the proposed eu aifm directive september 2009

The proposed EU Alternative Investment Fund Managers Directive

Impact on real estate funds

The European Commission proposed a new Directive on Alternative Investment Fund Managers (AIFM) in April 2009. The proposal aims to introduce a harmonized European regulatory and supervisory framework for the alternative investment sector. The Commission believes that closer regulatory engagement and supervision of the activities of managers of alternative investment funds across Europe is required. The proposed changes in the AIFM Directive will have a significant impact on the real estate fund sector – the managers, the funds, their service providers and investors. In this paper, we briefly outline the proposed regime and potential issues for the real estate fund sector.

Objectives

The AIFM Directive is designed to address a number of risks identified by the European Commission related to alternative investment funds (AIFs). The Commission does not believe that fragmented national approaches constitute a robust and comprehensive response to these risks.

The key objectives of the proposed AIFM Directive are to:

Ensure that all AIFM are subject to appropriate authorization and registration • requirements

Provide a framework for the enhanced monitoring of macroeconomic risks •

Improve risk management and organizational safeguards at the individual AIFM level•

Enhance investor protection •

Improve public accountability for AIFs holding controlling stakes in companies•

Develop a single market for AIFs•

Risks identified by the European Commission

Macroprudential Direct exposure of systemically important banks to the • alternative investment fund sector

Procyclical impact of herding and risk concentration•

Microprudential Weakness in internal risk management system•

Investor protection Inadequate investor disclosures on investment policy, risk • management and internal processes

Conflicts of interest and failures in fund governance•

Market efficiency and integrity

Impact of dynamic trading and short selling techniques on • market functioning

Potential for market abuse in connection with certain • techniques, such as short selling

Impact on market for corporate control

Lack of transparency when building stakes in companies, • or concerted action in “activist” strategies

Impact on companies controlled by alternative investment fund managers

Potential for misalignment of incentives in management • of portfolio companies, in particular in relation to the use of debt financing

Lack of transparency and public scrutiny of companies • subject to buy-outs

Overview of the Directive

The proposed EU Alternative Investment Fund Managers Directive: Impact on real estate funds 2

Scope

While the main focus of the AIFM Directive is on managers of alternative investment funds, the Directive will impact:

EU and non-EU AIFM •

EU and non-EU domiciled AIFs•

Service providers to these funds•

Investors•

In summary, the Directive applies to all AIFM established in the EU that provide “management services” to AIFs, irrespective of whether they provide the services directly or by delegation, and that have more than either:

€100 million of assets under management (including assets acquired through the • use of leverage)

€500 million of unleveraged assets under management with at least a five-year • lock-up period for each AIF

“Management services” means the activities of managing or administering one or more AIFs on behalf of one or more investors.

AIFs are any collective investment undertaking other than a UCITS,1 pension funds, endowments or sovereign wealth funds - for example, hedge funds, private equity and real estate funds.

The Directive will also impose requirements on other service providers to AIFs, such as custodians and valuators.

AIF passport

AIFM may market shares or units of their AIFs to professional investors in their home EU Member State, and in other EU Member States subject to a notification procedure. Under the notification procedure, the AIFM communicates required information to its home Member State authority. Once the home Member State authority has transmitted this information, together with an attestation that the AIFM concerned is authorized, to the host Member State authority, the AIFM receives a notification permitting it to start the marketing of AIF in the host Member State. The definition of “professional investor” is that of MiFID.2

AIFM domiciled in a third country may market the shares or units of their AIFs to professional investors in the EU providing that certain conditions are met. In particular, they must be subject to prudential regulation and supervision that is deemed equivalent to the provisions of the Directive and effectively enforced. These provisions are deferred for a three-year period, during which third-country AIFs may continue to be marketed in EU Member States under the current national regimes.

AIFM passport

AIFM domiciled in one Member State may also provide management services in relation to an AIF domiciled in another Member State, either directly or via the establishment of a branch, provided that the AIFM is authorized to manage that type of AIF. In both cases, a notification procedure is followed starting with the AIFM communicating required information to its home Member State authority.

1 An undertaking for collective investment in transferable securities, in accordance with the UCITS Directive.2 The Markets in Financial Instruments Directive, Directive 2004/39/EC.


Requirements

AIFM will be required, inter alia, to:

Comply with conduct of business requirements•

Implement adequate organizational and administrative arrangements to identify • conflicts of interest between it and the investors, and between investors, and implement adequate organizational and administrative arrangements to prevent conflicts of interest from adversely affecting the interests of the AIF and its investors

Implement separate portfolio management and risk management functions•

Implement risk management systems in order to measure and monitor appropriately • all risks associated with the AIF, review the risk management systems at least once a year and adapt them, whenever necessary. Risk management should include an appropriate, documented and regularly updated due diligence process when investing on behalf of an AIF.

Implement appropriate liquidity risk management systems and procedures•

Comply with initial and ongoing capital requirements of:• €125,000 plus 0.02% of assets under management exceeding €250 million −25% of annual expenditure (if greater than the capital required under the previous −sub-bullet)

Provide disclosures to investors when they invest (and inform them of any • subsequent changes) including:

A description of the investment strategy and objectives of the fund −The eligible assets and techniques, and their associated risks −The use of leverage and associated risks −Process to be followed when the investment strategy is modified −The identity of all service providers −A description of the AIF’s liquidity risk management, including the redemption −rights both in normal and exceptional circumstances, and how the AIFM ensures a fair treatment of investorsThe fund’s valuation procedures and pricing models −Description of fund fees, charges and expenses −Any favorable agreements with specific clients −

Provide periodic disclosures to investors on:• The percentage of the AIF’s assets that are subject to special arrangements −arising from their illiquid natureAny new arrangements for managing the liquidity of the AIF −A description of the risk profile and risk management systems employed −

Report to regulators, including:• Principal markets and instruments traded −The percentage of the AIF’s assets that are subject to special arrangements −arising from their illiquid natureRisk profile and risk management tools −Liquidity risk management arrangements −The use of short selling −

Provide further reporting to investors and regulators where one or more AIF • managed by the AIFM employs high levels of leverage on a systematic basis

Notify unlisted companies and their shareholders when the AIFM acquires 30% • of the voting rights (small and medium-sized companies are not covered by this requirement). These provisions also apply where the AIFM has concluded an agreement with one or more other AIFM that would allow the AIF managed by these AIFM to acquire 30% or more of the voting rights of the issuer or the nonlisted company.

AIFM will be required to appoint custodians and valuators that are independent from the manager.

When delegating functions, AIFM will require prior authorization from the competent authorities of the home Member State. Portfolio management and risk management functions may only be delegated to AIFM authorized to manage the same type of AIF.


The role of the custodian includes:

Receiving subscription payments and booking them in a segregated account•

Safekeeping of financial instruments of the AIF•

Verifying whether the AIF or the AIFM on behalf of the AIF has obtained ownership of • all other assets the AIF invests in

The custodian will be liable to investors for any losses suffered as a result of its failure to perform its obligations. This includes any loss of financial instruments unless the custodian can prove that it could not have avoided the loss. Custodians may delegate their tasks to other custodians.

The independent valuator must implement appropriate and consistent procedures to value the assets of the AIF in accordance with existing applicable valuation standards and rules, and ensure AIF valuation rules are in line with the law, and the fund rules or instruments of incorporation. It must ensure that the assets, shares and units are valued:

At least once a year•

Each time shares or units are issued or redeemed•

The domicile requirements for EU AIFM are set out as follows:

EU

AIF

M

EU AIF Custodian: EU credit institution•

Sub-custodian: EU credit institution•

Valuator: in EU or third country, if subject to “equivalent” • requirements

Administrator: EU or third country subject to certain • requirements

Non-EU AIF Custodian: EU credit institution•

Sub-custodian: in AIF domicile with “equivalent” legislation•

Valuator: in EU or third country, if subject to “equivalent” • requirements

Administrator: EU or third country subject to certain • requirements

Timeline for implementation

If the AIFM Directive were to be adopted according to plan by the European Parliament and the Council of the European Union, it would enter into force in 2011.

A number of areas in the Directive must be clarified by the European Commission before the Directive enters into force; these will be included in a separate implementing Directive.

The expected timeline for adoption and implementation for the AIFM Directive is as follows:

2009 2010 2011 2012 2013 2014

April 2009 AIFM draft

Directive published

Discussions with the industry and with EU

Member States

AIFM Directive should be approved by EU

Parliament and EU Council by the end of 2009

2011 Directive enters

into force

Publication of implementing

measures

2014Passport to market

AIF domiciled outside EU available}}


The proposed AIFM Directive raises a number of practical considerations for the real estate fund industry.

The regulation of AIFM will substantially impact those real estate fund managers who are currently not subject to any regulatory supervision in Europe at either a product or manager level. In particular, the private equity and opportunistic fund managers who are not associated with larger financial services organizations and typically use unregulated fund structures, will face the most substantial burden.

Practical considerations

6 The proposed EU Alternative Investment Fund Managers Directive: Impact on real estate funds

i) The definition of collective investment undertaking

While an AIF is defined in the proposed AIFM Directive as any collective investment undertaking excluding UCITS, “collective investment undertaking” is not clearly defined. The preamble of the Directive refers to “collective investment undertakings which raise capital from a number of investors with a view to investing it in accordance with a defined investment policy on the principle of risk-spreading for the benefit of those investors.” However, in practice, this is very generic. There are different relevant references to the concept of collective investment (e.g., the UCITS Directive, OECD, UK Financial Services and Markets Act 2000). Whereas a common feature of such definitions is that there is pooling of assets, there are often distinctions made between different legal forms.

It may be difficult to establish which alternative vehicles are covered by the definition – for example, would a listed and traded investment fund with fixed capital (which is in substance similar to a public limited company) or a Luxembourg SICAR (which operates with pooling and variable capital but is technically not an investment fund) fall under this regulation? In addition, it is unclear which portion of the population of Real Estate Investment Trusts (REITs) in Europe (which can either be private or listed products, all of which are regulated but do not fall under the UCITS regime, and are often self-managed) would be covered by the Directive.

It is interesting to note that a number of managers exclusively managing closed-ended real estate funds (which have a duration generally exceeding seven years) could have benefited from the exemption for managers with less than €500 million under management with at least a five-year lock-up period. However, the requirement for the assets under management to be unleveraged means that such managers will not be eligible (we discuss the importance of establishing consistent rules on how leverage is measured in v) Leverage).

It is fundamental that the exact scope of this Directive be clearly defined in relation to existing products and also that the Directive establishes clear principles to determine whether new products will be in scope. Exemptions for closed-ended institutional real estate funds as they exist today should be considered.

ii) Investors

The Directive limits the distribution to professional investors, as defined under MiFID. Today, High Net Worth Individuals (HNWIs) invest in such products to access benefits not achievable in privately managed portfolios. These include potential yields or capital gains, access to diversified portfolios of investments, benefiting from professional management of the portfolio and spreading costs.

We believe that one of the end results of the proposed Directive should be enhancing and protecting the flow of capital into such products in the future. The Directive would, however, be potentially damaging to the sector by excluding HNWIs investing internationally in such funds.

Furthermore, excluding HNWIs as eligible investors would significantly limit their individual options and potentially increase their overall investment risk by driving them, in the medium term, to listed securities or nondiversified personally managed portfolios.

The authors of the Directive should seriously consider the impact on the total amount of capital flowing into the sector as a result of excluding a significant number of qualified investors. They should also consider the rights of qualified individuals to access such products.



iii) Management services

It is critical to understand accurately what is meant by management services in the proposed Directive. In reality, “management services” could cover a number of different activities within typical real estate fund structures.

Generally management services could fall into four generic types. These are:

Fund management• : This sets the overall strategic direction of the fund. This is done by management companies or boards of self-managed funds.

Investment management• : This provides advice to fund management regarding transactions or the execution of specific tactical asset management programs. This is often subcontracted to investment advisors; however the final decisions based on the advice provided are taken by fund management.

Property management• : This provides day-to-day tenant and physical property management services.

Administration• : This covers a broad range of activities including accounting at fund or Special Purpose Vehicle (SPV) level, domiciliation, paralegal and corporate secretarial services and processing transactions in fund shares or units. In regulated funds, many of these activities are currently performed by service providers approved and supervised by the regulator.

There are several important open questions requiring further clarification regarding the scope of management services as defined by the Directive:

The Directive requires that when portfolio management services are • delegated to a third party, the third party must be authorized to manage equivalent AIFs. Today, although a significant part of fund management is regulated, investment management is typically not directly supervised as the responsibility for such activities ultimately lies with fund management. It is unclear whether the scope of the proposed Directive extends to investment management in this sense. If it were to be the case, this would have a significant structural impact on the real estate asset management sector.

The individual property managers are generally small local entities that • are often generally not subject to licensing requirements in the EU. It is unclear whether the proposed Directive also applies to individual property managers.

Although the proposed Directive refers to administration within the • definition of management services, it is unclear whether it is the intention of the authors to cover pure “administration activities.” In fact, currently for regulated funds, fund administration services are already carried out by regulated entities; these activities are not considered as “management services.”

Clearly the scope of “management services” needs to be clarified and needs to take account of current regimes and the organization of the sector. If investment management, property management and/or pure administration were being targeted under management services, the impact would be substantial and disproportionate.



iv) Capital requirements

The Directive imposes minimum capital requirements and an increase in proportion to the assets under management above €250 million.

The Directive suggests that minimum capital requirements will “ensure the continuity and the regularity of the management services provided by the AIFM” – i.e., to ensure there is sufficient capital to cover the ongoing operations of the manager.

The running expenses of a real estate fund are, however, not necessarily proportional to the size of the fund – many are fixed or semi-variable.

However, the Directive also refers to capital requirements to cover professional liability, which is a very different concept. It is highly unlikely that capital requirements would cover professional liability; such risks are normally mitigated through insurance.

Furthermore, it seems difficult to understand why the capital required for AIFM targeting professional investors is set at a similar level to that required for UCITS management companies that are concerned with retail investor protection.

A key objective of the Directive is to monitor risk at systemic level, and therefore it should sharply focus on this point. The Directive needs to clarify not only how managers will report on leverage, but more importantly how they will measure it. Fair and consistent rules should be applied across all types of funds, based on existing industry standards. An additional layer of rules redefining leverage would create a significant burden on EU real estate fund managers and investors with arguably minimum added value.


The capital required for AIFM should be proportional to the running expenses rather than assets under management. It should not exceed the capital required for UCITS management companies. It is unrealistic to assume that professional liability exposure can be covered by minimum capital requirements; the Directive should foresee other means of achieving this objective.

v) Leverage

The Directive imposes additional disclosure and reporting requirements on funds with “high levels of leverage on a systematic basis” defined as where the combined leverage from all sources exceeds the value of the equity capital of the AIF in two of the last four quarters. This will impact many real estate funds. Clearly, the degree of leverage is a significant risk factor that should be taken into account.

One of the issues arising from the European Commission’s definition of leverage relates to how it is calculated. While real estate funds will typically prepare consolidated accounts, and are therefore in a position to calculate leverage at a consolidated level, private equity and hedge funds do not generally consolidate their results, meaning that potentially a significant portion of leverage remains off-balance sheet.

The determination of the debt-to-equity-ratio, and hence leverage, is a highly complex technical issue. Accounting standards (e.g., IFRS) establish common rules for the identification and measurement of equity, debt and hybrid instruments. This includes a detailed framework covering among other things off-balance sheet and orphan entities, derivatives and hybrid instruments. A key question, therefore, is whether the measurement of leverage should be aligned with existing accounting rules, or whether the authors had something additional in mind for the purposes of the Directive.

To ensure the stability and integrity of the financial system, the Directive requires the Commission to adopt measures setting limits to the level of leverage AIFM can employ, taking into account the type of AIF, its strategy and sources of leverage. Member State authorities may temporarily impose additional limits. Current national regulation in a number of Member States requires regulatory approval of the proposed level of leverage or limits leverage, mainly for the purposes of investor protection. For regulated funds, it would appear that there would be no additional requirements in this sense, assuming that levels of leverage are set below the current levels. Obviously, for currently unregulated funds, this is a new concept.


vi) Independent valuation

The vast majority of real estate funds in Europe have an independent valuation process for property. Independent valuators generally implement industry valuation standards, such as those of the Royal Institute of Chartered Surveyors (RICS). In terms of valuing the real estate assets themselves, we conclude that these long-established valuation practices should not be impacted, in principle.

Many non-listed real estate funds permit subscriptions and/or redemptions on a quarterly basis, and some even more frequently, while the independent valuation of the underlying property assets does not necessarily match the timing of the issue and redemption cycle. The frequency of the valuation is adapted to the fund style. There are current, generally accepted industry guidelines on this subject (e.g., from INREV3 and EPRA4).

However, the proposed AIFM Directive requires that the independent valuator ensure that the assets, shares and units are valued at least annually and each time shares or units of the AIF are issued or redeemed.

External appraisals of property cannot be conducted on more than a monthly basis and are often only done annually for closed-ended funds. Given the nature of the independent property valuation process, it is impractical to call for independent valuations each time shares or units of the real estate fund are issued or redeemed in frequently traded funds. If this is the case, it either means more frequent valuations resulting in a significant additional expense burden for investors, or a reduction in investor liquidity due to a reduced subscription and redemption frequency.

Furthermore, there are significant other assets and liabilities held on the balance sheets of real estate funds, including among others debt, derivative hedging instruments, equity in joint ventures and associated companies, along with working capital balances and cash. The question is, what was in the minds of the authors with respect to the independent valuation of these other assets and liabilities that form a significant part of the determination of the net asset value?

Today, for regulated real estate funds, an independent central administrator in conjunction with the custodian monitors the valuation of all assets and liabilities, including the work of an independent property valuator, in the calculation of the net asset value. Is this the type of arrangement that the Directive aims to implement? If this is not the case, this may create an operating model without precedent for real estate funds and may have an adverse impact on investor liquidity and returns.

If the Directive imposes additional independent valuation requirements on real estate funds, this would be without precedent for any type of company or fund, including listed entities, in which the public can trade. Furthermore, the authors need to take account of the specific nature of the asset class and how valuations of immovable property are conducted in reality.


3 European Association for Investors in Non-listed Real Estate Vehicles.4 European Public Real Estate Association.


vii) Custodian

The proposed Directive segregates the custodian’s role for the financial instruments and other assets. For financial instruments, it imposes a safekeeping role. For other assets, it requires the custodian to verify “whether the AIF or the AIFM on behalf of the AIF has obtained ownership of all other assets the AIF invests in” as well as ensuring that title to assets has been effectively transferred. The supervisory role of custodian in relation to real estate titles is thus properly addressed in the proposed Directive.

However, the Directive also raises concerns over the custodian’s liability for ensuring that legal title has been established. There are divergent standards in Europe for establishing legal title. Much of the work, prior to, during and after an acquisition, is currently performed by service providers that are generally not EU credit institutions (including lawyers). The custodian’s role in acquisitions is generally to ensure that due care has been undertaken in the transaction assessment and completion. This includes ensuring that the acquisition has been discussed and agreed, that all advisable due diligence has been undertaken, that there is no apparent factor that may prohibit the fund from owning the property and that all documentation is consistent with the transaction as agreed. The actual safekeeping of documents relating to legal title is generally not performed by EU credit institutions, but is monitored by the custodian.

The custodian’s liability should be limited to ensuring that an adequate due diligence process for property transactions is conducted and an ongoing role of monitoring safekeeping. The Directive needs to clarify this role.

viii)Risk management

It is in all parties’ best interest that real estate funds implement an adequate risk management framework, irrespective of regulatory requirements.

In this area, the main thrusts of the proposed AIFM Directive are:

Risk management systems must be implemented by the AIFM in order to • measure and monitor appropriately all risks associated with each AIF investment strategy

Separate annual reviews of risk management systems are required•

A documented and regularly updated due diligence process is necessary when • investing on behalf of an AIF

While financial services organizations are used to such requirements, niche players with no previous experience of complying with such regulatory requirements will be challenged to formally document their existing risk management procedures and subject them to independent reviews. In the roll-out of risk management regulation in the past, there was a significant role for independent auditors in providing comfort on risk management standards. We are not sure whether this is what is anticipated under the current proposals regarding annual reviews.

However, investors in AIFs are sophisticated professional investors who are well aware of the risks they are taking when investing in a fund. A distinction needs to be made between standards applied for professional investors and those applied for the general public. The level of contractual due diligence undertaken by professional investors is generally high and therefore the standards applied and levels of comfort required in this area should take this into account.

Given the nature and practicalities of risk management frameworks, it is difficult to achieve pragmatic regulation in this area. To many commentators, the roll-out of Sarbanes-Oxley regulation in the US created a disproportionate burden on companies and resulted in dramatic shifts in capital flows. Also, there are already global standards, such as the COSO5 framework, covering the design and functioning of risk management models.

Clearly, AIFM need to implement adequate risk management processes and procedures to ensure that their fiduciary responsibilities towards investors are being met. Practically, the provisions of the Directive need to ensure that the level of formalization of risk management requirements is proportionate to the effort and expense.

A separate issue is that the custodian is required to book subscription payments from investors in a segregated account; however, such activities may currently be performed by other authorized entities. This is monitored, rather than executed, by the custodian; it is difficult to see how investors would benefit from the change.

The custodian’s role should be monitoring rather than booking subscription and redemption payments.


5 Commitee of Sponsoring Organizations (COSO).


ix) Conflicts of interest

The Directive requires that the AIFM take all reasonable steps to identify conflicts of interest between themselves and the investors, but also between investors, and implement adequate organizational and administrative arrangements to prevent conflicts of interest from adversely affecting the interests of the AIF and its investors. Where such arrangements are not sufficient to ensure that the risks of damage to investors’ interests will be prevented with reasonable confidence, the AIFM is required to disclose the nature and sources of conflicts of interest before they invest and develop appropriate policies and procedures.

While real estate fund managers are used to managing conflicts of interest between themselves, the fund and its investors, identifying all conflicts of interest between investors will be practically impossible. Our reading would indicate that this is more an obligation of means rather than results, but further clarification would be useful.

It is interesting to note that the proposed Directive is silent on common techniques used in the industry to align the interests of the managers and investors. Currently, players in the sector consider these types of financial alignment techniques as critical in balancing different agendas.

It is unreasonable to require real estate fund managers to be in a position to identify all conflicts of interest between investors, especially in large open-ended funds with hundreds of investors. The existence of commercially negotiated arrangements to align interests should be considered by regulators and give them some comfort.

x) Side letters

The Directive stipulates that no investor may obtain preferential treatment, unless this is disclosed in the AIF fund rules or instruments of incorporation; furthermore, it requires the disclosure to investors of the identity of investors receiving preferential treatment and a description of the preferential treatment.

Side letters, such as agreements with individual investors to reimburse fees or providing for other preferential arrangements outside the legal framework of the fund, are commonplace in real estate funds. There is an intense debate within the industry on whether the existence and content of side letters should be disclosed. Current INREV guidelines only go as far as calling for the manager to explain the general approach to disclosure of side letter arrangements to investors.

The Directive could target general disclosure of the framework and limits of such arrangements. It goes further, however, by requiring individual arrangements be disclosed. This approach raises significant investor confidentiality issues.

If there are to be provisions covering side letters, we suggest that the Directive should not go beyond requiring the existence, framework and limits of side letter arrangements be disclosed. The identity of the investor and exact content of each individual side letter should, however, remain confidential to the parties involved.



xi) Choice of domicile of AIFM and AIF

By establishing passports both for AIFM and AIF, the proposed AIFM Directive permits AIFM to choose to establish themselves and their AIF in the domiciles that offer the most advantageous conditions. Their choices of domiciles will depend on factors such as:

Flexibility of the regulatory environment•

Fiscal environment for investors and fund managers •

Reputation of financial center•

Accessibility of the authorities•

Expertise and cost competitiveness of locally based service providers•

Ability to outsource both within the domicile and cross-border•

Qualifications and knowledge of workforce (including languages)•

Although perhaps not intentionally, the AIFM Directive may lead to concentration of AIFM and AIF in the most attractive domiciles.

xii) Non-EU AIFM and non-EU AIF

Non-EU managers

Under the proposed Directive, non-EU AIFM will be able to market their funds in the EU subject to certain requirements, including equivalent regulation and supervision. There are no practical principles or processes defined in the Directive for establishing equivalence. Establishing “equivalence” will be a challenging task for the European Commission, which struggled with IFRS equivalence under the Transparency and Prospectus Directives. Furthermore, there is a three-year delay for the implementation of these measures.

Non-EU real estate fund managers will have significant incentives to establish themselves in the EU to be able to passport their products to investors in other EU Member States. More important, as a practical matter, it makes business sense to have a physical presence close to investors and assets – i.e., in the EU for an investment strategy primarily focused on European investors and/or property.

Non-EU funds

The shares or units of a non-EU AIF may only be sold to investors in EU Member States if the Member State has signed tax cooperation agreements and implemented information exchange on tax matters with the third country in which the fund is domiciled – again, there is a three-year delay before implementation. It remains to be seen how many offshore jurisdictions will enter into such agreements with EU Member States. No doubt this will drive a significant migration of funds to onshore domiciles.

Going forward, as a practical matter, and in the light of the proposed Directive, non-EU real estate fund managers will need to establish a base in the EU and domicile their funds in the EU at least for the foreseeable future.



6 White Paper on Financial Services Policy (2005-2010).

Conclusion

The challenge is to make sure that the new Directive

is targeted and effective on the one hand, and

pragmatic, practical to implement and proportional

to the objectives on the other. The specificities of the real estate fund sector need to be taken into account if it

is to continue to flourish.

The European Commission has indicated that it is committed to transparent, evidence-based policymaking founded on a dual commitment to open consultation and impact assessments.6

The proposed AIFM Directive was, however, drafted without the usual industry consultation process; therefore it is no surprise that there are many practical issues, some of which are raised in this paper, that need to be resolved if the authors’ objectives are to be met. It has generated much discussion and been the subject of heavy criticism.

AIFs have seen substantial growth in recent years and have now become significant players in global markets. Thus, overall, we understand the political viewpoint that the regulation of AIFM is a necessity. In the current political climate, it is almost inevitable that a new regulatory framework, in one form or another, will become a reality.

Real estate funds are not the primary target of the AIFM Directive. They do not present many of the types of risks that the AIFM Directive is designed to mitigate or expose. European real estate funds are generally well regulated and comply with industry standards, such as those of INREV. Recently, European open-ended real estate funds were being considered as potential investments for European retail investors.

While most of the proposed Directive was drafted as a one-size-fits-all approach, there are important distinctions that need to be made between the operations of hedge funds, real estate funds and private equity to ensure the authors’ intentions are translated into an appropriate regulatory regime.

From the perspective of real estate funds, we are particularly concerned that:

The collective investment undertakings covered by this Directive need to be clearly • identifiable

HNWIs may no longer be able to invest in these products internationally•

The scope of “management services” needs to be clarified•

Fair and consistent rules should apply to the measurement of leverage, based on • industry standards

The scope of the requirement for independent valuation needs to be clarified•

The provisions on risk management should not be overly burdensome on the industry•

The provisions on conflicts of interest need to be practical and proportionate to the • required result, in particular in relation to potential conflicts of interest between investors

While the existence and typical content of side letters should be disclosed, the • identity of the investors and exact content of each individual side letter should remain confidential

There is no doubt that the Directive, if implemented, will drive significant structural change in the real estate asset management sector. It may lead to a concentration of asset managers seeking to optimize their operations - and funds - in certain locations or to the migration of offshore products to European domiciles. It may even force, at least in the short term, non-EU asset managers to establish regulated operations in Europe.


EMEIA Real Estate LeaderDean Hodcroft +44 20 7951 4870 [email protected]

EMEIA Real Estate Asset Management LeaderMichael Hornsby +352 42 124 8310 [email protected]

EMEIA Real Estate country contactsBelgium Patrick Rottiers +32 3 270 1233 [email protected]

Channel Islands Geraint Davies +44 1534 288 639 [email protected]

France Bernard CharrueMarie-Henriette Joud

+33 1 4693 72 33+33 1 4693 67 49

[email protected]@fr.ey.com

Germany Karl Hamberger Dietmar Fischer

+49 89 14331 13662+49 6196 996 24547

[email protected]@de.ey.com

Ireland Des Quigley +353 1 2212 550 [email protected]

Italy Stefano CattaneoAlberto Romeo

+39 027 2212 452+39 027 2212 445

[email protected]@it.ey.com

Luxembourg Michael Hornsby +352 42 124 8310 [email protected]

Netherlands Jeroen PreijdeAd Buisman

+31 8840 71679+31 55 5291 428

[email protected]@nl.ey.com

Central and Southeast Europe Harry Kyrkos +30 210 288 6211 [email protected]

Spain Francisco Fernández RomeroJosé Carlos Hernandez Barrasus

+34 91 57 27 303+34 915 727 291

[email protected]@es.ey.com

Switzerland Rolf Bach +41 58 286 3870 [email protected]

UK Dean HodcroftCraig HughesMatt MaltzJames StuartRob Otremba

+44 20 7951 4870+44 20 7951 8397+44 20 7951 1886+44 20 7951 5349+44 20 7951 0607

[email protected]@[email protected]@[email protected]

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the proposed eu aifm directive september 2009

Documents

aifm passport aifm

proposed aifm directive

noneu aifm eu

alternative investment

home eu member state

aifs risks

real estate funds

directive objectives