AIFMs which are fully authorised under the Directive are subject to detailed rules regarding delegation. However, as per guidance issued by the Commission, the provisions of the Level 2 Regulations (Articles 76 to 83) apply to delegations of all functions noted in Annex I of the Directive.   

The AIFM's liability towards the AIF and its investors will not be affected by the fact that the AIFM has delegated functions to a third party, or by any further sub-delegation.  

The home regulator of the AIFM must be notified before any delegation or sub-delegation arrangements become effective. This also applies to the intended delegation of administration, marketing or activities related to the assets of the AIF for which the AIFM is responsible. In addition, the AIFM’s prior consent is required in respect of any further sub-delegation arrangements.

The Level 2 Regulations set out some general principles with which AIFMs must comply when delegating. Click here for those principles. In particular, the Level 2 Regulations require that the delegation arrangement takes the form of a written agreement between the AIFM and the delegate. The agreement must set out:  

The conditions to delegation (or any sub-delegation) are as follows:

  • the AIFM must be able to justify its entire delegation structure with objective reasons. The following criteria must be considered: (a) optimisation of business functions and processes; (b) cost saving; (c) expertise of the delegate in administration or in specific markets or investments; and (d) access of the delegate to global trading capabilities, and the AIFM may be required by competent authorities to provide further explanations and provide documents proving that the entire delegation structure is based on objective reasons;
  • the delegate must have sufficient resources to perform the delegated tasks and the persons who effectively conduct the business of the delegate must be of sufficiently good repute and sufficient experience. The Level 2 Regulations provide additional detail, noting that persons shall be considered to be of sufficiently good repute if they are regulated in respect of their professional services in the EU but will not be deemed of sufficiently good repute if they have “any” negative records relevant for the assessment of good repute and the performance of the delegated tasks, or if there is other relevant information affecting their good reputation. For these purposes, special attention is given to any offences related to financial activities, such as those relating to money laundering, dishonesty, fraud or financial crime, bankruptcy or insolvency. Other relevant information includes information that indicates the person is not trustworthy or honest. The delegate must  have an appropriate organisational structure to support the performance of the delegated tasks;
  • the delegation must not prevent the effectiveness of supervision by the AIFM. This will be deemed not to be the case where:
  • the AIFM, its auditors and the competent authorities do not have effective access to data related to the delegated functions and to the business premises of the delegate, or the competent authorities are not able to exercise those rights of access;

  • the delegation must not prevent the AIFM from acting, or the AIF from being managed, in the best interests of the AIF or its investors. Click here for the provisions of the Level 2 Regulations which set out the position on conflicts of interest on delegation in detail;
  • the AIFM must be able to demonstrate that the delegate is qualified and capable, it selected the delegate with due care, it can effectively monitor the delegate and can withdraw the delegation with immediate effect when this is in the interests of investors; and
  • in order to ensure continuity of delegation functions, the AIFM is required to ensure that the delegate establishes, implements and maintains a contingency plan for disaster recovery and periodic testing of backup facilities while taking into account the types of delegated functions. Further, in the event of termination of the delegation, the AIFM must ensure the continuity and quality of the delegation functions either by transferring the delegated functions or the delegated task of carrying out functions to another third party or by performing them itself.
Specific requirements for delegation of portfolio management and risk management

Where the delegation concerns portfolio management or risk management:

  • if the delegate is an entity that is not authorised for asset management or subject to supervision, prior approval from the home regulator is required. Entities that are deemed to be authorised or registered for these purposes are:
  • if the delegate is a non-EU entity, in addition to home regulator approval, co-operation between its regulator and the home regulator must be ensured; and
  • the ESMA Remuneration Guidelines state that where an AIFM delegates portfolio management or risk management activities, it must ensure that:

The portfolio management and risk management functions cannot be delegated to the depositary or a delegate of the depositary of the AIF in question .

The portfolio management and risk management functions cannot be delegated to any other entity whose interests  conflict with those of the AIFM or the investors, unless such entity has functionally and hierarchically separated the performance of the portfolio management and risk management from its other potentially conflicting tasks and potential conflicts of interest are properly identified, managed, monitored and disclosed to investors. Click here to read the detailed rules in the Level 2 Regulations which describe the conditions for establishing that portfolio management and risk management functions are functionally and hierarchically separated.

Timing and process in the United Kingdom

If the delegate is an entity that is not authorised for asset management and subject to supervision, the approval of the FCA will be required prior to such delegation arrangement becoming effective. The FCA has one month to determine an application for the approval of a delegation or sub-delegation arrangement.

Click here to access the form which may be used to notify the FCA of any delegation arrangements or to seek approval for the delegation of portfolio management and risk management functions.

The FCA may determine that an application is incomplete – in any event, even upon such determination, the regulator has a maximum of two months to determine the application from the date it was submitted. If the FCA proposes to refuse an application, it must provide the applicant written notice of its intention to do so.

Once the application is approved, the FCA may revoke its approval upon giving the applicant a warning notice of intention to do so. 

Letter-box entities

The Level 2 Regulations contain detailed rules regarding where an AIFM will be deemed to be a “letter-box entity” and hence no longer considered to be the manager of the AIF as a result of delegation. This will occur if:

  • the AIFM no longer retains the necessary expertise and resources to supervise the delegated tasks effectively and manage the risks associated with the delegation;
  • the AIFM no longer has the power to take decisions in key areas which fall under the responsibility of the senior management or no longer has the power to perform senior management functions in particular in relation to the implementation of the general investment policy and investment strategies;
  • the AIFM loses its contractual rights to inquire, inspect, have access or give instructions to its delegates or the exercise of such rights becomes impossible in practice; or
  • the AIFM delegates the performance of investment management functions to an extent that exceeds the investment management functions performed by the AIFM itself by a substantial margin. When assessing the extent of delegation, competent authorities will assess the entire delegation structure taking into account not only the assets managed under delegation but also the following qualitative criteria:

Where an AIFM manages multiple AIFs, when making an assessment  about letter-boxing, the assessment should be carried out at the level of each individual AIF and not in relation to a group of AIFs.

Regulatory position in the United Kingdom

Under the UK Regulations, where an AIFM has delegated its AIFM function to the extent that it is a letter-box entity, the delegate of such AIFM may be carrying out the regulated activity of managing an AIF. In addition, the letter-boxed AIFM may also be carrying on the regulated activity of managing an AIF.

It is worth noting that Article 82(1) of the Level 2 Regulation does not state that an AIFM will only constitute a letterbox entity where it has delegated portfolio management and/or risk management. This suggests that an AIFM may become a letterbox entity even where it has retained the performance of both of these functions, for example where, as a result of the delegation, it no longer has the power to take decisions in key areas which fall under the responsibility of the senior management.

If an AIFM delegates functions other than portfolio management and risk management, the delegate that carries out such other functions will not be deemed to be “managing an AIF” for the purposes of the UK Regulations. Accordingly, such delegate will not need to seek the FCA's permission to carry out the regulated activity of “managing an AIF”. However, where a delegate appointed by an AIFM carries on a regulated activity in the UK as part of its delegated function, it will need to hold the appropriate permission to do so. For example, a UK delegate appointed to perform portfolio management for an AIFM will typically require permission to carry on the regulated activity of managing investments.

The guidance from the FCA notes that where all the functions are delegated to the same delegate, it will be likely that the delegate is considered to be managing an AIF, whereas where the delegation is to a number of delegates, it may be that none of those delegates is considered to be managing an AIF. This approach to analysing the regulatory position of the delegate applies irrespective of whether the AIFM appointing the delegate is a UK AIFM or an overseas AIFM.