Advocates - Legal Consultants. 1. Funds regulation in Cyprus as a tool for asset growth and investor protection

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1 CGV CHRISTODOULOS G.VASSILIADES & CO. LLC Advocates - Legal Consultants Alternative Investment Funds: Investments in alternative asset classes, investor protection and active fundraising through Cyprus 1. Funds regulation in Cyprus as a tool for asset growth and investor protection Regulation of investment funds pursuing alternative investment strategies is not something new in Cyprus. The first piece of relevant Cypriot legislation had been introduced in 1999 and proved to be operational for private schemes seeking light regulation. However, the establishment of Cyprus as an international financial centre, in addition to its reputation as an international business centre, required:. The widening of the range of available Cypriot regulated collective investment products;. The broadening of the scope of services offered by local service providers; and. Cyprus to become a jurisdiction of choice for asset managers seeking for a European Union (EU) hub in the alternative investments sector. Furthermore, legal initiatives took place at EU level leading to the adoption of EU Directive 2011/61/EU widely known as Alternative Investment Fund Managers Directive (AIFMD) in The AIFMD has been transposed into Cypriot Law by means of Law 56 of 2013 on Alternative Investment Fund Managers (AIFMs) as amended (AIFM Law). The local needs and the European initiatives described above motivated the initiation of a legislative process encompassing both investment funds and investment fund management. The aim of such process was the modernisation of the legal framework governing investment funds pursuing alternative investment strategies in alignment with the AIFM Law, where applicable. This process ended up with the enactment of Law 131 of 2014 on Alternative Investment Funds Law as amended (AIF Law), which:. Understands the nature of alternative investments as a field, where the asset manager s ability to distinguish an asset s potential, development and value is of primary importance;. Is aligned with the AIFM Law, where applicable, offering access to a Paneuropean professional investor base and ensuring an adequate level of protection, even where the AIFM Law thresholds do not apply; and. Imposes a set of tasks to be carried out by local service providers, in order to safeguard investors interests.

2 2. Available collective investment products under the AIF Law and their key features Investment funds set-up and licensed in Cyprus in accordance with the AIF Law (AIFs) are regulated and supervised by the Cyprus Securities and Exchange Commission (CySEC). AIFs are categorised into:. AIFs targeting retail investors (Retail AIFs);. AIFs targeting an unlimited number of professional1 and/or well-informed 2 investors (Sophisticated AIFs); and. AIFs targeting a limited number of 75 professional and/or well-informed investors (Limited Investor AIFs). The intensity of an AIF s regulation under the AIF Law depends on whether the AIF in question is capable of being broadly marketed and on the sophistication of the targeted investor base. Retail AIFs stand at the top as far as intensity of regulation is concerned, whereas Limited Investor AIFs are the less regulated AIFs with no eligible asset and diversification limits applying. A Retail AIF and a Sophisticated AIF will qualify as open-ended, where they grant their investors a right of redemption at least annually. The said AIFs will qualify as closed-ended where they impose a lock-up period, which exceeds one (1) year but is not longer than five (5) years (Lock-up) or where they provide for redemptions only once during their life-time at a specified period. Where a Retail AIF or Sophisticated AIF is also a venture capital fund, within the meaning of EU Regulation Nr. 345/2013 known as EuVECA Regulation, Lock-up may be extended to up to ten (10) years. Limited Investor AIFs are not obliged to provide for minimum redemption frequencies. Units 3 of all AIFs are transferable, unless otherwise provided in the constitutional documents of the AIF. As to Sophisticated AIFs, the AIF Law requires the management of such AIF to have procedures in place which ensure that transfer of units will not result in their ownership by an investor not being a professional or well-informed investor. As to Limited Investor AIFs, the AIF Law additionally requires that management of such AIF also ensures that the number of 75 professional and/or well-informed investors is not exceeded. All AIFs can be set-up as umbrella funds with multiple investment compartments legally segregated from each other. As to the available legal forms, Retail AIFs and Sophisticated AIFs can take the form of:. A common fund, which is a mass of assets lacking legal personality and subject to external management only (CF); 1 A professional investor is an investor who qualifies as a professional client under the EU Directive 2004/39/EC widely known as Markets in Financial Instruments Directive as amended (MiFID). MiFID has been transposed into Cypriot Law by means of Law 144 of 2007 on Investment Services and Activities and Regulated Markets as amended (CIF Law). 2 The term well-informed investor has been introduced by the AIF Law and refers to investors, who do not qualify as professional investors. A well-informed investor adheres in writing to the status of a well-informed investor acknowledging the risks associated with the intended investment and either invests a minimum of EUR or provides a certification issued by a credit institution, an asset manager or an insurance undertaking, according to which the said investor can assess the suitability of the investment sought. 3 The term units encompasses units in a CF, interests in an LP and shares in a FCIC or VCIC.

3 . An investment company, of either fixed or variable capital, which can be either selfmanaged by its Board of Directors or externally managed (FCIC or VCIC for fixed capital and variable capital investment companies respectively); and. A limited partnership, where the investors in the partnership will have the status of limited partners (LP). A Limited Investor AIF can take the form of an LP, of a VCIC or of a FCIC. The entities that qualify as eligible external managers of an AIF are:. An entity licensed as an AIFM under either the AIFM Law or under the relevant legislation of any other EU Member State transposing AIFMD, as applicable (Licensed AIFM);. An entity licensed under the CIF Law or under the relevant legislation of any other EU Member State transposing MiFID (MiFID Firm); and. An entity licensed as a management company under Law 78 of 2012 on Open-Ended Undertakings for Collective Investment (UCI Law) transposing EU Directive 2009/65/EC on Undertakings for Collective Investment in Transferable Securities (UCITS IV Directive) or under the relevant legislation of any other EU Member State transposing UCITS IV Directive; A Limited Investor AIF has the option to be managed by a company not subject to any licensing, provided such company has as its exclusive object the management of only one Limited Investor AIF. Where a Retail AIF or a Sophisticated Investor AIF is managed by a MiFID Firm, then certain additional organisational requirements are imposed by the AIF Law upon such entity. Where a Retail AIF or a Sophisticated Investor AIF is managed by a Licensed AIFM then such AIF also enters the scope of application of the AIFM Law or of the relevant legislation of any other EU Member State transposing AIFMD, as applicable (AIFMD Provisions). Where a Limited Investor AIF happens to be managed by a Licensed AIFM, then, apart from the AIFMD Provisions becoming applicable, such AIF requalifies as a Sophisticated AIF and becomes subject to the provisions of the AIF Law governing Sophisticated AIFs instead of those governing Limited Investor AIFs. 3. Balance between mandatory rules and flexibility In the field of alternative investments the asset manager has a primary role instead of the market in identifying, selecting, valuing and developing an asset. The reason is that there may not even be a market price for an alternative investment; or that, in the alternative investment manager s view, the market may have over- or underestimated an asset. This means that the asset manager needs flexibility in terms of eligible assets, diversification limits, holding periods and valuation rules. At the same time there is a need to safeguard investors interests against any possible arbitrary decisions taken by the asset manager. In this context the AIF Law provides for a balancing between protective mandatory rules and the flexibility the manager requires, in order to deploy the envisaged investment policy.

4 In this context of ideas:. Open-ended or closed-ended Retail AIFs and Sophisticated AIFs are subject to minimum redemption periods. Such restrictions are not imposed on open-ended or closed-ended Limited Investor AIFs;. Eligible assets and diversification limits vary depending on the sophistication and number of the targeted investor base. Retail AIFs are subject to extensive regulation as to eligible assets and diversification limits, in order to compensate the lack of investors sophistication. Provisions on eligible assets and diversification limits as to Sophisticated AIFs exist but they still provide the manager of such an AIF with a very flexible framework. Limited Investor AIFs are not subject to any eligible asset restrictions and diversification limits at all with an exception for cross-investments within the same umbrella Limited Investor AIF;. The investors redemption right may be suspended as to Retail AIFs and Sophisticated AIFs subject to CySEC s approval, provided the other conditions laid down in the AIF Law are complied with. Limited Investor AIFs are not subject to any prior CySEC approval, in order to have investors redemption right suspended;. The AIF manager is allowed to unilaterally change the constitutional documents of an AIF, with such change being binding upon the investors. However, if such change affects the investors redemption rights, investors in Retail AIFs and Sophisticated AIFs are allowed, within a specified time period, to request redemption, in accordance with the condition prior to such change; and. Side pocket arrangements are allowed provided certain conditions are complied with. 4. Paneuropean Marketing possibilities Where an AIF is managed by a Licensed AIFM as described above, the AIFMD Provisions become also applicable. As an exchange for this additional regulation the AIF obtains the so-called passport, i.e. it is allowed to actively market its units to professional investors across the EU, without requiring any additional marketing approval by the regulator of the targeted host EU Member State(s). Thus, a Sophisticated AIF managed by a Licensed AIFM may freely market its units to that part of its regulatory designated investor base that constitutes professional investors. At the same time, certain EU Member States have, following AIFMD implementation, allowed marketing of investment funds managed by Licensed AIFMs to investors other than professional investors within their territories. Thus, Sophisticated AIFs managed by a Licensed AIFM may extend their free cross-border marketing in those EU Member States also to investors that fulfil the criteria of a well-informed investor under the AIF Law. Retail AIFs managed by a Licensed AIFM may also target retail investors, i.e. the general public, without requiring any marketing approval by the regulator of the said EU Member States. In this case, Retail AIFs managed by a Licensed AIFM must have determined in advance, whether the targeted host EU Member State(s) have extended marketing to retail investors.

5 5. The Depositary s role in safeguarding investors interests The recent Bank crisis in Cyprus has shown the importance and effectiveness of asset segregation by a bank acting as depositary of an investment fund. While deposits, above the threshold of EUR , have been subject to bail-in, assets belonging to local investment funds have been fully protected and remained untouched. Having seen the importance of providing for segregated accounts and their effective implementation in practice, the AIF Law took an approach towards enhancing investor protection regarding the role of the depositary of an AIF. For this reason the AIF Law provides that the tasks of the depositary of Retail AIFs and of Sophisticated AIFs are those laid down in the AIFMD Provisions. This happens, in order to ensure investor protection throughout the custody chain and diligent ownership verification and record-keeping, as applicable. As to the depositary of a Limited Investor AIF, such depositary has also to ensure asset segregation. 6. Conclusion Regulation of investment funds in Cyprus under the AIF Law, recognises the need for a variety of collective investment products tailored to the needs of investors of different sophistication, net worth and risk-appetite. At the same time, it also provides for a marketing passport, as described above, for AIFs managed by a Licensed AIFM. Furthermore, the need to be aligned with state of the art EU regulation is ensured through the synergies between AIF Law and AIFMD provisions, which result in Paneuropean marketing possibilities. The need for effective investor protection has also been acknowledged and implemented by means of the duties incumbent on the depositary of all types of AIFs. LEDRA HOUSE: 15 Agiou Pavlou Str. Agios Andreas 1105, Nicosia, Cyprus P.O.BOX: 24444,1704 Nicosia, Cyprus TEL: FAX:

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