On Thursday 12th November, the Swedish Presidency of the European Council released a new draft Directive on Alternative Investment Fund Managers (AIFM). The major changes to the draft Directive cover remuneration, marketing and third country regimes, and depository functions.
According to Peter ODwyer, Director, Trinity Fund Administration: The focus on remuneration could potentially be a bit of a diversion. I suspect the proposed limits on hedge fund pay will be resolved in due course and more closely aligned with reality. However a far more consequential issue remains. Notwithstanding many inputs and meetings in Brussels, the Scope of the Directive has still not been defined in a way that bears any resemblance to the true workings of the hedge fund world.
Remuneration-The new draft Directive sees an addition annex aiming to decrease risk-taking behaviour of those in charge of AIFs. This will be done by deferring up to 40% of variable remuneration by up to three years; and performance will be assessed over a longer time period. Remuneration will also have to be disclosed, although the individuals concerned will remain anonymous.
Scope-The definition of an AIF has been revised. According to a summary by law firm Linklaters: The definition of an AIF is any collective investment undertaking, including investment compartments thereof, (i) which raises capital from a number of investors with a view of investing it in accordance with a defined investment policy for the benefit of those investors, and (ii) which does not require authorisation pursuant to the UCITS Directive. This will still capture most if not all vehicles that would be regarded as funds but is less likely to capture many other products which might have inadvertently fallen within the previous definition of an AIF.
-There have also been a number of exemptions added, including intra group arrangement, national central banks, government bodies or public bodies that manage funds for social security or public pension systems, and securitisation special purpose entities. As Linklaters points out, the scope of the revised draft Directive is still very broad… the exemptions for securitisation special purpose entities is not broad enough to capture carious types of structure product which might fall within the definition of AIF as currently drafted.
-The definition of an AIFM has also seen some changes. According to the draft Directive, the definition of an AIFM means any legal person who manages one or several AIF and is responsible for the compliance with the requirements of this Directive and which, depending on the legal form of the AIF, could be either the AIF itself or an external entity.
Marketing and Third Country Regime-According to the draft Directive: Marketing means any 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 Community; this includes all unsolicited communication in any form and by any means presenting information on the AIF; [this does however not include information presented on the AIFM website].
-There has also been added confusion regarding marketing of AIFs outside the EU. According to Linklaters: National private placement regimes will apply to the marketing of AIF established in countries outside the EU… but it is unclear whether this only applies in the case of such third country AIF which are managed by authorised AIFM or whether these provisions also apply to third country AIF which are managed by entities outside the EU.
-The chapter entitled Conditions for the management of AIF in third countries is entirely new, and contains the following:
1. Member State shall ensure that an AIFM may only manage an AIF established in a third country where:
(a) the relevant legislation in the third country is in line with the standards set by international organisations, including the IOSCO standards on hedge funds oversight; and
(b) an appropriate cooperation agreement is in place between the competent authority of the home Member State of the AIFM and the supervisory authorities of the third country where the AIF is established.
-Master feed structures may not be allowed to circumnavigate the aims of the draft Directive: In order to ensure investor protection, the right for an AIFM to market AIF to professional investors in the Community on the basis of a single authorisation (the European passport for AIFM) should only be granted where the AIF is established in a Member State. This objective should not be circumvented through master-feeder structures. Therefore, when a feeder AIF invests in a master AIF which would not benefit from the right to market in the Community, the feeder AIF should not benefit from such passport either. Member States may, however, allow or continue to allow AIFM to market AIF established in third countries to professional investors on their territory subject to national law. The Commission is called upon to assess, three years after the entering into force of this Directive, whether to come forward with proposals to allow for a passport to market AIF established in third countries in the Community.
-The following articles have all been deleted:
Article 35: Conditions for the marketing in the Community of AIF domiciled in third countries;
Article 36: Delegation by the AIFM of administrative tasks to an entity established in a third country;
Article 37: Valuator established in a third country:
Article 38 Delegation of the depositary tasks in respect of AIF domiciled in third countries;
Article 39: Authorisation of AIFM established in third countries.
Depositaries-The definition of a depository for an AIFM can be either a credit institution having its registered office in the Community, or an investment firm authorised under accordance with MIFID.
-The following clause has been added for AIF which have no redemption rights exercisable during a period of 5 years following the date of constitution of each AIF and which, according to their investment strategy and objectives, make investments and divestments solely on a non-frequent basis, the depositary may be either: (a) a legal person which is subject to prudential regulation and ongoing supervision and which can furnish sufficient financial and professional guarantees to be able to effectively perform the relevant depository functions and meet the commitments inherent in those functions; or (b) a legal person which carries out depository functions as part of professional or business activities in respect of which it is subject to mandatory professional registration recognized by law or to legal or regulatory provisions or rules of professional conduct and which can furnish sufficient financial and professional guarantees to be able to effectively perform the relevant depository functions and meet the commitments inherent in those functions.
-Perhaps the most important changes cover what a depositary can or cannot delegate to a third party, an issue raised with the fallout from the Madoff funds, and an issue not covered sufficiently by UCITS or the upcoming UCITS II directive. According to the draft Directive, a depositary may delegate to third parties provided that sub-custodian fulfils the following conditions:
(a) it is subject to supervision in the jurisdiction concerned;(b) it has structures and expertise that are adequate and proportionate to the nature, scale and complexity of the AIF;
(c) it is subject to periodic audit to ensure that the financial instruments and other securities are in its possession;(d) it segregates the financial instruments and other securities from its own assets;
(e) it may not make use of the financial instruments and other securities without the prior consent of the AIFM () and such consent has not been withdrawn.
Valuation-Surprisingly, the AIFM no longer needs to appoint a third party to value the AIF. However, the new draft accepts that member states may have varying rules on the subject.
ResponsesThere has been a mixed response to the new draft Directives. According to ODwyer of Trinity Fund Administration: Whilst there has been useful progress made, (in terms of valuation and third countries for instance), issues remain unclear, not least the persistent confusion between the delegated investment manager and the manager of a fund. The most recent changes have also reinserted confusion on the depositary issue, through seeking to differentiate hedge funds from PE funds in this area. Implementing this directive, in its current form would be like trying to play snooker with a tennis racket.
Speaking to FTAdvisor, James Greig, partner for consultants PricewaterhouseCoopers Legal, said ”Our key reservations remain over the views that the European Parliament and the EU Commission will take. Parliament has not been heard yet and we expect the EU Commission to push back on aspects of the compromise.
According to Paul Compton, head of product management at SunGard Alternative Investments, speaking to Reuters, the draft directives disclosure requirements are unlikely to impose too onerous an additional burden given the regular reports that a well managed fund will be generating already for its management and stakeholders.
Perhaps the strongest claims against the draft came from Gerben Everts, head of the global regulations and compliance team at APG, who asked the European Commission to withdraw the draft Directive.
The next step on finalising the Directive is a report from Jean-Paul Gauzѐs, rapporteur for the AIFM Directive, which is expected on the 25th November.
Giles TurnerNews Editor
The Linklaters Report can be found here
The draft Directive can be found here