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The May 2009 edition of the International
Association of Hedge Funds Professionals
(IAHFP) newsletter |
Welcome to the May
2009 edition of the IAHFP Newsletter.
Breaking news
Brussels, 29 April 2009
The European Commission proposes EU framework for
managers of alternative investment funds
The European Commission has proposed a Directive on Alternative Investment
Fund Managers (AIFM).
The proposed Directive is an important part of the
European Commission's response to the financial crisis, as set out in
the Communication on Driving European Recovery.
It aims to create a comprehensive and effective regulatory and supervisory
framework for AIFM in the European Union.
AIFM, which include the managers of hedge funds and
private equity funds, managed around €2 trillion in assets at the end of 2008.
This is the first attempt in any jurisdiction
to create a comprehensive framework for the direct regulation and supervision
in the alternative fund industry.
The proposal now passes to the European Parliament and Council for
consideration.
Internal Market and Services Commissioner Charlie
McCreevy said:
"Alternative investement fund managers have become important participants in
the European financial system and their activities have had a significant
impact on the markets and companies in which they invest. There is now a
global consensus - as expressed by the G20 leaders - over the need for closer
regulatory engagement with this sector.
In particular, it is essential that regulators have the information and tools
necessary to conduct effective macro-prudential oversight.
The crisis has also underscored the importance of robust risk and liquidity
management systems and the need for reliable investor information as the basis
for effective due diligence.
I look forward to working with the European Parliament and Council to secure
the adoption of this important piece of legislation."
The proposed Directive will require all AIFM within scope to be authorised and
to be subject to harmonised regulatory standards on an ongoing basis.
It will also enhance the transparency of the activities of AIFM and the funds
they manage towards investors and public authorities.
This will enable Member States to improve the macro-prudential oversight of
the sector and to take coordinated action as necessary to ensure the proper
functioning of financial markets.
The proposal will help to overcome gaps and inconsistencies in existing
regulatory frameworks at national level and will provide a secure basis for
the development of the internal market.
The proposed AIFM Directive will:
· Adopt an 'all encompassing' approach so as to ensure that no significant
AIFM escapes effective regulation and oversight, while recognising the
legitimate differences in existing business models and providing exemptions
for smaller managers for whom the requirements would be disproportionate.
Therefore, the Directive will only apply to those AIFM
managing a portfolio of more than 100 million euros.
A higher threshold of 500 million applies to AIFM not
using leverage (and having a five years lock-in period for their investors) as
they are not regarded as posing systemic risks.
A threshold of € 100 million implies that roughly 30% of hedge fund managers,
managing almost 90% of assets of EU domiciled hedge funds, would be covered by
the Directive.
· Regulate all major sources of risks in the alternative investment value
chain by ensuring that AIFM are authorised and subject to ongoing regulation
and that key service providers, including depositaries and administrators, are
subject to robust regulatory standards.
· Enhance the transparency of AIFM and the funds they manage towards
supervisors, investors and other key stakeholders.
· Ensure that all regulated entities are subject to
appropriate governance standards and have robust systems in place for
the management of risks, liquidity and conflicts of interest.
· Permit AIFM to market funds to professional investors throughout the EU
subject to compliance with demanding regulatory standards.
· Grant access to the European market to third country funds after a
transitional period of three years. This should allow the EU to check whether
the necessary guarantees are in place in the countries where the funds are
domiciled (equivalence of regulatory and supervisory standards, exchange of
information on tax matters).
Background
In the EU, investment funds can be broadly categorised as
UCITS (Undertakings for Collective Investment in
Transferable Securities) and non-UCITS (or non-harmonised) funds.
The former are those that comply with the harmonised rules laid down in the
UCITS Directive (85/611/EEC) and are authorised for sale to the retail market.
For the purposes of the proposed Directive, Alternative Investment Funds (AIF)
are defined as all funds that are not harmonised under the UCITS Directive.
The AIFM sector in the EU is large, with around €2
trillion in assets at the end of 2008. It is also diverse: hedge funds,
private equity funds, commodity funds, real estate funds and infrastructure
funds, among others, all fall within this category. They invest in a wide
range of assets and employ different investment strategies and techniques.
AIF invest in financial instruments such as stocks, bonds and other securities
or commodities, as well as shares in real estate and infrastructure projects
and controlling stakes in companies.
Investments in AIF are typically regarded as entailing a level of risk or
other characteristics that render them unsuitable for retail investors. Access
to many types of AIF has therefore traditionally been restricted to
professional or institutional investors.
The activities of AIFM are currently regulated by a combination of Member
State financial and company law regulation, as well as cross-cutting
provisions of Community law.
These laws have been supplemented in some sectors by
industry-developed standards. However, recent events have demonstrated
that the activities of AIFM are not sufficiently transparent and that the
associated risks are not sufficiently addressed by current regulatory and
supervisory arrangements.
Crucially, the existing regulatory environment does not adequately reflect the
cross-border nature of the risks posed: the impact of risks crystallising in
the AIFM sector in one Member State will therefore also be felt beyond its
national borders.
In recognition of these vulnerabilities, the European Commission, in the
recent Communication to the Spring European Council on Driving European
Recovery, committed to ensuring that all relevant market actors are subject to
appropriate regulation and oversight and specifically to introducing a
harmonised regulatory and supervisory framework for the alternative investment
sector.
Directive on Alternative Investment Fund Managers (AIFMs)
: Frequently Asked Questions
What are the key objectives of the proposal?
The Directive will introduce harmonised comprehensive and effective regulatory
and supervisory framework for Alternative Investment Fund Managers (AIFM) in
the EU.
For the purposes of the Directive, AIF are defined as
all funds that are at present not harmonised under the UCITS Directive.
The AIF sector in the EU is relatively large - the AIFM
managed around €2 trillion in assets at the end of 2008 - and diverse
hedge funds, private equity funds, commodity funds, real
estate funds and infrastructure funds, among others, fall within this
category.
The specific objectives of the AIFM Directive are to:
· Ensure that all AIFM are subject to appropriate authorisation and
registration requirements;
· Provide a framework for the enhanced monitoring of macro-prudential risks,
e.g. through sharing of relevant data among supervisor;
· Improve risk management and organisational safeguards to mitigate
micro-prudential risks;
· Enhance investor protection;
· Improve public accountability for AIF holding controlling stakes in
companies;
· Develop the single market for AIFM.
What risks is the proposal tackling?
The financial crisis has underlined the extent to which AIFM are vulnerable to
a wide range of risks.
These risks are of direct concern to the investors in those funds, but also
present a threat to creditors, trading counterparties and to the stability and
integrity of European financial markets.
The nature and intensity of these risks varies between the different business
models that AIFM pursue. For example, macro-prudential
risks associated with the use of leverage relate primarily to the activities
of hedge funds and commodity funds managers; whereas risks associated with the
governance of portfolio companies are most closely associated with private
equity.
However, other risks, such as those relating to the management of
micro-prudential risks (in particular to the internal risk management systems
of the AIFM) and to investor protection are common to all types of AIFM.
The risks associated with their activities have manifested themselves
throughout the AIFM industry over recent month and may in some cases have
contributed to market turbulence.
Given the global nature of their activities, many risks posed by AIFM have an
important cross-border dimension. The impact of risks crystallising in the
AIFM sector in one Member State will therefore be felt beyond national
borders.
Were AIFM at the origin of the financial crisis? What
impact did this crisis have on them?
While AIFM were not the cause of the crisis, recent events have placed severe
stress on the sector.
The risks associated with their activities have manifested themselves
throughout the AIFM industry over recent months and may in some cases have
contributed to market turbulence.
For example, hedge funds have contributed to asset price inflation and the
rapid growth of structured credit markets.
The abrupt unwinding of large, leveraged positions in
response to tightening credit conditions and investor redemption requests has
had a procyclical impact on declining markets and may have impaired market
liquidity.
Funds of hedge funds have faced serious liquidity problems: they could not
liquidate assets quickly enough to meet investor demands to withdraw cash,
leading some funds of hedge funds to suspend or otherwise limit redemptions.
Private equity funds due to their investment strategies and a different use of
leverage than hedge funds, did not contribute to increase macro-prudential
risks.
They have experienced challenges relating to the availability of credit and
the financial health of their portfolio companies.
The inability to obtain leverage has significantly
reduced buy-out activity and a number of portfolio companies previously
subject to leveraged buy-outs are reported to be faced with difficulties in
finding replacement finance.
Commodity funds were implicated in the commodity price bubbles that developed
in late 2007.
Are not AIFM already regulated at national level?
Currently, the activities of AIFM are regulated by a combination of national
financial and company law regulations and general provisions of Community law.
They are supplemented in some areas by industry-developed standards. However,
recent events have indicated that some of the risks associated with AIFM have
been underestimated and are not sufficiently addressed by current rules.
This is partly a reflection of the predominantly national perspective of
existing rules: the regulatory environment does not
adequately reflect the cross-border nature of the risks.
Nationally fragmented approaches do not constitute a robust and comprehensive
response to risks in this sector.
Effective management of the cross-border dimension of these risks demands a
common understanding of the obligations of AIFM; a coordinated approach to the
oversight of risk management processes, internal governance and transparency;
and clear arrangements to support supervisors in managing these risks, both at
domestic level and through effective supervisory cooperation and information
sharing at European level.
What are the key provisions of the AIFM Directive? How
will the Directive work?
All EU domiciled AIFM with assets under management above
the threshold of 100 million EUR or, in case of AIF with no leverage and
lock-in period of 5 years or more, above the threshold of 500 million EUR will
need to be authorized by the home Member State competent authority (CA) and
subject to ongoing requirements.
All AIFM operating in the EU will be required to demonstrate that they are
suitably qualified to provide AIF management services and will be required to
provide detailed information on the planned activity of the AIFM, the identity
and characteristics of the AIF managed, the governance of the AIFM (including
arrangements for the delegation of management services), internal arrangements
with respect to risk management, arrangements for the valuation and
safe-keeping of assets, audit arrangements, and the systems of regulatory
reporting, where required.
The AIFM will also be required to hold and retain a
minimum level of capital.
AIFM will be required to report to the CA on a regular basis on the principal
markets and instruments in which it trades, its principal exposures,
performance data and concentrations of risk.
The AIFM will also be required to notify the CA of the home Member State of
the identity of the AIF managed, the markets and assets in which the AIF will
invest and the organisational and risk management arrangements established in
relation to that AIF.
Additional disclosure obligations will apply to AIFM managing leveraged AIF
and controlling stakes in companies.
AIFM authorised in its home Member State will be
entitled to market its funds to professional investors in any Member State.
The cross-border marketing of AIF would be subject to a notification
procedure, under which relevant information is provided to the home Member
State and transmitted to the host.
AIFM shall also be entitled to freely provide management services in Member
States other than their Member State of domicile, subject to a notification
procedure.
Why the AIFM Directive regulates fund managers instead
of funds?
The Directive is focused on regulating the activities of
AIFM, since it is the AIFM who is responsible for all key decisions in
relation to the management of the fund.
Financial stability and investor risks stem primarily from the conduct and
organisation of the manager and the providers of key services, notably the
depositary and valuation agents.
The most effective response is therefore to focus on these entities.
The proposal does not impose registration requirements directly on funds, nor
does it regulate investment policies.
Regulation of investment policies would be unnecessarily restrictive given the
professional nature of the investor base and would be impractical to implement
given the diversity of business models.
The proposal nevertheless has a strong indirect impact on the way that funds
are managed and ensures that authorities are fully informed about the funds
marketed in their jurisdiction through disclosure obligations on managers.
There is therefore no obvious regulatory need for regulating investment
policies directly or for requiring the registration of funds.
In the absence of direct fund regulation and in the context of robust
regulation of the main risk centres, the benefits of fund registration would
likely be outweighed by the additional burden on funds and regulators.
Moreover, the introduction of a fund registration system could be a source of
moral hazard. Investors may perceive that regulators exercise greater direct
control over the fund than is in fact the case.
This may result in investors foregoing the necessary due diligence and
exposing themselves to greater risks.
How does the proposal treat AIFM/AIF established in
third countries? Will they continue to be able to do business in Europe?
The Directive provides that only AIFM established in Europe can provide their
services in the Community.
In the same way, only funds domiciled in Europe can be marketed by EU
authorized AIFM on the European territory.
However, the Directive recognises that the management of
offshore funds is an important feature of the hedge fund and private equity
business models.
The proposal will provide a safe and secure framework for it to continue. It
will provide an "EU passport" for the marketing of those third country funds
which comply with stringent requirements on regulation, supervision and
cooperation, including on tax matters.
However more time will be needed to do the necessary preparation and
groundwork to make this a success.
Therefore the rules allowing the marketing of third country funds will come
into force 3 years after the rest of the Directive.
In the meantime third country funds will continue to be sold in those Member
States which currently allow that.
This will be a strong incentive in the years ahead for the jurisdictions and
managers concerned to deliver the necessary improvements in supervision,
cooperation with European supervisors and compliance with the
OECD Tax code.
This approach is consistent with the objectives of the
G20 to enhance the transparency and the quality of regulation in
offshore financial centres.
Will AIF need to comply with capital requirements
similarly to banks?
As regards capital requirements for AIFM, the proposals provides for a minimum
capital requirements to ensure the continuity and regularity of the AIFM
services.
It is a standard practice to oblige fund managers to retain capital for
investor protection reasons.
It shall enable investors to claim damages in case of
fraud or other wrongdoing by the manager.
This risk is however rather low, given that the fund's assets are segregated
from the AIFM and safe-kept by the depositary which also books the investor's
money on a segregated account.
The minimum capital for AIFM is EUR 125.000, but additional capital is
required if the assets under management exceed EUR 250 million.
The draft proposal does not provide for any capital requirements for the fund.
The rationale for capital retentions for banks does not extend to AIFM.
Investors which e.g. invest in hedge funds knowingly seek exposure to
(relatively) high risks with the aim of (potential) high profits.
There is no guarantee that investors will get paid back
the invested money (plus profits). Bank saving, by contrast, works on the
principle that deposits and interest payments are safe.
Furthermore, leverage of hedge funds is on average much lower than leverage of
investment banks. While the latter use leverage ratios of up to a factor of 30
or even 50 in some cases, leverage ratio of hedge funds is down from a factor
of 2 before the crisis to factor 1 in 2008, i.e. the average leverage used by
hedge funds equals their net assets.
These figures illustrate that the systemic risk posed by the use of leverage
by hedge funds is significantly lower than that of investment banks.
The possible impact of the failure of an individual hedge fund on the banking
sector is currently addressed through the prudential regulation of prime
brokers.
Prime brokers are required to hold capital against their
hedge fund exposures and to have in place robust counterparty risk management
systems. The reform of European banking regulation is part of the
comprehensive package of reforms announced in the Commission Communication on
Driving European Recovery[1].
The Basel Committee has recently started a
comprehensive review of the Basel II prudential treatment for counterparty
credit risk (posed by e.g. hedge funds) and the relevant disclosure
provisions.
In addition, the proposed Directive however obliges AIFM to employ a liquidity
risk management system.
This system shall ensure that the fund may satisfy requests by investors
wishing to withdraw money. This notably requires the AIFM to prevent a
mismatch between the frequency of investor redemptions and the illiquid nature
of the portfolio (i.e. the less liquid the assets are, the less frequent
investors may redeem
Will the proposal address the issues of short-selling
and remuneration?
This proposal focuses on those activities that are specific or inherent to the
AIFM sector and hence need to be addressed by targeted requirements.
A number of the concerns that are commonly expressed about the activities of
AIFM are linked to behaviours (e.g.
short-selling, and remuneration) which are not unique to this category of
financial market participants.
To be fully effective and coherent, these concerns must therefore be addressed
by comprehensive measures which apply to all market participants who engage in
the relevant activities.
The discriminatory treatment of particular market
actors would create distortions and would not respond in a comprehensive
manner to the risks posed.
Short-selling and its associated impacts on market efficiency and integrity
are not the exclusive preserve of the AIFM sector.
To the extent that stricter regulatory controls and/or greater transparency is
required in this area, actions would be better targeted at all market
practitioners.
The Commission is considering these issues as part of the ongoing reviews of
the existing acquis (eg. Consultation paper on Market Abuse Directive review
which will focus on abusive short selling).
Nonetheless, the AIFM Directive however includes
provisions regarding AIFM risk management and transparency requirements when
they engage in short-selling activities.
The Recommendation on Remuneration in the financial services sector will apply
to AIFM (having its registered office or head office in the EU).
Recommendation would apply to all staff of the companies having an impact on
the risk profile of the financial institution. The fees that AIFM charge for
the management service to the AIF are outside the scope of the draft
Recommendation as these issues concern relations with customers and are
partially covered by other regimes (such as MiFID) or are currently discussed
in other fora (remuneration of credit intermediaries).
Directors of AIF are covered and to the extent that the funds are listed the
more detailed Recommendation on directors' remunerationwill also apply.
Will the proposal improve investor protection? In what way?
When will the new AIFM Directive be in force?
The Commission has tabled a sound proposal which can serve as a good starting
point for negotiations on the sound EU legislative framework for AFIM. This
proposal will now be sent to the European Parliament and European Council
where it is expected to be the object of intense political discussion and
negotiation in view of the emblematic subject mater.
If a political approval on the Commission's proposal is reached by the end of
2009, the Directive could come into force in 2011. As an
exception, the provisions regarding the treatment of third countries will only
become applicable in 2014, after a period of transition of three years.
Dear members,
- Visit the website of our association.
www.hedge-funds-association.com
- Write in your CV, resume, websites etc. that you are members of
the International Association of Hedge Funds Professionals (IAHFP)
- Take advantage of the distance learning and online certification program of
our Association - at a cost that is unheard of.
www.hedge-funds-association.com/Distance_Learning_and_Certification.htm
My best wishes,
George
George Lekatis
President of the International Association of Hedge Funds Professionals (IAHFP)
General Manager, Compliance LLC
1200 G Street NW Suite 800, Washington DC 20005, USA
Tel: (202) 449-9750
Email: lekatis@hedge-funds-association.com
Web:
www.hedge-funds-association.com
HQ: 1220 N. Market Street Suite 804, Wilmington DE 19801, USA Tel: (302)
342-8828
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