Although most European private equity firms are regulated as Alternative Investment Fund Managers (AIFMs) under the Alternative Investment Fund Managers Directive (AIFMD), a significant minority are regulated as investment firms under the other main European rulebook for asset managers: the Markets in Financial Instruments Directive (or MiFID). Those firms had to grapple with the sweeping reforms introduced by MiFID II at the beginning of this year, but many are now much more concerned about the next wave of regulatory reforms that are on their way. These could be more costly and disruptive than MiFID II, especially for larger firms based in the UK.
The headline change is that capital requirements will rise – and rise very significantly. At the moment, many MiFID firms – for example, firms that give advice to a third-party fund manager – only need initial capital of €50,000. This makes sense given that they do not pose systemic risks, the risk of failure is low, and the consequences of failure for outsiders are usually insignificant. However, the European Banking Authority has been looking at capital requirements for MiFID-regulated firms more broadly and has suggested revised requirements that could see capital buffers rise to one-quarter of fixed overheads, even for low risk (so-called “Class 3”) firms. That could easily be more than €1 million for a relatively small firm, and significantly more for larger ones.
Alongside these increased capital requirements are tougher remuneration requirements for some advisers. At the moment, these tougher rules would only apply to “Class 2” firms – a category that is reserved for firms exceeding certain size thresholds. However, the Commission’s current version of the proposals includes a threshold for “assets under advice” (as well as assets under management), which could bring many private equity fund advisers within scope.
For any firm that is required to comply, the rules could be even more difficult to apply than those set out under the AIFMD – especially since they do not currently offer any specific recognition of the positive characteristics of carried interest, even though such an acknowledgement was secured when the AIFMD was being discussed. On the other hand, it is helpful that the most problematic rules on variable remuneration would only apply to very large firms: those whose asset value is on average more than €100 million.
The new regime is not yet final, and the European Parliament has been playing a helpful role in tailoring the Commission’s initial proposal (including asking for the key Class 2 threshold to be based in assets under management, rather than advice). And there is still some way to go: even if the provisions are finalised in early 2019, as expected, they will not be implemented until 2021 – and, even then, there is likely to be a lengthy transitional period to allow firms to adjust.
But larger firms need to engage in the legislative process now, because the final rules are quite likely to get written this year, and a lengthy adjustment period will offer only limited consolation.