I know, it sounds fun, right? OK, this one’s a bit technical but I seem to have had this conversation a few times recently…
Since the introduction of AIFMD back in 2013, the EU-derived definition of a fund (or “AIF”) have had to map onto our similar but subtly different UK-derived definition of a collective investment scheme (“CIS”). So when is an AIFM required rather than (or, in one case, as well as) an Operator?
For this purpose, we’ll only consider Unregulated CIS (“UCIS”) so we’re excluding the bigger funds which are sold to the public and focusing instead on private fund structures.
‘Alternative Investment Funds’ are defined in the Alternative Investment Fund Managers Directive and there are a few limbs to that definition:
- They are “undertakings”—while some have argued that this excludes certain, unincorporated arrangements, the consensus seems to be it is a broad enough concept to capture pretty much any arrangements, incorporated or otherwise, and in writing or otherwise.
- They are “collective”—this means that the risk and reward are pooled among the participants.
- They are “managed”—meaning arrangements where all of the participants have ‘daily’ control are not AIFs but if that control is passed to a manager, which may be one of the other participants, it will be.
- They “raise capital”—this means that arrangements between a small number of individuals which don’t then raise capital from others are unlikely to be an AIF.
‘Unregulated Collective Investment Schemes’ are defined in the Financial Services & Markets Act 2000 and again, there are a few limbs to that definition (some of which will look a little familiar):
- They are “arrangements” for income or profit—so, pretty much the same as ‘undertakings’ from the AIF definition.
- They are “pooled”—so, pretty much the same as ‘collective’ in the AIF definition.
- They are “managed”—there’s a very subtle distinction between the UK concept of ‘day-to-day’ control as defined by case law and the EU’s definition of ‘daily’ control as defined by ESMA guidance but that’s too fine grained to worry about here!
So what’s the problem? Other than AIFs needing to “raise capital” they sound the same as UCIS? Ah, but then there are all the exemptions!
There are few exemptions to the definition of AIFs and they’re all pretty practical, these ensure that holding companies, companies with a general commercial purpose, central banks, securitisation SPVs and employee share schemes don’t get caught up in the definition, generally because there is other EU legislation covering these areas.
Thee exemptions to the definition of UCIS are much more numerous and have evolved over the years to address particular circumstances and market effects the Treasury wanted to influence. This means that some arrangements and structures which would otherwise be a UCIS are subject to an exemption. In the fund context, this includes:
- All bodies corporate—i.e. any limited company (meaning that unregulated UCIS are generally LPs, LLPs or Trusts); and
- EIS or SITR funds.
AIFs but not CIS
So, the main categories of investment structure which are AIFs but not UCIS are:
- Investment Companies;
- EIS funds; and
- SITR funds.
These all require an authorised (or, in some cases, registered) AIFM with the regulatory permission of Managing an AIF to run them, even though they didn’t need the services of an Operator prior to AIFMD.
UCIS but not AIFs
And the main categories of investment structure which are CIS but not AIFs are:
- UCIS which don’t raise capital; and
- “Grandfathered” AIFs (being fully invested prior to AIFMD coming in).
These all require the appointment of an authorised Operator with the regulatory permission of Operating, Establishing & Winding Up an Unregulated Collective Investment Scheme.
Both UCIS and AIFs
To keep it simple, the Treasury introduced a regulation to say that if a fund’s manager has the permission to Manage an AIF (i.e. they’re an AIFM) this covers all regulated activity relating to their management of an AIF. This means that where a fund is both an AIF and a UCIS, the AIFM doesn’t require a separate permission to act as an Operator.
Small UK Property Funds
There is also one structure which requires both an operator and an AIFM.
When the UK implemented AIFMD in 2013, the Treasury took the opportunity to make some consequential changes to the UK’s local regime for smaller managers to whom AIFMD doesn’t apply. This resulted in them creating the concept of a Small UK Registered AIFM. The ‘registration’ required is a lot less onerous than the full ‘authorisation’ process and so this is a lighter-touch regime designed to reduce barriers to entry for some smaller fund managers.
These funds include property funds structured as a UCIS, i.e. a UCIS which holds the majority of its assets (save for their first and last six months) as land and does not hold any shares derivatives, bonds, fund units (save for shares in a company owning the property). The definition of small is derived from AIFMD and is applied to the manager, not the fund; small means less than €500m or less than €100m where any fund under management uses debt.
The trade off for this lighter-touch regime is that the registered AIFM for such a fund must also appoint an authorised Operator. This is the only scenario which requires both an AIFM and an Operator.