By Matt Mulry (pictured), Dillon Eustace – The Directive on Alternative Investment Fund Managers (Directive 2011/ 61/EU (“AIFMD”)) and its supplementary regulation will from 22 July 2013 introduce an authorisation regime for the marketing and management of alternative investment funds (“AIFs”) within the European Union (“EU”). Following 22 July 2013 a manager which is established outside the EU and which manages an AIF established in Cayman may only market that AIF into the EU in certain limited circumstances.
An AIF under the AIFMD is defined very broadly as any collective investment undertaking established anywhere in the world that (a) is not required to be authorised as a UCITS; (b) raises capital from a number of investors; (c) has a view to investing such capital in accordance with a defined investment policy; and (d) is intended to benefit its investors. AIFs would typically include Cayman hedge funds, Cayman private equity vehicles and any other Cayman fund structures which are not UCITS funds.
The AIFMD defines “marketing” as any direct or indirect offering or placement at the initiative of a manager of an AIF or on behalf of that manager, of units or shares in a fund it manages to or with investors domiciled in the EU. The primary condition for such marketing is that a co-operation agreement for the purpose of systemic risk oversight has been entered into between the regulators of the target EU member state and the Cayman Islands Monetary Authority (“CIMA”) and that such an agreement has also been entered into between the target EU members state and the home jurisdiction of the manager.
The entry by the Cayman Islands Monetary Authority (“CIMA”) into memoranda of understanding with members of the European Securities and Markets Authority (“ESMA”) was approved by the Board of Supervisors of ESMA on 22 May 2013. Shortly thereafter on 30 May 2013 CIMA announced that it has signed such memoranda of understanding with twenty EU member states. These memoranda of understanding will serve as co-operation agreements for the purpose of systemic risk oversight and will from 22 July 2013 allow the supervision by EU regulators of managers established outside the EU who market their Cayman AIFs into the EU. The terms of these memoranda of understanding will facilitate the exchange of information between CIMA and the relevant EU member states, cross-border on-site visits between the jurisdictions and also provide a framework for mutual assistance in the enforcement of the applicable supervisory laws between CIMA and these EU member states. The entry into these memoranda of understanding is an important step in maintaining Cayman’s competitiveness in the European market and thereby retaining its status as the pre-eminent jurisdiction for hedge funds.
The entry by CIMA into these memoranda of understanding has provided the necessary international regulatory framework for the marketing of Cayman AIFs into the EU by managers established outside the EU. However, additional conditions will also apply after 22 July and these will need to be assessed and complied with.
The AIMFD provides that AIFs may only be marketed to Professional Investors1 in the EU by way of an EU marketing passport or by way of any available private placement rules. Whilst the AIFMD will open up the European marketing passport regime to all EU AIF with managers established in the EU, an EU marketing passport will not initially be available to managers of Cayman AIFs. However the passport regime may become available in or around October 2015 if ESMA and the EU issue a positive opinion on such an extension and appropriate co-operation agreements are put in place. If the passport regime is extended at that time a manager whether it is established inside or outside the EU may be able to seek full authorisation from an EU member state and obtain a passport for marketing their Cayman AIFs across the EU.
The private placement rules of each target member state of the EU will need to be reviewed and advice obtained from advisers in the relevant states as to their application. Under the AIFMD each of the member states of the EU will be able to allow managers established outside the EU to market their Cayman AIFs within their state under their own private placement rules but will not be obliged to do so.
Generally the provisions of the AIFMD will mean that marketing Cayman funds to European investors by managers established outside the EU will become more restrictive after 22 July 2013. In addition the individual member states may impose even stricter rules than those set out in the AIFMD on managers established outside the EU in respect of the marketing of AIFs in their jurisdiction and may abolish their private placement regimes entirely. Specific advice will need to be taken on the provisions of such rules where they have been adopted.
In some EU member states transitional provisions may be available for a limited period after 22 July 2014 which could postpone compliance with the requirements of the AIFMD. These provisions where they are available are likely to vary in scope and application between the EU member states which implement them and specific advice should be sought from advisers in each target EU member state as to availability of any transitional provisions.
After 22 July 2013 managers which are established outside the EU and which are marketing Cayman AIFs to EU Professional Investors under any available private placement regime of a member state will need to comply with: (a) the relevant provisions of that regime; (b) the asset stripping requirements of the AIFMD where the AIF seeks to acquire control of EU registered non-listed companies; and (c) the following reporting and disclosure provisions of the AIFMD:
• Financial reporting requirements including remuneration disclosure requirements;
• Disclosure requirements to investors around the AIF and its manager; and
• Disclosure requirements to EU Regulators around the AIF and its manager.
Financial reporting and remuneration disclosure
A manager established outside the EU is required to produce, for each of the Cayman AIFs it markets in the EU, annual reports which must contain:
• balance sheet/statement of assets and liabilities;
• income and expenditure account for the financial year;
• report on activities of the financial year;
• any material changes during the financial year;
• total amount of remuneration paid to its staff for the financial year (fixed and variable) number of beneficiaries, and any carried interest; and
• the aggregate remuneration broken down by its senior management and staff whose actions have a material impact on risk profile of the AIF.
The information concerning remuneration as contained in the annual report must contain information on the total amount of remuneration for the financial year specifying:
• the total remuneration of the entire staff of the manager, with an indication of number of beneficiaries;
• the total remuneration of those staff of the manager who in part or in full are involved in the activities of the AIF with an indication of the number of beneficiaries; or
• the proportion of the total remuneration of the staff of the manager attributable to the AIF and an indication of the number of beneficiaries; and
• the carried interest paid by the AIF, where relevant.
Managers 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. Managers must disclose at least the information necessary to provide an understanding of the risk profile of the AIF and the measures it adopts to avoid or manage conflicts of interest.
Disclosure requirements to investors
The minimum level of information to be made available to investors must include, inter alia:
• the investment strategy and objectives of the AIF including how these can be changed, use of leverage and collateral and asset reuse arrangements;
• the identity of manager, and the AIF’s depositary, auditor and other service providers including prime broker and a description of their duties;
• any delegated investment management function and any delegation of safekeeping function;
• valuation procedures;
• the fund’s liquidity risk management;
• fees, charges and expenses;
• how fair treatment of investors is ensured by the manager, details of any preferential treatment, the type of investors who obtain such preferential treatment and their legal or economic links with the AIF or the manager;
• latest annual report;
• the historical performance of the AIF; and
• how information required regarding special arrangements or leverage is disclosed.
Managers are also required to periodically disclose to investors the percentage of AIF’s assets which are subject to special arrangements due to their illiquid nature, total leverage employed and any right of use of collateral under such leveraging arrangement, arrangements for managing liquidity and any changes to the maximum leverage that the manager may employ on behalf of the AIF.
Disclosure requirements to EU regulators
Managers are required to provide certain information on a regular basis to the supervisors of the EU member state in which a Cayman AIF is marketed2 including:
• the principal markets and instruments traded by it on behalf of the AIF;
• the percentage of AIF’s assets subject to special arrangements arising from their illiquid nature, arrangements for managing liquidity, the risk management systems employed, the current risk profile of the AIF, the main categories of assets invested in, and the results of stress tests performed in line with the AIFMD;
• an annual report of the AIF and for the end of each quarter, on request, a list of all AIFs managed by the manager; and
• where substantial leverage is employed, information on the overall level of leverage employed.
Frequency of reporting will be determined by reference to the size of the manager’s assets under management with more frequent reports being required from managers with a larger value of assets under management.
On or around October 2018 a decision will be made by the European Commission as to whether private placement of Cayman and other AIF established outside the EU should be permitted to continue within the EU or whether they should be abolished.
The definition of marketing under the AIFMD does not capture reverse solicitation which is outside the scope of the AIFMD. As a result where there as been no direct or indirect solicitation by managers established outside the EU for investment by EU investors into their Cayman AIFs there is no regulatory requirement to comply with the AIFMD. It should be noted however that at one stage during the evolution of the AIFMD the practice of reverse solicitation was to be prohibited and that any claim of reverse solicitation may well come under close scrutiny where it is relied upon to admit EU investors. Care should therefore be taken to ensure that there is a clear audit trail in each case which documents the circumstances of a reverse solicitation.
Steps to implementation
Mangers established outside the EU which are intending to market their Cayman AIFs into the EU will need to assess whether these AIFs are within the scope of the AIFMD and whether the intended marketing approach is within the definition of marketing under the AIFMD. If the outcomes of these assessments are both positive such managers will need to make sure that they comply with the requirements of their home jurisdiction, of the Cayman Islands, and of the EU member states in which the AIF is to be marketed.
1. A “Professional Investor” is an investor which is considered a professional client, in accordance with Annex II of Directive 2004/39/EC (the “MiFID Directive”) and includes credit institutions, investment firms, insurance companies, pension funds, sovereign funds and certain other institutional and private individual investors.
2. Annex IV of the EU Commission’s Regulation implementing the AIFMD contains templates for the filing of such information.