The UK Financial Services Authority (FSA) has released a discussion paper setting out provisional thinking in its approach to implementing the Alternative Investment Fund Managers Directive (AIFMD), the proposed law that will give the European Union authority to regulate hedge funds and private equity funds.
Along with other European Union member states, the UK is required to transpose the directive by July 22 2013 and Alternative Investment Fund Managers (AIFMs), whose regular business is managing Alternative Investment Funds (AIFs), will be required to be authorised or registered by the FSA, or the Financial Conduct Authority (FCA), the likely UK regulator for fund management and markets from 2013.
The European Securities and Markets Authority (ESMA) on Nov. 16. 2011 provided its technical advice on the implementation of the directive to the European Commission . The Commission is likely to propose implementing measures for adoption in the first quarter of 2012. It is anticipated that these measures will be adopted by mid-2012. The FSA aims to be in a position to receive potential AIFM applications for authorisation from the second quarter of 2013. This would benefit potential FCA-authorised AIFMs wishing to make use of the EU-wide passports for marketing and/or AIF management from the AIFMD affective date.
Existing MiFID firms and UCITS management companies will face several new general principles under AIFMD, including additional due diligence responsibilities and requirements relating to the appointment of counterparties and prime brokers, said the FSA.
Under the regulations, a UK AIFM will be required to ensure that a single depositary is appointed for each UK AIF it manages. A UK AIF must have a depositary established in the UK. The Directive gives some discretion to the UK authorities, however, to allow, until July 22 2017, a UK AIF to use a depositary established in another member state. Non-EU AIFMs marketing EU or non-EU AIFs are not required under the proposed regulation to have a depositary. UK AIFMs marketing non-EU AIFs are not required to have a single depositary, but are required to ensure one or more entities are appointed to carry out certain depositary functions. Authorized EU credit institutions, EU MiFID investment firms and UCITS depositories, could act as depositories under AIFMD.
The FSA currently requires a firm whose business consists solely of acting as trustee or depositary of authorised investment funds to have own funds of at least 4 million. As this requirement has not been updated, even for inflation, since 1988, and with the increased liability placed on depositaries by AIFMD to immediately return financial instruments in certain instances, the FSA says it will need to consider whether the current requirement needs to be changed. Options available for calculating a new requirement could include aflat rate increase in line with inflation; average of a firms net income, or a percentage of AUM of the AIF for which the depositary is appointed.
In addition to the three categories of firms permitted to act as a depositary, a member state may permit other entities to act as a depositary for AIFs that have no redemption rights exercisable during a five-year period from the date of the initial investments and generally either do not invest in financial instruments that must be held in custody, or invest in issuers or non-listed companies to potentially acquire control. The FSA says it considers this option could give rise to reduced costs and increase competition in this market, so it is considering making use of this Member State option. If the UK does make use of it, the FSA says it will need to consider what is deemed sufficient financial and professional guarantees for these types of firms. “We will also need to consider if any other FSA rules , should apply to these firms,” says the regulator.
The UK Authorities are considering making the necessary legislative changes to distinguish between the activity of being a depositary – cash monitoring, safekeeping of an AIF assets and oversight of certain operational functions – from other activities associated with the management or operation of AIF and CIS. “We consider that a depositary, in complying with existing FSA requirements, will mostly already be carrying on the key reconciliation activities contemplated by the Directive and currently applicable for UK-authorised funds,” says the FSA. For example, a depositary must ensure that the authorised fund manager can demonstrate compliance in accordance with existing regulatory requirements. “We consider, therefore, that in practice there may be little or no change to existing practices for these types of depositaries. These requirements, however, will be new for a depositary of an unauthorised AIF”.
A non-EU AIF marketed in the UK and managed by a UK AIFM is not required under the directive to have a single depositary to carry on all three of the primary depositary functions. In this instance, the requirement for a single depositary is removed but the AIFM must ensure that one or more persons are appointed to carry on these functions. “So as to reduce investor risks and any conflicts of interest, we will need to consider what requirements, if any, should be imposed on firms in the same group as the AIFM that offer these services,” says the FSA.
The Directive specifies that in the event of a loss of a financial instrument held in custody, the depositary shall return a financial instrument of the identical type or the corresponding amount to the AIF or the AIFM without undue delay. The FSA says it will first assess whether a loss has occurred, based on ESMA’s guidance that intentional transfer of ownership by the AIF to a third party (e.g. a prime broker) should not be considered as a loss. The next step is to consider whether the event that gave rise to the loss is one that is the result of an external event beyond [the depositarys] reasonable control, the consequences of which would have been unavoidable despite all reasonable efforts to the contrary, and if it is, the depositary will then not be deemed liable. Another aspect of this assessment is that even if the event is regarded as an external event beyond the reasonable control of the depositary, the depositary may still be liable if a judgement is made that it had not taken all reasonable efforts to avoid this risk.
The FSA is inviting comments to its discussion paper. The deadline for responses is March 23 2012.
(JDC)