The European fund managers directive poses several tricky questions for administrators of Cayman funds. Derbhil O’Riordan answers the top 10.
1) What is the AIFMD?
The Alternative Investment Fund Managers Directive (AIFMD), sometimes referred to as the European Dodd-Frank, is a European directive which came into force on July 22, 2013. It regulates the management and marketing of alternative investment funds (AIFs) and aims to provide for and harmonise an internal market for alternative investment fund managers (AIFMs) within the EU. The directive currently offers a marketing ‘passport’ to compliant EU AIFMs of EU AIFs. This passport is expected to be extended to non-EU AIFs, and to non-EU AIFMs from 2015.
2) What is an AIF?
AIFs are collective investment undertakings (excluding Undertakings for Collective Investment in Transferable Securities [UCITS]) which raise capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of investors. The phrase ‘collective investment undertaking’ is not defined but it is clear that a fund may be an AIF whether it is open or closed-ended and whether it is constituted under contract law, trust law, under statute or any other legal form. Almost invariably, Cayman funds will therefore meet the definition of an AIF.
3) What is an AIFM?
An AIFM is a legal person whose regular business is managing one or more AIFs (irrespective of where the AIF is established). ‘Managing’ means providing at least investment management services and risk management.
Depending on the structure of the AIF, more than one legal entity could be appointed as AIFM to the AIF, but there can be only one AIFM to an AIF. The directive provides that the AIFM shall be either an external manager, or the AIF itself, where its legal form permits an internal management and where the AIF’s governing body chooses not to appoint an external AIFM. In such a case, the AIF shall then be authorised as the AIFM (referred to as an internally managed AIF).
4) How can AIFMD apply to Cayman AIFs?
The directive applies to the management or marketing, within the EU, of all AIFs. To the extent therefore that AIFMs of Cayman funds (whether EU or non-EU based) are marketing Cayman funds in the EU, or, for EU based AIFMs, are managing Cayman AIFs, Cayman AIFs are within scope of the directive.
5) What is ‘marketing’ a Cayman AIF?
As defined in the AIFMD, the activity of ‘marketing’ is any direct or indirect offering or placement at the initiative of the AIFM or on behalf of the AIFM, of units or shares in an AIF it manages, to or with investors domiciled in the EU. The definition of marketing does not include reverse solicitation (see below), which should be considered to be outside of the scope of the directive.
Where Cayman AIFs are being marketed within the EU in line with the above, and subject to the individual rules of each member state, non-EU AIFMs will be permitted to continue to market such Cayman funds to professional investors on a private placement basis in that member state under the member state’s own private placement rules until at least 2018, provided that reporting requirements are met and cooperation agreements between the relevant countries are in place.
6) What is reverse solicitation?
"The directive’s definition of marketing excludes such unsolicited approaches by investors so sales made following reverse solicitation are not subject to the rules of AIFMD."
Reverse solicitation involves sales to investors who have, unsolicited by the AIFM or the AIF, approached the AIFM or the AIF requesting the purchase of shares in an AIF. The directive’s definition of marketing excludes such unsolicited approaches by investors so sales made following reverse solicitation are not subject to the rules of AIFMD. However, extreme caution should be exercised by Cayman AIFs seeking to rely on this reverse solicitation exclusion.
The exclusion simply means that reverse solicitation is not subject to the AIFMD. However, it will be subject to the national laws relating to reverse solicitation in place in each member state, almost all of which differ in their interpretation of what constitutes reverse solicitation and the rules applicable to it. Further, in a contentious situation, the burden of proof may be on the AIFM to show that it did not in any way solicit the relevant investor, so any publications, roadshows or communications made by an AIFM pursuant to an AIF may come under scrutiny.
7) What are the NPPRs?
For as long as the passport is not available to Cayman AIFs (see below), the AIFMD provides that EU member states are permitted, but not obliged, to allow non-EU AIFs to continue to be sold to professional investors in that member state via their own national private placement rules (NPPRs).
In this regard, the AIFMD imposes a number of rules, including that cooperation agreements between the relevant countries are in place and significantly, that certain provisions of the directive are complied with, including rules around gaining control of EU-registered non-listed companies, and the Transparency Rules of the directive (see below).
In order to take advantage of the NPPR regime, AIFMs of Cayman AIFs will therefore need to be familiar with the NPPR regime applied in each relevant state in which it seeks privately to place the AIF. Certain jurisdictions may prove too costly or difficult to access and Cayman AIFs and their AIFMs will need to take local advice in each member state it wishes to sell into before contemplating use of the NPPRs for sale to EU investors.
8) What are the Transparency Rules?
"AIFMS ARE REQUIRED TO PROVIDE CERTAIN INFORMATION ON A REGULAR BASIS TO THE SUPERVISORS OF THE MEMBER STATE IN WHICH EACH CAYMAN FUND IS MARKETED."
The Transparency Rules impose reporting requirements in respect of annual reports, disclosure to investors, and reporting to competent authorities.
The annual report must contain information that investors in Cayman AIFs would normally expect to receive, as well as a report on:
- Any material changes during the financial year;
- The total amount of remuneration paid to AIFM staff for the financial year (fixed and variable), the number of beneficiaries, and any carried interest; and
- The aggregate remuneration broken down by senior management and staff of the AIFM whose actions have a material impact on the risk profile of the AIF.
AIFMs must also provide general information relating to the financial and non-financial criteria of the remuneration policies and practices for relevant categories of staff to enable investors to assess the incentives created.
The requirements around the type of information to be made available to investors will again, largely, not be unfamiliar to investors in Cayman AIFs, although certain requirements, including the following, will be new:
- Disclosure on cover for professional liability risks;
- Details of any preferential treatment of investors, the type of investors who obtain such preferential treatment and their legal or economic links with AIF or AIFM;
- The percentage of AIF assets which are subject to special arrangements due to their illiquid nature and details of such special arrangements; and
- Any changes to the maximum leverage that the AIFM may employ on behalf of the AIF as well as any right of the reuse of collateral or any guarantee granted under the leveraging arrangement.
AIFMs are also required to provide certain information on a regular basis to the supervisors of the member state in which each Cayman fund is marketed. Such reporting will be in template format (Annex IV of the EU Commission’s Regulation) and is similar to, but not the same as, Form PF reporting in the US.
9) What is the AIFMD passport, and can I have one now?
At present the passport is available only to compliant EU AIFMs and their EU AIFs. The directive envisages that in 2015 the European Securities and Markets Authority (ESMA) will issue an advice on the extension of the European passport to EU AIFMs marketing non-EU AIFs in the EU, and to non-EU AIFMs managing and/or marketing AIFs in the EU.
Subject to the provisions of this advice, it is envisaged that certain provisions of the AIFMD will then be ‘switched on’ to allow for EU AIFs to apply for a passport for their Cayman funds, and for non-EU AIFMs to apply for authorisation under the AIFMD, which will afford them the benefit of the passport for their Cayman, as well as their EU, funds.
Most significantly for Cayman AIFs and AIFMs of Cayman AIFs in the longer term, the directive envisages that three years after the European passport becomes available to EU and non-EU AIFMS of Cayman AIFs, (ie, 2018 assuming the European passport becomes available to such AIFMs in 2015), ESMA will issue a further opinion on the continuation of the NPPR regime in the EU.
Subject to the provisions of this advice, it is envisaged that the EU will adopt rules to terminate the NPPRs as a means of access to the EU and the passport will become the sole and mandatory regime applicable in all member states.
10) I provide investment management services to Cayman funds managed from the EU—am I the AIFM, and what effect is the directive likely to have on me?
‘Managing’ means providing, at least, investment management services and risk management, therefore advisory or marketing companies are not AIFMs. Similarly, a sub-manager of an AIF may not be that AIF’s AIFM. A delegate or sub-investment manager of a Cayman AIF marketed, or managed, from Europe, need not be concerned that it will be that AIF’s AIFM.
Where that Cayman AIF is managed by a European AIFM, however, the delegate or sub-investment manager will be a delegate of that AIFM and is likely to be required to update its contract of appointment in order to allow the EU AIFM to comply with certain requirements, including disclosure requirements around remuneration.
Derbhil O’Riordan is a partner at law firm Dillon Eustace. Her legal expertise lies in the establishing, structuring and ongoing operation of Cayman and AIFMD hedge funds, sophisticated UCITS structures and exchange traded funds. O’Riordan also advises on the impact of AIFMD on Cayman funds. She can be contacted at: firstname.lastname@example.org
AIFMD, Derbhil O’Riordan, AIF, Transparency Rules, Dillon Eustace