© 2012 Dechert LLP

AIFMD Countdown:Breakfast Briefing No. 2

Key pressure points in the Directive

Gus BlackRichard FraseAna Gallo-AlvarezStuart Martin

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Agenda Today

1. Update on EU timetable and UK implementation

2. The status of implementation in the EU

3. Impact on management structures and the delegation restrictions

4. Impact on prime brokerage model

5. Remuneration provisions

6. Questions

© 2012 Dechert LLP

AIFMD Countdown:Update on EU timetable and UK implementation

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Timetable – Level 1

By way of reminder:

• Level 1: Primary Directive became EU law on 21 July 2011

• Must be implemented by Member States by 22 July 2013

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Timetable – Level 2

• Level 2: ‘regulations’ – publication and adoption still outstanding– Have ‘direct effect’

– Contain wide ranging implementing measures

• What is the likely adoption timetable?

EU legislative process – the Lamfalussy processLevel 1: Adoption of Directives and Regulations

• Framework and key political principles of the legislation - adopted by “ordinary legislative procedure” jointly by the Council and the European Parliament on a proposal from the Commission

Level 2: Adoption of implementing measures

• Commission adopts secondary legislation – Regulations and Directives (level 2) (under delegated power from the Council and the European Parliament) with assistance from ESMA (acting as technical advisor) and consultation with industry

• Before adoption the Commission sends the text to the Council and European Parliament for informal consultation

EU legislative process – the Lamfalussy process• At this point, the Commission is not bound by ESMA advice

• The European Parliament or the Council can reject Level 2 measures within three months of their adoption if the measures are not in line with the objectives of the underlying Level 1 legislation

EU legislative process – lobbying

How does a successful lobbying process work?• It has to be based on clear, concise and relevant

policy, legal and business arguments that can appeal to the legislator

• The arguments deployed need to find a common ground so the legislator can feel his policy objectives will be met one way or the other

EU legislative process – lobbying

• Lobbying successfully is not to express our views - however loud – it is to convince the legislator to change his

• It should be constructive – not confrontational

• It has to cover all levels of the policy-making; from desk officer to Cabinet or MEPs

• It has to be carefully planned with strategic and clearly defined steps

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Timetable – Authorisation

• FSA should accept applications “from Q2 2013”

• Existing EU managers: submit application by 22 July 2013 or by 22 July 2014? (the transitional period)

• What does transitional period mean?– Authorisation required to use EU marketing passport.– AIFM authorisation not required to operate, but MiFID

authorisation will be required. Extent of interim compliance obligations are unclear.

• Start-up managers: best timing?

© 2012 Dechert LLP

AIFMD Countdown:The status of implementation in the EU

EU implementation

Luxembourg

• Luxembourg expects to adopt its AIFMD implementing bill by the end of 2012

• In addition to transposing the Directive, has introduced a new fully tax transparent limited partnership vehicle. With the new limited partnership vehicle, carried interest will not be treated as salary but as “speculative income” (taxed at 25% of income tax rate) and co-investment returns will potentially be tax exempt, subject to conditions

• New category of depositary for private equity funds

• FCPs (non-UCITS funds) still need an authorised Luxembourg management company

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EU implementation

Germany• Germany has published a draft implementing bill which goes

beyond word-for-word transposition:• private placement rules revised so that all marketing (whether public or

private) is subject to AIFMD/UCITS rules – effectively abolishing existing private placement regime

• all investment funds currently placed under “private placement” regime will have to retroactively submit registration notifications

• no exemptions for small funds as per the Directive

• Unclear whether abolition of private placement regime is intentional policy decision

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EU implementation

Ireland• Implementation of Directive expected by 1 January 2013 (before

Ireland assumes Presidency of the EU)

• Implementation will be based on the existing QIF regime and principle of no gold plating

• Expect Promoter requirement to be removed

• Legislation also expected to introduce Irish SICAV to meet US tick the box requirements

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Private placement chart

15 6 April 201115

COUNTRY/MEMBER STATE PRIVATE PLACEMENT/SOLICITED SALES

UNSOLICITED SALES

United Kingdom Yes Yes

Austria Yes Yes

Belgium Yes Yes

Denmark No Yes

Finland Yes Yes

France No Yes

Germany Yes No? Yes

Greece No Yes

Ireland No Yes (depending on legal structure)

Italy No Yes

Luxembourg Yes Yes

Norway No Yes

Portugal Yes Yes

Spain Yes No Yes

Sweden Yes Yes

Switzerland Yes Yes

The Netherlands Yes Yes

Member of the European UnionMember of the European Economic Area/European Free Trade Association

© 2012 Dechert LLP

Key pressure points:Impact on management structures and delegation restrictions

AIF/AIFM pressure pointsTraditional Managed Account Structure (no

pooling)

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Single or multiple clients

Custodian

Investment Manager

AIF/AIFM pressure pointsManaged Account Platform

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Vehicle for single or

multiple clientsPB/custodian

Investment Manager

Risk Manager

AIF?

AIFM?

AIF/AIFM pressure pointsTypical Fund Structure

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“Third Country”Investment

Manager

Fund

Onshore Investment

Manager

Onshore v offshore AIFM - the implications of having an onshore AIFM

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EU fund – Directive heavy Non-EU fund – Directive light

EU Manager must be authorised. Once authorised, the marketing passport is available (depending on timely implementation by member states).

Private placement not available.

EU Manager must be authorised. No requirement to appoint a depositary or produce fund annual report, unless the fund is marketed in the EU. If the fund is marketed in the EU, note the reduced depositary regime - AIFM must appoint one or more entities to fulfil the depositary functions, but the strict liability regime is not applicable.

No marketing passport – private placement the only means for marketing.

Onshore v offshore AIFM - the implications of having an offshore AIFM

• Private placement is the only means for marketing until 2015

• Directive “super light”?

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The delegation challenge

• Where does the delegation concern come from?– A general anti-avoidance mechanism– Outsourcing rules in MiFID Implementing Directive

• To what extent can you delegate investment management?

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What will happen to MiFID authorised firms?

• A MiFID authorised firm cannot be the appointed AIFM nor obtain authorisation under the AIFMD.

• However, it may:

(i) provide portfolio management services as the AIFM’s delegate, subject to the delegation restriction; and

(ii) market an AIF on behalf of an AIFM.• Change authorisation to AIFM?• How possible is offshore or MiFID-only structuring?

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© 2012 Dechert LLP

Key pressure points:Impact on prime brokerage model

Prime brokerage

• Depositary liability

• Assets within the custody function

• Possible future structures and practical implications

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Prime brokerage

• Directive sees a conflict of interest between the depositary function (custody and supervision) and the prime broker (counterparty and lender)

• Prime broker can act as depositary if it has “functionally and hierarchically separated the performance of its depositary functions from its task as prime broker”

Depositary liability• What is the new depositary liability regime?

• The depositary is liable for loss of assets unless:

- it can prove that the loss had arisen as a result of an external event beyond its reasonable control; or

- the depositary, sub-custodian and the fund have entered into contractual arrangements to ensure that the sub-custodian is directly liable to the fund in the event of loss of assets – and subject to further conditions

What assets are within the custody function?• Directive states that “all financial instruments that can

be registered in a financial instruments account” must be held in depositary

• Draft Level 2 regulations state that financial instruments which are provided as collateral to a third party (e.g. the broker) have to be held in custody as long as they are owned by the AIF

• So, assets subject to a security interest in favour of the broker are held in custody, but re-hypothecated assets (i.e. title transfer collateral) are not held in custody

Prime brokerage – the existing structure

• Prime broker acts as lender and custodian – this assures the broker’s ability to settle fund’s trades, re-hypothecate and take security

• Prime broker waives liability for failures by sub-custodians and there is (generally) no recourse from the PB to sub-custodian

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Fund Prime broker and custodian

Sub-custodians (affiliates and non-affiliates)

Prime brokerage – possible future structures (1)

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Fund Depositary

Prime broker and sub-custodian

Sub-sub-custodians

Possible future structures – prime broker as delegate of depositary• Reflects some existing structures – prime brokers can

continue to settle their client’s trades into accounts controlled by the broker, can continue to re-hypothecate (i.e. transfer title) and can enforce a security interest over the account.

• However:- separation of functions rule applies to sub-custodians

- depositary will not want to take liability in the event of insolvency of the prime broker – so contractual pass- through of liability from the depositary to the prime broker?

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Prime brokerage – possible future structures (2)

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Fund

Sub-custodians

Depositary

Prime broker

Possible future structure – depositary jointly appointed by fund and PB

• Fund and prime broker together appoint the depositary

• Security interest in favour of the broker

• Depositary follows instructions of broker, save where broker is in default

• Broker may re-hypothecate (i.e. title transfer) as and when allowed

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Application of the depositary rules (pre-2015)

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EU Manager Non-EU Manager

EU fund Non-EU fund EU or Non-EU fund

Manager must be authorised as AIFM and must comply with the Directive, including depositary requirements.

Manager must be authorised as AIFM. A depositary is not required if fund is not marketed in the EU.If the fund is marketed in the EU, a depositary is required, but note relaxation of strict liability requirements.

As manager cannot be authorised under Directive, a depositary is not required, whether or not marketed in the EU.

© 2012 Dechert LLP

Key pressure points:Remuneration provisions

Remuneration

• Where did the remuneration rules derive from?– Capital Requirements Directive III (for banks)– AIFMD requires ESMA to develop guidelines on sound

remuneration policies which comply with Annex II to the AIFMD

• ESMA’s Consultation Paper on guidelines for sound remuneration policies under the Directive – June 2012

• ESMA will publish a final report with final text of the guidelines by the end of 2012

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Remuneration

• Proportionality - but no ability to disapply requirements

• How will all asset managers issue 50% of variable remuneration in non-cash instruments?

• Are new arrangements future-proof?

• Will I need new compensation structures (e.g. RemCom)?

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Remuneration – disclosure requirements

• A manager will need to disclose in the fund’s annual report:– Total remuneration (fixed and variable) paid to entire

staff, and the number of staff– Total remuneration paid to senior management and staff

“whose actions have a material impact on the risk profile”

– An allocation of the above information in relation to each fund

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Remuneration – carried interest

• Carried interest, but not the proceeds of co-investment, is subject to the Remuneration Provisions.

• As “variable” remuneration:– calculation must include an adjustment to deal with

future risks– at least 50% must consist of interests in the underlying

fund– at least 40% must be deferred to match the life cycle of

the fund

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Remuneration – carried interest

• How do you apply these rules in the context of carried interest schemes?

• ESMA’s view is that a classic whole fund carried interest structure will satisfy all the risk alignment requirements.

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QUESTIONS?

Gus Black, Richard Frase, Ana Gallo-Martinez and Stuart MartinDechert LLPgus.black@dechert.comrichard.frase@dechert.comana.gallo@dechert.comstuart.martin@dechert.com