AIFMD: Brussels flexes it muscles

"I sense that among GPs there is a resignation to the fact that more regulation is coming and that they are going to have to respond in positive way," says John Levack, managing director of Electra Partners Asia and chairman of the Hong Kong Venture Capital Association's technical committee.

Levack describes the recent the Alternative Investment Fund Manager Directive (AIFMD) brought in by EU's European Markets and Securities Authority (ESMA) as the latest in a line of new regulatory regimes that spell out a new reality for private equity. Just as the Foreign Account Tax Compliance Act (FATCA) has altered how the asset class is policed in the US, AIFMD will have far reaching implication to managers seeking to operate in Europe.

The AIFMD remit is broad, touching managers from the real estate, infrastructure and hedge fund spheres as well as private equity. If they want to market funds within the EU, they must comply with the directive's requirements on transparency, capital adequacy, remuneration and delegation restrictions, risk and valuations. Although the focus is on regulating the manager rather than the fund, AIFMD will hit areas such as use of financial leverage and portfolio liquidity.

As of July 22, all EU-based GPs will be expected to be fully compliant with the directive. Asian managers won't be held to the same standard, but neither will they be able exist beyond the regulators' reach. Regardless of their jurisdiction of origin within the region, GPs must adhere to a set of requirements governing information disclosed to investors before they commit to a fund and the information disclosed thereafter.

"Administratively it will be quite burdensome," says James Ford, a partner with O'Melveny & Myers in Hong Kong. "Each country in the EU will be coming out with new rules on how or even whether non-EU funds can market on a private placement basis with investors in their respective jurisdiction and that process is ongoing."

New regimes

If Asian GPs fail to comply with AIFMD and carry on as if nothing has changed - there is currently little or no restriction on marketing in the EU - they will simply be denied access to LPs in member states. Those that do must come to terms with the rigorous private placement regime.

Under the AIFMD, an Asian GP must market on a country-by-country basis, registering with each national private placement regime. As of last week, ESMA had approved co-operation arrangements between EU securities regulators and 34 of their global counterparts, including Hong Kong, the Cayman Islands, Canada, Australia, Brazil, Switzerland, Dubai and the US.

While this latest development is reassuring, there is still a lack of clarity as to how private placement rules will be implemented because ESMA has granted each member state the right to determine their own policy.

"Each member state can choose not to implement a private placement regime at all or even allow it," explains Alex Last, a partner with MourantOzannes in Hong Kong. "But on the other hand, if you are an Asian GP looking at raising money in Europe you are not going to be marketing in every jurisdiction."

Many member states are yet to announce the registration requirements for non-EU GPs under the private placement regime, prompting speculation that they are struggling to meet the July deadline. For its part, the UK has already said that non-EU managers won't have to register until July 2014. Other jurisdictions may follow suit.

"So far no one has been entirely clear as to when they are opening doors to let mangers get registered," says Mary Bruen, a senior manager at PricewaterhouseCoopers (PwC) in Jersey. "If you have to be registered before July to continue marketing in Europe then member states will need to facilitate this. If there are not able to facilitate it, they may be incentivized to defer it."

A passport to Europe

While it appears Asian GPs will not be subject to the same degree of oversight as their EU counterparts, the flip-side is they won't benefit from the passport system open to fully compliant managers within the region. The EU-wide management passport will permit EU GPs to market anywhere within EU without additional requirements being placed upon them in the invest they market.

"With the passport you have access to all jurisdictions so you can actively market your fund and it makes it much easier in this respect," says OlvierCoekelbergs, a partner with Ernst & Young in Luxembourg. "Without a passport, those GPs outside Europe would have to market through a private placement regime, which is likely to delay the fundraising process."

In theory, any Asian GP could access the passport system by setting up operations in Europe and complying with AIFMD, the financial burden of doing this would likely outweigh the benefits for many small to mid-size operators. Furthermore, from July 2015, the passport catchment area is to be extended and Asia will fall within it.

To qualify, an Asia-based fund manager would have to nominate an EU member as a "state of reference" and then identify a representative in that country to act as a point of contact for investors and regulators. "I think having the passport will give a lot of creditability to a product," says Coekelbergs. "It will demonstrate to investors it is a regulated product, supervised and subject to consistent disclosure, reporting and transparency standards."

Budget options

For those GPs with the resources to place a representative in Europe and meet the associated costs, there could be an advantage to opting in two years down the line. Many, though, will take the cheaper option of relying on access to European LPs through reverse solicitation- which thus far does not come under the purview of the directive.

The logic goes that if a GP is dealing with an investor with a headquarters in Europe but communicates exclusively with an office in Asia, it will not be regarded as marketing in the EU. However, this depends on how the investor is set up in Asia. If the investors merely has a representative office, which doesn't have any decision-making power - the major conversations taking place in Europe and then instructions passed down to the satellite office - then it would be more difficult to claim that marketing is taking place outside the EU.

In addition, the lack of consistency across European regulators means this approach is far from a cure-all. "The difficulty is that there are different standards in different jurisdictions as to what you can actually do before it trips from passive to active marketing," says Bruen.

Some industry commentators suggest the restriction could create an opportunity for regulatory arbitrage. Funds-of-funds, for example, could benefit because their fundraising model is often oriented towards investors that are typically harder to access. The idea is that a fund-of-funds is AIFMD compliant and provides a route out of the EU for capital without the GPs in the portfolio having to through the regulatory processes.

Yet the opportunity for this may be short lived if exploited: regulators might simply respond by introducing a stricter version of AIFMD as they close loopholes further down the line.

While many GPs are focused in the July 22, this is just the first stage of implementation. The intention is that by 2018, the private placement regime currently used across European member states will be abolished and all GPs seeking to market to European LPs will be covered by the passport system. This will mean greater compliance costs, potentially forcing smaller GPs to reconsider their European strategy.

"If we think about AIFMD and what the impact will be for Asian GPs, it is clearly time for them to have a strategic review of what they want to do in Europe in the future and decide if they really want to raise money there going forward," says Ernst &Young's Coekelbergs.

SIDEBAR: AIFMD - Comply after July

Until the Alternative Investment Fund Manager Directive (AIFMD) passport system applies to non-EU managers, Asian GPs will have to market their funds through the private placement regimes in each respective member state. To do this, they must comply with a minimum of three requirements laid out by the directive.

1) The first condition is that the non-EU Manager must comply with the disclosure and transparency provisions outlined AIFMD. These relate to:

• Making available an annual report for each non-EU fund which it markets in the EU, this includes disclosures in relation to the remuneration and management fees paid by the non-EU manager to its staff

• Making available to investors certain information, such as fees, before they commit, as well as notifying them of any material changes in that information

• Regular reporting by the non-EU manager to the competent authorities in the EU Member State where the fund is marketed

• Where a non-EU fund acquires control of an unlisted or listed EU company, the non-EU Manager must make a number f disclosures to that company, its shareholders and to regulators.

2) Appropriate information exchange agreements must be in place between the competent authorities in each EU member state in which the fund is to be marketed, the supervisory authority of the domicile of the non-EU fund and the supervisory authority of the country where the non-EU manager is established.

3) At the time of marketing, neither the non-EU fund nor the manager should be authorized or registered in a country which is listed by the Financial Action Task Force (FATF), an inter-governmental body tasked with combating money laundering and terrorist financing.

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