EU Alternative Investment Fund Managers Directive

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EU Alternative Investment Fund Managers DirectiveOverview as at 1 October 2012

Contents

A. Scope..........................................................................1

1. What is it? ...................................................................1

2. Who will it apply to?.....................................................1

3. What is the current status of the Directive? ...................1

4. What types of fund will it apply to? ...............................2

5. What is an AIF? ...........................................................2

6. Who does the Directive not apply to? ............................4

7. Is there an exemption for small fundmanagers?............................................................................5

B. Role of AIFM................................................................7

8. Who is the AIFM?.........................................................7

9. What are the rules for non-EU AIFM managingAIF with activities in the EU?..................................................7

10. What are the rules on marketing? .................................8

11. What else can an AIFM do? ..........................................9

12. What does the Directive regulate?.................................9

C. Capital requirements and conduct of business ............. 10

13. What are the regulatory capital requirementsfor AIFM?............................................................................ 10

14. What ongoing conduct of business rules willapply?10

15. Are there specific operating principles forAIFM?11

16. Can an AIFM still offer side letters toinvestors? ........................................................................... 11

17. Will the Directive regulate the remuneration ofAIFM?11

18. What rules relate to valuations of fund assets? ............ 11

19. Are there additional restrictions on privateequity type funds?............................................................... 12

D. Third party service providers ...................................... 13

20. Are there any restrictions on delegation ofAIFM functions? .................................................................. 13

21. Does an AIF require a depositary? .............................. 13

E. Disclosures ................................................................ 16

22. What information must be provided in the IMor similar offer documents?.................................................. 16

23. Are there any requirements on reporting? ................... 16

Appendix 1 ......................................................................... 17

Appendix 2 ......................................................................... 18

Berwin Leighton Paisner October 2012 01

A. Scope

1. What is it?

The Directive on Alternative Investment Fund Managers1 (the "Directive") is the cornerpiece of an extensive initiative by the European Commission to regulate the activities offund managers (referred to in the Directive as Alternative Investment Fund Managersor "AIFM"). Whilst, prima facie, the Directive only regulates fund managers, it will, inpractice, also regulate the activities of the funds that they manage (referred to in theDirective as Alternative Investment Funds or "AIF").

2. Who will it apply to?

The Directive applies to managers (i.e. AIFM) of all investment funds (other than UCITSfunds2) with operations in the European Union (the "EU"), irrespective of their place ofestablishment.

The Directive distinguishes between AIFM established in the EU ("EU AIFM") and AIFMestablished outside of the EU ("non-EU AIFM") and AIF established in the EU ("EU AIF")and AIF established outside of the EU ("non-EU AIF").

Article 2(1) confirms that the Directive applies to:

(a) all EU AIFM;

(b) non-EU AIFM managing EU AIF; and

(c) non-EU AIFM marketing EU AIF or non-EU AIF within the EU.

Broadly, the only AIFM not potentially caught by the Directive are non-EU AIFMmanaging non-EU AIF that are not marketed into the EU in any way.

3. What is the current status of the Directive?

The Directive was published in the Official Journal on 1 July 2011 and entered intoforce on 21 July 2011. Member States have until 22 July 2013 to implement theDirective into national law.

EU AIFM are required to be authorised under the Directive by their home stateregulator by 22 July 2014. It is envisaged that non-EU AIFM will be able to obtainauthorisation from their Member State of reference (broadly, the Member State inwhich an AIFM intends to perform the majority of its activities) from October 2015.

A swathe of secondary measures (comprising delegated acts and implementingmeasures to be adopted by the Commission) will need to be put in place before theDirective is implemented by Member States. The European Securities and MarketsAuthority ("ESMA") is in the process of developing recommended delegated acts andimplementing measures for endorsement by the European Commission.

1 Directive 2011/61/EC of the European Parliament and of the Council of 8 June 2011 on Alternative InvestmentFund Managers and amending Directives 2003/41/EC and 2009/65/EC.

2 Funds established under Directive 2009/65/EC on the coordination of laws, regulations and administrativeprovisions relating to undertakings for collective investment in transferable securities.


4. What types of fund will it apply to?

4.1 All asset classes

Whilst the Directive is often described as regulating the private equity and hedge fundindustry, it is much broader. The Directive will also regulate the activities of real estatefunds, securities funds, funds of funds, buy-out funds, debt funds, venture capital fundsand infrastructure funds etc. In fact, the scope of the Directive is not limited byreference to asset classes or investment strategies.

4.2 All types of structure

The Directive will apply to managers of AIF regardless of:

(a) whether an AIF is open- or closed-ended;

(b) whether an AIF is constituted in accordance with contract law, trust law, orstatute or has any other legal form; or

(c) what the legal structure of the AIF is.

4.3 Listed and unlisted vehicles

The recitals to the Directive state that the Directive will apply to AIFs which are listedand unlisted.

4.4 Perimeter remains unclear

The application of the Directive around the perimeter remains unclear. A key point ishow widely the definition of AIF is interpreted and how the various exemptions (e.g.holding companies, joint ventures, family office vehicles, insurance contracts andsecuritisation special purposes entities) are interpreted. ESMA issued a discussionpaper on 23 February 2012 (http://www.esma.europa.eu/system/files/2012-117.pdf)("ESMA DP") in which it discusses the meaning of AIF and the scope of the variousexemptions.

5. What is an AIF?

The definition of AIF in the Directive has been drafted incredibly broadly, such that weexpect it to capture substantially all arrangements that are generally considered to beinvestment funds. It is important to note that whilst the definition is different to thedefinition of collective investment scheme in s235 of the Financial Services and MarketsAct 2000 ("FSMA"), we expect it to capture substantially all arrangements falling withinthe definition of collective investment scheme in s235 FSMA. In addition, it is highlylikely that the definition will catch arrangements that fall outside the s235 FSMAdefinition, such as closed-ended investment companies.

5.1 Definition

An AIF is defined in the Directive to mean any collective investment undertaking(including any sub-compartments or sub-funds) that:

(a) raise capital from a number of investors with a view to investing it inaccordance with a defined policy for the benefit of these investors;

(b) do not fall to be regulated under the UCITS Directive.

http://www.esma.europa.eu/system/files/2012-117.pdf


5.2 Collective investment undertaking

In the ESMA DP, it is asserted that an arrangement will be a collective investmentundertaking if its purpose is to generate a return for its investors.

5.3 Single investor vehicles

ESMA asserts that an arrangement does not raise capital from a “number of investors”if there is a restriction on the sale of units to a single investor. As many existing singleinvestor vehicles do not have specific provisions in their rules or incorporationdocuments which preclude participation by third parties, it is hoped that ESMA willconfirm that arrangements will only fall within the scope of the “number of investors”element of the definition when it is intended that they become, or they actuallybecome, multi-investor arrangements.

5.4 Raising capital

5.5 ESMA’s view is that capital raising for the purposes of the Directive must involve someform of communication by way of business between the person seeking capital (or arepresentative) and prospective investors. It is clear from this that the issue of anyform of offering document will be conclusive evidence of capital raising.

5.6 Defined investment policy

ESMA suggests that a number of indicative criteria could be taken into account whendetermining if an arrangement has a defined investment policy including:

(a) the final form of the investment policy being fixed, at the latest, by the timethat investors' commitments to the entity become binding on them;

(b) the investment policy being set out in a document which becomes part of, oris referenced in, the constitutional documents of the entity;

(c) a contractual relationship between the entity and the investor binding theentity to follow the investment policy;

(d) the investment policy containing a series of investment guidelines (e.g. only toinvest in certain categories of asset, or conform to restrictions on assetallocation or pursue certain strategies);

(e) the investment policy being clearly set out and disclosed to investors;

(f) any change to the investment policy must be disclosed to or approved by theinvestors.

ESMA contrasts these relatively precise criteria with guidelines followed by ordinarycompanies that may be in the form of business strategies or, in certain cases,investment strategies.

5.7 Interaction with UK definition of CIS

From a UK perspective, it is important to note that the definition of an AIF can bedistinguished from the definition of a “collective investment scheme” under s235 of theFinancial Services and Markets Act 2000 ("FSMA"). Arrangements which fall outside ofthe definition of collective investment scheme under FSMA could be AIFs under theDirective, and vice versa.


HM Treasury and the Financial Services Authority ("FSA") are consulting on whether ornot it will be appropriate to amend the definition of collective investment scheme unders235 FSMA.

6. Who does the Directive not apply to?

6.1 Exemptions

The Directive does not apply to managers of the followingentities/arrangements:

(a) group arrangements;

(b) holding companies;

(c) occupational pension schemes covered by the IORP Directive3;

(d) supranational institutions, such as the World Bank, International MonetaryFund, European Central Bank, and European Investment Bank;

(e) national central banks;

(f) national, regional and local governments and bodies or other institutions whichmanage funds supporting social security and pensions systems;

(g) securitisation special purpose entities;

(h) investment undertakings, such as family office vehicles which invest theprivate wealth of investors without raising external capital4;

(i) insurance contracts5; and

(j) joint ventures6.

Many of these categories are unambiguous and do not require further clarification, butother categories are less clear.

6.2 Group exemption

The Directive does not apply to a manager in so far as it manages AIF whose onlyinvestors are members of the manager’s group. The Directive explicitly states that thisexemption is not available if one of the AIF’s investors is itself an AIF.

6.3 Exemption for holding companies

The term "holding companies" is defined in the Directive as "companies withshareholdings in one or more other companies, the commercial purpose of which is tocarry out a business strategy or strategies through subsidiaries, associated companiesor participations in order to contribute to their long-term value, and which is either acompany: (i) operating on its own account and whose shares are admitted to trading

3 Directive 2003/41/EC on the activities and supervision of institutions for occupational retirement provision.

4 The exemption relating to family office vehicles is stated in the recitals to the Directive, but is not referred to inthe main body.

5 The insurance contract exemption is stated in the recitals to the Directive, but is not referred to in the main body.

6 The joint venture exemption is stated in the recitals to the Directive, but is not referred to in the main body.


on a regulated market in the European Union; or (ii) not established for the mainpurpose of generating returns for its investors by means of divestment of itssubsidiaries or associated companies, as evidenced in its annual report or other officialdocuments."

Prima facie, the exemption extends to all companies holding significant stakes in othercompanies whose shares are admitted to trading on a regulated market in the EU.However, it is doubtful that the exemption is this wide on the basis that the recitals ofthe Directive envisage the Directive applying to listed funds.

The ESMA DP does not further clarify the holding companies exemption, except to statethat the explicit exclusion of holding companies should not be used as a mean tocircumvent the Directive. Accordingly, the scope of this exemption remains unclear.Further guidance on this category of exemption is expected in the second half of 2012.

6.4 Securitisation special purpose entities

Securitisation special purpose entities are defined as entities whose sole purpose is tocarry on a securitisation or securitisations within the meaning of Article 1(2) ofRegulation (EC) 24/2009 of the European Central Bank of 19 December 2008concerning statistics on the assets and liabilities of financial vehicle corporationsengaged in securitisation transactions and other activities which are appropriate toaccomplish that purpose. ESMA has not to date provided any additional guidance as tothe precise interpretation of this term.

6.5 Other important exemptions

Other categories of exemption (e.g. family office vehicles, insurance contracts, and jointventures) are not defined in the Directive and their scope remains ambiguous.

ESMA has not to date provided any meaningful guidance as to the precise interpretationof these terms. Further guidance on these categories of exemption is expected in thesecond half of 2012.

6.6 Exemptions under grandfathering provisions

There are limited exemptions available to AIFM for a transitional period. AIFMmanaging only closed-ended AIF which do not make additional investments after July2013 may continue to manage such AIF without being authorised under the Directive.In addition, AIFM managing only closed-ended AIF whose final closing has occurredbefore July 2013 and which will terminate by July 2016 may also continue to managesuch AIF without being authorised under the Directive or being required to comply withthe Directive (other than the provisions related to annual reporting and the disclosure,notification and asset-stripping provisions relating to interests in large privatecompanies.

7. Is there an exemption for small fund managers?

There is no exemption for smaller managers. However, the Directive provides thatindividual Member States may permit managers whose assets under management donot exceed certain specified amounts to operate under a registration and disclosureregime, pursuant to which the majority of the requirements of the Directive would notapply. AIFM qualifying for the registration and disclosure regime may choose to applyfor full status.

HM Treasury and the FSA are consulting on whether a registration and disclosureregime should be available for smaller AIFM in the UK or whether all AIFM in the UKshould be required to comply with the Directive in full.


7.1 Thresholds for smaller AIFM

The minimum thresholds for the registration and disclosure regime, if made available inindividual Member States, are:

(a) AIFM managing AIF with assets of up to a threshold of EUR 100 million; or

(b) AIF with assets up to a threshold of EUR 500 million and no redemption rightsexercisable during a period of 5 years following the date of initial investmentin each AIF.

7.2 Minimum requirements under registration and disclosure regime

AIFM subject to the registration and disclosure regime of the Directive need only:

(a) register with the competent authorities giving less information compared tofull scope AIFM;

(b) provide information regularly on the main instruments in which they aretrading and on the principal exposures and most important concentrations ofthe AIF in order to enable the competent authority to effectively monitorsystemic risk; and

(c) notify their competent authority in the event that they no longer comply withthe conditions qualifying to the limited application of the Directive.

7.3 Passport not available

The downside of operating under the registration and disclosure regime is that AIFMwill not be able to take advantage of the cross-border marketing rights.


B. Role of AIFM

8. Who is the AIFM?

The AIFM is the person responsible for the portfolio and risk management of the AIF.Every AIF will have one (but no more than one) AIFM.

8.1 Internally or externally managed

The Directive confirms that an AIF may be internally or externally managed.

An AIF is internally managed if it (e.g. its board of directors) maintains responsibility forthe portfolio and risk management of the AIF’s assets. If an AIF is internally managed,the AIF will be the AIFM. If an AIF has appointed a third person to take responsibilityfor the portfolio and risk management of an AIF, it will be an externally managed AIFand the third party manager will be the AIFM.

It is possible that an AIF will be deemed to be internally managed if the responsibilityfor portfolio and risk management is not expressly given to an external manager. Riskmanagement involves the identification, measurement and management of all risksrelevant to the AIF's investment strategy. It is possible that certain managers may nothave been expressly appointed to perform an AIF’s risk management function. Weanticipate that, in many instances, it will be unclear who should be regarded as theAIFM. It may be necessary to amend or clarify risk management arrangements inexisting structures to ensure this responsibility rests with the AIFM.

9. What are the rules for non-EU AIFM managing AIF withactivities in the EU?

9.1 When can a non-EU AIFM become authorised under the Directive?

Non-EU AIFM will not be able to obtain authorisation under the Directive until additionallegislation has been adopted to facilitate this. This additional legislation is expected tobe adopted in October 2015.

9.2 What additional requirements will be imposed on non-EU AIFM?

In order for a non-EU AIFM to be authorised under the Directive, information exchangearrangements are required to be in place between the non-EU AIFM’s home regulatorand the supervisory authorities of the Member State where the AIF is established (if inthe EU) or to be marketed (if outside of the EU). Further, the home jurisdiction of theAIFM or the AIF must not be a Financial Action Task Force ("FATF") Non Co-operativeCountry and Territory ("NCCT").

9.3 Can a non-EU AIFM continue to manage EU AIF before October 2015?

In the period between the final transposition date in July 2013 and October 2015, non-EU AIFM will be able to continue to manage EU AIF, provided they comply with certaininformation disclosure requirements.


10. What are the rules on marketing?

For a summary of the rules on the marketing of EU AIF and non-EU AIF by EU AIFMand non-EU AIFM, see Table 1 at Appendix 1.

10.1 What are the rules on EU AIFM marketing in their home Member State?

(a) Marketing to professional investors

Once an AIFM has been authorised, the Directive allows it to market shares orunits of the EU AIF that it manages to professional investors7.

An AIFM may also market non-EU AIF to professional investors. There are,however, some additional requirements that must be met (primarily in relationto reporting and co-operation arrangements between jurisdictions).

AIFM authorisation in accordance with the Directive will not automatically allowAIFM to market units or shares in AIF to investors not falling within theprofessional investor criteria.

(b) Marketing to retail investors

Member States may permit certain AIF to be marketed to retail investors intheir jurisdiction. In opting to allow AIFM to market to retail investors, MemberStates may choose to impose stricter requirements on the AIFM or the AIF thanthose applicable to AIF marketed to professional investors on their territory.However, Member States may not impose stricter or additional requirements onEU AIF established in another Member State and marketed on a cross-borderbasis than on AIF marketed domestically.

In the UK, it is expected that the Non-UCITS Retail Scheme ("NURS") regimewill continue to operate alongside the Directive, allowing the units in suchschemes to be distributed to retail investors.

10.2 Can an EU AIFM market AIF in other Member States with a passport?

An AIFM authorised in one Member State may market shares or units in EU AIF and,from October 2015, non-EU AIF that it manages to professional investors in otherMember States, under a passport, subject to compliance with the Directive’s notificationrequirements.

10.3 Can an EU AIFM market AIF in other Member States without a passport?

Individual Member States may, but are not required, to allow an authorised EU AIFM tomarket non-EU AIF outside of the passporting regime (i.e. on a private placementbasis). In order to be permitted, the home jurisdiction of the non-EU AIF must satisfyequivalence requirements. Member States are free to set their own restrictions on theprivate placement of non-EU AIF in their jurisdiction. The Directive envisages that theprivate placement of AIF will be prohibited throughout the EU from 2019.

EU AIFM may not market EU AIF outside of the passporting regime.

7 According to Article 4(1)(ag) of the Directive, "professional investor" means any investor which is considered tobe a professional client or may be treated as a professional client on request within the definition of Annex II ofDirective 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on Markets in FinancialInstruments ("MiFID").


10.4 Can a non-EU AIFM market EU AIF and non-EU AIF under existing privateplacement rules?

It is envisaged that, for a transitional period which is likely to end in 2019, individualMember States may allow non-EU AIFM to market AIF in their jurisdiction outside thescope of the Directive on a private placement basis. This is the way in which fundmanagers presently market funds that they manage.

It is important to note that a Member State may impose stricter rules on, or indeed,prohibit non-EU AIFM in relation to marketing on a private placement basis.

Although this issue remains to be determined in the UK, HM Treasury and the FSA haveindicated that the private placement of shares or units in non-EU AIF will probablycontinue to be permitted until 2019.

11. What else can an AIFM do?

The Directive imposes restrictions on the activities that an authorised AIFM mayconduct. These include the core functions (as described in Annex I to the Directive) ofportfolio management and risk management to AIF and UCITS. AIFM are alsopermitted to provide in the course of their management business: administration(including legal and fund management accounting services; customer enquiries;valuation and pricing; regulatory compliance; maintenance of registers; distributions ofincome and redemption proceeds; contract settlement and record keeping); marketing;and activities related to the assets of the AIF.

Member States may also permit AIFM to provide the following services:

(a) management of portfolios of investments including those owned by pensionfunds (i.e., segregated account management);

(b) non-core services such as the provision of investment advice; and receptionand transmission of orders in relation to one or more financial instruments.

An AIFM cannot, however, conduct activities such as proprietary trading or acting asbroker-dealer. In practice, many large groups split these activities into separatelyauthorised entities.

12. What does the Directive regulate?

The Directive regulates the following:

(a) registration and authorisation requirements for AIFM;(b) special authorisation requirements for non-EU AIFM and non-EU AIF;(c) restrictions on marketing AIF;(d) minimum capital requirements;(e) remuneration policies;(f) systems and procedures on conflicts of interest;(g) systems and procedures on risk management;(h) prescribed rules on the valuation of an AIF’s assets;(i) audit requirements for AIF;(j) requirements with respect to delegation of management functions;(k) appointment of depository with prescriptive minimum terms of appointment;

and(l) additional fund type specific requirements (such as on leverage and asset

stripping by buy-out and other private equity funds).


C. Capital requirements and conduct of business

13. What are the regulatory capital requirements for AIFM?

The Directive establishes minimum capital requirements for managed AIF to beobserved by AIFM, in particular:

(a) a minimum initial capital of at least EUR 300,000 if the AIF is internallymanaged;

(b) minimum initial capital of EUR 125,000 for any AIF which is managed by theAIFM acting as external manager together with additional amounts reflectingthe assets it has under management as described below.

For external AIFM managing assets within one or more AIF in excess of EUR 250 million(in aggregate), the AIFM will be obliged to increase its own funds by an additionalamount equalling 0.02% of the amount by which the value of the managed portfolioexceeds EUR 250 million (subject to a cap of total capital of EUR 10 million representingboth elements).

Where the AIFM is also subject to the Capital Requirements Directive8 ("CRD"), thoserequirements will also apply such that it will be required to maintain the greater of: (a)the amount calculated under the Directive; and (b) the amount that it is required tohold under the CRD.

14. What ongoing conduct of business rules will apply?

An AIFM must:

(a) act honestly, with due skill, care and diligence and fairly in conducting itsactivities;

(b) act in the best interest of the AIF or the investors of the AIF it manages andthe integrity of the market;

(c) hold, and employ effectively, resources and procedures sufficient for theproper performance of its business activities;

(d) take all reasonable steps to avoid and/or manage conflicts of interests;

(e) promote the best interests of the AIF or the investors of the AIF it managesand the integrity of the market; and

(f) treat all AIF investors fairly.

These rules are similar to the general principles that MiFID9 firms with which arerequired to comply.

8 Directives 2006/48/EC and 2006/49/EC

9 Markets in Financial Instruments Directive 2004/39/EC


15. Are there specific operating principles for AIFM?

The Directive introduces specific requirements in four key areas which are consideredto give rise to particular systematic risks: conflicts of interest; risk management;liquidity management; and investment in securitised assets.

15.1 What are the rules on conflicts of interest?

Each AIFM must take all reasonable steps towards identifying, preventing, managingand monitoring conflicts of interest that arise in the course of managing one or moreAIF between:

(i) the AIFM, including their managers, employees or any person directlyor indirectly linked to the AIFM by control, and the AIF managed by theAIFM or the AIF investors;

(ii) the AIF (or its investors) and another client of the AIFM (be that anindividual client, or other AIF or a UCITS);

(iii) two of the AIFM's clients.

15.2 Meaning of "interests of investors"

In considering how the conflicts of interest rules apply to the interests of investors in anAIF, AIFM should consider the interests of investors in their specific capacity as investorin that AIF. There is large scope for the interests of one investor to conflict with theinterests of other investors in the same AIF, for example, including in situations such aswhere one investor wants to redeem their holding and the AIFM is considering whetherto apply a gate to redemption.

16. Can an AIFM still offer side letters to investors?

Preferential treatment of an investor, though not prohibited, is permitted only wherethe other investors are informed of the preferential treatment (e.g. by disclosure in theAIF's rules or instruments of incorporation). This could have an impact on the ability ofAIF and AIFM to offer side letters and most favoured nations provisions.

17. Will the Directive regulate the remuneration of AIFM?

An AIFM must have remuneration policies and procedures in place in relation to thosestaff whose professional activities have a material impact on the risk profiles of AIF theymanage. Such policies and procedures must not encourage risk-taking which isinconsistent with the risk profiles and constitutional documentation of the AIF itmanages.

Staff, for these purposes, includes senior management, risk takers, holders of controlfunctions and any employee receiving total remuneration that takes them into the sameremuneration bracket as senior management.

18. What rules relate to valuations of fund assets?

AIFM are required to ensure that a proper and independent valuation of the assets ofthe AIF can be performed. Local accounting laws will apply. If the AIF is open-ended,such valuations and calculations must also be carried out at a frequency which both isappropriate to the assets held by the fund and its issuance and redemption frequency(i.e. a fund that deals daily and invests in liquid securities is likely to require more


frequent valuations than a fund that holds highly illiquid assets and only deals a fewtimes a year).

The valuation may be performed by: (i) an external valuer; or (ii) the AIFM itself,provided that the valuation task is functionally independent from the portfoliomanagement. Note that the AIFM remains responsible for the proper valuation ofassets and its liability to the AIF is not affected by the appointment of an externalvaluer.

19. Are there additional restrictions on private equity type funds?

There are two key types of additional restrictions that will be imposed on private equityand similar funds. First, there are disclosure and notification requirements on theacquisition of interests in large private companies. Second, there are some veryprescriptive rules against “asset stripping” which restrict what can be done to largerfirms for two years after acquisition.

The restriction in this section of the Directive that is likely to have the most impact onprivate equity and similar funds is that relating to asset stripping. An AIFM may notpermit the AIF to take any action that may enable the investee company to reduce itsnet assets by an amount in excess of its distributable profits and reserves. Thisrestriction will apply not only to a distribution, but also to a redemption of shares,capital reduction or own share acquisition. This restriction is in place for 24 monthsfrom the date of acquisition of control of the investee company by the AIF.

These rules will place AIF that are subject to the terms of the Directive at a competitivedisadvantage against any other person who may acquire a controlling interest in non-listed companies, including AIF of non-EU AIFM, individuals, corporates, banks andinsurers.


D. Third party service providers

20. Are there any restrictions on delegation of AIFM functions?

Whilst AIFM may delegate the portfolio management and risk management functions tothird parties, they must continue to have responsibility for these functions (i.e., theAIFM must not delegate these functions to the extent that it is reduced to a "letter-boxentity"). The liability of the AIFM will not be affected by the delegation. Also, thedelegation of functions must not serve as a means to circumvent the Directive'srequirements. Strict conditions apply to the appointment of any potential delegate ofportfolio management or risk management functions.

An important limitation to the rules on delegation is that it does not appear to prohibitthe use of investment advisers (i.e. persons providing investment advice to the AIFM orAIF, but not having the power to make discretionary investment decisions).

ESMA’s view is that AIFM may choose not to perform ancillary functions such asadministration and accounting. As such, there would not seem to be any restriction onthe delegation of such functions, provided an appropriately qualified and suitableperson is appointed.

A delegate may sub-delegate any functions with the prior consent of the AIFM andprovided that the sub-delegation has been notified to the relevant supervisoryauthority.

21. Does an AIF require a depositary?

AIFM must employ a single depositary for each AIF that it manages. This arrangementmust be formalised in a written contract which contains details about the flow ofinformation. There are different rules for certain closed-ended private equity, venturecapital and real estate funds.

21.1 What are the functions of the depositary?

Depositaries have two main functions:

(a) to safeguard the AIF’s assets; and

(b) to oversee the AIF’s compliance with its rules and instruments of incorporationand with applicable law and regulation.

21.2 What are the depositaries duties on safeguarding assets?

The depositary must hold all negotiable financial instruments in custody in a securitiesaccount opened in the depositary's books. All financial instruments that are capable ofphysical delivery must physically be delivered to the depositary. For all other assets ofthe AIF, the depositary must verify that they are indeed owned by the AIF (or, as thecase may be, the AIFM acting on behalf of the AIF). The depositary must keep up todate records of this assessment.

21.3 What type of firm may act as a depositary for an EU AIF?

There are strict limitations on the types of firm that can be appointed as depositaries.


A depositary for an EU AIF must be one of the following:

(a) an EU credit institution (for example, an EU bank);

(b) an investment firm authorised under MiFID, subject to the same CRD capitalrequirements as credit institutions (i.e. investment banks and other full BIPRUfirms will qualify, but most investment managers will not).

For AIFs that have no redemption rights exercisable during the period of 5 years fromthe date of the initial investments and which do not generally invest in financialinstruments or generally invest in non-listed companies to acquire control over suchcompanies, Member States may allow a depositary to be an entity which carries outfunctions as part of its professional or business activities and which is subject toappropriate regulatory rules and which can provide sufficient financial and professionalguarantees. It may therefore be possible for businesses such as fund administrators toact as depositaries for EU AIF.

As a general rule, the depositary for an EU AIF must be established in same MemberState as the EU AIF. However, the regulator in the home Member State of an EU AIFmay permit an EU credit institution established in another Member State to beappointed as a depositary until 22 July 2017.

21.4 What type of firm may act as a depositary for a non-EU AIF?

For a non-EU AIF, the depositary must be a non EU credit institution which must beregulated by similar standards to the EU. It must be established in the samejurisdiction as the AIF, or have its registered office or branch located in the homeMember State of the AIFM managing the AIF.

In order for a non-EU AIF to comply with the Directive, where the depositary isestablished outside of the EU, there must be a co-operation and information exchangeagreement in place between the supervisory authority in the home jurisdiction of thedepositary, the AIFM’s regulator and the regulators of the Member States where theAIF is marketed.

21.5 Are the rules on the appointment of depositaries reduced for certain types ofAIF?

Member States may relax the rules on the appointment of depositaries for AIF whichhave no redemption rights exercisable during the period of five years from the date ofthe initial investments and which have a restrictive core investment policy. In thesecircumstances, depositary functions can be carried out by a notary, lawyer or similarperson (e.g. fund administrator). This will be particularly useful for real estate funds aswell as venture capital and private equity funds that do not hold liquid securities.

21.6 Can depositaries delegate their functions to sub-custodians?

Depositaries can delegate their functions, subject to certain restrictions, however, theprimary depositary remains responsible (and liable) to the AIF for all delegates, unlessexpressly agreed otherwise.

The depositary's delegate may in turn, under certain conditions, sub-delegate the safe-keeping functions. There is an exemption from the requirements relating to delegationin situations where local law requires that assets are held within a jurisdiction that doesnot have depositaries that would meet the requirements of the Directive (although theconsent of the AIF must be obtained and its investors informed).


These restrictions could introduce significant administrative and cost burdens todepositaries of AIF in maintaining sub-custody networks (which will presumably bepassed on to the investors in the AIF).

21.7 What is the liability of depositaries?

Depositary liability has been and remains a controversial issue. The depositary issubject to near strict liability for the loss of financial instruments10 held in custody bythe depositary or a third party to whom custody has been delegated.

In the case of such a loss, the depositary must replace the lost financial instrumentswith ones of an identical type or otherwise credit the account with a correspondingamount without undue delay. The depositary will not be liable if it can prove that theloss has arisen as a result of an external event beyond its reasonable control, theconsequences of which would have been unavoidable despite all reasonable efforts tothe contrary (i.e., the Directive will seek to impose a standard concept of force majeureacross Europe).

The depository can discharge itself of liability for the loss of financial instruments heldin custody by a third party to whom the custody has been delegated, if it can provethat:

(a) it has complied with the necessary requirements for the delegation of itscustody tasks; and

(b) there is a written contract between the AIF and the depositary (and anotherbetween the depositary and the third party) that explicitly transfers the liabilityof the depositary to that third party and makes it possible for the AIF to makea claim against the third party in respect of the loss of financial instruments orfor the depositary to make such a claim on their behalf.

10 Note that real estate is not a financial instrument for the purposes of the Directive.


E. Disclosures

22. What information must be provided in the IM or similar offerdocuments?

Whilst the Directive does not purport to regulate the AIF, it sets out detailedrequirements on disclosures that are to be made to investors. These include:

(a) a description of the investment strategy and objectives of the AIF;

(b) a description of the procedures by which the AIF may change its investmentstrategy or investment policy;

(c) the identity of the AIFM, the AIF's depositary, auditor and any other serviceproviders and a description of their duties and the investors' rights;

(d) a description of any delegated management and depositary functions;

(e) a description of the AIF's valuation procedures and pricing methodology;

(f) a description of all fees, charges and expenses;

(g) how the AIFM ensures a fair treatment of investors and a description of anypreferential treatment gives (i.e., descriptions of side letters and similararrangements); and

(h) the latest annual report for the AIF.

23. Are there any requirements on reporting?

An AIFM must provide an annual report no later than six months following the end ofthe financial year for each AIF that it manages to investors and the supervisoryauthorities of the AIFM and the AIF.

The annual report must include a balance sheet; an income and expenditure accountfor the financial year; a report on the activities of that financial year; a summary of anymaterial changes in the information disclosed to investors during the financial yearcovered by the report; and details of the remuneration paid by the AIFM to its staffmembers.


Appendix 1

Table 1: Marketing rules under the Directive

Is authorisation requiredeven if no EUmarketing?

Is authorisation requiredwhere EU marketing is vianational private placement?

Is authorisation requiredwhere EU marketing is viathe passport?

EU AIF managed by EUAIFM

Yes Private placement notpossible

Yes

Non-EU AIF managed byEU AIFM

Yes Yes Yes, but passport notavailable until October 2015

EU AIF managed bynon-EU AIFM

Yes, but not untilOctober 2015 whenauthorisation will likelybe required

Yes, but not until October2015 when authorisation willlikely be required

Yes, but not until October2015 when authorisation willlikely be required

Non-EU AIF managed bynon-EU AIFM

No No Yes, but not until October2015 when authorisation andpassporting will be possible


Appendix 2

Glossary of Defined Terms

"AIF" means Alternative Investment Fund;

"AIFM" means Alternative Investment Fund Manager;

"CRD" means Directives 2006/48/EC and 2006/49/EC, together known as the CapitalRequirements Directive;

"Directive" means the Directive 2011/61/EC of the European Parliament and of the Council of8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/ECand 2009/65/EC;

"ESMA" means the European Securities and Markets Authority;

"ESMA DP" means the discussion paper issued by ESMA on 23 February 2012(http://www.esma.europa.eu/system/files/2012-117.pdf) in which it discusses the meaning ofAIF and the scope of the various exemptions;

"EU" means the European Union;

"EU AIFM" means an AIFM established in the EU;

"FSA" means UK Financial Services Authority;

"FSMA" means the UK Financial Services and Markets Act 2000;

"MiFID" means the Markets in Financial Instruments Directive (2004/39/EC);

"Non-EU AIFM" means an AIFM established outside of the EU;

"NURS" or "Non-UCITS Retail Scheme" means an authorised fund which is neither a UCITSscheme or a qualified investor scheme; and

"UCITS" means an undertaking established under Directive 2009/65/EC on the coordinationof laws, regulations and administrative provisions relating to undertakings for collectiveinvestment in transferable securities.

This document provides a general summary only and does not constitute legal advice. Specificlegal advice should always be sought in relation to the particular facts of a given situation.

http://www.esma.europa.eu/system/files/2012-117.pdf

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EU Alternative Investment Fund Managers Directive