Doing Business In The EU: US Investment Advisers Brace For AIFMD

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The Alternative Investment Fund Managers Directive (AIFMD) is a new regulatory environment that became effective 22 July 2013, and comprises of the following:

  • An EU directive issued 8 June 2011 that outlines the philosophy towards alternative investment fund management
  • An EU regulation issued 19 December 2012 that details how to comply with the above directive and
  • A set of guidelines published by the European Securities and Markets Authority (ESMA).

Apart from the broad regulatory framework discussed above, individual EU countries are also at liberty to implement their own country specific requirements within the overall AIFMD structure.

Compliance could be more onerous than the SEC

“Investment managers need to analyze all these documents together since important operating rules are often in separate documents,” say Ernst and Young authors John Sampson and Kai Braun in their research note ‘An American in AIFMD Land.’ ”Together, however, they form the EU’s rules of investment management, similar to the US Investment Advisers Act of 1940.”

“In fact the AIFMD may impose greater reporting and compliance burdens on investment managers than the US Securities and Exchange Commission (SEC) rules,” they add. “Many American investment advisers are struggling to dance to this newest European tune.”

AIFMD: Routes to compliance

American investment managers under the purview of the AIFMD have three options towards compliance, suggest the authors.

  • Full AIFMD compliance through the establishment of a fund and a manager
  • Take recourse to the National Private Placement Regime (NPPR)
  • Rely on reverse solicitation

Each option above has its own implication on fundraising, compensation, tax and reporting responsibilities.

Full-fledged compliance

Though onerous, the full compliance route comes with its just rewards. Fund managers can access all professional investors in the EU including the largest financial institutions during their marketing.

In return, US managers must comply with compensation norms such as the constitution of compensation committees depending on size, reinvestment of compensation incentives, and including lock-up thereof for 3 to 5 years depending on fund life cycle.

The advisers must establish autonomous risks management procedures that prescribe risk limits including leverage, monitoring and reporting any violation of these limits by managers to management committees.

Disclosure norms regarding investors are particularly tough on compensation. Annual reports must contain full details including fixed and variable components of the fund managers’ compensation and their staff. As usual investment managers and funds must be upfront with investors prior to receiving initial investment and should disclose full details of the fund such as investment strategy, valuation procedures, service providers, liquidity management, fees and expenses, performance details, prime brokers and custodians and the latest NAV as well as annual report.

Regulatory disclosures are very rigorous. “The data need is intense; although the AIFMD form is similar to Form PF, it is different enough to be challenging, especially regarding leveraged calculations, liquidity stress tests and the calculation of total assets when notional amounts of financial derivatives are calculated using the price of the cheapest-to-deliver securities instead of 10-year equivalents,” observe the authors. They also point to the rather stringent reporting deadline of one month after the end of the reporting period.

National Private Placement Regimes (NPPRs)

The NPPR is a mechanism that allows fund managers to market funds that are not allowed to be marketed under the AIFMD domestic marketing or passporting regimes.

This is an option for firms that are not compliant with AIFMD, but it replaces compliance headaches with onerous reporting responsibilities that extend to each national financial securities regulator in every country in which the fund is marketing. According to the authors, investment advisers may end up reporting to as many as 27 different country regulators.

Funds must follow an AIFMD reporting template that gives the minimum data requirements for compliance. The timeline is one month after the close of the reporting period.

Reverse solicitation

At the other end is the extreme trade-off: fund managers and advisers can cease marketing their products in the EU and as a result have no compliance headaches as far as AIFMD is concerned.

Fund managers cannot extend marketing communications to investors, and can only accept investments provided the inquiry is initiated by the investor himself.

“Managers should take care that the actions of all their client-interfacing employees do not inadvertently constitute marketing and make the reverse-solicitation option unavailable,” warn the authors.

A fund may be required to prove reverse solicitation and would therefore be required to maintain exhaustive documentation, restrict websites, monitor and scrutinize client meetings, consulting relationships and capital introductions.

“Policing reverse enquiry may be more expensive than selective registration,” remark the authors.

Conclusion: not an easy choice

  • Full AIFMD compliance = reporting simplicity and regulatory certainty
  • NPPR = reporting nightmare and uncertainty
  • Reverse solicitation = restricted fundraising, burden of proving compliance

“Just as Gene Kelly adapted in An American in Paris, US investment managers must understand the new tune and adapt quickly to the new environment,” suggests the research note. “If managers adapt successfully, the AIFMD may present opportunities for success. If US managers ignore the AIFMD, they may be too far behind in Europe to ever catch up.”

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