Alternative funds – A new beginning

After more than a year of intense negotiation and political manoeuvring, the Alternative Investment Fund Managers Directive (the “AIFMD”) was finally adopted on 11 November 2010. This article provides an overview of the general principles of the AIFMD and an appraisal of its implications for the alternative investment and private equity industry.

Scope

The AIFMD applies a basic catch-all approach to an alternative investment fund manager (“AIFM”) that engages in EU-related management or marketing activities, subject to specific exemptions. An AIFM is defined as any legal person whose regular business is managing one or more alternative investment funds (“AIFs”), an AIF is defined as a non-UCITS collective investment undertaking of any legal form which raises capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors. Subject to applicable exemptions, the Directive applies to all of the following AIFMs:

• all EU AIFMs managing EU AIFs or non-EU AIFs, irrespective  whether or not they are marketed in the European Union;
• non-EU AIFMs managing EU AIFs, irrespective whether or not they are marketed in the European Union; and
• non-EU AIFMs marketing EU AIFs or non-EU AIFs within the European Union.

Authorization

AIFMs (whether EU AIFMs or non-EU AIFMs) that are within the scope of the Directive are generally required to obtain authorization in order to carry out their management or marketing activities.

In order to be granted authorization from its home Member State, an AIFM will need to submit information on various aspects of its activities (including its structure, constitution, managers, shareholders, investment strategy and remuneration policy) and importantly provide evidence of its ability to comply with the Directive, its capital adequacy, the reputability and experience of its management and the prudence of its shareholders.

Private equity

The provisions on private equity generally apply to AIFMs that manage one or several AIFs which individually or jointly acquire control of an EU-based non-listed company (“control” being defined as having more than 50% of the voting rights in the company), and AIFMs that co-operate with other AIFMs to jointly manage AIFs that acquire control of an EU-based non-listed company. These provisions do not apply where the AIFs acquire control of small or medium enterprises (as per the EU definition) or real estate special purpose vehicles.

An AIFM must notify its home regulator, the non-listed company and the shareholders of the company when the voting rights in the company held by an AIF managed by the AIFM reach, exceed or fall below 10%, 20%, 30%, 50% and 75%. These parties must be provided with information on the AIFM, its conflict of interest policy and its communication policy regarding the company. Additionally, the company, its shareholders and its employees must be provided with information on the AIFM’s future intentions regarding the company and the likely repercussions for employees. The AIFM must also procure that the board of the company provides this information to the employees of the company or their representative, and that relevant past and likely future developments are taken into account in the company’s annual report.

On the issue of asset stripping, the AIFMD contains provisions that apply in respect of the acquisition of control of EU-based non-listed companies as well as issuers. In the period of 24 months from the acquisition, an AIFM must refrain from facilitating, supporting or instructing, and must use its best efforts to prevent, (i) any capital reduction; (ii) any share redemption; (iii) any distribution to shareholders or any own share purchase where the net assets of the company fall short of (or would consequently fall below) its subscribed capital and non-distributable reserves; and (iv) any distribution to shareholders that would exceed the amount of available profits.

Basic EU passporting

The basic passporting provisions in the Directive allow EU AIFMs to manage EU AIF throughout the European Union (on a freedom to provide services basis or via a local branch), and to market EU AIFs to professional investors in other Member States. However, there is no EU passport permitting marketing of AIFs to retail customers. Member States are free to ban marketing to investors who fall outside the definition of professional investors, or they may permit such marketing under non-discriminatory rules. The AIFMD defines “professional investor” narrowly in accordance with MiFID.

A new beginning

While the alternative investment industry has yet to be fully won over to the cause of the Directive, it will no doubt be breathing a sigh of relief over its final content. Compared with the initial draft proposed by the Commission in April 2009, the principal advances achieved are the inclusion of new exemptions for joint ventures and managers of private wealth undertakings, increased flexibility for the appointment of depositaries and sub-custodians, extended provisions allowing depositaries to avoid liability for acts of sub-custodians (although it may be argued that this will benefit some industry participants at the expense of others), a dual passporting and private-placement approach to third-country AIFMs and AIFs, removal of reverse solicitation from the scope of the Directive and, importantly, the incorporation of provisions setting out a framework for a general review of the Directive (scheduled to take place four years after its effective date) and a review of the third-country provisions more specifically.

Throughout the two-year implementation period, commencing in early 2011, the Commission and ESMA will adopt various implementing measures and guidelines to flesh out the detail of the new framework. While the AIFMD will have a less adverse effect on the alternative investment and private equity sectors than originally feared, the industry will need to continue lobbying throughout the implementation period in order to preserve and extend the advances achieved to date.