Where AIFMD level two measures will fall short

Author: | Published: 6 Sep 2012
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Participants in Europe’s alternative fund management industry have urged international regulators to adopt a more coordinated and considered approach to market supervision.

The European Commission’s Alternative Investment Fund Managers Directive (AIFMD) came into force on July 21 2011. When it takes effect in July 2013, it will fundamentally change the activities of all funds other than UCITS (Undertakings for Collective Investment in Transferable Securities).

The European and offshore non-UCITS fund sector must alter how they distribute funds, pay salaries and operate their businesses.

Many of the provisions in level one of the Directive require further clarification and a significant amount of the detail is to be defined at level two, through subordinate measures – the final version of which are yet to be published. Affected hedge funds, private equity funds and real estate funds therefore remain uncertain how best to prepare at a detailed practical level.

But Field Fisher Waterhouse’s Kirstene Baillie said the EU initiative could not be viewed in isolation. “The challenge for many of the alternative investment fund managers (AIFMs) is that they are operating in a number of jurisdictions,” she said.

For firms in jurisdictions where regulation is already required, many of the AIFMD requirements will be familiar. For example, the majority of alternative fund managers in Europe are based in the UK and therefore subject to Financial Services Authority (FSA) regulation.

“There could have been a gradual extension or evolvement of the FSA's approach of regulating operators of collective investment schemes – together with more information gathering on the alternative funds themselves,” said Baillie.

Good practice probably could usefully be enshrined in new regulation of alternative fund managers, which could have made a contribution to more robust alternative fund structures, she said.

But she did not believe this would necessarily be the result of the AIFMD implementation.

“Instead we have this wide ranging, and politically-driven, AIFMD initiative which will cause difficulties for many in adjusting to comply with it and yet may not achieve its purpose,” she said.

One-size-doesn’t-fit-all

Kirkland & Ellis’ private equity partner Stephanie Biggs said regulatory uncertainty was causing significant problems for the industry

“The biggest difficulty with AIFMD is that it takes a one-size-fits-all approach to regulating a diverse industry, and in some cases it is not clear what mischief the regulatory requirements are addressing,” she said.

Baillie said one approach simply could not suit all types of alternative investment funds.

Biggs warned the consequences of this oversight could be damaging. “Poorly targeted rules that create additional costs for firms, with no clear benefits for investors or other stakeholders, are frustrating and can affect the extent to which firms ‘buy-in’ to the regulatory regime,” she said.

The AIFMD process had demonstrated how vital it was to engage extensively with the EU process at an early stage, Biggs said, as it is easier to get key messages across before the legislative process gathers momentum. It had also demonstrated how important it was to understand the political drivers behind legislation, and to make the political case as well as the business case, she said.

Nonetheless, Baillie believed the tailoring within the level two measures may not be sufficient to resolve all issues created by the AIFMD.

She predicted implementation of some AIFMD changes would make some provisions more onerous for professional investors investing in affected funds than for UCITS funds intended for retail investors.

Recently-published proposals to amend the UCITS Directive have recognised the need to – at the least – level up the regulations. Even so, Baillie believed some wider consideration should probably now be given to which sorts of funds should be viewed as mainstream for retail investors or alternative for professional investors, and what sort of protection is really needed for each category of investor.

Biggs expected the new depositary rules would also have a big impact. “Private equity firms are not used to external oversight of their investment processes, and many would argue that this is unnecessary,” she explained.

Firms have also expressed concern over the limitations on their other business activities, the level of regulatory capital required and the remuneration rules. While, non-EU firms have questioned whether national private placement regimes will permit them to market funds to EU-based investors, as this will have a significant effect on firms’ marketing strategies.

“For firms in jurisdictions that do not currently regulate private equity, the transition from being unregulated to being a fully regulated asset manager will be very significant,” Biggs said.

The practical impact

Biggs was hopeful, however, that changes to firms’ day-to-day operations may be limited. Private equity firms have always had very transparent relationships with their investors, who are used to receiving detailed reports about the fund’s performance on a regular basis, she said.

Firms may have to tweak their existing investor reporting procedures to comply with AIFMD and Dodd-Frank, but they should not have to make wholesale changes.

“The biggest change is the amount of information to be reported to regulators,” she explained. “This is likely to be time-consuming for the back-office team, so firms are hoping that regulators will make the process as streamlined and straightforward as possible.”

“It is also likely that more information will end up in the public domain, although many larger firms are already used to being in the media spotlight from time to time,” she said.

She believed it was critical for firms that are currently fundraising to take steps to future-proof their fund structures and documentation as far as possible.