AIFMD – What you should be doing to comply (Part II)

July 1st, 2013
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Contributed by: Shane Brett, Global Perspectives
This is the second of our two part white paper covering AIFMD and what fund managers should be doing to comply. The first part of this white paper examined many of the main areas fund managers should be reviewing to comply with AIFMD. This included identifying the AIFM, leverage calculations, fund manager authorization, depository selection, remuneration policies, and the requirements for non-European managers.

The second part of this white paper will look at the other important areas of the directive and what is required. These include fund domiciliation, manager liability, reporting requirements, managing illiquid investments and opportunities presented by the legislation.

Introduction

The AIFMD regulation comes into force in the 27 countries of the European Union on July 22nd 2013. The main tenets of this wide ranging legislation are now well known throughout the industry. Its scope is very wide.

AIFMD applies to all non-UCITS funds either managed or marketed into Europe. As well as hedge funds this also includes private equity funds, fund of hedge funds and real estate Funds.

Currently fund managers should be completing a detailed impact assessment to ensure they are ready for AIFMD. They should also be putting in place concrete steps to ensure they will comply with the regulations.

Global Perspectives (www.globalperspective.co.uk) can assist in completing your AIFMD impact assessment and implementing its requirements.


1. Investor and Regulatory Reporting

Reporting is a major new requirement under the regulations. AIFMD requires significant initial, on-going and exception based reporting to both investors and regulators.

Regulators: AIFMD requires on-going reporting to European regulators, similar to the recent Form PF reporting requirement in the United States. Indeed some of the questions are nearly identical.

These questions cover the basic fund and fund manager information, as well as specific details regarding liquidity, exposure and the underlying investments of the fund.

The challenge here is that each fund manager must submit the report to their home regulator - and neither its final structure nor the date of first report submission has been published! This is making the reporting process a challenge for many managers.

Some regulators (like Ireland and the UK) are happy to have a transition period and allow managers to begin filing in 2014. Other countries (notably Luxembourg) have made noises about requiring their fund manager’s file for the first time in October this year based on the period July – September 2013. This will be a big ask for many managers.

To try and alleviate these concerns ESMA, the European super regulator, has just released draft guidelines as to how the reporting template should be completed and gives a timeline for submission beginning in January 2014.

Managers should now be reviewing this substantial document closely and potentially working with their service providers to agree the data gathering process.

Some administrators are offering to collate this data for managers as an additional service offering. They will have much of the required data on their software systems.

Finally, it is important to note that ESMA guidelines are only proposals and the final guidelines will not be known until at least September 2013 – 2 months after the AIFMD legislation comes into force!

Investors: Separately AIFMD has specific requirements regarding reporting information to your investors. Information regarding leverage, risk management and the use of collateral must be reported to investors at least annually.

Similarly if a fund manager enters any “special arrangements” on the fund (e.g. gating, side pockets etc.) investors must be immediately advised.

To ensure compliance here Managers should be speaking to the Transfer Agency department at their administrator. They should be able to facilitate the investor notification process as part of their TA service offering.

US Fund Managers: A final word regarding reporting for non-European managers. Going forward non-European managers who are in-scope for AIFMD (i.e. if they plan to market their funds into Europe) will be required to submit “transparency reports” to a European regulator. This will apply to most US managers. These reports must include details of the fund and its exposure and investments. Many US managers are now slowly waking up to these requirements.

We will cover the full AIFMD requirements for non- European managers in full detail in a forthcoming Global Perspectives white paper. Sign up to our distribution list (at the end of this white paper) to receive it.


2. Domiciliation

Over the past few years a debate has taken place within the industry about whether it would be easier for a manager to change the domiciliation of their funds, either to register them in Europe and have them fully in-scope for AIFMD or register them outside the EU to avoid some of the regulations main requirements (at least for the next few years).

Some large managers have already re-domiciled in recent years, either moving all their funds into the European Union, or moving them all to an offshore jurisdiction like Cayman.

A further option being discussed is whether fund “co-domiciliation” could be an attractive option. For this a manager would run both an offshore fund (e.g. domiciled in Cayman) and an onshore fund domiciled in Europe. The onshore fund would mirror the offshore entity.

While co-domiciliation would overcome the regulatory restrictions imposed by AIFMD, we would consider co-domiciliation a challenge to run operationally.

Costs would be higher for the onshore fund due to depository and leverage requirements. Reporting and regulatory obligations would also be much tighter.

Currently fund Managers should be considering the existing and likely future domiciliation of their funds. Future structures should be analyzed and may need to be restructured if a fund is judged to be inadvertently in-scope for AIFMD.

It is important to note however, that even funds registered outside Europe to avoid AIFMD will have to comply on a phased basis in the years ahead, if they want to market their fund into the European Union. In the future it will be very difficult to escape AIFMD’s net.


3. Liability

AIFMD substantially increases liability for fund managers in many areas. The obligation is now squarely on the manager to ensure their fund is compliant.

While the new depositary is on the hook to investors should the fund go belly up; the fund manager is responsible to their regulator in most areas should something go wrong.

For example, in the future it will be far harder to blame the fund administrator if a NAV is struck incorrectly or there are operational errors on the fund. The directive is clear that it is the responsibility of the fund manager to ensure its service providers comply with all aspects of the regulation.

It is also the manager’s responsibility to ensure the depositary receives all data and reporting required from the fund’s administrator. This will be required by the depositary in order to perform their on-going checks and reviews on the fund.

As part of this enhanced liability managers will also be obliged to conduct regular due diligence on their service providers (see part one of this white paper for more details). The top tier investment managers are doing this already. AIFMD now makes this a legislative requirement.

Managers should be completing a detailed review of the articles related to liability and performing a gap analysis against their internal set- up and processes. Where are their gaps? What changes need to be made? Are your service providers deficient in any area? Are you?


4. Illiquid Investments

AIFMD has specific requirements for funds that hold investments with limited liquidity.

To confuse matters AIFMD does not properly define “limited liquidity”!

Private equity and real estate will obviously fall into this category but it is not clear if lightly traded stocks or bonds (e.g. emerging market debt or small cap shares) are also in-scope.

The directive does not preclude or prohibit investment in these types of assets. Instead it prescribes a process that must be put in place regarding how these assets should be managed and documented by the fund manager.

If a manager holds assets with limited liquidity they must prepare a business plan for how these investments will be managed. This must be regularly updated by the manager. Transactions must be conducted in accordance with the business plan and due diligence must also be completed and documented on the assets in question. Performance of the assets must then be monitored on an on-going basis by the fund manager with reference to the business plan.

These requirements will obviously have a significant impact on Private Equity managers. These managers should currently be drafting their business plan in respect to all in-scope illiquid investments, as well as setting up the prescribed internal processes to document and manage these requirements. For some PE managers this will be a large, cumbersome task.

We will review the full AIFMD requirements for private equity managers in a forthcoming Global Perspectives white paper. Sign up to our distribution list (at the end of this white paper) to receive it.

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