The Directive introduces specific requirements in four key areas which are considered to entail particular risks associated with AIFM activities: conflicts of interest; risk management; liquidity management; and investment in securitization positions.
Conflicts of interest
Identification of conflicts of interests
Pursuant to Article 14(1), each AIFM must take all reasonable steps towards identifying conflicts of interest that arise in the course of managing one or more AIF between:
- the AIFM, including their managers, employees or any person directly or indirectly linked to the AIFM by control, and the AIF managed by the AIFM or the AIF investors;
- one AIF (or its investors) and another AIF (or its investors);
- the AIF (or its investors) and another client of the AIFM;
- the AIF (or its investors) and a UCITS managed by the AIFM (or its investors); or
- two of the AIFM's clients.
Meaning of "interests of investors"
In considering how the conflicts of interest rules apply to the interests of investors in an AIF, AIFM should consider the interests of investors in their specific capacity as investor in that AIF (see Recital (12)). There is large scope for the interests of one investor to conflict with the interests of other investors including in situations, such as where one investor wants to redeem their holdings and the AIFM is considering whether to apply a gate to redemption.
Minimisation of conflicts of interest
The AIFM is obliged to take appropriate operational and administrative measures to minimise conflicts of interest and to respond to any such conflict, in particular by segregation of the relevant tasks and responsibilities. In the event that a conflict of interest cannot fully be compensated by organisational measures, the AIFM must inform investors accordingly in advance.
Use of services of prime brokers
Pursuant to Article 14(3), in the event that the AIFM (on behalf of the AIF) uses the services of a prime broker, the terms of that appointment must be set out in a written contract. In particular, any possibility of transfer and reuse of AIF assets must be provided for in that contract and must comply with the AIF rules. The contract must require that the depositary be informed of the contract.
The AIFM must exercise due skill, care and diligence in the selection and appointment of prime brokers on behalf of the AIF.
Effective risk management
The AIFM must establish adequate risk management systems (which must be separate from the operating units, including the portfolio management functions of the AIFM) to identify, measure, manage and monitor any risks connected with the investment strategies applied by the AIF.
The AIFM must review the risk management system with appropriate frequency, no less than once a year, and adapt it, whenever necessary.
Pursuant to Article 15(3), the AIFM must (as a minimum):
- implement an appropriate, documented and regularly updated due diligence process for investments on behalf of the AIF, which must reflect the investment strategy, objectives and risk profile of the AIF;
- ensure that the risks associated with each investment position of the AIF (and their overall effect on the AIF's portfolio) can be properly identified, measured, managed and monitored on an ongoing basis, including through the use of appropriate stress testing procedures;
- ensure that the risk profile of the AIF corresponds to the size, portfolio structure and investment strategies and objectives of the AIF as laid down in the AIF's constitutional documents, prospectus and offering documents.
Liquidity risk management
Pursuant to Article 16(1), the AIFM must implement appropriate procedures for liquidity management for each AIF it manages, to ensure that the liquidity profile of the investments of the AIF complies with its underlying obligations. This requirement does not apply to unleveraged, closed-ended AIF.
The AIFM must conduct regular stress tests which enable it to assess the liquidity risk of the AIF and monitor the liquidity risk of the AIF accordingly.
The AIFM must ensure that the investment strategy, liquidity profile, and redemption policy for each AIF that it manages are consistent.
Investment in securitisation positions
The Directive provides for further risk management requirements with respect to investments in securitisation positions in order to ensure cross-sectoral consistency and to remove misalignment between originators1 and AIFM. The requirements, which are to be specified in detail by the Commission as delegated acts (see here), shall include additional qualitative requirements for AIFM, as well as requirements to be met by the originator of any securitisation positions issued after 1 January 2011 in order for an AIFM to invest in these securities. For example, originators will be required to retain a 5% net economic interest in its securities or financial instruments.
These restrictions will be in addition to the similar requirements that are to be added in to the Capital Requirements Directive.
Footnotes: 1. "Originator" is defined in Art. 4(41) of the Capital Requirements Directive.