Styperson POPE

Strategy & Compliance for Investment Firms


The Small Registered UK AIFM Regime for Property Funds

It sounds like another exciting one doesn’t it!  Actually, it’s very useful and still surprisingly unknown.

BACKGROUND

When the European Union introduced the Alternative Investment Fund Managers Directive (“AIFMD”), it brought UK fund managers (”AIFMs”) within the scope of European law… all except for “small” ones.  Small AIFMs are still within the scope of domestic law and the UK took the opportunity presented by AIFMD shake up to introduce a new, lighter-touch, regime for small AIFMs running property funds.

There are various types of small AIFM for funds of different structures investing in different asset classes but our focus here is only on property funds.  In order for an AIFM to access the lighter-touch regime, various conditions apply:

  • Value of funds under management (i.e. what counts as “small”?);
  • Fund structure;
  • Assets (i.e. what counts as “property”?); and
  • Appointment of an FCA Authorised Operator.

FUNDS UNDER MANAGEMENT

So what counts as a “small” AIFM? There are two thresholds, depending on whether any of the funds being managed by the AIFM contain any debt (leverage / borrowing / gearing—choose your preferred term!).  If any of the funds managed by the AIFM contain debt, the threshold is €100m (note Euros, not GBP) of gross assets under management but if none of their funds contain debt, the threshold is €500m.  That seems counterintuitive but makes sense when you consider that the intention is to push riskier fund managers (i.e. those who use debt to leverage their investors’ returns) into the full scope of European Law.  Note that I’ve said “if ANY of the funds contain debt”.  This threshold isn’t applied at the level of the fund but at the level of the manager and £1 of debt in any of their funds means the lower level threshold  applies to their total assets under management.  

FUND STRUCTURE

This regime only applies to managers of Unregulated Collective Investment Schemes.  Without going into the painful detail of this, it essentially means the fund must be structured as a Limited Partnership, LLP or Trust and it rules out funds structured as a limited company (external fund managers of funds structured as investment companies can’t access the lighter-touch regime and these AIFMs must be FCA authorised).  The good news is that because Limited Partnerships, LLPs and Trusts are all tax-transparent, they’re the preferred vehicle for most property investment in the UK.

ASSETS

The fund can only own property (or shares in a company through which it owns property) and certain types of property-related assets like insurance.  It can of course hold cash but must have invested most of it within the first six months and must distribute or reinvest it after selling the property so that the majority of the fund’s value remains in property.

Because the fund can’t own units in a collective investment scheme, the previous structure permitting SIPP investment (an Exempt Property Unit Trust over a Limited Partnership) no longer works but an alternative, slightly more complicated but still very usable, structure exists.

FCA AUTHORISED OPERATOR

The final requirement is that the AIFM must appoint an FCA Authorised Operator to establish, operate and wind up the funds it manages.  We’d be more than happy to introduce you to some Operators if needed.

BECOMING A SMALL REGISTERED UK AIFM

If all the above conditions are met and as long as the management are reputable, the AIFM can “register” with the FCA which is a much lighter-touch, quicker and cheaper process than becoming “authorised” by the FCA.

Once registered with the FCA (which can take up to three months), the fund manager can carry on regulated activities directly related to the management of its funds.  This includes the promotion and management of the fund; do note however that restrictions still apply to these activities, it’s not an unfettered licence, just a lighter touch regime!


Brexit & the UK AIFM

BREXIT: NOTHING EVER CHANGES BUT THE DATE
I was surprised to see, looking back, that I wrote my first Brexit regulatory analysis for a UK fund manager a full four months before the referendum. It considered two scenarios: 1) some deal covering financial services (be that no Brexit, Single Market membership, joining the EEA, or a Free Trade Agreement covering services—all of which seemed unlikely); or 2) a “Hard Brexit”. The rest was just timing. And nothing has changed since.

Now however, we find ourselves so much closer to the date on which the UK is due to leave the EU and, with not much more to go on than we had two and half years ago, every Board meeting I attend is taken up with speculation and discussion about where we’ll be in six months, two years, three years, five years.

So, what can we say?

AIFMD: ALL PAIN, NO GAIN
On the day we leave the EU the current law, derived from Directives and Regulations, will all be preserved in UK law. AIFMD will still govern UK fund managers who will need to comply with all its detailed requirements, including the need to retain a Depositary. However, UK AIFMs will lose the right to passport their management, and market their funds, into other EEA jurisdictions. These rights may be extended from 29 March 2019 to 31 December 2020 if a transitional deal can be agreed but if it’s a ‘no deal’ Brexit, the rights will be lost within months.

But if the EU marketing passports can’t be used, there are two other options, right? We can apply for ‘Third Country’ access to the passporting regime or we can market under the National Private Placement Regimes. Right? Right?!

Well… maybe… and probably not straight away.

THIRD COUNTRY PASSPORTS
Third Country access requires that we have an ‘equivalent regime’ (surely nobody can deny that) but it also requires that ESMA assess us (a process which has not yet started) and that the EU Commission accept ESMA’s advice to turn on the passports for us. It’s this third part which presents the biggest stumbling block. Given that the EU Commission have, for two years, declined to accept ESMA’s advice to turn on the passports for Canada, Guernsey, Japan, Jersey and Switzerland, it seems unlikely that they’ll bend over backwards to accommodate the UK, least of all amid what they will no doubt see as the frustrating recalcitrance of a no deal Brexit.

NATIONAL PRIVATE PLACEMENT REGIMES
So there’s always the NPPRs, patchy and complex as they may be. Well, there may not even be those. The NPPRs rely on a cooperation agreement existing between the relevant EU Member State and the Third Country but while we’re in the EU we don’t need these, so we don’t have them. And there doesn’t seem to be much of a rush among the 27 EU regulators to put them in place. It’s almost like Germany doesn’t see the benefit of letting all their pension funds and insurance companies put their money into the UK instead of, say, Germany.

So what do we do?

THERE ARE OPTIONS
Given that it’s (probably) too late to set up a second AIFM in the EU and, in any case, the combination of having to provide substance and shifting senior staff around is unattractive, it’s probably best to keep the principal activity in the UK and move from being an AIFM to being an Investment Adviser, at least until the dust has settled. This means buying in the services of an AIFM based outside the UK. While such AIFM platforms in the EU (typically Luxembourg and Dublin) have ready access to the marketing passports, it may also be worth considering working with a provider in a non-EU jurisdiction such as the Channel Islands which can then market into the EU under the established NPPRs. This is trade off between access and costs and will depend on which countries the fund is to be marketed into.

For some of our clients the regulatory aspects of Brexit just aren’t a big deal—usually because they are not using their passports (or can’t because they’re a Small AIFM) and they have no plans to. They’re definitely the lucky few!

AND WHAT ABOUT THE LONG TERM?
Well, my personal hope is that the UK will, over time, consider introducing a lighter-touch regime for AIFMs of funds which will never be marketed in the EU. We already have plenty of funds with UK assets, marketed only to UK investors. We could maintain an equivalent regime for anyone wanting to access the (eventual) Third Country passport and develop a lighter touch which would avoid, even large AIFMs needing to comply with the valuation, depositary and other onerous requirements of AIFMD. The big advantage would be a more cost-effective, and therefore competitive, funds environment in the UK

But don’t hold your breath! The Treasury may have a few other things on their post-Brexit plate ahead of deregulation for fund managers.


The Role of a Depositary under AIFMD

The Alternative Investment Fund Managers Directive (AIFMD) is due to be transposed into law on 22 July 2013 and while some Alternative Investment Fund Managers (AIFMs) will want to make use of the transitional year to avoid implementing changes straight away, others (for instance those marketing outside the UK) will want to comply from day one.  And on day one, they’ll need a Depositary.

The UK implementation of AIFMD allows for two types of Depositary (ignoring for the moment the ‘Depositary Lite’ model used  for non-EU AIFs).  These are the full blown Depositaries, the market for which is likely to be served by the established custodian banks, and the Private Equity AIF Depositary which is (albeit slowly) attracting some new entrants to the market.

Some prospective PE AIF Depositaries, generally existing, regulated fund administrators and third-party operators, are starting to put their head above the parapet and talk about their proposed services (and a little more reticently, their proposed pricing) but what does the Depositary role entail?

Cash Flow Monitoring
The Depositary is required to monitor all significant cash flows and quickly identify any that are inconsistent with the usual operations of the fund.  They must also reconcile all cash flows on a daily basis, although they may do so less frequently where cash movements are infrequent.

Subscriptions
The Depositary will receive information about subscription payments the same day they are received by the fund, the AIFM or a transfer agent.  The Depositary is then responsible for ensuring that the payments are booked into accounts in the name of the fund, the AIFM or the Depositary.

Safekeeping (Verification and Record Keeping)
Other rules apply where a Depositary is holding custodial assets but for non-custodial assets (such as real estate) the Depositary must verify the ownership of the assets and keep appropriate records.  What will create more complexity is the Depositary’s duty to ensure procedures are in place which prevent the assets being assigned, transferred, exchanged or delivered without the Depositary being informed, particularly as the Depositary’s responsibilities are on a ‘look through’ basis which limits the extent that these controls can be put in place in respect of structuring vehicles only.

AIFM Risk & Process Oversight
The most widely ranging responsibility of the Depositary, and the one which will require the most expertise and thought, is the duty to assess the risks of the fund’s strategy and the AIFM’s organisation and implement ongoing controls and verifications of the AIFM’s processes and procedures.

AIFM Instructions
The oversight functions of the Depositary extend to verifying the instructions of the AIFM to ensure compliance with the fund’s rules, offering documents and applicable law.

Valuation
The Depositary is required to ensure that procedures are in place for the valuation of the fund’s assets and that these are implemented effectively on an ongoing basis and reviewed periodically.

Distributions
The Depositary must ensure that the fund’s net income is handled in accordance with its rules, including ensuring that auditors’ reserves are taken into account and that any distributions are correctly made.

Many of these processes will be familiar to (better or more risk averse) regulated fund administrators and third-party operatorsSTYPERSON POPE has assisted a number of these firms to create and implement operational procedures, ensure appropriate governance, and identify and manage the risks involved in providing these services.