Focus on alternative investment

Director of Government and Regulatory Affairs of The Alternative Investment Management Association, Jirí Król visited Cayman in April to give a presentation to the AIMA Cayman membership on recent regulatory and legislative developments affecting the alternative investment industry writes Allison Nolan, managing director, Athena International Management Limited.

The presentation which took place at the Hollywood Theatres in Camana Bay was well attended by representatives from all areas of the Cayman hedge fund community. As Stu Sybersma, partner in Deloitte, Cayman and Chair of AIMA Cayman’s Events Committee pointed out in his introduction, Król was the most senior representative of AIMA globally to speak in Cayman to date.

Król began by giving an overview of the activities of the Government and Regulatory Affairs Department, which aims to keep AIMA members updated with relevant developments which might affect their business, pro-actively engage with key political leaders in its bid to promote the best interests of the hedge fund industry and to enhance understanding of alternative investments. His department seeks to bring regulators together and help explain what is going on elsewhere in the world. The focus of his presentation was the implications of recent regulatory developments to the Cayman Islands hedge fund industry.

Król began with the US by giving a shortlist of important issues arising from the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was passed in July 2010. Of these, adviser registration has received a great deal of attention: a large number of US and non-US managers will have to register with the SEC from July 2011 and comply with all of the provisions of the Advisers Act. Initially the proposed exemptions from registration were perceived as being very limited but AIMA and other industry bodies engaged with the US authorities regarding implementation of Dodd-Frank and now is encouraged by the feedback from the SEC regarding interpretation of the provisions and is striving to ensure that the SEC works hard to use workable and practical exemptions in relation to foreign advisers and fund managers where applicable.

The full exemption for foreign private advisers who have no place of business in the US, less than US$25 million AUM attributable to US clients and 15 or fewer US clients will be relevant to many managers of Cayman domiciled hedge funds. There is also a partial exemption for private fund advisors who have AUM of less than US$150 million managed in the US that advise only private funds in that they are exempt from reporting adviser status but still have to file periodic reports. Król advised that AIMA has made over 20 submissions in relation to Dodd-Frank to date and continues to engage with the US regulators and policy makers.

Next Król focused on the Foreign Account Tax Compliance Act; US legislation aimed at making the financial services industry more transparent and preventing tax evasion by US persons though use of offshore holdings. This will apply from January 2013 to all foreign financial institutions, which is broadly defined and includes non-US investment vehicles such as hedge funds with direct or indirect US ownership. FATCA will require all FFIs to obtain and report information on foreign accounts of US persons/US owned foreign entities to the Internal Revenue Service. These requirements go far beyond the current obligations and non-compliance will result in a 30 per cent withholding tax penalty.

Król noted that AIMA made submissions in June and November 2010 to argue for “widely held collective investment vehicles” including hedge funds to be “deemed to meet the requirements of FFI agreements on the basis that (a) they already have in place prohibitions on actively marketing to US persons, (b) the inclusion of prohibitions on US investors in prospectuses effectively means that investors represent that they are not US persons, (c) interests in funds are typically acquired / held and distributions received through other FFIs who will have FATCA reporting obligations and (d) they already have well-developed KYC and AML procedures which should safeguard against unidentified US holders.”

He said that AIMA called for such collective investment funds to be allowed a simplified agreement with UST with limited reporting requirements. Król said the hope and tentative expectation is now that such collective investment vehicles will obtain some relief from the new provisions.

Moving on to Europe and the Alternative Investment Fund Managers Directive, Król noted that AIMA has engaged constructively with European and international policy makers since the original draft was produced. He said the directive was intended to regulate the management not just of hedge funds but any collective investment activity that is not covered by the UCITS provisions so that the impact is far reaching. “There are four levels to the legislative and regulatory structure in Europe of which the first two levels involve binding legislation. A lot of the details were already fixed in the Level 1 Directive but now AIMA is looking into the key issues for the Level 2 implementing measures”. The European Commission and the European Securities and Markets Authority will be responsible for overlooking Level 2 where ESMA will act as a principal policy adviser to the Commission. AIMA has set out its recommendations to ESMA and has called for the implemented form of the AIFMD to be flexible and non prescriptive in order to accommodate the diversity of the alternative asset management industry.

“Proportionality is key” according to Król, as the vast majority of hedge fund managers have between 10 to 20 employees. Their capacity to bear a disproportionately heavy compliance burden is therefore much smaller than that of the traditional large financial institutions. For example, the Level 2 proposals to separate risk management and portfolio management activities should be reflective of the size, internal organisation and the nature scope and complexity of managers’ activities.

Król noted that crucial third country issues have been postponed. It is unclear at this point whether the third country passporting provisions will come into effect and ultimately he said that there is a possibility that ESMA may well decide not to issue a recommendation to introduce third party passporting, leaving the private placement regime as the main gateway for third country managers to the EU. Interestingly, some important exemptions are available under the private placement regime for EU managers and third country funds. “For example a UK manager with a Cayman Islands fund would not have to comply with the AIFMD depositary provisions so managers may want to think twice before moving the domicile of funds away from Cayman”. He added that AIMA will be seeking input from third countries like the Cayman Islands in relation to these provisions.

Mark Lewis, partner at Walkers and chairman of AIMA Cayman concluded the presentation by commenting that “a year ago Cayman faced a period of uncertainty particularly in relation to the AIFMD”. However he had just obtained the up to date statistics from the Cayman Islands Monetary Authority revealing that fund registrations are once again on the increase with 414 new funds registered in the first quarter of 2011, which is up from 362 for the same period last year so clearly confidence in Cayman as a jurisdiction has been maintained. Lewis said that AIMA Cayman recognises the efforts and involvement of AIMA in London and the progress that has been made on behalf of the hedge fund industry as a whole in working on the AIFMD as well as AIMA’s input into US legislation and regulation.

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