Complex and controversial, the Alternative Investment Fund Managers Directive has finally emerged, with huge regulatory implications for global funds. Legal Business asks if offshore jurisdictions can chart their way through
In force since 22 July, the EU directive on alternative investment fund managers (AIFMD) marks a huge change to the European private equity and venture capital industry. Developed to regulate hedge funds and private equity and the promotion of alternative investment funds within the EU, the AIFMD is set on advancing the stability and transparency of investment vehicles.
AIFMD – an overview
Those managing an EU alternative investment fund (AIF) – or marketing an EU/non-EU AIF in the EU – are now subject to the provisions of the EU directive on alternative investment fund managers (AIFMD). Managers of such funds established outside of the EU will not be fully affected by the directive if no marketing of their interests is carried on within the EU after 22 July 2013.
Key features of the AIFMD include EU alternative investment fund managers (AIFMs) being required to appoint a depositary to each AIF they manage – such depositaries must be established in the same member state as the fund. For non-EU AIFs, the depositary may be established in the same country as the fund, the home member state of the manager, or their member state of reference.
Other significant elements include those managers established in the EU, which are subject to the directive, being able to market their funds into the EU with the benefit of an EU-wide marketing passport; non-EU AIFMs will not gain a passport.
EU-wide marketing passports will not be available to non-EU AIFMs until 2015 at the earliest, when the European Securities and Markets Authority (ESMA) will review the passporting regime with a view to recommending that it be extended to the non-EU AIFMs.
Meanwhile, the non-EU AIFMs will enjoy the EU member states’ national private placement rules subject to the non-EU country (third country) in which that AIFM is established having co-operation agreements in place between the EU member state into which the fund is to be marketed and the third country.
Furthermore, to benefit from the placement rules the third country cannot be listed as a non-co-operative country and territory by the Financial Action Task Force on anti-money laundering and financing of terrorism and the directive’s transparency, reporting and acquisition of control provisions apply to non-EU AIFMs as they do for the EU managers.
Even if non-EU AIFMs do gain an EU-wide passport from 2015, the directive anticipates that they will be able to market under the private placement rules until at least 2018. During 2018, marketing under the member states’ placement rules is likely to come to an end, and non-EU AIFMs will be fully subject to the directive.
The directive requires AIFMs to invest substantial resources to ensure compliance. Consequently, the increased regulatory scrutiny and compliance obligations put greater pressure on fund managers, and increases their need to utilise specialist third-party providers to deliver oversight and ongoing administrative support.
Having been a member of the Jersey Finance-established AIFMD working group for two years, Bedell’s Jersey partner Emily Haithwaite – like many others who worked around the clock in the run-up to the AIFMD’s implementation (Ogier, Mourant Ozannes, Carey Olsen and Appleby were also represented on the working group) – expected there to be mayhem after 22 July.
There was initially some concern within the group that Jersey’s regulator would not be able to dedicate sufficient resources to the AIFMD project, given the amount of work required and the looming implementation deadline. One of the greatest challenges for the working group was in deciding how to interpret the directive and the requirements of the co-operation agreements that Jersey had signed with member states.
As with other forms of internationally-driven legislation, the AIFMD gives offshore countries the opportunity to show the world how they deal with sweeping change, and how they co-operate with their onshore counterparts without compromising the offshore fund’s renowned quality or globally competitive status.
Business as usual
For most offshore funds lawyers, it is a great relief that the directive has finally arrived. ‘We’ve been monitoring its arrival for several years and the build-up to July 2013 was a rollercoaster ride,’ says Graham Hall, corporate and finance head at Carey Olsen’s Guernsey office.
There was a lot of criticism thrown at the AIFMD when it was first unveiled in 2009 and the uncertainty of its implementation over the past four years has had a stifling effect on the EU funds industry, according to Craig Fulton, a shareholder in Conyers Dill & Pearman’s Cayman office. As managers now have certainty as to the directive’s requirements, confidence has returned to the funds industry in general.
Hall’s main concern was the impact on third countries and the marketing of their offshore funds into Europe. ‘Now the dust has settled, we’re all feeling more comfortable, but it’s still a learning process and the final effect of full implementation is not yet known,’ he says.
Jersey is no stranger to the regulation of its service providers and products, but having been a frontrunner in terms of getting its regulatory regime up to speed with the AIFMD, the island is in an especially good place. Dedicated teams of professionals were set up at every level and Jersey fields an exceptional level of expertise on the directive.
‘The excellent job that the Jersey Financial Services Commission, Jersey Finance and the government did in getting ready has to be commended,’ says Bedell’s Haithwaite.
Consequently, on 22 July, Jersey was ready to offer not only a regime for Jersey managers marketing under the EU member states’ national private placement rules, but also an opt-in AIFMD-compliant system for those managers and funds that wish to operate in Europe from 2015 onwards. This is in addition to providing a good home for those looking to conduct their activities outside of Europe.
‘We believe in offering all things to all people,’ says Heather Bestwick, technical director and deputy chief executive at Jersey Finance.
Guernsey is also set up to deal with the additional regulation. It has 27 co-operation agreements in place with European regulators, is fully compliant with the AIFMD’s third-country requirements, and the filing process with its regulator is relatively straightforward.
The Caribbean has also responded proactively to the AIFMD. Cayman has changed its Monetary Authority Law in response, leading to the Cayman Islands Monetary Authority (CIMA) signing memoranda of understanding with 25 European countries in May 2013.
Source of funds
The Cayman Islands are a particular jurisdiction of choice for the establishment of both open-ended and closed-ended offshore funds in the Hong Kong and Asian markets.
Cayman is also a favourite of the Brazilian market. ‘We have the largest investment funds practice for Brazilian asset managers, acting for ten of the 20 largest Brazilian asset managers, including Itaú Unibanco, HSBC, BTG Pactual, BNY Mellon, Santander and Pátria Investimentos,’ says Giorgio Subiotto, Ogier’s Cayman investment funds head.
Recent Cayman deals involving emerging markets include Harneys’ Cayman office head, Marco Martins, acting for Western Capita Guatemala on setting up a fund structure that invests in portfolios targeting different key industries in the country, including agriculture, energy and finance – the first structuring of its kind in Guatemala.
Asia is increasingly feeding Jersey with significant work. ‘From a geographic standpoint, the trend of inward investment from South-East Asia has continued over the last year, with investors from Malaysia and Korea buying up a number of trophy assets in London,’ says Mourant Ozannes’ Jersey partner Joel Hernandez.
Jersey is also keen to grow the levels of business coming to the island from Russia. ‘We already have somebody working out of London who is successfully making inroads into the Russian funds market for Jersey,’ says Heather Bestwick, technical director and deputy chief executive at Jersey Finance.
The BVI is similarly enjoying an increase in Russia-related fund instructions. ‘I’m hoping that this will become a growth area for BVI funds,’ says Marie-Claire Fudge, the BVI funds head at Mourant Ozannes.
In response to the volumes of quality work coming out of Asia, several offshore law firms have expanded their Asian-based offerings in recent years. Harneys has considerably beefed up its Hong Kong presence; Mourant Ozannes opened in Hong Kong in 2012; and Maples and Calder and Bedell both launched Singapore offices in 2012.
‘All the leading offshore firms now recognise that to grow they need to service developing markets such as Asia. However, some firms have struggled to persuade their best partners to relocate from their established offices in the Caribbean and the Channel Islands,’ says Edward Strickland, director at legal recruitment firm Glass.
In such cases, and where firms are looking to buy a book of business, they have sought to recruit laterally from the better-established offshore practices in that region. However, culturally, the offshore firms in Asia tend to be different to their longstanding offices: ‘This brings its own set of challenges, but also offers accelerated opportunities for advancement,’ says Strickland.
The signing of these agreements reflects Cayman’s own strong commitment to ensuring that Cayman-domiciled funds are able to be marketed into the EU in compliance with the directive.
‘This is extremely good news for Cayman’s investment funds industry’, says Maples and Calder’s Cayman-based global investment funds head, Jon Fowler.
The BVI’s Financial Services Commission likewise announced that it had entered into co-operation arrangements with the securities regulators of the 25 European countries. This is also welcome news. In addition to being able to be marketed into the EU in compliance with the AIFMD, both Cayman and the BVI are now well placed to enable their respective investment funds to qualify for the EU marketing passport if it is extended in 2015 to funds based in non-EU countries.
But despite fears of chaos, when 22 July eventually came around, there was no Big Bang. ‘It was something of a false start,’ says Appleby’s Cayman partner Ian Gobin.
To date, there has been an apparent lack of engagement by some managers, who have perhaps not considered the AIFMD’s impact or how it applies to them. This is surprising, says Bedell’s Haithwaite, considering the lead-in time to the implementation date, the level of media coverage the directive has received, and the information put out by governments, regulators, industry bodies and advisers.
Nonetheless, even though the offshore world is well set up to deal with the directive, and some managers have opted into its requirements in order to market to EU investors using the national private placement regimes, many managers have taken advantage of the one-year transition period for implementation of the directive. This was granted to non-EU alternative investment fund managers (AIFMs) on a member-state-by-member-state basis.
Other concerns in Jersey include the issues faced by funds that are marketed into several European jurisdictions. Such funds need to take legal advice in every European country in which they are marketed, even though the Jersey side of meeting the private placement requirements is relatively simple.
‘This creates a significant administrative and cost burden for these funds, and has led to some managers creating European funds into which their Jersey funds will feed,’ says Kate Anderson, an associate at Voisin.
Some managers have struggled with the sub-threshold levels, which are difficult to interpret. There is also confusion as to which provisions apply to non-EU managers; which EU member states have extended the one-year transitional period to non-EU AIFMs; and when a depositary needs to be appointed.
Certain US managers also appear not to have fully cottoned-on to how the directive has been implemented in various member states and the available exemptions, according to Haithwaite. Others have taken a blanket approach, prohibiting European managers from investing into US funds because they are worried about the extra cost of regulation.
Limited impact
The AIFMD’s launch has prompted the offshore law firms to get up to speed quickly to assist those managers of third-country funds that are looking to market into the EU. According to Michael Padarin, a partner in Walkers’ Cayman office, for the firm’s funds lawyers the signing of memoranda of understanding and the directive’s implementation signify closer collaboration with the firm’s EU law specialists in Ireland.
The offshore law firms that can offer a European alternative, be it in Ireland or Luxembourg, are well placed. ‘Clearly Dublin is attractive to offshore firms currently without a presence – more so than Luxembourg, where they will be in competition with onshore practices that provide referral work elsewhere,’ says Edward Strickland, a director at legal headhunters Glass.
Otherwise, it is business as usual for Cayman. For the majority of law firm clients, the traditional Cayman fund structure remains the product that blends an appropriate level of regulation with the flexibility and cost structure that managers need. This is not being affected significantly by regulatory developments in the EU or any other jurisdiction.
And although there are the AIFMD’s disclosure and transparency issues to consider – and factor into a current offering – for Cayman funds marketed within the EU, much of the detail required by the directive would have formed part of a typical Cayman fund offering.
Consequently, many believe that the directive’s overall impact on Cayman will be marginal, given the jurisdiction’s international reputation as a centre for investment funds and its ability to adapt to an ever-changing global economy. The most recent statistics available from CIMA show that as of 31 March 2013, there were 10,932 funds domiciled in Cayman, the largest proportion of hedge funds in the world.
‘We have to remember here that there is a lot more to the global funds industry than the EU and that for managers outside of the EU and offering to non-EU investors – in theory about 93% of the global population – the AIFMD is not relevant,’ says Conyers’ Fulton. Cayman, with the lion’s share of this market, will, therefore, continue to prosper irrespective of the directive.
Europe-focused practices in Cayman have, nonetheless, enjoyed a steady increase in fund launches. Confidence has returned to the markets, which is backed up by increased regulatory certainty as the post-AIFMD landscape begins to take on a defined shape.
For example, Fulton has seen a number of managers, where the EU is a significant market, setting up a parallel EU-regulated fund to complement their Cayman fund offering. ‘Whether this will be the new norm, we will have to wait and see,’ he says.
Even without Europe, the Cayman funds market is currently booming. At Appleby, Gobin has seen an upsurge of new fund launches over the last eight months. ‘We’re not back up to 2007 levels, but we’ve definitely turned a corner,’ he says. ‘The economy has improved, investors are feeling more confident, and they’re finally seeing better returns.’
The US hedge fund market is particularly hot right now, especially hedge funds investing in US corporate debt. Gobin is seeing US managers setting up a large number of new funds that are often heavily seeded, particularly from banks’ proprietary trading desks that are spinning out. Asia is also doing well for BVI and Cayman, as is Russia/CIS.
According to Walkers’ Cayman partner Tim Buckley, it was clear in recent months that international investors were looking to gain exposure to the US recovery, whether through equities or credit-based strategies. Investment funds provided that opportunity, with significant levels of new money coming in from Asia, the Middle East and Latin America.
In the BVI, Conyers’ funds practice is likewise busy launching new funds for existing clients as they diversify their investor base. ‘The majority of the managers for our fund structures are based in New York and New York continues to be the centre of excellence for the hedge fund industry,’ says Robert Briant, head of Conyers’ BVI office.
Walkers’ BVI office is also pulling in new work streams. Its BVI partner Marianne Rajic has seen an increased number of parallel master feeder structures being set up in the BVI and a larger number of private equity funds. ‘BVI open-ended funds are commonly used as wealth management vehicles by Swiss managers and administrators, and US managers use BVI master feeder structures to attract non-US investors,’ she says.
The Channel Islands’ funds market has also remained buoyant. In the build-up to 22 July, both Jersey and Guernsey saw a significant uptick in instructions from managers and funds looking to raise capital. Many managers and investors decided it was in their interests to conclude the raisings, rather than bear the costs of additional compliance obligations or the rewriting of offering memoranda that might be required if they wanted to continue marketing into Europe.
Firms reporting high levels of activity include Carey Olsen, which reports seeing plenty of European promoters launching clean tech, renewable energy, infrastructure, real estate and debt funds since the AIFMD was implemented and Mourant Ozannes, which recently advised on the closing of several Jersey-domiciled private equity funds that were both high-profile and high-value.
‘2013 was an incredibly busy year across all asset classes in terms of fund formation, structuring and transactional work,’ says Dan Birtwistle, the firm’s Jersey managing partner.
Mourant Ozannes’ practice is also seeing significant activity in the real estate sector. ‘The use of Jersey structures remains a popular choice for real estate funds and as direct acquisition vehicles, particularly for UK commercial real estate,’ says Mourant Ozannes’ Jersey partner Joel Hernandez.
As for Guernsey, Mourant Ozannes’ office continues to receive instructions from London firms on private equity deals, particularly establishing infrastructure and alternative investment funds, according to Guernsey partner Darren Bacon.
Examples of recent high-profile Guernsey legal expertise include the advice provided by Carey Olsen’s Guernsey partners Andrew Boyce and David Crosland to Blue Water Energy on the Guernsey aspects of the structuring, establishment and closing of a Guernsey closed-ended fund that will invest in transactions across the global energy supply chain. This is believed to be one of the largest fund raisings by a start-up in recent years; its first closing in September 2012 was oversubscribed, and it closed at its hard cap in May 2013, raising $861m.
Investor returns
Even if the impact of the AIFMD on the offshore world is currently marginal, many also believe that it has missed its target. This is because from an investor perspective – particularly when considering non-EU investors – the issue at stake is not just regulation, but also achieving healthy returns in the right regulatory environment.
‘It was designed to protect the financial system and to protect investors; my concern is that it will do neither if the compliance cost is too high, risk-taking decreases and the strategic performance of funds is affected,’ says Hall.
The directive does, without a doubt, increase the cost and regulatory burden on fund managers. ‘This is extremely unfortunate, as the result of this is that these additional costs are likely to be carried by the ultimate investor – the people that the AIFMD was intended to protect,’ says Fulton.
Others believe that the directive may actually have increased systemic risk. This is because it has increased both the barriers to entering the funds industry and the potential for concentration of assets in the few large managers that can afford the infrastructure necessitated by the AIFMD. For a start-up, the higher break-even and compliance costs are significant factors – they now have to target a significantly higher initial capital raising to get into the market.
‘There was a desire to use the financial crisis as an excuse to regulate the shadow banking sector but I don’t think the AIFMD has been particularly well thought out,’ says Peter Tarn, London-based global managing partner at Harneys.
But whatever the directive means for the offshore funds industry in the long term, legal advisers are braced for change. LB
julian.matteucci@legalease.co.uk