Keeping up with AIFMD
The much-discussed Alternative Investment Fund Manager Directive (AIFMD) is almost upon us. Transposition in the European Union Member States is scheduled for 22 July 2013. While certain elements of the final version of the new rules remain fluid even at this late stage in the process, there will be few credible excuses available to any firm affected by its requirements that does not comply with them by the future target dates.
The very biggest hedge funds, private equity funds and other alternative investment funds might be able to cope in-house with the new demands being placed upon them. Many will have no option but to turn to a third-party provider for help.
To help participants in the alternative investment world cope with the changes, and with the awkward transition to the new regime, SGSS recently completed a detailed white paper on the AIFMD. This has two main purposes. One, it sets out the challenges facing the alternative investment industry. Two, it updates readers on the range of services and products available to ensure that they are fully compliant with the Directive, and that they remain fully compliant post implementation.
The name AIF (Alternative Investment Fund) refers to any collective investment vehicles, excluding UCITS funds (which are covered by Directive 2009/65/EC), and all are covered by the AIFMD. In particular, hedge funds, investment capital funds and real estate funds, with or without leverage, closed or open, fall within the scope of the AIFMD.
“The Directive aims to harmonise regulations in the EU by creating a common set of rules for the marketing of AIFs within the EU.”
The AIFMD will apply to all Alternative Investment Funds Managers (AIFMs) which have a link with the EU:
- AIFMs with a registered office in an EU Member State – EU AIFMs
- AIFMs with no registered office in an EU Member State – Non-EU
- AIFMs – managing AIFs domiciled in the EU – EU AIFs
- Non-EU AIFMs marketing any AIFs (EU or Non-EU) within the EU
- AIFMs with total AuM (Asset under Management) under the applicable thresholds can enjoy a lighter regime, especially in terms of reporting.
The Directive aims to harmonise regulations in the EU by creating a common set of rules for the marketing of AIFs within the EU. More particularly, the Directive introduces passports that will allow AIFMs to: market AIFs domiciled in one country to various EU Member States; manage AIFs domiciled in various Member States from one country, either directly or through branches.
The Directive also lists the various conditions the AIFMs have to comply with to obtain the authorisation to manage and/or market AIFs. Such conditions mainly aim to increase investor protection, limit systemic risks and enhance transparency.
To increase investor protection and limit systemic risks, the AIFMD lists the conditions the AIFMs have to comply with to obtain the authorisation to manage and/or market AIFs within the EU. These conditions include:
- Initial capital requirement for AIFMs
- General principles in the way the AIFMs should conduct their business
- Supervision of delegation
- Requirements in terms of organisation to ensure the independence of some key functions
- Implementation of risk and liquidity management systems
- Appointment of a single depositary, with extended functions, for each AIF
- Implementation of procedures for specific funds
The AIFM (Alternative Investment Fund Manager) Directive has the objective of regulating the alternative investment fund managers that manage and/or market these funds and not the funds themselves, considering the extreme heterogeneity of this type of fund.
In fact all funds not subject to the UCITS Directive and managed within the EU, irrespective of their country of domiciliation, are considered alternative investment funds by the AIFM Directive, along with all alternative investment funds domiciled and managed outside of the EU and sold on EU territory.
In particular, hedge funds, investment capital funds and real estate funds, with or without leverage, closed or open, fall within the scope of the AIFM. It should be noted that the passport granted by the Directive only allows marketing within the EU for investors that are at least professionals (in reference to the terminology of the MiFID) and therefore not for the broad population of individual investors targeted by the marketing of UCITS funds.
“For the first time at European level, however, the Directive clearly establishes the principle of the liability of the depositary with regard to the fund managed in the event of loss of the assets under management.”
Aiming for harmonisation, the Directive lists the various conditions for approval in terms of the minimum level of equity, competence and good character of the directors, management of conflicts of interest, organisation of controls, delegation of duties to third parties, use of leverage funds, etc.
The passport created for European fund managers will be effective as of the application date in 2013; it will be extended to nonEU fund managers in 2015.
Furthermore, for each fund managed by a fund manager, this fund manager, as is the case with UCITS funds, must mandate a depositary which must be subject to a supervisory authority. For the first time at European level, however, the Directive clearly establishes the principle of the liability of the depositary with regard to the fund managed in the event of loss of the assets under management. This obliges the custodian to return identical assets or the cash value of these assets to the fund managed, with the exception of an external event beyond reasonable control.
Conditions for exoneration will be specified in the level 2 measures: in the current proposal, the European Commission would tend towards stronger responsibility of the depositary in the event of loss of assets due to fraud/bankruptcy of a sub-custodian unless local insolvency law does not recognise the effects of the segregation of assets.
At the same time, based on the current proposal, due diligence at the sub-custodian level will be reinforced specifically requiring the depositary to inform the fund manager of any risks which might impact assets held abroad. In addition, if, for reasons of the applicable law, including the law relating to property or insolvency, the segregation of the assets cannot be achieved, the depositary should take additional measures to minimise the risk of loss and maintain an adequate level of protection of the assets held by the sub-custodian.
AIFMs need to appoint a single depositary per AIF. The AIFM or a prime broker acting as counterparty to an AIF can never act as depositary.
Depositaries are an additional guarantee for Investors as they:
- Monitor all AIF cash flows
- Keep AIF assets safe with an obligation to return financial instruments held in custody
- Oversee (control and audit) AIFM responsibility
- The depositary appointment needs to be evidenced by a written contract.
- Monitoring of cash flows
- The depositary will monitor all cash flow movements to ensure that all the AIF’s cash is booked in appropriate cash accounts
- Reconcile cash flows – daily basis or in case of infrequent cash movements
- Identify significant cash flows – daily basis
- Follow up on identified discrepancies
- Compare the depositary’s cash positions with those of the third party and the AIFM
- Periodically review the procedures related to cash
- Safekeeping of assets
- Safekeeping duties apply on a look-through basis to underlying assets held by financial or legal structures controlled by the AIF/AIFM. The look-through basis does not apply to fund of funds structures and master- feeder structures where the underlying funds have a depositary which provides ownership verification and record keeping functions for the fund.
- Safekeeping duties depend on the qualification of the assets
- Financial Instruments held in custody
- Other assets
- In case of loss of a Financial Instrument held in custody, the depositary shall return to the AIF or to the AIFM a financial instrument of identical type or of an equivalent amount without undue delay.
Contact us to request a copy of our latest white paper dedicated to AIFMD.