The Esma proposals cover both physical ETFs, which replicate the performance of stock, bond, commodity, currency or other indices by holding shares or other securities in the proportions that make up the index in question, or a sample thereof, and synthetic ETFs, which use swap transactions to obtain the economic performance of the index, using a basket of securities as collateral.

The consultation paper, ESMA/2012/44, proposes regulatory requirements covering Ucits ETFs, other index-tracking UCITS, efficient portfolio management techniques, total return swaps and strategy indices, which seek to replicate a quantitative or trading strategy.

The proposals envisage additional obligations regarding collateral where any Ucits funds, not just ETFs, use total return swaps, tighten the eligibility criteria for investment by Ucits in strategy indices, oblige Ucits ETFs to identify themselves as such, and seek to facilitate the redemption of ETF shares by investors directly with the fund’s provider or on a secondary market.

A Ucits ETF is defined as “a Ucits, at least one unit or share class of which is continuously tradeable on at least one regulated market or multilateral trading facility with at least one market maker which takes action to ensure that the stock exchange value of its units or shares does not significantly vary from their net asset value.”

According to chairman Steven Maijoor, Esma has drawn up the proposals in response to concerns about the increasing complexity of ETF products marketed to retail investors, which involve investment strategies and risks far removed from the simple replication of well-known indices covering highly liquid markets.

Regarding a mooted distinction between complex and non-complex Ucits, Esma says it will wait for the outcome of negotiations on the revised MiFID directive, on which the European Commission has proposed removing structured Ucits from the scope of instruments automatically categorised as non-complex.

The guidelines have been broadened to reflect 65 responses to a discussion paper issued by Esma in July 2011, which urged the authority to cover not only ETFs but all Ucits engaged in securities lending or tracking an index.

The discussion paper on policy orientations on Ucits ETFs and Structured Ucits (ESMA/2011/220) examined possible measures to mitigate the risk of highly complex products that might be difficult to understand and evaluate being made available to retail investors, the potential systemic risk such funds might cause, and their impact on financial stability.

Esma proposes that all Ucits exchange-trade funds be obliged to use ‘ETF’ in their name as an identifier, and that investors should be provided with additional information about the investment policy and valuation of actively-managed ETFs that do not track an index or seek to outperform one.

It is also seeking feedback on an appropriate regime for secondary market dealings in ETF shares. For example, one option is that that a Ucits ETF or its management company should replace the market-maker if it is no longer willing or able to act as such, and if necessary make arrangements for investors to sell shares directly back to the fund or manager if redemption in the marketplace is disrupted. Alternatively, investors could be given the right to redeem their shares directly with the ETF at any time.

The consultation paper proposes that index-tracking ETFs disclose through their prospectus the index being tracked and details of its components, the means by which it replicates the index and its implications, for example counterparty risk in the case of synthetic ETFs, the degree of tracking error exhibited by the fund and the factors likely to affect this, such as transaction costs, liquidity and dividend reinvestment.

Esma says index-tracking leveraged ETFs should disclose their leverage policy, its costs and risks, and the impact of short exposure combined with leverage.

Esma recommends that collateral posted to mitigate counterparty risk in securities lending transactions should comply with the criteria set out in the July 2010 guidelines of the Committee of European Securities Regulators on Risk Measurement and Calculation of Global Exposure and Counterparty Risk for UCITS (CESR/10-788), as well as the strengthening of diversification and haircut criteria.

These requirements would also apply to repo and reverse repo activities. This is designed to ensure that collateral posted in the context of efficient portfolio management techniques should respect the Ucits diversification rules, and that Ucits should have a documented and appropriate haircut policy for each category of assets received as collateral.

Esma proposes that all Ucits investing in total return swaps be subject to the same obligations on collateral management as with securities lending. On Ucits investing in strategy indices, it mostly follows the proposals in the 2011 discussion paper on eligibility of indices, including the 20/35 per cent diversification requirement, disclosure to investors and due diligence to be carried out by the Ucits.

The authority also reiterates the need to tackle issues such as the sale of complex ETFs to retail investors and the absence of harmonised regulation on the manufacturing and management of these products.

Esma also says it will consider whether and how guidelines agreed for Ucits can be applied to regulated non-Ucits funds established or sold within the EU and the establishment of harmonised definitions covering all exchange-traded products.

The consultation paper calls for industry members and other stakeholders to submit comment on the draft guidelines by March 30. The final guidelines should be ready for adoption by mid-2012 and apply to any new investment made, collateral received, or document or marketing communication issued after that date. Requirements relating to information to investors and the general public, including a fund’s Key Investor Information Document, will take effect at the latest 12 months after the guidelines are adopted.

Nevertheless, until the Commission comes up with the final rulebook and all primary and secondary AIFMD-related legislation is adopted into the national law of European Union member states, questions will remain about the overall impact of the directive, especially as it affects managers, funds or service providers located in jurisdictions outside the EU.

‘Equivalence’ dropped

For industry members, one of the most important aspects of the final advice document sent to the Commission on November 16 is the removal of reference to the ‘equivalence’ of third-country jurisdictions, which had already been dropped from the legislative text finally agreed by the European Council and Parliament in November 2010.

The concept of equivalence was re-introduced in Esma’s consultation paper on possible implementing measures relating to supervision and third countries, published in August 2011. With regard to the delegation of investment management or depositary functions to entities outside the EU, the requirement for equivalence was regarded as a potential barrier to investment by funds in non-EU jurisdictions, as well as creating the probably impossible task of assessing the equivalence or otherwise of dozens of jurisdictions before the directive came into force.

Regulatory co-operation approach

Esma’s advice to the Commission tackles the issue of regulatory co-operation between third countries where funds or managers are domiciled and EU member states by proposing an approach based on Iosco’s Multilateral Memorandum of Understanding Concerning Consultation and Co-operation and the Exchange of Information.

It proposes that an MMoU be centrally negotiated by Esma to avoid the need for third-country regulators to conclude multiple bilateral co-operation arrangements, ensuring a level playing field by removing the opportunity for regulatory arbitrage. However, details what this would mean in practice and how co-operation agreements should be concluded may not be announced before mid-2012.

Article 20 of the directive provides that where portfolio or risk management functions are delegated by an EU-based manager (or sub-delegated) to an entity located outside the union, regulatory co-operation arrangements should be in place between the manager’s home regulator and the third-country supervisor of the entity to which the functions are delegated.

The regulatory co-operation arrangements should be based on written agreements and enable the manager’s home regulator to obtain on request information required for its supervisory duties under the AIFMD, obtain documents held in the third country and conduct on-site inspections of the entity to which portfolio or risk management functions have been delegated (either directly, by the third-country regulator, or jointly).

The co-operation arrangements should also ensure notification by the third-country regulator of any breach of the directive’s requirements and the ability to perform “sufficiently dissuasive” enforcement actions in such a case.

The third-country entity will be deemed to meet the AIFMD’s requirements for delegation if it is authorised or registered to carry out asset management based on local criteria and is effectively supervised by an independent regulator. Independence in this case means compliance with the criteria and methodology set out in Part II of the Iosco Objectives and Principles for Securities Regulation and the Basel Committee Core Principles.

The EU manager’s home regulator must approve in advance the delegation of portfolio or risk management to a third-country entity that is not authorised as an asset manager, as it would also have to do if such an entity was based in the EU.

Framework for depositaries

As with the criteria for delegation of portfolio or risk management, the concept of equivalence of third-country regulation has been removed from the advice on assessing the prudential regulation and supervision of non-EU depositaries to alternative funds.

Instead Esma says the depository should be authorised and supervised by an independent regulator with adequate resources to fulfil its tasks. The local regulatory framework should set out eligibility criteria for depositaries “that have the same effect” as those applicable to credit institutions or investment firms within the EU.

The minimum capital requirements and operating conditions applicable to the depositary should have the same effect as those applicable within the EU, depending on whether it is a bank or an investment firm, while the local requirements regarding performance of the depositary’s duties should have the same effect as those set out in the AIFMD. Esma advises that the third-country legislation should be assessed by comparing eligibility criteria and operating conditions with EU requirements.

The local regulatory framework should provide for the application of enforcement action in the event of breaches of the directive’s requirements, and ensure that the liability of the depositary to investors in the event of loss of assets should be capable of being invoked either directly or indirectly through the manager, depending on the nature of the investment structure. If the depositary is supervised to more than one regulatory authority, all of them should meet the requirements.

Under Article 21 of the directive, if the criteria are met, the Commission should adopt implementing acts stating that the prudential regulation and supervision of a particular third country have the same effect as EU law and are effectively enforced.

Private placement rules

Regarding co-operation between EU and third-country regulators for the marketing of non-EU funds within the EU under national private placement arrangements – and subsequently the marketing of non-EU funds or EU funds run by non-EU managers under a passport – Esma says the agreements should cover exchange of information for supervisory, enforcement and other regulatory purposes, as well as the ability of the EU regulator to carry out on-site inspections directly or jointly with the non-EU regulator.

The latter should co-operate in the event or breach of either EU or local regulation, and assist the EU regulator by providing information required for systemic risk oversight. Co-operation agreements should allow information provided to the EU regulator to be passed on to its counterparts in other member states, to Esma itself or to the European Systemic Risk Board.

This part of the Esma advice, as well as that regarding depositaries, stresses that managers, funds or service providers should not benefit from more lenient regulatory treatment as a result of being based in a non-EU jurisdiction, and that regulatory co-operation arrangements should take this into account.

Determining the member state of reference

Finally, the Esma advice proposes more detailed guidelines for determination of the member state of reference that will supervise non-EU managers taking advantage of the AIFMD passport in or after July 2015.

In the event of a dispute over the designation of the member state of reference, the decision should take into account in which EU member state the manager intends to develop effective marketing to investors for most of its funds, either through direct relationships or third-party distributors. The criteria should include the domicile of most targeted investors, the language of the offering and promotional documents, and the member states where advertisements are “most visible and frequent”.

EU regulators identified by the manager as being potentially its member state of reference should contact each other and Esma. Following consultation or receipt of relevant documentation, they should exchange views within a week and subsequently take a joint decision on the designation. The Level 1 text of the directive provides that where the regulators cannot agree, Esma will decide.

According to Esma, its proposed rules should establish a comprehensive framework for alternative investment funds, their managers and depositaries, and by achieving the directive’s aim of increasing transparency and mitigating systemic risk, ultimately contribute to improved protection of investors.

Esma’s advice is in response to a 2010 request originally sent by the Commission to Esma’s predecessor, the Committee of European Securities Regulators. An advisory body comprised of EU securities regulators that advised the European Commission from 2001 to 2010 on securities legislation policy issues, Cesr was replaced by Esma at the beginning of this year.

November 16 was the deadline for delivery of Esma’s advice to the Commission. The 500-page document takes into account industry feedback received by Esma in response to two consultation papers, published in July and August. The Commission has indicated that it remains open to further input from the industry and other stakeholders before it finalises the rules.

Esma says that while not binding on the Commission, the proposed rules will bring greater clarity on the application of the thresholds that determine the scope of the AIFM Directive, while the provisions regarding operating conditions impose stronger organisational and conduct rules for alternative fund managers, on top of increased reporting requirements to investors and regulators and the rules governing use of leverage.

The advice seeks to clarify the duties of depositaries to alternative investment funds, such as monitoring funds’ cash flows, as well as defining the circumstances in which assets held in custody can be deemed to be lost and the consequences. It also fleshes out the framework under which third-country firms and managers will be able access European investors, both before and after the AIFM Directive’s marketing ‘passport’ is due to be extended to non-EU firms and funds after mid-2015.

The advice document covers four broad areas. The first part, covering general provisions for managers, authorisation and operating conditions, clarifies how the asset thresholds determining whether a manager is subject to the directive will operate. It also details how managers should cover risks arising from professional negligence through the holding of additional capital or insurance. Esma notes that many of its rules in areas such as conflicts of interest, recordkeeping and organisational requirements are based on equivalent provisions of the Mifid and Ucits legislative frameworks.

The second part of the advice proposes a framework governing depositaries of alternative funds, include the criteria for assessing whether the prudential regulation and supervision applicable to a depositary established in a third country has the same effect as the provisions of the AIFM Directive.

In response to protests from industry bodies such as the Alternative Investment Management Association (Aima), Esma has dropped the nebulous concept of ‘equivalence’ of third-country regimes with the directive’s provisions. Instead it sets out criteria such as the independence of the financial regulator, the eligibility requirements for organisations seeking to act as a depositary, and the existence of sanctions to punish violations.

Esma says that determination of the circumstances in which a financial instrument held in custody should be considered as lost is crucial in determining whether a depositary is required to return an asset or its value. It proposes that an asset should be considered lost if financial instruments supposedly owned by a fund either cease to exist or are found never to have existed, if the fund has been permanently deprived of its right of ownership over the instruments, or if it is permanently unable to dispose of the instruments directly or indirectly.

The document also aims to clarify what constitutes external events beyond the reasonable ability of the depositary to control or protect against. It also clarifies the reasons that would allow a depositary contractually to discharge its liability to make restitution of the assets.

To assist in preventing the build-up of systemic risk, Esma’s advice clarifies the definition of leverage, how it should be calculated and in what circumstances a regulator should be able to impose limits on the leverage used by a particular manager. It confirms the proposal set out in one of the consultation papers to prescribe two different calculation methodologies for leverage, the commitment and gross methods, as well as a further option, the advanced method, which can be used by managers on request. To increase transparency of alternative funds and their managers, Esma sets out the form and content of information to be reported to regulators and investors, and what information should be included in a fund’s annual report.

Regarding the regulatory co-operation and exchange of information arrangements required to allow non-EU funds or funds from non-EU managers to be marketed in Europe, Esma proposes the institution of written agreements allowing for exchange of information for both supervisory and enforcement purposes.

Agreements should be signed by the European regulators concerned and the third-country regulator of the manager and/or fund, which could take the form of a multilateral memorandum of understanding centrally negotiated by Esma. The detailed content of the co-operation arrangements would take into account international standards, notably the Iosco Multilateral Memorandum of Understanding on co-operation for enforcement purposes and the Iosco Technical Committee Principles for Supervisory Co-operation.

The AIFM Directive was first proposed by the European Commission in April 2009 and agreed by the European Parliament and EU member states in November 2010. The directive was formally signed on June 8 this year, published in the EU Official Journal on July and came into force on July 21; the deadline for transposition into the national legislation of EU member states is July 22, 2013. The marketing passport provisions may, by decision of the Commission, be extended to non-EU jurisdictions any time after July 22, 2015.

The European Securities and Markets Authority (Esma) has published proposals on October 13 to deal with the fact that the majority of European Union member states have not yet approved legislation implementing the Ucits IV directive, even though the deadline to do so passed on July 1.

The European regulator says the proposals are designed to avoid difficulties, where this is possible, arising from the fact that in some cases the legislative framework for proper implementation of the directive, including cross-border regulatory measures, are not yet in place.

Without prejudice to any measures taken by the European Commission with regard to the late transposition of Ucits IV, Esma says it aims to “address the situation at an operational level in order to minimise, as far as possible, the impact on industry and investors” resulting from failing to bring the directive into national law, and is putting forward practical arrangements for cross-border operations involving one member state that has not yet transposed the directive.

According to PricewaterhouseCoopers, as of September 29 the EU member states that had not yet implemented the directive included Belgium, Finland, Greece, Hungary, Italy, Lithuania, Poland, Portugal, Romania and Spain.

Esma has identified a number of issues that could be handled by arrangements between regulators. Ucits management companies in a member state where the directive has passed into national law may not be able to benefit from the management company passport if the country where it wants to establish a fund has not transposed the directive.

Regulators in member states that have transposed the directive may have difficulties delivering notification of the marketing of Ucits established in their jurisdictions to their counterparts in countries that have not done so, while the regulator of a member state that has transposed the directive may receive a notification for marketing of a Ucits from its counterpart in a country that has not.

In addition, Esma notes that a management company in a member state where the directive has not been transposed cannot create a feeder fund to a master fund established in another EU jurisdiction, nor can it merge one of the Ucits it manages with a Ucits domiciled in another jurisdiction.

The European regulator notes that not all situations arising from failure to transpose the directive can be accommodated through practical arrangements that are “legally sound”.

It says the practical arrangements proposed are based on the jurisprudence of the EU Court of Justice on the direct applicability of self-executing provisions contained in EU directives.

Ucits IV “unequivocally” gives Ucits management companies and investment companies the rights to market Ucits units on a cross–border basis and to provide services that for management companies include the management of collective portfolios on a cross-border basis, Esma says.

It argues that European primary law obliges member states to transpose directives into their national law, leaving them the choice of form and methods, and to create a legal framework in which “the rights and obligations arising from the directive can be recognised with sufficient clarity and certainty to enable citizens to invoke them.”

In other words, member states have an obligation to reconcile their legislation with the objectives of a directive at the end of the transposition period. The European court has held that they are liable to pay damages where loss results from their failure to transpose a directive in whole or part.

Esma is proposing that regulators should not be able to refuse a valid notification for the marketing of a Ucits on their territory under the directive on the ground that their member state has not yet implemented the directive.

However, the regulator of a country that has not transposed the directive cannot deliver new notifications for the marketing of Ucits unless they can satisfy Esma that their national legislation, while not fully implementing Ucits IV, does at least comply with articles 12, 14, 15 and 51 of the directive – governing prudential provisions, rules of conduct, investor complaints and risk management – and where applicable their related implementing measures.

The regulator in the non-transposing country should also able to fulfil its obligations on access to documents under the directive. If these conditions are satisfied, notification can take place on a regulator-to-regulator basis as if both countries had transposed the directive, using a template that Esma will draw up.

Even if the legislation of the non-transposing member state does not comply with the articles in question, this procedure remains possible on condition that the management company and its home regulator certify that the management company complies with these provisions on a voluntary basis.

Esma says management companies in a member state that has implemented Ucits IV should be able to create a fund via the management company passport in a country where the directive has not been transposed, since it says the relevant provisions of the directive are of a self-executing nature. Any existing local rules to the contrary will not be valid.

However, management companies in a country that has not transposed the directive can make use of the passport only if its national legislation already materially complies with articles 12, 14, 15 and 51, and their regulators can provide the co-operation required by Article 101 and implementing measures in the case of remote management.

Esma considers the case of a merger between two Ucits established in the same member state that has not transposed the directive, where at least one Ucits is marketed in other EU countries.

Since the directive requires that both Ucits involved in a merger provide information to their investors, including those in different member states, the merger may take place where the national legislation of the non-transposing fund domicile nevertheless materially complies with the Ucits IV merger rules contained in articles 40, 41, 42, 43 and 45 and their implementing measures –otherwise not.

Due to the “inherent complexity of the operation”, Esma believes that cross-border mergers involving Ucits established in different member states, one of which has not transposed the directive, are not possible on the sole basis of the direct applicability of the directive.

The European regulator also believes that master-feeder structures should not be permitted if one of the two member states in which the Ucits are established has not transposed the directive because this issue also cannot be addressed solely on the basis of the direct applicability of the directive.

Nor, it says, should master-feeder structures be permitted if both the proposed master and feeder Ucits are domiciled in a member state that has not transposed the directive and the proposed feeder Ucits is the subject of a notification of marketing in another member state.

The new legislation, which was placed before the Chamber of Deputies (Parliament) on August 12 and which is expected to become law before the end of this year, aims principally to adapt the SIF law to the requirements of the European Union’s Directive on Alternative Investment Fund Managers, which will take effect in July 2013, including rules on delegation, risk management and the handling of actual or potential conflicts of interest.

In addition, in some instances the proposed changes will bring the SIF regime into line with Luxembourg’s funds legislation of December 17, 2010, which transposed into national law the Ucits IV Directive governing cross-border distribution of retail funds within the EU as well as introducing other changes affecting non-Ucits funds. For example, the law will enable sub-funds of a SIF umbrella structure to invest in other compartments of the same structure, as is already now the case for Ucits funds.

Moving early to adopt requirements to be introduced by the AIFM Directive is in keeping with Luxembourg’s tradition, maintained over more than two decades, of putting EU legislation in place ahead of many competing European jurisdictions, enabling promoters to plan future fund launches with confidence about the stability of the country’s regulatory regime.

The first of 18 articles of the draft legislation states that the activity of management of a SIF must comprise at a minimum management of the investment portfolio. This stipulation aims explicitly to exclude from the SIF regime passive funds that seek to create value solely by the long-term holding of assets and to create a distinction between SIFs and private wealth management companies governed by Luxembourg’s law of May 11, 2007. However, it does not exclude private equity or real estate funds from the SIF regime. Article 2 requires SIFs to have in place procedures to determine that its investors qualify as sophisticated rather than retail.

Article 3 aligns the SIF rules with various features of the 2010 law. Where the fund’s articles of association are drawn up in English, the legislation no longer insists that these be translated into French or German. Funds no longer need to send shareholders physical copies of their annual reports unless this is specifically requested, and in addition, SIFs may establish a registration date five days preceding an annual general meeting of shareholders for the purposes of determining voting rights and what constitute a quorum.

Article 5 of the draft law amends Article 42 of the 2007 SIF legislation, which allowed promoters of a fund to apply for authorisation by Luxembourg’s regulator, the Financial Sector Supervisory Authority (CSSF) up to one month following their launch. This provision, which in any case was not widely used by the promoters, is now abolished; once the law comes into force funds must have received approval from the CSSF before they can be launched, as is the case for funds created under the 2010 legislation.

A new requirement makes authorisation subject to notification of the persons responsible for management of the SIF’s investment portfolio to the CSSF, which must henceforth ascertain that they are of good reputation and have the experience necessary to manage the type of alternative investment fund in question. Any changes in the identity of the fund’s portfolio managers must also be notified to the regulator.

Under Article 6, SIFs must implement systems to monitor, measure and manage the investment risk of its individual positions and their contribution to the portfolio’s overall risk profile. They must also be structured and organised to minimise the risk of conflicts of interest, and draw up rules to manage such conflicts that do arise. The CSSF may draw up further regulations setting out detailed requirements on risk management and conflicts of interest.

Article 7 defines the conditions under which SIFs may delegate various tasks and functions to third-party providers. Such delegation should not affect regulation of the fund; entities to which portfolio management is delegated must be approved for that function and subject to prudential regulation, unless the CSSF grant permission for delegation to individuals or entities to which this condition does not apply.

A fund’s directors must be able to determine that the delegated provider is qualified and capable, and they must retain ultimate control over the fund’s activities. Delegation should not create conflicts of interest – so, for instance, investment management may not be delegated to the fund’s custodian – and the delegation of functions must be revealed in the fund’s offering documents.

The CSSF’s powers of supervision and enquiry over funds set out in Article 8 aligns the provisions of the SIF legislation with those laid down by the Ucits IV directive, while Article 9 set out circumstances in which the CSSF or the Luxembourg prosecutors may apply to the courts for the dissolution and liquidation of one or more fund compartments. Article 10 deals with administrative fines, which the CSSF may publish unless this would seriously affect financial markets, damage the interests of investors or cause disproportionate prejudice to the parties affected.

Under Article 12, the CSSF’s approval is now required for any substantial change made to the SIF’s offering documents, such as the name of the fund or of sub-funds, the replacement of the custodian, administrator, auditor or manager, the creation or new sub-funds or a significant change in investment policy.

Article 13 authorises funds to deviate from their exclusive investment policy for the purposes of liquidity management, hedging or efficient portfolio management, while Article 14 bars SIFs in the form of companies that are in the course of being liquidated from issuing new shares, except where this is beneficial to the outcome of the liquidation itself. Article 15 allows the CSSF to withdraw authorisation for one or more sub-funds of a SIF while maintaining the authorisation for other sub-funds of the same structure.

The draft law follows the 2010 legislation in allowing one sub-fund of a SIF to invest in another, although not all provisions are identical. This clarifies that the rules set out in Luxembourg’s 1915 company law regarding a company’s investment in its own shares do not apply to SIFs. Sub-funds of the same SIF may not cross-invest in each other, and voting rights of shares held by one sub-fund in another are suspended.

Finally, Article 17 stipulates that SIFs established before the date of entry into force of the revision law will have a transitional period up to June 30, 2012 before they are obliged to comply with its requirements on ascertaining that their investors are sophisticated (Article 2, paragraph 3) and risk management and conflicts of interest (Article 42bis) and up to June 30, 2013 to comply with the new rules on the delegation of functions (Article 42ter).

According to Esma, the proposed rules have been drafted to reflect the global nature of the alternative investment management industry and the need for a framework covering entities outside the European Union.

The consultation paper, which follows an earlier document published in July inviting comment on its Level 2 proposals for other aspects of the directive, is Esma’s response to the European Commission’s request for technical assistance from the organisation’s predecessor, the Committee of European Securities Regulators (Cesr).

Esma is due to deliver its finalised advice to the Commission by November 16 this year, and it requests responses to the consultation to be delivered by September 23 in order for it to meet the deadline.

Admission of third-country managers and funds to EU markets through national private placement regimes or, after 2015, a passporting regime for alternative funds will involve a framework of supervisory co-operation and exchange of information between EU regulatory authorities and their counterparts in non-EU countries.

According to Esma’s proposals, these co-operative arrangements should be organised through written agreements allowing for exchange of information for both supervisory and enforcement purposes. The agreements should impose a duty on the third-country authority to assist the EU regulator in question where it is necessary to enforce EU or national legislation, and provide for exchange of information for the purposes of systemic risk oversight.

The 30-page paper also invites comment on Esma’s proposals for the additional requirements to be applied when alternative fund managers delegate portfolio or risk management functions to a provider based in a third country. They cover the content of the written agreement to be concluded with the regulator of the third country, which would have to allow for access to information, the possibility of on-site inspections of the entity to which functions are delegated and enforcement actions in the event of a breach of the AIFM Directive rules.

Under the directive, a fund’s depositary may be established in a third country subject to certain conditions. Esma sets out its proposals on the elements to be taken into account when assessing whether the prudential regulation and supervision applicable to a third-country depositary is equivalent to the AIFM Directive provisions, and whether it can be considered to be effectively enforced.

Esma lists a number of criteria such as the independence of the third-country regulator, its eligibility requirements for depositaries, the equivalence of capital requirements and the existence of sanctions in the case of violations.

Regarding the co-operation arrangements with third country regulators in general, Esma expresses a preference for a single agreement to be negotiated by itself in each case to ensure consistency and avoid a proliferation of bilateral agreements. It has also identified documents produced by the International Organisation of Securities Commissions as benchmarks for the written agreements.

The AIFM Directive was first proposed by the European Commission in April 2009 and agreed by the European Parliament and EU member states last November. On December 2 last year the Commission formally sent a request for technical advice on Level 2 measures to Cesr, Esma’s forerunner. The directive was formally signed on June 8 this year and came into force on July 21; the deadline for transposition into the national legislation of EU member states is July 22, 2013.

The Commission’s request for technical advice has been divided into four parts covering general provisions, authorisation and operating conditions, implementing measures regarding the depositary, transparency requirements and leverage, and implementing measures on supervision. Esma’s proposed advice on Parts I to III was covered by a consultation paper published on July 13, responses to which are due by September 13.

The proposals published in Esma’s consultation paper cover three broad areas: general provision for managers, authorisation and operating conditions; governance of depositaries to alternative investment funds; and transparency requirements and leverage.

The first section seeks to clarify issues regarding the thresholds determining whether managers are subject to the directive as well as areas such as valuation and delegation. Esma’s draft advice on criteria for the proper valuation of assets identifies general principles that should guide managers in developing and implementing policies and procedures, and that can be adapted to the various types of asset in which alternative funds may invest.

Regarding the criteria justifying delegation, Esma sets out two proposals, one taking a flexible approach under which delegation can be justified where the manager can demonstrates that delegation will result in more efficient management of the fund, the other setting out a proposed list of criteria to be used when making the assessment.

Esma’s proposals on the framework governing depositaries of alternative funds include advice on the content of the written contract appointing the depositary and clarification of the depositary’s oversight duties. It also makes proposals on the key issue of depositary liability including three conditions to be used in determining whether a financial instrument held in custody should be considered as lost and therefore whether the depositary should be required to return an asset.

The advice also seeks to define what would constitute external events causing loss of assets that are beyond the reasonable control of the depositary, and considers options for objective reasons that would allow a depositary contractually to discharge its liability, such as legal constraints that oblige the depositary to delegate custody to a third party.

Bearing in mind the core aim of the directive to help prevent systemic risk, the proposals include consideration of how leverage should be defined and calculated, and under what circumstances regulators may impose limits on the leverage a manager may employ. Given the wide variety of funds and assets covered by the scope of the directive, Esma proposes commitment and gross methods for calculation of leverage as well as a further option available to managers on request subject to certain criteria.

On transparency, Esma specifies the form and content of information to be reported to regulators and investors, and of the annual report to be prepared for each fund, developing a framework compatible with existing national and international accounting standards.

The AIFM Directive was first proposed by the European Commission in April 2009 and agreed by the European Parliament and EU member states in November 2010. On December 2 last year the Commission formally sent a request for technical advice on Level 2 measures to the Committee of European Securities Regulators, Esma’s forerunner. The directive was formally signed on June 8 this year and will come into force on July 21.

The request for technical advice is divided into four parts covering general provisions, authorisation and operating conditions, implementing measures regarding the depositary, transparency requirements and leverage, and implementing measures on supervision. The consultation paper covers Esma’s draft advice on most of the elements in the first three parts.

Some of the measures covered in the fourth part relate to the proposed passport for non-EU managers and funds, which will not be established for at least two years after the directive takes effect on July 22, 2013. However, Esma is working on draft proposals for implementing measures on co-operation arrangements in certain circumstances with non-EU regulators and will publish these in a separate consultation paper later this summer.

The circumstances in question, which will require implementing measures to be in place by July 22, 2013, involve authorised EU-domiciled managers of non-EU funds that are not marketed within the EU, and the marketing under national private placement rules of non-EU funds managed by EU-based managers as well as of funds managed by non-EU managers.

The early passage of the law by Luxembourg, the first EU member state to adopt the Ucits IV rules, has given the country’s fund industry the maximum time to prepare for the entry into effect of the directive on July 1, 2011. However, it also offered the opportunity to amend other aspects of Luxembourg’s fund legislation including measures affecting vehicles not subject to the Ucits regime for the cross-border distribution of retail funds across Europe.

The legislation clarifies a number of areas relating to the regulation and tax treatment of Luxembourg funds and investment management entities. For example, it abolishes the subscription tax on fund assets in the case of exchange-traded funds, which are Ucits funds, as well as non-Ucits funds whose strategy involves investment in microfinance, an area in which the grand duchy has carved out a leading role.

Ucits IV was formally approved by the EU on July 13, 2009 under the designation of Directive 2009/65/EC. Rather than introducing sweeping changes to investment rules, as did its 2002 predecessor, the directive mostly involves changes designed to improve the efficiency of the European fund market, as well as strengthening the safeguards for investors that have been a key factor in the success of Ucits funds not only in Europe but elsewhere in the world.

These include notably facilitating cross-border fund mergers, simplifying and shortening notification procedures required to sell funds in other EU member states, authorising master-feeder structures under the Ucits regime and creating a ‘passport’ for management companies established in one member state to provide services to funds in another. In addition, the directive has created the Key Investor Information Document (KIID) to help retail investors understand the investment goals, risk and performance of Ucits funds. For more information about Ucits IV, please see our guide to the directive, Removing barriers to Europe’s single fund market.

This guide is designed to help fund industry participants and investors understand the changes made to the Luxembourg fund industry as a result of the law of December 17, 2010 as well as the new opportunities available to establish both Ucits and non-Ucits funds in the grand duchy for marketing across Europe and beyond.

Please find below a link to the guide:

The new Luxembourg fund law implementing UCITS IV - download (448.37 KB)

On July 16, 2009 the European Parliament appointed its Economic and Monetary Affairs Committee (Econ) to review the draft directive. The report of the legislation’s rapporteur, French MEP Jean-Paul Gauzès, was delivered to the Parliament on November 23, 2009.

Fresh drafts amending the Commission’s original proposals were issued by the Swedish presidency of the EU Council of Ministers on December 15, 2009 and by the Spanish government, which took over the presidency on January 1, 2010, on February 15, 2010.

The Parliament’s Econ committee approved its own revised version of the directive, based on the Gauzes report, on May 17, 2010. The following day, the Council of EU Economic affairs and Finance Ministers voted to approve its own, different revised draft. In June, representative of the Parliament, Council and Commission began a series of meetings in the ‘trialogue’ process aimed at reaching an agreement on a single final text of the directive.

On August 27, 2010 the new holder of the EU Council of Ministers presidency, Belgium issued a further proposed compromise draft, omitting sections on issues including third country managers and funds and disclosure requirements for private-equity owned companies where further discussion remained necessary to reach agreement.

The directive received formal approval by the EU Council at a meeting of transport, telecommunications and energy ministers on May 27, 2011. It was formally signed at Strasbourg on June 8 by Jerzy Buzek, the president of the European Parliament, and Enikő Győ, Hungary’s minister of state for European affairs, on behalf of the EU Council.

The formal title of the legislation is now Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010.

The European Union’s Directive on Alternative Investment Fund Managers will come into force on July 21, 2011 following its publication in the Official Journal of the European Union on July 1, 2011.

EU member states will now have until July 22, 2013 to transpose the directive into their national legislation. This is one day longer than the two-year period allocated for transposition, apparently because July 21, 2013 falls on a Sunday.

Detailed regulations and subsidiary legislation to implement the AIFM Directive, so-called Level 2 measures, will be drawn up by the European Commission over the next two years on the basis of advice provided by the European Securities and Markets Authority, which is due to report back in November. In April Esma issued a discussion paper on its proposals for implementing measures, soliciting views from market participants.

Under the legislation, EU-domiciled funds run by managers also based within the union will benefit from a ‘passport’ enabling them to be marketed to sophisticated investors throughout the union two years after the legislation comes into force, from July 22, 2013.

According to the timetable set out in the directive, Esma is due to report on the functioning of the passporting system and advise the Commission on its extension to non-EU managers and funds by July 22, 2015.

Three years after access is extended, presumably some time in the second half of 2018, Esma is due to publish its advice to the Commission on the planned abolition of current national regimes permitting distribution of alternative funds through private placement arrangements.

The directive received formal approval by the EU Council at a meeting of transport, telecommunications and energy ministers on May 27. It was formally signed at Strasbourg on June 8 by Jerzy Buzek, the president of the European Parliament, and Enikő Győ, Hungary’s minister of state for European affairs, on behalf of the EU Council.

The formal title of the legislation is now Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010.

The finalisation of the legislation, which was agreed by EU economic affairs and finance ministers and then by the European Parliament last November, was delayed by the extended process of legal and linguistic revision to correct any typographical or drafting errors in the text and to ensure the internal consistency of the directive’s provisions, followed by translation into the various official languages of the European Union.

The final version of the directive was published on May 13. EU member states will now have until July 22, 2013 to transpose the directive into their national legislation. This is one day longer than the two-year period allocated for transposition, apparently because July 21, 2013 falls on a Sunday.

Detailed regulations and subsidiary legislation to implement the AIFM Directive, so-called Level 2 measures, will be drawn up by the European Commission over the next two years on the basis of advice provided by the European Securities and Markets Authority, which is due to report back in November. In April Esma issued a discussion paper on its proposals for implementing measures, soliciting views from market participants.

Under the legislation, EU-domiciled funds run by managers also based within the union will benefit from a ‘passport’ enabling them to be marketed to sophisticated investors throughout the union two years after the legislation comes into force, from July 22, 2013.

According to the timetable set out in the directive, Esma is due to report on the functioning of the passporting system and advise the Commission on its extension to non-EU managers and funds by July 22, 2015.

Three years after access is extended, presumably some time in the second half of 2018, Esma is due to publish its advice to the Commission on the planned abolition of current national regimes permitting distribution of alternative funds through private placement arrangements.