Unraveling EU regulation for US Managers - Bovill New York Briefing


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Bovill - the UK financial services regulatory consultancy - held a breakfast seminar in New York for US investment managers and regulatory experts to 'unravel' EU regulation. For more information visit www.bovill.com.

Further information on the event is below:

Unraveling EU regulation for US Managers

Any financial services firm doing business in Europe needs a firm grasp of EU regulation.

Whether you are establishing an office in one country, marketing into several, or simply investing in a firm regulated in the UK, you will need to understand how EU-wide directives are translated into local rules.

Bovill – the London-based regulatory compliance experts – hosted a seminar in New York to give US firms an overview and update on European regulation.
The breakfast event covered:

The structure of the EU regulatory landscape – how EU directives are implemented by member states

The parallels and crossovers between EU and US regulation

The practical steps to consider, including a brief introduction to
- Alternative Investment Fund Manager Directive (AIFMD)
- European Markets Infrastructure Regulation (EMIR)
- Markets in Financial Instruments Directives (MiFID I & II)

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Unraveling EU regulation for US Managers - Bovill New York Briefing

  1. 1. Unraveling EU Regulation June 2014 Ben Blackett-Ord Richard Cross
  2. 2. 2 Agenda • Overview of EU regulatory structure • AIFMD • EMIR • MiFID II • Questions
  3. 3. 3 Overview of the EU regulatory structure
  4. 4. The European Union 4
  5. 5. 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 5 European Commission European Parliament Represents citizens European Council Represents national governments Proposes legislation Co-decision
  6. 6. European System of Financial Supervision (ESFS) 6 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)
  7. 7. 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 7
  8. 8. 8 Alternative Investment Fund Managers Directive (AIFMD)
  9. 9. 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 9
  10. 10. 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. 10
  11. 11. 11 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
  12. 12. 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 12
  13. 13. 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. 13
  14. 14. Different AIFMs 14 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
  15. 15. 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. 15
  16. 16. 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 16
  17. 17. EU Member states – categorisation Straightforward • UK • Ireland • Luxembourg • Finland • Sweden • Netherlands More demanding (Goldplating) • Germany Difficult / Uncertain • The rest …. 17
  18. 18. 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). 18
  19. 19. 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. 19
  20. 20. “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. 20
  21. 21. 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” 21
  22. 22. 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. 22
  23. 23. AIFMD Summary Time Line 23 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
  24. 24. 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. 24
  25. 25. 25 European Market Infrastructure Regulation (EMIR)
  26. 26. 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. 26
  27. 27. 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. 27
  28. 28. 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 28
  29. 29. 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. 29
  30. 30. 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. 30
  31. 31. EMIR: Direct, substantial and foreseeable effect (1) 1. Guaranteed by an EU financial counterparty 31 EU Third Country (Non-EU + Non- equivalent) Financial Counterparty Counterparty Counterparty Guarantee Derivative
  32. 32. EMIR: Direct, substantial and foreseeable effect (2) 2. Entered into through EU branches of financial counterparties 32 EU Branch Branch Derivative Third Country (Non-EU + Non- equivalent) “Quasi” Financial Counterparty “Quasi” Financial Counterparty
  33. 33. 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. 33
  34. 34. 34 Markets in Financial Instruments Directive II (MiFID II)
  35. 35. 35 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
  36. 36. 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. 36
  37. 37. 37 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…
  38. 38. Questions 38