REGULATION: Why should you care about the AIFMD?

Chris-HarranWhat do fund managers in the Middle East need to know about the Alternative Investment Fund Managers Directive? Funds Global Mena asked Chris Harran, national partner at Dechert’s Dubai office.

What is the Alternative Investment Fund Managers Directive (AIFMD)?
The AIFMD is a piece of European legislation that attempts to regulate the largely unregulated world of private equity, venture capital and hedge funds. Among other things, the directive states that these and other alternative fund managers must register their products, appoint custodians and meet annual reporting and disclosure requirements.

What are regulators hoping to achieve with the directive?
There is a desire to create a level playing field between investment products and avoid the abuses that came to light during the financial crisis, such as the Bernard Madoff scandal. In the past, the argument from the industry was that alternative investments were only for sophisticated investors, which didn’t need the same kind of protection as retail investors. Regulators now believe these investors are not all as sophisticated as once thought, and also need protection.

What is the deadline for complying with the directive?
The directive entered into force on July 22, 2013, but must be transposed into law by each European member state. Some, such as the UK and Germany, have made use of transitional arrangements, which give fund managers until July 22, 2014 to comply with the rules. In other countries, such as France, the directive is already law. Others still, such as Ireland, have restricted transitional arrangements under which fund managers are allowed to finalise any current arrangements but not do new fund marketing unless it complies with the AIFMD.

Why has the AIFMD proved so controversial?
The directive adds a layer of regulation where none existed, and people are resistant to change. All the aspects must be implemented and, ultimately, the end investor will bear the cost. Besides these general concerns, some individual worries have been raised. Having to appoint a custodian for a private equity fund is perceived as overkill and the rules on remuneration are controversial. The remuneration principle is that fund managers must disclose who they are paying and how.

This includes which individuals get what share of any performance fees. Regulators want to know that individual fund managers are not incentivised to take unnecessary risks.

Why should alternative investment fund managers outside the EU care about the AIFMD?
If you have a fund domiciled in Europe, such as a Luxembourg fund, you will have to comply with the directive. If your fund is not domiciled in Europe but you have investment advisers there, those advisers will have to be compliant. You will also be affected if you are a sub-adviser to an EU-domiciled fund.

Most importantly, you will have to comply with the directive if you are trying to raise assets in Europe. If you have a hedge fund domiciled in the Cayman Islands that is trying to raise money in Europe, say, you need to know about the AIFMD.

Is there a way for non-EU fund managers to continue to sell products to European investors under the AIFMD?
If a private placement exemption exists in the European country you are targeting, you have until 2015 or 2016 to continue marketing your products to investors in that country using private placement, and so sidestep some of the AIFMD’s requirements (this deadline could be extended). However, you will have to register your product with the local regulator and, depending on the country, face compliance burdens you have not faced before. After the deadline, you will be blocked from operating in those countries unless you are established in the EU as an alternative investment manager under the AIFMD.

Is it true that non-EU alternative fund managers will face a “patchwork quilt” of different laws as they seek to continue marketing under private placement regimes?
The truth is there always was a patchwork when it came to private placement rules.

However, yes, the countries are taking very different approaches under the AIFMD. France has scrapped its whole private placement regime, while the UK and Luxembourg have kept theirs in place. Germany has kept its regime but imposed new conditions, such as requiring funds to appoint a custodian.

Are there any other routes beyond the ones described that could allow non-EU alternative fund managers to continue to sell to European investors?
Some funds will be exempt. It is written into the directive that the AIFMD doesn’t apply to closed-ended funds with assets under management of less than €500 million, non-leveraged. However, the sting in the tail is that these funds would need to be marketed by private placement, and private placement regimes are being shut down.

The final option is reverse solicitation, which is enshrined in the directive. Fund managers need to have evidence that they were genuinely approached by an investor in Europe who was interested in the product. What constitutes marketing a product and making an offer is still a grey area and may differ between countries.

Will some non-EU alternative fund managers decide that marketing in Europe isn’t worth the cost of complying with the AIFMD?
If a fund manager has no European investors and isn’t interested in gaining assets there, they may decide to ignore both Europe and the AIFMD. However, it might be unwise to make a permanent decision. If a European pension fund came knocking and said it wanted to invest $100 million, a fund manager might want to change its mind.

Might the AIFMD give a boost to the non-EU alternative funds industry, both alternative fund managers and service providers such as hedge fund administrators?
European fund managers might decide to set up alternative investment funds in jurisdictions outside Europe, such as in the Middle East, where they can avoid the increased costs of complying with the AIFMD. Dechert has set up DIFC funds to take advantage of this. It’s a potentially big opportunity for asset managers in this region and for service providers such as hedge fund administrators. People see the bad side for the Middle East, but actually the AIFMD presents an opportunity for asset managers in the region.

©2014 funds global mena

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