The Alternative Investment Fund Managers Directive What you need to know

Size: px

Start display at page:

Download "The Alternative Investment Fund Managers Directive What you need to know"

Chad Dalton
5 years ago
Views:

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

1 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. Timeline AIFMD Level 1 Directive published 2011 AIFMD Level 2 Regulation and implementing measures published December 2013 HM Treasury consultation on implementation (Part 1 of 2) January 2013 Submission deadline for ESMA consultations on the Key Concepts of an AIF and Types of AIFM closed February These technical standards will be finalised in the first half of ESMA s final guidelines on sound remuneration policies under the AIFMD February 2013 FSA consultation on implementation (Part 2 of 2) March 2013 HM Treasury consultation on implementation (Part 2 of 2) March 2013 UK policy statements on implementation June 2013 AIFMD becomes law 22 July 2013 and firms not subject to the transitional periods will need to comply. FCA (successor to FSA from April 2013) ready to receive authorisation applications July The BVCA have stressed the need for the FCA to be in a position to accept applications at an earlier date. Finalisation of co-operation agreements with non-eu supervisors Q Technical standards, advice, guidelines and Q&A Q Must comply with the Directive 22 July Third country AIFM / AIF passport consideration by ESMA 2015 Review from Commission AIFMD II(?) 2017 Private placement regime may be phased out depending on the decision by ESMA 2018 Private placement regime may be switched off Transitional provisions The AIFMD allows firms that are already managing existing funds, before 22 July 2013, a transitional period of 12 months to comply with the relevant laws and regulations and to apply for authorisation. In order to market to EEA investors after 22 July 2013, firms may need to be authorised and compliant with the Directive. The rules for firms based in other member states may vary. What is an AIF? An Alternative Investment Fund is defined in Level 1 as Collective investment undertakings, including investment compartments thereof, which: (i) raise capital from a number of investors, with a view to investing it in accordance with a defined investment policy for the benefit of those investors; and (ii) Are not UCITS Undertakings for Collective Investment in Transferable Securities. ESMA is consulting on the elements of the definition and will finalise its guidelines in the first half of 2013.

2 Who will the Directive apply to? The AIFMD contains a partial exemption for AIFM whose total assets under management do not exceed the following thresholds: 500m, provided the AIF are not leveraged and investors have no redemption rights for the first five years; 100m (including assets acquired through leverage). Corporate and group structure and resource location Identify the AIFM and AIFs Each AIF is deemed to have a single AIFM responsible for complying with the Directive. Is the AIF internally or externally managed? Is it based in the EU or not? Is the AIFM managing an EU or non EU AIF? Supervisory functions will differ for each of these. Capital requirements The initial capital for AIFMs which are internally managed AIFs must at least amount to 300,000 and will not be subject to an own funds requirement. An AIFM appointed as an external manager must satisfy the initial capital requirement under the Directive of 125,000 and the own funds requirement. This means holding reserve capital at least equal to the higher of (i) a quarter of annual fixed overheads and (ii) 125,000 plus 0.02% of assets under management above 250m (capped at 10m). In addition, any AIFM must choose between having either (i) qualifying professional indemnity insurance, or (ii) additional own funds of 0.01% AIF assets under management to cover potential liability for professional negligence. Own funds can only be invested in liquid assets or assets readily convertible to cash. Remuneration ESMA has published detailed guidelines on sound remuneration policies under AIFMD. National regulators now need to implement these on a comply or explain basis. The guidelines apply to certain employees within an AIFM who are considered risk takers, senior management or are in the same earnings bracket as these categories of staff. Firms are required to put in place policies that do not encourage risk taking which is inconsistent with the risk profile of the AIFs managed. These guidelines were based on the rules initially developed for banks and financial institutions meaning that applying them to PE AIFMs will not be straightforward. They cover how remuneration is paid, restrictions for all staff (such as guaranteed bonuses), disclosure and oversight. A key component of the guidelines is that: - At least 40% to 60% of variable remuneration must be deferred appropriately and vest over a period of 3-5 years. - At least 50% of any variable remuneration must be paid in units or shares in the AIF or equivalent. - Performance related remuneration will be subject to clawback if performance is poor.

3 Carried interest The Level 1 Directive requires carried interest to be subject to the remuneration provisions and the final guidelines now clarify that carried interest itself is not considered to be remuneration it only is for the purposes of these guidelines. ESMA has helpfully recognised that carried interest schemes demonstrate the risk alignment criteria required by the guidelines. It gives one example of a carried interest scheme below: - It returns all capital plus any profits at an agreed hurdle rate to investors before the relevant staff receive any variable compensation for management of the AIF; and - The compensation received is subject to clawbacks until the liquidation of the AIF. The guidelines recognise the need for proportionate application depending on the size, nature and risk profile of the AIFM and this is an area where guidance from national regulators could be helpful. Marketing AIFM domiciled in the EU can actively market EU AIF to professional investors in all EU member states using the new marketing passport, which is considered to be a benefit (compared to a regime where you go to different countries separately). The Directive does not cover marketing to retail investors where national rules apply. In contrast, AIFM marketing non-eu AIF may only market by way of private placement to those EU member states which permit private placement and even then, additional conditions may apply depending on the your structure and the countries you are marketing too. This is a developing area as Member States have discretion as to how they apply these rules E.g. they can choose to apply this to sub-threshold AIFMs and restrict the use of the private placement regime. Fund documentation and reporting Greater transparency AIFMs will need to provide their respective competent authorities (i.e. the FCA) with new information covering (this list is not exhaustive): - Principal exposures and concentration across AIFs managed by them - Liquidity management arrangements - Risk profile and management tools - Stress testing results - Categories of assets the AIF invests in - Additional reporting if AIFs employee leverage on a substantial basis - Other areas that may be requested include: annual reports, list of AIFs, leverage employed. AIFMs will also need to disclose the following to investors prior to investing (this list is not exhaustive): - Investment strategy, objectives and restrictions - Procedures to ensure the fair treatment of investors and any details of preferential treatment (e.g. side letters). - Depositaries (see below) - Delegated functions - Matters if monitors against constitution - Valuation procedure - Subscription and redemption procedures - Fees and charges

4 - Liquidity and risk management procedures Leverage What is leverage? any method by which the AIFM increases the exposure of an AIF it manages whether through borrowing of cash or securities, or leverage embedded in derivative positions or by any other means. A recital in the Level 1 Directive also states: In particular for private equity and venture capital funds this means that leverage that exists at the level of a portfolio company is not intended to be included when referring to such financial or legal structures. Limits are not set in stone The following conditions apply: - An AIFM is required to set a maximum level of leverage in respect of each AIF it manages; - An AIFM will be required to demonstrate that the leverage limits set are reasonable and are complied with at all times. - Leverage is the ratio between the exposure of an AIF and its net asset value Commitment and gross method - It is the duty of the AIFM to calculate the exposure of the AIFs managed in accordance with two methodologies presented in the Level 2 Regulation from the European Commission these are known as the commitment method and the gross method. The Commission will review no later than 21 July 2015 whether the calculation methods are appropriate for all types of AIF. The calculations under both these methods are complicated. Essentially, the commitment method involves calculating the exposure of the AIF by way of the absolute values of its positions in instruments, assets or liabilities but takes account of hedging arrangements and netting between derivatives in reducing the overall exposure. The gross method is broadly similar but does not cater for hedging or netting (more detail can be found in Articles 7 and 8 under section 2 of the Regulation). Temporary borrowing facilities that are backed by capital commitments from investors are excluded from the leverage calculation, but this does not extend to revolving credit facilities. Other exposures at the fund level arising directly or indirectly from financial and/or legal structures with third parties also need to be included in the calculation of leverage. Conduct of business / segregation of functions General requirements these mandate the AIFM to: - Act honestly, with due skill and diligence when conducting their activities; - Act in the best interest of the AIFs, the investors, and the integrity of the market; - Have and employ effectively the resource and procedures that are necessary for the proper performance of their business activity; - Take all reasonable steps to avoid conflict of interests; - Comply with all regulatory requirements applicable to the conduct of their business; and - Treat all investors fairly

5 Specific and more detailed requirements are also contained on areas such as depositary oversight, risk management, leverage, liquidity management, details of which can be found in the Level 2 Regulation. Segregated functions there must be appropriate firewalls within the management structure of the AIFM. The Directive specifies that: - Risk management must be hierarchically and functionally separate from the operational units. - The valuation function can be carried out either by an independent external valuer with no links to the AIFM or AIF (although the AIFM would remain liable) or by the AIFM itself provided there is functional separation of the valuation function from both the portfolio management and remuneration policy functions, and that employees are protected from undue influence. Depositaries A burdensome requirement The AIFMD requires that all AIF have a depositary and the devil is in the detail. The UK FSA s first consultation on implementation of the Directive from November 2012 allows entities other than banks to perform this role (for certain types of AIF, including PE funds). The key issue is that near strict liability is imposed on depositaries for loss of relevant instruments / assets, for themselves and their sub-custodians. As a result, it is likely that AIFMs will find that there may well be few depositaries prepared to accept the heightened risks of operating in this new regime; and those that do will charge significant fees for their services. Further disclosure obligations for AIFMs where the AIFs they manage hold controlling interests in EU non-listed companies. The Anti-Asset Stripping provisions - This part of the Directive includes reporting obligations as AIFMs build up stakes in non-listed companies, and requirements to prevent asset-stripping of companies. These requirements apply to EU AIFM and also non-eu AIFM who market to EU investors. Further, local jurisdictions have the option of gold plating these requirements so managers will need to understand the requirements in each country. The rules do not apply to special purpose vehicles established to buy, hold or administer real estate; or small or medium-sized enterprises. The following requirements apply to non-listed companies with registered offices in the EU: o o Disclosures required on acquisition: When control is acquired, the AIFM must disclose its intentions to the regulator, the company and its shareholders about the future of the business and likely repercussions on employment by the company and material change in the conditions of employment. Other areas where disclosure is required include policies for preventing and managing conflicts of interest, including information about the safeguards established, and communications regarding the company and employees. Disclosures in the annual report: The following disclosures are required about each nonlisted company over which an AIF individually or jointly has control. They can be included in the annual report of the AIF and/or the non-listed company. - A fair review of the development of the company s business representing the situation at the end of the period covered by the annual report; - Any important events that have occurred since the end of the financial year; - The company s likely future development; and - Details of any acquisitions of own shares

6 Delegation The letterbox issue The Directive prevents delegation by the AIFM to the extent that it becomes a letterbox entity. The Level 2 Regulation outlines that to avoid the risk of being categorised as a letterbox entity an AIFM must perform a significant degree of day-to-day investment management itself, without delegation, and that proportionately, this should not be significantly outweighed by the amount of day-to-day investment management that it has delegated. ESMA has been empowered to issue guidelines to ensure consistent assessment of delegation structures across the European Union. The Commission has power to make further provisions on the letterbox test after two years and is tasked with monitoring the application of the letterbox provisions.

AIFMD. Fundamental considerations to be addressed at a strategic level for marketing in the EU:

AIFMD. Fundamental considerations to be addressed at a strategic level for marketing in the EU: AIFMD Are you ready? The Alternative Investment Fund Managers Directive ( AIFMD or the Directive ) came into force on July 22, 2013 with certain activities or requirements being governed by transitional