AIFM directive: a Luxembourg perspective - Ernst & Young - Luxembourg

AIFM directive: a Luxembourg perspective

By Michael Ferguson*, Ernst & Young, Luxembourg  
Business Review 
September 2009 

The European Commission proposed a new Directive introducing a harmonized EU regulatory and supervisory framework for Alternative Investment Fund Managers (AIFM) in April 2009. In return for more regulation, the proposed Directive provides for the introduction of passports enabling AIFMs to offer their management services and market their Alternative Investment Funds (AIF) throughout the EU. Although several provisions are highly controversial, the Directive, albeit in an amended state, is likely to be approved, given the political pressure for greater regulation over the alternative sector. Luxembourg will be required to implement this Directive, which, as currently drafted, would cover all non-UCITS funds and their managers. It may create new opportunities for Luxembourg.

According to the Commission, the Directive is designed to address a number of risks it has identified relating to the activities of AIF. These include exposures of financial institutions to the AIF sector, the impact of short selling by AIFs, inadequate disclosures, conflicts of interest, and lack of transparency and disclosure when building stakes in companies.

The Commission is of the view that coordinated EU regulatory oversight is a better mechanism to deal the potential danger of systemic risk that may arise from the activities of AIFs than current fragmented national approaches.
 
New requirements

In summary, the Directive applies to all medium-sized and larger EU firms that provide management services to AIF. It sets organizational, conduct of business, capital, disclosure, and reporting requirements and regulates the delegation of activities.

It will apply to most collective investment undertakings other than UCITS, such as hedge funds, private equity and real estate funds.

It also imposes requirements on service providers to AIF. For custodians, it sets out their role and their liability. It also introduces the concept of an independent valuator.

Passports

AIFMs may market shares or units of their AIF to professional investors in their home EU Member State, and in other EU Member States subject to a notification procedure. Non-EU AIFM may market the shares or units of their AIF to professional investors in the EU, providing that certain conditions are met.

AIFM domiciled in one EU Member State may provide management services in relation to an AIF in another EU Member State, either directly or via the establishment of a branch.

At the time of writing, a revised proposal was expected. Issues generating most discussion include the “one size fits all” approach to the diverse segments of the alternative sector, the extensive scope of vehicles covered, the rules on delegation of activities by AIFMs, the rules on distribution of non-EU AIF within the EU, the ability of regulators to intervene regarding the level of leverage being used by AIF, the requirement for an independent valuator and the extensive liability of the custodian.

Luxembourg perspective

By establishing passports both for AIFM and AIF, the proposed AIFM Directive permits AIFM to choose to establish themselves and their AIF in the domiciles that offer the most advantageous conditions. The AIFM Directive may thus lead to concentration of AIFM and AIF in the most attractive domiciles.

There are a number of complex issues surrounding the marketing non-EU AIF in the EU. As a result, many non-EU AIFMs are considering establishing operations both for themselves and their AIF in the EU to be able to passport their products. It is expected that the Directive will therefore speed up the migration of AIF to onshore domiciles.

The choice of domiciles for AIFM and AIF will depend on several factors such as the flexibility of the regulatory environment, fiscal environment, reputation of the financial center, expertise and competitiveness of local service providers and knowledge of the workforce. These are all areas where Luxembourg scores highly, experiencing the highest growth in Europe in all alternative sectors over the last five years. In addition, Luxembourg is already the world’s leading domicile of traditional funds distributed cross-border (UCITS).

I therefore believe that Luxembourg will prove to an attractive domicile for AIFM, and well placed to become a leading domicile for EU AIF.

*Michael Ferguson is a Partner in Ernst & Young’s Luxembourg Assurance Services practice and Luxembourg Asset Management Leader.

Posted on 14 September 2009