The EU directive on alternative investment fund managers (AIFMD) came into force on 21 July 2011. This means that each EU Member State is now required to transpose the AIFMD into national law by 22 July 2013.
The AIFMD lays down rules for the authorisation, ongoing operation and transparency of managers of alternative investment funds (AIFs). The AIFMD will apply to a non-EU fund manager if it is (a) managing or marketing one or more AIFs established in the European Union to investors in the European Union; or (b) marketing one or more AIFs established outside the European Union (a non-EU AIF) to investors in the European Union.1
This briefing considers the impact of the AIFMD on a non-EU fund manager that is marketing one or more non-EU AIFs to investors in the European Union (a non-EU Manager) and the issues that may affect its operations and marketing activities.
Overview of the AIFMD
The scope of the AIFMD is extremely wide. The AIFMD applies to any legal person appointed by or on behalf of the AIF whose regular business is managing one or more AIFs. For these purposes, "managing" an AIF means providing risk management [or]2 portfolio management services to the AIF. Firms which provide portfolio or risk management services will therefore have to consider whether they are really appointed "by or on behalf" of the AIF or whether they are only a delegate of the person so appointed.
An AIF is defined as any collective investment undertaking (which is not an undertaking for collective investment in transferable securities (a UCITS)) which raises capital from investors with a view to investing that capital in accordance with a defined investment policy. Such a fund will be an AIF regardless of whether it is open or closed-ended and whatever its legal structure (including limited partnerships, limited liability partnerships and limited liability corporations).
As a result, nearly all funds3 will be caught by the AIFMD unless a specific exemption applies.
There are a number of key exemptions to the scope of the AIFMD. In summary, the AIFMD will not apply to managers of:
- one or more AIFs whose only investors are companies within the same group as the manager (provided that none of these investors itself is an AIF)
- "small" AIFs with aggregate total assets of (a) less than €100 million; or (b) less than €500 million, subject to the AIF not having any debt and not having redemption rights during a period of 5 years following the date of initial investment in the AIF4
- securitisation special purpose vehicles (SPVs).
For real estate fund managers, it is also worth noting that the only typical real estate ownership structures which are entirely outside the scope of the AIFMD are joint ventures and co-management arrangements for a particular asset where each of the investors co-owns directly the asset under management (as there will be no AIF).
What should I do if I'm within the scope of the AIFMD?
What happens if I'm managing a closed-ended non-EU AIF in run-off or with a limited life?
The AIFMD will not apply if a non-EU Manager is managing a closed-ended non-EU AIF which either:
- is not making any investments after 22 July 2013 or
- will be wound-up under its constitution no later than 22 July 2016 (provided that the fund's subscription periods closed prior to 21 July 2011).5
What happens from now until the date of transposition of the AIFMD into national law?
The AIFMD will only apply to a non-EU Manager that is carrying on marketing activities in a EU Member State that has transposed the AIFMD into national law (the long-stop date for each EU Member State to make this transposition is 22 July 2013).
As a result, until such transposition takes effect in the EU Member State in question, a non-EU Manager would continue to be able to market the non-EU AIF to professional investors in that EU Member State by using the existing private placement regime in that EU Member State.
What happens after the date of national transposition?
Until the passporting system is extended to non-EU fund managers (which is expected to be after September 2015), any marketing that takes place in a EU Member State after the date of national transposition of the AIFMD will need to be carried out in accordance with the AIFMD.
This means that in order for a non-EU Manager to continue to take advantage of the private placement regime in a EU Member State, the non-EU Manager must comply with a minimum of three conditions.
Disclosure: The first condition is that the non-EU Manager must comply with certain of the disclosure and transparency provisions in the AIFMD, these being in relation to:
- making available an annual report for each non-EU AIF which it markets in the European Union6 (the annual report is required to contain, amongst other things, disclosures in relation to the remuneration and management fees paid by the non-EU Manager to its staff (which would include disclosure of the total amount of carried interest payments made))
- making available to investors certain information before they invest, as well as notifying them of any material changes in that information (for example, information on all fees, charges and expenses directly or indirectly borne by investors (as well as the maximum amounts thereof) and details of any preferential treatment provided to an investor)
- regular reporting by the non-EU Manager to the competent authorities in the EU Member State where the AIF is marketed (for example, reporting in relation to the percentage of the non-EU AIF's assets which are subject to special arrangements arising from their illiquid nature and also reporting in relation to the main categories of assets in which the non-EU AIF invests)
- where a non-EU AIF acquires "control"7 (individually or jointly) of an unlisted or listed EU company, the non-EU Manager must make a number of disclosures to that company, its shareholders and to regulators (NB: the AIFMD does include a general exemption from such requirements with regard to the acquisition of SPVs purchasing, holding or administrating real estate). In addition, where a non-EU AIF has acquired control of an unlisted EU company, it may not (for the two years after acquiring control) facilitate any share buy-back, distribution, capital reduction or share redemption unless a specific exemption applies.
Co-operation: The second condition is that appropriate information exchange agreements8 must be in place between (a) the competent authorities in each EU Member State where the non-EU AIF is to be marketed; (b) the supervisory authority of the domicile of the non-EU AIF; and (c) the supervisory authority of the country where the non-EU Manager is established. This is to ensure that information on the non-EU AIF and its manager can be exchanged efficiently to allow the competent authorities of the relevant EU Member States to carry out their supervisory duties effectively under the AIFMD.9
FATF: The third condition is that at the time of marketing neither the non-EU AIF nor the non-EU Manager should be authorised or registered in a country which is listed by the Financial Action Task Force (FATF) on anti-money laundering and terrorist financing as a "Non-cooperative Country and Territory".10
If any of these "minimum" conditions are not satisfied after the date of national transposition, then a non-EU Manager cannot continue to market to, and therefore raise capital from, investors in the European Union.
In addition, non-EU Managers should also be aware that EU Member States have discretion under the AIFMD to impose stricter conditions on non-EU fund managers. As a result, the three conditions referred to above may not be exhaustive.
How long will the AIFMD private placement regime last?
The AIFMD private placement regime is expected to be in place until at least 2018 when the European Security and Markets Authority (ESMA) is expected to report on whether this regime should remain a route available to access investors in the European Union.
However, if ESMA recommends that the AIFMD private placement regime should be abolished, then the passporting system (described below) would become the only route available for a non-EU Manager to access investors in the European Union.
How will the passporting system affect me?
The passporting system under the AIFMD currently allows only EU fund managers to market AIFs established in the European Union to professional investors across the European Union (subject to certain conditions being satisfied). If ESMA reports favourably on the functioning of this passporting system (the report is expected during September 2015), it may be extended to allow non-EU fund managers to passport their non-EU AIFs throughout the European Union.
If the passporting system is extended to non-EU Managers and a non-EU Manager decides to take advantage of it, the non-EU Manager will first need to obtain authorisation under the AIFMD from the regulatory authorities in its "Member State of Reference."
A non-EU Manager seeking such authorisation would be expected to comply in full with all the provisions of the AIFMD. This would mean having to comply with strict provisions in relation to the use of liquidity, limits on leverage, use of depositaries, delegation to service providers, valuation of assets, minimum capital requirements, remuneration policies and practices, use of risk management systems and more general reporting obligations.11 For many non-EU managers of private equity funds and hedge funds, the requirements under the AIFMD would also mean that their existing custodian and prime brokerage relationships would need to be restructured in order to comply with the AIFMD (although this should not really be an issue for many real estate fund managers).12
A non-EU Manager would also need to comply with the second and third conditions referred to above (ie, Co-operation and FATF), as well as a new additional condition. This additional condition provides that a tax information exchange agreement must be in place between (a) the EU "Member State of Reference" for the non-EU Manager13; (b) the non-EU country in which the non-EU AIF is domiciled; and (c) the non-EU country in which the non-EU Manager is established. This tax information exchange agreement must also fully comply with Article 26 of the OECD Model Tax Convention.14
If, however, a non-EU Manager decided that authorisation would be prohibitively costly or burdensome, then it could continue to use the AIFMD private placement regime until at least 2018.
Should the manager be re-domiciled?
If the European Union is a key source of capital for a non-EU AIF, then in some certain circumstances it may be sensible for the non-EU Manager to consider re-domiciling the managing entity either into another non-EU country or the European Union.
In the context of the AIFMD private placement regime, the non-EU Manager should consider re-domiciling if either:
- the necessary information exchange agreements referred to above are not entered into by the relevant entities or
- the non-EU country in which the non-EU AIF or the non-EU Manager is domiciled is listed by FATF as a "Non-cooperative Country and Territory"15.
In the context of the passporting system, the non-EU Manager should consider re-domiciling if either:
- the tax information exchange agreement referred to above is not fully compliant with Article 26 of the OECD Model Tax Convention16 or
- there is no tax information exchange agreement in place with the non-EU country in which the non-EU AIF is domiciled.
Save in relation to the above circumstances, there would be no specific advantage or benefit in re-domiciling a non-EU managing entity.
Does the AIFMD affect "reverse solicitation"?
"Reverse solicitation" or "passive marketing" (ie, marketing which is not at the direct or indirect initiative of the non-EU fund manager) continues to be permitted under the AIFMD. Investors in the European Union can therefore seek out and contact non-EU fund managers about investing in non-EU AIFs.
As a result, if the non-EU Manager is unable to satisfy the conditions to use either the AIFMD private placement regime or the passporting system, then this may be the only route available for a non-EU Manager to access investors in the European Union.
Should any changes be made to existing fund documentation?
Whether changes should be made to existing fund documentation will depend on whether or not further marketing of the non-EU AIF in the European Union is anticipated.
Using the AIFMD private placement regime
If private placement is anticipated in a Member State which has transposed the AIFMD into national law, then the AIFMD imposes certain transparency and disclosure obligations on the non-EU Manager. Fund documents will therefore need to be amended to ensure that the non-EU Manager is able to obtain all the information that it needs in order to comply with the transparency and disclosure obligations set out in the AIFMD.
Using the passporting system
If a non-EU Manager wants to take advantage of the passporting system (assuming it becomes available to non-EU fund managers), then full compliance with the AIFMD will be required. This would therefore entail a significant review of existing fund documentation, as well as the non-EU Manager's own internal arrangements, in order to ensure (amongst other things) that:
- appropriate remuneration and management fee policies are in place to enable the non-EU Manager to promote effective risk management (for example, the use of guaranteed bonuses is restricted)
- where the non-EU Manager carries out its own valuations in-house, it is able to ensure independence between the valuation and portfolio management functions (for example, appropriate conflict of interest policies would need to be in place)
- the risk management function is adequately separated from the portfolio management function
- the non-EU Manager's liability to a non-EU AIF is not affected by any delegation or sub-delegation
- the non-EU Manager holds initial capital of €125,000 and, where the non- EU Manager's total assets under management exceeds €250 million, the non-EU Manager has its own funds equal to 0.02 per cent of the amount by which the portfolio exceeds €250 million (subject to a cap of €10 million).
What are my next steps?
Even now with the AIFMD in force, we are still very much only at the start of the process, with a number of milestone dates yet to take place. However, at this stage:
- a non-EU Manager should be considering whether it is in fact the manager (as opposed to a delegate) of a non-EU AIF for the purposes of the AIFMD
- if the non-EU Manager concludes that it is the manager of the non-EU AIF, the non-EU Manager will need to consider whether the European Union will be a key ongoing source of capital for the non-EU AIF
- if the European Union is a key ongoing source of capital, then a non-EU Manager must carefully consider what changes may need to be made to its operations and marketing activities in order to comply with the AIFMD private placement regime and the passporting system.
As an ongoing process, it will also be important for the non-EU Manager to follow the progress of the "level 2" implementing measures to assess what further impact these measures could have on the non-EU Manager.17
1 The AIFMD will not apply to a non-EU fund manager managing an AIF established outside the European Union unless the non-EU fund manager is marketing that AIF to investors in the European Union.
2 The text of the AIFMD suggests that a manager needs to perform either portfolio or risk management services. However, it remains to be seen whether the implementing measures to be adopted by EU Member States could change this to refer to the word "and" (ie, a manager would need to perform both portfolio and risk management services).
3 This would include real estate funds, hedge funds, private equity funds, commodity funds, debt funds, energy and carbon funds, infrastructure funds, investment trusts and real estate investment trusts.
4 Certain notification requirements will however apply.
5 A closed-ended non-EU AIF falling within this limb will however also need to comply with certain limited disclosure and transparency provisions in the AIFMD.
6 This must be provided to investors on request and also be made available to the competent authorities in the EU Member State where the non-EU AIF is marketed.
7 For unlisted EU companies, "control" means more than 50 per cent of the voting rights in the unlisted company. For listed EU companies, "control" means as defined in Article 5(3) of the Takeover Directive (which, generally speaking, is usually 30 per cent or more of the voting rights).
8 The agreement could take the form of a Multilateral Memorandum of Understanding (MMoU) based on a template that will be established by ESMA at EU level.
9 ESMA has developed a pro-forma reporting template which lists the relevant information to be communicated by non-EU Managers to competent authorities. This information represents the minimum information which ESMA considers should be exchanged between competent authorities pursuant to co-operation agreements. A copy of the pro-forma template is available on their website at http://esma.europa.eu/popup2.php?id=8059.
10 The list now includes Iran, Bolivia, Cuba and Turkey. However, countries such as the Bahamas, the British Virgin Islands, the Cayman Islands, Grenada, Guernsey, Jersey and Panama are excluded.
11 For more detailed information on all the provisions of the AIFMD, please see the Norton Rose LLP briefing The directive on alternative investment fund managers.
12 For example, multiple prime broker models would need to be restructured so that there is one custodian who then delegates custody to prime brokers.
13 The Member State of reference for a non-EU Manager should be identified by taking into account the Member State in which the non-EU Manager intends to develop effective marketing for most of its non-EU funds.
14 Article 26 creates an obligation to exchange information that is foreseeably relevant to the correct application of the convention as well as for the purposes of the administration and enforcement of domestic tax laws (concerning taxes of every kind and description) of the contracting states.
15 Countries such as the Bahamas, the British Virgin Islands, the Cayman Islands, Grenada, Guernsey, Jersey and Panama are all excluded from this list. This may therefore be unlikely.
16 For example, the agreements which the United Kingdom currently has in place with the British Virgin Islands, the Cayman Islands, Guernsey, Jersey and the United States are generally considered not to fully comply with Article 26.
17 The AIFMD empowers ESMA with a significant number of separate tasks in relation to the implementation of the AIFMD, much of which is intended to be adopted as secondary rule making (known as "level 2") by the European Commission.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.