The European Commission finally adopted a delegated regulation supplementing the Alternative Investment Fund Managers Directive (AIFMD) on 19 December 2012.  The adoption of the level 2 regulation was subject to considerable delay and a certain degree of controversy as the Commission diverged in a number of important respects from the technical advice provided to it by the European Securities and Markets Authority (ESMA) on possible implementing measures.

The level 2 regulation is subject to a three-month scrutiny period by the European Parliament and the Council and will enter into force, provided that neither co-legislator objects, at the end of this period on the day following publication in the Official Journal of the European Union.  The level 2 regulation will be directly effective in each EU member state and therefore will apply to managers falling within the scope of AIFMD without requiring any implementing measures to be adopted by national legislators or regulators.  The link below will direct you to the text of the level 2 regulation:

 http://ec.europa.eu/internal_market/investment/alternative_investments/index.en.htm

Delegation Provisions

One key area of controversy related to the provisions contained in earlier drafts of the level 2 regulation relating to the “over delegation” of functions and how this could result in an AIFM becoming a “letter-box” entity that would no longer be considered the manager of the AIF. Significant concerns were raised that the provisions of the regulation, as reflected in earlier drafts, would have required many fund managers to carry out significant restructuring of their operations to comply with the requirements without any apparent benefits accruing to investors.

While the regulation still provides that an AIFM shall be deemed to constitute a letter-box entity if it delegates the performance of investment management functions to an extent that exceeds by a substantial margin the investment management functions performed by the AIFM itself, the final wording adopted at least provides that a qualitative approach must be adopted in the assessment of the extent of any delegation.  In particular, when assessing the extent of the delegation of any investment management functions, national competent authorities are required to assess the entire delegation framework, taking account not only of the assets managed under delegation but also of the following qualitative criteria:

• The assets of the AIF and the importance of the assets managed under delegation for the risk/return profile of the AIF
• The importance of the assets under delegation for the achievement of the investment goals of the AIF
• The geographical and sectoral spread of the AIF’s investments
• The risk profile of the AIF
• The type of investment strategies pursued by the AIF or the AIFM acting on behalf of the AIF
• The types of tasks delegated in relation to those retained
• The configuration of delegates and their sub-delegates, their geographical sphere of operation and their corporate structure, including whether the delegation is conferred on an entity belonging to the same corporate group as the AIFM

The regulation provides that the Commission will review the application of these provisions after a two year period and may further specify the conditions under which an AIFM shall be deemed to have delegated its functions to the extent that it becomes a letter box entity and can no longer be considered to be the manager of the AIF.  Furthermore, ESMA may issue guidelines to ensure a consistent assessment of delegation structures across the EU.

While some uncertainty remains as to the application of the provisions of the level 2 regulation in relation to the delegation of investment management functions by an AIFM, the final text of the regulation would now appear to us to be workable from a practical perspective and should allow for the continuation of the delegation model commonly employed by fund promoters and managers.  It also means that in most circumstances it should be possible to establish a self-managed EU AIF (which is specifically provided for in the Directive) or an AIFM within the EU which delegates portfolio management activities to a non-EU manager.  This should ensure that the structure developed very successfully in Ireland for UCITS funds can in most respects be replicated for AIFs and will enhance the jurisdiction’s attractiveness to non-EU managers looking to follow a “co-domiciliation” model by establishing regulated onshore versions of their offshore funds in order to access European assets following the implementation of AIFMD.

Other Key Provisions

The level 2 regulation also contains detailed provisions in relation to the following matters:

• Capital requirements for AIFMs
• Conditions and procedures in relation to the authorisation of AIFMs
• Reporting requirements and leverage calculation methodology
• Requirements for cooperation agreements with third countries
• Rules on depositaries, including detail on their obligations and liability
• Conditions for delegation of functions
• Requirements in relation to operating conditions for AIFMs, including remuneration provisions, conflicts of interest, valuation provisions and risk management requirements

We intend to prepare a more detailed summary of the level 2 regulation shortly but please do not hesitate to contact your usual contact in William Fry in the meantime if you have any specific queries.

Contributed by Paul Murray