AIFMD and CISA-Revision

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AIFMD and CISA-RevisionRegulatory Challenges for Swiss AIFMs

Dr. Guenther Dobrauz-SaldapennaPwC Zurich

Bloomberg presents » AIFMD Rules and Regulation«

Geneva | 17th July 2013

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Agenda

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01 The Regulatory Tsunami

02 AIFMD

03 CISA Changes

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The Regulatory Tsunami

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The Regulatory Tsunami visualized

2015

2013Packaged

retail investme

nt products

Credit rating

agencies

UCITS IV

Solvency II

ASSET MANAGEMENT

INSURANCE

Bank capital rules

FATCA

AIFMD

UCITS V

Consumer

protection

Corporate governance &

executive remuneration

Target 2 Securiti

es

MiFID II

BANKING

2020

IMD II

IFRS 4 Phase II

CISA

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Horses for coursesInitiatives have different goals and thus impact

• US-led ones like the Foreign Account Tax Compliance Act (»FATCA«) and the Dodd-Frank Wall Street Consumer Protection Act (»Dodd-Frank«) increase tax transparency by requiring intermediaries to look through structures to identify taxable income

• The EU Alternative Investment Fund Managers Directive (»AIFMD«) focuses on strengthening supervision by requiring licensing where the actual substance is and indirectly impacts on distribution

• Swiss Collective Investment Schemes Act (»CISA«) amendments try to ensure continued access of Swiss-based financial intermediaries to the EU market for product distribution and service provision

Combination of AIFMD and CISA will modify established structures, business models and distribution channels of Swiss advisors and managers of alternative investment funds

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AIFMD

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AIFMD key concepts

• Directive regulating activities of Alternative Investment Fund Managers (»AIFMs«) operating in the EU, i.e., any EU or non-EU AIFM managing and/or marketing any EU or non-EU Alternative Investment Fund (»AIF«) in the EU

• “Managing” broadly means performing portfolio and risk management, “Marketing” covers (active) direct or indirect offering/placement by/on behalf of an AIFM of shares/units in an AIF to EU investors; reverse solicitation not covered

• AIFMD does not regulate AIFs per se but indirectly imposes requirements on EU and on non-EU funds

• An AIF is any non-UCITS fund, both EU and non-EU domiciled, explicitly including hedge funds, private equity funds and real estate funds

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EU carrot & stick approach

• AIFMD will offer an EU-passport for compliant EU AIFMs and EU AIFs as of 2013

• EU passport may be available from 2015 to EU AIFMs marketing non-EU AIFs, and non-EU AIFMs marketing EU or non-EU AIFs if AIFM fully complies with directive and supervision is recognised as equal

Cooperation and OECD-compliant TIEAs are in place between AIFM and AIF domiciles, EU AIFM reference member state and EU states where AIF is marketed

AIF and AIFM domicile not FATF blacklisted

• National private placement schemes may remain until 2018

• Directive does not apply to AIFM with (»de minimis«): less than €100m under management; or less than €500m AuM if funds not leveraged and lock-up of min. 5 years

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Publication in the Official Journal (1 July)

AIFMD Timeline

Jul 11

Aug 11

Jul 13

Jan 19

Entry into Force(21 July)

1st Draft ESMA advice on Delegated Acts(consultation deadline 13 Sep)

• Deadline for transposition into national law

• Passport introduction for EU AIFMs managing EU AIFs (21 July)

Jul 14

Deadline for authorisation of AIFMs (21 July)

Jul 15

ESMA opinion on implementation of the passport regime for non-EU funds and managers

Oct 15

Oct 18

EU passport available for non-EU AIFM

ESMA opinion on withdrawal

of national PPRs

Withdrawal of national PPRs following receipt of ESMA’s positive advice

Final ESMA advice on Delegated Acts to be submitted to the EC(16 November)

Nov 11

2nd Draft ESMA advice on Delegated Acts(consultation deadline 23 Sep)

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Jun/ Jul 12

Level 2 measures by EU Commission

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The Directive – Structure

Art. 6-11: Authorisation of AIFM

Art. 12-17: Operating conditions for AIFM

Art. 19-20: Valuation; Delegation

Art. 21: Depositary

Art. 22-24: Transparency Requirements

Art. 25-30: AIFM managing specific types of AIF

Art. 31-33: Rights of EU AIFM to market and manage EU AIF in the EU

Art. 34-40: Rules in relation to 3rd countries

Art. 41-53: Marketing to retail investors. Competent authorities

Art. 12-13: General principles and remuneration

Art. 15: Risk Management

Art. 16: Liquidity Management

Art. 17: Investment in securitisation positions

Art. 22: Annual report

Art. 23: Disclosure to investors

Art. 24: Reporting obligations to competent authorities

Art. 1-5: Definitions, exemptions, determination of AIFM

Art. 6: Conditions for taking up activities

Art. 8: Conditions for granting

Art. 9: Initial capital and own funds

Art. 11: WithdrawalArt. 18: Organisational requirements

Art. 14: Conflicts of interest

Art. 7: Application

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Overview of key provisions

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Authorisation

• All AIFMs need to be regulated by their EU «home state» financial regulator;

• Authorisation process will require submission of detailed information to the regulator about shareholders, members, managers and cont-rollers, a programme of activity, including information concerning how the AIFM will comply with its operational obligations under the Directive, about the AIFs to be managed, the countries where the AIFs are to be sold and details of the custodians, valuers and other third parties to whom material functions are delegated;

• As from 2015, non-EU AIFMs who manage EU AIFs and/or want to market an AIF to professional investors in the EU under the AIFMD passport will need to be authorised and regulated for AIFMD purposes by their MS of reference.

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Operational requirements (I)

General provisions

• Documented internal systems of management and control complying with EU standards (partly following UCITS models) relating to liquidity, management of conflict of interest and risk management (see later);

• AIFM requires independent «valuer» and an independent depositary (see later);

• For external AIFM, regulatory capital of not less than € 125,000, with additional funds equal to the higher of 0,02 % of the amount by which portfolios under management exceed € 250m – this includes portfolios the AIFM manages on a delegated basis (capped at € 10m) or one quarter of fixed annual overheads;

• Internally managed AIFs need to maintain regulatory capital € 300,000.

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Operational requirements (II)

Delegation

• An AIFM is permitted to delegate its functions subject to having objective reasons for doing so;

• An AIFM must not delegate its functions to the extent that it can no longer be said to be the AIF’s AIFM and becomes a «letter box entity».

Risk management

• AIFM must create a functionally and hierarchically separate risk management function, and formally documents a risk management policy relevant to the specific dynamics of each fund it manages;

• Provisions are analogous to the requirements contained in recent UCITS requirements – emphasis on creation of robust framework rather than prescriptive rules.

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Operational requirements (III)

Liquidity management

• ESMA recommends that the AIFM documents a liquidity policy consistent with, and appropriate for, the liquidity profile of the investors, and of the portfolio of investments;

• Specific reporting and notification requirements are provided in the event of ‘special arrangements’, to include side pockets, illiquid investments and suspension of NAVs as a result of liquidity issues.

Conflict of interest

• AIFM will be required to establish, implement and maintain an effective conflicts of interest policy;

• Possibility of a firm disclosing circumstances that represent a conflict of interest as a solution to the conflict significantly limited, requiring instead a firm to manage its affairs to avoid such conflicts.

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Operational requirements (IV)

Valuation

• For each fund, either the AIFM or an external third party needs to own the valuation function;

• If the AIFM assumes the responsibility, the function needs to be functionally independent from the portfolio management process.

Leverage

• Basically three options for calculating the leverage – the Gross Method, the Commitment Method and an «Advanced Method». The first two would be mandatory calculations; the third would be used at the discretion of the national supervisor.

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Depositaries

• Duties:- custody of financial assets and non-financial assets;- cash-flow monitoring, cash booking and record-keeping;- oversight duties both in terms of due diligence into sub-

custodian and also of oversight AIFM conduct.• Depositaries will be responsible for ensuring that

transactions are in accordance with investment strategies, as explained to investors;

• Depositaries will be liable for repaying to the fund the value of any financial assets held by them or their sub-custodians, which subsequently are lost.

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Transparency

General provisions

Transparency requirements are envisaged in three main categories:

• Annual reporting and periodical reporting to investors;• Reporting to national regulators;• Remuneration.

Remuneration (1/2)

Aspects of remuneration need to be disclosed to investors: • Total amount of remuneration for the financial year, split into

fixed and variable remuneration paid by the AIFM to its staff, and number of beneficiaries, and, where relevant, carried interests paid by the AIF;

• Aggregate amount of remuneration broken down by senior management and members of staff of the AIFM whose actions have a material impact on the risk profile of the AIF.

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Transparency

Remuneration (2/2)

• AIFMD requires the deferral of performance related payments, participation in equity based compensation and reward policies that align bonuses to the wider strategy of the business;

• Managers will be required to defer for an «appropriate» period at least 40-60 % of the bonuses and carried interest of affected staff, and at least 50 % of the variable compensation will need to be equity interests in the relevant fund, share linked instruments or equivalent non-cash instruments.

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Third-country provisions

Requirement for equivalence

Focuses is on three major areas:

• Delegation of portfolio or risk management to third-country undertakings

• Appointment of a depositary based in a third country

• Cooperation arrangements between EU and third-country competent authorities in connection with the management and marketing of third-country (or third-country managed) AIFs

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Do

mic

ile

of

Fu

nd

EU

No

n-E

U

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What are the impacts for AIFMs?AIFMD decision tree (simplified assumptions)

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CISA Changes

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BackgroundIndirect Swiss AIFMD transposition/partial MiFID alignment• CISA revision attempts to align the Swiss legal framework with EU

standards to ensure continued access of Swiss managers and service providers to the EU harmonised market and to close perceived gaps in investor protection in Switzerland;

• Revised CISA and CISO have entered into force 1 March 2013;

• Under the revised law the FINMA licencing regime for managers of collective investment schemes has been expanded to also include the management of foreign AIFs and Swiss branches of foreign asset managers unless de minimis rules apply;

• The Swiss regime for the placement of AIFs in Switzerland has been brought closer in line with MiFID standards by narrowing the definition of qualified investor and introducing additional qualitative requirements on product and distributor level with further significant changes expected in the near future.

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New licensing regimesAsset Managers

• Under the revised CISA branches of foreign asset managers and managers of all foreign investment funds will require licencing unless: these funds are exclusively open to qualified investors; and

these funds do not in aggregation exceeded CHF 100m AuM (open-ended and including leverage) or CHF 500m (no leverage and closed ended) (de minimis); or

investors are exclusively member firms belonging to the same group as the Swiss-based asset manager.

• Capital requirements for AIFMs remain at CHF 200k, CHF 500k is required if fund business for foreign collective investment schemes is also conducted.

• Asset managers who fall under new licencing regime must contact FINMA by 31 August 2013 and file an application within 2 years.

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New licensing regimesBranches and consolidated supervision

• Branches of foreign AIFMs must and can obtain licencing if they: are in toto (head office and branch) subject to adequate

supervision at their domicile; have adequate financial resources, qualified personnel and

organisational infrastructure to operate a branch in Switzerland; they are not entirely controlled from Switzerland or the majority of

their business is conducted from Switzerland; all general requirements with the exception of capital

requirements are complied with, and if cooperation between FINMA and competent authority is in place.

• FINMA may require adequate consolidated (group) supervision of asset managers who are part of a financial group or conglomerate if this is required by international standards.

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New licensing regimesDistributors and Representatives

• Distributors of foreign collective investment schemes intended for distribution to qualified investors (unless exclusively to supervised financial intermediaries and insurance companies) require licencing unless they are: adequately supervised by their home regulator; licenced for such activity; and have concluded a written distribution agreement with a Swiss representative.

• Representatives of foreign collective investment schemes intended for distribution to qualified investors (unless exclusively to supervised financial intermediaries and insurance companies) require licencing;

• Representatives of foreign collective investment schemes as well as distributors now requiring licencing must contact FINMA by 31 August 2013 and file an application within 2 years;

• Banks, securities dealers, insurance companies and asset managers of collective investment schemes require an additional representative licence – file by end 02/14.

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New transparency rules

Incentivisation of distribution chain

Following the CISA revision:

•All commissions and other benefits paid to distributors must be disclosed to investors in full;

•All commissions received by fund management companies and asset managers when acquiring investment funds managed by them on behalf of their clients must be disclosed.

Recording /minuting

In all instances of distribution activity (i.e., not if placement with supervised financial intermediaries and insurance companies) it will be required to record determined investors’ requirements and reasons for investment recommendations in writing.

Such minutes (protocols) have to be delivered to investors.

Actual form and content of minutes will be determined via self-regulatory bodies recognised by FINMA.

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Modified catalogue of Qualified Investors

Discretionary asset management clients of regulated financial intermediaries who have not opted out and where the asset manager is:• In his capacity as financial intermediary governed by

the Anti-Money Laundering Act;

• Bound by an industry body code of conduct recognised by FINMA as minimum standard; and

• The discretionary asset management agreement similarly complies with the guidelines of an industry body recognised by FINMA as minimum standard.

Discretionary asset management clients of regulated financial intermediaries who have not opted out.

Regulated financial intermediaries•Banks•Securities dealers•Fund management companies•Asset managers of collective investment schemes•Central banks•Representatives of foreign collective investment schemes•Swiss corporate investment vehicles

(SICAVs, SICAFs, Swiss LPs).

Regulated insurance institutions.

Public entities and retirement

benefits institutions with professional treasuryoperations.

HNWIs who have opted in and are able to prove that at the time ofinvestment into an AIF they either• Have assets of at least CHF 500k, and • Have sufficient knowledge to asset the

investment’s risk based on education and professional experience or based on comparable experience in the financial sector; or

• Have assets of at least CHF 5 Mio. which may also comprise real estate of up to a maximum of CHF 2 Mio net value (market value net debt).

Qualified investors

Companies with professional

treasury operations.

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New distribution rules

• All distribution of foreign collective investment schemes to qualified investors requires nomination of a Swiss representative and paying agent on behalf of the AIF and a distributor’s licence, unless marketing of foreign AIFs only to regulated financial intermediaries

and insurance companies; or acquisition of AIFs based on reverse solicitation; acquisition in the course of a discretionary asset management

agreement with regulated financial intermediary or IAM on behalf of the client; or

acquisition in the course of an investment advisory mandated based on a long-term, written advisory agreement with a regulated financial intermediary an or independent asset manager.

• No distributor’s licence is required for the distribution of Swiss AIFs to Swiss qualified investors.

• The product if not offered to public does not require authorisation by FINMA but adequate product supervision.

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State of play in SwitzerlandWhat we see in the market

• Huge questions around distribution of products;

• Entire business models – for example of distributors only – are endangered if these do not have appropriate licensing outside of Switzerland, enough local substance to obtain licensing or if expected additional cost on product level are prohibitive;

• Independent asset managers chiefly relying on AIFs to create alpha for portfolios and make money from incentives have to reconsider;

• Independent asset managers with own (label) AIFs have to become licensed which is often difficult;

• Incentivisation of distribution chain further threatened by initiated Financial Intermediaries Law which may in turn lead to disruption of existing business models.

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Dr. iur. Guenther Dobrauz-Saldapenna, MBA

Director, Asset Management Regulatory & Compliance Services

PricewaterhouseCoopers AG

Birchstrasse 160

CH-8050 Zürich

Switzerland

+41 58 792 14 97

guenther.dobrauz@ch.pwc.com

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