Alternative fund managers face regulatory regime
The Channel Islands are set to face a new regulatory regime later this year when a European directive targets alternative investment fund managers. Martin Paul of Bedell Cristin reports.
The Alternative Investment Fund Managers Directive (the "Directive") seeks to regulate alternative investment fund managers ("AIFMs") who either manage or market alternative investment funds ("AIFs") in the European Union. With effect from 22 July 2013 Channel Island-based AIFMs will be affected by certain aspects of the Directive if they manage EU AIFs or market EU or non-EU AIFs to investors in the EU.
There are a number of exemptions which may apply – including where assets under management fall below certain thresholds and closed-ended funds which are closed for subscription and will be wound up by 2016. The marketing of AIFs into the EU by way of "reverse solicitation" will also be permitted without triggering application of the Directive. However, for many Channel Island AIFMs the Directive will introduce new rules.
The Directive defines an AIFM as the entity which manages the AIF, that is which performs investment management functions, namely, portfolio or risk management. This could be a third party appointed by the AIF, or the AIF could be "internally managed".
The Directive then restricts delegation of the AIFM's duties to third parties: the delegate must have sufficient resources, the AIFM must be able to effectively supervise the delegate, and (where delegation is to a non-EU entity) the delegate must be subject to home country regulatory supervision. The delegation must also not lead to a circumvention of responsibilities or liability, and must be undertaken for good reason. In short a "brass plate" entity which outsources everything and retains no resources or competency - in the jargon of the Directive, a "letter box entity" – is insufficient.
Offshore structures typically involve a delegation of functions. For Jersey and Guernsey, the delegation requirements could create opportunities. Many managers already operate staffed offices in the Islands, and it should be a straightforward matter to demonstrate substance offshore. In addition, for those without a presence in the Islands, the "managed entity" model which has successfully operated on a regulated basis for a number of years, together with the availability of a highly skilled workforce, allows arrangements to be put in place ensuring that an AIFM can provide the requisite functions from the Islands.
From July, AIFMs established in the EU will be subject to the full impact of the Directive, and will be able to market AIFs into the EU with the benefit of an EU-wide marketing "passport". In contrast, AIFMs outside the EU (e.g. in the Channel Islands) will be subject only to some of the Directive's requirements, but will be marketed within the EU under Member States' national "Private Placement Rules".
Conditions for using the Private Placement Rules are as follows:
• Co-operation agreements must be in place between the regulator in the EU Member State where the AIF is marketed and the home regulator of the AIFM. Jersey and Guernsey are currently engaged with European regulators for the purpose of agreeing and signing these co-operation agreements prior to July 2013.
• The third country must not be listed as non-cooperative on anti-money laundering by the Financial Action Task Force. Neither Jersey nor Guernsey is listed as non-cooperative by FATF.
• The transparency, reporting and acquisition of control (including asset stripping) provisions of the Directive will apply to non-EU AIFMs in the same way as for EU AIFMs.
AIFMs will also become subject to operational rules on transparency, including requirements:
• to publish annual reports to investors, including financial information, a report on activities and remuneration details
• that certain specified information is made available to investors before they invest in the AIF, and periodic disclosures are made in respect of illiquidity and leverage (where relevant)
• to submit reports to relevant regulators including information on assets, illiquidity, leverage and stress tests.
In addition, private equity fund AIFMs may be subject to rules relating to the acquisition and control of non-listed companies, including requirements:
• to notify relevant regulators and subject companies and shareholders when acquiring (alone, or with others) major holdings or control of non-listed companies
• that investee company annual reports must be made available to employees of that company, and include reports on past developments and future plans for the company
• restricting "asset stripping" - the excess withdrawal of cash from investee companies within two years of acquisition.
While the obligations set out in the Directive impose additional burden on AIFMs, the burden for non-EU AIFMs marketed under the Private Placement Rules will be significantly reduced. Restructuring may be required to ensure that the appropriate entity is treated as the AIFM, and that any functions of the AIFM are delegated appropriately. The transparency and acquisition of control obligations will necessitate some additional procedures being put in place, but compared with full compliance using non-EU AIFMs will allow continued flexibility until at least 2018. The Channel Islands are well positioned to offer this flexibility.
Looking ahead, it is expected that from 2015 the passporting system will be extended to non-EU AIFMs. For this, third countries will need to have entered into Tax Information Exchange Agreements (TIEAs) with relevant EU Member States. Jersey and Guernsey already have a wide network of TIEAs with EU Member States and are working on signing additional TIEAs where necessary.
Finally, for those managers who operate entirely outside the EU space and who do not intend to raise capital in the EU, the current regulatory regimes in Jersey and Guernsey will continue to offer a further choice completely outside the scope of the Directive.
Martin Paul is head of the Investment Funds and Private Equity Group at Bedell Cristin.
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