Industry news / 10 June 2016

AIFM Directive - The Final Steps

On November 16, 2011 Esma published its final advice to the European Commission on the possible implementing measures for the AIFM directive. Esma had previously called the industry to consultation and has been busy reviewing over 150 responses since July 2011.

The final advice represents a considerable progress in what has been a long and highly debated process, leading to the final steps of the implementation of the directive. It remains to be seen to what extent the European Commission is going to adhere to or amend the advice before its adoption into regulations (directly applicable) or directives (to be transposed into local legislation - more flexible). It is currently anticipated that the legislation should be adopted mid-20l2, with implementation following in June 2013.

The level 2 advice has given clarification to several key questions, focusing on four main areas: i) general provisions, authorisation and operating conditions, including risk management, conflict of interest policy, liquidity management, valuation and delegation; ii) depositary; iii) transparency requirements and leverage; iv) supervision. A few areas of concern persist.

Below follows a summary of the key areas of impact for asset managers included in the final advice:

Calculation of regulatory assets under management: The AIFM directive must calculate its regulatory assets at least once a year. Esma is not using a classical NAV (net asset value) approach when calculating the thresholds of €100 million and €500 million (if no leverage and five year lockup from the initial investment date). Instead Esma requires a few adjustments such as the conversion of derivatives into the absolute value of the underlying and to add assets that have been acquired through leverage. This method, which does not allow netting, may result in some asset managers being caught by the directive, despite their NAV being below the threshold.

Additional funds and professional indemnity insurance: Esma is providing further advice on the requirements to cover for professional risk and, taking into consideration the comments received during the consultation has introduced the possibility to either hold professional indemnity insurance (PII), hold additional capital (0.008% to 0.01%), or a combination of both.

Leverage and exposure: Esma’s advice covers in detail the methods for calculating the leverage and the exposure of an alternative investment fund (AIF). Leverage is to be calculated as the ratio of the exposure of the AIF divided by its net asset value (NAV). The exposure is to be calculated in accordance with the “gross method” and the “commitment method”. An “advanced method” can be used in addition, upon notification to the competent authorities of the home member state. The level of leverage should be disclosed to the investor using at minimum the gross method and either the commitment or the advanced method. The use of different methods may lead to confusion and will require the AIFM to effectively manage investor communication.

Risk management: The AIFM shall functionally and hierarchically separate the functions of risk management from the operating units, including the portfolio management. It is also worth noting that the remuneration of the control functions shall be independent of the performance of the business areas they control. The AIFM is required to put in place a detailed risk management policy, including the assessment, monitoring and review of the risk management policy, the measurement and management of risk and the setting of risk limits. Esma further clarifies the purpose and structure of the risk management function as regards its independence and the responsibility for ensuring such independence remaining with the governing body of the AIFM. The structure, nature and measurement of risk are to be disclosed to investors at least in the annual report.

Liquidity management: The AIFM shall adopt appropriate liquidity management policies and procedures taking into account the investment strategy of each AIF, its liquidity profile and redemption policies. In addition, the AIFM shall put in place adequate limits and conduct regular stress tests. It is expected that the AIFM shall put in place the necessary tools and arrangements to ensure that the quantitative and qualitative risks of positions are accurately assessed.

Depositary: One of the most debated issues within the directive, the depositary provisions have taken a step forward in the right direction as regards the clarification of oversight, safekeeping obligations and cash monitoring. In particular, Esma has set out a clear definition of the financial instruments to be held in custody and adopts an “a contrario” approach to define the “other assets” for which the depositary has an obligation of record-keeping and ownership verification. This is a key element since it defines the scope of the depositary’s custody function and, consequently the scope of its liability.

The depositary liability regime is a controversial issue that Esma has had to deal with. The AIFM directive reinforces significantly the depositary’s liability regime in case of loss of financial instruments in custody compared with Ucits IV. It introduces the obligation for the depositary to return a financial instrument of the identical type, or the corresponding amount, without undue delay, unless it can demonstrate that the loss was the result of an external event.

Esma further clarifies the definition of loss and sets out a three-step approach to define what external events could be considered beyond the control of the depositary, the burden of proof lying with the depositary.

With regards to its oversight duties, the depositary should perform ex-post controls and verification of processes and procedures that are under the responsibility of the AIFM, the AIF and appointed third parties. In addition to cash monitoring, the oversight duties cover subscriptions and redemptions, valuation of shares/units and compliance with the investment restrictions set by national regulations, as well as restrictions and the leverage limit set in the AIF’s offering document. If a breach is observed, the depositary is expected to instruct the AIFM to reverse the transaction at its own cost.

Looking ahead

Although we need to wait for the European Commission and Parliament to express their opinions, which may conflict with Esma’s, the advice gives a thorough framework for the implementation of the directive.

Esma’s advice is intentionally aligned with Ucits IV requirements, and in some cases more detailed, for instance as regards the definition of leverage and liquidity management. It is not unlikely that some of these could inspire Ucits V.

The accrued duties and liabilities of the custodian will add an additional layer of controls to the AIF / AIFM that will inevitably increase costs. Increased co-operation between the depositary and the central administration will be required to avoid duplication of tasks.

Asset managers and service providers will need to perform a review and re-assessment of the current arrangements, including investment in systems able to calculate the risk using quantitative measures and to apply appropriate back and stress testing.

Although proportionality rules reflecting the size and structure of the AIF / AIFM are considered, medium to smaller asset managers may well struggle to comply with these requirements without significantly upgrading their operations.


Delegation is an option. Considering that delegation rules are again largely in line with those currently applied within the Ucits directive, it is legitimate to anticipate that similar models of governance, substance and delegation could be applied to AIF / AIFM as those currently applied and known to work within the Ucits regime.

The implementation of the AIFM directive will no doubt mark a profound change within the alternative asset management world. Some will be less affected than others, however, all players will have to thoroughly reassess their current operational models, delegations and contractual arrangements, systems and processes. We will see a clear convergence of the AIFM directive versus Ucits.

There are challenges but also opportunities for market participants and member states that are able to combine the lessons learned from Ucits and the experience of managing regulated funds with specific sector knowledge within the alternative asset classes.

Although it remains to be seen how the passport will work in practice, the possibility to market AIFs freely and to consolidate existing structures is a huge opportunity for global asset managers. The next challenge is making AIFs as strong and widely recognised as the Ucits brand.

This article was published in ICFA on 20 Dec 2011

Daniela Klasén-Martin Managing Director DCG Management Company S.A.
+352 26 215 420

DCG Management Company S.A. is regulated by the CSSF