The Alternative Investment Fund Mangers (AIFM) directive has been seemingly dragging on forever, leaving private equity firms captured by the law with a sense of uncertainty since its passage in the European Parliament way back in November 2010.
But the UK’s financial regulator, the Financial Services Authority (FSA), provided GPs active in the UK some guidance with the release of its first consultation paper, just one month before the European Commission had adopted “level 2” implementing measures for the directive.
KNOWN KNOWNS
One issue that the FSA felt confident enough to give a view on was timing, despite ongoing AIFM negotiations between the European Commission and member states.
The question the FSA needed to answer was whether every fund manager had to be fully compliant with the directive by a 22 July go-live date, or whether existing managers can get their shop in order during a transitional year before becoming authorised with the FSA.
“It’s good that the FSA has come out firmly saying it considers that existing managers will only need to comply from the date they get authorised, which is sensible. I hope there is no push back elsewhere in Europe,” said in a recent interview SJ Berwin partner Tamasin Little.
Not all in the consultation was positive news however, especially for those GPs who want to start fundraising next year. The FSA previously said they would accept early applications for fund managers hoping to be authorised under the directive by next July, but the consultation paper revealed the regulator no longer expects to be able to offer that opportunity. The backpedal on early authorisation means any GP based in the UK who was hoping to seamlessly solicit investments across EU borders – as is possible with a marketing passport provided by AIFM supervision – will no longer be able to do so on day one of the directive’s effective date.
The industry will be buoyed however by the FSA’s stamp of approval on the use of non-bank depositories for private equity firms. The directive mandates GPs hire a depository to safekeep funds’ financial assets, monitor cash flows and ensure funds comply with their own governing documents. Private equity firms have argued that many actors should be allowed to take on this responsibility (and not solely in the hands of lending institutions). The industry argues extending the depository function, to fund administrators for example, would increase market competition and lower costs.
Under the FSA paper, any entity that is subject to “mandatory professional registration recognised by law or to legal or regulatory provisions or rules of professional conduct” can take on the role of depository. Non-bank depositories, such as fund administrators, notaries, lawyers and accountants, will be allowed to take on certain responsibilities without necessarily needing to hold assets in custody, which private equity firms argue is unnecessary for illiquid long-term assets. It is also the intention of the FSA for non-bank depositories to have lower capital requirements than other depositories.
“Though not limited to private equity, this is important for the sector, and the FSA even describes them as private equity AIF depositories. There was concern originally as the FSA hinted these might still need to be heavily capitalised businesses but the capital requirement is now at €125,000, the same as investment firms,” explained Little.
KNOWN UNKNOWNS
One issue the FSA was only expected to pay lip service to was delegation, sources say. It is understood that this issue in particular pushed back release of level II measures, meaning the FSA had reason to not yet draft in detail its own interpretation of delegation provisions.
The directive states a manager must remain in charge of its basic functions and not become a “letter-box entity”. This is when a manger delegates so many of their responsibilities that the delegated tasks substantially exceed the tasks remaining with the manager. UK legal sources are seemingly split as to how much the FSA consultation tells us about the regulator’s attitude regarding delegation.
“What is positive to see is the FSA talking very firmly about the benefits of delegation. They talk about how they will look at everything on a case by case basis in a robust and flexible way,” said Andrew Henderson, counsel at law firm Ropes & Gray.
Gus Black, partner at law firm Dechert, agreed: “They have come out in the consultation and said things about delegation that seems to be making the right noises.”
“The consultation paper talks about focusing principally on qualitative rather than quantitative factors, including things like whether or not decision making is genuine rather than a rubber stamp,” added Black. “This suggests a willingness by the FSA to take a pragmatic view, to the extent they can under level II, which is to be welcomed.”
However sources stress this should not be interpreted as saying that the FSA can deviate from the directive itself. Sources tell PE Manager the European Commission has still not provided crystal clear rules on delegation – which are intended to prevent GPs from significantly outsourcing fund operations to other countries. The text provides some qualitative factors GPs can use to determine when too much delegation has occurred, but these factors do not clearly distinguish “risk management” from “portfolio management”, which elsewhere in the directive are viewed as separate elements, said in reaction to the level II text Gregg Beechey of London-based law firm SJ Berwin.
“In private equity, risk management and portfolio management are usually handled by the same team; and so without a clear separation in terminology the asset class will have a difficult time understanding exactly what can be delegated to a third party entity,” Beechey said.
With respect to its own implementation of delegation rules and other AIFM provisions, market sources say the FSA is seeking to position itself as an “enlightened regulator”.
Then again not everyone sees such a clear silver lining. “They have said nothing substantive about delegation because they [were] waiting for [level II],” said Little.
Nonetheless UK private equity may not have to drastically overhaul their compliance programmes when fine-tuned AIFM rules finally take effect. “UK firms are not in a bad place,” according to one UK-based private equity lawyer. “If you are FSA authorised, you are already required to have quite extensive systems and controls. It’s much more of a leap for German firms who have not been conventionally regulated and are in effect starting from scratch.”
Consequently UK-based private equity firms may have a better sense of what AIFM supervision will look like in practice, which will become a reality for a number of firms later this year.
If you do not receive this within five minutes, please try to sign in again. If the problem persists, please email: