(a) EC's Draft Directive on Alternative Investment Fund Managers

At its meeting held in Luxembourg on 19 October, 2010, the ECOFIN reached agreement on the draft Alternative Investment Funds Managers Directive ("AIFMD"). On 11 November, a successful plenary vote by the European Parliament has led to the adoption of the AIFMD. Further details on the implementation of the AIFMD will be decided in 2011. The AIFMD is due to be implemented across the EU in 2013.

In November, 2010 the IFIA published an "Industry Information Note" outlining some of the main issues that apply to the fund industry in Ireland.

As previously set out, the draft AIFMD on AIFM covers Non-UCITS funds including hedge funds, private equity and commodity funds and aims to create a harmonised regulatory and supervisory framework for AIFM within Europe.

The AIFMD will require all applicable AIFM to be authorised and subject to harmonised regulatory standards on an ongoing basis. It will also increase the reporting and transparency of AIFM and the funds they manage for investors and public authorities. The aim is to improve Member States macro prudential oversight of the funds sector and take harmonised action where appropriate with regard to the proper functioning of financial markets.

It is proposed that the AIFMD will:

  • Adopt an 'all encompassing' approach to ensure that no significant AIFM is outside of regulation and oversight, while providing exemptions for much smaller managers. It will only apply to AIFM managing a portfolio of €100 million plus. A higher threshold of €500 million applies to AIFM not using leverage (and having a five year lock-in period for their investors) as they are not regarded by the EC as posing systemic risks. According to analysis by the EC, a threshold of €100 million implies that about 30% of hedge fund managers, managing almost 90% of assets of EU domiciled hedge funds, would be covered by the proposed Directive;
  • Aim to regulate major sources of risks in the alternative investment value chain by ensuring that AIFM are authorised and subject to ongoing regulation and that key service providers, including depositaries and administrators, are subject to robust regulatory standards, as is currently the situation in Ireland;
  • Increase the transparency of AIFM and the funds they manage for supervisors, investors and other key stakeholders;
  • Ensure that all regulated entities are subject to governance standards and have robust systems in place for the management of risks, liquidity and conflicts of interest;
  • Permit AIFM to market funds to professional investors throughout the EU subject to compliance with regulatory standards; and
  • Grant access to the European market to third country funds after a transitional period of three years. The EC have said this is to allow the EU to check whether the necessary guarantees are in place in the countries where the funds are domiciled (with respect to among others equivalence of regulatory and supervisory standards and exchange of information on tax matters).

The Directive is subject to a co-decision process which includes the ECON Committee of the European Parliament and the Council of Ministers Working Group. The ECON Committee of the European Parliament appointed a Rapporteur (MEP Jean-Paul Gauzes) who is responsible for guiding the Directive through Parliament.

In October, 2009 the IFIA reported that the European Fund and Asset Management Association ("EFAMA") AIFM Working Group on which the industry participates reached broad agreement on the issues they had been considering:

  • Agreement on a level playing field, but as of yet without clarity on impacts for closed ended, listed funds passported under the prospectus directive or securitization vehicles (discretionary managed fund versus company issues);
  • Definition of management services aligned to UCITS Annex II;
  • Capital requirements aligned with UCITS with a similar cap;
  • Valuation to be a function as per UCITS model;
  • Depositary rules to follow current UCITS requirements and for there not to be full liability;
  • Delegation requirements to be more flexible as current UCITS requirements, allow for delegation of portfolio / investment management to third country non AIFM entities;
  • To make the leverage requirements much more flexible; and
  • Third country funds, to allow private placement and reverse solicitation according to national rules to continue, but not have provision for an EU passport.

MEPs of the European Parliament's ECON had voted in favour of the Parliamentary version of the EU's AIFM and European finance ministers have agreed to give the Presidency the mandate to negotiate on behalf of the Council with Parliament.

The three-way ("trilogue") discussions between representatives of the European Parliament's ECON (Economic and Monetary Affairs) Committee, the Presidency of the Council of the European Union and the European Commission have now begun.

On the negotiating table are the two differing versions of the draft Directive, approved in May by ECON and the Economic and Financial Affairs ("ECOFIN") Council, part of the Council of the European Union. The ECON team is understood to include the chairwoman of ECON, Sharon Bowles, the rapporteur, Jean-Paul Gauzès, and the six shadow rapporteurs taken from the main political blocs in the European Parliament. The Council is represented by the Belgian government as the President of the Council of the EU. The Commission officials present at the discussions are there to assist the parties agreeing on a compromise text. But they will naturally favour any wording which backs up their original version of the draft Directive, published in April, 2009.

Where there is already broad agreement between the texts, such as on registration and authorisation of EU managers, those areas will be incorporated immediately into the new compromise text, drafted by the EC. This will leave the negotiating teams free to discuss solutions to areas where there is disagreement – including the issue of third countries. The other controversial areas include: valuation; depositaries; scope; leverage; remuneration; delegation; capital requirements; and short selling.

In order to reconcile the different approaches taken, the groups may agree to adopt either the ECON or Council position on a particular issue. Alternatively, they may agree to adopt a compromise position that combines elements of both texts.

The aim will be for all the issues to be resolved, and majority backing effectively secured, before the compromise text is finally voted on. In preparation for this vote and in an ongoing attempt to reach agreement the Belgian Presidency has released several compromise texts.

The latest texts do not include any detail on either requirements for marketing or private placement of 3rd country funds/managers or on requirements relating to Private Equity. The treatment of 3rd country funds is the most significant unresolved issue in the ongoing negotiations with there still being divergent views between countries within the European Council.

It is understood that the primary differences relate to the provisions to allow private placement to continue, possibly for a limited period, subject to certain conditions and the possibility of a European marketing passport, under certain conditions, for 3rd country funds.

Once the text has been approved by Parliament, it will pass to the next meeting of ECOFIN, which would be expected to adopt it.

In the unlikely event of a simple majority of MEPs voting against the eventual text, there would follow a second reading, a process limited to three months, during which a further compromise version of the Directive would need to be drafted and agreed upon. However, all parties to the trilogues have stated a preference for a First Reading passage.

Once Parliament and Council have voted in favour of the Directive, it will pass to the next stage, which is its implementation into national law. This process is expected to last until 2012, when the Directive would come into force.

(b) New European Systematic Risk Board

A new European Systemic Risk Board ("ESRB") was established on Thursday 16 December, 2010.

It is aimed at contributing to the prevention or reduction of systemic risks to financial stability in the EU that arise from developments within the financial system.

The European Central Bank has commented that the ESRB will also contribute to the smooth functioning of the internal market and is aimed to ensure a sustainable contribution of the financial sector to economic growth.

However, the European Commission has stated that the ESRB will not have any binding powers to impose measures on Member States or national authorities. It has been conceived as a "reputational" body with a high level composition that should influence the actions of policy makers and supervisors by means of its moral authority.

The seat of the ESRB will be in Frankfurt, Germany. The Chair of the ESRB is the President of the European Central Bank, Jean-Claude Trichet, while Mervyn King, Governor of the Bank of England, was elected as first Vice-Chair of the ESRB by the members of the General Council of the European Central Bank.

The General Board of the ESRB will have its inaugural meeting on 20 January, 2011.

(c) CESR's Definition of European Money Market

CESR has published its guidelines on a common definition of European money market funds. The guidelines aim to improve investor protection by setting out criteria to be applied by any fund that wishes to market itself as a money market fund. The criteria reflect the fact that investors in money market funds expect the capital value of their investment to be maintained while retaining the ability to withdraw their capital on a daily basis. A common definition will also help provide a more detailed understanding of the distinction between funds which operate in a very restricted fashion and those which follow a more 'enhanced' approach.

CESR's guidelines set out two categories of money market fund: Short-Term Money Market Funds and Money Market Funds. This approach recognises the distinction between shortterm money market funds, which operate a very short weighted average maturity and weighted average life; and money market funds which operate with a longer weighted average maturity and weighted average life. For both categories of fund, CESR expects that there should be specific disclosure to explain clearly the implications of investing in the type of money market fund involved. For Money Market Funds, for example, this means taking account of the longer weighted average maturity and weighted average life of such funds. For both types of money market fund, this should reflect any investment in new asset classes, financial instruments or investment strategies with unusual risk and reward profiles.

The guidelines will enter into force in line with the transposition deadline for the revised UCITS Directive (1 July, 2011). However, money market funds that existed before that date will be granted an additional six months to comply with the guidelines as a whole.

(d) EC's Proposal for Regulating Short Selling

Following CESR's consultation paper on short selling in June, 2010 the EC has now published its draft proposal for regulating short selling and certain aspects of credit default swaps.

The Alternative Investment Management Association ("AIMA") has set out the key points to note from the EC's proposal and they include:

  • scope –covers:
    • financial instruments admitted to trading on an EU regulated market or MTF (even when such instruments are traded outside that trading venue);
    • derivatives which relate to such a financial instrument or an issuer of such a financial instrument (even when such derivatives are traded outside a trading venue);
    • debt instruments issued by a Member State or the European Union and derivatives relating to such debt instruments or an obligation of a Member State or the Union;
  • a disclosure regime is proposed in respect of significant net short positions whereby:
    • for shares - private disclosure to the regulator at 0.2% and further increments of 0.1% of issued share capital; public disclosure at 0.5% with 0.1% increments;
    • for sovereign debt and CDS – private disclosure only, thresholds to be determined;
  • short sell orders are to be marked as such and weekly or more regular summaries of the volume of short selling are to made available;
  • buy-in procedures for settlement failures at T+4 are to be required and fines would apply to those who fail to deliver on the due date;
  • an exemption would be available to market makers when acting in this capacity;
  • restrictions will be imposed in respect of uncovered short sales, requiring the seller to have already borrowed or entered into an agreement to borrow the shares or debt instrument, or to have arranged with a third party that the share or debt instrument has been located and reserved for lending – the details of these provisions remain to be worked out;
  • emergency powers are to be given to competent authorities in respect of imposing bans, restrictions or temporary suspension of short sales, with similar powers (along with a facilitation and coordination role) being provided to ESMA.

It is expected that a new Regulation will be implemented across Europe and this will apply from 1 July, 2012.

(e) Introduction of New QIF Criteria & Competitive Issues

The IFIA recently met with the Central Bank to discuss the introduction of new QIF criteria and competitive issues. Below is a summary of items the Central Bank has agreed to amend / consider amending through revised draft notices / guidance notes.

Regulated markets:

It was proposed that the Central Bank should remove the requirement that the articles of association of an investment company list the regulated markets on which the transferable securities and money market instruments acquired by the investment company must be listed or traded and allow this information to be included in the prospectus instead.

Qualifying investor criteria:

It was requested that the Central Bank revise the criteria for QIF investors to take into account MiFID "professional clients", the proposals under the AIFMD and the investor requirements for the equivalent structure in Luxembourg.

The Central Bank has agreed to reduce the minimum subscription to €100,000 and have agreed to change the qualifying investor criteria to include professional investors.

Frequency of calculation of net asset value:

It was proposed that the Central Bank review its requirement for the NAV to be calculated on a twice yearly basis (it is acknowledged that a NAV would still have to be calculated in respect of any day on which securities are to be issued or redeemed by the QIF).

The Central Bank agreed to a minimum of one valuation per year for QIFs subject to dealing frequency.

(f) Reduction in Minimum Subscription for Professional Investor Funds

As outlined above, the Central Bank has reduced the minimum subscription amount for a QIF from €250,000 to €100,000. This meant that while the minimum subscription amount for a QIF was €100,000, the minimum subscription amount for a Professional Investor Fund (PIF) was €125,000. The Central Bank recently confirmed that the minimum subscription amount for a PIF will be reduced from €125,000 to €100,000 and amendments to NU12 of the NU Series of Notices to reflect this change will be made in due course.

(g) Re-domiciliation of Collective Investment Schemes to Ireland

The Companies (Miscellaneous Provisions) Act 2009 amended the Companies Act 1990 and the European Communities (Undertakings for Collective Investments in Transferable Securities) Regulations 2003, to provide an efficient legislative mechanism for corporate investment funds to re-domicile into Ireland. The Companies Act 1990 (Relevant Jurisdictions under Section 256F) Regulations 2010, identified the following as relevant jurisdictions from which corporate CIS could re-domicile into Ireland: Bermuda, BVI, Cayman Islands, Guernsey, Isle of Man and Jersey.

Since the introduction of this legislation a number of funds have re-domiciled and more are in the process of re-domiciling. While the legislation provided an efficient legal mechanism for funds to re-domicile to Ireland, the Central Bank has now provided further guidance regarding the regulatory process and procedure for re-domiciling funds into Ireland e.g. the documentation that must be submitted to the Central Bank, confirmations required, etc. In addition, although there are no legislative provisions which specifically address the redomiciliation of unit trusts to Ireland, the Central Bank has determined that a re-domiciliation process similar to that in place for corporate CIS should apply in respect of unit trusts.

Please contact a member of the Regulatory and Compliance Department in Dillon Eustace should you need further information on the regulatory process and procedure for redomiciling investment funds into Ireland.

(h) Amended Guidance Notes

The following guidance notes were updated to reflect recent discussions between the Central Bank and the IFIA:

Guidance Note 1/96

Notices UCITS 9 and NU 13 require that the stock exchanges and markets on which a UCITS or non-UCITS may invest must be set out in the trust deed, deed of constitution or in an investment company's articles of association. Guidance Note 1/96 provides that this requirement will now be met if a reference to the relevant section of the fund's prospectus is contained in such documents. Please note that the Central Bank will not be updating the notices to reflect this change.

Guidance note 2/96: Promoters of Collective Investment Schemes

The requirement to maintain shareholder funds shall now only apply as long as a promoter acts as promoter to Irish collective investment schemes.

Guidance note 2/99: Money Market Funds: European Central Bank Reporting Requirements

There were some minor amendments to Guidance Note 2/99 relating to the European Central Bank reporting requirements. These changes do not alter the reporting requirements for ECB money market funds rather update the references to ECB legislation.

Guidance Note 1/00: Valuation of Assets of Collective Investment Schemes

The minimum dealing frequency for UCITS is now twice per month. Such dealing day should be at regulator intervals to ensure that dealing days occur on a regular and frequent basis.

Guidance Note 1/07: Authorisation of Qualifying Investor Schemes – Application process

Notifications to the Central Bank of extensions to initial offer periods can now be made on an annual basis.

(i) Standardisation and Exchange Trading of OTC Derivatives / Transaction Reporting

In a consultation paper issued in July, CESR explored the need for taking regulatory actions in relation to further standardisation for credit, equity, interest rate, commodity and foreign exchange derivatives to ensure efficient and safe derivatives markets in response to the financial market turmoil.

Following this consultation, the European Commission tabled a proposal on 15 September, with a view of bringing greater transparency, safety and efficiency to the OTC derivatives market.

The proposed directive on regulating the OTC, central counterparty and trade repository markets requires that information on OTC derivative contracts should be reported to trade repositories and be accessible to supervisory authorities, with additional information also being made available to market participants to increase transparency in the markets. It is proposed that the new ESMA will be responsible for the surveillance of trade repositories and for granting their registration. These trade repositories will have to publish aggregate positions by class of derivatives to give all market participants a clearer view of the OTC derivatives market.

The Commission also proposes that standard OTC derivative contracts be cleared through central counterparties ("CCPs"), to reduce counterparty credit risk, i.e. the risk that one party to the contract defaults. CCPs may interpose themselves between two counterparties to a transaction and thus become the 'buyer to every seller', as well as the 'seller to every buyer'. This will prevent the situation where a collapse of one market participant causes the collapse of other market participants, thereby putting the entire financial system at risk.

(j) Corporate Governance Code for Irish Domiciled CIS

In late September, the IFIA published the voluntary Corporate Governance Code for Irish Domiciled Collective Investment Schemes (the "Code").

The Code may be adopted by Irish domiciled collective investment schemes on a voluntary basis but the Code does reflect existing practices imposed under the Companies Acts 1963 to 2009 and the Central Bank's UCITS & Non-UCITS Notices along with Guidance Notes.

Adoption of the Code should enable Irish domiciled collective investment schemes with shares admitted to trading on a regulated market to refer to this Code in a specific section in the Directors' Report of that collective investment scheme's Annual Report and in doing so comply with the provisions of the S.I. No. 450 of 2009.

The Code covers general requirements applicable to a board of directors including its composition, meetings, its role and committees. It further deals with the audit, compliance and risk management function.

Please contact your usual contact in Dillon Eustace for further details on the Code or if you would like a copy thereof.

(k) National Recovery Plan

The Government's four year 'National Recovery Plan' has highlighted the importance of the Irish funds industry to the country's wider economy. The plan, which includes a guarantee that the corporation tax rate will remain at 12.5%, indicates that Ireland will maintain its strong support for the funds industry which it views as key to promoting Ireland's financial recovery.

The Central Bank has reported that the value of Irish domiciled investment funds had reached almost €899 billion for the first time as at the end of August. This figure represents a 20 per cent increase in the value of Irish domiciled investment funds since the beginning of 2010 (27 per cent year on year) and is a new high for the total value of Irish domiciled funds.

It has confirmed that assets under administration now exceeds €1.8 trillion.

Dillon Eustace have prepared a brochure on the AIFMD's Third Country Provisions which is available on our website: www.dilloneustace.ie

(l) Credit Rating Agencies

Article 4(1) of Regulation (EC) No 1060/2009 on credit rating agencies came into force on 7 December, 2010. The second paragraph of Article 4(1) contains the following requirement which applies to any credit rating mentioned in a prospectus:

"Where a prospectus published under Directive 2003/71/EC and Regulation (EC) No 809/2004 contains a reference to a credit rating or credit ratings, the issuer, offeror, or person asking for admission to trading on a regulated market shall ensure that the prospectus also includes clear and prominent information stating whether or not such credit ratings are issued by a credit rating agency established in the Community and registered under this Regulation."

As such, all documents seeking approval under the Prospectus Directive must state whether or not a credit rating agency is registered in the Community and registered under Regulation (EC) No 1060/2009.

(m) CESR Consultation on Structured UCITS

With a view to the implementation of UCITS IV In July 2011, CESR has issued Final Guidelines on the risk measurement, calculation of global exposure and counterparty risk for UCITS.

The Final Guidelines deal with a range of issues including calculations for the commitment approach, procedures in respect of VaR calculations, stress testing, back testing and regulatory reporting. They also provide guidelines on hedging, collateral and netting.

"CESR has provided a definition of structured UCITS (which is different from the definition for key investor information (KII) requirements). In summary, structured UCITS are passively managed and offer investors a predefined payoff depending on different scenarios based on the value of the underlying assets. The investor can only be exposed to one scenario at any time during the life of the UCITS.

CESR has came to the conclusion that, rather than introducing a specific regime per se for the calculation of the global exposure for these structured UCITS, it would be more appropriate to have an alternative approach to the application of the existing guidelines.

The specific approach as proposed by CESR consists of the calculation, for each scenario to which investors can be exposed at any one time, of the global exposure using the commitment approach. Under this approach, each scenario must comply at all times with the 100% global exposure limit using the existing CESR Guidelines. CESR have set out a very useful set of examples in this regard.

There is a risk that some existing structured UCITS will not comply with these proposals and also that it may limit the types of products that can be made available. Note for example the CESR comment that "UCITS which use derivatives that incorporate a barrier-type feature are required to ensure that the maximum loss the UCITS can suffer when the payoff switches from one scenario to another is limited."

In this regard, CESR's proposal is that existing structured UCITS will not need, as regards global exposure, to comply with CESR's July Guidelines on Risk measurement, Calculation of Global exposure and counterparty risk, but that in this case, such structured UCITS will no longer be able to actively market their UCITS. However, this is provided that such UCITS comply with whatever provisions have been put in place by Member States."

(n) Amendments to the Prospectus Directive and Transparency Directive

Directive 2010/73/EU which will amend certain provisions of the Prospectus Directive and the Transparency Directive became effective on 31 December, 2010. Ireland has until July 1, 2012, to implement the relevant directive into domestic law.

Of particular note is the replacement of Article 8(1)(b) of the Transparency Directive and the additional paragraph (4) of the same article. Article 8 is amended as follows:

  • in paragraph 1, point (b) is replaced by the following:

'(b) an issuer exclusively of debt securities admitted to trading on a regulated market, the denomination per unit of which is at least EUR 100 000 or, in the case of debt securities denominated in a currency other than euro, the value of such denomination per unit is, at the date of the issue, equivalent to at least EUR 100 000.';

  • the following paragraph (4) is added to Article 8:

'By way of derogation from paragraph (1)(b), Articles 4, 5 and 6 shall not apply to issuers of exclusively debt securities the denomination per unit of which is at least EUR 50 000 or, in the case of debt securities denominated in a currency other than euro, the value of such denomination per unit is, at the date of the issue, equivalent to at least EUR 50 000, which have already been admitted to trading on a regulated market in the Union before 31 December 2010, for as long as such debt securities are outstanding.'

These amendments will result in an increase in the minimum denomination to at least €100,000 for Issuers wishing to avail of the exemptions set out in Article 8 and also to state that in order to rely on the grandfathering provisions for securities issued with a minimum denomination of at least €50,000, they must have been issued before 31 December 2010.

The exemptions from the periodic financial reporting requirements of the Transparency Directive for "wholesale" issuers will only continue to apply if they exclusively issue securities with a minimum denomination of €100,000.

(o) Consultation on legislative changes to the UCITS depository function and to UCITS managers' remuneration

The European Commission intends to publish a new legislative proposal in order to review the current framework applicable to UCITS depositories and to introduce new provisions on UCITS' managers' remuneration with a view to improving the level of UCITS investor protection and has issued a consultation document in that regard. The consultation document and relevant information can be found on the European Commission's website at the following link:

http://ec.europa.eu/internal_market/consultations

The Consultation is open until 31 January 2011.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.