AIFMD will increase costs and create regulatory uncertainty, says expert

The Alternative Investment Fund Managers Directive (AIFMD) must be implemented into national law by EU member states by 22 July 2013 yet an absence of some vital details will cause confusion and uncertainty.

The AIFMD is part of the EU response to the financial crisis and it is designed to place more regulatory controls on the managers of investment funds to ensure that investors are better protected and informed than previously.

But some of its provisions will damage the industry. It creates onerous disclosure obligations for alternative investment funds managers (AIFMs), for example, which will require putting in place regular monitoring and reporting on each alternative investment fund (AIF) managed and extra reports on each fund's risk and liquidity profile and the main instruments it trades.  This will increase management operational costs.

The rules will apply to many different kinds of funds. A real estate fund has a very different set of risks to a hedge fund, yet rules on how much capital each fund must retain are uniform, which will be onerous and will increase funding costs for some funds.

Both the capital and disclosure requirements will require thorough and independent asset-valuation procedures, which will add yet more cost.

The AIFMD contains rules designed to stop funds conducting asset stripping. These restrict the ability of funds to transfer value from a purchased non-listed company for a period of two years. This will prevent companies in some cases from realising the value of an investment when it would otherwise be allowed to do so.

More fundamentally, the AIFMD in its current form creates confusion about exactly which funds or companies it regulates and which it does not. If an AIF delegates the actual investment management function to another company then if that other company performs more of the investment management then it will be the one that is regulated by the Directive. The original fund management company will be deemed to be a 'letterbox entity'.

This means that the company listed in fund documentation as the 'manager' will not be the manager as far as the Directive goes, which will cause confusion.

There are also likely to be scenarios where an offshore manager is deemed to be a letterbox entity, meaning that a sub-manager becomes the AIFM. The sub-manager may not be in a position to fulfil the AIFM conditions such as those demanding the holding of certain amounts of capital.

Some of the problems with the implementation of the Directive are more local. The agency responsible for AIFMD in the UK is the Financial Conduct Authority (FCA), but it has yet to make public its processes for receiving applications to become an AIFM or to vary the permissions relating to an organisation's existing AIFM status.

The Directive will be implemented in July this year but AIFMs and potential AIFMs are still not sure of the detail of the process of ensuring they comply. Many firms have started to prepare this internally as much as they can with the hope of submitting applications as soon as the FCA announces its requirements, but this is adding more expense and tying up more management time than it needs to.

The AIFMD will succeed in some of its aims, but to be a true success it must be more flexible to the requirements of the industry and work must be done to clarify some areas of it.

Monica Gogna is an expert in financial services regulation at Pinsent Masons, the law firm behind Out-Law.com