Many family offices, while recognising themselves as managers of investment funds, are unlikely to view their activities as being particularly “alternative.” Nevertheless, the sector will not be wholly insulated from the legal and operational effects of the biggest shake-up in investment management in years, the Alternative Investment Fund Managers Directive (AIFMD or directive), which is due to come into force in July 2013.
The AIFMD is the European Union’s (EU) legislative response to the perceived
role in the 2008 financial crisis of the “alternative investment” industry, and, in particular, hedge and private equity funds. Hitherto regulated only on a national
basis, the view of the EU institutions is that a lack of intrusive cross-border supervision of such funds contributed to the atmosphere of instability that drove
the credit crunch and in particular lay at the root of the roller-coaster swings in the prices of publicly listed financial stocks.
The directive is the most complicated – and contentious – piece of financial services legislation to come out of the EU since MiFID in 2007 and has been the subject of intense debate. The 736 members of the European Parliament together tabled nearly 1,700 amendments to the initial text. In a nutshell, the AIFMD, for the first time, subjects managers of alternative investment funds, and the funds themselves, to regulation on a pan-European basis. The key areas of new regulation under the Directive include:
• a requirement that managers retain regulatory capital explicitly based on assets under management;
• the imposition of various governance and conduct of business standards above and beyond those already imposed by national regulators;
• the imposition of rules around the use of prime brokers and depositaries/ custodians;
• a new set of regulations concerning remuneration;
• expanded reporting and disclosure obligations, with respect to both regulators and investors; and
• restrictions on the use of non-EU structures and service providers.
The AIFMD has in general been poorly received by the investment management industry. It has been estimated that implementation of the directive may
cost the European asset management industry £2 billion and many market participants have said it will involve greatly increased cost and regulatory burdens.
Due to the way that EU directives are drafted and approved, there is still a significant lack of clarity around the final impact of the provisions of the directive. While the big-ticket items are settled, national regulators have significant discretion as to how they implement the AIFMD and some may well choose to “gold-plate” the requirements
of the directive. In the UK, the Financial Services Authority (FSA) has said that it aims to publish its proposals for transposition in the middle of 2012, with a view to meeting the July 2013 implementation deadline.
Until those proposals are finalised, uncertainty will persist.
Who is affected?
The good news for family offices is that the thrust of the directive is to restrict
the impact on European financial stability of large hedge funds and private equity groups. There are a number of features of the AIFMD that means most family offices will not be subject to the full directive regime and some will be exempted entirely.
Essentially, any entity that manages a collective investment scheme, which is not a (regulated) Ucits, is likely to be an Alternative Investment Fund Manager
(AIFM) managing alternative investment funds (AIFs) for the purposes of the directive and as such will be subject to its provisions. Therefore, to the extent a family office does not operate AIFs, it will not be in scope.
However, in recent years many family offices have expanded the scope of their operations, looking for better rates of return in difficult market conditions and many do operate AIFs. That being the case, there are a number of means by which family offices in this situation may be able to avoid bringing themselves, either partially or at all, within the scope of the directive and thereby avoid some or all of the expense associated with compliance.
The ‘Family Office’ Carve-Out
Recital 7 to the AIFMD contains a carve-out that will be available to family offices that do not accept external capital: “family office vehicles which invest the private wealth of investors without raising external capital, should not be considered to be AIFs in accordance with this directive.”
This carve-out will apply even where the family office is managing AIFs. However, this exemption is obviously only likely to be of use to family offices that have
not expanded their activities to include non-family wealth. The carve-out will also be subject to interpretation and transposition by the FSA into UK regulation and is likely to be drawn tightly.
The Small AIFM Exemption
Article 3(2) of the directive provides that AIFMs which manage AIFs amounting to less than Ð100 million in AIFs are partially exempt from the requirements of the directive, on the basis that AIFs of this scale do not pose the sort of systemic risk that EU policymakers are attempting to limit via this initiative. This exemption is, however, only partial and will still entail a significant extra compliance burden for AIFMs. The requirements (aside from establishing that its assets under management fall under the €100 million threshold) for a small UK AIFM seeking to benefit from this exemption are:
• registration with the FSA, including details of:
\- its own identity;
\- the AIFs it manages; and
\- the investment strategies of
those AIFs, including information on asset allocation and any borrowing or leverage policy; and
• filing with the FSA, on a regular basis:
\- information on the main instruments in which the AIFs are trading/holding;
\- information on the AIFs principal exposures; and
\- information on concentrations within the largest AIF which it manages.
It is, as yet, unclear what ‘on a regular basis’ might mean. The current thinking is that this will probably be an annual filing, but it will not know for certain until the FSA publishes its implementing measures. Registration will clearly represent a one-off cost, although the degree to which the FSA is likely to test applications, particularly where AIF assets under management fall at or near the €100 million threshold, remains unclear. It is also possible that family offices do not currently collect
on a regular basis the sorts of data that will be required to be filed and acquiring this capability may also prove costly.
What should family offices do now?
• First and foremost, family offices should ensure that their professional advisers are keeping them up to date with developments. As noted above, there will not be full certainty on the impact of the directive in the UK until the FSA finalises its proposals next year.
• Where family offices are close to the €100 million threshold and manage AIFs that accept external capital, they should consider whether they are prepared to take the risk that they will exceed that threshold by mid-2013 and whether they are consequently prepared to accept the full scope of the Directive regime. If not, they may wish to consider redeeming units, or restructuring their operations by closing or floating off AIFs. Another option maybe to convert AIFs into managed accounts, which do not fall within the scope of the AIFMD.
• Where family offices deal with a small amount of external capital, they should consider whether or not the trade-off between having access to that capital and the extra costs of complying with the directive regime continues to make economic sense.
• Where family offices deal with external capital and expect to fall within the small AIFM regime, they should consider whether their current reporting capabilities will enable them to provide the sorts of information that will need to be filed annually. Will they need further services from existing third party providers, or will new providers need to be sought to enable compliance?
• Finally, family offices should be aware that as well as impacting AIFMs,
the directive also contains extensive provisions relating to the activities
of prime brokers and depositaries/custodians in relation to AIFs. Prime brokers and depositaries/custodians are undertaking wholesale reviews of their existing documentation, and may well begin approaching family offices with a view to renegotiation.
