The requirement in the Alternative Investment Fund Managers Directive (AIFMD) to either take out indemnity insurance or hold extra capital has not been on the radar for many GPs, according to legal sources.
“It’s not seen as an overriding operational issue; it was a bit of a sleeper topic,” says Rob Moulton, a regulatory partner at law firm Ashurst.
But working out whether to hold extra capital or take out insurance, and then implementing that decision, raises a number of important questions for both GPs and insurers.
Chiefly amongst GPs is, “What is cheaper, the insurance option or holding my own capital?”
“I always have the default assumption that people are going to go for insurance,” says Moulton, who explains that because of the “relatively nimble and lightly capitalized nature of private equity houses, the insurance would have to be surprisingly expensive for it to be less cost effective than tying up capital.”
GPs that forgo insurance must hold at least 0.01 percent of funds captured by the directive in emergency reserve. The directive allows EU member states to ratchet that threshold up or down within their own jurisdiction (most as of yet have elected to not tweak the threshold). However the UK’s securities regulator, the Financial Conduct Authority (FCA), requires firms to hold .08 percent.
If insurance is purchased, the directive requires GPs to purchase indemnity insurance that covers at least 0.9 percent of assets under management. The coverage must also have an initial term of no less than one year and the GP must be covered by a third party who is authorized to provide professional indemnity insurance. The GP must also review the policy annually.
For firms that decide the insurance route is the way to go, the first step is engaging with insurers. A likely first question from GPs will be whether all the risks set out in the directive are covered by the current fund manager insurance policies, or whether a tailored approach is needed. (See box out for the list of risks that need to be covered.)
“GPs may find they want a bit more certainty in the policy on exactly what is covered; whereas insurers may well prefer to stick to the broad policy wording they already use,” says Imogen Garner, senior associate in Norton Rose Fulbright’s financial services practice.
“Additionally GPs may want to ask insurers to explicitly confirm that they are covering the risks of the directive. Tweaks to the coverage’s language or broad policy wording could result in interpretational issues in the event of a claim,” adds Floortje Nagelkerke, senior associate in Norton Rose Fulbright’s financial services practice.
Indeed the provisions necessary for indemnity insurance do not necessarily jive with standard insurance terms, according to one legal source. For example the directive requires insurers to provide a 90 day heads up before a policy is cancelled, which isn’t a standard feature in insurance contracts.
And with securities regulators such as the FCA urging GPs to become AIFMD-authorized as early as possible, sources recommend taking a look at items such as the insurance policy requirement sooner rather than later.