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AIFM Directive: EU Parliament sees its priorities through on hedge funds directive

Thursday, October 28, 2010
Opalesque Industry Update - European Parliament and Council negotiators on Tuesday overcame the final major hurdles to an agreement on the alternative investment fund managers directive. Parliament succeeded in pushing through new chapters on asset stripping and remuneration principles, as well as strongly influencing the rules on the passporting system, depositary liability, capital requirements, and use of leverage.

Over a year in the making, this often-controversial law will impose registration, reporting and initial capital requirements on a financial industry sector which until now has been subject only to "light touch" regulation. Alternative investment funds (AIF), notably hedge funds and private equity, will henceforth be subject to more substantial regulatory oversight, so as to enhance investor protection and financial stability, both key priorities for Parliament all throughout the negotiations.

Three key problems were resolved today, by deals on a passport for non-EU AIF and AIF managers, combating asset stripping, and ensuring tough rules on depositary liability.

A passport for everyone without a free for all culture

Today's agreement will enable non-EU AIF and AIF managers to market to investors across the EU without first having to seek permission from each Member State and comply with different national laws. This was a bone of contention between Parliament and some Member States, with Parliament pushing for a marketing passport to be granted to non-EU players. Parliament allayed these Member States' fears by proposing the provisions now in the text whereby AIF and AIF managers will obtain passports only if the non-EU country they are located in meets minimum regulatory standards and has agreements in place with Member States to allow information sharing.

Initially, only EU AIF and AIF managers will be able to obtain a passport with those based outside the EU having to market through the current national private placement regimes. After an opinion from the European Securities and Markets Authority (ESMA) and the adoption of implementing legislation (a delegated act) by the Commission, the passport will then also become available to non-EU AIF and AIF managers. The national private placement regimes will not end automatically by the extension of the passport system however. Instead a period of co-existence will be in place which will only be terminated when the Commission adopts another delegated act to this effect.

Special attention to asset stripping by private equity funds

The initial Commission proposal did not contain rules to deal with asset stripping, and Member States were for a long time reluctant to tackle the issue.

Parliament's negotiators insisted from the outset on the need to combat asset stripping. The Commission's initial proposal did not address this in any way. The agreement now includes a number of provisions to this end, relating primarily to limits on the distribution of capital within the first years that a company is taken over by a private equity investor. This is intended to deter private equity investors from attempting to take control of a company solely in order to make a quick profit.

Parliament's representatives also won strong information and disclosure requirements to be imposed on private equity investors, particularly regarding the information to be provided to employees and their representatives on the planned strategy for the company. Again, the intention is to oblige these investors to develop longer-term strategies for the companies that they take over. The directive includes provisions to ensure that sensitive information which could help competitors to acquire industrial secrets will not be disclosed.

Moreover, the Commission will be tasked with assessing the need to toughen the rules on private equity during its general review of the directive.

Depositary liability

Although the Commission's very first proposal had already dealt with regulating depositaries' liability, MEPs felt that too much leeway was being given to depositaries to delegate this liability. To this end, MEPs inserted a clause stating that if a depositary legally delegates its tasks to others, then it must provide a contract which allows the fund or the fund manager to claim damages against the entity which received the delegation. This should ensure that at no point in the chain will liability be irretrievably lost. MEPs also secured a requirement that the AIF investors concerned must be closely involved with the potential delegation of liability.

This much stricter liability imposed on depositaries had originally been strongly opposed by Member States.

Parliament's mark in other areas

Besides the deals reached on the above three issues, Parliament shaped the requirements on initial capital levels, on prohibiting the delegation of responsibility from the AIF manager to a valuator and won the inclusion of remuneration rules. Remuneration had not been addressed in the Commission's initial proposal, and it was MEPs who pushed for AIF managers to have the same rules as those soon to exist for bank managers so as to remove the incentive for excessive risk taking. MEPs also advocated enabling AIF managers to set their funds' leverage limits based on a list of criteria, with national supervisors and ESMA able to require that these limits be corrected.

Next steps

The agreed text will now be put to a vote of approval at the EP's plenary session on the 11th November. Following the directive's entry into force, Member States will have two years in which to incorporate its rules in their national laws. ESMA and the Commission will also have the considerable task of fleshing out the details of how the directive works, through guidelines and implementing legislation.

(Press release sent out 26/10/10 by the European Parliament’s press office)

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