ALTERNATIVE INVESTMENT FUND MANAGERS DIRECTIVE

January 11, 2010

Scope of the Directive ­- Closed ended-investment companies

Given the legal structure and organisation of a closed ended investment trust listed on an EU regulated market, and the existing and stringent rules and regulations to which they are already subject, we believe that such investments trusts could sensibly be removed from the ambit of the Directive without the loss of the protections which the Directive is seeking to bring.

If it is decided, however, that listed investment trusts must remain within the scope of the Directive, in order to recognise the Board of Directors as ultimately responsible for the affairs of the AIF when it is a corporate entity, the amendments below permit the AIF, as an investment trust listed on an EU regulated market, to be treated as its own AIFM.  A number of consequences flow from this, including that the investment trust would require authorisation by the competent authority as an AIFM, which permits that authority to review the substance of the entity and the arrangements made for the valuation and safekeeping of assets etc., and to be satisfied that they are sufficient to protect investors.

One fundamental aspect of permitting the listed investment trust, as the AIF, to be its own AIFM is that it would allow the AIF to issue its own shares, something which (as the Directive is currently drafted) it would be prohibited from doing.  Any such prohibition would frustrate any attempt by it to raise further equity funding (whether from existing or new investors and whether or not in compliance with the Prospectus regime), a fundamental and long-recognised corporate activity and essential strategic device.  Such a prohibition would create a conflict between this Directive and the Prospectus Directive.

New Article 3a

Definitions

 1                     Without prejudice to the right granted under Article 18 to delegate functions, Member States shall ensure that each AIF managed within the scope of this Directive shall have a single AIFM, which shall be responsible for ensuring compliance with the requirements of the Directive.

2                     In cases where the law under which the AIF is organised requires the management of the AIF to be conducted through an appointed  board of directors (or other substantially analogous governing body) the AIF shall, whether or not the AIF designates a third party to perform all or some of the management services, be considered as the AIFM under this Directive, and shall be subject to the requirements for authorisation set out in Article 4.   [The competent authorities of the home Member State shall be enabled to make rules applying a ‘substance’ test to determine whether the AIF is suitable to be so authorised]. [NB Wording in square brackets could be included instead in Article 6 "Conditions for granting authorisation" provisions]

 

Justification

In order:

·        to recognise the responsibilities, duties and liabilities of the board of directors of a company constituted under company law;

·        to ensure that there is no sharing of, or lack of clarity in defining,  ultimate responsibilities for managing the affairs of the company for the benefit of stakeholders between the board and any third party to whom management functions may be delegated;  and

·        to ensure there is no conflict between the requirements of this Directive and those of company law or other directives setting out the requirements for listing within the EU.  The AIF would then itself, as the authorised AIFM, have the power to market, and be responsible for any marketing of, its shares, consistent with the Prospectus Directive.

Valuator

Article 3

Definitions

In order to enable the appropriate valuation of assets of various types which may be held by AIF, different procedures and systems may be required in practice, and the appointment of a ‘valuator’ could prove costly and unnecessary in the circumstances.  The amendments outlined below are designed to enable the following sources of valuation to operate for each type of asset listed and to recognise the oversight mechanism relevant to investment trusts (although note that, for other fund structures, other oversight mechanisms may also exist and be relevant).

“Valuation”	Asset Type
	Equities	Other
	Listed	Unlisted	Cash	Real Estate or other real property	Derivatives
For investment trusts	Oversight in hands of independent Board
Valuation Source	External Market Data Feed	Fund Manager or Valuer	N/A	Professional Valuer	External Market Data Feed (or similar, depending on fund model)

 

1 (c)       (Valuator)           Delete entire definition

Justification

See redrafted Article 16 below.  The intention is to introduce practical, proportionate and independent processes for valuation of all asset types, appropriate to their nature and to the organisation of the AIF itself.

Article 16

 

Valuation

 

1. The AIFM shall ensure that, for each AIF that it manages, (…) appropriate and consistent procedures are established so that the proper valuation of the assets of the AIF can be performed and the net asset value of the shares or units of the AIF can be calculated and, where appropriate, published.

 

1a. The AIFM shall, where appropriate, ensure the functional independence of the valuation function and the portfolio management function in view of the nature, scale and complexity of each AIF that it manages.

 

1b. The (…) valuation procedures used shall ensure that the assets (…) and shares (…) or units are valued at least once a year.   (…) (…) If the AIF is of the open-ended type, such valuations shall also be carried out at a frequency which is appropriate given the underlying asset held by the fund and its issuance and redemption policy.  If the AIF is of the closed-ended type, such calculations of net asset value per share or unit shall be published in accordance with the constitutional requirements of the AIF, or of the disclosure and transparency rules made by the competent authorities of the home Member State.  (…) Where the AIF is invested in immovable assets, the specificities of those assets may be taken into account.

 

2. When an external valuer (…) is used (…), the AIFM must be able to demonstrate that the third party is qualified and capable of undertaking the functions in question, that it was selected with due care and that the AIFM is in a position to monitor effectively at any time the activity of the external valuer. The use of an external valuer should not prevent the effectiveness of supervision of the AIFM, and, in particular, it must not prevent the AIFM from acting, or the AIF from being managed, in the best interests of its investors.

 

2a. When an external valuer is not used, the competent authorities of the home Member State may require the AIFM to have its valuation procedures and/or valuations verified by an external valuer or, where appropriate, an auditor. The competent authorities of the home Member State may also require all valuation, whether carried out by the AIFM or by an external valuer, to be subject to oversight by the depository or an independent auditor.

 

3. The rules applicable to the valuation of assets and the calculation of the net asset value per share or unit (…) of the AIF shall be as set out in the relevant financial reporting standards or, where such financial reporting standards do not automatically apply, it should be laid down in the law of the country where the AIF is (…) established and/or in the AIF rules or instruments of incorporation that such standards must be applied.

 

4. The Commission shall adopt appropriate implementing measures further specifying the criteria (…) concerning the procedures for the proper net asset valuation of the assets and shares or units of AIF. Such measures shall also specify the frequency of valuation carried out by open-ended funds which is appropriate given the underlying assets held by the fund and its issuance and redemption policy. The Commission shall also adopt implementing measures further specifying the criteria when there is a need for external verification as referred to in paragraph 2a.

 

Those measures, designed to amend non-essential elements of this Directive by

supplementing it, shall be adopted in accordance with the regulatory procedure with

scrutiny referred to in Article 49(3).

 

Justification

A             To ensure that proportionate and appropriate arrangements are in place, with suitable oversight as necessary, relevant to (a) the asset type being valued (eg listed financial instruments or securities, unlisted financial instruments or securities, derivatives of financial instruments or indices, real estate and cash); and (b) the use to which the valuation is to be put.  These arrangements should be properly independent of the fund management function and may or may not use the services of an independent expert valuer.  For example, listed securities may be valued on the basis of an independent ‘market data feed’ provided by one or more of several commercial providers such as Telekurs or FT Interactive, whereas real estate or other real property assets may require the services of an expert property valuer.

B             To ensure that the appropriate valuation principles accepted in financial reporting standards across the EU will be applied to all AIFs at any one time, without the need to wait until the appropriate national law or AIF constitution can be amended, and reflect any change to generally accepted accounting or valuation principles when it comes into operation.

NB          The above draft text is based on the Council’s proposals of 24 November 2009, with underlining and italics to indicate changes from those proposals.

Depositary 

Our proposed amendments are intended to offer a practical solution to this particular area covering the provisions concerning the requirement for a Depositary. In particular, in the context of a closed ended company, some functions proposed to be undertaken by a Depositary are already carried out by the Board of Directors, and imposing a further layer of responsibilities duplicates the duties of the Board potentially at high cost – indeed, there is a need to ensure that any Depositary function does not conflict with, or seek to override, the responsibilities of the Board. 

We believe that the Depositary function should be split into its component parts – custodian of tradeable securities and other tradeable financial instruments, receiving banks for cash subscriptions where investment trusts (infrequently, as closed ended funds) issue new shares, and being responsible for verifying the completeness of assets held.    These functions would then be capable of being allocated to different entities depending on the requirements appropriate for particular AIF structures. 

It is necessary for this approach to be possible that, in the context of a closed ended company, the company is capable of acting as the custodian of certain asset types (eg unlisted securities and property) which are illiquid and only acquired following extensive due diligence.  The company itself will carry out its obligations to safeguard its assets, and the processes and completeness of which safeguarding are always subject to annual external audit as required for public companies in all circumstances.  So it is necessary to permit ‘other entities’ such as ‘legal persons subject to prudential regulation and supervision’ (which a company authorised as its own AIFM would be) to carry out Depositary functions. 

This break up would also help to ensure more competitive pricing of various functions.

We show below a grid which sets out the allocation we suggest for closed ended companies of responsibilities the Commission proposed to be allocated to a Depositary, in the case of each of the main asset types.  Note that a Depositary would still be responsible where an open ended, non corporate AIF without adequate independent oversight is involved.

 

“Depositary”	Investment trusts – companies regulated under company law and the UK listing regime
	Asset Type
	Equities	Other
	Listed	Unlisted	Cash	Real Estate or other real property	Derivatives
Custodian (NB  Oversight in hands of independent Board)	Custodian Bank	Company	Company	Company	Custodian Bank (whether or not a clearing bank/agent/house is used as the counterparty)
Cash       Subscription (NB  Oversight in hands of independent Board)			Receiving Banker as agent for Company approved by Board
Completeness       of Assets (NB  Oversight in hands of independent Board)	Company administration obligation, verified annually by auditor

 

Definitions

New 1(p)             "Depositary" means, as the context so requires, either:

(pa)    a credit institution having its registered office in the Community and (…) authorised in accordance with Directive 2006/48/EC of the European Parliament and Council of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions (recast); or

 (pb)   an investment firm authorised in accordance with Directive 2004/39/EC to also provide the ancillary service (…) of safe-keeping and administration of financial instruments for the account of clients in accordance with Section B(1) of Annex I to that Directive, having its registered office in the Community; or

(pc)    a legal person which is subject to prudential regulation and ongoing supervision and which can furnish sufficient financial and professional guarantees to be able to effectively perform the relevant depository functions and meet the commitments inherent in those functions,

provided that the AIFM shall not, unless appropriate to the legal and governance structure of the AIF (acting as its own AIFM), act as Depositary.

In addition to the provisions in subparagraphs (pa), (pb) and (pc) of this definition, for AIF which have no assets which can be safe-kept in accordance with paragraph 1(a) of Article 17A, the depositary may be a legal person which carries out depository functions as part of professional or business activities in respect of which it is subject to mandatory professional registration recognized by law or to legal or regulatory provisions or rules of professional conduct and which can furnish sufficient financial and professional guarantees to be able to effectively perform the relevant depository functions and meet the commitments inherent in those functions.

 

Justification

See redrafted Article 17 below (spilt into 3 new Articles).  NB The above draft text is based on the Council’s proposals of 24 November 2009 for paragraph 3 of Article 17, with underlining and italics to indicate changes from those proposals.  It also incorporates the essence of the Council’s proposals of 24 November 2009 for paragraph 2 of Article 17, marked in bold text, amended as required (marked by italics and underlining) to deal with the fact that companies (being closed ended) may themselves carry out functions which may properly be allocated to separate Depositaries for open ended structures.

Article 17

Depositary

To be split into 3 new Articles

Justification

To enable the Article concerning Depositaries to be applied in a proportionate manner both to different types of asset and to different organisational structures of AIF. 

This will:

·         enable competition to apply to the pricing of services to be provided;

·         eliminate duplication of the function of the Board of Directors of a listed company by a Depositary and so clarify where ultimate responsibility lies under company law;  and

·         reduce or eliminate unnecessary cost of the original proposals, which might seriously undermine the viability and returns to investors of using these structures.

New Article 17A

Appointment of a Depositary

1.       For each AIF it manages, the AIFM shall ensure that appropriate arrangements are made to ensure the safe-keeping of assets held by, or to the order of, the AIF.  A custodian, acting as depositary, should be appointed to fulfil the function to safe-keep any of the following financial instruments which belong to the AIF, as follows:

(a)               hold in custody all financial instruments that can be kept by book-entry or  otherwise and are subject to(…) trading on a regulated market as defined in Article 4(1)(14) of Directive 2004/39/EC or on other regulated markets within the Community or a third country or on a multilateral trading facility and ensure that these are registered within segregated accounts opened in the name of (…) AIF, so that in the event of a default by the depositary, acting as custodian, they can be clearly identified as belonging to a given(…) AIF;

 

(b)          maintain the records necessary to verify the ownership of financial instruments that cannot be kept by book-entry or otherwise and are subject to (…) trading on a regulated market as defined in Article 4(1)(14) of Directive 2004/39/EC or on another regulated markets within the Community or a third country or on a multilateral trading facility or over the counter, based on the information provided by the AIFM and external evidence of transactions made;

 

(c)                ensure that the financial instruments referred to in point (a) of this paragraph may not be re-used without the prior consent of the AIFM, and such consent has not been withdrawn.

 

2.       Any appointment of a custodian, acting as depositary, who is not eligible to be depositary under subparagraphs (pa) or (pb) of paragraph 1 of Article 3 shall be subject to approval from the competent authorities of the home Member State of the AIF or in case where the AIF is not regulated the competent authorities of the home Member State of the AIFM.

 

[NB  Insert here the Council’s proposals of 24 November 2009 for paragraphs 4 to 10 of Article 17 (other than the text of subparagraphs 4(d) and 10(c) of Article 17).  In addition, insert the Council’s proposals of 24 November 2009 for paragraph 2a. of Article 17 as a new paragraph within Article15.]

 

Justification

To ensure that there is a general duty on the AIFM to make appropriate arrangements for safe-keeping of assets.  Normally, either a custodian bank or a depositary is, following approval as such, recognised as the appropriate mechanism to safe-keep the marketable financial instruments of an AIF.  For other asset types such as property and unlisted securities, other arrangements are normally made, including having the assets registered or otherwise recorded in the name of the AIF concerned, which is suitable given the nature of these instruments.

To ensure that this function can be delegated in order to enable the safe-keeping of assets in certain (eg Far Eastern) jurisdictions where local regulation requires the use of local custodians and such local custodians may not conform to EU "norms".

To ensure that the liability of depositaries is limited to that which is capable of being fulfilled, at reasonable cost, and that there is no imposition of a standard that cannot be achieved in practice, particularly in the context of overseas assets where investors may lose the opportunity to invest in such assets if the standards are set too high.

New Article 17B

Verification of ownership

1.     For each AIF it manages, the AIFM shall ensure that suitable systems are in place to record the interest of the AIF in all other assets held by, or to the order of, the AIF and shall further ensure, subject as set out below, that a depositary is appointed, as appropriate, to verify whether the AIF or the AIFM on behalf of the AIF holds an ownership interest in all other assets the AIF invests in, based on internal and external evidence of ownership.   Where the constitution of the AIF requires the appointment of an independent auditor, it shall be sufficient for the independent auditor appointed by the AIF to carry out this verification at least annually on behalf of the AIF and, in such circumstances, no depositary need be appointed.

 

Justification

To ensure that there is a general duty on the AIFM to verify the ownership of the assets of the AIF, which may be carried out through annual audit procedures.

New Article 17C

Payments made by or on behalf of investors upon the subscription of shares or units

For each AIF it manages, the AIFM shall ensure that appropriate arrangements are made, by appointing an independent receiving bank, acting as a depositary, to ensure that all payments made by or on behalf of investors (…) upon the subscription of shares or units (…) of an AIF managed by the AIFM and all payments received by or for the benefit of investors upon the repurchase of shares or units of such an AIF have been correctly (…) booked (…) on behalf of the AIF (…) in (…) segregated accounts.

 

Justification

 

To ensure that appropriate arrangements are made to receive moneys from investors.  Such arrangements may, eg in the case of an AIF which is a listed company and which only infrequently, therefore, issues new shares, be to appoint a receiving banker as is normal under the normal processes adopted for raising cash through regulated markets.

Delegation

We believe it is essential for AIFM to be able to continue to delegate some or all of their functions.  This is particularly relevant in the context of delegation to third country investment managers so as to be able to make use of the intimate, local market knowledge which those third country investment managers possess. 

We recognise that it is appropriate for the investment manager to whom the AIFM's functions are delegated to be subject to appropriate authorisation or registration and also to appropriate supervision, but that it should also lie within the power of the competent authorities of the home Member State to sanction, where appropriate, delegation to an investment manager who does not fulfil all of these conditions.

In the case of delegation to a third country investment manager, we also consider it appropriate for there to be appropriate co-operation between the competent authorities of the home Member state and the supervisory authority of the third country investment manager.  Fundamental to that concept is the need for the level and process of co-operation to be capable of fulfilment rather than acting as a prohibitive mechanism and we believe the competent authorities of the home Member State should be empowered to determine what constitutes "appropriate co-operation" in any given circumstance.

Equally, we recognise that the liability of the AIFM should not be affected by the delegation of some or all of its functions to a third party and also the need to ensure that the AIFM, in delegating its functions, should not become a letter-box entity.

Consistent with the above, we would suggest that the Council’s proposed amendments of 24 November 2009 to the provisions of Article 18 ("Delegation") should be incorporated, subject to the suggested change to the Council's proposed paragraph 1(ba) of Article 18, highlighted by underlining and italics below.

Revised paragraph 1(ba) of Article 18:

(ba)  where the delegation concerns the portfolio management or the risk management and is given to a third-country undertaking, in addition to the requirements in point (b), appropriate co-operation (as determined by the competent authorities of the home Member State) between the competent authorities of the home Member State and the supervisory authority of the undertaking shall be ensured;

 

Justification

To ensure that investment funds have the freedom to appoint, and investors have access to, the best investment managers globally - as choice is key to ensuring a robust and fair investment environment - whilst at the same time recognising the need for those investment managers to be subject to appropriate supervision and controls.
Provision of management and marketing services by AIFM

We support the notion of the passporting by EU AIFM of EU managed AIF but believe that provisions in the Directive which operate so as essentially to prohibit certain investment opportunities from being available to investors should be deleted, especially given that the Directive relates, generally, to professional investors rather than to retail investors.  We understand that the underlying thrust to the Directive is investor "protection" but feel that measures which effectively restrict EU investors from investing in, or following existing investments in, third country funds instead amount to investor "prohibition".  Such prohibition could be seriously detrimental to the returns of existing investors in such investments and we believe it is not appropriate for the European Parliament to prohibit any investment opportunities in circumstances where there is adequate disclosure of the risks and rewards available.

We believe that national private placement regimes provide the appropriate protection for investors in respect of third country funds being marketed into the EU.

As such, we consider that changes broadly equivalent to the Council’s proposed amendments of 24 November 2009 to the provisions of Chapter VI and Chapter VII should be incorporated into the Directive. 

Additionally, we would propose that the provisions of Chapter VI regarding marketing are not relevant to companies domiciled in the Community whose shares are admitted to trading on a regulated market (within the meaning of MiFID) and which are subject to the Prospectus Directive.  As a result, we would propose that such entities are included in a relevant exemption (in Article 2) from the provisions of Chapter VI of the Directive.

 

 

Justification

To ensure that professional investors covered by the Directive continue to have access to third country investment opportunities, both on an "already invested" basis and also on a "new investment" basis and that the interests of existing investors are not damaged.

To ensure that the marketing provisions of the Directive do not apply in circumstances where, were they to do so, they might inadvertently vitiate the provisions of the Prospectus Directive.
Risk management

We believe any requirements for the separation of risk management and portfolio management should be appropriate and proportionate in view of the nature, scale and complexity of the AIFM and the AIF is manages.

We also consider that operational and risk management procedures related to short sold securities and other financial instruments are not appropriate for inclusion in the Directive given other initiatives regarding this aspect being undertaken by the Commission.

As a result, we consider that changes broadly equivalent to the Council’s proposed amendments of 24 November 2009 to the provisions of Article 11 should be incorporated into the Directive. 

Justification

To ensure that risk management systems and processes are appropriate and proportionate to the AIFM and the AIF it manages.

Leverage

We do not believe it is appropriate for the EU to adopt measures limiting the level of leverage which AIFMs can employ in relation to AIF. Any limitation on leverage does (in principle) create an unlevel playing field in the market with regards to other market participants and therefore any measures limiting leverage must be carefully considered and made on an appropriately reactive basis, in response to clear indicators of serious risk to the financial system. Therefore, we believe that any measures limiting leverage should be made at home Member State level and in response to carefully analysed information which has been disclosed to Member States by AIFM regarding the use of leverage. Any measures adopted at European level should surround disclosure requirements only, and should not seek to impose limits (at European level).

In addition, we believe the definition of leverage should be clarified as normally leverage should be assessed and analysed based on a net basis and this should be part of the high level definition of leverage.

Definitions - Article 3(l) (Leverage) – the underlining marks revisions made to original Commission draft:

 

“'Leverage' means any method by which the AIFM increases the exposure of an AIF it manages to a particular investment (deletion, see note 1 below) whether through borrowing of cash or securities, or leverage embedded in derivative positions, (deletion, see note 2 below) and the level of leverage shall be assessed normally on an appropriately netted and risk-adjusted basis.”

 

Note 1 – deletion of "s" at the end of "investment"

Note 2 – deletion of "or by any other means”

 

 

Article 25(3) is deleted.

 

Article 25(4) is revised as follows (the underlining marks revisions made to original Commission draft):

 

“In exceptional circumstances and when this is required in order to ensure the stability and integrity of the financial system, the competent authorities of the home Member State may impose (deletion, see note 3 below) limits to the level of leverage that AIFM can employ. Measures taken by the competent authorities of the home Member States shall have a temporary nature and should (deletion, see note 4 below) take into account the dynamic nature of the management of leverage by AIFM using leverage”.

 

Note 3 – deletion of “additional”

Note 4 – deletion of “comply with the provisions adopted by the Commission pursuant to paragraph 3”.

 

Justification

 

The revised wording is necessary in order to ensure a proportionate and measured approach to the oversight and governance on the use of leverage. Home Member States will have the level of detail required (further to disclosures made by AIFM to the home Member States) in order to take appropriate action, where necessary, in order to protect the stability and integrity of the financial system.

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