After several challenging years during which the alternative asset management industry has grappled with the impact of the AIFMD – the most comprehensive regulatory restructure in the industry's history – the fog appears to finally be clearing (in Ireland, at least). In the six months since the 22 July 2013 deadline for AIFMD implementation across EU member states, we have seen a notable growth (and an even more substantial pipeline) in new Irish regulated structures.
On the product side, the marketing appeal of EU-domiciled AIFs in the new regulatory paradigm (which under AIFMD can provide a pan-European product passport) has substantially increased. Ireland's Qualifying Investor Fund (QIF) had already developed a brand as a leading onshore regulated product for hedge and other alternative funds. As part of the re-tooling of the Irish regulatory regime, the QIF (now recast as the Qualifying Investor Alternative Investment Fund or QIAIF) has been substantially enhanced and updated, offering managers superior structuring flexibility while still retaining robust regulatory oversight and investor protection measures.
The increased demand for QIF/ QIAIF products has, therefore, not been a surprise. A more interesting development is the emerging trend of managers also choosing Ireland as the EU domicile in which to establish an authorised alternative investment fund manager (AIFM).
TRANSPARENT AND PRAGMATIC REGULATORY PROCESS
A great deal of credit for this must go to the Central Bank of Ireland (CBI). In its role as competent authority for Ireland's implementation of the AIFMD, the CBI has taken a proactive and reasonable approach, and provided much-needed clarity and transparency during a period characterised in most EU member states by regulatory uncertainty and opacity.
For more than a year leading up to implementation, the CBI carried out a thorough consultation with industry on how best to adapt the Irish regime for AIFMD compliance. It published drafts of its revised AIF Rulebook and application forms months in advance of the July deadline, to facilitate managers seeking to be authorised early to avail of 'first mover' advantage on the AIFMD marketing passport. Moreover, once it became apparent that the formal July deadline would not be met in practice by the industry, and by most EU regulators, the CBI offered prudent and transparent grandfathering measures to existing Irish AIFMs and to other AIFMs of Irish AIFs.
CLEAR VIEW ON AIFM STRUCTURAL REQUIREMENTS
That pragmatism now extends to the CBI's approach towards the operational and substance requirements for Irish AIFMs. Although relatively few have been approved so far by the CBI (with the majority of managers availing themselves of the full transitional period), the process is already clear and predictable.
One of the most contentious aspects during the drafting of the AIFMD was the extent to which an AIFM may delegate its activities, in particular, the requirement that investment management functions should not be delegated to the extent that the AIFM is in reality a mere 'letterbox entity'. Since historically many alternative funds have operated a delegation model to some degree, the concern was that an overly restrictive requirement for minimum substance would render the EU uncompetitive in the global market. Although the final delegation text was a palatable compromise, it was left to national regulators to determine exactly what local substance would be required.
In the absence of any meaningful guidance at EU level, the CBI has prudently used the Ucits substance/delegation model as its starting point. The rationale is that a governance structure which is deemed adequate for Ucits products targeting retail investors should theoretically also be adequate for alternative products aimed at sophisticated investors.
In the Ucits space, the board of an Irish self-managed Ucits or Ucits management company must, in order to
pass an equivalent 'letterbox entity' test, demonstrate that it retains and discharges ten key management functions, namely: decision-making; supervision of delegates; monitoring compliance; monitoring of investment policies; risk management; financial control; monitoring of capital; internal audit; complaints handling; and implementing accounting procedures.
Although the day-to-day discharge of these management functions may be delegated to a large extent, they remain the overall responsibility of the board and, therefore, the CBI's focus is on ensuring the existence of sufficiently clear reporting lines, escalation procedures and frequency of reports to ensure that the Ucits board retains meaningful management oversight. The CBI requires this governance model to be documented in a detailed Ucits business plan, which it reviews on a detailed basis before it will grant its approval.
This delegation model is well-entrenched in the Irish funds industry and accordingly was the logical template for the CBI in assessing AIFM substance. Accordingly, in framing the minimum substance for an Irish AIFM, the CBI has identified 16 key management functions which must be retained: the same ten listed above for Ucits, as well as liquidity management; conflicts of interest; operational risk management; record-keeping; remuneration; and AIFMD reporting obligations. Akin to the Ucits business plan, the CBI's main focus is on ensuring that these functions are comprehensively addressed in a detailed programme of activities (the PoA).
Our experience from our clients which have applied for AIFM authorisation so far is that while the CBI will permit much of the day-to-day exercise of these functions to be delegated, it will scrutinise the credentials and expertise of those carrying out the functions (whether directly or by delegation), and the existence and adequacy of clear reporting lines and escalation procedures, particularly in respect of the delegation of portfolio management.
In terms of process, the CBI will review and comment on the draft PoA in extreme detail, leading to several rounds of drafts and comments (familiar to managers with Ucits products), and we anticipate that the overall duration of the CBI review will reduce as the new regime settles, possibly to around three months. In addition to the PoA, managers need to produce a compliance manual and risk management process (again taken from the Ucits regime) as well as detailed financial projections, organisational structure charts, proof of minimum capital and other ancillary confirmations. The same process will apply regardless of whether the AIFM is an external AIFM or an internally managed AIF.
It should be noted that in 2015, the European Commission intends to review the various AIFMD delegation models implemented across the EU and consider further harmonisation measures if it deems it necessary. It is therefore conceivable that the CBI's model may need to be revised following that review, but we expect the CBI to remain in continuing contact with its EU counterparts so that any such changes will be clearly flagged in advance (and likely subject to a grandfathering period).
Nonetheless, as things stand, Ireland's position on substance requirements offers a fair balance by ensuring effective and meaningful governance while continuing to permit the delegation model which is so prominent in the alternatives industry. Most importantly, by closely reflecting the highly successful Ucits structural framework, it offers managers and service providers rare clarity and certainty in a very uncertain regulatory environment.
For existing Irish AIFMs that have availed of the CBI's transitional period, the next steps are non-negotiable and immediate: the CBI has set a deadline to receive completed AIFM applications by 21 February 2014. Conversely, non-EU managers of Irish alternative funds have more time to play with, as the grandfathering period in those cases is extended to at least July 2015. Understandably, most managers are sitting on the proverbial fence to assess whether the additional marketing appeal of an AIFMD-compliant structure justifies the additional costs of its establishment and operation. We are, however, seeing a definite rise in interest among non-EU managers who are considering raising European Capital by 'opting in' to the AIFMD before 2015 by setting up an internally managed Irish QIAIF.
Our longer term view is that the patchwork of global regulation in recent years on both sides of the Atlantic dictates that it will no longer be possible for managers to run a single fund product which accommodates all investors. In the alternatives space, we expect the traditional offshore fund domiciles such as the Cayman Islands and the British Virgin Islands to continue to thrive and satisfy the needs of most global investors. Conversely, we believe that access to EU investors will, in future, realistically necessitate an AIFMD-compliant EU structure. We are therefore confident that one effect of the AIFMD will be to continue the trend of co-domiciliation, with Irish QIAIFs/ internally managed AIFMs serving as the most eligible option in which to structure funds in parallel to the traditional offshore hubs.
Originally published in HFMWEEK . COM.
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