7 Financial services: alternative
investment fund managers
| (34599)
18038/12
+ ADDs 1-2
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| Commission delegated Regulation No ../.. of 19.12.2012 supplementing Directive 2011/611/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision
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| Legal base | Article 53(1) TFEU; co-decision; QMV
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| Document originated | 19 December 2012
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| Deposited in Parliament | 9 January 2013
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| Department | HM Treasury
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| Basis of consideration | EM of 24 January 2013
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| Previous Committee Report | None
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| Discussion in Council | Not known
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| Committee's assessment | Politically important
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| Committee's decision | Not cleared, further information requested
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Background
7.1 Directive 2011/61/EU on alternative investment fund managers
(AIFMD) establishes an EU-wide harmonised framework for monitoring
and supervising risks posed by alternative investment fund managers
(AIFMs) and the funds they manage (AIFs) and for strengthening
the internal market in AIFs. The Directive contains provisions
relating to the conduct of business, transparency and marketing
and provides for cross-border managing and marketing of funds.
It covers managers of the major types of fund, that are not already
subject to EU regulation through the Undertakings for Collective
Investment in Transferable Securities (UCITS) Directive, including
hedge funds, private equity funds, venture capital funds and real
estate funds.
7.2 The Government is transposing AIFMD ahead
of the July 2013 deadline for implementation.
The document
7.3 AIFMD makes provision for an extensive set
of implementing measures in delegated acts and this Commission
Regulation is being made under those provisions. The main elements
of the Regulation are as follows.
Calculation of assets under management
7.4 AIFMs are required to calculate their total
assets under management and the Regulation sets out a standardised
approach for this. It also requires AIFMs to monitor the assets
under management and covers action to be taken in the event of
occasional breach.
Calculation of leverage
7.5 Many AIFMs increase exposure of the AIFs
they manage, including through borrowing or the use of derivatives.
AIFMD requires AIFMs to calculate, report and manage the leverage
of their AIFs. The Regulation requires the use of two methods
for calculating leverage — the 'gross' method and the 'commitment'
method. The Regulation leaves open the possibility of the Commission
adopting an additional 'advanced' method of calculating leverage
on the basis of technical advice provided by the European Securities
and Markets Authority.
Additional own funds and professional indemnity
insurance
7.6 AIFMD requires AIFMs to hold additional own
funds or professional indemnity insurance to cover potential liability
claims in the event of professional negligence. The Regulation
defines the liability risks and determines the conditions for
determining the appropriate levels of own funds and professional
indemnity insurance.
Operating conditions for AIFMs
7.7 The Regulation sets harmonised standards
for the operating conditions set out in AIFMD:
- clarifying how AIFMs can be
assessed to act honestly, with due skills, care and diligence,
in the best interest of the AIFs, to treat investors fairly and
to employ appropriate resources and procedures;
- setting out requirements for AIFMs' conflicts
of interest policies;
- setting out requirements for AIFMs' risk management
systems, including how the AIFMD requirement for a permanent risk
management function, which must be functionally and hierarchically
separated from operating units, is to be implemented;
- specifying in more detail requirements for a
liquidity management system for AIFs other than unleveraged closed-ended
AIFs, so that underlying liquidity risk can be monitored and managed,
including how special arrangements for handling illiquid assets
are to be managed;
- requiring AIFMs to consider liquidity limits
where appropriate and conduct stress tests;
- setting out arrangements for ensuring the interests
of firms that repackage loans into tradable securities and the
AIFMs that invest in those securities are aligned, for example
by requiring that the originator retains an economic interest
in the securities; and
- setting out how these requirements are to be
implemented, including arrangements that qualify as retained economic
interest.
General organisational requirements
7.8 AIFMD has a general requirement for AIFMs
to have appropriate human and technical resources for the proper
management of AIFs. The Regulation sets out requirements, including
responsibilities of senior management, audit and compliance function,
separation of compliance and internal audit functions and systems
to safeguard information and ensure business continuity.
Valuation
7.9 The Regulation sets out requirements for
AIFM's valuation policies and how they are to be applied, ensuring
they are applied consistently and contain a review process.
Delegation of AIFM functions
7.10 AIFMD allows AIFMs to delegate the performance
of function to third parties provided that this is for objective
reasons, for example, for reasons of efficiency to gain access
to specialist skills, and that an AIFM does not delegate to the
extent that it becomes a letterbox entity and can no longer be
considered the manager of the AIF. The Regulation:
- specifies conditions under
which the AIFM may delegate, and the circumstances in which the
AIFM would have delegated its functions to the extent that it
becomes a letterbox entity;
- provides rights to competent authorities to ensure
the delegation is being carried out appropriately; and
- specifies arrangements for ensuring effective
supervision and avoiding conflicts of interest.
Depositary
7.11 AIFMD requires appointment of a depositary
to ensure cash flows are properly monitored, to provide oversight
of the management of the assets and, where this is possible, to
hold assets in custody. It provides that the depositary is liable
for certain losses. The Regulation:
- contains detailed provisions
about the obligations and rights of depositaries, which specify
the activities depositaries must undertake to meet each of these
obligations and which assets are to be held in custody;
- specifies due diligence obligations; and
- specifies how the loss of a financial instrument
held in custody is defined and the liability of depositary for
that loss — this includes liability of a depositary for
loss in an unaffiliated third party and the extent to which the
depositary may discharge liability for that loss.
Transparency requirements
7.12 AIFMD sets out requirements on AIFMs to
report to regulators and investors, to allow for assessment of
systemic risk and other risks. The Regulation:
- sets out minimum standards
for reporting, including content and format, and, where appropriate,
frequency; and
- specifies the threshold above which an AIF would
be considered to be employing leverage on a substantial basis
and hence be subject to enhanced reporting and oversight requirements.
Cooperation arrangements with third countries
7.13 AIFMD requires regulators to put in place
cooperation arrangements with non-EEA regulators for the purposes
of effective supervision. The Regulation sets out some aspects
of the cooperation arrangements.
Exchange of information relating to potential
systemic consequences
7.14 The Regulation specifies what information,
as a minimum, should be exchanged between regulatory authorities.
The Government's view
7.15 The Economic Secretary to the Treasury (Sajid
Javid) says that the Government is comfortable with much of the
Regulation, which is very broad-ranging and informed by work by
national regulators through the European Securities and Markets
Authority. He comments that the measures in the Regulation should
allow AIFMD to be implemented successfully, bringing the benefits
of stronger investor protection, improved monitoring of systemic
risk and opening up of the single market. The Minister quotes
two examples approvingly:
- third country arrangements,
where the Government considers most of the provisions relating
to third country access, such as the regulations for cooperation
agreements with third country regulators, to be appropriate and
the basis for continuing trade with third countries; and
- operating conditions, where the Government considers
many of the operating conditions, for example around liquidity
management, to be appropriate in achieving their aims of ensuring
standardised investor protection.
7.16 However the Minister continues that there
are a number of areas in which the Regulation diverges from the
European Securities and Markets Authority advice and where the
Government believes they have the potential to impose some unnecessary
cost and potentially restrict flexibility for the industry to
meet investors' needs. He says these areas include a letterbox
entity test, depositary provisions and leverage.
7.17 On a letterbox entity test the Minister
says:
- that there is potential for
the Regulation to be interpreted in an unduly prescriptive manner,
which would limit the ability for AIFMs to delegate portfolio
and investment management in the interests of efficiency, access
to skills and other grounds; and
- the Government considers, however, that there
remains scope for the Financial Conduct Authority to take a proportionate
approach in application which prohibits true letterbox entities
but does not impede legitimate business models.
7.18 The Minister says that the depositary provisions
could impose a greater level of cost than is necessary to provide
effective investor safeguards, noting as examples that:
- the Regulation requires depositaries
to perform cash reconciliations, whereas this is a task best performed
by AIFMs and verified by depositaries; and
- the Government considers the
European Securities and Markets Authority's advice, that all collateral
should be excluded from the scope of custody, to be appropriate,
whereas the final text excludes only some type of collateral.
7.19 The Minister says that the Government would
have preferred the Regulation to permit the advanced method for
calculating leverage, which would allow regulators and investors
a more nuanced understanding of AIF's exposure. He adds, however,
that the opportunity for the Regulation to permit this in future
upon further work by the European Securities and Markets Authority
is welcome.
Conclusion
7.20 The Minister tells us that he will write
to us again if the Government decides to oppose the Regulation.
However, given the reservations about the Commission's proposal
that the Minister has drawn to our attention, we should like to
hear, before considering this document again, about whichever
outcome the Government decides on. Meanwhile the document remains
under scrutiny.
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