AIFMD - Now is the time to act
Analysis of the position for offshore boards, their investment managers and advisers
The Alternative Investment Fund Managers Directive (AIFMD) provides a new regulatory framework for the management and marketing of private equity, real estate, hedge funds and investment trusts in the EU.
The AIFMD sets out the rules for authorisation, ongoing operation and transparency for alternative investment fund managers (AIFMs). National regulators in each member state will supervise AIFMs, not the alternative investment funds (AIFs) they manage.
The EU and national regulators continue to develop the detailed rules to apply the AIFMD, however many key aspects are now published, as listed below:
- The Directive
- European Commission Level 2 Regulation
- ESMA consultation on the key concepts of the AIFMD
- FSA consultation paper on implementation of the AIFMD
- HM Treasury consultation paper on the transposition of the AIFMD
In our view the time has come for each manager and fund to consider their position in respect of AIFMD. This paper has been set out as a guide to assist with this process.
Why does AIFMD matter?
All AIFs which are managed or marketed in the EU will be affected to some extent by AIFMD. At the very minimum it will be necessary to conclude whether management (as defined by AIFMD) or marketing is being undertaken in the EU.
For AIFMs managing total assets below the €500m threshold (€100m with leverage), AIFMD allows national regulators to decide the approach and this has yet to be finally determined in the UK.
The introduction of AIFMD requires strategic consideration and, ultimately, important decisions by the boards of offshore* AIFs together with their investment advisers.
In most cases, some change will be required, resulting in either more regulatory responsibilities being taken onshore or more substance offshore.
Such changes may require careful consideration, not only from regulatory and governance perspectives, but also in terms of remuneration issues and from a tax perspective (including residency, transfer pricing and VAT).
Analysis and decision making needs to start now as AIFMD begins to take effect in the summer of 2013.
It is important to note that the scope of the AIFMD is very broad and will capture investment management structures which may not have been traditionally seen as ‘alternatives’.
AIFs are defined as non UCITS “collective investment undertakings, which: 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.”
AIFs do not include “ordinary companies with a general commercial purpose”. A business strategy for a general commercial purpose is not a defined investment policy. Certain structures may choose to make changes which would see them fall outside of the AIF definition (subject to further clarifying guidance from regulators).
Although it is the AIFM rather than the AIF that is regulated by AIFMD, the AIF will need to comply with the transparency requirements in terms of disclosures (including remuneration, leverage and liquidity management) in financial statements, offering documents and regular reporting to the regulator.
Timing and authorisation
AIFMD will take effect from 22 July 2013, when EU based AIFMs will begin seeking authorisation with their national regulators. The FSA has indicated that authorisation applications must be made by July 2014 with compliance expected from the date of application.
Non EU based AIFMs marketing in the EU will need to register from 22 July 2014, using a self-certification style form, with compliance required from that date.
As it is the AIFM and not the AIF which needs to register, the location of the AIFM is important. The AIF may be self-managed, meaning that the AIFM and AIF are the same entity. The responsibilities and activities required of the AIFM are critical in determining which entity performs this role.
Responsibilities of the AIFM and the AIF board
Industry norms in respect of the split of functions between an investment manager, investment advisers and the board (or managing entity) of the fund do not neatly correspond with the AIFMD descriptions of the AIFM's role.
The AIFMD dictates that the AIFM must be fully legally responsible for, at least:
- portfolio management; or
- risk management; and
- complying with the requirements of the AIFMD.
AIFM senior management has broad duties including:
- responsibility for the implementation of AIFs’ general investment policies;
- overseeing the approval of the AIFs’ investment strategies;
- responsibility for establishing and implementing compliant valuation policies and procedures;
- ensuring and verifying that the AIFs’ general investment policies, investment strategies and risk limits are implemented and complied with; and
- approving and reviewing the AIFs’ risk management policies and implementation, including the risk limit system.
A number of these areas would typically be seen as under the control of the board of the AIF.
Issues of management and control for taxation and power over the investment manager for investor protection need to be carefully considered where the AIF is not internally managed.
The tax analysis of AIF structures is determined to a large extent by the specific functions and locations of key individuals, the nature and location of decision making and the contractual arrangements and other documentation which underpin these. To the extent that AIFs are making operational or legal changes to structures due to AIFMD, the potential tax impact must be an important part of the overall analysis. For example, the residence of the AIF could be compromised if decision making powers of the board are assumed by a UK based AIFM, thereby creating an establishment of the AIFM in the UK for indirect tax purposes. Changes to remuneration may require equivalent amendments to the manager’s and/or adviser’s transfer pricing policy. For VAT purposes, it is important that the offshore AIFM has the appropriate local human and technical resources necessary to carry out its key functions.
AIFMD requires that the AIFM ensure a depositary (separate from the AIFM) is appointed for each AIF. For many AIFs there has been no historical requirement to appoint a custodian of assets. Even for those AIFs that already have a custodian the responsibilities of the depositary under AIFMD are more extensive and onerous (somewhat similar to a corporate trustee role) and will therefore be more expensive. In addition to strict liability safekeeping responsibilities, other responsibilities include:
- monitoring of cash flows;
- compliance with investment restrictions and leverage limits;
- ensuring income calculations and distributions are correct; and
- oversight of the AIFMs processes and procedures, including:
- subscriptions and redemptions, and
A number of AIFs make use of administrators to provide services including, inter alia, compliance, bookkeeping, valuation, subscriptions and redemptions and corporate secretarial functions. There may be an opportunity for certain service providers to provide a managed solution to fulfil the regulatory requirements of AIFMD either on a standalone basis or in support of existing structures. In order to do this, service providers will need to carefully consider the level of expertise and resources required to take on these responsibilities and/or perform such functions.
Whilst the responsibilities of the AIFM are extensive and require significant resources to deliver, the AIFMD does permit elements of delegation. The extent of delegation permitted will, along with the nature of the managed AIF, determine the level of internal resources that an AIFM will require in order to fulfil its obligations under AIFMD.
The AIFM will no longer be considered the manager if it does not:
- retain the necessary expertise and resources to supervise delegated tasks effectively and manage the risks;
- have power to take decisions in key areas or to perform senior management functions in implementation of the general investment policy and investment strategies; and
- maintain rights to give instructions.
The AIFM is required to perform at least functions relating to either risk or portfolio management.
Interpretation of “performing the functions” is critical. Supervisory functions could be performed with substantially lower levels of resources than performing actual portfolio or risk management.
If the performance of investment management functions is delegated to a substantially greater extent than the investment management functions performed by the AIFM itself, it will no longer be considered the manager of the AIF.
The extent of delegation must be assessed with reference to risk and return profile of the investments, achievement of investment goals, geographical and sectoral spread of investments, risk profile of the AIF, type of investment strategy, types of tasks delegated and the structural relationship of delegate and AIFM.
As a practical example, delegation of investment management for a large proportion of the overall portfolio; or a small level of assets which have a very significant risk profile in the overall portfolio will likely fall foul of the delegation criteria.
Solely performing supervisory functions may not be sufficient to be the AIFM. A detailed analysis of the functions delegated and those retained will be required, including review of contractual agreements.
The delegation position and interpretation of the rules will be reviewed by the EU after two years and guidance may be issued in the interim, leaving the door open to force changes if market practice is not in line with EU expectations.
The vast majority of offshore funds will be impacted by AIFMD.
The impact will vary significantly depending on whether the AIFM is judged under AIFMD to be onshore or offshore and on whether the AIF is marketing or not.
Offshore AIFMs that are not marketing AIF in the EU will not need to comply with AIFMD, but it will still be important to consider whether the AIFM is genuinely offshore under AIFMD.
Offshore AIFMs may be able to continue utilising the national private placement regimes for marketing until 2018. Both onshore and offshore AIFM managing offshore AIF may be able to take advantage of the EU marketing passport from 2015, subject to regulatory equivalence.
For some funds, determining the location of the AIFM will be clear cut. For many, there will be a significant amount of judgement required; there may be scope to change operating models to achieve the most appropriate outcome. Contractual relationships will need to be reconsidered in all cases. The interaction of fund governance, tax status and the AIFMD will need to be carefully managed.
The time to act on AIFMD is now.
How Deloitte can help
We have a cross functional team of specialists well versed in AIFMD and, importantly, in the practical organisation of Offshore AIF. We have developed a structured approach to help boards rapidly address the key issues in AIFMD including
- Is the fund an AIF?
- Is it in scope of the AIFMD?
- What functions are performed by the AIF and by management and advisory entities?
- What are the current marketing routes used by the fund?
- What options are available under AIFMD?
- High level gap analysis
- Contractual and resource implications
- Governance implications
- Tax implications for the AIF and the AIFM
Our team works across offshore and onshore to bring parties together on AIFMD and provide practical advice.
We recognise that the regulatory environment and market interpretation of the impact is developing at pace. Furthermore, conflicting information and views abound.
In response, our approach quickly provides a bespoke overview for limited cost to assist boards in structuring and moving forward with their urgent response to the key AIFMD issues above.
* "offshore" and "onshore" are used throughout to refer to "non EU" and "EU" respectively