Alternative Investment Management Association Representing the global hedge fund industry
22 July 2013 marks the "go-live" date of the Alternative Investment Fund Managers Directive (AIFMD) in the EU Member States, Iceland, Liechtenstein and Norway.
Despite being only weeks away, it is by no means certain that the 22 July deadline will be met in all Member States. Here we consider the key issues for non-EU managers and the significant uncertainties they face, as they grapple with AIFMD implementation.
Issue 1: How will I market to EU investors after July 2013?
Non-EU managers need to consider how the AIFMD impacts marketing to EU investors. The AIFMD introduces an EU-wide passport for marketing to professional investors. However, this will only be available to non-EU managers after 22 July 2015 at the earliest (and likely several months later).
Some third country managers might consider changing their operating structures to take advantage of the passport from July 2013, but this is unlikely to achieve the desired result, as the passport will only be available before 22 July 2015 to fully on-shored structures, meaning that both the AIFM and AIF must be EU domiciled. Therefore Asian or US fund managers cannot "go Europe halfway" by setting up an EU subsidiary qualifying as AIFM (or "renting-in" a third party AIFM).
Delegation is also a thorny issue: in delegating investment management services from the EU affiliate back to the fund manager's home office, careful consideration should be given to the AIFMD's letterbox provisions.
Most non-EU fund managers of alternative investment funds (e.g. hedge funds) will therefore continue marketing in the EU under the national private placement regimes until 2015 or even 2018. Only where there is a compelling commercial argument for "going fully European", or where individual Member States withdraw national private placement regimes, will non-EU managers consider taking on the burden of full AIFMD compliance ahead of those milestones.
Issue 2: What must I consider when marketing without a passport using private placement?
Non-EU managers must comply with the minimum requirements of Article 42 of the AIFMD in order to market to EU investors using national private placement regimes.
Article 42 requires:
· Co-operation arrangements to be in place between the competent authorities of the Member States where the AIFs are marketed and the competent authorities of the non-EU AIFM/AIF; and
· The "third country" in which the AIFM or the AIF is established must not be listed as a Non-Co-operative Country or Territory by the Financial Action Task Force (FATF).
The market has expressed concern as to the (apparent lack of) progress made by third countries and Member States in adopting the standard form co-operation arrangement proposed by ESMA. To date, only the regulators of Switzerland and Brazil have agreed the terms of the arrangement with ESMA (although we understand that they have not yet been signed), while discussions with the other main fund jurisdictions are in progress – some having advanced further than others. The absence of such arrangements by 22 July 2013 could effectively bring marketing into some Member States to a complete stand-still. Non-EU managers will therefore need to monitor closely the progress on co-operation arrangements over the coming months.
Non-EU managers will have additional compliance requirements after July 2013 as Article 42 triggers certain transparency requirements:
· Publication of annual reports for the AIFs concerned, including disclosure of employee remuneration;
· Pre-investment disclosure of certain information to investors, e.g. with regard to fees, preferential treatment and (sub)custody structure; and
· Reporting to national regulators on liquidity, risk management arrangements and leverage.
Non-EU managers need to determine exactly what the transparency/reporting requirements are in the Member States in which their investors are located; for example, will the forms set out in the AIFMD Regulations be adopted "as is" or will Member States go further? Currently this is difficult, given that it is not certain, across most of the EU, exactly what the reporting requirements are as in most cases implementing legislation has not been passed; in some cases (e.g. Belgium and Italy) even draft legislation has not been made publicly available. An additional complication is that many third country managers have their own reporting regimes e.g. form PF in the US and complying with the EU requirements (which has to be done on a Member State by Member State basis) potentially creates a huge compliance burden, particularly if existing systems and operational infrastructure needs to be reconfigured.
Uncertainty around private placement
The AIFMD gives individual Member States the discretion to impose stricter requirements than those set out in Article 42. In addition, some Member States may interpret Article 42 as being optional, imposing instead their own marketing restrictions. Currently, as Member States proceed with transposing the AIFMD into national laws, we are in a period of flux. National private placement regimes are patchy and Member States may take a more conservative stance in anticipation of the full roll-out of the EU passport (e.g. with regard to reverse solicitation and capital introduction models). Germany, for example, intends to impose additional requirements with regard to depositaries.
Consequently, non-EU managers intending to use the private placement route should, before marketing, check the private placement regimes where the investors are located. In particular, if marketing into Germany, a non-EU manager will need to ascertain whether their existing depositary arrangements are sufficient.
Uncertainty around grace periods
As transposition progresses, the scope and application of the grace period under Article 61(1) of the AIFMD is uncertain as Member States appear to be taking diverging views. Some Member States, (e.g. the UK, according the UK Treasury Q&A issued on 1 May 2013), may extend the 12-month grace period to non-EU managers, which could effectively allow marketing in those EU jurisdictions based on private placement regimes until 21 July 2014, without encountering the above compliance hurdles.
Clarification of a Member State's interpretation of grace periods should therefore be factored in to any marketing due-diligence at the outset.
Issue 3 – How do I plan ahead?
With so much uncertainty surrounding key issues, non-EU managers have plenty to consider in the run up to July 2013 and beyond. Going forward, however, non-EU managers need to start thinking about full compliance with the AIFMD and identifying their gateways to the EU. Major UCITS centres and European fund distribution hubs will likely come out on top because of their wide regulatory co-operation network, tested resources and the vast expertise that is available to on-shoring managers amongst long-established market participants.
Full AIFMD compliance triggers a number of further requirements: identification of a Member State of reference; the appointment of a legal representative in the Member State, and the existence of an OECD model tax agreement between the supervisory authorities of the AIF's Member State of reference and any other Member State in which the AIF is marketed.
It will also raise other significant considerations, likely to stimulate considerable debate, including on:
· Remuneration – in relation to the sustainability of carried interest schemes and the payment and deferral of bonus payments;
· Depositaries – with regard to strict liability (and the contractual discharge and/or additional cost thereof) and the role of prime brokers; and
· Risk management – in respect of splitting out portfolio and risk management functions and the introduction of due diligence procedures.
Finally, although it is undoubtedly the case that the AIFMD imposes more regulation on the alternative fund sector than has so far been the case, stricter regulation does not always have to be an obstacle to boosting investor appetite. This is illustrated by the recent Swiss experience where there has been a clear pick-up of hedge fund launches since the beginning of 2013, notwithstanding the tightening of applicable regulation. Indeed, tighter rules may actually attract investors that had previously been precluded from investing in alternative investment funds by increasing protection.
There are a number of significant obstacles to overcome in the next few weeks as we move towards implementation of the AIFMD. As has been shown, there is considerable uncertainty in a number of key areas which will need to be resolved as the market strives for an orderly implementation of the AIFMD.
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