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European Fiduciary Services News and Views | Second Edition | 2012

18RDR: hi-de-hi or woe-de-woe?A summary of the changes that will be seen by the industry as a result of the RDR and possible implications for advisers, platforms, products and fund groups.

22Tax Transparent FundsA detailed overview of HMT’s much welcomed consultation paper and the two types of fund proposed - Contractual Schemes and Limited Partnership Schemes.

46Luxembourg’s AIFMD-ready AIF product of choiceA focus on the Luxembourg SIF and an explanation of why the success of this type of fund is expected to be boosted as a result of the AIFMD.

50New Swedish rules on taxationA discussion of the new legislation recently adopted by Sweden on the taxation of Swedish and foreign investment funds.

European Fiduciary Services

NEWS & VIEWS

European Fiduciary Services News and Views | Second Edition 2012 1

CoNtENtSCoNtRIBUtoRS

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36

44

46

50

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54

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12

18

22

UnITED KIngDoM

UK’s provisional thinking on the approach to implementing the AIFMD

Amanda Hale

IRELAnD

Regulatory reform in the oTC derivatives markets

Ian McCarthy

JERSEy

Codes of Practice for Certified Funds

Ann-Marie Roddie

LUxEMboURg

The SIF: Luxembourg’s AIFMD-ready AIF product of choice

Michael Ferguson Michael Hornsby

SwEDEn

new Swedish rules on taxation of Swedish and foreign investment funds and their investors

Emelie Lindahl Erik Hultman

EURoPE

Inside brussels

Michael Collins

InTRoDUCTIon

by David Morrison

gLoSSARy

EURoPE

will the European Commission make a U-turn on ESMA’s final advice?

Amanda Hale

UnITED KIngDoM

The story of FATCA: a fairytale ending?

Selina Staines

UnITED KIngDoM

RDR: hi-de-hi or woe-de-woe?

Iain buckle

UnITED KIngDoM

Tax Transparent Funds

guy Sears

EuropE

Michael Collins Managing Director, European government Affairs Citibank International plc E. [email protected] T. +32 2 626 6047

Amanda Hale Head of UK Fiduciary Technical Citibank International plc E. [email protected] T. +44 (0) 20 7508 0178

IrElANd

Ian McCarthy Senior Fiduciary Monitoring officer Citibank International plc E. [email protected] T. +353 1 622 1012

JErSEy

Ann-Marie roddie Fiduciary Manager Citibank International plc E. [email protected] T. +44 (0) 1534 608 201

luxEMbourg

Michael Ferguson EMEIA Regulated Funds Leader Ernst & young E. [email protected] T. +352 42 124 8714

Michael Hornsby EMEIA Real Estate Funds Leader Ernst & young E. [email protected] T. +352 42 124 8310

SwEdEN

Emelie lindahl Associate, Corporate and International Tax Services Ernst & young E. [email protected] T. +46 8 520 597 29

Erik Hultman Partner, International Tax Services Ernst & young E. [email protected] T. +46 8 5205 9468

uNItEd KINgdoM

Iain buckle Head of Commercial Development Aviva Investors UK Funds Limited E. [email protected] T. +44 (0) 1904 723139


guy Sears Director, wholesale Investment Management Association E. [email protected] T. +44 (0) 20 7831 0898

Selina Staines Fiduciary Technical Analyst, UK Citibank International plc E. [email protected] T. +44 (0) 20 7500 9741

European Fiduciary Services news and Views | Second Edition 2012Citi Transaction Services | Introduction2 3

welcome to our latest “new look” edition of European Fiduciary Services News and Views, the second issue of 2012, which follows our AIFMD Special, published in January.

In comparison to 2011, it could be suggested that EU policymakers have been fairly quiet. nevertheless, a number of key initiatives are gradually progressing, and the second half of 2012 is expected to deliver more detail on the latest reforms to our industry.

with this in mind, Michael Collins, Citi’s Managing Director of European government Affairs, begins by providing us with an insight into some of the reasons why he believes an element of calm has been restored to the markets across the EU. In addition, Michael comments on the progress of the key regulatory and legislative developments currently taking place.

The work on the AIFMD continues to gain momentum. This edition contains three articles on the Directive, two of which have been written by our Head of UK Fiduciary Technical, Amanda Hale.

The first related article focuses on the most recent discussion paper issued by ESMA in February on key concepts of the AIFMD and types of AIFM. It includes analysis of responses provided to ESMA by some of the relevant UK trade associations.

Amanda’s second article summarises the content of the discussion papers published by the FSA and HMT on the implementation of the AIFMD in the UK.

The third article on the AIFMD, written by Michael Ferguson and Michael Hornsby, Ernst & young, Luxembourg, focuses on the Luxembourg SIF and explains why the success of this type of fund is expected to be boosted further as a consequence of the Directive.

Also in February, the IRS and the US Treasury issued their proposed draft regulations for the next phase of implementing FATCA. Selina Staines, Fiduciary Technical Analyst, UK, provides a summary and analysis of the draft regulations and joint statement on the intergovernmental agreement, which was issued on the same day. while these publications offer some positive developments, particularly in the UK, further clarification is still required on a number of important elements if the regime is to be implemented successfully and without major detriment to investors.

with just over six months to go before the FSA’s Retail Distribution Review (RDR) takes effect, the focus on this initiative is at its height as managers, distributors and other service providers make the final adjustments to their business models as appropriate. Iain buckle, Head of Commercial Development at Aviva, provides a summary of the changes that will be seen by the industry as a result of the RDR and the possible implications for advisers, platforms, products and fund groups.

Early this year, HM Treasury issued a consultation paper on introducing tax-transparent funds in the UK. This was a development welcomed by many within the industry and drew much discussion and debate. guy Sears, Director of wholesale at the IMA, provides us with more detail on the consultation paper and an overview of the two types of fund proposed – Contractual Schemes and Limited Partnership Schemes.

INtRodUCtIoN

David Morrison

Director and Head of Fiduciary Services, EMEA

next, Ian McCarthy, Senior Fiduciary Monitoring officer, Ireland, provides an interesting overview of the reform taking place in the oTC derivatives space. EMIR is an important development that will revolutionise the clearing process for eligible oTC derivative transactions and the reporting of positions to trade repositories. The associated MiFID II developments are also covered.

The Jersey Financial Services Commission has recently issued its Codes of Practice for Certified Funds. Ann-Marie Roddie, our Fiduciary business Manager in Jersey, provides an overview of the Codes, which came into force with immediate effect on 2 April 2012.

Sweden has recently adopted new legislation on the taxation of Swedish and foreign investment funds. In our final article, Emelie Lindahl and Erik Hultman, Ernst & young, Ab, discuss the new regime, which transfers tax liability from the investment funds to their unitholders, abolishing withholding tax on dividends to certain foreign investment funds.

we hope you enjoy this edition of European Fiduciary Services News and Views and very much welcome your comments and suggestions on anything of interest to you in these engaging articles.

European Fiduciary Services news and Views | Second Edition 2012Citi Transaction Services | Europe4 5

The European Central bank’s (ECb’s) provision of significant amounts of liquidity via its two Long Term Refinancing operations (LTRo) 1 clearly played a key role in restoring calm, ensuring that the credit crunch that was looming over parts of the Eurozone banking sector did not materialise.

but, Eurozone politicians also believe that they — not just the ECb — have played a part in restoring some calm to markets. They can point to their agreement to strengthen the firewalls available to bail out Member States (MSs) in difficulty; the use of the new tools of fiscal discipline agreed last year to require the governments in belgium, Hungary and Spain to deliver tougher fiscal consolidation; the speedy negotiation of a new Fiscal Compact Treaty that requires MSs to introduce a “balanced budget” rule at the national level; and the successful conclusion of a second bail out for greece, including haircuts for private sector bondholders.

These are important developments in a relatively short period of time, but it is not clear that they are sufficient to have convinced market participants that the Eurozone crisis is now behind us. And the recent spike in Eurozone bond yields, particularly in Spain, suggests that concerns over the fundamentals do indeed remain high.

These concerns are amplified by the disturbing picture on growth and jobs in the Eurozone, which itself risks worsening the fiscal position, as tax revenues fall and non-discretionary spending on welfare programmes increases. Eurozone unemployment now stands at a record 10.8% (and rising), and even this figure masks major divergences across the 17 MSs – germany, for example, has an unemployment rate of just 5.7%, while Spain has 23.6.% (and over 50% for young people).

EU heads of state and government have demonstrated that they are aware of the need

to do more to deliver growth, and agreed a series of actions at their meeting in January to try to facilitate this. Leaders agreed to try to improve training and apprenticeship opportunities for young people to tackle remaining barriers to the EU Single Market in key sectors such as energy and e-commerce and to seek to improve financing for SMEs. but such measures will take some time to deliver growth and jobs — if they can actually be implemented. The EU’s track record in delivering such measures is not good, with many of the items agreed in January echoing promises that have been made by European leaders in the past.

The imperative for growth that now exists might be sufficient to unlock some of these measures once and for all. Even so, many of the key sources of growth remain in the hands of national, not European, policymakers. Structural reform in labour markets or reform of pension provision can be encouraged by brussels, but not delivered.

It is against this background that the EU continues with its extensive agenda of regulatory reform. The first wave of post-crisis legislation has now been completed, with the European Parliament and the Council of Ministers having reached agreement on the Alternative Investment Fund Managers Directive (AIFMD), the Short Selling Regulation and the European Market Infrastructure Regulation (EMIR).

All three pieces of legislation are now the subject of the so-called “Level 2” process — the preparation of the detailed technical standards needed to provide the “single rulebook” for implementation of the legislation by market participants and their supervisors. with the European Supervisory Authorities (ESAs) still only a little more than a year old, both market participants and EU policymakers are still finding their way with this new element of the EU rule-making process.

INSIdE BRUSSElSlike many market participants, EU policymakers have been pleasantly surprised by the comparatively benign market conditions of the first quarter of 2012. Following the turmoil that brought 2011 to a close, this relative calm has been very much welcomed, with policymakers secretly pleased at the contribution they have made to this shift.

one issue, which some in the industry are already expressing concern over, is the potential for important issues of substance to be reopened during the Level 2 process. In the Short Selling Regulation, for example, some trade associations have noticed that the proposed Level 2 rulebook would impose tougher conditions on short sellers than required by the original regulation. And, with these Level 2 rules being prepared and agreed much more quickly than the 18 months or so that it usually takes to agree a piece of EU law, and with fewer parties involved, the industry is learning that it has far fewer opportunities to make its voice heard at this stage of the process.

but, as the first wave of legislation passes, the second wave is now upon us. The fourth Capital Requirements Directive (commonly known as CRD IV) is currently being negotiated by the Parliament and the Council, and is designed to deliver the new basel III capital regime in the EU. A key part of this debate is whether individual MSs should be permitted to impose higher capital requirements than those set by EU law, which is of particular importance to the UK government, as it seeks to implement the Independent Commission on banking’s (ICb’s), recommendation that british banks hold more capital.

In the markets arena, the key piece of legislation is the revision of the Markets in Financial Instruments Directive (MiFID), which seeks to extend pre- and post-trade transparency, and to create a new category of trading venue — the organised Trading Facility (oTF). In parallel with the review of MiFID, the EU regime for Market Abuse is also being revised, with the Commission proposing a much broader definition of “inside information” than is contained in the current regime.

In the tax arena, debate continues on the proposed Financial Transaction Tax (FTT), though, with the UK indicating its strong opposition, the prospects of this proposal being adopted are

remote indeed. Discussion in brussels is therefore shifting to whether some form of “stamp duty” at EU level might be an acceptable alternative.

Looking further ahead, a third wave of legislation is forming. A revision of the UCITS regime is imminent, which is likely to follow the AIFMD, imposing tougher liability requirements. In addition, the European Commission is still intending to propose a new Crisis Resolution regime for European banks, but seems unwilling to make a legislative proposal until concerns over the health of the European banking system have passed. And following the work of international supervisors, the EU has recently launched a debate on shadow banking, and whether revisions are needed to the legal regime to ensure that entities performing similar roles and functions to those traditionally carried out by banks are appropriately supervised and regulated.

Finally, Commissioner barnier has decided that Europe needs to launch its own debate on the structure of banking, mirroring those that in the US led to the Volcker Rule, and in the UK to the ICb proposing the ring-fencing of certain activities. The Liikanen group — named after its chair, Erkki Liikanen, Head of the Finnish Central bank — will consider whether such structural changes are needed in European banking. It is expected to make recommendations by late summer. while the European Commission is not obliged to adopt the group’s proposals, its very existence demonstrates how the brussels agenda is never settled.

Michael Collins Managing Director European government Affairs Citibank International plc

1 The LTRo is one of the ways in which the ECb controls liquidity in the financial sector on an ad hoc basis. The refinancing operations are basically repurchase agreements.


WIll thE EURopEaN CommISSIoN makE a U-tURN oN ESma’S FINal adVICE?In our Uk “sister” article, we discuss the implementation of the aIFmd into Uk legislation by the FSa and hm treasury. here we focus on further work undertaken by ESma 1 in relation to article 4 of the aIFmd and on comments received from associations in the asset management industry.

there has also been a lot of publicity in the financial press recently regarding a leaked version of the European Commission’s proposed level 2 measures, which, it is reported, diverges from the final advice provided by ESma to the European Commission in November 2011. the draft text has generated strong reactions from interested parties and is covered later on in the article.

on 23 February 2012, ESMA issued a Discussion Paper (DP) on key concepts of the AIFMD and types of AIFM.2 Comments were requested by 23 March 2012 and feedback has since been published on ESMA’s website.3

In summary, the paper covered the following areas: the definition of an AIFM; the definition of an AIF; the treatment of UCITS management companies; and the treatment of MiFID firms and credit institutions. we discuss each of these areas in more detail below.

the definition of an AIFM ESMA has determined that the AIFM must be able to provide both portfolio management and risk management to be authorised, but may choose to delegate these functions. However, ESMA also states that the AIFM may not delegate both functions in their entirety at the same time. Respondents to ESMA’s consultation expressed concern both at this proposal and at the proposal that the AIFM must be responsible for fund administration.4 They are seeking clarification from ESMA on the intent behind these statements.

Entities performing either the portfolio management or the risk management under a delegation arrangement with an AIFM will not be required to be authorised as an AIFM. The delegation of these functions should comply with Article 20 of the AIFMD and relevant Level 2 measures. Liability for the AIFM will not be affected by delegation to a third party, and the AIFM must not become a “letter-box” entity.

the definition of an AIF (questions 1–12)ESMA says that it is likely that there are many different types of AIF established in Member States (MSs), and these are either regulated or unregulated and will fall within the scope of the AIFMD.

This section of the paper also covers vehicles that are not AIFMs or AIFs or are exempted from the AIFMD. It also covers a mapping exercise among the competent authorities of MSs to determine what types of AIF currently exist. The most detailed area discussed in this section is the proposed criteria to help identify an AIF.

According to Article 4 (1) (a) of the AIFMD, AIFs are “collective investment undertakings, including investment compartments thereof, which raise capital from a number of investors, with a view to investing it in

accordance with a defined investment policy for the benefit of those investors”.5 The DP goes on to discuss criteria that could be extracted from this definition, as follows.

Raise capitalCapital raised for the purposes of the AIFMD must involve some kind of communication by way of business (which may or may not constitute marketing within the meaning of the AIFMD) between the entity seeking capital or a person acting on its behalf and the prospective investors, resulting in the transfer of investors’ cash or other assets to the AIF.

ESMA states it would not be sufficient to say that the absence of capital-raising is conclusive evidence that an entity is not an AIF (i.e. where an AIF that originally raised capital from investors is liquidated and some or all of its assets are transferred to become the first property of another newly constituted entity). It would be wrong to argue that the new entity itself cannot be an AIF simply because it does not raise capital directly from investors.

EVCA comments on this in its response to ESMA.6 In a private equity context, EVCA explains that it is typical for certain senior executives of an AIFM to participate in a “carried interest” vehicle. The carried interest vehicle will be a limited partnership, which is itself a limited partner in a main fund limited partnership (i.e. the true AIF), alongside third-party investors. EVCA would not wish “capital-raising” to apply in respect of carried interest limited partnerships. The same vehicle, or a different vehicle, may also be used to effect executive co-investment in transactions alongside the AIF. This would require the executives to commit capital that is more than merely nominal. In this case, EVCA also states that the vehicle should be considered an AIF.

Along similar lines, AIMA does not consider that any co-investment of the manager should be taken into account when determining whether or not an entity raises capital from a number of investors, since it believes it would not constitute raising external capital. AIMA also believes this approach should be taken in relation to co-investment by an affiliate of the AIFM, a third-party funded by the AIFM and a service provider to the AIF (such as a general partner of a limited liability partnership).7


Collective investmentAn AIF must be a collective investment undertaking that pools together capital raised from investors. It should also generate a return for its investors through the sale of its investments.

number of investorsESMA says that the AIF’s rules or instruments of incorporation cannot contain provisions that restrict the sale of units or shares to a single investor. The exception to this would be in the case of nominee arrangements or feeder or fund of fund investments. Here the fund would fall within the definition of an AIF for the purposes of the AIFMD.

Defined investment policyAn AIF should have a defined investment policy. ESMA has determined that the following indicative criteria could be taken into account when determining whether an entity had a defined investment policy:

The final form of the investment policy is fixed, at the latest, by the time that investors’ commitments to the AIF become binding on them.

The investment policy is likely to be set out in a document that becomes part of, incorporated in or referenced in, the constitutional documents of the AIF.

A contractual relationship between the AIF and the investor binds the AIF to follow the investment policy (and as it might be further amended).

The investment policy contains a series of investment guidelines. For example, only to:

• Invest in certain categories of asset or conform to restrictions on asset allocation.

• Pursue certain strategies.

• Invest in particular geographical regions.

• Conform to restrictions on leverage.

• Conform to minimum holding periods.

• Conform to other restrictions designed to provide risk diversification.

• The investment policy should be clearly set out and disclosed to investors.

• Any change to the investment policy should be disclosed to investors and, in many cases, investors should provide their consent to such change.

ESMA also discusses further factors that could be relevant in determining whether an entity is an AIF.

• ownership of underlying assets: where ownership of assets is represented by shares or units in an AIF.

• Control of underlying assets: the AIFM or internally managed AIF is responsible for the management of the AIFs assets, with investors having no day-to-day discretion or control over the assets.

The IMA responded to the paper by saying that the definitions proposed by ESMA seem fairly consistent with UK views on what constitutes a collective investment scheme and therefore an AIF. However, the list provided by ESMA (paragraph 20 of the paper) omits a key subset of AIF — those that invest in asset classes similar to those in which UCITS invest, but that are closed-ended or not open to the public.8

The IMA also does not agree that any co-investment of the manager should be taken into account when determining whether or not an entity raises capital from a number of investors as it sees this as irrelevant. The IMA believes that the question is whether there is some form of communication by way of business to third parties who are potential investors.

EFAMA agreed overall with ESMA’s views, but had concerns regarding raising capital for the purposes of the AIFMD, because in commercial practice, there are situations where an AIFM is approached by an investor/group of investors with a specific concept for the AIF set-up.

the appointment of AIFMsESMA acknowledges that the AIFMD (Article 5) provides that there may be more than one legal entity that could be appointed as the AIFM of the AIF — for example, the AIF itself or an entity acting on behalf of the AIF. ESMA states that there are no provisions in the AIFMD that impose criteria or conditions on the AIF for the appointment or selection of the AIFM. Therefore, the AIF is free to appoint any entity as the AIFM, provided the entity is authorised as such. ESMA further states that it is important to distinguish between circumstances where a legal entity is performing investment management

services for an AIF under a delegation agreement and where the legal entity is the appointed AIFM for such AIF. The agreement entered into between the AIF and the third party should be clear regarding the nature of the relationship and the responsibilities of each party.

the treatment of uCItS management companies (question 13)Article 6(2) provides that an AIFM may also act as a management company for UCITS provided the AIFM is authorised in accordance with the UCITS Directive for that purpose. The UCITS Directive currently allows UCITS management companies to manage non-UCITS, but after AIFMD comes into force, a UCITS management company that manages AIFs and is appointed as the AIFM for the purposes of the AIFMD, will no longer be subject to the UCITS Directive for that activity and will be required to obtain an additional authorisation under the AIFMD.

ESMA's analysis also says that it is possible for a UCITS management company to provide services, including investment management services, to an AIF but not be its appointed AIFM — for example, where the AIF is

internally managed or the UCITS management company provides administrative services and the selected AIFM is the investment manager to the AIF.

In this situation, the UCITS management company’s activities will continue to be covered by its authorisation under the UCITS Directive and it will not need to seek authorisation under the AIFMD.

treatment of MiFId firms and credit institutions (question 14)The DP acknowledges that the AIFMD provides that a firm authorised under MiFID 9 or credit institutions authorised under the banking Consolidation Directive,10 cannot be the appointed AIFM nor obtain authorisation under the AIFMD. The AIFMD (Article 6 (8)) states that MiFID firms and credit institutions are not required to be authorised under the AIFMD to provide investment services such as individual portfolio management to AIFs. This allows such firms to continue to provide services to AIFs under delegation arrangements. The thresholds in Article 3 (2) are not relevant since such firms would not be considered as an AIFM under the AIFMD.

the aIFmd provides that a firm authorised under miFId or credit institutions authorised under the Banking Consolidation directive, cannot be the appointed aIFm nor obtain authorisation under the aIFmd.


In its final response to ESMA, the IMA strongly disagrees with this interpretation. In practice, there are a large number of UK and other European asset management firms that are currently authorised under MiFID for the activities described in Article 6.4 (a) and (b), that passport these activities under MiFID. They also act as the operator for a number of schemes that qualify as AIFs.

More importantly, the IMA questions whether these firms would be able to passport these activities as it is unclear whether these firms would be able to do so under Chapter VI of the AIFMD or that the passport extends to MiFID activities.

The last concern the IMA makes in this part of its response is about the divergent approaches to capital requirements across MSs, depending on whether firms are subject to UCITS,11 MiFID or CRD 12 capital requirements. The IMA asks for a harmonised approach to be applied.

The Level 2 measures from the European CommissionThe final Level 2 measures from the European Commission are expected to be published imminently, but there has been a great deal of press coverage regarding the content of a leaked version of the provisions.

A letter published in the Financial Times says that the announcement of the latest iteration of the AIFMD, with a two-week consultation period falling over Easter, should have set alarm bells ringing in Downing Street.13

The author says that proposed rules relating to depositaries may, in their current form, deal a devastating blow to the manner in which hedge funds have historically operated in the EU and, together with limitations on leverage and risk, accelerate the exodus of fund managers from the EU with a potentially devastating drop in tax revenues to the UK Treasury.

The letter ends by saying that the EU intentions are political and not technical. Michel barnier, the EU Commissioner, has said that he “could not care less if jobs are lost in the City of London as a result of the introduction of AIFMD”. The author says that “as matters are proceeding, that is the likely outcome”.

According to another published letter, barnier’s reaction to legitimate concerns expressed by the private equity and hedge fund industries exposes an agenda within the Commission of staring down the industry, rather than working with it to create workable legislation.14

global banks have also commented on the draft, sounding the alarm over the proposed rules for the hedge fund and private equity industries, warning they would “cause a significant and undesirable disruption to financial markets”.15

Should the rules go through unchanged, the banks believe they will overturn many market practices and contracts, and restrict investment options for fund managers, particularly in emerging markets.

Finally, in another article, barnier hit back at “rearguard lobbying” by the hedge fund and private equity industries, saying he “will not be intimidated” by an attempt to undermine a deal to regulate the industry for the first time.16

Most recently, AIMA published a note providing an analysis between the EU Commission’s draft regulation and the ESMA advice. AIMA says the text differs in several areas, including: third country provisions; depositaries; delegation; leverage; own funds; professional indemnity insurance; appointment of prime brokers; and definition of assets under management.17

As a result of the press coverage, industry concerns have been raised regarding the substance behind these articles, so the IMA felt it necessary to issue a circular to its members providing information about the legislative process, the substantive issues and the IMA’s activities.18

ConclusionResponses to the DP will help ESMA finalise its policy approach. From the responses received, ESMA will develop a consultation paper in Q2 2012, setting out formal proposals for draft regulatory technical standards on Article 4 (4) of the AIFMD.

Results from that public consultation will be used by ESMA in finalising the draft regulatory technical standards to be submitted to the EU Commission by the end of 2012. This will not be the end of the work that ESMA must

complete on the AIFMD, though, as Level 2 measures are still expected from ESMA.

work still to be published by ESMA includes advice covering the third country framework for non-EU entities, setting out in broad terms what ESMA considers to be the key content of the co-operation arrangements that have to be put in place with non-EU authorities. In this respect, Stephen Maijoor, Chair of ESMA, has indicated that ESMA is now moving towards the establishment of these arrangements in view of the deadline of July 2013.19 In particular, he stated that, although the agreements themselves are between non-EU and EU authorities, ESMA intends to centralise the process and to negotiate on behalf of the EU competent authorities, in order to ensure an efficient process and contribute towards a level playing field across Europe.

ESMA is also developing guidelines on the content of the cooperation arrangements. Maijoor described these guidelines as “a model memorandum of understanding that will serve as the basis for the negotiations with third country authorities.”

To complete its work on the AIFMD, ESMA is also working on guidelines on remuneration under Article 13 of the AIFMD, and it plans to publish a consultation paper with its proposals in the second quarter of 2012. Maijoor has said that in developing these guidelines, ESMA will draw inspiration from existing material, such as the Commission recommendation of 2009 20 and the Committee of European banking Supervisors (CEbS) guidelines of 2010,21 bearing in mind the need to adapt that material to the alternative investment fund sector.

It remains to be seen whether the views and concerns raised in the recent press coverage of the “unofficial” version of the Level 2 measures discussed in this article carry any weight. one certainty is that many people will welcome sight of the “official” final text from the European Commission, providing one of the remaining pieces to the puzzle that is the AIFMD.

Amanda Hale Head of UK Fiduciary Technical Citibank International plc

proposed rules relating to depositaries may, in their current form, deal a devastating blow to the manner in which hedge funds have historically operated in the EU and, together with limitations on leverage and risk, accelerate the exodus of fund managers from the EU with a potentially devastating drop in tax revenues to the Uk treasury.

1 European Securities and Markets Authority.

2 “Key Concepts of the Alternative Investment Fund Managers Directive and Types of AIFM”, ESMA Discussion Paper, 23 February, ESMA/2012/117.

3 From www.esma.europa.eu/consultation/Key-concepts-Alternative-Investment-Fund-Managers-Directive-and-types-AIFM#responses, accessed on 20 April 2012.

4 The Investment Management Association (IMA), European Fund and Asset Management Association (EFAMA) and the Alternative Investment Management Association (AIMA).

5 Directive 2011/61/EU, dated 8 June 2011.

6 The European Private Equity & Venture Capital Association; and see www.esma.europa.eu/system/files/120323_esma_consultation_pae_response_final.pdf, accessed on 20 April 2012.

7 From www.esma.europa.eu/system/files/aima_response_to_esma_discussion_paper_on_key_concepts_23032012.pdf, accessed on 20 April 2012.

8 IMA's final response is available at: www.esma.europa.eu/system/files/esma_final_response_230312.pdf, accessed on 20 April 2012.

9 Directive 2004/39/EC.



12 Capital Requirements Directive 2006/49/EC.

13 Financial Times article, “Political Intentions behind AIFMD”, published 9 April 2012, written by Anthony Travers.

14 Financial Times article: “brussels Should Honour Its Commitment on non-EU Funds”, published 5 April 2012, written by Syed Kamall MEP.

15 Financial Times article “big banks warn over Funds Shake-up”, published 5 April 2012, written by Alex barker in brussels and brooke Masters in London.

16 Financial Times article, “EU Rejects Fund Fears over Rules”, published 3 April 2012, written by Alex barker in brussels and brooke Masters in London.

17 From www.aima.org/objects_store/aifmd_divergences_from_esma_advice_-_aima_note_-_ec.pdf, accessed on 20 April 2012

18 Investment Management Association Circular 116-12 “AIFMD Level 2 — Update”, published 5 April 2012.

19 From www.esma.europa.eu/content/Keynote-speech-Steven-Maijoor-Chair-ESMA-EVCA-Investors%E2%80%99-Forum, accessed on 20 April 2012.

20 From http://ec.europa.eu/internal_market/company/docs/directors-remun/financialsector_290409_en.pdf, accessed on 20 April 2012.

21 From www.eba.europa.eu/cebs/media/Publications/Standards%20and%20guidelines/2010/Remuneration/guidelines.pdf, accessed on 20 April 2012.

European Fiduciary Services news and Views | Second Edition 2012Citi Transaction Services | United Kingdom12 13

the story so faronce the HIRE Act was signed into law, there was intensive lobbying activity throughout Europe and the UK, most notably from industry bodies such as the European Fund and Asset Management Association (EFAMA) and the Investment Management Association (IMA) on behalf of the asset management sector. The key focus of this lobbying activity was on trying to obtain a carve-out for widely held funds (collective investment schemes) so they may be deemed compliant foreign financial institutions (DCFFIs) for the purposes of FATCA. This would, among other things, reduce the compliance burden placed on firms as a result of the Act.

on 27 August 2010, the Internal Revenue Service (IRS) published notice 2010-60, which contained some preliminary guidance on the priority implementation issues of FATCA and included a positive statement that the US Treasury and IRS were considering whether certain collective investment schemes could be treated as DCFFIs.1

The IMA responded to this notice by highlighting, among other things, the difficulties faced by UK asset managers due to the UK’s unique and highly intermediated distribution landscape, which, in its view, would make it impossible for any fund or manager to comply.2

EFAMA’s response supported that of the IMA and pushed for flexibility in the implementation rules, particularly in those countries, such as the UK, where the sales distribution models did not easily fit with the suggested proposals. EFAMA also requested a carve-out for low-risk funds, publicly-traded funds, widely held funds and those funds

that prohibit US investors. In addition, EFAMA pointed out that the extra-territorial reach of FATCA placed burdens on firms that conflicted with local laws and practices.3

on 8 April 2011, the IRS published notice 2011-34, which still contained no apparent carve-out for widely held funds. And, despite the relaxation of some of the rules, the requirements for funds to be “deemed compliant” were unlikely to benefit many of the funds distributed in the UK. There were also concerns that the original implementation date for FATCA remained at 1 January 2013 – there was still much uncertainty at this stage about who would be captured under the FATCA provisions, which would have a knock-on effect in terms of firms having the required systems and procedures in place to meet the implementation deadline. And, there was no final word on any transitional provisions — throughout their lobbying processes both EFAMA and the IMA had urged the US Treasury and the IRS to adopt a “sensible” transition period.4

on 14 July 2011, the IRS published notice 2011-53, which established a phased implementation of the FATCA regime. This appeared to be the first concession afforded to the industry.5

on 8 February 2012, the US Treasury and IRS issued proposed regulations for the next major phase of implementing FATCA.6 The regulations lay out a step-by-step process for US account identification, information reporting and withholding requirements for foreign financial institutions (FFIs), other foreign entities and US withholding agents. In addition, regulated funds were provided with ways in which they could

thE StoRy oF FatCa: a FaIRytalE ENdINg? the Foreign account tax Compliance act (FatCa) provisions were contained within the US hiring Incentives to Restore Employment (hIRE) act, which was signed into law on 18 march 2010. While FatCa is US legislation, it imposes US compliance and withholding taxes on banks and financial institutions worldwide, regardless of their connection with the US. many financial institutions have been concerned that FatCa conflicts with local data protection and other laws and that FatCa could also result in US withholding tax applying to non-US transactions between non-US parties.

exempt themselves from FATCA — a second concession afforded to the industry?

on the same day, a joint statement was issued by France, germany, Italy, Spain, the UK and the US announcing an intergovernmental approach to FATCA implementation, which would address local impediments to compliance, simplify practical implementation and reduce FFI costs. This was a third concession for the industry.

the draft regulations The proposed regulations make it clear that the US Treasury and IRS have listened to the many stakeholders who have lobbied them since the publication of notice 2010-60. As a result, the overall burden on financial institutions has been reduced. The IRS has also recognised the need to provide sufficient lead time for systems development and any necessary process changes by postponing the imposition of withholding tax on certain passthru payments.

So, what are the key changes of note in the proposed regulations?

grandfathering obligationsThe “grandfathering” date has been pushed back from 18 March 2012 to 1 January 2013. This means that most debt securities issued, derivatives entered into and loans advanced or committed to in 2012 will be outside FATCA throughout their life. However, some types of arrangement, including equity (and debt that is treated as equity for US tax purposes) are not grandfathered. In addition, grandfathering can be lost if an agreement is materially amended post 1 January 2013.

The exclusion of equity interests from the grandfathering provisions will be a problem for many securitisation vehicles as their more subordinated debt tranches may be regarded as

equity for US tax purposes. This means that old deals will fall within FATCA. on a positive note, the IRS has said it is considering grandfathering existing equity interests in securitisation vehicles in cases where the underlying assets are themselves grandfathered.7

Passthru paymentsThe date on which FATCA withholding begins on foreign passthru payments has been extended from 1 January 2015 to 1 January 2017. However, in the interim, an FFI must report the aggregate amount of certain payments to each non-participating FFI.

Exemptions from FATCA withholdingPayments of interest and original discounts on certain short-term obligations and payments made in the ordinary course of a withholding agent’s business for non-financial services, goods and the use of property are identified as being exempt from FATCA withholding.

The transitional rule for affiliates Under the original FATCA rules, withholding, reporting and other requirements imposed on an FFI also applied to each other FFI that was a member of the same expanded affiliated group (FFI group) that included the FFI. An expanded affiliated group includes partnerships, insurance companies and foreign corporations.

Under the new draft rules, there is a two-year transition period, from 1 January 2014 to 1 January 2016, for certain members of an expanded affiliated group to become a participating or deemed compliant FFI. This provides FFIs located in jurisdictions whose tax laws prohibit the tax withholding or reporting required under FATCA with additional time to fully implement FATCA, without preventing other FFIs within the same expanded affiliated group

"there is a misconception that FatCa is only about preventing tax evasion. It is really about increasing the transparency of the global financial system.”

Mark Schulz Chief Compliance officer, global Life


from entering into an FFI agreement. However, an FFI will still need to agree to perform due diligence to identify US accounts and maintain certain records during this transition period. PwC has observed that during this two year transition period, an FFI member of an expanded affiliated group that does not enter into an FFI agreement will be subject to FATCA withholding on withholdable payments that it receives.8

Additional categories of DCFFIsThe categories of DCFFIs have been expanded and are broader than those described in the notices issued by the IRS. The proposed regulations provide for the following types of DCFFIs.

A registered dCFFI A registered DCFFI is required to register with the IRS and declare its status as deemed compliant to attest to the IRS that it satisfies certain procedural requirements and certify to the IRS every three years that it meets the criteria for its category of DCFFI.

In the draft regulations, there are four types of registered DCFFI, including:

• Local FFIs: These are entities licensed or regulated in their country of organisation, must not be investment funds, must have no place of business outside their country of organisation and must not solicit accounts from outside their country of organisation. ninety-eight per cent of their accounts must be local, and local tax laws must require information reporting or withholding. This category may be relevant for some fund intermediaries, such as wealth managers, platforms and IFAs with nominee accounts.

• non-reporting members of participating FFI (PFFI) groups: This category applies to group entities where at least one member of the group is a PFFI and where the DCFFI agrees to transfer US accounts to that PFFI entity.

• Qualified collective investment vehicles: These are collective investment schemes, and must be regulated as such in their country of incorporation. Investors must be limited to financial institutions and tax exempt or low risk persons. Each holder of debt or equity in such entities that exceeds USD50,000 must themselves be PFFIs, registered DCFFIs, US persons or exempt beneficial owners. This category may be of relevance to funds with exclusively institutional investors, such as

Common Investment Funds (whose investors are charities), Exempt Unauthorised Unit Trusts and Qualified Investment Schemes (QIS).

• Restricted funds: These are collective investment schemes, and must be regulated as such in their country of incorporation. They must fulfil certain criteria in relation to how they are distributed and who their direct accountholders are. Therefore, this category can apply to funds generally, provided they are willing and able to meet the restrictions on distribution.

There will also be an additional category of FFIs deemed compliant by intergovernmental agreement (see the section on the joint statement).

A certified dCFFI A certified DCFII is not required to register with the IRS, but will need to certify its status to the relevant withholding agent. In the draft regulations, there are four types of certified DCFFI including:

• non-registered local banks: These are banks licensed in their country of organisation, must have no fixed place of business outside such country and must not solicit accounts from outside their country of organisation.

• Retirement funds: This category is for retirement funds that are not otherwise exempted by virtue of being an exempt beneficiary or outside the definition of financial accounts. This category applies to funds where all contributions are government, employer or employee contributions that are limited by reference to income. The IMA has stated that the definition would not apply to most UK pension schemes as these generally have no such limit.9

There are three sections within the draft regulations that cover retirement funds and that deal with the definition of financial account, exempt beneficial owners and certified DCFFIs. Each section provides an exemption from the FATCA provisions for pension funds and through a number of tests to achieve exemption.

However, each of the definitions contains overlapping tests and is potentially confusing in its application and purpose. As such, the IMA believes that this is an area that requires greater clarification and guidance.10

• non-profit organisations: This category applies to charities and organisations established

for religious, scientific, artistic, cultural or educational purposes, which are exempt from tax in their local jurisdiction and which satisfy certain other rules. This category may be applicable to registered charities in the UK.

• FFIs with low-value accounts: This category applies to FFIs (other than investment funds) that do not have any financial accounts with a balance in excess of USD50,000 and that, together with the rest of their expanded affiliated group, do not have total assets in excess of USD50 million.

owner-documented FFI This status applies only to payments received by, and accounts held with, a designated withholding agent that agrees to undertake additional due diligence and reporting.

Modification of due diligence procedures for account identificationThe guidance on account identification has been significantly modified in the draft regulations and contains detailed procedures to follow for identifying pre-existing and new accountholders for both entity and individual accountholders.

pre-existing accounts The proposed regulations have reduced the burden associated with reviewing the records of those accounts which are held on the effective date of the FFI agreement.

• Individual accountholders: An FFI will need to perform an electronic review of all accounts in excess of USD50,000. Accounts less than USD50,000 are exempt from review and are not treated as US accounts. The electronic review will need to look for any of the following US indicia:

– Record of US residence or citizenship

– US place of birth

– US address

– US telephone number

– Standing order to transfer funds to the US

– Power of attorney in the US or US signatory

– only address is a c/o address

There is no requirement for records of existing accounts to include details that would be required to determine indicia, so if an FFI holds only a customer name and address, only those records need to be examined.

If US indicia are found, the FFI will need to obtain further information in order to determine the accountholder’s status.

The threshold for manual reviews has been increased to accounts in excess of USD1 million. Manual reviews will examine documentation for US indicia.

• Entity accountholders: A USD250,000 de minimis rule has been introduced, which means that pre-existing accounts will be exempt from review and not treated as US accounts.

For pre-existing entity accounts in excess of USD250,000, an FFI can generally rely on “know-your-customer” (KyC) records, information collected during an “anti-money-laundering” (AML) process or other existing accountholder information to determine whether an accountholder is a US account or an FFI. If the accountholder is a passive non-foreign financial entity (nFFE) and the account is over USD1 million, the FFI will need to obtain additional records from the accountholder to determine all substantial US owners.

New accounts

• Individual accountholders: The default requirement is that an FFI should obtain either a Form w8, which identifies the accountholder as a non-US person, or Form w9, which identifies the accountholder as a US person. However, for non-US accounts, the requirement to obtain a w8 can be replaced by the requirement to review information provided pursuant to the FFI account opening procedures, provided it contains enough information to support the accountholders status.

The IRS is expected to publish a modified withholding certificate (Form w-8) and a modified information return (Form 1042-S) at some future date.

• Entity accountholders: The FFI will need to implement procedures to identify types of entity by reference to the withholding certificate or make assumptions as to status based on indicia. If the entity accountholder is a passive nFFE, the FFI will need to obtain additional records from the accountholder to determine all substantial US owners.

guidance on procedures required to verify complianceThe guidance provided in the notices has been modified by confirming that the responsible

Under the new draft rules, there is a two-year transition period, from 1 January 2014 to 1 January 2016, for certain members of an expanded affiliated group to become a participating or deemed compliant FFI. however, an FFI will still need to agree to perform due diligence to identify US accounts and maintain certain records during this transition period.


officer of an FFI will be expected to certify that the FFI has complied with the terms of the FFI agreement. Verification of compliance through a third-party audit is not required.

The FFI agreementThe IRS is expected to issue further guidance by way of a draft FFI agreement, which is expected to be published in the first half of 2012, with a final FFI model agreement to be published in Autumn 2012. There will be an online process for registering as an FFI, which is to be in place no later than 1 January 2013.

Until the model agreement is published, there is no certainty as to the form and content of such an agreement. However, the regulations do set out that the agreement will specify the following:

• withholding obligations on passthru payments to recalcitrant non-participating FFI accountholders.

• obligations to obtain information on accountholders necessary to determine which accounts are US, recalcitrant and non-participating FFIs.

• Annual reporting obligations on US accountholders.

• How account identification, reporting and withholding requirements are met for expanded affiliated groups.

• The obligation to obtain waivers from accountholders to any data protection restrictions that would prevent them from meeting FATCA reporting requirements, or close account in circumstances where waivers are not obtained.

• The obligation to adopt written policies and procedures for account identification and documentation in order to comply with FATCA. The agreement will also require periodic reviews of these policies whereby an officer of the FFI will need to certify compliance with the FFI agreement to the IRS. Any patterns of compliance failure may result in an audit by the IRS.

• Default events under which the FFI agreement is breached.

• The obligation to provide further information to the IRS on request.

Reporting requirementsThe proposed regulations extend the transition period on the scope of information reporting by FFIs as shown in the table below.

2014 and 2015

FFIs must begin reporting name, address, taxpayer identification number (TIn), account balance and account number for US recalcitrant accountholders (for calendar years 2013 and 2014).

2016 FFIs must begin reporting income associated with US accounts for calendar year 2015.

2017 FFIs must begin reporting gross proceeds from securities transactions (for calendar year 2016).

the joint statementThe joint statement issued on 8 February 2012 by the French, german, Italian, Spanish and UK governments explains that they are exploring a common approach to FATCA implementation through domestic reporting and reciprocal automatic information exchange. The Irish government has indicated that it plans to be a part of future inter-governmental negotiations and Luc Frieden, the Luxembourg Finance Minister, stated that the Luxembourg government “favours a coordinated approach at EU level”.11 other countries, including Denmark and Mexico, are negotiating possible agreements as well.12 The intention is to provide the US with similar information to that required under FATCA, but in a way that avoids the serious conflicts of law problems previously mentioned.

The five European jurisdictions will enact legislation under which local FFIs will be required to collect and report FATCA-style information to their local tax authorities. Then each jurisdiction will transfer the information to the US. However, for the UK, it is not envisaged that the agreement will require legislation; rather, it will be made under the auspices of the existing US/UK double-taxation treaty. In return, most FFIs in those jurisdictions will be DCFFIs and will be required to register with the IRS, rather than enter into an IRS agreement. The arrangement is reciprocal, so US institutions will be required to report similar information to the IRS, which will be passed to each of the five jurisdictions.

According to the IMA, this could open up the possibility of the development of a model for international tax reporting based on local jurisdiction reporting and government exchange of information — the statement commits the participating governments to working with other FATCA partners, the oECD, and where appropriate the EU, on adapting FATCA in the medium term to a common model for automatic exchange of information, including the development of reporting and due diligence standards.

The IMA also states that this could enable the UK to negotiate separate categories of DCFFIs that would be purposefully matched to the UK market. This could make it easier to exempt, for example, UK pension funds, collective investment schemes and ISAs.13

while the agreement is a positive step forward, FFIs will have to put systems and compliance in place so they can commence the reporting regime by 2014. To date, there has been no indication as to when the implementing legislation will appear. This begs the question as to whether FFIs will have enough time to put the necessary systems in place.

So, financial institutions will be entering into arrangements today that may become subject to FATCA withholding in 2014 or 2017, but until they know for sure whether they will be able to sign up to FATCA (or deemed to be compliant) they will be unable to assess the risk.

In addition, the statement implies mandatory reporting for FFIs — this is distinct from the current FATCA proposals under which an FFI may choose whether or not to become a participating FFI.

Next stepsThe IRS has requested comments on a number of issues in the draft regulations, which include certifying compliance with an FFI agreement and the administration of passthru payment withholding. These are to be addressed in the final regulations.

In addition, the US Treasury and IRS intend to review the list of defined terms used in the proposed regulations. Many of these terms are used under the current withholding and reporting rules and the intention of the review is to ensure consistency between the existing definitions and those in the proposed FATCA regulations effective 1 January 2014.

“the Joint Statement regarding anintergovernmental approach to improving international tax compliance and implementing FatCa addresses some concerns about breaches of the data protection act and the legality of passthru withholding. however, I think it will add a further layer of complexity. While the initial focus is on bilateral reporting between the US and the other participating territories it also opens the way for multilateral reporting in the future.”

CIP Client, Head of Tax

1 For more detail on notice 2010-60, please see our previous European news and Views article, “FATCA — A wolf in Sheep’s Clothing?”, published in our third edition 2011.

2 IMA’s response can be viewed at: www.investmentuk.org/policy-and-publications/consultation-responses/responses-and-representations, accessed on 16 April 2012

3 EFAMA's response can be viewed at: www.investmentuk.org/members/circulars/2010/446-10, accessed on 16 April 2012

4 Ibid.

5 Ibid.

6 Reg — 121647-10 Regulations relating to Information Reporting by FFIs and witholding on certain payments to FFIs and other Foreign Entities

7 Clifford Chance briefing note: FATCA — The new Regulations, and what They Mean for Financial Institutions worldwide, 9 February 2012.

8 global IRw newsbrief: Information Reporting and withholding (IRw), 9 February 2012.

9 IMA Circular 063-12: FATCA — IMA Initial Analysis and Comment.

10 Ibid.

11 “Ireland and Luxembourg Support European FATCA Deal”, nick Reeve, FT Adviser, 17 February 2012.

12 Anti-laundering Professionals Have Key Role to Play in FATCA Compliance, Conference Speakers Say, 23 March 2012, brett wolf, Thomson Reuters Accelus.

13 Ibid.

Comments on the draft regulations were to be submitted by 30 April 2012 and a public hearing was scheduled for 15 May 2012.

A fairytale ending? not quite. but the recent developments have alleviated some of the compliance burdens initially anticipated as a result of FATCA.

Selina Staines Fiduciary Technical Analyst, UK Citibank International plc


The RDR consultation process is now reaching its conclusion with most (although not all) of the final rules now published. with a little over six months remaining before it comes into force, little time remains for firms to finalise their strategies and implement all the necessary changes.

while some of the rules remain unclear at this stage, it is clear that to continue to write new business post-R-Day, many distributors will

need to adapt their business models and fund management groups will need to make changes to their product propositions and operations.

note that the scope of the RDR (as far as fund management companies are concerned) not only includes UK oEICs and unit trusts but also collective investment vehicles such as SICAVs that are distributed to retail clients in the UK.

RdR: hI-dE-hI oR WoE-dE-WoE? the Retail distribution Review (RdR) comes into effect on 31 december 2012 (R-day) following over six years of consultation between the Financial Services authority (FSa), financial services product providers, distributors and their representative bodies. It forms a key part of the FSa’s “Consumer protection” strategy and will have an impact on all financial services providers and distributors. the FSa’s original idea was to identify and address the “perceived problems” associated with the distribution of retail investment products.

Summary of changesThe FSA’s stated primary objective of the RDR is to reduce customer detriment by increasing industry professionalism and removing the payment of commission to advisers. The FSA has believed for a long time that the method by which customers pay for advice implicitly through product charges has potentially led to one provider’s products being selected over another’s on the grounds of commission levels alone rather than actual suitability. The RDR aims to remove commission as a potential reason for any such product selection bias.

Adviser remuneration

• Commission is banned for all new retail collective investments where the investor receives advice.

• Legacy commission (commission on increments to existing collective investment holdings) is similarly no longer allowed.

• Trail commission on existing collective investment holdings can continue (at least for the moment) but only until a further “advice event” occurs (including a fund switch).

• Advisers must agree up front a separate fee (or fees) for advice with their clients (an “adviser charge”) that cannot be met out of product charges.

• “Factoring” (providers advancing the fees for advice for regular payments) is banned.

• Platform charges must be unbundled and transparent, with the continuation of fund manager rebates still under review.1

note that in a recent Aviva survey, 46% of customers said they believed the financial advice they had received was free, despite the payment of commission being loaded into the price of the product they actually purchased. This is likely to mean that many distributors will have to change their business models considerably and clearly demonstrate the value they are adding.

Professionalism and capital adequacy Advisers offering financial advice post-R-Day will need to be qualified up to “QCF Level 4” as a minimum. In addition, they will be required to undertake at least 35 hours’ Continuing Professional Development and sign a Statement of Professional Standing each year. Furthermore, from December 2013, an advising firm will need to set aside a percentage (reaching 25% by

many advisers are likely to disappear from the industry altogether as they deem the additional qualification requirements as “one last straw”. of those who remain, the industry’s view is that there will be a significant shift from those offering independent advice to the restricted-advice model as satisfying the requirements for full independence becomes increasingly difficult.

December 2015) of its expenditure each year to demonstrate that it is adequately capitalised.

Advice modelswhile the current advice market is already split into fully independent and tied (either single or multi-tied) channels, post-R-Day, advisers will need to make it clearer to their clients in what capacity they are operating.

To be fully “independent”, advisers must be able to recommend products (on which they advise) from any provider. These requirements will be subject to enhanced review requirements post-R-Day and are therefore likely to be more onerous to provide. Hence, fewer advisers than currently will choose to operate as “independent” post-R-Day.

“Restricted” advice is similar to the current “multi-tied” arrangement whereby advisers select products from a narrower range (or panel) of providers. There is increasing evidence that this is the advice model that is likely to grow the most post-R-Day as the requirements and costs are likely to be less onerous on advisers than independence. we have already seen larger firms of advisers announcing their intentions to go down this route and begin to select the preferred providers for their panels.

“Simplified” advice is a new option whereby a recommendation will be reached via a decision tree. This would typically be automated, but if an adviser is involved, then they may have to be fully qualified (depending on the service they are providing), which may in practice make this channel too problematic.

“non-advised” is similar to today’s “execution-only” model, and, perhaps somewhat bizarrely, commission can continue to be paid on such sales.

possible implications

Adviser modelsMany advisers are likely to disappear from the industry altogether as they deem the additional qualification requirements as “one last straw”. of those who remain, the industry’s view is that there will be a significant shift from those offering independent advice to the restricted-advice model as satisfying the requirements for full independence becomes increasingly difficult.

As more clients become aware of the cost of advice and fewer become willing to pay for it, advisers may either be forced to take lower levels of remuneration, or, perhaps more likely, target a client base higher up the wealth


spectrum. This, combined with a market with fewer advisers could well result in a significant proportion of clients without advisers. However, the emergence of this new “orphan client” market segment could in itself attract players into the market purely to serve these customers, perhaps using the non-advised model.

Some advisers may step away altogether from providing investment advice and move towards advising on product lines that remain outside of RDR, such as risk products, general insurance or deposit-based investments.

Aviva also expects to see the direct market (D2C) opening up, particularly for customers with less complex needs. This is again mainly due to the wedge driven between advisers being able to charge for — and customers being willing to pay for — financial advice in the post-RDR marketplace. In the fund management industry, we have recently seen groups such as Threadneedle and J.P. Morgan building RDR-friendly products for sale through direct platforms with low charges.

PlatformsFund platforms will become increasingly important as advisers look for ways to service their customers more efficiently. However, with the likely ban on platform rebates, platforms themselves will have to adapt their own business models. we have already seen CoFunds announce its new platform tariff, which will be collected through an explicit deduction from a client’s unit account and include both a flat fee and an ad valorem fee (which may result in an overall higher total fee for some clients). others, such as Skandia, seem to be adopting a more “wait and see” approach.

ProductsDemand for simpler, more transparent and cheaper products is expected to increase. In the fund management space, a number of “multi-asset” fund ranges have already been launched by fund groups such as Aviva Investors, 7IM and Schroders with more expected to follow. The salient features of this type of fund, which makes them particularly “RDR-friendly” includes their predominantly passive holdings across a wide range of asset classes. From an adviser’s perspective, they are also “straightforward” to recommend as they are managed in line with customers’ attitude to risk (ATR) ratings (as opposed to against more traditional peer group benchmarks). So that, once selected, the fund should remain suitable for as long as the customer maintains their ATR. This makes the “effort”

required by an adviser much less both at outset and on an ongoing basis, consistent with the lower advice fees likely to be billable post-RDR.

Collective sales could increase across the market at the expense of more traditional life and pensions products. The latter includes those products that have historically been sold with much higher levels of commission. RDR will effectively remove any previous product bias that may have existed as a result of the level of commission being paid, and hence collectives will be placed on a much more level playing field. However, somewhat bizarrely, the FSA rules permit the continuation of legacy trail commission following a fund switch inside a life and pensions product wrapper but not if held as an unwrapped collective fund. This has led to suggestions that, certainly in the run-up to R-Day, some advisers may recommend a life and pensions product over a collective investment in order to be able to “lock into” this future trail commission flow after advising on fund switches.

Another by-product of the new RDR rules might be that advisers recommend fewer regular contribution plans. Previously, for setting up a product where the customer was committing to paying in a series of regular contributions, a product provider could effectively “advance” commission in respect of future contributions (so-called “factoring”). RDR bans this and so sales of regular contribution business could fall correspondingly.

Fund groupsCommentators predict that those fund houses with the strongest brands and investment team pedigrees are likely to be the biggest winners from RDR and fund ratings will become even more important as advisers and customers “fly to quality”. Such funds and houses could take market share as some advisers seek to abdicate individual fund-picking and the use of mechanical online fund selection tools becomes more widespread.

As has already been mentioned, there could be a growth in demand for more passive and managed solutions such as multi-asset funds although overall gross industry sales could fall as reinvestment of existing assets reduces (but with a corresponding increase in net sales).

The annual management charges (AMCs) being levied on funds will become more prominent with fund managers needing to demonstrate the value they are adding and the charges they are making for active management.

Perhaps the most significant operational implication for fund managers is that they will need to establish a new range of retail share classes (or make their institutional share classes more widely available) for new business post-R-Day. Typically, retail share classes include implicit loadings for commission and/or AMC rebates and these will need to be stripped out. The diagram above shows how the AMC for a typical 1.50% a year AMC fund share class is currently shared and how this might change after-R-Day.

The new range of share classes (the second diagram above) have been termed “factory gate” or “clean” share classes.

given that each fund management group is likely to have in place a multitude of different commercial arrangements with different distributors (reflecting the financial value of each relationship) this could potentially mean some groups will have to set up many new share classes in order to replicate the range of current arrangements. In practice, given the operational cost of running share classes, there is likely to have to be a delicate balance between maintaining the current net terms for each distributor and simply having a manageable number of share classes. Fund management groups will aim for their own pre- and post-revenue to be broadly neutral, but may come under pressure from some distributors seeking to increase their own share of the value chain.

CoFunds has already announced its intention to launch a range of RDR clean share classes in the summer, and all fund groups wishing to have their RDR share classes on the CoFunds platform from the start need to have them available within these timescales. In addition, J.P. Morgan and Schroders have already launched RDR-friendly share classes on some of their funds available directly.

As described above, commission will be replaced by an adviser charge — a fee for the provision of advice agreed explicitly between the adviser

and their client. while platforms already largely support an explicit payment to advisers, fund groups will need to consider if they also wish to support this facility. This is likely to mean a significant investment on behalf of any fund group although it is not clear what the demand might be.

ConclusionThe next six months is unlikely to be a holiday camp for fund management groups as they struggle to develop their RDR strategies. whatever path they decide to follow, they will need to be flexible as the new rules become embedded and reactions of customers and advisers alike evolve. Longer term it remains to be seen whether or not RDR is viewed as a high point or one of woe!

Iain buckle Head of Commercial Development Aviva Investors UK Funds Limited

disclaimerExcept where stated otherwise, the source of all information is Aviva Investors. Any opinions expressed are based on the internal forecasts of Aviva Investors and they should not be relied upon as indicating any guarantee of return from an investment managed by Aviva Investors. no part of this document is intended to constitute advice or recommendations of any nature. The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested.

Aviva Investors is a business name of Aviva Investors UK Funds Limited. Registered in England no. 2503054. Authorised and regulated by the Financial Services Authority. FSA Registered no. 147088. Registered address: no. 1 Poultry, London EC2R 8EJ. An Aviva company.

www.avivainvestors.co.uk CI062145 04/2012

1 A rebate is a refund given on a fund’s annual management charge (AMC) and has historically been the mechanism used by fund management groups to enable fund platforms to pay trail commission to distributors and collect their own platform fee.

Total AMC = 1.50% a year (all elements loaded into AMC).

Fund manager charge 0.75%

Adviser charge 0.50%

platform fee 0.25%

Total AMC = 0.75% a year (only fund manager element in AMC, other charges separate and explicit).

Fund manager charge 0.75%

Adviser charge e.g. 0.50%

platform fee e.g. 0.25%

the annual management charges (amCs) being levied on funds will become more prominent with fund managers needing to demonstrate the value they are adding and the charges they are making for active management.


During the progress of what became the Financial Services Act 2010 (the Act), the then opposition led an amendment to introduce contractual schemes and limited liability partnerships into the parts of FSMA 2000, which deal with the authorisation and regulation of collective investment schemes. These provisions did not survive into the Act.

In January, however, the consultation proposed two new models of authorised collective investment scheme known as contractual schemes. one type of contractual scheme is the co-ownership scheme; the other, a partnership scheme based on the Limited Partnership Act 1907. The consultation closed in March and the industry awaits further details from the government concerning the final form of the regulations. This article looks at the overall legal structure of the two types of contractual schemes.

As the regulations are principally designed to introduce models of UCITS, they can be made by HM Treasury under the European Communities Act 1972. while this has some procedural requirements, it should prove simpler and faster than needing to introduce primary legislation to amend FSMA 2000. Since there is a desire not to distort the promotion of collective investment schemes (CISs), then it is expected the regulations will also apply so as to allow the new models to be used for non-UCITS retail schemes (nURSs) and qualified investor schemes (QISs).

The contractual scheme regime is constructed by amendments to FSMA 2000, to the Limited Partnership Act 1907, and consequent changes to secondary legislation. The Treasury has also published proposed changes to relevant tax legislation to remove tax impediments to investment.

The FSA has also consulted on relevant changes to the Collective Investment Schemes sourcebook (CoLL) section of its Handbook of

rules. while the response of government and the FSA following the consultations are not yet known, it is clear from the comments made by several respondents that there could be significant changes in some of the areas.

The two types of scheme proposed are very different. In co-ownership schemes, the arrangements constituting the scheme are contractual. They must be constituted by a deed entered into between the operator and depositary. Participants in the scheme have units and are co-owners of the scheme property itself as tenants in common (in England and wales).

the co-ownership schemeThe co-ownership scheme itself has no legal personality. This fact gives rise to several important characteristics. In the more common example of open-ended investment companies (oEICs) entering into financial transactions, it is the company itself that is the party and is liable under the contract but also entitled to the fruits of any transaction. of course, a manager of one form or another may arrange the financial transaction as agent for the oEIC. but what does not occur when the scheme is a legal person is that the participants (unit-holders) themselves become liable for any of the financial transactions. The participants’ entitlement is simply to share proportionally and collectively in profits and losses arising from the acquisition and disposal of scheme property and any income or profits arising from the holding and management of that property. In the co-ownership scheme, however, as there is no legal personality, then the scheme property itself is actually owned by the participants (with the legal title of course vested with the depositary).

In case the significance of this is lost, if the co-ownership scheme enters into a derivative contract under which it is possible that there is significant downside risk, then since the scheme itself has no legal personality, the

tax tRaNSpaRENt FUNdS Early this year, hm treasury issued a consultation on introducing tax-transparent funds in the Uk.1 the primary intention? to facilitate the authorisation of pooled master funds both UCItS- and tax-transparent.

participants are themselves directly liable for that debt. This means that the regulations must address three important areas:

• The power of the operator to make the participants so liable.

• The extent to which third parties must be concerned with powers and capacity of the participants.

• And the extent to which the participants liability should be limited and the attribution of any losses in an insolvency.

The power of the operator to bind participantsThe regulations provide that the deed must authorise the operator to enter into contracts that are binding on the participants only for the purposes of, or in connection with, any acquisition or disposal of property, and subject to that, the deed must not authorise the operator to enter into contracts.

There is still a question as to whether this limited power to enter into contracts that bind the participants is widely enough expressed. In policy terms, it is quite understandable that the government should be cautious about allowing an operator to bind participants for any form of agreement. whatever for example, if the operator took on onerous leases of IT equipment, and it was then suggested that the participants themselves were liable for that contract or any termination payment? nevertheless, in the usual course of the narrow business of managing the property of a CIS, there may be a need in the final regulations to have slightly wider powers to bind the participants.

Third partieswhen a bank enters into a financial transaction with a CIS, it will ask itself whether the scheme has the power and capacity to enter into the transaction. but in a co-ownership scheme, the participant itself becomes an owner of the property. what if that person is not allowed directly to hold such property? For example, the participants may be of any type or located in a particular country such that is not permitted to enter into certain financial transactions. A bank dealing with an oEIC does not have to be concerned with the nature and identity of the present unit holders. but if a participant is not allowed (by its own law or regulation) to hold certain property

It is quite understandable that the government should be cautious about allowing an operator to bind participants for any form of agreement. Nevertheless, there may be a need in the final regulations to have slightly wider powers to bind the participants.

directly, then it would still not be allowed to in a co-ownership scheme since it is still directly owning this prohibited property (as a co-owner with the other participants).

This has two aspects to it. on the one hand, the draft regulations provide that a person who enters into a contract (of the type where the operator can bind participants) is deemed to have actual knowledge of the scope of the authority given to the operator by the contractual scheme deed. So if an operator is acting outside its powers, then a third-party is fixed with that knowledge and therefore exposed to certain legal risks if they proceed (the nature of which is outside the focus of this article as is the question as to whether the precise drafting needs some revision).

but the regulations also provide that the validity of an authorised contract shall not be called into question on the ground that a participant lacks capacity to authorise the operator to enter into such a contract. So although a bank will need to consider the scheme deed, it will not have to be concerned with the identity of the participants. As an aside, existing approaches to anti-money-laundering are also not expected to require this.

InsolvencyAs a participant is bound by any authorised contract they could in theory have unlimited liability for losses. The regulations, therefore, need to limit the liability of any participant to the value of its participation at the time when any debts fall to be discharged.

As the operator is bound to enter into contracts only as an agent, it follows that there can be circumstances in which a liability attributable to the co-ownership scheme — for instance, on hugely loss-making derivative contracts — may exceed the value of the scheme property. As the participants are not further liable, there would therefore be a circumstance in which the all creditors’ claims can be satisfied. So the regulations also provide for the winding-up of the scheme as if it were an unregistered company. This application of the Insolvency Act through seeing certain entities as unregistered companies is not unusual and does therefore impose the well regarded principles of pari passu distribution notwithstanding the country in which a claimant is based or, subject to very few exceptions, the nature of their claim.


limited partnershipsThe regulations introduce limited partnership CISs by modifying the Limited Partnership Act 1907. To introduce a tax-transparent scheme compliant with UCITS has required quite a number of changes.

The proposal in the consultation was that the operator of the scheme would be the general partner. Clearly some respondents to the consultation have pointed out that the current practice with unauthorised schemes of this type is that the general partner appoints an external manager and that it is that manager who is the operator. one impact of this is that the authorised firm (the operator) can have limited liability, whereas the general partner, of course, has unlimited liability for the debts of the partnership. The FSA consultation also proceeds on the basis that the operator must be the general partner. How the government responds to the calls to allow an external manager to be the operator will be of interest to many and may impact the attractiveness of the limited partnership scheme; especially as the co-ownership scheme operator can, and therefore will, have limited liability.

Since the Limited Partnership Act 1907 requires on formation of a partnership that there is at least one general partner and at least one limited partner, the regulations propose that the depositary is the first limited partner. Since the depositary is in no other sense a participant, this characterisation has met with some criticism, especially as it appears to have no other role than to meet existing incorporation requirements of the 1907 Act. This criticism is, despite the regulations, making it clear that if the depositary does become involved in management in any way, it does not thereby get treated as a general partner with unlimited liability, which would otherwise be the position under the 1907 Act. Again, this is an area in which it must be possible that the final regulations show some changes.

The participants in the scheme will be limited partners. Under the 1907 Act, there are very severe restrictions on when a limited partner can take out its contribution with immunity. but it is necessary for the partnership scheme to work commercially as a CIS so that the participants can receive their proportionate share of the value of the scheme property by being paid out. The provisions of the 1907 Act have been re-written to allow this.

Umbrella schemesIn the consultation, umbrella schemes are only addressed in relation to co-ownership schemes. Some have asked why this is and whether the regulations ought to be extended.

given that the protected cell regime was introduced in the UK last year for oEICs, it has also been noted that the draft regulations use different language to that regime when referring to the segregation of assets. one reason is that the protected cell regime provisions were designed to bolster investor protection; in the draft contractual scheme regulations, the provisions on segregation are needed to create a sub-scheme where there is no legal personality. nevertheless, this is one area in which there may be no harm in ensuring identical language is used. At the very least, it should ensure more consistent documentation and more consistent interpretation in case any of these provisions ever need to be tested by the courts.

ConclusionThe full structure of the contractual scheme regime is not yet finalised, but in many areas it is now sufficiently clear. given the amount of work and analysis that has had been carried out, the government and the FSA have followed a very fast and compressed timetable. Many industry representatives have assisted and the IMA has played its part. It is very welcome that the government has listened to industry and committed to address competitive weaknesses in the range of fund structures available here, not least given the very extensive suite of tax treaties negotiated by the UK from which these new vehicles will benefit.

Guy Sears Director, wholesale Investment Management Association

as a participant is bound by any authorised contract they could in theory have unlimited liability for losses. the regulations, therefore, need to limit the liability of any participant to the value of its participation at the time when any debts fall to be discharged.

1 HM Treasury consultation on contractual schemes for collective investment, published 9 January 2012.


FSA discussion paper (dp12/1) This was the first paper to be published in the UK outlining the FSA’s initial thoughts on implementing the AIFMD.

The FSA says that it is likely that the final rules will probably take the form of a directive and a regulation.

The types of funds that the FSA believes will be within scope are: hedge funds, fund of hedge funds; private equity and venture capital funds; property funds; investment trusts; real estate investment trusts (REITs); FSA-authorised non-UCITS funds, including nURSs, FAIFs and QISs; charity funds; commodity funds; and infrastructure funds. However, the DP states that the FSA intends to undertake a preliminary firm categorisation exercise to determine the scope more clearly.

The Directive will also result in changes to the way in which AIFs are managed and marketed to retail consumers, including non-UCITS retails schemes (nURSs).

The paper was split into nine chapters that included the following:

Chapter 4: operating requirements of AIFMsExisting MiFID firms and UCITS management companies that consider they will be AIFMs should be aware of several new principles, including the following.

due diligenceFor investments in real-estate and partnership interests, there are new requirements for AIFMs:

• AIFMs to establish a business plan consistent with the duration of the AIFs and market conditions.

• Due-diligence policies and procedures that take account of the nature, scale and complexity of the assets invested in.

• ongoing requirements for business plans to be updated to take account of any material changes in investment strategy or market conditions and for regularly reviewing and updating their due-diligence procedures and policies.

AIFM’s will be required to keep records of significant opportunities and detail the risks identified with these investments.

Record-keeping responsibilities include requirements to retain minutes of meetings, preparatory documentation and economic and financial analysis conducted to assess the feasibility of a project or contractual commitment.

thE Uk'S pRoVISIoNal thINkINg oN thE appRoaCh to ImplEmENtINg thE aIFmd In our previous edition of European Fiduciary Services News and Views, we provided you with an update on how things stood in terms of the aIFmd negotiations. We summarised the requirements of the level 1 directive 1 and provided various commentary on ESma’s final advice to the European Commission.2 here we will provide a summary of the Financial Services authority’s 3 and hm treasury’s 4 discussion papers on the implementation of the aIFmd in the Uk.

Appointment of counterparties and prime brokersFair treatment: whose provisions are similar to the FSA’s Treating Customers Fairly (TCF) principles.

Conflicts of interest: the FSA requirements are already roughly aligned with the AIFMD provisions and ESMA’s advice on: types of conflicts, policies to be put in place, independence in conflicts management, record-keeping and disclosure obligations, and strategies for exercising voting rights. However, the FSA advises firms to take particular note of the examples of conflicts of interest indicated in ESMA’s advice (box 20).

Remuneration: work on detailed guidelines for the remuneration provisions has not yet commenced, but the FSA is considering two possible options to implement the remuneration provisions:

• bringing AIFMs within the scope of the existing FSA Remuneration Code.5

• And having a new Remuneration Code specifically for AIFMs “modelled closely on the existing code.”

If a new code is created, the FSA will need to address the potential issues faced by those AIFMs caught by both the Remuneration Code and the AIFMD.

organisational requirementsRisk management: ESMA has set out conditions that satisfy the test of risk management being functional and hierarchically separated from other functions, including portfolio management in box 30.

The FSA says that it needs to review a UK AIFMs approach to separation of the risk management function in line with the principle of proportionality. The FSA suggests that if a common platform firm is to be subject to the AIFMD, it may need to review its risk management functions to ensure it meets the Directive requirements.

Systems and governance arrangementsLeverage and collateral delegation: UK-authorised investment managers are already required to comply with Handbook requirements for general outsourcing, with an obligation to notify the FSA when they intend to rely on a third-party provider (SySC and SUP). but, the AIFMD imposes stricter notification requirements on AIFMs intending to outsource some of their activities. while not significantly different to that required by MiFID,6 it does require advance notification to the competent authority before delegation arrangements can commence.

Capital requirements and professional indemnity insurance: following the transposition of the AIFMD, the FSA expects there will be at least six prudential categories of AIFM (excluding smaller AIFMs). The FSA provides examples in the paper, which are intended to be descriptive only (pages 39-40).

Requirements for internally managed AIFsThe AIFMD requires an internally managed AIF to have initial capital of at least EUR300,000 and specifies that such an AIF should also have either additional own funds or hold Private Indemnity Insurance (PII) to cover potential liability risks arising from professional negligence.

the types of funds that the FSa believes will be within scope are: hedge funds, fund of hedge funds; private equity and venture capital funds; property funds; investment trusts; real estate investment trusts (REIts); FSa-authorised non-UCItS funds, including NURSs, FaIFs and QISs; charity funds; commodity funds; and infrastructure funds.


The FSA feels that it is not absolutely clear whether the other requirements of Article 9 of the AIFMD applies to internally managed AIFs, but its view is that they do not apply and therefore do not expect to apply them.

Cross-reference to the Capital Adequacy Directive (CAD) 7

The FSA needs to take account of the changes currently being made under the CAD to ensure that they are properly reflected in its final rules. The FSA also intends to consider the current interpretations of the terms set out in the Prudential Sourcebook for UCITS Firms (UPRU) and general Prudential Sourcebook (gEnPRU) for UCITS firms and UCITS investment firms, respectively.

Chapter 5: AIFM management requirements This chapter covers the following topics for discussion:

ValuationThe FSA needs to consider the compatibility of the current requirements relating to valuations and those of AIFs under the AIFMD. The AIFM must ensure the valuation function is performed either by itself or an external valuer, but when performed by the AIFM, the FSA may require that the valuation procedures and/or valuations are verified by an external valuer or, where appropriate, an auditor.

External valuerThere are already obligations placed on an AIFM to demonstrate certain requirements to the FSA, but the FSA will now need to consider what professional guarantees by an external valuer would be sufficient to show that it could meet the requirements of the AIFMD.

The calculation of nAVESMA’s advice sets out the general requirements for calculating the net asset value (nAV) per unit or share, but does not prescribe the calculation itself.

The FSA is aware that for certain participations in a fund, such as equity or partnership interests in a private equity fund, they are not evidenced by the usual concept of holding a share or unit in that fund. The FSA needs to consider how nAV calculations should apply to these funds.

liquidity managementThe heterogeneous and diverse nature of the population of AIFs within scope of the AIFMD present significant challenges in specifying the detailed mechanics or procedures for the management of liquidity requirements.

leverageThe AIFMD defines leverage as a method by which the AIFM increases the exposure of an AIF it manages, whether through borrowing of cash and securities or leverage embedded in derivative positions or by other means (Article 4 (1) (v)) (box 94 ESMA Advice).8

The FSA asks what criteria should be taken into account when considering whether arrangements of capital commitments might be temporary in nature.

Calculating leverageThere are three methods allowed: gross, commitment and advanced.

In all instances where the AIFMD requires the calculation of leverage, the AIFM will be required to carry out its calculations using at least both the gross and commitment methods.

These are based on the commitment approach as set out by CESR.9

It is only if the AIFM considers that neither of these methods provides a fair reflection of the leverage levels within a given AIF that the AIFM may also use the advanced method. This would have to be in addition to using the gross and commitment methods, and only where the AIFM had notified the FSA.

In the discussion paper, the FSA asks for instances where neither the gross nor commitment approach provide a reasonable or approximate reflection of leverage within an AIF.

with regards to limits and supervisory restrictions on AIFM leverage, under the AIFMD, an AIFM must set a maximum level of leverage for each AIF under management.10 AIFMs also need to keep investors regularly informed on the levels of leverage used in relation to the AIF in which they have invested and any changes to the maximum levels of leverage that AIFMs have set.

AIFMs must demonstrate to regulators that these self-set leverage levels are reasonable and that they abide by them. The AIFMD also requires competent authorities to assess the risks that the use of leverage by AIFMs could pose to the financial system. If concerns arise, the FCA will have powers to take action for a group of AIFMs and use leverage over a single or group of AIFMs independently of the Financial Policy Committee (FPC).

Investment in securitisation positionsThe FSA explains that this refers to investment in asset-backed securities. The FSA asks what aspects of the proposed requirements in the AIFMD present the most significant challenges or create the most significant degree of uncertainty for AIFMs, including the interaction with existing requirements applicable to credit institutions and insurance undertakings.

Chapter 6: transparencyThis chapter covers the following topics.

disclosure to investorsAIFMs are required to make available certain information for investors before they invest in an AIF. However, there is no prescribed format for this in the AIFMD.

In the FSA’s view, as requirements for professional investors are similar to those for

QISs, there is a need to avoid any duplication of requirements, and consider what additional requirements might need to be implemented.

Retail investorswhen marketing UK-authorised AIFs to retail investors, the FSA needs to consider whether the additional FSA disclosure requirements for nURSs should be maintained after AIFMD implementation.

Preferential treatmentAIFMs must describe how they ensure fair treatment of all investors, especially in relation to situations where an investor or sub-set of investors has received preferential treatment.

If the Commission adopts implementing measures on the basis of ESMA’s final advice on fair treatment (box 19), the FSA will need to consider whether its existing fair treatment requirements, i.e. TCF, need further clarification for professional investors.

The FSA DP then goes on to explain the AIFMD and ESMA’s requirements for the following on liquidity disclosure: disclosure obligations relating to liquidity arrangements; special arrangements for purposes of liquidity management; new arrangements or material changes where the AIFM must notify investors; risk profile and management with a requirement for the AIFM to disclose current risk profiles of AIFs; and frequency of disclosure, which is intended to be consistent with an AIFMs periodic reporting to investors.

AIFMs’ use of leverageThe FSA requires disclosure of: any changes to the maximum level of leverage the AIFM may employ on the AIFs behalf; any right to re-use collateral or any guarantee granted under the leverage arrangements; and total amount of leverage employed by the AIF.

For all of these requirements (contained in Article 23 of the AIFMD), the FSA asks whether firms consider that their existing QIS disclosure requirements should be maintained.

Annual reportingwhile the AIFMD does not specify much detail in the annual reporting requirements, it does list a minimum set of mandatory information to be provided to investors, competent authorities of the AIFMs and, in some circumstances, the competent authority of the AIF.

If the Commission adopts implementing measures on the basis of ESma’s final advice on fair treatment (Box 19), the FSa will need to consider whether its existing fair treatment requirements, i.e. tCF, need further clarification for professional investors.


disclosure of remunerationArticles 22 (e) and (f) of the AIFMD introduce new requirements on AIFMs for disclosure of remuneration. This must be disclosed in the AIFs annual report.

1. Information must cover: total amount of remuneration in a given financial year, split into fixed and variable remuneration, paid by the AIFM to its staff and number of beneficiaries. where relevant, the AIFM must disclose carried interest paid by the AIF.

2. The annual report must also contain the aggregated amount of remuneration broken down by senior management and members of staff whose actions have a material impact on the risk profile of the AIFM or the AIF.

The FSA asks in the DP what the implications are for firms already subject to the Remuneration Code, and also those outside it, i.e. real estate funds and private equity firms.

reporting obligations to the FSAAIFMs will be required to provide certain information regularly to the FSA for each AIF under their management. Reporting will contain information on principal markets and instruments in which they trade on behalf of the AIFs and on principal exposures and concentrations in AIF portfolios. The FSA may also require further information on a periodic and ad-hoc basis to monitor systemic risk.

Chapter 7: depositariesThis section outlines the requirements on depositaries, including duties such as the safekeeping of assets, oversight of administrative functions and the standard of liability.

Chapter 8: marketing – professional investorsThe AIFMD will replace the UK’s existing rules on the marketing of EU AIFs managed by EU AIFMs to UK professional investors, including through national private placement (nPP).

one way of testing whether the distribution of an AIF is within the scope of the AIFMD is by determining who initiates the marketing. Unfortunately, the AIFMD does not provide any specific details or a test to determine who initiated an investment transaction.

Exemptions generally exist in retail marketing rules for professional investors. These

rules, and any relevant industry practice for marketing of AIFs in the UK, including by private placement, may need adapting for AIFMs to ensure firms comply with the AIFMD.

Marketing on behalf of a uK AIFMMarketing in line with the AIFMD applies only to offering or placement of units or shares on behalf of AIFMs in relation to AIFs under management (Article 4(1)(x) of the AIFMD).

The FSA believes that some AIFMs also distribute units or shares of AIFs managed by other AIFMs. Its current view is that the AIFMD may prevent MiFID investment firms and credit institutions (including those outside the EU) from offering or placing units and shares of AIFs to EU investors.

The FSA believes it is possible that the Commission, along with national regulators, may consider the definition of “marketing” in AIFMD transposition workshops during 2012. So it has asked firms which marketing practices they consider may be within the definition of “marketing” in Article 4(1)(x) of the AIFMD.

The FSA also needs to consider in which instances offering or placement is undertaken on behalf of the AFM and, if so, whether this may be subject to other aspects of the UK or EU regulatory framework, including MiFID.

private placementThe Treasury has provisionally indicated its intention to continue to permit the marketing of non-EU AIFs managed by EU AIFMs, and EU and non-EU AIFs managed by non-EU AIFMs, to UK professional investors, subject to compliance with minimum requirements specified in the AIFMD.

In many if not all cases, this will mean that, subject to these additional requirements, the private placement of non-EU AIFs and EU AIFs managed by non-EU AIFMs in the UK, will continue. The section goes on to discuss the areas for consideration by the FSA.

public offers of listed AIFsSome AIFMs will be managing and/or marketing listed AIFs, so it is important to draw a distinction between listing (“admission to trading”) and “marketing”.

FSA discussions with practitioners suggest that in many instances listed shares are also normally marketed by virtue of the public offer

that is made under a prospectus drawn up and published in line with the requirements of the Prospectus Directive.11 In instances where an offer has been made, it appears that the AIFM of the listed AIF will be required to comply with the relevant provisions in the AIFMD.

The FSA asks if firms agree that those listed AIFs marketed by virtue of a public offer are undertaking the activity of “marketing” as defined in the AIFMD and are therefore subject to the relevant requirements.

Chapter 9: categories of AIF and specialised regimesMost if not all listed closed-ended investment funds will be AIFs once the AIFMD is implemented. This section of the DP considers how the existing listing regime might be adapted.12

Application of the AIFMd to listed AIFsThe AIFMD determines that an AIFM must either be an external manager or be the AIF itself.

Most listed AIFs have contractually appointed external portfolio managers, who could potentially be the AIFM when the AIFMD is implemented. but unfortunately, as discussed in the paper, the FSA’s key regulatory strategy for this sector has been an emphasis on the role of the board of directors of a listed fund.

There are oversight obligations under the AIFMD on AIFMs, and the FSA would attribute some of these responsibilities to the governing body in a listed fund. As such, the FSA is considering introducing a requirement into Chapter 15 of the Listing Rules to set out that, in the case of a premium listed closed-ended investment fund, the board of directors of an AIF must be able to exercise ultimate and unfettered oversight over certain matters.

The paper then goes on to discuss possible amendments to the listed investment fund regime as well as application to non-EU AIFs.

retail AIFsThe AIFMD permits UK authorities to allow AIFMs to market AIFs to UK retail investors and impose stricter requirements than those applicable to AIFs marketed to professional investors.

The FSA’s provisional analysis is that most, if not all, existing nURSs will be categorised as AIFs, so they will be required to have an AIFM complying with the requirements of the AIFMD.

aIFms will be required to provide certain information regularly to the FSa for each aIF under their management. Reporting will contain information on principal markets and instruments in which they trade on behalf of the aIFs and on principal exposures and concentrations in aIF portfolios.

Some of the requirements in the AIFMD are more detailed than the nURS rules (i.e. valuation rules), but in other areas (i.e. investor disclosure) nURS rules contain more detailed requirements than the AIFMD.

Some nURS funds may deem themselves to be internally managed under the AIFMD, so the FSA will need to consider its approach to authorising nURSs, including how APER is applied to directors of internally managed nURSs, for example.

The AIFMD contains a number of requirements common to the UCITS Directive and MiFID. For example, rules include elements of organisational requirements and operating conditions and the duties of the depositary to oversee certain aspects of the management of the AIF.

The FSA asks whether it should consider aligning the requirements for UCITS management companies and AIFMs where the AIFMD and UCITS Directive contain common requirements.13

The AIFMD will permit an EU AIFM to market an EU AIF to UK professional investors, as long as it notifies the FSA. The FSA therefore needs to consider under what conditions an AIFM would be entitled to market to UK retail investors.

recognised AIFsUnder the current recognition regime, regulators assess whether the levels of investor protection in the countries or territories to be designated is equivalent. The FSA needs to consider whether it is possible and/or desirable to maintain the current FSMA regimes and their purpose and compatibility with the AIFMD. Also, as the regime currently only applies to CISs, they must consider whether it applies to those AIFs outside the current definition.

Internally managed AIFsFSA discussions with firms suggest that investment funds structured as corporate vehicles, including oEICs, are likely to be deemed capable of being internally managed. In the instance where the authorised investment fund is an oEIC, the oEIC itself would have to seek authorisation as an AIFM and as an AIF.


The FSA will now need to review the oEIC regulations and its rules applicable to authorised investment funds to ensure they are compatible with the AIFMD requirements for internally managed AIFs.

Qualified Investor Schemes (QISs) It is likely that most if not all QISs will need to become AIFs so the rules currently applicable to managers of QISs need to remain compatible with the AIFMD.

one option might be to remove most or all of the FSA’s rules applying to a QIS manager, rules which go beyond the requirements of the AIFMD, but the FSA seeks views on this matter.

Charity pooled Investment Funds (CpIFs)Many CPIFs are subject to regulation by the Charity Commission under domestic rules similar to those applicable under the domestic authorised investment funds regime.

Many if not all CPIFs will be AIFs under the AIFMD. Managers of CPIFs will be required to become AIFMs and be subject to the requirements of the AIFMD.

The FSA had previously consulted on developing a bespoke CPIF regime open only to charity investors, bringing the regulation of CPIFs more fully into the FSAs regulatory remit, while preserving the existing UK tax regime.

The FSA now needs to consider responses to the consultation against the requirements of the AIFMD.14 It will also consider how the marketing requirements under the AIFMD operate, given that a number of charities may be classed as retail rather than professional investors. The FSA’s initial discussion with the industry suggests that some of the AIFMD requirements may create particular challenges for certain types of CPIFs.

unregulated AIFs and CISsThe AIFMD permits the UK authorities to allow the marketing of AIFs to UK retail investors with the safeguard of stricter requirements.

Managers of unregulated CISs (UCISs) might come within the scope of the AIFMD, but managers carrying on the regulated activity of operating a UCIS are already authorised by the FSA.

The FSA has recently expressed concerns about the promotion and sale of UCIS to UK retail investors.15 As such, the FSA will be

considering the current prohibitions on the retail marketing of unregulated AIFs and more broadly the circumstances in which these funds are sold to retail investors.

HM treasury policy options for implementing the AIFMdThis informal discussion paper, published on 14 March 2012, highlighted initial views on a number of high-level policy decisions that need to be taken into consideration for transposition of the AIFMD in the UK.

The paper is of most relevance to UK-based fund manager’s that deem at least part of their regular business as managing AIFs (including UCITS management companies if they manage AIFs as well). It will also be relevant to discretionary investment managers, operators of unregulated collective investment schemes and investment companies that do not employ an external fund manager.

In summary, the paper covers a number of high-level policy decisions and a considerable number of operational ones: requirements for AIFs falling below the Directive’s threshold for full authorisation; interaction with proposed regulations on venture capital and social entrepreneurship funds; application of the approved persons regime; the extent to which AIFs should be marketed to retail investors; and the Private Placement regime.

The government has an expectation that a “copy-out” approach will be adopted wherever possible and says that strong justification will be required for proposed additional measures that exceed the terms of EU legislation (so-called gold-plating).

More detail is provided on the following subjects.

Requirements for sub-threshold AIFMs The AIFMD requires AIFMs to be authorised, but permits Member States (MSs) to establish a de minimus regime for AIFMs managing AIFs with assets under management below certain thresholds (EUR 100 million or EUR500 million for leveraged AIFMs). MSs may, however, apply additional requirements and the government will need to decide the categories of small AIFMs for which it will exercise this option, and also the extent to which additional requirements should be applied.

A range of options open to the government for smaller AIFMs, include the following:

Full application of the directive requirements to all smaller AIFMsAIFMs will need to be authorised by the FSA. The FSA has indicated that, in practice, it would apply Directive requirements in a proportionate way to smaller AIFMs according to the regulatory risks that these might present.

Under this option, small AIFMs newly subject to FSA regulation would be subject to the full requirements of the Directive. The greatest impact would be on the managers of a small number of UK-domiciled funds that neither fall within the current UK definition of Collective Investment Scheme nor are subject to Listing Rules and the requirements of the Prospectus Directive.

This option also represents a significant increase in regulation for companies that are subject to the requirements of the Prospectus Directive and the Listing Rules but that fall outside the current UK definition of Collective Investment Scheme. In practice, this includes UK-domiciled investment trusts and venture capital trusts (VCTs).

AIFMs already subject to FSA authorisation would be subject to a limited number of additional obligations. For example, the depositary, use of leverage by AIFMs and private equity provisions.

This option goes well beyond the minimum requirements of the Directive and, depending on how the FSA chooses to implement it, a proportionate regime could represent significant gold plating.

Potential drawbacks with this approach are that it would impose the costs of full authorisation on all AIFMs, irrespective of other safeguards;

the government has an expectation that a “copy-out” approach will be adopted wherever possible and says that strong justification will be required for proposed additional measures that exceed the terms of EU legislation (so-called gold-plating).

for example, for small investment trusts already subject to the Listing Rules and the Prospectus Directive and irrespective of whom the funds are marketed to.

Apply a lighter regime selectively, differentiating between AIFMHere a lighter regime would be applied selectively to some small AIFMs. Depending on the type of small AIFM, it would be subject to registration only, selective application of authorisation requirements or full Directive authorisation. Differentiation between different types of AIFM would be based on objective criteria.

The regime most closely resembling the status quo would involve:

1. Retaining FSA authorisation for small AIFMs managing CISs, including QISs, nURSs and UCISs, with minimal new Directive requirements applying.

2. Retaining FSA authorisation (with minimal new Directive requirements applied) for small external AIFMs of non-CIS funds, i.e. those managing investment trusts and VCTs, together with those hedge funds, private equity firms and other types of fund that are structured as investment companies.

3. And applying a limited registration-only regime to internally managed non-CIS funds with assets below the Directive’s thresholds.

For AIFMs already authorised this could include:

1. Applying some of the new Directive requirements selectively where these are considered to bring in appropriate levels of investor protection.


2. Differentiating between AIFMs that are currently authorised, for example, on the basis of applying a lighter regime for external AIFMs of non-CIS funds or a heavier regime for AIFMs of retail funds.

For AIFMs not currently authorised, this could include applying the Directive requirements selectively, e.g. applying the leverage requirements to internally managed non-CIS funds that routinely use leverage.

The government could potentially apply the sub-threshold exemption in full — all small AIFMs would be subject only to the de minimus AIFMD registration regime. In practice, this would entail registration with the FSA and the requirement to make certain disclosures to the FSA identifying the AIFM, the AIFs it manages and to provide sufficient information for the FSA to monitor systemic risk. For AIFMs not currently regulated by the FSA, it would represent the minimum increase in regulation required by the Directive; for AIFMs currently authorised, it would represent a substantial reduction in regulation.

The government is minded to apply a more selective approach as this would be consistent with the “copy-out” approach to EU regulation.

Proposed regulations on EVCFs and ESEFsThe Commission has proposed regulations on European venture capital funds (EVCFs) and European social entrepreneurship funds (ESEFs) under which managers of certain sub-threshold AIFs would be entitled to market to professional investors (and certain non-professionals) in the EU on compliance with the regulation provisions. The DP asks to what extent these types of funds are likely to benefit from the proposed regulations.

Approved persons regimeThe “approved persons” regime is a UK concept under the Financial Services and Markets Act 2000 (FSMA 2000) and is not required under the AIFMD. The UK is permitted, but not compelled, to apply the regime. The government may therefore decide whether or not to apply the regime to individuals within AIFMs newly subject to regulation, e.g. internally managed listed investment funds. The FSA has indicated that if the regime is applied, it would exercise its powers in a proportionate manner.

prosApplying the “approved persons” regime would give the FSA the opportunity to vet the suitability

of an individual to perform important functions because the regime covers individuals rather than the firm.

Cons Directors of companies are already subject to company law requirements and, in many cases, the Listing Rules, which impose corporate governance requirements. It could be argued that, given the existing degree of regulation, application of the “approved persons” regime in addition would be regarded as unnecessary gold-plating.

Marketing to retailThe AIFMD prohibits the marketing of AIFs to retail investors but gives MSs the discretion to permit marketing selectively and impose greater restrictions than those for marketing to professional investors.

Under the current UK regime, there are two types of UK fund within the scope of the AIFMD that may be marketed to retail investors: nURSs and companies subject to the general rules of company law, i.e. investment companies that need to produce a prospectus approved by the FSA and that comply with the Prospectus Directive.

Transposition of the AIFMD provides the opportunity to extend or restrict the range of schemes permitted to be marketed to retail investors. Any extension of the retail boundary may well require significant extra regulation before the additional schemes become suitable for retail investors.

Private Placement RegimeThe AIFMD permits MS to continue national private placement for at least the first 5 years of the application of the AIFMD. It requires that third party country (i.e. non-EU) managers of third country AIFs that wish to market their funds in a MS must comply with the Directive’s provisions on transparency and (if applicable) the rules on private equity disclosure.

The government may opt to apply additional AIFMD requirements for national private placement in the UK. In order to ensure continued investor access to third country AIFs, the government is minded not to impose additional requirements for third country managers of third country funds above the AIFMD minimum.

ConclusionThe FSA DP 12/1 closed for comments on 23 March 2012, and the HM Treasury paper closed for comments on 4 May 2012.

In terms of the FSA implementing the Directive into UK law, some measures may be reproduced in the new Handbook (FUnD) and other sourcebooks such as SySC and CobS.16 Questions relating to proposed Handbook changes will be discussed in a 2012 AIFMD consultation paper.

The FCA will be the competent authority for most AIFMs falling within the scope of the Directive and the FSA (FCA) aims to be in a position to receive potential AIFM applications for authorisation from Q2 2013.

The Commission was due to conduct transposition workshops from early 2012 with output (such as Commission Q&As), but unfortunately these appear to have been delayed. output from these workshops will be factored into perimeter guidance proposed by the FSA.

In terms of the HM Treasury paper, responses will help to inform a policy position for a formal consultation, which is expected in the summer 2012.

Following conclusion of both the FSA DP 12/1 and this HM Treasury discussion paper, draft legislation will be prepared and this will be the subject of a formal consultation that will take place in autumn 2012.

below is a timeline that summarises what is still to come.

Early 2012 EC to conduct transposition workshops (delayed).

Q1 2012 EC to propose implementing measures, including directly applicable EU regulations (delayed — although draft leaked).

Q2 2012 FSA/HMT to publish UK consultation paper.

Q2 2012 FCA (as successor to FSA) to receive AIFM applications for authorisation.

22/07/2013 UK is required to implement the AIFMD.

Amanda Hale Head of UK Fiduciary Technical Citibank International plc

transposition of the aIFmd provides the opportunity to extend or restrict the range of schemes permitted to be marketed to retail investors. any extension of the retail boundary may well require significant extra regulation before the additional schemes become suitable for retail investors.

1 From http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=oJ:L:2011:174:0001:0073:En:PDF, accessed in november 2011.

2 Final report: ESMA's technical advice to the European Commission on possible implementing measures of the Alternative Investment Fund Managers Directive, ESMA/2011/379, 16 november 2011.

3 DP12/1 implementation of the alternative investment fund managers directive, January 2012.

4 HM Treasury policy options for implementing the alternative investment fund managers directive, March 2012.

5 From http://fsahandbook.info/FSA/html/handbook/SySC/19A/3, accessed on 20 April 2012.

6 Directive 2004/39/EC on Markets in Financial Instruments.

7 Directive 2006/49/EC on capital adequacy of investment firms and credit institutions.

8 Final report ESMA's technical advice to the European Commission on possible implementing measures of the Alternative Investment Fund Managers Directive ref: ESMA/2011/379.

9 CESR/10-788.

10 Article 15(4).

11 CESR/10-788.

12 Article 15(4).

13 Directive 2009/65/EC on the coordination of laws, regulations and administrative provisions relating to undertaking for collective investment in transferable securities.

14 Charity pooled funds consultation, July 2009.

15 From www.fsa.gov.uk/Pages/consumerinformation/product_news/saving_investments/ucis/index.shtml, accessed on 20 April 2012.

16 which might replace the Collective Investment Scheme sourcebook (CoLL).

European Fiduciary Services news and Views | Second Edition 2012Citi Transaction Services | Ireland36 37

with the 1980s came an explosion in the use of oTC derivatives. This was really when the use of oTC derivatives became commonplace as a way of hedging and speculating on everything from exchange rates to the commodity markets. oTC derivatives became very complex very fast thanks to the involvement of wall Street-employed mathematicians and physicists. The 1990s saw a further surge in the complexity of the oTC derivatives market with significant growth taking place in the Credit Default Swap (CDS) market in particular. A CDS essentially acts like a form of insurance contract whereby in the event of a default or credit event, the buyer of the CDS receives the face value of the loan and the seller of the CDS takes possession of the defaulted loan. However, a CDS can be purchased where the buyer does not hold the loan instrument itself: these are called “naked CDSs”. This led to an increasing number of companies trading CDS contracts for speculative purposes, where they did not hold any of the debt they were insuring against.

naked CDS exposure contributed greatly to the default of AIg and Lehman, as outlined below. It is worth noting that this market carried with it considerable systemic risk, yet it was growing in the absence of accompanying regulation and even a certain amount of oTC deregulation, such as the Commodity Futures Modernisation Act of 2000 in the US.1

on 17 March 2008, J.P. Morgan Chase offered to acquire bear Stearns at a price of USD2 a share. The acquisition was completed at the renegotiated price of USD10 a share on 30 March. Six months later, on 15 September, Lehman brothers filed for bankruptcy with proprietary positions of approximately USD780 billion in mortgage-backed securities and a highly leveraged portfolio of stocks, bonds, oil, gold, derivatives and other investments. The following day, AIg suffered a liquidity crisis brought about by its CDS portfolio, insuring approximately USD441 billion’s worth of securities originally rated

REgUlatoRy REFoRm IN thE otC dERIVatIVES maRkEtS otC derivative trading is nothing new. Contracts for future delivery of commodities can be traced back as far as the Bronze age, from mesopotamia to hellenistic Egypt, and then on to the Roman Empire. at the turn of the 17th and throughout the 18th centuries, derivative trading on securities spread from amsterdam to England, France and germany. historical records suggest that banks came to prominence in the world of derivative trading during the 18th and 19th centuries. the creation of the Chicago Board of trade in 1848 was a significant event in the development of the derivatives market as it led to the development of the “to-arrive” contract in grain trading, which allowed grain farmers and traders to lock in the price of grain for delivery at a later stage. the need for the development of a to-arrive contract arose from the seasonality of grain and the resulting impact this had on the price. the to-arrive contract was standardised a number of years later and has developed into the futures contract as we know it today with the first futures clearinghouse formed in 1925. the Chicago Board options Exchange and the option pricing model formula of Fischer Black and myron Scholes were both created in 1973. these were significant events in the investment world that were to ultimately revolutionise the derivatives markets.


AAA, USD57.8 billion of which were structured debt securities backed by subprime loans, which led to its much publicised bailout by the Federal Reserve two months later.

The unprecedented events of 2008 have resulted in the proposal of far-reaching regulatory reforms in the oTC derivatives markets in particular. In September 2009, nine months after the AIg bailout, the g20 leaders held a summit in Pittsburgh at which the following was agreed:

“All standardised oTC derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by [the] end [of] 2012 at the latest. oTC derivative contracts should be reported to trade repositories. non-centrally-cleared contracts should be subject to higher capital requirements.”

The g20 believed the events of 2008 revealed specific problems within the oTC market. oTC deals are negotiated and executed on a bilateral basis and the nature of these bilateral arrangements means that the risks of the trade (e.g. counterparty default) lie with the individual counterparties to that trade.2 The opacity of the exposures resulting from these bilateral arrangements was also identified as a source of concern by the g20. The g20 is seeking to address the risks it has identified in the oTC market through the implementation of an intensive set of regulatory reforms with the aim of:

• Mitigating counterparty risk.

• Increasing transparency.

• Reducing operational risk.

These measures will be introduced via a series of new and updated regulations and directives on both sides of the Atlantic, primarily through the European Market Infrastructure Regulation (EMIR) and the review of the Markets in Financial Instruments Directive (known as MiFID II) in Europe and through the Dodd–Frank wall Street Reform and Consumer Protection Act (Dodd Frank) in the US. The interwoven nature of these reforms cannot be overemphasised, however, as updates to other directives such as the Market Abuse Directive (MAD) and the Capital Requirements Directive (CRD) also need to be considered when assessing and attempting

to understand the implications of the extensive changes to the oTC derivatives world that are in the process of being finalised.

EMIR

what is EMIR?on 15 September 2010, the European Commission published a draft regulation which proposed the introduction of mandatory central clearing for eligible oTC derivative transactions through clearing counterparties (CCPs) and the reporting of oTC derivative positions to trade repositories (TRs). This regulation has become known as EMIR. The mandatory clearing obligation will apply to “financial counterparties” as defined in EMIR. The definition includes a broad range of EU-authorised entities, including UCITS and non-UCITS collective investment schemes.

Even those who do not meet the “financial counterparty” definition could be captured — if their volume of oTC derivative trading is “material” and for purposes other than commercial hedging. The materiality of this trading will be measured using a clearing threshold, the setting and calculation of which is currently under discussion by ESMA in their “Discussion paper on draft technical Standards for the Regulation on oTC derivatives, CCPs and Trade Repositories” (Discussion Paper). This Discussion Paper was published on 16 February 2012, and market participants were invited to provide feedback by 19 March. The EMIR text was agreed on 9 February 2012 by the European Parliament and the Council of the European Union (EU). Michel barnier, the EU’s commissioner for internal markets and services, has said the EMIR rules will end an era of “opacity and shady deals”. ESMA will play a key role in the implementation of the new legal proposals as ESMA has been tasked with assessing the eligibility of the different classes of oTC derivatives that will be subject to the clearing obligation. This assessment has commenced in the Discussion Paper wherein ESMA has outlined its intention to take into consideration criteria defined in EMIR in determining the relevant clearing-eligible oTC contracts, namely: their degree of standardisation, volume, liquidity and the availability of pricing information.

EMIR is anticipated to apply from the end of 2012, in accordance with the g20 deadline.

Counterparty riskThe primary purpose of EMIR will be to ensure that all eligible standardised oTC derivative contracts traded between financial counterparties are cleared through a CCP. The CCP operates essentially as a type of “middle-man” sitting between buyers and sellers. In a traditional oTC transaction, the buyer bears the credit risk of the seller and vice versa. once EMIR is transposed, the CCP will assume the credit risk for eligible oTC transactions in the event of a default of one of the counterparties before it can discharge its financial obligations. So, in the event of a market crisis, the CCP will act as a type of safety net that, in turn, and through the mitigation of counterparty credit risk, will reduce the systemic risk perceived as inherent in oTC derivative contracts. The assuming of credit risk by CCPs will introduce significant new collateral and margin obligations for all financial counterparties trading in oTC derivatives, and the impact this will have on market liquidity and fund performance should be factored into investment strategies and planning by all fund managers.

Collateral requirementsThe collateralisation of oTC derivative contracts will likely take effect through the posting of initial and/or variation margin by the parties to the contracts to the CCP as intermediary to the trade. The demand for high-quality collateral in the market will rise as a result. This will not just be as a result of the requirement for oTC counterparties to post collateral to the CCPs but also for the interoperability of CCPs, i.e. the need for CCPs to collateralise each other.

where will this collateral come from? Collateral re-use or rehypothecation could become increasingly important. Although rehypothecation in the US is limited by Reg T to 50% of the value of the fully-paid-for securities, there is no such restriction in the UK or in Ireland, for example in the case of the Qualifying Investor Fund (QIF) fund structure, provided that the QIF has arrangements in place to ensure compliance with the requirements of the Central bank of Ireland (e.g. the oTC counterparty must have a minimum credit rating of A-2 or equivalent or is deemed by the QIF to have an implied rating of A-2 or equivalent). whether or not differences such as this will give rise to potential regulatory arbitrage is probably

part of a much bigger question, and should be considered when looking at how EMIR will interact with Dodd-Frank.

A more obvious difficulty posed by the CCP collateral requirements will be the holding of collateral. Variation margin will be required to be paid to CCPs every time the value of an oTC derivative contract changes, which could result in daily variation margin movements. For these payments to be made, instruments such as cash and government bonds will need to be available, solely for managing collateral obligations. Financial counterparties will therefore need to hold a proportion of their assets in collateral-eligible instruments. This has caused much controversy in the pension fund industry due to concerns regarding the impact of the collateral requirement on pension fund performance. A three-year exemption has been secured for pension funds as a result. However, no such exemption exists for other financial counterparties.

The whole area of collateral management and collateral transformation, whereby less liquid securities are converted into eligible collateral, is set to become increasingly important as a consequence. As part of the technical standards applicable to collateral under consultation in the Discussion Paper, ESMA is not only required to define the type of collateral that can be considered highly liquid but also the conditions under which commercial bank guarantees may be accepted as collateral. In order for a guarantee to be acceptable, one of the overriding requirements will be in ensuring a CCP’s prompt access to the collateral when required so that the CCP’s financial resources will be sufficient to cover the defaulted clearing member’s losses. As a result, we may see increased use of pledge arrangements as an efficient way to provide collateral to a CCP without having to actually transfer those assets to the CCP safekeeping accounts. Also worthy of mention are the legal considerations that will arise from these new collateral obligations – the addition of a Credit Support Annex to existing ISDA Master Agreements will be necessary for standardised oTC derivative transactions.

To clear or not to clear?Article 6/8 of EMIR requires the use of risk mitigation techniques for transactions that are not centrally cleared by a CCP. It is seen by the

We may see increased use of pledge arrangements as an efficient way to provide collateral to a CCp without having to actually transfer those assets to the CCp safekeeping accounts.


EU Commission as essential that counterparties apply robust risk-mitigation techniques to their bilateral relationships to reduce the counterparty credit risk and potential systemic risk arising from default. The impact of trading oTC derivatives on an uncleared basis following the implementation of EMIR should be looked at in the context of the discussion paper published by the three European Supervisory Authorities (ESAs) on 6 March 2012. The discussion paper covers the level of capital and collateral that counterparties to derivatives transactions should maintain, in addition to the types of collateral and segregation arrangements that should be in place to facilitate these transactions. Market participants were invited to provide feedback to the paper by 2 April 2012.

It is stressed in the paper that capital and collateral should be appropriate so as to reflect the risks they are meant to cover, and not dis-incentivise central clearing or create incentives to use less standardised derivatives with the objective of circumventing the clearing obligation. As many of these requirements are still under discussion, they will need to be analysed in more depth in future articles. However, it should be kept in mind that these discussions will also need to be assessed in conjunction with revisions to the Capital Requirements Directive (CRD IV), subject to which new charges for unexpected loss arising from changes in Credit Value Adjustment (CVA) 3 are being proposed, in addition to higher capital charges for complex/illiquid margined oTC positions or oTC positions with a history of margin disputes.

In summary, even those highly bespoke oTC derivatives that do not adhere to the level of standardisation (to be further defined by ESMA) required for central clearing under EMIR will fall within the scope of the g20’s counterparty risk-mitigation goals.

Trade repository reportingThe intended reduction in the opacity of the oTC derivative market will be accomplished under EMIR by introducing a mandatory disclosure and reporting of oTC activity to TRs. This reporting will include the details of any oTC derivative contract and any ensuing modification or termination of that contract. TRs will then be required to aggregate oTC derivate positions and make this data available to both the public and the European

Even those highly bespoke otC derivatives that do not adhere to the level of standardisation (to be further defined by ESma) required for central clearing under EmIR will fall within the scope of the g20’s counterparty risk-mitigation goals.

regulators. Reported data will include the number of outstanding contracts, size of outstanding positions in a particular contract and exposures of a specific entity.

The implementation of a Legal Entity Identifier (LEI) to facilitate the identification and reporting of parties to an oTC trade is also being discussed. If implemented, a unique alphanumeric reference ID will be associated with each corporate entity thereby facilitating the integration of oTC counterparty data on a global scale, undoubtedly serving as a useful tool in understanding the systemic risk posed by individual institutions.

Several international trade repositories are already in operation, such as DTCC Derivatives Repository Ltd in London, which maintains data for both equity derivatives and credit default swaps. Swap data repositories regulated under Dodd-Frank are the US equivalent, with Trade Information warehouse in new york being one example. This new trade and transaction reporting regime will need to be incorporated in parallel with the updating of similar regimes proposed as part of the revisions to MiFID and MAD.

MiFId II Following on from an EU Commission consultation on revisions to MiFID in December 2010, on 20 october 2011 the MiFID II proposals were published. The proposed revisions to MiFID are part of the effort to address the operational risks identified in the oTC market.

oTC transactions are not specifically regulated under the first iteration of MiFID, and they are not subject to the trading venue requirements of MiFID as they are not currently carried out on MiFID regulated venues. There are three regulated venues under MiFID: Systematic Internalisers, Regulated Markets and Multilateral Trading Facilities (MTFs). Under MiFID II, a fourth is proposed: the organised Trading Facility (oTF). The objective of the creation of the oTF is the setting-up of an appropriate regulatory framework for:

• broker crossing systems present in the equities markets, e.g. goldman Sachs Sigma and Credit Suisse Cross Finder. This will also have an impact on what is termed as “dark-pool” trading, as trading venues such as non-MTF dark pools are not


captured by MiFID. (Dark-pool trading can be simply defined as trading activity that is not openly available to the public. This is usually made up of large bulk trades by financial institutions that are carried out off-exchange to avoid market impact).

• Trading systems currently not regulated as trading venues, e.g. multi-dealer platforms. This will impact bond and oTC derivative trading. It is worth noting here that many multi-dealer platforms such as Tradeweb and bloomberg have adopted an MTF status. but in the future, platforms such as these will have the choice of opting for either the MTF or the oTF regime.

• Trading systems and solutions that could emerge in the future.

operating an oTF would be a new licensable activity under MiFID. oTFs would be subject to a certain number of core regulatory requirements regarding notification and transparency. As oTC derivative trading will fall under the definition of an oTF, these requirements will have a direct impact on the oTC derivative market, e.g. post-trade transparency reports to the competent authorities and to the public, rules to manage conflicts of interest and monitor trading activity for market abuse. It is worth noting here that some industry lobbying against the introduction of this new venue category has taken place. In response, the European Parliament’s Economic and Monetary Affairs Committee has begun the process of scrutinising and amending the Commission’s proposed MiFID II text, and we await with interest the publication of revisions to the oTF category as currently proposed.

In addition to the new venue, MiFID’s existing pre- and post-trade transparency rules are to be extended to new asset classes, including bonds and derivatives that are traded on an organised trading venue (i.e. an oTF) and oTC as well as derivatives that are clearing eligible or reported to a trade repository. It is here that the direct link between MiFID II and EMIR becomes even more evident with the ultimate aim being to bring the transparency regime more in line with the scope of MAD.

It is also proposed that the existing MiFID transaction reporting regime be extended to cover instruments admitted to trading on

Regulated Markets, MTFs or oTFs, instruments whose value is dependent on instruments traded on these venues and instruments that have or are likely to have an effect on a financial instrument admitted to trading or traded on an MTF or oTF. The broadened regime will bring oTC derivatives into the scope of the MiFID reporting regime.

All of these changes are proposed to not only increase transparency but ensure the successful implementation of the g20 recommendation that trading in standardised oTC derivatives is carried out on exchanges or electronic trading platforms, primarily through the introduction of the new oTF venue. we can probably expect this to lead to an increase in the number of multilateral platforms in the market as trades are executed electronically on these venues. The MiFID II timetable is still unclear with some expecting it to be implemented by 2015 while other sources cite 2016-2018 as a more likely time frame.

Market participants in Europe should prepare for the significant cost implications of these regulatory changes on their current derivative-trading and reporting activities.

Interaction with other regulations?Concern has been expressed in the industry over the lack of alignment of the oTF definition as proposed in MiFID II with that of the equivalent “swap execution facilities” as defined in Dodd-Frank. Dark pools are already regulated in the US as Alternative Trading Systems. So considering the oTF venue is so broadly defined as to also encompass dark pool trading in Europe, differences are to be expected. These differences still exist and with different rules governing the electronic trading of oTC derivatives between the two jurisdictions, the possibility for regulatory arbitrage is feared.

In addition, although the Dodd-Frank final rulemaking process has yet to be completed, there has been a clear signal of intent from policymakers that Fx swaps and forwards will not be required to comply with the new central clearing obligations. The authorities in both Singapore and Hong Kong have similarly recognised the specifics of these markets in their recent consultation papers on oTC derivatives.4 It is as yet unclear if a similar exemption will apply to Fx swaps and forwards in EMIR.

Irish regulated non-UCITS retail funds are required to value oTC derivatives on a weekly basis with closed ended funds and/or Professional Investor Funds (PIFs) and QIFs permitted to perform these valuations on a monthly basis. given that CCP-cleared oTC derivatives will require daily variation margin calculations, it would seem reasonable to expect that many Irish regulated non-UCITS funds will need to commence a daily independent valuation of oTC derivative positions, assuming a reluctance to place sole reliance on the CCP for these valuations.

Another thing worth considering is the implication that EMIR might have on UCITS funds adhering to the UCITS counterparty exposure restrictions.

Currently the risk exposure of an Irish UCITS to a counterparty to an oTC derivative may not exceed 5% of net asset value. This limit can then be raised to 10% in the case of counterparties that are credit institutions authorised (i) in the EEA, (ii) within a signatory state (other than an EEA Member State) to the basel Capital Convergence Agreement of July 1988 or (iii) in Jersey, guernsey, the Isle of Man, Australia or new Zealand.

At the moment, UCITS regulations do not differentiate between oTC derivatives that are centrally cleared and those that are bilaterally traded. So the same limits apply.

As the primary purpose of EMIR is to mitigate counterparty risk, should oTC derivatives cleared through CCPs be subject to the same limits? If so, to whom should these limits apply — the CCP, the counterparty or both?

ConclusionThe events of 2008 have instigated new and updated regulations that will have an unprecedented impact on the world of oTC derivatives in particular. The potential impact the new collateral requirements introduced under EMIR will have on market liquidity and investment fund performance and strategies cannot be overstated. one lesson to be learned from the work that has been undertaken since the g20 meeting of September 2009 is the need for greater regulatory convergence. Despite regulations such as Dodd-Frank, EMIR and MiFID II, which are all part of the same initiative and timetable (the end of 2012), a clear

market participants in Europe should prepare for the significant cost implications of these regulatory changes on their current derivative-trading and reporting activities.

1 The American International group (AIg).

2 The fund manager will receive collateral from the counterparty, such as the swap dealer it does business with, when it is “in the money”, but it will need to give collateral when it is it “out of the money”.

3 The traditional approach to controlling counterparty credit risk has been to set limits against future exposures and verify potential trades against these limits. Credit Value Adjustment (CVA) offers an opportunity for banks to move beyond the control mindset of limits by dynamically pricing counterparty credit risk directly into new trades.

4 For more information about the Singapore consultation papers, please refer to the following Monetary Authority of Singapore weblink: http://www.mas.gov.sg/publications/consult_papers/Reports_and_Consultation_Papers.html, last accessed in April 2012. For more information about the Hong Kong consultation paper, please refer to the following Securities and Futures Commission weblink: https://www.sfc.hk/sfcConsultation/En/sfcConsultFileServlet?name=otcreg&type=1&docno=1, last accessed in April 2012.

divergence in approaches has been evident from the beginning. with similar reforms currently under discussion in a number of countries in the Asia-Pacific region, the need for a globally consistent approach cannot be overemphasised.

Recent crises such as the failure of MF global should also be taken into account during the various ongoing regulatory consultation processes. The importance of margin segregation has been highlighted by the MF global collapse, for example. This is an area that will become increasingly relevant once the initial and variation margin requirements of CCPs for cleared oTC derivative transactions becomes effective under EMIR, with an anticipated implementation date of 1 January 2013. The re-investment of collateral received by the CCPs may be crucial to their commercial viability, but restrictions around the financial instrument types in which this collateral can be invested is of paramount importance.

Ian McCarthy Senior Fiduciary Monitoring officer, Ireland Citibank International plc

European Fiduciary Services news and Views | Second Edition 2012Citi Transaction Services | Jersey44 45

The Codes were implemented by the JFSC to address areas where Jersey had previously not met the international standards set by the International organisation of Securities Commission (IoSCo). They are intended to ensure that Jersey will achieve a “fully implemented” rating based on IoSCo’s Methodology for Assessing Implementation of the IoSCo objectives and Principles of Security Regulation as at october 2008. As a result of the Codes, Jersey should also be in a stronger position to address the requirements of the EU Alternative Investment Fund Managers Directive (AIFMD).

All unclassified investment funds issued with a certificate by the JFSC in accordance with Article 8b of the CIF (J) L 1988 must comply with the Codes. This includes expert funds, as expert funds are not exempted from these Codes.

Certain fund structures that are not required to comply with the Codes are: unregulated funds in accordance with Article 1 of the Collective

Investment Funds (Unregulated Funds) (Jersey) order 2008 as amended, recognised funds in accordance with Article 1 of CIF (J) L 1988, and non-Jersey-domiciled funds. Structures such as private placement funds, investment syndicates and clubs that are approved under the Control of borrowing (Jersey) Law 1947, as amended, are also exempt.

The Codes’ eight principles are detailed below, each with specific obligations that must be met to demonstrate adherence to the individual principles:

1. A fund must conduct its business with integrity.

2. A fund must always act in the best interests of unitholders.

3. A fund must organise and control its affairs effectively for the proper performance of its activities and be able to demonstrate the existence of adequate risk management systems.

CodES oF pRaCtICE FoR CERtIFIEd FUNdS on 2 april 2012, following extensive consultation with the Jersey Funds industry, the Jersey Financial Services Commission (the JFSC) issued Codes of practice for Certified Funds (the Codes).1 the Codes, consisting of eight primary principles, were issued in accordance with the authority assigned to the Commission under article 15 of the Collective Investment Funds (Jersey) law 1988 (“CIF(J)l 1988”) and came into force with immediate effect.

4. A fund must be transparent in its business arrangements with unitholders.

5. A fund must maintain and be able to demonstrate the existence of both adequate financial resources and adequate insurance.

6. A fund must deal with the JFSC and other authorities in Jersey in an open and cooperative manner.

7. A fund must not make statements that are misleading , false or deceptive.

8. A fund must at all times comply and be operated in accordance with any applicable guide.

The responsibility for compliance with the Codes rests firmly with the certified fund operating through its governing body (the certificate holder).2 The certificate holder must be in no doubt that it has satisfactory controls in place to ensure proper management of its business. where a certified fund is not in a position to comply with all of the Codes’ principals immediately, it must demonstrate that it is proactively working towards implementing any required practices that will result in full compliance. A fund may, in exceptional circumstances, apply to the JFSC for a variance from the Codes, where it is believed that strict adherence to them would result in an anomalous result.

Principal 8 refers to “any applicable guide” and it should be noted that the expert fund, the listed fund and the oCIF 3 guides have all been included in the Codes, thereby reaffirming that they are fundamental requirements when applying these Codes. For funds that fall outside of the structures documented in the guides, the oCIF guide should be consulted initially.

Regulatory action will be taken where failure to comply with the Codes is identified. As with other Codes under the CIF (J) L 1988, the JFSC will have the authority to issue a direction or take enforcement action. Potentially, for the more severe cases of non-compliance, the JFSC could order the winding-up of a fund and the revocation of its certificate. Failure to comply with the Codes will not result in any person being liable for prosecution. However, where deemed appropriate, it could be used as evidence in court.

although there are new requirements within the Codes, certain aspects of them replace conditions previously imposed on funds by virtue of its certificate and for that reason should already be in operation.

Prior to the issuance of the Codes, fund services business providers had been subject to minimum standard requirements while conducting their business by virtue of the fund services business codes of practice. but the funds themselves had not been. The intention of the Codes is to codify the existing administrative processes already undertaken, while keeping Jersey funds regulation consistent with international standards. To date, a number of issues identified by the JFSC had occurred due to failings in corporate governance and consequently within the codes particular emphasis has been placed on corporate governance. They provide practical guidance to enable certified funds to manage their affairs in accordance with JFSC expectations. Although there are new requirements within the Codes, certain aspects of them replace conditions previously imposed on funds by virtue of its certificate and for that reason should already be in operation.

It is acknowledged that the codes may overlap in certain areas with the fund services business codes. For example, a trustee of a unit trust may be subject to both sets of codes. where this scenario occurs, and one set of procedures is fully compliant with both codes’ requirements, in the interest of reducing duplication they can be applied to both codes.

Arguably, the issuance of the Codes will result in additional administrative responsibilities giving rise to additional costs. That said, the introduction of the Codes will undoubtedly increase investor protection, hopefully resulting in the augmentation of Jersey’s reputation as a jurisdiction of choice for funds.

Ann-Marie Roddie Fiduciary business Manager, Jersey Citibank International plc

1 Jersey Financial Services Commission Collective Investment Funds (Jersey) Law 1988 “Codes of Practice for Certified Funds”, issued 2 April 2012.

2 Company — board of directors, limited partnership, general partner, unit trust — trustee.

2 guide to Jersey open-ended unclassified collective investment funds offered to the general public.

European Fiduciary Services news and Views | Second Edition 2012Citi Transaction Services | Luxembourg46 47

recent changes to the SIF lawA law was passed by the Luxembourg Parliament in March 2012 modifying the SIF. The amendments to the SIF cover the authorisation process, delegation, risk management, conflict of interest and cross-investment between compartments of SIFs, among other things. They also simplify certain reporting and general meeting requirements.

Prior authorisationThe amended SIF law requires SIFs to obtain the authorisation of the CSSF before commencing operations. The CSSF must also approve the appointment of the directors of the SIF, or its management company in the case of a common fund (FCP), and the choice of depositary.

Risk management and conflicts of interestSIFs are required to implement risk management systems to identify, measure, manage and monitor appropriately the risks associated with the investment positions and their contribution to the overall risk profile of the portfolio.

SIFs are also required to be structured and organised in such a way as to mitigate the risk of any conflict of interest between the SIF and, where applicable, any person involved in the activities of the SIF, or directly or indirectly related to the SIF, adversely affecting the interests of the investors. In case of potential conflicts of interest, the SIF is required to protect the interests of its investors.

A CSSF regulation is expected to clarify the implementation of the measures on risk management and conflicts of interest. SIFs existing in March 2012 have until 30 June 2012 to comply with these provisions.

Delegationwhen a SIF or its management company delegates one or more of its own functions to third parties with a view to conducting operations in a more efficient manner, they will be required to comply with the following conditions:

• The CSSF must be adequately informed.

• The mandate cannot prevent the effectiveness of supervision over the SIF, and it must not prevent the SIF from acting, or the SIF from being managed, in the best interests of the investors.

• when the delegation concerns portfolio management, the mandate may only be given to persons or entities authorised or registered for the purpose of asset management and subject to prudential supervision. In cases of delegation to a third-country undertaking, there must be cooperation between the CSSF and the supervisory authority of the third country. where these conditions are not met, the delegate must be of sufficiently good repute and sufficiently experienced, and prior approval from the CSSF must be obtained.

thE SIF: lUxEmBoURg’S aIFmd-REady aIF pRodUCt oF ChoICEluxembourg’s Specialised Investment Fund (SIF), launched in 2007, has been used extensively to launch all types of alternative Investment Fund (aIF) products. It is expected that the aIFmd will further boost SIF’s use over the coming years. to some extent, many of the requirements of the aIFmd are already implemented in the SIF law. Recent changes to the law will further strengthen the position of the SIF as the aIFmd-ready investment-fund product of choice.

It is expected that, over a period of time, the aIFmd will establish a quality “aIF brand” for aIFmd-compliant products, comparable to the UCItS brand established by the UCItS directive for the traditional products.

European Fiduciary Services news and Views | Second Edition 2012Citi Transaction Services | Luxembourg48 49

many of these requirements are already implemented by SIF Law.

the SIF: a response to the AIFMdIn return for more regulation of AIFMs, its service providers and its funds, the proposed Directive provides for the introduction of passports enabling AIFMs to offer their management services and market their AIF throughout the EU.

From July 2013 onwards, investors in AIF products will have two broad options:

• AIFs subject to a set of harmonised pan-European regulatory standards.

• AIFs not subject to such standards.

From 2013 until at least 2015, only European-domiciled products from European-domiciled AIFMs will benefit from these pan-European regulatory standards.

It is expected that, over a period of time, the AIFMD will establish a quality “AIF brand” for AIFMD-compliant products, comparable to the UCITS brand established by the UCITS Directive for the traditional products. Investors in alternative products will therefore expect alternative investment groups to offer them a range of products, including AIFMD-compliant products.

From 2018 onwards, European investors may face limitations on their investments in non-AIFM Directive compliant products.

with these deadlines looming, alternative investment groups (including initiators, sponsors, advisers, general partners and managers of all types of non-UCITS funds) are carefully considering the domiciles of their future AIF ranges.

For many, Luxembourg will be their domicile of choice, and the SIF their AIFMD-ready investment fund vehicle.

The SIF will offer the alternative investment groups the following, among other things:

• A well- established, flexible, regulated investment fund vehicle adapted to any type of investment fund strategy.

• Access to all the advantages of Luxembourg, including its position as the world’s leading cross-border distribution hub.

• AIFMD-compliant products:

− Access to the “AIF brand”, reflecting the success of the UCITS brand, a truly international product whose reputation is renowned on a global basis.

− A passport to distribute to investors across the EU.

• non-AIFMD-compliant products:

− Medium-sized self-managed AIFs, outside the scope of the AIFMD.

− AIFs of smaller managers, which benefit from AIFMD exemptions.

ConclusionFor many initiators, Luxembourg is already the domicile of choice for their AIF products and, among these products, the SIF their product of choice. Recent amendments to the SIF law further strengthen this position.

we expect Luxembourg’s implementation of the AIFMD to be practical and pragmatic.

going forward, the SIF will offer the alternatives industry flexible solutions for AIFMD-compliant products and for non-AIFMD-compliant products.

Michael Ferguson EMEIA Regulated Funds Leader Ernst & young, Luxembourg

Michael Hornsby EMEIA Real Estate Funds Leader Ernst & young, Luxembourg

going forward, the SIF will offer the alternatives industry flexible solutions for aIFmd-compliant products and for non-aIFmd-compliant products.

• The directors of the SIF must be able to demonstrate that the delegate is qualified and capable of undertaking the functions in question, that it was selected with all due care and that the SIF is in a position to monitor effectively the delegated activity at any time, to give further instructions to the delegate at any time or to withdraw the mandate with immediate effect to protect the interests of investors.

• Investment management functions cannot be delegated to the depositary.

• The prospectus or offering document of the SIF must list the delegated functions.

SIFs in existence as of March 2012 have until 30 June 2013 to comply with these provisions.

Cross-investmentMultiple compartment SIFs may invest in other compartments of the same SIF (cross-investment) if permitted by the issuing document and provided that certain conditions are met, among them:

• The target compartment does not invest in the investing compartment.

• The voting rights of the investing compartment in relation to its investment into target compartment are suspended during the period of investment.

• The value of cross-investments is not be taken into account in calculating the SIF’s net assets in the context of meeting the minimum net assets requirements.

These provisions on cross-investment would permit, for example, the creation of fund of funds, master-feeder structures and tailor-made portfolios for family offices within an umbrella SIF.

Administrative simplificationThe amended SIF law exempts investment companies (variable capital — SICAVs and fixed-capital — SICAFs) from the requirements of:

• Translating the articles of incorporation or any modifications to the articles of incorporation or constitutional document into French or german, if these documents have been prepared in English.

• Sending the annual accounts, the independent auditor’s report, the management report and the observations of the supervisory board (if applicable) to shareholders at the same time as convoking the annual general meeting. The convocation must indicate how to obtain these documents and state that the investor may request that these documents be sent to them.

Impact of the AIFMd on SIFs while the main focus of the AIFMD is on managers of AIFs, the Directive will also have an impact on the AIFs themselves, service providers to these funds and their investors.

The Directive covers all alternative sectors such as hedge funds, real estate and private equity, but also traditional sectors where the funds are not registered as UCITS. It applies to funds and certain corporate collective investment vehicles. Such products are generally for professional investors, but may also be sold to retail investors.

The Directive lays down requirements that must be met by AIFMs, covering authorisation, capital, marketing, organisation, remuneration, conduct of business, conflicts of interest, functions and service providers and transparency. Specific provisions cover the use of leverage and the acquisition of major holdings and control.

Almost all SIFs will be in scope of the AIFMD. Such SIFs will be covered by the requirement to ensure that an authorised AIFM is identified and appointed or comply with the requirements of the Directive as an internally managed AIF. An external AIFM may, for example, be determined to be the management company or general partner.

For SIFs, the main impact of the AIFMD will therefore be on their managers. In many cases, providers will establish or appoint a single AIFM (a super AIFM) for an ensemble of their fund ranges, or convert an existing entity, such as a management company, into their single AIFM.

The AIFMD will indirectly impose additional requirements on the SIFs, which relate to the depositary, valuation function, reporting and disclosure to investors, and reporting to regulators, for example. To some extent,

European Fiduciary Services news and Views | Second Edition 2012Citi Transaction Services | Sweden50 51

NEW SWEdISh RUlES oN taxatIoN oF SWEdISh aNd FoREIgN INVEStmENt FUNdS aNd thEIR INVEStoRSSweden has adopted new legislation on the taxation of Swedish and foreign investment funds and their investors. the new regime, which consists of transferring the tax liability from the investment funds to their unitholders and abolishing withholding tax on dividends to certain foreign investment funds, entered into force on 1 January 2012. the following article summarises these recent changes.

transferring tax liability to unitholderson 1 January 2012, Swedish investment funds were no longer liable to tax on their assets under the Swedish Income Tax Act.1 The new legislation is aimed at preventing the introduction of the UCITS IV Directive 2 from causing assets invested in Swedish investment funds being moved abroad and thus resulting in a reduction of the Swedish tax base.3

Under the previous legislation, Swedish investment funds were subject to tax at a rate of 30% on certain taxable income derived from their assets. However, Swedish investment funds were, in practice, usually tax exempt, as they were entitled to deduct any dividend distributions to the unitholders from their taxable income and thereby decrease the tax base.

The new rules set forth a tax exemption regime for Swedish investment funds and foreign investment funds equivalent to Swedish investment funds. Swedish investment funds will still be regarded as non-transparent for tax purposes, i.e. as legal entities. At the same time, standardised-basis taxation is introduced at unitholder level.

According to the new rules, unitholders are taxed on a notional income in proportion to the value of their units in both Swedish and foreign investment funds. In general, the new regime applies to individuals and legal entities resident or otherwise fully taxable in Sweden. The notional income consists of 0.4% of the value of the units held at 1 January each year. Furthermore, unitholders will continue to be taxed on dividends and capital gains deriving from their unitholding. However, for dividends, it should be noted that as a consequence of the new tax-exemption regime, Swedish investment funds are generally no longer likely to distribute. In addition, the requirement for fund companies, investment companies and custodians to file a tax return for their Swedish investment funds has been abolished.

No withholding tax on dividends to fundsIn connection with the abolished taxation of Swedish investment funds, a new exemption from Swedish withholding tax for certain foreign investment funds was introduced on

1 January 2012. According to the main rule of the Swedish Coupon Tax Act,4 withholding tax is levied at a rate of 30% on dividend payments from Swedish companies to non-residents. However, under certain exemptions no withholding tax is to be levied.

According to the new exemption, withholding tax should not be levied on dividends paid to foreign investment funds that qualify as a “fund company” (Sw. fondföretag) as defined under the Swedish Investment Fund Act,5 provided that they are resident within the EEA or in a state with which Sweden has a tax treaty including an article on exchange of information on tax matters or a separate agreement on exchange of information on tax matters.

According to the Swedish Investment Fund Act, a “fund company” is defined as a foreign company:

• which, in its country of residence, carries on an authorised business with the sole purpose of undertaking collective investments in certain assets, as specified in Chapter 5 and 6 of the Swedish Investment Fund Act, by the use of capital raised from the public or a certain and delimited circle of investors.

• which operates under the principle of risk-spreading.

• whose units may be repurchased or redeemed by means of the company’s assets on request of the unitholders.

In order for a foreign investment fund to qualify as a “fund company”, all three requirements must be met.

The Swedish Tax Agency has issued an interim statement that provides some guidance on the interpretation of the new rules.6 According to the view of the Swedish Tax Agency, at least the following funds should qualify as equivalent to a Swedish investment fund and thereby as “fund companies”:

• Funds established in accordance with the UCITS IV Directive (2009/65/EC).

• non-UCITS funds that are authorised by the Swedish Financial Supervisory Authority to market and sell units of the fund in Sweden.

Swedish investment funds are generally no longer likely to distribute. In addition, the requirement for fund companies, investment companies and custodians to file a tax return for their Swedish investment funds has been abolished.

European Fiduciary Services news and Views | Second Edition 2012Citi Transaction Services | Sweden52 53

In general, the new exemption from withholding tax for foreign investment funds should provide tax relief “at source”, i.e. the fund should not be required to file a reclaim for withholding tax paid by the fund.

disclaimerThe information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, tax or any other professional advice or service. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact his or her tax professional prior to taking any action based upon this information

1 Sw. Inkomstskattelag (1999:1229).

2 Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS).

3 bill 2011/12:1, p. 393 ff.

4 Sw. Kupongskattelag (1970:624).

5 Sw. Lag (2004:46) om investeringsfonder.

6 Information from the Swedish Tax Agency of 24 January 2012, registration number 131 48746-12/111.

According to the Swedish Tax Agency, all non-UCITS funds that are currently authorised by the Swedish Financial Supervisory Authority to market and sell units of the fund in Sweden are established within the European Economic Area (EEA), except for one fund that is established in Jersey. with regard to the entitlement to the exemption for other foreign investment funds, the Swedish Tax Agency has yet to finalise its analysis. Further guidance from the Swedish Tax Agency is expected later this year.

whether or not a foreign investment fund should be entitled to the exemption from withholding tax should be subject to analysis on a case-by-case basis based on the requirements above. Funds not qualifying under such requirements should, in our view, be entitled to the exemption from withholding tax in so far as the fund fulfils the requirements of being a “fund company” and is resident within the EEA or in a state with which Sweden has a tax treaty, including an article or agreement on exchange of information on tax matters. on applying the exemption in practice, it should be noted, however, that there are currently no general guidelines on interpreting the requirements for qualifying as a “fund company”.

In general, the new exemption from withholding tax for foreign investment funds should provide tax relief “at source”, i.e. the fund should not be required to file a reclaim for withholding tax paid by the fund. In practice, the Swedish payor may require proof of the receiver’s eligibility for the new exemption, e.g. a certificate of the fund being established in accordance with the UCITS IV Directive. If there are any uncertainties over a fund’s eligibility, the payor may decide to levy withholding tax at the domestic statutory rate. In such cases, a foreign investment fund that is eligible for the exemption would be required to file a reclaim for any withholding tax paid.

ConclusionThe UCITS IV Directive has expanded the possibilities of cross-border fund management operations. From a Swedish tax perspective, the new tax-exemption regime for investment funds should be considered as an important step towards

achieving equivalence for tax purposes between investing in Swedish investment funds compared to foreign investment funds. The new exemption from dividend withholding tax for certain foreign investment funds should be regarded as a step in the right direction for eliminating any difference in treatment of foreign investment funds compared to Swedish investment funds. As a consequence, Sweden may also be heading in the direction of being regarded as a more attractive country by foreign management companies.

Emelie Lindahl Associate, Corporate and International Tax Services Ernst & young, Sweden

Erik Hultman Partner, International Tax Services Ernst & young, Sweden

European Fiduciary Services news and Views | Second Edition 2012Citi Transaction Services | glossary54 55

AFR Annual Funding Requirement

AIFMDAlternative Investment Fund Managers Directive

AIF Alternative Investment Fund

AIFM Alternative Investment Fund Manager

AIMAAlternative Investment Management Association

AML Anti Money Laundering

APERStatements of Principle and Code of Practice for Approved Persons — FSA High Level Standard

ARRowAdvanced Risk-Responsive operating Framework

basel IIIInternational regulatory framework in the banking sector

bCbS basel Committee on banking Supervision

bIPRUUK Prudential Sourcebook for banks, building Societies and Investment Firms

bRIC brazil, Russia, India and China

CbU UK Conduct business Unit

CCP Central Counterparty

CDS Credit Default Swap

CEbS Committee of European banking Supervisors

CESRCommittee of European Securities Regulators

CF Control Functions

CFT Counter-financial Terrorism

CIS Collective Investment Scheme

CobS Conduct of business Sourcebook

CRD Capital Requirements Directive

CRE Commercial Real Estate

CSSFCommission de Surveillance du Secteur Financier

DFI Development Finance Institution

Dodd-FrankDodd-Frank wall Street Reform and Consumer Protection Act

EbA European banking Authority

EbRDEuropean bank for Reconstruction and Development

ECb European Central bank

EConEU Parliament’s Economic and Monetary Affairs Committee

EEA European Economic Area

EEC European Economic Community

EFAMAEuropean Fund and Asset Management Association

EFSE European Fund for Southeast Europe

EFSF European Financial Stability Facility

EIoPAEuropean Insurance and occupational Pensions Authority

EIU European Intelligence Unit

EMEA Europe, the Middle East and Africa

EMIR Emerging Markets Infrastructure Regulation

EP European Parliament

ESA European Supervisory Authorities

ESMA European Securities and Markets Authority

ESRb European Systemic Risk board

ETF Exchange-traded Fund

EU European Union

EVCAEuropean Private Equity and Venture Capital Association

FAIF Fund of Alternative Investment Fund

FATCA Foreign Account Tax Compliance Act

FATF Financial Action Task Force

FCA UK Financial Conduct Authority

FCP Fonds Communs de Placement

FFI Foreign Financial Institution

FIFinansinspektionen — Swedish Financial Supervisory Authority

FInMARFinancial Stability and Market Confidence Sourcebook

FPC Financial Policy Committee

FSA UK Financial Services Authority

FSb Financial Stability board

FSMA UK Financial Services and Markets Act 2000

FTfm Financial Times Fund Management

g20The group of Twenty Finance Ministers and Central bank governors

gDP gross Domestic Product

HIRE Hiring Incentives to Restore Employment Act

HMT Her Majesty’s Treasury

IbC Independent banking Commission

ICSD Investor Compensation Scheme Directive

IFA Independent Financial Adviser

IFC International Finance Corporation

IFI International Finance Institutions

IFIA Irish Funds Industry Association

IFRS International Financial Reporting Standards

IMA Investment Management Association

IMF International Monetary Fund

IoSCoInternational organisation of Securities Commissions

IRS Internal Revenue Service

JFSC Jersey Financial Services Commission

KIID Key Investor Information Document

LHFILag om Handel med Finansiella Instrument — Swedish Financial Trading Act

LVMLag om Vardepappersmarknaden — Swedish Financial Markets Act

MAD Market Abuse Directive

MEP Member of the European Parliament

MiFID Markets in Financial Instruments Directive

nAV net Asset Value

newcitsA phrase used to describe hedge fund strategies used within the UCITS III framework

nFFE non-Financial Foreign Entity

nURS non-UCITS Retail Scheme

oECDorganisation for Economic Co-operation and Development

oRA ongoing Regulatory Activity

oTC over-the-counter (derivatives)

PbU UK Prudential business Unit

PCF Pre-Approved Control Functions

PIF Professional Collective Investment Scheme

PFFI Participating Foreign Financial Entity

PRA UK Prudential Regulation Authority

PRIPs Packaged Retail Investment Products

PRo Prudential Risk outlook

QCF Qualifications and Credit Framework

QI Qualifying Intermediary

QIF Qualifying Investor Fund

QIS Qualified Investor Scheme

RCRo Retail Conduct Risk outlook

RDR Retail Distribution Review

RIS Regulatory Information Service

SAR Special Administration Regime

SEC Securities and Exchange Commission

SEPA Single European Payments Area

SICAV Société d’Investissement à Capital Variable

SICARSociétés d’Investissement en Capital à Risque

SIF Significant Influence Function

SIF Specialised Investment Funds

SIFA Swedish Investment Funds Association

SLD Securities Law Directive

SME Small and Medium Sized Enterprises

SoPARFI Sociétés de Participation Financière

SUP Supervision — FSA Regulatory Process

SySCSenior Management Systems and Controls — FSA High Level Standard

TIEA Tax Information Exchange Agreement

TSC UK Treasury Select Committee

UCIsUndertakings for Collective Investment (Part II Funds)

UCISUnauthorised Collective Investment Scheme

UCITSUndertakings for Collective Investment in Transferable Securities

USFI US Financial Institution

VaR Value at Risk

gloSSaRy

European Fiduciary Services news and Views | Second Edition 2012Citi Transaction Services | Contacts56 57

EURoPE

david Morrison Director and Head of Fiduciary Services, EMEA E. [email protected] T. +44 (0) 20 7500 8021

IRELAnD

Shane baily Head of Fiduciary Services, Ireland E. [email protected] T. +353 1 622 6297

Ian Callaghan Head of Trustee Client Management & Fiduciary Monitoring E. [email protected] T. +353 1 622 1015

JERSEy

Ann-Marie roddie Fiduciary Manager E. [email protected] T. +44 (0) 1534 608 201

LUxEMboURg

patrick watelet Head of Fiduciary Services, Luxembourg E. [email protected] T. +352 451 414 231

ulrich witt Fiduciary Relationship Manager E. [email protected] T. +352 451 414 520

Francis pedrini Fiduciary Relationship Manager E. [email protected] T. +352 451 414 228

davide tassi Fiduciary Relationship Manager E. [email protected] T. +352 451 414 630

SwEDEn

Johan Ålenius Head of Swedish Fiduciary Services E. [email protected] T. +46 8 723 3529

UnITED KIngDoM

therese lundie Fiduciary business and Relationship Manager E. [email protected] T. +44 (0) 131 524 2825

Iain lyall Head of Relationship Management E. [email protected] T. +44 (0) 20 7500 8356

Francine bailey Senior Fiduciary Relationship Manager E. [email protected] T. +44 (0) 20 7500 8580

Andrew Newson Senior Fiduciary Relationship Manager E. [email protected] T. +44 (0) 20 7500 8410


Selina Staines Fiduciary Technical Analyst, UK Citibank International plc E. [email protected] T. +44 (0) 20 7500 9741

CoNtaCtSIf you have any comments on any of the articles covered in this edition of European Fiduciary Services News and Views, any ideas for future content or an article you would like to submit for publication in the next edition, please contact amanda hale or Selina Staines.

Citi transaction Services www.transactionservices.citi.com

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