AIFMD: Clears key votes and trilogue begins, May 2010

The last few days has seen significant reporting on the EU having ‘agreed’ the Alternative Investment Fund Managers Directive (“AIFMD” or “the Directive”). However, such a definitive statement is far from the full story as there continue to be competing versions of the Directive. In fact, the European Parliament and Council have only each agreed their own version of the Directive, which are best considered as their opening negotiating position.

The European Parliament's ECON Committee (“the Parliament”) passed its version of the draft Directive with 75% of the votes on 17 May 2010.  The Parliament stated that under the Directive, Alternative Investment Fund Managers (“AIFM”) in third countries would have to comply with the Directive in order to market funds within the EU.  We understand that funds such as private equity and investment trusts could be more lightly regulated than hedge funds and some other types of Alternative Investment Funds (“AIF”) could be completely exempted.  However it is recognised that Parliament is influenced by the socialist agenda and many of the recent proposed amendments accepted by the Committee have been made by the Socialist MEPs to further their political objectives. 

The Council of the European Union- Economic and Financial Affairs Council (“the Council”) also reached agreement on the AIFMD on 18 May 2010.  The Council (made up of the Finance Ministers of EU Member States) agreed a mandate for negotiations with the European Parliament based on the revised draft Directive developed by the Spanish presidency.  The Spanish presidency has pushed hard for a political compromise, and they made several compromise proposals, largely building on the positive amendments made under the Swedish presidency.  Whilst this is the most Industry friendly version of the Directive; problems still remain.  

We now enter into probably the most intense lobby period as the process of ‘trilogue’ begins — wherein the Council, Parliament and Commission seek agreement on a common text.  Our industry has long given up hope that the AIFMD will be cancelled and are now striving for a Directive that can be practical and workable, however it is generally agreed that the current proposals are a long way off.  There is a great deal of concern that the Directive singles out our industry for special treatment and imposes controls and burdens that it does not place on other financial market participants who may pursue identical investment objectives. 

Key issues

The most critical issues for the hedge fund and private equity industries include:

• Third Country Rules: The approaches taken by the Council and Parliament remain diverged.  The Parliament’s text requires non-EU based fund managers to comply with various standards in order to market their funds to EU investors, while the Council’s version proposes individual country regimes apply which will mean that managers would need to register and make arrangements with each national regulator.  Parliament’s approach could prove unworkable given the limited history of successful EU equivalence regimes.  Equally the Council approach could prove impractical, meaning that the third country regulator of funds to be marketed across the EU could have to conclude up to 27 separate agreements with the relevant national supervisors.
• Depositary liability continues to be problematic and seeks to place new obligations on the Industry to "investors of the AIF" for "any" loss (so without the normal limitations on remoteness) which is interpreted as a strict liability regime.  Depositaries could be required to assume liability for any losses (even from circumstances beyond their control) which would make it extremely costly to provide their services.  The knock on impact would be a restriction on choice of depositary which could increase systemic risk as it will create concentrations of risk among fewer depositaries. The proposal could end the multi-prime broker model.  Additionally, EU AIFs must have their depositary in the EU - and non EU AIFs must have their depositary in the EU unless very onerous conditions are satisfied including cooperation agreements; equivalence; compliance with OECD tax standards and exchange of information on tax matters.
• Portfolio Company Disclosure: For private equity and venture capital backed small and medium enterprises (SMEs) the industry argues that the provisions are disproportionate and unfairly target their investee companies.  The Council’s text stresses that the disclosure requirements should not be extended to ‘SMEs’, the Parliament’s  proposals only exclude firms with less than 50 employees and those with less than a 10% private equity or venture capital stake. Investee companies could need to divulge finances, strategy and planning information during the early stages of development of their businesses putting the companies at a severe competitive disadvantage.
• Remuneration rules were added to both versions of the text and were brought in from the banking directive. The industry is arguing that these rules are not appropriate for investment managers since they have completely different compensation structures, such as performance fees.
• Leverage: Both the Commission and the Parliament have adopted softer stances than some early interpretations of the draft had suggested. The Parliament’s position is that it should be for managers to set their own leverage limits with reporting to their local supervisors. The Commission only goes one step further by saying that supervisors would be empowered to set limits (as opposed to required to).

Also on the industry agenda is the need for further changes on the provisions that deal with delegation, valuation, leverage and short selling all of which create additional requirements for Alternative Fund Managers as opposed to other financial institutions operating in the EU.

Conclusions

The Parliament and Council’s votes were the second key stage in passing an AIFMD. We have now entered the end game for the directive itself running down to the first reading vote by the full European Parliament which is currently scheduled for 6 July 2010, assuming a compromise position can be reached.  We note through that if a comprise was reached there will still be 18-24 months for the AIFMD to be made law in each European State and that in that time a substantial amount of detail would be added in the so called level 2 provisions. Therefore the end of 2012 still appears to be the likely time when we could expect to see any changes having been incorporated into UK law and FSA regulation.

Disclaimer

24th May 2010