Transposing the AIFM Directive into UK Law – The Process Begins
Sarah Jane Leake | Bloomberg Law
The Alternative Investment Fund Managers Directive1 (AIFM Directive) came into force on 21 July last year. Like all Member States, the UK must transpose the Directive’s provisions2 into national law by 22 July 2013. In such a tight timeframe, there is therefore a great deal of work to be done.
To stimulate discussion and debate with key stakeholders, the Financial Services Authority (FSA), on 23 January, published a discussion paper setting out material areas for policy development. This represents the first step in the process of implementing the Directive.
In the FSA’s estimation, some 1,000 firms and schemes are likely to fall within scope of the AIFM Directive in the UK.
Together with implementing measures currently being considered by the European Commission,3 the AIFM Directive will directly regulate UK-based fund managers where at least part of their regular business is the management of alternative investment funds4 (AIFs) (including UCITS5 management companies that manage AIFs), certain discretionary investment managers, operators of UCIS, investment companies that do not employ an external fund manager, and depositaries and custodians holding AIF assets. Firms providing AIFMs with services such as prime brokerage facilities, external valuation, client administration, and the marketing/distribution of AIFs will also be affected.
The FSA expects the following to be considered as AIFs: hedge funds, funds of hedge funds, private equity and venture capital funds, investment trusts, real estate investment trusts, FSA-authorised non-UCITS funds (including non-UCITS retail schemes funds, funds of AIFs, and qualified investor schemes (QIS)), charity funds, commodity funds, and infrastructure funds.
The FSA’s latest paper sets out its provisional thoughts on implementation, on areas including operating and management requirements, depositaries, transparency, and marketing. The key issues necessitating further discussion are set out below.
— Management Requirements
Factors to be considered by the FSA when determining whether an alternative investment fund manager (AIFM) should have its valuation procedures and/or valuations externally verified;
How the net asset value of AIFs that do not use the “share/unit” concept should be calculated;
Challenges posed by the introduction of liquidity requirements under the AIFM Directive;
Criteria that should be taken into account when determining whether arrangements of capital commitments are temporary in nature;
The circumstances in which neither the gross,6 nor the commitment7 methods of leverage calculation would provide a reasonable or approximate reflection of leverage and, as a result, the “advanced method”8 should instead be used; and
Challenges or uncertainties arising out of ESMA’s proposed requirements for investment in securitisation positions.
Whether any other entities (e.g., lawyers, accountants, fund administrators, etc.) should be allowed to act as a depositary.
A depositary will, controversially, be liable for the loss of financial instruments held in custody and other losses suffered as a result of the depositary’s failure (whether negligent or intentional) to properly fulfil its duties under the AIFM Directive. The FSA asks what changes depositaries will have to make in order to avoid liability, and the anticipated direct and indirect costs of these changes.
The AIFM Directive provides that a prudentially-regulated firm that is eligible to be a UCITS depositary under the UCITS Directive10 may also be appointed an AIF depositary. The FSA asks whether the capital requirements of such depositaries should be increased and, if so, how best to approach it.
Depositaries, in having to meet existing FSA requirements, may already be meeting most or all of the AIFM Directive’s requirements regarding monitoring cash flow. Should this assumption be misconceived, the FSA queries the likely costs and benefits of compliance with this.
Categories of assets not needing to be registered by the depositary in a segregated account.
Whether additional guidance is required regarding the verification of assets.
How depositaries, when valuing assets, should ensure that the valuation procedures are appropriate in terms of the nature, scale, and complexity of the AIF under management.
Whether entities performing primary depositary functions11 (PDFs) should act independently of the AIFM in question (i.e., not part of the same group) and how firms that carry on one or more PDFs for non-EU AIFs should be regulated.
When delegating safe-keeping to a third party, depositaries must assess whether assets held in custody are “insolvency remote.” To assist depositaries in this regard, the FSA asks which jurisdictions do not recognise the segregation of assets in insolvency proceedings and queries what actions could be taken to minimise the risk of loss in these jurisdictions.
AIFMs will be required to provide a minimum level of information for each AIF managed and/or marketed in the EU. The FSA asks whether, subject to the Directive’s minimum disclosure requirements, its existing disclose regime for QIS should be maintained since it contains similar requirements.
Likely implications of the AIFM Directive’s remuneration disclosure requirements for firms already subject to the FSA’s Remuneration Code13 and also for those currently outside its scope (e.g., real estate funds).
The best means to capture reporting by non-EU AIFMs marketing AIFs in the UK, in order to help the FSA assess potential systemic risk to financial stability.
The AIFM Directive describes marketing as a “direct or indirect offering or placement at the initiative of the AIFM on behalf of the AIFM.” The FSA anticipates that the Commission may, together with national regulators, consider redefining the definition of “marketing” during the course of the year and, to be as fully informed as possible, asks which marketing practices should fall within scope.
In the FSA’s view, listed AIFs marketed by way of public offer should be considered “marketing” and should therefore be subject to the AIFM’s provisions on marketing.
Initially, the marketing of non-EU AIFs managed by EU AIFM, and EU and non-EU AIFs managed by non-EU AIFM will continue to be permitted on a national basis at the discretion of the UK authorities. HM Treasury has already indicated an intention to permit the marketing of these AIFs to professional investors, subject to certain conditions, via the PPR. To facilitate supervision, the FSA suggests creating a public register for non-EU AIFMs that intend to market AIFs in the UK through the PPR.
— Operating Requirements
The requirements of the AIFM Directive applicable to the operation of AIFMs draw heavily on those set out in MiFID15 and the UCITS Directive, transposed into UK law via the FSA Handbook, in particular the New Collective Investment Schemes sourcebook (COLL), the Conduct of Business manual (COBS), and SYSC.
As many AIFMs already carry out investment activities covered by MiFID and the UCITS Directive, they will already be familiar with the rules on operating requirements set out in the FSA Handbook. The AIFM Directive does, however, introduce several new general principles (particularly in the areas of due diligence, the appointment of counterparties and prime brokers, and fair treatment) and firms are advised to familiarise themselves with these at their earliest convenience. The FSA sets out its provisional thinking on these issues in the fourth chapter of its discussion paper.
Amending UK Regulation
The FSA envisages that most of the AIFM Directive’s provisions will be implemented via rules in the FSA Handbook, while others will be implemented via regulations made by HM Treasury to amend the Financial Services and Markets Act 2000 and amending secondary legislation.
Many issues arising out of the AIFM still need to be shaped by implementing measures, currently being considered by the Commission. It is anticipated that many of these will be adopted as regulations, having direct effect. As such, these would either be reproduced in the FSA Handbook, as is the case with other directives (e.g., UCITS Directive), or made reference to in the relevant sourcebook (e.g., as is proposed for Solvency II transposition).
The FSA sees this as an opportunity to streamline the Handbook’s fund management rules, which, most recently, have been maintained principally in COLL. In view of the pressing need to implement the AIFM Directive, and the likelihood of subsequent Directive provisions emerging (such as those proposed under UCITS V16), the FSA is considering adopting a more strategic approach to implementation. This would involve creating a new sourcebook, provisionally entitled FUND, to contain fund management rules generally. COLL would therefore be replaced by FUND, which would contain requirements for both UCITS and AIFMs. Rules that fit outside these sourcebooks would, to the extent possible, be contained in non-fund sourcebooks, as outlined above.
Interested parties have until 23 March to submit their views to the FSA for consideration. Shortly thereafter, the FSA will launch a consultation, setting out detailed proposed policy positions and any rule amendments. Meanwhile, the regulator will undertake a preliminary firm categorisation exercise to determine the likely population of AIFMs that will fall within the scope of the regime.
The FSA anticipates being able to receive applications for registration (which are likely to be dealt with by the new Financial Conduct Authority (FCA)) around mid-2013. This would benefit potential FCA-authorised AIFMs wishing to make use of the EU-wide passport for marketing and/or AIF management from 22 July 2013.
While the proposal to establish an internally-managed fund regime (i.e., by creating one set of common rules applicable to both AIFMs and UCITS) would bring the UK into line with several other Member States, such as Ireland, where similar structures are common, the precise impact on UK AIFMs still remains unclear. Much remains dependent on the outcome of the implementing measures due to be adopted by the Commission later this year.
1 Directive 2011/61/EU. Under the Directive, all EU-domiciled funds above €100 million (or, where there is no leverage and a lock-in period in excess of five years, assets under management above €500 million) will be subject to authorisation by the home Member State’s competent authority and to ongoing requirements.
2 For an overview of the AIFM’s provisions, see Simon Morris and Ash Saluja, CMS Cameron McKenna, AIFM Directive – A New Beginning, Bloomberg Law Reports® – UK Financial Services Law, Vol. 3, No. 2 (7 February 2011).
3 The Commission is in the process of considering the European Securities and Markets Authority’s (ESMA) advice on the detailed rules underlying the AIFM Directive. See ESMA’s technical advice to the European Commission on possible implementing measures of the Alternative Investment Fund Managers Directive – ESMA Final Report ESMA/2011/379 of 16 November 2011. For an overview, see Future Rules for Alternative Fund Managers: ESMA Publishes Technical Advice, Bloomberg Law Reports® – UK Financial Services Law, Vol. 3, No. 12 (5 December 2011).
4 AIFs are defined fairly broadly in the AIFM Directive at Article 4(1) as collective investment undertakings that: (1) raise capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors, and (2) do not require authorisation under the UCITS Directive.
5 Undertakings in collective investment in transferable securities (UCIS).
6 The sum of the absolute values of all financial derivative instrument, non-financial derivative instrument positions and other asset or liability positions calculated in line with Article 19 of the Directive.
7 The sum of the absolute values of all financial derivative instrument, non-financial derivative instrument positions and other asset liability positions calculated in line with Article 19 of the Directive.
8 See ESMA/111/209 at 203, Box 97 for an overview of how this approach works in practice.
9 By way of background information, all EU AIFMs will be required, subject to certain exemptions, to appoint a single depositary for each AIF they manage.
10 Directive 85/611/EEC.
11 These are: (1) cash monitoring, (2) safe-keeping of AIF assets, and (3) oversight of certain operational functions.
12 The AIFM Directive sets out minimum requirements for annual reporting, disclosure and reporting to competent authorities.
13 This is set out in the FSA’s Senior Management Arrangements, Systems and Controls manual (SYSC) at SYSC 19A.
14 The Directive will replace existing rules on the marketing of EU AIFs managed by EU AIFMs to UK professional investors, including through national private placement regimes (PPRs).
15 Directive 2004/39/EC.
16 UCITS V is still at the proposal stage with the Commission. See Consultation Paper on the UCITS Depositary Function and on the UCITS Managers’ Remuneration – Commission Paper MARKT/G4 D (2010) 950800 of 14 December 2010. The draft UCITS V Directive is expected to be published before April 2012.
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