The AIFMD is expected to be published in the Official Journal of the European Union sometime in June 2011 with individual EU Member States required to implement it during the course of 2013.
In respect of Level 2 implementing measures, the European Commission in December 2010 issued a request for technical advice to the Committee of European Securities Regulators (replaced by ESMA1 in January 2011) with a response deadline now extended to November 2011.
Industry-wide consultation is now taking place as the AIFMD moves towards practical implementation.
For the Cayman Islands, Bermuda and the British Virgin Islands, as the leading international financial centres for alternative investment funds, many of which have EU based managers, the AIFMD is something which these jurisdictions need to understand and to work alongside in the interests of their funds industry constituents.
Application of the AIFMD
The AIFMD is extremely broad in scope and covers all managers of funds which are not regulated as UCITS2, regardless of whether the fund is open-ended or closed-ended. As such, it includes managers of hedge, private equity, infrastructure, property and all other funds “… which raise capital from a number of investors with a view to investing that capital for the benefit of those investors in accordance with a defined investment policy.”
Managers who manage AIFs with a cumulative value of assets under management of less than €100 million or manage only unleveraged AIFs with a five year lock-in and cumulative assets under management of less than €500 million will be subject to a lighter regulatory regime of registration within their EU member state of domicile.
Family office funds are not considered AIFs under the AIFMD nor does the AIFMD apply to holding companies, securitisation special purposes vehicles, the management of pension funds, employee participation or savings schemes and certain government related operations.
The third country issue
The effect of the AIFMD on funds or managers domiciled in countries outside the EU (such as the Cayman Islands, Bermuda and BVI), who have European investors or who want to market their funds within the EU has been a contentious issue.
Indeed, around 20 per cent of the body of the AIFMD is dedicated to rules relating to so-called third countries. Despite earlier fears, the final version appears to offer a workable solution, with existing private placement regimes in EU Member states importantly being permitted to remain in place for some time at least, subject to conditions.
For an EU manager managing a non-EU AIF, which is not marketed in the EU
(i) the manager will be required to comply with all the requirements of the AIFMD except for Article 21 (Depositary) and Article 22 (Annual report);
(ii) appropriate cooperation arrangements must be in place between the competent authorities of the home member state of the AIFM and the supervisory authorities of the third country where the non-EU AIF is established; and
(iii) the country in which the non-EU AIF is established must not be listed as a non-cooperative country and territory by the Financial Action Task Force on anti-money laundering and terrorist financing (the “FATF condition”).
For an EU manager managing a non-EU AIF, which is marketed in the EU
(i) national private placement regimes will be allowed to remain in place;
(ii) the manager will be required to comply in full with the AIFMD apart from Article 21 (Depositary);
(iii) appropriate cooperation arrangements must be in place between the competent authorities of the home member state of the manager and the supervisory authorities of the third country where the non-EU AIF is established; and
(iv) the FATF condition applies.
For a non-EU manager managing an AIF, which is marketed in the EU
(i) national private placement regimes will be allowed to remain in place;
(ii) the manager will be required to comply with the transparency requirements of the AIFMD (annual report, disclosure to investors, reporting obligations to competent authorities);
(iii) appropriate cooperation arrangements must be in place between the competent authorities of the member state where the AIFs are marketed, insofar as applicable, the competent authorities of the EU AIFs concerned and the supervisory authorities of the third country where the non-EU manager is established and, insofar as applicable, the supervisory authorities of the third country where the non-EU AIF is established; and (iv) the FATF condition applies.
ESMA is developing guidelines regarding the required cooperation arrangements. The Cayman Islands, Bermuda and BVI, with their long histories of compliance with international standards of financial regulation and international cooperation, are expected to be in a position to implement the requisite cooperation arrangements.
Industry concerns that the third country provisions had the potential to be detrimental to the traditional offshore jurisdictions have been addressed. A level playing field remains for non-EU jurisdictions, with the AIFMD stating that “…cooperation arrangements should not be used as a barrier to impede non-EU AIFs…”.
In respect of marketing, the AIFMD is narrower in scope than earlier drafts and passive marketing and reverse solicitation remain outside of the AIFMD’s scope. As such, a non-EU AIF may retain existing EU investors and may admit new EU investors provided that neither the manager nor the AIF market in the EU.
Much discussion has centred on passport provisions as they relate to non-EU managers and non-EU AIFs. Whilst it is not certain when or if the passport regime will ever become a reality for third countries, it is certain that the use of private placement regimes by EU managers of non-EU AIFs and non-EU managers will be permitted until at least 2018. In 2015 passports will, if introduced and subject to conditions, be made available to non-EU managers and to non-EU AIFs managed by EU managers
A dual system of PPRs and passports will then exist until at least 2018 when ESMA will review the passport regime and consider whether to recommend that national PPRs be brought to an end.
To be clear, if the passport is not switched on, then PPRs would not be switched off. Should PPRs be switched off sometime during 2018, a passport to market in the EU will be required in respect of all AIFs managed by a non-EU manager and all non-EU AIFs managed by an EU manager.
For a non-EU AIF marketed in the EU with a non-EU manager, under the passport regime, the manager must comply with the requirements of the AIFMD and the following conditions apply
(i) appropriate cooperation arrangements are in place between the competent authorities of the Member State of reference and the supervisory authority of the third country where the non-EU AIF is established;
(ii) the FATF Condition applies;
(iii) the third country where the non-EU AIF is established must have signed a tax information exchange agreement with the member state of reference and with each other member state in which investments in the non-EU AIF are proposed to be marketed; and (iv) the non-EU manager must have a legal representative established in its member state of reference.
For a non-EU AIF with an EU manager, the manager, under the passport regime, must comply with all the relevant requirements of the AIFMD and the following conditions apply:
(i) appropriate cooperation arrangements are in place between the competent authorities of the home Member State of the manager and the supervisory authorities of the third country where the non-EU AIF is established;
(ii) the FATF condition applies; and
(iii) the third country where the non-EU AIF is established must have signed a TIEA with the home member state of the manager and with each other member state in which investments in the non-EU AIF are proposed to be marketed.
The Cayman Islands, Bermuda and BVI have all been proactive in signing TIEAs. As of May 2011 Cayman had signed 24, Bermuda 26 and the BVI 17, many of which with EU member states.
The AIFMD requires the appointment by a manager of a single depositary for each AIF it manages, however, the depositary requirements of the AIFMD, for a period, will not apply to non-EU AIFs managed by an EU manager. There will be a requirement to appoint an entity to undertake depositary functions, although the liability provisions of the AIFMD will not apply to such entity.
This flexibility could prove to be a competitive advantage to jurisdictions such as the Cayman Islands, Bermuda and the BVI.
An enhanced regulatory regime?
The AIFMD will undoubtedly increase the regulatory burden on managers. What form this regulation will take and whether it is a good thing for managers and investors alike is open to debate.
Some observers have questioned the ability of regulators in offshore jurisdictions to regulate effectively in the era of AIFMD. However, regulatory regimes already exist in the leading offshore jurisdictions; with more robust regulation for retail funds and a lighter touch for funds reserved for sophisticated and professional investors. A typical offshore hedge fund is indeed subject to a lighter regulatory regime than, for example UCITS, but unlike UCITS they are not designed for, or targeted at, retail investors.
Rather, their investor base is comfortable operating in a less regulated environment, in anticipation of absolute returns, many of whom may not appreciate the inevitable performance drag that the cost of compliance with the AIFMD will bring.
As the funds industry’s regulatory burden increases, international offshore financial centers, are, where appropriate, increasing their regulatory frameworks accordingly and their governments have confirmed they will do what is necessary in order to comply with the AIFMD.
The infrastructure to regulate is already in place and the headcount of employees to regulated entities at the regulators of these jurisdictions compares favourably to many onshore jurisdictions. Once the AIFMD regulatory framework is complete and known, the Cayman Islands, Bermuda and BVI can begin to fine tune their regulatory regimes to accommodate its requirements.
When the AIFMD was first unveiled in its draft form, it sent shockwaves through London, home to many of Europe’s hedge fund and private equity groups. Some commentators predicated a rush of managers relocating to more benign jurisdictions such as Switzerland or that UCITS might replace traditional fund structures, however, in reality many managers sensibly adopted a “wait and see” approach.
As the AIFMD has evolved and the status quo appears to have been maintained, the attraction of quality, well regulated jurisdictions, such as the Cayman Islands, Bermuda and BVI as fund domiciles, has remained.