The delegation model of fund management, whereby self-managed investment vehicles or their management companies appoint third party investment managers and advisers, has been a key basis upon which the success of the funds industry in Ireland has been built. There are currently in excess of 5,000 Irish domiciled funds and sub-funds, with assets in excess of 1 Trillion Euro, which have been established by over 400 fund promoters based in over 50 countries. An incredible 98% of these promoters are based outside Ireland and in most cases investment management services will be provided from the promoter's home jurisdiction, clearly showing the attraction of Irish domiciled vehicles and the delegation model for international fund managers.
The finalised text of the level 2 measures ("Level 2") to the Alternative Investment Fund Managers Directive, (Directive 2011/61/EU) (the "AIFMD"), approved and published by the European Commission (the "Commission") on 19 December, 2012, details the specific conditions to be applicable where investment management functions are to be delegated or sub-delegated under this legislation. This article explores the specific requirements contained in this finalised text relating to delegation and highlights the legal documentation which will be required to ensure compliance.
Background to the AIFMD and the Level 2 Regulation
The European Commission (the "Commission") first published a proposal for a directive regulating alternative investment fund managers ("AIFMs") at a European level in April 2009 in the wake of the global financial crisis. Fundamental aims of this proposed directive were stated to be to assist in securing investor protection and to limit the potential for alternative products to pose a systematic risk to financial systems. Following numerous counter-proposals and amendments, a draft directive was ultimately agreed in October 2010. This directive, which regulates alternative managers, proposed a potential new European "passport" for compliant alternative funds similar to the highly successful one currently afforded to UCITS. Accordingly it is expected to lead to a significant boost for the alternative funds industry within Europe once this becomes operational from mid-2013.
The AIFMD does note in its preamble1 that, depending on their legal form, it should be possible for alternative investment funds falling under the directive ("AIFs") to be either externally or internally managed and that AIFs that do not appoint an external AIFM will themselves constitute the AIFM. AIFs structured as self-managed investment companies, for example, will typically fall into this category. The AIFMD does specifically address the right of AIFMs to delegate their functions, subject to applicable conditions2. However, the AIFMD was prepared as a principle-based framework document under the "Lamfalussy Process" and accordingly, following its implementation, much of the fine detail remained to be determined as "Level 2" measures.
As a result, the European Securities and Markets Authority ("ESMA"), which replaced the Committee of European Securities Regulators ("CESR"), prepared advice in 2011 to assist in finalising the relevant details for the ultimate implementation of relevant aspects of this directive. The Commission then produced draft finalised text in light of this for Level 2 in 2012.
The initial draft wording for the Level 2 measures circulated by the Commission in 2012, disregarded the advice of ESMA in key respects, including in relation to delegation, and raised concerns that this legislation might jeopardise Ireland's position as the leading European domicile for AIFs due to the constraints imposed in this regard. However, the finalised text contained in a regulation approved by the Commission on 19 December 2012 (the "Regulation") clarifies that delegation will continue to be acceptable under this legislation in practice and sets out the relevant applicable requirements in greater detail.
Overview of Delegation under the AIFMD
Delegation of investment management was provided for in the AIFMD itself3 and this general concept is addressed and expanded upon in Section 8 of the Regulation4. This section addresses the topic under a number of headings, including general principles, reasons for the delegation, the nature of the delegate, potential conflicts of interest and the effective supervision of the delegate.
The relevant "General principles" include ensuring that the delegation structure does not allow for the circumvention of the AIFM's responsibilities, obligations or liability (including in relation to its authorisation). Delegation arrangements must be documented in written agreements between the AIFM and the delegate and there are significant requirements relating to the specific contents of such agreements5 including obligations to set out in the agreement:
the respective rights and obligations of the parties, including rights of information, inspection, admittance and access for the AIFM and its instruction and monitoring rights with regard to the delegate in order to ensure effective supervision; terms requiring the delegate to properly supervise the performance of the delegated functions and adequately manage associated risks internally; instruction and termination rights, including a requirement that sub-delegation can take place only with the consent of the AIFM; a requirement on the delegate to disclose to the AIFM any development that may have a material impact on the delegate's ability to carry out the delegated functions effectively and in...