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ESMA launches discussion paper on AIFMD technical standards

March 2012 - Finance. Legal Developments by Chevalier & Sciales .

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The European Securities and Markets Authority has published on February 23 a discussion paper on key concepts of the Alternative Investment Fund Managers Directive and types of alternative fund manager to initiate a consultation process aimed at finalising its policy approach.

Esma says that in the light of responses to the discussion paper, it will draw up a consultation paper during the second quarter of this year setting out formal proposals for draft regulatory technical standards under Article 4(4) of the directive, “to determine types of AIFMs, where relevant in the application of this directive, and to ensure uniform conditions of application of this directive”.

The authority says it will use the results of the public consultation to finalising the draft regulatory technical standards, which it will submit to the European Commission for endorsement by the end of 2012. Comments must be received by March 23.

Esma seeks to align supervisory practices among European national regulators in the interpretation of certain key concepts of the AIFMD as part of its efforts to achieve a harmonised application of the directive, and may consider developing additional convergence tools for this purpose in future.

Definition of an alternative investment fund manager

Esma notes that Article 4(1)(w) defines the activity of managing alternative funds as performing at least portfolio management or risk management functions, and argues that therefore an entity performing either of the two functions should be considered as managing a fund. Such an entity must therefore seek authorisation as an alternative fund manager under Article 6 of the directive.

No authorisation is required where either portfolio or risk management is carried out under a delegation arrangement with an alternative manager. Article 20 requires that any entity to which portfolio or risk management functions are delegated is authorised or registered for the purpose of asset management and subject to supervision, otherwise prior approved is required from the manager’s home regulator.

According to Esma, Article 6(5)(d) should be interpreted as requiring a manager to be capable of providing, and take responsibility for, both portfolio management and risk management functions in order to be authorised under the AIFMD. However, it may choose to outsource either or both of these functions according to the delegation rules set out in Article 20 of the directive and the Level 2 measures to be announced by the European Commission later this year.

The manager’s liability is not affected by delegation (or further sub-delegation) of portfolio and/or risk management functions to a third-party entity. Esma emphasises that these functions may not be delegated to such an extent as to make the manager effectively a letterbox entity that can no longer be considered as manager of the fund in question. Subject to these requirements, Esma says that a manager may delegate both portfolio and risk management in whole or in part, but it may not delegate both functions in whole simultaneously.

Esma says this also means the manager of an alternative fund does not have to perform the additional functions set out in Annex 1 of the directive, comprising administration, marketing and services relating to fund assets. However, if it does not, these functions should be considered to be delegated to a third party, leaving the manager responsible for their performance under the directive’s rules on liability for delegation liability and responsibility for compliance.

Definition of an alternative investment fund

Regarding the definition of what constitutes an alternative investment fund, Esma acknowledges that the scope of the directive is extremely broad, embracing both funds that invest in traditional assets and those that invest in non-traditional asset classes including shipping, forestry and wine.

Article 2(3) of the directive lists various entities that fall outside its scope, including holding companies. This is defined as a company with shareholdings in one or more other companies through which it carries out a business strategy or strategies. It must either operate on its own account and be listed on a regulated EU market, or alternatively its annual report or other official documents must make clear that it has not been established for the main purpose of generating returns for its investors through divestment of its subsidiaries or associated companies. However, Esma cautions that the holding company exemption should not be used as a means of circumventing the provisions of the directive.

Article 3 lists entities that would fall under the scope of the directive were they not exempted.  These include managers of one or more funds whose only investors are the manager itself, its parent or subsidiaries, or other affiliated companies within the same group that are not themselves funds. Family office and similar private investment vehicles that do not raise external capital should not be considered as alternative investment funds, while insurance contracts and joint ventures are also excluded.

Esma is calling for feedback from stakeholders on whether they see merit in further clarification of the notion of family office vehicles and what “investing the private wealth of investors without raising external capital” should cover. It also asks whether “insurance contracts” and “joint ventures” need further clarification, whether further detail of the characteristics of holding companies is required, and whether any of the other exclusions or exemptions need further clarification.

Through a ‘mapping exercise’ surveying EU regulators, Esma has identified six categories of alternative fund: funds that invest in similar assets as Ucits funds but do not meet Ucits diversification or leverage rules; funds that invest in assets not eligible for Ucits; private equity funds; venture capital funds; real estate funds; and ‘alternative alternatives’ vehicles including commodity funds.

Esma has concluded that concentrating on asset classes or on investment strategies are not the best methods of determining what constitutes an alternative investment fund under the directive.

Instead it proposes various criteria: capital-raising that involves at least some kind of communication between the entity seeking capital or its representatives and prospective investors that results in the transfer of cash or assets to the fund; collective investment seeking to generate a return from pooling investors’ capital; the absence of any rule limiting the sale of shares or units to a single investor; a fixed and defined investment policy that is communicated to investors; the fund rather than the investors owns underlying assets; and the manager has responsibility for the management of those assets.

The application of various articles of the directive depends on different factors such as whether they are open-ended or closed-ended, internally or externally managed, whether they employ substantial leverage and or whether or not they use a prime broker. In addition, Esma’s Level 2 advice to the Commission notes that the principle of proportionality should be followed in some (but not all) areas.

Esma suggests that open-ended funds be defined as those whose units or shares may, at the holder's request, be repurchased or redeemed without any limitation, directly or indirectly, at least annually. It proposes to tackle the question of what constitutes an alternative fund “of significant size” in drawing up guidelines on sound remuneration policies.

Appointment of an alternative investment fund manager

Article 5 of the directive requires each alternative fund to have a single manager responsible for compliance with the directive. However, depending on the fund’s structure, more than one entity could be capable of being designated – for instance the fund itself, where internal management is legally possible, or another entity responsible for the portfolio and risk management functions.

The directive itself does not set conditions or criteria for the appointment or selection of a manager – it can be any legal entity authorised as an alternative investment fund manager under the directive.

Treatment of Ucits management companies

Article 6(2) allows an authorised alternative manager also to act as a Ucits management company provided it is authorised as such. After the AIFMD enters into force, a Ucits management company that already manages alternative funds must seek separate authorisation under the directive.

Esma says a Ucits management company will be able to provide services including investment management to an alternative fund even where it cannot be the appointed manager, for example because the fund is internally managed. In such a case the Ucits management company’s activities will continue to be authorised under the Ucits Directive and it will not need separate authorisation under the AIFMD. A single entity will be able to obtain authorisation under both directives.

Treatment of MiFID firms and credit institutions

Investment firms authorised under MiFID and credit institutions authorised under the Banking Consolidation Directive are not required to obtain authorisation under the AIFMD to provide investment services such as individual portfolio management to alternative funds. They may continue to provide services to funds under the rules governing delegation arrangements.

Although Article 6(2) of the AIFMD says no external alternative fund manager may engage in activities other than those referred to in Annex I or the management of Ucits, Article 6(4) permits a manager to provide portfolio management services to clients including funds where it is not the appointed manager, as well as non-core services such as investment advice, safekeeping and administration, and receipt and transmission of orders.

Esma therefore argues that a firm authorised under MiFID or the Banking Consolidation Directive cannot be the appointed manager of an alternative fund nor obtain authorisation under the AIFMD, but they may provide investment services such as individual portfolio management in respect of alternative funds.

Olivier Sciales is a partner at Chevalier & Sciales. More information can be found on the our AIFM Directive blog at www.cs-avocats.lu/aifm-directive.

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