AIFMD

The aim of AIFMD is to provide greater market integration of AIFs and tackle potential risks to the broader financial markets whilst maintaining investor protection. Core objectives of the AIFMD include limiting systemic risk and ensuring appropriate risk management of asset managers, providing a common understanding for authorisation and supervision of asset managers, as well as creating a market for AIFs. It is important to note that this Directive is not intended to regulate AIFs, but the Managers of AIFs.

Like UCITs the AIFM must appoint a depositary for each AIF it manages to be responsible for custody and record keeping of the AIFs assets. The depositary must be located in the AIFs home member state, and it may, with objective reasons, delegate its safekeeping function and discharge its liability for loss of financial instruments. This permits prime brokers to act as the sub-custodian of the depositary, provided that they have functionally and hierarchically separated their depositary functions from their prime broker activities. A non-EU AIF’s depositary must be located in the country where the AIF is located or in the home member state of the AIFM managing the AIF.  If justified, the AIFM may also delegate it portfolio management and/or risk management functions to regulated entities, but it cannot delegate to the extent it becomes a mere letter-box entity.

Whilst there are no prescribed investment criteria, the AIFM must disclose to investors the details of its investment strategy, risk characteristics, liquidity and risk management systems, fees and charges, and any delegations, as well as any assets subject to special arrangements due to illiquidity.

The AIFM is responsible for the valuation of the fund’s assets and is required to set reasonable leverage limits for each AIF. The AIFM must have remuneration policies and practices which do not encourage risk taking inconsistent with the risk profile of the AIF, hold sufficient capital based on assets under management, and own funds to cover liability risks.

AIFMD II introduces a new loan originating activity and regime for Loan Originating Funds (LOFs), i.e. funds whose main investment strategy is to lend and has issued loans (directly or indirectly through an SPV) representing 50% or more of its NAV. Loans to financial undertakings, other AIFs or UCITS are limited to 20% of the AIFs capital. An open-ended LOF can leverage up to 300% and a close-ended LOF to 175%. These limits do not apply to shareholder loans where notional value of the loans is below 150% of the fund’s capital.

Under AIFMD II an AIFM of an open-ended fund must select at least 2 suitable liquidity management tools to counter redemption pressure with detailed policies about their use. To counter lack of depositaries in some member states, an AIFM may select a depositary in another member state. In addition to loan origination, AIFMs can offer permitted activities comprising servicing securitisation special purpose entities, benchmark administration, credit servicing, and other non-core services.

The AIFMs leverage calculation is not limited to borrowing and includes a wide range of exposures including repo and securities lending agreements and derivatives.

AIFMs must report on the jurisdictions of the three main fund sources (excluding shares of the AIF bought by investors) as well as on the aggregate amount of borrowing and cash financing. They should also include all liquidity that is made available to the AIF, including the cash received for securities lending transactions. Collateral, which is transferred to a lender to protect them in the event of default is used in order to reduce counterparty risk that arises from efficient portfolio management techniques, including securities lending. ISLA have been working with Tri-party Agents (TPAs) to respond to the recent public consultation on the review of AIFMD, and issues that arise from various industry models when addressing the flow of information and reconciliation of books of records between TPAs and Depositories.

In addition, Article 13 of the Securities Financing Transactions (SFTR) requires AIFMs to provide information to investors on the use made of SFTs, in the annual report of each AIF under management.

ISLA monitors developments in AIFMD through its Regulation and Market Practice group and reports on any proposals which may impact securities lending and borrowing markets.