22 July 2013 was the 'deadline' for the European Union (EU) and the European Economic Area (EEA) Member States to transpose the Alternative Investment Fund Managers Directive (AIFMD) into national law.
A survey from the Alternative Investment Managers Association (AIMA) and EY published soon afterwards showed that 12 out of 31 countries had completed full legislative transposition within the deadline. However, AIFMD does allow Member States some discretion to provide a transitional period to allow the market to adjust to the Directive. Countries such as Spain, Portugal and Belgium are either only in the very early stages of drafting or have not finalised their required domestic legislation at the time of writing.
Indeed, even where the Directive is in force, it remains to be seen how Member States will interpret many of its provisions, including those relating to outsourcing. In the meantime, the investment community continues to use 'third countries' (i.e. jurisdictions not in the EU/EEA), such as Guernsey, for the management, administration and custody of funds targeted at EU and/or non-EU investors. Many investment houses are examining the structuring arrangements for their funds and especially the location of the management entity (EU Vs non-EU) and therefore, the implications for its administration (in-house Vs third-party) and depositary requirements (established custodian Vs 'one-stop shop'). No clear pattern has emerged as yet, but the next 12 to 18 months will prove pivotal in the Directive's implementation, especially as Member States each develop their own interpretations of its many provisions.
Management: EU Vs non-EU
AIFMD seeks to regulate EU-based Alternative Investment Fund Managers (AIFMs), managers of EU established Alternative Investment Funds (AIFs) and managers that market AIFs into the EU. So, in essence, if either the manager or the fund has a relationship with the EU then the Directive comes into play.
However, the exact requirements under AIFMD are dependent on the structuring arrangements. For example, non-EU AIFMs may market funds into the EU/EEA through the continuing National Private Placement (NPP) regimes. This is subject to the third country location of the manager having the necessary agreements with the EU/EEA Member States where the fund will be marketed. Guernsey issued its marketing rules in June, together with a notification form, to allow continued access to European markets post 22 July.
In a July 2012 report from Deloitte 61% of managers claimed that AIFMD would affect their choice of domicile, with the majority of these managers looking to continue establishing funds outside the EU.2 A June 2013 survey of European asset managers by fund software provider Multifonds showed 77% of respondents were considering establishing funds for non-EU investors 'offshore' to put them outside the scope of the Directive. However, this can only be achieved if there is sufficient substance in the jurisdiction to demonstrate that not just the fund but also the manager can be genuinely considered to be based outside the EU. This would also apply to managers of AIFs for EU investors who are looking to avail of the continuing NPP regimes. One option might be for a non-EU AIF to opt to be self-managed and therefore a non-EU AIFM but this will be subject to proving sufficient substance to the arrangements.
Administration: In-house Vs third-party
So called 'letter box' entities cannot claim to be managers and substance will be required where a manger is claiming to be domiciled. Similarly, the extent to which activities such as portfolio and risk management can be outsourced must be considered and care must be taken to ensure that the real decision making powers lie with the entity that is claiming to be the manager. This might, in certain circumstances, encourage investment houses to build their presence offshore and take back in-house some of the previously outsourced_functions. Guernsey has a huge advantage as a fund domicile in the existing standards regarding oversight and due to the substance already present in existing Guernsey domiciled structures. Guernsey already plays host to major managers, such as Apax, BC Partners, Man Group, Mid Europa, Permira and Terra Firma which all have offices and staff in the Island.
There are also fund administrators, ranging from major international names to boutique, independent operations, coupled with a significant pool of qualified Non-Executive Directors. Yet, there is a potential tension between the need for robust substance in third country arrangements (with the associated implications of possibly moving functions in-house) and capacity for investment houses to be able to deal with the increased requirements from AIFMD and other regulatory initiatives.
An April 2012 report from EY noted that leading hedge fund managers have evolved in response to calls from institutional investors to develop more sophisticated operating practices along the lines of those used by asset managers for mutual funds. The report adds that the private equity sector is facing investor sentiment which means it needs to continue developing and evolving its operating model not just to "keep pace with the rest of the asset management industry" but increasingly as "a prerequisite for attracting capital."4 Such is the industry concern about its ability to cope with the increased requirements of AIFMD that in a July 2013 survey from KNEIP, 77% of AIFMs are either considering outsourcing, or have already outsourced, their reporting functions to a third party. Reporting requirements were the primary concern to 40% of AIFMs, with 30% most concerned about risk management, followed by third-party supervision (18%) and staffing of the management company (12%).
Guernsey's advantage is that it has the infrastructure, such as fund administrators, which can not only provide support to inhouse teams but also can provide third-party services. Quality of service is evidenced by the fact that Guernsey providers now not only administer or manage assets of Guernsey open and closed ended funds but also more than £100 billion worth of assets from open-ended funds which are domiciled in other jurisdictions, typically the Cayman Islands, where there are local substance challenges.
Depositary: Established custodian Vs 'one-stop shop'
Deloitte's July 2012 report shows that managers are highly concerned about delegation under AIFMD but they are more concerned about the implications regarding depositary functions.7 AIFMD not only requires depositaries to provide extra oversight to structures but it also introduces the concept of a depositary for the first time for many asset classes, such as private equity and real estate.
Unlike many competitor jurisdictions, Guernsey already has well-established custody providers. They provide dealing and settlement and also offer services over and above traditional custody services to encompass robust support for corporate governance, often performing a fiduciary role. Much of Guernsey's core business of closed-ended private equity and real estate funds will be able to access AIFMD's lighter touch regime for non-financial assets that permits a wider range of entities, such as lawyers and registrars, to carry out custody functions, thus benefitting from cost and operational advantages of not requiring a formal custodian.
We are seeing some Guernsey based administrators setting up depositary functions. They are targeted at the likes of private equity and real estate clients who are new to the requirement for a depositary and may be most likely to favour a bespoke 'one-stop shop' for third-party administration and depositary services. Having said that, there is also a need to consider the fact there are also established custodians who already provide a specialist service, including independent oversight. It should be emphasised that any arrangements need to have sufficient substance to work not just from a regulatory perspective but also in terms of tax, for example corporate residence and implications for VAT and transfer-pricing. What we have seen is that Guernsey has an existing operating model which means it can provide sufficient substance and oversight in terms of management, administration and depositary functions so that investment houses have a choice to meet their specific needs and yet, be comfortable that it will meet both regulatory obligations and tax objectives.
Third country: Routes to market
Guernsey provides investment houses with a choice in terms of structuring arrangements but also options in terms of routes to market. Guernsey is not in the EU (although it is in the European time zone) and therefore, is not required to implement AIFMD. However, with Europe still one of our biggest markets, a large proportion of business relates to the EU in some form. Yet, we also have a substantial amount of funds business which originates outside of Europe and does not touch the EU at all. Therefore, Guernsey has evolved its regime to ensure that we can continue to service both EU and non-EU business in the most effective way. Managers and funds with no connection to the EU continue to be able to use the existing regulatory regime which is completely free from the requirements associated with AIFMD, which will have significant operational and cost benefits. Secondly, Guernsey's position as a third country means that we have not immediately had to introduce a fully equivalent AIFMD regime to maintain access to EU markets.
Ahead of 22 July, the Guernsey Financial Services Commission (GFSC) signed bilateral cooperation agreements with 27 securities regulators from the EU and the EEA, including the UK, Germany and France. The agreements mean Guernsey funds continue to be able to market to appropriately qualified investors in these European countries through their NPP regimes, subject to completion of the notification procedure of the relevant national securities supervisor. NPP regimes are expected to remain in place until 2018.
However, it is anticipated that a full passporting regime for non-EU managers will be implemented from July 2015. Guernsey intends to ensure that managers will be ideally placed to take advantage of being able to market AIFs on a pan-European basis with a single authorisation, as passporting is currently envisaged to operate. Indeed, the GFSC is expected to shortly issue a domestic consultation on a full AIFMD equivalent opt-in regime. These opt-in rules are expected to be fully operational from 1 January 2014 and certainly well in time for the passporting regime for third countries in July 2015.
For those marketing into Europe the NPP route will likely be favoured by many due to the depth and breadth of requirements that fund managers will have to satisfy. Indeed, it is expected that full-blown AIFMD compliance will only be sought if there are particular reasons to do so, e.g. for investor relations. The potentially onerous and costly compliance with AIFMD will mean that parallel structures are likely to be given serious consideration. It will be possible to break non-EU business away into a parallel or feeder structure for which AIFMD compliance would neither be required nor necessary.
If on the other hand, it is necessary or otherwise desirable to comply with the AIFMD requirements, then you can do this in Guernsey too.
Guernsey's position as a third country, its regulatory regime and its infrastructure and expertise mean that as a domicile it offers optionality for the international fund community which is coming to terms with the implications of AIFMD.
Originally published in Clearpath Analysis' 2013 Fund Outsourcing Report, September 2013.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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