The directive is intended to regulate funds that were lightly regulated or not regulated at all previously, such as hedge funds, venture capital funds, and private equity funds and their managers. Funds that are already regulated, such as pension funds and Undertakings for Collective Investment in Transferable Securities (UCITS) funds are not covered by the AIFMD. The aim is to create an overarching prudential and supervisory framework for alternative investment funds (AIFs). It is intended that this directive will:
- Increase transparency.
- Provide regulators with the information and tools needed for effective micro and macro supervision.
- Improve the protection of individual investors.
- Improve the accountability of funds as investors.
- Strengthen the single market.
Firms are required to be compliant from July 2013; however AIFMs already in operation may need to wait until July 2014. This article lays out the parameters of the directive and highlights how AIFMs are affected.
Who is exempt from the AIFMD?
Firstly, it is import for one to remember that not all funds fall under the AIFMD. Funds that are already covered by European supervisory and prudential regulation are exempt, as are funds administered by governments, local authorities and supra national organisations. AIFMs that manage funds with a value of less than €100m, or managers of funds less than €500m where funds have no leverage and there are no redemption rights for five years after initial investment, are also both exempt.
What is required of those affected by the AIFMD?
- Funds will state the maximum amount of leverage they will be using and manage themselves according to the published limits.
- AIFMs will be required to have remuneration policies that do not encourage excessive risk taking.
- Funds will need to ensure that they have established the correct depositories and prime brokerage relationships. Under the AIFMD, these relationships are important as they have specific monitoring responsibilities.
- Private equity and venture capital funds (VCFs) will be required to disclose material holdings of companies they invest in.
- AIFMs must also be in a position to disclose more information than previous regimes about issues such as potential conflicts of interest and prime brokerage relationships. They will need to publish extensive information regarding investment strategy and lay out rules and processes governing any changes in investment strategies.
How best to prepare for the implementation of AIFMD?
Businesses need to ensure that they understand what activities will fall under the directive and which will not. They will also need to make sure that the legal structures’ marketing activities and information published to investors, the public and regulators, meets the conditions of the directive.
The disclosure and operating requirements for many firms will be onerous. Many fund managers will already have in place processes for measuring risk and liquidity factors that affect their investments. However few will have a process that has undergone the level of regulatory scrutiny proposed in this framework. Fewer still will already be attuned to disclosing this information as widely as proposed.
Issue for fund managers include:
- Ensuring all measures and appropriate metrics are being monitored, including the results of periodic stress testing.
- Ensuring that these metrics, where relevant, are part of the decision making process and this can be demonstrated.
- Creating the necessary reporting process, so that the correct information can be disclosed and communicated to the regulatory authorities in a timely and error-free way.
Fund managers will need to invest extra technical and human resources to ensure these requirements can be adequately met. This will ensure the proper operating framework set out by the AIFMD are met, including having the appropriate capital, risk and liquidity management, valuation and reporting infrastructures in place. The more astute fund managers will see this also as an opportunity to create competitive advantage.
It must be remembered that all AIFs selling into the European Union (EU) are subject to this directive also, so as such it will have an impact beyond the border of the EU.
What benefits are there from meeting/following the AIFMD rules?
The main benefit will be a badge of quality for those that are deemed to be compliant and reduced competition, as some may choose to withdraw from the market rather than incur the administrative burden required. Consumers should be better protected by the increase in transparency and more demanding disclosure requirements. There have been concerns, however, that many acceptable funds may find it difficult to adhere to this new framework thereby limiting consumer choice. It should be noted that the first two years will be a transition period and only EU AIFs will be allowed an EU passport. After the transition period non-EU AIFs will be allowed to have access to an EU passport. During the transition period and three years after non-EU funds will be able to access the EU market using national regimes.
Reporting requirements of the AIFMD
The reporting requirements are relatively simple for the AIFMD, as it reflects detailed information of the make-up of each fund. However, for the many that are not used to such regulatory reporting, the reports required under the AIFMD will appear daunting, especially given that most will have to be submitted through automated means. AIFMs are required to report to their regulators monthly on the following:
- Main instruments in which they are trading, including investment strategy, geographical and sectorial focus.
- Markets where they actively trade.
- Diversification, including principle exposures and important concentrations.
For each AIFM, the following must be reported (half-yearly for those over €100m, quarterly for funds over €1bn):
- Percentage AIF asset subject to special liquidity arrangements.
- Any new arrangements for managing liquidity.
- Risk management systems employed.
- Current risk profile of the AIF including:
o Market risk profile of the investments of the AIF including expected return and volatility in normal market conditions.
o Liquidity profile of the investment, including redemption terms and financing provided by counterparties.
- Main asset categories invested.
- Results of periodic stress tests.
The consultation paper from the European Securities Market Authority (ESMA), shows the reports that AIFs and AIFMS will need to submit to their regulators. Also worth noting is the increased disclosure to be made to actual and potential investors which also needs to be addressed.
The AIMFD brings financial activity that was lightly or not regulated previously into the financial regulation framework. As such, fund managers will have to deal both with the shock of a new process and the application of a new way of thinking.
The impact of these changes on a firms existing business model should not be underestimated. There are the predictable changes relating to reporting, monitoring and the subsequent changes to workflow and resources that this brings. There is also the less quantifiable change that will be brought about by increased scrutiny and transparency. Firms will need to be concerned with the possibility of the increase of information disclosures resulting in their product becoming more or less attractive, relative to the competition and other asset classes. If that is so, it will be intriguing to see what is the correct competitive response?
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