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Guest Comment: Alternative Investment Firms - Should They Restructure As New Regulations Approach?
Rosalyn Breedy
Breedy Henderson Solicitors
18 July 2013
Alternative
Investment Fund Management Groups - do you need to re-structure? Managers
of EU alternative investment funds, or non-EU alternative
investment funds marketed into the EU, with assets under management above or
nearing the €100 million ($130.9 million) threshold need to lift their heads up from trying to
comply with the detail of the Alternative Investment Fund Managers Directive.
According to Rosalyn Breedy, of Breedy Henderson
Solicitors, some managers may need to step back from the small print and
consider whether they need to re-structure or even close down. Managers of EU alternative investment
funds (AIFs), or of non-EU AIFs marketed into the EU, have faced an onslaught
of new regulation and legislation over the last three years. They have had to
consider whether they need to register with the SEC under The Dodd-Frank Wall
Street Reform and Consumer Protection Act 2010 which reduced the available
foreign advisor SEC registration exemptions. They have to review the
requirements under US Foreign Account and Tax Compliance Act and, if necessary,
implement a compliance programme. And, they need to keep an eye on the G8 focus
on fiscal recovery which is likely to affect taxation of their staff and
investors. In keeping their heads down and
focusing on the detailed application of these changes, some managers may be
neglecting key strategic issues brought on by these changes in the post 2008
macro-environment. Big picture issues
which may have been put to one side include issues such as retirement and
succession planning, re-structuring the group, change or at least re-evaluation
of current service providers, merger or other transformational changes. As managers are well aware, for the
purposes of the AIFMD the key issue to resolve is which entity within the group
will be treated as the Alternative Investment Manager (AIFM). This is the entity with the portfolio and
risk management responsibilities, which because of the application of the AIFMD
‘letterbox’ provisions may not be the offshore entity with those
responsibilities legally ascribed at present. Managers looking to stay as a non-EU
AIFM may need to bulk up their offshore presence by moving people offshore.
They will need to review the associated impact on transfer pricing if group
activities are moved to low tax jurisdictions. Non-EU AIFMs, and those who market
non-EU AIFs for them, need also to revisit their processes for marketing within
the EU. This is because, although the national private placement regime and
reverse solicitation rules will still apply until 2018, the application of
these regimes in some member states may be stricter. The directive has narrowed
the definition of the professional investor and their ability to elect as such.
This will affect those targeting family office investors. Notification with
individual EU member states may be also required. The non-EU AIFMs need to
ensure that the appropriate global supervisory co-operation agreement is in
place with the European Securities Markets Authority for the domicile of their
non-EU AIF. Non-EU managers of above-threshold EU
AIFs, or of above-threshold non-EU AIFs marketed into the EU, need also to
understand the detailed content, accounting standards and shorter timing
requirements for their next set of annual report and accounts, the information
required to be reported to their EU member state regulator and investor
disclosure requirements. They should be speaking to their accountants now and
reviewing any special arrangements such as side letters and side pockets,
liquidity management, risk profile and the calculation and reporting of
leverage if employed. EU AIFMs managing above threshold EU
AIFs or above threshold non-EU AIFs have to add to that list the requirement to
separate risk management from portfolio management. They will need to apply the remuneration
code, considering to whom it applies, types of remuneration covered, the
internal governance relating to remuneration including the application of
deferral and claw-back, disclosure in report and accounts, etc. There is also a
requirement to have procedures for the calculation and disclosure of proper and
independent valuation. The requirement to appoint a full
depositary applies to EU-based managers of the above-threshold EU AIF. But, managers
of above-threshold non-EU AIFs marketed into the EU will also need to appoint
someone to carry out reduced AIFMD article 36 depositary functions which
include safe custody, cash flow monitoring and oversight. There are other issues facing managers
looking to become authorised under the new directive, whether because they have
to or because they wish to avail themselves of the EU marketing passport. First,
there is the application of initial capital requirement, own funds requirement
and the requirement to maintain qualifying professional indemnity insurance or
additional own funds to cover professional negligence liability. Second, the choice of member state for
authorisation is important as although there is not much scope for deviation it
is clear that there are differences in the approaches of the individual EU
member state regulators. Implications There will be substantial increased
costs incurred because of the need to seek professional advice, implement
changes to structure, appoint or at least review the scope of existing service
providers, comply with additional regulatory burdens and the need for some to
increase their regulatory capital. Indirect costs will arise from keeping
own funds in liquid instruments, the mismatch between the AIFMD remuneration
deferral requirements and the timing of taxation on payments. Opportunities to market may be lost as
managers take time to learn the new marketing rules, and spend more time on
compliance rather than managing money. The threshold for being successful has
changed. Managers of EU-AIFs or non-EU AIFs marketed into the EU nearing the
threshold of Eur 100 mn will need to get bigger to be able to amortise the
increased costs, or should consider whether to shut down. The opportunity to passport through the
EU and through that to develop other international market will be enhanced
because of the increased barriers to entry for competitors. Finally, it is important to consider
the human dimension with each fund’s talent pool comprising a range of
professionals at differing stages in their career and life. Any manager
thinking of retiring in the not-too-distant future might want to bring those
plans forward. In any event, at a time of such
strategic change it is worth considering whether the current fund structure and
plans are fit for purpose.