EN Official Journal of the European Union L 83/1

COMMISSION DELEGATED REGULATION (EU) No 231/2013

of 19 December 2012

supplementing Directive 2011/61/EU of the European Parliament and of the Council with regard to exemptions, general operating conditions, depositaries, leverage, transparency and supervision

(Text with EEA relevance)

THE EUROPEAN COMMISSION,

Having regard to the Treaty on the Functioning of the European Union,

Having regard to Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010 (1), and in particular Article 3(6), Article 4(3), Article 9(9), Article 12(3), Article 14(4), Article 15(5), Article 16(3), Article 17, Article 18(2), Article 19(11), Article 20(7), Article 21(17), Article 22(4), Article 23(6), Article 24(6), Article 25(9), Article 34(2), Article 35(11), Article 36(3), Article 37(15), Article 40(11), Article 42(3) and Article 53(3) thereof,

Having regard to the opinion of the European Central Bank,

Whereas:

(1) Directive 2011/61/EU empowers the Commission to adopt delegated acts specifying, in particular, the rules relating to calculation of the threshold, leverage, operating conditions for Alternative Investment Fund Managers (hereinafter ‘AIFMs’), including risk and liquidity management, valuation and delegation, requirements detailing the functions and duties of depositaries of Alternative Investment Funds (hereinafter ‘AIFs’), rules on transparency and specific requirements relating to third countries. It is important that all these supplementing rules begin to apply at the same time as Directive 2011/61/EU so that the new requirements imposed on AIFMs can be effectively put into operation. The provisions in this Regulation are closely interrelated, since they deal with the authorisation, ongoing operation and transparency of AIFMs which manage and, as the case may be, or market AIFs in the Union, which are inextricably linked aspects inherent to the taking up and pursuit of the asset management business. To ensure coherence between those provisions, which should enter into force at the same time, and to facilitate a comprehensive view and compact access to them by persons subject to those obligations, including investors that are non-Union residents, it is desirable to include all delegated acts required by Directive 2011/61/EU in a single Regulation.

(2) It is important to ensure that the objectives of Directive 2011/61/EU are achieved uniformly throughout the Member States, to enhance the integrity of the internal market and offer legal certainty for its participants, including institutional investors, competent authorities and other stakeholders, by adopting a Regulation. The form of a Regulation ensures a coherent framework for all market operators and is the best possible guarantee for a level playing field, uniform conditions of competition and the common appropriate standard of investor protection. Furthermore it ensures the direct applicability of detailed uniform rules concerning the operation of AIFMs, which by their nature are directly applicable and therefore require no further transposition at national level. The recourse to a regulation allows, in addition, to avoid a delayed application of Directive 2011/61/EU in the Member States.

(3) As the Delegated Regulation specifies the tasks and responsibilities of the ‘governing body’ and of the ‘senior management’ it is important to clarify the meaning of these terms, in particular the fact that a governing body may be comprised of senior managers. Furthermore, as this Regulation introduces also the term ‘supervisory function’ the definition of the governing body should make clear that it is the body which comprises the managerial function in case the supervisory and the managerial functions are separated in accordance with national company law. Directive 2011/61/EU requires AIFMs to provide certain information to competent authorities, including the percentage of the AIF’s assets which are subject to special arrangements arising from their illiquid nature. This Regulation clarifies the meaning of special arrangements so that AIFMs know exactly what information they should provide to competent authorities.

(4) Directive 2011/61/EU provides for a lighter regime applicable to those AIFMs who manage portfolios of AIFs whose total assets under management do not exceed the relevant thresholds. It is necessary to specify clearly how the total value of assets under management should be calculated. In this context it is essential to define the steps necessary for calculating the total value of assets, to determine clearly which assets are not included in the calculation, to clarify how the assets acquired through the use of leverage should be valued and to provide rules for handling of cases of cross-holding among AIFs managed by an AIFM.

(5) The total value of assets under management needs to be calculated at least annually and using up-to-date information. The value of assets should therefore be determined in the 12 months preceding the date of calculation of the total value of assets under management and as close as possible to such a date.

(6) To ensure that an AIFM remains eligible to benefit from the lighter regime provided for in Directive 2011/61/EU, it should put in place a procedure making it possible to observe on an ongoing basis the total value of assets under management. The AIFM may consider the types of AIFs under management and the different classes of assets invested in order to assess the likelihood of breaching the threshold or the need for an additional calculation.

(7) Where an AIFM no longer meets the conditions related to the thresholds it should notify its competent authority and apply for an authorisation within 30 calendar days. However, where exceeding or falling below the thresholds occurs only occasionally within a given calendar year and such situations are considered as temporary the AIFM should not be obliged to make an application for authorisation. In those cases, the AIFM should inform the competent authority of the breach of the threshold, and explain why it considers such breach to be of a temporary nature. A situation lasting for more than three months cannot be considered as being temporary. When assessing the likelihood of a situation to be temporary, the AIFM should consider anticipated subscription and redemption activity or, where applicable, capital draw-downs and distribution. The AIFM should not use anticipated market movements as part of this assessment.

(8) Data used by AIFMs to calculate the total value of assets under management do not need to be available to the public or to investors. However, competent authorities must be able to verify that the AIFM is correctly calculating and monitoring the total value of assets under management, including the assessment of occasions when the total value of assets under management temporarily exceeds the relevant threshold and should therefore have access to these data on request.

(9) It is important that AIFMs benefiting from the provisions of the lighter regime in Directive 2011/61/EU provide the competent authorities with up-to-date information at the time of registration. Not all types of AIFMs may have updated offering documents reflecting the latest developments related to the AIFs they manage and such AIFMs may find it more practical to specify the required information in a separate document describing the funds’ investment strategy. This could be the case of private equity or venture capital funds which often raise money through negotiations with potential investors.

(10) An AIF which holds only equity shares in listed companies should not be regarded as being leveraged as long as the equity shares are not acquired through borrowing. Where the same AIF purchases options on an equity index, it should be regarded as being leveraged, since it has increased the exposure of the AIF to a given investment.

(11) In order to ensure a uniform application of AIFM obligations to grant an objective overview of the leverage used, it is necessary to provide two methods to calculate the leverage. As it results from market studies, the best results can be achieved by combining the so-called ‘gross’ and ‘commitment’ methods.

(12) In order to receive appropriate information for monitoring systemic risks and to gain a complete picture of the use of leverage by the AIFM, information about the exposure of an AIF should be provided to competent authorities and investors both on a gross and on a commitment method basis and all AIFMs should therefore calculate exposure using both the gross and the commitment method. The gross method gives the overall exposure of the AIF whereas the commitment method gives insight in the hedging and netting techniques used by the manager; therefore both methods shall be seen in conjunction. Specifically, the degree to which overall exposure differs between the gross method and the commitment method may provide useful information. If necessary to ensure that any increase of the exposure of AIFs is adequately reflected the Commission may adopt additional delegated acts on an additional and optional method for the calculation of leverage.

(13) When calculating the exposure, all positions of the AIF should initially be included, including short and long assets and liabilities, borrowings, derivative instruments and any other method increasing the exposure where the risks and rewards of assets or liabilities are with the AIF, and all other positions that make up the net asset value.

(14) Borrowing arrangements entered into by the AIF should be excluded if they are temporary in nature and relate to and are fully covered by capital commitments from investors. Revolving credit facilities should not be considered being temporary in nature.

(15) In addition to calculating exposure using the gross method, all AIFMs should calculate exposure using the commitment method. According to the commitment method financial derivative instruments should be converted into equivalent positions in the underlying asset. However, if an AIF invests in certain derivatives in order to off-set the market risk of other assets in which the AIF is invested, under certain conditions, those derivatives should not be converted into an equivalent position in the underlying assets as the exposures of the two investments balance one another. That should be the case where, for instance, an AIF portfolio invests in a certain index and holds a derivative instrument which swaps the performance of that index with the performance of a different index, that should be equivalent to holding exposure to the second index in the portfolio and therefore the AIF’s net asset value would not depend on the performance of the first index.

(16) When calculating exposure according to the commitment method, derivatives which fulfil the criteria set out in this Regulation do not provide any incremental exposure. Thus, if the AIF invests in index future contracts and holds a cash position equal to the total underlying market value of future contracts, this would be equivalent to directly investing in index shares and therefore the index future contract should not be taken into account for the purpose of calculating the exposure of the AIF.

(17) When calculating exposure according to the commitment method, AIFMs should be allowed to consider hedging and netting arrangements provided they fulfil the criteria relating to the commitment method.

(18) The requirement that netting arrangements refer to the same underlying asset should be interpreted strictly so that assets which the AIFM considers as equivalent or highly correlated, such as different share classes or bonds issued by the same issuer, should not be considered as identical for the purposes of netting arrangements. The definition of netting arrangements aims to ensure that only those trades which offset the risks linked to other trades, leaving no material residual risk, are taken into account. Combinations of trades which aim to generate a return, however small, by reducing some risks while keeping others should not be considered as netting arrangements, as with arbitrage investment strategies which aim to generate a return by taking advantage of pricing discrepancies between derivative instruments with the same underlying but different maturities.

(19) A portfolio management practice which aims to reduce the duration risk by combining an investment in a long-dated bond with an interest rate swap or to reduce the duration of an AIF bond portfolio by concluding a short position on bond future contracts representative of the interest rate risk of the portfolio (duration hedging) should be considered as a hedging arrangement provided that it complies with the hedging criteria.

(20) A portfolio management practice, which aims to offset the significant risks linked to an investment in a well diversified portfolio of shares by taking a short position on a stock market index future, where the composition of the equity portfolio is very close to that of the stock market index and its return highly correlated to that of the stock market index and where the short position on the stock market index future allows an unquestionable reduction of the general market risk related to the equity portfolio and the specific risk is insignificant, such as a beta-hedging of a well-diversified equity portfolio where the specific risk is considered to be insignificant, should be considered as complying with the hedging criteria.

(21) A portfolio management practice which aims to offset the risk linked to an investment in a fixed interest rate bond by combining a long position on a credit default swap and an interest rate swap which swaps that fixed interest rate with an interest rate equal to an appropriate money market reference rate plus a spread should be considered as a hedging arrangement where all the hedging criteria of the commitment method are in principle complied with.

(22) A portfolio management practice which aims to offset the risk of a given share by taking a short position through a derivative contract on a share that is different to but strongly correlated with that first share should not be considered as complying with the hedging criteria. Although such a strategy relies on taking opposite positions on the same asset class, it does not hedge the specific risk linked to the investment in a certain share. Therefore, it should not be considered as a hedging arrangement as laid down in the criteria related to the commitment method.

(23) A portfolio management practice which aims to keep the alpha of a basket of shares (comprising a limited number of shares) by combining the investment in that basket of shares with a beta-adjusted short position on a future on a stock market index should not be considered as complying with the hedging criteria. Such a strategy does not aim to offset the significant risks linked to the investment in that basket of shares but to offset the beta (market risk) of that investment and keep the alpha. The alpha component of the basket of shares may dominate over the beta component and as such lead to losses at the level of the AIF. For that reason, it should not be considered as a hedging arrangement.

(24) A merger arbitrage strategy is a strategy that combines a short position on a stock with a long position on another stock. Such a strategy aims to hedge the beta (market risk) of the positions and generate a return linked to the relative performance of both stocks. Similarly, the alpha component of the basket of shares may dominate over the beta component and as such lead to losses at the level of the AIF. It should not be considered as a hedging arrangement as laid down in the criteria related to the commitment method.

(25) A strategy, which aims to hedge a long position in a stock or bond with purchased credit protection on the same issuer, relates to two different asset classes and therefore should not be considered as a hedging arrangement.

(26) When using methods which increase the exposure of an AIF, the AIFM should observe general principles such as considering the substance of the transaction in addition to its legal form. Specifically with respect to repurchase transactions, the AIFM should consider whether the risks and rewards of the assets involved are passed or retained by the AIF. The AIFM should also look through derivative instruments or other contractual arrangements to the underlying assets to determine the possible future commitments of the AIF resulting from those transactions.

(27) As the commitment method leads to interest rates with different maturities being considered as different underlying assets, AIFs that according to their core investment policy primarily invest in interest rate derivatives may use specific duration netting rules in order to take into account the correlation between the maturity segments of the interest rate curve. When setting out its investment policy and risk profile, an AIF should be able to define the level of the interest rate risk and consequently to determine its target duration. The AIF should take into account the predefined target duration when making its investment choices. When the portfolio duration diverges from the target duration, the strategy should not be considered as a duration netting arrangement as laid down in the criteria related to the commitment method.

(28) The duration netting rules allow long positions to be netted with short positions whose underlying assets are different interest rates. The maturities serving as the thresholds of the maturity ranges are two years, seven years and 15 years. Within each maturity range, netting positions should be allowed.

(29) Netting positions between two different maturity ranges should be partially allowed. Penalties have to be applied to the netted positions to allow only partial netting. They should be expressed by means of percentages relying on the average correlations between the maturity ranges for two years, five years, 10 years and 30 years of the interest rate curve. The longer the difference between the maturities of the positions, the more their netting must be subject to a penalty, and therefore the percentages must increase.

(30) Positions whose modified duration is much longer than the whole portfolio’s modified duration are not in line with the investment strategy of the AIF and fully matching them should not be allowed. Thus, it should not be acceptable to match an 18 months maturity short position (set in maturity range 1) with a 10 years maturity long position (set in maturity range 3), if the target duration of the AIF is around two years.

(31) When calculating the exposure, AIFs can firstly identify the hedging arrangements. The derivatives involved in these arrangements are then excluded from the global exposure calculation. AIFs should use an exact calculation in hedging arrangements. AIFs should not use duration netting rules in the hedging calculation. The duration-netting rules may be used to convert the remaining interest rate derivatives into their equivalent underlying asset positions.

(32) Pursuant to Directive 2011/61/EU, an AIFM has to ensure that the potential professional liability risks resulting from its activities are appropriately covered either by way of additional own funds or by way of professional indemnity insurance. Uniform application of this provision requires a common understanding of the potential professional liability risks to be covered. The general specification of the risks arising from an AIFM’s professional negligence should determine the features of the relevant risk events and identify the scope of potential professional liability, including damage or loss caused by persons who are directly performing activities for which the AIFM has legal responsibility, such as the AIFM’s directors, officers or staff, and persons performing activities under a delegation arrangement with the AIFM. In line with the provisions of Directive 2011/61/EU, the liability of the AIFM should not be affected by delegation or sub-delegation and the AIFM should provide adequate coverage for professional risks related to such third parties for whom it is legally liable.

(33) To ensure a common understanding of the general specification, a list of examples should serve as benchmark for identifying potential professional liability risk events. That list should include a wide range of events resulting from negligent actions, errors or omissions, such as the loss of documents evidencing title to investments, misrepresentations, or breach of the various obligations or duties incumbent on the AIFM. It should also include the failure to prevent, by means of adequate internal control systems, fraudulent behaviour within the AIFM’s organisation. Damage resulting from failure to carry out sufficient due diligence on an investment that turned out to be fraudulent would trigger the AIFM’s liability for professional liability and should be appropriately covered. However, losses incurred because an investment has lost value as a result of adverse market conditions should not be covered. The list should also include valuations that are improperly carried out, which should be understood as a valuation failure breaching Article 19 of Directive 2011/61/EU and the corresponding delegated acts.

(34) In line with their risk management obligations, AIFMs should have appropriate qualitative internal control mechanisms to avoid or mitigate operational failures, including professional liability risks. Therefore, an AIFM should have, as part of its risk management policy, adequate policies and procedures for operational risk management, appropriate to the nature, scale and complexity of its business. Such procedures and policies should in any event enable an internal loss database to be built up to serve for the purpose of assessing the operational risk profile.

(35) To ensure that additional own funds and professional liability insurance appropriately cover potential professional liability risks, quantitative minimum benchmarks should be established for determining the proper level of coverage. Such quantitative benchmarks should be determined by the AIFM as a specific percentage of the value of portfolios of AIFs managed, calculated as the sum of the absolute value of all assets of all AIFs managed, irrespective of whether they are acquired through use of leverage or with investors’ money. In this context, derivative instruments should be valued at their market price as they could be replaced at that price. As coverage through professional indemnity insurance is by nature more uncertain than coverage provided through additional own funds, different percentages should apply to the two different instruments used for covering professional liability risk.

(36) To ensure that professional indemnity insurance is effective in covering losses that result from insured events, it should be taken out from an insurance undertaking which is authorised to provide professional indemnity insurance. This includes EU insurance undertakings and non-EU undertakings to the extent that they are permitted to provide such insurance service by Union law or by national law.

(37) In order to allow some flexibility when devising appropriate professional indemnity insurance, it should be possible for the AIFM and the insurance undertaking to agree on a clause providing that a defined amount will be borne by the AIFM as the first part of any loss (defined excess). Where such a defined excess is agreed, the AIFM should provide own funds corresponding to the defined amount of loss to be borne by the AIFM. Such own funds should be in addition to the initial capital of the AIFM and to the own funds to be provided by the AIFM pursuant to Article 9(3) of Directive 2011/61/EU.

(38) As a matter of principle, the adequacy of coverage through additional own funds or professional indemnity insurance should be reviewed at least once a year. However, the AIFM should have procedures in place that ensure ongoing monitoring of the total value of AIF portfolios managed and ongoing adjustments to the amount of coverage of professional liability risks should there be significant mismatches identified. Furthermore, the competent authority of the home Member State of an AIFM may lower or increase the minimum requirement for additional own funds, after taking into account the risk profile of the AIFM, its loss history and the adequacy of its additional own funds or professional indemnity insurance.

(39) Directive 2011/61/EU requires AIFMs to act in the best interests of AIFs, the investors in the AIFs and the integrity of the market. AIFMs should therefore apply appropriate policies and procedures which allow them to prevent malpractices such as market timing or late trading. Market timers take advantage of out of date or stale prices for portfolio securities that impact the calculation of AIF’s net asset value (NAV) or buy and redeem units of the AIF within a few days, thereby exploiting the way the AIF calculates its NAV. Late trading involves placing of orders to buy or redeem units of AIFs after a designated cut off point but the price received is the one of the cut off point. Both malpractices harm the interests of long term investors as they dilute their return and have detrimental effects on AIF’s returns as they increase transaction costs and disrupt portfolio management. AIFMs should also establish appropriate procedures to ensure that the AIF is managed efficiently and should act in such a way as to prevent undue costs being charged to the AIF and its investors.

(40) In line with the approach applied to UCITS managers, AIFMs should ensure a high standard of diligence in the selection and monitoring of investments. They should have appropriate professional expertise and knowledge of the assets in which AIFs are invested. In order to ensure that investment decisions are carried out in compliance with the investment strategy and, where applicable, risk limits of the AIFs managed, AIFMs should establish and implement written policies and procedures on due diligence. These policies and procedures should be reviewed and updated on a regular basis. When AIFMs invest in specific types of assets for a long duration, less liquid assets such as real estate or partnership interests, due diligence requirements should apply also to the negotiation phase. The activities performed by the AIFM before closing an agreement should be well documented in order to demonstrate that they are consistent with the economic and financial plan and therefore with the duration of the AIF. AIFMs should maintain minutes of the relevant meetings, the preparatory documentation and the economic and financial analysis conducted for assessing the feasibility of the project and the contractual commitment.

(41) The requirement that AIFMs act with due skill, care and diligence should also apply where the AIFM appoints a prime broker or counterparty. The AIFM should select and appoint only those prime brokers and counterparties, which are subject to ongoing supervision, are financially sound and have the necessary organisational structure appropriate to the services to be provided to the AIFM or the AIF. In order to ensure that investors’ interests are adequately protected, it is important to clarify that one of the criteria against which financial soundness should be assessed is whether or not prime brokers or counterparties are subject to relevant prudential regulation, including adequate capital requirements, and effective supervision.

(42) In line with Directive 2011/61/EU, which requires AIFMs to act honestly, fairly and with due skill, persons who effectively direct the business of the AIFM, who are members of the governing body or of the senior management, in the case of entities which do not have a governing body, should possess sufficient knowledge, skills and experience to exercise their tasks, in particular to understand the risks associated with the activity of the AIFM. In line with the Commission’s Green Paper on corporate governance in the financial sector (2), persons who effectively direct the business of the AIFM should also commit sufficient time to perform their functions in the AIFM and act with honesty, integrity and independence of mind to, inter alia, effectively assess and challenge the decisions of the senior management.

(43) To ensure that the relevant activities are performed properly, AIFMs should employ personnel with the necessary skills, knowledge and expertise to carry out tasks assigned to them.

(44) AIFMs that provide the service of individual portfolio management have to comply with inducement rules laid down in Commission Directive 2006/73/EC of 10 August 2006 implementing Directive 2004/39/EC of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive (3). For reasons of consistency, those principles should extend to AIFMs that provide the service of collective portfolio management, and marketing. The existence, nature and amount of the fee, commission or benefit, or, where the amount cannot be ascertained, the method of calculating the amount, should be disclosed in the AIFM’s annual report.

(45) Investors in AIFs should benefit from protection similar to that of AIFM clients to whom AIFMs provide the service of individual portfolio management, as in such a case they have to comply with the best execution rules laid down in Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC (4) and Directive 2006/73/EC. However, the differences between the various types of assets in which AIFs are invested should be taken into account, since best execution is not relevant, for instance, when the AIFM invests in real estate or partnership interests and the investment is made after extensive negotiations on the terms of the agreement. Where there is no choice of different execution venues, the AIFM should be able to demonstrate to the competent authorities and auditors that there is no choice of different execution venues.

(46) For reasons of consistency with requirements applying to UCITS managers, rules on handling of orders and on aggregation and allocation of trading orders should apply to AIFMs when providing collective portfolio management. However, such rules should not apply where the investment in assets is made after extensive negotiations on the terms of the agreement, such as investment in real estate, partnership interests or non-listed companies as in such cases no order is executed.

(47) It is important to specify the situations where conflicting interests are likely to occur, in particular where there is a prospect of financial gain or avoidance of financial loss or where financial or other incentives are provided to steer the behaviour of the AIFM in such a way that it favours particular interests at the expense of interests of other parties, such as another AIF, its clients, undertakings for collective investments in transferable securities (UCITS) or other clients of the AIFM.

(48) The conflicts of interest policy established by the AIFM should identify situations in which activities carried out by the AIFM could constitute conflicts of interest that do or do not lead to potential risks of damage to the AIF’s interests or the interests of its investors. To identify them the AIFM should take into account not only the activity of collective portfolio management but also other activities it is authorised to carry out, including activities of its delegates, sub-delegates, external valuer or counterparty.

(49) In line with the approach considered in Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (5) for UCITS management companies and in Directive 2004/39/EC for investment firms, AIFMs should adopt procedures and measures to ensure that relevant persons engaged in different business activities that could involve conflicts of interest carry out these activities at an independent level, appropriate to the size and activities of the AIFM.

(50) It is essential to provide for a general framework according to which conflicts of interest, if they occur, should be managed and disclosed. The detailed steps and procedures to be followed in such situations should be clarified in the conflicts of interest policy to be established by the AIFM.

(51) One of the central components of a risk management system is a permanent risk management function. In the interest of consistency, its tasks and responsibilities should be similar in nature to those assigned by Commission Directive 2010/43/EU of 1 July 2010 implementing Directive 2009/65/EC of the European Parliament and of the Council as regards organisational requirements, conflicts of interest, conduct of business, risk management and content of the agreement between a depositary and a management company (6) to the permanent risk management function in UCITS management companies. This function should have a primary role in shaping the risk policy of the AIF, risk monitoring and risk measuring in order to ensure that the risk level complies on an ongoing basis with the AIF’s risk profile. The permanent risk management function should have the necessary authority, access to all relevant information and regular contacts with the senior management and the governing body of the AIFM in order to provide them with updates so that they can take prompt remedial action where needed.

(52) The risk management policy forms another pillar of the risk management system. That policy should be appropriately documented and should explain, in particular, measures and procedures employed to measure and manage risks, the safeguards for independent performance of the risk management function, the techniques used to manage risks and the details of the allocation of responsibilities within the AIFM for risk management and operating procedures. In order to ensure its effectiveness, the risk management policy should be reviewed at least annually by the senior management.

(53) As required by Directive 2011/61/EU, the function of risk management should be functionally and hierarchically separated from the operating units. It should thus be clarified that such separation should be ensured up to the governing body of the AIFM and that those in the risk management function should not carry out any conflicting tasks or be supervised by someone who is in charge of conflicting functions.

(54) It is essential to specify the safeguards to be employed by the AIFM in any event in order to ensure the independent performance of the risk management function, and in particular, that those performing the risk management function should not be entrusted with conflicting duties, that they should make decisions on the basis of the data which they can appropriately assess and that the decision making process should be capable of being reviewed.

(55) Although Directive 2011/61/EU does not impose any investment restrictions on AIFs, the risks incurred by each AIF cannot be managed effectively if the risk limits have not been set in advance by AIFMs. The risk limits should be in line with the risk profile of the AIF, and should be disclosed to investors in accordance with Directive 2011/61/EU.

(56) For consistency reasons, the requirements relating to identification, measuring and monitoring of risk are built on similar provisions of Directive 2010/43/EU. AIFMs should deal appropriately with the possible vulnerability of their risk measurement techniques and models by carrying out stress tests, back tests and scenario analysis. Where stress tests and scenario analysis reveal particular vulnerability to a given set of circumstances, AIFMs should take prompt steps and corrective actions.

(57) Directive 2011/61/EU requires the Commission to specify the liquidity management systems and procedures enabling the AIFM to monitor the liquidity risk of the AIF, except where the AIF is an un-leveraged closed-ended AIF, and ensure that the liquidity profile of the AIF’s investments complies with its underlying obligations. Therefore, it is important to set out fundamental general requirements addressed to all AIFMs, the application of which should be adapted to the size, structure and nature of the AIFs managed by the AIFM concerned.

(58) AIFMs should be able to demonstrate to their competent authorities that appropriate and effective liquidity management policies and procedures are in place. That requires due consideration to be given to the nature of the AIF, including the type of underlying assets and the amount of liquidity risk to which the AIF is exposed, the scale and complexity of the AIF or the complexity of the process to liquidate or sell assets.

(59) Liquidity management systems and procedures can allow AIFMs to apply the tools and arrangements necessary to cope with illiquid assets and related valuation problems in order to respond to redemption requests. Such tools and arrangements may include, where allowed under national law, gates, partial redemptions, temporary borrowings, notice periods and pools of liquid assets. ‘Side pockets’ and other mechanisms where certain assets of the AIF are subject to similar arrangements between the AIF and its investors should be regarded as ‘special arrangements’ as they impact the specific redemption rights of investors in the AIF. The suspension of an AIF should not be considered as a special arrangement as this applies to all of the AIF’s assets and all of the AIF’s investors. The use of tools and special arrangements to manage liquidity should be made dependent on concrete circumstances and should vary according to the nature, scale and investment strategy of the AIF.

(60) The requirement to monitor the liquidity management of underlying collective investment undertakings in which AIFs invest, along with the requirements to put in place tools and arrangements to manage liquidity risk and identify, manage and monitor conflicts of interest between investors should not apply to AIFMs managing AIFs of the closed-ended type regardless of whether they are deemed to be employing leverage. The exemption from those redemption-related liquidity management requirements should reflect the differences in the general redemption terms of investors in a closed-ended AIF compared to those in an open-ended AIF.

(61) The use of minimum limits regarding the liquidity or illiquidity of the AIF could provide an effective monitoring tool for certain types of AIFMs. Exceeding a limit may not of itself require action by the AIFM as this depends on the facts and circumstances and the tolerances set by the AIFM. Limits could thus be used in practice in relation to monitoring average daily redemption versus fund liquidity in terms of days over the same period. That could also be used to monitor investor concentration to support stress testing scenarios. Those limits could provide triggers for continued monitoring or remedial action depending on the circumstances.

(62) The stress tests should, where appropriate, simulate shortage of liquidity of the assets as well as atypical redemption requests. Recent and expected future subscriptions and redemptions should be taken into consideration together with the impact of anticipated AIF performance relative to peers on such activity. The AIFM should analyse the period of time required to meet redemption requests in the stress scenarios simulated. The AIFM should also conduct stress tests on market factors such as foreign exchange movements which could materially impact the credit profile of the AIFM or that of the AIF and as a result collateral requirements. The AIFM should account for valuation sensitivities under stressed conditions in its approach to stress testing or scenario analysis.

(63) The frequency with which stress tests should be conducted should depend on the nature of the AIF, the investment strategy, liquidity profile, type of investor and redemption policy of the AIF. However, it is expected that those tests will be conducted at least on an annual basis. Where stress tests suggest significantly higher than expected liquidity risk, the AIFM should act in the best interest of all AIF investors taking into consideration the liquidity profile of the AIF’s assets, the level of redemption requests and where appropriate the adequacy of the liquidity management policies and procedures.

(64) Directive 2011/61/EU requires the Commission to specify how the investment strategy, liquidity profile and redemption policy are to be aligned. The consistency between those three elements is ensured if investors are able to redeem their investments in accordance with the AIF redemption policy, which should cover conditions for redemption in both normal and exceptional circumstances, and in a manner consistent with the fair treatment of investors.

(65) Directive 2011/61/EU requires cross-sectoral consistency and the removal of misalignment between the interests of originators that repackage loans into tradable securities and AIFMs that invest in those securities or other financial instruments on behalf of AIFs. To achieve that aim, the relevant provisions of Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions (7) that lay down the quantitative and qualitative requirements to be met by investors exposed to the credit risk of a securitisation, by originators and by sponsors have been taken into account. As the same objective of aligning the interests of the originator or sponsor and the interests of investors are pursued by this Regulation and the relevant provisions of Directive 2006/48/EC it is essential that the terminology is used consistently in both legal acts, therefore the definitions given in Directive 2006/48/EC are taken as reference. Given that the Committee of European Banking Supervisors, the predecessor of the European Banking Authority, has provided detailed Guidelines for interpreting the relevant provisions of Directive 2006/48/EC (8), achieving cross-sectoral consistency requires the current provisions seeking to align interests between originators, sponsors and AIFMs to be interpreted in light of those Guidelines.

(66) It is important that transactions that re-package loans into tradable securities are not structured in such a way as to avoid the application of the requirements relating to investments in securitisation positions. Therefore, the reference to an investment in tradable securities or other financial instruments based on repackaged loans should not be interpreted strictly as a legally valid and binding transfer of title with respect to such instruments, but as an investment made in a material economic sense so that any other forms of synthetic investments should be covered and subject to the specific requirements. To avoid misunderstandings and align the language with that used in the banking legislation, the terms ‘assumption of exposure to the credit risk of a securitisation’ should be used instead of ‘investment in tradable securities or other financial instruments based on repackaged loans’.

(67) The requirements that need to be met by institutions acting as originators, sponsors or original lenders of a securitisation are directly imposed on them by way of Directive 2006/48/EC. It is therefore important to prescribe the corresponding duties of an AIFM assuming exposure to securitisations. Consequently, the AIFM should assume exposure to securitisations only if the originator, sponsor or original lender has explicitly disclosed to the AIFM the retention of a significant economic interest in the underlying asset, known as retention requirement. Furthermore, the AIFM should ensure that various qualitative requirements imposed on the sponsor and originator through Directive 2006/48/EC are met. In addition, the AIFM should itself meet qualitative requirements in order to have a comprehensive and thorough understanding of the securitisation investment and its underlying exposure. To achieve that, AIFMs should make their investment decision only after having conducted careful due diligence from which they should have adequate information on and knowledge of the securitisations concerned.

(68) There are circumstances in which entities meet the definition of originator or sponsor, or fulfil the role of original lender; however, another entity that neither meets the definition of sponsor or originator, nor fulfils the role of original lender — but whose interests are most optimally aligned with those of investors — may seek to fulfil the retention requirement. For the sake of legal certainty, such other entity should not be required to fulfil the retention requirement if the retention requirement is fulfilled by the originator, sponsor or original lender.

(69) In case of a breach of the retention requirement or the qualitative requirements the AIFM should consider taking some corrective action, such as hedging, selling or reducing the exposure or approaching the party in breach of the retention requirement with a view to reinstating compliance. Such corrective action should always be in the interest of the investors and should not involve any direct obligation to sell the assets immediately after the breach has become apparent, therefore avoiding a ‘fire sale’. The AIFM should take the breach into account when considering making another investment in a further transaction in which the party in breach of the requirement is involved.

(70) In order to comply with the requirements of Directive 2011/61/EU to specify internal procedures and organisational arrangements, which each AIFM should apply, AIFMs should be required to establish a well-documented organisational structure that clearly assigns responsibilities, defines control mechanisms and ensures a good flow of information between all parties involved. AIFMs should also establish systems to safeguard information and ensure business continuity. When establishing those procedures and structures, AIFMs should take into account the principle of proportionality which allows procedures, mechanisms and organisational structure to be calibrated to the nature, scale and complexity of the AIFM’s business and to the nature and range of activities carried out in the course of its business.

(71) Disclosure to investors is of paramount importance to protect those investors, so AIFMs should implement appropriate policies and procedures to ensure that the redemption terms applicable to a particular AIF are disclosed in sufficient detail and with sufficient prominence to investors before they invest and in the event of material changes. That could include disclosure of notice periods in relation to redemptions, details of lock-up periods, an indication of circumstances in which normal redemption mechanisms might not apply or may be suspended, and details of any measures that may be considered by the governing body, such as gates, side pocketing, as they have an impact on the specific redemption rights of investors in the particular AIF.

(72) To ensure that the relevant activities are performed properly, AIFMs, in particular, should use suitable electronic systems in order to fulfil the recording requirements with regard to portfolio transactions or subscription and redemption orders and establish, implement and maintain accounting policies and procedures to ensure that the calculation of the net asset value is carried out as required in Directive 2011/61/EU and this Regulation.

(73) In order to ensure consistency with the requirements imposed on UCITS managers by Directive 2009/65/EC, the governing body, the senior management, or, where relevant the supervisory function of the AIFM should be entrusted with similar types of tasks to which adequate responsibilities should be allocated. However, such allocation of responsibilities should be consistent with the role and responsibilities of the governing body, the senior management and the supervisory function under applicable national law. Senior management may include some or all of the members of the governing body.

(74) The requirement to establish a permanent and effective compliance function should always be fulfilled by the AIFM, irrespective of the size and complexity of its business. However, details of the technical and personnel organisation of the compliance function should be calibrated to the nature, scale and complexity of the AIFM’s business and the nature and range of its services and activities. The AIFM should not have to establish an independent compliance unit if such a requirement would be disproportionate in view of the size of the AIFM or the nature, scale and complexity of its business.

(75) Valuation standards differ across jurisdictions and asset classes. This Regulation should supplement the common general rules and establish benchmarks for AIFMs when developing and implementing appropriate and consistent policies and procedures for the proper and independent valuation of the assets of AIFs. The policies and procedures should describe the obligations, roles and responsibilities pertaining to all parties involved in the valuation, including external valuers.

(76) The value of assets can be determined, in different ways, such as by reference to observable prices in an active market or by an estimate using other valuation methodologies according to national law, the AIF rules or its instruments of incorporation. As the value of individual assets and liabilities can be determined by different methodologies and can be taken from different sources, the AIFM should determine and describe the valuation methodologies it uses.

(77) Where a model is used for valuing assets, the valuation procedures and policies should indicate the main features of the model. Before it is used, that model should be subject to a validation process conducted by an internal or external individual who was not involved in the process of building the model. A person should be considered qualified to conduct a validation process in respect of the model used to value assets if he is in possession of adequate competence and experience in the valuation of assets using such models; such person could be an auditor.

(78) Since AIFs operate in a dynamic environment where investment strategies may change over time, valuation policies and procedures should be reviewed at least yearly and in any event before AIFs engage with a new investment strategy or a new type of asset. Any change in the valuation policies and procedures, including the valuation methodologies, should follow a predetermined process.

(79) The AIFM has to ensure that the individual assets of an AIF have been valued properly, in line with the valuation policies and procedures. For some assets, especially complex and illiquid financial instruments, there is a higher risk of inappropriate valuation. To address this type of situation, the AIFM should put in place sufficient controls to ensure that an appropriate degree of objectivity can be attached to the value of the AIF’s assets.

(80) Calculation of the net asset value per unit or share is subject to national law and, as the case may be, or the fund rules or instruments of incorporation. This Regulation covers only the procedure for the calculation, and not the methodology of the calculation. The AIFM may itself carry out the calculation of the net asset value per unit or share as part of the administration functions it performs for the AIF. Alternatively, a third party may be appointed to perform administration, including calculation of the net asset value. A third party that carries out the calculation of the net asset value for an AIF should not be considered an external valuer for the purposes of Directive 2011/61/EU, as long as it does not provide valuations for individual assets, including those requiring subjective judgement, but incorporates into the calculation process values which are obtained from the AIFM, pricing sources or an external valuer.

(81) There are valuation procedures that can be performed on a daily basis such as the valuation of financial instruments, but there are also valuation procedures that cannot be carried out with the same frequency as issues, subscriptions, redemptions and cancellations take place, for instance the valuation of real estate. The frequency of valuation of the assets held by an open-ended fund should take into account the differences in the valuation procedures with respect to the types of assets held by the AIF.

(82) The strict requirements and limitations which have to be complied with when an AIFM intends to delegate the task of carrying out functions are set out in Directive 2011/61/EU. The AIFM remains at all times fully responsible for the proper performance of the delegated tasks and their compliance with Directive 2011/61/EU and its implementing measures. The AIFM should therefore ensure that the delegate performs and applies the quality standards which would be applied by the AIFM itself. Also, if necessary to ensure that delegated functions are performed to a consistently high standard, the AIFM has to be able to terminate the delegation and the delegation arrangement should therefore confer flexible termination rights on the AIFM. The delegation limitations and requirements should apply to the management functions set out in Annex I to Directive 2011/61/EU, whereas supporting tasks like administrative or technical functions assisting the management tasks such as logistical support in the form of cleaning, catering and procurement of basic services or products, should not be deemed to constitute delegation of AIFM functions. Other examples of technical or administrative functions are buying standard software ‘off-the-shelf’ and relying on software providers for ad hoc operational assistance in relation to off-the-shelf systems or providing human resources support such as sourcing of temporary employees or processing of payroll.

(83) To ensure a high level of investor protection in addition to the increase of the efficiency of the conduct of the business of the AIFM the entire delegation should be based on objective reasons. When assessing these reasons, competent authorities should consider the structure of the delegation and its impact on the structure of the AIFM and the interaction of the delegated activities with the activities remaining with the AIFM.

(84) In order to assess whether the person who effectively conducts the business of the delegate is of sufficiently good repute, the person’s conduct of business should be verified as well as whether he has committed offences regarding financial activities. Any other relevant information concerning personal qualities which might adversely affect the person’s conduct of business such as doubts in relation to his honesty and integrity should be considered when assessing the requirement of sufficient good repute.

(85) Investment companies authorised under Directive 2009/65/EC are not deemed to be undertakings which are authorised or registered for the purposes of asset management and subject to supervision because they are not allowed to engage in activities other than collective portfolio management under that Directive. Similarly, an internally managed AIF should not be deemed to be classified as such an undertaking because it should not engage in activities other than the internal management of the AIF.

(86) Where the delegation concerns portfolio management or risk management, which are the core business of the AIFM and therefore of high relevance with respect to investor protection and systemic risk, in addition to the requirements of Article 20(1)(c) of Directive 2011/61/EU the competent authority of the home Member State of the AIFM and the supervisory authority of the third country undertaking should have concluded a cooperation arrangement based on a written agreement. The arrangement should be in place prior to the delegation. The details of this agreement should take international standards into consideration.

(87) Written arrangements should confer on competent authorities the right to carry out on-site inspections, including where they request the third-country supervisory authority of the undertaking, to which functions were delegated, to carry out on-site inspections and where they request permission from the third-country supervisory authority to carry out the inspection themselves, or to accompany staff of the third-country supervisory authority in order to assist them in carrying out on-site inspections.

(88) Based on the obligations laid down in Directive 2011/61/EU, AIFMs should always act in the best interests of the AIFs or the investors in the AIFs they manage. Therefore, delegation should be admissible only if it does not prevent the AIFM from acting or managing the AIF in the best interests of the investors.

(89) To maintain a high standard of investor protection possible conflicts of interest have to be taken into account for any delegation. Several criteria should set benchmarks for identifying situations which would result in a material conflict of interest. Those criteria should be understood as non-exhaustive and meaning that non-material conflicts of interest are also relevant for the purposes of Directive 2011/61/EU. Thus, the carrying out of compliance or audit functions should be deemed as conflicting with portfolio management tasks, whereas market making or underwriting should be understood as conflicting with portfolio or risk management. That obligation is without prejudice to the obligation of the delegate to separate functionally and hierarchically the tasks of portfolio and risk management from each other according to the provisions of Article 15 of Directive 2011/61/EU.

(90) The requirements applying to the delegation of the task of carrying out functions on behalf of the AIFM should apply mutatis mutandis where the delegate sub-delegates any of the functions delegated to it and also in the case of any further sub-delegation.

(91) To ensure that in any event the AIFM performs investment management functions, the AIFM should not delegate its functions to the extent that, in essence, it can no longer be considered to be the manager of the AIF and to the extent that it becomes a letter-box entity. The AIFM should at all times keep sufficient resources to supervise the delegated functions efficiently. The AIFM has to perform itself investment management functions, to have the necessary expertise and resources, to keep the power to take decisions which fall under senior management responsibility and to perform senior management functions, which could include implementation of the general investment policy and investment strategies.

(92) The assessment of a delegation structure is a complex exercise that has to be based on a series of criteria in order for the competent authorities to form their judgement. The combination is necessary to take into account the variety of fund structures and investment strategies across the Union. ESMA may develop guidelines to ensure a consistent assessment of delegation structures across the Union.

(93) The Commission shall monitor how the criteria are applied and their impact on the markets. The Commission shall review the situation after two years and, should it prove necessary, shall take appropriate measures to further specify the conditions under which the AIFM shall be deemed to have delegated its functions to such an extent that it becomes a letter box entity and can no longer be considered to be the manager of the AIF.

(94) Directive 2011/61/EU lays down an extensive set of requirements regarding the depositary of an AIF in order to ensure a high standard of investor protection. The respective concrete rights and obligations of the depositary, the AIFM and, as the case may be, or the AIF and third parties should therefore be set out clearly. The written contract should comprise all details necessary for the appropriate safe-keeping of all the AIF’s assets by the depositary or a third party to whom safe-keeping functions are delegated in accordance with Directive 2011/61/EU and for the depositary to properly fulfil its oversight and control functions. In order to allow the depositary to assess and monitor custody risk, the contract should provide sufficient detail on the categories of assets in which the AIF may invest and cover the geographical regions in which the AIF plans to invest. The contract should also contain details of an escalation procedure. Thus, the depositary should alert the AIFM to any material risk identified in a particular market’s settlement system. With respect to the termination of the contract, it should reflect the fact that the termination of the contract is the depositary’s last resort if it is not satisfied that the assets are sufficiently protected. It should also prevent moral hazard whereby the AIFM would make investment decisions irrespective of custody risks on the basis that the depositary would be liable in most cases. In order to maintain a high standard of investor protection, the requirement laying down the details for the monitoring of third parties should be applied in relation to the whole custody chain.

(95) A depositary established in a third country should be subject to public prudential regulation and to prudential supervision performed by a supervisory authority which is competent for ongoing supervision, undertaking investigations and imposing sanctions. Where that supervision of the depositary involves multiple supervisory authorities, one supervisory authority should act as the contact point for the purposes of Directive 2011/61/EU and all delegated and implementing measures adopted pursuant to it.

(96) The assessment of the law of the third country according to Article 21(6) last subparagraph of Directive 2011/61/EU should be made by the European Commission by comparing the authorisation criteria and the ongoing operating conditions applicable to the depositary in the third country with the corresponding requirements applicable under Union law to credit institutions and, as the case may be, or to investment firms for access to the depositary business and performance of the depositary functions, with a view to ascertaining whether the local criteria have the same effect as those established under Union law. A depositary which is subject to prudential oversight and licensed in the third country under a local category other than a credit institution or an investment firm may be assessed by the European Commission with a view to ascertaining whether the relevant provisions of the law of the third country have the same effect as those established by the law of the Union for credit institutions and, as the case may be, or for investment firms.

(97) In order for the depositary to have a clear overview of all inflows and outflows of cash of the AIF in all instances, the AIFM should ensure that the depositary receives without undue delay accurate information related to all cash flows, including from any third party with which an AIF’s cash account is opened.

(98) In order for the AIF’s cash flows to be properly monitored the depositary’s obligation consists of making sure that there are procedures in place and effectively implemented to appropriately monitor the AIF’s cash flows and that these procedures are periodically reviewed. In particular, the depositary should look into the reconciliation procedure to satisfy itself that the procedure is suitable for the AIF and performed at appropriate intervals taking into account the nature, scale and complexity of the AIF. Such a procedure should for example compare one by one each cash flow as reported in the bank account statements with the cash flows recorded in the AIF’s accounts. Where reconciliations are performed on a daily basis as for most open-ended AIFs, the depositary should perform its reconciliation also on a daily basis. The depositary should in particular monitor the discrepancies highlighted by the reconciliation procedures and the corrective measures taken in order to notify without undue delay the AIFM of any anomaly which has not been remedied and to conduct a full review of the reconciliation procedures. Such a review should be performed at least once a year. The depositary should also identify on a timely basis significant cash flows and in particular those which could be inconsistent with the AIF’s operations, such as changes in positions in AIF’s assets or subscriptions and redemptions, and it should receive periodically cash account statements and check the consistency of its own records of cash positions with those of the AIFM. The depositary should keep its record up to date in accordance with Article 21(8)(b) of Directive 2011/61/EU.

(99) The depositary has to ensure that all payments made by or on behalf of investors upon the subscription of shares or units of an AIF have been received and booked in one or more cash accounts in accordance with Directive 2011/61/EU. The AIFM should therefore ensure that the depositary is provided with the relevant information it needs to properly monitor the receipt of investors’ payments. The AIFM has to ensure that the depositary obtains this information without undue delay when the third party receives an order to redeem or issue shares or units of an AIF. The information should therefore be transmitted at the close of the business day from the entity which is responsible for the subscription and redemption of shares or units of an AIF to the depositary in order to avoid any misuse of investors’ payments.

(100) Depending on the type of assets to be safe-kept, assets are either to be held in custody, as with financial instruments which can be registered in a financial instruments account, or which can be physically delivered to the depositary in accordance with Directive 2011/61/EU, or to be subject to ownership verification and record-keeping. The depositary should hold in custody all financial instruments of the AIF or of the AIFM acting on behalf of the AIF that could be registered or held in an account directly or indirectly in the name of the depositary or a third party to whom custody functions are delegated, notably at the level of the central securities depositary. In addition to these situations those financial instruments are to be held in custody that are only directly registered with the issuer itself or its agent in the name of the depositary or a third party to whom custody functions are delegated. Those financial instruments that in accordance with applicable national law are only registered in the name of the AIF with the issuer or its agent, such as investments in non-listed companies by private equity and venture capital funds, should not be held in custody. All financial instruments which could be physically delivered to the depositary should be held in custody. Provided that the conditions on which financial instruments are to be held in custody are fulfilled, financial instruments which are provided as collateral to a third party or are provided by a third party for the benefit of the AIF have to be held in custody too by the depositary itself or by a third party to whom custody functions are delegated as long as they are owned by the AIF or the AIFM acting on behalf of the AIF. Also, financial instruments owned by the AIF or by the AIFM on behalf of the AIF, for which the AIF, or the AIFM on behalf of the AIF, has given its consent to re-use by the depositary, remain in custody as long as the right of re-use has not been exercised.

(101) Financial instruments which are held in custody should be subject to due care and protection at all times. To ensure that the custody risk is properly assessed, in exercising due care, the depositary should in particular know which third parties constitute the custody chain, ensure that the due-diligence and segregation obligations have been maintained throughout the whole custody chain, ensure that it has an appropriate right of access to the books and records of third parties to whom custody functions are delegated, ensure compliance with these requirements, document all of these duties and make these documents available to and report to the AIFM.

(102) In order to avoid circumvention of the requirements of Directive 2011/61/EU, the depositary should apply the safe-keeping duties to the underlying assets of financial structures and, as the case may be, or legal structures controlled directly or indirectly by the AIF or by the AIFM acting on behalf of the AIF. That look-through provision should not apply to funds of funds or master-feeder structures provided they have a depositary which safe-keeps the fund’s assets appropriately.

(103) The depositary should at all times have a comprehensive overview of all assets that are not financial instruments to be held in custody. Those assets would be subject to the obligation to verify the ownership and maintain a record under Directive 2011/61/EU. Examples of such assets are physical assets which do not qualify as financial instruments under Directive 2011/61/EU or could not be physically delivered to the depositary, financial contracts such as derivatives, cash deposits or investments in privately held companies and interests in partnerships.

(104) To achieve a sufficient degree of certainty that the AIF or the AIFM acting on behalf of the AIF is indeed the owner of the assets, the depositary should make sure it receives all information it deems necessary to be satisfied that the AIF or the AIFM acting on behalf of the AIF holds the ownership right over the asset. That information could be a copy of an official document evidencing that the AIF or the AIFM acting on behalf of the AIF is the owner of the asset or any formal and reliable evidence that the depositary considers appropriate. If necessary, the depositary should request additional evidence from the AIF or the AIFM or as the case may be from a third party.

(105) The depositary should keep a record of all assets for which it is satisfied that the AIF holds ownership. It may set up a procedure to receive information from third parties, whereby procedures which ensure that the assets could not be transferred without the depositary or the third party to whom safe-keeping functions are delegated having been informed of such transactions may be feasible in the case of AIFs with infrequent transactions and, as the case may be, or transactions which are subject to pre-settlement negotiation. The requirement to have access to documentary evidence of each transaction from a third party could be appropriate for AIFs with more frequent portfolio trading, such as investments in listed derivatives.

(106) In order to ensure that the depositary is able to conduct its duties, it is necessary to clarify the tasks provided for in Article 21(9) of Directive 2011/61/EU, and in particular the second layer controls to be undertaken by the depositary. Such tasks should not prevent the depositary from conducting ex-ante verifications where it deems appropriate, and in agreement with the AIFM. In order to ensure that it is able to conduct its duties, the depositary should establish its own escalation procedure to address situations where irregularities have been detected. That procedure should ensure the notification of competent authorities of any material breaches. The oversight responsibilities of the depositary towards third parties specified by this Regulation are without prejudice to the responsibilities incumbent on the AIFM under Directive 2011/61/EU.

(107) The depositary should check the consistency between the number of units or shares issued and the subscription proceeds received. Moreover, to ensure that payments made by investors upon subscription have been received, the depositary should further ensure that another reconciliation is conducted between the subscription orders and the subscription proceeds. The same reconciliation should be performed with regard to redemption orders. The depositary should also verify that the number of units or shares in the AIF’s accounts matches the number of outstanding units or shares in the AIF’s register. The depositary should adapt its procedures accordingly, taking into account the frequency of subscriptions and redemptions.

(108) The depositary should take all necessary steps to ensure that appropriate valuation policies and procedures for the assets of the AIF are effectively implemented, through the performance of sample checks or by comparing the consistency of the change in the NAV calculation over time with that of a benchmark. When setting up its procedures, the depositary should have a clear understanding of the valuation methodologies used by the AIFM or the external valuer to value the AIF’s assets. The frequency of such checks should be consistent with the frequency of the AIF’s asset valuation.

(109) By virtue of its obligation of oversight under Directive 2011/61/EU, the depositary should set up a procedure to verify on an ex-post basis the AIF’s compliance with applicable law and regulations and its rules and instruments of incorporation. This covers areas such as checking that the AIF’s investments are consistent with its investment strategies as described in the AIF’s rules and offering documents and ensuring that the AIF does not breach its investment restrictions, if any. The depositary should monitor the AIF’s transactions and investigate any unusual transactions. If the limits or restrictions set out in the applicable national law or regulations or the AIF rules and instruments of incorporation are breached, the depositary should, for example, obtain an instruction from the AIFM to reverse the transaction that was in breach at its own costs. This Regulation does not prevent the depositary from adopting an ex ante approach where it deems it appropriate and in agreement with the AIFM.

(110) The depositary should ensure that the income is calculated accurately in accordance with Directive 2011/61/EU. In order to achieve this the depositary has to ensure that the income distribution is appropriate and, where it identifies an error, that the AIFM takes appropriate remedial action. Once the depositary has ensured this, it should verify the completeness and accuracy of the income distribution and in particular of the dividend payments.

(111) When delegating safe-keeping functions related to other assets according to Directive 2011/61/EU, delegation is likely to concern administrative functions in most cases. Where the depositary delegates record-keeping functions, it would therefore be required to implement and apply an appropriate and documented procedure to ensure that the delegate complies with the requirements of Article 21(11)(d) of Directive 2011/61/EU at all times. In order to ensure a sufficient level of protection of assets, it is necessary to set out certain principles that should be applied in relation to the delegation of safekeeping. For the delegation of custody duties it is important to set out some key principles which have to be effectively applied throughout the delegation process. Those principles should not be taken to be exhaustive, either in terms of setting out all details of the depositary’s exercise of due skill care and diligence, or in terms of setting out all the steps that a depositary should take in relation to these principles themselves. The obligation to monitor on an ongoing basis the third party, to whom safekeeping functions have been delegated should consist of verifying that this third party correctly performs all the delegated functions and complies with the delegation contract. The third party should act honestly, in good faith with a view to the best interests of the AIF and its investors, in compliance with regulatory and supervisory requirements, and should exercise care, diligence and skill that are normally expected from a highly prudent operator of that financial profession in comparable circumstances. The depositary should review, inter alia, elements assessed during the selection and appointment process and put these elements into perspective by comparing them with the development of the market. The form of the regular review should reflect circumstances, so that the depositary is in a position to appropriately assess the risks related to the decision to entrust assets to the third party. The frequency of the review should be adapted so as to always remain consistent with market conditions and associated risks. For the depositary to effectively respond to a possible insolvency of the third party, it should undertake contingency planning, including the design of alternative strategies and the possible selection of alternative providers as may be relevant. While such measures may reduce the custody risk faced by a depositary, they do not alter the obligation to return the financial instruments or pay the corresponding amount should they be lost, which depends on whether or not the requirements of Article 21(12) of Directive 2011/61/EU are fulfilled.

(112) When delegating safe-keeping functions, the depositary should ensure that the requirements of Article 21(11)(d)(iii) of Directive 2011/61/EU are fulfilled and that the assets of the AIF clients of the depositary are properly segregated. This obligation should particularly ensure that assets of the AIF are not lost due to insolvency of the third party to whom safekeeping functions are delegated. In order to minimise that risk in countries where the effects of segregation are not recognised by insolvency law, the depositary should take further steps. The depositary could make a disclosure to the AIF and the AIFM acting on behalf of the AIF so that such aspects of the custody risk are properly taken into account in the investment decision or take such measures as are possible in the local jurisdictions to make the assets as insolvency-proof as possible according to local law. Furthermore, the depositary could prohibit temporary deficits in client assets, use buffers or put in place arrangements prohibiting the use of a debit balance for one client to offset a credit balance for another. While such measures may reduce the custody risk faced by a depositary when delegating custody functions, they do not alter the obligation to return the financial instruments or pay the corresponding amount where these are lost, which depends on whether or not the requirements of Directive 2011/61/EU are fulfilled.

(113) The depositary’s liability under Article 21(12) second subparagraph of Directive 2011/61/EU is triggered in the event of the loss of a financial instrument held in custody by the depositary itself or by a third party to whom the custody has been delegated, provided that the depositary does not demonstrate that the loss results from an external event beyond reasonable control, the consequences of which would have been unavoidable despite all reasonable efforts to the contrary. That loss should be distinguished from an investment loss for investors resulting from a decrease in the value of assets as a consequence of an investment decision.

(114) To be ascertained as such, it is important that the loss is definitive, and there is no prospect of recovering the financial asset. Thus, situations where a financial instrument is only temporarily unavailable or frozen should not count as losses within the meaning of Article 21(12) of Directive 2011/61/EU. In contrast, three types of situations can be identified where the loss should be deemed to be definitive: where the financial instrument no longer exists or never did exist; where the financial instrument exists but the AIF has definitively lost its right of ownership over it; and where the AIF has the ownership right but can no longer transfer title of or create limited property rights in the financial instrument on a permanent basis.

(115) A financial instrument is deemed no longer to exist for instance when it has disappeared following an accounting error that cannot be corrected, or if it never existed, when the AIF’s ownership was registered on the basis of falsified documents. Situations where the loss of financial instruments is caused by fraudulent conduct should be deemed a loss.

(116) No loss can be ascertained when the financial instrument has been substituted by or converted into another financial instrument, for example in situations where shares are cancelled and replaced by the issue of new shares in a company reorganisation. An AIF should not be considered as permanently deprived of its right of ownership over the financial instrument if the AIF or the AIFM acting on behalf of the AIF has legitimately transferred ownership to a third party. Where there is a distinction between the legal ownership and the beneficial ownership of the assets, the definition of loss should refer to loss of the beneficial ownership right.

(117) Only in the case of an external event beyond the reasonable control of the depositary, the consequences of which are unavoidable despite all reasonable efforts to the contrary, could the depositary avoid to be held liable under Article 21(12) of Directive 2011/61/EU. The cumulative fulfilment of these conditions should be proven by the depositary in order for it to be discharged of liability.

(118) It should first be determined whether the event which led to the loss was external. The depositary’s liability should not be affected by delegation and therefore an event should be deemed external if it does not occur as a result of any act or omission of the depositary or the third party to whom the custody of financial instruments held in custody has been delegated. Then, it should be assessed whether the event is beyond the reasonable control, by verifying that there was nothing a prudent depositary could reasonably have done to prevent the occurrence of the event. Under these steps both natural events and acts of a public authority may be considered as external events beyond reasonable control. Thus, in the context of the insolvency of a third party to whom custody was delegated, the law of the country where the instruments are held in custody, which does not recognise the effects of an appropriately implemented segregation, is deemed to be an external event beyond reasonable control. In contrast, a loss caused by failure to apply the segregation requirements laid down in Article 21(11)(d) (iii) of Directive 2011/61/EU or the loss of assets because of disruption in the third party’s activity in relation to its insolvency cannot be seen as being external events beyond reasonable control.

(119) Finally, the depositary should prove that the loss could not have been avoided despite all reasonable efforts to the contrary. In this context, the depositary should inform the AIFM and take appropriate action depending on the circumstances. For instance, in a situation where the depositary believes the only appropriate action is to dispose of the financial instruments, the depositary should duly inform the AIFM, which must in turn instruct the depositary in writing whether to continue holding the financial instruments or to dispose of them. Any instruction to the depositary to continue holding the assets should be reported to the AIF’s investors without undue delay. The AIFM or the AIF should give due consideration to the depositary’s recommendations. Depending on the circumstances, if the depositary remains concerned that the standard of protection of the financial instrument is not sufficient, despite repeated warnings, it should consider further possible action, such as termination of the contract provided the AIF is given a period of time to find another depositary in accordance with national law.

(120) To ensure the same standard of investor protection, the same considerations should also apply to the delegate to whom a depositary has contractually transferred its liability. Therefore, in order to be discharged of liability under Article 21(12) of Directive 2011/61/EU the delegate should prove that it fulfils cumulatively the same conditions.

(121) A depositary is allowed under certain circumstances to discharge itself of liability for the loss of financial instruments held in custody by a third party to which custody was delegated. For such liability discharge to be permitted there must be an objective reason for contracting such discharge that is accepted by both the depositary and the AIF or the AIFM acting on behalf of the AIF. An objective reason should be established for each discharge of liability taking into account the concrete circumstances in which custody has been delegated.

(122) When considering an objective reason, the right balance should be established to ensure that the contractual discharge can be effectively relied upon if needed and that sufficient safeguards are put in place to avoid any misuse of the contractual discharge of liability by the depositary. The contractual discharge of liability should under no circumstances be used to circumvent the depositary’s liability requirements under Directive 2011/61/EU. The depositary should demonstrate that it was forced by the specific circumstances to delegate custody to a third party. Contracting a discharge should be always in the best interest of the AIF or its investors, and the AIF or the AIFM acting on behalf of the AIF should make it explicit that they act in such best interest. Examples of scenarios should indicate the situations where a depositary may be considered as not having other options but to delegate custody to third parties.

(123) It is important for competent authorities to obtain appropriate and sufficient information in order to supervise activities of AIFMs and the risks related to them appropriately and consistently. Also, since the activities of AIFMs could have effects across borders and on the financial markets, competent authorities should monitor AIFMs and AIFs closely in order to take appropriate action to avoid the build-up of systemic risks. The increased transparency and consistency through provisions on reporting and disclosing relevant information as outlined in the implementing measures should make it possible for competent authorities to detect and respond to risks in the financial markets.

(124) It is essential for investors to obtain the minimum information necessary with respect to particular AIFMs and AIFs and their structure in order to be able to take the right investment decision tailored to their needs and risk appetite. That information should be clear, reliable, readily understandable and clearly presented, whereas the usefulness of the information is enhanced when it is comparable from AIFM to AIFM and AIF to AIF and from one period to the next. An AIFM should not engage in activities which might be detrimental to the objective understanding and practical use of the information to investors prior to its disclosure such as window dressing.

(125) It is necessary to set out a framework which provides for minimum standards with respect to annual reporting requirements, including key elements and a non-exhaustive list of items. Material changes in the information as referred to in Article 22(2)(d) of Directive 2011/61/EU should be disclosed in the annual report within the financial statements. In addition to the non-exhaustive list of underlying line items additional line items, headings and sub totals may be included where the presentation of these items is relevant for the understanding of an AIF’s overall financial position or performance. Items of a dissimilar nature or function could be aggregated provided such items are individually not materially relevant. Those items could be aggregated under ‘other category’ such as ‘other assets’ or ‘other liabilities’. Where line items do not apply to a particular AIF at all, they do not need to be presented. Regardless of the accounting standards followed in accordance with Directive 2011/61/EU, all assets should be valued at least once a year. The balance sheet or the statement of assets and liabilities under Directive 2011/61/EU should include, inter alia, cash and cash equivalents. Thus, cash equivalents should be considered highly liquid investments for the purpose of calculating the exposure of an AIF.

(126) With respect to the content and format of the report on activities for the financial year which has to be part of the annual report under Directive 2011/61/EU, the report should include a fair and balanced review of the activities of the AIF with a description of the principal risks and investments or economic uncertainties that it faces. That disclosure should not result in the publication of proprietary information of the AIF which would be to the detriment of the AIF and its investors. Therefore, if the publication of particular proprietary information would have such effect, it could be aggregated to a level that would avoid the detrimental effect and would not need to capture, for example, the performance or statistics of an individual portfolio company or investment that could lead to the disclosure of proprietary information of the AIF. This information should form part of the management report in so far as this is usually presented alongside the financial statements.

(127) With respect to the content and format of the disclosure of remuneration where information is presented at the level of the AIFM, further information should be provided by disclosing an allocation or breakdown of the total remuneration as it relates to the relevant AIF. This could be achieved through disclosure of the total AIFM remuneration data split into fixed and variable components, a statement that these data relate to the entire AIFM, and not to the AIF, the number of AIFs and UCITS funds managed by the AIFM and the total assets under management of such AIFs and UCITS with an overview of the remuneration policy and a reference to where the full remuneration policy of the AIFM is available at the request of investors. Further details may be provided by disclosure of the total variable remuneration funded by the AIF through payment by it of performance fees or carried interest, as the case may be. In addition to the remuneration disclosure, it may be appropriate for AIFMs to provide information relating to the financial and non-financial criteria of the remuneration policies and practices for relevant categories of staff to enable investors to assess existing incentives created.

(128) Where the AIF issues units, transfers of any assets to side pockets should be calculated, at the time of transfer, based on the number of units allocated on transfer of assets multiplied by the price per unit. The valuation basis should be clearly disclosed in all circumstances and include the date at which the valuation was performed.

(129) In order to manage liquidity AIFMs should be permitted to enter into borrowing arrangements on behalf of AIFs they manage. Those arrangements can be short term or more permanent. In the latter case it is more likely that such an arrangement would be a special arrangement for the purpose of managing illiquid assets.

(130) In line with the principle of differentiation, and recognising the diversity of types of AIFs, the disclosure to investors required of an AIFM should vary according to the type of AIF and would depend on other factors such as investment strategy and the portfolio composition.

(131) Directive 2011/61/EU requires AIFMs to provide certain information on a regular basis to the competent authority of their home Member State for each EU AIFs they manage and for each of the AIF they market in the Union. It is therefore important to further specify the information to be provided and the frequency of the reporting which depend on the value of assets under management in portfolios of AIFs managed by a given AIFM. Pro-forma reporting templates should be provided for and should be completed by the AIFM for the AIFs it manages. Where an entity which is authorised as an AIFM markets AIFs which are managed by other AIFMs, it does not act as the manager of those AIFs but as an intermediary as any investment firm covered by Directive 2004/39/EC. It therefore should not have to report for these AIFs, as this would lead to double- or multiple reporting. This reporting requirement should nevertheless apply to non-EU AIFMs that manage AIFs which are marketed in the Union.

(132) The threshold provided in this Regulation triggers only reporting requirements laid down in Article 24(4) of Directive 2011/61/EU. An AIF with a leverage ratio calculated in accordance with the commitment method of less than three times its net asset value would not be considered as employing leverage on a substantial basis. However, competent authorities may request additional information where necessary for the effective monitoring of systemic risks. Setting a reporting threshold also ensures that information relating to the build-up of systemic risk is collected throughout the Union in a consistent way and provides certainty to AIFMs.

(133) A competent authority’s supervisory powers under Article 25(3) of Directive 2011/61/EU are exercised within the new supervisory system, forming part of what are ongoing supervisory processes and systemic risk assessments of AIFMs by competent authorities and the European supervisory authorities, with reference to the stability and integrity of the financial system. Competent authorities should make appropriate use of the information they receive and should impose limits to leverage employed by an AIFM or other restrictions on the management of the AIF with respect to the AIFs managed where they deem this necessary in order to ensure the stability and integrity of the financial system. The assessment of systemic risk is likely to vary depending on the economic environment, whereby any AIFM, with respect to the AIFs it manages, has the potential to be systemically relevant. It is therefore a basic requirement that competent authorities obtain all the information necessary to assess those situations appropriately in order to avoid the build-up of systemic risk. Competent authorities should then assess the information thoroughly and take appropriate measures.

(134) To allow EU AIFMs to manage and market non-EU AIFs and non-EU AIFMs to manage and market AIFs in the Union, Directive 2011/61/EU requires appropriate cooperation arrangements to be put in place with the relevant supervisory authorities of the third country where the non-EU AIF and, as the case may be, or the non-EU AIFM is established. Such cooperation arrangements should ensure at least an efficient exchange of information that allows Union competent authorities to carry out their duties in accordance with Directive 2011/61/EU.

(135) Cooperation arrangements should allow competent authorities to carry out their supervisory and enforcement duties in respect of third country entities. Cooperation arrangements should therefore set out a clear concrete framework for access to information, for the carrying out of on-site inspections, and for assistance to be provided by the third country authorities. The cooperation arrangements should make sure that information received may be shared with other competent authorities concerned as well as with ESMA and the ESRB.

(136) In order to allow competent authorities, AIFMs and depositaries to adapt to the new requirements contained in this Regulation so that they can be applied in an efficient and effective manner, the starting date of application of this Regulation should be aligned with the transposition date of Directive 2011/61/EU,

HAS ADOPTED THIS REGULATION:

CHAPTER I

DEFINITIONS

Article 1

Definitions

In addition to the definitions laid down in Article 2 of Directive 2011/61/EU, the following definitions apply for the purposes of this Regulation:

(1) ‘capital commitment’ means the contractual commitment of an investor to provide the alternative investment fund (AIF) with an agreed amount of investment on request by the AIFM;

(2) ‘relevant person’ in relation to an AIFM means any of the following: (a) a director, partner or equivalent, or manager of the AIFM; (b) an employee of the AIFM, or any other natural person whose services are placed at the disposal and under the control of the AIFM and who is involved in the provision of collective portfolio management services by the AIFM; (c) a natural or legal person who is directly involved in the provision of services to the AIFM under a delegation arrangement to third parties for the purpose of the provision of collective portfolio management by the AIFM;

(3) ‘senior management’ means the person or persons who effectively conduct the business of an AIFM in accordance with Article 8(1)(c) of Directive 2011/61/EU and, as the case may be, the executive member or members of the governing body;

(4) ‘governing body’ means the body with ultimate decision making authority in an AIFM, comprising the supervisory and the managerial functions, or only the managerial function if the two functions are separated;

(5) ‘special arrangement’ means an arrangement that arises as a direct consequence of the illiquid nature of the assets of an AIF which impacts the specific redemption rights of investors in a type of units or shares of the AIF and which is a bespoke or separate arrangement from the general redemption rights of investors.

CHAPTER II

GENERAL PROVISIONS

SECTION 1

Calculation of assets under management

(Article 3(2) of Directive 2011/61/EU)

Article 2

Calculation of the total value of assets under management

1. In order to qualify for the exemption provided for in Article 3(2) of Directive 2011/61/EU an AIFM shall:

(a) identify all AIFs for which it is appointed as the external AIFM or the AIF for which it is the AIFM, where the legal form of the AIF permits internal management, in accordance with Article 5 of Directive 2011/61/EU;

(b) identify for each managed AIF the portfolio of assets and determine in accordance with the valuation rules laid down in the law of the country where the AIF is established and, as the case may be, or in the AIF rules or instruments of incorporation the corresponding value of assets under management, including all assets acquired through use of leverage;

(c) aggregate the determined values of assets under management for all AIFs managed and compare the resulting total value of assets under management to the relevant threshold laid down in Article 3(2) of Directive 2011/61/EU.

2. For the purposes of paragraph 1, undertakings for collective investment in transferable securities (UCITS) for which the AIFM acts as the designated management company under Directive 2009/65/EC shall not be included in the calculation.

For the purposes of paragraph