Following leaked draft regulations and official regulatory releases, John Langan, of Maitland, assesses how the regulatory landscape for alternative asset management may look after summer 2013.
The funds industry in Europe has been for almost three years preoccupied with the EU’s Alternative Investment Fund Managers Directive (Aifmd), which must be implemented by 13 July, 2013.
With the European Securities and Markets Authority (Esma) presenting its advice on the proposed Level 2 regulations to the European Commission in November, the first tentative steps were taken to implementation.
Then, on January 23, the UK’s Financial Services Authority (FSA) set out its provisional thinking on implementation and, in late March, a leaked draft of the European Commission’s proposed Level 2 regulations were circulated (the contents of which have proved controversial).
So are the mists beginning to clear, and can we now see the way ahead for managers that Aifmd affects?
One of the major concerns with Aifmd has been its exceptionally wide scope – extending beyond the hedge and private equity funds, which are often perceived to be its target. The FSA paper gave useful hints on the carve-out of those funds or structures which are mentioned, briefly, in the Aifmd as being exempt, but without them being spelt out.
The FSA paper suggested such funds would be characterised by a family relationship between the investors, money or assets connected with that relationship (and not raised from outside the relationship) and these elements would predate the relationship with the fund managers.
Depending on how this translates itself into definitive regulatory text, it could prove a very useful exemption for EU-based family offices and, indeed, family limited partnership structures. The leaked draft Level 2 regulations, however, throw no light on this: on an optimistic reading, this may leave individual member states free to craft their own exemptions within the Aifmd parameters. This may create potential for regulatory arbitrage, as different jurisdictions are unlikely to frame exemptions in an equally advantageous way.
The FSA paper considered the likely approach to those alternative investment fund managers (which it termed “small Aifms”) which fall below the threshold at which the directive automatically applies: that is, such small Aifms would manage less than €100 million in assets on a leveraged basis, or less than €500 million if unleveraged (and in funds with no redemption rights within five years of subscription).
The issue is what to do with small Aifms which must be “registered”, according to the directive, but are not required to be “authorised” (and who may not necessarily be FSA-authorised). Should the implementing legislation, as permitted by the Aifmd, impose requirements on them which are in excess of the minimum requirements of registration?
The small managers may seem a narrow category, since most alternative managers will be FSA-authorised. However, there are a few structures who may be caught by this, so the question is not entirely academic. Again, the draft Level 2 regulations do not deal with this, so its implementation by different member states may allow scope for regulatory arbitrage.
In terms of the valuation of assets, the FSA made clear its view that the requirement for a valuer is not satisfied by an independent administrator simply calculating net asset values based on a price feed. The valuer must value individual assets. The paper stated that the FSA may require valuation procedures and/or valuations to be certified by an external valuer, or where appropriate, an auditor. The draft Level 2 regulations adopt the same approach. This seems likely to increase the expense of running an Aifmd-compliant fund; however, there is a business opportunity for those who can supply such a valuation service.
In a similar vein, the FSA paper raised an interesting query as to which types of firm might take advantage of the opportunity presented by the Aifmd for firms, other than traditional providers of banking and custody services, to act as depositories for certain types of alternative fund. The funds concerned are those which do not invest in “financial instruments” and do not offer redemption rights within five years of subscription. What the Aifmd is aiming at is private equity and property funds.
The depositories of such funds must be subject to mandatory professional registration, provide sufficient financial and professional guarantees to enable them to perform their functions, and must carry out those functions as part of their professional or business activities. The FSA stated that it was considering making this option available to interested would-be depositories and they mentioned specifically lawyers, accountants and fund administrators. The draft Level 2 regulations, however, maintain a strict line on the liability of custodians for “loss” and for the actions of sub-custodians, so need to be prepared to face custodial obligations more onerous than those currently imposed on custodians under typical fund documentation.
At this stage, the stand-out provisions in the draft Level 2 regulations, in terms of the impact on the funds market, would appear to be the “third-country” provisions and the restrictions on delegation. The draft suggests that the proposed co-operation agreements, under which investment managers and funds established outside the EU could gain access to EU markets (and potentially a form of passport), would need to be contractually binding, rather than a memoranda of understanding.
Furthermore, the draft suggests that a manager that delegates tasks which, in their totality, substantially exceed those which it retains, will be regarded as a mere “letter-box entity” and, therefore, not directive-compliant. This would undermine, as potential alternative fund structures, the “management company” model which is currently widely used for Ucits and retail non-Ucits funds. One impact of such provisions, if adapted as per the draft, may be to boost the usage of structures unaffected by Aifmd, for instance, Ucits III funds and managed account platforms.
In conclusion, the last few months have revealed some glimpses of the post-Aifmd world: nevertheless, with less than 15 months to go before implementation, much of the landscape remains somewhat indistinct. As the FSA paper remarked, however, industry participants must now begin to “engage with the issues”, and consider the potential for new business opportunities.
John Langan is a funds partner at Maitland, London
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