On 11 November 2010 the European Parliament finally approved the Directive on Alternative Investment Fund Managers. The Directive has changed significantly since the European Commission's original proposal of April 2009, not least in the "third country" provisions dealing with the application of the Directive to non-EU alternative investment fund managers (AIFM) and alternative investment funds (AIF).
Key points to note are:
EU Member States have until 2013 to implement the Directive into their local law; from 2013 EU AIFM authorized under the Directive will be able to sell EU AIF on passported basis across the EU to institutional and sophisticated investors. National private placement regimes will be discontinued; non-EU AIFM and non-EU AIF may market/be marketed under Member States' national private placement regimes to institutional and sophisticated investors subject to compliance with national law and certain provisions of the Directive (including provisions relating to co-operation arrangements between Member States and non-EU countries); from 2015 the European Securities and Markets Authority (ESMA) may approve the introduction of a passport regime for non-EU AIFM/non-EU AIF. This will effectively require a non-EU AIFM to be regulated under, and comply with, the entire Directive as if it were an EU AIFM; the national private placement regimes may exist in parallel with this passport regime until at least 2018, at which point ESMA may approve the termination of national private placement regimes; AIFM authorized under the Directive will be subject to an extensive set of obligations, including those relating to: minimum capital requirements; delegation arrangements; disclosure to investors; reporting to Member State regulators; remuneration; the location and standard of liability of depositaries; valuation of AIFs; additional obligations for AIFM of: funds engaged in substantial leverage; private equity AIF (including provisions on "asset stripping"); numerous provisions of the Directive to be elaborated on by more detailed "level 2" rules to be developed by ESMA over the course of 2011. This bulletin summarises the material provisions of the Directive, with a focus on its impact on promoters and managers of alternative investment funds.
The Directive is expected to come into effect in March/ April 2011 and Member States will have until early 2013 to transpose the Directive into national law. The extended timetable for the introduction of the "third country" passports is discussed below under 'EU passport, private placement and "third country" rules'.
In the meantime, a significant amount of "level 2" implementing measures (Level 2 Rules) and "level 3" technical standards and guidelines will be issued to flesh out the detail of the Directive. ESMA will lead the drafting of the Level 2 Rules and is working towards a deadline of September 2011 to produce its advice to the Comission on the Level 2 Rules. In December, ESMA issued a "call for evidence" on these rules. The deadline for replies to this consultation paper was 14 January 2011 and the replies submitted may be found on the ESMA website at: http://www.esma.europa.eu/index.php?page=responses&id=176.
At EU level, the work on the Level 2 Rules has been split into four areas:
general provisions of the Directive, the authorization of, and operating conditions for, alternative investment fund managers; depositary requirements; transparency requirements and leverage; and supervision of AIFM, including "third country" AIFM. The Commission intends to adopt the Level 2 Rules by early 2012, allowing Member States one year to implement any rules which take the form of EU directives. To achieve this deadline, ESMA is requested to provide its advice on the Level 2 Rules by September 2011. Given the range and complexity of issues involved, this is an ambitious timetable. The Commission has acknowledged this by noting that there may be scope for prioritizing some areas over others (e.g., those which will take the form of an EU regulation and therefore do not require further implementation into the local law of a Member State or those which relate to the "third country" passport which is not expected to take effect until 2015).
AIF and AIFM within scope
The Directive's scope is broad: it applies to managers (AIFM) of alternative investment funds (AIF). An AIF is defined as "any collective investment undertaking ...which raises capital from a number of investors, with a view to investing it in accordance with a defined investment policy for the benefit of those investors" and which does not require an authorisation under the UCITS Directive. Therefore, AIF comprise all non-UCITS funds, not just hedge funds commonly considered to be "alternative" funds. Whether or not a particular AIFM is within the scope of the Directive depends on its location and that of the AIF it manages, as well as the countries into which the AIF are marketed.
The Directive applies to:
all EU AIFM, which manage one or more EU or non-EU AIF; all non-EU AIFM, which manage one or more EU AIF; and all non-EU AIFM, which market one or more EU or non-EU AIF in the EU. AIF and AIFM outside of scope
The Directive does not apply to the following:
holding companies; institutions for occupational retirement provision (IORP) covered by EU Directive 2003/41/EC; supranational institutions (e.g., the World Bank, the IMF, the ECB etc.); central banks; governments and institutions which manage funds supporting social security and pension systems; employee participation schemes or employee saving schemes; securitisation special purpose entities; and AIFM insofar as they manage one or more AIF whose only investors are the AIFM or its affiliates, provided that none of those investors itself is an AIF (e.g., true "family offices"). "Registration only" regime for smaller AIFM
The Directive also contains de minimis exemptions based on the level of assets under management. It does not require the authorization of AIFM who, together with any affiliates, manage:
AIF with total assets, including those acquired through the use of leverage, of less than €100 million; or AIF with total assets of less than €500 million, provided that the AIF are unleveraged and are subject to redemption lock-up periods of at least five years. Such AIFM cannot benefit from the passporting rights under the Directive unless they opt-in to the Directive. Therefore, this exemption may be of limited interest to managers with cross-border businesses. It is also important to note that those managers that do not opt-in are still required by the Directive to:
be subject to registration with a national regulator; notify that regulator of the AIF they manage and the investment strategies employed; provide that regulator with periodic information on the main instruments they hold and the principal exposures and concentrations of the AIF; and notify the regulator if they breach the de minimis thresholds. For those managers who, to date, have been entirely unregulated, these additional registration and reporting requirements are significant.
Possibility of AIF being internally managed and not appointing an external AIFM
The AIFM itself can be either an external manager of the AIF or, where the legal form of the AIF permits internal management and the AIF chooses not to appoint an external AIFM, the AIF itself. Ireland already has a regulated hedge fund product, the qualifying investor fund (QIF), many of which are structured as self-managed investment companies. This has particular significance when one considers that an authorized AIFM may delegate the portfolio or risk management function to entities which themselves are not required to be authorized AIFM (see below under "Delegation"). Accordingly, if an internally managed AIF were authorized as an AIFM and were permitted to delegate this function to a US-regulated manager, that manager would not have to be authorized as an AIFM under the Directive. Therefore, the QIF may offer some interesting structures, subject to further clarification in Level 2 Rules as to what level of delegation by internally-managed AIF is permissible. In particular, clear guidance is needed as to when an AIF would be considered to have delegated its functions to the extent that it becomes a "letter-box entity". There is a precedent for self-managed funds in Ireland in the form of UCITS established as self-managed investment companies.
WHAT DOES THE DIRECTIVE MEAN FOR MANAGERS OF AIF?
EU passport, private placement and "third country" rules
The EU passport, private placement and "third country" provisions of the Directive are complex. A summary of those provisions is set out below. A more detailed overview, including details of the cooperation arrangements applicable to non-EU AIFM and non-EU AIF, is contained in the appendix to this bulletin.
EU AIFM of EU and non-EU AIF (e.g., a UK, French or German manager of Irish- and Cayman-domiciled funds)
Passport for EU AIF; national private placement regimes discontinued
From 2013, EU AIFM will be required to be authorized under, and comply in full with, the Directive. The Directive will enable EU AIFM to market EU AIF on a passported basis to "professional investors" (broadly speaking, institutional and sophisticated investors) across the EU. The definition of "marketing" captures both public offerings and private placements, but does not encompass "reverse solicitations" (i.e., where the investment in the AIF is unsolicited and is at the initiative of the investor). From 2013 onwards, national private placement regimes will no longer be available.
National private placement regimes continue for non-EU AIF; possibility of passport
National private placement regimes will continue to apply to the marketing by EU AIFM of non-EU AIF to professional investors in the EU from 2013...