International Legal Services - The Alternative Investment Fund Managers Directive
By Lowtax Editorial
20 February, 2014
Although its a piece of European Union legislation, the Alternative Investment Fund Managers Directive (AIFMD) is having an impact on the funds industry way beyond European shores, prompting changes to legal frameworks for investment funds in several jurisdictions.
This feature provides an overview of the directive and its requirements, before looking at how fund managers are viewing the controversial changes and summarising the reaction to the AIFMD in offshore and low-tax fund jurisdictions.
The Directive: An Overview
The AIFMD, although controversial for many in the fund management industry, has been formulated as part of the response by the European Union to the financial crisis.
The directive will increase the regulatory requirements for fund managers, including those based outside the EU, for any Alternative Investment Funds, such as hedge funds and private equity, marketed or operated in the EU. It will impose registration, reporting and initial capital requirements on a financial industry sector which until now has been subject only to "light touch" regulation.
Under the directive, a European AIFM with a portfolio of more than EUR100m will be required to obtain an authorization from national authorities to operate. This permit will entitle them to market funds throughout the EU single market.
It is hoped that the enhanced regulatory oversight over AIFM will enhance investor protection and financial stability. The EUs stated aim is: "to create harmonized regulatory standards for all alternative investment fund managers within its scope and to enhance transparency of the industry and reduce risks to financial stability."
After the Council of the European Union agreed for negotiations to begin with the European Parliament on the draft directive on May 18, 2010, the final agreement on the framework directive was reached in November 2010 (known as the Level 1 text) and the Directive entered into force on 21 July 2011.
The Level 1 text left many implementing matters to the Commission to resolve through delegated acts. So the European Commission then requested that the European Securities and Markets Authority (ESMA) provide technical advice on the implementing measures of the directive, and this was submitted to the Commission on November 16, 2011. The delegated regulation supplementing the AIFMD was then adopted by the Commission on December 19, 2012.
The delegated regulation is a precondition for the application of the AIFMD in the EU member states, and was adopted to supplement certain elements of the AIFMD. Its rules concern the conditions and procedure for the determination and authorisation of AIFMs; and operating conditions for AIFMs, including rules on remuneration, conflicts of interest, risk management, liquidity management, investment in and securitisation positions, organisational requirements and rules on valuation. In addition, it contains rules on depositaries, including the depositary's tasks and liability, reporting requirements and leverage calculation, and rules for cooperation arrangements.
The regulation was subject to a three-month scrutiny period by the European Parliament and the Council, and entered into force on July 22, 2013, the date by which time EU member states should have transposed the Level 1 directive into their national legal frameworks.
Final guidelines on the reporting obligations for alternative investment fund managers were published by the ESMA in October 2013. The Guidelines clarify provisions of the AIFMD on required information, which will help to create a more comprehensive and consistent oversight of AIFMs' activities. ESMA has also published an opinion that proposes introducing additional periodic reporting including such information as Value-at-Risk of AIFs or the number of transactions carried out using high frequency algorithmic trading techniques.
Steven Maijoor, ESMA Chair, said: "One of the key objectives of the AIFMD is bringing the alternative fund world under supervision thus providing more transparency to investors and regulators. As the AIFMD came into force in July, both AIFMs and national supervisors now need to prepare for their regulatory filings as it is these reports which will enable supervisors to monitor the systemic risks of AIFs. In order to achieve this objective, national supervisors should receive all the necessary information in order to ensure an appropriate overview of the sector. Our guidelines and opinion will help to standardize the reporting across the EU. It will also facilitate the exchange of information between national regulators, ESMA and the ESRB."
Managers need to report investment strategies, exposure and portfolio concentration. According to the Guidelines, key elements AIFMs will have to report to national supervisors include information on:
- the breakdown of investment strategies of AIFs
- the principal markets/instruments in which an AIF trades;
- total value of assets under management of each AIF managed;
- turnover of the AIFs; and
- principal exposures and most important portfolio concentration of the AIFs.
The key elements of the additional information proposed by ESMA's Opinion would include:
- AIFs' risk measures;
- the liquidity profile of the AIFs; and
- the leverage of the AIFs.
AIFMD Memoranda of Understanding
AIFMD MoUs allow the exchange of information between EU and non-EU supervisors thus enabling non-EU fund managers to market alternative funds within the EU. The MOUs are required by the AIFMD and are in identical terms and conditions for all of the countries. They are deemed to have come into effect from July 22, 2013.
The cross-border marketing of alternative investment funds to professional investors between jurisdictions is also subject to the non-EU jurisdiction not being listed as a non-cooperative jurisdiction by the Financial Action Task Force and having co-operation agreements in place with EU member states regarding the exchange of information on tax matters.
ESMAs Board of Supervisors, at its July 2013 meeting, approved MoUs with authorities from the Bahamas, Japan, Malaysia, Mexico and the United States, including the Commodity Futures Trading Commission. ESMA has now negotiated 38 agreements on behalf of the 31 EU/EEA national competent authorities for securities markets supervision.
Several other offshore, low-tax and specialist fund jurisdictions are among the territories which have entered into these MoUs with European Union/European Economic Area member states. They include Bermuda, the Cayman Islands, Dubai, Guernsey, Hong Kong, Jersey and the Isle of Man.
Naturally, with the AIFM directive representing one of the greatest shake-ups in financial regulation, the new law has attracted a great deal of criticism from within the funds industry.
Firstly, there is the sheer cost of implementing such a complex piece of legislation, and a recent survey by BNY Mellon suggested that initial AIFMD project/one-off costs will range from between USD300,000 to over USD1m per institution. Regulatory reporting is seen to have the greatest time and cost implications, followed by risk and compliance reporting. Respondents remain uncertain about the cost of depository services, which are not included in the estimates above. Additionally, most fund managers believe that the cost of funds will increase as a result of AIFMD.
Half of the respondents of the survey, which was published on July 22, 2013 the day the directive became effective believed that uncertainty remained within their organizations, while a third revealed a fear of not complying on time and of negative financial implications. The same amount predicted that their organization will be disadvantaged in some way by AIFMD over the medium-term, with only 18 percent anticipating there to be a benefit.
Two thirds of survey respondents believe the cost and complexity of compliance will lead to reduced choice of opportunities for investors.
The findings further indicated that over half of respondents did not expect the AIFMD requirements to be adopted by other jurisdictions. 62 percent believed however that investors would keep their money in European-domiciled funds rather than invest in jurisdictions with less onerous requirements.
Nevertheless, while fund managers do not expect to be the winners in this regulatory change, those surveyed believe that the key benefits of AIFMD will be seen mostly by investors and in the industrys ability to distribute more widely, making funds more accessible to the end user.
The results of BNY Mellons survey tally with the findings of an earlier study by Deloitte, which found that nearly three quarters of fund managers view the AIFMD as a threat.
The biggest concerns for fund managers are depositary costs (84%), delegation (78%), and changes to contractual arrangements and routes to market (67%). Deloitte warns that collectively, these reduce the attractiveness of Europe as a place to do business.
Smaller managers, private equity and real estate funds are more likely to see AIFMD as a business threat, according to the survey. However, large funds, mainly those managing more than USD1bn in assets, regard the AIFMD as an opportunity.
The AIFMD was expected to lead the re-domiciliation of alternative investment funds from offshore jurisdictions to onshore locations in Europe, with Ireland and Luxembourg predicted to be the main beneficiaries. In reality however, this doesnt seem to have happened. Indeed, some offshore jurisdictions are also seeing the AIFMD as an opportunity to enhance their fund platforms, as can be seen in the following sections.
In 2013, the Bahamas Financial Services Board enlisted London-based international law firm Charles Russell LLP to advise of necessary alterations to the territory's funds regime to comply with the AIFMD.
The firm was commissioned to undertake an analysis of the Bahamas' regime to identify any legislative shortcomings that could hinder Bahamas' funds' ability to continue to market their offerings to EU participants.
BFSB's CEO, Aliya Allen, said: "We have the analysis in hand and it appears that some changes will need to be made in order for The Bahamas to comply, and thereby to protect the necessary channels of distribution for our funds and continued access by our fund managers. It may be possible to introduce a tiered system; we are still seeking advice on this point."
The firm's input will contribute towards the revision of the Investment Funds Act, as well as work being undertaken by the Securities Commission of the Bahamas and the Ministry of Financial Services to ensure the territory achieves AIFMD compliance.
The Bermuda Monetary Authority confirmed on July 21 the signing of a co-operation agreement with EU member states in relation to the AIFMD, allowing new and existing Bermuda-based funds and fund managers to continue conducting business with the European market.
"We are pleased to finalize our agreements with the EU Member States under the AIFMD," said Jeremy Cox, CEO of the Authority. "This is the result of a concerted effort by the Bermuda team, led by Shauna MacKenzie, our Director of Policy, Legal and Enforcement at the Authority." He added, "The ongoing work on this initiative also involves a legislative review of our regime and appropriate adaptations in relation to the oversight of Bermuda-based investment managers. This work will ensure that investment managers may fully participate in European markets from Bermuda and reinforces our position as a competitive jurisdiction for the global funds sector."
The Cayman Islands' Government has legislated to allow the island's regulator, the Cayman Islands Monetary Authority, to enter into cooperation agreements with regulators in the European Union as part of the jurisdiction's preparations for the entry into full effect of the AIFMD from July.
The Cayman Islands' Minister for Financial Services, Rolston Anglin explained that: "Without the amendment to the law, about 26% of Caymans funds would have been blocked from being marketed in the EU."
Anglin said that with the amendment, Cayman now complies with the three AIFMD conditions that are particularly pertinent for the jurisdiction. The other two: that the territory comply with the Financial Action Task Force's (FATF) anti-money laundering standards; and that Cayman has tax information exchange agreements with EU member states, have already been satisfied, he said.
On July 15, 2013, Albert Isola, minister with responsibility for Gibraltar's Financial Services, signed regulations that transpose the AIFMD into Gibraltar law. It was a development that Isola said would provide Gibraltar with an excellent opportunity and competitive advantage which should provide for further growth in this key area of our financial services industry.
In December, the Guernsey Financial Services Commission (GFSC) released a new set of rules which form an opt-in regulatory regime of measures equivalent to the Alternative Investment Fund Managers Directive (AIFMD).
The AIFMD Rules, 2013 have been published on the GFSC's website and took effect from January 2, 2014.
Fiona Le Poidevin, Chief Executive of Guernsey Finance the promotional agency for the Island's finance industry, said: "The introduction of the opt-in regime means that we have another piece of the jigsaw in place to ensure that Guernsey funds can continue to be distributed to both EU and non-EU countries in the future."
Guernsey is not in the EU and therefore considered a "third country" for the purposes of AIFMD.
In response to AIFMD and to cater for its global client base, Guernsey has adopted a "dual regime" where there are two parallel regulatory regimes for investment funds: the existing regime remains in place for managers and investors not requiring an AIFMD fund, including those using EU national private placement regimes and those marketing to non-EU investors; and an opt-in regime which is fully compliant with AIFMD.
Miss Le Poidevin said: "Third countries are not required to implement an AIFMD equivalent regime until the third country passport becomes available in 2015, but we felt that it was important to provide Guernsey managers and depositaries with certainty as soon as possible. It is therefore very pleasing that we have been able to publish the rules now and will have them effective from the start of 2014.
"Of course, many of our clients will continue to use our existing regulatory regime based on a commercial preference either to access the EU through national private placement regimes which is expected to continue until 2018 or because they are not marketing to EU investors."
Guernsey's dual regime is expected to become a model for other offshore jurisdictions as such an approach will enable the jurisdiction to cater for investors that are completely outside the EU and have no interaction with AIFMD at all.
"The Directive will inevitably impose additional costs on in-scope funds managed by an AIFM and if you stay outside the regime, principally if you're not marketing to Europe, it's helpful to have a regime that allows you to do that. Equally, if you do want to market to Europe it is helpful to have a regime, which is respected as the same standard as Europe and you can market when passporting for such non-EU funds comes on stream."
Miss Le Poidevin added: "Our dual regime provides clients with real options in structuring their investment funds so that they can best meet commercial objectives as well as investor demands, and industry practitioners are reporting a growing number of enquiries from those who are wishing to take advantage of the solutions Guernsey can provide."
Jersey's Financial Services Commission confirmed plans in May 2013 for the implementation of a new funds vehicle, and accompanying regulations and guidance, in anticipation of the implementation of the European Union's Alternative Investment Fund Managers Directive in July. Clarification of the territory's plans followed confirmation from the European Securities Markets Authority of its approval of a cooperation agreement with the Jersey regulator.
Jersey's new funds framework, legislated for in the Alternative Investment Funds (Jersey) Regulations 2012, which came into force in April 2013, was not effective until July 22, 2013, which was the implementation date for the Directive.
The Commission has prepared Codes for the purpose of establishing sound principles and providing practical guidance for the conduct of Alternative Investment Funds (AIFs), AIF managers and depositories established in Jersey who, from July 22, 2013, are either: managing a European AIF; or marketing any AIF in Europe.
A consultation was launched on a Jersey Eligible Investor Fund Guide setting out the principal characteristics of an additional new type of fund devised to respond to the requirements of the Directive; and also on proposals to introduce a straightforward fees regime to apply a levy on AIFs and service providers to AIFs which have not previously paid fees.
Mike Jones, Deputy Director of Securities, Jersey Financial Services Commission, commented: "It has always been Jerseys intention to be in the first tranche of jurisdictions to sign this AIFMD cooperation agreement and I am delighted that, following months of preparation work and constructive engagement with ESMA and the regulators of individual EU Member States, that agreement is now in place. It puts Jersey in a very strong position and ahead of schedule in terms of the AIFMD introduction date on July 22."
As a non EU jurisdiction, alongside an AIFMD-compliant regime, Jersey will also continue to offer fund managers a separate regime that lies outside the scope of the AIFMD for managers wishing to market to the rest of the world.
Geoff Cook, CEO, Jersey Finance, welcomed the approval of the MoU, stating: "This is a major step in ensuring that Jersey can continue to facilitate alternative investment funds business within Europe, and will give alternative investment fund managers a huge amount of confidence in using Jersey. While Jerseys approach to the Directive will offer a seamless transition when it comes into force in July, it will also offer a welcome degree of flexibility in offering a completely separate regime for fund managers wishing to market to non-EEA countries. This is not something all international finance centers, nor any EU nations, can offer, so in this sense the Directive will actually enhance Jerseys appeal as a specialist center for alternative funds business."
Nigel Strachan, Chairman of the Jersey Funds Association, added: "With the alternative asset classes, including hedge, private equity and real estate, accounting for almost three quarters of funds business done in Jersey, this is an extremely welcome move that secures Jerseys position as a leading funds center both in a European and a wider global context. Jersey has positioned itself well ahead of the game and is in a strong position to support managers and service providers ahead of the July introduction date. This also reflects once again Jerseys commitment to complying with international standards."
A report from Luxembourgs fund industry body ALFI in January 2014 reported a positive year in 2013, but warned that challenges still remain.
Net assets managed by investment funds under Luxembourg law reached EUR2.6 trillion (USD3.5 trillion) at the end of December 2013, compared to EUR2.4 trillion at the end of 2012, ALFI said. With EUR193bn in 2013, net sales of Luxembourg investment funds accounted for nearly half of all sales for the European fund industry.
Commenting on the past year, Marc Saluzzi, Chairman of ALFI, said: "2013 was positive, but there are challenges ahead for the sector. For example, whilst the Alternative Investment Fund Managers Directive (AIFMD) has finally been implemented, and despite positive developments in the negotiations on FATCA, the regulatory agenda remains a heavy burden.
The association also noted that six months after implementation of the AIFMD, the effect of the new regulation is beginning to take shape. In Luxembourg some 90 alternative investment fund managers have applied to the Commission de Surveillance du Secteur Financier (CSSF) for approval under the new regulations. At this point, 12 companies are listed on the official CSSF list of AIFM, whilst six others have received approval and are finalizing the paperwork.
"Total Assets under management in alternative funds in Luxembourg is currently around EUR500 billion and ALFI's objective is to double these assets within 5 years," says Saluzzi.
In this context, two developments are of particular interest:
- The new Limited Partnership regime introduced with the law transposing the AIFM Directive into Luxembourg law has met with success, with 83 units established so far under the plan;
- Similarly, specialised investment funds (SIFs) continue their momentum of growth. More than 1,500 SIFs have been created since its introduction in 2007, and they now manage more than EUR300bn of assets. This is the most popular investment product in its class in Europe.
Mr Saluzzi concludes: "Whilst initial results on AIFMD are very encouraging, we need to wait until at least the end of July 2014 to see Luxembourg's role in this sector."
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