AIFMD final report: Implementing new measures

The European Securities and Market Authority has recommended that managers either keep funds on hand or buy insurance against losses incurred by fraud or accounting errors in its final advice on the alternative investment fund managers directive.

The recommendation was included in a report the organization released Friday. ESMA is responsible for providing European policymakers technical advice on the Alternative Investment Fund Mangers Directive, which the European Commission proposed in 2009 for the purpose of establishing a comprehensive regulatory structure for alternative investment fund managers. 

One of several proposals included in Friday’s report is that fund managers cover potential losses caused by professional negligence with either additional own funds or professional indemnity insurance. These would be losses incurred through activities for which the manager holds legal responsibility, such as negligent loss of documents or errors, dishonest or fraudulent acts by managers and business disruption or system failures. Managers should also keep and update regularly reports on historical and potential losses or liabilities.

In order to cover potential losses, ESMA recommended that fund managers hold sufficient financial resources to ensure that liability risks are covered by their own funds, insurance or both. The additional own funds requirement for liability risk is 0.01 percent of the value of a firm’s portfolio. For indemnity insurance, a policy must be wide enough to cover all liabilities outlined by ESMA, and should last no less than a year.

Regarding depositories, ESMA offers proposals on what should be considered a “loss” that makes a depository liable for the loss of any financial holding in its custody. ESMA suggested instances that the depository would be responsible for a loss:

-A stated right of ownership of the AIF is uncovered to be unfounded because it either ceases to exist or never existed.

-The AIF has been permanently deprived of its right of ownership over the financial instrument.

-The AIF is permanently unable to directly or indirectly dispose of the financial instrument.

To reduce risk further, ESMA has also advised on transparency and leverage, potentially stopping managers from using high levels of debt in transactions. The report suggests how leverage should be calculated, prescribing two methodologies, referred to as the gross method and the commitment method. An additional option, known as ‘the advanced method’, can also be used upon request and subject to certain criteria.

In regards to third countries, ESMA’s indicated that arrangements between EU and non-EU authorities should be made through written agreements that allow for exchange of information to facilitate supervision and enforcement.