Unraveling EU Regulation

June 2014

Ben Blackett-Ord

Richard Cross

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Agenda

• Overview of EU regulatory structure

• AIFMD

• EMIR

• MiFID II

• Questions

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Overview of the EU regulatory structure

The European Union

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EU Regulatory Structure

• Directives – implemented in each EU Member State through domestic

legislation

• Regulations – directly applicable in each Member State and thus apply

to firms directly

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European

Commission

European Parliament Represents citizens

European Council Represents national

governments

Proposes

legislation

Co-decision

European System of Financial Supervision

(ESFS)

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European Banking

Authority (EBA)

European Insurance

and Occupational

Pensions Authority

(EIOPA)

European Security

and Markets

Authority (ESMA)

National supervisors in Member States (PRA / FCA in the UK)

Joint Ctee of European

Supervisory Authorities

European Systemic Risk

Board (ESRB)

EU regulation in the UK

UK regulators

• PRA – 2,500 banks and insurers

• FCA – 28,000 firms, including the above

The role of the FCA / PRA in relation to Directives and Regulations is to:

• implement directives

• provide guidance

• supervise and monitor compliance with the Directives / Regulations

• report on compliance to the European Commission and/or ESAs as

required

• take enforcement action where appropriate

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Alternative Investment Fund Managers

Directive (AIFMD)

Introducing AIFMD

• Seeks to control:

- management of “alternative investment funds” in the EU;

- management of AIFs from the EU;

- marketing of AIFs in the EU

• AIF – means a collective investment undertaking, including

investment compartments of such an undertaking, which raises

capital from a number of investors, with a view to investing it in

accordance with a defined investment policy for the benefit of

these investors; and does not require authorisation pursuant to

Article 5 of the UCITS Directive.

Included: hedge funds, private equity, real estate funds

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Who’s affected by AIFMD

• Anyone who manages an AIF based in the EU

• Anyone in the EU who manages an AIF based outside the EU

• Anyone who markets an AIF in the EU

Knock-on effects on related parties – delegates, service providers,

placement agents, etc.

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Transitional relief is coming to an end

• AIFMD came into effect on July 22 2013

• Most member states took advantage of ‘transitional relief’

Transitional relief expires July 22 2014

Establishing how you're affected

Thresholds for inclusion in AIFMD:

• total managed AIF assets (including those acquired through

use of leverage) is less than or equal to €100m

or

• total assets are under €500m if all the AIFs managed are

unleveraged and have no redemption rights for the first

five years

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Calculating AuM

• Undrawn commitments are not counted in the AUM.

• There are some provisions which allow certain AIFs to be

excluded from the calculation of an AIFM’s AUM:

• If an AIF is closed-ended and makes no additional

investments after July 22, 2013

• If a closed-end AIF had its final closing by July 21, 2011 and

will terminate in accordance with its constitution

by July 22, 2016.

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Different AIFMs

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EU AIFMs Third-Country AIFMs (e.g.

US managers)

Below-threshold • Sub-threshold AIFM

• Not subject to AIFMD

• No marketing passport

• Market under NPPR if EU

member state permits

• Small Third-Country AIFM

• No marketing passport

• Market under NPPR

• Notification to EU member

state in order to market

under NPPR

Above-threshold • Full-Scope AIFM

• EU-wide marketing

passport for EU AIFs

• Subject to full AIFMD

• No marketing passport

• Market under NPPR

• Subject to transparency

and disclosure

requirements of AIFMD

• Annex IV reporting

• Private Equity provisions

AIFMD and Marketing

“a direct or indirect offering or placement at the initiative of the AIFM or on

behalf of the AIFM of units or shares of an AIF it manages to or with

investors domiciled or with a registered office in the EU”

• does not include reverse solicitation or passive marketing

• does not include marketing using draft documentation

• includes controls on intermediary marketing

EU-wide marketing passport available to EU full-scope AIFMs for

marketing to “professional” investors.

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Marketing in EU by US Managers

• Up to EU Member State concerned to allow marketing from US manager

• Currently permissible in the UK

(NB – additional requirements imposed by AIFMD implementation)

Small US AIFMs – simple notification to UK FCA

Above threshold US AIFMs:

• “Transparency and disclosure” requirements for each fund:

• annual report contents (some remuneration disclosure)

• investor disclosure

• notification and reporting to EU regulators

• ‘private equity’ provisions where relevant

• Co-operation agreements between the regulators of countries

• in which the fund is to be marketed

• where the manager is established

• where the fund is established

• The US manager and the fund must not be based in FATF non-cooperative

countries or territories

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EU Member states – categorisation

Straightforward

• UK

• Ireland

• Luxembourg

• Finland

• Sweden

• Netherlands

More demanding (Goldplating)

• Germany

Difficult / Uncertain

• The rest ….

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Marketing and US Managers – Disclosure Reporting

• Information about US managers and their funds to be disclosed to both

their investors and to European regulators.

• Annual report which must be provided to investors. Must contain

total of remuneration paid to staff and details of the management fees of

the fund.

• Before investors come into the fund the US manager must make specific

information available to them regarding both fees and special

arrangements in place with other investors.

• Regular reporting to the regulator in the EU country where the fund is

marketed (most likely the FCA in the UK). The reporting template is quite

similar to Form PF in the US (eg. type of asset held, exposure, leverage

etc).

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Private Equity Provisions

• US managers of funds which acquire control of listed and unlisted

companies in the EEA will, subject to certain exceptions, be required to

comply with AIFMD provisions specific to private equity, including:

• A requirement to notify the company, shareholders and regulators of

acquisitions of major holdings in unlisted companies when

certain thresholds are passed (starting at 10%).

• A requirement to include additional information in the annual

report (including future development plans).

• The so-called “asset stripping” provisions which restrict dividend

recapitalisations and other returns of capital for the first two years of

portfolio company ownership.

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“Asset stripping” provisions

• Application of “asset stripping” provisions to US AIFMs marketing in

Europe.

• AIFMD imposes restrictions on distributions, capital reductions,

share redemptions and purchases of own shares by a “controlled”

portfolio company during the first two years of ownership of that

company by a fund.

• The restriction affects only portfolio companies who have a registered

office in the EU and that are not “small and medium enterprises”.

• Whether a portfolio company is “controlled” for these purposes

depends on whether it is unlisted or listed. An unlisted company is

generally “controlled” if the AIF holds more than 50% of voting rights.

The test for when a listed company is controlled varies from member

state to member state.

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Marketing Passport for US Managers

• Planned for 2015/16

• Manager must be authorised by their “Member State of reference” and

have a “legal representative” there

• Certain co-operation agreements and tax exchange information

agreements must be in place

• Must comply with all Directive requirements except where:

- it would conflict with the law applying to the manager or the fund to do

so; and

- those laws provides an “equivalent rule having the same regulatory

purpose and offering the same level of protection to the investors”

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Full scope requirements

For a full scope EU manager of an EU fund:

• general organisational requirements

• capital requirements

• conflicts of interest controls

• risk management controls

• due diligence requirements

• depositary

• leverage limits

• liquidity management systems

• delegation controls

• investor disclosure requirements

• regulatory reporting requirements (equivalent for Form PF)

• remuneration controls

• ‘private equity’ requirements.

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AIFMD Summary Time Line

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Date Event

July 2013 • AIFMD implemented in Member States • Marketing via NPPR

July 2014 • End of transitional period (most member states) • Marketing via NPPR plus Directive minimum disclosure / reg • Marketing passport available for EU AIFMs

July 2015 • ESMA issues opinion on whether to extend passport to third countries

October 2015

• Marketing passport available for non-EU AIFMs via member state of reference mechanism

July 2017 • EC starts a review of AIFMD

October 2018

• ESMA issues opinion on third party marketing passport

Jan 2019 • Potential switch off of NPPR

AIFMD and US Managers: a summary

• Are you above or below thresholds?

• If a small third country AIFM, fairly simple but still need to:

• notify FCA (or other EEA regulator) of marketing;

• comply with national private placement regime; and

• complete minimal reporting

• If above threshold (some refer to as Article 42 AIFM), you will need to:

• Register marketing with FCA (or other EEA regulator)

• Check whether you need to create/update documentation to comply

with transparency and disclosure requirements

• Look at reporting requirements and find solution.

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European Market Infrastructure Regulation

(EMIR)

EMIR

• EU Regulation - came into effect August 2012.

• Three key requirements on those trading derivatives:

• To clear derivatives that are subject to the clearing obligation

through a central counterparty

• To implement risk mitigation measures for OTC transactions

that are not cleared

• To report derivatives trades to a trade repository.

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The clearing obligation

• Obligations depend of categorisation of counterparties as

“financial” or “non-financial”.

• Obligations in respect of non-financial counterparties are subject

to volumes “clearing threshold”.

• CCPs become “the buyer to every seller” and “the seller to every

buyer”.

• Applies to all derivative contracts not executed on a regulated

market under MiFID or on a non-EU exchange declared as

“equivalent” by the Commission.

• Currently 8 CCPs approved by ESMA.

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The risk mitigation obligation

• Applies to trades not cleared by a CCP

• Parties must ensure “appropriate procedures and arrangements

are in place to measure, monitor and mitigate operational risk

and counterparty credit risk”. Must include:

• Timely confirmation of terms of the transaction; and

• Formalised processes to reconcile portfolios, manage risk,

identify and resolve disputes and monitor the value of

outstanding contracts.

• ISDA 2013 EMIR Portfolio Reconciliation, Dispute Resolution and

Disclosure Protocol

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The reporting obligation

• Applies to all counterparties (including NFCs and CCPs) and to

all derivative contracts (whether or not centrally cleared).

• Reporting is to trade repositories (6 currently approved)

• Derivatives entered into before 16th August 2012 and remain

outstanding at that date

• Entered into on or after 16th August 2012

• EMIR Reporting Delegation Agreement.

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Extraterritoriality

• The clearing obligation and the risk mitigation obligation apply to

transactions between two third country entities, which would be

subject to the obligations if established in the EU, if either of the

following apply:

• The contracts have direct, substantial and foreseeable effect

with in the EU; or

• Such obligations are necessary or appropriate to prevent the

evasion of the provisions of EMIR.

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EMIR: Direct, substantial and foreseeable effect (1)

1. Guaranteed by an EU financial counterparty

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EU Third Country

(Non-EU + Non-equivalent)

Financial Counterparty

Counterparty

Counterparty

Guarantee

Derivative

EMIR: Direct, substantial and foreseeable effect (2)

2. Entered into through EU branches of financial counterparties

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EU

Branch

Branch

Derivative

Third Country (Non-EU + Non-

equivalent)

“Quasi” Financial

Counterparty

“Quasi” Financial

Counterparty

EMIR – current issues

• Considerable teething issues arising from lack of Trade

Repositories

• Confusion over whether FX forwards are considered derivatives

under the MiFID definition; clarification sought from ESMA

• Impact of AIFMD registration on financial counterparty/non-

financial counterparty/third country status of fund counterparties.

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Markets in Financial Instruments Directive

II (MiFID II)

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MiFID II: main changes

• Review of MiFID – impact Europe-wide with knock-on effect

internationally

• Increased scrutiny over algorithmic trading together with more

detailed reporting

• Regulation of Organised Trading Facilities (OTFs) and new

permissions

• ESMA powers to impose commodity position limits

• Structured UCITS no longer to be ‘non-complex’ so will not be

able to be sold Execution Only

MiFID II: Third country firms

• A third country firm based and authorised in a third country

deemed equivalent, can perform investment activities or provide

investment services to ECPs and professional clients across

all EU Member States from their local jurisdiction once

registered with ESMA

• Alternative to ESMA registration, establish an EU branch to

perform investment activities or provide investment services to

ECPs and professional clients

• Member States may require establishment of a branch to access

retail clients and certain professional clients.

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The world is shrinking

• You no longer need a physical presence in the EU to be affected

by EU regulatory requirements

• Managing money for EU investors and undertaking derivative

transactions with EU counterparties are sufficient to trigger

EU regulatory obligations

• Looking on the bright side…

Questions

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