Trialogue meeting endorses EU AIFM Directive compromise

Representatives of the European Parliament, the European Commission and European Union member states have endorsed with minor changes the version of the Directive on Alternative Investment Fund Managers agreed last week by EU economic affairs and finance ministers.
The accord by the so-called ‘trialogue’ meeting means that both the Parliament and the European Council, which in May approved conflicting drafts of the directive, have now signed up to the compromise proposal and paves the way for a vote on the proposal in a full session of the Parliament in the second week of November.
The compromise text introduces an EU marketing ‘passport’ for alternative fund managers whether based within the 27-member union or (after a two-year transition period, and subject to compliance with EU standards)) outside it.
It also preserves the existing system of country-by-country private placement rules for distribution of alternative funds for at least five years, or until the Commission determines that the passport system is operating satisfactorily.
The agreement has been criticised both by industry members, who say it retains measures that will add disproportionate costs and regulatory burdens, and EU parliamentarians lamenting that the legislation does not impose stricter rules on alternative funds. However, the Parliament is widely expected to give the directive a first reading at its plenary session in Brussels on November 10th and 11th.

by Olivier Sciales

UK and French ministers to discuss AIFM Directive deadlock

UK finance minister George Osborne and his French counterpart, Christine Lagarde, are expected to hold discussions next week (between 18 October and 23 October) on the European Union’s Directive on Alternative Investment Fund Managers ahead of a full meeting of the EU Council of economic affairs and finance ministers.
Talks in Brussels on Wednesday between member states’ ambassadors to the EU failed to resolve continuing differences over the rules governing access to EU markets for funds and managers based outside the union, according to media reports.
In a bid to break the impasse negotiators suggested options such as a delay in the implementation of the ‘passport’ that would allow the marketing to member states of non-EU funds whose managers comply with the directive.
However, the UK is reported to have rejected a proposed amendment that would allow individual member states to bar funds from their territory even if they have an EU passport. The continuing deadlock makes it increasingly unlikely that the directive will be ready to be submitted on schedule to the European Parliament for a formal first reading next week.

by Olivier Sciales

Talks continue on new Belgian AIFM directive compromise

Talks are continuing on a fresh compromise draft of the Directive on Alternative Investment Fund Managers issued by the Belgian EU presidency last week despite the failure of representatives of the European Parliament, the European Commission and member states to reach agreement at a meeting in Brussels on Monday, October 11.
The new round of meetings, which was scheduled to continue on Tuesday, follows France’s indication that it is willing to compromise by allowing funds and managers from outside the EU to benefit from the same marketing ‘passport’ as EU-based managers, as long as their compliance with the directive is monitored by the future European Securities and Markets Authority.
The revised draft of the directive would offer non-EU managers a choice between compliance with the directive in order to qualify for their funds to be marketed freely within the EU, and continued use of national private placement rules.
The draft text says the private placement mechanism may be abolished after a transitional period of five years if the Commission certifies that that passport system is operating with “no negative effects” in areas including investor protection, market disruption, competition and monitoring of systemic risk.
The draft also proposes the designation of a “member state of reference” that would authorise the marketing of funds within the EU by non-EU managers and within which the manager must appoint a legal representative to act as a contact point for EU-based investors and regulatory authorities.

by Olivier Sciales

AIFM Directive prospects backed at Luxembourg fund conference

Luxembourg politicians and officials have expressed confidence that the European Union’s AIFM Directive will soon win final approval dispute this week’s latest dispute between member states on the contentious issue of access to EU markets for managers and funds based outside the union.
Speaking to delegates at the annual investment fund conference organised by the Luxembourg fund association Alfi and US trade body Nicsa, the country’s finance minister, Luc Frieden, said he hoped an agreement would be reached soon, acknowledging that “a lot of work still lies ahead.”
Frieden threw his support behind allowing third-country funds to access European investors, saying: “We do not want a ‘Fortress Europe’. We want non-European funds and those managed outside the EU to be distributed within the EU as long as they meet our rules [in areas such as] transparency and investor protection.”
Speakers from the CSSF, the Luxembourg regulator, expressed satisfaction with the general direction of the draft directive, noting that hedge funds and other alternative investment products are already regulated under existing Luxembourg legislation.
However, there is some concern about the prospect of the final version of the directive imposing strict liability on fund depositaries for a broad spectrum of losses on the part of alternative funds. The Luxembourg regulator believes the role and duties of a fund custodian should be clearly spelled out, but that depositaries should not be put in the position of guarantor of the fund’s assets under all circumstances.

by Olivier Sciales

Third-country managers and the AIFM Directive

Luxembourg’s fund industry is keenly awaiting the outcome of negotiations between the European Union’s legislative institutions on the final form of the proposed Directive on Alternative Investment Fund Managers. Finalisation of the directive could open up new opportunities for Luxembourg as a domicile and servicing centre for alternative funds, but the EU has been slow to reach agreement on 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 intense debate and repeated redrafting. In May this year the European Parliament and the EU Council of Ministers approved versions of the text that differ significantly on a number of issues. Since then representatives of the Parliament, Council and Commission have been seeking agreement through ‘trialogue’ discussions on a compromise version that can be sent to the Parliament for a first reading during its October session.

On August 27 Belgium, which holds the presidency of the Council of Ministers, published a further proposal incorporating areas where the trialogue negotiations appear to have resulted in a consensus, but notably excluding the contentious topics of access to EU investors by third-country managers and funds, as well as disclosure requirements for private equity funds on their portfolio companies.
The Parliament’s current draft of the directive lays down in Article 35 the conditions under which an alternative investment fund domiciled outside the EU can be marketed to professional investors in Europe. This requires an agreement between the regulator of the targeted EU market(s) and that of the fund domicile’s regulator to ensure full exchange of information on the fund’s activities, certification by the Commission that the third-country jurisdiction meets EU standards on countering money laundering and terrorist financing, tax information exchange agreements are in force with the fund domicile jurisdiction, and that the third country offers EU-based alternative managers comparable market access.

According to the Parliament’s version, a non-EU manager seeking to market funds within EU member states must comply with Article 39a of the draft text, which requires that the manager agrees with the future European Securities and Markets Authority (Esma) to comply with the directive voluntarily and accepts the jurisdiction of EU courts on any matter arising from the directive. There must also be an agreement between Esma and the manager’s home regulator under which the latter would exercise Esma’s regulatory powers with regard to the manager. Similar provisions apply to non-EU managers seeking to offer management services within one or more EU member states.
Article 39a requires that if the non-EU manager wishes to market a non-EU fund within a member state, the funds must meet the conditions of Article 35, as they would in the case of an EU-based manager. The text says the agreement can be revoked should either the non-EU manager fail to comply with the directive or its regulator fail to adhere to its agreement with Esma on delegation of regulatory powers. The Commission is charged with supervising whether the third countries are complying satisfactorily with the agreements.

It should be noted that the European Parliament’s version of the text does not grant non-EU managers the same marketing ‘passport’ enjoyed by EU managers under the directive, under which a fund authorised in one EU jurisdiction may be marketed to professional investors in other EU states once the manager notifies its home regulator of its intention to do so. By contrast, the text makes third-country managers subject to the approval process described above for each EU member state in which it seeks to market funds to investors.

The version of the text approved by the Council in May simply proposes that member states may allow authorised EU-based managers to market non-EU domiciled funds to professional investors on their territory as long as the manager complies with the directive and appoints an independent depository, and yet-to-be-defined “co-operation arrangements” are in place between the manager’s home regulator and the supervisory authority of the fund domicile.
The Council would also let member states allow managers based outside the EU to market their funds to professional investors subject to national rules as well as articles 19, 20 and 21 of the directive covering the publication of annual reports, disclosure to investors and regulatory reporting, and Section 2 covering minimum capital requirements. The text also requires co-operation between the home regulator of the fund manager and that of the target market covering exchange of information for oversight of systemic risk. Again, the co-operation arrangements are to be worked out subsequently by the Committee of European Securities Regulators, the forerunner of Esma.

What do these proposals mean for managers based outside the EU that currently access European investors through national private placement regimes? The Council text as it stands would allow this channel to remain open, subject only to regulatory co-operation on systemic risk and the same transparency and capital requirements to which EU managers would be subject under the directive.

By contrast, the Parliament’s draft insists that non-EU managers comply with the AIFM Directive and requires their regulators to act as Esma’s proxy in overseeing that compliance, as well as subjecting the managers to the jurisdiction of EU courts, if they wish to gain access to professional investors within an EU market. Because this process does not offer all the benefits of the full cross-border distribution passport, it has to be repeated for each additional member state the manager wishes to target, with the likelihood of both further delays and additional bureaucratic effort and cost.

Take the example of a Brazilian manager seeking to market its fund to pension schemes in France. If the fund were domiciled in the Cayman Islands, this would require that the manager comply with the directive and that the Brazilian regulator, the CVM, agree with Esma to oversee the manager’s compliance. In addition, there would have to be a separate agreement between Cima, the Cayman regulator, and France’s AMF covering supervision of the fund.

Were the manager to offer French institutions a Luxembourg-domiciled SIF, for example, rather than a Cayman fund, this additional oversight of the fund would not be necessary. It’s not fully clear from the Parliament’s draft, but it appears that the oversight agreement between Esma and the CVM would cover the marketing of the fund to investors in other EU countries.

However, this would require active approval from regulators in these additional markets, rather than the mere notification procedure that would apply to EU-based managers. If the Brazilian manager planned to focus on investors throughout Europe, they might consider it worthwhile to shoulder the cost of setting up a Luxembourg management company in order to enjoy the full benefits of the AIFM passport and avoid the need to be supervised by the CVM according to EU rules, which may prove complicated in practice.

However, this may not be the end of the story. The Belgian presidency is understood to be seeking a compromise on the third-country access issue that would contain elements of both approaches. Under this idea, which is reported to be under consideration by member states, non-EU managers would be able to obtain access to EU member states’ markets by complying with the directive, but existing national private placement regimes would remain in place for at least another five years.

After this period the national regimes would end, according to one suggestion, or be subject to a review and a possible rollover for a further five years, according to another. Belgium has also suggested that ‘passive marketing’ – where investors take the initiative in approaching fund managers – continue to be permitted with regard to funds outside the EU, subject to only limited restrictions on the investors. This contrasts with a provision in the Parliament’s draft that would explicitly bar European investors from non-EU funds that do not meet all the conditions set out in Article 35.

Discussions over the coming weeks are likely to determine the final form of the AIFM Directive and the rules that will apply to third-country managers and funds. Once the text is finalised and the final stages of the legislation procedure is underway, non-EU managers may soon face a choice on the best method of accessing European investors. If agreement is reached soon, the directive will stay on track for implementation in 2012.

by Olivier Sciales

Luxembourg and the AIFM Directive

On April 29, the European Commission submitted a draft Directive on Alternative Investment Fund Managers to the European Parliament and European Council, marking the first attempt to create a comprehensive regulatory framework for managers of non-Ucits funds in the European Union. In return, they would benefit from a EU passport for cross-border distribution to professional investors.
The main innovations focus on the supervision, disclosure requirements and distribution of alternative funds. These proposals will only introduce a minimum threshold for member states, and countries such as France and Germany may well impose stricter requirements.
The directive would apply to all managers that manage and market non-Ucits funds in the EU with assets under management exceeding EUR100m, or EUR500m if the funds are not leveraged and are not redeemable for at least five years. Hedge, venture capital, infrastructure, private equity, real estate, commodity and non-EU retail funds are all concerned, irrespective of their type, legal structure or domicile.
The directive also regulates the marketing of non-EU funds and the authorisation of non-EU managers. A manager wishing to market a non-EU fund may only do so if the country of domicile has signed an agreement with the member state in which the manager is authorised agreeing to an effective exchange of information on tax matters as laid down by the OECD.
A non-EU manager wishing to market funds within the EU must apply for authorisation by a member state, which will only be granted if the manager’s home country exercises prudential regulation and ongoing supervision equivalent to those laid down in the directive.
The directive would therefore impose significant hurdles on non-EU managers. However, if an authorisation is granted, it will be valid for all member states, allowing those managers to manage and market funds throughout the EU either directly or via a branch without having to comply with each country’s particular legislative requirements.
An independent third party must value the fund assets at least yearly, as well as the shares or units. An independent depositary, an EU credit institution, must be appointed to receive payments from investors, provide safekeeping for financial instruments and verify ownership of fund assets.
Managers must separate risk management from portfolio management functions, measure and monitor the risks associated with each strategy, and implement a due diligence process when investing on behalf of the fund.
The proposal introduces regular reporting requirements to the authorities of the manager’s home member state. The manager must also report to investors on the valuation procedures, liquidity risk management, the existence of illiquid, hard-to-value or side-pocketed assets and each fund’s risk profile.
Once authorised, the manager may provide management services to funds established elsewhere in the EU and market its funds to professional investors in other member states. The European passport to market non-European funds is scheduled to enter into force only three years after the transposition of the directive.
The directive could offer Luxembourg huge opportunities. As drafted, the distribution of offshore funds, such as those established in the Cayman Islands, may only be possible three years after the directive’s ratification, which could accelerate the redomiciliation of offshore funds to Luxembourg.
The proposal will now be debated in the European Parliament. The directive has been criticised by the industry as disproportionate and discriminatory, but if political agreement comes this year, it could come into force in 2011.

by leohil