The European Commission
adopted a Regulation supplementing the
Alternative Investment Fund Managers Directive. With the AIFMD, all investment funds in the EU fall into one of the
following two categories: They are either UCITS (undertakings for collective
investment in transferable securities) or hedge funds and other types of
alternative investment funds. UCITS funds are governed by the UCITS Directive
(2009/65/EC) and are authorized for sale to the retail market.
Following its implementation, the AIFMD will introduce authorization
and regulation requirements for hedge funds and private equity funds and
regulatory standards for depositaries and administrators; minimum capital
requirements related to portfolio size, governance and risk management
requirements for fund managers. The Directive will also allow EU-wide marketing
of hedge funds through a passport scheme, initially for EU fund managers only,
and then to be extended to non-EU based fund managers two years later. EU
Member States must transcribe the AIFMD into their respective national laws by
July 22, 2013.
The Regulation clarifies the general duty of hedge
fund managers and other alternative investment fund managers to act in the best
interests of the fund and fund investors and the integrity of the market. It
clarifies the scope of due diligence in general and the scope of due diligence
which should be applied if investments are made in assets of limited liquidity
and where fund managers are selecting and appointing counterparties and prime
brokers. The Regulation sets out rules on inducements and handling of orders,
including reporting obligations in respect of execution of subscription and
redemption orders, and rules on placing orders to deal on behalf of hedge and
private equity funds with other entities for execution and aggregation and
allocation of orders.
The Regulation specifies the types of conflicts of
interest that may arise and sets out a conflict of interests policy which
includes procedures and arrangements that fund managers are expected to
implement and apply in order to identify, prevent, manage, monitor and disclose
conflicts of interest.
The Regulation lays down rules concerning the risk
management system that should be established and applied by fund managers. The
system comprises the organizational structure, policies and procedures for
managing the risks relevant to each fund’s investment strategy and the
processes and techniques used to measure and manage those risks. The Regulation
requires a permanent risk management function to be established and entrusts it
with specific tasks, including the implementation of the risk management
policy, risk monitoring and measuring the risk level and ensuring that it
complies with the fund’s risk profile. The Regulation also requires the
functional and hierarchical separation of the risk management function from
operating units and specifies safeguards against conflicts of interest which
should ensure that the risk management activities are carried out
independently.
The fund manager must ensure that, for each fund it
manages, appropriate and consistent procedures are established so that an
independent valuation of the fund’s assets can be performed in accordance with Article 19 of the AIFMD
and the applicable national rules. The Regulation requires the fund manager to establish
and implement for each fund policies and procedures for the valuation of assets, and lays down
the main features of such valuation policies and procedures. Specific rules are adopted
for the use of models for valuing asset. There must be periodic review of valuation
policies and procedures, as well as a review of individual values of assets,
the calculation of the net asset value per unit or share, and the professional
guarantees to be provided.
Under the Regulation, in calculating total assets under management,
the preference is to use the value of all
assets managed by the fund manager without deducting liabilities and valuing
financial derivative instruments at the value of an equivalent position in the
underlying assets. Valuing financial derivative instruments as if the
underlying assets were acquired by the fund reflects the fund’s exposure to
these assets.
With regard to the calculation of leverage, the
preferred option is to combine the so-called gross and the commitment methods,
The leverage ratios that result from applying the gross method are consistent
with the objective to monitor macro-prudential risks. The commitment method is
well established and recognized in the asset management sector. Its results can
be easily compared with those for UCITS funds. It provides, in particular when
combined with the gross method, a good insight into the investment strategies
and exposure of hedge funds and private equity funds relevant for both
investors and supervisors.
In case of proven necessity for an additional method
to better apprehend systemic risk, the precise parameters of such an advanced
method should be established by EMSA. This method would then be adopted by
modifying the delegated act. Recourse to an advanced method must not obviate
the calculation of leverage according to the gross and commitment method, noted
the Commission, both remain obligatory for all hedge fund and other alternative
fund managers.
All financial instruments which can be registered in a
financial instruments account, essentially, transferable securities, money
market instruments units in collective investment undertakings, and which
belong to a hedge fund or private equity fund must be held in custody.
Alternative investment funds may not be excluded from the scope of custody
simply because they are the subject of a security interest collateral arrangement.
Therefore, should a hedge fund provide its assets as collateral to a collateral
taker, the AIFMD requires that these assets remain in custody, except if the fund
transfers ownership of the collateralized assets to the collateral taker.
Custody of the collateralized fund assets can be
ensured in three ways: (1) the collateral taker is appointed custodian over the collateralized fund’s
assets; (2) the fund’s depositary appoints a sub-custodian that acts for the collateral taker or
(3) the collateralized assets remain with the fund’s depositary and are
earmarked in favor of the collateral taker. All of the above custody arrangements reflect industry practice to ensure that
the depositary is not liable for the return of assets that are beyond its control. In addition, the
proposed approach, in line with the AIFMD, does not require that a central
counterparty become a sub-custodian.