Under the Alternative Investment Fund Managers Directive (“AIFMD”), Alternative Investment Fund Managers (“AIFMs”) must functionally and hierarchically separate the function of risk management from portfolio management and other operating units. EU regulators must monitor this separation in accordance with the principle of proportionality. It is important for AIFMs, particularly in smaller groups, to understand how they can satisfy these requirements. The Financial Conduct Authority (“FCA”) has now clarified its approach to this.

The FCA’s website sets out how it will review compliance with the principle of proportionality. http://www.fca.org.uk/firms/markets/international-markets/aifmd/latest-news

The FCA explains that the principle of proportionality is intended to ensure that regulatory measures go no further than is required to achieve a set objective, which is to ensure an AIFM has specific safeguards against conflicts of interest to allow for the independent performance of risk-management activities. The FCA does, however, recognise that achieving functional and hierarchical separation may be disproportionate for some firms, given their size, internal organisation and the nature of their business.

To satisfy these requirements, the FCA considers that an AIFM must be able to demonstrate that it has specific safeguards in place against conflicts of interest that allow for the independent performance of risk-management activities. The FCA will review and assess the safeguards implemented by the AIFM to ensure that conflicts of interest do not compromise that independence.

If a firm which is applying to be an AIFM wants to comply other than through functional and hierarchical separation, and on the basis of proportionality, then the FCA advises that the firm should describe briefly in its application form the specific safeguards that achieve the desired objective.