Alternative Investment Fund Managers Directive - An Update. 8 December 2010 Ash Saluja, Simon Morris and Jerome Sutour

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2 Alternative Investment Fund Managers Directive - An Update 8 December 2010 Ash Saluja, Simon Morris and Jerome Sutour

3 Looking at Timeline, scope and basics 2. The key issue cross-border business 3. A continental perspective

4 Timeline, scope and basics Ash Saluja

5 How we got here Policy + Financial crisis and need to manage systemic risks + Protection for investors (Madoff etc.) + Paranoia about the activities of hedge & private equity funds + Continental protectionism Process + A controversial initial draft + A short consultation period with numerous competing drafts + Last minute compromises/deferring (or ignoring) some difficult decisions Result =???

6 Timeline AIFMD adopted by EP Deadline for AIFM to comply / apply for authorisation Commission to activate thirdcountry passport Commission to carry out general review of AIFMD Commission to terminate private placement? 2 years 1 year 4 years Level 2 / Level 3 implementation 2 years 3 years AIFMD enters into force March 2011? Effective date (except for thirdcountry passport) ESMA to issue advice on passporting ESMA to issue advice on private placement

7 Scope Alternative Investment Fund (AIF) means: any non-ucits collective investment undertaking AUT, ICVC, LLP, PLC, IT which raises capital from a number of investors to invest in accordance with a defined investment policy for their benefit closed or open-ended; EU or non-eu; any asset class Alternative Investment Fund Manager (AIFM) means: any legal person whose regular business is managing one or more AIF external or self-managed Managing AIF means: portfolio management risk management

8 Typical in-scope structure Investor 1 Investor 2 Investor 3 Portfolio management Investment vehicle Risk management AIFM Internal (e.g. investment trust) or external (e.g. fund operator or portfolio manager) AIF For example, an ICVC, AUT or LP, but does not need to meet the UK concept of collective investment scheme can also be a body corporate, e.g. an LTD, PLC or LLP Portfolio / assets

9 Geographic scope 1. All EU AIFM, wherever they market or manage 2. Non-EU AIFM managing EU AIF, wherever marketed 3. Non-EU AIFM marketing AIF in the EU, wherever managed

10 And some basic building blocks

11 A Exemptions Holding companies: any company applying a business strategy through subsidiaries, associated companies or participations to contribute to their long-term value, and - listed on a European regulated market and operating for own account; or - not established for main purpose of generating returns by means of divestment of subsidiaries or associated companies AIFM managing limited AUM: < 100m, or < 500m if unleveraged 5 year + lock-in Joint ventures Intra-group structures Private wealth undertakings

12 B Authorisation All EU AIFM and non-eu AIFM require authorisation, except: - Non-EU AIFM marketing via private placement - AIFM of closed-ended AIF no longer investing after early 2013, or closing to further subscriptions by early 2013 and expiring by early 2016 Regulator to be provided with information on: - managers, shareholders or members of the AIFM - programme of activity & organisational structure of the AIFM - remuneration policies and practices compatible with AIFMD - arrangements for delegation and sub-delegation - investment strategies, use of leverage and risk profiles; fund rules; custody Authorisation conditional on: - Fit & proper - head office and registered office of AIFM in same MS Authorisation to be determined in three months; may be limited

13 C Other services / MiFID Non-self-managed AIFM may, in addition to managing AIF: manage UCITS provide the following services (if specific, separate permissions exist): individual portfolio management as non-core services: investment advice safekeeping and administration of shares and units of CIS reception and transmission of orders MiFID firms: do not require authorisation under the AIFMD to provide MiFID services in respect of AIF (e.g. individual portfolio management) cannot also be AIFMs under the AIFMD (they need to be either MiFID or AIFMD firms) may market AIF if AIFMD-compliant

14 D Capital requirements - External AIFM to have capital of at least 125,000 - Self-managed AIFM to have capital of at least 300,000 - AIFM managing funds exceeding 250m = own funds of 0.02% of the excess - 50% of own funds: may take the form of a bank/insurance company guarantee - In all cases, total capital requirement cap = 10m - Additional own funds or professional indemnity insurance to cover potential professional liability risks

15 E Reporting Annual report for investors Required for each EU AIF managed and each AIF marketed in the EU To be prepared by EU auditor Reporting to regulator Regular reporting on each EU AIF managed and each AIF marketed in the EU Disclosure to investors Detailed, similar to current good practice

16 F Leverage An AIFM must: set a maximum level of leverage for each AIF limit the reuse of any collateral or guarantee under a leveraging arrangement be able to demonstrate that leverage limits are reasonable and complied with The AIFM s home MS can: set limits to leverage impose other restrictions to prevent systemic risk

17 G Valuation Rules of AIF jurisdiction and AIF documentation apply, subject to additional AIFMD rules Commission to adopt further rules (on valuation procedures, guarantees required from valuer, frequency of valuations for open-ended funds) Valuer can be AIFM or external, provided it is independent from the AIF and portfolio management Depositary appointed for AIF can act as valuer if depositary and valuation functions are separate Open-ended AIF: frequency of valuation based on asset classes and redemption frequency Closed-ended AIF: additional valuations required whenever AIF increases or decreases its capital

18 H Delegation The AIFM must be able to: provide objective reasons for the delegation demonstrate the delegate is qualified and capable and selected with due care monitor the delegate be effectively supervised by the regulator withdraw the delegation immediately when in the interest of investors obtain regulator s approval The delegate of portfolio management functions must: be authorised for asset management or approved by AIFM home MS have regulator s approval be subject to regulatory supervision If non-eu, need cooperation between AIFM home MS and third country regulator(s)

19 J Depositary Single depositary required for each AIF (high level of liability) For EU AIF: Credit Institution, MiFID firm or other UCITS-compatible depositary based in AIF jurisdiction For non-eu AIF: eligible entity in AIFM home MS or in AIF home state Non-EU entity is only eligible subject to: - cooperation agreements between MS where non-eu AIF marketed and MS of AIFM - third-country entity subject to EU-equivalent prudential regulation and supervision - third country not on blacklist of Financial Action Task Force - OECD tax agreements between home MS of AIFM, third country where AIF established, and each other MS where AIF marketed - entity contractually liable to AIF as per AIFMD liability requirements

20 The key issue of cross-border business Simon Morris

21 A Basic EU passport To take effect in 2013 Will supersede domestic rules in EU MS for marketing and management Will allow EU AIFM authorised in one MS to: - market EU AIF to professional investors throughout the EU; and - manage AIF throughout the EU For non-eu funds & managers a dual framework: Private placement to remain possible until at least 2018 Marketing / management passport for third-country AIFM and AIF may be introduced in 2015

22 B Third-country AIFM and AIF private placement EU AIFM may market non-eu AIF if: - Full compliance with AIFMD (with relaxed depositary rules) - Cooperation re systemic risk between AIFM home MS and third country - Third country not on FATF blacklist Non-EU AIFM may market EU/non-AIF if: - Compliance with disclosure, reporting and (if applicable) private equity requirements only - Cooperation re systemic risk between AIFM home state, home MS/state of AIF and MS where marketed - Third countries not on FATF blacklist

23 C Third-country AIFM and AIF passporting EU AIFM may market non-eu AIF if: - Cooperation arrangements between AIFM home MS and third country - Third country not on FATF blacklist - OECD tax information agreement between AIFM home MS, third country and MS where marketed Non-EU AIFM may manage EU AIF and/or market EU/non-EU AIF if: - Full compliance with AIFMD - Disclosure of marketing strategy to MS of reference - Legal representative in MSOR - Cooperation arrangements between MSOR, AIFM home state, and MS where managed/marketed - AIFM home state not on FATF blacklist - OECD tax information agreement between AIFM home state and MSOR - AIFM home state laws must not prevent effective supervision of AIFM

24 And EU AIFM may manage non-eu AIF marketed outside EU if: -Full compliance with AIFMD except depositary rules and annual report -Information exchange agreement between AIFM home MS and AIF home state -MS may allow marketing of EU AIF or non-eu AIF to retail investors on their territory on a non-discriminatory basis.

25 Model 1 UK AIF managed by UK AIFM Management Marketing UK AIFM UK investor UK AIF

26 Model 1 UK AIF UK AIFM - authorisation required under AIFMD (grandfathering of existing firms) - may provide following additional services: - individual portfolio management - as non-core services: - investment advice - safekeeping and administration - reception and transmission of orders Regular AIFMD requirements apply No pan-eu or third-country aspects

27 Model 2 EU AIF managed by UK AIFM Management Marketing UK investor Ireland AIF UK AIFM

28 Model 2 Irish AIF UK AIFM - authorisation required - MiFID implications as for Model 1 Irish depositary required (Credit Institution / MiFID firm / UCITS depositary) Management and marketing of Irish AIF in UK via EU passport from 2013 No third-country aspects

29 Model 3 EU AIF managed by EU AIFM Management Marketing Delegation Swedish delegate UK investor Luxembourg AIF Luxembourg AIFM

30 Model 3 Luxembourg AIF Luxembourg AIFM authorisation required Swedish delegate must have sufficient resources, be managed by experienced staff, etc (and for delegation of portfolio or risk management, must be authorised and supervised) Luxembourg depositary required (Credit Institution / MiFID firm / UCITS depositary) - Marketing of Luxembourg AIF in UK via EU passport from 2013 No third-country aspects

31 Model 4 EU AIF managed by non-eu AIFM Management UK MiFID firm Marketing Distribution Advice UK investor Luxembourg AIF Hong Kong AIFM

32 Model 4 Luxembourg AIF Hong Kong AIFM - will no longer be permitted to manage Luxembourg AIF as of 2013 (subect to Luxembourg discretion)? - may be able to manage when third-country passport introduced in 2015, if: - full AIFMD compliance - disclosure of marketing strategy to MSOR (Luxembourg or UK) - legal representative in MSOR - cooperation arrangements between HK, MSOR and UK (if different to MSOR) - HK non-fatf-blacklisted + OECD tax agreement between HK and MSOR - HK laws must not prevent effective supervision of AIFM - AIF marketed not by AIFM but by UK distributor - Luxembourg depositary required (Credit Institution / MiFID firm / UCITS depositary)

33 Model 5 Non-EU AIF managed by non-eu AIFM Management Marketing UK MiFID Firm EU Investors Investment advisory/ management mandate Management mandate Cayman AIF Cayman Manager

34 Model 5 Cayman AIF Cayman open-ended investment company: qualifies as an AIF Cayman Manager no role under AIFMD, as has appointed UK AIFM to carry out regulated functions UK AIFM can continue to market via private placement until at least 2018 can market throughout EU via passport from 2015, if: - full compliance with AIFMD (with relaxed depositary rules) - cooperation re systemic risk between UK and Cayman Islands - Cayman Islands not on FATF blacklist

35 Key cross border questions Analyse for each structure: who and where is the AIF, AIFM, delegate, depositary? where will marketing to investors occur? For each manager that qualifies as an AIFM, ask: can it comply with AIFMD requirements? is it preferable to restructure (in light of AIFMD and, if applicable, UCITS IV)? which compliance aspects require preparation now (in view of compliance deadline in early 2014)? Focus especially on structures with non-eu entities viability as of 2013? Look out for Level 2 and Level 3 measures

36 A continental perspective Jerome Sutour

37 Depository (1/2) Principles AIFMD does not regulate funds. AIFM must appoint a single depository Depository may be: European credit institution, MiFID firms authorised to carry out custody Eligible entities under UCITS IV. For non EU AIF: credit institution or equivalent or provided entity is subject to effective prudential regulation and supervision of the same effect as the provisions laid down in European Union law and which are effectively enforced. Single depository if the AIFM is subject to AIFMD 37

38 Depository (2/2) Specific depositories: Option of MS for AIF : other professionals for AIF which have no redemption rights exercisable during the period of five years from the date of the initial investments and which, in accordance with their core investment policy, generally do not invest in assets that must be held in custody (real estate) or generally invest in issuers or non-listed companies in order to potentially acquire control over such companies (private equity) Prime brokers: NO UNLESS it has functionally and hierarchically separated the performance of its depositary functions from its tasks as prime broker and the potential conflicts of interest are properly identified, managed, monitored and disclosed to the investors of the AIF. Exemption for non listed instruments 38

39 Depository s obligations Custody functions include: Recording the assets on a segregated account under the name of the AIF or of the AIFM For all other assets of the AIF, the depositary shall verify the ownership of the AIF or of the AIFM (external evidence) Control obligations Check the NAV Control subscription/redemption processes; carry out the instructions of the AIFM, unless they conflict with the applicable national law or the AIF rules or instruments of incorporation; ensure that in transactions involving the AIF's assets any consideration is remitted to the AIF within the usual time limits; ensure that an AIF's income is applied in accordance with the applicable national law and the AIF rules. Extended obligations 39

40 Delegation by the depository Generic provisions: may only delegate custody Control of the delegate due skill, care and diligence in the selection and the appointment of any sub-custodian periodic review and ongoing monitoring assets of AIF are clearly identified as belonging to clients of a given depositary Reuse is subject to AIF s approval Conditions to exemption to segregation at level of sub-custodian: only as long as there are no local entities that satisfy the delegation requirements; the investors of the AIF have been duly informed; and the AIF or the AIFM on behalf of the AIF instructed the depositary to delegate. UK / UK / UK / Possibility for subcustodian not to apply segregation 40

41 Delegation to the depository Delegation of portfolio management or risk management Principle: No delegation shall be given to (i) the depositary or to a delegate of the depositary or a (sub)delegate thereof (ii) any other entity whose interests may conflict with those of the AIFM or the investors Exception: such entity has functionally and hierarchically separated the performance of its portfolio management or risk management tasks from its other potentially conflicting tasks Review of the delegation UK / UK / UK /

42 Liability of the depository Principles: Financial instruments Liable with respect to the AIF of losses of financial instruments by the depository or its sub-custodian Not liable if demonstration that the loss is the result of an external event beyond its reasonable control, the consequences of which would have been unavoidable despite all reasonable efforts to the contrary. Other Liable in case of intent or negligence Direct or indirect action by investors contemplated by AIFMD Derogations: discharge of liability with respect to losses of financial instruments at the level of sub-custodians where: AIF/AIFM has a direct action against that sub-custodian; Has duly supervised the sub-custodian Possibility to discharge its liability 42

43 Questions on Marketing AIF compliant: marketing possible Professionals disclosure of the marketing strategy + 2-year validity Quid of complaints by other MS Retails option: MS may allow and impose stricter requirements on the AIFM or the AIF than the requirements applicable to the AIF marketed to professionals. However, MS may not impose stricter or additional requirements on EU AIF established in another MS and marketed on a cross-border basis than on AIF marketed domestically AIF non compliant: marketing is not possible (passive marketing) Marketing means any direct or indirect offering or placement at the initiative of the AIFM UK / UK / UK /

44 UK / UK /

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