timberland outlets Delegation of Investment Management Under the AIFMD
The delegation model of fund management, whereby self managed investment vehicles or their management companies appoint third party investment managers and advisers, has been a key basis upon which the success of the funds industry in Ireland has been built. There are currently in excess of 5,000 Irish domiciled funds and sub funds, with assets in excess of 1 trillion euro, which have been established by over 400 fund promoters based in over 50 countries. An incredible 98% of these promoters are based outside Ireland and in most cases investment management services will be provided from the promoter home jurisdiction, clearly showing the attraction of Irish domiciled vehicles and the delegation model for international fund managers.
The finalised text of the level 2 measures (Level 2) to the Alternative Investment Fund Managers Directive, (Directive 2011/61/EU) (AIFMD), approved and published by the European Commission (Commission) on 19 December, 2012, details the specific conditions to be applicable where investment management functions are to be delegated or sub delegated under this legislation. This article explores the specific requirements contained in this finalised text relating to delegation and highlights the legal documentation which will be required to ensure compliance.
The European Commission (Commission) first published a proposal for a directive regulating alternative investment fund managers (AIFMs) at a European level in April 2009 in the wake of the global financial crisis. Fundamental aims of this proposed directive were stated to be to assist in securing investor protection and to limit the potential for alternative products to pose a systematic risk to financial systems. Following numerous counter proposals and amendments, a draft directive was ultimately agreed in October 2010. This directive, which regulates alternative managers, proposed a potential new European assportfor compliant alternative funds similar to the highly successful one currently afforded to UCITS. Accordingly it is expected to lead to a significant boost for the alternative funds industry within Europe once this becomes operational from mid 2013.
The AIFMD does note in its preamble1that depending on their legal form, it should be possible for alternative investment funds falling under the directive (AIFs) to be either externally or internally managed and that AIFs that do not appoint an external AIFM will themselves constitute the AIFM. AIFs structured as self managed investment companies, for example, will typically fall into this category. The AIFMD does specifically address the right of AIFMs to delegate their functions, subject to applicable conditions2. However, the AIFMD was prepared as a principle based framework document under the amfalussy Processand accordingly, following its implementation, much of the fine detail remained to be determined as evel 2measures. The Commission then produced draft finalised text in light of this for Level 2 in 2012.
The initial draft wording for the Level 2 measures circulated by the Commission in 2012, disregarded the advice of ESMA in key respects, including in relation to delegation, and raised concerns that this legislation might jeopardise Ireland position as the leading European domicile for AIFs due to the constraints imposed in this regard. However, the finalised text contained in a regulation approved by the Commission on 19 December 2012 (Regulation) clarifies that delegation will continue to be acceptable under this legislation in practice and sets out the relevant applicable requirements in greater detail.
Overview of Delegation under the AIFMD
Delegation of investment management was provided for in the AIFMD itself3 and this general concept is addressed and expanded upon in Section 8 of the Regulation4. This section addresses the topic under a number of headings, including general principles, reasons for the delegation, the nature of the delegate, potential conflicts of interest and the effective supervision of the delegate. Delegation arrangements must be documented in written agreements between the AIFM and the delegate and there are significant requirements relating to the specific contents of such agreements5 including obligations to set out in the agreement:
the respective rights and obligations of the parties, including rights of information, inspection, admittance and access for the AIFM and its instruction and monitoring rights with regard to the delegate in order to ensure effective supervision;
terms requiring the delegate to properly supervise the performance of the delegated functions and adequately manage associated risks internally;
instruction and termination rights, including a requirement that sub delegation can take place only with the consent of the AIFM;
a requirement on the delegate to disclose to the AIFM any development that may have a material impact on the delegate’s ability to carry out the delegated functions effectively and in compliance with applicable laws and regulatory requirements;
an obligation to protect any confidential information relating to the AIFM, the relevant AIF itself and the investors in that AIF; and
a requirement to ensure that the delegate establishes, implements and maintains an appropriate contingency plan for disaster recovery and periodic testing of backup facilities. investment management agreements, will need to be reviewed and may need to be revised to ensure all of these requirements are addressed where the relevant fund structure falls under the terms of the AIFMD. In addition to specific requirements, such as those above, required to be included in the actual delegation contract itself, a series of on going obligations are also imposed on the AIFM by the applicable general principles. It is likely that these will be addressed and documented separately in a procedures manual or business plan of the AIFM. Examples of these obligations include6:
establishing methods and procedures for reviewing on an on going basis the services provided by delegates to ensure that they carry out the delegated functions effectively and in compliance with applicable law and regulatory requirements to an appropriate quality standard;
setting out the appropriate action to be taken if it appears that the delegate cannot carry out the functions effectively or in compliance with applicable laws and regulatory requirements;
ensuring that the AIFM has the necessary expertise and resources to supervise the delegated functions and in fact effectively supervises the delegated functions and manages the risks associated with the delegation; and
instructing the delegate regarding implementation of the investment policy of the AIF and monitoring compliance on an on going basis.
Many investment managers will already have some form of internal procedures and policy manuals which can be adapted to specifically address these requirements. Otherwise, and for self managed corporate structures in particular, the form of usiness plancurrently required for UCITS may constitute a useful basis upon which to base such a document.
Delegation of portfolio or risk management
At present, the decision to delegate investment functions is entirely one at the discretion of management. Examples of reasons which would be acceptable for this purpose are included in the Regulation8 and these include: (a) cost savings; (b) expertise of the delegate in specific markets or investments; or (c) access of the delegate to global trading capabilities.
Delegates are required to have sufficient resources and to employ sufficient personnel with the skills, knowledge and expertise necessary (including appropriate training and previous experience) for the proper discharge of the tasks delegated. Personnel of the delegate are also required to be of sufficiently good repute and examples of the research to be undertaken to confirm such matters are detailed, for example specific attention is required to be paid to any previous convictions for dishonesty or fraud9. The requirements in this regard are broadly similar to those currently applicable under the itness and probityregime of the Central Bank of Ireland (Central Bank) and therefore this can essentially be regarded as applying concepts similar to those that apply to, for example, directors of Irish regulated funds, to delegates.