The European Alternative Investment Fund Managers Directive (the “Directive” or “AIFMD”) was implemented by European Union (“EU”) Member States on 22 July 2013. The purpose of this article is to highlight the ramifications of the Directive for managers and advisers (“Managers”) to Cayman Islands alternative investment funds (“Cayman Funds”) who are located outside the European Economic Area (“EEA”) (“Non-EU Managers”).
Any Manager of a Cayman Islands or British Virgin Islands (“BVI”) Fund which conducts activities in the EEA, or has EEA investors, should urgently assess the impact of how to comply with the relevant parts of the AIFMD as the ramifications could be substantial.
Executive summary
Managers of Cayman Funds who perform risk management or portfolio management functions from within the EEA will need to consider whether or not they have to comply with the Directive in its entirety and will need detailed advice from legal counsel in the relevant EEA jurisdiction(s). Maples and Calder can assist in arranging that advice where clients do not have existing relationships.
The deadline for compliance in many cases was 22 July 2013; but due to the peculiarities of individual Member States’ interpretation or implementation of the Directive, it may be at a later date in certain countries. Again, clients should seek advice from appropriately qualified legal counsel in the relevant jurisdiction(s). Maples and Calder can assist in arranging that advice where clients donot have existing relationships.
A Manager who has no risk management or portfolio management operations in the EEA but actively markets their Cayman Funds in the EEA will need to comply with limited aspects of the Directive, in particular:
(a) Reporting obligations to regulators in the EEA (annual and periodic). Managers will need to put in place systems to collect and monitor certain information and processes to make periodic reports to the relevant EEA regulators;
(b) Disclosure obligations to investors. Managers will need to update or supplement their offering documents and periodically prepare and distribute reports to investors covering prescribed information; and
(c) (If relevant) obligations in relation to investment in EU non-listed portfolio companies, which might particularly impact private equity funds.
A Non-EU Manager will only be able to continue marketing their Cayman Fund in the EEA if the Non-EU Manager’s regulator and the Cayman Fund’s regulator (“CIMA”) have entered into the relevant cooperation arrangements with the EU Member State in which the Cayman Fund is to be marketed. CIMA has currently entered into cooperation agreements with 25 European regulators and is in the process of completing execution of the rest. Clients will need advice from legal counsel in the relevant EEA jurisdiction(s) where they intend to market their funds in order to ensure compliance with local marketing requirements under relevant national private placement regimes. Maples and Calder can assist in arranging that advice where clients do not have existing relationships.
A Manager who has no risk management or portfolio management operations in the EEA and does not actively market their Cayman Funds in the EEA, but only accepts EEA investors on a ‘passive placement’ or ‘reverse solicitation’ basis will not have to comply with the Directive. Clients should take advice from legal counsel in the relevant EEA jurisdictions in which investors who approach them are typically based to ensure that their interaction with EEA investors falls within this safe harbour. Maples and Calder can assist in arranging that advice where clients do not have existing relationships.
A Manager who has no risk or portfolio management operations in the EEA, does not actively market in the EEA, and only manages EEA investors’ money on a single investor basis (e.g. through a managed account or ‘fund of one’) will not have to comply with the Directive. Clients will need advice on whether the relevant managed account or ‘fund of one’ satisfies the requirements of the safe harbour provided for in the Directive, which applies a ‘look through’ test (e.g. to fund of funds, feeder funds and nominees) and may require amendments to the terms of the relevant structure to be compliant.
A Manager who wants to maximise marketing opportunities across the EEA will be able to obtain a ‘passport’ for marketing to ‘professional investors’ in the EEA if they establish an AIFMD compliant fund structure within an EEA jurisdiction. The passport will not be available to Non-EU Managers or Cayman Funds until at least 2015. Maples and Calder’s Dublin office can advise on the relevant opportunities and challenges in establishing such a structure.
Background
The Directive was due to be implemented by the 27 EU Member States and 3 EEA States on the 22 July 2013. It is supplemented by delegated regulation (Level 2) which will automatically apply across all 30 EEA States from the date of implementation of the Directive.
The Directive regulates the management of worldwide Alternative Investment Funds (“AIFs”) from within the EEA, the management of EEA AIFs from outside the EEA and the marketing of AIFs to investors domiciled or with a registered office in the EEA. The key definitions in Directive are “AIFM”, “AIF”, “managing” and “marketing”.
(a) AIF: any non-UCITS collective investment undertaking which raises capital from a number of investors, with a view to investing it in accordance with a defined investment policy for the benefit of those investors.
(b) AIFM: a legal person whose regular business is managing AIFs.
(c) Managing: means performing at least the investment management functions of portfolio management or risk management for one or more AIFs.
(d) Marketing: a direct or indirect offering or placement at the initiative of the AIFM, or on behalf of the AIFM, of units or shares of an AIF it manages to or with investors domiciled or with a registered office in the EU.
Every AIF must have a single AIFM which is responsible for ensuring compliance with the Directive, so there can only be one AIFM in any structure; hence the number of Managers, their domicile and the delegation arrangements are extremely important.
Analysis
Q1. Could the Directive apply to my business?
The Directive may apply to your business if you fit into any one of the following categories and cannot rely on an applicable exemption (see Q2 below):
(a) You manage one or more AIFs from within the EEA, irrespective of whether such AIFs are EEA AIFs or non-EEA AIFs and irrespective of whether they are marketed in the EEA (e.g. a London subsidiary of a US investment adviser which is managing a Cayman Fund);
(b) You manage one or more EEA AIFs (e.g. a US investment adviser to an Irish QIF). (This is beyond the scope of this update but is covered in a previous Maples and Calder update); or
(c) You market one or more AIFs in the EEA irrespective of whether such AIFs are EEA AIFs or non-EEA AIFs (e.g. a US investment adviser to a Cayman Fund).
Q1(a). Am I ‘managing’ an AIF from within the EEA?
If you, your affiliate or your delegate are conducting risk management functions or portfolio management functions for Cayman Funds from within an EEA Member State then you will need to consider whether or not you have to comply with the Directive. Identifying the relevant entity as the ‘AIFM’ in a fund structure is not always obvious but is critical to understanding the application of the Directive (or otherwise). You will need advice from legal counsel qualified in the relevant EEA jurisdiction(s) in which the management functions are performed. Maples and Calder can assist in arranging that advice where clients do not have existing relationships. The deadline for compliance could have been 22 July 2013, depending on the relevant jurisdiction. Advice should be obtained as soon as possible as the ramifications for your business could be substantial.
Q1(b). Am I ‘marketing’ an AIF in the EEA?
If you are seeking to raise capital in the EEA then you will need carefully to consider whether your capital raising activities constitute ‘marketing’ for the purposes of the Directive. A client who would otherwise be entirely outside scope of the Directive will trigger compliance obligations under the Directive if they, or anyone on their behalf, are ‘marketing’ an AIF to EEA investors.
The definition of marketing contemplates active marketing; i.e. it requires an offering or placement at the initiative of the AIFM (or on its behalf). It does not include capital raising at the initiative of the investor, or what is commonly termed ‘passive placement’ or ‘reverse solicitation’.
The Directive does not provide further guidance on the distinction between ‘active’ and ‘passive’ marketing and therefore it will fall to each Member State to determine the scope and limits of this ‘grey area’ upon implementation. Clients will therefore need to obtain advice from legal counsel in the EEA jurisdictions in which they propose to accept investors in order to ensure that they understand the scope of this safe harbour. Maples and Calder can assist in arranging that advice where clients do not have existing relationships.
Q2. Can I rely on any exemptions to stay outside scope of the Directive?
Even if the Directive potentially applies to your business, a number of key exemptions are available. The main exemptions are summarised below and a full list of the exemptions is set out here
Stop active marketing in the EEA
Following from the above, Non-EU Managers can avoid compliance with the Directive if they:
(a) stop taking investments from investors domiciled or with a registered office in the EEA; or
(b) only raise capital from investors in the EEA on a ‘passive’ or ‘reverse solicitation’ basis; or
(c) only accept capital from existing EEA investors in existing funds (provided they do not engage in further marketing to those investors).
Manage EEA Investments through Single Investor Structures
Investment structures which do not raise capital ‘from a number of investors’, such as managed account fund structures and ‘funds of one’, fall outside the definition of an AIF and therefore do not trigger compliance obligations. However, the European Securities and Markets Authority (“ESMA”) has indicated that this exemption will only be available where there is an enforceable obligation (whether under national law, under the fund’s rules or instruments of incorporation or under any other provision of binding legal effect) which restricts the sale of units / shares of the relevant fund to a single investor. It will not be sufficient if there is a single investor as a matter of fact without also complying with this technical requirement.
ESMA has also indicated that the test for the single investor exemption will be applied on a ‘look through’ basis, so that it will not be available if the investment itself is made by collective investment vehicles (such as nominee arrangements, funds of funds or feeder funds).
Clients should seek advice on whether their single investor structures are compliant with this exemption; whether those structures will require amendments to their constitutive documents in order to comply; and whether they will satisfy the ‘look through’ test suggested by ESMA.
Rely on a specific exemption
AIFMD exempts certain specific categories of investment vehicles, including intra-group investments, pension funds, holding companies, Government and supra-national entities, national central banks, employee savings schemes, family office vehicles and UCITS funds.
AIFMD also exempts certain categories of securitisation special purpose entities. However, the scope of the exemption is very narrow and referenced to a specific EU regulation so the applicability would need to be assessed on the individual facts.
Finally, there are some useful transitional arrangements particularly in the context of closed-ended and private equity funds. These apply to closed-ended AIFs which are fully invested prior to 22 July 2013; and there is also a partial exemption for funds which are terminating prior to 21 July 2016. However, the transitional provisions will be narrowly construed and AIFs which are capable of falling within these exemptions will need to take care not to obviate them by making follow-on investments or carryingout other business outside the prescribed limits.
Q3. If you are in scope and no exemptions apply, what are your marketing options?
A Non-EU Manager of a Cayman Fund has the following options to market that fund in the EEA:
Continue to market to professional investors in the EU on a private placement basis
Currently, marketing to EEA investors is governed by individual Member State national law. For Non-EU Managers of Cayman Funds, that approach will continue until at least 2018, provided that:
(a) appropriate cooperation arrangements are in place between the relevant regulators to ensure effective enforcement of the Directive (“Cooperation Agreements”); and
(b) the Fund and Manager’s jurisdiction are not listed as a ‘Non-Cooperative Country and Territory’ by the Financial Action Task Force on anti-money laundering and terrorist financing (“FATF Compliance”).
Exactly who the cooperation agreements must be between depends on the location of the fund, the Manager and the country in which the Fund is to be marketed. In the case of a Non-EU Manager of a Non-EU Fund, the cooperation arrangements will need to be between the Manager’s regulator (e.g. the SEC), the Fund’s regulator (e.g. CIMA) as well as the regulators in each of the EEA Member States in which the Fund will be marketed (e.g. the FCA).
The Cayman Islands have agreed the form of the required cooperation arrangements with ESMA on behalf of the EU Member States. The model agreement is now in the process of being executed by each of the relevant Member States and Non-EEA countries (“Third Countries”), including the Cayman Islands. Currently, CIMA has completed the execution of cooperation agreements with 25 European regulators in the following countries:
• The Netherlands
• France
• Belgium
• Ireland
• Portugal
• Romania
• Luxembourg
• Cyrpus
• Czech Republic
• Sweden
• Finland
• Denmark
• Latvia
• Estonia
• Poland
• United Kingdom
• Bulgaria
• Greece
• Malta
• Slovak Rupublic
• Hungary
• Iceland
• Norway
• Liechtenstein
• Lithuania
Other EU Member States still to sign agreements with the Cayman Islands are Austria, Germany, Italy, Slovenia and Spain and CIMA is in the process of entering into them as soon as possible. We will update clients as to the progress of the execution of the balance of the cooperation agreements in relation to the Cayman Islands and the BVI.
If a Non-EU Manager chooses to market its Cayman Funds in the EEA using the national private placement regimes, then that will trigger the obligation to comply with the ‘Transparency Requirements’ (see further below) and, where relevant, the ‘EU Private Equity Requirements’ of the Directive.
However, Non-EU Managers will not have to comply with any other aspects of the Directive, including remuneration restrictions, leverage restrictions or depositary requirements.
Transparency Requirements
The Directive imposes certain requirements in relation to reporting to regulators and disclosure to investors, which are known as the ‘Transparency Requirements’. If a Non-EU AIFM wants to market its Cayman Fund to investors in the EEA using existing national private placement regimes it may need to comply with these requirements from 22 July 2013.
The Transparency Requirements are set out in detail here and summarised in the list below.
– Total remuneration for the financial year, split into fixed and variable remuneration, paid by the AIFM to its staff, and number of beneficiaries, and, where relevant, carried interest paid by the AIF; and
– The aggregate amount of remuneration broken down by senior management and members of staff of the AIFM whose actions have a material impact on the risk profile of the AIF.
Pre-investment disclosure to investors
Periodic disclosure to investors
• Must, for each EU AIF managed / each AIF marketed in the EU, periodically disclose details of:
– Any illiquid assets which are subject to special arrangements (i.e. side pockets);
– Any change to the AIF’s liquidity position (e.g. activation of gates, redemption suspension);
– AIF’s risk profile; and
– For leveraged AIFs, the total leverage and any changes to the maximum leverage / rehypothecation rights.
• Must be provided as often as required by AIF’s rules and, at a minimum, at same time as annual report.
Reporting to regulators
EU Private Equity Requirements
Additional notification and disclosure requirements, together with provisions preventing asset-stripping, apply in respect of AIFMs which engage in the takeover of unlisted EU companies. The full extent of these requirements is set out here.
Establish an EU AIFM now to take advantage of immediate AIFMD passport
If a Non-EU Manager wants to materially expand its ability to market across the EEA, then the second marketing option would be to establish an EEA fund structure that will benefit from the pan-EEA marketing passport. That may assist not only in expanding distribution across the EEA in the short term, but will also guard against any potential restriction on Member States’ national private placement regimes in future. In our experience, it may also assist in securing investment from certain types of EU investors (such as European pension plans or insurance companies).
Until at least July 2015, only EEA AIFMs of EEA AIFs will be eligible for the marketing passport. Consequently, a Non-EU Manager of a Cayman Fund (or, indeed, any other fund) will not be able to access the passport until at least 2015 unless it restructures its management entity and fund structure so that both are EU domiciled.
There are various ways in which an AIFMD compliant fund structure can be established to take advantage of the passport. Our Dublin office would be happy to advise on the relevant process, challenges and opportunities.
Wait and see whether the AIFMD passport is made available to Third Countries
In July 2015, ESMA will recommend whether or not the passport regime should be extended to Third Countries.
If the passport regime is extended to include Third Countries then there will be a period of a further three years where Non-EU Managers may choose whether or not to apply for the passport or to continue to use national private placement regimes; after which those private placement regimes will fall away and Third Country Funds and Third Country Managers will only be able to market in the EU with a passport. If it is decided that the passport regime should not be extended to Third Countries then the private placement regimes will continue indefinitely.
If the passport is ‘turned on’ for Third Countries then, in addition to the Cooperation Agreements and FATF Compliance that are required for private placement (above), in order to obtain a passport the relevant Third Country will need a tax information exchange agreement (“TIEA”) in accordance with OECD requirements in place with each jurisdiction in which the non-EU Fund will be marketed. The Cayman Islands currently has 30 such TIEA’s in place, including such EEA Member States as the Czech Republic, Denmark, Finland, France, Germany, Iceland, Ireland, Italy, Netherlands, Norway, Portugal, Sweden and the United Kingdom.
If a non-EU Manager wants to access the passport it will also have to ‘opt in’ to comply with the Directive. To do so, it will have to effectively ‘adopt’ an EU home, called a ‘Member State of reference’. This will entail the Manager applying to a particular EU regulator for authorisation; submitting to that EU regulator’s supervision in respect of its compliance with the terms of the Directive; and appointing a legal representative in the relevant EU Member State to act as a point of contact with that EU regulator. We will update clients further on this process once it is known whether or not the passport regime is to be extended to Third Countries.
Conclusion
We have set out here a summary of how Non-EU Managers will be affected in respect of the management and marketing of both EU and non-EU AIFs.
As this illustrates, there is no ‘one-size fits all’ answer for Non-EU Managers who are formulating their distribution strategy in the EEA. Clients will need to analyse their current fund structures, delegation arrangements, target investors and the relevant national private placement regimes across the EEA in order to determine what works best for them.
For certain clients, it may be that raising capital in the EEA only by reverse solicitation or through single investor structures is sufficient against the background of the Transparency or Private Equity Requirements that would otherwise arise by virtue of marketing a fund in the EEA.
For others, the limited nature of the Transparency and Private Equity Requirements may not put them off actively marketing their Cayman Fund in the EEA under the national private placement regimes.
For still others, the opportunity presented by the marketing passport to access professional investors across the EEA for the first time may be sufficiently attractive for them to ‘opt in’ and obtain authorisation for an AIFMD-compliant EEA fund structure.
We would be delighted to work with our clients and their existing legal counsel in the US, EU and beyond to ensure that their fund structures are ‘fit for purpose’ in a post AIFMD Europe.