Yesterday afternoon the draft text of the "Proposal of the European Parliament and of the Council on Alternative Investment Fund Managers" (the "Draft Directive") was published. Though widely heralded as a measure directed at the hedge fund industry, the proposals in fact affect the operations of managers of all funds that are not registered as UCITS (Undertakings for Collective Investments in Transferable Securities), including private equity, real estate, infrastructure and venture capital funds. There are restrictions on the marketing of alternative investment funds ("AIFs") domiciled in third countries.
The proposals have already been the subject of considerable press comment based upon leaked earlier texts but the text now published differs from those in significant ways. The reaction of the hedge fund industry body, the Alternative Investment Management Association, and the Financial Services Authority to the proposals has been strongly negative. A period of intense lobbying will now commence at European level. As with past EU Directives affecting the financial services industry, ultimately there will be a workable result that is unlikely to have a significant detrimental effect on the commercial objectives of managers based in London. It will take some effort though to get to that result and the lobbying process needs to be based on a careful and reflective analysis of adverse unintended consequences and we are preparing a briefing paper on these to assist our clients. In the meantime the purpose of this alert is to outline the main lines of the Draft Directive proposals.
- Management and marketing of non-UCITS funds (whether domiciled within or outside the UK) can only be done by an authorised entity and in accordance with the requirements of the Draft Directive. The Draft Directive will apply to alternative investment fund managers ("AIFMs") with assets under management of €100 million or more (although AIFMs that manage AIFs with no leverage and that prohibit redemptions for the first five years have a higher threshold of €500 million). This is considerably lower than the threshold limit of €250 million that had been widely trailed.
- Marketing is permitted by AIFMs to professional investors, as defined in the Markets in Financial Instruments Directive ("MiFID") only, although Member States may permit the promotion of AIFs to retail investors in limited circumstances. It is not clear whether credit institutions or firms regulated by MiFID will be permitted to continue to promote AIFs as well as AIFMs. As currently drafted, non-UCITS retail schemes, such as an authorised unit trust that does not meet the requirements of the UCITS directive, could not be marketed to retail investors unless the AIFM complies with the additional requirements in this Draft Directive.
- AIFMs will be subject to conduct of business rules, conflicts of interest procedures and other requirements. The Draft Directive incorporates concepts such as "treating customers fairly" that may not be familiar to AIFMs outside the UK.
- AIFs must be valued by an EU domiciled "valuator", the assets of the AIF must be deposited with a "depositary" that is an EU credit institution although that EU credit institution is allowed to appoint a "sub-depositary" in the country of incorporation of the AIF where that "sub-depositary" is subject to prudential regulation, supervision and anti-money laundering rules equivalent to those under EU law, and for third country funds, that country must be signatory to a reciprocal tax disclosure treaty with the EU. The precise role of the depositary has not been made clear but it appears to incorporate the role of custodian.
- There are strict restrictions on delegation which may prove to be difficult or unworkable if the Draft Directive is passed as drafted.
- The manager must maintain base capital of at least €125,000 plus 0.02 per cent of the amount by which the aggregate value of assets under management exceeds €250 million.
- Details of the use of systematic leverage by an AIF must be reported to the regulator when the combined leverage exceeds the value of the equity capital in two of the past four quarters.
- Specified disclosure must be given to investors in relation to the AIF.
- Whilst the Draft Directive purports not to require the regulation or approval of the underlying AIFs, it sets out detailed rules proposed for the content of scheme documentation and imposes a requirement for them to be filed ten days before the relevant AIF can be marketed. This is likely to result in AIFMs needing to undertake substantial redrafting of the documentation for existing AIFs that they manage.
- Where an AIFM can exercise 30% or more of the voting rights of a non-listed company on behalf of an AIF (small and medium enterprises excluded) the AIFM must provide specified information to the issuer and all other shareholders about the investment objectives and strategy of the acquiring AIF.
- Private equity funds that acquire and take private a listed company will be required to continue to make disclosures in line with the Transparency Directive as if it were still listed for two years.
- There is significant detail that is left to be covered by further legislation at the "Level 2" stage. The Recitals to the Draft Directive provide wide scope for further regulation by way of these additional measures.
- It is intended that the Draft Directive will be implemented by 2011 (with a three year transitional period for the promotion of third country AIFs).
For further information please contact one of the following members of our Financial Services Regulatory team
Tel: +44 20 3130 3311
Tel: +44 20 3130 3197
Tel: +44 20 3130 3998
Tel: +44 20 3130 3726