UK begins work on AIFM rules

The UK Financial Services Authority has released a 90-page discussion paper outlining its provisional thinking in implementing the Alternative Investment Fund Managers directive into national law. EU sovereigns are required to implement the directive by July 2013.

The FSA acknowledged its rulemaking would draw heavily from past work, including that done for the MiFID and UCITS directives.

With respect to remuneration rules, the UK regulator is considering either bringing private funds within the scope of its existing remuneration code for banks and other financial firms, or creating a more tailored set of pay rules for private equity and hedge fund professionals.

Other considerations include how to sensibly require firms to split their portfolio management team from a risk management division. ESMA, the new EU authority responsible for drafting the directive’s technical advice, wants firms to build a Chinese wall between those responsible for monitoring and mitigating risk from those compensated on the success of their investments (and thus incentivised to seek higher risk-return payouts).

However, in private equity, the two roles are virtually one in the same, said one London-based lawyer. The industry argues that a risk management team could not monitor portfolio company risk as well as those fund managers actually responsible for overseeing the company’s development. The FSA is asking in what circumstances GPs would be unable to meet “the requirement to have functional and hierarchical separation of the risk management function”.

The UK regulator will accept feedback on its discussion paper for a two-month period ending 23 March. Comments will then be used to “help shape our thinking” before formal proposals are unveiled later this year, in turn opening a new round of public consultation, the FSA said.

The directive, which aims to harmonise private fund rules across EU sovereigns, has significant implications for how GPs will structure, market, operate and manage funds in the future. Moreover, the directive creates new obligations for third-party service providers, such as fund depositaries, external valuers and administrators.

“With the detail still far from being finalised, fund managers are facing a dilemma – to structure onshore or offshore,” said Daniel Green of law firm Pinsent Masons. However, as a way of creating a safety net if the rules become too burdensome, some GPs “are hedging their bets and putting structures in place now allowing for flexibility in the future”.

Comments can be submitted electronically by using this 69 question form on the FSA’s website.