24th July 2014
Given we are now 12 months post the publication of the Level II Regulation it seems appropriate that we reflect upon how the Directive’s requirements for a depositary are being applied. Langham Hall is now in the fortunate position to have been selected to act as depositary for 25 AIFs. Having negotiated several agreements, which have been influenced by a broad cross section of views from our clients' advisors, it is clear that we will have to closely monitor various drafting differences caused by variations in interpretation of a few remaining aspects of the Directive. During the due diligence and take on phase of our clients we have identified two grey areas where the market seems to have a divided opinion – the treatment of cash below AIF level and the identification of the AIFM for Jersey Unit Trusts.
ISSUE 1 - Treatment of cash below AIF level
The Delegated Regulation supplementing the AIFM Directive of December 2012, otherwise known as the Level II Regulation of the EU Commission, serves to expand upon certain aspects of the Directive and its application in practice. Articles 85 and 86 focus specifically upon cash flow monitoring requirements. Article 86 states that ‘A depositary shall ensure effective and proper monitoring of the AIF’s cash flows’.
The question is whether the wording specifically refers to the AIF in isolation or whether it includes entities below AIF level. For many funds, the assets are owned directly by the AIF and therefore cash monitoring at AIF level only is appropriate. Despite this there are some funds with numerous SPVs whose lawyers are relying on this interpretation to exclude cash monitoring in the SPVs and therefore the wording in the depositary agreement specifically excludes monitoring of cash below AIF level. Given there can be no unlimited liability for something the depositary is not supposed to monitor, in these cases we have inserted wording to exclude liability for loss of cash below AIF level.
However, for AIFs holding cash in entities below AIF level, although the prospect of loss of cash is remote, if it were to go missing it would probably be from one of the SPVs which from time to time hold cash and in respect of which the AIFM delegates control to a third party despite being majority owned by the AIF. Examples are where cash is left in the bank account of the SPV for capital expenditure, or where a joint venture partner controls banking at country level for a pan European real estate fund. It is unclear where responsibility lies for monitoring the cash in these circumstances.
At this stage it is the view of most lawyers that although the wording of the Directive specifically excludes monitoring cash at the level of these entities, it probably meant to capture these entities given the investor protection purpose behind the cash monitoring requirements. Whether this is based on any specific guidance in the Directive or whether it is just a “belt and braces” approach is difficult to determine but as yet only a handful of lawyers have taken a clear stance on any alternative interpretation. As a result, we are taking the view that we will, on a risk based approach, undertake a light monitoring of cash which mainly comprises –
For the foreseeable future we will continue on the basis of the latter interpretation, namely that although the wording of the Level II Regulation specifically excludes liability for monitoring cash below AIF level the SPVs were probably meant to be in scope. However, please do contact us if you have any views on this.
ISSUE 2 - Identification of the AIFM for offshore unit trusts
We spent some time before Christmas with David Porter who is spearheading the AIFMD project for the Jersey Financial Services Commission (JFSC). One of the unresolved matters is the identity of the AIFM in Jersey Unit Trusts.
The AIFM might be the Manager of the Unit Trust itself or alternatively the AIF’s administrator may operate an “umbrella” or “host” AIFM entity which could act as AIFM for several Trusts. We look to the UK and Luxembourg for ideas as to how this might work.
In the UK we have had acknowledgement from various client lawyers that as Manager and Operator of various Unit Trusts we are not automatically the AIFM because we do not undertake, nor do we take responsibility for, the risk management and portfolio management in relation to such Unit Trusts. If we were the AIFM then the entity responsible for investment management would go unregulated and we may need to appoint a third party depositary to the extent that on an aggregate basis we were AIFM to AIFs with total NAV in excess of €500m (assuming no leverage at Unit Trust level).
Regarding the concept of “umbrella” or “host” AIFMs in Jersey, we look to Luxembourg for precedent where, although one or two administrators are intending to offer this “umbrella” service, the legal community seem to favour the alleged CSSF endorsed route of each AIF client setting up a separate AIFM SPV which has part time employees and contains risk management expertise. In Langham Hall’s opinion the umbrella AIFMs in Jersey pose serious risks as a depositary will need to assess the competitor administration business that is intending to provide this “umbrella” service. Such an “umbrella” AIFM may drag otherwise sub-threshold Unit Trusts into needing a depositary due to the aggregate NAV across different client Unit Trusts for which the AIFM acts.
The JFSC has indicated that the depositary permissions will be available to those licensed to administer Expert Funds so our own opinion is that where we have been selected as depositary to Jersey AIFs, we would act from our existing regulated business and monitor the client SPV manager which could itself be AIFM to various Unit Trust AIFs in the same family of funds.
Again, as this is a very new area, we would be keen to hear your views.