|
|
THE EUROPEAN COMMISSION’S DIRECTIVE ON ALTERNATIVE INVESTMENT FUND
MANAGERS - THE CONTROVERSY CONTINUES |
|
|
In April 2009, the European Parliament and Council issued its draft
Proposal for a Directive on Alternative Investment Fund Managers, which
is aimed at extending uniform European Community (EC) regulation and
oversight to investment funds not currently subject to regulation as
Undertakings for Collective Investment in Transferable Securities (UCITS).
UCITS are essentially mutual funds that are marketed and sold to retail
investors. The proposed Directive would affect virtually all private and
institutional alternative investment funds, including hedge funds,
private equity funds, larger venture capital funds, commodities funds
and real estate funds (with certain possible exceptions, which will be
discussed below), as well as portfolio companies owned by private equity
funds, and is particularly restrictive of funds and managers established
outside of the European Union (EU).
There is currently an estimated €2 trillion in assets under management
invested in alternative investment funds in the EU. Since Romania is a
member of the EU, the Directive would apply to non-UCITS funds
established in Romania as well as funds established in other countries
that are marketed to institutional investors in Romania; but it should
also be noted that there are several areas where the Directive will most
likely allow some discretion to each individual Member state. For
example, the Directive would allow each Member state the discretion to
determine whether to allow covered funds to be marketed to retail
investors as well as the discretion to enter into cooperation agreements
with so-called “third-country” states. In addition, the regulatory
authority in each Member state is charged, subject to EU guidelines,
with determining standards for authorization under the new scheme.
Informed use of such discretion in tailoring Romania’s internal
regulations and standards could help to make Romania a more attractive
home jurisdiction and market for alternative investment funds.
 The regulatory approach taken by the Commission is similar to that taken
by U.S. regulators, in that it focuses on fund managers (dubbed “AIFM”)
rather than on the funds themselves. Unlike U.S. regulations, however,
the Directive would affect a host of players acting in various different
capacities. Fund marketers, administrators, custodians, appraisers and
valuation specialists and their delegates, as well as investment
advisors, would all be subject to a raft of regulations, including
authorization and approval requirements, reporting requirements, minimum
capital and liquidity and risk management requirements and restrictions
on marketing and management of non-EU funds, remuneration policies,
retention of sub-managers and service providers and use of leverage and
certain trading techniques (such as short sales) as well as other
industry practices.
The original draft Proposal was written in the wake of the global
financial crisis in response to political pressure resulting from
perceptions that AIFM contributed to elevated levels of leverage and
risk of various types that exacerbated market volatility and led to the
near-collapse of the banking and financial system. In addition, there
was expressed concern with, among other things, the level of secrecy
characteristic of AIFM, which operate with minimal public disclosure
requirements, and that private equity funds in particular jeopardize the
companies they acquire by over leveraging and are responsible for job
loss. The Proposal calls for the institution of a new regulatory
framework aimed at creating more transparency and reducing the
“macro-prudential” (i.e., systemic) and “micro-prudential” (i.e.,
specific to individual companies).
The failure of the Council to solicit input from the funds industry,
among other things, provoked fierce criticism of the Proposal following
its initial issue. On November 12, 2009, the Swedish Presidency of the
European Council of Ministers published a modified proposal which
incorporated a number of compromises from the original draft; however, a
subsequent text published on February 15 by the new Spanish Presidency
of the Council reverses some of those changes. In addition, the European
Parliament, through its Rapporteur, issued a detailed report or its view
on each article of the proposal.
According to the Secretary General of the European Venture Capital
Association, Members of the European Parliament have submitted well over
a thousand proposed amendments. On January 27, the JURI Committee (the
EU Committee on Legal Affairs), which is advising the European
Parliamentary Committee on Economic and Monetary Affairs, held a meeting
to discuss the potential impact of the Directive and presented 29
amendments, including a proposal to change the name of the Directive
itself to include funds. Last month, the Economic and Monetary Affairs
Committee of the European Parliament held its first formal consideration
of some 1,700 amendments. A second consideration is scheduled to be held
this month.
Among the more hotly debated provisions of the Directive are:
- Provisions regulating the marketing of non-EU, “third-country”
funds
- Restrictions relating to depositaries
- Rules relating to fund valuations
- Rules relating to remuneration policies of AIFM
- Reporting and disclosure requirements as applied to certain
types of funds
- Caps on the use of leverage
 The Directive requires EU fund managers to obtain authorization from the
relevant regulatory authority in their home jurisdictions to market alternative
investment funds in EU countries. Under the Commission’s proposal, AIFM with
less than €100 million in assets under management, including assets acquired
through leverage, or with funds that are not leveraged and not subject to
redemption for the first five years and who have less than €500 million under
management, are exempt from the requirements of the Directive; however, the
Parliament’s text would eliminate this threshold exemption. Some have argued
that these thresholds are too high, while others have argued they are too low.
While the original draft allowed such authorities up to two months to determine
whether to grant authorization, the current amended draft allows up to six
months – a considerably longer period of time. In addition, material changes,
such as establishing a new fund or sub-fund, or changes in investment strategy
or the level of leverage used, would require pre-approval by the relevant
authority, which could take up to three months to obtain. Such delays,
particularly as regards changes, could prove cumbersome and result in an
inability of fund managers to timely respond to changing or volatile market
conditions; a result which would be detrimental both to fund managers and to
fund investors. A regulatory authority which is capable of providing swift and
timely responses to applications and requests for authorization would greatly
improve a Member state’s attractiveness to the alternative investment fund
industry.
Once authorized, AIFMs would be able to market EU-based funds to institutional
investors in countries throughout the EU - a sort of “passport” system. In
addition, individual Member states would have discretion to allow marketing of
funds to retail investors, subject to additional requirements. Management and
marketing of so-called “third country” funds based outside of the EU, however,
would be subject to substantial restrictions. Under the Commission’s proposal,
AIFM would be able to market third country funds only if the funds’ home country
has legislation in place that is ‘substantially equivalent’ to the Directive.
[1] A key distinction between the Commission’s original proposal and
the current text is the additional requirement by the latter of approval by each
individual Member state for marketing of a non-EU based fund except where there
is a cooperation agreement in place [2] between the Member states and
the home third-country, which effectively renders the “passport” system for
EU-based funds unavailable to non-EU-based funds. No provision is made for the
authorization of Non-EU-based AIFM under the Directive.
[1] An
initial proposal for a three-year freeze on the marketing of
non-EU funds has been dropped.
[2] The cooperation agreements would be required to meet certain
criteria established by the Commission.
The restrictions on marketing of non-EU-based funds have elicited particularly
fierce criticism over concerns that they are protectionist and would limit the
choices of funds available to EU investors. Many countries do not have
legislation comparable to the EU’s Directive; most notably, the U.S. does not
have any substantially equivalent legislation, nor do many of the other, more
popular “jurisdictions of choice” for alternative investment funds. Thus, for
practical purposes, funds in most third-country jurisdictions would be
off-limits to EU fund managers. The net effect of such restrictions could
therefore prove detrimental to EU fund managers and investors alike, putting
them at a relative disadvantage to fund managers and investors in other
countries.
The authorization requirement applies to sub-managers as well, thereby
restricting the ability of AIFM to delegate their functions to non-EU
sub-managers unless they are in jurisdictions that meet the criteria for AIFM to
market and manage funds in the EU. In addition, under the new scheme AIFM would
be held strictly liable to their investors for the acts of their delegees. AIFM
would need to notify the regulatory authorities of any delegations of its
functions; an earlier requirement that delegations be pre-approved by regulatory
authorities has been dropped.
Other criticisms of the Directive center on its treatment of depositaries. The
Directive calls for the appointment of an independent depositary, which must be
approved by competent authorities of the home Member state of the fund (or,
where the fund’s home state does not regulate, then by a regulatory authority of
the AIFM’s home state). Depositaries must be EU-established undertakings and
must be either a credit institution or an investment firm – a requirement which
some have argued is too restrictive. In addition, the Directive would charge the
depositary with custodial, administrative and transfer agent duties, as well as
with responsibility for verifying compliance of trades with applicable laws and
the fund’s governing documents, which functions are not currently performed by
most depositaries. It would also impose strict liability on depositaries for the
actions of their sub-custodians, except where liability for lost securities is
contractually discharged, and require the maintenance of a performance bond,
contrary to current practice in which depositaries do not accept primary
obligations for functions that they do not themselves perform. The Directive
would also require that all financial instruments be kept in segregated accounts
in the names of the funds, thereby precluding securities from being held in
“street name,” as is currently common practice where global custodian banks
rather than prime brokers are used.
 The Directive also requires that AIFM ensure the independence of the valuation
function where the AIFM’s compensation is determined either directly or
indirectly by the fund’s performance. A blanket requirement in the original
proposal that the valuator be an external, independent entity has been dropped
in the revised version.
Remuneration is another area which has provoked much criticism. Although the
Council’s Proposal requires AIFM to maintain remuneration policies that align
compensation to performance and partially defer payment of variable
compensation, and sets out a number of guidelines, the most specific of which
appears in brackets and requires that at least 40% (60%, if the variable
remuneration component is very high) of the variable remuneration component be
deferred. In addition, the Parliament’s Proposal indicates that remuneration
policies should be consistent with those of credit institutions – a requirement
that has provoked fierce objections form the fund industry.
The Directive imposes new disclosure requirements aimed at achieving greater
transparency. Members of the fund industry argue that some of these requirements
would put them at a competitive disadvantage, particularly with respect to funds
established in third-countries. Funds would be required to make available to
investors and relevant authorities disclosure regarding, among other things,
their remuneration, risk and liquidity management, delegation policies and
investment strategies. In addition, in cases where a fund acquires more than 50%
(increased from the 30% specified in the original draft) of the outstanding
voting rights of a non-listed company, the fund would be required to disclose to
both the acquired company’s shareholders and its employees information regarding
the acquisition, use of leverage, the resulting change in ownership structure
and fund’s intent regarding management of the company.[3] Hedge fund managers argue
that disclosing their investment strategies would put them at a competitive
disadvantage to funds in other jurisdictions, while AIFM of funds that invest in
or acquire non-listed companies argue that they would be put at a disadvantage
relative to other buyers and investors.
A final area of particular debate concerns proposed caps on the use of leverage.
The original proposal called for the Commission to set caps on the amount of
leverage allowed to a fund. Industry lobbies argued forcefully that such caps
could prevent funds from responding to changes in market conditions or, more
seriously, could result in forced liquidations which would exacerbate market
volatility in downturns. The new draft eliminates the caps, but still provides
for Member state authorities to establish caps as appropriate
In sum, the Commission’s new draft incorporates many compromise changes from the
original; however, certain areas of vigorous debate and challenges of
feasibility relative to current market practices and capabilities remain.
Therefore, we can expect to see a lot more commentary and further changes as the
Directive works its way through the rule-making process. Careful observation and
consideration to the evolving framework and provisions, however, could provide
Member states with opportunities to make internal adjustments that would
increase their attractiveness to alternative investment funds and their managers
and investors.
[3] An exception is made for
“small and medium enterprises,” defined as companies which,
according to their latest annual consolidated accounts, meet two
out of three of the following: (i) have an average number of
employees less than 250; (ii) have a total balance sheet not
more than €43 million; and (iii) have annual net turnover of
note more than €50 million.
|
|
[ Up
to Contents ] |
Editors Note: It is our policy not to mention our clients by name in
The Romanian Digest™ or discuss their business unless it is a matter of
public record and our clients approve. The information herein is correct
to the best of our knowledge and belief at press time. Specific advice
should be sought from us, however, before investment or other decisions
are made.
Copyright 2010 Rubin Meyer Doru & Trandafir, societate civila de avocati.
All rights reserved. No part of The Romanian Digest™ may be reproduced,
reused or redistributed in any form without prior written permission
from the publisher.
|
RUBIN MEYER DORU & TRANDAFIR
societate civila de avocati
Str. Putul cu Plopi, Nr.7, Sector 1
Bucharest, Romania
Tel: (40) (21) 311 14 60
Fax: (40) (21) 311 14 65
E-Mail:
office@hr.ro
VISIT OUR WEB SITE:
http://www.hr.ro
The Romanian Digest Archive
|
AFFILIATED WITH:
Herzfeld & Rubin, P.C.
125 Broad Street
New York, New York 10004
Tel: (212) 471-8500
Fax: (212) 344-3333
http://www.herzfeld-rubin.com
Long Island Office
Herzfeld & Rubin, P.C.
1225 Franklin Avenue, Suite 315
Garden City, New York 11530
Tel: (212) 471-3231
Herzfeld & Rubin LLP
1925 Century Park East
Los Angeles, California 90067
Tel: (310) 553-0451
Fax: (310) 553-0648
Chase Kurshan Herzfeld & Rubin
354 Eisenhower Parkway, Suite1100
Livingston, New Jersey 07039-1022
Tel: (973) 535-8840
Fax: (973) 535-8841
Israeli Affiliated Law Firm
Balter Guth Aloni & Co.
96 Yigal Alon Street,
Tel Aviv, 67891, Israel
Tel: +972-3-511-1111
Fax: +972-3-624-6000 |
|
|
New York — California — New Jersey — Romania |
|
If you no longer wish to receive emails
from us, please send an e-mail with UNSUBSCRIBE
in the subject line to
Romanian.Digest@hr.ro. |
|
