1 Investment Management & Funds Practice AIFMD Client Memorandum April 2012
2 INDEX PARAGRAPH PAGE 1 INTRODUCTION HOW DO YOU IDENTIFY THE AIFM? IS THE AIFMD APPLICABLE TO YOU? Scope In or out of Scope Grand-Fathering Rules Exemptions Opt-in Possibility WHAT IF YOU ARE A NON-EU AIFM? TIMELINES CAPITAL REQUIREMENTS FOR THE AIFM General Principle Initial Capital and Own Funds Notions Additional Own Funds Requirement Additional Own Funds Requirement for Potential Professional Liability Risks Computation Rules Risks to be Covered Professional Indemnity Insurance DELEGATION Regulatory Notification Sub-delegation Letter-box Entity Issue OPERATIONAL AND ORGANISATIONAL REQUIREMENTS Operational Requirements & Policies Organisational Requirements TRANSPARENCY REQUIREMENTS Annual Reporting Disclosure to Investors Reporting to Regulator CONCLUSION SCHEDULE 1 Third Country Conditions and Requirements
3 1 1 INTRODUCTION This memorandum aims to provide an overview of the key elements of Directive 2011/61/EU of the European Parliament and of the European Council of 8 June 2011 on Alternative Investment Fund Managers (the AIFMD) and is written particularly with a view to managers of investment funds investing in non-liquid assets. This memorandum may help you in determining the consequences the AIFMD will have with respect to the business and affairs of your investment management organisation and the funds managed by you. The AIFMD entered into force as of 21 July 2011 and must be implemented by the Member States of the European Union (EU) into national law not later than 22 July On 16 November 2011, following various market consultations, the European Securities and Markets Authority (ESMA) issued a final report which provides ESMA s technical advice on Level II implementing measures concerning the AIFMD (the ESMA Advice). The ESMA Advice is the response to the European Commission s request for assistance to ESMA s predecessor CESR as of 2 December This memorandum is based on the information as set out in the AIFMD itself and the ESMA Advice. At the time of drafting this memorandum the European Commission is still in the process of preparing the implementing measures based on the ESMA Advice. As a result thereof and of the fact that Member States have not yet implemented the AIFMD, the final implications of the AIFMD may differ from what is set out in this memorandum. Although this memorandum has been compiled with great care, Loyens & Loeff cannot accept any liability for the consequences of making use of the information set out in this memorandum without further advice. The information provided is intended as general information and cannot be regarded as advice. In case you wish to receive any further information regarding the AIFMD or any of the information set out in this memorandum, please let us know. We are more than happy to assist you in making your business and the funds managed by you AIFMD compliant. Any reference in this memorandum to an Article shall, subject to any contrary indication, be construed as a reference to an article of the AIFMD. 2 HOW DO YOU IDENTIFY THE AIFM? The AIFMD states that any legal person whose regular business is to manage (the AIFM) one or more AIFs (as defined below) must comply with the AIFMD unless they fall out of its scope, see paragraph 3 (Is the AIFMD applicable to you?) below. An alternative investment fund (AIF) is defined as a collective investment undertaking, or its compartments: which raises capital from a number of investors; with a view to investing it in accordance with a defined investment policy for the benefit of those investors; and
4 2 which is not covered by the Directive 2009/65/EC (Undertakings for collective investment in transferable securities (UCITS and the UCITS Directive)). An AIFM may be either: external i.e. an external manager, which is the legal person appointed by the AIF or on behalf of the AIF and which is responsible for managing the AIF; or internal i.e. where the legal form of the AIF permits an internal management and where the AIF s governing body chooses not to appoint an external AIFM, the AIF itself, which shall then be authorised as AIFM. Whereas Article 6(5)(d) states that, in order to be authorised under the AIFMD, AIFMs have to provide portfolio management functions and risk management functions, Article 4(1)(w) defines the activity of managing AIFs as performing at least portfolio management functions or risk management functions. ESMA considers that this means that an entity performing either of the two functions (i.e. portfolio management or risk management) is to be considered as managing an AIF according to Article 4(1)(w). Such entity must therefore seek authorisation as an AIFM under Article 6, it being understood that delegation of either the portfolio management or the risk management function is allowed as long as it is in accordance with Article 20 of the AIFMD. 3 IS THE AIFMD APPLICABLE TO YOU? 3.1 Scope In or out of Scope The AIFMD applies to AIFMs established in a Member State of the EU which manage one or more AIFs irrespective of where such AIFs are established. In addition, the AIFMD applies to AIFMs that are established outside of the EU to the extent that they manage AIFs established within the EU, or market AIFs (wherever these funds are located) to investors in the EU. Subject to transitional provisions in relation to non-eu based AIFMs (and non-eu AIFs), the AIFMD enables authorised AIFMs to freely market their alternative investment funds to professional investors (within the meaning of the Directive 2004/39/EC (MiFID)) in the EU. This is commonly referred to as the AIFMD s passport. The AIFMD does not apply to inter alia, (i) holding companies, (ii) pension funds, and (iii) securitisation vehicles. It furthermore does not apply to AIFMs managing UCITS funds only or to non-eu AIFMs managing one or more non-eu AIFs without marketing said AIFs in the EU. 3.2 Grand-Fathering Rules The AIFMD mentions two grand-fathering rules for AIFMs managing existing AIFs of the closedended type that have been offered pursuant to a private placement. If such AIFs (i) do not make any additional investments after 22 July 2013, or (ii) closed their subscription period for investors prior to 21 July 2011 and if their term expires at the latest by 22 July 2016, the relevant AIFM may, however, continue to manage such AIFs without needing an authorisation under the AIFMD.
5 3 3.3 Exemptions The AIFMD provides for the following exemptions: AIFMs in so far as they manage AIFs whose only investors are their parent undertakings, their subsidiaries or other subsidiaries of their parent undertakings, provided that none of those investors itself is an AIF (intra group exemption); or AIFMs that directly or indirectly (through a company with which such AIFM is linked by common management or control, or by a substantive direct or indirect holding) manage: (i) (ii) AIFs whose assets under management (the AuM), including any assets acquired through use of leverage, in total do not exceed a threshold of EUR 100 million; or AIFs whose AuM in total do not exceed a threshold of EUR 500 million, that are unleveraged and have no redemption rights exercisable during a period of 5 years following the date of the initial investment in each AIF (de minimis exemption). AIFMs that are exempt on the basis of the de minimis exemption must nonetheless register with the relevant supervisory authorities of their home Member State (the Regulator). Such exempted AIFMs (the Exempted AIFMs) will, at the time of their registration with their Regulator, identify the AIFs that they manage to the Regulator, and provide information to the Regulator on the investment strategies of such AIFs. After their registration is completed, the Exempted AIFMs will have to regularly (at least annually) provide the Regulator with information on the main instruments in which they are trading, on the principal exposures and on the most important concentrations of the AIFs they manage in order to enable the Regulator to effectively monitor systemic risk. Should the Exempted AIFMs no longer fall under the de minimis exemption, they will have to notify the Regulator of such change and apply for a full authorisation AUM Calculation For the purpose of calculating the value of the AuM in light of the de minimis exemption: UCITS for which the AIFM acts as designated management company under the UCITS Directive; foreign exchange and interest rate hedging positions that according to the investment strategy of the AIF are not used to generate a return; and AIFs for which the AIFM would not require to be authorised pursuant to the aforementioned grand-fathering rules, are excluded from the threshold calculation. AIFs investing in other AIFs (including a compartment of an AIF investing in another compartment of that same AIF) managed by the same AIFM may be excluded from the threshold calculation subject to appropriate adjustments for leveraged exposure of these AIFs.
6 4 The following items should be included in the threshold calculation: value of the AuM of each AIF, including assets acquired through leverage (as set out in paragraph below); and the absolute value of each financial derivative (including derivatives embedded in transferable securities) equivalent position in the underlying assets of that derivative Leverage Calculation The term leverage is defined by the AIFMD as any method by which the AIFM increases the exposure of an AIF it manages whether through borrowing of cash or securities, or leverage embedded in derivative positions or by any other means. The ESMA Advice sets out various calculation methods for the purpose of calculating the leverage of an AIF. When calculating the exposure/leverage under any of such methods, exposure which is contained in any financial and/or legal structures involving third parties controlled by the relevant AIF where said structures are specifically set up to directly or indirectly increase the exposure at the level of the AIF, should always be included. Therefore, AIFMs, when calculating exposure, should look through corporate structures to the extent that those structures have recourse to the AIF via cross-collateralisation or guarantees. The ESMA Advice furthermore specifies that guarantees should include circumstances where there is an expectation that the AIF will contribute to a third party even though there is no legally enforceable obligation. In addition, the AIFM should look through financial derivative instruments or other instruments where leverage is embedded in the contract so as to convert to an equivalent underlying position. Subject to the above, for AIFs whose core investment policy is to acquire control of non-listed companies or issuers, AIFMs should not include in the calculation any leverage that exists at the level of those non-listed companies and issuers, provided that the relevant AIF does not have to bear potential losses beyond its capital share in the respective company or issuer. On the other hand, borrowing arrangements entered into by the AIF are excluded under any of the abovementioned methods if these: are temporary in nature; and relate to and are fully covered by capital commitments from investors (i.e. the contractual commitment of an investor to provide the AIF with the agreed amount of investment on request by the AIFM). 3.4 Opt-in Possibility When relying on the de minimis exemption, the relevant AIFM will not benefit from the AIFMD s passport. However, there is an opt-in right for these AIFMs. To opt-in, an AIFM will have to follow the authorisation procedure outlined in Articles 7 and 8. However, once opted-in the AIFMD will become applicable to such AIFM in its entirety.
7 5 4 WHAT IF YOU ARE A NON-EU AIFM? The authorisation of non-eu AIFMs is expected to become available as from July Until that date non-eu AIFMs may manage EU AIFs to the extent permitted by national laws and may continue to market AIFs in Europe subject to national placement regimes and certain additional conditions set out in the AIFMD. Following the introduction of the passport for non-eu AIFM which is currently expected to occur in mid-2015: non-eu AIFMs may either apply for authorisation under the AIFMD and manage EU AIFs and market AIFs with the AIFMD s passport, or alternatively may continue to market non-eu AIFs to EU investors subject to national placement regimes and certain additional conditions of the AIFMD; non-eu AIFM must apply for authorisation under the AIFMD to manage EU AIFs and it would appear that marketing of EU AIFs in Europe is to be established in accordance with the AIFMD s passport. As from 2018, after obtaining advice from ESMA, the European Commission may decide that national placement regimes will be withdrawn. After such time, non-eu AIFMs may only market AIFs in the EU subject to prior authorisation in the Member State of reference and in compliance with the AIFMD. Reference is made to Schedule 1 (Third Country Conditions and Requirements) summarising third country conditions and requirements. 5 TIMELINES Member States have until 22 July 2013 to implement the AIFMD into their national law. Should they transpose the AIFMD before said date, they still have the possibility to delay the application of said provisions until 22 July 2013 (the Deadline). From the Deadline, should you not fall under any of (i) the grand-fathering rules, or (ii) the exemptions set out in paragraph 3.3 (Exemptions), you will have to comply with national law stemming from the AIFMD and submit an application for authorisation at the latest by 22 July For the avoidance of doubt, please note that AIFMs setup after the Deadline will have to comply with the national law having implemented the AIFMD from day one. 6 CAPITAL REQUIREMENTS FOR THE AIFM 6.1 General Principle As described in paragraph 2 (How do you identify the AIFM?), an AIF may either be internally or externally managed. The initial capital for internally managed AIFs must at least amount to EUR 300,000. Where an AIFM is appointed as external manager of one or more AIFs, the AIFM must have an initial capital of at least EUR 125,000.
8 6 6.2 Initial Capital and Own Funds Notions The notion of initial capital refers to (i) capital (i.e. all amounts, regardless of their actual designations, which, in accordance with the legal structure of the entity concerned, are regarded under national law as equity capital subscribed by the shareholders or other proprietors) in so far as it has been paid up, plus share premium accounts but excluding cumulative preferential shares, and (ii) reserves (i.e. legal reserves, in so far as national law requires such a reserve; reserves for own shares, in so far as national law requires such a reserve; reserves provided for by the articles of association of the AIFM; and (d) any other reserves) and profits and losses brought forward as a result of the application of the final profit or loss. With respect to the reserves Member States may permit the inclusion of interim profits before a formal decision has been taken only if (i) these profits have been verified by the AIFM s auditors, and (ii) it is proven to the satisfaction of the AIFM s Regulator that the amount thereof has been evaluated in accordance with the principles set out in Directive 86/635/EEC and is net of any foreseeable charge or dividend. The term own funds on the other hand includes the notion of initial capital and adds in particular (i) revaluation reserves ; (ii) value adjustments ; (iii) other items within the meaning of article 63 of Directive 2006/48/EC; and (iv) fixed-term cumulative preferential shares and subordinated loan capital as referred to in article 64(3) of Directive 2006/48/EC. Own funds (including any additional own funds) must be invested in liquid assets or assets readily convertible to cash in the short term and cannot include speculative positions. 6.3 Additional Own Funds Requirement In addition to the initial capital, where the value of the portfolios of externally managed AIFs all managed by the same AIFM exceeds EUR 250 million, the AIFM must provide an additional amount of own funds equal to 0.02% of the amount by which the value of the portfolios of the AIFM exceeds EUR 250 million without the sum of the required initial capital and the additional own funds exceeding EUR 10 million. Member States may authorise AIFMs not to provide up to 50% of said additional amount of own funds if they benefit from a guarantee of the same amount given by a credit institution or an insurance undertaking which has its registered office in a Member State, or in a third country where it is subject to prudential rules considered by the competent authorities as equivalent to those laid down in EU rules and regulations. The AIFM s own funds may never be less than the amount equivalent to one quarter of their preceding year's fixed overheads. Regulators may adjust that requirement in the event of a material change in an AIFM's business since the preceding year. 6.4 Additional Own Funds Requirement for Potential Professional Liability Risks In addition to the rules on additional own funds as explained above, AIFMs must either: have additional own funds which are appropriate to cover potential liability risks arising from professional negligence; or
9 7 hold a professional indemnity insurance against liability arising from professional negligence which is appropriate to the risks covered, to cover potential professional liability risks resulting from activities such AIFMs may carry out pursuant to the AIFMD. The additional own funds requirement for liability risk is equal to 0.01% of the value of the portfolios of AIFs managed by the AIFM. The own funds requirement must be recalculated and adjusted (if need be) on a yearly basis at the end of each financial year. The ESMA Advice provides that each Regulator may either: authorise an AIFM to lower such threshold to 0.008% if the AIFM can demonstrate (based on its historical loss data and a minimum historical observation period of 3 years) that liability risks have adequately been captured (which provision aims at incentivising AIFMs to implement adequate operational risk management systems); or increase said threshold requirement if liability risks have not been adequately captured by the AIFM. In order to adequately capture a risk, an AIFM will have to implement and keep up-to-date appropriate internal control mechanisms and risk management policies and procedures for the risks mentioned below under paragraph 6.6 (Risks to be Covered). This also includes, where appropriate considering the size and organisation of the AIFM and the nature, scale and complexity of its business, the implementation of a separate operational risk management function which ensures independent internal oversights and the implementation of the four-eye principle to avoid that failures could be hidden. A log/database for operational failures and losses must be kept in order to assess the operational risk profile of the relevant AIFM. 6.5 Computation Rules For computation purposes, AIFs managed by the AIFM, including AIFs for which the AIFM has delegated functions in accordance with Article 20 but excluding AIF portfolios that the AIFM is managing under delegation, shall be deemed to be the portfolios of the AIFM. 6.6 Risks to be Covered The potential liability risks to be covered are the risks of losses arising from the activities of the AIFM for which the AIFM has legal responsibility. There are two main types of such risks: (i) risks in relation to investors, products and business practices, and (ii) risks in relation to business disruption, system failures, and process management Risks relating to Investors, Products & Business Practices These risks may include in particular: negligent loss of documents evidencing title of assets of the AIF;
10 8 (d) (e) misrepresentations and misleading statements made to the AIF or its investors by the AIFM or the AIFM s directors, officers or staff or third parties for whom the AIFM has vicarious liability; negligent acts, errors or omissions by the AIFM resulting in a breach of: (i) obligations according to law and regulatory framework, (ii) duty of skill and care to the AIF when carrying out its professional activities, (iii) confidentiality obligations, (iv) AIF rules or instruments of incorporation, or (v) terms of its appointment by the AIF (except for internally-managed AIFs); failure by the AIFM s senior management to establish, implement and maintain appropriate procedures to prevent dishonest, fraudulent or malicious acts by the AIFM s directors, officers or staff or third parties for whom the AIFM has vicarious liability (i.e. if an AIFM negligently failed to carry out sufficient due diligence on an investment which turned out to be a fraud (e.g. a pyramid scheme such as the Madoff funds)), the AIFM's liability to third parties must also be covered; and improper valuation of the relevant AIF s assets and calculation of unit/share prices. Any such risks when materialised may lead to losses arising from a negligent failure to meet a professional obligation to specific investors and clients. This is of course distinct from the risk of an investment losing value due to adverse market conditions, which does not have to be covered Risks relating to Business Disruption, System Failures, Process Management Such risks may also lead to losses and must therefore be adequately captured and covered in case of materialisation. 6.7 Professional Indemnity Insurance As an alternative to the additional own funds requirement for potential professional liability risks as mentioned in paragraph 6.3 (Additional Own Funds Requirement), the AIFM may take out and maintain at all times professional indemnity insurance complying with the following cumulative requirements (the Insurance Policy Requirements): (d) (e) the insurance policy must have an initial term of no less than one year; the cover provided by the policy is wide enough to include the liabilities of the AIFM s directors, officers or staff or third parties for whom the AIFM has vicarious liability; the liability risks listed in paragraph 6.6 (Risks to be Covered) are covered; any defined excess is covered by own funds which are in addition to the own funds to be provided as set out in paragraph 6.3 (Additional Own Funds Requirement) and paragraph 6.4 (Additional Own Funds Requirement for Potential Professional Liability Risks); the insurance is taken out from an insurance undertaking authorised to transact professional indemnity insurance, which is subject to prudential regulation and on-going supervision.
11 9 There is a presumption of solvency for EU regulated insurance undertakings. In case of non- EU regulated insurance undertakings, the AIFM has to demonstrate to the Regulator that those requirements are fulfilled and that the insurance undertaking has sufficient financial strength with regard to the claims paying ability; and (f) the insurance is provided by a third party entity. The coverage of the insurance per claim must be adequate for the individual AIFM s liability risk. The ESMA Advice states that the insurance should have minimum coverage of: for each claim an amount of the higher of (i) 0.75% of the amount by which the value of the portfolios of the AIFM exceeds EUR 250 million, and (ii) EUR 2 million; and for claims in aggregate per year an amount of the higher of (i) 1% of the amount by which the value of the portfolios of the AIFM exceeds EUR 250 million, (ii) EUR 2.5 million, and (iii) the amount calculated in conformity with the calculation methodology mentioned in paragraph 6.4 (Additional Own Funds Requirement for Potential Professional Liability Risks). These coverage thresholds are expected to be simplified in the final Level II implementing measures and may be changed to an amount equal to 0.7% of the value of the AIFs portfolios per claim with a total annual coverage of 0.9% of the value of the AIFs portfolios. Overall, the minimum coverage given through a professional indemnity insurance may be higher than the amounts calculated as own funds pursuant to paragraph 6.4 (Additional Own Funds Requirement for Potential Professional Liability Risks). This can be explained by higher uncertainty and risk in relation to the insurance coverage (e.g. higher legal and contractual uncertainty, possible insolvency of the insurer) and aims to compensate this disadvantage. The AIFM should review the insurance policy and its compliance with the above requirements (i) at least once a year, and (ii) in the event of any change which affects compliance of the policy with the requirements. 7 DELEGATION 7.1 Regulatory Notification An AIFM may delegate some of its management functions, even where it concerns portfolio and risk management, under the following conditions: the contemplated delegation has to be notified to the Regulator prior to the delegation arrangement becomes effective; and it does not become a letter-box entity (as explained in paragraph 7.3 (Letter-box Entity Issue); The ESMA Advice clarifies that the requirements as to delegation do not apply to functions or tasks that are not considered critical or important or in other words should be seen as supporting tasks.
12 Supporting Tasks The ESMA Advice provides the following examples of functions or tasks that are not considered critical or important or could be seen as supporting tasks : (d) (e) (f) (g) (h) (i) provision to the AIFM of advisory services; provision to the AIFM of other services which do not form part of the functions the AIFM may additionally provide in the course of the collective management of an AIF. These services may include legal advice, training of the AIFM s staff, billing services, security of the AIFM s premises and personnel; purchase by the AIFM of standardised services, including market information services and provision of price feeds; participation in securities settlement systems and payment systems; provision of one-off, expert assistance with compliance, internal audit, accounting or risk management issues; provision of logistical support, e.g. cleaning, catering and procurement of basic services/products, including property management services; provision of human resources support, e.g. sourcing of temporary employees and processing of payroll; buying standard off-the-shelf software; and reliance on software providers for ad-hoc operational assistance in relation to off-the-shelf systems General Principles for the Delegation of Critical or Important Functions A function or task will be regarded as critical or important if a defect or failure in its performance would materially impair the continuing compliance of the AIFM with the conditions and obligations of: its authorisation or its other obligations under the AIFMD; its financial performance; or the soundness or continuity of the functions it performs. In case of delegation of functions that are critical or important the following conditions must be met: objective reasons: the AIFM must be able to justify its entire delegation structure on objective reasons. To comply with this obligation the AIFM should be able to demonstrate that the delegation is done for the purpose of a more efficient conduct of the AIFM s management of the AIF. Objective reasons for delegating tasks include but are not limited to: (i) optimising of
13 11 business functions and processes, (ii) cost saving, (iii) expertise of the delegate, and (iv) access of the delegate to global trading capabilities. sufficient resources and experience and sufficiently good repute of the delegate: the AIFM has to evaluate in this regard if: (i) (ii) the delegate has sufficient resources to perform the delegated tasks by verifying whether the delegate employs sufficient personnel with the skill, knowledge and expertise necessary for the discharge of the tasks delegated to it and has the appropriate organisational structure for the delegated tasks; the persons who effectively conduct the business of the delegate are: - sufficiently experienced; and - of sufficiently good repute (where the delegate is regulated in respect of its professional services within the EU, the AIFM may presume that this sufficiently good repute factor is satisfied). (d) (e) the delegation must not prevent the effectiveness of supervision of the AIFM: a delegation would prevent the effective supervision of the AIFM under certain circumstances, e.g. if the AIFM, its auditors and the relevant competent authorities do not have effective access to data related to the delegated functions, as well as to the business premises of the delegate or if the delegate does not cooperate with the competent authorities of the AIFM in connection with the delegated functions. the delegation must not prevent the AIFM from acting, or the AIF from being managed, in the best interests of its investors: a delegation would prevent the AIFM from acting, or the AIF from being managed, in the best interests of its investors where the interests of the delegate may conflict with those of the AIFM or the investors of the AIF unless the potential conflicts of interest are properly identified, managed and monitored. capability of the delegate and monitoring of the delegate: the AIFM must be able to demonstrate that: (i) the delegate is qualified and capable of undertaking the functions in question, and was selected with all due care. In any event, even if the delegate is duly qualified: - the delegation should not result in the delegation of senior management s sole responsibility i.e. senior management cannot exclude its liability for the delegated tasks and should ensure that the delegated tasks continue to meet the performance and quality standards that would apply if the tasks were carried out by the AIFM itself; - the obligations of the AIFM towards the AIF and its investors under the AIFMD should not be altered due to the delegation. For instance, the delegation should
14 12 not undermine the condition of sufficiently good repute and experience of the senior management; and - the conditions with which the AIFM must comply in order to be authorised and remain so under the AIFMD, should not be undermined; (ii) the AIFM is in a position to monitor effectively at any time the delegated activity, to give at any time further instructions to the delegate and to withdraw the delegation with immediate effect when this is in the interest of investors. In particular, the AIFM should ensure that: - the delegate carries out the delegated functions effectively and in compliance with applicable laws and regulatory requirements. This is done by establishing methods for reviewing the services provided by each delegate on an on-going basis. The AIFM should take appropriate action if it appears that the delegate is not carrying out the functions effectively or not in compliance with applicable laws and regulatory requirements; - the AIFM retains the necessary expertise and resources to supervise the delegated tasks effectively and manage the risks associated with the delegation. The AIFM should also ensure that the delegate properly supervises the carrying out of the delegated functions it received, and adequately manages the risks associated with the delegation; - continuity and quality of the delegated tasks are maintained also in case of a termination of delegation either by transferring the delegated tasks to another third party or by incorporating it into the AIFM; and - the respective rights and obligations of the AIFM and the delegate are clearly allocated and set out in a written agreement. In particular, the AIFM must contractually ensure that the delegate grants the AIFM the right of information, inspection, admittance and access as well as instruction and monitoring. The AIFM should be able, if necessary, to terminate the delegation through the provision of flexible termination rights. The agreement should make sure that sub-delegation could take place only with the AIFM s prior written specific consent. A general consent given in advance by the AIFM to any subdelegation would be considered as insufficient Conditions to the Delegation of Portfolio and/or Risk Management Functions Where the delegation concerns portfolio management or risk management, the following additional conditions shall be met: the delegation must be in accordance with the investment policy of the AIF. The delegate should be instructed by the AIFM how to implement the investment policy and the AIFM should monitor whether the delegate complies with it on an on-going basis;
15 13 such delegation must be conferred only on undertakings which are authorised or registered for the purpose of asset management and subject to supervision 1 or, where that condition cannot be met, only subject to prior approval of the Regulator; and in case the delegation is conferred on a third-country undertaking, a cooperation agreement between the relevant AIFM s Regulator and the delegate s Regulator must be ensured. No delegation of portfolio or risk management shall be conferred on (i) the depositary or a delegate of the depositary, or (ii) any other entity whose interests may conflict with those of the AIFM or the investors of the AIF, unless such entity has functionally and hierarchically separated the performance of its portfolio management or risk management tasks from its other potentially conflicting tasks, and the potential conflicts of interest are properly identified, managed, monitored and disclosed to the investors of the AIF. The portfolio or risk management tasks should be considered as functionally and hierarchically separated from other potentially conflicting tasks where the following conditions are satisfied: (d) those engaged in portfolio management tasks are not engaged in the performance of potentially conflicting tasks, such as controlling tasks; those engaged in risk management tasks are not engaged in the performance of potentially conflicting tasks, such as operating tasks; those engaged in risk management tasks are not supervised by those responsible for the performance of the operating tasks; and the separation is ensured up to the governing body of the delegate/sub-delegate. The criteria whether potential conflicts are properly identified, managed, monitored and disclosed to the investors of the AIF are the following: the delegate/sub-delegate should take all reasonable steps to identify, manage and monitor conflicts of interest that may arise between the delegate/sub-delegate and the AIFM or the investors of the AIF; and the delegate/sub-delegate should disclose potential conflicts of interest as well as the procedures and measures to be adopted by it in order to manage such conflicts to the AIFM, which should disclose them to the investors of the relevant AIF. 7.2 Sub-delegation The conditions set-out in paragraph 7.1 (Regulatory Notification) should mutatis mutandis apply where the delegate sub-delegates any of its functions to a sub-delegate. 1 i.e. (i) management companies authorised under the UCITS Directive, (ii) investment firms authorised under MiFID to perform portfolio management, (iii) credit institutions authorised under Directive 2006/48/EC having the authorisation to perform portfolio management under MiFID, and (iv) externally-appointed AIFMs authorised under the AIFMD.
16 14 The AIFM will have to demonstrate its consent to each sub-delegation in writing and prior to the sub-delegation. A general consent given in advance by the AIFM to each sub-delegation does not suffice. 7.3 Letter-box Entity Issue An AIFM would become a letter-box entity and could no longer be considered to be the manager of an AIF if: the AIFM is no longer able to effectively supervise the delegated tasks and to manage the risks associated with the delegation. This might be the case where the AIFM only retains few resources to supervise the delegated tasks in proportion to the extent to which it has delegated tasks and these resources are not sufficient for an effective supervision of the delegated tasks; the AIFM no longer has the power to: (i) (ii) take decisions in key areas which fall under the responsibility of the senior management. The ESMA Advice does not expand on what the key areas are. It is therefore to be assumed that such key areas may vary depending on the AIFMs and the AIFs; or perform senior management functions. Senior management functions include inter alia (i) the implementation of and compliance with the relevant AIF s general investment policy and investment strategies, (ii) ensuring that valuation procedures in accordance with Article 19 are in place, (iii) ensuring that the AIFM has a permanent and effective compliance function, and (iv) approving and periodically reviewing risk management policies and processes; or as a consequence of the delegation the totality of the individually delegated tasks substantially exceeds the tasks remaining with the AIFM. 8 OPERATIONAL AND ORGANISATIONAL REQUIREMENTS 8.1 Operational Requirements & Policies AIFMs must use appropriate human and technical resources at all times to ensure the proper management of the AIFs, including sound administrating and accounting principles; and adequate internal control mechanisms. These administrative organisation and internal control principles (AO/IC) should be documented and address, inter alia, the following matters that are broadly similar to MiFID and the UCITS Directive:
17 15 (d) (e) (f) (g) (h) (i) (j) (k) fair treatment of investors of the AIF to ensure that no investor obtains a preferential treatment that has an overall material disadvantage to other investors; best execution; market integrity; personal transactions; conflicts of interests; liquidity management only for leveraged open-ended funds; strategy for exercise of voting rights; record of operational failures; recording of portfolio and subscription and redemption transactions to ensure that these are notified in a durable medium to investors; permanent compliance and internal audit function; and due diligence to ensure that investment decisions on behalf of the AIF are carried out in compliance with the objectives, investment strategy and, where applicable, risk limits of the AIF. Below we will summarize some of these elements in more detail Rules on Personal Transactions The AO/IC must include rules for personal transactions by employees of the AIFM or with regard to investments for the AIFM s own account. These must ensure that each transaction involving the AIFs may be reconstructed according to its origin, the parties to the transaction, the time and place the transaction was effected and the assets of the AIF managed by the AIFM are invested in accordance with the rules/instruments of incorporation and the law Conflict of Interest Management The AIFM must implement a procedure in order to identify, prevent, manage, monitor and disclose conflicts of interest that arise in the course of managing one or more AIF between (i) the AIFM, an AIF and its investors (ii) several AIF, and (iii) AIF/investors on the one hand and another client of the AIFM on the other, (iv) AIF/investors, and (v) the AIFM s clients. In line with the approach considered in the UCITS Directive and MiFID, the AIFM should adopt procedures and measures to ensure that relevant persons engaged in different business activities that could involve conflicts of interest carry out these activities on an appropriately independent level. This level should be in proportion to the size and organisation of the AIFM and the nature, scale and complexity of its business.
18 Liquidity Management The AIFM needs to adopt appropriate liquidity management policies and procedures for each AIF managed that is not an unleveraged closed-ended AIF. These should enable the AIFM to monitor the liquidity risk of each AIF and comply with their underlying obligations to investors, counterparties, creditors and other parties and should take into account the investment strategy, the liquidity profile and the redemption policy of each AIF. Liquidity policies are required only for leveraged open-ended funds Strategy for Exercise of Voting Rights The AIFM should develop adequate and effective strategies for determining when and how any voting rights held in the managed portfolios are to be exercised, to the exclusive benefit of the AIF concerned and its investors. Although strategies for the exercise of voting rights should be developed, this does not exclude the possibility not to exercise voting rights if this is to the exclusive benefit of the AIF and its investors Record of Operational Failures Any operational failures and loss experience must be recorded and a historical loss database must be set up by the AIFM Recording of Portfolio Transactions The AIFM should make without delay for each portfolio transaction relating to AIF a record of information which is sufficient to reconstruct the details of the order and the executed transaction or of the agreement. With regard to portfolio transactions by the AIF outside an execution venue (e.g. in case of private equity AIFs, where no order will be placed to purchase partnership interests but rather a sale and purchase agreement will be negotiated), the record shall include: the name or other designation of the AIF; the legal and other documentation that forms the basis of the portfolio transaction, including in particular the agreement as executed; and the price. In addition, the AIFM should ensure that the required records referred to above are retained for a period of at least five years, unless the relevant national law provides for a longer retention period Permanent Compliance Function and Internal Audit Function ESMA proposes that the AIFM should ensure that its senior management is responsible for ensuring that the AIFM has a permanent and effective compliance function, even if this function is performed by a third party. In addition ESMA proposes that, where appropriate to the size and
19 17 business of the AIFM and the AIFs managed by it, the AIFM should establish and maintain an internal audit function separate and independent from other functions and activities of the AIFM. 8.2 Organisational Requirements In addition the AIFMD introduces the following key organisational requirements: Risk Management The AIFM shall establish and maintain a permanent risk management function, which may be performed by a third party. This risk management function shall be functionally and hierarchically separate from the functions of risk management from the operating units, including the portfolio management. If in light of the size and business of the AIFM a full functional and/or hierarchical separation of the risk management function is not feasible, the AIFM should take such measures as are necessary to mitigate any adverse consequence thereof. It must implement adequate risk management systems in order to identify, measure, manage and monitor appropriately all risks relevant to each AIF s investment strategy and to which each AIF is or can be exposed (including appropriate stress testing procedures). The governing body of the AIFM, and where it exits the supervisory function, shall review the risk management function at least once a year. Before designing risk management systems, the AIF should first of all draw up a risk profile for the AIFs under management that corresponds to the size, portfolio structure and investment strategies and objectives of the AIFs. Secondly, as part of risk management, the AIFM should implement an appropriate, documented and regularly updated due diligence process when investing on behalf of each AIF. Lastly, the AIFM should review the control and safeguard arrangements for electronic data processing that are in place. Within the risk management framework, the AIFM should make use of its historical internal loss data and, where appropriate, of external data, scenario analysis and factors reflecting the business environment and internal control systems Valuation The AIFM must ensure that, for each AIF it manages, appropriate and consistent procedures are established for the proper and independent valuation of the assets of the AIFs and that the net asset value (NAV) of the AIFs assets per share or unit is calculated and disclosed to investors. The valuation may either be performed by the AIFM or by an independent external valuer. Such external valuer shall, in general, not be the depositary appointed for the relevant AIF (unless it, inter alia, has functionally and hierarchically separated its depositary functions from its tasks as external valuer). If the AIFM carries out the valuation itself, it must ensure the (functional) independence of the portfolio management and valuation function. Also, the AIFM must put in place measures to mitigate conflicts of interests in connection with in-house valuations. Member States may require verification of in-house valuations by an external valuer or auditor. Valuations must be performed in accordance with the applicable law of the country where the AIFs have their registered office or in accordance with the rules or constitutional documents governing the AIFs.
20 18 Valuations must be performed at least once a year. In addition, a valuation must be established: in respect of open-ended funds, at such frequency as is appropriate, having regard for the assets held by the AIFs and the issue and redemption frequency; and in respect of closed-ended funds, in case of an increase or decrease of capital Remuneration Policy The AIFM must have remuneration policies and practices that promote sound and effective risk management for those categories of staff whose professional activities have a material impact on the risk profiles of AIFs they manage. These categories of staff should at least include senior management, risk takers, control functions and any employees receiving total remuneration that takes them into the same remuneration bracket as senior management and risk takers. The AIFM shall set up remuneration policies and practices in accordance with the principles listed in Annex II to the AIFMD setting forth, inter alia, that: guaranteed variable remuneration is exceptional and may only occur in the context of hiring new staff and must be limited to the first year; subject to the legal structure of the AIF, a substantial portion and in any event 50% of any variable remuneration consists of units or shares of the AIF concerned or equivalent ownership interests unless the management of the AIF accounts for less than 50% of the total portfolio managed by the AIFM, in which case the minimum of 50% does not apply; and a substantial portion, and in any event 40% of the variable remuneration component, is deferred over a period which is appropriate in view of the life cycle and redemption policy of the AIF concerned and is correctly aligned with the nature of the risks of the AIF in question; this period should be a least three to five years; in the case of the variable remuneration component and of a particularly high amount, at least 60% of the amount is deferred. However, compliance with these principles may take into account the appropriateness of the principles considering the size, internal organisation and the nature, scope and complexity of an AIFM Remuneration Committee In the event the AIFM qualifies as significant in terms of its size or the size of the AIFs it manages, its internal organisation and the nature, the scope and the complexity of its activities, the AIFM will need to establish a remuneration committee. The remuneration committee shall be responsible for the preparation of decisions regarding remuneration, including those which have implications for the risk and risk management of the AIFM or the AIFs concerned and which are to be taken by the management body in its supervisory function. The members of the committee shall be members of the management body who do not perform any executive functions in the AIFM.
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