AIFMD Guide for Asset Managers Knowledge Expertise Experience By Carne - the AIFMD experts

Transcription

1 AIFMD Guide for Asset Managers Knowledge By Carne - the AIFMD experts Expertise Experience 1

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3 Contents Page 1 Preface 3 2 Overview of the AIFM Directive 4 3 What is an AIF / AIFM? 8 4 Why launch an AIF? 8 5 What Do Investors Want? 9 6 Product types and fund structures 10 7 Operating model and practical solutions to the AIFMD (options for accessing EU markets under the Directive) 11 8 Choice of domicile 13 9 Considerations for non-eu AIFMs AIFM authorisation process Costs for set up Delegation arrangements Risk management requirements Remuneration provisions Transparency reporting Role of the depositary Distribution opportunities, issues and challenges Converting existing structures to EU AIFs How can Carne help? 36 Knowledge Expertise Experience 1

4 About Carne Carne is a leading provider of governance and oversight support for the global asset management industry. We are experts in AIFMD and UCITS funds and provide governance services for regulated and offshore funds in various jurisdictions both within and outside the EU. Carne has offices currently in Ireland, Luxembourg, London, Cayman, Channel Islands, Chicago, New York and Switzerland. Our independent governance services include: AIFMD Oversight UCITS Oversight Fund Directors AIFM & UCITS Management Companies Risk Management Services MLRO Services Company Secretarial Services Compliance Officer Services Carne Global Financial Services Limited. 2nd Floor, Block E, Iveagh Court, Harcourt Road, Dublin 2 t: Copyright Carne Group All rights reserved. No part of this guide may be reproduced in any form or by any means without written permission from Carne. 2

5 Preface The introduction of the Alternative Investment Fund Managers Directive ( AIFMD or Directive ) represents both a challenge and an opportunity for alternative fund managers. Many asset managers may initially regard the Directive as an obstacle to future distribution of their funds in the EU, but the Directive also clarifies both the future passporting regime for alternative funds and provides a regulatory framework that will encourage more investors in Europe to revisit alternative strategies outside the UCITS world. At Carne we work with alternative managers of both UCITS and now AIFs in a variety of jurisdictions, helping them to meet the new regulatory requirements in an effective and professional manner. We have published this guide to help alternative fund managers to understand what the AIFMD means for them and some of the new choices it delivers. With the right support, it is possible to build a governance and reporting framework that will reassure investors and demonstrate the seriousness of an organisation s investment proposition. Our AIFMD and risk teams have pooled their collective experience within this guide to bring managers an informative primer on the Directive to aid them in launching or converting products they will be able to distribute with confidence within the EU. Carne believes that the passport allowed under the Directive will be much more important than the industry presently recognises and will lead to a similar distribution model to the highly successful UCITS brand (which outside of the 40x Act regime is the world s leading investment product). In the alternative investment space, we believe that the passported AIF will become the leading global alternative branded product with tremendous distribution potential. This comes at a time when liquid alternatives are growing at a phenomenal rate and long term income producing real assets are critical to institutional investors for meeting their future liabilities. As with the advent of the UCITS product directive Carne is again taking a market leading role in seizing the opportunities of this Directive by further developing our leading governance team with more risk management and investment professionals in order to deliver best in class AIFMD solutions. Carne is the only third party AIFM to have licences in both Ireland and Luxembourg and was the third AIFM globally to receive its licence. Carne was involved in four out of the first five AIFM applications in Ireland. We are working with many new and existing large global asset manager clients in providing our innovative AIFMD solutions. This gives Carne a unique perspective and puts us in a market leading position as a provider of independent third party AIFMD solutions. John Donohoe, CEO Carne Global Financial Services 3

6 2. Overview of the AIFM Directive The Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers ( AIFMD or Directive ) entered into force in the European Union in 2011, with implementation into national legislation by EU Member States required by 22 July The aim of the Directive is the monitoring and supervision of alternative investment funds, such as private equity and hedge funds, through the creation of an EU-wide harmonised regulatory framework. Since its release, the original Directive has been supplemented by additional regulations and implementing measures issued by the European Commission, to provide further details on a number of areas set out by the Directive, as well as by detailed guidance from ESMA and national regulatory authorities. The Directive seeks to regulate the investment managers of alternative funds. It applies to entities managing Alternative Investment Funds ( AIFs ) who distribute or domicile their products within the European Union. The managers of these products (referred to as Alternative Investment Fund Managers, or AIFMs ) must comply with a comprehensive set of compliance, risk, organizational and reporting requirements under the Directive. The Directive makes a distinction on the basis of whether the AIFM is EU or non-eu domiciled. EU domiciled AIFMs ( EU AIFMs ) are required to register with their home state regulatory authority for approval or authorisation as an AIFM and must, as a result of such registration, comply with a number of provisions. The AIFs under the management of the AIFM are in this way also caught by the Directive and must by proxy comply with a series of requirements around reporting, oversight and disclosure. Non-EU based AIFMs ( non-eu AIFMs ) are also caught if they advise a European-domiciled alternative investment fund ( EU AIF ) or a non-european alternative investment fund ( non-eu AIFs ) that is currently distributed in the EU. The obligations on non-eu AIFMs are lighter than those imposed on their EU counterparts, although the Directive provides for the possibility of full registration being made available to non-eu AIFMs from 2015 (subject to regulatory review and assessment of the Directive s effectiveness until then), with associated requirements for full compliance with the Directive s provisions. Although the Directive became effective on 22 July 2013, a number of EU member states have introduced a transitionary period to allow EU AIFMs, currently managing existing alternative collective investment schemes, enough time to implement the necessary changes to their organisational structure and to prepare the necessary regulatory applications. As such, in practice EU AIFMs based in a number of jurisdictions (most notably the UK, Luxembourg and Ireland) have until 22 July 2014 to fully comply with the Directive. Such a transitionary period is however not applicable to newly established EU-domiciled alternative investment funds, whereby such schemes fall fully within the scope of the Directive and therefore must be compliant with the Directive s provisions (including the requirement to appoint an EU AIFM) upon launch. 4

7 Key Dates 22 July 2013 EU member states required to implement AIFMD into national law 22 July 2014 Deadline for those AIFMs that have been carrying out activities within scope of AIFMD prior to 22 July 2013 to submit application for authorisation as an AIFM (a number of jurisdictions have extended the deadline to 2015 for non-eu AIFMs of existing AIFs in their domicile) 2015 ESMA will report on functioning of passporting regime and will review whether to extend this to non-eu AIFs and non-eu AIFMs 2018 ESMA review of impact of AIFMD and whether to end existing private placement regimes of member states The Directive allows for certain thresholds and exemptions, whereby managers of funds falling in the following categories are outside the scope of the Directive: - Small AIFMs, i.e. managers of AIFs with total AUM of less than EUR 100 million or equivalent, and managers of AIFs with total AUM of less than EUR 500 million or equivalent, where the AIFs are unleveraged and with no redemption rights for five years following the date of initial investment in each AIF; - Securitisation special purpose vehicles; - Single investor funds as defined in the regulations; - AIFs whose sole investors are group companies of the manager (as long as none of these investors is in itself an AIF). Nonetheless there are still certain notification requirements that the exempted AIFMs must comply with (such as confirmation of below threshold status to the regulatory authorities). The key provisions of the Directive are as follows: Appointment of Depositary: For every AIF under its management, the EU AIFM is required to appoint a single independent depositary with responsibility for the safekeeping of assets, oversight of compliance by the AIF with applicable laws and regulations and monitoring of cash flows. In the case of EU AIFs, the depositary must be established in the home state of the AIF and must be a regulated EU credit institution, EU investment firm or another institution already approved to act as a UCITS depositary. In the case of non-eu AIFs, the depositary may be domiciled either in the country of the AIF, or the home state of the AIFM, or in a member state of reference Knowledge Expertise Experience 5

8 and further requirements apply in addition to the prudential and supervisory equivalence. For non-eu AIFs, the depositary may be a non-eu institution equivalent to an EU credit institution or EU investment firm, provided that it is subject to EU-equivalent effective prudential regulation (including minimum capital requirements) and supervision. An exemption from the depositary requirement exists for private equity and real estate AIFs, whereby they can use professional advisers to act in this capacity. A lighter depositary regime ( depo-lite ) applies to EU AIFMs managing non-eu AIFs, if these schemes are marketed or distributed across the EU. The Directive introduces a number of obligations on the depositary, the most debated being in relation to the strict liability of the depositary with regards to sub-custody/delegation arrangements (subject to a negligence/intentional failure test). The Directive specifies that a written agreement must be in place with the depositary and prescribes specific requirements for inclusion in such agreement. The AIFM must be a party to the depositary agreement alongside the AIF and there needs to be an ongoing exchange of information and oversight between all parties (which would be formalised via a service level agreement). Delegation Arrangements: One of the key provisions of the Directive is that the AIFM cannot delegate functions to the extent that it becomes a letterbox entity and while there has so far been limited regulatory guidance to assess what exactly would constitute this, the understanding is that the AIFM must be able to retain a certain level of substance, activity and expertise, particularly in the area of risk management and/or portfolio management, even if certain roles are in practice delegated to third parties. An important area of focus is the need to have appropriate due diligence prior to engaging with the third party and what processes need to be put in place for the ongoing monitoring of the delegate. Governance and Oversight: The Directive has a substantial impact on the governance framework of AIFs and AIFMs as it imposes additional responsibilities on the AIFM itself. Emphasis is placed on having a robust governance and effective risk management culture, in particular in light of the AIFM s accountability for delegation arrangements, responsibility for valuation, necessary flow of information and ownership of key decisions. Risk Management: The risk management activity needs to be functionally and hierarchically segregated from the portfolio management function and must operate independently and with sufficient expertise, authority and resources to ensure all risks in the AIFM and AIFs are appropriately quantified, monitored and managed on an ongoing basis. Policies and Procedures: The AIFM is required to have in place a number of documented policies and procedures to cover areas including but not limited to delegation arrangements, risk management, conflicts of interest, due diligence processes, conduct of business, valuation and remuneration practices, setting out escalation arrangements, responsibilities of senior management and oversight of the board. These policies need to be reviewed on a regular basis and should be aligned with the operational complexity and characteristics of the AIFM/AIFs. Valuation: Under the Directive, ultimate responsibility for the valuation of the AIFs under management falls to the AIFM, unless this is delegated to an approved third party acting as external valuer. Whilst in practice the pricing activity may continue to be undertaken by the administrator, the AIFM is required to have procedures in place to document the valuation process and for escalation and review of any issues, with ultimate responsibility resting with the AIFM s board. 6

9 Remuneration: AIFMs are required to have in place a written remuneration policy designed to prevent conflicts arising from the compensation arrangements of staff at the AIFM, who, through their role within the AIFM or the delegates activities, could materially impact the risk profile of the AIFs. While the Directive s provisions in this regard are aligned to other regulatory initiatives that are currently being implemented in the EU (e.g. CRD IV, MIFID II), the provisions represent completely new territory for non-eu investment managers who are now within the scope of these requirements when acting as delegates to the AIFs for the provision of portfolio management services. Transparency Reporting: AIFMs and AIFs are required to provide substantial reporting to the regulatory authorities on a quarterly or semi-annual basis, (depending on AUM) as well as to investors on a regular basis. While a number of the requirements set out in the Directive relating to investor disclosures would already typically be covered in a prospectus/offering memorandum, there are some new items that must now be disclosed to investors pre-investment (e.g. latest NAV, historical performance) and on an ongoing basis (e.g. total leverage employed). Leverage: there is no limit for leverage that may be employed but limits must be disclosed on a regular basis to investors and to the regulatory authorities (both total leverage employed and maximum allowed) and the limits must be monitored on an ongoing basis through the AIFM s risk management framework. For AIFs where the leverage calculated under the Commitment method is 3X or greater, the fund is deemed to be employing leverage on a substantial basis and additional reporting requirements will apply to the AIF. The amount of leverage in the fund will have an effect on the amount of capital required by the AIFM (see below). Capital Requirements: The Directive imposes capital requirements on both AIFs and AIFMs. AIFs are required to hold minimum capital of EUR 300,000, while AIFMs are required to hold minimum capital of EUR 125,000 plus 2 basis points of assets under management (NAV) greater than EUR 250 million. The Directive provides detailed guidance as to the basis for the calculation of the figure for assets under management. In addition AIFMs must ensure that they have in place sufficient funds to cover risks arising from professional liability risks, either in the form of professional indemnity insurance provided by a third party, or through additional own funds (equal to 1 basis point of gross assets). AIF/AIFM Passport: Under the Directive it is now possible for an AIF to obtain a passport from the AIF s home state, which allows its cross-border marketing and distribution in other member states across the EU to qualified (i.e. non-retail) investors. The authorisation process for the passport is straightforward and based on an exchange of information between regulators. Approval can be obtained within a month of the filing being made in the AIF s home state. It is also possible for the AIFM itself to obtain a passport from its home state regulator, allowing it to provide AIFM services cross-border (i.e., to act as AIFM for AIFs domiciled in another EU jurisdiction). The passport is currently only available to AIFs and AIFMs that are EU-domiciled, but there is the intention for the passport provisions to be extended to non-eu AIFs/AIFMs from 22 July 2015 (subject to ESMA review). Knowledge Expertise Experience 7

10 3. What is an AIF / AIFM? The definitions of what should be considered an AIF and what is an AIFM are set out in the Directive under Article 4 (1) and a number of terms contained in the Directive for these definitions were further clarified in a guidance paper from ESMA 1. Under the definition in the Directive, an AIF is a collective investment undertaking, which (i) 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 (ii) does not require authorisation as a UCITS scheme. In its definition of an AIF, the Directive therefore aims to capture all collective investment schemes that are not UCITS regardless of their legal structure, investment strategy or open-ended/closed-ended characteristics. The definition of an AIFM is a legal person whose regular business is managing one or more AIFs. There are a number of exemptions set out in the Directive whereby the following entities are not to be considered as AIFMs: - holding companies; - occupational retirement schemes and the managers thereof (in so far as they do not manage AIFs); - supranational institutions (such as the European Central Bank, the World Bank, the International Monetary Fund, and other supranational institutions and similar international organisations), in the event that such institutions or organisations manage AIFs and in so far as those AIFs act in the public interest; - national central banks; - employee participation schemes or employee savings schemes; - securitisation special purpose entities. 4. Why launch an AIF? One of the primary reasons to launch an AIF is their increasing popularity with investors. A number of investors that do allocate to alternative investment funds want to continue having such exposure but are reluctant to invest in offshore vehicles. A number of continental European countries have campaigned actively against offshore jurisdictions and in some instances it has become difficult to invest in vehicles domiciled in offshore centres with a low level of regulation which the EU has no control over. The fact that AIFs are regulated by onshore EU jurisdictions delivers a certain level of comfort to a number of institutional investors such as pension funds, and financial institutions such as banks and insurance companies. Another element which comforts European clients is the AIF s obligation to have a European financial institution acting as depositary and therefore responsible for the safe keeping of the assets. 8 1 ESMA - Final Report: Guidelines on key concepts of the AIFMD (24 May 2013)

11 From a fund manager s perspective, the AIFMD will enable active marketing, a key advantage for raising capital. Cayman Islands funds and other offshore domiciled funds are becoming more difficult to market proactively in continental Europe. Most EU countries are tightening their private placement regimes that have been used traditionally, thereby restricting active marketing. Allocators to alternative funds are heavily solicited. Not being able to actively market, to have the visibility expected by investors, is a serious impediment to the success of an AIF. With an AIFMDcompliant structure the investment manager can register the fund in the various EU jurisdictions for active marketing purposes, allowing it to actively solicit business using one-on-one meetings and investor promotion events. 5. What do investors want? Within Europe, if investors are sophisticated and have no internal restrictions regarding investment in offshore funds, they will typically continue to favour those offshore funds, as they are cheaper to run and offer scope for the investment manager to manage assets with no restrictions. However investors that fall into this category are shrinking in number, which would restrict European marketing considerably. The new European regulatory framework is already giving most investors a higher level of comfort and the depositary aspect of AIFMD and UCITS will also provide additional confidence regarding the safekeeping of their assets. Liquidity is also often an important consideration and while the approach of investors will vary, the UCITS framework has already shown how successful a regulated European structure can be in this regard. For private clients and family offices tax reporting will also be a key element. Some European countries will have a lower capital gains tax rate than the income tax rate. Private clients in these jurisdictions will want to report capital gains, and compliant funds will have to allow such reporting, already provided for in UCITS funds and a fairly easy process for AIFs. Offshore funds may find it difficult to report such data in a properly tax compliant manner. Increasingly European institutional allocators are coming under pressure from the political environment and their shareholders to steer away from offshore centres, which have become fiscally less tolerable for governments. Large investors in alternative assets will be under pressure to custody their assets in Europe in a European fund structure. Knowledge Expertise Experience 9

12 6. Product types and fund structures An AIF that comes under the scope of the directive is broadly defined as being a Collective Investment Scheme ( CIS ) that is not a UCITS. Therefore AIFs are going to take many shapes and forms in the context of domicile, fund structure and product type. The below table illustrates some common jurisdictions where managers may choose to domicile their AIF in order to market the fund to European investors. It must be highlighted that an AIF can be domiciled anywhere and take many different forms and can comply with the Directive (although Non-EU AIFs will not be able to avail of the passport until earliest 22 July 2015). Table 1: Product structures and passporting under the AIFMD Jurisdiction Product Types Passport Passport Fund Structure (any product type) EU AIFM Non-EU AIFM Ireland QIAIF RIAIF - Retail AIF Yes Yes - for institutional investors only Earliest July 2015* Earliest July 2015* VCC ICAV Unit Trust CCF Luxembourg SIF Part II Fund Yes Yes Earliest July 2015* Earliest July 2015* FCP SICAV SICAR Cayman Licenced Fund Administered Fund Registered Fund Earliest July 2015* Earliest July 2015* LP SPC Jersey/ Guernsey Jersey/Guernsey AIF** Earliest July 2015* Earliest July 2015* LP PCC Unit Trust * ESMA review of passporting ** these are various fund structures which have been designated under Jersey/Guernsey law as AIFs As Ireland and Luxembourg are well developed alternative fund jurisdictions, we are beginning to see asset managers set up new AIF products in these jurisdictions to avail themselves of the AIFMD passport. European Institutional investors are very familiar with Irish QIF structures (now QIAIF) and Luxembourg SIFs as hedge fund / alternative investment vehicles. With the advent of the ICAV structure for funds, in Ireland, both Luxembourg and Ireland have AIF products with corporate legal structure (which don t require a management company) that would allow US investors to tick the box. This enables asset managers to develop one single product that can be marketed and sold to global and US investors, without the necessity for needing a tax transparent feeder. In addition, the CCF in Ireland is gaining in popularity among asset managers looking to attract large pension investors where minimum income tax leakage is a large consideration. 10

13 Some European institutional investors are comfortable with investing in a less regulated non-eu jurisdiction, e.g. Cayman Islands. This will remain the case and these funds (as non-eu AIFs) will adapt to become compliant with the Directive as and when required. They will be sold on a private placement basis (where eligible) and eventually may look to access the passport from 22 July 2015 (subject to the passporting regime undergoing ESMA review). Jersey and Guernsey, given their nature as significant private equity fund and property fund domiciles, are likely to be key jurisdictions within the AIFMD regime. Private equity and property fund managers in many cases will be subject to a financial regulatory regime for the first time as a consequence of the Directive. Many existing private equity and property funds in these jurisdictions will become AIFs under the new regime and will have to comply with the Directive. 7. Operating model and practical solutions to the AIFMD (options for accessing EU markets under the Directive) EU AIFMs All EU-based fund managers that currently manage AIFs (whether EU or non-eu AIFs) are required to be authorised (or approved, if below the authorisation thresholds) by their home state regulator from 22 July As mentioned above, a number of regulators have introduced transitionary periods of one year to allow managers to put in place the necessary organisational infrastructure and documentation, whereby authorisation in practice is required as of 22 July 2014, although any new AIF launched post-22 July 2013 (e.g. QIAIF, SIF) needs to fully comply with the Directive and therefore appoint an AIFM. Implementation of the Directive across the EU has been varied, with jurisdictions such as Ireland and Luxembourg being among the early adopters of the Directive. There seems to be four distinct models that are being adopted by alternative investment funds as they restructure as AIFs: 1. The fund s EU-based investment manager is appointed as an AIFM - this requires the investment manager to file an application for authorisation as an AIFM with its home state authority. As most investment managers across the EU are already regulated under the MiFID framework, a number of procedures, organisational and compliance frameworks would already be in place (the Directive is aligned to MiFID) although certain provisions will be new concepts for traditional fund management houses (e.g. remuneration or AIFM oversight and board governance) and smaller investment managers may find some of the Directive s requirements particularly onerous (e.g. segregation of risk management and portfolio management function, etc). 2. The fund s existing EU-based management company is appointed as an AIFM - where the fund already operates under a management company structure (either a UCITS or non-ucits management company), it is possible for the management company to apply for authorisation Knowledge Expertise Experience 11

14 as an AIFM. The UCITS management company in particular is already aligned in a number of aspects to the requirements of the Directive (e.g. oversight and board governance) although the requirements around certain procedures and carrying out risk management activities may not have been previously addressed. Where substance on the ground is an issue it is also possible for the management company to act as AIFM but delegate the day-to-day activities in respect of oversight and risk management to secondees from a local third party provider (provided the management company can demonstrate that it has sufficient local substance). 3. An EU-based third party provider is appointed as an AIFM - a number of existing UCITS management companies (in particular in Luxembourg and Ireland) have sought additional authorisation for approval as AIFMs and would offer to act as AIFM for third party funds. For the EU fund manager who may not wish to undertake this function in house, the solution can be convenient from a risk and timing perspective as the regulatory responsibility rests with the third party for AIFM activities (in terms of oversight, risk management, reporting, etc). The fund manager, appointed as a delegate to the AIFM/AIF to provide portfolio management services, can concentrate on providing the discretionary portfolio management activity. 4. The Fund itself becomes an AIFM as an internally managed AIF - it is possible for AIFs to be authorised themselves as internally managed AIFs, whereby the AIFM requirements are internalised within the fund. This means that the AIF legal entity must demonstrate local substance (for example through employees or secondees) to design and implement the required frameworks of oversight, governance, compliance and risk as per the Directive. Similarly to the set up described in point #2 above, whereby substance on the ground may be an issue, it would be possible for the AIF to delegate the day-to-day activities in respect of its AIFM tasks and responsibilities to secondees from a local third party provider. Non-EU AIFMs Under the provisions of the Directive, non-eu AIFMs are not required to seek authorisation until July 2015, however until then their marketing and distribution activities across the EU will be impacted by the AIFMD regimes that have been implemented by the different countries in Europe in relation to private placement, whereby even if the funds are distributed under the private placement regimes certain initial and ongoing disclosures to investors need to be complied with. In addition, the private placement regime in different countries is changing and some jurisdictions have either repealed existing private placement regimes or have gold plated the requirements, so that it is becoming increasingly difficult for non-eu AIFMs to distribute their funds in Europe if they are not authorised under the Directive. The possibility for non-eu AIFMs to be authorised under the Directive should become available in Until then, non-eu based fund managers will need to navigate the evolving requirements of the private placement frameworks across the different EU jurisdictions, or rely on reverse solicitation methods. For EU AIFs the possibility of taking advantage of an EU-wide passport already exists under the Directive (the provisions of the Directive in this regard mirror those already in place for UCITS funds) and there seems to be a growing preference among institutional investors for funds that have obtained the passport (as perceived to operate under a greater EU regulatory scrutiny), rather than for funds that are not passported. However, the passport can only be obtained if the fund has appointed an AIFM. 12

15 Additionally, all new European alternative funds launched from July 2013 are obliged to operate under the new framework, i.e. they are required to operate as AIFs and appoint an AIFM. For the non-eu based fund manager, at the moment there are a few options available: 1. Wait until 2015 when the AIFMD regime may be extended to non-eu managers and apply for authorisation as a non-eu AIFM (via member state of reference). This solution would require the non-eu manager to have in place a substantial organisational, risk and compliance framework required by the Directive, including new policies and procedures (e.g. for remuneration, transparency reporting, delegation, etc), and most importantly to fall under the regulatory scrutiny of the EU regulators; 2. Leverage off its existing presence in an EU jurisdiction (e.g. a subsidiary or branch) with a view to upgrading the local EU entity to AIFM status again, depending on the existing set up the entity will need to comply with the full suite of AIFMD organisational, risk and compliance requirements; 3. Establish a new AIF (or convert an existing alternative investment fund) as an internally managed AIF, whereby the AIFM requirements are undertaken not by a separate entity but met by the fund itself. This means that the AIF would need to demonstrate the necessary substance, infrastructure and organisational framework as required by the Directive (one solution may be for the fund to appoint employees, or have staff seconded from a local entity to provide substance); 4. Establish a presence in an EU jurisdiction for authorisation as an AIFM (for example a management company) - this solution requires substantial investment in terms of substance, personnel, systems, etc, as the entity will need to establish a brand new entity to be approved as an AIFM; 5. Leverage off established third party AIFM providers (e.g. management companies) to launch / operate an AIF under the management company set up of the existing approved third party AIFM. 8. Choice of domicile EU vs non-eu For an asset manager interested in establishing an AIF, the choice of domicile will be dictated by a number of factors, the principal considerations being: tax, investor demand / requirements, the quality of the domicile (in terms of product, servicing capability and regulatory regime), and cost. Another factor that will determine the domicile is whether or not the asset manager wants to avail itself of the passporting provisions under the Directive (prior to 22 July 2015). If so, then the asset manager must domicile the AIF in the EU. In addition, to access the passport the AIF must have an EU domiciled AIFM (as mentioned below the AIF could be its own AIFM if structured as an internally managed AIF ). Therefore an Irish/Luxembourg AIF set up as an internally-managed fund can access the passport. Knowledge Expertise Experience 13

16 Other options include: an Irish/Luxembourg AIF appointing a third party AIFM (i.e. not the asset manager or related entity) in Ireland / Luxembourg or in any other EU country; or an Irish / Luxembourg AIF appointing the Investment Manager as AIFM (or related entity), as long as the entity acting as AIFM is regulated as an AIFM with its home state regulatory authority. The key point is that any AIFM regulated in an EU jurisdiction can passport its services to act as AIFM for an AIF domiciled in any other EU country for the purposes of complying with the Directive and accessing the passport. Ireland versus Luxembourg For asset managers setting up new structures who want to market the fund globally and avail themselves of the passport immediately (prior to 22 July 2015), the most obvious choice is to set up the AIF in either Ireland or Luxembourg. These two fund domiciles have the necessary infrastructure to service AIFMDcompliant AIFs for international investors with a wide choice of administrators, custodians, law firms and consultants. It is important to note also that for AIFs established in Luxembourg and Ireland there is no taxation on the income or capital gains of the fund. In addition each jurisdiction has extensive and beneficial double taxation treaty networks. Luxembourg and Ireland are materially similar as domiciles for AIFs. There are however, some subtle differences between these two domiciles. Some of these are outlined below: i) Legal System Luxembourg has a continental civil law European legal system whereas Ireland has a common law legal system. Despite the different legal systems, the nature of the legal agreements and fund documentation are similar. Both jurisdictions have excellent law firms, both locally based and subsidiaries of the international law firms. ii) Language / Culture Business in Luxembourg is usually conducted in French although German and English are widely spoken and legal documentation can be drafted and submitted to the CSSF in English, French or German. All business in Ireland is conducted in English. iii) Service Providers Both Luxembourg and Ireland are very well served by administrators / custodians. Most of the international service providers have substantial operations in both locations. Ireland, however, is more widely recognised for the servicing of hedge funds and is the predominant jurisdiction globally for servicing European managed hedge funds. iv) Independent Directors / Conducting Officers Where an AIF is structured in corporate form in Luxembourg (e.g. SICAV-SIF), there is no formal requirement to have Luxembourg-resident Directors. However the market practice is that there is usually at least one Luxembourg-resident Director. In addition, the CSSF s requirements for internallymanaged AIFs are very much in line with the existing substance requirements imposed on UCITS funds and management companies, with a requirement for the AIF to have an administrative centre in 14

17 Luxembourg and to be able to demonstrate proper local infrastructure, organisation and substance. The Board of the AIF is ultimately responsible for the oversight function in relation to the various provisions of the Directive (e.g. compliance, risk management, supervision of delegates, etc) and these activities can be discharged by the Board itself, or by dedicated senior management (which in Luxembourg is understood to correspond to the role of conducting officer/dirigeant already implemented under the UCITS framework). In this regard, members of the board can act as conducting officers, or separately appointed individuals can be employed/seconded to undertake such role. Because of the potential for conflicts arising from the oversight of certain activities being undertaken by the same person (e.g. risk management and portfolio management) and to cater for cover arrangements, at least two conducting officers should be appointed. More may be required depending on the complexity of the AIF and nature of investments. The CSSF would require that at least one conducting officer is Luxembourgresident although depending on the nature of the proposed AIF, the CSSF may require that further conducting officers are also Luxembourg based, to demonstrate adequate local substance of mind and management. An Irish-domiciled AIF structured in a corporate form (e.g. a company) must appoint a minimum of two Irish resident Directors. Regardless of the domicile of the AIF, it is considered good practice to have locally resident Directors to anchor the tax residency of the fund in the domicile of the AIF. The Irish funds industry has recently issued a voluntary Corporate Governance Code (the Code ), which sets out, among other things, the requirements as to the role and make-up of the Board of Directors of an Irish fund or management company. Further details can be accessed at Furthermore, at the end of 2011 the Central Bank of Ireland implemented a new fitness and probity regime, which is proposed to serve as further improvement to investor protection. In addition, the Central Bank s requirements for internally-managed AIFs, similarly as with Luxembourg, are very much in line with the existing substance requirements imposed on UCITS funds and management companies with a number of additional managerial functions and a greater emphasis on risk management. The Central Bank requires a number of suitably experienced individuals ( Designated Persons ) to oversee the managerial functions. Although not specifically stated anywhere the Central Bank would expect the majority of these functions to be overseen by persons resident in Ireland. As in Luxembourg the designated persons could be members of the Board or separately appointed employees or secondees. Further details are set out later in the booklet under Organisation of AIFM, on page 20. Knowledge Expertise Experience 15

18 An alternative manager setting up a Passported AIF could be able to attract new investors and money not otherwise available to them. 16

19 Considerations for non-eu AIFMs The primary consideration for non-eu fund managers is marketing, since AIFMD requirements apply where an AIF is being marketed. As mentioned previously, several EU jurisdictions have implemented definitions of marketing that limit the scope of the Directive to active marketing. This definition appears to allow the concept of reverse solicitation to continue, however managers should be aware that the documentation should be comprehensive and the burden of proof to evidence whether client interaction was carried out on the basis of reverse solicitation lies with the fund. Additionally, fund managers should be warned that regulators will be sensitive to attempts to circumvent the provisions of the AIFMD via a reverse solicitation veil. Fund managers who decide to actively market their fund products via the various national private placement regimes should be cogniscent of the minimum required standards and any additional member state specific requirements. Minimum required standards A cooperation agreement must be in place between the regulatory authority of the member state being targeted for distribution and the regulatory authority of the AIFM. In addition the regulatory authority of the AIF s domicile (typically an offshore jurisdiction) must have in place a cooperation agreement with the member state. Neither the country where thenon-eu AIF is domiciled nor the non-eu AIFM is domiciled may be listed as a non-cooperative country and territory by FATF The non-eu AIFM must also comply with the disclosure requirements (EU AIF only) and transparency requirements set forth in the regulations which includes additional disclosure to investors in the AIF s offering documents, the regular reporting to member states outlined in the AIFMD s Annex IV, and additional information in the AIF s annual report including disclosure concerning remuneration. As mentioned above, EU member states have the option of imposing additional requirements to the minimum standards for private placement. Some jurisdictions require the appointment of local agents or have restrictions on the type and content of documentation that can be provided as well as target audience, while other jurisdictions impose an extremely restrictive regime which effectively eliminates private placement opportunities. The AIFMD also envisions the ability of non-eu AIFMs to obtain a marketing passport for AIFs as early as July 2015, where non-eu AIFMs fully comply with all aspects of the Directive, but the details of the proposed process are not final as the existing AIF passporting regime is due to undergo a review by Knowledge Expertise Experience 17

20 ESMA prior to its extension to non-eu AIFMs, and it is possible that the proposal could be pushed well beyond Finally for those fund managers who pursue the private placement road, it should be noted that member states may terminate their private placement regimes at any point and may be required to do so by the end of Fund managers seeking longer, more secure options, should consider launching stand-alone EU AIFs managed by EU AIFMs, as well as potentially taking advantage of the streamlined process which allows for the conversion of an existing offshore fund structure into an EU AIF. 10. AIFM authorisation process While the requirements for AIFMs and AIFs are set out in the Directive the procedural details for authorisation are provided by each EU regulatory authority in its own local transposition of the Directive. The application process will vary from regulator to regulator. Authorisation timescales are typically 4-6 months for the authorisation of an AIFM, however the process could take longer depending on the availability and workload of each regulatory authority, in light of the number of applications having to be considered. Sub-threshold AIFMs are only required to register with the regulatory authorities and the registration process is much quicker. It should be noted that any EU-domiciled asset manager who manages an AIF (which is not deemed to be out of scope), regardless of where the AIF is domiciled, is required to be authorised as an AIFM, unless the AIF has appointed another entity as its AIFM (e.g. a third party AIFM). This means that, for example, a UK-based asset manager who manages a US 40 Act Fund (which would be considered a non-eu AIF) must obtain approval as an AIFM, unless the fund has appointed another party to act as its AIFM. AIF Authorisation Ireland and Luxembourg The authorisation process for AIFMs in Ireland and Luxembourg is broadly similar, with the Central Bank of Ireland and the CSSF respectively requiring the filing of a number of documents by the AIFM evidencing how the AIFM intends to comply with the various aspects of the Directive. Once the filing is made, the regulatory authorities would engage with the applicant firm to request further information as needed and clarify specific items. In Ireland the Central Bank has published set application forms to assist with the submission of the application pack. The AIFM is required to prepare a Programme of Operations document, setting out in detail its proposed organisational structure, the role of the Board and the oversight framework in place to supervise and monitor the various activities of the AIFs under management, the delegation arrangements, the risk management framework in place, the compliance framework and in particular the arrangements in place to ensure compliance with required conduct of business rules, the arrangements in place to monitor prudential capital requirements and a summary of the various required policies and procedures (e.g. around remuneration provisions, conflicts of interest, valuation etc). The information 18

21 contained in the Programme of Activity must be supplemented by organisational charts and corporate details of the applicant AIFM (e.g. ownership structure, etc). In Luxembourg, the CSSF has also issued set application forms and AIFMs are required to complete these and provide supporting documentation in the same way as in Ireland. The information required by the CSSF is the same as required to be provided in Ireland, even if the format of the submission is slightly different (in Luxembourg there is no requirement to prepare a Programme of Operations document, although the information contained therein is the same as would need to be filed with the CSSF). Legal counsel or specialised consultants (such as Carne) can assist firms with the preparation of the AIFM application pack and in drafting the relevant policies and procedures. AIF The AIF authorisation process is very much in line with the previously existing regimes for fund authorisations (e.g. QIFs, SIFs), whereby various legal documentation needs to be filed with the regulatory authorities (e.g. fund constitutional documents and offering documents) as well as material agreements with third parties and delegates (e.g. depositary agreements, investment management agreement, administration agreement, etc). Timescale for approval will depend on the type of structure and jurisdiction, with Ireland offering approval for QIAIFs within 24 hours upon submission of a completed fund application, while CSSF approval for SIFs takes longer (3-4 months). Post-22 July 2013, any new funds established in the EU must be compliant with the AIFMD regime and therefore must be set up as AIFs and it is required to appoint an AIFM. In this regard an AIFM Agreement also needs to be filed with the regulator setting out the responsibilities of the AIFM and its powers for delegation of certain activities. Where the AIF is appointing an AIFM in another EU jurisdiction, the authorisation process is reasonably straightforward from a regulatory point of view. The AIFM would need to apply to its home state regulator for a passport to provide cross-border services (as per the provisions of the Directive), which would allow it to manage AIFs domiciled in another EU jurisdiction. The passporting process for AIFMs is based on a regulator-to-regulator notification, whereby the application is made by the AIFM to its own home state regulator and the intention is then communicated by said regulator to the host-state regulatory authority. The most difficult part of the process in this instance is the negotiation of the legal agreements for the cross-border services, particularly the depositary agreement, and agreeing the operational set-up. The home state regulator must be satisfied that the AIFM will be able to oversee and manage the local delegation arrangements in the host jurisdiction, so comfort is usually sought by the regulator in this regard. Knowledge Expertise Experience 19

22 Internally managed AIF Where it is intended that the AIF is internally managed, the authorisation process becomes much more cumbersome, as in addition to the AIF being authorised, a full AIFM authorisation also has to be granted by the regulatory authorities. The internally managed AIF must demonstrate sufficient local substance and provide details on how it proposes to comply with the full provisions of the Directive from an organisational and operational perspective (for example, through the employment of dedicated individuals to carry out oversight and management tasks, or through secondee arrangements). The timescale for the approval of an internally managed AIF is likely to be in the region of six months. Organisation of AIFM (Ireland and Luxembourg) In Ireland, the Central Bank has implemented the provisions of the Directive in relation to the oversight arrangements of the AIFM over the AIFs under management through a framework of managerial functions, effectively areas of supervision and review that must be allocated to named individuals within the AIFM (or the internally managed AIF as the case may be). The AIFMD managerial functions framework is akin to that already in place for UCITS funds and management companies and comprises the following functions, which must be allocated to either the governing body of the AIFM or senior management (the designated persons ): Ireland - AIFMD managerial functions Decision making Monitoring of investment policy, investment strategies and performance Monitoring compliance Risk management Liquidity management Operational risk Conflicts of interest Supervision of delegates Financial control Monitoring of capital Internal audit Complaints handling Accounting policies and procedures Recordkeeping Remuneration AIFMD reporting process In Luxembourg the CSSF has not been as prescriptive with the implementation of the Directive and has not set out specific roles that must be allocated, however the Luxembourg AIFMD framework is based on the same proviso whereby the various areas identified in the Directive as being key areas of an AIFM s operations must be monitored and supervised appropriately and remain the responsibility of the governing body of the AIFM, or the management function (i.e. the conducting officers ). The various areas of review must be allocated between named individuals and would include oversight of compliance with conduct of business rules for both the AIFM and the AIFs under management, supervision of delegated arrangements, risk management in its various aspects, etc. 20