The Financial Services Authority (FSA) issued a discussion paper on the implementation of the Alternative Investment Fund Managers Directive (AIFMD) in January 2012. The paper serves as an initial discussion platform between the FSA and stakeholders, and sets out a number of questions seeking the views of the fund management industry as to how best to approach the implementation of the AIFMD.
We set out below a summary of the principal issues affecting third country fund managers seeking to market funds within the European Union. This alert does not discuss the issues affecting UK-based fund managers, which will be the subject of separate communications.
Marketing by non-EU fund managers
For a transition period following the implementation of the AIFMD in July 2013, the marketing of any type of pooled investment fund (other than UCITS funds) sold to investors in the EU with aggregate assets under management in excess of €100 million (or €500 million for unleveraged funds where investors are subject to a five year lock-in period) (AIFs) by non-EU fund managers will, at the discretion of the relevant national regulatory authorities and subject to compliance with certain conditions, be permitted to continue under the existing national regimes (i.e. under the existing “private placement” rules).
The AIFMD provides for a staggered approach such that an EU “passport” for non-EU AIFMs could be introduced some two years after AIFMD comes into force. EU member states may, if desired, retain in place their national private placement regimes for a period of at least three years following the introduction of the EU “passport” for non-EU AIFMs.
In the UK, it is likely that the marketing of AIFs by fund managers based outside the EU (non-EU AIFM) to professional investors will continue to be permitted under the existing private placement regime until July 2018, subject to compliance with the minimum requirements specified in the AIFMD.
A non-EU AIFM is required to notify the FSA (or its successors) of its intention to market a fund in the UK and comply with the transparency requirements in the AIFMD (see discussion below). In addition to the requirement that the jurisdiction in which the non-EU AIFM (or any non-EU AIF it markets) is established must not be listed as a “Non-Cooperative Country and Territory” by the Financial Action Task Force (FATF), there must also be in place supervisory cooperation arrangements between the regulators of the non-EU jurisdiction of the non-EU AIFM and the FSA (or its successors).
The UK regulators will need to consider how most appropriately to integrate into the current regulatory and legislative framework those requirements in the AIFMD which apply to the marketing of non-EU AIFs to UK professional investors. This will likely result in a number of consequential changes to existing legislation, e.g. the financial promotions regime. Additionally, the UK regulators will need to consider how non-EU AIFMs can prove their compliance with the minimum requirements in the AIFMD — the transparency requirements in particular.
The FSA’s discussion paper seeks industry views as to the best way of ensuring and proving compliance, particularly as regards the reporting obligations of non-EU AIFMs marketing AIFs in the UK. As there is no existing process for this, the FSA is open to suggestions as to how to address these issues in practice.
The discussion paper also proposes the creation of a register or list for those non-EU AIFMs who have submitted a notification of intention to market an AIF in the UK under the national private placement regime, and the FSA is requesting industry views regarding the proposal.
Non-EU AIFMs will be required to disclose material information relating to each AIF they market in the EU, including information about the investment strategy and objective, restrictions on leverage, incorporation details, information about liquidity risk management, and valuation basis, etc. Much of the information is already disclosed to prospective investors as market practice. However, the AIFMD may require the disclosure of additional information, which is currently not, or less frequently, disclosed. In any event, non-EU AIFMs will be required to undertake a certain degree of due diligence to ensure that the required disclosures are made (and may be required to make confirmations of the same to the FSA or its successors). A summary of certain additional transparency requirements is set out below.
Disclosure of preferential treatment
Non-EU AIFMs will be required to disclose how they will ensure the fair treatment of all investors in relation to each AIF marketed in the EU. Non-EU AIFMs must also identify the type of investors who obtain preferential treatment and, where this is relevant, the investors’ economic or legal links to it or the AIFs concerned.
This is likely to be relevant in relation to side letter arrangements or other arrangements pursuant to which a fund manager has issued or proposes to issue interests in the AIF under different terms, offering preferential treatment to some investors, e.g. reduced management or performance fees or a waiver of the lock-up or redemption period.
The FSA’s existing fair treatment requirements may be amended depending on the final content of the European Commission’s implementing measures.
Disclosure of liquidity
The Directive includes a number of specific disclosure requirements relating to liquidity management. Non-EU AIFMs will be required periodically to disclose, inter alia, the percentage of assets subject to special arrangements in respect of illiquid assets, and any new arrangements for managing liquidity.
Non-EU AIFMs will be required to notify investors of any material change to the liquidity management arrangements applicable to managed AIFs other than unleveraged, closed-ended AIFs. The new European markets regulator, ESMA, has defined “material change” as any change in information which causes a reasonable investor to reconsider its investment in the relevant AIF.
Non-EU AIFMs are also required to notify investors without delay if any “special arrangements” for managing liquidity for unleveraged, closed-ended AIFs are used, and upon using gates, side pockets or similar special arrangements, or if the manager decides to suspend redemptions.
Risk profile and management
A non-EU AIFM will be required to periodically disclose the current risk profile of each AIF it markets in the EU. This periodic disclosure should include measures to assess any sensitivity in an AIF portfolio against the most relevant risks to which the AIF could potentially be exposed. If the risk limits have been exceeded, the disclosure should also include details of the reasons for the same and any steps taken to remedy the situation. The disclosure obligations will be proportionate to the risk and the characteristics of the AIF, and will vary depending on other factors, including the investment strategy of the AIF. In addition, it is expected that fund managers will be required to ensure that information setting out the main features of the risk management system for the AIF is made available to investors prior to investment, and when material changes occur.
Disclosure relating to AIFM use of leverage
The AIFMD contains specific disclosure requirements applicable to fund managers in respect of AIFs which use leverage. Such specific disclosure obligations include, inter alia, any changes to the maximum level of leverage the fund manager may employ on the AIF’s behalf, any rehypothecation rights granted or guarantees given under the leverage arrangements, and the total amount of leverage employed by the AIF.
Disclosure of remuneration
The AIFMD also introduces new requirements on fund managers for disclosure of remuneration in the annual report of the AIF marketed in the EU. The information must cover the total amount of remuneration in a given financial year, split into fixed and variable remuneration, paid by the fund manager to its staff and other beneficiaries, as well as the carried interest paid by the AIF to the fund manager, if relevant. The annual report must also contain the aggregated amount of remuneration broken down by senior management and material risk-takers (i.e. staff whose actions have a material impact on the risk profile of the fund manager or the AIF).
Additional disclosures to the regulator
Non-EU AIFMs will be required to report regularly to the FSA (or its successor) on the principal markets and instruments in which they trade on behalf of AIFs marketed in the EU, as well as on the principal exposures and concentrations in the relevant AIF portfolios. For each AIF marketed in the EU, the AIFMD provides a list of required information.
Non-EU AIFMs employing leverage on a “substantial basis” in relation to the AIF marketed in the EU must make available to the FSA a variety of information detailing such leverage arrangements. To this end, a non-EU AIFM will have to make an assessment for each AIF it markets in the EU about whether leverage is being employed on a substantial basis. ESMA’s advice issued on 16 November 2011, sets out a non-exhaustive list of criteria that may be used for such assessment, including, inter alia, the nature, scale and complexity of the AIF; the investment strategy; liquidity; and counterparty risk.
Non-EU fund managers intending to market AIFs in the EU will need to consider the extent to which they have in place systems and processes to generate, capture and provide to relevant recipients the information required to be disclosed to investors and reported to competent regulators in the EU in order to satisfy their obligations in relation to the AIFMD’s transparency provisions.
The FSA is expected to issue a consultation paper later in 2012 outlining its proposals for new regulatory rules and requirements as well as proposed amendments to existing laws, regulations and regulatory requirements. The consultation paper will set out in more detail the requirements applicable to non-EU AIFMs wishing to market AIFs in the EU.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:Joseph-Roger
This article was originally published by Bingham McCutchen LLP.