The AIFMD, which aims eventually to require authorisation for any hedge, private equity or real estate fund manager – and indeed the managers of most other funds – wanting to manage or market its product within the European Union has recently taken another major step forward. The transitional period allowed for EU managers of AIFs to apply for authorisation finally expired on the 22nd July 2014.
However, this does not mean that all EU Member States have fully implemented the AIFMD, even though they should all have done so a full year earlier. There are still a number of stragglers, such as Spain, where relevant legislation or regulation is only in draft form, though even in those countries the AIFMD Delegated Regulation should be directly effective.
Nor does it mean that all EU AIFMs have been authorised under the AIFMD. The requirement was only that AIFMs who had been actively managing funds prior to 22 July 2013 should file an authorisation application within one year of that date. Regulators still then have the normal time to consider and decide whether to approve the application. Meanwhile, AIFMs who benefited from the transitional provisions can continue their fund management activities, even though new entrants to the market had to obtain authorisation under the AIFMD before starting business.
In the United Kingdom, despite the efforts made by the Financial Conduct Authority to persuade firms to submit their AIFM authorisation applications earlier, many applications were filed just before the deadline. On 4 August 2014 the FCA said it had received 1,130 AIFM applications, of which 706 had been approved and a further 86 were “ready for imminent approval”. The FCA went on to say that the remaining applications are being processed in line with the deadlines laid out in the Directive.
The AIFMD allows regulators three months from the date of receipt of a complete application to consider it and permits them to extend that period by up to another three months. It is therefore possible that some of those remaining 338 applications filed with the FCA by existing AIFMs – even assuming they are all complete – might not be determined until 22 January 2015. Until their applications are decided, those firms effectively have an extended transitional period.
Firms awaiting authorisation
Firms which acted as AIFMs before 22 July 2013 and applied for authorisation of their AIFM activities before 22 July 2014 are in an odd limbo situation. According to the AIFMD, those who are subject to the Directive are obliged to “take all necessary steps to comply with national law stemming from the AIFMD”, which is intended to mean they should comply in full with all of the AIFMD obligations, including regulatory capital, putting in place a depositary for the AIFs they manage and segregating risk management and valuation functions from portfolio management, to name a few.
In some cases it is not easy to comply with those obligations prior to actual authorisation, particularly where approvals from or other interaction with the regulator is required. However, the firms must do all they can to comply.
They do not, in return for these obligations, receive the dubious benefit of the “passport” permitting them to market EU funds which they manage in other EU Member States. That is only available once they become fully authorised AIFMs under the AIFMD. Instead they must, like non-EU AIFMs, conduct a jurisdiction-by-jurisdiction review of how far marketing is permitted and what requirements individual States impose. In principle, they should not be treated worse in any EU Member State when marketing their funds than non-EU AIFMs. However, that will not necessarily be much comfort.
Firms which have successfully been authorised continue to wrestle with the practical requirements for compliance. Reporting under the AIFMD is proving particularly complex in some cases.
Generally, firms are likely to find that once their regulator gets over the initial hurdle of authorising existing AIFMs, it increases the level of attention it gives to authorised firms and the obligations applying to them. For some firms this may result in increased regulatory burdens if, when they turn their attention to particular topics such as valuation or risk management, the regulators disagree with interpretations individual firms have made.
A more immediate concern and irritation is the way in which the marketing “passport” is being applied in a number of EU Member States. It may be a passport permitting cross-border marketing, but some countries think they can still require those crossing the border to line up for security checking, remove their shoes, pass through a scanner and pay for a visa. More specifically several EU Member States seek to charge a fee for inward passported marketing.
France goes further and also requires the appointment of a centralising correspondent in France to fulfil various functions, similar to those required under the UCITS Directive. Where, as is normally the case, interests in the AIF concerned are not held at Euroclear France it is possible for the correspondent’s responsibilities to be cut back to information provision obligations. Even so the AMF expects the correspondent appointed to be a French depositary or French branch of an EU depositary. A complaint has been made to the EU Commission about these requirements which appear to be contrary to the spirit of the AIFMD.
A more basic problem arises with the provisions of the AIFMD relating to “material changes”. Essentially when an AIFM plans to make a material change to matters covered by either its original authorisation application or its marketing approval application, it must give one month’s notice to its regulator before implementing the change.
These requirements are an entirely intentional part of the AIFMD but have a disproportionate effect for those AIFMs who have traditionally negotiated fund terms with their investors, as is normal for private equity, real estate and infrastructure, though less common for hedge funds. Changes required by investors in the course of those negotiations will, if material, require notification to the AIFM’s regulator and a delay before their implementation. This in turn may require admission of investors to be delayed, made conditional or held in escrow pending completion of the regulatory process.
Marketing of non-EU AIFs or by non-EU AIFM
Some, though not all, EU Member States which implemented the AIFMD on time allowed non-EU AIFMs who had marketed funds in the EEA, or the relevant jurisdiction, prior to that date to continue marketing during a transitional period. Where national implementing legislation did allow for such transitional marketing arrangements, these should also have expired by 22 July 2014.
As the various EU States have implemented the AIFMD, all have imposed some form of notification or approval process for non-EU AIFM marketing in their territory, in order to enable them to monitor future reporting. Fees frequently apply and in some countries there is either an outright prohibition of marketing by a non-EU AIFM, or of an non-EU AIF, or additional requirements. These range from full scale local authorisation and AIFMD compliance to lighter but still significant obligations to put in place a depositary, or entities fulfilling depositary functions, or to provide reciprocity statements. In a few countries, including the UK, there is a relatively straightforward notification process and marketing is permitted once the notification has been completed. In most countries, even if described as a “notification”, positive approval is required from the local regulator before marketing can commence.
Generally, therefore, marketing in the EU, even when confined to a “private placement” to professional investors of the kind with which the AIFMD is concerned, has ceased to be “private” in nature and instead requires interaction with the local regulators in each country targeted.
Inevitably this has led to many firms focussing on how far they, or their agents are really “marketing” in the sense given in the Directive. Some firms are taking a relatively aggressive approach to “reverse solicitation” i.e. to the fact that the recitals to the AIFMD expressly permit “own initiative” investment by EU professional investors. This is a dangerous area where very careful records need to be kept.
The regulators can be expected to focus increasingly on preventing “evasion” of the AIFMD and questioning how far investors are really acting on their own initiative, rather than being solicited by the AIFM or those acting for it. Perhaps more importantly, reliance on “own initiative” investment puts the firm at risk of an investor subsequently alleging that it was the “victim” of illegal marketing contrary to the AIFMD. That in turn would commonly enable the investor to withdraw from the fund and claim compensation for losses – effectively giving them an “upside only” option for their involvement in the fund.
For practical purposes, the AIFMD has only just moved out of its transitional phase. Some countries have not finalised implementation, some existing AIFM applications may not be determined until the beginning of 2015, and the practical workings of management and marketing under the AIFMD are only just beginning to settle down.
Nevertheless the timetable set out in the AIFMD requires ESMA to deliver a report to the EU Parliament, Council and Commission by 22 July 2015 on the functioning of the management and marketing passport for EU AIFMs, marketing non-EU AIFs and management and marketing by non-EU AIFMs. This is with a view to extending the application of passporting under the AIFMD to the marketing of non-EU AIFs and of authorisation and passporting to non-EU AIFMs who market in the EU or manage EU AIFMs. It is hard to see that there will be sufficient practical experience available for useful recommendations to be made in that timescale.
Tamasin Little is a partner in the financial markets group at King & Wood Mallesons SJ Berwin