The Cyprus Securities and Exchange Commission (the ‘CySEC’) released guidance relating to Alternative Investment Fund Managers (AIFM) and Alternative Invest Funds (AIFs) externally managed by Cyprus Alternative Investment Fund Managers (CAIFMs). The guidance relates to the AIFM principles, delegation of functions and the ‘letter-box entity’ concept. Importantly, if CAIFMs and AIFs practices are found to not be in line with the relevant Legal Framework or the delegation principles listed below, the CAIFM could be assessed as not acting in the best interests of the AIF and its investors.
A. SINGLE AIFM PRINCIPLE
The AIFM Legal Framework’s objective is to ensure that the CAIFM is the only legal person with ultimate responsibility to manage an AIF in accordance with CAIFM laws, for instance:
An appointed CAIFM is the person legally responsible for ensuring compliance of the management of the AIF in accordance with the relevant laws.
A CAIFM should not be considered a delegate or a third party provider to the AIF, the Investment Management agreement between a CAIFM and an AIF should be construed on this basis.
An externally managed AIF cannot itself perform or be involved in the execution of functions performed under the Alternative Investment Fund Managers Directive 2011/61/EU (AIFMD).
The AIF’s Board of Directors (BoD) / Partners should only be involved in delegation agreements as so far as necessary to meet their obligations stemming from regulations not related to the AIFM laws and AIFMD; the CAIFM however must always be part of the delegation agreement.
B. DELEGATION PRINCIPLES - 'LETTER-BOX ENTITY' CONCEPT
The CAIFM and Internally Managed AIFs remain responsible for ensuring compliance with the CAIFM Laws, particularly the CAIFM must ensure at all times that it does not delegate such functions, especially investment management functions, to the extent that it becomes a ‘letter-box entity’.
The following practices should be implemented by CAIFMs and Internally Managed AIFs in order to ensure compliance and to avoid becoming a ‘letter-box entity’:
Each time a function is delegated the sufficiency and appropriateness of human and technical resources should be assessed, due diligence should be carried out at the selection stage and on an on-going basis as well as supervision of each delegated function.
Regarding investment management functions, every time a new function is delegated the volume of delegation should be assessed using qualitive criteria (as per Article 82(1)(d)(i) to (vii) of the EU Regulation 231/2013); where further delegation would cause the AIFM to exceed the margin of functions performed internally, they should refrain from further delegation.
ESMA is of the opinion that AIFMs must perform the investment management function, and that they cannot delegate portfolio management and risk management functions for a particular AIF in their entirety.
C. AIFMD AND AIF SCOPE
Investment managers who manage one or more AIFs where the only investors are the CAIFM itself or a related party of the CAIFM do not fall within the scope of the AIFMD Framework.
Investment undertakings who invest the private wealth of investors and do not raise external capital should not fall within the definition of AIF as per the AIFMD.
AIFs should be assessed in accordance with the ESMA Guidance on Key Concepts of the AIFMD when evaluating if they fall under the scope of the AIFM Legal Framework.
D. FINAL REMARKS
CySEC warns that CAIFMs engaging in ‘white-label’ business should be especially diligent, particularly regarding section A and B above.
It should be noted that the ‘Delegation Principles – Letter-box Entity’ concept legal framework is expected to be further enhanced through upcoming AIFM and UCITS Directive review.
CySEC encourages CAIFMs and Cyprus UCITs Managers to keep this in mind when reviewing their delegation practices, policies and procedures; if upon review the CAIFMs identify areas not in line with above, CySEC expects the CAIFM to take immediate action in order to ensure compliance.
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By Andie Henderson, Legal & Compliance Associate, Financial Associates International (FAI Comply)