AIMA GUIDANCE NOTE. AIFMD own funds required in respect of professional indemnity policy exclusions

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1 AIMA GUIDANCE NOTE AIFMD own funds required in respect of professional indemnity policy exclusions November 2013

2 IMPORTANT While AIMA has used all reasonable efforts to produce this Guidance, neither AIMA, the members of the AIMA committees, nor their officers, employees and agents (together AIMA ) make any representation or warranty, express or implied, as to the adequacy, completeness or correctness of the Guidance. To the fullest extent permissible under applicable law, AIMA accepts no responsibility jointly or individually for any loss howsoever arising from the use of the Guidance or otherwise arising in connection with this document. This Guidance has been produced by AIMA. Although AIMA has informed the Financial Conduct Authority (FCA) of the existence and contents of this Guidance and will continue to liaise with the FCA in this respect, the FCA has had no role in the drafting of the Guidance and the FCA gives no approval and bears no responsibility for this Guidance. Please ensure that you have the latest version of this Guidance. This can be found by checking the AIMA website. All copyright in this document belongs to AIMA and reproduction of part or all of the contents is strictly prohibited unless prior permission is given in writing by AIMA. Introduction This Guidance is intended to assist alternative investment fund managers ( AIFMs ) that have elected to use a professional indemnity insurance policy ( PI Policy ) in respect of their professional liability risks pursuant to Article 9(7) of the Alternative Investment Fund Managers Directive 2011/61/EU (the Directive ). The Directive and its supplementing Delegated Regulation (EU) 231/2013 (the Level 2 Regulation ) do not contain any express requirements in respect of any exclusions of liability contained in such PI Policy. The FCA Handbook (GENPRU R and IPRU(INV) R) provides that an AIFM must hold adequate own funds to cover any exclusions in the PI Policy that would otherwise result in the AIFM having insufficient resources to cover liabilities arising. SCOPE The intention of this Guidance is to provide assistance to AIFMs in assessing whether they need to hold own funds in respect of PI Policy exclusions. Please note that there are several other PI Policy requirements prescribed by the Directive, the Level 2 Regulation and the FCA Handbook which are not detailed in this Guidance but which AIFMs will need to consider. AIMA strongly recommends you obtain your own legal advice in relation to all aspects of compliance with the AIFMD. You are reminded that AIFMs retain sole responsibility for their AIFMD compliance. 2

3 Own funds only to be held in respect of non-standard PI Policy exclusions The FCA has explained that it would normally take the view that AIFMs only need to hold own funds in respect of non-standard PI Policy exclusions. We understand this to be because the requirements of the Directive have already taken into account the higher legal and contractual uncertainty inherent in holding a PI Policy compared with holding own funds as a form of protection against liability for professional negligence. This is evidenced by the fact that the Directive requires that AIFMs which choose to hold own funds in respect of their professional liability risks are required to hold 0.01% of relevant assets under management (AUM), whereas the PI Policy option requires that the prescribed policy limits are 0.7% (per claim) and 0.9% (in the aggregate) of an AIFM s relevant AUM. As the FCA does not intend to issue any guidance on which exclusions are standard, AIMA has sought to provide some assistance in this respect. RISK ANALYSIS OF STANDARD EXCLUSIONS Although AIMA s understanding of the FCA Handbook rules is that there is no requirement to hold own funds in respect of any standard exclusions, AIMA still recommends that AIFMs consider, as part of their overall risk analysis, the impact of the standard exclusions on their potential professional liability exposure and whether they wish to choose to hold additional own funds in respect of such standard exclusions. Guidance on which exclusions are standard in PI Policies: no own funds to be held In order to assess which exclusions are standard in PI Policies, AIMA has sought the views of a specially convened insurance industry working group (the Insurance Working Group, see Appendix for more details). AIFMs should be aware that the wordings of PI Policies vary from policy to policy, evolve continuously in light of market conditions and may be adapted in light of policyholders specific circumstances and requirements. For these reasons, the list of standard PI Policy exclusions set out below can only be indicative. (i) IMI PI Policies The majority of AIFMs will be insured for professional liability risks under a specialist Investment Manager Insurance (IMI) policy. The Insurance Working Group has identified the following exclusions as standard in these types of policies. Exclusions standard in an IMI Policy Continuity Date Prior Knowledge and Prior Discovery Excludes claims arising from any litigation running or pending as at the continuity date (usually the date when cover was first purchased) or deriving from the same facts alleged in such litigation. Excludes claims arising from matters or circumstances known to the insured when the policy incepted which could reasonably be expected to result in a claim. 3

4 Exclusions standard in an IMI Policy Prior Notifications Retroactive Date Contractual Liability / Representation, Guarantee or Warranty of Investment Performance Trustee Exclusion: Pension Administration Corporate Acts Market Abuse Money Laundering Personal Profit or Advantage which the Insured is not Entitled to Retain Disputes over Fees, Commission or Expenses Bodily Injury / Property Damage Excludes claims arising from matters notified to insurers of policies incepting prior to the policy in which the exclusion is applied. Excludes claims arising from acts committed prior to a specified date, usually the date cover is purchased for the first time. Typically only required on new excess layers or for newly acquired entities. Excludes liabilities arising under contract unless such liability would have arisen in law in the absence of the contract. In some versions this exclusion appears as one of guarantees or warranties which the insured might give to others, especially in relation to investment performance. Excludes liability arising in the capacity of a pension trustee or administrator to the AIFMs own pension, profit sharing or employee benefit plans often specific to the U.S. Employee Retirement Income Security Act of 1974 or UK pensions legislation. Excludes institutionalised fraud. i.e. liability arising out of company policy that the board knew or should have known would financially disadvantage two or more third parties whilst delivering an illegal financial advantage to the insured entity. Cover for such act is deemed against public interest. Seen as a criminal act and therefore against public interest to cover under a PI policy. Seen as a criminal act and therefore against public interest to cover under a PI policy. Seen as a criminal act and therefore against public interest to cover under a PI policy. Remuneration disputes not viewed as fortuitous losses and are therefore not usually covered under a PI policy. Excludes liability arising from bodily injury, sickness and disease and from loss of or damage to property which are outside the intent of PI cover and are usually covered by other types of insurances. Cover is usually carved back within the exclusion for emotional injury and mental anguish. NOTE: For a policy to cover professional liability risks pursuant to Article 9(7) of the Directive, cover should be carved back for negligent loss of documents evidencing title to the assets of the alternative investment fund. 4

5 Exclusions standard in an IMI Policy Mechanical Breakdown / Infrastructure Nuclear Pollution War Terrorism SEC ERISA RICO Insured versus Insured Parent Company Property Management Subsidiary Acts whilst Entity was not a Subsidiary Excludes claims arising from mechanical breakdown, infrastructure failure, software failure, electrical surge, power failure or 'brown out' as well as computer programming errors in design and other computer failures. NOTE: For a policy to cover professional liability risks pursuant to Article 9(7) of the Directive, cover should be carved back for negligence. Excludes radioactive contamination and liability arising from the explosive properties of explosive nuclear assemblies and the like. Excludes claims for seepage and pollution and the costs of clean-up which the insured entity might be ordered to pay. Excludes liability arising from war risks (including insurrection, riots, civil commotion and nationalisation by government). Excludes liability arising from terrorism (usually defined in terms of acts of individuals or groups which are aimed at seeking to influence governments or putting the population or a section of the population in fear). Excludes liability for violation of SEC regulations. Some versions apply only to violations of Section 16(b) under the U.S. Securities Exchange Act of 1934 (where short term or "swing" profits are made by directors and officers of the insured trading the entity's shares within a short time of an offering). Excludes liability arising from violations as a trustee, fiduciary or administrator of an AIFMs pension, profit-sharing or employee benefits programme, or the U.S. Employee Retirement Income Security Act of Excludes liability arising from violations of the U.S. Racketeer Influenced and Corrupt Organizations Act. Excludes claims made by one insured against another (including by insured persons - employees or others, if these are included as insureds in the policy). Cover should be carved back for claims by managed funds. Excludes claims by the parent company of the insured entity. May be included as part of the Insured versus Insured exclusion. Excludes liability arising from such activities. Only standard where the AIFM manages real estate assets. Excludes liability arising from subsidiaries when they were not such. However run off cover should be provided for claims arising out of acts committed during the insured s period of ownership. 5

6 Exclusions standard in an IMI Policy Post Takeover Employment Practice Claims Other items which may be excluded within the definition of loss Removes cover after the insured entity is taken over - usually accompanied by an exclusion of cover after liquidation/ receivership or administration of the insured entity. Excludes claims for breach of employment law (discrimination, unfair dismissal, breach of employment contract and the like). Fines and penalties, punitive damages, fees or commissions, matters uninsurable by law. (ii) FIPI Policies Some AIFMs may be part of a diverse organisation offering financial services other than investment management and could therefore be insured for professional liability risks under a more general Financial Institutions Professional Indemnity (FIPI) policy. The Insurance Working Group has identified the following exclusions, in addition to the ones identified above for IMI policies, in these types of FIPI policies. Additional Exclusions standard in a FIPI policy Proprietary Trading Market Fluctuations/Diminution in Value Lender Liability M&A/IPO of Insured Insolvency of the Company Insolvency of any Broker or Dealer or Financial Institution Failure to Maintain Insurance Excludes claims arising from any transaction undertaken by the insured entity as a principal Excludes claims arising from fluctuations in markets which are outside of the influence or control of the insured. A variety of versions are in use. Some exclude all liability from claims arising from the insured providing loans; some carve back cover for loan administration activities. Others apply only to liability resulting from the refusal by the insured to provide credit. Excludes liability arising out of corporate transactions involving the insured s own securities Excludes claims arising from the insolvency of the insured entity. Excludes claims arising from the insolvency of brokers or dealers or financial institutions Excludes claims arising from a failure to arrange or renew insurance. When seeking to identify any PI Policy exclusions, AIFMs should also be aware that exclusions of liability under PI Policies may not appear solely in the exclusions section of the PI Policy. They might appear within the other sections or in the definitions, for example in the definition of loss. Calculation of own funds to be held in respect of PI Policy exclusions Given the individual nature of each AIFM, it was decided that it would not be appropriate for AIMA to provide guidance as to the quantum impact of PI Policy exclusions. AIFMs should use their tailored internal risk management processes to calculate the amount of own funds which would need to be held in respect of PI Policy exclusions to ensure that the AIFM could meet its professional liabilities in the event of a negligent act, error or omission. 6

7 The FCA s AIFM Variation of Permission Application Form For AIFMs which elect to use a PI Policy to cover their professional liability risks under the AIFMD, the FCA s AIFM Variation of Permission Application Form contains a request for details of the PI Policy s business line exclusions. Please note that we understand that the FCA wants applicants to provide details in response in respect of: (1) non-standard exclusions contained in the PI Policy; and (2) any standard exclusions against which the AIFM has determined it should choose to hold additional own funds as part of its overall risk analysis (see the box headed Risk analysis of standard exclusions on page 3 above). Further information AIMA recommends that each AIFM discuss this Guidance with its insurance broker or insurance provider to aid its assessment of whether the exclusions in its PI Policy are non-standard or how the standard exclusions could affect the AIFM s overall risk assessment and, if so, the amount of own funds which should be held in respect of these exclusions. The Alternative Investment Management Association Limited (AIMA)

8 Appendix: Insurance Working Group Members Arrowgrass Capital Partners LLP Arthur J Gallagher (UK) Ltd Brit Insurance Howden Insurance Brokers Limited Jardine Lloyd Thompson Ltd Kinetic Partners Lockton Companies LLP Miller Insurance Services LLP Simmons & Simmons LLP Travelers Insurance Company Limited Travers Smith LLP Willis Limited 8