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Laven Partners AIFM Directive Update – August 2010

Posted on 20 Aug 2010

Welcome to the fourteenth edition of the monthly Laven Partners’ Monitoring Update on the proposed AIFM Directive. Laven Partners is a global leader in advising on financial regulations in a practical and comprehensive way. Please do not hesitate to contact us if you have any questions with regards to the new Directive and how it will affect your business.

The new Directive seeking to regulate hedge funds is charging ahead to become law. Laven Partners provides a monthly update on the development and status of this Directive. In the true Laven Partners style, we also look at any interesting comments made by regulators and leading industry players in relation to the Directive. We have now decided to include brief commentary on related regulatory developments as the EU goes legislation mad!

Our aim is to involve the financial community and notably to aggregate the representation of investors as we believe the Directive severely reduces their access to investment opportunities. Please register your interest and comments by emailing us at ecdirective@www.lavenpartners.com. Please feel free to forward our monitoring update to anyone who may be interested.

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The AIFM Directive

With President Obama signing into law the Dodd-Frank Wall Street Reform and Consumer Protection Act on 21 July 2010, bringing about the much awaited financial services regulation reform in the US, the industry’s concerns about the likely outcomes of the AIFM Directive are escalating. The regulation for alternative investment managers in the US is seen as more relaxed in comparison to the regulation proposed by the AIFMD.

Unfortunately, uncertainty about the AIFM Directive is likely to continue until at least late September when, in the event that agreement is finally reached on the final version, the Directive is to be voted on during the Plenary Sitting of the European Parliament. Even if the September deadline is met, the lack of clarity within the industry will continue; there are already overlapping rules from other sources including on bonuses and remuneration for asset managers as set out in the Capital Requirements Directive. The Director-General of EFANA (the European Fund Association), Peter de Proft, told the Financial Times that there are too many “bits and pieces on remuneration regulation”. These will presumably have to be harmonised by the European Commission in due course once the Directive becomes effective, making things even worse for managers.

While the US regulator according to Forbes has adopted a “business as usual” approach with regard to regulating alternative investment managers, there are growing fears that the Directive will create larger obstacles for asset managers, creating imbalances in marketing opportunities, affecting investment flows within the industry. Concerns over the implications of the Directive have resulted in an increasing demand for UCITS, coming not only from the EU but also from the US and Asia. New York based Paulson & Co is planning to set up a UCITS compliant fund in Luxembourg later this year while Apex Fund Services, a fund administration services firm headquartered in Bermuda, has recently opened up in Luxembourg. The fast implementation of UCITS IV in Luxembourg is likely to result in more off-shore hedge funds considering setting up a UCITS fund for their European operations

Although adopting a UCITS structure seems to be a smart way for overseas hedge funds to access the EU market without having to comply with the demanding requirements of the Directive, managers remain cautious whether investment strategies allowed for UCITS will generate as much profit as traditional off-shore hedge funds. Sources close to the Brussels negotiations have however told the Financial Times that the final outcome of the proposed Directive will not be as harsh as originally feared and the European Council’s version is likely to prevail over the one proposed by the European Parliament. It is understood that third country funds will not be required to obtain an EU passport. Instead, the equivalence requirement will be removed and mostly national rules on registration together with the following four principles will apply to third country funds:

  • reciprocity promise by national regulator of the hedge fund or its manager (keeping their markets accessible for EU products);
  • the existence of a tax treaty between the third country fund’s home jurisdiction and the EU;
  • the existence of a cooperation agreement between the EU and the domestic regulator of the third country fund; and
  • the fund must not be blacklisted for failing to prevent money laundering or terrorist financing.

On the other hand should the third country fund prefer enhanced access to the EU market, it will have the option to meet more demanding requirements than complying with national registration rules and the above principles for acquiring an EU passport.

Due to the holiday period, the progress of reaching an agreement on the Directive has significantly slowed down and over the past month only speculations filled the industry. September should reveal more about the future of hedge funds in Europe and it remains to be seen whether the anticipated compromise on passporting will break the stalemate and lead to further consensus on remaining disputed issues such as depositary liability.

US Dodd-Frank Wall Street Reform

Under the Dodd-Frank Wall Street Reform bill, in the new Private Fund Investment Adviser Registration Act (PFIA Act) the “private adviser exemption” as known in the Investment Advisers Act of 1940 has been removed and new exemptions have been created overall. The PFIA Act is expected to come into force in July 2011. Whereas previously investment advisers with less than 15 clients were exempt from registration, according to the new regulation every investment adviser in the US will now have to register if he has more than $100 million AUM. Investment advisers not meeting the threshold will still have to register with their home state authority.

The SEC’s tightening control over hedge funds will also affect foreign advisers with no place of business in the US. They will have to register with the SEC if they present themselves out to the US public as investment advisers and have over 15 clients or private fund investors in the US or if they hold more than $25 million AUM from US clients or investors.

The PFIA Act will thus bring new restrictions especially for smaller EU investment funds and fund managers willing to operate in the US as they will now have to register, bearing increased costs and disclosure requirements. It can however be argued that the registration and abovementioned qualification requirements to be set by the AIFM Directive are much more demanding than those to be implemented in the US, giving potential competitive advantage to the US investment management market. Although much depends on the final version of the AIFM Directive, it seems the transatlantic harmonisation in financial regulation as originally advocated by G20 and regulators last year is not likely to materialise any time soon.