Quarterly Funds Update: Winter 2015

Written on 17 Feb 2015

Our Quarterly Funds Update looks at issues affecting fund managers, investors and advisers in the alternative asset space. In this edition we look at how the reporting requirements brought in by the Alternative Investment Fund Managers Directive (“AIFMD”) will affect fund managers; a number of topical tax issues including the simplification of partnership tax law, proposals relating to the taxation of multinational companies and new anti-avoidance measures for investment managers; and finally, for those involved or interested in the US, we include a guest article from Lowenstein Sandler LLP looking at the regulatory priorities set by the US Securities and Exchange Commission for 2015.

In this issue

1. AIFMD reporting: time for action 

The deadline for Alternative Investment Fund Managers (“AIFMs”) reporting to the Financial Conduct Authority (“FCA”) for the first time has now passed. Any AIFMs who have not yet complied with their reporting obligations must do so as soon as possible. 

At the end of January, most AIFMs managing or marketing Alternative Investment Funds (“AIFs”) in the UK should have submitted information about themselves and the AIFs they manage to the FCA. Some AIFMs will already have had to make reports last quarter; however for many this was the first time they had to report. 

What information must you report to the FCA? 

If you are a qualifying AIFM, you are required to submit to the FCA:

  • the main instruments in which you trade;
  • the markets where you actively trade or are members of; and
  • the principal exposures and most important concentrations of each AIF you manage. 

In addition to this, you may be required to submit a significant amount of additional information regarding:

  • the percentage of an AIF’s assets which are subject to special arrangements arising from their illiquid nature;
  • any new arrangements for managing the liquidity of an AIF;
  • the current risk profile of an AIF and the risk management employed by the AIFM to manage the market risk, liquidity risk, counterparty risk and other risks, including operational risk;
  • information on the main categories of assets in which the AIF invested;
  • the results of the stress tests performed in accordance with AIFMD; and
  • further information specified in the FCA Handbook (e.g. in relation to VaR). 

Further, an AIFM managing an AIF that employs leverage on a substantial basis has to provide further information relating to that leverage. 

When must you report to the FCA by?

Information concerning the relevant AIFM and AIF must be reported to the FCA no later than one month after the end of the relevant reporting period. In the case of an AIF that is a fund-of-funds, the period available for reporting may be extended by the AIFM by 15 days. 

So, if you haven’t already reported your information to the FCA, it is important that you report as soon as possible. 

Looking forward, reporting frequency depends on the type of AIFM (e.g. above or below the “small” AIFM threshold, EU or non-EU) and the nature and level of assets of the AIF or AIFs managed, and varies from quarterly to annual. 

How do you make the report to the FCA?

Reporting to the FCA is done through the online GABRIEL system (Gathering Better Regulatory Information Electronically), using AIF001 forms to provide information about AIFMs and AIF002 to provide information regarding AIFs. 

What are the consequences of missing the reporting deadlines?

Initially, a failure to report to the FCA may result in a £250 administration fee. If no report(s) are filed, and the FCA has sent a non-compliance letter, enforcement action can be taken (including, ultimately, the possibility that the relevant AIFM may have its authorisation revoked).

Please note, even if you delegate your reporting duties to a third party, you remain responsible for ensuring that the submission of the report is fully compliant with the FCA rules and AIFMD.

Additional guidance and further reading

The FCA website has a selection of documents which set out the reporting obligations on different AIFMs. 

Some key reading includes the European Securities and Markets Authority guidelines and the FCA information on reporting Annex IV transparency information, links to which can be found at the address above.

If you have any questions regarding AIFMD reporting, or any other questions please contact a member of the OC team.

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2. An update: topical tax issues 

Simplification of partnership taxation 

The Office of Tax Simplification (“OTS”) has published its final proposal on updates to the law on the tax treatment of partnerships. 

The plans of the OTS to simplify the UK’s arcane rules on the tax treatment of partnerships have been generally well received. On 19 January 2015, the OTS published its final proposals. Particularly welcome are the plans to update the rules on the application of capital gains tax to partnerships (which rely on a statement of practice published almost 40 years ago), but it appears that the OTS will not go for the more radical option of codifying the rules. It is also proposed that there will be more consistency between the tax treatment of companies and partnerships (for example, the deductibility of partners’ expenses). 

Of particular interest for funds is the recommendation that more focus be given to partnerships in international tax matters, particularly in negotiating the UK’s Double Tax treaties to ensure that the impact on tax transparent entities will be considered and dealt with explicitly. 

The BEPS Project

The media and political storms that followed the disclosure of the tax mitigation strategies adopted by a number of high profile multinational companies have also given rise to a number of international tax initiatives by Governments looking to increase their tax revenues in times of austerity. 

The most significant and possibly most far-ranging of these initiatives is the OECD ‘Base Erosion and Profit Shifting’ initiative, which is known by the catchier acronym of “BEPS”. 

The BEPS project has developed into an ambitious plan to update international tax rules by the end of 2015.

Whilst work on the project is still on-going and there is still uncertainty about the extent to which the changes will be adopted by all G20 countries (for example, China, India, Brazil and Russia are not members of the OECD and although the US is a member, it is not clear the extent to which the proposed changes will gain political support in the US). However, a number of key themes are emerging:

  • Tax planning strategies that seek to exploit hybrid mismatches (either because of different tax treatment of income or the entities involved) are unlikely to survive the changes.
  • Harmful tax practices (which could cover beneficial tax regimes, such as co-ordination centres or “patent boxes” but could extend to administrative arrangements such as so-called “sweetheart deals“) are likely to be phased out.
  • Multi-lateral tax treaties are likely to become the norm – rather than the current bi-lateral treaties. Whilst this may ultimately benefit funds and their investors operating across a number of jurisdictions, this is also likely to mean that information sharing and disclosure between tax authorities will also be accelerated. 

Investment managers – disguised fee income

A new anti-avoidance rule provision will be included in the Finance Bill 2015, which seeks to ensure that investment fund managers are not able to avoid income tax on fee income, for example by waiving a right to receive income in exchange for higher capital returns. The changes are retrospective in that they will apply to sums arising on or after 6 April 2015, whenever the fund was set up. The new rules are focussed on fee income and do not apply to returns on genuine investments made by the investment manager or to carried interests.

For further information, please contact a member of the OC team.

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3. SEC Office of Compliance Inspections and Examinations: Priorities for 2015 

The US Securities and Exchange Commission (“SEC”) Office of Compliance Inspections and Examinations (“OCIE”) recently issued its priorities for 2015, focusing on retail investors, market-wide risks and data analysis to identify illegal activity. 

The OCIE serves as the eyes and ears of the SEC and conducts examinations of registered entities to identify risk, ensure compliance, prevent fraud, and inform policy. In its statement, the OCIE announced its intent to prioritise three thematic areas, namely:

  1. Examining matters important to retail investors and investors saving for retirement, including whether the information, advice, products, and services being offered are consistent with applicable laws, rules, and regulations.
  2. Assessing market-wide risks.
  3. Using data analysis to identify and examine registrants that may be engaged in illegal activity, such as excessive trading and penny stock ‘pump-and-dump’ schemes. 

The OCIE will focus on retail investors and investors saving for retirement by protecting against enumerated risks facing those investors from a number of sources, including fee selection and reverse churning, sales practices, suitability, branch offices, ‘alternative’ investment companies, and fixed income companies. The OCIE notes that financial professionals are increasingly operating as investment advisers as well as broker-dealers, and that investment advisers employ a variety of fee structures rather than the commissions or mark-ups typically charged by broker-dealers. 

The OCIE will assess whether recommendations of account types are in the best interests of the client at the inception of the arrangement and thereafter, as well as whether the financial professionals’ due diligence, disclosures, and recommendations meet legal requirements. The OCIE will further investigate registered entities’ supervision of representatives in branch offices and whether alternative investment companies and fixed income investment companies institute appropriate compliance policies and are truthful and not misleading in their marketing. 

The SEC is responsible not only for investor protection, but maintaining fair and efficient markets. To this end, the OCIE intends to prioritise monitoring of individual large firms as well as clearing agencies which are designated as systemically important. The OCIE will continue to monitor broker-dealers’ and investment advisers’ cyber-security compliance and controls, and will expand cyber-security monitoring to cover transfer agents as well. Finally, the OCIE will assess whether firms are prioritising trading venues based on payments for order flow in violation of their best execution duties.

Data analytics also will play an evolving role in 2015 enforcement priorities. The OCIE will continue to use analytics to identify individuals with a track record of misconduct, as well as to prioritise microcap fraud to identify illegal activities such as “pump-and-dump” schemes or market manipulation. Data from clearing brokers will be analysed to identify excessive trading, and analytic capabilities also will be used to focus on firms’ anti-money laundering programs, with emphasis on firms that have not filed suspicious activity reports or broker-dealers that allow customers to deposit or withdraw cash. 

Aside from these thematic areas, the OCIE notes it will continue to conduct examinations of newly registered municipal advisers, select proxy services, and never-before-examined investment companies. The OCIE further notes a high rate of deficiencies among private equity fund advisers in connection with fees and expenses and will continue to prioritise examinations in this area. Finally, more resources will be allocated to examining transfer agents, who are characterised as “important gatekeepers to prevent violations of Section 5 of the Securities Act of 1933 and other fraudulent activity.” 

The OCIE concludes its priorities list by noting that OCIE staff will also focus examinations on risks, issues, and policy matters that arise from market developments and information learned from other sources. If you have any questions regarding the OCIE or United States investment management law in general, please feel free to contact one of the authors.

This article was provided by Dan Rayner at Lowenstein Sandler

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Team update

Osborne Clarke’s funds team has expanded over the past few months, with Associate Director Elizabeth Winder and Associate Seema Chandaria joining from K&L Gates; Associate Director Alison Riddle joining from Berwin Leighton Paisner; and Lizette Hunter soon to qualify as a solicitor. The team is now nine strong in terms of specialist funds lawyers (two partners, four associate directors, a senior associate and two associate solicitors), with additional teams supporting on regulatory and tax issues related to fund management.


Upcoming seminars

17 March: Crowdfunding: why financial institutions need to understand its rise and significance (London)

21 April: Funds and alternative asset management: an update on legislative, tax and regulatory developments (London)