AIFMD: State Street’s Keith Burman asks what should alternative fund managers do now?
Keith Burman, senior managing director at State Street in Luxembourg, has outlined four key steps managers should consider as they prepare for the introduction of the AIFMD.
The final countdown to the July 2013 introduction of the Alternative Investment Fund Managers Directive (AIFMD) has begun. Many fund managers are already well prepared for this far-reaching regime change, but others may need to accelerate the pace of preparation.
With this in mind, what practical steps can be taken now to meet the initial deadline? We’ve pinpointed four main areas: Identifying relevant funds and fund manager entities, appointing a depositary, tackling the data challenge, and preparing for distribution.
History of AIFMD
The AIFMD seeks to put a common regulatory framework around non-Undertakings for Collective Investment in Transferable Securities (Ucits) investment funds including hedge funds, private equity and real estate funds – collectively known as Alternative Investment Funds (AIFs). The goals of the directive include the reduction of systemic risk, enhanced investor protection and, ultimately, greater integration of the European internal market for financial services.
In general terms, the directive creates a common framework for Alternative Investment Fund Managers (AIFMs) that operate and/or distribute their AIFs in the EU. It sets out to achieve the following:
• Determines conditions and requirements for the authorisation, operation and organisation of AIFMs
• Includes prescriptive investor and home state authority disclosure and reporting requirements
• Offers a European passport for the sale of AIFs to professional investors on a cross-border basis
• Provides a phased approach with different requirements for non-EU entities depending on the domicile of the AIFM/AIF, and on the distribution of the AIF
Industry bodies, including the European Fund and Asset Management Association (Efama) and the Association of Global Custodians, have raised significant objections to elements of the regulations.
Worries over the cost of implementation and the timeline for the transposition of the AIFMD in EU member states have added to the uncertainty. As a result, some fund managers waited for the final Level 2 measures – hoping for a greater degree of clarity before beginning their preparations. With these measures finally announced in December 2012, there is an uptick in focus on the directive as the implementation deadline of July 2013 looms.
For larger fund managers who already operate regulated Ucits funds, the new rules and approach will be familiar and they should be able to utilise some of their existing know-how and frameworks. While the details differ, the process of compliance should largely fit into their existing business models.
For other fund managers, the AIFMD will be a major upheaval and may require a fundamental review of business and operating models.
Action Points for Alternative Investment Fund Managers
Here are the four main areas which are likely to require significant investments of both time and resources for an AIFM to be AIFMD-ready. Fund managers should be putting these into action now.
1 Identify relevant AIF and AIFM entities and create a delegation-compliant structure
The starting point for fund managers will be: “Which investment vehicles will be in scope and which entity will act as the AIFM?”
AIFs are generally defined as “collective investment undertakings … which raise capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors, and … do not require authorisation … [as Ucits]’.
While there are a number of exemptions for, among others, grandfathering, de minimus size, group undertakings, holding companies, pension funds and securitisation vehicles, the vast majority of current alternative fund vehicles, regulated or not, and regardless of legal form, will be in scope of the AIFMD.
The AIFM is the single entity responsible for investment management (i.e., portfolio and risk management) and for reporting to the local regulator on its activities and the AIFs under its responsibility. While it may seem obvious that the legal governing body of an AIF should be the AIFM (e.g., the general partner of a limited partnership), under AIFMD the AIFM may change when the delegation rule is considered.
The delegation rule of the AIFMD is designed to ensure that legally appointed fund managers are not purely “letter box” entities – i.e., a plaque on a wall – with all of the investment management functions being handled by entities separate from the appointed manager itself. The thinking behind the rules is that if a fund manager transfers duties on a wholesale basis, they will be unable to effectively undertake and satisfy the AIFM responsibilities under the directive. In a case like this, the directive follows the delegation of the substance of portfolio and risk management activities, to identify the AIFM, which may be an entity that currently only operates under an “advisory” agreement with the AIF.
Under the new rules, the AIFM must be able to demonstrate objective reasons to its competent authority for delegating any of its responsibilities. The authority will consider the nature of the delegation, taking account of other pertinent matters including the overall risk profile of the assets in which the AIF is invested and the function and scope of tasks delegated, compared to those that are retained.
Many fund managers may need to reassess their group’s operational and financial set-up and look carefully at how they organise portfolio and risk functions, which may be spread across several legal entities and geographical centres. Essentially they need to work out the best structure and the part of their (often geographically diverse) businesses that will be assigned as the central AIFM for the purposes of the directive.
AIFMs will not be able to delegate a significantly greater proportion of the tasks than they perform themselves. Meeting this requirement may involve a reorganisation of portfolio and risk management functions across a fund management group to provide AIFM entities with sufficient resources and expertise to carry out their required duties.