware notification issues Intervention of criminal investigators eg SFO Scope of cover for criminal proceedings Which individuals are covered? Internal investigations AML/Anti-bribery controls Data breaches and cyber attacks klgates.com 84

85 Points To Keep In Mind Claims and regulatory activity may well increase The driver behind AIFMD is investor protection Make sure you have proper controls and procedures in place Make sure you have sufficiently broad PI and D&O cover (regardless of AIFMD) Review your policies to avoid what could be very costly gaps in cover klgates.com 85

86 Operations and Compliance Issues for Private Funds Sean P. Donovan-Smith, Partner (London) Nicholas S. Hodge, Partner (Boston) Michael W. McGrath, CFA, Partner (Boston) Philip J. Morgan, Partner (London) Copyright 2014 by K&L Gates LLP. All rights reserved.

87 Summary Registration and entity-level obligations Reporting obligations and how to manage them Trading issues klgates.com 87

88 Registration and Entity-level Obligations AIFMD / remuneration U.S. adviser registration obligations for non-u.s. advisers Activities requiring registration Participating Affiliates Dual-registrants Exempt Reporting Advisers klgates.com 88

89 Reporting Obligations U.S. Form PF and CPO-PQR AIFMD Annex IV EMIR Additional requirements? klgates.com 89

90 Trading Issues Cross trades and principal trades SEC expectations regarding best execution Transaction and trade reporting Use of dealing commissions from the view of the FCA and SEC klgates.com 90

92 Exempt Reporting Adviser ( ERA ) Status: Initial Requirement File a truncated initial Form ADV Part 1A Item 1 (Identifying Information) Item 2.B. (SEC Reporting by ERAs) Item 3 (Form of Organization) Item 6 (Other Business Activities) Item 7 (Financial Industry Affiliations and Private Fund Reporting) Item 10 (Control Persons); and Item 11 (Disciplinary Information) Any corresponding schedules klgates.com

93 ERA Status: Ongoing Obligations After Initial Filing Amendments to Form ADV File an annual updating amendment to Form ADV within 90 days after the end of the adviser s fiscal year Update Form ADV Part 1A promptly if any of the following items becomes inaccurate in any way: Item 1 (Identifying Information) Item 3 (Form of Organization) Item 11 (Disciplinary Information) Update Form ADV Part 1A promptly if Item 10 (Control Persons) becomes materially inaccurate. klgates.com

94 ERA Status Ongoing Obligations After Initial Filing Prevention and Misuse of Nonpublic Information Implement procedures to prevent the misuse of material nonpublic information by the ERA and any persons associated with the ERA Prevention and Misuse of Nonpublic Information Make any applicable filings under the U.S. Securities Exchange Act of 1934 (e.g., Schedule 13G and 13D filings, Section 16 filings, Form 13F and 13H filings) Antifraud Requirements Subject to Section 206 of the U.S. Investment Advisers Act of 1940 klgates.com

95 ERA Status Ongoing Obligations After Initial Filing (Cont d) Recordkeeping Requirements Subject to recordkeeping requirements, although the scope of these requirements has not been specifically articulated by the SEC SEC Cause Inspections SEC has indicated that it does not expect to inspect ERAs routinely SEC may, however, conduct cause examinations (e.g., pursuant to a tip, complaint or referral from another agency or self-regulatory organization) klgates.com

96 Registration Requirements What can advisers expect if they do not qualify as ERAs and must register as investment advisers under the U.S. Investment Advisers Act of 1940? klgates.com

97 Investment Adviser Registration - Impacts Preparation, maintenance and delivery of Form ADV (including full Part 1A, as well as Parts 2A and 2B) Preparation, maintenance and filing of Form PF Regulation of client communications/advertisements Compliance Program Appointment of Chief Compliance Officer Implementation of a comprehensive compliance program Annual compliance review Code of ethics (including regulation and reporting of personal securities holdings and transactions) and insider trading policies Record keeping klgates.com

98 Investment Adviser Registration Impacts (Cont d) Strict safeguards regarding custody Contractual provisions (e.g., change of control of manager requires client consent) Routine SEC examinations and strict enforcement klgates.com

99 This presentation is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer K&L Gates LLP. All Rights Reserved.

US OTC derivatives reforms Impact on UK and other non-us asset managers. Second update October 2013

US OTC derivatives reforms Impact on UK and other non-us asset managers Second update October 2013 Table of contents Important notes 1. Dodd Frank decision tree 2. What is regulated as a swap? 3. When