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AIFM Directive is still not good enough
Michael Jackson
Conceived in panic, delivered in haste and reared against a background of parental disharmony, the Alternative Investment Fund Managers Directive is likely to be a problem child for EU legislators and an unnecessarily disruptive influence on the alternative fund management industry in Europe says Michael Jackson
First published on 29th April 2009, following what can best be described as a somewhat token consultation process, the AIFM Directive has been controversial from the outset. While the origins of this initiative clearly lie in the meetings and decisions of the G20 leaders called to address a united response to the financial crisis, it is noticeable how much more quickly Europe has moved in this regard than any of the other trading blocks represented at the G20. Post the G20 meetings, the US and Asia have also reflected on how best to address systemic risks associated with the alternative investments and have announced some planned changes to their regulatory approach. Nothing announced by them to date, however, even begins to match the level of regulation or the fundamental operational changes which would be required were the AIFM Directive to become law.
Michael Jackson


The phrase ‘festina lente’ is often associated with the Dutch humanist Erasmus, a name now closely linked with many EU educational initiatives. It is somewhat ironic that the approach of more modern European political thinkers in relation to the AIFM Directive has been to ignore the advice of Erasmus at every turn, despite clear signals that, on this issue, chaos may ensue from dogmatism and undue haste.

From an Irish perspective, 2009 has been notable for the increase in activity in the regulated investment funds space. Ireland is the largest hedge fund administration centre in the world, with over 15,000 people employed in establishing, servicing and advising investment funds. The traditional alternative investment funds model has been to establish a Cayman fund with an Irish listing and Irish service providers. In 2009 we have seen managers of alternative funds in offshore jurisdictions come under increased pressure from distributors and institutional investors to offer regulated product, with the result that many have either re-domiciled product to Ireland or have taken a decision to establish their new funds in Ireland. The great irony of the AIFM Directive is that at a time when there was a noticeable move to regulation in Europe, the controversial aspects of the proposal have caused some managers to start to plan for a shift out of Europe. If that comes to pass, it would surely count as one of the great own goals of EU financial services legislation.

The stated aim of the AIFM Directive is expressed in the latest commission draft as follows:-
‘The impact of AIFM (alternative investment fund managers) on the markets in which they operate is largely beneficial, but recent financial difficulties have underlined how activities of AIFM may also serve to spread or amplify risks through the financial system. Uncoordinated national responses to these risks make the efficient management of these risks difficult. This Directive therefore aims at establishing common requirements governing the authorisation and supervision of AIFM in order to provide a coherent approach to the related risks and their impact on investors and markets in the Community.’

Management of systemic risk is the stated priority. One would therefore expect that the provisions of the AIFM Directive will all have the effect of clearly reducing or facilitating the management of systemic risk. An analysis of some of the most controversial provisions of the AIFM, however, leads to a somewhat different conclusion. Looking at the provisions relating to scope, depositaries, remuneration and third country funds, one cannot help concluding that the stated aim and objective has either been forgotten or has taken a back seat to more immediate political objectives on behalf of certain member states.

The evidence produced to date confirms that levels of leverage in alternative investment funds at the height of the financial crisis was substantially lower than that of other financial institutions. The perceived tendency of other institutions to utilise leverage in the expectation that they had the benefit of implied state support in the event of a catastrophe led directly to the move against ‘moral hazard’ which saw decisions taken which led to the collapse of some of those institutions. In light of this, it is hard to believe that any draft of the AIFM Directive could have provided that it should be mandatory that depositaries of AIFM should be credit institutions and that they should have strict liability for the assets in their custody. How could systemic risk be managed or reduced by requiring banks or MiFID firms to effectively act as insurers of market risk in the alternative space? The fact that some involved in the process are reported to believe that the credit institution requirement will provide investor protection because there will be an element of ‘implied guarantee’ from member states suggests that far from learning lessons from the crisis, some continue to ignore those lessons.

Leaving aside the question of moral hazard or systemic risk, the suggested provisions (which have recently been modified in the Swedish compromise proposal but received some support from the provisions of the Gauzes report published on 26th November and which reflects the initial views of the MEPs tasked with reviewing the AIFM Directive) would also have a detrimental effect on investors. I believe that they would reduce the number of entities willing to act as depositaries and result in increased fees for the additional risks being assumed. The investors will ultimately be the ones to pay the price and the level of increased protection they will receive in reality will, in my opinion, be minimal.

It is hardly credible that eight months after the original publication of the proposed AIFM Directive, the question as to what its scope will be remains unresolved. The ‘quick fix’ solution of defining its scope to be anything that is not a UCITS has quickly been seen to be flawed in concept and potential application. The latest Swedish compromise proposal continues to raise questions about whether there will be monetary thresholds below which funds would be exempt from the provisions of the AIFM Directive and have suggested excluding pension funds and structured product vehicles. Financial thresholds would appear to be consistent with the stated aim of the AIFM Directive, unless it is feared that a proliferation of small funds could impact on systemic risk. The provision of other exemptions is broadly to be welcomed but opens the probability that these exemptions will be used to structure around the proposals through the use of financial products which fall outside the scope of the AIFM Directive. By specifically addressing the risk of feeder funds being established to feed into unregulated third country master funds, the Swedish proposal acknowledges that such structuring will take place. The Commission needs to understand, however, that structuring is not limited to the investment funds arena and that the only effective way to prevent this is to ensure that the final version of the AIFM Directive is sufficiently sensible and provides sufficient benefits to make such structuring unnecessary.

The provisions introduced in the recent Swedish proposal relating to manager compensation also unfortunately appear to reflect a nod towards political correctness and the populism of the times rather than a considered response to the question of how best to address risks created by alternative investment compensation mechanisms. If Europe continues to proceed alone on this issue managers will look elsewhere for a home for their products. Driving managers out of Europe is hardly the best way to ensure that European regulators have sufficient information to hand about the activities of those managers to enable them to manage systemic risk. The Commission and the Parliament need to remember that Europe does not exist in a vacuum and that it cannot operate as an isolated fortress against perceived ‘evils’. Managers who object to unreasonable restrictions being placed on their ability to do business in Europe will find welcoming homes in jurisdictions outside Europe and it is notable that Singapore, Hong Kong, Shanghai and Taipei are all currently reviewing their competitive positioning as international fund centres. Just as the UCITS has dominated retail distribution in Asia, we could quickly find Asian funds dominating the institutional market in Europe in the area of alternative investments if the issues are not satisfactorily resolved.

The phrase ‘fortress Europe’ has been used to describe the thinking which led to the provisions of the AIFM Directive relating to third country funds. The original proposal suggested prohibiting even private placement of third country funds in Europe and limiting the passport to European funds. More recent drafts and commentary from the Commission and the Parliament suggest that there is a growing acknowledgement of the difficulty of regulating private placement at an EU level, but a continuing over-estimation of the extent to which the European passport will really act as an incentive to alternative fund managers. The passport will bring distribution benefits, but the market for alternative funds is and will likely remain an institutional market in which the benefits of a passport are less evident than in the retail space. If the cost of obtaining the passport in terms of restrictions on operational efficiency, liability and remuneration are too great managers will be willing to trade that passport for a lower level of regulation and a private placement regime. Driving funds and managers out of Europe would constitute a failure of policy and a failure of vision by the EU at a time when, as mentioned previously, EU regulated funds are more popular than ever before.

As a service centre to over 5,500 non Irish domiciled funds, as well as the largest European jurisdiction for regulated alternative investment funds, Ireland is in a unique position to judge the impact of the AIFM Directive. The introduction of the one day authorisation process for the QIF, the efficiency of our funds regulation, the fact that Ireland is already a key destination on the well trodden route for alternative investment funds and the fact that the expertise built up in Ireland in relation to alternative investment management significantly surpasses that available in any competitor jurisdiction should mean that Ireland will stand to benefit greatly from a sensible AIFM Directive. Those benefits will only materialise, however, if the European Commission and the European Parliament recognise before it is too late that you stand to increase rather than reduce systemic risk if you effectively force investment funds and investment managers who wish to operate in Europe to structure around the AIFM Directive or to operate from outside Europe. It’s time to put an end to the distracting skirmishes and focus on achieving the real objectives.


Michael Jackson is a partner in the asset management and investment funds group at Matheson Ormsby Prentice and chairman of the Irish Funds Industry Association.

The information in this article is not intended to provide, and does not constitute, legal or any other advice on any particular matter, and is provided for general information purposes only. The views expressed in this article are personal and do not necessarily reflect the views of the IFIA.