Melville Rodrigues looks at the challenges - and benefits - of the AIFM Directive for both EU and non-EU fund managers
The Alternative Investment Fund Managers Directive (AIFMD), which takes effect in July 2013, will apply to fund managers, whether based in the EU or elsewhere, promoting and/or managing real estate and other alternative investment funds in the EU.
Given the complexity of the directive - and the uncertainties yet to be addressed by proposals for implementing legislation - real estate fund managers should start preparing. The UK's Financial Services Authority (FSA), for instance, has issued a discussion paper, which is a significant step towards the UK implementing AIFMD.
The scope of the directive is wide. An alternative investment fund (AIF) is defined as any collective investment undertaking which raises capital from a number of investors with a view to investing in accordance with a defined investment policy, but excludes undertakings for collective investment in transferable securities (UCITS) funds. An AIF includes open- and closed-ended funds and could extend to entities not usually considered to be funds, such as corporates operating as investment vehicles.
An alternative investment fund manager (AIFM) is any person or organisation whose regular business is managing one or more AIFs. ‘Managing' an AIF means portfolio management, or risk management, or both. AIFM can be either external managers or the AIF itself, if internally managed.
There are, however, limited exemptions in the directive that may be relevant to fund managers' businesses - for example, for managers of small portfolios, joint ventures and fully invested funds. Small portfolios refer to funds not exceeding €100m, or unleveraged funds of less than €500m with a minimum five-year lock-in. The FSA's discussion paper recognises the need to clarify the extent of the joint venture exemption, and suggests that a commercial joint venture between participants actively involved in its management and control may not be considered an AIF. Fully invested funds are closed-ended funds that will not make additional investments after July 2013 or will expire by July 2016.
EU managers within the scope of the directive will need to apply to their national regulator to be authorised under the directive from July 2013, and obtain authorisation before July 2014. They will also have to comply with depositary and other AIFMD operational requirements. Non-EU managers, meanwhile, can utilise the private placements rules and may, in due course, benefit from a passporting regime.
Authorisation is compulsory for any AIFM managing an AIF after July 2014, and is conditional upon the AIFM fulfilling capital requirements. The minimum requirements are €125,000 for external AIFM and €300,000 for internal AIFM. These sums increase according to the level of funds under management: where the funds exceed €250m, the AIFM must hold capital equal to 0.02% of the excess. The maximum capital in all cases is €10m.
Authorisation is also conditional upon other factors: for instance, the AIFM has to demonstrate it can comply with the directive's operational requirements and has suitable management staff. Fund management organisations may need to review their operations, which may include consolidating management activities within a single AIFM.
All AIFs are required to have a depositary, typically a custodian bank, which is independent from the AIFM. The depositary will be responsible for monitoring the AIF's cash flows, verifying the ownership of the AIF's assets and overseeing various administrative procedures. These procedures include the sale and redemption of fund units and the calculation of net asset value. AIFMs should ensure the depositary works efficiently with the administrator and other fund service providers: for example, in relation to information flows, decision-making processes and formalising transactions.
In addition, the AIFM must comply with other operational requirements, including the maintenance of risk and liquidity management procedures, independent valuations, and transparency obligations to investors and the regulator. Given that the operational costs arising from the directive will be passed on to fund investors, they will no doubt be concerned that AIFMs obtain competitive pricing for the depositary and other operational services.
In the case of a non-EU manager looking to promote and/or manage real estate funds in the EU, it is envisaged there will be two frameworks: the private placement rules and, from 2015, a passporting regime.
Currently, non-EU managers may be able to market funds under national private placement rules in EU member states. This entitlement will continue until 2018, subject to certain requirements: principally, the home regulator enters into co-operation agreements with relevant EU states and complies with Financial Action Task Force (FATF) requirements (in other words, implements anti-money laundering and terrorist financing regulations), and the manager observes the transparency requirements of the directive.
The EU plans to introduce a passport for non-EU managers from 2015. The passporting framework will run alongside the private placement rules from 2015 for three years, during which period non-EU AIFMs will be able to utilise both regimes. The passporting regime will require the non-EU manager to be authorised with its home regulator and comply with the directive. The passport will be available to managers where: co-operation agreements are in place between the home regulator and the EU regulators; the jurisdiction is FATF-compliant, and there are OECD-compliant tax information exchange agreements between the non-EU jurisdiction and each EU state in which the fund is to be marketed. This passporting regime will eventually become the single framework allowing non-EU managers to manage and promote real estate funds in the EU if, as currently intended, the EU discontinues the private placement rules from 2018.
Non-EU managers should therefore recognise that their ability to utilise the private placement rules and the passporting regime will depend on their home regulator and government. Given this dependence (and associated risks), managers looking to market funds to EU investors may need to consider re-domiciling either to another non-EU state or the EU.
Benefits, not just burdens
Notwithstanding the greater compliance burden imposed by the directive, it does have an important benefit for managers of real estate funds, whether based in or outside the EU.
EU AIFMs will be entitled to market, or passport, EU funds throughout the EU to professional investors, and will no longer need to comply with different national requirements. The AIFMs may also be entitled to market the AIFs to retail investors under national law. The equivalent benefit should apply to non-EU managers looking to market to EU investors under the third-country passporting regime to be introduced in 2015.
The directive presents opportunities for fund management organisations to operate more effectively on a pan-European basis, and to market fund products to EU investors.
Managers should exploit these opportunities, but also address investors' key concern - that any erosion of investment returns resulting from compliance with the directive is kept to a minimum.
Melville Rodrigues is a partner at CMS Cameron McKenna