This month marked a milestone in EU Alternative Investments Funds, as the first EU Limited Persons Alternative Investments Fund License (LPAIF) was granted. As regulation of Alternative Investments intensifies in the jurisdiction, more and more firms are expected to apply for licenses.
In order to detail this fully, LeapRate discussed its finer points with Advocate and Notary Tal Itzhak Ron, Chairman of Tal Ron, Drihem & Co. Law Firm, and US-born Offshore Specialist Kovi Skier from his team, for a word about the LPAIF trend and what it means for investment funds.
Tal and Kovi: What is the LPAIF license all about, and how does it differ from a regular EU AIF license?
In order to understand the LPAIF license, we need to understand the legislative framework behind it. In 2013 the EU passed into law the Alternative Investments Fund Manager Directive (AIMFD), establishing new regulatory guidelines for AIF funds. Since then, over the course of the last two years, the various countries that are party to the EU have begun the process of incorporating these regulations into their internal legal systems.
In Cyprus, this happened in July of this year with the passing of the Alternative Investment Funds law of 2014. The law gave Cyrpus’ financial watchdog, CySEC, the authority to enforce regulation on those AIF’s which met the criteria of the EU Directive, as well as on those which did not meet those criteria – i.e., AIF’s whose size did not surpass the minimum threshold for regulation in the EU Directive. These are termed Limited Persons Alternative Investment Funds, and they are now regulated separately under their own CySEC license and may be applied for passporting throughout the EU.
Not falling under the AIFMD’s scope of application, means having total assets not in excess of 100 million Euros with leverage, or 500 million without it. It also means investors have no exercisable redemption rights during the initial five year investment period.
What do the new regulations entail?
“Limited Persons” means exactly that: No more than 75 investors may comprise the fund. This applies even to umbrella funds – in order to qualify as an LPAIF, the total sum of all the investors operating under a single management may not exceed 75.
Membership may only be offered to informed/professional investors, (in other jurisdictions this is also known as “Qualified Investors”), i.e. not retail. The AIFM requirement to appoint a custodian is still in effect, if the firm’s assets surpass 5 million Euros or if there are more than 5 investors. Unlike with AIF’s, however, there are no investment limitations with regards to risk or liquidity.
The license will also require that annual reports be filed with CySEC. These reports will require independent auditor review and will need to be made available to investors’ scrutiny as well. The license also requires internal quarterly reports to be filed in order to keep investors updated regarding the fund’s investments.
Tal, do you believe that regulating shall affect an Alternative Investments Firm’s competitive edge?
It’s certainly possible in the short term. Any time an industry undergoes an increase in regulation, liquidity is somewhat decreased. What this means for individual AIF’s is that they may find themselves being forced to turn down investments or investors that their competitors will pick up.
In fact, a 2012 study showed that a majority of UK-based AIF managers polled, believed the implementation of the AIFMD would reduce the EU’s competitiveness as a whole versus foreign markets, as well as the number of foreign AIF’s willing to do business in the EU. But neither of these facts is surprising, and indeed, both would have been accounted for by the drafters of the legislation.
Increased regulation is a long term project aimed at achieving long term gains, trust and benefits. Let’s not forget that many experts believe unregulated hedge funds and other alternative investments to have been among the root causes of the global recession in 2008. Regulation limits risk, which leads to a more stable – if less liquid – market. And in the case of investments funds, a stable investment is a responsible investment.
The LPAIF license in particular does not limit the investments that limited persons funds are allowed to deal in, but it does limit the amounts that can be invested in such, and thus, limits the potential fallout from high risk investments.
What is the alternative?
AIF’s that continue to do business without licenses, run the risk of running afoul of the EU’s regulatory enforcement agencies. And the last couple of years have shown us that the EU is not afraid to doll out large fines to violators. On the other hand, failure to regulate also exposes your investments fund to greater risk, especially at a time when competitors are beginning the process of procuring their licenses and turning away higher risk investments.
As Chairman of a leading firm dealing with financial technologies and financial markets investors, I always advise my clients to get regulated as soon as possible. This is the best way to minimize risks, which include not only the risk of losses in the event of bad investments – but also the risk of closure by EU regulatory enforcement agencies.
Kovi, why Cyprus?
Cyprus has long been considered an essential hub of FX and other trading and investment activities in Europe. The CySEC license in particular represents an advantage for traders and investors and is respected in the EU owing to CySEC’s high regulatory standards.
How can a firm get regulated?
If your Alternative Investment Firm meets the above specifications –i.e., does not fall under the AIFMD regulations – then this may be the perfect time to apply for a CySEC LPAIF license. This also applies if your firm has been operating on a Cypriot International Collective Investment Scheme license, in which case you won’t need to make substantial structural changes – but only as long as you don’t meet the minimum threshold for AIFMD regulation, as stated above. To obtain a license, a request form and documentation package should be submitted to CySEC for approval. Our firm handles this procedure with our Cypriot partnering consultants.
The documents required will depend on the structure of the applying firm; i.e. profile of fund manager, custodian or board of directors where applicable, financial statements and corporate documentation. Of course, upon receiving the license, annual reports must be filed as well.
Photographs: Top left, Advocate Tal Izhak Ron, Lower right: Kobi Skier