Focus: EU AIFM Directive affecting Australian and Asian fund managers finalised
14 February 2011
In brief: The European Parliament and the Council of Ministers have, after lengthy debate, reached political agreement on the text of a Directive on Alternative Investment Fund Managers, which may ultimately offer non-EU fund managers the ability to access institutional investors in EU markets that were previously off-limits. Partner Robert Clarke , Senior Associate Marc Kemp and Lawyer Lisa Bau report.
- What the Directive covers
- What are the main obligations the Directive imposes on AIF managers?
- How does the final Directive differ from previous drafts?
- How it will affect non-EU AIF managers' ability to market funds in the EU – the opening of new frontiers?
- Timing and next steps
How does it affect you?
- The Directive on Alternative Investment Fund Managers (the Directive) applies to the management and marketing of institutional fund products (described as alternative investment funds (AIFs) in the Directive) by fund managers (AIF managers) established both inside and outside the EU.
- Australian- and Asian-based funds (including real estate, utilities, infrastructure, private equity, hedge funds, and even other financial products not traditionally seen as 'funds') and fund managers that market to EU investors will fall within the Directive's ambit.
- The marketing rules applying under the Directive will operate to regulate the manner in which non-EU managers are able to market to EU investors and, after 2015, may provide non-EU managers with access to institutional investors in EU markets that were previously legally, or practicably, inaccessible, via an EU-wide 'marketing passport'.
- However, changes to the Directive's final text mean that non-EU managers will, subject to compliance with only some parts of the Directive, continue to be able to market to professional investors in the EU, until at least 2018, by way of the current national private placement regimes in place across the EU.
The aim of the Directive (which is now in a final form and, subject to the making of 'Level 2' rules supporting the Directive, is expected to come into force in 2013) is to establish a consistent EU-wide regulatory and supervisory framework for the activities of the managers of institutional investment fund products (ie AIFs) that are managed or marketed in the EU.
The definition of an AIF under the Directive is broad, and is designed to capture any 'collective investment undertaking' (other than 'retail' fund products already regulated by the EU Undertakings for Collective Investments in Transferable Securities (UCITS) Directive) that raises capital from investors with a view to investing that capital according to a defined investment strategy.
Given this broad definition, the Directive is expected to regulate products traditionally seen as institutional fund products, such as hedge funds, private equity funds and real estate funds, but may also apply to other types of financial products that have not traditionally been seen as 'funds' (such as securitisation vehicles in certain circumstances).
Subject to certain exceptions, the Directive will apply to:
- all AIF managers established in the EU (whether they manage AIFs established in the EU or elsewhere); and
- any AIF manager established outside the EU that:
- manages an AIF established in the EU (irrespective of whether the AIF is marketed in the EU or not); or
- markets an AIF (established in the EU or elsewhere) to investors resident in any EU member state.
Set out below is a summary of the main obligations imposed on AIF managers that are subject to the Directive (noting that not all of the following obligations apply to non-EU AIF managers targeting EU investors in all circumstances – see below).
- AIF manager authorisation: AIF managers that are subject to the Directive will be required to be authorised by an appropriate financial services regulatory authority in their 'home member state' of the EU. Currently, this is the case in some, but not all, EU jurisdictions.
- AIF manager capital requirements: All AIF managers will be required to meet certain 'own capital' requirements, with the minimum requirement starting at €125,000 and increasing in line with the size of the AIFs managed.
- Mandatory appointment of depository: In a significant departure from current practice in much of the industry, all AIFs established under the Directive will be required to appoint a 'depository' (ie a custodian) to perform certain functions on the AIF's behalf. The 'depository', which will be subject to strict liability, will be responsible for holding good title to the AIF's assets, as well as other administrative tasks (such as ensuring that the AIF's cash flows are properly monitored; monitoring the issue, redemption and cancellation of the AIF's shares or units; and ensuing that valuations of the AIF's shares or units are undertaken according to the applicable national law).
- Leverage limits: While at this stage the Directive stops short of setting strict maximum leverage limits on AIFs, it does make provision for such limits to be introduced by individual EU member states in the future. Further, the Directive requires that each AIF manager must internally set leverage limits for each AIF it manages (and demonstrate that those limits are reasonable and are complied with) and provide certain reporting to investors for any AIF utilising leverage on a 'substantial basis'.
- Asset stripping: In a move directly aimed at the private equity industry, any AIF that acquires control of a non-listed company will be restricted, for a period of 24 months following the acquisition, from engaging in certain 'asset stripping' activities, including facilitating or voting in favour of a distribution, capital reduction, share redemption and/or acquisition of shares by the company occurring.
- Disclosure and transparency: Each AIF manager must comply with certain minimum reporting and transparency requirements, including providing potential investors with information regarding the investment strategy and objectives of the AIF, the identity of the AIF manager and depository, the latest annual report, the historical performance of the AIF, and certain other prescribed information. In addition, an AIF manager must make an annual report available to its investors upon request.
- Conduct of business: An AIF manager must ensure that it acts honestly, and with due skill, care and diligence, and complies with certain other 'conduct of business requirements' (including that it acts in the best interest of the AIF or the investors, takes all reasonable steps to avoid conflicts of interest, complies with all relevant regulatory requirements and treats all AIF investors fairly).
- Remuneration rules: AIF managers must have remuneration policies and practices in place in relation to senior management, and any other person whose professional activities materially impact the risk profile of the AIFs they manage, which promote effective risk management and discourage risk taking.
Previous drafts of the Directive received much criticism from industry participants. Fortunately, the final text has addressed many of the key controversies surrounding the depository and valuation requirements and the 'third country marketing' rules.
In particular, and while the changes to the previous drafts of the Directive are too numerous to detail in this article, the most significant change so far as non-EU fund managers are concerned is the introduction of the new marketing 'passport regime', which is discussed in detail below – the regime potentially represents a significant development for non-EU AIF managers, as it establishes a true EU-wide marketing regime for non-retail fund products for the first time. This is particularly helpful in light of the current disjointed nature of the national 'private placement' regimes that managers seeking EU capital are required to navigate.
How it will affect non-EU AIF managers' ability to market funds in the EU – the opening of new frontiers?
As noted above, the Directive is only relevant to those non-EU fund managers who intend to manage an AIF that is established within the EU or who otherwise seek to market an AIF (whether established in the EU or otherwise) to EU investors.
In particular, the key element of the Directive that will apply in those circumstances is the rules specifying when an AIF (whether established in the EU or elsewhere) can be marketed to EU-domiciled investors. Specifically, those rules provide non-EU AIF managers with two alternate marketing routes:
- Continued application of private placement rules (to, at least, 2018): The current national 'private placement regimes' governing the circumstances in which institutional funds may be offered to investors in each jurisdiction will, at least for now, remain in place upon the commencement of the Directive around 2013 (which is contrary to what was originally proposed). However, from the Directive's commencement, the private placement regimes, which differ greatly from jurisdiction to jurisdiction, will only continue to be available to a non-EU AIF manager where:
- the manager complies with the transparency, asset stripping and disclosure requirements of the Directive (but not the more onerous provisions of the Directive, including the authorisation and depository requirements); and
- there is a 'co-operation agreement' in place between the relevant regulator in the relevant EU member state and the home regulator of the non-EU manager. It is possible that these private placement regimes will be phased out in 2018 following a review of the Directive.
- New marketing passport regime available from 2015: In addition, the amended Directive introduces a 'marketing passport' under which an AIF manager that is authorised in one EU member state will be able to market an AIF to professional investors in other member states without additional authorisation or registration requirements. However, non-EU AIF managers will not be eligible to utilise the marketing passport regime until two years after the Directive commences (subject to approval of the European Securities and Markets Authority (ESMA)). To qualify for the benefit of a marketing passport, the non-EU AIF manager will be required to comply with all the requirements of the Directive, including the authorisations requirements (although it is not yet clear how these requirements will apply in practice where the manager is already authorised in a non-EU jurisdiction) and the depository requirements. Further, as for the application of the private placement regimes, there must be a 'co-operation agreement' in place between the relevant regulators in the relevant EU member state and the home regulator of the non-EU manager.
We view the potential application of the marketing passport regime to non-EU managers as a significant opportunity for those managers (and, indeed, for EU-based managers), as it will avoid the need for managers to expend considerable time and expense in complying with disjointed, complicated and often contradictory national private placement regimes (and, in some cases, will provide managers with an ability to market to institutional investors that were previously off-limits under the national regimes).
However, non-EU managers' practical ability to obtain a marketing passport is not yet entirely clear, as there are at least two further hurdles to be cleared over the next few years if Australian and Asian fund managers are to realise the potential benefits of the marketing passport.
In particular, the need for 'co-operation agreements' to be in place between Australian and Asian financial services regulators and relevant EU member state regulators by 2015 may, in practice, delay (or, in some cases, even deny) the ability of non-EU managers in those jurisdictions to utilise the marketing passport system. Further, the form of the 'Level 2' rules (which sit below the high-level Directive text and will provide much of the crucial detail missing from the Directive), once drafted, may well throw up further unexpected challenges for non-EU managers.
Official publication of the final Directive is expected early this year. Following formal adoption of the final text of the Directive, the European Commission and ESMA will be involved in the 'Level 2' secondary-rule-making process, focusing on the formulation of binding legislation and providing greater certainty around some of the concepts set out in the Directive. It is expected that this process will be undertaken during the course of 2011-2012, with each member state transposing the Directive into their national laws in early 2013. The Directive will also be subject to review in relation to its application and scope in 2017.
We will continue to monitor the development of the Directive and the Level 2 rule-making process.
- Mark CerchéConsultant,
Ph: +61 3 9613 8872
- John BeckinsalePartner,
Ph: +61 7 3334 3520