In previous issues of the Debevoise & Plimpton Private Equity Report, we have reported extensively on the European Alternative Investment Fund Managers Directive (the “AIFMD”).1 The AIFMD will regulate, in stages, the managers (“fund managers”)2 of European and non-European private equity funds, hedge funds and other alternative investment funds (simply referred to below as “funds”), whether those fund managers are based in one of the Member States of the European Economic Area (the “EU”) or outside the EU.3 The AIFMD is required to be implemented into national law by EU Member States by July 22, 2013 (the “Effective Date”).4
In this article we discuss the impact of the AIFMD on one subset of industry players that will be impacted by the AIFMD: fund managers that are based outside the EU (even if they have sub-advisors in the EU) and that will be marketing funds organized outside the EU (such as funds organized as Cayman Islands or Delaware limited partnerships) in one or more of the Member States of the EU.5
The bottom line for non-EU fund managers wishing to market non-EU funds to professional investors in the EU is that, for the period from the Effective Date until at least the fourth quarter of 2015 (subject to any transitional relief that may be adopted by EU Member States), the AIMFD will require those managers (1) to comply with new disclosure rules (including extensive reporting to regulators) and “no asset stripping” requirements and (2) to continue to market their funds by complying with national private placement regimes in the relevant EU Member States, as those regimes may be modified from time to time. The impact of the AIFMD’s on these non-EU managers is discussed in further detail in the frequently asked questions (“FAQs”) and answers below.
What are the key steps that non-EU fund managers must take now to prepare for the implementation of the AIFMD?
Non-EU fund managers that may be marketing non-EU funds in the EU in the near future must take five key steps right away, if they have not already done so. The Effective Date of the AIFMD is July 22, 2013.
Specifically, a non-EU fund manager that may be marketing a non-EU fund in one or more of the EU Member States after the Effective Date must:
- identify those funds that it may be marketing in the EU after the Effective Date;
- identify those EU Member States in which the manager may be marketing funds after the Effective Date (the “relevant EU Member States”);
- determine whether the private placement regimes in the relevant EU Member States will be retained (or modified) after the Effective Date and, for each relevant EU Member State where the current private placement regime will be eliminated or modified, determine the requirements of the new fund marketing rules;
- monitor how the AIFMD is implemented in the relevant EU Member States (including whether a relevant EU Member State provides for a “transitional” regime); and
- prepare the necessary compliance procedures, which in most cases (unless a transitional regime applies) will involve satisfaction of new disclosure obligations and compliance with new “no asset stripping” rules.
Does the AIFMD apply to non-EU fund managers that only manage non-EU funds?
Yes, the AIFMD applies to non-EU fund managers marketing non-EU funds to “professional investors” in the EU.
The AIFMD applies to fund managers based in the EU, to non-EU fund managers managing EU funds, and to non-EU funds marketing its funds in the EU. These FAQs discuss the application of the AIFMD to non-EU managers marketing non-EU funds to professional investors in the EU Member States.
Professional investors include large pension plans (and other undertakings) and institutional investors. A natural person will only be considered a “professional investor” in limited circumstances. Different regulatory regimes apply to non-professional (retail) investors.
Does the AIFMD impose consistent marketing rules across the EU for non-EU fund managers marketing non-EU funds?
No, because each EU Member State has its own private placement regime and its regulator may take a different approach to implementing the AIFMD.
Each EU Member State is required to adopt legislation incorporating the AIFMD’s requirements in that country by the Effective Date. Although the AIFMD sets forth certain basic, uniform principles, the details of implementation are left to the Member States. These details can differ from country to country. The Member States and their regulators have adopted–or are expected to adopt, because at the time this article is being published not all EU Member States have adopted AIFMD implementing legislation–somewhat different approaches to implementation. This means that the impact of the AIFMD will not necessarily be consistent across the EU.
Initially, how will the AIFMD apply to non-EU fund managers marketing non-EU funds in the EU?
From the Effective Date until at least the fourth quarter of 2015, non-EU fund managers generally will be able to (continue to) market their non-EU funds in the EU in reliance on local private placement regimes, subject to new AIFMD disclosure requirements and “no asset stripping” rules. However, some EU Member States may change their national private placement regimes.
The first stage of the (three-stage) AIFMD regime begins on the Effective Date. In general, from July 22, 2013 until the fourth quarter of 2015 (and possibly until a later date),6 a non-EU alternative investment fund manager may (continue to) market non-EU funds to professional investors in the EU so long as it complies with the various private placement regimes in effect in each of the relevant EU Member States. If, however, a country changes its private placement regime (which Germany has done), the non-EU fund manager will be required to comply with the new regime in that country.7 See question E below.
In addition, a non-EU fund manager marketing a non-EU fund in the EU will be required to comply with the AIFMD’s new disclosure and “no asset stripping” requirements. See questions F and G below. Even these new AIFMD rules may not apply in limited circumstances where a transitional regime applies. See question H below.
Stages two and three of the implementation of the AIFMD are discussed at question I below.
Will non-EU fund managers be able to market non-EU funds in the EU in the same way after the Effective Date as before the Effective Date?
Not necessarily. Under the AIFMD, non-EU fund managers may continue to market their non-EU funds in reliance on national private placement regimes after the Effective Date. However, it is possible for an EU Member State to change its laws to add new and more onerous requirements that must be satisfied before a fund manager may rely on its national private placement regime, and Germany has already done this. Also, a non-EU Member State could withdraw (repeal) its national private placement regime altogether. Subject to any available transitional regimes, non-EU fund managers will also be subject to the disclosure and “no asset stripping” requirements described in the answer to the next question.
The AIFMD allows EU Member States to keep their existing national private placement regimes in place until the fourth quarter of 2018 (or possibly later), although it does not require that they do so. The hope and expectation is that most EU Member States will retain their private placement regimes, in one form or another, at least until such time as non-EU fund managers are able to apply for an AIFMD marketing passport (which would be in the fourth quarter of 2015 at the earliest).
It is possible for an EU Member State to change its national private placement regime, for example by adding new and more onerous requirements, and Germany is an example of an EU Member State that has done so. Germany has used the implementation of the AIFMD into national law as an opportunity to significantly re-write its national private placement regime. The modified German national private placement regime will apply from July 22, 2013 (or July 22, 2014, for certain fund offerings if the German transitional regime applies). The new German regime will make marketing of funds by non-EU fund managers to professional investors in Germany more difficult than is currently the case.
Because the AIFMD does not require EU Member States to retain their national private placement regimes, it is also possible for an EU Member State to withdraw its national private placement regime completely before the date when non-EU fund managers are able to apply for AIFMD marketing passports (in the fourth quarter of 2015 at the earliest). Were an EU Member State to do this, non-EU fund managers would not be able to market their funds in that country at all (as compared to AIFMD authorized EU fund managers, which may obtain marketing passports as early as the Effective Date).
In addition to possible burdens that might be imposed by changes to national private placement regimes, what are the most important new requirements that the AIFMD imposes on non-EU fund managers?
Subject to any available transitional regimes, beginning on the Effective Date non-EU fund managers marketing non-EU funds in the EU will be subject to new disclosure requirements and to new “no asset stripping” requirements applicable to control investments in EU portfolio companies.
Subject to any transitional regimes (see question H below) and beginning on the Effective Date, non-EU fund managers will be subject to new disclosure obligations if they market funds in the EU. These new disclosure obligations are summarized as follows.
First, the fund manager must prepare an annual report for each fund that was marketed in the EU after the Effective Date no later than six months following the end of the fund’s financial year. The annual report must be provided to investors on request and made available to the regulators in the relevant EU Member States. Most importantly, the annual report must contain certain prescribed information, including disclosure of certain compensation information. See question G below.
Second, the fund manager must provide specified information to prospective investors prior to their investment in the fund, typically in the private placement memorandum (or a supplement thereto) of the fund being marketed. A standard offering document ordinarily contains most of the information that will be required by the AIFMD, although there may need to be enhanced disclosure around certain matters, including in respect of side letter arrangements.
Third, the fund manager must regularly report certain matters, such as information on aggregate assets under management, fund-level leverage and the main categories of assets in which its fund is invested, to the regulators in the relevant EU Member States. These reporting obligations will require fund managers to gather and report a significant amount of detailed information to EU regulators and, at least initially, are likely to be the most onerous of the AIFMD disclosure requirements.
Fourth, where its fund acquires control (greater than 50% of the voting rights) of an EU portfolio company, the fund manager must disclose certain matters (such as information on the financing of the acquisition of the portfolio company) to the regulators in the relevant EU Member States and to the EU portfolio company (with the request that information be passed on to the company’s shareholders).
In addition to these disclosure requirements, non-EU fund managers will be subject to certain “no asset stripping” requirements. In broad terms, when a fund acquires control (greater than 50% of the voting rights) of an unlisted EU portfolio company, the non-EU fund manager will be required to use its best efforts to prevent distributions, capital reductions, share redemptions and/or the acquisition of its own shares by the portfolio company, unless (1) any resulting payments to effect a distribution to shareholders will be made out of distributable profits and (2) after giving effect to the distribution, the portfolio company’s net assets would remain at or above the level of subscribed capital plus non-distributable reserves.
Note: Once authorized as an “alternative investment fund manager” (on July 22, 2013 at the earliest), an EU fund manager that manages one or more EU-based funds will be subject to greater regulation than non-EU managers. Such EU fund managers will be required to comply not only with the disclosure and “no asset stripping” rules described above, but also with additional AIFMD duties and obligations including the appointment of depositaries meeting specified standards (per fund), obtaining independent valuations (per fund), meeting regulatory capital requirements and implementing certain systems and controls (including with respect to compensation of employees).
Will non-EU fund managers be subject to the remuneration provisions of the AIFMD?
Only in part. Non-EU fund managers initially will be required by the AIFMD to disclose certain compensation information in their annual reports. Fortunately, non-EU fund managers will not be subject, initially, to the AIFMD’s guidelines and requirements concerning compensation (including deferral of a portion of variable compensation).
Until a non-EU fund manager obtains an AIFMD marketing passport (in the fourth quarter of 2015 at the earliest), the only impact of the AIFMD’s remuneration provisions will be to require the fund manager to disclose certain compensation information if it markets a fund in the EU after the Effective Date.
Specifically, a non-EU fund manager will be required to disclose in its annual report (see question F above) the following information:
- the total remuneration for the financial year, split into fixed and variable remuneration, paid by the fund manager to its staff,8 and the number of staff who received such remuneration;
- to the extent that the information exists or is readily available, whether the total paid remuneration relates to the entire staff of the fund manager or only to those staff who are fully or partly involved in the activities of the fund, as well as the total remuneration paid to the staff of the fund manager that is attributable to each fund;
- the total remuneration for the financial year, split into fixed and variable remuneration, paid by the fund manager to senior management and members of staff of the fund manager whose actions have a material impact on the risk profile of the fund;
- where relevant, any incentive allocation or carried interest distributed by the fund; and
- a general description of the financial and non-financial criteria of the fund manager’s compensation policies and practices for relevant categories of staff, so that investors may assess the incentives created.
Aside from disclosure and until such time as it obtains an AIFMD marketing passport, a non-EU fund manager is not required to have any particular compensation policies or procedures in place.
Note: EU fund managers will be required to comply with the disclosure obligations described above, and in addition will be required to comply with all other AIFMD duties and obligations, including the requirement to adopt remuneration policies that satisfy the AIFMD guidelines. These remuneration policies must be consistent with and promote sound and effective risk management and, in addition of other matters, require at least 50% of variable remuneration to consist of non-cash instruments and at least 40% of variable remuneration to be deferred over at least a three to five year period. Until market practice develops and additional guidance is made available, it is likely to be quite difficult in practice to apply these remuneration guidelines.
Have any EU Member States adopted transitional regimes that mitigate the impact of the AIFMD?
Yes, the United Kingdom and Germany are proposing to adopt transitional regimes (transition or “grandfathering” rules) that provide limited relief from the AIFMD’s requirements for funds being marketed in certain ways before the Effective Date.
The United Kingdom is proposing to adopt a transitional regime that exempts a non-EU fund manager from the AIFMD’s disclosure and “no asset stripping” requirements, until July 21, 2014, with respect to any non-EU fund that the non-EU fund manager has marketed anywhere in the EU prior to the Effective Date. The current position being taken by the UK regulator is that “marketing” of a fund for this purpose begins on the distribution of near final forms of the fund’s constitutional documents (e.g., its limited partnership agreement and subscription agreement) to any investor in the EU. Distribution of only a private placement memorandum in the EU is not considered marketing for this purpose.
Germany has its own transitional regime. The proposed German transition rules would permit a non-EU manager to market a non-EU fund in Germany in reliance on the existing German private placement regime (not the more onerous regime that goes into effect on the Effective Date), and without have to comply with the AIFMD’s disclosure and “no asset stripping” rules, until July 21, 2014, if the non-EU manager marketed the fund in Germany prior to the Effective Date. In Germany, the current position is that marketing of a fund is considered to have begun as soon as the fund’s final private placement memorandum is distributed to a single German investor.
Looking further down the road, what should non-EU fund managers know about the second and third stages of the AIFMD?
The questions and answers above relate to the first stage of the AIFMD. It is not too early, however, for alternative investment fund managers to begin to consider with their advisers the impact of the second and third stages of the implementation of the AIFMD.
In stage two, beginning in the fourth quarter of 2015 (or possibly later), the AIFMD provides that a non-EU fund manager has the option to obtain a “marketing passport.” The AIFMD marketing passport would allow the fund manager to market its funds to professional investors throughout the EU, without being required to satisfy the different requirements of the national private placement regimes that apply in the countries where the funds are being marketed. To hold a marketing passport, a non-EU fund manager would be required to comply in full with the requirements of the AIFMD. These requirements include appointing depositaries meeting specified standards (per fund), obtaining independent valuations (per fund), meeting regulatory capital requirements and implementing certain systems and controls (including with respect to compensation of the fund manager’s staff). Alternatively, a non-EU fund manager that does not wish to satisfy the requirements imposed by the AIFMD as a condition to obtaining a marketing passport may continue to rely on the national private placement regimes until the fourth quarter of 2018 (or possibly longer), but only to the extent that national private placement regimes are retained in the EU Member States where the fund manager will be marketing its funds.
In stage three, beginning in the fourth quarter of 2018 (or possibly later), a non-EU fund manager will only be able to market its funds to professional investors in the EU if it holds an AIFMD marketing passport.
Should non-EU fund managers restructure themselves or their funds in light of the AIFMD?
For most non-EU fund managers, the answer at this stage is likely no, although the business objectives and structure of a particular fund manager may lead to a different answer. Also, restructuring may become a more attractive option in the future when, for example, acquisition of an AIFMD marketing passport (and full compliance with the AIFMD) becomes necessary or desirable (see question I above).
It is possible that, after implementation of the AIFMD, some European investors may show a bias towards investing in EU-based funds (although these investors are most likely to be the same group of investors that already raise concerns about investing in Cayman Islands and Channel Islands funds). If this pattern emerges (and depending on the types of investor and the size of their likely investments), consideration may need to be given to incorporating an EU-based fund (potentially managed by an EU-based fund manager) into the overall fund structure.
Other forms of restructuring – including, for example, the establishment of a parallel fund structure, with one fund being managed by the existing manager (and not being marketed to EU investors) and the other fund being managed by a new manager (and being marketed to EU investors pursuant to the AIFMD) – seem premature for most non-EU fund managers, given the added complexity and cost, and the limited advantage, of modifying existing structures. Restructuring may become a more attractive option from 2015, however, when the acquisition of an AIFMD marketing passport would have the consequence of requiring full compliance with the AIFMD.
- See “EU Directive on Alternative Investment Fund Managers: Good News at Last” in our Fall 2010 issue and “Alert: UK/EU Developments: More Disclosure, More Regulation and a Potentially Shrinking Pool of Investors” in the Winter 2012 issue.
- The AIFMD defines the “manager” as the entity performing at least portfolio management or risk management in respect of an alternative investment fund, or “AIF”. The concept of “AIF” is very broadly defined and includes almost any investment fund, whether closed or open ended and however structured, other than regulated retail funds.
- The Member States of the European Economic Area are: the 27 Member States of the European Union (Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and the United Kingdom), together with Iceland, Liechtenstein and Norway. Croatia will become the 28th Member State of the European Union on July 1, 2013. References in these FAQs to “EU Member States” (or the equivalent) are references to the Member States of the European Economic Area, from time to time.
- As many as 16 EU Member States have not yet published draft AIFMD implementing legislation. Some EU Member States (including Italy and Norway) are unlikely to implement the AIFMD into national law by the Effective Date.
- The application of the AIFMD to EU-based alternative investment fund managers, and to non-EU managers managing funds organized under the laws of an EU Member State (e.g., a private equity fund or hedge fund organized as an English limited partnership) in the EU, differ from those outlined in this article. We would be happy to discuss those rules with interested clients.
- The dates for implementation of stages two and three are not yet known and are dependent on the European Securities and Markets Authority (“ESMA”) making a positive recommendation that these stages should be implemented. The earliest that stage two will be implemented is the fourth quarter of 2015. The earliest that stage three will be implemented is the fourth quarter of 2018.
- In addition, the AIFMD requires that appropriate cooperation agreements, intended to help regulators oversee potential systemic risk, be in place between regulators in the relevant EU Member States and regulators in the jurisdictions in which the fund and the fund manager are established. On May 22, 2013, forms of cooperation agreements were agreed to by ESMA and regulators in over 30 non-EU countries, including the United States and the Cayman Islands. While ESMA negotiated the forms of cooperation agreements centrally, the cooperation agreements are bilateral agreements that must be signed between the regulator in the relevant EU Member State and the regulator in the relevant non-EU country. Theoretically, the regulator of an EU Member State may decide not to enter into a bilateral agreement with a particular non-EU jurisdiction. There is no set date on which the bilateral cooperation agreements will be signed.
The concept of “staff” has been broadly construed by ESMA and is not limited to employees of the fund manager. The concept extends to those individuals whose services are made available to the fund manager and includes the staff of entities to which portfolio management or risk management activities have been delegated by the fund manager.