Commission staff working document accompanying the proposal for a Directive of the European Parliament and of the Council on Alternative Investment Fund Managers and amending Directives 2004/39/EC and 2009/…/EC - Executive summary of the impact assessment {COM(2009) 207} {SEC(2009) 576}
Date: 2009-04-30
Institutions: European Commission
Subjects: credit institution, financial instrument, financial market, impact study, investment company, provision of services, securities

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COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 30.4.2009 
SEC(2009) 577 

COMMISSION STAFF WORKING DOCUMENT 

Accompanying the 

Proposal for a  

DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL  

on Alternative Investment Fund Managers and amending Directives 2004/39/EC and 
2009/…/EC 

EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT  

{COM(2009) 207} 
{SEC(2009) 576} 

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EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT  

The  financial  crisis  has  exposed  a  series  of  vulnerabilities  in  the  financial  system.  These 
necessitate  a  comprehensive  review  of  regulatory  and  supervisory  frameworks  for  all 
significant  actors  in  European  financial  markets.  As  described  in  the  Commission's 
Communication for the Spring European Council and in accordance with the conclusions of 
the G20, the Commission is committed to ensuring that 'all relevant actors … are subject to 
appropriate regulation and oversight'. This requires filling gaps in areas where European and 
national provisions are incomplete. 

One such area concerns the activities of the managers of Alternative Investment Funds (AIF), 
defined as all funds that are not harmonised under the UCITS Directive1. The AIF sector is 
large – managing around €2 trillion in assets at  the end of 2008 – and diverse. AIF managers 
(AIFM) employ a wide range of investment strategies and techniques and invest in an array of 
financial and physical assets. Hedge funds, private equity funds, commodity funds, real estate 
funds  and  infrastructure  funds,  among  others,  fall  within  this  category.  In  view  of  the  risks 
that  these  investments  entail,  investment  in  AIF  is  restricted  primarily  to  professional 
investors. 

The activities of AIFM pose a series of risks for their investors and counterparties and for the 
efficiency and stability of financial markets (see Table 1). The nature and intensity of these 
risks  varies  between  business  models.  For  example,  macro-prudential  risks  associated  with 
the  use  of  leverage  relate  primarily  to  the  activities  of  hedge  funds  and  commodity  funds; 
whereas  risks  associated  with  the  governance  of  portfolio  companies  are  most  closely 
associated with private equity. However, other risks are common to all types of AIFM. 

Table 1: Overview of key risk areas 
Macro-prudential 
(systemic) risks, relating 
in particular to the use 
of leverage 

to the AIFM sector  

•  Direct exposure of systemically important banks (as the providers of leverage) 

•  Pro-cyclical impact of herding behaviour, risk concentrations in particular 
market segments and ('forced') deleveraging which are transmitted to the 
counterparties through asset prices and market liquidity  

Micro-prudential risks 

•  Possible weaknesses in internal risk management systems with respect to 
liquidity risks, market risk, counterparty risks (credit and settlement risks, 
especially in the case of short selling) and operational risks 

Investor protection 

•  Gaps in investor disclosure on investment policy, risk management, internal 

processes etc as barrier to effective due diligence 

•  Conflicts of interest and failures in fund governance, in particular with respect 

to remuneration, valuation and administration 

Market efficiency and 
integrity  

• 
Impact of dynamic trading and short selling techniques on market functioning  
•  Potential for market abuse in connection with certain techniques, for example 

short-selling. 

Impact on market for 
corporate control 

•  Lack of transparency when building stakes in listed companies (e.g. through 
use of stock borrowing, contracts for difference), or concerted action in 
'activist' strategies 

Acquisition of control of 
companies by AIFM 

•  Potential for misalignment of incentives in management of portfolio 

companies, in particular in relation to use of debt financing 

1 

Directive 85/611/EEC on Undertakings for Collective Investment in Transferable Securities (UCITS). 

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•  Lack of transparency and public scrutiny of companies subject to buy-outs 

The  financial  crisis  has  shed  further  light  on  the  role  that  AIFM  play  in  financial  markets. 
While AIFM were not the cause of the crisis, recent events have placed severe stress on the 
sector.  Many  AIFM  have  experienced  liquidity  problems  as  they  struggle  to  manage  the 
mismatch  between  the  degree  of  liquidity  promised  to  investors  and  the  illiquidity  of  their 
investments. In some cases, adverse impacts have been felt by the wider market. For example, 
the abrupt unwinding of large, leveraged positions by hedge funds in response to tightening 
credit conditions and investor redemption requests has had a procyclical impact on declining 
markets and may have impaired market liquidity. 

Problem definition 

The  core  concern  of  this  impact  assessment  is  whether  current  regulatory  and  supervisory 
arrangements  for  the  AIFM  sector  in  the  EU  represent  a  sound  basis  for  monitoring  and 
controlling these risks. In particular, the report considers whether the cross-border dimension 
is  taken  into  account  adequately,  given  the  international  nature  of  AIFM  investors  and 
counterparties and their active role in financial markets throughout Europe. 

Despite  this  interconnectedness,  the  regulatory  environment  for  AIFM  is  currently  highly 
fragmented.  While  AIFM  are  subject to certain  cross-cutting provisions of  Community law, 
there is no Community regulation targeted directly at AIFM. This does not mean that AIFM 
are  unregulated:  many  are  subject  to  regulation  and  supervision  in  the  Member  States  in 
which  they  are  established.  However,  the  scope  and  content  of  national  regimes  vary 
significantly,  for  example  with  regard  to  the  requirements  for  the  registration  and 
authorisation  of  AIFM,  regulatory  reporting  and  standards  for  investor  disclosure  and  risk 
management. 

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The report considers two related problems associated with this regulatory fragmentation: 

•  First,  regulatory  fragmentation  may  inhibit  the  effective  regulation,  supervision  and 
macro-prudential  oversight  of  AIFM  by  failing  to  take  account  of  the  cross-border 
dimension of their activities. This may result in incomplete or inconsistent monitoring and 
control  of  the  macro-prudential,  micro-prudential  and  market  efficiency  risks  and 
weaknesses in frameworks for ensuring investor protection. 

•  Second,  it  may  also  impede  market  integration  and  the  development  of  the  single 
market  by  creating  barriers  to  the  efficient  cross-border  distribution  of  AIFM  products. 
This  may  prevent  AIFM  from  achieving  the  available  economies  of  scale  and  investors 
from diversifying their portfolios optimally. 

The  report  concludes  that,  when  judged  from  an  EU  perspective,  the  current  regulatory 
environment  does  not  represent  a  comprehensive  or  effective  basis  for  monitoring  and 
responding  to  risks  posed  by  AIFM  to  their  counterparties  and  the  financial  system.  The 
European dimension of the public good to be protected by regulation and supervision is not 
sufficiently taken into account.  

In  particular,  the  absence  of  a  consistent  approach  to  the  collection  of  relevant  macro-
prudential  data  from  AIFM  (for  example  on  leverage  and  risk  concentrations)  and  of  an 
effective  mechanism  for  macro-prudential  authorities  to  share  this  information  at  the 
European  or  global  level  is  a  significant  barrier  to  effective  macro-prudential  oversight. 
Moreover, the absence of a consistent standard of supervision and regulatory protection across 
the EU is a source of uncertainty for investors and counterparties. 

Objectives: 

In response to these problems, the report defines as an over-arching objective the achievement 
of a comprehensive and effective regulatory and supervisory framework for AIFM in the EU. 

The report recognises that some of the risks described are not unique to the AIFM sector and 
hence  are  better  addressed  by  cross-cutting  initiatives.  These  include  measures  to  address 
concerns  in  relation  to  short-selling  and  to  the  transparency  of  certain  techniques  for  the 
acquisition  of  voting  rights  in  listed  companies.  In  addition,  the  report  notes  that  other 
elements of the broad reform agenda announced in the Communication Communication to the 
Spring European Council will impact on the AIFM sector.  

However,  many  other  risks  relate  directly  to  the  activities  of  AIFM  and  as  such  warrant  a 
targeted response. The specific objectives of this response would be to: 

•  Ensure that all AIFM are subject to appropriate authorisation and registration requirements 

•  Provide a framework for the proper monitoring of macro-prudential risks  

•  Ensure the proper monitoring and limitation of micro-prudential risks 

•  Provide a common approach to the protection of professional investors in AIF 

•  Enhance public accountability of AIFM holding controlling stakes in companies 

•  Develop the single market in AIF 

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•  Ensure that actions are proportionate to the risks posed and appropriately differentiated to 

take account of differences in AIFM business models. 

What type of action is needed to achieve these objectives? 

In  assessing  the  appropriate  form  of  a  response  to  the  problems  identified,  the  impact 
assessment addresses a series of key questions as to the target and scope of that action, before 
proceeding to consider the level at which such action should be taken. 

Which parts of the value chain should be targeted? 

The report finds that the objectives could best be achieved by an approach targeted at the level 
of the AIFM. While the AIF is merely a legal structure for the pooling of assets and has no 
economic  life  of  its  own,  the  AIFM  is  responsible  for  all  key  decisions  in  relation  to  the 
management  of  the  fund.  These  include  decisions  on  investment;  the  use  of  leverage;  the 
governance structure and internal systems for risk management and the avoidance of conflicts 
of  interest;  the  management  of  relationships  with  investors,  counterparties  and  regulators, 
including the provision of information; the organisation of administrative functions (including 
valuation),  safekeeping  of  assets  and  audit,  even  if  these  functions  are  delegated  to  third 
parties. The risks therefore lie almost exclusively at the level of the AIFM. 

The  report  notes,  however,  that  an  approach  targeted  at  the  AIFM  would  need  to  be 
supplemented by appropriate controls on third party service providers (such as valuators and 
depositaries). Moreover, robust counterparty risk management by lenders plays a vital role in 
mitigating the risks posed by AIFM to the banking sector. 

What is the appropriate scope for action: should specific AIFM business models be targeted, 
or is a more horizontal approach preferable? 

The report then considers the case for targeting specific business models or for developing a 
horizontal approach to the AIFM sector. It concludes that a horizontal approach would be the 
preferred  option,  provided  that  it  is  designed  so  as  to  be  proportionate  and  sensitive  to  the 
differences between business models. Individual business models would be difficult to define 
in  a  precise  and  legally  robust  way  and  any  such  definitions  would  create  opportunities  for 
regulatory  circumvention.  In  addition,  many  of  the  risks  to  which  these  actions  respond  are 
not limited to individual business models but are found to a greater or lesser extent throughout 
the  AIFM  universe.  Wider  coverage  would  thus  ensure  that  risks  were  controlled  in  a 
comprehensive way. 

The  preference  for  an  'all-encompassing'  measure  does  not  imply  that  a  'one-size-fits-all' 
approach  is  appropriate.  An  appropriately  designed  measure  would  be  sensitive  to  the 
differences  in  business  models,  with  provisions  targeted  at  the  risks  posed  by  particular 
activities.  

How much of the AIF value chain should be required to be located in the EU for action to be 
effective? 

For the regulation and oversight of AIFM activity in the EU to be effective, the AIFM would 
need to be located in the EU. However, the report recognises that important parts of the AIF 
value-chain often reside in off-shore jurisdictions, in particular the AIF itself and key third-
party service providers. 

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The  report  recalls  that  since  the  risks  lie  almost  exclusively  at  the  level  of  the  AIFM,  the 
domicile of the AIF does not jeopardise the achievement of the objectives. However, certain 
third-party  services,  for  example  valuation  and  asset  safe-keeping,  are  critical  to  the 
protection of investors yet are often conducted off-shore for certain types of AIFM. In these 
instances, an effective response to the risks would require effective controls to be put in place 
for these activities. 

What is the appropriate level for action? 

The  report  assesses  five  options:  'do  nothing',  self-regulatory  approaches,  amd  legislative 
action  at  Member  State,  European  or  international  level.  It  concludes  that  the  effective 
monitoring  and  mitigation  of  AIFM-related  risks  requires  legally  binding  and  enforceable 
measures to ensure a high standard of regulation and oversight throughout the EU. Industry-
developed standards may have a role to play in informing these provisions and in providing 
additional guidance to industry.  

Member States could in principle upgrade their own regulatory and supervisory arrangements 
and seek to improve cooperation between jurisdictions. However, an uncoordinated approach 
would risk failing to take account of the cross-border nature of risks and binding cooperation 
and information-sharing agreements may prove elusive. Moreover, it could not be guaranteed 
that single market freedoms would be achieved. 

It is therefore considered that legislative action at the EU level offers clear advantages, both in 
terms  of  risk  monitoring  and  control  at  a  pan-European  level,  and  in  providing  a  secure 
framework  for  pan-European  AIF  distribution.  Given  the  potential  for  international  risk 
spillovers, action in the EU would ideally be coordinated with international action in this area. 
The development of a robust framework in Europe could provide a useful starting point for 
global discussion and sharing of information. 

Subsidiarity 

The report argues that European action in this area would respect the principle of subsidiarity 
by virtue of the inherently transnational nature of the risks and the need for a high degree of 
consistency in the requirements placed on AIFM and in the information collected from them. 
Article 47(2) of the EC Treaty would provide the legal basis for such action. 

With regard to the choice of instrument, a Directive would provide for the appropriate balance 
between harmonising key risk control measures and allowing Member States the flexibility to 
incorporate these provisions in national law. A European regime could also provide sufficient 
flexibility  for  Member  States  to  implement  additional  requirements  to  AIFM  operating  in  a 
purely  domestic  environment;  and  if  appropriate  to  provide  a  regime  for  the  distribution  of 
certain types of AIF to retail investors. 

Provisions of a potential proposal and expected impacts 

The  final  section  discusses  how  action  in  this  area  could  be  structured  so  as  to  be 
proportionate to the risks posed and to avoid creating excessive administrative burdens. 

General provisions 

The  report  describes  a  set  of  general  provisions  to  be  applied  to  all  AIFM.  These  would 
include  authorisation  requirements  designed  to  provide  the  competent  authority  with 

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sufficient  assurance  that  the  AIFM  is  fit  and  proper,  holds  sufficient  capital,  and  has  the 
appropriate  arrangements  in  place  for  inter  alia  risk  management,  valuation,  asset  safe-
keeping, audit and the management of conflicts of interest. Additional provisions would seek 
to  ensure  that  AIFM  provide  appropriate  and  timely  information  to  investors  on  their 
investment  policy,  fees  and  internal  systems;  and  to  regulators  on  the  nature  of  the  AIF 
managed  and  on  major  positions  and  risk  concentrations.  Subject  to  these  requirements, 
AIFM  would  be  granted  the  right  to  provide  their  services  in  all  Member  States  (subject  to 
notification) and to market the AIF they manage to professional investors throughout the EU. 

In order to be proportionate, these requirements would apply only to AIFM managing a total 
of €250mn or more. For smaller AIFM, the add itional administrative burden and the burden 
for  supervisors  would  outweigh  the  marginal  benefit  in  terms  of  the  mitigation  of  the  risks 
associated with their activities. 

Activity-based provisions 

In addition to the general provisions, a number of provisions would apply if and only if the 
AIFM engaged in particular activities. These would be sensitive to the differences in AIFM 
business models and calibrated to the risks posed. In particular: 

•  AIFM using leverage systematically and at a relevant scale would be required to provide 
additional disclosure to investors and would have to report to competent authorities on the 
use of leverage; and 

•  For  AIFM  acquiring  stakes  in  companies,  additional  information  and  disclosure 
requirements would be triggered once an AIF reached a controlling stake in a (non-SME) 
company;  and  if  an  AIFM  delists  a  company,  reporting  obligations  as  required  for  listed 
companies would continue to apply for a temporary period. 

Administrative burdens 

The  requirements  of  the  proposed  measure  would  create  some  administrative  burden  on 
AIFM.  The  additional  cost  would  depend  primarily  on  the  national  requirements  already  in 
place in the home country. These additional costs to AIFM (and their supervisors) would be 
justified  by  the  enhanced  supervision  and  the  benefits  to  AIFM  in  terms  of  cross-border 
provision  of  AIFM  services  and  AIF  marketing  to  professional  investors  upon  a  simple 
notification procedure.  

Due to uncertainties about costs, it is not possible to assess or to quantify precisely the impact 
of the proposal on the competitiveness of EU-domiciled AIFM. 

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