AIFM - the Alternative Investment Fund Managers Directive Swedish Presidency compromise proposal of 25 November 2009 1
The European Commission proposed an initial draft of a new Directive introducing a harmonized EU regulatory and supervisory framework for Alternative Investment Fund Managers (AIFMs) in April 2009. In return for more regulation, the proposed Directive provides for the introduction of passports enabling AIFMs to offer their management services and market their Alternative Investment Funds (AIFs) throughout the EU. Several of the provisions in the Commission s draft were highly controversial. The Swedish Presidency of the Council of the European Union publicly issued a compromise proposal on 12 November 2009, followed by a revised text on 25 November 2009. The latest compromise proposal addresses many of the areas of concern for the industry but others still remain. The text will be influential as a basis for discussion; it should be noted, however, that the text needs to be agreed by the Council, before also reaching an agreement at European Commission and European Parliament levels. On 23 November 2009, the rapporteur of the European Parliament s Committee on Economic and Financial Affairs on the AIFM Directive, Jean-Paul Gauzès, issued its draft report proposing amendments to the text proposed by the Commission. The proposed amendments will be considered and revised by the Committee on Economic and Financial Affairs. The European Commission is the sole institution empowered to draft legislation, and therefore may come forward with a new draft in the light of the Council s proposals, the amendments proposed by the European Parliament, and other discussions. Given the political pressure for greater regulation over the alternative sector, the Directive, albeit in an amended state, is likely to be approved. Member States will be required to implement this Directive, which, as currently drafted would cover non-ucits funds and their managers. It will mean new opportunities and challenges for the alternatives sectors. The Council is more advanced than the European Parliament in its work on the Directive. This publication provides our views of the Swedish Presidency s revised compromise proposal. 2
Background The Commission s proposal followed consultations, studies and work led by the European Commission on related topics and two resolutions adopted by the European Parliament. In September 2008, the European Parliament adopted a resolution requesting the European Commission to submit legislative proposals on hedge funds and private equity. The resolution covered, inter alia, financial stability, capital and universal regulatory coverage, transparency and conflicts of interest. On the same day, a second resolution was also adopted on transparency of institutional investors calling for the Commission to examine a number of issues with a view to proposing appropriate legislative measures. The resolution covered, inter alia, disclosures and conditions in contract terms, disclosures by shareholders holding more than a certain proportion of holdings, transparency of voting policies of hedge funds and reinforcing long term investment against short term excessive risk taking in corporate governance. Objectives The AIFM Directive is designed to address a number of risks identified by the Commission related to alternative investment funds (AIFs), including systemic risks. The Commission is of the view that coordinated EU regulatory oversight is a better mechanism to deal the potential danger of systemic risk that may arise from the activities of AIFs than current fragmented national approaches. The key objectives of the proposed AIFM Directive are to: Ensure that all AIFM are subject to appropriate authorization requirements Provide a framework for the enhanced monitoring of macroeconomic risks Improve risk management and organizational safeguards at the individual AIFM level Enhance investor protection Improve public accountability for AIF holding controlling stakes in non-listed companies Develop a single market for AIFs Risks identified by the European Commission Macroprudential Microprudential Investor protection Market efficiency and integrity Impact on market for corporate control Impact on companies controlled by alternative investment fund managers Direct exposure of systemically important banks to the alternative investment fund sector Procyclical impact of herding and risk concentration Weakness in internal risk management systems Inadequate investor disclosures on investment policy, risk management and internal processes Conflicts of interest and failures in fund governance Impact of dynamic trading and short selling techniques on market functioning Potential for market abuse in connection with certain techniques, such as short selling Lack of transparency when building stakes in companies, or concerted action in activist strategies Potential for misalignment of incentives in management of portfolio companies, in particular in relation to the use of debt financing Lack of transparency and public scrutiny of companies subject to buy-outs 1 An undertaking for collective investment in transferable securities, in accordance with the UCITS Directive 3
Scope While the main focus of the AIFM Directive is on managers of alternative investment funds, the Directive will impact: EU and non-eu AIFM EU and non-eu domiciled AIFs Service providers to these funds Investors The Directive applies to all AIFM established in the EU which manage AIFs, irrespective of whether the AIF are established inside or outside the EU and the type or legal structure of the AIF, and that have more than either: 100 million of assets under management, including assets acquired through the use of leverage 500 million of unleveraged assets under management with at least a five year lock-up period for each AIF Smaller AIFM may opt in i.e., they are entitled to be treated as AIFM falling under the scope of the Directive. AIFM are legal persons which manage one or more AIF. This includes both external managers and self-managed (internally managed) AIF. Managing AIF means providing investment management services (portfolio management and risk management) to one or more AIF. AIFM may also engage in the activities of administration and marketing as well as activities related to the underlying assets of the AIF, such as performing services necessary to meet the fiduciary duties of the AIFM, facilities management, real estate administration activity, corporate, financial and investment strategy advice. Externally appointed AIFM may also provide the additional service of management of portfolios of investments with mandates given by investors on a discretionary, client-by-client basis, including portfolios owned by pension funds and institutions for occupational retirement provision, and other additional services including reception and transmission of orders in relation to financial instruments, underwriting and/or placing of financial instruments on behalf of the AIF it manages, investment advice, safekeeping and administration in relation to units of collective investment undertakings and foreign exchange services where these are connected to the provision of investment services. However, if also authorized as management companies under the UCITS 1 Directive, externally appointed AIFM are limited in the additional services permitted to management of portfolios of investments, investment advice and safekeeping and administration in relation to units of UCIs. The following are excluded from the scope of the Directive: AIFM which manage AIF exclusively for group entities (their parents, subsidiaries and other subsidiaries which are not themselves AIF) Pension funds (institutions for occupational retirement provision), and their managers which do not manage AIF established in the EU Bodies or institutions which manage funds supporting social security and pension systems Employee participation schemes Certain supranational, international and national organizations, institutions and bodies Securitization special purpose entities Authorized AIFM may only manage AIF established in third countries if the legislation of the third country is in line with international standards (such as the IOSCO principles on hedge fund oversight) and if the competent authorities of the home Member State of the AIFM and the supervisory authorities of the third country where the AIF is established have appropriate cooperation arrangements. An AIF is any collective investment undertaking which raises 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, other than a UCITS. Thus, the Directive will have a very broad scope, covering, for example, hedge funds, real estate funds, private equity vehicles, real estate investment trusts (REITS), exchange traded funds (ETFs) and listed funds; it is noted, however, that holding companies are excluded in so far as they hold shares in subsidiaries and aim to carry out a business strategy through the subsidiaries. The Directive will also impose requirements on service providers to AIFs, as outlined in the Requirements section. 4 1 An undertaking for collective investment in transferable securities, in accordance with the UCITS Directive
AIFM marketing passport EU AIFM may market shares or units of the AIFs which they manage and which are established in the EU to professional investors in their home Member State and in other EU Member States. In both cases, a notification procedure must be followed. The AIFM communicates required information to its home Member State authority. In the case of: Marketing in AIFM s home Member State: The AIFM s home Member State competent authorities have up to ten working days after receipt of the complete notification to inform the AIFM that it may begin marketing the AIF Marketing in another Member State: The AIFM s home Member State authorities transmit this information, together with an attestation that the AIFM concerned is authorized to manage AIF with that particular investment strategy, to the other Member State authority within ten working days after receipt of the complete notification. The AIFM receives a notification of transmission from its home Member State authority permitting it to start the marketing of AIF in the host Member State. Marketing refers to the direct or indirect offering or placement, at the initiative of the AIFM, of shares or units in an AIF to or with investors domiciled in the EU; this includes all unsolicited communication presenting information on the AIF. Therefore, marketing covers active marketing under current private placement regimes. The definition of professional investor is an investor which is considered to be a professional client, or may be treated as such on request, within the meaning of MiFID 2. Member States may continue to allow AIFM to market AIF established in third countries to professional investors on their territory subject to national law. A feeder AIF 3 can only invest in a master AIF which is established in a Member State and managed by an authorized AIFM; however, Member States may permit the marketing of the non-compliant feeder funds to professional investors on their territory. Member States may also permit the marketing of all or certain types of AIF managed by AIFM to retail investors on their territory; they would be expected to make a case-by-case assessment of each specific AIF beforehand. AIFM management passport AIFM domiciled in one Member State may manage AIF domiciled in other Member States, either directly or via the establishment of a branch, provided that the AIFM is authorized to manage that type of AIF. In both cases, a notification procedure is followed starting with the AIFM communicating required information to its home Member State authority. 2 The Markets in Financial Instruments Directive, Directive 2004/39/EC. 3 An AIF which invests at least 85% of its assets in the shares or units of another AIF. 5
Requirements Any EU AIFM falling within the scope of the Directive or opting in will be required to obtain authorization and, inter alia, to: Comply with capital requirements of: AIFM which are appointed as external managers of one or more AIF: -- 125,000 plus an additional amount of 0.02% of assets under management exceeding 250 million (excluding AIF portfolios that the AIFM is managing under delegation) up to a maximum of 10 million. This additional amount of capital may be reduced by up to 50% by guarantees from credit institutions or insurance undertakings in the EU or subject to equivalent supervision. -- 25% of annual expenditure (if greater than the capital required under the previous sub-bullet) AIFM which are internally managed AIF: an initial capital of 300,000 Lower requirements apply to AIFM managing non-leveraged AIF, with less than 500 million in assets under management, no redemption rights exercisable with five years of constitution and which make divestments on a non-frequent basis. Have at least two conducting persons of sufficiently good repute and experience in relation to the investment strategies of the AIF to be managed Have suitable shareholders: those shareholders or members of the AIFM with qualifying holdings should be suitable to ensure sound and prudent management Have the head office and registered office in the same Member State Comply with conduct of business requirements, including acting in the best interests of the AIF or the investors of the AIF it manages, and the integrity of the market Have remuneration policies and practices which are consistent with sound and effective risk management and include information in the annual report of the AIF on: The total amount of remuneration, split into fixed and variable remuneration, paid by the AIFM, and number of beneficiaries, and, where relevant, carried interest paid by the AIF Aggregate amount of remuneration broken down by senior management and members of staff whose actions have a material impact on the risk profile of the AIF Take reasonable steps to identify conflicts of interest between the AIFM and the AIF it manages or the investors in the AIF, between one AIF and another and between the AIF or the investors of the AIF and other clients of the AIFM. Where the organizational arrangements are not sufficient to ensure that investors interest will not be damaged, the AIFM shall clearly disclose the nature or sources of conflicts of interest. Implement separate portfolio management and risk management functions in so far as this is appropriate in view of the nature, scale and complexity of the AIFM and the AIF it manages Implement adequate risk management systems in order to measure and monitor appropriately all risks associated with the AIF investment strategy and to which it is exposed, or can be exposed. Risk management should include an appropriate, documented and regularly updated due diligence process when investing on behalf of an AIF. Appropriate stress testing should be applied to ensure that the risks associated with each investment position and its effect on the AIF s portfolio is identified, measures and monitored on an ongoing basis. The AIFM is required to review the risk management system no less than once a year. Implement appropriate liquidity risk management systems and procedures, including regularly conducting stress tests under normal and exceptional conditions (except for closed ended, unleveraged AIFs) Have adequate human and technical resources Establish appropriate and consistent procedures for the proper valuation of the assets of the AIF, and the calculation of the value of shares or units. The AIFM s valuation function must be independent from the portfolio management, where appropriate in view of the nature, scale and complexity of each AIF it manages. The assets, shares or units must be valued at least once a year. For open-ended AIFs, the valuation shall be carried out at an appropriate frequency in view of the underlying assets of the fund and its issuance and 6
redemption policy. Member States may require valuation to be subject to oversight by a depositary. The valuer may be external, but this is not required. The AIFM must be in a position to monitor effectively the activity of an external valuer. Where an external valuer is not used, the competent authorities of the home Member State may require the AIFM to have its valuation procedures and/or valuations verified by an external valuer or auditor. Ensure that a depositary is appointed for each AIF it manages (see p.8 ) Provide disclosures to investors when they invest (and inform them of any subsequent changes) including, inter alia: A description of the investment strategy and objectives of the fund The eligible assets and techniques and their associated risks The use of leverage and associated risks Process to be followed when the investment strategy is modified A description of the main legal implications of the contractual relationship entered into The identity of the AIFM and the AIF s service providers, a description of their duties and investors rights, as well as a description of any delegated management or depositary functions and any conflicts of interest which may arise from such delegations The fund s valuation procedures, where applicable, and pricing methodology for valuing assets A description of the AIF s liquidity risk management, including the redemption rights both in normal and exceptional circumstances, and how the AIFM ensures a fair treatment of investors Description of fund fees, charges and expenses A description of any preferential treatment which an investor obtains or has the right to obtain Latest financial reports Provide periodic disclosures to investors on: The percentage of the AIF s assets that are subject to special arrangements arising from their illiquid nature Any new arrangements for managing the liquidity of the AIF A description of the risk profile and risk management systems employed Where the AIFM manages AIF employing leverage on a systematic basis, periodically disclose to investors the total amount of leverage employed by the AIF, and the maximum level of leverage and any right to reuse collateral or any guarantee, where relevant Report to regulators: Regular aggregated information on the main instruments traded, markets of which it is a member or where it actively trades, principal exposures and most important concentrations for each AIF it manages On request, inter alia, on: -- Risk profile, results of required stress tests, and risk management tools -- The percentage of the AIF s assets that are subject to special arrangements arising from their illiquid nature -- Any new liquidity risk management arrangements -- The use of short selling The overall level of leverage employed by each AIF employing leverage on a systematic basis, and a breakdown between leverage arising from cash and securities and from embedded financial derivatives, and the extent to which the assets have been reused under leveraging agreements Notify non-listed companies and their shareholders within ten working days of acquiring control (more than 50% of the voting rights) in the company. It must provide disclosures to the company, its shareholders and representatives of employees on the identity of the AIFM which have reached control and the policy for preventing and managing conflicts of interest in particular between the AIFM and the non-listed company; this also applies where the AIFM has acquired a control in agreement with other AIFM. Disclosure in the AIFM s annual report is required on the operational and financial developments of the non-listed company, the number of employees, and significant divestments. The AIFM is also required to provide the competent authorities and investors of the AIF concerned with information on the debt supported by the non-listed company, directly before and immediately after the AIFM has reached control, and 6 and 12 months thereafter. Small and medium-sized companies are not covered by this requirement. 7
When delegating functions to a third party, AIFM must provide prior notification to the competent authorities of their home Member State. The AIFM must select the third party entity with due care, be able to demonstrate that the third party is qualified and capable of undertaking the functions in question, and monitor the delegated activity. The persons who represent the third party must be of sufficiently good repute and experience. Delegation must not prevent the AIFM from acting, or the AIF being managed, in the best interests of the investors of the AIF. Third parties may sub-delegate functions. The AIFM s liability is not affected by its delegation of functions to third parties. The AIFM cannot delegate its functions to the extent that it becomes a letter-box entity. Portfolio management and risk management functions may only be delegated to entities which are authorized to perform asset management and subject to supervision (or to other entities following prior authorization of the AIFM s home Member State competent authorities); in the case of delegation to a third country entity, cooperation between the entity s supervisory authority and the AIFM s home Member State competent authorities is also required. The depositary must be either a credit institution having its registered office in the EU or an investment firm authorized to provide ancillary services under the MiFID Directive, or a legal person subject to prudential regulation and ongoing supervision which can furnish sufficient financial and professional guarantees to be able to perform its functions and meet the corresponding commitments. Where the AIF has no financial instruments which both can be kept and are subject to trading on an EU or third country regulated market or multilateral trading facility, the depositary may be a legal person which carries out depositary functions as part of its professional or business activities, in respect of which it is subject to professional registration and to provisions or rules of professional conduct, and which can furnish sufficient financial and professional guarantees to be able to perform its functions and meet the corresponding commitments. The AIFM cannot itself act as a depositary. For AIF established in the EU, the depositary must be established in the AIF s home Member State. The appointment of the depositary is subject to approval by the home Member State of the AIF, or, where the AIF is not regulated, the competent authorities of the home Member State of the AIFM. The roles of the depositary are set out in the following table: Depositary functions Delegation possible Sub-delegation possible Ensuring that subscription and redemption payments are booked correctly on behalf of the AIF in segregated accounts Safekeeping financial instruments of the AIF: Holding in custody all financial instruments which can be kept and are subject to trading on an EU or third country regulated market or multilateral trading facility, and ensuring that they are registered in segregated accounts in the name of the AIF(s). The depositary must furthermore ensure that these financial instruments cannot be reused without the prior consent of the AIFM. Maintaining records to verify the ownership of financial instruments that cannot be kept in custody and are subject to trading on an EU or third country regulated market or multilateral trading facility Verifying whether the AIF or the AIFM on behalf of the AIF has obtained ownership interest in all other assets the AIF invests in, based on internal and external evidence of ownership No - Yes, but must exercise due skill, care and diligence in selection, appointment and periodic review of third party, and subject to specific conditions Yes, but must exercise due skill, care and diligence in selection, appointment and periodic review of third party Yes, but must exercise due skill, care and diligence in selection, appointment and periodic review of third party Yes Yes Yes 8
The depositary is required, where relevant, to ensure that: Depositary functions Delegation possible Sub-delegation possible The transactions on the shares or units of the AIF are carried out in accordance with the applicable law and the AIF instruments of incorporation or fund rules The value of the shares or units is calculated in accordance with the law and the AIF instruments of incorporation or fund rules Any consideration involving the AIF s assets is remitted within the usual time limits No instruction from the AIFM which conflicts with the law or AIF instruments of incorporation or fund rules is carried out The AIF s income is applied in accordance with the applicable national law and the AIF instruments of incorporation or fund rules No - No - No - No - No - The depositary is liable for any losses as a result of its failure to perform its obligations. In the case of loss of financial instruments which can be kept and are subject to trading on an EU or third country regulated market or multilateral trading facility, it must return financial instruments of the same type or the corresponding amount without undue delay; in the case of loss of financial instruments held by a sub-custodian, the depositary may discharge itself of its liability on a contractual basis, if it can prove it fulfilled its obligations. These liability provisions do not apply in the case of abnormal or unforeseeable circumstances beyond the control of the depositary or sub-depositary the consequences of which would have been unavoidable despite all efforts to the contrary or where the depositary is bound by other legal provisions. The depositary provisions are not applicable in the case of AIF not established in the EU, marketed in the EU or outside the EU, and managed by an EU AIFM. 9
Timeline for implementation The AIFM Directive will set out a general framework. Given the ongoing debate on the Directive, it now seems unlikely that it will be adopted before mid-2010; it should be transposed within 24 months of its entry into force, which is shortly after publication. A number of specific areas in the Directive must be clarified by the European Commission before the Directive enters into force; these will be included in a separate implementing Directive to be established by the European Commission. The following is a possible timeline for the adoption and implementation the AIFM Directive; we consider it, however, as optimistic: April 2009 - AIFM draft Directive published by Commission Discussions with Council, European Parliament and others } Publication? 2012 - Directive transposed? 2 years 1 year Commission review of the application and scope of the Directive? } 2009 2010 2011 2012 2013 2014 } November 2009 - New draft from Council AIFM Directive approval by European Parliament and Council? Publication of implementing measures? AIFM existing before transposition must apply for authorization? 10
Practical considerations Several provisions of the proposed Directive on AIFM are a formalization of current industry good practice. The Presidency s revised compromise proposal addresses many of the issues of concern in the Commission s initial draft. A number of outstanding issues of concern remain, however, and these tend to be in areas where the proposal goes beyond current industry good practice. Issues of concern which have been addressed in the Presidency s draft The definition of alternative investment fund: The scope of the Directive is broad; this avoids discrimination between alternative funds and other vehicles. The scope of the alternative investment fund managers covered has been clarified. The Directive focuses on alternative investment fund managers with collective portfolio management and risk management functions, and which may also have administration and marketing functions, and not on activities relating to the underlying assets of the AIF. Selfmanaged AIF are, themselves, AIFM. Externally appointed AIFM may also be authorized to perform other functions such as management of portfolios of investments. Investors: Extending the scope from professional client as defined under MiFID to include those which may be treated as such on request enables high net worth individuals (HNWIs) to access AIFs. This enables HNWIs access to diversified portfolios of investments, benefiting from professional management of the portfolio and spreading costs with a view to benefiting from potential yields or capital gains. Capital requirements: These are now envisaged to ensure the continuity and the regularity of the management; they were previously set higher than UCITS management company requirements, and have now been aligned with them. Furthermore, guarantees and insurance can be used to cover up to 50% of the additional own capital requirement. However, it is unclear why the initial capital requirement for internally managed AIF is higher. Independent valuation: Independent valuation is no longer required; proportionality is applied to the independent valuation function requirement; external valuers may also be used. On the other hand, the opportunity has been missed to clearly refer to international valuation standards, such as the International Private Equity and Venture Capital Valuation (IPEVC) guidelines for private equity. NAV calculation is not necessarily required at each subscription and redemption. The depositary is no longer required to book subscription and redemption payments from investors itself, but rather to oversee this process. Separate portfolio management and risk management functions are only required when this separation is appropriate in view of the nature, scale and complexity of the AIFM and the AIF it manages. This may permit niche players and private equity players in particular to continue with their current business models. Side letters: A description of any preferential treatment which an investor obtains, or has the right to obtain, should be disclosed to investors, but disclosure of the identity of investors receiving the preferential treatment is no longer required. It remains to be seen whether the description of the preferential treatment will mean details of the content, or rather a general statement on the existence, framework and limits. 11
Control of non-listed companies: The concept of control replaces that of controlling influence and the threshold is raised from 30% to 50% of the voting rights. Requirements for disclosure to the non-listed company, its shareholders and employees on acquisition of control are less onerous. In particular, disclosure of sensitive information on the AIFM s strategy with regard to the non-listed company is not required. The information which has to be disclosed in the AIFM s annual report is more focused on the long-term and less detailed. Continuity with currently existing regimes appears to be ensured: Member States may allow or continue to allow AIFM to market AIF established in third countries to professional investors on their territory subject to national law. However, given the importance of non-eu AIF to EU investors, it would nevertheless seem appropriate to clarify that this also refers to funds managed by non-eu managers. Member States may allow the marketing of all or certain types of AIF managed by AIFM to retail investors on their territory. Issues of concern which still need to be addressed Cumulative authorization: AIFM are required to obtain authorization in accordance with the AIFM Directive, even if they are already authorized to manage UCITS. MiFID authorized investment firms and credit institutions are not required to obtain an authorization as AIFM in order to provide investment services in respect of AIF. Remuneration: While requiring a remuneration policy which does not favor undue risk taking can only be supported, the disclosure of AIFM management and staff remuneration breakdowns in the AIFM s annual report is not relevant in terms of risk management, where the incentives structure already achieves alignment of interests. Conflicts of interest: The requirement to identify conflicts of interest that arise in the course of managing one or more AIF between one AIF or investor of the AIF and another client of the AIFM need to be clarified. It is unreasonable to require AIFM to be in a position to identify conflicts of interest between AIF investors and other clients, especially those with numerous investors. Depositary: The custodian remains liable, in general, to the AIFM, the AIF and investors for any losses suffered by them as a result of its failure to perform its obligations, except in circumstances beyond its control with unavoidable consequences. This imposes a heavy burden for custodians, which may, as a consequence, raise costs and even exit more risky, less developed financial markets. It may also entail consolidation in the custodian space, which may not be to the advantage of the asset management industry, with reduced choice and increased potential counterparty risk. However, the modification of the burden of proof requirements for custodians is welcome. The duties of the depositary with respect to the application of the AIF s income need to be clarified; should this relate to performance fees and carried interest, it would be inappropriate for AIF. 12
Leverage: Leverage is integral part of many alternative investment fund business models. The main questions relate to the definition of leverage, how the leverage will be calculated in practice, and the potential restrictions on leverage imposed, rather than on the disclosure requirements themselves: Defining and calculating leverage: Leverage is defined in the Directive as any method by which the AIFM increases the exposure of the AIF it manages, as part of its investment strategy, whether through borrowing of cash or securities, or leverage embedded in derivative positions or by any other means, considered on a netted basis. Different business models need to be taken into account: while real estate funds will typically prepare consolidated accounts, and are therefore in a position to calculate leverage at a consolidated level, private equity funds do not generally consolidate their results, meaning that potentially most of the leverage remains off-balance sheet. Fair and consistent rules should be applied across all types of funds, based on existing standards. The European Commission is required to adopt implementing measures clarifying the methods of leverage, in which circumstances it will be considered a part of the investment strategy, how leverage will be calculated, as well as when leverage is considered to be employed on a systematic basis for reporting purposes. We cautiously welcome this development if the industry is to be given the opportunity to express its views. Potential restrictions: When deemed necessary to ensure the stability and integrity of the financial system, Member State competent authorities may impose restrictions on the level of leverage that an AIFM may employ or other restrictions. They are required to inform the competent authorities of the home Member State of the AIF and CESR of actions taken in this respect. Current national regulation in a number of Member States requires regulatory approval of the proposed level of leverage or limits leverage, mainly for the purposes of investor protection. For regulated funds, it would appear that there would be no additional requirements in this sense, assuming that levels of leverage are set below the current levels. For currently unregulated or lightly regulated funds, this is a new concept. Non-EU AIFM: Assuming that non-eu alternative investment fund managers may be permitted to continue to sell their products to EU investors under national regimes: It nevertheless remains to be seen how long EU Member States will continue to permit this, following the implementation of an EU passport for marketing AIF. Furthermore, adequately regulated non-eu managers will not benefit from a passport for their funds (at least unless and until the Commission examines this issue in the framework of its review of the application and scope of the Directive - a review which is to take account of developments at international level and discussions with third countries and international organizations), and therefore cannot raise capital across the EU. Nor will they benefit from a passport for their management services. On the other hand, non-eu AIFM are not required to comply with standards equivalent to those of the Directive to access EU investors via national private placement regimes. Non-EU AIF managed by EU AIFM: as the depositary provisions are not applicable in the case of non-aif marketed in the EU, and managed by an EU AIFM, this creates an unlevel playing field for these funds. International guidelines: the opportunity has been missed to refer to international guidelines for alternative investment funds, such as those of the Hedge Fund Standards Board, the Alternative Investment Management Association (AIMA), the European Private Equity and Venture Capital Association (EVCA) and the European Association for Investors in Non-listed Real Estate Vehicles (INREV). 13
Luxembourg perspective By establishing passports both for AIFM and AIF, the proposed AIFM Directive permits AIFM to choose to establish themselves and their AIF in the domiciles that offer the most advantageous conditions. The AIFM Directive may thus lead to concentration of AIFM and AIF in the most attractive domiciles. Many non-eu AIFM may have incentives to establish themselves in the EU to be able to passport their products to investors in other EU Member States. The Directive may also drive a significant migration of funds to onshore domiciles. Their choice of domicile for AIFM and AIF will depend on factors such as: Flexibility of the regulatory environment Fiscal environment for investors and fund managers Reputation of the financial center Accessibility of the authorities Expertise and cost competitiveness of locally based service providers Ability to outsource both within the domicile and cross-border Qualifications and knowledge of workforce (including languages) These are all areas where Luxembourg scores highly, as demonstrated by the growth in the alternative sector in Luxembourg in the last five years, which outpaced all other European countries. Luxembourg is already the world s leading domicile of traditional funds distributed cross-border (UCITS). We therefore believe that Luxembourg will prove to be an attractive domicile for AIFM, and well placed to become a leading domicile of EU AIF as well. 14
15
Ernst & Young Assurance Tax Transactions Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 144,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. For more information, please visit www.ey.com. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. The Ernst & Young organization is divided into five geographic areas and firms may be members of the following entities: Ernst & Young Americas LLC, Ernst & Young EMEIA Limited, Ernst & Young Far East Area Limited and Ernst & Young Oceania Limited. These entities do not provide services to clients. Contacts Michael Ferguson Luxembourg Asset Management Leader +352 42 124 8714 michael.ferguson@lu.ey.com Michael Hornsby Luxembourg Real Estate Leader +352 42 124 8310 michael.hornsby@lu.ey.com Alain Kinsch Luxembourg Private Equity Leader +352 42 124 8355 alain.kinsch@lu.ey.com 2009 EYGM Limited. All Rights Reserved. This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. www.ey.com/luxembourg