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Luxembourg and the proposed Alternative Investment Fund Managers Directive (AIFM)

August 2009 - Finance. Legal Developments by Chevalier & Sciales .

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As part of a legislative package to tackle the financial crisis, the European Commission submitted on 29 April 2009 a Directive on Alternative Investment Fund Managers (“AIFM”) to the European Parliament and to the Council. This proposal emerged rather swiftly following a general consensus across European leaders that AIFM, which managed around EUR 2 trillion in assets at the end of 2008, should be subject to closer regulatory scrutiny. This proposed Directive marks the first attempt to create a comprehensive and effective supervisory and regulatory framework for AIFM in the European Union (“EU”) by imposing on European investment managers of non-UCITS investment funds a common set of rules in terms of licensing and supervision. In return, AIFM would benefit from a European passport for cross-border distribution to EU professional investors. The main innovations focus on the regulatory supervision, the disclosure requirements and the distribution of Alternative Investment Funds (“AIF”). Key elements of the proposed Directive are set out below. However, it should be pointed out that those proposals will only introduce a minimum threshold for Member States, and countries such as France and Germany will probably pass harsher requirements.

(1)    Scope of the Proposed Directive


The proposed Directive would apply to all managers that manage and market non-UCITS funds in the EU, unless their assets under management do not exceed EUR 100 million, or EUR 500 million when the Alternative Investment Funds (“AIF”) managed are not leveraged and have no redemption rights exercisable during a period of five years following the date of constitution of the AIF. This constitutes a major innovation since AIF have so far been immune from any harmonized regulatory regime within the Europe Union.


All non-UCITS funds are concerned (hedge funds, venture capital funds, infrastructure funds, private equity funds, real estate funds, commodity funds, non-EU retail funds), irrespective of their type, their legal structure or their country of domicile (even outside the EU). Indeed, the Directive also regulates the marketing of non-EU funds and the authorization of non-EU AIFMs. Consequently, an AIFM wishing to market a non-EU fund may only do so if the country of origin has signed an agreement with the relevant EU Member State(s) agreeing to an effective exchange of information on tax matters complying with the standards laid down in Article 26 of the OECD Model Tax Convention[1]. In addition, a non-EU AIFM wishing to market within the EU must apply for authorization by a Member State, which will only be granted if the AIFM’s own country has in place prudential regulation and ongoing supervision equivalent to those of the Directive.  


The Directive would therefore impose significant hurdles on non-EU fund managers, triggering calls from opponents of the Directive to avoid excessive protectionism. However, if granted, the authorization will be valid for all Member States, thereby allowing those managers to manage and market AIF within the EU either directly or via a branch without having to comply with each country’s particular legislative requirements


(2)    Operating conditions


(i)                   Organizational requirements


AIFM shall only delegate activities following prior authorization of the home Member State regulator, which will have regard to the quality of the service provider. It should be noted that delegation does not affect the liability of the AIFM. AIFM must entrust a legally and functionally independent valuator with the valuation of the assets of the AIF under management, the frequency of which should be at least yearly as well as the valuation of their shares or units. The AIFM must also make sure that for each AIF it manages, a depositary is appointed in order to receive payments made by investors and book them on behalf of the AIFM in a segregated account, safe-keep the financial instruments of the AIF and verify ownership over all the assets of the AIF. The depositary must be independent from the AIFM and must be a duly authorized credit institution having its registered office in an EU Member State.


(ii)                 Minimum Capital Requirements


AIFM should have an initial capital of at least EUR 125,000. However, when the value of the portfolio managed (directly or by delegation) exceeds EUR 250 million, additional own funds of 0.02% must be provided.


(iii)                Risk management


AIFM are required under the proposal to separate the functions of risk management and portfolio management, and to implement systems to measure and monitor all risks associated with each AIF strategy. In particular, the AIFM must implement an appropriate, documented and regularly updated due diligence process when investing on behalf of the AIF, according to the investment strategy, the objectives and the risk profile of the AIF. Lastly, the AIFM shall ensure that the risk profile of the AIF corresponds to the size, portfolio structure and investment strategies of the AIF as laid down in the AIF’s rules or instruments of incorporation.


(iv)                Reporting obligation


In line with the objective to impose tighter scrutiny on AIFM, the proposal introduces regular reporting requirements towards the authorities of their home Member State. The AIFM is indeed in the obligation to provide information on the principal instruments in which it trades, and on the principal exposure of each of the AIF it manages. At the end of each quarter, the AIFM must provide a list of the AIF it manages.


In relation to investors, the AIFM must for the sake of their protection provide them with specific procedure information, including a description of the valuation procedures and the liquidity risk management. Moreover, the percentage of illiquid, hard-to-value or side-pocketed assets, as well as the updated risk profile will have to be periodically disclosed.


(v)                 European passport


Once approved by its home Member State regulator, the AIFM shall be free to provide management services to an AIF established in any other EU Member State. Moreover, the AIFM will be able to market the AIF it manages in another Member State. However, this option shall only be possible in relation to professional investors, and retail cross-border marketing of units or shares of AIF should not be authorized by the European regulator. It should be noted that the European passport to market non-European AIF is scheduled to enter into force only three years after the transposition of the proposed Directive.


(vi)                Specific obligations for AIFM managing leveraged AIF


Particular reporting obligations apply when the combined leverage from all sources exceeds the value of the equity capital in two out of the previous four quarters. In this situation, the AIFM must disclose to investors the maximum level of leverage that he may employ in relation to each AIF, as well as any right of re-use of collateral, guarantees granted under the leveraging agreement and on a quarterly basis, the actual amount of leverage in the previous quarter.


The AIFM will also have to disclose to the competent authorities of its home Member State the overall level of leverage employed by each AIF it manages.


(vii)             Specific obligations for AIFM managing AIF which acquire controlling influence in companies


AIFM in position to exercise 30% or more of the voting rights of an issuer or of a non-listed company must notify the company and shareholders of that control. This obligation does not apply when the issuer or non-listed company employs fewer than 250 persons, has an annual turnover not exceeding EUR 50 million, and/or annual balance sheet does not exceed EUR 43 million.


Produced in record time, the proposal is now in the hands of the European Parliament, where it is expected to be subject to stormy political negotiations. From a Luxembourg perspective, this Directive is bearing huge opportunities, and, if ratified, could have a major impact on the alternative investment industry. Indeed, under the current proposal, the distribution of offshore funds (e.g. established in the Cayman Islands) to professional investors (as defined by the MIFID Directive) will only be possible after a period of three years following the Directive’s ratification. This could, by accelerating the re-domiciliation of offshore funds to the Grand Duchy, strengthen Luxembourg’s position as a major hub for investment funds.


However, across Europe, the project is widely criticized by the industry as disproportionate and discretionary, and it still divides important European actors, such as the United Kingdom and France. Amendments or delay in its enforcement should therefore be expected in the forthcoming months.


Should a political approval be reached by the end of 2009, the Directive could come into force in 2011.  


[1] There are currently 52 such agreements (as at June 2009), and 22 others are under negotiation or awaiting approval by the Luxembourg Parliament  ,

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