1.1.1 Authorisation

Every AIF within the scope of this directive must have one and only one AIFM, and that AIFM is in charge of compliance with this directive with respect to all AIFs it is managing. Only authorised AIFMs can manage AIFs, and managing AIFs and performing the ancillary activities listed in Annex I and Article 6 are the only activities an AIFM is allowed to perform (Art 6).

EU AIFMs must apply for authorisation in their home Member State. AIFMs must notify their regulator of all changes—including those regarding their AIFs—and only if the regulator does not object to those changes can they be implemented (Arts 7, 10). Authorisation can be withdrawn (Art 11). In order to qualify for authorisation, AIFMs have to inter alia satisfy a minimum capital requirement, and both management and dominant owners have to be suitable for their respective roles. Authorisation of an AIFM in one Member State is passported into all other Member States (Arts 8, 9). ESMA keeps a public register of all authorised AIFMs within the EU (Art 7).

1.1.2 General Requirements

AIFMs have to adhere to a number of general principles. In particular, they must treat investors fairly, and preferential treatment of some investors is only acceptable when it is disclosed in the relevant AIF's rules. AIFMs who also offer discretionary portfolio management cannot invest in their own AIFs unless this has been agreed with the customer (Art 12). AIFMs must have remuneration policies for key staff in place in line with this directive and ESMA guidance (Art 13, Annex II). AIFMs must manage conflict of interest at all levels where it may arise (Art 14). They must have a risk management structure that is functionally and hierarchically separate from the operational units. Risk management systems and procedures must be documented and reviewed at least annually (Art 15). There must be maximum levels of leverage at each AIF individually (Art 15).

All AIFs must employ an appropriate liquidity management system, and must conduct regular liquidity stress tests. In particular, they must ensure that redemption terms offered to the AIF's investors are commensurate with the liquidity profile of the assets. Unlevered closed‐ended funds, which by design don't run liquidity risk, are exempt from those requirements (Art 16). AIFMs must support securitisation retention requirements (Art 17), they must employ at all times adequate and appropriate human and technical resources, and they must ensure that appropriate personal‐transactions policies are in place (Art 18).

All AIFs must be periodically valued. The absolute minimum valuation frequency is once per year. Otherwise it depends on the fund's assets—more‐liquid assets require more‐frequent valuation—and its subscription and redemption conditions. It must be ensured that inflow and outflow are recorded at fair valuations (Art 19). The valuation must either be performed by an external valuer, or internally, provided it is done in a unit that is independent from the operational units and does not have conflicts of interest, eg vis‐à‐vis remuneration (Art 19).

AIFMs can sub‐contract functions where it is justifiable for objective reasons. By and large, the sub‐contractors employed must satisfy the same authorisation and registration requirements as the top‐level AIFMs. Sub‐delegation is possible provided the top‐level AIFM consents. Delegation does not release an AIFM from its responsibilities vis‐à‐vis its customers (Art 20).

1.1.3 Depositaries

Every AIF must appoint a single depositary as custodian of its assets. The depositary must be a regulated entity eligible to be a depositary under the UCITS 4 directive, for example a bank or an investment firm. For non‐EU AIFs, and for some AIFs holding long‐dated illiquid assets, slightly more relaxed rules apply. Conflicts of interest should be avoided, so the AIFM cannot act as a depositary, and neither can a prime broker who is also acting as a counterparty unless the depositary function is functionally and hierarchically separated. The depositary must be located in the same Member State as the AIF for EU AIFs. For non‐EU AIFs it can either be in the same country, or in the home/reference member state of the AIFM managing the AIF. If a depositary is established in a third country there must be regulatory cooperation agreement in place between that country, and every country where the fund is being marketed. That country cannot be listed as non‐cooperative by the FATF, and it must comply with the OECD Model Tax Convention (Art 21).

Depositaries must ensure that the AIF's cash flows are properly monitored. Assets that can be held in custody—including physical custody—must be held in custody by the depositary, in segregated accounts. For assets that cannot be held in custody—eg because they are established via a contractual relationship rather than as bearer securities—the depositary must verify ownership, and maintain a register. The depositary must ensure that dealing in, operations on, and valuation of the shares and units they hold in custody is done appropriately and according to applicable law. A depositary must not delegate their duties other than the actual custody of the assets. If they do delegate, the depositary remains liable to AIFs and their investors for losses caused by delegates, except where there is an agreement to the contrary between the depositary and the AIF or the AIFM. Depositaries must provide to the regulators all information necessary that those might need with respect to the relevant AIFs and the AIFMs (Art 21).

1.1.4 Transparency

AIFMs must prepare an annual report for every AIF they manage. This report must be provided to their regulators and—on request—to their investors. This report must include at least audited basic financials (balance sheet, income statement), as well as an activities report, a material changes report, and a remuneration report (Art 22).

Before investors invest in an AIF, the AIFM must provide them with a specific set of information in relation to this investment (Art 23). AIFMs must also report directly to their regulators information that is relevant with respect to market integrity. This includes general information on positions taken, concentrations and illiquid exposures, leverage, and results of stress tests employed (Art 24).

1.1.5 Rules for Specific Types of Funds

This regulation singles out and addresses two areas of concern where funds could negatively impact the functioning of the markets, and the overall economy more generally: highly leveraged funds and—to use the term commonly employed rather than the legal term used in the regulation—private equity funds.

The concern with highly leveraged funds is that they—either on their own or in concert with others who are running similar strategies—lead to the creation of bubbles. When on the way up excessive leverage leads to large rises in assets that suddenly turn, and where the downwards movement is accelerated by highly leveraged players who have to liquidate their positions before the value of the assets falls below the amount of debt outstanding against them.

We have discussed above the reporting requirement under Article 24 where AIFs have to report to their regulator information about positions, concentration and liquidity risk, results of stress tests, etc. It is the regulators' responsibility—together with ESMA and ESRB in order to ensure a pan‐European or even global view—to look at this data in aggregate, and to identify areas of the market where there is a risk of unsustainable leverage building up.

Where those areas are identified, regulators can implement a number of measures, including limiting the leverage that specific AIFs are allowed to employ. The authority to do this rests solely with the fund regulators; ESMA can only issue recommendations, and expect regulators to follow them on a comply‐or‐explain basis (Art 25).

Regulators are also concerned about private equity funds, which, loosely speaking, are AIFs that purchase controlling stakes in unlisted large companies; SMEs are specifically excluded (Art 26). Under this directive, whenever an AIF, or a group of AIFs acting as a consortium, changes its stake (upwards or downwards) that brings it to cross one of the thresholds (10%, 20%, 30%, 50%, 75%) the home regulator must be notified.

If an AIF acquires control—individually or jointly—then also the company in question and its identifiable shareholder must be notified, and the company board must be asked to inform the employee representatives (Art 26). The relevant AIFM in this case has to provide some additional information, notably information that is interesting for the employees, including future plans that the acquirer has with respect to that company (Arts 27, 28).

1.2.1 AIF Domiciled in Home Member State

First, we consider the case where the AIF is in the home Member State of the AIFM.

• Investor in same Member State as AIF. The AIFM provides its home regulator with a notice according to Annex III. Unless the AIFM is not compliant with the regulations, it should be authorised to market the AIF to professional investors within 20 days (Art 31 for EU funds, Art 39 for non‐EU funds).
• Investor in different Member State than AIF. The AIF provides its home regulator with a notice according to Annex IV. Unless the AIFM is not compliant with the regulations, the home regulator should forward the notice to the host regulator within 20 days, from which point onwards the AIFM is authorised to market the AIF to professional investors there (Art 32 for EU funds, Art 39 for non‐EU funds).

1.2.2 AIF Domiciled in Another Member State

Now we consider the case where the AIF is in the EU, but in another Member State than the home Member State of the AIFM. In this case, the AIFM has to notify its home regulator that it wants to manage an AIF in another Member State, either directly or via a branch. Unless the AIFM is not in compliance with this regulation, the home regulator approves this request within 1 month in the case of direct management, or 2 months in the case of a branch (Art 33 for EU funds, Art 41 for non‐EU funds).

At this point the AIFM has to follow the aforementioned processes—notably notification to its home regulator (not the regulator of the Member State where the AIF is located) under Annex III for marketing in the same Member State as the AIF (not AIFM), and notification under Annex IV for marketing in another Member State—and within 20 days those notices should be forwarded and the fund should be available for marketing.

1.2.3 AIF Domiciled in a Third Country

If the AIF is established in a third country, then first there must be a cooperation agreement between the regulator in the country where the AIF is located, and the home regulator of the AIFM. Second, between the third country and every EU country where the AIF is meant to be marketed there must be an agreement compliant with the OECD Model Tax Convention.

Provided all this is in place, the AIFM gives Annex III notice to its home regulator to be allowed to market the AIF in its home country, and Annex IV notice to its home regulator to market in another EU country. In both cases, after 20 days the AIFM should be allowed to market the fund, assuming compliance with the regulations (Art 35 for EU AIFMs, Art 40 for non‐EU AIFMs).

1.2.4 Special Cases

The cases we have considered above were the regular cases that followed the rules, but there are some special cases to consider.

• EU AIFM marketing non‐EU AIF to non‐EU customers. In the case where an EU‐based AIFM is marketing a non‐EU‐based AIF to non‐EU‐based professional investors, the rules as far as the EU is concerned are pretty simple; they mostly care about there being a cooperation agreement between the regulator in the AIFM's home Member State and the third country where the AIF is located (Art 34).
• AIFM marketing non‐EU AIF in its home MS. In the case where an AIFM is marketing a non‐EU‐based AIF to investors in its home/reference Member State, instead of demanding a process according to Article 35 or 40, Member States can require simplified rules that mostly require supervisory cooperation between the home regulator and the regulator in the country where the AIF is located (Art 36 for EU AIFMs, Art 42 for non‐EU AIFMs).

1.2.4 Retail Investors

Member States can allow AIFMs—locally domiciled or not—to market AIFs—again, locally domiciled or not—to retail investors within their territory. This regulation imposes no other requirements in this case other than that ESMA has to be informed, and that Member States cannot treat AIFs domiciled in another EU country and being marketed cross‐border any worse than those domiciled locally (Art 43).