A Score to Settle with the EU

How do we handle the AIFMD?

Two years ago, we lobbied vigorously and in vain against the proposed Alternative Investment Fund Managers Directive (AIFMD) of the European Union (EU), which was deliberately designed to punish U.S. hedge funds for exacerbating the global financial crisis.

At that time, Senator Charles Schumer of New York called the AIFMD “protectionist” and threatened to retaliate by proposing legislation prohibiting foreign funds from raising money in the U.S.

A few months later, the U.S. passed the Dodd-Frank Act, which requires foreign fund managers who raise more than $25 million in the U.S. to register with the SEC. Registration requires compliance with a plethora of policy, reporting and record-keeping requirements and exposes foreign fund managers to surprise SEC examinations. It is, however, exactly the same regulatory scheme as the one that applies to U.S. fund managers.

Despite Senator Schumer’s threat, and a warning from Treasury Secretary Timothy Geithner about the potentially adverse impact of the AIFMD on cross-border investment, the EU stuck to its guns and, in July of last year, adopted an AIFMD that will, by July of next year, effectively reduce U.S. private funds to second-class citizens in all 27 of its member states.

On July 22, 2013, burdensome new requirements will be grafted onto the EU’s private placement regimes on which U.S. hedge funds, venture capital funds, private equity funds and funds of funds have traditionally relied in raising capital from EU investors. In order for U.S. fund managers to continue to utilize these regimes after that date, cooperation agreements will have to be in effect between each of the member states where the U.S. funds are to be marketed and the jurisdictions where they were formed. U.S. fund managers will have to report regularly to EU authorities and include certain sensitive disclosures in their offering documents (such as details of side letter arrangements) and in their communications with private equity targets (such as the likely effects on employment). Private equity funds will also be restricted in taking distributions from their portfolio companies (which the AIFMD refers to as “asset-stripping”) for two years following the buy-outs.

Of even greater concern to U.S. fund managers is the AIFMD provision granting EU passports in 2013 to EU-based fund managers, which will enable them to freely market their funds throughout the EU by simply registering in their home jurisdictions and notifying local regulators in the other member states. U.S. fund managers, on the other hand, will not be eligible for EU passports until 2015, and then only if they meet a host of stringent conditions, some beyond their control and one in particular clearly “protectionist” on its face.

Under the AIFMD, a U.S.-based fund manager, for example, will not be eligible for an EU passport unless cooperation and tax information exchange agreements are negotiated between the jurisdiction in which its funds (for offshore investors) are formed (typically, the Caymans) and each EU member state where they are to be marketed. The AIFMD also requires the assets of all funds marketed with EU passports to be safekept with EU custodians, which was for Senator Schumer its coup de grâce.

While the preliminary draft of the AIFMD was being debated in the EU, U.S. private fund managers were dreading the possibility of EU private placements being abolished altogether in 2013. Managers were actually relieved when the final draft of the AIFMD permitted the private placement regimes of the EU member states to remain in place until at least 2018.

Be that as it may, U.S. private fund managers are still facing a highly discriminatory regulatory scheme in the EU which I believe they don’t deserve. Our funds and service providers are just as effective as, and certainly no more dangerous than, their EU counterparts. Dodd-Frank has gone some of the way in leveling the regulatory playing field between the U.S. and EU by requiring foreign fund managers to register with the SEC, but what is our answer to the AIFMD’s “protectionism” elements? A good place to start would be with Senator Schumer’s suggestion two years ago to require “all funds operating in the U.S. to use only U.S.-headquartered custodian banks.”