European Union ('EU') finance ministers, meeting in Luxembourg yesterday, have reached agreement on the text of the draft of the proposed Alternative Investment Fund Managers Directive ('AIFM Directive') expected to be proposed to the European Parliament for a vote in November.
Whilst it is still not certain that Parliament will accept this latest compromise text, or that further amendments will not be made, some tentative conclusions can at least now be advanced, as regards the shape of things to come.
It has been tempting, over the last eighteen months or so since the first draft of the AIFM Directive emerged, to view the document (along with adverse taxation changes, and other regulatory moves in relation to fund manager remuneration) as part of an increasingly hostile climate for alternative fund managers in the UK. But is the Directive really likely to drive fund managers to leave the UK? Or make it less likely that (say) US fund managers will expand their operations, or at least their marketing efforts, into Europe?
It is fair to say that the text has been much modified since its first appearance (and it did need to be). In its current incarnation, it is also probably fair to say that the Directive, in itself, is unlikely to inspire hedge fund and private equity fund managers to decamp, en masse, for Switzerland or Singapore. Much is likely to depend on two things: the size of the fund management operation concerned, and the relative importance to that operation of EU based money.
Taking size first of all: the AIFM Directive proposes only 'light' requirements (relatively speaking) for those fund managers whose fund portfolios do not exceed Euros 100 million (including investments 'acquired with leverage': the limit increases to Euros 500 million where the fund portfolio is not leveraged and investors have no rights to redeem within five years of investment, ie the classic private equity structure). This will therefore exclude many 'friends and family' and other small start-up fund managers (though they will still be obliged to register with their home state regulator and provide basic information on instruments in which they trade and principal exposures, and will not have an EU 'passport' for their funds unless they voluntarily 'opt in'). Note that only fund portfolios count for the purposes of this limit, not 'managed account' and similar non-collective arrangements: some managers may therefore be in a position to avoid the full scope of the Directive by managing large single investors' portfolios through managed accounts, rather than fund structures. At the small end of the alternative funds industry, we may therefore see little change as a direct result of the Directive, save for an increase in compliance costs and (perhaps) custodian and prime broker fees.
For larger fund managers, based already in the EU, the additional layer of compliance imposed by the Directive, and certain of its more problematic features - for instance, the requirement to defer at least 40% of variable remuneration for three to five years, and to disclose overall leverage to the home state regulator - may not, of themselves, be sufficient of a spur to leave the EU, if a manager has a significant EU investor base (and all else being equal in terms of tax and personal considerations). The hassle of upping sticks and migrating a whole operation, including relocating staff, reorganising business and contractual structures and disrupting personal lives, may be considered the greater of two evils (especially given the EU passporting rights which are the quid pro quo for the increased level of regulatory pain).
The requirements of the Directive may, however, act as a significant disincentive to (for instance) US fund managers, who might otherwise have considered expanding their operations, or at least their investor base, within the EU. Again, the result will likely depend on the extent of a fund manager's existing commitment to EU-based investors. Once existing private placement regimes are phased out (from 2018 onwards, under the present draft), such managers would be required to become authorised pursuant to the Directive in order to market their funds actively (ie otherwise than by 'passive marketing' or 'reverse solicitation') into the EU. The loss of the private placement exemption will force non-EU managers to take a position on this, one way or the other.
Note that managers who remain EU based, or (if based outside the EU) continue to distribute their funds into the EU, will also need to consider the jurisdiction of choice for the funds themselves: the marketing of non-EU domiciled funds will depend upon (inter alia) the ability of their respective jurisdictions to negotiate the required co-operation agreements with those EU jurisdictions into which such funds are to be promoted. This seems unlikely however, on the face of it, to prove problematical for the more established offshore jurisdictions.
If anything, it seems clearer now that the markets for alternative funds will bifurcate into those managers with a significant commitment to EU-based investment, and those focussed purely on non-EU investment (from, in particular, the US, Far East, Middle East or Switzerland). These latter may now see little advantage in moving into the EU. It will be interesting also to see how the leading offshore (or 'onshore-offshore') financial centres now position themselves, in terms of attracting those investment managers, or at least their funds, who either choose to have an EU focus, or (on the other hand) consciously avoid soliciting EU investment. One can foresee Ireland and Luxembourg heading the pack (with Malta chasing) on the 'EU-focussed' side of this divide, with the Channel Islands and Cayman Islands, followed by the BVI and Isle of Man (according to the main focus of their various fund industries), heading up the 'non-EU' jurisdictions.
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