The Alternative Investment Fund Managers Directive: UK’s Road to the Impending Implementation

INTRODUCTION

As one of the most controversial pieces of EU law, the Alternative Investment Fund Managers Directive (AIFMD)[1] may be the most significant European asset management regulation of the early 21^st century.[2] Proposed in the wake of the financial crisis, it was heralded as a measure responding to the difficulties in the financial markets and addressing concerns levelled against the alternative fund industry, especially hedge funds and private equity. The Directive establishes for the first time a comprehensive pan-European regulatory and supervisory framework which will affect an important cross section of alternative investment fund managers (AIFMs) that manage and/or market alternative investment funds (AIFs)[3] across EU Member States. Despite the good intentions, the Directive has introduced a very stringent regime which will inevitably create substantial burdens for fund managers in the EU and globally. Unsurprisingly, the AIFMD attracted sharp criticism from many quarters, being considered unduly intrusive and out of tune with regulatory recommendations.[4]

The text of the first draft of the Directive, proposed in April 2009, had undergone extensive review to respond to and remedy controversial issues, most notably the “one size fits all” approach. The finalisation of the Directive was the result of protracted consultations and compromise suggestions, involving a dense and complicated trilogue procedure. Regardless of the commentary suggesting it was a deeply ‘flawed knee-jerk political reaction’,[5] the final text of AIFMD was adopted by the EU Parliament on 11 November 2010 and by the EU Council on 27 May 2011.[6] EU Member States must transpose the AIFMD by 22 July 2013 and this rests on the EU Commission’s Level 2 Regulation.[7]

TRANSPOSITION OF AIFMD INTO UK LAW

The UK Financial Services Authority (FSA) and HM Treasury have been working together to implement the Directive in the UK. The FSA is responsible for transposing those requirements of the Directive which need to be reflected in the FSA Handbook rules and guidance, whilst HM Treasury is responsible for transposing those Directive requirements which necessitate changes to primary and secondary legislation.

Before proceeding to the discussion of the relevant documents, it is important to note that the FSA has recently undergone a significant strategic and operational change[8] which has split the regulator between the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). The Financial Services Act 2012 delivered the fundamental reform, with effect as of 1 April 2013. The FCA has subsequently become the competent authority for AIFMs falling within the scope of the AIFMD’s provisions.

FSA/FCA Implementation

The FSA has published a number of documents in connection to the transposition of the AIFMD. First, on 23 January 2012, a Discussion Paper (DP12/1)[9] was issued and requested views on the AIFMD’s potential impact to develop a well-informed, proportionate and effective regulatory policy and assist stockholders towards ‘AIFM Directive-readiness’.[10] The paper delineated the background to the Directive and the regulator’s general approach to implementing it in the country. Thus, DP12/1 furnished a very high level and initial view on the regulator’s policy thinking for transposing the Directive and drew attention, inter alia, to a sequence of implementation issues, operational and management requirements for AIFMs, transparency, depositary, marketing, and the categories of AIFs and specialised regimes. No policy thinking was provided in relation to a range of areas, most notably, remuneration and the Directive’s scope, as the regulator was awaiting further guidance from the European Securities and Markets Authority (ESMA) before embarking on setting out its own thinking. This was thought to be a sensible choice given that at the time many of the central provisions under the AIFMD remained undecided at EU level.[11]

DP12/1 revealed that the implementation would have implications for the FSA Handbook, requiring revision of a considerable number of its sections.[12] Fund management rules have traditionally been maintained in the Collective Investment Scheme Sourcebook (COLL). However, the regulator had considered creating a new investment funds sourcebook called FUND, which would supplant the current rules and guidance from the COLL. FUND would amend non-fund sourcebooks in the FSA Handbook in order to incorporate the Directive’s requirements for systems and controls and conduct of business. To reflect the new regulatory landscape, FUND will have a much wider scope than COLL, encapsulating rules for all fund managers and being more easily adaptable to future EU legislation. The FSA expects that the Directive will apply to a significant number of UK-based firms, managing the assets of retail and professional investors. Based on internal and industry estimates, the regulator considers that over 1,000 firms and funds will likely fall within the scope of the Directive.[13]

Following on from DP12/1, on 14 November 2012, a second document was published. CP12/32[14] (CP1) was the first consultation paper aimed at, amongst others, investors, fund managers, depositaries and non-EU AIFMs wishing to manage and/or market EU and non-EU funds in the UK, or elsewhere in the Union.[15] CP1 covered the prudential regime for all types of AIFMs and depositaries, as well as the Level 1 Directive requirements on AIFMs. It clarified that the AIFMD is principally maximum harmonising, and hence gives little discretion to the regulator with regard to implementation, and restricts its ability to create additional regulatory requirements. Irrespective of this, a small number of options or derogations can be exercised,[16] and these are appurtenant to conditions for taking up activities as AIFM (Article 6), initial capital and own funds (Article 9), depositary (Article 21), annual report (Article 22), disclosure in case of acquisition of control (Article 28), marketing of AIFs to retail investors (Article 43) and transitional provisions for depositaries (Article 61(5)).

Third, on 19 March 2013, the FSA published CP13/9[17] – a second consultation paper (CP2) on the FCA’s proposed approach to implementation. The most significant issues concerned the definition of an AIF (a concept that is indubitably central to the Directive’s scope, but one that is curiously vague) and the UK approach to delegation and marketing. CP2 also outlined revised approaches concerning non-EU IFMs and AIF passport provisions, authorised fund provisions[18] and private equity provisions.[19] The regulator’s approach generally appears to be in line with industry expectations, save for the restrictive approach regarding passive marketing. UK AIFMs and industry bodies will work through the details of the proposals; however, given the nearness to the implementation deadline, CP2 will have an unusually short consultation period and the FCA will issue a full AIFMD Policy Statement in June 2013.[20]

HM Treasury Implementation

On 14 March 2012, HM Treasury published Policy Options for Implementing the Alternative Investment Fund Managers Directive, an informal discussion paper which highlighted and invited initial views on a number of the high-level policy decisions that needed to be taken as part of the transposition of the Directive into the UK. The consultation ran from 14 March 2012 to 4 May 2012 and responses helped inform a policy position for a formal consultation at a later date. The transposition issues raised in the Treasury’s paper covered full authorisation of sub-threshold AIFMs, interaction of the AIFMD with other EU proposals,[21] applications of the approved persons regime, marketing to retail investors, and private placement regime. The paper emphasised that the Directive provided for an extensive set of implementing measures and necessitated a range of high-level policy and operational decisions. It was elucidated that wherever possible the Government would adopt a copy-out approach and avoid ‘gold-plating’, that is, adding domestic requirements over and above the requirements of the AIFMD, unless supported by strong justification.

An initial consultation paper,[22] setting out the Government’s proposed approach towards transposition, was published on 11 January 2013. With the purpose to allow AIFMs to prepare for the impact of the Directive, the paper addressed several key policy decisions as well as draft regulations and impact assessment. On 14 March 2013, HM Treasury published a further consultation paper[23] concerning the treatment of particular fund types under the AIFMD, including marketing and passporting, approved persons regime and investor redress. The consultation was accompanied by draft regulations[24] intended to be combined with the draft version of regulations appended to the first consultation paper. Government responded to this consultation in May 2013,[25] setting out decisions based on discussions with relevant stakeholders. Importantly, the intention to copy-out the Directive’s provisions without gold-plating was confirmed in order to minimise the regulatory burden on UK-licensed AIFMs and to maintain and enhance the UK’s competitiveness.

The Alternative Investment Fund Managers Regulations 2013[26] have been published on gov.uk. The 70-page, near-final draft of implementing regulations defines the meaning of AIF and AIFM, operational conditions for fund managers, depositaries and external valuers, acquiring control of non-listed companies and issuers, marketing of AIFs, duties and powers of the FCA, transitional provisions and, in addition, provides the detail of amendments to primary and secondary legislation, most notably, the Financial Services and Markets Act 2000 and the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001. The updated version of the implementing regulations represents a significant improvement for AIFMs compared to the initial draft. It should be laid before Parliament shortly and will be effective as of 22 July 2013.

CONCLUSION

The lengthy process of implementing the AIFMD will bring a fundamental change in the UK regulatory environment. As evidenced by the above-mentioned discussion and consultation papers, UK transposition of the Directive will require the amendment of a range of sourcebooks within the FSA Handbook and legislative changes to be made by HM Treasury and approved by Parliament. It is imperative that the Directive is implemented in a fashion that will maintain its status quo to the largest degree possible in order not to stymie the activities of the industries concerned. This is because the AIFMD’s adoption marks the advent of a harmonised, yet unusually stringent, regulation for the AIF sector in Europe. Accordingly, it has been welcome to observe the UK adopting a light-touch regime where feasible and following the necessary requirements where there was no other choice. Such an approach should help the UK preserve its European dominance of investment management activity and reduce the likelihood of regulatory arbitrage, which would see fund managers relocating their business to another, less restrictive domicile.

Many provisions contained in the AIMFD will be familiar to fund managers already authorised and operating in the UK. The perusal of the Directive shows that some of the new regulatory requirements may seem relatively innocuous, whilst others may prove much more burdensome. Nevertheless, the immediate impact will concern the steps required to be taken by AIFMs to manage and/or market AIFs in the EU. The implications and costs of complying with the more extensive requirements in relation to governance, capital requirements, delegation, depositary functions and EU passport regime will be significant. Fortunately, the industries affected, especially hedge funds and private equity, invariably managed to adapt and reinvent themselves. As the dust after the apex of the financial crisis has already settled, it is hoped that the new regulatory landscape will make for a stronger alternative investment industry which is capable of contributing to the much-desired recovery of the EU economy.

Robert K. Rajczewski, LL.M.

Doctoral Student, Goethe University Frankfurt