EU Directive on Alternative Investment Fund Managers (AIFMs)
from the International Association of Hedge
Funds Professionals (IAHFP)
Proposal for a Directive on Alternative Investment Fund Managers
The
Directive on Alternative Investment
Fund Managers (AIFMs) introduces a regulatory and supervisory
framework for Alternative Investment Fund Managers (AIFM) in the
European Union.
For the purposes of the
Directive, Alternative Investment Funds
are defined as all funds that are at present
not
harmonised under the
UCITS Directive.
The
Alternative Investment Fund
sector in the
European
Union
is large - around €2 trillion in assets at the end of 2008 - and
diverse.
Hedge funds, private equity funds, commodity
funds, real estate funds and infrastructure funds, among
others, fall within this category.
The specific objectives of the
Alternative Investment Fund Managers (AIFM)
Directive are to:
-
Ensure that all
Alternative
Investment Fund Managers
are subject to
appropriate authorisation and registration requirements;
-
Provide a framework
for the enhanced monitoring of macro-prudential risks, e.g.
through sharing of relevant data among supervisor;
-
Improve risk
management and organisational safeguards to mitigate
micro-prudential risks;
-
Enhance investor
protection;
-
Improve public
accountability for
Alternative Investment Fund
holding controlling
stakes in companies;
-
Develop the single
market for
Alternative
Investment Fund Managers
-
What risks is the
proposal tackling?
The financial crisis
has underlined the extent to which
Alternative
Investment Funds
are vulnerable to a wide range of risks.
These risks are of
direct concern to the investors in those funds, but also present a
threat to creditors, trading counterparties and to the stability
and integrity of European financial markets.
According to the European Commission, hedge
funds have contributed to asset price inflation and the rapid
growth of structured credit markets.
The unwinding of
large, leveraged positions in response to tightening credit
conditions and investor redemption requests has had a
procyclical impact on declining markets
and may have impaired market liquidity.
Funds of hedge funds have faced serious liquidity problems: they
could not liquidate assets quickly enough to meet investor demands
to withdraw cash, leading some funds of hedge funds to suspend or
otherwise limit redemptions.
Private equity funds due to their investment strategies and a
different use of leverage than hedge funds, did not contribute to
increase macro-prudential risks.
They have
experienced challenges relating to the availability of credit and
the financial health of their portfolio companies.
The
inability to obtain leverage has
significantly reduced buy-out activity and a number of portfolio
companies previously subject to leveraged buy-outs are reported to
be faced with difficulties in finding replacement finance.
Commodity funds were implicated in the
commodity price bubbles that developed in late 2007.
The activities of
Alternative
Investment Funds
were regulated by a combination of national financial and company
law regulations and general provisions of Community law.
They were
supplemented in some areas by industry-developed standards.
However, recent
events have indicated that some of the risks associated with
Alternative
Investment Funds
have been underestimated and are not sufficiently addressed by
current rules.
This is partly a
reflection of the predominantly national perspective of existing
rules: the regulatory environment does not adequately reflect the
cross-border nature of the risks.
Nationally fragmented approaches do not constitute a robust and
comprehensive response to risks in this sector.
Effective management
of the cross-border dimension of these risks demands a common
understanding of the obligations of AIFM; a coordinated approach
to the oversight of risk management processes, internal governance
and transparency; and clear arrangements to support supervisors in
managing these risks, both at domestic level and through effective
supervisory cooperation and information sharing at European level.
Key
provisions of the
Alternative
Investment Fund Managers
Directive
All EU domiciled
Alternative
Investment Fund Managers
with assets under management above the
threshold of 100 million EUR or, in case of AIF with no leverage
and lock-in period of 5 years or more, above the threshold of 500
million EUR will need to be authorized by the home Member State
competent authority (CA) and subject to ongoing requirements.
All
Alternative
Investment Fund Managers
operating in the EU will be required to demonstrate that they are
suitably qualified to provide AIF management services and will be
required to provide detailed information on the planned activity
of the
Alternative
Investment Fund Managers,
the identity and characteristics of the AIF managed, the
governance of the
Alternative
Investment Fund Managers
(including arrangements for the delegation of management
services), internal arrangements with respect to risk management,
arrangements for the valuation and safe-keeping of assets, audit
arrangements, and the systems of regulatory reporting, where
required.
The
AIFM will also be required to hold and retain a minimum level of
capital.
Alternative
Investment Fund Managers
will be required to report to the CA on a regular basis on the
principal markets and instruments in which it trades, its
principal exposures, performance data and concentrations of risk.
The
Alternative
Investment Fund Managers
will also be required to notify the CA of the home Member State of
the identity of the AIF managed, the markets and assets in which
the AIF will invest and the organisational and risk management
arrangements established in relation to that AIF.
Additional
disclosure obligations will apply to
Alternative Investment Fund Managers (AIFM) managing leveraged AIF
and controlling stakes in companies.
Alternative
Investment Fund Managers
authorised in its home Member State will be entitled to market its
funds to professional investors in any Member State.
The cross-border
marketing of AIF would be subject to a notification procedure,
under which relevant information is provided to the home Member
State and transmitted to the host.
Alternative
Investment Fund Managers
shall also be entitled to freely provide management services in
Member States other than their Member State of domicile, subject
to a notification procedure.
The
management and administration of any non-UCITS in the European
Union must be authorised and supervised in accordance with the
requirements of the Directive.
This broad coverage does not imply a 'one size fits all' approach.
A common set of basic provisions will govern the conditions for
the initial authorisation and organisation of all
Alternative
Investment Fund Managers.
These core
provisions will be tailored to the different types of AIFM so that
irrelevant or inappropriate requirements are not imposed on
investment policies for which they make no sense.
In addition to these
common provisions, the proposal foresees a number of specific,
tailored provisions which will only apply to
Alternative Investment Fund Managers (AIFM) that employ
certain techniques or strategies when managing their AIF (for
instance, systematic use of a high degree of leverage, acquisition
of control of companies) and will ensure an appropriate degree of
transparency with respect to these techniques.
Why the AIFM
Directive regulates fund managers instead of funds?
The Directive is focused on regulating the activities of
Alternative
Investment Fund Managers,
since it is the AIFM who is responsible for
all key decisions in relation to the management of the fund.
Financial stability
and investor risks stem primarily from the conduct and
organisation of the manager and the providers of key services,
notably the depositary and valuation agents. The most effective
response is therefore to focus on these entities.
The proposal does not impose registration requirements directly on
funds, nor does it regulate investment policies.
Regulation of
investment policies would be unnecessarily restrictive given the
professional nature of the investor base and would be impractical
to implement given the diversity of business models.
The proposal
nevertheless has a strong indirect impact on the way that funds
are managed and ensures that authorities are fully informed about
the funds marketed in their jurisdiction through disclosure
obligations on managers.
There is therefore no obvious regulatory need for regulating
investment policies directly or for requiring the registration of
funds.
In the absence of
direct fund regulation and in the context of robust regulation of
the main risk centres, the benefits of fund registration would
likely be outweighed by the additional burden on funds and
regulators.
Moreover, the
introduction of a fund registration system could be a source of
moral hazard.
Investors may
perceive that regulators exercise greater direct control over the
fund than is in fact the case.
This may result in
investors foregoing the necessary due diligence and exposing
themselves to greater risks.
Will
Alternative Investment Fund
Managers need
to comply with capital requirements similarly to banks?
As regards capital requirements for
Alternative Investment Fund Managers (AIFM), the proposals provides
for a minimum capital requirements to ensure the continuity and
regularity of the AIFM services.
It is a standard
practice to oblige fund managers to retain capital for investor
protection reasons. It shall enable investors to claim damages in
case of fraud or other wrongdoing by the manager.
This risk is however
rather low, given that the fund's assets are segregated from the
AIFM and safe-kept by the depositary which also books the
investor's money on a segregated account.
The minimum capital for AIFM is EUR 125.000,
but additional capital is required if the assets under management
exceed EUR 250 million.
The draft proposal does not provide for any capital requirements
for the fund. The rationale for capital retentions for banks does
not extend to AIFM.
Investors which e.g.
invest in hedge funds knowingly seek exposure to (relatively) high
risks with the aim of (potential) high profits.
There is no
guarantee that investors will get paid back the invested money
(plus profits). Bank saving, by contrast, works on the principle
that deposits and interest payments are safe.
Furthermore, leverage of hedge funds is on average much lower than
leverage of investment banks.
While the latter
use
leverage ratios of up to a factor of 30 or even 50 in some cases,
leverage ratio of hedge funds is down from a factor of 2 before
the crisis to factor 1 in 2008, i.e. the average leverage used by
hedge funds equals their net assets.
These figures
illustrate that the systemic risk posed by the use of leverage by
hedge funds is significantly lower than that of investment banks.
The possible impact of the failure of an individual hedge fund on
the banking sector is currently addressed through the prudential
regulation of prime brokers.
Prime brokers are required to hold capital against their hedge
fund exposures and to have in place robust counterparty risk
management systems.
The reform of
European banking regulation is part of the comprehensive package
of reforms announced in the Commission Communication on Driving
European Recovery.
The Basel Committee has recently started a
comprehensive review of the Basel II prudential treatment for
counterparty credit risk (posed by e.g. hedge funds) and the
relevant disclosure provisions.
In addition, the proposed Directive however obliges AIFM to employ
a liquidity risk management system. This system shall ensure that
the fund may satisfy requests by investors wishing to withdraw
money.
This notably
requires the
Alternative Investment Fund Manager (AIFM) to prevent a mismatch between the frequency of
investor redemptions and the illiquid nature of the portfolio
(i.e. the less liquid the assets are, the less frequent investors
may redeem
The Directive builds on an extensive consultation and on the
numerous insights and research that the Commission has gathered in
recent years through studies and impact assessments on the
functioning of the non-harmonized investment fund segment. The
latest round of consultations took place in February 2009 and
concerned the activities of hedge funds.
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Proposal for a Directive on Alternative Investment Fund Managers
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