The ability to adapt to the ever-changing regulatory landscape will be crucial to the success of any first time hedge fund manager.
Regulatory compliance and, in particular, compliance with the EU’s Alternative Investment Fund Managers Directive (AIFMD or the directive) will be a key consideration for UK-based start-ups.
AIFMD affects both how a hedge fund is managed and how it is marketed. Some of the issues which may affect the manager (and with which MJ Hudson can assist) are set out below.
All UK-based hedge fund managers will be subject to AIFMD to a greater or lesser extent, although its precise application depends on a variety of factors including the manager’s aggregate assets under management (AUM), where the fund vehicle is established and to whom it is marketed.
The directive has only a very limited application to managers whose total AUM does not exceed €500m where none of the manager’s funds are leveraged or €100m where leverage is employed. Such managers are commonly referred to as ‘sub-threshold’ AIFMs. Managers which are not sub-threshold AIFMs are known as ‘full-scope’ AIFMs.
Full-scope UK AIFMs must be authorised by the FCA and (and in general) must comply with AIFMD in full. This includes obligations in relation to regulatory capital, conduct of business, remuneration, disclosure and transparency and the appointment of a depositary (although the depositary and disclosure/transparency requirements may be relaxed in certain circumstances).
Compliance with the full-scope regime can be costly and burdensome. On the other hand, where the fund in question is established in the EU, it permits full-scope managers access to the AIFMD ‘passport’, allowing them to provide management or marketing services across the EEA subject to compliance with the harmonised rules set out in the directive (as opposed to member states’ own rules – see below).
Start-up hedge fund managers in the UK will typically opt into the sub-threshold regime as a ‘small authorised UK AIFM’.
As the name suggests, small-authorised UK AIFMs are regulated by the FCA and are subject to its rules. From an AIFMD perspective, however, they need only comply with very limited reporting requirements. Accordingly, falling within the small authorised AIFM regime will significantly lower compliance costs both for the manager and for the fund.
On the other hand, unlike full-scope UK AIFMs, small authorised AIFMs will not have access to the passport. This means that a start-up manager’s ability to market to European investors (other than in the UK) will be subject to the prevailing private placement rules (if any) in the jurisdictions in which any target investors are situated.
AIFMD allows individual member states the discretion to permit private placement subject to the fulfilment of certain generally applicable criteria. However, a number of jurisdictions have gone beyond (or gold-plated) what was envisaged in the directive, only allowing private placement subject to specific (often onerous) local rules. Others have taken the opportunity to ban the practice altogether. Moreover, the application of national private placement regimes to sub-threshold AIFMs in certain jurisdictions remains unclear.
For start-up managers looking to avail themselves of the benefits of the marketing passport, but for whom the burden of full-scope compliance may (at least initially) be a challenge, help could be at hand in the form of a regulatory ‘host’.
Here, the start-up manager would appoint a host (a specialist third party undertaking authorised in the EEA as a full-scope AIFM) as AIFM of its fund with overall management responsibility for AIFMD purposes.
Under a typical hosting arrangement, the host would perform risk management and other administrative and compliance functions, delegating portfolio management activities back to the start-up manager. This has the advantage of allowing the manager to focus its resources on what it does best – managing money – without the distraction of regulatory compliance.
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