The AIFMD mistake

comment - 02 June 2014

The AIFMD mistake

With the transitional period ending on 22 July, we have prepared a paper explaining in some detail the scale of the AIFMD mistake. Using Luxembourg and its new LP as a possible example, this paper is intended to show where the ‘one-size-fits-all-approach’ originated, what is really wrong with it and why it could prove so disastrous. Moreover, we hope to show why AIFM-status should almost always be unnecessary.

Commenting on the tragedy of the European Union, George Soros recently wrote:

“That is the tragedy of Europe: the European Union is now endangered by too much respect for the rule of law. We think of the rule of law as something that we all aspire to, but laws are fallible, like all human constructs. And when laws are based on faulty economic doctrines, the rule of law can do a lot of harm, especially if applied too literally, as it is at present.”

While he may have been writing about the euro, these words could apply equally to the AIFMD. This directive originated at the G20 summit in November 2008 at which representatives concluded that a secure and stable financial system required all significant financial market participants to be subject to ‘appropriate’ regulation and supervision for the protection of investors as well as for financial stability reasons. In Europe this was used to justify proposing a new directive in April 2009. The AIFMD proved controversial from the start and the final text was not published until 21 July 2011, entering into effect on 22 July 2013.

At some point after the publication of the AIFMD, European and certain national authorities began to recognise that the drafting of the AIFMD did not reference partnerships at all and sought to adjust transposition on policy-based grounds:

  • To make reference to ‘partnership interests’ alongside the terms ‘units’ and ‘shares’; or
  • In the case of the FCA in the UK, to deny the need for interests, units or shares altogether under the AIFMD (and the UCITS Directive). The AIFMD is another example of gold-plating by the UK authorities.

After all, the private equity industry could not escape regulation. The embarrassment would have been too great.

In adjusting the transposition of the AIFMD, however, the relevant authorities failed to appreciate the scale of the differences between (i) UCI and (ii) co-investment vehicles, and the differing ways in which these arrangements operate and are managed by industry. As a consequence, the rather superficial (and arguably unlawful) adjustments have had little effect in accommodating partnerships within the text of the AIFMD and have helped obscure  further the true nature of partnership (as a specific group of persons carrying on a business in common with a view of profit). The consequences of this will extend far beyond the AIFMD and, as has already been seen in Sweden (carried interest) and the UK (taxation of LLP’s), touches directly on other commercial, legal, regulatory and fiscal principles that depend on a proper understanding of partnerships.

The AIFMD mistake is a challenge to the integrity of the European rulebook. This challenge, however, is also an opportunity to re-examine the commercial principals of co-investment and better explain the real nature of private equity investment. After all, as George Soros argues,

“…it’s better to confront harsh reality than to passively submit to it… when the rules are wrong, they must be changed…”

Private equity partnerships will not be safe within the European Union until they are properly understood. This is the only protection that counts.

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