AIFMD & Private Equity Managers

Transcription

1 A White Paper AIFMD & Private Equity Managers An implementation checklist By Shane Brett, Managing Director Date 23 July 2013

2 Contents Introduction 2 Background 2 1. Identifying the AIFM 3 2. Illiquid investments 3 3. Remuneration 4 4. Depositary 4 5. Risk management 5 6. Reporting 6 7. Fund Valuation 6 8. Managing non-listed companies6 9. Asset stripping Leverage calculations 7 Conclusion 7 Introduction The new European AIFMD regulations will significantly impact the private equity (PE) industry. The regulations were primarily designed for hedge funds but are being applied wholesale to the private equity industry. Compliance will present a challenge for many PE managers. In this white paper we will look at the main impacts of AIFMD on private equity managers and what they should be doing to comply. This will include:- 1. Identifying the AIFM 2. Illiquid investments, 3. Remuneration policy, 4. Depositary requirements 5. Risk management, 6. PE reporting requirements, 7. PE Fund valuations 8. Managing non-listed companies 9. Asset stripping regulations 10. Leverage calculations Background AIFMD will impact private equity managers who manage in aggregate of 500 million unleveraged. They will also impact those managers who manage or market funds into Europe as well as funds that have European investors. Under AIFMD in scope funds are referred to as Alternative Investment Funds ( AIFs ). In scope fund managers are referred to as

3 Alternative Investment Fund Managers ( AIFMs ) There are a large number of impacts to Private Equity managers, which include:- Fund managers may need to take legal advice on this because under AIFMD the AIFM is responsible for ensuring the funds they manage (the AIF) complies with the directive. AIFMD places the onus on the fund manager, not on the fund. 1. Identifying the AIFM One of the key questions for PE managers under AIFMD is to identify who is the fund manager (the AIFM). This may be a challenge because of the structure of PE funds, using General and Limited Partners. Many PE funds also use Special Purpose Vehicles to structure investments and this may make identifying the correct fund manager more difficult. The regulation also clamps down on Letterbox entities. This means that if a PE manager is registered in one non-eu country (e.g. Cayman, BVI etc) but the core investment management functions are based within the EU, AIFMD deems that they are in scope for full AIFMD compliance. PE managers that wish to be outside the scope of AIFMD will have to show that their risk and portfolio management functions take place outside the EU. AIFMD focuses on substance rather than form. 2. Illiquid investments AIFMD has specifies requirements for funds that hold investments with limited liquidity. To confuse matters AIFMD does not properly define limited liquidity! Nonetheless private equity will obviously fall into this category. The directive does not preclude or prohibit investment in unlisted companies or illiquid assets. Instead it prescribes a process that must be put in place regarding how these assets should be managed and documented by the PE manager. If a PE manager holds assets with limited liquidity they must prepare a business plan for how these investments will be managed. This must be regularly updated by the manager. Transactions must be conducted in accordance with the business plan and due diligence must also be completed and documented on the assets in question. Performance of the PE fund must then be monitored on an on-going basis by the PE manager. These requirements will obviously have a significant impact on PE managers. Managers should currently be drafting their business plan in respect of all in-scope illiquid

4 investments, as well as setting up the required internal processes to document and manage these requirements. For some larger PE managers this will be a substantial task. 3. Remuneration Some of AIFMD s most controversial new rules are around the area of remuneration (which includes carried interest ). The directive has specific requirements which will impact PE managers. ESMA, the European super regulator, issued new remuneration guidelines on July 3rd These guidelines provide more operational detail regarding reporting remuneration details to the regulators, setting up a remuneration committee and identifying which staff is impacted by the new remuneration rules. AIFMD s remuneration regulations will affect senior management, staff in control functions in the organisation or individuals who have a material impact on the risk profile of the PE fund they manage. Remuneration must be weighted towards long-term incentives. This means that employees must be paid at least half their bonus as shares in the fund. Furthermore they are not allowed to sell those shares for a minimum of 3 (and preferably 5) years. PE managers are also being asked to introduce prudent remuneration policies and organisational structures to avoid a conflict of interest or which may encourage excessive risk-taking. The implementation of the AIFM s remuneration policy must be reviewed at least annually. Remuneration policy must be disclosed to investors and regulators. PE managers should be engaged in an internal review of their remuneration policies and taking steps to ensure they comply with AIFMD. This will mean the establishment of a remuneration committee (if the managers total AUM is above 1.25 billion). 4. Depositary All private equity funds in scope for AIFMD will be required to have a depositary. This is a new entity created under AIFMD, which will provide oversight of the fund for the investors. They will have a very wide scope of liability and will be expected to provide detailed monitoring of the fund on an on-going basis. These will work like super-charged custodians who will closely monitor the assets in the fund, reconcile daily cash movements and provide independent verification that the fund is being run properly and the assets are where the manager says they are.

5 This level of external intrusion is a sea-change for private equity funds. Private equity managers will need to engage in a detailed depositary selection process, ensuring their short list matches their cost, investor s expectations as well as investment strategy. Due to the severe level of liability AIFMD imposes, only large companies with deep pockets will be able to offer this service (often tier 1 administrators who are part of global banks). There is confusion in the industry regarding how much depositories are expected to charge for this service. This will be clarified as we move into 2014 when private equity funds complete their depositary engagement. Private equity managers will require a depositary that understands their business. This will include a deep knowledge of business valuation, cash monitoring and the safekeeping of assets. Some depositories may not be willing to support an investment strategy weighted towards illiquid or exotic asserts. This means in-depth depositary due diligence will be required. This process should be on-going at present. For managers the selection of a suitable, cost effective depository aligned to their investment strategy will be a key consideration. Once a suitable depositary had been engaged, private equity fund managers will need to put in place procedures with their administrator to ensure the depositary receives all the regular reporting they will require to complete their oversight duties. Under AIFMD it is the responsibility of the PE manager to ensure the depositary has the data and reporting they require. 5. Risk management AIFMD requires that PE managers functionally and hierarchically separate their risk management and portfolio management functions. This means risk management responsibility must be given to a senior member of the management team; someone who is not involved in the investment management function. Smaller Private Equity houses, with fewer resources, may find it difficult to achieve this functional separation. PE managers must also put in place risk management systems which will identify, measure and manage all the risks in the fund s PE investment strategy. Risk monitoring is of key importance. Risk management processes must be adequately documented and managers must ensure detailed due diligence is completed as part of their due diligence process. AIFMD places emphasis on due diligence across the regulations and this includes reviews of new and existing service providers

6 and appropriate documentation of all investments made by the PE fund. 6. Reporting Under AIFMD PE managers must complete two forms of reporting. These are:- Annual reporting to investors Managers must send an annual report to their investors. This will include details of the type of investments the fund is making, its concentration, management fees and the valuation of the assets. Regulatory reporting PE managers will have to submit regular reporting to their home EU country regulator. This will include similar details as in the annual report as well as information regarding fund liquidity, stress tests, special arrangements etc. Reporting will be required quarterly for larger PE funds (over 1.5 billion). The reporting template and ESMA guidelines are now available. The format and detail required is very similar to Form PF in the US, however unfortunately the proposed format of the answers is prescriptive and inflexible. 7. Fund Valuation Under AIFMD PE managers must value their investments on at least an annual basis. This valuation must be done by either an independent external valuator (for example an administrator or specialist 3rd party valuator) or by the fund manager itself provided that the valuation is completed by those functionally separate from both the remuneration policy and investment management functions within the company. PE managers must also document their valuation policy and processes in detail as part of AIFMD s requirements. Most managers will already be doing this to a degree. AIFMD formalises this process. 8. Managing non-listed companies AIFMD will impact investments into underlying portfolio companies, specifically if the company is based in the EU, employs over 250 people or has a turnover of 50 million. PE managers must notify the appropriate portfolio company register as they build up or change their holding of voting shares. There are a large number of thresholds which require notification (e.g. 10%, 20%, 30%, 50% and 75%) and this must be done as the holding exceeds or falls below each threshold. PE managers need to put in place processes to monitor, calculate and notify these changes.

7 Similarly if a PE manager gains control of a portfolio company there are additional requirements stipulated under AIFMD. Control is defined as >50% of shares in an unlisted company and >30% of a listed entity. Finally, PE managers must also disclose their intentions regarding the future of the portfolio company, its business operations and how the acquisition has been financed to either the employees themselves or their representative body. 9. Asset stripping AIFMD has specific rules regarding asset-stripping from portfolio companies. For 2 years following the acquisition of a large EU company, PE managers are prohibited from executing and distributions, or capital reductions that would reduce the company s capital base or exceed its distributable profit and reserves. These rules also apply to share redemption and repurchases. These provisions apply to all large EU companies, either listed or unlisted. This restriction on corporate actions of portfolio companies will have a substantial impact on some PE managers. The importance of long term strategy when making the portfolio investments will increase. This will feed into the need for greater due diligence in the acquisition process. 10. Leverage calculations AIFMD stipulates two new ways to calculate leverage. These are the Gross & Commitment methods. The Gross method attempts to give a picture of the funds overall exposure. The Commitment method focuses more on the hedging and netting techniques used by the fund manager. The key point here is that these are new, compulsory methods for leverage calculation. The more common Value at Risk (VAR) methodology is not acceptable. PE Managers will need work with their system vendors and internal departments to ensure these calculations are built into their software applications. They also need to be making initial leverage calculations using these new methodologies in preparation for AIFMD. This is important because PE managers will have to report leverage to their home regulators and to investors on an on-going basis. They will also have to monitor it closely and advise their investors if they breach their stated leverage threshold. Conclusion The impact of AIFMD on PE managers is substantial. AIFMD is a one size fits all regulation, primarily aimed at the hedge funds industry. The fact that its

8 main focus is not actually on private equity may make its implementation all the more challenging for PE managers. The wide scope of the regulation may even mean managers outside Europe fall into its net. PE managers across the industry are now getting down to the task of implementing this legislation across their business. The next year up until July 2014 is the crucial transitionary period to build out full compliance to the PE specific requirements identified in this checklist. can assist in all areas of compliance, impact assessment and operational implementation. Sign up for all our white papers. - o.uk

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