AIFMD Q&A- better late than never
ESMA has published a major update to its Q&A document on the application of the Alternative Investment Managers Directive (AIFMD). The Q&A specifically pertains to:
- the reporting obligations to national competent authorities
- the obligations for depositaries and the calculation of leverage
The AIFMD was transposed into UK law a year ago, 22 July 2013. The Directive allowed for a transitional period during which AIFMs could apply for necessary variation of permissions and authorisations. Today marks the end of the transition period for UK AIFMs- the update is on time, but hardly timely. The Q&A is technical and only of specific interest for those targeted by the Directive; the new (18 July 2014) clarifications are excerpted in full below.
Section III: Reporting to national competent authorities under Articles 3, 24 and 42
Question 22 : How should AIFMs calculate the percentage of trade volumes for derivatives cleared by a CCP and bilaterally (questions 152 and 153 of the consolidated reporting template)?
Answer 22: AIFMs should take into account the total number of trades and report the percentage of number of trades cleared by a CCP and bilaterally. The total should equal 100%.
Question 23 : How should AIFMs calculate the percentage of market value for repo trades cleared by a CCP, bilaterally or on a tri-party basis (questions 154 and 156 of the consolidated reporting template)?
Answer 23: AIFMs should aggregate the market value of all repo trades and report the percentage of the market value of repo trades cleared by a CCP, bilaterally or on a tri-party basis. The total should equal 100%.
Question 24 : How should AIFMs classify FX spot trades when answering questions such as on individual exposures (questions 121 to 124 of the consolidated reporting template for AIF-specific information) or value of turnover in each asset class over the reporting period (questions 125 to 127 of the consolidated reporting template for AIF-specific information)?
Answer 24: When reporting information other than value of turnover, “IFMs should classify FX spot trades as “other cash equivalent (excluding government securities)” with the sub-asset type code “SEC_CSH_OTHC”. When reporting information on value of turnover, AIFMs should classify FX spot trades as “other cash equivalent‟ with the sub-asset type code “SEC_CSH_CSH”.
Question 25 ]: AIFMs have to report value of turnover in each asset class over the reporting period (questions 125 to 127 of the consolidated reporting template for AIF-specific information). What information should AIFMs report for these questions when no trades took place during the reporting period?
Answer 25: AIFMs should use the field “total other” with the sub-asset type code “OTH_OTH_OTH” and report “0”.
Question 26 : How should AIFMs classify cross-currency interest swaps when answering questions such as those on individual exposures (questions 121 to 124 of the consolidated reporting template for AIF-specific information) or value of turnover in each asset class over the reporting period (questions 125 to 127 of the consolidated reporting template for AIF-specific information)?
Answer 26: When reporting information other than value of turnover, AIFMs should classify cross-currency interest swaps as “interest rate derivatives” with the sub-asset type code “DER_IRD_INTR”. When reporting information on value of turnover, AIFMs should classify cross-currency interest swaps as “interest rate derivatives” with the sub-asset type code “DER_IRD_IRD”.
Question 27 : When answering questions 148 and 149 of the consolidated reporting template, should AIFMs include repo and reverse repurchase agreements?
Answer 27: Yes.
Question 28 How should AIFMs managing AIFs holding cash report the breakdown of investment strategies?
Answer 28: When the holding of cash is part of a strategy such as a CTAstrategy, AIFMs should not report cash separately. For example, an AIF with a CTA strategy representing 70% of its NAV, out of which 30% of the NAV is made up of cash at the time of the reporting date, should allocate 70% of its NAV to the CTA strategy.
Question 29 Question 6 above clarifies that negative values can be reported for investment strategies. How should AIFMs report information on investment strategies with negative values?
Answer 29: AIFMs should allocate the status of predominant AIF type to the strategy with the highest absolute percentage of the NAV. The predominant AIF type “multi-strategy hedge fund” should be used when no strategy has an absolute value greater than 50% of the NAV.
Question 30 : Should AIFMs consider bank overdrafts as funding sources?
Answer 30: Yes.
Question 31 : Pursuant to Article 111 of the implementing Regulation, leverage shall be considered to be employed on a substantial basis when the exposure of an AIF, as calculated according to the commitment method, exceeds three times its NAV. How should AIFMs assess this limit?
Answer 31: AIFs should be considered as employing leverage on a substantial basis if, over the reporting period, the average daily calculation of the exposure as calculated according to the commitment method exceeds three times the average daily calculation of the NAV. If the exposure is calculated less frequently than daily, AIFs should be considered as employing leverage on a substantial basis where, at least once during the reporting period, the exposure as calculated according to the commitment method exceeds three times its NAV.
Question 32 : How should AIFMs managing AIFs with multiple share classes identify the AIFs?
Answer 32: AIFMs reporting information for AIFs with multiple share classes should answer questions 24 and questions 30 to 40 of the consolidated reporting template. For AIFs with only one share class, AIFMs should only answer questions 24 to 33 of the consolidated reporting template.
Question 33 : In question 282 of the consolidated reporting template, should AIFMs report the percentage of collateral posted to all counterparties that has been re-hypothecated as of the last business day of the reporting period or during the reporting period?
Answer 33: AIFMs should report the percentage of the market value of the collateral that has been re-hypothecated during the reporting period. This percentage should be the ratio of the aggregated market value of the collateral re-hypothecated during the reporting period by all counterparties over the aggregated market value of all the collateral posted by AIFMs to all counterparties.
Question 34 : What information should AIFMs report under questions 283 to 286 of the consolidated reporting template?
Answer 34: For questions 283, 284, 285 and 286, AIFMs should aggregate the market value of cash and securities borrowed.
Question 35: In which currency, should AIFMs report information on the five principal markets and five principal instruments in which they trade (questions 29 and 32 of the consolidated reporting template for AIFM-specific information)?
Answer 35: AIFMs should report this information in euro.
Section VI: Depositaries
Question 1 : Do the cash monitoring duties apply on a look-through basis to cash accounts which are not opened in the name of the AIF/AIFM, but in the name of financial and/ or legal structures established by the AIF or by the AIFM acting on behalf of the AIF for the purposes of investing in the underlying assets and which are controlled directly or indirectly by the AIF or by the AIFM acting on behalf of the AIF?
Answer 1: No, the cash monitoring requirements under Articles 85 and 86 of Commission Regulation (EU) No 231/2013 (the AIFMD Level 2 Regulation) do not apply to cash accounts opened in the name of companies in which the AIF/AIFM holds investments.
Question 2 : Is it possible for the depositary to delegate to a third party (e.g. an administrator which is not an affiliate of the depositary) the cash flow reconciliation duties?
Answer 2: No. According to the provisions of Article 21(11) of the AIFMD, the monitoring of the cash flow is an activity which cannot be delegated. For example, the depositary should not rely exclusively on the reconciliation processes performed by a third party, even where the depositary performs due diligence on those processes.
In line with the provisions of recital 42 of the AIFMD, the only delegation which is permitted in relation to the monitoring of the cash flow is that of the depositary’s supporting tasks, such as administrative or technical functions performed by the depositary as a part of its depositary tasks.
Question 3 : How far down the distribution chain is the depositary to reconcile subscription flows?
Answer 3: The cash monitoring duties relate to any of the cash accounts – including accounts used for subscriptions and redemptions – referred to in Article 21(7) of the AIFMD (as implemented by Articles 85 to 87 of the AIFMD Level 2 Regulation): accounts opened in the name of the AIF, in the name of the AIFM acting on behalf of the AIF or in the name of the depositary acting on behalf of the AIF. The rules on reconciliations linked to subscriptions are further detailed in Article 93 of the AIFMD Level 2 Regulation.
Question 4 : Does the obligation to verify that the AIF and AIFM comply with applicable laws and regulations in Article 95 (a) of the AIFMD Level 2 Regulation cover anti-money laundering rules, labour law and contracts of the AIF/AIFM with third parties which do not relate to the asset or risk management activities?
Answer 4: In general, the obligation to set up and implement appropriate procedures for the verifications required under Article 95(a) of the AIFMD Level 2 Regulation should be linked to the requirement in Article 21(9) of the AIFMD for the depositary to ensure oversight of the AIF‟s operations. The verifications required under Article 95(a) of the AIFMD Level 2 Regulation are meant to ensure that the AIF and/or the AIFM acting on behalf of the AIF comply with the applicable laws and regulations applying to the AIF including fund rules, instruments of incorporation (e.g. investment restrictions, leverage limits, etc.). They do not relate to the laws and regulations applying to these entities that do not have any direct relation with the instructions of the AIFM to the depositary (e.g. the application of the remuneration rules by the AIFM). This is without prejudice to the depositary voluntarily (or in agreement with the AIF/AIFM) performing more extensive verifications.
Therefore, the obligation to verify that the AIF and AIFM comply with applicable laws and regulations does not cover labour law or contracts with third parties unrelated to asset or risk management activities.
As for the compliance with the relevant anti-money laundering rules, the contract by which the depositary is appointed shall include information on the tasks and responsibilities of the parties to the contract in respect of obligations relating to the prevention of money laundering and the financing of terrorism (Article 83(1)(m)) of the AIFMD Level 2 Regulation. This is without prejudice to the relevant anti-money laundering obligations applying to the depositary, AIF and AIFM under the EU legislation on the prevention of the use of the financial system for the purpose of money laundering and terrorist financing.
Question 5 : Is it correct to say that where derivative contracts contain a netting clause, derivatives should fall exclusively under the cash flow monitoring obligation of the depositary and that it is only in the absence of a netting clause – where the AIF/AIFM gets an owner-ship claim for the underlying – that the depositary is in a position to verify whether the AIF/AIFM has acquired ownership of the underlying asset according to Article 90(2)(c) of Commission Regulation (EU) No 231/2013?
Answer 5: No. Recital 103 of the AIFMD Level 2 Regulation gives examples of assets that are not financial instruments to be held in custody and specifically includes ‘financial contracts such as derivatives’ among these examples. Therefore, these assets are subject to the obligation to verify the ownership and maintain a record according to the provisions of Article 90(2)(c) of the AIFMD Level 2 Regulation. This duty involves, inter alia, looking at the contract to assess what the AIF/AIFM is entitled to.
Question 6 : Are holdings in collective investment undertakings to be held in custody or subject to record keeping?
Answer 6: Unless, in accordance with applicable national law, they are only directly registered with the issuer itself or its agent, in the name of the AIF or the AIFM acting on behalf of the AIF (in which case the provisions of Article 88(2) of the AIFMD Level 2 Regulation apply), units of collective investment undertakings (CIUs) should be held in custody and subject to the relevant provisions of the AIFMD.
Question 7 : Within the cash monitoring duties of a depositary, what is the meaning of “close of business day”?
Answer 7: Given that the requirements relating to the monitoring of the AIF’s cash flows apply to the depositary (Article 86 of the AIFMD Level 2 Regulation), the “close of business day” should be determined in relation to the jurisdiction where the depositary is established which, for EU AIFs, is also the home Member State of the AIF. This means that the identification of significant cash flows referred to under Article 86(c) of the AIFMD Level 2 Regulation should be made with reference to the close of business day in the jurisdiction where the depositary is established, but the relevant checks may be carried out after the close of business in the depositary’s jurisdiction, typically the following business day.
Section VII: Calculation of leverage
Question 1 : An AIF that is a private equity fund as referred to in recital 78 of the AIFMD, controls a financial structure that is used to acquire non-listed companies or issuers. The financial structure raises debt to finance the acquisition of those assets. When calculating the exposure of the AIF, shall the AIFM include the debt raised at the level of the financial structure?
Answer 1: According to Article 6(3) of Regulation 231/2013, exposure contained in any financial or legal structures controlled by an AIF shall be included in the calculation of the exposure where those structures are specifically set up to directly or indirectly increase the exposure at the level of the AIF. Therefore, debt raised by such a financial structure to finance the acquisition of assets shall be included in the calculation of the exposure where those structures are: (1) specifically set up to directly or indirectly increase the exposure at the level of the AIF and (2) the AIF controls such a structure. If these two conditions are fulfilled, the debt raised by the financial structure is to be included in the calculation of the exposure of the AIF.
Where the AIF does not have to bear losses beyond its investment in a financial structure that is used to acquire non-listed companies or issuers, the financial structure should not be considered as having been set up to directly or indirectly increase the exposure at the level of the AIF. In any case, these structures should not be used as a means to circumvent the provisions of the AIFMD on leverage.
Question 2 : An AIF controls a financial structure that is used to acquire non-listed companies or issuers. When calculating the exposure of the AIF, shall the AIFM include the debt raised at the level of the non-listed companies or issuers?
Answer 2: No, provided that the AIF does not have to bear potential losses beyond its investment in the non-listed companies or issuers.
However, if the debt at the level of the non-listed companies or issuers exposes the AIF to potential losses beyond its investment in those non-listed companies or issuers, the debt shall be included in the calculation of the exposure of the AIF.
Question 3 An AIF controls a financial structure that acquires non-listed companies or issuers by raising debt. At the time of the acquisition, the non-listed companies or issuers were not leveraged. Subsequently, the non-listed companies or issuers raise debt to finance a dividend distribution enabling the financial structure to reimburse entirely its acquisition debt. When calculating the exposure of the AIF, shall the AIFM include the debt raised at the level of the non-listed companies or issuers?
Answer 3: No, provided that the AIF does not have to bear potential losses beyond its investment in the non-listed companies or issuers.
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