MiFID and AIFMD Compared
Abigail Bell
Richard Frase
Richard Heffner
12 February 2013
© 2013 Dechert LLP
MiFID and AIFMD Compared
Agenda
•
Authorisation and exemptions
•
Permitted services
•
Marketing
•
Organisation and Conduct of Business
•
Delegation
•
Financial resources and insurance
•
Remuneration
Authorisation, Services and Marketing
AIFM Authorisation
(AIFMD arts 6-11; MiFID arts 5-10)
Similar application process
–
New activity of collective portfolio management (carved out of MiFID concept of “portfolio
management”).
–
AIFMD requires detailed information on each AIF, investment strategy, depositary,
delegation arrangements, remuneration policies.
–
EU wide public register of AIFMs.
MiFID firm must have head office in EU state where it is authorised (art 5(4))
AIFM can be outside EU and use “state of reference”
Changes in scope of authorisation
MiFID: Notification under FSA Principle 11 and authorisation terms; no MiFID equivalent
AIFMD article 10: Formal requirement to notify material changes to FSA. Includes new fund
launches, changes to investment strategy etc.
Formal right to restrict or reject the change within 1 month
Same ability to withdraw authorisation in both MiFID and AIFMD
Exemptions
MiFID
Range of different exemptions
Collective investment undertakings are excluded from MiFID (art 2(1)(h))
Group exemption for services provided exclusively to parents and subsidiaries (art 2(1)(b))
AIFMD
Exemptions are AIF specific
100 million AIF AUM de minimis regime
Family office
Group exemption for AIFs whose sole investors are parents or subsidiaries (recital (16))
Permitted services
MiFID
Core Services
AIFMD
Core services
Reception and transmission of orders
Execution of orders on behalf of clients
Dealing on own account
Portfolio management
Investment advice
Underwriting and/or placing on a firm commitment basis
Placing without a firm commitment basis
Operation of Multilateral Trading Facilities
Acting as an AIFM
Portfolio management
MiFID
Ancillary services
AIFMD
Ancillary services
Safekeeping and administration (becomes a core service under
MiFID 2)
Granting credits or loans to carry transactions
Advice to undertakings on capital structure, industrial strategy
and related matters; advice and services relating to mergers and
the purchase of undertakings
Foreign exchange services connected to the provision of
investment services
Investment research and financial analysis or other forms of
general recommendation
Services related to underwriting
Core and ancillary MiFID services relating to the underlying of
certain derivatives connected to the provision of such services
Investment advice
Reception and transmission of orders
Safekeeping and administration for shares or collective investment
undertakings
Marketing & Passporting
MiFID
Marketing is not a MiFID regulated activity.
UK rules on financial promotion apply.
Placing and receiving and transmitting orders have some impact.
AIFM
EU standardised marketing regime (both passported and unpassported)
Difference between marketing and financial promotion
MiFID firms can market AIF units only if the AIF can be marketed in accordance with AIFMD (art
6(8))
An AIF can be listed only if the AIFM is compliant (recital 60)
Passporting (MiFID 31-32; AIFMD arts 32-42)
MiFID allows passport for all services on cross-border or branch basis
AIFMD passport focuses on marketing and managing of AIFs on branch or cross-border basis
(article 33)
Operating conditions
applicable to the firm
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© 2013 Dechert LLP
General Principles (Article 12 of AIFMD)
Member States shall ensure that AIFMs:
•
Act honestly, with due skill, care and diligence (existing obligation under Principle 2 of the
FSA’s Principles of Business)
•
Act in the best interests of the AIF and the integrity of the market (existing obligation under
Principle 6 of the FSA’s Principles for Business, but a higher standard and additional
responsibility to maintain the integrity of the market)
•
Have and employ effectively the necessary resources and procedures (existing obligation
under Principle 4 of the FSA’s Principles for Business)
•
Take all reasonable steps to avoid conflicts of interests and, where they cannot be avoided,
identify, manage and monitor and disclose these conflicts (existing obligation under Principle 8
of the FSA’s Principles of Business and Articles 13(3) and 18 of MiFID)
•
Comply with all regulatory requirements applicable to the conduct of their business (existing
obligation under Principle 5 of the FSA’s Principles for Business and Article 13(2) of MiFID).
•
Treat all AIF investors fairly (existing obligation under Principle 6 of the FSA’s Principles for
Business)
Action Point:
Any preferential treatment must be disclosed in the AIF’s constitutional documents .
Conduct of Business Obligations
(Articles 18-19 of the Regulations)
•
Due diligence requirements are new.
•
Some of these apply only in respect of AIFM which manage AIFs investing in limited liquidity
assets.
•
Impact on due diligence conducted by AIFMs on the AIFs they manage.
•
Requirement to establish a business plan consistent with the duration of the AIF and market
conditions.
•
Must have in place in diligence policies and procedures that take into account the nature,
scale and complexity of the AIF’s assets.
•
Ongoing responsibility for updating business plan to account for changes in investment,
strategy or market conditions and regularly reviewing and updating due diligence policies and
procedures.
•
Will be required to retain records of activities for at least 5 years.
Action Point:
Records will need to be kept of the AIFM’s analysis of investment opportunities.
Conduct of Business Obligations
(Article 20 of the Regulations)
Counterparty selection:
•
Under CASS 6.3, where a firm arranges the registration of safe custody assets deposited with
a third party, it must exercise all due skill, care and diligence in the selection and appointment
of the third party.
•
Principle 10 of the FSA’s Principles for Business requires a firm to arrange “adequate
protection” for its client’s assets when responsible for them.
•
Under Article 20 of the Regulations, when selecting and appointing counterparties and prime
brokers, AIFMs must exercise due skill, care and diligence before entering into an agreement
and on an ongoing basis thereafter taking into account the full range and quality of their
services.
•
Under AIFMD therefore, this obligation is extended beyond custodians to derivatives and
securities lending counterparties and will apply on a continuing basis.
Fair Treatment of Investors
(Article 12 of AIFMD; Articles 23 and 57
of the Regulations)
•
Principle 6 of the FSA’s Principles for Business:
“A firm must pay due regard to the interests of its customers and treat
them fairly”.
•
Position under AIFMD: No investor should obtain preferential treatment
having an overall material disadvantage to other investors BUT treatment
differentiating between investors is permitted provided that it is properly
disclosed e.g. preferential fees for seed investors.
Inducements
(Article 24 of the Regulations)
•
A firm cannot pay or be paid any fee or commission or provide or be provided with any nonmonetary benefit other than:
-
a fee, commission or non-monetary benefit paid or provided to or by the AIF or a person
on behalf of the AIF;
-
a fee, commission or non-monetary benefit paid or provided to or by a third party or a
person acting on behalf of a third party where:
(1) the existence, nature and amount of the fee, commission or benefit or, where the amount
cannot be ascertained, the method of calculating that amount is clearly disclosed to the
investors in the AIF in a manner that is comprehensive, accurate and understandable,
prior to the provision of the relevant service;
(2) the payment of the fee or commission, or the provision of the non-monetary benefit are
designed to enhance the quality of the relevant service and not impair compliance with
the AIFM’s duly to act in the best interests of the AIF its manages or the investors in the
AIF.
-
proper fees which enable or are necessary for the provision of the relevant services and
do not give rise to conflicts with the AIFM’s duties.
Key Point: No material change from current position under COBS 2.3.
Risk Management
Article 13(5) of MiFID:
“An investment firm shall have sound administrative and accounting
procedures, internal control mechanisms, effective procedures for risk
assessment and effective control and safeguard arrangements for
information processing systems.”
Risk Management (cont.)
SYSC 7.1.6: A common platform firm must, where appropriate and
proportionate, establish and maintain a risk management function that
operates independently and carries out the following tasks:
–
Establish, implement and maintain adequate risk management policies and procedures
which identify the risks relating to the firm’s activities, processes and systems and set the
level of risk tolerated by the firm.
–
Adopt effective arrangements, processes and mechanisms to manage the risk relating to
the firm’s activities, processes, and systems, in light of that level of risk tolerance.
–
Monitor:
1.
the adequacy and effectiveness of the firms risk management policies and procedures.
2.
the firm’s level of compliance with the arrangement, processes and mechanisms
adopted; and
3.
the adequacy and effectiveness of measures taken to address any deficiencies therein.
Risk Management (cont.)
•
Post AIFMD, an AIFM will be required to :
– functionally and hierarchically separate the functions of risk management
from the operating units, including portfolio management; and
– (to the extent it has not already done so) implement adequate risk
management systems to identify, measure, manage and monitor all risks
relevant to each AIF investment strategy.
•
Note that the test under Level 2 as to whether these functions are independent is
quite onerous.
•
The FSA has indicated that it would review this separation in line with the principle
of proportionality.
•
The AIFM must review its systems at least once per annum.
Risk Management (cont.)
•
Where it is considered disproportionate for the risk management function to be
functionally and hierarchically separate, the FSA will take the following into
account when considering the safeguards to ensure independence of the risk
management function:
– use of data that is reliable and subject to a degree of appropriate control;
– risk management staff compensated in accordance with the performance of
the risk management function and independent of the performance of the
business areas;
– independent decision making; and
– the segregation of competing duties.
•
The FSA may also take into account the existence of a review of the risk
management function by an independent third party or by the internal audit
function.
Risk Limits
The AIFM will be subject to an additional obligation to establish and implement
quantitive and/or qualitative risk limits for each AIF that it manages covering:
–
Market risks
–
Credit risks
–
Liquidity risks
–
Counterparty risks
–
Operational risks.
Must be aligned with the AIF’s risk profile as disclosed to investors and take into
account the AIF’s strategies and assets and the national rules applicable to the AIF.
Operating conditions
applicable to the AIF
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© 2013 Dechert LLP
MiFID Custody v AIFM Depositary
•
MiFID: No duty to appoint or supervise client’s custodian.
•
Principle 10 of the FSA’s Principles of Business:
“A firm must arrange adequate protection for its client’s assets when it is
responsible for them”.
•
CASS 6.3 imposes duties on firms which control the appointment of a custodian.
•
Article 12 of AIFMD prescribes duties on the AIFM regarding the appointment of a
depositary for each AIF.
Liquidity Management
(Article 16 of AIFMD and Articles 46-49
of the Regulations)
•
For each AIF which is not a closed-ended unleveraged AIF, AIFMs must:
–
employ an appropriate liquidity management system, and
–
adopt procedures enabling them to monitor the AIF’s liquidity risk and to ensure that the
liquidity profile of the AIF’s investments comply with its underlying obligations.
•
AIFMs must also ensure for each AIF they manage the investment strategy, liquidity profile
and redemption policy are consistent. This will be the case where investors have the ability to
redeem in a manner consistent with the fair treatment of AIF investors and in accordance with
the AIF’s redemption policy and obligations.
•
AIFM must also have regard to the impact of redemptions on underlying prices or spreads of
the AIF’s individual assets.
•
Not directly addressed in MiFID; indirect responsibility under the FSA’s Principles for
Business.
Liquidity Management (cont.)
Note in particular the requirement for AIFMs to:
•
monitor compliance by AIFs with the risk limits set by the AIFM and determine a
course of action where these limits have been or are likely to be exceeded; and
•
regularly conduct stress tests to assess the liquidity risk of each AIF under their
management.
The AIFM must conduct an annual review of its liquidity management policies and
procedures and update them as necessary.
Action Point:
For AIFs investing in less liquid assets, AIFMs should consider prior to launch the
liquidity profile of the AIF, the appropriate redemption schedule and the use of liquidity
management tools to assist in managing redemptions (e.g. hard and soft locks/gates
etc).
Valuations (Article 19 of AIFMD; Articles
67-74 of the Regulations)
•
Likely to require a substantial reallocation of responsibility as between the AIF’s
service providers and its governing body.
•
AIFMs required to take responsibility for the proper valuation of AIF assets and
calculation of the NAV.
•
An external valuer may be appointed in which case the external valuer will be
liable to the AIFM for losses arising from its negligence or intentional failure.
•
Third parties may be unwilling to take on this responsibility meaning that the AIFM
will have to perform this function internally.
Conflicts of Interest
•
Current rules set out in SYSC 10.1.
•
The rules on conflicts contained in AIFMD are broadly similar but some points to
note:
– Potential conflicts must be considered in terms of investors in the AIF not just
in terms of the AIF itself.
– Conflicts policy needs to reference activities carried out by delegates, subdelegates, external valuers and counterparties, not just those of the AIFM
itself.
– A requirement for AIFM managing open-ended AIFs to identify, manage and
monitor for conflicts between redeeming and continuing investors and
conflicts between the AIFM’s incentive to invest in illiquid assets and the AIF’s
redemption policy.
– The AIFM must develop strategies for determining when and how to exercise
any voting rights held in the AIF portfolios it manages. This follows the
UCITS approach but is not contained in MiFID.
Delegation
AIFM level 1
Requirements for prudent delegation track UCITS
AIFM level 2
Quantitative/qualitative restrictions on delegation
MiFID 1
Outsourcing of critical or important functions
MiFID 2
Restrictions on permitted delegates (will catch delegation by AIFMs)
A firm may receive services at its own exclusive initiative (MiFID 2 recital 74, MiFIR article 36(4))
Otherwise, for retail client business (and professional client business?) (MiFID 2 article 41):
• the sub-manager must establish a branch in the EU (not just a representative office)
• the branch must be authorised by its EU state
• the sub-manager must be authorised in its 3rd country
• the 3rd country must meet equivalence and reciprocity requirements
• the authorised branch gets a MiFID passport (article 44)
Regulatory Capital
& Remuneration
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© 2013 Dechert LLP
Current Requirements
•
MiFID regime – FSA prudential categories
–
Hedge Fund Manager – BIPRU limited licence / 50K firm
–
Private Equity / Venture Capital (advisory only) – Exempt CAD firm
•
BIPRU limited licence / 50K firm – capital requirement highest of:
–
€50,000
–
Fixed Overheads Requirement (FOR) - 25% of annual fixed overheads
–
Sum of market risk and credit risk capital requirements
–
Individual Capital Adequacy Assessment Process (ICAAP)
•
Exempt CAD firm – capital requirement (at firm’s option) of:
–
€50,000; or
–
insurance (min €1 million each claim / €1.5 million all claims); or
–
combination of capital and insurance
(subject to £5,000 capital floor)
AIFMD Requirements
•
FSA’s proposed prudential categorisation of AIFMs
–
Collective Portfolio Management Firm (CPM firm) – IPRU(INV) Chapter 7
–
Collective Portfolio Management Investment Firm (CPMI firm) – GENPRU & BIPRU
•
Based on whether AIFM has extended “MiFID” permissions
–
CPM firm – collective portfolio management only
–
CPMI firm – collective portfolio management, PLUS additional permissions for any of:
•
client-by-client discretionary portfolio management (managed accounts)
•
investment advice
•
reception and transmission of orders (not available for UCITS investment firm)
•
custody of CIS units
AIFMD Requirements - 2
CPM firm – AIFMD requirements only
•
capital requirement is higher of:
–
€125,000, plus 0.02% of AUM over €250 million (subject to €10 million cap)
–
Fixed Overheads Requirement (FOR) – 25% of annual fixed overheads
•
Plus: additional own funds OR professional indemnity insurance
•
Plus: liquid assets requirement
CPMI firm – AIFMD requirements + CAD
•
capital requirement is higher of:
–
CPM capital requirement (as above)
–
BIPRU limited licence firm capital requirements
Additional Own Funds / PI Cover
•
To cover Professional Liability Risks – defined in Level 2 Regulation as:
–
•
“risks of loss or damage caused by a relevant person through the negligent performance of activities
for which the AIFM has legal responsibility”
Alternative 1 – Additional Own Funds
–
must be at least 0.01% of the value of AIF portfolios under management
–
limited home state discretion to reduce to 0.008% (but FCA not expected to exercise)
•
Alternative 2 – PI Cover
–
Required terms:
•
must cover “Professional Liability Risks” defined in Level 2 Regulation
•
coverage limits of at least:
each claim: 0.7% of the value of the AIF portfolios under management
all claims: 0.9% of the value of the AIF portfolios under management
•
initial term at least 1 year
•
cancellation notice at least 90 days
–
Any agreed excess – fully covered by additional own funds
–
Policy exclusions – FSA expects to be covered by adequate own funds
AIFMD Liquid Assets Requirement
AIFM own funds and any additional own funds must be:
•
“invested in liquid assets or assets readily convertible into cash in the short term
and shall not include speculative positions”
•
per FSA, “readily convertible into cash” means capable of being realised for
cash within 1 month
•
Does not apply to €125,000 base requirement
MiFID firms – CRD IV proposals
•
Directive and Regulation not final – implementation delayed
–
was due 1 Jan 2013
–
now 1 Jan 2014?
•
CAD investment firms – BIPRU Limited License / 50K firms
–
Base capital requirement remains €50,000
–
New calculation basis for variable capital requirement
•
New requirements based on Total Risk Exposure Amount
–
For BIPRU limited licence category, calculated as higher of:
•
sum of credit risk capital and market risk capital requirements
•
12.5 x 25% of fixed annual expenditure
CRD IV proposals - 2
•
Three new requirements (% of total risk exposure amount):
–
Common Equity Tier 1 capital ratio:
4.5%
–
Tier 1 capital ratio:
6%
–
Total capital ratio:
8%
(Common Equity Tier 1 and Tier 1 rates phased in over 1st, 2nd and 3rd years)
•
Plus, as Common Equity Tier 1 capital (phased in over 4th, 5th & 6th years):
–
Capital Conservation Buffer – additional 2.5% of total risk exposure amount
–
Countercyclical Capital Buffer ? – between 0% to 2.5% of total risk exposure amount
–
Possible exemption for SME investment firms
•
Once phased in, potential increase in regulatory capital requirements
–
Min total capital requirement = 10.5% ratio = 32.8% of annual fixed overheads
Remuneration
•
AIFMD requirements similar to CRD III (current FSA Rem Code)
–
•
BUT limited basis to apply proportionality
Possible new AIFMD requirements for MiFID firms currently in
Proportionality Level 3
–
To pay at least 50% of variable remuneration in units / shares of AIFs managed or
equivalent non-cash (subject to AIF legal structure)
•
but not if AIFs represent less than 50% of portfolios managed by the firm
–
To defer at least 40% of variable remuneration (or 60%, for very high remuneration) for
at least 3 to 5 years (unless AIF life cycle shorter)
–
To adjust variable remuneration to reflect the financial situation of the AIFM and the
performance of the business unit, the AIF and the individual concerned
–
To set an appropriate balance between fixed and variable remuneration
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