Monday, May 14, 2012

US Hedge Fund Industry Comments on UK Proposed Implementation of EU Hedge Fund Directive

The US hedge fund industry applauds the UK Government’s proposal to implement the Alternative Investment Fund Managers Directive in a way that does not impose additional requirements for third-country hedge fund and other fund managers or third-country funds under the UK private placement regime. In a letter to the UK Treasury, the Managed Funds Association also called for flexible application of the Directive’s provisions differentiating between the types of alternative investment funds according to their size and structure.

 The Alternative Investment Fund Managers Directive was adopted by the European Parliament and Council on June 8, 2011 and is due to be transposed into UK national law by July 22, 2013. The Government said that strong justification will be required for gold-plating proposed additional measures exceeding the terms of the EU legislation.

The Directive establishes an EU-wide harmonized framework for monitoring and supervising risks posed by alternative investment fund managers and the funds they manage. It covers the investment managers of hedge funds and private equity funds, among others, and is therefore relevant to many different types of asset managers. The Directive will also affect firms providing relevant services such as prime brokerage facilities, external valuation, client administration, and marketing and distribution.

According to HM Treasury, the Directive will have a significant impact on firms that run any type of collective investment scheme other than a UCITS and provides a number of opportunities and risks. Transposition into UK law will require a number of high-level policy decisions as well as a considerable number of operational ones. The MFA is commenting on a discussion paper covering the policy issues. It is a first step toward implementation of the Directive.  Comments from the MFA and others will help the Government develop formal policy positions for future consultation and eventual legislation.

The Directive requires fund managers to be authorized but permits Member States to establish a de minimis registration regime for fund managers managing funds with assets under management below certain thresholds. The MFA urges a full exemption for all sub-threshold hedge fund managers subject to the de minimis registration regime. Sub-threshold fund managers should, however, be given the option to opt-in to the Directive regime and become fully authorized. Some investors want their investments managed by authorized fund managers, reasoned the MFA, and allowing this opt-in will allow alternative investment fund managers to satisfy investor expectations.

The Discussion Paper noted that smaller fund managers subject to the sub-threshold regime may not benefit from the Directive’s marketing and management passports. However, they have the right to opt-in to full authorization in order to benefit from these passports.
More generally, the MFA does not believe that the full application of the Directive to sub-threshold fund managers is likely to benefit the managers,, their funds or investors or enhance the reputation of the UK regulatory regime. The MFA noted that a multiple-tier regime is likely to continue after the implementation of the Directive in any case, as, for example, fund management activities which are subject to the UCITS Directive will fall outside the scope of the Directive. Moreover, as noted in the Discussion Paper, portfolio management activities in the case of delegation of certain management functions to an investment firm by a self-managed hedge fund or by third-country fund managers will be subject to the MiFID Directive.

Given the extremely broad definition of alternative investment fund and the many different types and sizes of investment fund structures that fall within the scope of the Directive, the MFA considers flexibility important in the application of the Directive. The MFA is concerned that the proposed approach, which does not take into consideration the divergent fund structures, could be disproportionately costly and, ultimately, prohibitive for small UK-based fund managers, which could reduce investor choice of fund managers and increase investor costs.

More broadly, the hedge fund association believes that a review of the existing UK regulatory regime applicable to unregulated collective investment schemes should be undertaken in the context of implementing the Directive. In particular, the current definition of a collective investment scheme in Section 235 of the Financial Services and Markets Act is much broader than the definition of alternative investment fund in the Directive. In this regard, there is a significant risk that the Directive would be applied to a significantly broader range of structures and arrangements than in other EU Member States.

By default, the Directive prohibits the marketing of hedge funds and alternative investment funds to retail investors, but gives Member States the discretion to permit marketing selectively and impose greater restrictions than those for marketing to professional investors. Treasury noted that UK transposition of the Directive provides the opportunity to extend or restrict the range of schemes permissible as being marketed to retail investors. Treasury cautioned that any extension of the retail boundary may require significant extra regulation before the additional schemes became suitable for retail investors.

In its comment letter, the MFA said that an activity should be considered marketing under the Directive only when it is specific enough to relate to a particular hedge fund or other alternative investment fund. The regulations should clarify that generic marketing of investment funds, such as a meeting in which a fund manager’s general investment strategy is discussed with potential investors, should not be considered marketing for the purposes of the Directive, since no specific fund shares are being marketed. In addition, the MFA urged the Government to review its existing financial promotion regime in the context of marketing alternative investment funds to ensure that an appropriate exemption is provided for marketing such funds at the initiative of the investor, as provided under Article 4(1)(x) of the Directive.

Although not specifically addressed in the Discussion Paper, the current definition of retail investors also includes high net worth individuals. The MFA believes that this approach is unduly restrictive, since the marketing of hedge funds and other alternative funds is only permitted in very limited circumstances. The MFA urged Treasury to modify the regulations in the context of high net worth individuals to allow these sophisticated investors greater flexibility in selecting investment opportunities.