Operating and organisational requirements
The AIFM Directive sets out some very wide and general operating and organisational requirements which will be applicable to real estate fund managers. A real estate fund manager will be required to:
- act honestly, with due skill, care and diligence and fairly in conducting its activities
- act in the best interests of the real estate fund it manages, the investors of the real estate fund and the “integrity of the market” (the practical effect of this remains unclear) and
- ensure that all investors are treated fairly.
Of particular interest to those real estate fund managers that have previously entered into side letters with certain key investors is that the AIFM Directive provides that no individual investor can receive preferential treatment unless this is disclosed to the other investors (either in the real estate fund’s rules or incorporation documents).
Conflicts of interest
During the course of managing a real estate fund, a real estate fund manager will be required to take all reasonable steps to identify conflicts of interest that arise between it and the investors in the real estate fund or between one investor and another. More generally, real estate fund managers will be required to maintain and operate effective organisational and administrative arrangements “with a view to taking all reasonable steps” designed to prevent conflicts of interest from “adversely” affecting the interests of the real estate fund and its investors. Where such arrangements are insufficient, the real estate fund manager will be required to make disclosures of the general nature (or sources) of conflicts of interest to investors before undertaking business on their behalf.
Although many real estate fund managers are well used to having policies in place to deal with the management of conflicts of interest, the requirements on real estate fund managers to identify conflicts between it and investors or vis a vis one investor and another, seem unduly onerous and difficult in practice to manage operationally.
Delegation of functions
The AIFM Directive will require real estate fund managers to obtain prior authorisation from the relevant competent authority before delegating any services to third parties. The AIFM Directive also makes it clear that the real estate fund manager’s liability will not be affected by the fact that it has delegated functions to a third party. For most real estate fund managers, this will just reflect the existing widespread market practice in drafting service agreements.
There is also a requirement on real estate fund managers to appoint an independent valuer that is both legally and functionally independent of the real estate fund manager. Although the appointment of such an independent valuer has long been market practice for real estate funds, where the valuer is based outside the EU, delegation will only be permitted under the AIFM Directive if that valuer is licensed by an equivalent regime. More controversially however will be the requirement for a real estate fund manager to ensure that the assets of the real estate fund are independently valued each time shares (or units) are issued or redeemed. This requirement therefore has the potential to add significant costs to the operation and management of real estate funds given the illiquid nature of the underlying asset class.
For each real estate fund managed by a real estate fund manager, there will also be a requirement to appoint a bank incorporated in the EU to act as a depositary to receive (amongst other things) subscriptions from investors in the real estate fund. Given that subscriptions from investors are usually received directly into a real estate fund’s bank account, it is not clear why the AIFM Directive requires subscriptions to be received by a bank instead.
Given the wide scope of regulation of delegated functions under the AIFM Directive, many real estate fund managers will not only need to re-assess the roles and responsibilities of existing third party service providers, but will also need to factor these additional regulatory compliance requirements into the real estate fund’s administrative, operating and management costs.
Transparency and disclosure
Despite the marketing of real estate funds being limited to professional investors, the AIFM Directive establishes certain transparency and disclosure requirements to ensure a minimum level of investor protection. For example, the following disclosures will have to be made to potential investors before they invest in a particular fund (as well as there being a requirement to notify those investors of any changes thereafter):
- the investment strategy and objectives of the real estate fund, all the assets which the real estate fund can invest in and the techniques it may employ, details of all associated risks and any applicable investment restrictions and the types of leverage used
- the procedures by which the real estate fund may change its investment strategy and/or investment policy
- a description of the real estate fund’s risk management and valuation procedures
- a description of all fees, charges, costs and expenses
- the identity of third party service providers and
- a description of any preferential treatment given to particular investors.
Real estate fund managers will also be required to make available to its competent authority and to each investor in the relevant fund an audited annual report no later than four months following the end of the fund’s financial year. In addition, various other reporting disclosures must be made periodically by real estate fund manager’s to the fund’s competent authority (for example, the real estate fund manager must provide a list of all the real estate funds managed and details of the risk management procedures used by the real estate fund manager).
Use of leverage
The AIFM Directive introduces requirements to impose limits on high levels of leverage. Real estate fund managers will be required to check whether their real estate funds employ a high level of leverage on a systematic basis every quarter. Under the AIFM Directive, real estate funds will be deemed to employ a high level of leverage where combined leverage from all sources exceeds the value of the equity capital of the real estate fund in two out of the four preceding quarters. Where this is the case, the real estate fund manager will have to make certain disclosures to the fund’s investors and to inform the competent authorities accordingly. The AIFM Directive provides that member state regulators will share this information to identify any build up of systemic risk. The AIFM Directive also gives member state regulators emergency powers to restrict leverage to the extent required in order to ensure the orderly operation of the EU market.
Although these obligations will be of most relevance to hedge fund managers, it has been stated that further rules will be introduced to limit the leverage that managers may employ, depending on the nature of the underlying fund. This is therefore an area that real estate fund managers will need to monitor closely.