The directive on alternative investment fund managers ("AIFMs") proposed by the European Parliament (the "EU Directive") continues to create uncertainty and controversy in the alternative investment funds ("AIFs") world. This analysis proposes an outlook of where the European Union ("EU") is at, with respect to the EU Directive as well as the position of fund industry observers and participants in Switzerland.
The approval process of the EU Directive is being postponed because there is no consensus yet between the European Commission (which is the executive of the EU), the Economic Financial Affairs Council ("EU Council") and the European Parliament's Committee for Economic and Monetary Affairs ("EU Parliament"). The debate is focused on the versions proposed by the EU Council and the EU Parliament. The two drafts differ notably on the question of "third country funds".
The draft of the EU Parliament would allow a non-EU fund to be marketed into the EU where the jurisdiction of the fund grants the EU reciprocal access to their market. The approach of the EU Parliament is that EU investors would only be able to invest in a fund that is eligible for a passport under the EU Directive. To be eligible for a passport under the EU Directive, a third country fund would need to demonstrate compliance with international standards on money laundering and to have signed an agreement with all relevant member states relating to tax information sharing. It is unclear how the test of reciprocal access would be assessed and what would need to be shown to demonstrate this to the satisfaction of the EU authorities.
Where the fund and its manager are both outside the EU and such a fund is looking to market to EU investors, the non-EU manager would need to manage its funds in accordance with the requirements of the EU Directive and the local regulator would be required to have agreed with the European Securities and Markets Authority ("ESMA") that the local regulator will effectively act as ESMA's agent in supervising compliance with the directive. This proposal is perceived by some observers as an unrealistic attempt to extend global regulatory co-operation without any form of international agreement on which to base such arrangements.
The draft of the EU Parliament precludes EU investors from seeking to invest at their own initiative in non-EU AIFs unless the conditions set out above in relation to marketing of non-EU AIFs are complied with.
The draft of the EU Council requires that an EU AIFM seeking to market a non-EU fund into the EU complies with most provisions of the EU Directive. There would need to be co-operation agreements between the regulator of the third country jurisdiction and the regulator of the AIFM. AIFMs based outside the EU would be able to distribute their funds into the EU using national private placement regimes provided that the AIFM complies with the reporting and disclosure obligations set out in the EU Directive and provided that there is a cooperation agreement in place between the AIFM's regulator and the regulator in the EU jurisdiction in which the fund will be marketed/distributed.
As we can see, the EU Council and the EU Parliament each take very different approaches to the rules applying to third countries. A compromise was supposed to take place in time for the European Parliament's full plenary vote in July 2010, but unfortunately this did not happen. Therefore the discussions will continue at least until the European Parliament plenary sitting scheduled for 21 September 2010. Observers fear that unless an agreement is reached before September, the proposed EU Directive may go through a second reading, adjourning the process until the beginning of 2011. EU parliamentarians have reportedly argued that a September vote is unlikely.
It is interesting to note that under the EU Directive, the asset management functions of AIFMs cannot be delegated at all to investment managers in third countries. This presents a threat to investment management firms outside the EU, notably in Switzerland. According to observers, EU institutional investors would face massive restrictions in their selection of investment managers and products, and this would be to the detriment of their clients, such as pension funds.
A number of observers suggest that the hedge fund industry might end up in a "Europe Prison" situation, where non-EU based AIFMs will not be able to market their funds in the EU and likewise EU investors will not be able to invest in offshore funds. Because of the many restrictions in the EU Directive, AIFMs may decide to stop marketing their funds to EU investors altogether. Restraining the alternative investment funds sector could also lead to less investment in European firms and make the EU a less attractive place for investors and talent from around the world, therefore reducing the EU's overall competitiveness.
Critics say that the restrictions on funds and managers based outside the EU are problematic since they could trigger protectionist countermeasures from other countries such as the US and Switzerland. These critics believe that the EU Directive contradicts the conclusions from the April 2009 G20 summit, which instructed world leaders to promote global trade and investment and reject protectionism. According to the Swiss Fund Association ("SFA"), material improvements must be made to the proposal for the EU Directive to ensure that countries such as Switzerland are not discriminated against with protectionist measures and that the European institutional investors are not massively restricted in their selection of asset managers and products. The SFA chief executive officer stated that the SFA supports the efforts to ensure that Switzerland has access to the market for collective investments but if this is not the case, "Switzerland's financial sector - which plays an important role especially with regard to hedge funds, private equity, real estate funds and fund for qualified investors – is in danger of being left by the wayside".
EU AIFMs seeking to maintain a competitive return might choose to leave the EU or open an additional office outside the EU in a more lightly regulated jurisdiction. In that occurrence, no doubt Switzerland would become a favoured jurisdiction for EU based AIFMs to relocate within the proximity of Europe. One can ascertain that there are numerous advantages offered by Switzerland that rival jurisdictions cannot offer: a very good reputation globally as a business and banking centre; lower taxes, especially in lower tax cantons; very good infrastructure; and legal, political and economical stability with an independent and secure currency. Switzerland is neither a member state of the EU nor of the European Economic Area (EEA), but a member of the European Free Trade Association (EFTA) and the Organisation for Economic Co-Operation and Development (OECD). This renders Switzerland the autonomy to regulate its financial services industry as it deems appropriate. Switzerland is one of the world's leading financial centres, supervised since 2009 by the FINMA (the Financial Market Supervisory Authority), incorporating the former banking, insurance and anti-money laundering authorities. It appears that more and more finance firms such as AIFMs are moving to Switzerland. The Geneva Economic Development Office estimated recently that thirty to forty funds have arrived in Switzerland in the last year, up on the twelve to twenty-four the previous two years. These include subsidiaries of London-based hedge fund giants Brevan Howard Asset Management, Blue Crest Capital Management and more recently Moore Capital.
Switzerland could no doubt succeed in gaining EU equivalence pursuant to the EU Directive mainly because it has sound financial regulation in place. On the other hand, it could well decide not to adhere to the EU Directive and instead promote Switzerland as a domicile for AIFMs who intend to offer their funds to investors outside of the EU. Therefore, we could face a situation where AIFMs already established in the UK would keep their London headquarters for EU investors but would open an office in Switzerland to deal with the non-EU investors from the rest of the world. This situation could turn in favour of Switzerland. In this case, the relationship between the off-shore fund jurisdiction (such as the Cayman Islands) and the Swiss based AIFM would remain unchanged.
Until the trialogue between the European Commission, the EU Council and the EU Parliament is concluded and until the EU Directive is approved, uncertainty prevails for AIFMs and it is pre-mature for them to make decisions on the EU Directive. The most sensible option for AIFMs under the circumstances is therefore to monitor the development of the EU Directive and to conduct business as usual with respect to the set-up of AIFs and their domiciles.
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