Presently, national financial and company law regulations and general provisions of Community law regulate the Alternative Investment Funds Managers (AIFM) activities. The European Commission adopted, last year, a proposal for a Directive establishing regulatory and supervisory standards for hedge funds and private equity. The proposal is going through the ordinary legislative procedure (co-decision procedure) with QMV required at the Council. The negotiations were conducted through trialogues on an informal and secretive basis.

The draft directive as proposed by the European Commission would have imposed considerable unnecessary burdens on the financial industry. Last October, the European Parliament reached an agreement with the Council on the proposal.  The European Parliament endorsed the compromise deal on 11 November and approved the Alternative Investment Fund Managers draft Directive (AIFMD). The agreed text still has to be formally adopted by the Council. The draft directive is expected to come into force in January, but member states will have till 2013 to transpose it into national law.

The European Commission proposal has been, therefore, amended. Although the agreed text is not as damaging as the Commission proposal, it would still have damaging consequences for the hedge fund and private equity industries. The directive would entail further costs and red tape for these industries. Andrew Baker, head of hedge-fund industry group AIMA said "There is still much in the directive that will be difficult to implement and there will be a heavy compliance burden that the industry will have to bear," but he noted "the impact will be far less severe than if something close to the original proposal had been agreed."

Most hedge funds and private equity that are market within the EU are based and registered in the UK. However, the UK government could not veto the proposal. One could say that the draft directive, even amended, would have a negative impact on the UK hedge fund and private equity competitiveness. This a clear example of why the Government should repatriate powers from Brussels.


The directive establishes, for the first time, common requirements governing the authorisation and supervision of AIFM. Managers of all alternative investment funds would be required to register to operate in the EU. The directive not only imposes registration but also reporting and capital requirements on AIFM.

For the purposes of the directive, Alternative Investment Funds (AIF) are defined as all funds that are not harmonised under the UCITS (Undertakings for Collective Investment in Transferable Securities) Directive such as hedge funds and private equity, as well as real estate funds, commodity funds and infrastructure funds. The proposal puts therefore all AIF in the same bag.

The draft Directive will regulate the way in which AIFM manage alternative investment funds (AIF) under their responsibility rather than the funds themselves. The Directive will apply, therefore, to all EU AIFM managing EU AIF or non-EU AIF and to non-EU AIFM managing EU AIF, irrespective of whether they are marketed in the EU or not.

The management and administration of any AIF in the EU must be authorized and supervised in accordance with the requirements of the Directive. The directive introduces a legally binding authorization and supervisory regime. All AIFM that operate in the EU will be required to obtain authorisation from the competent authority of their home Member State. Such authorization would cover the services of management and administration of AIF throughout the Union.

The Commission has exempted all AIFM managing AIF portfolios with total assets of less than €100 million from the provisions of the draft Directive. The directive will apply to all AIFM managing hedge funds above €100 million in value and private equity funds of €500 million or more not using leverage.

The European Parliament and the Council agreed on the Commission threshold system and provide for a “lighter regime for AIFM where the cumulative AIF under management fall below a threshold of EUR 100 million and for AIFM that manage only unleveraged AIF that do not grant investors redemption rights during a period of five years where the cumulative AIF under management fall below a threshold of EUR 500 million.”

These smaller AIFM would not be subject to full authorisation but to a registration in their home Member States. Under the proposal all AIFM that operated in Europe would have to meet reporting, governance and risk management standards. They would also be required to have minimum capital requirements and to ensure that their investors' money is secured in depositary banks. The directive will require AIFM to inform regulators and investors about their activities, including their investment strategies, and their plans on how to manage risk. The draft directive will therefore impose further costs on managers since they will be required to implement new fund reporting and risk management systems.

AIFMs authorised in one Member State will be allowed to market their funds throughout the EU. Consequently, if AIFMs fail to comply with the new rules they would not be allowed to operate in the EU.

The Commission proposal would have allowed a EU AIFM to market AIF domiciled in third countries to professional investors throughout Europe, three years after the transposition period. Until then the member states could allow AIFM to market AIF domiciled in third countries to professional investors on their territory subject to national law. Moreover, three years after the transposition period the European Commission's draft proposal would have allowed AIFM domiciled in a third country to market their funds in the EU provided that the third country has a similar regulatory framework and supervisory arrangements to those proposed in the draft Directive, and EU operators enjoy equivalent access to that third country market. Global industry centres such as the United States, Canada, Switzerland, Hong Kong, Singapore, Japan, and Australia will be affected by this proposal. Paul Marshall, Chairman of Hedge Fund Managers Marshall Wace, has said that the Commission’s proposal has a "strong protectionist element, since it would prevent fund managers in third countries – such as the US – from accessing the European market unless those countries adopted "equivalent regulation."

The main controversial issue during the negotiations between the European Parliament and the Council has been the access that non-EU fund managers should get to operate in the EU. Whereas France wanted to limit the access of non-EU funds to the EU market, being against the so-called the EU passport for funds, the UK favour this idea.

It was agreed that a EU passport for EU AIFM would be available when the directive is implemented, in 2013, a passport for non-EU AIFM can be granted two years after the final transposition date of the present Directive, expected to be in 2015. Non-EU AIF and AIF managers would be allowed to market to investors in the EU without having to seek permission from each Member State. The passport system would be extended to non-EU AIFMs and AIFs by the Commission through implementing legislation. Hence, after a transitional period of two years a European Passport system would also apply to non-EU AIFM performing management or marketing activities within the EU and to EU AIFM managing non-EU AIF, after the entry into force of a Commission delegated act, likely to be in 2015.  Then, a non-EU AIFM established in a third country would be entitled to the rights provided in the Directive but they must comply with the directive obligations, namely the authorization procedure. A non EU AIFM is allowed to manage or market AIF in the EU with a passport or an EU AIFM to market non-EU AIF in the EU with a passport, but first  it has to be authorised in accordance with the present Directive. The authorised EU AIFM planning to market non-EU AIF to investors in their home Member State or in other Member States would be allowed to do it with a passport providing they comply with all the provisions of this Directive. However, in very exceptional circumstances, if compliance with a Directive provision is incompatible with compliance with the law to which the non-EU AIFM marketed in the EU, is subject, the non-EU AIFM may be exempted from complying with that Directive provision, but it has to be demonstrated that: it is not possible to comply with a provision of this Directive and with a mandatory provision in the law to which the non- EU AIFM  is subject. Moreover, the third country law has to provide for an equivalent rule offering the same level of protection to the relevant AIF investors and the non-EU AIFM or the non-EU AIF must comply with that equivalent rule.

The European Securities and Markets Authority (ESMA) would have mediation powers in case of disagreement between the member states competent authorities as regards the application of the exemption in case of incompatibility of equivalent rules and the assessment regarding the fulfilment of the requirements concerning the third country of the non-EU AIFM or the third country of the non-EU AIF. If national supervisors are unable to reach an agreement, the European Supervisory Authorities would “settle the matter.”

Moreover, non EU AIF and AIF managers would be only able to obtain passports if their home country meets minimum regulatory standards and has agreements in place with Member States to allow information sharing. ESMA would have a huge role in regulating fund managers. ESMA would develop technical regulatory standards on the contents of the cooperation arrangements that must be concluded by the AIFM home Member State and the supervisory authorities outside the EU as well as on the procedures for the exchange of information. ESMA will also be involved in the negotiation and conclusion of the cooperation arrangements.

During a transitional period, of three years, which will be then terminated by a delegated act, a non-EU AIFM planning to market AIF in the territory of an EU Member States without a passport, might be allowed to do it by the concerned Member States providing that certain conditions are met. Those AIFM would be subject to equivalent rules to those applicable to EU AIFM managing EU AIF with respect to the disclosure to investors.

The EU harmonised regime would co-exist with Member State’s national regimes for an additional transitional period of three years, till 2018, then national rules would be abolished and it would be for the Commission to decide which funds may have access to the EU's market. The national private placement regimes will be terminated when the Commission adopts another delegated act to this effect.

Three years after the entry into force of the abovementioned delegated act, likely to be 2018, EU AIFM planning to market non-EU AIF within the territory of an EU Member States without a passport, may be allowed to do this by the Member States concerned, but providing they comply with all the Directive provisions with the exception of the depositary requirements. Moreover, there should be suitable cooperation arrangements for the purpose of systemic risk oversight between the home Member State of the AIFM competent authorities and the third country of the non-EU AIF supervisory authorities. Furthermore, the third country where the non-EU AIF is established may not be in the list of the Financial Action Task Force on anti-money laundering and terrorist financing as Non-Cooperative Country and Territory.

As Syed Kamall, European Conservatives and Reformists group chief negotiator on the directive, said "Ideally, we would have kept national regimes for the marketing of funds in place forever, now it looks as though they will expire in 2018.” 

The Commission pointed out that AIFM employing high levels of leverage in their investment strategies may contribute to the build up of systemic risk however the information needed to detect and respond to those risks, according to the Commission “has not been collected in a consistent way throughout the Community, and shared across Member States so as to identify potential sources of risk to the stability of financial markets in the Community.” Hence, those AIFM would be obliged to disclose information regarding their use and sources of leverage, which would be shared with other authorities as well as with ESMA and the ESRB. Under the original draft, the Commission would impose limits on the level of leverage that AIFM may use through the comitology procedure. Under the text recently approved the AIFMs would set leverage limits as regards each AIF they manage following defined guidelines. The “suitability” of such limits will be monitored by national supervisors and ESMA. The competent authorities of the home Member State of the AIFM will be allowed to impose limits on the level of leverage that AIFM could employ in AIF “where the stability and integrity of the financial system may be threatened.” Furthermore, ESMA would be allowed to “determine that the leverage used by an AIFM or by a group of AIFM, poses a substantial risk to the stability and the integrity of the financial system and to issue an advice to competent authorities specifying the remedial measures to be taken.” The Commission through delegated acts (comitology procedure) will adopt measures indicating the methods of leverage as defined in the present directive.

Under the directive an AIFM will be required to provide all companies over which it can exercise a controlling or dominant influence, with the information necessary for the company to assess how this controlling influence may impact on its economic and social situation. The draft directive provides, therefore, for a list of information that AIFM, which are in a position to exercise controlling influence over a company, will have to supply to shareholders. They will be required to disclose their intentions with regard to the future business development and other planned changes of the controlled company. The AIFM would be required to issue an annual disclosure on the investment strategy and objectives of its fund when acquiring control of companies as well as general disclosures about the performance of the portfolio company. Such information should be made available to the representatives of the company employees and to the investors of the relevant AIF.

The original Commission proposal has not provided for rules dealing with asset stripping and Member States have been against it. Nevertheless, at the European Parliament request, the draft directive now contains provisions aiming at preventing private equity investors from endeavouring to take control of a company just to make a quick profit. The agreed text includes several provisions concerning limits on the distribution of capital within the first years that a company is taken over by a private equity investor. Moreover, when it controls 10% of a company's shares, private equity would be required to notify the company and the other shareholders as well as to ensure that the company's board of directors informs employees of this control.

Moreover, the European Parliament was also able to include a clause imposing stricter liability on depositaries in order to ensure that investors can always claim damages. Hence, under the draft directive, a depositary who delegates its tasks to third parties would be required to provide a contract of transfer of liability to the third party.

The European Commission has not address the issue of remuneration but, at request of the European Parliament, the draft directive provides for remuneration rules, hence AIF managers would be subject to the same rules as bank managers.

The measures necessary for the Directive implementation would be adopted through implementing acts. The Commission has, therefore, been empowered to adopt delegated acts. In fact, the compromise deal has left a lot of room to delegated acts (comitology procedure) that will diminish Member States control over the content of such measures.

Uli Fricke, chairwoman of the European Private Equity and Venture Capital Association, has said that the draft directive “will impose unnecessary costs on our investors and ultimately Europe's pensioners, as well as unfair burdens on companies we invest in to help them grow,"

Syed Kamall pointed out that "This directive could have been disastrous for our financial institutions, pension funds and venture capital investment”, but “Instead, we have a directive that promotes transparency without closing our markets.” He said that "This proposal is not perfect but it is workable.” Moreover, he stressed that "We will need to keep a close eye on ESMA and the European Commission to make sure they do not overburden the EU passport with too much costly red tape or try to restrict funds from being marketed in the EU."