New disclosure requirements for private equity funds

Date: June 5, 2014

The AIFMD is designed to provide greater protection to those who invest in alternative investment funds. 

One of the most important ways that it does this is by increasing transparency through the imposition of more onerous reporting requirements.

Amongst those affected by the legislation are private equity managers who have funds or investors located in the EU, although smaller firms that fall below the minimum assets under management threshold will face less stringent disclosures. There are also other exemptions for closed-ended funds that were fully invested prior to 2013 or that are due to end before 2016.

The annual report

All of the alternative funds covered by the legislation will have to meet certain minimum requirements in terms of the contents of the annual report. This will need to include: a balance sheet, an income and expenditure account and a report on the activities during the financial year.

Not much of this is new. In fact most of it would have been mandatory under the home country’s accounting standards and will require very little change. The more contentious area is the greater level of detail in respect of the remuneration.

AIFMD requires the disclosure of the total remuneration and how this is split between fixed and variable. In other words, the aggregate basic salaries have to be shown separately to the bonuses and other performance-related pay. These figures need to be further broken down between those whose actions have a material impact on the risk profile of the fund and those who don’t.

Additional information for investors

There are also additional disclosure requirements that have to be made to investors at the same time as the annual report or in some cases more frequently. The first of these relates to the percentage of assets that are subject to special liquidity arrangements that affect the redemption rights of investors.

Liquidity risk is clearly a key concern, which is why those running open-ended funds need to disclose any material changes to the policies and procedures used to monitor and control this area as soon as they happen.

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Another critical area is the overall risk profile of the fund. If the manager ever exceeds a specific limit – in respect of market, credit, liquidity, counterparty or operational risk – they must notify investors immediately explaining the circumstances together with any remedial action.

Equally as important is the leverage or gearing. The total leverage has to be disclosed in the annual report along with the maximum and average levels employed during the reporting period. Investors must also be told if there is any material change to the maximum limit or the rights or guarantees relating to the collateral.

Specific disclosure requirements

The AIFMD imposes specific disclosure requirements that are only relevant to private equity. These apply to funds that acquire control of more than 50% of the voting rights of a company that meets two or more of the following criteria: more than 250 employees, annual net turnover exceeding €50m, or a balance sheet exceeding €43m.

Where this is the case the fund manager must notify the regulator whenever an acquisition or disposal of shares takes it above or below the 10%, 20%, 30%, 50% and 75% thresholds.

Once the fund acquires a controlling interest it must also alert the Board of the target company and the shareholders. The notification must contain details of any conflicts of interest, as well as its future intentions and the likely repercussions for the employees.

These disclosure requirements go beyond what would be required of other types of buyers and could potentially result in the publication of strategically confidential information.

Reporting to regulators

The most onerous disclosure requirements are in relation to the reports made to the local regulators. These have to cover each alternative investment fund based in the EU in addition to any non-EU funds marketed in the European Union.

Firms with between €100m and €1bn in assets under management must report twice a year and only have 30 days after the end of the period in which to submit the details. Those managing more than €1bn have to compile quarterly returns. The main exception is where the assets relate to unleveraged private equity funds, in which case the managers only need to report on an annual basis.

The content depends to a large extent on the nature of the underlying funds and is more detailed for those that use leverage on a substantial basis (which will mainly be hedge funds) or that have a controlling interest in non-listed companies.

Best practice

It remains to be seen how difficult it will be to comply with the new requirements as the private equity industry has already made great strides in improving its reporting capabilities.

Justin Marchi, a consultant who has worked for iLevel Solutions and Burgiss, and is now a Charlotte, North Carolina-based consultant working with teams focused in the Capital Markets, Alternative Investments, Private Equity and Real Estate, says that he has researched, reviewed, and analyzed the data of hundreds of firms.

“The data has come in the form of collected financials from portfolio companies and holdings, DDQs, investor reporting such as Partners Capital statements and Schedules of Investments, etc.  The trend has proved data transparency has become one of the core best practice standards.  This trend is NOT by accident, but not exactly by regulatory requirement either.  In fact, it is a result of the combination of the regulatory changes, the need for auditability and traceability, and higher ethical standards the industry is challenged to attain and exude to the masses.”

Marchi attributes this improvement to the advancements in private equity-focused financial technology. “What has allowed the data transparency to become very important are the advancements in Private Equity-focused FinTech.  From portfolio company data collection to investor reporting, every stakeholder that makes up this industry now has access to a better way to collect, report, and analyse data.  This readily available information has improved cost structure at the Limited Partner level, provided General Partners with platforms for benchmarking their performance for fund raising and overall provided justification for the value proposition that Private Equity investing brings to the overall global economies.”

Visit our AIFMD resource page for more articles and information.

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