A guide to the AIFM directive compromise text – update on third country rules

Luxembourg’s fund industry is looking forward to the finalisation of the proposed Directive on Alternative Investment Fund Managers, which will create a single market for the marketing of alternative funds to professional investors throughout the European Union. Agreement on the directive after some 18 months of debate and negotiation is set to open up new opportunities for Luxembourg as a domicile and servicing centre for alternative funds, now that EU and institutions have resolved a number of outstanding issues, notably the treatment under the directive of managers and funds based in countries outside the union.
Following the publication of a first draft of the directive by the European Commission on April 30, 2009, the directive has been subject to repeated redrafting. In May this year the European Parliament and the European Council approved versions of the text that differed significantly on various issues, which required representatives of the Parliament, Council and Commission to conduct ‘trialogue’ discussions on a compromise version to the Parliament for a first reading.
Two-year transition period for non-EU managers and funds
The text agreed by the trialogue meeting on October 26 is largely based on a series of proposals from Belgium, which holds the presidency of the Council of Ministers. The new text meets concerns on the part of some member states about access to their markets for non-EU managers and funds by introducing a two-year transition period before such access is granted and by giving the future European Securities and Markets Authority (Esma, successor to the Committee of European Securities Regulators) oversight authority, power to decide authorisation questions on which regulators from different EU member states disagree, and a co-ordinating role in the exchange of information between national regulatory authorities within the EU.
The draft directive now states that a review mechanism has been introduced to reflect the “uncertain and difficult to predict … practical consequences and possible difficulties” of offering a harmonised regulatory framework and European internal market for non-EU alternative fund managers performing management and/or marketing activities within the EU, and for EU managers of non-EU funds.
Managers in either of these cases are intended to benefit from a harmonised European passport regime following the two-year transition period, after the entry into force of a Commission ‘delegated act’. The draft directive says the harmonised regime will coexist for a further period of three years with existing national regimes that allow alternative funds to be distributed through private placement arrangements on a country-by-country basis and permit non-EU managers to manage funds and/or market them to investors within their territory, subject to certain minimum requirements. The stated intention is that the Commission will terminate these national regimes at the end of this total period of five years.
In addition, four years after the final deadline for transposition of the directive into the national law of member states, which is expected to be in early 2013, the Commission is to review that application and scope of the directive in the light of its stated objectives and will assess whether this harmonised approach to regulation of alternative funds has caused any major ongoing market disruption and whether it is operating effectively in terms of the principles of the EU single market and the goal of creating a level playing field for EU and non-EU managers and funds.
Application to all non-Ucits funds
The directive will apply to managers of all funds not covered by the successive Ucits directives governing retail funds eligible for cross-border distribution, whether open- or closed-ended, whatever their legal form and whether or not they are listed. Its remit excludes managers of private wealth such as family offices and of holding companies (although this does not exempt private equity firms or managers of listed fund vehicles), pension funds or employee benefit schemes, supranational institutions, central banks, public social security and pension bodies, securitisation SPVs, insurance contracts and joint ventures.
Subject to various exemptions and restrictions, the AIFM Directive will apply to all European-based managers of alternative funds, irrespective of whether the funds are domiciled within the EU or outside and whether they are marketed within the EU or not; non-EU managers of EU-domiciled funds; and non-European managers marketing EU or non-EU funds within the union.
EU-based managers of non-EU funds
The rules relating to third-country managers and funds are set out in Chapter VII of the directive, articles 34 to 40. Article 34 stipulates that an EU manager may manage non-EU funds that are not marketed within the union as long as the manager complies with the terms of the directive apart for its depositary and annual report requirements in relation to those funds.
In addition, co-operation arrangements must be in place between the supervisory authorities of the manager’s home member state and the regulator of the jurisdiction in which the fund is domiciled in order to ensure “at least an efficient exchange of information” to facilitate regulation of the manager at home. As with other provisions regarding non-EU domiciled funds, the directive requires the Commission to enact measures setting out a common framework for the establishment of co-operation arrangements with third countries, and Esma to draw up guidelines for the application of these measures adopted by the Commission.
EU managers authorised under the directive may market non-EU funds (or EU-domiciled feeder funds investing with non-EU master funds) under Article 35. In addition to complying with all the terms of the directive apart from Chapter VI, which governs the pan-European marketing of EU-domiciled funds by EU managers, the conditions include co-operation arrangements between the manager’s home regulator and that of the fund domicile, certification that the fund jurisdiction meets Financial Action Task Force standards on countering money laundering and terrorist financing, and OECD-standard tax information exchange agreements between the fund domicile and the manager’s home member state as well as all other EU countries in which the fund is to be marketed.
Notification of marketing intentions
If an EU country targeted for marketing of the fund disagrees with the manager’s home regulator on the fund domicile’s co-operation arrangements or money laundering compliance, the issue may be referred to Esma for adjudication.
An EU manager seeking to market a non-EU fund at home may only be refused if the manager or its management of the fund fails to comply with the terms of the directive, otherwise it may begin marketing on receipt of confirmation from the local regulator (a decision is due within 20 working days of the submission notifying its intention to the regulator).
Similarly, the home regulator must transmit notification of marketing intentions to other EU member states within 20 working days of reception and the manager may begin marketing once it has been notified of the transmission. Marketing in EU countries outside the manager’s home state is subject to national rules on marketing and distribution including measures to prevent the fund being marketed to retail investors. Managers should give notice in advance where possible of any change in the information provided in marketing notifications. If the changes mean the management of the fund no longer complies with the directive, marketing authorisation may be withdrawn.
Member states may also – temporarily – continue to allow non-EU funds to be marketed on their territory without a passport (Article 36) as long as depository arrangements are in place equivalent to those stipulated by the directive for EU funds, as well as co-operation arrangements with the fund domicile and certification of AML compliance. These funds may be subject to stricter rules than those for equivalent EU funds.
Non-EU managers of EU-domiciled funds
Under Article 37, non-EU managers intending to manage EU-based alternative funds or market funds they manage within the EU must receive prior authorisation from a “member state of reference”, which plays the same role as the home state of EU managers. They must appoint a legal representative in the member state of reference to act as a contact point in the EU and conduit for any official correspondence with EU regulators and investors, as well as carrying out compliance functions relating to fund management and marketing together with the manager. The member state of reference may be changed if the manager’s marketing strategy changes within two years in a way that would have resulted in a different designation.
In addition, the non-EU manager’s home jurisdiction must have concluded co-operation arrangements with the member state of reference, the EU fund domicile and the EU countries where the fund(s) are to be marketed, meet FATF money laundering and terrorist finance standards, and have in place a Tiea with the member state of reference. Again, any dispute over compliance with these conditions may ultimately be decided by Esma.
The member state of reference is determined according to where the manager’s funds are domiciled (if within the EU) or where they will be marketed. If there are several possibilities, the manager may submit a request to all the member states that would qualify, which will determine the choice between them within a month (or the manager can choose if they fail to do so). A member state that disagrees with the manager’s determination with its member state of reference can refer the matter to Esma for review.
Articles 38 and 39 set out the conditions for non-EU managers seeking to market EU and non-EU funds respectively within the European Union with a passport. In each case, the regulator of the member state of reference is subject to the same 20-working day deadline for a decision on marketing within the member state of reference or transmission of a notification to other EU member states. Non-EU funds are subject to the fund domicile having co-operation arrangements with the member state of reference, AML and terrorist financing compliance, and Tieas with the member state of reference and all EU target markets. Again, managers should give advance notice of any change in the information in marketing notifications.
Article 39bis of the directive sets out the requirements for non-EU managers to manage funds domiciled in EU countries other than their member state of reference either directly or through establishment of a branch. Finally, under article 40 EU member states may allow non-EU managers to market non-EU funds on their territory subject to co-operation arrangements, AML compliance and the directive’s disclosure and reporting rules.
Implications for non-EU managers targeting EU investors
What do these proposals mean for managers based outside the EU that currently access European investors through national private placement regimes? They can continue to do so, subject to certain minimum EU requirements and local rules, for at least five years, or until the European Commission decides to terminate this channel after reviewing the effectiveness of the passport regime and its ability to create a level playing field for managers and funds inside or outside the EU.
The compromise version of the directive upholds the principle that the European marketing passport should be available to non-EU managers and funds as long as they are subject to the same or equivalent regulatory requirements as their EU counterparts and that the jurisdiction in which they are domiciled meet FATF money laundering standard and set up regulatory co-operation agreements as well as conclude OECD-standard tax information exchange agreements with relevant EU countries.
However, there is much about the way the directive is to be implemented that is unclear, notably the mechanisms for establishing and operating co-operation agreements between EU member states and outside jurisdictions. These will be drawn up by the European Commission and Esma, the latter a body that does not yet exist.
In addition, the Commission ‘delegated acts’ required to open up the passport to non-EU managers and to abolish national private placement regimes are subject to vetoes, in theory at least, by the European Council and European Parliament. Unlike previous drafts, the compromise text makes no mention of “passive marketing”, but the preamble to the document sets out the principle that EU professional investors should remain free to invest on their own initiative in alternative funds regardless of where the manager or fund is based.
Implications of an EU or non-EU fund domicile
Take the example of a Brazilian manager seeking to market its fund to French pension schemes. If the fund were domiciled in the Cayman Islands, this would require that the manager comply with the directive and probably in this case adopt France as its member state of reference, in charge of regulating the manager’s compliance with the directive. In addition the Brazilian regulator, the CVM, would need a co-operation agreement with France’s AMF, as would Cima, the Cayman regulator, and both Brazil and Cayman would need to satisfy France of their compliance with FATF standards as well as having Tieas in place with France.
Were the manager to offer French institutions a Luxembourg-domiciled SIF, for example, rather than a Cayman fund, these additional conditions regarding the fund domicile would not be necessary, but in this case the member state of reference – the manager’s de facto regulator for funds offered within the EU – might instead be Luxembourg. Seeking to access investors in additional EU markets would be easier using a Luxembourg fund because no additional agreements between those regulators and the fund domicile would be necessary.
The current timetable for the directive envisages that the legislation would come into force at the beginning of 2011. Now that the final stages of the legislation procedure seem to be underway, non-EU managers can start examining the best methods of accessing European investors up to 2018 and beyond, and the potential role for Luxembourg in the creation of a level playing field for managers and funds both within and outside Europe.