Hedge funds and the AIFMD: a cheat-sheet for first-time managers

• United Kingdom

• Financial services and markets regulation - Briefings and articles
• Financial services and markets regulation - Hedge funds

17-09-2019

Compliance is key and in the UK the EU’s Alternative Investment Fund Managers Directive (AIFMD or the Directive) is the hedge fund manager’s most significant regulatory hurdle. Nor is this changing any time soon. The Directive was enacted into UK law and will be retained, subject to modifications which ensure that it will still work post Brexit, but without changing the underlying policy objective or regulatory framework, so: whatever flavour Brexit eventually takes, the Directive is set to be an integral part of the UK’s future regulatory framework, with the UK version known as UK AIFMD.

Here is how you get to grips with it.

Who qualifies?

The AIFMD impacts all hedge fund managers in the UK, but some will find the going easier than others. Who the fund markets to, where the fund vehicle is established and the aggregate funds under management (AUM), will all determine the extent of the regulatory burden.

‘Sub-threshold’ mangers enjoy a lighter touch, but to qualify mangers need to have an AUM under €500m – assuming the funds aren’t leveraged – or under €100m if they are. Mangers which do not meet these criteria are described as ‘full-scope’.

Hedge fund managers are categorised as Alternative Investment Fund Managers (AIFMs) under the Directive, so you will often see the two sub-categories referred to as ‘sub-threshold AIFMs’ and ‘full-scope AIFMs’ respectively.

A lighter touch

Sub-threshold AIFM status offers the first-time fund manager a number of benefits. In the UK, ‘sub-threshold’ managers can opt in for ‘small authorised UK AIFM’ status. These funds are regulated by the Financial Conduct Authority (FCA), but (crucially) are subject to reduced AIFMD reporting requirements. As a result, managers qualifying as small authorised UK AIFMs enjoy significantly lower compliance costs, making this a popular legal path for start-up fund managers.

Should a sub-threshold AIFM wish to market into the EU they will need to follow the national private placement route. Provided they meet certain general requirements, individual EU states are free to permit private placement under AIFMD. But they are also free to ‘gold plate’ these requirements with exacting local rules, or even ban the practice outright. A sub-threshold AIFM may find that meeting these requirements is as exacting as being a full-scope AIFM under UK AIFMD. It should be noted that the fund must seek a national private placement for each EU member state it wishes to sell into.

Full-scope

Like their sub-threshold counterparts, full-scope managers are authorised by the FCA, but must additionally meet all the AIFMD requirements (in most cases). Conduct of business, regulatory capital, disclosure, transparency and remuneration rules – not to mention the costs of implanting them – will all impact a full-scope fund. A depositary must also be appointed to carry out certain functions, though this requirement can be relaxed in some circumstances, as can the aforementioned transparency rules.

Prior to Brexit, the main benefit of being a full-scope AIFM was to benefit from the EU passport. Post Brexit that will fall away and a full-scope AIFM that seeks to sell into an EU member state using a national private placement regime will find that by complying with UK AIFMD they are already comply in substance (if not specifics) with national rules. Consequently, this process will be eased where it is available.

On the fence?

If neither of these options appeals, start-up mangers might wish to consider appointing a regulatory ‘host’. That is, a third party undertaking authorised as a full scope AIFM either in the UK or within the EEA depending on which markets the manager seeks to target. The host takes responsibility for the fund’s AIFMD marketing responsibilities. This is an attractive option for start-up managers, particularly in the fund’s first few years.

Typically the host handles risk management and compliance, while delegating portfolio management back to the start-up manager. In other words, the host tackles the AIFMD leaving the you free focus on the fundamentals.

How Eversheds Sutherland can help

Our team has been at the forefront of regulatory interpretation and product development for the fund management industry since the 1980s. We advise on all types of fund structures and prepare all documentation necessary to achieve a successful fund launch.