AIFMD Impact on QIF Exposure to Unregulated Funds
With over 40% of the world’s regulated and unregulated hedge funds serviced in Ireland, it is no surprise that the Irish funds industry has also long been a leading global centre for funds of funds and feeder funds. At present it is possible to establish these products as UCITS or non-UCITS, and in a variety of legal structures to suit the taxation requirements of global investors (including U.S. taxable investors).
From July 2013 at the latest, the Central Bank of Ireland (“CBI”) must bring its rules in line with the Alternative Investment Fund Managers Directive (“AIFMD”), which looks likely to create additional opportunities for master/ feeder and fund of funds structures, particularly in the context of unregulated master/ underlying funds. This note contrasts the regimes before and after AIFMD implementation.
Current Irish rules
A QIF is permitted to invest up to 100% of its assets in unregulated funds, but the CBI applies two sets of rules, depending on the maximum exposure that the relevant QIF may obtain to any single underlying fund (or sub-fund/ cell thereof):
(a) where this maximum permitted exposure is below 50%, the CBI treats the QIF as a fund of funds, and allows considerable flexibility for investment in unregulated funds. In general, most CBI requirements can be satisfied through adequate prospectus disclosure.
(b) Conversely, where this maximum permitted exposure exceeds 50%, the CBI treats the QIF as a feeder fund. In this case, the CBI rules are much more protective in favour of investors regarding unregulated funds. In general, a QIF cannot be structured as a feeder into an unregulated master fund, unless it can be shown that the unregulated fund complies in all material respects with the CBI’s QIF requirements. In practice, this test is difficult to meet.
The CBI may allow a further derogation (on a case-by-case basis) where the promoter of the proposed QIF feeder and the unregulated master are both part of the same large financial group, which has a proven track record in asset management and which provides adequate comfort to the CBI regarding its control and supervision of the unregulated master. However, the CBI imposes specific pre-conditions for such derogations, including a need for the unregulated fund to use an independent custodian; to be subject to annual audit; and to have adequate oversight/ monitoring procedures.
Future AIFMD rules
So what will AIFMD change? The Commission has yet to publish final implementing rules, but the Directive defines “feeder AIF” as an alternative investment fund (AIF) which (i) invests at least 85% of its assets in units or shares of another AIF (the 'master AIF'); (ii) invests at least 85% of its assets in more than one master AIFs where those master AIFs have identical investment strategies; or (iii) has otherwise an exposure of at least 85% of its assets to such a master AIF.”
Therefore, for an Irish AIF the permitted exposure to a single unregulated fund should increase under AIFMD from 50% to 84.99% before master-feeder restrictions apply, so promoters should have greater flexibility in structuring Irish funds of funds.
Moreover, even once the 85% threshold is breached, the AIFMD master-feeder requirements appear less onerous than the existing CBI regime. The Directive does not restrict an EU AIF from feeding into an unregulated master AIF per se. Instead, apart from certain additional disclosure requirements, the only material impact would be the application of a different marketing regime.
From July 2013, where an EU AIFM manages an Irish AIF, that AIF can be marketed on a ‘passport’ basis to professional investors across the EU. However, if that Irish AIF feeds into a master fund which is not itself an EU AIF managed by an EU AIFM (for example, an unregulated fund), then the Irish feeder AIF will be subject to the same marketing regime as if it was a non-EU AIF. In other words, it will not benefit from the product passport from July 2013 and will instead be subject to the same pre-conditions applicable to unregulated funds. While these pre-conditions are not insignificant, arguably they could be easier to fulfil than the CBI’s current policy regarding unregulated masters.
In conclusion, we await clarity in the Commission’s final implementing rules, but on the face of it, AIFMD appears to increase the flexibility and structuring options for QIF funds of funds and feeder funds to access unregulated funds.