The FSA has issued a Consultation, CP12/32, on Implementation of the Alternative Investment Managers Directive. This is the first of two planned FSA consultations on rules and guidance to transpose the requirements of the Alternative Investment Fund Managers Directive (AIFMD) into UK law, which must be done by 22 July 2013. The FSA has little scope for discretion in how it does this, because AIFMD is mostly a maximum-harmonising directive, but Member States of the EU are allowed a limited number of options or derogations.
The FSA states that it has taken “a coherent copy-out approach to transposition, following the words of the Level 1 text as closely as possible while trying to ensure that rules and guidance are expressed in clear language and organised in a logical way”, which could be read as a sly dig at the fact that the Level 1 text is itself not always so expressed. This briefing summarises some key points from the Consultation.
Delay and FSA approach
Implementing AIFMD depends on the completion of a number of other areas of work being carried on at the European level. The delay that has occurred in completing this work affects what the FSA is able to address in the Consultation.
In particular, theEuropean Commission regulation (the Level 2 Regulation) specifying much of the detail with which AIFMs, depositaries and others will have to comply, a key element in implementing the AIFMD, has not been issued. Despite this obvious difficulty, the FSA has clearly endeavoured to be helpful to firms grappling with AIFMD implementation by publishing the Consultation now, at least on the matters where it believes there is sufficient certainty to do so. Thus the Consultation addresses:
• The prudential regime for all types of AIFM, including capital requirements, risk of professional negligence, the liquid assets requirement and reporting matters, as well as changes affecting UCITS management companies;
• The regime for depositaries, including the eligibility of firms to be an AIF depositary, the capital requirements, and the requirement to act independently; and
• The Level 1 AIFMD requirements on AIFMs, including organisational matters, duties in relation to management of funds, and transparency obligations towards investors and the FCA.
The prudential regime for AIFMs and the regime for depositaries are the areas where the FSA has to make choices about the best way to implement the AIFMD. In transposing other parts of the AIFMD by “copy-out”, it has generally avoided “gold-plating”.
Matters covered in the Consultation
Chapter 2 sets out the FSA’s approach to consultation and transposition, in the context of both the European process and the reform of UK financial regulation due in the first part of 2013, which is when the FSA expects to be replaced by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA). Chapter 3 describes the FSA’s current understanding of the scope and application of the AIFMD to firms, and the areas in which further clarification is needed.
Chapter 4 explains the requirement to be authorised under the AIFMD, and the effect of the changes that the Treasury will propose making to certain regulated activities. Chapter 5 describes the FSA’s proposals for the prudential regime applicable to AIFMs, as well as consequential changes affecting UCITS management companies.
Chapters 6, 7 and 8 describe how the FSA intends to copy into the FSA’s Handbook the other main Level 1 requirements of the AIFMD affecting the organisation and management activities of AIFMs, and the information they will need to disclose to the FSA and to investors.
Chapter 9 describes the FSA’s proposals for firms acting as depositaries. Chapter 10 briefly explains some of the key issues relevant to the marketing of AIFs, which the FSA will explain in more detail in the second part of the consultation (CP2). Each chapter outlines the following, where appropriate:
• The AIFMD article(s) being transposed;
• The new rules firms must comply with under AIFMD and any related guidance;
• The policy intention and its expected effect on firms;
• Matters where the FSA proposes, or is required, to make a discretionary decision;
• Where it is clear, any existing requirements of the FSA’s rules that will be disapplied for AIFMs;
• Whether an issue is likely to be affected by the Level 2 Regulation or expected ESMA guidelines; and
• Where an issue is not covered in this paper but is planned to be included in CP2.
The Consultation also contains the FSA’s cost benefit analysis, including some relatively detailed figures on the likely initial and ongoing AIFMD compliance costs for firms, which firms may read with interest.
A full scope UK AIFM will need to be authorised under Part IV of FSMA by the FCA. Firms that already hold a Part IV permission to carry on a regulated activity and consider they should be authorised as an AIFM, may seek avariation of permission (VoP). The FSA is considering whether it might apply a “grandfathering” process to VoPs for those firms currently holding the permissions of operating a CIS or acting as sole director of an OEIC, and will tell firms in due course what it intends to do. Some firms with the Part IV permission of managing investments may decide they should also be authorised as AIFMs.
The FSA expects to assess these applications for VoPs on an individual basis. The FCA does not expect to begin accepting applications for authorisation or a VoP from prospective AIFMs before 23 July 2013. In the ordinary course, where an applicant provides all the relevant information, the FSA will determine an application for authorisation or VoP within the three-month period specified in the AIFMD.
Prudential requirements for AIFMs
An AIFM that provides MiFID services is required to comply with specified provisions of MiFID. The FSA has considered to what extent this means the firm is subject to the Capital Adequacy Directive (CAD). The FSA indicates it will apply the same interpretation as for UCITS investment firms when the FSA implemented the UCITS Directive, meaning an AIFM that provides MiFID services is a BIPRU limited licence firm, but only subject to the pillar 1 requirements of BIPRU for its designated investment business. The alternative, less favoured by the FSA, would be to apply the capital requirements of AIFMD only, meaning the FSA would not need to apply the rest of the CAD and would treat an AIFM undertaking MiFID activities in the same way as one that did not undertake such business.
The FSA anticipates that some AIFMs will use professional indemnity insurance (PII) to meet the Article 9(7) AIFMD requirement. The FSA does not expect the Regulation to make any reference to potential policy exclusions so it proposes that a firm should maintain adequate own funds to cover any exclusions in the insurance policy.
In the context of investment of own funds, the FSA propose that a proportionate interpretation of the term “assets readily convertible to cash in the short term” is those that could be realised for cash within one month. The FSA has suggested, as guidance, that acceptable assets include cash, readily realisable investments that are not held for short-term resale and debtors. The firm could also include any other assets that fall within the definition, but would need to be able to demonstrate that it could practically realise the relevant asset within one month.
Here, the FSA has stressed that the Commission’s decision to implement most of the Level 2 measures through a directly-applicable Regulation has meant that the FSA now has no national discretion in many areas where questions about the costs and benefits of policy options might otherwise have determined its course of action. The FSA notes that many respondents to its discussion paper DP12/1, published in January 2012, voiced concerns about the costs of appointing a depositary where none currently exists, but explains that the FSA cannot alleviate costs that are a consequence of the AIFMD’s investor protection measures.
On one area where the FSA has some discretion, the interpretation of the requirement for an AIFM and depositary to act independently, the FSA proposes that an AIF other than an authorised fund, or its AIFM on its behalf, should be able to appoint an affiliate of the AIFM as depositary if it meets the AIFMD requirements and there is proper management of any conflicts of interest.
This is a key area of the AIFMD, believed to be the issue delaying the Level 2 Regulation. The Level 1 Directive specifies that an AIFM must not delegate its functions to the extent that it can no longer be considered to be the manager of the AIF, but will instead be considered by its competent authority to have become a “letterbox entity”. The Level 2 Regulation is likely to specify in considerably more detail the considerations the FSA should take into account when the FSA assess whether a “letterbox entity” would result from an AIFM”s proposed delegation arrangements. The Commission may impose requirements additional to those advised by ESMA in its technical advice.
At the time of publishing this paper, the FSA cannot say with any legal certainty how the FSA might assess a proposed delegation. The FSA has nonetheless been considering the line at which appropriate delegation should be drawn to avoid an improper delegation by an AIFM to a delegate entity, whether that entity is within the internal market or offshore.
The FSA envisages that the assessment of a “letterbox entity” should principally be a qualitative rather than a quantitative test. The FSA hope that the Level 2 Regulation has been issued or adopted by the time of publication of the FSA’s second AIFMD consultation. At that time, given that the more detailed requirements for delegation will be settled, the FSA will give firms a further steer as to how the FSA will exercise the FSA’s supervisory judgement in relation to proposed delegation arrangements and what factors might result in an AIFM becoming a “letterbox entity”.
Definition of marketing
DP12/1 posed several questions about marketing AIFs. The FSA states that respondents generally argued that certain communications and practices such as reverse solicitation, secondary transactions or communications about net asset values should not be considered marketing.
The Directive definition of “marketing” is “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 Union”. The FSA intends to transpose this definition into the Glossary of its Handbook.
As the FSA notes, despite the overlap between the concepts of marketing under the AIFMD and a promotion under the FSMA financial promotion orders, marketing under the AIFMD contains distinctive features outside the FSMA definition. In particular, the prohibitions on financial promotions do not include the AIFMD concept on “the placing of units or shares of an AIF with investors”, while some activities of placement agents to promote new AIFs may not be included in the AIFMD concept.
Alignment with reform of the FSA
The FSA is preparing for AIFMD at the same time as undergoing significant strategic and operational change under the government’s regulatory reform programme. The principal outcome is that the FSA is expected to be split into the FCA and the PRA in 2013. The Financial Services Bill, which gives effect to these changes, is likely to become law in Q1 2013, with the two new regulators expected to assume their responsibilities on 1 April 2013.
Under the Financial Services Bill 2012, an AIFM will be subject to both conduct and prudential regulation by the FCA. This will also generally be the case for depositaries; however, systemically important depositaries such as major banks will be prudentially regulated by the PRA.
Conclusion and next steps
The deadline for responses to the Consultation is Friday 1 February 2013. This consultation period is slightly shorter than the three months the FSA would normally aim to give stakeholders, because of the need to finalise rules and guidance as early as possible before 22 July 2013.
The FSA intends to publish CP2 in February 2013. This will include:
• Scope issues (including further clarifications on scope of AIFMD; regimes for sub-threshold AIFMs; the authorisation/registration process for firms that are not full scope UK AIFMs and AIFMs carrying on additional activities under Artic••le 6(4) AIFMD; and final transitional provisions);
• The retail regime (regimes for NURS, QIS and UCITS schemes; and marketing to retail investors);
• The regime for marketing to professional investors;
• Further clarification on Level 2 delegation requirements, including supervisory assessment of “letterbox entity”;
• AIFMD provisions applicable principally to private equity fund managers.
• Fee-raising arrangements for firms within scope of AIFMD;
• Reporting processes for firms within scope of AIFMD;
• Restructuring of Handbook rules into FUND sourcebook and transitional rule for deletion of UPRU; and
• The position for depositaries of AIFs managed by sub-threshold AIFMs.
The exact timing depends on several factors, including the further development of the Treasury’s regulations, the timing of any further consultation the Treasury expects to carry out, and the further progress of European work on AIFMD. CP2 will have an eight-week consultation period, rather than the usual three months because of the nearness to the July 2013 implementation deadline.
The FSA intends to publish one Policy Statement, relating to both parts of its consultation, in June 2013. The exact timing, including the point at which the Board of the FCA will be able to make final rules and guidance, will depend on external factors, including when the Treasury regulations become law.
The FSA will consider how we might give feedback at an earlier date on key issues arising from the consultation, to help stakeholders prepare for implementation.
Lucy Frew is head of Gide London’s Investment Funds and Financial Regulation practice. She is a senior financial services lawyer specialising in financial services regulation and investment management.