With the recent approval of the EU Council of Ministers and publication in the Official Journal expected imminently, the new EU Directive on alternative investment fund managers (the AIFM Directive) is more real than ever.
Unlike the UCITS Directive (governing retail mutual funds), the AIFM Directive does not directly introduce European legislation for alternative investment funds (AIFs). Instead, it introduces an authorisation and supervisory regime for alternative investment fund managers (AIFMs) managing AIFs in the European Union (EU), which in many respects is similar to the regime for managers of UCITS funds. Moreover AIFs will be required to have a depositary having custody of their assets and having a degree of governance oversight, which is also similar in concept from the UCITS regime.
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The AIFM Directive was announced with the aim of enhancing investor protection and financial stability but extends well beyond the supposedly systemically important players to touch most EU participants of any size across the panoply of the alternative investment world.
Although much that was unworkable in the original proposals has been watered down, many key controversies remain. For example, though improved the depositary rules do not sit comfortably with many limited partnership funds or funds employing prime broking strategies. The valuation models are prescriptive, the rules restricting delegation still prejudice many multi-manager strategies and the rules on marketing remain subject to further review and advice from The European Securities and Markets Authority (ESMA). Other key controversies include the protectionist restrictions on marketing non-EU domiciled AIFs (although these too have been substantially watered down since the original proposal) and the powers of the Commission, rather than Member States, to determine limits on leverage (in certain circumstances), levels of investor disclosure and deemed equivalence of third party countries’ regulatory regimes and service providers.
Even now, with the AIFM Directive about to come into force, we are very much only at the end of the beginning. The AIFM Directive empowers ESMA with 72 separate tasks, much of which is intended to be adopted as “Level 2” secondary rule making by the EU Commission during the course of 2011–2012.
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Part 1 – Scope
Who is an AIFM?
An AIFM is defined as “Any legal person whose regular business is managing one or more AIF”. Each AIF must have only one AIFM, which may either be an external appointment or an AIF may itself be internally managed where its legal form allows, in which case the AIF must itself be authorised as an AIFM.1
ESMA will develop technical standards to determine the types of AIFM and ensure “uniform conditions of application”.2
What is an AIF?
An AIF is defined as any “collective investment undertaking” (including any separate investment compartments) which is not a UCITS and which:
- raises capital from a number of investors
- intends to invest such capital in accordance with a defined investment policy for the benefit of those investors.
Such a fund will fall within the definition regardless of whether it is open or closed-ended, however it is constituted or whatever its legal structure.
What funds/strategies are covered?
Nearly all funds which are not currently subject to product regulation (and even some that are), regardless of domicile or form. The key is that the AIF has an AIFM providing management or marketing services from within the EU, subject to the thresholds and exemptions set out below.
This means that a wide range of AIFs are captured by the AIFM Directive including hedge funds, private equity funds, commodity funds, real estate funds, debt funds, energy and carbon funds and infrastructure funds. In addition, authorised retail funds that do not qualify as UCITS funds and listed investment companies also fall within the definition.
Thresholds and exemptions
The AIFM Directive will not apply to:
- AIFMs managing AIFs that have total assets of less than €100 million or
- AIFMs managing AIFs that have total assets of less than €500 million subject to the AIFs not being leveraged and have no redemption rights during a period of 5 years following the date of initial investment in each AIF.
These thresholds raise the question of whether parallel funds, each under the threshold, could each have a separate AIFM advised by the same investment adviser. We expect this is unlikely to be the case but further clarification will be needed in secondary legislation.
Note that AIFMs falling below threshold must still register with their competent authority and provide the following:
- the identity of all AIFs managed and information on their investment strategies (at time of registration)
- regular reporting on main instruments trading and principal exposures and concentrations for systemic risk monitoring purposes.
However, Member States are free to impose stricter requirements and so we expect to see certain Member States disapply the thresholds completely or apply them at lower levels. Member States also have to enable any AIFM the ability to choose to “opt-in” to the AIFM Directive regime.3 Where an AIFM chooses to opt in, the AIFM Directive will become applicable in its entirety.
The AIFM Directive does not apply to:
- holding companies
- supranational institutions, such as the World Bank, the International Monetary Fund, the European Central Bank, the European Investment Bank, the European Development Finance Institutions (DFIs) and bilateral development banks, the European Investment Fund, other supranational institutions and similar international organisations
- EU regulated occupational pension schemes (being institutions covered by the IORP Directive);
- national central banks
- national, regional and local governments and bodies or institutions which manage funds supporting social security and pension systems
- employee participation schemes or employee saving schemes
- securitisation special purpose entities (being an entity whose sole purpose is to carry on a securitisation within the meaning of Article 1(2) of Regulation 24/2009)
- entities managing AIFs whose only investors are companies within the same group (provided none of those investors are themselves an AIF).
A “holding company” is defined as:
- a company holding shares in other companies the commercial purpose of which is to carry out a business strategy through such investee companies in order to contribute to their long term value and either:
- its shares are admitted to trading on a European regulated market and which is operating for its own account; or
- it is not established for the main purpose of generating returns for its investors by means of divestment of its subsidiaries or associated companies (evidenced by annual report or other official documents).
The AIFM Directive does not apply to:
- a manager of a closed-ended fund not making any investments beyond the final transposition date in 2013 or
- closed-ended funds with subscription periods closed prior to the AIFM Directive entering into force which under constitution will be wound-up no later than three years after the final transposition date.4
- Article 5(1).
- Article 4(4).
- Article 3(4).
- Article 61.
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Part 2 – Authorisation and operational requirements
AIFMs that come within the AIFM Directive must be authorised to provide management services to, or market the shares or units of, AIFs.5
Authorisation is granted to the AIFM by the competent authorities of its home Member State. Once authorisation has been granted it is valid for operating in all Member States under passporting arrangements. Amongst the conditions for authorisation, an AIFM must have its head office in the same Member State as its registered office.6
Article 6 sets out what activities AIFMs can do, drawing a distinction between an “externally appointed AIFM” and AIFs “that are internally managed”. For example, Article 6 provides that:
- no externally appointed AIFM shall engage in activities other than those referred to in Annex I of the AIFM Directive (these match the permitted activities of a UCITS management company), unless also authorised to manage UCITS
- no internally managed AIF shall engage in activities other than the internal management of the AIF in accordance with Annex I of the AIFM Directive.
Additionally (as with UCITS management companies), Member States may authorise an externally appointed AIFM to provide the following services:
- management of portfolios of investments
- as non-core services: investment advice; safekeeping and administration in relation to units of collective investment undertakings and reception and transmission of orders in relation to one or more financial instruments.
Authorisation may be restricted to conducting particular investment strategies.7
Application of and to MiFID
Various provisions of the Markets in Financial Instruments Directive (MiFID) apply to the provision of such services, including those governing a firm’s organisational requirements and conduct of business.8
Article 6(8) stipulates that MiFID investment firms do not need authorisation under the AIFM Directive to provide MiFID investment services, such as discretionary portfolio management, to an AIF. However, investment firms may only offer or place (directly or indirectly) units in an AIF with investors in the EU to the extent that the units in question are able to be marketed in accordance with the AIFM Directive.
Capital requirements9 for AIFMs closely follow the regime for UCITS management firms (on whom no additional capital requirements are imposed). In particular it should be noted that the calculation is based on funds under management. It is difficult to see how this is appropriate in terms of comparative treatment of, for example, real estate and hedge fund managers with billions under management but the very different systemic risks each may pose. Again, following the MiFID capital regime (perhaps with appropriate modifications) might be considered to have resulted in a more proportionate treatment.
Member States shall require that where an AIFM is appointed as an external manager of an AIF, the AIFM has an initial capital of at least €125,000. (Where an AIF is internally managed, it must have an initial capital of at least €300,000.)
Where the value of an AIFM’s AIF portfolios exceed €250 million 10, the AIFM shall provide an additional amount of own funds. The additional amount of own funds shall be equal to 0.02 per cent of the amount by which the portfolio exceeds €250 million. The required total of the initial capital and the additional amount must not exceed €10 million. The justification for this is to ensure alignment with Article 7 of the UCITS Directive.
In order to remove the double counting of delegated funds in AIFM capital requirements, portfolios deemed to be portfolios of the AIFM include AIFs managed by the AIFM in respect of which it has delegated one or more functions but exclude AIFs which are managed under delegation from another AIFM.
Member States may authorise an AIFM not to provide up to 50 per cent of the additional amount of own funds if they benefit from a guarantee of the same amount given by a credit institution or an insurance undertaking which has its registered office in a Member State, or a third country where it is subject to prudential rules considered by the competent authorities as equivalent to those laid down in EU law. The own funds required by this provision shall be invested in liquid assets or assets readily convertible to cash in the short term and shall not include speculative provisions.
Irrespective of the above, AIFMs shall not hold an amount of own funds which is less than that required under the Capital Requirements Directive (CRD).
AIFMs are also required to hold appropriate professional indemnity cover.11
Operating conditions and organisational requirements
Articles 12 to 17 cover ongoing operating conditions for AIFMs, which are very similar to the equivalent provisions of MiFID. Articles 18 to 20 set out additional organisational requirements including those in relation to the valuation function and delegation powers generally.
The general principle is that AIFMs shall use at all times adequate and appropriate resources that are necessary for the proper performance of their management activities, including accounting, data processing and personal account dealing.12
The AIFM Directive sets out some very wide ranging general principles13 with which the AIFM must comply, including the requirement to act in the best interests of the AIF it manages, the investors of the AIF and the integrity of the market. An AIFM is required to treat investors fairly and no individual investor may receive preferential treatment unless this is disclosed in the AIF’s rules or incorporation documents. Whilst this will be a major restriction on side letters with the AIF itself, it is not clear whether it would also restrict side letters between an investor and the AIFM in relation to fee rebates, for example. Level 2 legislation or guidance clarifying how regulators should interpret these principles is envisaged.
Furthermore, there is a requirement for an AIFM to “have, and employ effectively, the resources and procedures necessary for the proper performance of its business activities”. Moreover, an AIFM that conducts discretionary portfolio management will not be permitted to invest all or part of the client’s portfolio in units or shares of an AIF it manages unless it receives prior general approval from the client.
The AIFM Directive details the categories of staff of an AIFM subject to the remuneration policy, which include senior management, risk takers, control functions and any employee receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers. An AIFM’s remuneration policy must be “consistent with and promote sound and effective risk management” and should not “encourage risk-taking which is inconsistent with the risk profiles, rules or instruments of incorporation of the AIFs they manage”. The principles which must be taken into account when establishing a remuneration policy are similar to those being recommended by the Commission for introduction for all investment firms (which are reflected, for example, in the Financial Services Authority’s Remuneration Code) eg, in relation to performance related remuneration, the aggregate remuneration should be based on a combination of the assessment of the performance of the individual (including an assessment of financial and non-financial criteria) as well as the business unit or AIF concerned and the overall results of the AIFM. Furthermore, guaranteed variable remuneration is stated to be exceptional and should only occur when hiring new staff and should be limited to the first year. Payments relating to the early termination of a contract should reflect performance achieved over time and should not reward failure.
After extensive lobbying, an element of proportionality has been introduced in terms of how such principles should be applied to fund management firms, so that now an AIFM is obliged to follow the remuneration policy “in a way and to the extent that it is appropriate” 15. However, this proportionality principle has been included in an annex and not the main provisions of the AIFM Directive, which means the drafting is far from ideal and a truly proportionate implementation is not ensured. The guidelines on sound remuneration policies to be developed by ESMA will be a major concern for the industry.
Conflicts of interest 16
The general requirement is for AIFMs to take all reasonable steps to identify conflicts of interests between it and the investors in the AIF or between one investor and another that arise in the course of managing one or more AIF. AIFMs are also required to maintain and operate effective organisational and administrative arrangements with a view to taking all reasonable steps designed to prevent conflicts of interest from adversely affecting the interests of the AIF and its investors. Significantly, there is a requirement for an AIFM to segregate incompatible tasks and responsibilities with the potential to generate conflicts. Where such arrangements are not reasonably certain to be sufficient, the AIFM is required to make disclosures of the conflict of interest to investors before undertaking business on their behalf.
Risk management 17
The general principle is for AIFMs to separate the risk management function from the portfolio management function both “functionally” and “hierarchically”, which shall be subject to review by the regulator. This would presumably require such functions to be carried out by separate divisions or groups of employees. AIFMs will be required to review their risk management systems at least once a year and to adapt them when necessary. As a minimum, AIFMs will be required to implement and document a due diligence process when investing on behalf of the AIF and ensure that the risks associated with each investment position of the AIF and their overall effect on the AIF’s portfolio can be accurately identified, measured and monitored at any time through stress testing procedures. The AIFM must be able to demonstrate that the risk management process satisfies the requirements of Article 15 and is consistently effective. There is also an obligation on the Commission to adopt measures to specify the risk management system to be employed and the appropriate frequency of review of such system.
Liquidity management 18
The AIFM Directive stipulates that AIFMs (other than in relation to unleveraged closed-ended AIFs) should use an appropriate liquidity management system and adopt procedures that ensure that the liquidity profile of the investments in the AIF complies with its underlying obligations. AIFMs should also regularly conduct stress tests both under normal and exceptional liquidity conditions. AIFMs should also ensure that for each AIF it manages the investment strategy, the liquidity profile and the redemption policy are consistent.
All regulatory provisions relating to short selling have been removed from the AIFM Directive, thus leaving such arrangements to be dealt with separately under the forthcoming European Commission legislation on short selling.
In order to ensure consistency between the interests of firms which repackage loans into tradable securities, originators and an AIFM who invest in such securities, Article 17 provides that the Commission will adopt requirements to be met by the originator and qualitative requirements to be met by an AIFM which invests in tradable securities. This includes a requirement that the originator, the sponsor or the original lender retain at least a five per cent net economic interest.
The AIFM Directive provides that AIFMs will ensure appropriate and consistent procedures are established so that a proper and independent valuation of the assets of the AIF can be performed.
The valuation of assets and the calculation of the net asset value per share or unit should occur at least once a year and be disclosed to investors. In the event that the AIF is open-ended, such valuations and calculations shall be carried out at a frequency appropriate to the assets held by the AIF and its issuance and redemption frequency. In the event that the AIF is closed-ended, such valuations and calculations shall be carried out in case of an increase or decrease of the capital by the relevant AIF.
The AIFM Directive calls for ‘functional independence’ of the valuation function and the portfolio management function. An external valuer may be used but the AIFM must be able to show that the third party is, inter alia, subject to mandatory professional registration, can provide sufficient professional guarantees to enable it to perform effectively the relevant valuation function, is qualified and capable of undertaking the functions in question and has been selected with due care. When an external valuer is not used the home Member State may require the AIFM to have its valuation procedures and/or valuations verified by an external valuer or auditor.
“Proper” valuation remains the responsibility of the AIFM and liability is unaffected by any delegation to an external valuer. Notwithstanding, the contract with any valuer must ensure that it is liable to the AIFM for negligence or intentional failure to perform its tasks.
Delegation of AIFM functions 20
The provisions governing delegation to third parties, whilst much improved from the draft directive, are still highly restrictive and delegation of portfolio management to other best of breed managers, particularly outside the EU, will become more challenging for managers of multi-manager products.
Before an AIFM can delegate any functions it needs to notify its regulator and certain conditions need to be complied with, which will be the subject of further detail in Level 2 legislation from the Commission. In particular:
- the AIFM must objectively justify the entire delegation structure, which must not prevent management in best interests of investors
- the delegate must be qualified and capable and have sufficient resources and be of sufficiently good repute and experienced
- portfolio management or risk management may only be delegated to an authorised and supervised entity, unless with the prior approval of the AIFM’s regulator
- a delegate may only be a third country entity where a co-operation agreement is in place between that third country and the AIFM’s own jurisdiction.
An AIFM’s own liability will be unaffected by delegation. Moreover the AIFM must demonstrate that the delegate has been selected with all due care, can be monitored effectively, that instructions may be given at any time and that the appointment may be terminated immediately where it is in the interests of investors, all of which will require existing investment management agreements to be revisited. All delegation must be subject to ongoing review.
Sub-delegation is permitted but the conditions attached to delegation must be applied down the delegation chain.
An AIFM may not delegate to the depositary or to a delegate of the depositary, or to any other undertaking whose interests may conflict with the AIFM or the investors of the AIF. AIFMs are not allowed to delegate their functions to such an extent that, in essence, they could no longer be considered to be the manager of the AIF.
- Article 6.
- Article 8(1)(e).
- Article 8(4).
- Article 6(6).
- These are set out in Article 9.
- Not applicable to internally managed AIFMs.
- Article 9(7).
- Article 18.
- Article 12.
- Article 13.
- Annex II.
- Article 14.
- Article 15.
- Article 16.
- Article 19.
- Article 20.
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Part 3 – Depositaries
For each AIF it manages, an AIFM must ensure that a single depositary is appointed. The depositary must act independently and in the interests of the AIF and the AIF investors. As well as overseeing custody, the depositary is also responsible for overseeing that valuations and pricing of, and dealings in, interests in the AIF, and portfolio transactions on behalf of the AIF, are all carried out in accordance with relevant regulations and the AIF constitution (concepts imported from the UCITS Directive).21
Who can act as a depositary?
There has been significant movement in relation to who can act as depositaries. A depositary can be an EU credit institution, a MiFID authorised investment firm or institutions that are subject to prudential regulation and ongoing supervision and are eligible to be a depositary under the UCITS IV Directive.
Non-EU AIFs may appoint an entity of the “same nature” as long as it is subject to “effective” prudential regulation and supervision of the “same effect” as EU requirements, which are effectively enforced. Level 2 requirements in this respect will necessarily have a big impact on the ability of non-EU AIFs to be marketed in the EU.
Importantly for the hedge fund industry, it has become easier for prime brokers to act as depositaries. A prime broker may only act as depositary where: (a) the performance of its depositary functions is functionally and hierarchically separated; and (b) any conflicts of interest are properly identified, managed, monitored and disclosed.
An interesting addition to the AIFM Directive is the power for Member States may allow, in relation to AIFs which have no redemption rights exercisable during a period of five years from the date of initial investments and which generally do not invest in assets which must be held in custody, a depositary to be an entity that carries out “depositary functions as part of professional or business activities in respect of which it is subject to mandatory professional registration recognised 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 depositary functions and meet the commitments inherent in those functions”. Recital 34 makes it clear that it is anticipated this will enable professionals such as lawyers, notaries or registrars to provide the depositary function to AIFs with limited custody requirements, in particular real estate funds, venture capital funds and private equity funds.
For EU AIFs, the depositary must be established in the home Member State of the AIF. For non-EU AIFs, the depositary must be established in the third country where the AIF is established or the home Member State of the AIFM managing the AIF or the Member State of reference of a non-EU AIFM managing the AIF (determined as set out below).
Depositary liability regime
As with AIFMs, the AIFM Directive imposes a duty on depositaries to act honestly, fairly, professionally, independently and in the interests of the AIF and the investors of the AIF.22
Depositaries are restricted from delegating any of their functions other than their custody functions, the delegation of which is subject to strict conditions. Other than in relation to its custody functions, a depositary may absolve itself from liability except where it has performed its role negligently or where it has intentionally failed to properly perform its obligations.
The depositary provisions contain a strict liability regime pursuant to which the depositary would be liable to the AIF or to the investors of the AIF for the loss of financial instruments held in custody, unless such loss was as a result of an external event beyond its reasonable control. A carve out is also included where custodian activities are delegated to a third party and such delegation was appropriately conducted and there is a written contract between: (i) the depositary and the AIF (or the AIFM acting on its behalf) allowing for such discharge; and (ii) the depositary and the third party that explicitly transfers the liability of the depositary to that third party in circumstances where the AIF would have a direct right of action against the third party.
Where a depositary is prevented from exercising its custodial functions under the national law of the country where the AIF invests, it may shift its liability to a third party. However, this shift in liability is conditional upon:
- the constitutional documentation of the AIF concerned expressly permitting this
- the investors of the AIF being duly informed
- such delegation being instructed by the AIF (or the AIFM on its behalf)
- written contracts between: (i) the depositary and the AIF (or the AIFM acting on its behalf) allowing for such discharge; and (ii) the depositary and the third party explicitly transferring the liability of the depositary to that third party in circumstances where the AIF would have a direct right of action against the third party
These measures seek to ensure depositaries are held responsible in the event they accept fake assets on behalf of fraudulent investors. However, such measures may make it extremely expensive or even impossible for depositaries to take custody of certain emerging market instruments.
- Article 21.
- Article 21(9).
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Part 4 – Transparency requirements and investor reporting
Transparency provisions are set out in Articles 22 to 24. This goes to the core of the primary stated aim of the legislation, which is to provide an effective mechanism for gathering, pooling and analysing information on the impact the activities of AIFs have on macro-prudential risks. However, these provisions extend way beyond such aim, notably in relation to private equity funds, are detailed and are potentially quite onerous.
Reporting to investors
Article 22 covers requirements in relation to the annual report, which must be made available to competent authorities and investors upon request no later than six months following the end of the financial year. The annual report must include, inter alia, information on remuneration paid by the AIFM and AIF. Article 23 covers information that an AIFM needs to provide its investors and Article 24 deals with periodic information an AIFM needs to provide the competent authorities of its home Member State, including trading information, risk management information and details of leverage employed.
An AIFM is required to set a maximum leverage limit for each AIF it manages, taking account of various factors including the AIF’s strategy, the scale, nature and extent of the AIF’s activity in the relevant markets, collateral and counterparty exposures.23
Article 25 sets out specific obligations for AIFMs managing leveraged AIFs. The AIFM must demonstrate that the leverage limits for each AIF it manages are reasonable and that it complies at all times with the leverage limits set by it. Where an AIFM manages an AIF which employs leverage on a substantial basis, the AIFM has to make certain disclosures to the AIF’s investors and also to the competent authorities of its home Member State, who can then use this information to identify the extent to which the use of leverage contributes to the build up of systemic risk in the financial system.
Member States also have an ability to impose limits on the leverage that AIFMs employ in circumstances where the regulator deems it necessary to ensure the stability and integrity of the financial system. Discussions around these limits have been some of the most controversial provisions of the AIFM Directive and again the level 2 legislation to be developed in this regard will be keenly watched.
Private equity – AIFs acquiring controlling interests
The AIFM Directive sets out notification and detailed reporting requirements on private equity managers that acquire controlling stakes in companies. Articles 26 to 30 set out specific obligations for AIFMs managing AIFs which acquire a controlling influence in non-listed companies and issuers. Article 26 provides that these sections apply to:
- an AIFM managing one or more AIF which either individually or jointly on the basis of an agreement aimed at acquiring control, acquires 50 per cent or more of the voting rights of a non-listed company
- an AIFM cooperating with one or more other AIFMs on the basis of an agreement pursuant to which the AIF managed by these AIFMs jointly, acquires 50 per cent or more of the voting rights of a non-listed company.
However, the provisions do not apply where the non-listed company:
- employs fewer than 250 persons, has an annual turnover not exceeding €50 million and/or an annual balance sheet not exceeding €43 million or
- is a special purpose vehicle with the purpose of purchasing, holding or administering real estate.
Article 27 provides that when an AIFM acquires, disposes or holds shares of a non-listed company above or below certain thresholds, it has to notify the competent authorities of its home Member State of the proportion of voting rights held by the AIF. Where an AIF acquires, individually or jointly, 50 per cent or more of the voting rights of a non-listed company, the AIFM must notify the non-listed company, all other shareholders and the competent authorities of the home Member State within ten working days of such acquisition. Article 28 sets out further disclosure requirements on the AIFM, including making available its intentions with regard to the future business of the non-listed company to the non-listed company and its other shareholders.
An industry paper published by the European Private Equity and Venture Capital Association has criticised these disclosure requirements as “discriminatory with no cost-benefit justification”. Furthermore, a press release issued by the Global Venture Capital Congress in September 2010 expressed concern over the impact of such provisions, which might lead to the disclosure of highly sensitive portfolio information.
There are also additional requirements which must be included in the annual report of the AIF exercising control of a non-listed company.24
In order to prevent asset-striping, an AIFM managing such an AIF must not, within 24 months following the acquisition of 50 per cent or more of the voting rights of a non-listed company by the AIF, facilitate any distribution, capital reduction, share redemption or acquisition of own shares by the company. This is subject to certain carve outs for some distributions from distributable reserves.25
- Article 15(4).
- Article 29.
- Article 30.
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Part 5 – Marketing an AIF in the EU
The marketing of EU AIFs by authorised AIFMs in Member States is covered in Articles 31 to 33. These provisions provide for the introduction of a cross-border passport for marketing AIFs to professional investors throughout the EU, which represents the one carrot amongst the forest of sticks contained in the AIFM Directive.
An “EU AIF” means an AIF authorised or registered in a particular Member State or, if neither, which has its registered office and/or head office in a particular Member State. An AIF “established” in the EU is an AIF registered in a third country jurisdiction but which has its head office in a EU Member State. The home jurisdiction for an AIFM for these purposes will depend on location of its registered office.
What counts as marketing?
“Marketing” is defined as “any direct or indirect offering or placement at the initiative of the AIFM or on behalf of the AIFM of the units or shares in an AIF it manages to or with investors domiciled in the EU”.
“Passive” marketing or “reverse solicitation” (ie, not at the direct or indirect initiative of the AIFM) continues to be permitted as a result of being taken outside the scope of AIFM Directive.
EU AIFM/EU AIF
An AIFM authorised in its home Member State will be entitled to market its AIFs to professional investors (as defined in MiFID) in any Member State. The cross-border marketing of AIF is subject only to a notification procedure, under which relevant information is provided to the host Member State by the AIFM’s regulator (in line with the revised notification procedure introduced for UCITS firms under UCITS IV).
Third country issues
The provisions on marketing non-EU AIFs and the marketing of AIFs by non-EU AIFMs have been the most hotly contested issues and provoked the most press comment on the AIFM Directive.
There are two methods which allow the marketing of AIFs into the EU. The first method is a marketing “passport” which has been introduced by the AIFM Directive, which broadly allows AIFs to be marketed to professional investors across the EU subject to certain conditions being met. The second method allows AIFs to be marketed in a specific Member State in accordance with such Member State’s private placement regime, subject to certain conditions being met.
EU AIFM/Non-EU AIF
Article 34 provides that an authorised EU AIFM may manage a non-EU AIF not marketed in the EU, provided that the AIFM complies with the requirements of the AIFM Directive (other than depositary and annual reporting requirements) and cooperation agreements exist between the competent authorities of its home Member State and the supervisory authorities in the third country where the non-EU AIF is established, in order to ensure efficient exchange of information to allow the competent authorities of the AIFM’s home Member State to carry out their duties pursuant to the AIFM Directive. The European Securities and Markets Authority (ESMA) is tasked to develop guidelines in relation to such cooperation arrangements.
Subject to the implementing measures described below, Article 35 provides that an authorised EU AIFM may manage a non-EU AIF marketed to professional investors in the EU with a passport provided the EU AIFM complies with the AIFM Directive in full and complies with the following additional requirements:
- cooperation agreements exist between the competent authorities of its home Member State and the supervisory authorities in the third country where the non-EU AIF is established, in order to ensure efficient exchange of information to allow the competent authorities of the AIFM’s home Member State to carry out their duties pursuant to the AIFM Directive
- the third country where the non-EU AIF is established is not listed as a Non-Cooperative Country and Territory by the Financial Action Task Force on anti-money laundering and terrorist financing (NCCT)
- the third country where the non-EU AIF is established has signed an agreement with the home Member State of the AIFM and with each other Member State in which the AIF is to be marketed in, which complies with Article 26 of the OECD Model Tax convention and ensures an effective exchange of information in tax matters (collectively the “triple-lock conditions”).
Where a competent authority of another Member State disagrees with the assessment made on the application of points (1) and (2) above by the competent authorities of the home Member State, such disagreement may be referred to ESMA.
Subject to the implementing measures described below, Article 36 provides that an authorised EU AIFM may manage a non-EU AIF marketed to professional investors in the EU without a passport provided:
- the AIFM complies with the requirements of the AIFM Directive other than full compliance with the depositary regime (instead the requirement is that an independent party provides the duties required of the depositary)
- cooperation agreements exist between the competent authorities of the home Member State and the supervisory authorities in the third country where the non-EU AIF is established, in order to ensure efficient exchange of information to allow the competent authorities of the AIFM’s home Member State to carry out their duties pursuant to the AIFM Directive
- the third country where the non-EU AIF is established is not listed as a NNCT.
Once again, ESMA is tasked with developing guidelines in relation to such cooperation arrangements.
Subject to the implementing measures described below, Article 37 provides that a non-EU AIFM intending to manage an EU AIF and/or to market an AIF (whether EU or non-EU) managed by it in the EU with a passport will need to meet a number of requirements, including:
- acquiring prior authorisation by the competent authority in the Member State of reference (determined in accordance with Article 37 paragraph 4 which is broadly dependent on the domicile of the AIF(s) concerned or the jurisdiction such AIF(s) is intended to be marketed in)
- complying with the provisions of the AIFM Directive (except the marketing provisions in Chapter VI)
- appointing an EU legal representative to be a point of contact within the EU for regulators and others
- cooperation agreements must exist between the competent authorities of the Member State of reference, the competent authorities of the EU AIF concerned (where applicable) and the supervisory authorities of the third country where the non-EU AIFM is established
- the third country where the non-EU AIFM is established must not be listed as a NNCT
- the third country where the non-EU AIFM is established must have signed an agreement with the Member State of reference which complies with Article 26 of the OECD Model Tax convention and ensures an effective exchange of information in tax matters
- the effective exercise by the regulators of their supervisory functions under the AIFM Directive must not be prevented by the laws of a third country governing the AIFM.
Where a competent authority of another Member State disagrees with the assessment made by the competent authority of the Member State of reference, such disagreement may be referred to ESMA.
Non-EU AIFM/EU AIF
Further to the conditions set out above (and subject to the implementing measures described below), a non-EU AIFM may market shares of an EU AIF it manages to professional investors in the EU with a passport by submitting a notification to the competent authorities of its Member State of reference in respect of each EU AIF it intends to market.
Non-EU AIFM/Non-EU AIF
Subject to the implementing measures described below, a non-EU AIFM may market shares of a non-EU AIF it manages to professional investors in the EU with a passport subject to the triple-lock conditions set out above for an EU AIFM (except that the cooperation agreements must be between the Member State of reference and the third country where the non-EU AIF is established and the OECD tax agreements must be between the third country where the non-EU AIF is established, the Member State of reference and each relevant Member State).
National private placement exemptions
It is important to note that Member States may allow a non-EU AIFM to market an AIF (the AIFM Directive does not specify whether this relates specifically to EU or non-EU AIFs, or both) it manages without a passport to professional investors on their territory only pursuant to Article 42 without full compliance with the AIFM Directive. The non-EU AIFM must, instead, comply with the annual report, disclosure and reporting requirements in respect of each AIF and, where relevant, obligations for AIFMs managing AIFs which acquire control of non-listed companies and issuers. Furthermore, the non-EU AIFM must comply with the following additional requirements:
- appropriate cooperation arrangements for the purposes of systemic risk oversight and in line with international standards are in place between the competent authorities of the Member State where the AIFs are marketed, the competent authorities of the EU AIF concerned (where applicable) and the supervisory authorities of the third country where the non-EU AIFM is established and the supervisory authorities in the third country where a non-EU AIF is established (where applicable), in order to ensure efficient exchange of information to allow the competent authorities of the relevant Member States to carry out their duties according to the AIFM Directive
- the third country where the non-EU AIFM and, where relevant, the non-EU AIF is established is not listed as a NNCT.
Member States may impose stricter rules on an EU AIFM in respect of the marketing of non-EU AIFs and on a non-EU AIFM in respect of the marketing of an AIF (whether EU or non-EU) to investors on their territory without a passport.
The AIFM Directive makes special provision for the implementation of the passport for non-EU AIFMs and non-EU AIFs.
Two years after Member States have implemented the AIFM Directive, ESMA will produce a report on the functioning of the European passport together with the private placement regimes which exist in individual Member States. ESMA will provide advice to the Commission in relation to the implementation of the passport for EU AIFMs marketing non-EU AIFs in the EU and to non-EU AIFMs managing AIFs (whether EU or non-EU) marketed in the EU. If ESMA’s advice is positive, the Commission must produce implementing measures specifying when the passport provisions will come into force. In this scenario, the passport would be available to EU AIFMs marketing non-EU AIFs in the EU and to non-EU AIFMs managing AIFs (whether EU or non-EU) marketed in the EU by approximately 2015, whilst EU AIFMs managing and marketing EU AIFs marketed in the EU will be able to obtain a passport from the initial implementation date of the AIFM Directive in 2013. The existing private placement regime of individual Member States will remain in place throughout this period but may be withdrawn if and when the passport extension is granted. The AIFM Directive also requires ESMA to review the passport regime three years after its implementation by the Commission (ie, approximately 2018).
At that stage, ESMA must advise the Commission in relation to whether or not the national private placement regimes should be removed and the passport regime will become the sole regime applicable in all Member States. This would mean that until 2018 Member States can continue to authorise non-EU AIFMs to operate in their own territory without having to comply fully with the AIFM Directive, but after 2018 compliance will be compulsory.
Furthermore, four years after the ultimate transposition date of the AIFM Directive, the Commission will undertake a review of the AIFM Directive and assess its impact on investors, funds and managers both within and outside the EU and how far the objectives of the AIFM Directive have been achieved and, if necessary, propose appropriate amendments.
Marketing to retail investors 26
Member States may allow an AIFM to market an AIF they manage to retail investors on their territory, irrespective of whether the AIF is marketed on a domestic or cross-border basis or whether they are EU or non-EU AIFs. In such cases, Member States may impose stricter regulatory requirements on the AIFM or AIF than the requirements applicable to the AIF marketing to professional investors on their territory. However, they may not impose stricter requirements on EU AIFs established in another Member State and marketed on a cross-border basis than on AIFs marketed domestically.
- Article 43.
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Next steps for the AIFM directive
The AIFM Directive received approval from the EU Parliament on 11 November 2010 and from EU finance ministers on 27 May 2011. The next step is publication in the Official Journal, which is expected imminently. The AIFM Directive will come into force 20 days later, with Member States being required to implement in 2013.
There is still much work to be done during the course of 2011–2012 in relation to the “Level 2”, secondary rules. ESMA is expected to consult in July 2011 on its advice to the Commission on specific areas covered by Level 2.
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