Luxembourg’s fund industry is keenly awaiting the outcome of negotiations between the European Union’s legislative institutions on the final form of the proposed Directive on Alternative Investment Fund Managers. Finalisation of the directive could open up new opportunities for Luxembourg as a domicile and servicing centre for alternative funds, but the EU has been slow to reach agreement on a number of outstanding issues, notably the treatment under the directive of managers and funds based in countries outside the union.
Following the publication of a first draft of the directive by the European Commission on April 30, 2009, the directive has been subject to intense debate and repeated redrafting. In May this year the European Parliament and the EU Council of Ministers approved versions of the text that differ significantly on a number of issues. Since then representatives of the Parliament, Council and Commission have been seeking agreement through ‘trialogue’ discussions on a compromise version that can be sent to the Parliament for a first reading during its October session.
On August 27 Belgium, which holds the presidency of the Council of Ministers, published a further proposal incorporating areas where the trialogue negotiations appear to have resulted in a consensus, but notably excluding the contentious topics of access to EU investors by third-country managers and funds, as well as disclosure requirements for private equity funds on their portfolio companies.
The Parliament’s current draft of the directive lays down in Article 35 the conditions under which an alternative investment fund domiciled outside the EU can be marketed to professional investors in Europe. This requires an agreement between the regulator of the targeted EU market(s) and that of the fund domicile’s regulator to ensure full exchange of information on the fund’s activities, certification by the Commission that the third-country jurisdiction meets EU standards on countering money laundering and terrorist financing, tax information exchange agreements are in force with the fund domicile jurisdiction, and that the third country offers EU-based alternative managers comparable market access.
According to the Parliament’s version, a non-EU manager seeking to market funds within EU member states must comply with Article 39a of the draft text, which requires that the manager agrees with the future European Securities and Markets Authority (Esma) to comply with the directive voluntarily and accepts the jurisdiction of EU courts on any matter arising from the directive. There must also be an agreement between Esma and the manager’s home regulator under which the latter would exercise Esma’s regulatory powers with regard to the manager. Similar provisions apply to non-EU managers seeking to offer management services within one or more EU member states.
Article 39a requires that if the non-EU manager wishes to market a non-EU fund within a member state, the funds must meet the conditions of Article 35, as they would in the case of an EU-based manager. The text says the agreement can be revoked should either the non-EU manager fail to comply with the directive or its regulator fail to adhere to its agreement with Esma on delegation of regulatory powers. The Commission is charged with supervising whether the third countries are complying satisfactorily with the agreements.
It should be noted that the European Parliament’s version of the text does not grant non-EU managers the same marketing ‘passport’ enjoyed by EU managers under the directive, under which a fund authorised in one EU jurisdiction may be marketed to professional investors in other EU states once the manager notifies its home regulator of its intention to do so. By contrast, the text makes third-country managers subject to the approval process described above for each EU member state in which it seeks to market funds to investors.
The version of the text approved by the Council in May simply proposes that member states may allow authorised EU-based managers to market non-EU domiciled funds to professional investors on their territory as long as the manager complies with the directive and appoints an independent depository, and yet-to-be-defined “co-operation arrangements” are in place between the manager’s home regulator and the supervisory authority of the fund domicile.
The Council would also let member states allow managers based outside the EU to market their funds to professional investors subject to national rules as well as articles 19, 20 and 21 of the directive covering the publication of annual reports, disclosure to investors and regulatory reporting, and Section 2 covering minimum capital requirements. The text also requires co-operation between the home regulator of the fund manager and that of the target market covering exchange of information for oversight of systemic risk. Again, the co-operation arrangements are to be worked out subsequently by the Committee of European Securities Regulators, the forerunner of Esma.
What do these proposals mean for managers based outside the EU that currently access European investors through national private placement regimes? The Council text as it stands would allow this channel to remain open, subject only to regulatory co-operation on systemic risk and the same transparency and capital requirements to which EU managers would be subject under the directive.
By contrast, the Parliament’s draft insists that non-EU managers comply with the AIFM Directive and requires their regulators to act as Esma’s proxy in overseeing that compliance, as well as subjecting the managers to the jurisdiction of EU courts, if they wish to gain access to professional investors within an EU market. Because this process does not offer all the benefits of the full cross-border distribution passport, it has to be repeated for each additional member state the manager wishes to target, with the likelihood of both further delays and additional bureaucratic effort and cost.
Take the example of a Brazilian manager seeking to market its fund to pension schemes in France. If the fund were domiciled in the Cayman Islands, this would require that the manager comply with the directive and that the Brazilian regulator, the CVM, agree with Esma to oversee the manager’s compliance. In addition, there would have to be a separate agreement between Cima, the Cayman regulator, and France’s AMF covering supervision of the fund.
Were the manager to offer French institutions a Luxembourg-domiciled SIF, for example, rather than a Cayman fund, this additional oversight of the fund would not be necessary. It’s not fully clear from the Parliament’s draft, but it appears that the oversight agreement between Esma and the CVM would cover the marketing of the fund to investors in other EU countries.
However, this would require active approval from regulators in these additional markets, rather than the mere notification procedure that would apply to EU-based managers. If the Brazilian manager planned to focus on investors throughout Europe, they might consider it worthwhile to shoulder the cost of setting up a Luxembourg management company in order to enjoy the full benefits of the AIFM passport and avoid the need to be supervised by the CVM according to EU rules, which may prove complicated in practice.
However, this may not be the end of the story. The Belgian presidency is understood to be seeking a compromise on the third-country access issue that would contain elements of both approaches. Under this idea, which is reported to be under consideration by member states, non-EU managers would be able to obtain access to EU member states’ markets by complying with the directive, but existing national private placement regimes would remain in place for at least another five years.
After this period the national regimes would end, according to one suggestion, or be subject to a review and a possible rollover for a further five years, according to another. Belgium has also suggested that ‘passive marketing’ – where investors take the initiative in approaching fund managers – continue to be permitted with regard to funds outside the EU, subject to only limited restrictions on the investors. This contrasts with a provision in the Parliament’s draft that would explicitly bar European investors from non-EU funds that do not meet all the conditions set out in Article 35.
Discussions over the coming weeks are likely to determine the final form of the AIFM Directive and the rules that will apply to third-country managers and funds. Once the text is finalised and the final stages of the legislation procedure is underway, non-EU managers may soon face a choice on the best method of accessing European investors. If agreement is reached soon, the directive will stay on track for implementation in 2012.
By Olivier Sciales, partner of Chevalier & Sciales (Luxembourg). You may find more information on our AIFM blog at http://www.cs-avocats.lu/aifm-directive. The purpose of this blog aims to provide up to date news coverage and timely analysis of the legislative process and issues raised by the European union’s Directive on Alternative Investment Fund Managers.
Follow me on twitter: http://www.twitter.com/oliviersciales