This presentation serves as study notes for the e-learning material titled: "South African Hedge funds and international developments" These notes focus on AIFMD and its Impact on the Hedge Fund Industry. http://www.hedgefund-sa.co.za/aifmd

1. AIFMD Summary
Study Notes

2. Brief Overview
• The Alternative Investment Fund Managers
Directive (AIFMD) arose from a G-20 summit in
2008 that discussed the stability of the financial
industry
• Composed by the European Commission in 2010,
and set into motion July 21, 2011
• Countries in the European Union who will be
impacted by AIFMD have been given two years to
prepare for its start date on July 22, 2013

3. Products of AIFMD
• AIFMD is comparable to the United States’
Dodd Frank Act, but focuses on alternative
investment funds (AIFs)
• Managers are required to be licensed under
AIFMD if they fall within specified domiciles
• Managers that qualify for the licensing
requirements are:
– Managers that manage an AIF in the EU or from
the EU

4. Products of AIFMD
• Managers that qualify for the licensing
requirements are:
– Markets an AIF in or into the EU
• AIFs can be open or closed-ended funds
• If a fund does not fall under UCITS IV, it is
considered an AIF

5. Products of AIFMD
• Exemptions include:
– Joint ventures
– Pension funds
– Family offices
– Holding companies
– Securitization special interest entities
– Saving schemes
– Employee participation

6. Products of AIFMD
• Closed-ended funds may be exempt if:
– They do not perform any more investments after July 22, 2013
– The fund closes before July 22, 2016
• Topics discussed in AIFMD include:
– Changes to banking
– Depository requirements
– AIFs
– How AIFMs need to adapt
– Marketing of AIFs
– Impacts to offshore funds and some strategies
– Deadlines
– Tax concerns

7. Products of AIFMD
• Administration and transparency help disclose
how compliance and accountability will be
enforced
• Those who manage AIFs outside of the EU
may have to make structural changes to
accommodate to AIFMD standards

8. Depository Requirements
• New depository requirements obligate third party
providers domiciled in the EU to administer capital for
AIFs
• Third parties that are independent of the AIF will be
chosen as the depositories
– The depository must be domiciled in the jurisdiction of
either the AIF or AIFM
Overview
• Acceptable institutions and requirements
• Conflicts of interest involving depositories
• Downside for depositories

9. Acceptable Institutions and
Requirements
• AIFs in the EU register with the managers
Member State
• Non-EU AIFs can register with an EU credit
institution or investment from the AIF’s
residence, or with the managers Member State if
located within the EU
• Non-EU depositories may be used if they follow
the strict guidelines set by the EU
– This would require the depository to report all
holdings for tax purposes, and would be liable to the
AIF and AIFM

10. Acceptable Institutions and
Requirements
• Depositories will have many responsibilities
and will be liable for funds being administered
– Any losses of capital would be liable to the
institution with the holdings
• Managers are required to confirm that the
depository is adequate for holdings, and
holding entities will need to prove they have
the required resources to manage the tasks at
hand

11. Acceptable Institutions and
Requirements
• Depositories should consider the risk before
deciding to control any amount of holdings
– Appropriate fees will need to be charged
depending on the risk of holding certain AIFs
assets
• Prime brokers are allowed to act as
depositories if they can prove there is no
conflicts that would interfere with operations
as a holding agent

12. Acceptable Institutions and
Requirements
• AIFs take on the liability if they choose to use
a prime broker
• It may be more affordable to implement a
prime broke as a holding agent, but if
circumstances were to change dramatically it
may be wise to choose a third party
depository

13. Conflicts of Interest Involving
Depositories
• AIFMs who manage more than one AIF are
required to have a separate depository for
each AIF
• Depositories are obligated to a fiduciary duty
• If a depository desires, they may also act as a
prime broker if there is clear separation from
its depository and brokerage functions

14. Downside for Depositories
• There is much to be gained in operating as a
depository, but potential risk as well that
should be considered
• AIFMs will be required to clearly communicate
between depositories and prime brokers for
operations flow more smoothly
– Depositories will need to track all trades that
occur with the prime broker to know where assets
are located at all times, and later register account
balances after trading to assure accuracy

15. Downside for Depositories
• AIFMs will be required to clearly communicate
between depositories and prime brokers for
operations flow more smoothly
– Prime brokers view the total amount in
depositories as investable for even its own trading
purposes, depositories are left with all liability
– If a prime broker was to fail, depositories have 27
days under current AIFMD requirements to
restore the whole amount, even if they had no
fault

16. Reporting and Transparency
• AIFMD requires licensed managers to produce
a annual report and holdings report
• Valuations for the annual report will be
performed either by third parties, or the
manager if there is no conflict of interest
• Other requirements for reporting involving
transparency will assist with previous issues
that may have been problematic

17. Reporting and Transparency
Overview
• Annual Report
– Remuneration Disclosures
• Disclosures to Investors
– Percentage of Assets Subject to Special Arrangements
and Managing Liquidity of an AIF
– Risk Profile, Risk Management, and Leverage
• Reporting to Regulators
– Frequency, Content and Format
– Substantial Leverage

18. Annual Report
• Annual reports consist of:
– Investment holdings
– Financials
– Changes in holdings and value of the fund
– Historical performance
– Net asset value per share
– Fixed and variable remuneration to the manager
and employees
– Plus details of the carried interest

19. Annual Report
• Annual reports should be delivered to
regulators within six months of the ending
fiscal year, and available to investors if
requested
• Other changes in reporting will rely upon the
GAAPs used and the disclosures that writers of
the AIFMD deem necessary for proper
transparency

20. Annual Report
• Remuneration Disclosures
– Details involving the disclosure of compensation
will vary depending upon the size of the AIF
– Disclosure of remuneration will not be made
public, but will be available through disclosures of
an
• Annual report
• Separate compensation policy
• Any other form

21. Annual Report
• Remuneration Disclosures
– Requirements of the disclosures are listed in
AIFMD
– The compensation amount that is disclosed will be
itemized in given several ways
– Those under the private placement regime are still
required to produce a remuneration disclosure

22. Disclosures to Investors
Annual reports to investors are a required
minimum of AIFs
• Percentage of Assets Subject to Special
Arrangements and Managing Liquidity of an
AIF
– Disclosures of redemption rights on special
arrangements should be made available to
investors along with details of how the special
arrangements are set up

23. Disclosures to Investors
• Percentage of Assets Subject to Special
Arrangements and Managing Liquidity of an
AIF
– Notifications should be delivered to investors
when changes to liquidity or the risk management
of liquidity are made
• Risk Profile, Risk Management, and Leverage
– Details involving risk management must be
transparent prior to investments being made

24. Disclosures to Investors
• Risk Profile, Risk Management, and Leverage
– Risk profile should be made available in offering
documents and annual reports
– If a risk profile is compromised, investors should
be notified immediately to develop a solution
– Changes made to leverage caps and collateral
should be informed to investors
– All levels of leverage that are used or may be used
should be disclosed to investors

25. Reporting to Regulators
• Reporting requirements found in AIFMD were
developed to control the flow of risk in AIFs
– These requirements are upon all EU AIFMs who desire
to market their AIFs within the EU
• Frequency, Content and Format
– AIFs who manage between 100 million and 1 billion
Euros must disclose reports semiannually, while AIFs
that manage over 1 billion Euros must disclose reports
quarterly
• There is a 30 day deadline for both, but is extended to 45
days for fund of funds

26. Reporting to Regulators
• Frequency, Content and Format
– Special AIFs, like private equity funds that are
unlevered must only report on an annual basis with
the same deadlines arranged
– AIFMs have many details to include with the reports
and have additional requirements if using leverage or
non-listed companies in their strategies
– AIFMs who manage more than one AIF must list all in
a single report, as well as each AIF individually

27. Reporting to Regulators
• Frequency, Content and Format
– The report that is filed consists of over 41
questions and has many details
• Substantial Leverage
– Regulators plan on limiting leverage that is
considered substantial
• Substantial leverage is considered three times the NAV
– Disclosures on AIFs that manage substantial levels
of leverage have an extraneous amount of details
to report

28. Reporting to Regulators
• Substantial Leverage
– Authorities are responsible for amounts of
leverage AIFs use, and can limit the amount of
leverage an individual may use if it can endanger a
financial systems status
– AIFMs must notify authorities when changes to
the infrastructure involving leverage is made, and
inform regulators on how the change aligns with
policies that have been made

29. Regulations on Remuneration
Overview
• Remuneration on Delegators
• Remuneration Committee
• Timing and Intertwining of Remuneration
Provisions

30. Remuneration on Delegators
• AIFMD encompasses delegators beneath the
AIFM who were associated with responsibilities
of assisting risk and portfolio management
• AIFMs must assess whether the delegator(s) are
accountable to the compensation subtext under
the AIFMD, or if they will demand a contractual
agreement that excludes them from submitting
information relating to their remuneration

31. Remuneration Committee
• AIFs are required to develop a Remuneration
Committee (RemCo) if it meets requirements
of:
– Specific size
– Organization
– Nature of operations
• AIFs consisting of 1.25 billion Euros or less in
assets under management, and employing 50
or fewer individuals may be exempt from this

32. Remuneration Committee
• AIFs may be able to circumvent these
compensation provisions completely if:
– A RemCo is started
– 50% of remuneration is received as shares in the
AIF
– Risk management involved with compensation is
maintained

33. Timing and Intertwining of
Remuneration Provisions
• AIFMs managing AIFs before the initiation date
are allowed one year to comply
• Those receiving salary and remuneration before
2014 may need prior evaluation to the
compliance date
• Managers receiving compensation from domiciles
with different directives will be evaluated on a
pro rata substance
• Materials required of multiple regulators will be
adjusted to fit proper provisions

34. Risk Management
New policies that are brought on by risk management
clauses develop assessments for risk, risk management,
and liquidity of investments
• Permanent and Segregated Risk Management Divisions
• Risk Management Policies
• Measuring and Management of Risk and Risk Limits
– Setting Risk Limits and Managing Potential Risks
• Liquidity
• Examining and Reviewing the Risk Management Policy

35. Permanent and Segregated Risk
Management Divisions
• Segregated risk management independent of the
AIFM is now mandatory to reduce risk in AIFs
• This is troublesome for the structure when risk
management was previously integrated with
investment operations
• Audits of the segregated risk management team
will be performed annually by either a third party
or an inside source if there are no conflicts of
interest

36. Permanent and Segregated Risk
Management Divisions
• Employees on the segregated risk
management team will be compensated for
goals met for managing risk and not
performance of the fund

37. Risk Management Policies
• The policies involved with risk management are critical
to the implementation of risk management in AIFMD
• Crucial elements of the policies are:
– Distribution of responsibilities in the AIF
– Safeguards to segregate risk duties
– Constructing a risk profile and monitoring potential risks
Ways in which to monitor risk and make checkpoints for it
to clear
– Set risk limits
– Description of the kinds of reports
– Frequency of reporting for AIFs and the AIFM

38. Risk Management Policies
• More intricate AIFs may bring on Risk Officers
to communicate with upper level
management

39. Measuring and Management of Risk
and Risk Limits
• Scenario and stress tests may be performed to
monitor potential risks
• When placing risk limits, issues to be
considered include:
– Market
– Liquidity
– Credit
– Operational
– Counterparty risks

40. Measuring and Management of Risk
and Risk Limits
• Risk management provisions may affect the
strategy of the fund and influence changes to
– Market risk in volatility
– Bilateral transactions that raise risks for the
counterparty
– Operational risks influencing performance
– Liquidity of investments
– Credit investments

41. Measuring and Management of Risk
and Risk Limits
• Provisions in place require AIFs and AIFM to
– Implement risk management and prevention
methods
– Perform pre-tests to analyze accuracy of the
measures taking place
– Perform scenario and stress tests frequently to
adjust to fluctuations in the market
– Design reliable measures for liquidation when
needed

42. Measuring and Management of Risk
and Risk Limits
• Setting Risk Limits and Managing Potential
Risks
– Risk limits should be checked on a day-to-day
basis by the independent risk management team
– AIFMD does not restrict investing decisions, but it
does have two steps to be taken beforehand:
• Ensure the decisions made do not contradict with risk
limits set
• Construct a fail safe in case anything were to go terribly
wrong so that it can be solved poste haste

43. Liquidity
• AIFMs will need to link the liquidity profile and
redemption policies to how they structure their
strategy, once it has been chosen
• If they plan on supplementing less liquid assets
into their portfolios, they will need to
contemplate
– Redemption restrictions
– Pre-launch
– And other characteristics involved

44. Liquidity
• Special tools will be needed to control risk in
liquidity
• AIFMs be responsible for supervising
– Liquidity profiles
– Conflicts of interest that may arise with investors
– Enlightening potential investors of the redemption
restrictions that apply in great detail before they
invest
– Initiating stress tests to ensure the liquidity profile
– Reporting liquidity policies along with fail safes that
have been set in place

45. Examining and Reviewing the Risk
Management Policy
• AIFs must continually supervise its risk
management procedures and notify regulators
if changes are made
• AIFMs should assure that
– Compliance is followed
– Safeguards are currently inline with risk
management functions
– Necessary actions are taken when the
accurateness of current policies have changed

46. Disclosures of Control over Non-listed
Companies
• Funds must report in addition to changes in
holdings of non-listed companies when they
have voting rights that surpass or descend
below 10%, 20%, 30%, 50%, or 75%
• If an AIFM acquires a company, he has to
inform investors of the purchase and proper
authorities in the Member State

47. Disclosures of Control over Non-listed
Companies
• AIFMs must
– Inform employees of the acquisition immediately
– Furthermore enlighten the board of directors and
shareholders of changes to operations of the
company and outcomes that would effect
employment
– and update employees on conditional changes to
employment

48. Restrictions on Asset Stripping
• AIFs managed in the EU by EU and non-EU AIFMs
are prohibited from
– Distributing
– Reductions in assets
– Allowing redemption of shares
– And acquiring additional shares through one’s
separately managed AIFs during the first two years of
ownership under the passport regime
• This applies to public and private portfolio
companies

49. Restrictions on Asset Stripping
• Responsibilities fall on the AIFM and it is
illegal for him to perform or instruct these
actions upon others, as he is liable for
preventing these actions from taking place to
the best of his abilities
• Exceptions to these restrictions include:
– Companies with net turnover of less than EUR 50
million
– Balance sheet totals under EUR 43 million

50. Restrictions on Asset Stripping
• Exceptions to these restrictions include:
– Special purpose real estate funds
– SMEs that make portfolio companies with fewer
than 250 employees exempt
– And portfolio companies whose registered office
is located outside of the EU
• Dividend payments may be affected by this,
but AIFMD did not discuss interest payments
on bonds

51. Tax Consequences
• AIFMs may be confronted with double
taxation that may come with the passport
regime
• AIFs will primarily be a tax resident of the
location in which it is domiciled, but if AIFMs
are managing from across borders, it can
become complex and rely upon the
authorities in the jurisdictions that are being
dealt with

52. Tax Consequences
• Investors of the AIF and delegates of the AIFM
bring even more complexity when AIFs have
to monitor multiple jurisdiction tax guidelines
and/or maintain tax treaties
• A recent change to the taxation of AIFs was
brought on through the Value Added Tax (VAT)
Directive

53. AIFMs have to adapt
• AIFMs are required to attain an AIFMD license
when specific criteria is met
• Managers are now accountable for
– Directing of depository and risk management
requirements
– Accounting and compliance requirements
– Compensation requirements
– Prudential capital requirements

54. AIFMs have to adapt
• . Managers are only allowed to delegate their
portfolio and risk management roles to the
proper regulated entities defined by AIFMD
• Depository and risk management will add a
safety net in managing the portfolios, and
accounting and compliance regulations will
assist with transparency and minimize
deceptive practices

55. AIFMs have to adapt
• Compensation requirements will reduce the
amount of risk a manager is willing to take
• Prudential capital regulations set a minimum
amount of capital that must be on hand at all
times
• Managers who fall under the AIFMD are
confronted with special marketing and
passport regulations

56. AIFMs have to adapt
• Other guidelines include details about
– Annual reports Tracking of assets under
management
– Due diligence
– Observing cash flow
– Annual audits from disparate third parties Setting
limits on leverage

57. AIFMs have to adapt
Overview
• Impact on Hedge Funds
– Risk Management and Compliance
– Other Provisions
• Impact on Private Equity Funds
– Depositories
– Risk Management

58. AIFMs have to adapt
Overview
• Impact on Private Equity Funds
– Remuneration
– Capital Requirements
– Reporting, Control of Non-listed Companies,
Delegating of Manager Functions, and
Transparency
– Anti-asset Stripping Regulations

59. AIFMs have to adapt
Overview
• Impact on Real Estate Funds
– Depositories
– Remuneration and Conflicts of Interest
– Risk Management and Compliance
• Marketing and Passports in the EU
– EU Marketing Passports
– Private Placement Regimes

60. Impact on Hedge Funds
• Risk management and compliance
– Numerous larger firms had already employed
Chief Risk Officers to their funds in the recent
past, and now mid to small size firms are following
the trend
– Potential investors who inspect AIFs before
investing examines where risk level is on the
operational pyramid and how intimate the Risk
Officers are with the investment teams work

61. Impact on Hedge Funds
• Risk management and compliance
– Not all firms will require a compliance team but it
is well advised to stay accountable
– Third party compliance teams can be hired
frequently to perform tasks of valuations that
would be requisite under AIFMD

62. Impact on Hedge Funds
• Other provisions
– Depository and reporting requirements will reflect
the same standards upon hedge funds
– Compensation received by the fund manager will
be reported with the annual report in compliance
with AIFMD, as a way of discouraging managers
from taking excessive risks
– Changes to leverage will be executed as well to
lessen liabilities

63. Impact on Hedge Funds
• Other provisions
– Contracts will need to be adapted for the entities
associated with the operations of the AIF, and for
those contemplating co-domiciliation of an AIF
will require “mirror” entities in any dominion
outside of the EU

64. Impact on Private Equity Funds
• Unless the fund is closed-ended and dissolves
before July 16, 2016, private equity funds are
included as an AIF under AIFMD
• All AIFs are only permitted a single AIFM who
manages the fund
• Administration and marketing functions are
available to AIFMs that are outside the
boundaries of AIFMD

65. Impact on Private Equity Funds
• AIFs that have multiple EU and non-EU domiciled
managers, have the opportunity to select a
desired manager and transport the AIF to the
managers domicile
• Depositories
– Because investments involved with private equity are
most often illiquid, managers see this as a hassle that
wastes time and money
– Adjustments to the AIFMD may be changed in the
future to adjust for different AIFs and their investment
positions

66. Impact on Private Equity Funds
• Risk Management
– Risk management teams would be hired on to
assist with monitoring potential risks involved
with investments
– The risk management section covered by AIFMD is
for the most part, already used by private equity
funds through the due diligence process in
valuating prospective investments.

67. Impact on Private Equity Funds
• Remuneration
– Up to 40% of compensation must be received over a
spread of 3 to 5 years
• Compensation that is in holding for the time being could be
placed into the fund temporarily
– Lead roles that would be associated with risk involved
in remuneration are
– The investment manager
– Fundraising managers
– Investment management team and board members

68. Impact on Private Equity Funds
• Capital Requirements
– Capital requirements that are set require
managers to either hold their own assets aside, in
very liquid investments or cash, or to possess
adequate insurance

69. Impact on Private Equity Funds
• Reporting, Control of Non-listed Companies,
Delegating of Manager Functions, and
Transparency
– The only changes incorporated into reporting that
is not usually performed by private equity funds is
the separation of portfolio management,
remuneration policy, and valuations
– Outside valuators would use service providers as
third party contributors to access needed
information from private equity funds

70. Impact on Private Equity Funds
• Reporting, Control of Non-listed Companies,
Delegating of Manager Functions, and
Transparency
– Issues at hand for operations would lean towards
asset stripping for future acquisitions,
miscommunication regarding objectives for
production of the company and the impact on
employment
– The delegation of manager functions clause is
primarily not applicable to private equity funds since
the bulk of the work performed is internal

71. Impact on Private Equity Funds
• Reporting, Control of Non-listed Companies,
Delegating of Manager Functions, and
Transparency
– Transparency is predominantly not an issue
– Private equity funds have been known to keep
their investors current with what holdings are
within the fund, AIFMD only re-states what has
already been done in the past
– How the report is manifested is the only
significant area of improvement for transparency

72. Impact on Private Equity Funds
• Anti-asset Stripping Regulations
– Regulations on asset stripping will restrict
activities in structuring that was previously
performed in most private equity firms
– If there were to be an economic crisis equivalent
to 2008, the fund would be unable to implement
exit strategies for assets enclosed by the
regulation

73. Impact on Real Estate Funds
• Even though real estate funds, also known as
REITs, are a type of mutual funds, they are still
incorporated with AIFs after German regulators
pushed that they should be embraced under
AIFMD
• With investors more leery about REITs since the
crash in 2008, they have been less popular and
the regulations that have been implemented
recently do not contribute many positive aspects
to these vehicles

74. Impact on Real Estate Funds
• Depositories
– Depositories are a considerably pricy vehicle for
REITs and require clear communication between
the two for confirmation of where investments
are located and when
– Custodians will have to face sizeable liability and
may have to regulate which investments are too
risky for it to accept

75. Impact on Real Estate Funds
• Depositories
– Performing annual valuations would be
convoluted due to the structuring of operations
through multiple entities
– Many who are working on interpreting AIFMD are
still uncertain of how regulators propose to
implement depository, reporting, and numerous
other requirements involved with REITs

76. Impact on Real Estate Funds
• Remuneration and Conflicts of Interest
– Disclosure of compensation in annual reports is
common for REITs, but new provisions will need
clarification before they can be initiated
– Conflicts of interest have also been covered in the
past; some when involving investors and clients
with various investors under them consider the
additions that come with AIFMD inequitable

77. Impact on Real Estate Funds
• Risk Management and Compliance
– REITs have previously performed risk management
in the past without the sanctioned regulations
that enforced teams to be implemented, but this
can come across as challenging for some
– Latest provisions of the compliance implications
are considered very arduous compared to the
compliance platforms that had formerly been in
place

78. Marketing and Passports in the EU
• Two exceptions marketing in the EU are the
pursuit of retail investors, and investors who
introduce the AIF to others
• Member states oversee marketing to retail
investors, so AIFMs must check with the
applicable jurisdiction to see what restrictions
are in place

79. Marketing and Passports in the EU
• EU Marketing Passports
– Special marketing passports will be made accessible to
AIFMs who qualify under specific criteria, and allow
them to market in the EU
– Specific criteria must be met before an AIFM passport
may be obtained
– Passports will be accessible to all EU AIFMs marketing
AIFs domiciled within the EU by July 22 of 2013, non-
EU AIFMs marketing EU AIFs or non-EU AIFs and EU
AIFMs marketing non-EU AIFs July 22 of 2015

80. Marketing and Passports in the EU
• EU Marketing Passports
– Applications for AIFMs in Member states will be
processed within 20 days of submitting and
obtaining the application
• Processing entities would then notify all EU domiciles in
which the AIFM intends to market his AIF(s) after the
AIFM has received notification of its acceptance

81. Marketing and Passports in the EU
• Private Placement Regimes
– EU AIFMs who market non-EU AIFs, and non-EU
AIFMs who market EU and non-EU AIFs in the EU
would be allowed to proceed with operations if
compliant with the national private placement
regimes guidelines
– AIFMs must conform to the standards of AIFMD
that are installed during 2013, with exceptions to
the depository clauses to be eligible

82. Marketing and Passports in the EU
• Private Placement Regimes
– Compliance and reporting for the transparency of the
fund must be functioned through a third party
valuator who is not the AIFM
– Authorities, which require reporting, are the countries
in which the AIFM is marketing his or her AIF
– Risk management of the AIF(s) will be co-monitored
between/ among the regulators of the domiciles
within the EU where they are marketed, the
regulators of the non-EU AIFM’s country of residence
and/ or residence of the non-EU AIF

83. Marketing and Passports in the EU
• Private Placement Regimes
– Non-EU AIFMs and AIFs may not reside within
domiciles that are in violation of FAFT policies
– This national private placement regime would be
established in July of 2015 through July of 2018
along with the passport regime, but may very well
be removed after 2018 and substituted with the
passport regime altogether

84. Impact on Investment Strategies
• AIFMD does not specifically outlaw certain
investments strategies, the safeguards which
have been set with risk management,
depositories, disclosure requirements and
everything else will assist in AIFMs cherry-
picking their investment choices
• A due diligence process is also required of
current and prospective ventures before
managers make investment decisions

85. Conclusion
• There are many safeguards that have been set
in place for this directive
• Risk management, reporting, and depository
requirements presented will be inconvenient
for many managing AIFs
• The benefits of implementing AIFMD can only
be known once the time comes for it to be
tested