An early Christmas present for GPs from the European Securities and Markets Authority (welcomed with about as much excitement as a pair of socks) was the publication of the Level 2 regulations to implement the Alternative Investment Fund Managers (AIFM) directive. So perhaps now is a good time for GPs in Europe to start setting themselves some New Year's resolutions to prepare for compliance with AIFM starting in July (or the end of any relevant grandfathering period).
If GPs haven't done so already – and many have been waiting until the requirements were more precisely defined – they could use the momentum that the New Year brings and the clarity that the regulations have (in some areas) provided to take the following basic steps to review their internal operations, structures and procedures and plan for any required changes.
Suggested New Year's resolutions for a GP operating in Europe might include:
1. Review fund, management and advisory structures for any existing and contemplated funds to identify all European Economic Area AIFMs and AIFs. Consider whether the firm will be actively marketing funds within Europe after 23 July 2013. Map out in broad terms the relevant AIFM requirements that it will need to comply with and by when.
2. Set a methodology to calculate (and monitor) assets under management (including any exposure to derivative instruments). Consider whether any older funds need to be taken into account. Confirm whether funds are leveraged or not (and, if any are, calculate the amount of exposure using the gross and commitment methods).
3. Assess the appropriate amount of any additional funds and professional indemnity insurance that are required to be held to cover potential liability risks from professional negligence, using ESMA's guidance on “appropriateness”.
4. Consider ways of improving the robustness of policies on managing conflicts of interest and fair treatment of investors. Review valuation, as well as reporting procedures, in light of transparency requirements.
5. Review internal organisational structures. Examine whether there is sufficient functional and hierarchical separation of risk management from the operational side of the business. For smaller GPs, consider (and document) how risk management is embedded into investment evaluation procedures. Consider adequacy of human and capital resources generally.
6. Identify potential depositaries and consider what they will be responsible for. Factor in the cost implications of appointment. Check whether existing fund documents allow depositary costs to be paid for by the fund. Make sure new fund documents include such a provision.
7. Review delegation arrangements. Assess, in light of the nature and extent of the tasks delegated, whether there is any risk of the GP/manager being deemed to be a letterbox entity (note that ESMA has promised to issue guidance on what constitutes a letterbox entity to ensure consistency of interpretation across the EEA). Consider whether the delegation arrangements will require regulatory approval.
Attempting to apply the new and ill-fitting rules on remuneration to current bonus, carry and co-investment schemes might perhaps be better deferred until February when (we hope) there should be greater clarity.
2013 is set to be another challenging year for the private equity industry, with a massive increase in regulation likely to drive further the trend towards institutionalisation. The better prepared the GP, the better its chances of survival in the brave new world.
Liz Judd is a London-based lawyer in SJ Berwin's private funds practice.