The Alternative Investment Fund Managers Directive (AIFMD) introduced a common regulatory framework for EU-based managers of alternative investment funds (AIFs) and imposed additional requirements on non-EU based managers when marketing AIFs within the European Economic Area (EEA).
Who is caught by AIFMD?
Nearly everyone! Only a non-EU fund manager, managing a non-EU AIF and not marketing it in the EEA is outside its scope.
Why was AIFMD introduced?
As a result of the financial crisis. Following the crash which began in late 2008, many hedge funds went bust, and pension funds and other institutional investors lost huge amounts of money on many of their investments. This caused a knock-on effect for the end beneficiaries, such as pension holders, retail investors and shareholders.
Prior to the AIFMD, professional funds were largely unregulated. Therefore, after the crisis, as part of a wider G20 regulatory drive, the European Union set out to create a "harmonised, comprehensive and effective regulatory framework for AIFMs", in order to:
- prevent market instability;
- increase investor protection;
- level the playing field among EU countries; and
- increase competition.
What is an AIF?
Any form of collective investment vehicle. The legal definition of an AIF is a collective investment undertaking that raises capital from a number of investors and which has a defined investment policy. This will include real estate funds, hedge funds, private equity funds, alternative funds and investment companies, among others. The scope of the AIFMD is wider than the pre-AIFMD collective investment scheme regime in the UK. However, an AIF cannot be an undertaking for collective investment in transferable securities, or a UCITS fund, since these largely retail funds are regulated separately.
The diagram below show the constituent elements which each undertaking must satisfy to be an AIF.
What is an AIFM?
The legal entity that manages an AIF. Only one alternative investment fund manager (AIFM) is permitted for each AIF. The AIFM is usually separate from the AIF itself (although AIFs can also be self-managed). The AIFM must be responsible for risk and/or portfolio management of the AIF. The key consideration, therefore, is broadly "who makes the investment/divestment decisions?" The answer to this question should point to the AIFM. Beware there are specific provisions dealing with "letter-box entities" to prevent circumvention of the AIFMD. The AIFM must genuinely be making the decisions and have the capacity to do so. It is important to bear this in mind when delegating certain functions.
Does an exclusion apply?
Exclusions are available to the following vehicles or structures:
- UCITS funds (which are regulated under their own directive);
- holding companies (meaning large PLCs, for example, rather than a fund holding company);
- securitisation vehicles (mortgage-backed securities, for example, rather than fund SPVs);
- pension funds;
- employee participation / savings schemes;
- group structures (where the investors are in the same group as the manager and are not AIFs); and
- joint ventures (this is a grey area – joint ventures are not expressly excluded but many will fall outside of the definition of an AIF – care should be taken when structuring a joint venture).
Is there a lighter-touch regime for smaller managers?
Yes, there is a lighter-touch regime for AIFMs whose assets under management fall below a threshold of €100m. This threshold increases to €500m for AIFMs which solely manage unleveraged AIFs without redemption rights during the first five years. In the UK, AIFMs able to rely on this regime will either continue to be regulated by the Financial Conduct Authority in the same way they were pre-AIFMD, or will need to register with the FCA (which is a fairly straightforward process.)
What obligations does an AIFM face?
- AIFMs must be authorised and are subject to supervision by the regulator in their home member state;
- AIFMs are subject to appropriate governance and conduct of business standards, and must have robust systems in place to manage risks, liquidity and conflicts of interest;
- AIFMs must have capital of at least €125,000, plus a variable capital element. There are also additional requirements covering professional negligence risks;
- AIFMs must have remuneration policies and practices "consistent with sound and effective risk management" in place for staff affecting the risk profiles of managed AIFs;
- There are controls on the delegation of AIFM functions (such as portfolio and risk management);
- AIFMs must have procedures in place for the independent valuation of AIF assets;
- AIFMs must ensure each AIF they manage appoints a depositary to perform certain oversight and custodial functions;
- Key service providers, including depositaries, are subject to robust regulatory standards;
- AIFMs are subject to transparency, disclosure and reporting requirements in relation to the AIFs they manage;
- A European marketing "passport" has been introduced (which could eventually replace private placement regimes) under which AIFMs can market AIFs to professional investors throughout the EU, subject to compliance with certain "gold plating" requirements;
- AIFMs can also passport their management services to other European member states via a branch or simply on a cross border basis. This saves the need for multiple regulated AIFMs in Europe.
- Non-EU AIFs are also subject to conditions on management and marketing in the EU; and
- Supervisors (such as the FCA in the UK) have wide powers of inspection and intervention.
What are considered to be the benefits of AIFMD?
There are few! Obviously the AIFMD should increase investor protection and bring greater transparency but considering this is aimed at professional funds, one might question how far the AIFMD has gone.
The main benefit of the AIFMD is the pan-European marketing passport. It was intended to reduce the barriers for fund managers wishing to raise capital throughout Europe. The idea was that an AIFM regulated in one member state and complying with the AIFMD, should not need to concern itself with the local laws in every other EU member state when distributing its funds. Sadly, that intention is yet to be realised. Many jurisdictions have imposed fees on AIFMs using the passport, some regulators trawl through fund documents whereas others require AIFMs to self-certify that they comply with AIFMD, and some jurisdictions require the appointment of third parties to channel money through.
What have people complained about?
Many fund managers and investors do not see any benefit from AIFMD. It has been costly for fund managers to implement and will continue to have a cost burden on funds. Even investors have complained about it because some AIFMs have stopped marketing new products to them now because of concerns about the cost of complying with new regulations.
What is next?
The European Securities and Markets Authority (ESMA) recently published its consultation on expanding the AIFMD marketing regime. ESMA said it is too early to properly comment on the functioning of the passport and it looks like it will adopt a laboured, jurisdiction-by-jurisdiction approach to extending the passport to non-EU jurisdictions.
The AIFMD marketing passport is likely to be expanded to Jersey, Guernsey, Switzerland, Canada, Japan, Australia and the US in the near future.