LETTER REGARDING THE ALTERNATIVE INVESTMENT FUND MANAGERS DIRECTIVE (AIFMD)
May 13, 2010
Commissioner Michel Barnier
European Commissioner for Internal Market and Services
European Commission
BERL 10/034
B-1049 Brussels
Belgium
Alternative Investment Fund Managers Directive (AIFMD)
Scottish Financial Enterprise is the representative body for the financial services industry in Scotland. Our membership includes a wide range of companies from investment advisers and stockbrokers, banks and building societies to institutional investors such as insurance and pensions firms and fund managers, and to other business services organisations. So we represent the views of private investors, savers and pensionholders, as well as institutional investors, and through them the asset management community in Scotland.
We are particularly concerned to ensure that, as the AIFMD moves towards finalisation, the text reflects the real needs of investors and does not inadvertently cause long term consumer detriment or confusion through an overly restrictive, prescriptive or protectionist stance which has high costs but insufficient or no corresponding benefit to investors.
There are four main issues which we have previously highlighted and which we wish to bring again to your attention. We are raising them again because the directive is now entering its final stages, with critical decisions due to take place. In particular we are raising these major areas of concern in advance of the meetings in Brussels on 17 and 18 May when the AIFMD will once again be under discussion by the European Parliament and the Council. If the directive goes ahead unaltered, it will have a major negative impact on Scotland’s financial services industry and its customers. The main issues are:
1. Scope of AIFMD
2. Depositary requirements
3. Third country provisions
4. Remuneration provisions
1. Scope – the position of investment companies
We support the approach of the European Parliament in recognising the nature of investment companies, already regulated by other European and national regulations. The directive as redrafted both by the Council and by the European Parliament takes the stance that a closed ended listed company, whose governing articles require the appointment of a Board of Directors to take charge of its affairs, may be authorised by the competent authority in each member state to be its own Alternative Investment Fund Manager (AIFM). We believe this is a sensible approach for investment trusts, which are a common and long standing form of investment vehicle in the UK.
The proposal of the European Parliament, which we strongly recommend, is then to detail a small number of provisions of the directive which would then apply to such listed companies which, as is acknowledged, already comply with and are regulated under the relevant directives concerning prospectuses, market abuse and consolidated admissions and reporting. Particularly in the light of the fact that investment trusts are listed, with shares which trade at market value (not a calculated net asset value), and whose shareholders have no right to redeem shares, we agree with the approach taken by the European Parliament.
The current Council draft (11 March 2010) still applies a number of provisions – in particular the depositary provisions under Article 17 taken together with the valuation provisions under Article 16 – which we believe duplicate the existing responsibilities of the Board of Directors and, as such, add unnecessary costs and complexity to the operations of listed investment companies without there being any enhanced protection for consumers. Most importantly, they risk conflict with the relevant company law directives since directors have duties under UK company law which would overlap with or be duplicated by legal duties required to be undertaken by the depositary under the AIFMD as currently drafted. For example, directors must act in a way which would be most likely to promote the success of the company for the benefit of its shareholders as a whole – as a result, they must safeguard the company's assets, and ensure they are properly valued, and must prepare and deliver accounts to shareholders in accordance with company law and accounting standards. Requiring the Depositary to undertake several of these tasks as well risks conflict and would create uncertainty as to who bears ultimate legal responsibility (and, therefore, liability), which would be an unsatisfactory position.
2. Depositary requirements
We believe a more proportionate approach on the obligations and liabilities of depositary arrangements is essential in order to preserve a functioning investment market and allow investor choice (and reasonable investor cost) to continue. The current Council and European Parliament drafts of the directives contemplate strict liability for depositaries in safeguarding the assets of AIFs, and an extension of the role of depositaries to include legal compliance. We are concerned that, if the wording is left as it is, there could be serious consequences for AIFs in that:
· there is a risk that the relatively small pool of banks that currently act as depositaries will narrow still further, as the uncontrollable risks of undertaking the business (through no fault of the firm concerned) increase; this will concentrate risks and likely cause consumer detriment;
· there is a risk that the classes of assets and/or markets that depositaries are prepared to safeguard or cover will diminish, potentially reducing the returns for investors from, or denying access to, newer and dynamic sources which are of their nature likely to be in less developed markets; and
· even if these issues do not arise, there will be an increase in cost, the full scale of which cannot yet be quantified but which is likely to be significant, and this cost increase may be much more significant than the theoretical protection to investors is worth.
In these circumstances, there is a real need only to incur such costs where the services of a depositary are really adding value, and even then, ensure that any increases are on a realistic and proportionate basis.
There is, for example, no real benefit from employing a depositary to safeguard assets such as unquoted shares or property. These should be exempted. There are already suitable alternatives for appointing receiving bankers to safeguard subscriptions (eg for listed companies).
Where ‘risky’ assets in less developed markets are concerned, the risk is already priced into the market hence (in part) the potentially greater returns available. Where a depositary can add value, we strongly recommend that depositary liabilities only arise through improper performance of their duties (not failure for any reason), and where unforeseeable circumstances arise, liability shall not arise except where all reasonable efforts to avoid the resulting costs have not been made.
We believe that some of the costs and lack of availability of depositary services (which are, we believe, not available for all the requirements suggested through a single firm currently) may be mitigated by allowing more than one person to undertake the functions suggested for the depositary – for example, a firm of lawyers could be responsible for legal oversight and reporting on compliance to the AIFM shareholders; and auditors could undertake some of the confirmation of existence of assets.
3. Third country provisions
We believe the latest proposed provisions on the marketing of third country funds will lead to significant and adverse consequences for EU investor choice and that national private placement regimes for third country funds (whether the fund manager is EU or non-EU based) must continue.
For EU based fund managers, the Council draft (11 March) looks to introduce a regime of establishing co-operation arrangements between the home member state of the AIFM, and the country of the AIF. For non-EU based fund managers, the draft goes further and co-operation arrangements are to be in place between each EU member state in which the AIF is marketed, and the home country of the AIFM. In addition, the draft requires the AIFM to comply with various aspects of the directive, including those AIFM established outside the EU. Whilst requiring that co-operation arrangements are to be in place may sound reasonable enough, the practical consequences are likely to be that these arrangements will be difficult to establish and comply with. Therefore the end effect will be to restrict the market choice of EU investors. For example, EU pension funds will potentially be unable to continue investing in some markets that offer good opportunities for diversified and above-average returns for EU investors/pensioners.
It has been suggested (Mr Gauzes' latest proposed approach) that an alternative regime may be to allow private placement regimes to continue for a transitional period, pending an EU based assessment on the marketing of third country funds into the EU, the outcome of which may ultimately ban the marketing of third country funds (by certain jurisdictions that do not “make the grade”). During the assessment period, various co-operation arrangements are required between the third country AIF, the AIFM country (whether EU or non-EU) and the relevant EU member states (into which the AIF is marketed). This approach is very complex and in practice would only work over an extended timescale, if indeed it were ever to work effectively. Again, the end effect is most likely to lead to restricting EU investor choice.
Ultimately, the restriction of EU investor choice (on such a scale) will most likely lead to adverse consequences in non-EU financial centres and jurisdictions worldwide. There is such a level of concern already circulating the market that the potential repercussions cannot be ignored. The accusations of protectionism continue and there is also a real danger of retaliation in the market, which can only further harm the global economy and the EU in particular.
In summary, the current proposals have potential to cause considerable consumer detriment if the third country provisions do not proceed on the basis of allowing the continuation of the existing private placement regimes of the EU member states. A large number of existing vehicles will be affected, leading therefore to immediate adverse consequences for EU investors and adverse impact on the worldwide market. It is also extremely important that any new provisions do not have retrospective effect, requiring assets of investors to be sold in less than optimal market conditions.
We strongly recommend that the private placement regimes continue under local member state regulation until harmonisation of worldwide regulatory regimes is possible, and negotiation and agreement is reached on a global basis, as is intended for bank regulation, as to what is acceptable before the EU unilaterally imposes its own restrictive regime.
4. Remuneration provisions
At a late stage in the development of the directive, new disclosure requirements were inserted to require the accounts of AIFs to disclose the total remuneration (split between variable and fixed) paid by the AIFM. The Council draft goes further and requires the information broken down by senior management and staff who have a material impact on the risk profile of the AIF.
We believe this approach is fundamentally flawed.
· First, a parallel is in effect being drawn with banks, but their remuneration is completely differently structured. Banks will often be paid fees for transactions whose success or otherwise will not be evident before the fee is paid. Fund managers, on the other hand, are usually paid for historical performance after the performance has been determined.
· Second, there is an assumption that the variable remuneration of individual employees in some way impacts the risk profile of the AIF. This is incorrect. It is the management contract of the AIF, particularly that part which specifies any performance-based fees payable to the fund manager, which is relevant to the AIF's shareholders' assessment of the AIF's risk profile.
· Third, we believe that disclosure of remuneration in the accounts of AIFs will be misleading. A fund manager may have many hundreds of clients and hundreds of employees. The accounts of any one AIF may well be dwarfed by the total remuneration disclosure for the entire AIFM – indeed, the remuneration of a single employee may far exceed the level of management fees paid by an AIF to its fund manager. Moreover the extent of variable remuneration is much more likely to reflect the volume of business undertaken by the firm, rather than the impact of risk taking in respect of any given AIF. So the implications which the investor is being invited to take from the disclosure are nothing to do with the particular AIF's risk profile.
· Finally, the natural response to requirements to limit variable remuneration for employees will be to increase the fixed element. This has the effect of increasing the risk profile of the AIFM since it is expected to bear a higher fixed cost, which puts its viability at greater risk when volumes decline (eg when markets fall). That model for AIFM's is ultimately potentially detrimental to the financial services market and investors as a whole.
We recommend that salary disclosure is not required at all under the AIFMD, due to its potential to mislead. Instead there should be a requirement, which is of relevance to AIF shareholders, specifically to disclose the fee basis of the charges made by the AIFM to the AIF and, importantly, the total amount of costs involved. This transparent disclosure requirement is already operated successfully in the UK's investment trust industry. Whatever approach to the codes applying to fund manager remuneration is finally adopted, this should at the very least be consistent across the various G20 bodies and pronouncements, and other EU directives (such as the CRD).
I would be pleased to discuss these matters further with you or with any of your colleagues.
Yours sincerely
Owen Kelly Mark Tennant
Chief Executive Chairman
