Advisory: The rules under the AIFMD are extensive, some still provisional, and their detail falls beyond the scope of a short discussion.  Please contact us for specific advice on whether they affect your business conducted in or from the Cayman Islands.

Here we continue our look at the AIFM Directive with an overview of some of the proposed new disclosure rules it proposes. The EU adopted a Directive to regulate alternative investment funds (AIFs) and their managers (AIFMs) following concerns over the regulatory failures and excessive risk-taking that led to the 2008 financial crisis. Those concerns are reflected in the Directive's requirements on what a fund needs to tell its investors, the regulators, and what information needs to be included in a fund’s annual report.

 Disclosure

The EUs aim is to impose some minimum reporting standards across a collection of countries each with different national accounting standards. A key aim is to make sure investors and regulators are able to keep themselves informed about what is going on with the fund, particularly about areas such as fees, risk management and liquidity, and any material changes to the information they are given when they join an AIF.

Does that mean me?

The new reporting obligations to regulators and investors will apply to all AIFMs marketing or managing AIFs in the EU. (For transitional rules see our previous article Marketing a Cayman AIF in the EU after July.)

 Annual Report

There may be more rules to come, but so far the requirements are that within 6 months of the end of the relevant financial year the fund manager must allow its home Member State Regulator to see each relevant fund’s Annual Report. This should be prepared to the accounting standard of the AIF’s home country (either the member state where it is authorised or the country where the fund has its registered office) and must be audited. The Annual Report must be provided to investors, if they ask for it.

The report should include the usual balance sheet, income and expenditure accounts and a summary of the year’s activities. In addition it should show any material changes in certain information which was provided to the AIF’s investors when they joined. Concerns that payment structures encouraged excessive risk taking leading up to the 2008 financial crisis are reflected in the information the Annual Report needs to provide on remuneration. The Annual Report needs to include details of the total remuneration, broken down into fixed and variable elements, and the aggregate remuneration of members of management and those employees whose jobs could influence the level of risk the AIF is taking.

Disclosure to investors

Before an investor joins an AIF, - [d1] the rights the investor will have and the obligations it will assume by signing up must be made clear.The simplest way to comply is to ensure you have a Prospectus which complies with the requirements of the Directive. Much of the information would normally be disclosed to or even insisted upon by an institutional investor and relates to risk, liquidity, and leverage. Leverage is clearly a key concern, as can be seen by the definition given in part of the guidance received from  the European Securities and Markets Authority  (ESMA) on whether an AIF is using leverage on a substantial basis: "whether the use of leverage could contribute to the aggravation of, or a downward spiral in, the prices of financial instruments, or to the build-up of systemic risk in the financial system or a risk of disorderly markets."*

By way of example, and not an exhaustive list, the investor needs to know fundamentals such as the identity of the manager and any independent parties employed in the management and regulation of the AIF, such as the auditor or depositary. They need to know how the AIF is valued, its value, how shares or units in the fund are sold, any preferences, what fees need to be paid, redemption rights, and how the AIF has performed in the past.  They also need to have current details of the AIF’s aims, its investment strategy, including risks the AIF is taking, or may take and any risk management systems in place. Details need to be provided on the investment policy and any restrictions on investment, any rules on illiquid investments (such as the percentage of illiquid investments held and any consequent redemption restrictions), and leverage arrangements, including any ability to reuse any collateral or guarantee granted.

Some of this information relating to risk, leverage and liquidity needs to be regularly disclosed and updated and the fund manager will need to make sure the investor is advised of the regularity of any such "periodic" disclosure.  The investor  also needs information[d2], including on any conflicts of interest, on material agreements the AIF has whereby management decisions are delegated and with others such as the depositary, prime broker, and any professional indemnity insurers.

Report to the home regulator

Regular reports should be made available to the regulator that initially authorised or registered the fund manager, giving aggregated information what it trades, where and how diverse the AIF's assets are, and the risks it is running – including management of liquidity and changes thereto. (The Directive provides stress tests for risk and liquidity, and the regulator will need to see the results of these).  The regulator may also ask for annual reports, quarterly lists of relevant funds managed by the fund manager or anything else that it considers it needs to know to make sure that undue risks are not being taken. Whether these reports should be provided quarterly, bi annually or annually depends on the size of the AIF (and its strategies).

Summary

These are dry and dusty rules and there are still plenty of gaps still to be filled, but most of the actual information will prove to be little different to what has been provided to investors before: just that now they will need to have a touch more detail, and in some cases be provided a little more often.

2011-ESMA-379 AIFMD FINAL advice- Esma- Europa p 214, Box 101  Principles specifying the circumstances under which competent authorities will exercise the powers to impose leverage limits or other restrictions on AIFM 4(b) and Explanatory Text p215 para 8 (iii)

 

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