The Alternative Investment Fund Managers Directive which became effective on 22 July 2013 not only represents a sea change in the regulation of managers established in Europe but also has significant effects on managers outside of Europe. Much has already been written in relation to the restrictions on the marketing of alternative investment funds (AIFs) by non-EU managers to EU-based investors but another aspect of the Directive that has received less attention but which has a material impact on non-EU managers is the appointment of delegates, both where an EU manager seeks to appoint a non-EU delegate and where a non-EU manager seeks to appoint an EU delegate.
This article examines some of the key elements of the new regime under the Directive relevant to the appointment ofdelegates and focuses on the practical implications both for non-EU managers and non-EU delegates.
Non-EU delegates of EU managers
EU managers may, provided they have first notified the relevant competent authority of their home Member State, delegate one or more of their functions to a delegate. Three key principles apply where a manager seeks to appoint a delegate:
The obligations placed on EU managers when appointing delegates will have an impact on, and a number of practical implications for, non-EU delegates appointed by EU managers. These are discussed below.
EU delegates of non-EU managers
Where a non-EU manager appoints an EU delegate, consideration will have to be given to which of the entities is deemed to be the manager. Where the functions delegated to the EU delegate include both portfolio management and risk management, the EU delegate could potentially be characterized as the manager under the Directive. The main consequences of the EU delegate being characterized as the manager are that first, the EU delegate will need to be authorised by the relevant competent authority and have the necessary permissions to undertake the portfolio management and risk management functions, second, that the restrictions on remuneration will apply to the EU delegate and third, that a depository will have to be appointed on behalf of each AIF (whether EU-based or not) that the EU delegate is deemed to be managing. These are more onerous requirements than the disclosure, transparency and reporting requirements that apply to non-EU managers.
Where a manager delegates both the portfolio management and risk management functions to the extent that it effectively becomes a mere “letter-box entity”, the delegate to whom such functions have been delegated will likely be characterized as the manager. The delegation of only one of the portfolio management or risk management functions will not give rise to this risk. Although the anti-letter-box provisions apply to EU managers and not to non-EU managers delegating to EU delegates, non-EU managers should be prepared to be able to make the case to a competent authority that it has not delegated to an EU delegate to such an extent that the non-EU manager would be deemed to be a letter-box entity. The Delegated Regulation sets out four situations in which a manager would be viewed as a letter-box entity. These are where the manager:
How competent authorities in the different Member States intend to apply these criteria remains to be seen. In the UK, for example, the Financial Conduct Authority has noted that, notwithstanding the criteria set out in the Delegated Regulation, in its view “[t]he importance of tasks carried out by the manager is a key consideration, taking particular account of the right and ability of the manager to exercise oversight and control and the degree to which those rights are exercised.” Parties should therefore consider taking local counsel’s advice in relation to any structure that could potentially be viewed as falling afoul of the anti-letter-box provisions.
The European Commission has been tasked with monitoring the application of the anti-letter-box provisions and their impact on the market. The Commission is obliged to review the situation in 2015 and where necessary take appropriate measures to further specify the conditions under which an entity will be deemed to have become a letter-box entity.
Remuneration and non-EU delegates
In its February 2013 Guidelines on sound remuneration policies under the Directive, the European Securities Markets Authority suggested that delegates to whom portfolio management or risk management activities have been delegated be “subject to regulatory requirements on remuneration that are equally as effective as those applicable under [the] guidelines.” The Guidelines alternatively provide that appropriate contractual arrangements be put in place with such delegates to ensure that there is no circumvention of the remuneration requirements, with such arrangements covering any payments made to a delegate’s identified staff in respect of portfolio management or risk management carried out on behalf of the manager. This requirement can be interpreted in one of two ways:
If the first view is taken, the consequences to the delegate are considerable as the Directive imposes considerable restrictions on compensation. It could be argued that the concept of extending the remuneration requirements to non-EU delegates extends the scope of the Directive beyond the original legislative intent and as such could be subject to legal challenge.
If the second view is taken, a legitimate delegation of the portfolio management or risk management function to a non-EU delegate would not result in restrictions on the delegate’s compensation.
It is unclear at the time of writing which approach the various Member State competent authorities will take with respect to the Guidelines. Managers and delegates should, in the absence of clear guidance from the relevant Member State competent authority, engage with local counsel in the relevant Member State to determine an approach to this issue.
The Directive, including the provisions relating to delegation, became effective on 22 July 2013. A number of jurisdictions, including the UK, have adopted transitional measures which mean that, in certain circumstances, these provisions will not fully apply until 22 July 2014.
Manager: an entity that undertakes portfolio management (i.e., discretionary management of portfolios) and/or risk management (i.e., operational risk). In the US context the manager is likely to be either the general partner of the fund if it has investment discretion or a separate entity appointed to act as manager.
AIF: an alternative investment fund – a collective investment undertaking, not including UCITS funds, that 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.
Delegate: any entity to whom the manager has delegated all or part of the portfolio management or risk management functions. Note, however, that to the extent that an entity is merely providing investment advice to the manager of the AIF and does not exercise any discretion over the AIF then it would not be a delegate. Delegation of portfolio management or risk management to a depositary or a delegate of a depositary is prohibited in view of the potential conflict of interest (a depositary’s functions are broader than just those of a custodian and include monitoring the AIF’s cash flows, ensuring that the value of shares or units in the AIF are correctly calculated and that the AIF’s income is correctly distributed).
Directive: Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers.
Delegated Regulation: Commission Delegated Regulation (EU) No 231/2013 of 19 December 2012 supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision.
Nora Jordan is the head of Davis Polk’s Investment Management Group. She was named one of the “50 Leading Women in Hedge Funds” by The Hedge Fund Journal in 2013.
Richard Small is regulatory counsel in Davis Polk’s London office. He works closely with the Investment Management Group advising alternative investment funds on a wide variety of regulatory issues.