Alternative Investment Fund Managers Directive (“AIFMD”) –

Implementation GuideJuly 2013

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On 22 July 2013, the EU Alternative Investment Fund Managers Directive (“AIFMD”) was implemented in the UK

The AIFMD is part of a wide package of measures drafted by the European Commission to regulate financial services following the global financial crisis. The AIFMD applies to managers of all Non-UCITS alternative investment funds (“AIF”) that are managed or marketed in the EU. The AIFMD applies to all EU managers (“AIFM”) managing and marketing an AIF in the EU and all non-EU AIFMs who are either managing and marketing an EU AIF or marketing a non-EU AIF to EU investors.

This note provides a high level summary of the AIFMD’s key provisions and highlights those issues which firms active in the investment funds sector should be considering.

Key issues What are the key implications of the AIFMD?• All EU AIFMs will need authorisation to provide management

services to an AIF (regardless of whether the AIF is an EU or non-EU AIF)

• Firms should carefully consider who will be caught by the AIFMD, as the AIFM definition is intentionally wide to cover work traditionally done by both on-shore and off-shore entities. Firms will need to make this assessment looking at their individual structures of where their fund(s) and manager(s) are located and what functions are being performed

• An entity that holds itself out as managing an AIF will be deemed a letterbox entity (and not an AIFM) where it delegates investment management functions to such an extent that the delegated entity performs significantly more investment management functions than itself. This provision has been highly controversial as it may mean that some entities which are designated as the ‘manager’, for instance under fund documentation, are not regarded as the AIFM for purposes of the AIFMD. There are also likely to be scenarios where, as a result of the offshore manager being deemed a letterbox entity, the sub-manager (who is not in a position to fulfil the AIFMD conditions,

such as in relation to capital requirements) will become the AIFM

• The disclosure and conduct of business obligations will require regular monitoring and, as such, are likely to increase management operational costs

• Despite the varying level of risks posed by, for instance, a real estate fund and a hedge fund, the capital requirements on all AIFMs are determined by the same calculation and as such may be onerous and significantly increase management funding costs

• To comply with the capital and disclosure requirements, thorough and independent asset-valuation procedures will need to be established

• The asset stripping requirements may prevent a company from making a distribution when it could otherwise lawfully do so

• AIFMs must be aware of their potential liability as the Directive’s delegation rules specify that an AIFM’s liability to an AIF and its investors cannot be limited by it delegating its duties

• The leverage requirements will affect AIFMs that are intending to market non-EU AIFs into the EU through a non-public offering, such as a private placement regime

• Marketing will be a key factor for many AIFMs with EU AIFMs being able to utilise ‘passporting’ rights provided under the AIFMD, whilst non-EU AIFMs will be subject to an un-harmonised regime based on individual Member State private placement regimes.

Scope of the AIFMDWho will the AIFMD apply to?The AIFMD confirms that the new regulatory framework will apply to both: • EU AIFMs that manage one or more AIF (regardless of whether the

AIF is in the EU or not)

• Non-EU AIFMs that manage one or more AIF from within the EU (regardless of whether the AIF is an EU fund or a non-EU fund).

Which entities will be classified as AIFs?• An AIF is any ‘collective investment undertaking’ that raises

capital from investors with a view to investing it in accordance with a defined investment policy for the benefit of its investors. The phrase ‘collective investment undertaking’ is not specifically defined but the AIFMD confirms that an entity may be an AIF regardless of its legal structure, for instance, whether the structure is closed or open ended

• It should be noted that the term ‘collective investment undertaking’ within the AIFMD is designed to be wider than the definition of ‘collective investment scheme’ within the Financial Services and Markets Act 2000. The AIFMD will apply to a wide range of structures, including hedge funds, private equity funds, investment trusts and real estate funds.

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Which entities are specifically excluded from being AIFs?• Funds that require authorisation under the UCITS regime will not

be classified as AIFs

• Holding companies (as defined in the AIFMD) will not be subject to the AIFMD

• The AIFMD will also not apply to any of the following entities:

– EU regulated occupational pension schemes

– Governmental bodies which manage funds supporting social security and pension systems

– Supranational institutions

– National central banks

– Employee participation and saving schemes

– Securitisation special purpose entities, although the Commission, in its answers to questions it received on the AIFMD, specified that SPE should be interpreted narrowly and that the European Securities Markets Authority (“ESMA”) will publish further guidance on the application of the AIFMD to SPE’s (See link for Commission’s response to questions on SPE)

– Entities managing AIFs whose only investors are companies within the same group (provided none of those investors are themselves an AIF). This is potentially relevant, for example, in the case of a pension common investment fund (CIF), where the trustee of the CIF as well as the participants of the CIF (e.g. the corporate trustees of separate occupational pension schemes which co-mingle their assets through the CIF) are all members of the same corporate group

• There is also a lighter regulatory regime for AIFMs that manage AIFs with total portfolio assets below a specified ‘small portfolios’ threshold.

Which entities will be classified as AIFMs?• An AIFM is any legal person whose regular business is to manage

one or more AIF. The AIFMD specifies that ‘manage’ includes both the provision of “portfolio management services” and the provision of “risk management services”. Unhelpfully, neither of these terms is defined within the Directive and firms will need to make an assessment based on the factual circumstances of each entity

• An AIFM can be either an externally appointed manager (appointed by or on behalf of the AIF); or a self-managed AIFM, where the AIF itself will be treated as the AIFM.

Which AIFMs will the partial exemption from the AIFMD be applicable to?• A partial exemption from the AIFMD exists for AIFMs managing

AIFs with assets under management which in total do not exceed €500 million where (i) the AIF is not leveraged and (ii) investors have no redemption rights for the first five years of the initial investment

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• Where an AIF is leveraged and/or investors have redemption rights within the first five years, the AIFM can benefit from the exemption where the AIF’s assets (including assets acquired by leverage) do not exceed €100 million

• An AIFM wishing to rely on this exemption must be satisfied that its aggregate assets under management across all AIFs for which it is the AIFM do not exceed the limits. AIFMs relying on the exemption will be subject to registration and limited regulatory reporting requirements, though member states will have discretion to require more

• AIFMs relying on an exemption will not benefit from the AIFMD’s management or marketing passports unless they choose to opt into the entire AIFMD

• Further guidance on the application of the partial exemption is set out in the Pinsent Masons briefing note on small AIFMs which can be accessed by clicking here.

The requirement for AIFMs to be authorisedWhat are the authorisation requirements on AIFMs?• The AIFMD requires AIFMs to be authorised in order to perform

management services

• An AIFM wishing to be authorised must apply to the competent authority of its home Member State (in the UK this is the Financial Conduct Authority (FCA)). To obtain and retain authorisation, an AIFM must comply with the various requirements of the AIFMD. (The substantive requirements on the AIFMD are explored in detail below)

• Once authorised, AIFMs will be permitted to market the funds they manage

• The FCA has published final versions of the applications forms which firms should complete to vary their existing permission to include the activity of managing an AIF or to apply for a new authorisation. These forms can be found on the UK AIFM section of the FCA website.

Are AIFMs able to ‘passport’ their authorisation to other Member States? • Once authorised and subject to certain notification requirements,

EU AIFMs will be able to perform management services to funds domiciled in any Member State, either directly or via the establishment of a branch. This is known as ‘passporting’

• Two years after the main elements of the Directive come into force, ESMA will provide an opinion on extending the passporting regime to

third country non-EU AIFMs.

Requirements AIFMs must satisfy to obtain and retain authorisationWhat are the minimum capital requirements for AIFMs?• An AIFM that is internally-managed must hold a minimum

capital of €300,000

• An AIFM that is externally managed must hold a minimum capital of €125,000

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• Where the value of the AIF portfolio exceeds €250 million, the AIFM will be subject to an additional capital requirement equal to 0.02% of the amount by which the portfolio’s value exceeds €250 million

• The AIFMD contains a maximum capital requirement of €10 million although this can be overridden by the overarching requirement that the amount of capital held by the AIFM must never be less than one quarter of the previous year’s fixed overheads.

What are the general conduct of business and organisational requirements? • The AIFMD requires that AIFMs must act honestly, with due

skill, care and diligence and in the best interests of the fund, the investors and the market

• Every AIFM will need to ensure that it has appropriate procedures in place to deal with conflicts of interest and risk management

• The AIFMD contains remuneration rules for those staff within an AIFM whose professional activities have a material impact on the risk profiles they manage. The remuneration rules are designed to enhance risk management within AIFMs

• The AIFMD also includes extensive requirements relating to delegation of AIFM functions, valuation procedures and liquidity management policies.

What are the disclosure and reporting requirements?• In addition to the requirement to produce an annual report on

each AIF they manage, the AIFMD imposes periodic disclosure obligations on AIFMs

• AIFMs will be expected, for instance, to disclose to the FCA and investors on matters such as the fund’s risk and liquidity profile and the main instruments it trades. AIFMs must also give investors detailed information, before they invest, on a fund’s investment policy, how the fund is managed and what fees will be charged

• There are also specific disclosure requirements on AIFMs that manage private equity funds where the fund acquires shareholdings in a non-listed company or issuer.

Does an AIF need to appoint a depositary? • Each AIF must have one single credit institution acting as

depositary in order to receive and safe-keep both payments made by investors and financial instruments held by the AIF

• The AIFMD imposes strict liability on depositaries, with limited exemptions, for any loss of financial instrument

• In the event of a loss, the depositary will therefore be required to produce, without undue delay, an identical financial instrument or a cash equivalent to the instrument lost

• For funds that do not generally invest in assets held in custody and which do not have redemption rights exercisable for five years, Member States can authorise them to appoint a lawyer or other professional adviser to act as their depositary.

What are the leverage limits for AIFs?• AIFMs must set leverage limits for each AIF they manage. This limit

must be set by taking into account several guiding factors, such as an AIF’s investment strategy

• AIFMs will need to show that their leverage limits are reasonable and being complied with. AIFMs will also be required to disclose to investors and the FCA on a regular basis the type, total amount and risks associated with any leverage used

• Where an AIF employs leverage on a ‘substantial basis’ (another term requiring clarity on definition), the annual report to the FCA must include information on the overall level of leverage employed

• The FCA, where deemed necessary for the stability and integrity of the financial system, can impose limits on the level of leverage that an AIFM is able to employ.

What are the restrictions on asset stripping companies recently acquired by an AIF?• In the two years following the acquisition of a non-listed company

by an AIF, an AIFM must not facilitate any distribution, capital reduction, share redemption or acquisition of own shares by the acquired company

• This is subject to certain carve outs for some distributions from distributable reserves.

AIFMD marketing rules What effect does the AIFMD have on marketing AIFs into the EU? • EU AIFMs will be able to market AIFs using the passport regime.

Non-EU AIFMs will only be able to market EU AIFs and/or non-EU AIFs to professional investors under each Member State’s private placement regime, provided that (a) the non-EU AIFM complies with disclosure rules; and (b) relevant co-operation arrangements are in place with the competent authorities of the Member State where the AIF is marketed and the supervisory authorities of the third country where that AIF is established. For example, if a non-EU AIFM were to market a Guernsey Fund in France, a co–operation arrangement must be in place between Guernsey Financial Services Commission and the Autorité des Marchés Financiers

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• The negotiations for co-operation arrangements are being conducted by ESMA. ESMA has confirmed that 38 co-operation arrangements are in place between the EU Member States and third country regulators. Most significantly, this includes Canada, Australia, Brazil, Dubai, USA, Hong Kong and Singapore. Co-operation arrangements are also in place between the EU Member States and Jersey, the British Virgin Islands, the Cayman Islands, the Isle of Man and Guernsey. To access Pinsent Masons update tracking co-operation arrangements Click Here

• In 2015, ESMA will assess whether the passport regime should be extended to non-EU AIFs and non-EU AIFMs operating within the EU. Up until this time, Member States are able to impose their own restrictions to their existing private placement regimes. Whilst there is no clear indication for each Member State as to their intention on whether or how to maintain their private placement regime, certain regulators such as BaFIN have made clear their wish to review existing private placement regime and to potentially tighten their rules, including potentially extending this to REITs

• Between 2015 and 2018, Member States’ national private placement regimes and the European passport could co-exist (provided ESMA recommends that the passport be extended to non-EU AIF and non-EU AIFM). However, in 2018, ESMA is required to provide a recommendation as to the desirability of terminating the Member State national private placement regimes. If it does so, the Commission will have to pass secondary legislation phasing out these private placement regimes.

ImplementationWhat are they key dates for implementation of the AIFMD?

July 2013

2018

22 July 2013 – Member States implement the AIFMD into national law

22 July 2014 – Deadline for AIFMs that performed activities before 22 July 2013 within the scope of AIFMD to submit an application for authorisation

2015 – ESMA to report on the functioning of the passporting regime for EU AIFs and EU AIFMs and to consider extension of the passporting regime to non-EU AIFs and non-EU AIFMs

2018 – ESMA to review the AIFMD’s impact and to consider ending Member States’ private placement regimes.

How will the AIFMD be implemented into UK law?• HM Treasury has been responsible for transposing the

requirements of the AIFMD that require changes to primary and secondary legislation, the key piece of legislation being the Alternative Investment Fund Managers Regulations (“AIFM Regulations”). The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 has been amended to include management of an AIF as a new regulated activity

• The FCA is responsible for transposing the AIFMD into the FCA Handbook. The main substance of the changes is likely to be found in a new investment funds sourcebook within the FCA Handbook, referred to as “FUND” which applies to UK AIFMs and EU AIFMs which have passported their authorisation and established a branch into the UK. A UK AIFM of an authorised AIF (such as a NURS) is subject to the requirements in FUND and Collective Investment Schemes sourcebook (COLL)

• Where a AIF is managed by an authorised investment manager, that manager will be able to take advantage of a transitional period of up to one year before needing to vary its permission to include the ‘managing an AIF’ permission and comply with all the requirements of the AIFMD

• Despite the transitional provision, firms active in the investment management sector should be taking steps to determine the extent to which the AIFMD may impact their businesses.

Key Links• To access the full text of the AIFMD Click Here

• To access publications by Commission on the AIFMD Click Here

• To access the latest information on the FCA’s implementation of the AIFMD Click Here

• To access the latest information on HMT’s transposition of the AIFMD Click Here

• To access Pinsent Masons briefing note on the partial exemption Click Here

• To access Pinsent Masons update tracking co-operation arrangements Click Here.

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Our AIFMD TeamIf you would like to discuss the impact of the AIFMD further, please contact our AIFMD specialists:

Monica GognaPartnerT: +44 (0)20 7490 9695M: +44 (0)7500 760840E: monica.gogna@pinsentmasons.com

Michael LewisPartnerT: +44 (0)20 7490 6549M: +44 (0)7585 996254E: michael.lewis@pinsentmasons.com

Ian WarnerPartnerT: +44 (0)20 7418 9536M: +44 (0)7795 126912E: ian.warner@pinsentmasons.com

Daniel GreenawayPartnerT: +44 (0)20 7490 9331M: +44 (0)7585 996272E: daniel.greenaway@pinsentmasons.com

Financial Regulation

Funds

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