alerts & publications
Financial reforms in the EU and the US
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Implications for Asian managers of private equity funds
Both the European Union (the “EU”) and the US Government are implementing financial reform legislation that will have a material impact on managers of private equity and other alternative investment funds managed out of Asia (including Asian funds which are managed out of offshore jurisdictions such as the Cayman Islands and Mauritius). Whilst in each case the legislation has not been finalized, there is sufficient certainty at this stage to suggest that Asian managers who wish to raise and manage money from investors based in the EU and/or the US will be subject to new regulatory hurdles (in addition to existing rules governing the placement of fund interests in both the EU and the US, which are not covered in this alert) that could make raising capital and/or operating their funds significantly more difficult.
The proposed EU legislation
The draft EU Directive on Alternative Investment Fund Managers (the “Directive”) is now entering its final stages in the legislative process. The question now is not whether the Directive will be passed but instead what will be the scope and extent of the Directive. The Economic and Monetary Affairs Committee of the European Parliament (the “Parliament”) and the Economic and Financial Affairs Council of the Council of the EU (the “Council”) have proposed their own versions of the Directive. The two versions differ in material respects in certain areas. The next step is for the European Commission, the Parliament and the Council to agree a consolidated version which will be voted on by the Parliament (scheduled for July).
Until the final version of the Directive is agreed, the scope and extent of the Directive remain uncertain. Indeed, even when finalised, the scope and meaning may not be wholly clear. Further, there are many areas in the Directive that are to be amplified by supplementing EU “Implementing Measures”, which will not be known for some time. However, it seems fairly certain that Asian managers seeking to market their funds to EU investors will be subject to increased costs, onerous disclosure and compliance obligations, and increased administration. The current versions indicate that non-EU managers may well be subject to the following obligations:
- the manager and the jurisdiction(s) of the manager and the fund being required to meet a number of conditions before marketing in the EU is permitted (see below);
- extensive disclosure requirements and, potentially, restrictions with regards to the leverage that can be employed by the fund (which might include leverage at the portfolio level);
- the imposition of reporting obligations in respect of certain portfolio companies;
- restrictions on, and disclosure of, the manager’s remuneration practices (including with respect to carried interest and co-investments) for certain of its staff requiring deferral or even clawback of part of their remuneration.
With regards to marketing to EU professional investors, the Parliament’s version of the Directive imposes much more stringent conditions on a non-EU manager - including that the manager would need to agree to comply with the entire Directive, its own regulator would need to agree to monitor the manager’s compliance with the Directive, and the jurisdiction(s) of the manager and the fund would have to comply with a host of anti-money laundering and anti-terrorism obligations as well as enter into information exchange and cooperation agreements with any Member State that the manager intends to fundraise in. The Council’s version would not require non-EU managers to comply with the entire Directive - instead, such managers would need to comply with certain disclosure and reporting requirements, and will only be able to market in any Member States with which its regulator has entered into a cooperation arrangement.
Some Asian managers may find that as a result of the Directive, raising capital in the EU will be cost prohibitive, or simply impossible due to the failure or unwillingness of their or their fund’s regulators to comply with the Directive.
It is expected that national implementation of the Directive by the Member States will be required within two years after the Directive comes into force. The Implementing Measures are likely to be in the form of binding regulations that will not require separate implementation into the national laws of Member States. In the meantime, it may be advantageous for managers to secure commitments from EU investors under current national regimes before the Directive applies.
The proposed US legislation
We have previously issued a separate client alert (Click to read “Senate Passes Financial Reform Legislation”) dealing with sweeping financial reform legislation that was introduced by the Senate recently. Included in the legislation is the Private Fund Investment Advisers Registration Act of 2010 (the “Senate Bill”). While the Senate Bill will need to be reconciled with a similar bill previously passed by the House of Representatives (the “House Bill”), it is now clear that many non-US advisers to private funds that are not currently registered will need to register with the Securities and Exchange Commission (the “SEC”) as investment advisers. We previously analyzed the Senate Bill and the House Bill in an O'Melveny & Myers Client Alert dated April 5, 2010 (Click to read “Private Fund Investment Advisers Registration Act of 2010”).
Of particular relevance to Asian managers has been the scope of a proposed exemption for “foreign private advisers”. The scope of this exemption now seems clear and unfortunately will only be available to a very limited number of foreign advisers. Specifically, a foreign adviser would be required to register if (1) it had 15 clients (e.g., managed accounts or pooled investment vehicles) in the US or (2) US$25 million of assets under management are attributable to US investors.
While the differences between the House Bill and Senate Bill still need to be resolved, there are sufficient similarities between the bills to conclude that the final legislation will have a significant impact on non-US advisers to private funds by (1) requiring many unregistered advisers with more than US$100 million in assets under management to register with the SEC under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), and (2) imposing certain reporting, disclosure and record-keeping obligations on registered and unregistered investment advisers.
The Senate Bill does provide certain other exemptions from registration for advisers (for example “venture capital funds” and “private equity funds,” but these are expected to be defined more narrowly than they are commonly understood within the industry) and we expect most managers will not be able to rely upon them.
The final legislation will likely contain a one year transition period from the date of enactment and non-US advisers to private funds which will need to register should begin planning for registration by taking the following steps:
- Preparing a written supervisory procedures manual and code of ethics that are tailored to their businesses. Preparing the manual can take a significant amount of time and should be started well in advance of registration;
- Reviewing business activities to identify potential conflicts of interest, such as outside business activities of firm employees, allocation policies between funds with overlapping investment objectives, and conflicts in dedicating time among funds;
- Reviewing the existing compliance infrastructure to determine whether additional resources or compliance personnel are necessary to comply with the Advisers Act and related regulations; and
- Assessing the impact that complying with the Advisers Act will have on ongoing activities.
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