AIFM directive: a question of regulation

JAMES BURNETT - BAKER & MCKENZIE

ANDERS FAST - BAKER & MCKENZIE

1. In recent years, the industry has gone some way to increase transparency, but the AIFM Directive goes even further. Do you think this forced disclosure skews competition to the disadvantage of private equity?

While the extent of disclosure required under the AIFM Directive is being contested, a separate issue is the prejudicial treatment of private equity compared to other shareholders. As the Directive does not apply to SWFs, pension funds, insurance companies, credit institutions, family offices or HNWs, the disclosure obligations, particularly compliance with the Transparency Directive, put private equity at a disadvantage.

Furthermore, disclosure of the development plan for non-listed companies and the communication policy with employees should be obligations of the company, not the shareholder. Imposing such requirements exclusively on private equity owners (especially those with a minority interest) is seen by many as unjust.

2. The third-country rule, whereby non-EU-based fund managers cannot market their funds within the EU, is one of the most contentious issues in the draft. How do you view this clause?

The protectionist provisions within the Directive have come under particular scrutiny. Non-EU-based managers are unlikely to be willing to comply with the Directive as it stands, particularly with the rising importance of Middle Eastern, South American and Asian investors. These provisions could also provoke retaliation from other jurisdictions, restricting EU-based managers' ability to market funds outside the EU.

The third-country rule also restricts a manager's ability to employ non-EU-based service providers. This could reduce competition amongst EU managers and service providers (potentially reducing quality), limit investor choice and reduce tax revenue currently generated by EU governments from the private equity industry.

3. Would you prefer a self-regulatory regime along the lines of the Walker Report, to hard-edged regulation?

The current self-regulatory regime predominantly stems from investor influence on market practice and guidance or best practice promoted by industry associations. However, these measures do not secure commitment from industry players to any set standard.

In light of the scrutiny the financial industry as a whole has faced, in order to assuage the perceived public disquiet concerning the sector and rebuild the reputation of the industry, some form of hard-regulation seems inevitable. That being said, introducing regulation hastily without proper consultation is likely only to harm the industry and its participants including managers, investors, service providers, regulators and government authorities.

4. What can the industry do to influence the final result, and do you see a sensible outcome, a directive the private equity industry can live with?

Industry bodies, including national regulators such as the FSA in the UK, have generally voiced serious concerns about the implications of most of the draft Directive's provisions. However, given the tight timetable and the political will at European level, the effects of the lobbying remain to be seen. Ultimately, it is likely that the core political thrust of the original proposals will be difficult to derail.

Even watered down, it is unlikely that a re-draft would be in line with the industry's proposed amendments. Private equity will have to re-adjust to the new regulatory environment, although we suspect that hedge funds will face a more onerous task in complying with a new Directive.

JAKOB LARSEN - NIELSEN NORAGER

1. In recent years, the industry has gone some way to increase transparency, but the AIFM Directive goes even further. Do you think this forced disclosure skews competition to the disadvantage of private equity?

With a few well-founded exceptions, the basic transparency and disclosure requirements in the draft Directive are not far from the standards already adopted by a number of private equity funds.

However, the scope should be extended to include all private investors, to ensure a level playing field. Requiring greater disclosure from private equity-backed companies than from companies owned by other investors excluded from the Directive, such as SWFs, HNWs and subsidiaries of multinational companies, will discriminate against private equity-owned businesses and skew competition, not only to the disadvantage of private equity investors but also the portfolio companies, due to the added disclosure obligations and associated costs.

2. The third-country rule, whereby non-EU-based fund managers cannot market their funds within the EU, is one of the most contentious issues in the draft. How do you view this clause?

The restrictions on non-EU-based funds and managers are clearly problematic. In addition to limiting investors' choice and ability to implement investment strategies internationally, the restrictions could cause protectionist counter-measures from other countries, including the US. The three-year delay included in the draft should be abandoned.

Taking into account the possible violations of the Directive on Article 56 of the EC Treaty (free movement of capital), the conditions imposed on non EU-managers should be limited to ensuring that they are subject to prudential supervision and regulation in their home countries. The requirements for mutual agreements with non-EU countries should be abandoned.

3. Would you prefer a self-regulatory regime along the lines of the Walker Report, to hard-edged regulation?

A self-regulatory regime is clearly preferable. Currently, the European private equity industry is voluntarily moving towards increased openness and transparency. The DVCA has created guidelines for responsible ownership and good corporate governance, which on a number of points goes further than the Walker Report, particularly on openness and transparency.

The draft will impose substantial costs without offering sufficient benefits for the industry and the wider economy. For private equity funds it is hard to see the reasoning, as they do not increase macro-prudential risks. Furthermore, investors in private equity funds are in general highly skilled and fully capable of negotiating and understanding the terms of their investments.

4. What can the industry do to influence the final result, and do you see a sensible outcome, a directive the private equity industry can live with?

While it is clear that there will be a directive, the content is currently subject to complex political discussions with no consensus yet on whether the proposal should be moderated or tightened up. The draft Directive's "one size fits all" approach is highly inappropriate and will result in private equity and venture capital firms being burdened by disproportionate, inappropriate and even irrelevant regulations. To influence the final result, the industry should continue its dialogue with national parliaments and the European parliament and argue against the clauses lacking logic, not fulfilling their purpose, or that are disproportionate. Backed by factual data, these arguments should lead to a sensible outcome.

ARE HERREM - SELMER

1. In recent years, the industry has gone some way to increase transparency, but the AIFM Directive goes even further. Do you think this forced disclosure skews competition to the disadvantage of private equity?

Increased transparency can strengthen trust, and investment funds are trust-based businesses. The few advantages that a lack of transparency can bring, are not sustainable long-term.

As the private equity industry matures, it must learn to accept increased scrutiny, a prerequisite for continued growth. However, forced disclosure must ensure that all participants are treated fairly and equally, and must reflect best corporate governance practice.

2. The third-country rule, whereby non-EU-based fund managers cannot market their funds within the EU, is one of the most contentious issues in the draft. How do you view this clause?

In a globalised financial world it is hard to see that barriers to marketing of funds dependent on the domicile of the fund manager would have any real effect, and I do not think it is a good idea.

At the very least, the Directive should grant passport rights to legitimate fund managers located outside the EU so these managers can market their fund to professionals within the EU.

3. Would you prefer a self-regulatory regime along the lines of the Walker Report, to hard-edged regulation?

Regulation has some advantages over self-regulatory regimes. After all, few cowboys want to return to the self-justice in the Wild West.

Introduction of regulation might require some changes to the industry, but in most cases regulation turns out to be a stepping stone to further growth.

4. What can the industry do to influence the final result, and do you see a sensible outcome, a directive the private equity industry can live with?

The industry must continue its work through the Brussels Task Force, backed the EVCA and the national associations.

Sweden currently holds the EU Presidency, and it is important that the Nordic private equity industry participates in the lobbying efforts.

For more regulation insight, go to www.unquote.com to see a video interview with Ronald Paterson, partner at Eversheds.

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