IMPLEMENTATION OF THE AIFMD IN THE UK

IMPLEMENTATION OF THE AIFMD IN THE UK FSA PUBLISHES CONSULTATION PAPER CP12/32 INTRODUCTION Following the publication of DP 12/11 in February 1, the FSA has published CP 12/32, the first consultation paper giving the detail of how the FSA (and the new Financial Conduct Authority) intends to implement the Alternative Investment Fund Managers Directive ("AIFMD") within the UK. 2 Given that the final text of the implementing regulation for the AIFMD is still to be published by the European Commission, and that the European Securities and Markets Association ("ESMA") is still to finalise its regulatory standards on the types of Alternative Investment Fund Managers ("AIFMs") affected and related materials as well as issue "Level 3" guidelines on remuneration policies and practices, the CP is suitably caveated. Nevertheless, the FSA still believes that there is enough certainty to consult on the following matters: the prudential regime for all types of AIFM, including capital requirements, risk of professional negligence, the liquid assets requirement and reporting matters, as well as changes affecting UCITS management companies; the regime for depositaries, including the eligibility of firms to be an Alternative Investment Fund ("AIF") depositary, their capital requirements, and the requirement to act independently; and the Level 1 Directive requirements on AIFMs, including organisational matters, duties in relation to management of funds, and transparency obligations towards investors and the FSA/FCA. THE PRUDENTIAL REGIME FOR AIFMS Capital requirements FSA proposes three new firm categorisations with associated capital requirements: Collective portfolio management firm ("CPM firm") a firm that undertakes external collective portfolio management of AIFs, UCITS or both, but does not provide any Markets in Financial Investments Directive ("MiFID") services. This includes what is currently defined as a UCITS firm. Internally managed AIF an AIF where the legal form permits internal management and where the AIF s governing body chooses not to appoint an external AIFM. Collective portfolio management investment firm ("CPMI firm") a firm that undertakes external collective portfolio management of AIFs, UCITS

or both and provides MiFID services (as permitted by AIFMD and/or the UCITS Directive). This includes what is currently defined as a UCITS investment firm. The capital requirements for each type of firm are outlined as follows: CPM firm: 125,000, met from initial capital when the firm is first authorised and own funds on an ongoing basis ; ongoing capital requirements will be calculated as own funds being maintained at at least the higher of 125,000 plus 0.02% of the portfolio of UCITS and AIFs under management over 250m and one quarter of the firm's relevant fixed expenditure. Internally managed AIF funds: initial capital of at least 300,000 with ongoing capital requirements to be met from own funds; requirements based on either funds under management or expenditure will not be applied to internally managed AIFs; requirements will be imposed directly on AIFs. CPMI firms: will be treated in the same way as a UCITS investment firm and be BIPRU limited licence firms; they must also meet the requirements of the AIFMD and UCITS Directive; own funds must therefore be maintained at the higher of the GENPRU or BIPRU requirements for a limited licence firm and the higher of 125,000 plus 0.02% of the portfolios of AIFs and UCITs under management over 250m and one quarter of the firms' relevant fixed expenditure. Note that in all cases, the FSA takes the view that these are ongoing requirements, and not simply requirements that should be met when the relevant entity is first authorised. Guarantees The AIFMD allows AIFMs to provide up to 50% of the additional own funds with a guarantee from an insurance undertaking or credit institution. The FSA has not implemented this provision of the Directive but may consult further in the future if there is demand. Professional negligence The AIFMD requires AIFMs to have either own funds or Pillar II capital to cover potential liability for professional negligence. Risk management and operational requirements in this respect are expected to be set by regulations from the European Commission. The FSA expects that EU law will give them the option to lower the standard percentage of AIFs under management that AIFMs must use to calculate own funds, on the basis of the firm's historical loss data. However, the FSA considers that this will likely create undue costs for both firms and the regulators of AIFs under management and does not intend to lower the standard percentage. The FSA expects regulation from the European Commission on how Pillar II capital coverage of professional negligence is to be computed. Liquid asset requirement 'Own funds' must be invested in liquid assets under the AIFMD and the FSA proposes that this should be "assets readily convertible to cash in one month". The FSA proposes to apply the liquid assets requirements to UCITS that do not manage AIFs as the requirements are designed to address similar risks such as are faced by UCITS. DEPOSITARIES Further non-discretionary regulations from the European Commission will provide much of the detail in respect of depositaries. The FSA is still examining whether the terms of the AIFMD and the regulations to follow will require changes to the Client Assets Sourcebook and will address this in their second CP in February 2013. Eligibility and capital requirements The AIFMD allows any UK firm authorised as a credit institution or certain MiFID firms to act as depositary for any AIF as well firms as authorised to act as depositaries for UCITS. The FSA proposes to make no changes to the capital requirements already in place for such firms and the AIFMD is silent on the authorisation and capitalisation of depositaries. This means the current capital requirement of minimum fixed capital of 4m will remain in place. The FSA has indicated that it will revise this requirement in line with the UCITS V legislative proposal so that the depositaries being used for both AIFs and UCITS are the same. A new rule has also been proposed that would mean MiFID firms acting as depositaries would be subject to the 4m requirement. The CP describes the 'private equity (PE) depositary' model wherein professional firms fully authorised by the FSA (not including those designated professional bodies that are covered by other regulators) provide depositary services. The FSA proposes that for such firms to do so, they must provide such services as part of their overall business activities and hold own funds of at least 125,000. 02

Independence The FSA proposes that AIFs (or AIFMs on their behalf) may appoint affiliates from their own group as depositaries where the requirement from the AIFMD that conflicts of interests are properly managed is met. THE LEVEL 1 DIRECTIVE OPERATING REQUIREMENTS ON AIFMS Transparency The FSA is proposing new rules in respect of disclosures by AIFMs to investors and reporting to the regulator: Pre-sale disclosures (before investors invest in an AIF); to include: investment strategy and decisions; use of leverage; liquidity risk management arrangements; fees and charges; valuations procedures; net asset value; procedures for the issue and sale of units or shares; third-party service provider arrangements; any arrangements by which depositaries contractually discharge liability; Ongoing disclosure requirements; to include: changes to maximum levels of leverage; periodic disclosures of liquidity and risk profile of the AIF; further details expected in regulations from the European Commission; Annual reporting; reports produced no later than 6 months following the end of the financial year and to include: details of the AIF's activities: material changes to previous disclosures; information on staff remuneration; Reporting to the FSA; more detail is expected in the European Commission regulations and ESMA is expected to publish details of a harmonised reporting template for use across Europe however the FSA will require regular reporting on: main markets and instruments of AIFs; principal exposures managed by AIFs; risk and liquidity management systems; and results of stress testing. Operating requirements Proposed new rules include: Fair treatment; all investors are to be treated fairly and equally and no investor treated differently unless this is stated in the constitution of the AIF; this is in line with the FCA's stated interventionist approach to ensure fair treatment of experienced customers in the wholesale markets; Conflicts; administrative arrangements are to be in place for the effective identification, prevention, management and monitoring of risks; this is with particular reference to relationships between the AIF, the AIFM and other clients/ funds managed by the AIFM; Compliance; a permanent and independent compliance function is to be in place, similar to the requirements of the UCITS and MiFID directives; Risk management; function to be separated from operations with appropriate safeguards to ensure independence; Leverage risk; leverage limits are to be demonstrated to the FSA/FCA and the extent to which re-use of collateral can be undertaken must be set out by the AIFM. Delegation; delegation of AIFM functions must be notified to the FSA/FCA and meet operational requirements in respect of supervision and adequate resources; Management requirements Proposed new rules include: Valuation; appropriate and consistent procedures for valuation are to be in place with net asset value of shares or units to be calculated and disclosed at least once a year; www.dlapiper.com 03

Liquidity management; AIFMs must monitor, assess and stress test liquidity risk for the AIFs they manage in a way consistent with the AIF's obligations and redemption policy. Becoming AIFMs; The liquidity management requirements will not apply to AIFMs managing unleveraged closed ended funds and the FSA notes that firms applying to become AIFMs must examine the funds they manage to assess if they are closed or open ended. and DLA Piper based on results from a survey of 350 leading industry executives. A copy of the report can be obtained from Ra'ana Rix at ra'ana.rix@dlapiper.com or Mark Hickson at mark.hickson@dlapiper.com. If you have any questions around this briefing, implications for your business or would like to find out more about our Financial Services Regulatory expertise, please contact: FINAL THOUGHTS AND NEXT STEPS The FSA is not gold plating the requirements of the AIFMD and is not willing to derogate too widely from it, particularly where those requirements are relevant to the protection of investors. This, coupled with the sign-post given in the publication Journey to the FCA, indicates that although AIFs and AIFMs are being given as much time as possible to comply with the new requirements, the FSA/ FCA will be focussing more on the wholesale markets and on their conduct in the future. The deadline for responses to the CP is Friday 1 February 2013. The FSA intends to publish a Policy Statement, relating to both CPs, in June 2013. Final rules and guidance will be in place by 22 July 2013. You can read about the financial service industry's reaction and concerns on the impact of European regulatory reform and splitting the FSA into PRA and FCA in "The New Twin Peaks Model", a report by BDO Michael McKee Partner T +44 (0)20 7153 7468 michael.mckee@dlapiper.com Simon Wright Legal Director T +44 (0)20 7796 6214 simoncj.wright@dlapiper.com 04

1 See DP and our client briefing 2 A second consultation paper is expected to be published in February 2013 and will address the following issues: 1. Scope issues: a) Further clarifications on scope of AIFMD, subject to ESMA developments. b) Regimes for sub-threshold AIFMs, including both authorised and registered AIFMs. c) Authorisation/registration process for: i) firms that are not full scope UK AIFMs; and ii) AIFMs carrying on additional activities under Article 6(4) AIFMD. d) Final transitional provisions. 2. Retail regime (Article 43 AIFMD): a) regimes for Non UCITS retail schemes, qualified and UCITS schemes, including the transition from COLL to FUND (the proposed new rules for AIFs); and b) marketing to retail investors. 3. Regime for marketing to professional investors. 4. Further clarification on Level 2 delegation requirements, including supervisory assessment of letterbox entity. 5. AIFMD provisions applicable principally to private equity fund managers. 6. Application of the Financial Services Compensation Scheme and the Financial Ombudsman Service in relation to firms within scope of AIFMD. 7. Fee-raising arrangements for firms within scope of AIFMD. 8. Reporting processes for firms within scope of AIFMD. 9. Any consequential amendments to existing rules. 10. Restructuring of Handbook rules into FUND sourcebook. 11. Transitional rule for deletion of UPRU. 12. The position for depositaries of AIFs managed by sub-threshold AIFMs. This publication is intended as a general overview and discussion of the subjects dealt with. It is not intended to be, and should not be used as, a substitute for taking legal advice in any specific situation. DLA Piper UK LLP and DLA Piper SCOTLAND LLP will accept no responsibility for any actions taken or not taken on the basis of this publication. If you would like further advice, please speak to [ ] [your DLA Piper contact] on 08700 111 111. www.dlapiper.com DLA Piper UK LLP is authorised and regulated by the Solicitors Regulation Authority. DLA Piper SCOTLAND LLP is regulated by the Law Society of Scotland. Both are part of DLA Piper, a global law firm operating through various separate and distinct legal entities. For further information please refer to www.dlapiper.com UK switchboard: +44 (0) 8700 111 111 Copyright 2012 DLA Piper. All rights reserved. NOV 12 Ref: 46521764.1