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The information
contained in this Newsletter is of a general nature and does not constitute
legal advice |
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Introduction
On May 3, the Spanish National
Securities Commission (the “CNMV”) approved Circular 1/2006 of 3 May 2006 on
Free Investment Collective Investment Schemes (the “Circular”) implementing
the provisions of the Regulations on Collective Investment Schemes (“RIIC”)
on Free Investment Collective Schemes (“IICIL”) and Funds of Hedge Funds (IIC
of IICIL). The Circular will enter into force on the day after its
publication in the Spanish Official Gazette (Boletín Oficial del Estado)
(which is likely to occur next week), except for information obligations
which will be enforceable as from October 1, 2006. Following the entry into force of
the Circular, authorisations to incorporate or extend the activities of
management companies that intend to manage hedge funds and to manage this
type of collective investment institutions (CIIs) may be filed with the CNMV.
Thus, the much awaited Spanish “hedge funds” market
will finally be created. The Circular implements the
applicable regime for Spanish management companies which intend to manage
IICIL and IIC of IICIL, as well as the regime of such IICIL, and IIC of IICIL
which is initially contained in Articles 43 and 44 of the RIIC and in the
Ministerial Order 1199/2006, of 25 of April 2006 (the ”Order”). We have
summarised the main contents of the Circular in two sections: § The applicable rules for Spanish management
companies which intend to manage IICIL and IIC of IICIL; and § The applicable rules for IICIL and IIC of
IICIL. I. Rules
applicable to Spanish management companies which intend to manage IICIL and
IIC of IICIL
As foreseen in the Order, Spanish
management companies which intend to manage IICIL and IIC of IICIL are not
required to have an exclusive purpose. Management companies may therefore
manage IICIL and IIC of IICIL by amending their business activity plan and
complying with certain additional requirements: ·
Access to the activity
Management companies will be
obliged to have a business activity plan which expressly includes managing
IICIL and IIC of IICIL as well as a description of internal control measures
which shall include their organizational structure, the specific technical
and human resources and a general description of the controls and procedures
applicable to the management of this type of CIIs. In addition, the controls
over the activity of entities which have been entrusted with certain delegated
functions and the activity of entities with which the management companies
have executed financial collateral arrangements will have to be described. ·
Own resources
Finally, in order to better cover
eventual operational risks, additional own resources of 4% of the gross
income from management fees (calculated as the average of the three latest
years) of IICIL and IIC of IICIL are required. ·
Material and human resources
-
Board of Directors and Executive Officers: management companies must
have directors and executive officers or similar posts with a minimum
experience on IICIL and IIC of IICIL or other similar alternative management
functions of at least 2 years. -
Training programs: management companies must establish training and
continuous testing programs in order to ensure that their personnel have the
appropriate professional experience. -
Calculation and risk control systems: management companies must have
appropriate calculation and risk control systems for the concrete investment
strategies that are going to be implemented in order to calculate the current
and potential risk exposure, in particular when they are going to carry out
transactions which imply leverage or transactions on non-listed securities,
illiquid financial instruments or financial derivatives with complex
valuations, or short sales. Management companies are also obliged to perform stress tests and tests
simulating specific crisis scenarios periodically. -
Internal communication systems: management companies must establish
internal communications systems to ensure that relevant information from
third party service providers or companies with delegated functions is
rapidly disclosed to the management company’s personnel. -
Assets provided as collateral: management companies must have
procedures to ensure control over the assets provided as collateral and the
assets which have been executed by the beneficiary of the collateral. -
Liquidity control: management companies must have mechanisms to
control the liquidity of the underlying investments in order to duly comply
with the redemptions on time. -
Control over use of managed CIIs underlying structured transactions:
management companies must have internal measures to know the units or shares
of the managed CIIs used by third parties as underlying assets of structured
transactions. This requirement will not be easily complied with. -
Separation of duties: duties must be separated, especially with regard
to management, administration and control duties, whether they are carried
out by the same management company or delegated to third party service
providers. In principle, individuals carrying out management duties, whether
delegated or not, must not participate in the calculation of the net asset
value of the IIC that are being managed. -
Valuation and analysis of investments in IICIL: management companies
must include, as part of their internal control proceedings, the quality,
quantitative and operational criteria used for the valuation and analysis of
the investments made in IICIL for the IIC of IICIL which they manage. Such
criteria must have been agreed with the depositary and must have been
authorised by the Board of Directors of the management company. Finally, the
participation of the depositary shall be limited to the duties that pertain
to it as depositary. ·
Delegation of duties
Management duties
Management companies may delegate the
management of IICIL and IIC of IICIL to third parties subject to the
requirements set forth in Article 68 of the RIIC. In the event of delegation,
the management company shall keep the necessary means to control the
delegated activities. In any event, the delegation of duties must not make
the management company an instrumental entity without any duties. In addition, management companies
may receive investment advice on their investment policy from third party
entities and must provide information of any such entities in the Prospectus. Administration duties
Management companies may delegate the
administration duties provided that: a)
The entity to which
the administrative duties are delegated has human resources with
sufficient experience in the valuation of the investments that the Management
Company intends to make, as well as the necessary material resources
to carry out these duties. b)
The delegation of
administration duties does not cause the controls required by the
regulations to be reduced. In particular, the entity to which the delegation
is made must not be the depositary, or exercise sub-custodial duties, or
exercise Control Unit duties. c)
A system is
established to control the activities of the entity to which the
delegation has been made. There must be, among other controls,
regular reconciliation procedures among the entity to which the
administration has been delegated, the management company and the depositary
and the entities with which a financial collateral arrangement has been
entered into, if any, of the cash and securities positions. d)
If the task of determining
the net asset value is delegated, the corresponding delegation agreement
must contain provisions that ensure appropriate consistency between
the valuation practices of the entity to which the task is delegated and
the asset-valuation criteria imposed by the standards and collected in the
fund prospectus. In addition, the agreement should contain clauses
to allow the depositary to comply with its supervisory functions. In any
event, specific procedures for the resolution of discrepancies that may arise
between the calculations of the net asset value made by the entity to which
the task was delegated must be reconciled and the estimated net asset value
calculated by the management company should be established. The above mentioned requirements
will also be applicable to Free Investment Companies (SICAVs) and
SICAVs of IICIL which may have not appointed a management company for the
management of their assets. II. Applicable rules for IICIL and IIC of IICILIn addition to the rules contained
in the RIIC and in the Order regarding the applicable regime for IICIL and
IIC of IICIL, the Circular sets forth and specifies the following rules: ·
Investment policy of IICIL
The Circular has not included
additional investment restrictions for IICIL. For the purposes of calculating
their indebtedness limit (five times the CII’s assets), the calculation shall
only be made taking into account all the amounts received in cash by the institution,
excluding temporary assignments of assets, financing received through
simultaneous transactions and financing from the sale of borrowed securities.
Diversification and leverage limits and further restrictions shall be
specified in the Prospectus. ·
Investment limits of IIC of IICIL
With regard to IIC of IICIL, both
the Circular and the Order refer to the assets that are suitable for the
compulsory investment coefficient of 60% of IIC of IICIL, as follows: a)
Spanish IICILs. b)
Other CIIs domiciled in OECD countries, or with a management
company or
entity with similar functions to the management company and similar
responsibility,
subject to supervision with domicile in a country of the OECD and with
similar investment rules to those established for Spanish IICILs. As foreseen in the Order, the
Circular has deleted the reference to CIIs which investment advisor is based
in the OECD but not its management company. There is only a reference to CIIs
from the OECD or other CIIs with a management company or entity with similar functions to the
management company and similar responsibility, subject to supervision in the
OECD and with similar investment rules. In any event, we shall wait and see
how the CNMV interprets this rule when applying it in practice to the new
vehicles and whether or not it will allow investments in CIIs with an
investment advisor based in the OECD. c)
Management companies, portfolio companies and vehicles or similar structures,
which prospectus or incorporation documents provide investment rules similar
to those established for the Spanish IICILs, the purpose of which is to
imitate an IIC with the same characteristics (managed accounts). The said
companies must be domiciled in countries of the OECD, or the company in
charge of the management must be subject to supervision and be domiciled in a
country of the OECD. The mentioned coefficient may be
reached through investing in derivative financial instruments, which
underlying assets are referred to in letters a), b) and c) above, or
financial indices composed of such assets which meet certain requirements. The final wording of the Circular
allows IICs of IICILs to invest more than 10% of their assets in other IICILs
or similar entities, which in turn may also invest more than 10% of their
assets in other CIIs. ·
Information duties
Specific information obligations
regarding IICIL and IIC of IICIL are set forth in the Circular. Among others,
the Prospectus and simplified Prospectus must include information regarding subscriptions
and redemptions, the general policy on the collaterals granted by
the institution, information about advisory agreements, the CII`s investment
and management strategy and its risk exposure, the policy on
investments in liquid assets and on liquidity management to make
redemptions, the indebtedness limit, as well as the additional
leverage, the criteria on valuation of the assets of the portfolio and
the maximum management and depository accumulated fees that they may bear. Furthermore, every investor must
subscribe a consent document declaring that he/she is aware of the
risks inherent in investments in IICIL and IIC of IICIL and also assumes the
risk of loosing part or the whole of his/her investment, and of the liquidity
restrictions. In addition, the investor declares in this document that he/she
has been duly informed about all the characteristics of the IIC in which
he/she is investing, releasing the management company or the IIC from the
burden of proof concerning the information to be provided. The alternative of
excluding qualified investors from the obligation of subscribing this
document has been removed. The annual, semi-annual, and
quarterly reports of IICIL and IIC of IICIL shall comply with the general
provisions applicable to ordinary CIIs, with certain special characteristics. IICIL and IIC of IICIL managers
must submit to the CNMV on a monthly basis two documents containing information
on statistical, operational and investment portfolio issues with respect
to the last day of the referred period, according to the standard version
provided by the CNMV. We shall wait and see the rules
applicable in practice on this matter. Notwithstanding this, this type of
management is mainly based on the competence, talent and know-how of the
manager. The excess of public information available on these CIIs could cause
the risk of an imbalance between the necessary information to be delivered to
investors on the risks assumed by the CII and the maintenance of certain
privacy on its positions which safeguards the know-how and management style
of the manager before its competitors. As it is not strictly necessary to
inform investors, an excess of transparency could deter the most innovative
foreign managers. ·
Rules for estimated liquidation values and
subscriptions and redemptions
IICIL and IIC of IICIL can choose not to provide investors with redemption rights on every NAV calculation date, provided that it is specified in their Prospectuses. In addition, IICIL may pay redemptions in kind if this is foreseen in the Prospectus. Unit holders and shareholders of IICIL and IIC of IICIL may receive from management companies, as regularly as they deem appropriate and in accordance with the Prospectus, preliminary or indicative estimates of the NAV, calculated by the management company. The final version does not include the possibility of having a lock-up period of at least 2 years, or of providing notice for redemptions of up to 3 months for IICIL or 1 month for IIC of IICIL, or of having a maximum limit for redemptions on a given date. These possibilities are common in international hedge funds and are caused by the illiquid nature of the underlying assets. The application of these sections of the RIIC remains to be seen but if the omissions referred to above cause an IICIL or IIC of IICIL to be subject to general rules, it will make the management of these entities’ liquidity extremely difficult. · Pledged assetsThe Circular provides an obligation to inform the Depositary when a financial collateral arrangement is entered into with a third entity, by virtue of which the ownership of the asset is transferred or pledged, with the pledgee having disposal rights. This is a positive advance since in previous drafts, it was compulsory to sign a sub-custodian agreement with the Depository. The agreement executed must set forth that the Depositary will receive the necessary information to comply with its duty of oversight and supervision, the execution of the mentioned arrangements is limited to financial entities subject to the supervision of an OECD country. Furthermore, agreements containing financial collateral arrangements must include clauses that facilitate and allow for the CNMV’s supervisory duties, specially regarding the financing transactions and loans on securities. Likewise, these agreements shall clearly foresee the liability of both the IIC and the beneficiary of the pledge in the event of non-fulfilment of their respective obligations or the right to termination in case of insolvency by making a sole net payment by the party whose debt is higher than the other. The CII prospectus must contain the CII general policy regarding collaterals and identify the entities with which financial collateral arrangements have been made, as well as providing information concerning its financial solvency. Furthermore, the Prospectus must provide information about the guaranteed obligations in favour of third parties on financial collateral arrangements and about the maximum percentage market value of the assets assigned to guarantees that its beneficiaries can dispose of.
ConclusionThe Circular completes the regime for IICIL and IIC of IICIL and implies the effective creation of a hedge funds market in Spain. On a more general basis, the Circular is a positive advance as the starting point of a Spanish hedge funds market, although in some issues, it could be seen to be a step back from previous drafts and to move away from the standards of the international hedge funds market. In any event, we must wait and see how the CNMV interprets the Circular in order to further assess the possibilities of establishing a domestic hedge funds market.
May 9, 2006
* * * * * * For further information, please contact Salvador Ruiz Bachs (srb@uria.com) or Marta Oñoro Carrascal (moc@uria.com) (phone number 915860696) in our Madrid office, or Juan Carlos Machuca (jcm@uria.com, phone number +44.20 7.645.02.80 ) in our London office.
The information contained in this Newsletter is of a general nature and does not constitute legal advice |