Focus: Proposed EU directive affecting Australian and Asian fund managers
25 March 2010
In brief: Significant amendments to a proposed European Union Directive on Alternative Investment Fund Managers will have a major impact on Australian- and Asian-based funds and fund managers. Partner Robert Clarke (view CV), Senior Associate Marc Kemp and Lawyer Elizabeth Lee report.
- Are any exemptions available?
- Marketing to investors in the European Union
- Transitional provisions
- Next steps
How does it affect you?
- The Directive on Alternative Investment Fund Managers (the directive) applies to the marketing of alternative investment funds (AIFs) in European Union member states by (or on behalf of) alternative investment fund managers (AIFMs) established outside the EU. The directive also extends to AIFs that are internally managed. The directive defines AIF to mean any collective investment undertaking which:
- raises capital from a number of investors, with a view to investing such capital in accordance with a defined investment policy for the benefit of those investors; and
- does not require authorisation under EU Directive 2009/65/EC, which puts in place a regulatory framework for undertakings for collective investments in transferable securities (UCITS). UCITS are open-ended collective investment schemes that invest only in transferable securities or in other liquid financial assets such as financial derivative instruments.
- Australian- and Asian-based funds (including real estate, infrastructure, private equity and hedge funds) that market to investors in the EU and that do not require UCITS authorisation will fall within the ambit of the directive.
Our previous report on the directive looked at the significant regulatory burdens on managers of alternative investment funds (including real estate, utilities, infrastructure, private equity and hedge funds) based outside Europe. Since that report, significant amendments have been made by the Council of the EU to the directive. In this article, we examine the amendments and the impact they will have on Australian- and Asian-based funds and fund managers.
An earlier draft of the directive gave an exemption from the operation of the regulations to:
- AIFMs whose cumulative funds under management do not exceed €100 million; and
- AIFMs whose cumulative funds under management do not exceed €500 million and where the AIFs are not leveraged and where investors are subject to a lock-up period of at least five years.
These exemptions now appear to be available only where the relevant AIFM is established in an EU member state, and only at the option of that member state, which may choose whether to apply the directive to the AIFM.
Accordingly, it now appears that Australian and Asian AIFMs seeking to attract EU investors will not have the benefit of these blanket exemptions, and will need to comply with the directive's terms as they relate to marketing.
What constitutes 'marketing'?
The directive defines 'marketing' broadly to include any direct or indirect offering or placement, at the initiative of the AIFM (or on behalf of the AIFM) of shares or units in an AIF it manages, to investors domiciled in the EU. This definition has been clarified so that it no longer includes an unsolicited approach by a prospective investor. Marketing does, however, include the distribution of an offering document (such as a private placement memorandum) by an agent or dealer on behalf of the manager.
The directive does not detail when an AIFM is required to determine the domicile of the ultimate investors. For example, it is not clear whether marketing to a non-EU domiciled investment sub-manager appointed by, or on behalf of, an EU investor is intended to be caught by the directive.
Marketing to professional investors
Under the directive, an AIFM established outside the EU may only market to 'professional investors' in an EU member state if permitted by that member state, and if appropriate cooperation arrangements are in place between authorities of the member state and the authorities of the home country of the AIFM (for example, in Singapore, the Monetary Authority of Singapore, in Hong Kong, the Securities and Futures Commission and in Australia, the Australian Securities and Investments Commission). It is unclear from the directive what a 'cooperation arrangement' will entail, and this vague and uncertain requirement is a source of unease to certain EU member states. The need for cooperation arrangements may also present significant challenges for AIFMs established in jurisdictions traditionally selected for tax neutrality (such as the British Virgin Islands, Cayman Islands and Mauritius).
What is a 'professional investor'?
A professional investor is an investor that possesses the experience, knowledge and expertise to make its own investment decisions and properly assess the risks that it incurs. To be considered a professional investor under the directive, the investor must comply with specified criteria relating to its activities or financial position. Typical examples of professional investors include investment firms, insurance companies, collective investment schemes, national and regional governments and other regulated financial institutions. An entity that holds net assets of at least €20 million and has net turnover of at least €40 million, for instance, will also be considered a professional investor.
In some circumstances, entities and private individual investors who do not meet the specified criteria may be treated as professional investors upon request. However, AIFMs should not presume these investors possess market knowledge and experience comparable to recognised professional investors and, accordingly, AIFMs must assess the expertise, experience and knowledge of each prospective investor. AIFMs must also follow procedures to ensure that the entity or individual is aware of the consequences of losing the protections afforded to retail investors.
If allowed to market to professional investors in a member state's territory (the investor member state), a non-EU established AIFM must also comply with at least the following requirements:
- The AIFM must, for the relevant AIF, make available to the competent authorities of the investor member state, and to investors (on request) in that investor member state, an audited annual report for each financial year. The annual report must contain a balance sheet, an income and expenditure account for the financial year, a report on the activities of the financial year and details of remuneration (including carried interest) paid by the AIFM.
- The AIFM must disclose specified information to prospective investors before they invest in the AIF, as well as any relevant changes in circumstances. Information to be disclosed includes:
- a description of the investment strategy and objectives of the AIF, the assets that the AIF may invest in and associated risks, investment restrictions and use of leverage;
- the identity of the AIF's service providers and a description of their duties and the investors' corresponding rights;
- a description of the AIF's valuation procedure, pricing methodology for valuing assets and liquidity risk management;
- a description of any preferential treatment given to an investor;
- a description of all fees and expenses that investors will bear; and
- the procedure and conditions for the issue and sale of units or shares.
- The AIFM must regularly report to the authorities of the investor member state on the principal markets and instruments in which it trades on behalf of the AIF it manages. Information to be disclosed includes:
- the percentage of the AIF's assets that are subject to special arrangements arising from their illiquid nature;
- the actual risk profile of the AIF and the risk management tools employed by the AIFM to manage it;
- the main categories of assets in which the AIF has invested;
- the use of short selling, where relevant; and
- the results of stress tests conducted to identify, measure and monitor the risks (including liquidity risk) associated with the investment position of the AIF.
- If an AIF acquires control of a non-listed company (excluding small and medium businesses), the AIFM must comply with notice and disclosure requirements in favour of the company and its shareholders and employees (or employee representatives). For example, the AIFM must provide information to the regulators and investors in the investor member state about the relevant company's debt before and after the change in control.
The investor member state may stipulate requirements in addition to those set out above.
Is marketing to retail investors still possible?
AIFMs may also be allowed to market to retail investors in EU member states that permit this. If the relevant member state permits marketing to retail investors, it may impose stricter requirements on the AIFM or the AIF than the requirements applicable to AIFs marketed solely to professional investors in the relevant member state's territory. A retail investor is defined as an investor who is not a professional investor.
An AIFM established outside the EU and marketing an AIF in an EU member state must adopt all necessary measures to comply with the directive within three years of the date on which the directive comes into force. However, member states may choose not to apply the articles dealing with marketing by a non-EU AIFM to retail or professional investors until the end of the specified grace period (currently five years from the date the directive comes into effect).
The directive remains the subject of vigorous debate and comment, particularly on the rules as they apply to non-EU funds and fund managers, with critics claiming that these provisions unfairly discriminate against non-EU fund managers and may have protectionist consequences.
Assuming it is passed, the directive is anticipated to come into effect in late 2012 or early 2013, with the EU finance ministers due to next discuss the directive in May 2010. We will follow any developments and provide updates following any significant further amendments to the directive.
- Robert ClarkePartner,
Ph: +61 3 9613 8034
- John BeckinsalePartner,
Ph: +61 7 3334 3520
- Mark CerchéPartner,
Ph: +61 3 9613 8872