The Alternative Investment Fund Managers Directive – UK Treasury Releases Near-Final Draft of Implementing Regulations

By Goodwin Procter LLP - Glynn Barwick | Posted on

[Editor’s Note: The following Post is authored by Goodwin Procter LLP’s Glynn Barwick.]

The UK Treasury has recently published a new, and near final, version of the implementing Regulations for the Alternative Investment Fund Managers Directive (the “AIFMD”). (We have commented on the consequences of the AIFMD for EU managers and non-EU managers in our 4 January, 11 January, 27 February and 27 March client alerts.) This updated version of the implementing Regulations represents a considerable improvement for managers compared to the initial draft.

In summary, with effect from the implementation date (22 July 2013), European managers of Alternative Investment Funds (“AIFs”) – essentially:

(a) any European manager of a PE, VC, hedge or real estate fund will need to be authorised in its home member state and comply with various requirements regarding the funds that it manages concerning information disclosure and third-party service providers; and

(b) any non-European manager of a PE, VC, hedge or real estate fund will need to comply with various marketing and registration restrictions if it wishes to obtain access to European investors.

This Client Alert discusses the major changes to the AIFMD implementing Regulations.

Click here to read the complete story.

The “Franken Amendment” Receives New Life; Plan Calls for SEC to Promulgate New Rules for Credit Rating Agencies

By Luke Burton, J.D. Candidate 2015 | Posted on

Senators Al Franken (D-MN) and Roger Wicker (R-MS) have renewed the call for the SEC to regulate how credit-rating agencies generate revenue. Eight of the nine registered credit-rating agencies employ what is known as the “issuer-pays” model in which ratings agencies receive “their principal revenue stream from issuers whose products they rate.” This model has been blamed for inflating the value of financial products, particularly mortgage-backed securities, and thus misleading investors and contributing to the 2007-2009 financial crisis. The senators want to prevent future manipulation by empowering the SEC to better regulate these credit-rating agencies’ revenue generating systems.

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BHCs Instructed to Conduct First Round of Mid-Cycle Stress Tests

By Sarah G. Nowland, J.D. Candidate 2014 | Posted on

This month the Federal Reserve instructed 18 Bank Holding Companies (BHCs) to conduct their first biannual Mid-Cycle Stress Test in compliance with the Dodd-Frank Act.  While the Federal Reserve has conducted its own stress tests since 2009, this is the first time firms will conduct the test based on their “own processes and analyses.” (more…)

Recent Lessons on Management Compensation at Various Stages of the Chapter 11 Process

By Kirkland & Ellis LLP - James H.M Sprayregen, Christoper T. Greco, and Neal Paul Donnelly | Posted on

[Editor’s Note:  The following Post is authored by Kirkland & Ellis LLP’s James H.M Sprayregen, Christoper T. Greco, and Neal Paul Donnelly.]

Setting compensation for senior management can be among the most contentious issues facing companies reorganizing under Chapter 11 of the US Bankruptcy Code. Corporate debtors argue that such compensation—often in the form of base salary, bonuses, or stock of the reorganised company–helps retain and incentivize management, whose services are believed necessary to achieve a successful reorganisation. Creditors, by contrast, may be loath to support compensation packages that they perceive as enriching the very managers who led the company into bankruptcy.

This tension over management compensation, though long present in corporate bankruptcy cases, has been more pronounced since 2005, when the US Congress added Section 503(c) to the Bankruptcy Code. Section 503(c) limits bankrupt companies’ freedom to give management retention bonuses, severance payments, or other ancillary compensation. For instance, under the current regime, a company cannot pay managers retention bonuses unless it proves to a bankruptcy court that the managers both provide essential services to the reorganising business and that they have alternative job offers in hand. Even then, the Bankruptcy Code caps the amount of the retention bonuses. Severance payments to managers are similarly restricted by Section 503(c).

Despite these restrictions, companies continue to search for ways to boost managers’ compensation in and around the time of bankruptcy. They do so because retaining existing managers is often the best way to maximise the value of the company in a restructuring. Existing managers typically have valuable institutional knowledge and industry-specific experience that is hard to replace. They may also be vital to preserving relationships with customers, employees, and suppliers. Recognising their value, leaders of bankrupt companies often demand incentives to stay on during bankruptcy. Even where a company would prefer new management, it can be hard to recruit top people to a bankrupt company undergoing a restructuring. Companies must therefore choose how and when to compensate managers without running aground on Section 503(c) and related provisions of the Bankruptcy Code.

Click here to read the complete story.

Firm Advice: Implementing Dodd-Frank

By Joseph Santiesteban, J.D. Candidate 2014 | Posted on

The comment period recently expired on the Federal Reserve’s proposal to require foreign banking organizations with at least $50 billion in global assets and $10 billion in U.S assets to form an intermediate holding company for most of their U.S. assets.  The proposal is part of the Board’s implementation of Sections 165 and 166 of the Dodd-Frank Act. In a recent Client Alert, Gibson Dunn advises that “the IHC requirement likely exceeds the Board’s legal authority in implementing Sections 165 and 166 of Dodd-Frank, has the tendency to increase, rather than reduce, financial instability in the United States and globally, threatens other adverse effects, and does not effectively respond to the developments that the Board perceives in the U.S. operations of FBOs and in international banking regulation generally.” Gibson Dunn explains why here.

On April 10th, the White House released its proposed budget, which contained significant new tax proposals. While often general, the budget laid out specific proposals for: 1) the Buffet Rule, 2) marking to market of derivatives, and 3) alternative treatment for debt purchased on the secondary market. Skadden’s recent Client Alert explains the various proposals and both their foreign and domestic tax implications.

Class Action Complaint Alleges Conspiracy to Fix CDS Market

By Joseph Santiesteban, J.D. Candidate 2014 | Posted on

A group of institutional investors recently filed a class action complaint against some of the world’s largest banks alleging a conspiracy fix prices and monopolize the market for Credit Default Swaps (“CDS”) in violation of the Sherman Act § 1.  Defendants include Bank of America, Barclays, Citibank, and Goldman Sachs.   The complaint also names the International Swaps and Derivatives Association (“ISDA”), a financial trade association, which the complaint alleges is controlled by the defendant banks.  The plaintiffs are claiming potentially billions of dollars in damages.

A credit default swap is a method of transferring the risk of default for a financial instrument.  The purchaser pays a fixed payment to the seller in exchange for the promise to pay off the underlying debt in the event of a default.  The complaint alleges that because of the CDS market structure is unregulated and over the counter, every transaction must be with one of the defendant banks.

The complaint characterizes the CDS market as “starkly divided” between the defendant banks “who control and distort the market” and the plaintiffs “who, in order to participate in the market, must abide their distortions.”  The complaint alleges that this is the result of an opaque trading environment in which the defendant banks manipulate the bid-ask spreads through their negotiations with individual traders.  These manipulations cost the plaintiffs billions of dollars, says the complaint.  Plaintiffs allege that several of their attempts to create and regulated exchange were rebuffed by defendants.

Both the DOJ and the European Commission have been conducting their own investigations into these activities.  In March, the EU indicated that “ISDA may have been involved in a coordinated effort of investment banks to delay or prevent exchanges from entering the credit derivatives business.”

Federal Reserve FBO Proposal: Will Comments on the Intermediate Holding Company Requirement Be Heeded?

By Gibson, Dunn & Crutcher LLP | Posted on

[Editor’s Note:  The following post is a Gibson, Dunn & Crutcher LLP Publication, authored by its Financial Institutions Practice Group.]

The comment period has now closed on the controversial proposed rule (FBO Proposal) of the Board of Governors of the Federal Reserve System (Board) implementing Sections 165 and 166 of the Dodd-Frank Act (Dodd-Frank) for foreign banking organizations (FBOs) and foreign nonbank financial companies supervised by the Board.  If the FBO Proposal becomes final in the manner proposed, it will mark a sea change in the regulation of the U.S. operations of FBOs, by requiring FBOs with $50 billion or more in total global consolidated assets and $10 billion or more in total U.S. nonbranch assets to form an intermediate holding company (IHC) for almost all of their U.S. subsidiaries.  In our view, the IHC requirement likely exceeds the Board’s legal authority in implementing Sections 165 and 166 of Dodd-Frank, has the tendency to increase, rather than reduce, financial instability in the United States and globally, threatens other adverse effects, and does not effectively respond to the developments that the Board perceives in the U.S. operations of FBOs and in international banking regulation generally.

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Professor Paulus Speaks on Sovereign Debt Restructuring

By John Muse-Fisher, J.D. Candidate 2014 | Posted on

On April 17, legal practitioners, bankers, scholars, and students met at the Federal Reserve Bank of San Francisco to discuss recent developments in sovereign debt restructuring.  Sovereign debt restructurings date to at least 300 B.C. and are a practical fact of life in today’s global economy.  Recent developments in the realm of sovereign debt restructurings include Greece’s recent restructuring, the Second Circuit’s potentially destabilizing decision in NML Capital v. Argentina, and the seemingly perpetual Eurozone debt crisis.

Professor Christoph Paulus, Director of the Institute for Interdisciplinary Restructuring (Berlin) and graduate of Berkeley School of Law (LLM ’84), presented his framework for creating a Eurozone sovereign debt restructuring mechanism (SDRM).  The IMF proposed an international SDRM in the early 2000s, but the plan lost out to market driven approaches.  Market driven approaches to sovereign debt restructuring include the use of Collective Action Clauses (CACs) in debt contracts, which allow a qualified majority of bondholders to change the terms of the contracts to effectuate a restructuring. 

Professor Paulus’s proposed Europe-centered SDRM envisions a “resolvency” proceeding for sovereigns – a more optimistic and palatable vision of restructuring than an “insolvency” proceeding.  The proposal includes three key requirements: (1) the inclusion of a resolvency clause in bond contracts that would trigger resolvency proceedings under certain circumstances; (2) the creation of a resolvency court overseen by a president who would in turn select 30–40 elder statespersons to serve as judges in potential resolvency proceedings, and; (3) the development of the resolvency court rules of procedure.  The envisioned resolvency process is roughly comparable to insolvency proceedings under most country’s corporate laws and would be intended to promote orderly negotiations between sovereigns and bondholders.

Following Professor Paulus’s presentation, Professor Barry Eichengreen facilitated a lively discussion detailing the limitations and virtues of an institutional approach as compared to market driven approaches, including CACs.  Professor Eichengreen described the moral hazard argument against the creation of an SDRM – that such an institution could make it too easy for sovereigns to write down their debt.  Nonetheless, Professor Eichengreen pointed out that the moral hazard argument now cuts the other way out of concerns that sovereigns borrow too much, and the market for sovereign debt requires greater discipline.  The group also considered Contingent Convertibles (CoCos), an additional market driven approach, as a means to facilitate smooth sovereign debt restructurings.  CoCos would convert sovereign debt to equity on the occurrence of certain measurable conditions, such as sustaining a particular GDP.

The ideas and issues raised at the Federal Reserve Bank provided a useful framework for understanding the potential of a Europe-centered SDRM to facilitate sovereign debt restructurings in the future.  Limitations and questions remain. There are hurdles to applying resolvency clauses in non-European jurisdictions. Certification is required for ensuring the legitimacy of the elder statespersons who would serve as judges. Methodological questions remain about calculating accurately the effect of an SDRM on liquidity in the bond market, and an account of the insufficiency of market-based solutions (especially CACs) to shore up the argument that an SDRM is in fact needed. Indeed, these ideas are still being developed and stakeholders are not in consensus about the best way forward.

Experience from the Anti-Monopoly Law Decision in China – Part II

By TC Tsui | Posted on

[Editor’s note:  This post continues yesterday’s article, found here.]

3.2. Methodology and Assumptions

This “legal discount” test provides how much Coca Cola may lose in the acquisition of Huiyuan Juice if the application were rejected because of improper enforcement of law.

The potential loss Coca Cola suffered was the potential net income of the Huiyuan Juice for fiscal year 2009, the first year of operation if the transaction were approved.

It was difficult to predict whether the profit of the new company would increase because it was a component of the Coca Cola (by economies of scale, for example) or decrease (as actually occurred with Huiyuan in year 2010). We assumed that the annual profit of the new company was stable.

It was not sufficient that we merely estimated the profit if Coca Cola successfully purchased Huiyuan, because Coca Cola’s funding does not exist in a vacuum, i.e., Coca Cola would not be required to pay for the costs of funding, whether dividends to shareholders or interest expense to creditors, if it did not spend the USD24 billion for the deal.

Thus, potential income should be divided by the weighted average cost of capital (WACC) of Coca Cola.

Because legal risk is variable case by case, the analysis only examines the highest level of loss caused by uncertainty in the rule of law in the Chinese legal environment. This assumption also matches the conservatism in accounting principle, which suggests that expenses should be over-estimated at their highest possibility when the amount is not certain.

To reflect the possibility of judicial intervention, the discount should be multiplied by 1/67, which reflects the highest legal risk.

The potential return on the project resulting from the assumptions made above is that made for USD24 billion in investment funds.

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Experience from the Anti-Monopoly Law Decision in China – Part I

By TC Tsui | Posted on

1. Introduction – Reasons of Estimating Cost of Legal Risks

The general public typically has a positive view of liberty, democracy, and a reliable legal system. For their part, analysts are likely to take the legal system for granted because they have a positive view of the rule of law and are able to construct airtight arguments explaining why a reliable legal environment is important for investors.

However, simply stating that having the rule of law is always better than not having it may not be sufficient. Scholars rarely evaluate the magnitude of the positive effect of the rule of law. Certain studies may consider that legal risk increases costs at the operating level, such as the risk of suffering litigation expenses, but these studies have not analyzed how legal risk may cause investment loss.

Additionally, scholars may attempt to show that the rule of law is not a foundational concern for investors by developing models based on the interaction between governments and investors; however, these studies may miss the mark when investors hesitate to enter the market because of the perception of an unfair legal environment or when the same model is applied to a variety of industries.

In reality, it is not easy to calculate accurate figures of profit or loss resulting from the stability of the legal environment for an entire society, but a test estimating a rough ceiling of loss that might be caused by the improper application of the rule of law in a particular circumstance might be a valuable indicator for investors.

Robert Hahn et al. suggest a cost-and-benefit approach to examine the enactment of regulations; they apply it to the question of whether legislators should prohibit drivers from using cellphones while driving in 2001 and 2007.

Subject to assumptions and adjustments, such an approach might provide investors with a general idea about how much the application of the rule of law affects profitability by applying the analysis to judicial matters.

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