On 28 June 2013, the UK Financial Conduct Authority (FCA) published its policy statement on the implementation of the Alternative Investment Fund Managers Directive (AIFMD). The new rules transposing the provisions of the AIFMD are supplemented by the additions to the FCA Perimeter Guidance (PERG) which provide useful insights to a number of important policy decisions taken by the FCA in interpreting the provisions of the directive.
The FCA has approached the implementation with a considerable degree of pragmatism. The FCA’s views on regulating marketing activities, in particular, signal the intention to preserve the ability of UK professional investors to access a broad choice of funds in which they may invest.
Although the FCA was constrained in its interpretation by the express provisions of the AIFMD and the Level 2 Regulation,1 it is clear that a concerted effort was made to match the various provisions of the AIFMD to the realities of alternative asset management practices and, where possible, to ensure a proportionate application of the various requirements to UK managers of alternative investment funds (AIFMs).
This article highlights some of the aspects of the new FCA regime for AIFMs that would be of particular interest to both UK-based managers, and non-EU managers that market their funds to UK investors.
Definition of AIF
PERG contains a detailed discussion of the definition of an alternative investment fund (AIF) and the types of schemes (including joint ventures, co-investment and carried interests vehicles) that may or may not constitute an AIF. Building on the European Securities and Markets Authority’s (ESMA) guidelines,2 the FCA has clarified some of the key elements of the AIF definition. In relation to single-investor funds, for example, PERG states that a fund formed as a limited partnership would not be an AIF, if it only allows a single investor and the general partner is only making a nominal capital contribution (while the sole limited partner is making a substantive contribution of capital).
Further clarity has been provided on the FCA’s approach to umbrella fund structures. In the FCA’s view, sub-funds of an umbrella fund should normally be viewed as compartments of a single AIF, rather than separate AIFs, at least for the purposes of the “single AIFM” requirement (so that a single AIFM is appointed for the entire umbrella structure). The policy statement, however, provides that for marketing (e.g., registration for the purposes of the UK private placement regime) and FCA reporting purposes, these compartments may be treated as separate AIFs. The latter statement mirrors the draft reporting guidelines released by ESMA which provide that reporting to EU member state regulators (e.g., as a condition for marketing AIFs under the private placement regimes) should be carried out at a sub-fund level, rather than for the umbrella fund as a whole.3
PERG explains the FCA’s views on the application of the “letter-box entity” rule, including in the context of AIFMs based outside the EU (e.g., Cayman Islands management companies) which delegate their functions to UK managers.
The AIFMD does not contemplate the possibility of an AIF with multiple co-managers or investment advisers and requires that a single AIFM should be appointed by or on behalf of each AIF. Such an AIFM must be responsible for compliance with the AIFMD and for “managing” the AIF (defined in the AIFMD as carrying on portfolio management and/or risk management functions). Any other investment managers of the AIF would be “delegates” of the AIFM.
Although the AIFMD permits an AIFM to delegate its portfolio management and/or risk management functions, it may not do so to the extent that it becomes a “letter-box” entity and can no longer be considered the AIFM, in which case the delegate becomes the AIFM. Article 82 of the Level 2 Regulation provides detailed guidance on the criteria that must be met by an AIFM to show that it is not a letter-box, including that an AIFM must retain effective oversight and control over the delegated functions and may not delegate to the extent that the delegated functions exceed the functions retained by the AIFM “by a substantial margin”.
The application of the “letter-box entity” test to third-country (that is, non-EU) AIFMs that delegate their functions to EU AIFMs is unclear under the AIFMD. In any case, it is questionable how any EU regulator would be able to apply and enforce this test in relation to third-country AIFMs it does not regulate. In a step to curb the circumvention of the AIFMD by UK managers establishing offshore “letter-box” management companies, the FCA has clarified that it would require a UK-based sub-manager to demonstrate to the FCA that the third-country AIFM is not a “letter-box” by reference to the Article 82 test and, accordingly, that the UK entity is not the AIFM (but is merely a delegate of an AIFM).
PERG provides that, in these circumstances, it is less important that every condition in Article 82 is met, the key considerations being the importance of the tasks delegated to the sub-manager and the rights and ability of the AIFM to exercise oversight and control. The FCA does not specify how it intends to supervise or enforce compliance with these requirements. Firms that apply for FCA authorisation to manage investments (e.g., as MiFID portfolio managers) may be the first to be challenged by the FCA on this point.
As a separate point, PERG states that a UK AIFM that becomes a “letter-box” (e.g., by delegating all of its investment management functions to another manager) will still be carrying on the regulated activity of “managing an AIF” and be required to be authorised by the FCA as an AIFM.
These statements in PERG are likely to indicate that the FCA has adopted a rather formalistic approach to determining which entity is the AIFM within the overall structure. That is, if a UK firm is appointed as an investment manager by a fund, then the presumption is that it is carrying on the regulated activity of “managing an AIF” as the AIFM, even if, in practice, it does not provide the AIFM services to that fund. UK managers should conduct a comprehensive review of all of their investment management, portfolio management and advisory mandates to determine whether they may be considered to be carrying on the regulated activity of managing the relevant AIF based on this analysis.
UK firms that only provide sub-management, portfolio management or advisory services should ensure that the relevant agreements and investor disclosure documentation reflect the delegation arrangements, as appropriate. Fund documentation may need to be updated or, as an alternative, separate agreements in relation to compliance with the AIFMD may need to be put in place giving control and oversight powers to the entity designated as the AIFM.
UK managers that are part of a group may also need to assess the effects of the AIFMD delegation from a tax perspective, including any existing transfer pricing analysis.
Marketing an AIF
The FCA’s view is that the concept of “marketing” in the AIFMD has a specified meaning that is different, in some respects, from the ordinary meaning of the word. The activities that constitute “marketing” for these purposes – “offering” and “placement” – are not defined in the AIFMD. In the FCA’s view, an offering or placement takes place when an AIFM or a person acting on its behalf raises capital for the AIF by making its units or shares available for purchase by an investor (such as in the case of an invitation to subscribe). Notably, the FCA does not consider that a secondary transfer of units or shares in an AIF is “marketing” for the purposes of the AIFMD, because such transfers do not generally constitute capital-raising for the AIF. The only exception is where units or shares are temporarily purchased by a third-party underwriter or a placement agent, acting at the initiative, or on behalf of, the AIFM.
PERG also explains the concept of “indirect” offering or placement in the AIFMD. Such “indirect” marketing exists where an AIFM distributes AIF shares or units through a chain of intermediaries. PERG clarifies that a distributor may only offer or place shares in an AIF, if the AIFM would be permitted to do so (e.g., by registering with the FCA for the purposes of the AIFMD private placement regime). Some questions still remain unanswered by the guidance; for example, whether an investment adviser (that receives trail fees or other form of commission from the AIFM) would be “marketing” on behalf of the AIFM if he recommends an AIF investment to its client.
In a very pragmatic policy move, the FCA has clarified that any communications with investors on the basis of draft fund documentation, such as a promotional presentation or a draft version of the private placement memorandum would not constitute an offer or placement within the scope of the AIFMD. The rationale for this policy decision is that an AIFM may only notify the FCA that it intends to market an AIF for the purposes of the AIFMD when all of the fund documentation is in final form. The only reservation is that the AIFM must not accept investments on the basis of such draft documentation, if it wishes to benefit from this safe-harbour.
Marketing at the initiative of the investor
Offering and placement of shares or units in an AIF made “at the initiative” of the investor is outside the scope of the AIFMD marketing rules. The FCA has decided to abandon the onerous test for “passive marketing”, which appeared in the earlier draft of PERG,4 in favour of a simple statement that a confirmation from the investor that the offering or placement was made at the investor’s initiative should generally be sufficient.
Firms that intend to rely on “passive marketing” investor representations in subscription documents should bear in mind that such a representation must be factually correct in all circumstances. It is unlikely that the inclusion of a self-serving statement of this nature would hold up to regulatory scrutiny. Indeed, the FCA has warnedfirms that they will not be able to rely on such a confirmation, if it was obtained to circumvent the requirements of the AIFMD. Managers should also be aware that investor subscriptions entered into in violation of the AIFMD marketing restrictions may be unenforceable and the UK investor may be entitled to compensation from the manager (including any amounts originally invested).
As expected, the new rules and guidance do not yet fully address how the FCA intends to apply remuneration provisions of the AIFMD to UK AIFMs. The FCA has announced that it will comply in full with the ESMA remuneration guidelines5 (including the controversial guidance on the application of remuneration rules in the context of delegation) and is planning to consult on the proportionality framework for the application of the remuneration requirements in September 2013. This will, hopefully, take account of the potential impact that the ESMA guidelines could have on the UK alternative investment fund management industry and help to ensure that the UK continues to be an attractive place for managers of AIFs to establish their businesses.
Anna Maleva-Otto is a counsel in Akin Gump’s investment funds practice based in London. She advises asset managers on a range of UK financial services regulatory matters, including the impact of EU directives and regulations.